Cell Phones, Value Chains and Technology

Source: The China Story

A popular meme inside the Beltway is that China is stealing us blind. In the background is the assumption that domestic technological capabilities are minimal, and that anything and everything incorporating technology or design must be stolen or counterfeit. In the automotive industry, this turns into the claim that companies are being “forced” to hand over technology. Never mind that 11 of the top 100 global universities is now Chinese – see Bloomberg that, based on English-language publication counts, Chinese researchers now outperform Americans in important subfields (mathematics, engineering). [In economic geography, the few publications I’ve found on the auto industry are in Chinese, not English, but are of high quality.]

Products such as cell phones are assembled goods, where a firm such as Apple makes nothing itself (even assembly is contracted to Foxconn, a Taiwanese company, not a Chinese one). Gorilla glass is made by Corning, at least until recently only in the US (it’s a tricky process, and one production line turning out a sheet several feet wide turns out enough per day for a staggering number of phones). The sensors for cameras, the central processors, the radio circuitry, almost all of this is imported. Some is covered under patents, but 2-year-old components are bigger and/or more power-hungry than those used by an Apple or a Samsung. And the architecture is modular: you plug the pieces together, the interfaces are standardized, so by and large you can plug in old-generation components and have a functional phone. If you’re making an Android device, the operating system is free, too, or nearly so. Now squeezing them all into a top-line phone is hard, and you’re likely to have a year’s exclusivity for any components developed to your specs. But Apple and Samsung don’t buy the old stuff, yet the production setup can still churn out those parts. Samsung is happy to sell anyone and everyone the old-generation cell phone parts it makes on fully depreciated equipment.

Chinese entrepreneurs spotted this possibility and ran with it. Initially they turned out “shanzhai-ji” (guerrilla 山寨机) cell phones. The industry developed in Shenzhen 深圳市, a former mudhole of 80,000 peasants between Hong Kong and Guangzhou [Canton] that now has 13 million people and is one of the richest cities in the world. But it’s where Foxconn, a Taiwanese factory, located their initial megafactory for assembling iPhones. [Shenzhen is now too expensive so Foxconn is moving their operations to the interior of China and to other countries. You can still see peasants, but they’re in the distance, across a river in Hong Kong!]

They were innovative. In the era of local cell phone operators with different rate plans in different cities or provinces, the shanzhai makers created clunky phones with two SIM card slots. They made phones with a built-in buzzer for daily prayers, and a compass that would indicate the direction to Mecca. Apple was uninterested in turning out phones for niche markets. In Shenzhen, you could find programmers, electrical engineers and marketers. A 5-person company could develop a concept, find programmers and purchasing specialists, contract with a backyard assembler [or for big orders, Foxconn], locate a wholesaler willing to buy some, and be off and running. In the end Xiaomi and several other big manufacturers grew out of these customizers.

What is the iPhone market share in India, in China, in Southeast Asia? Minimal. Then there’s Africa, where the largest, if not dominant player, is Shenzhen-based Transsion, whose only factory is in Ethiopia, not China.

Was there theft along the way? Well, you could find Samsang and Goople phones. But did this hurt Apple? Or did it enhance their brand?After all, how many Chinese could afford a $200+ phone 10 years ago (the original iPhone launched in 2007)? Having one was a mark of status, and if you had one, you didn’t buy a phone case that would cover the logo – you wanted everyone to know you had the real thing. So did Apple lose sales, or gain free advertising?

Global value chains change the nature of intellectual property. Do you want to put together a modern car? Well, every global supplier (OK, every one that I’ve checked) has an engineering center in Shanghai. After all, China is the world’s biggest market!! You need ABS (antilock brakes)? Fuel injectors? Backup cameras? GPS navigation? Voice recognition? The hardware to implement Apple Play? All are commodities, and the companies that make them can help you integrate them into your vehicle. So where’s the theft? And again, in its early days Geely may have, er, borrowed liberally from the styling of foreign brands. Chinese consumers were under no illusion that they were buying the real thing. Meanwhile, GM and VW minted more money in China than in their home markets. Yes, they were required to use joint ventures, but did their bottom lines suffer? In 2017 China paid $30 billion in technology licensing fees, and untold billions more in mark-ups on imported components that VW and GM sourced from overseas. (What’s the markup you pay if you damage a body panel and have to buy it from Toyota or Honda??)

So … is China guilty of theft? If so, did they help or harm US companies? (And remember: Apple is an Irish company, not an American one. Ireland paid $75 billion in license fees in 2016…)

What do global value chains mean for the ability of the US (or China) to capture the gains from exports? How much of an iPhone’s $1,000+ price is represented by wages and profits earned inside China? the US? or anywhere else!!

Outside sources

  • Chen, Xiangming, and Taylor Lynch Ogan. “China’s Emerging Silicon Valley: How and Why Has Shenzhen Become a Global Innovation Centre.” European Financial Review (2017): 55.

  • Tang, Li, Michael Murphree, and Dan Breznitz. 2016. “Structured Uncertainty: A Pilot Study on Innovation in China’s Mobile Phone Handset Industry.” The Journal of Technology Transfer 41 (5): 1168–94. https://doi.org/10.1007/s10961-015-9432-9.

About Mike

Prof of Economics, Wms School of Commerce, Washington and Lee University, Lexington VA
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9 Responses to Cell Phones, Value Chains and Technology

  1. Joe Wen says:

    The development in China’s technology sector largely involves simulating foreign companies’ IPs, or sometimes straight up copying (for example, the emergence of shan zhai cell phones). However, the process of learning how foreign tech is built has inspired many original technological developments; a good example is Huawei, a Chinese multinational networking, telecommunications equipment, and services company headquartered in Shenzhen, Guangdong. The sheer market size and in China enabled many companies with original IPs to be able to scale quickly, and the government certainly provides policies that incentivizes original technological development (though sometimes the policies have an undertone of protectism).

    An interesting story that happened a few weeks ago: https://www.scmp.com/tech/article/2160072/redcore-ceo-admits-100pc-china-developed-browser-built-googles-chrome-says

    Redcore, a Chinese internet company that specialzies in building a secure browser, admitted that its technology is almost entirely based on Google Chrome. Redcore has raised $36mm in funding, including capital from some of the most reputable VCs and PEs in china. In my opinion, Redcore is guilty of theft, and punished for its actions. What’s more concerning is that Redcore is one of many tech companies in China that focus on copying and rebranding established technology IPs instead of actual innovation. The VCs sometimes are aware of this, but often not. I think hard lessons will be learned before we see more truly innovative companies like Xiaomi or Huawei emerge.

    • Jack says:

      Pertaining to China’s transition from learning how foreign tech is built to its original technological developments, it’s quite understandable for China, with once an immature technology industry, to use Western products as the basis for its technology industry. As to if China’s adoption of such technology is theft, companies such as Samsung acknowledge and continue to sell their depreciated equipment to the Chinese. In this case, I do not consider China guilty of theft, but as Joe mentions in his post, certain companies copy Western developments and rely on theft as the foundation for a “new” company such as Redcore.
      Since China rapidly produced technology products with the guide of foreign technology, the typical American views China as a “copycat” in the sense of China lacking creativity and innovative spirit. However, it’s important to recognize China’s development of technology hubs like aforementioned Shenzhen.
      For instance, Zhongguancun, referred to as China’s Silicon Valley, houses 20,000 entities since its inception as a center for high-tech enterprises. Due to its location in Beijing, Zhongguancun’s developments provide Tsinghua and Peking Universities’ students opportunities to engage with the innovative spirit of China. Its global impact is clearly recognized as Google, Ericcson, Microsoft, and IBM have set up research and development centers in Zhongguancun.

      Of China’s developing technology, e-commerce heavily dominates the attention of many start-ups and established companies such as Alibaba. The rapid transition from mimicking Western technology to developing original products led to the popularity of China’s e-commerce by practically skipping the online era of payments. According to research firm iResearch, China’s mobile payment market is 50 times the size of that in the US with the prominence of Alipay and WeChat Wallet. Thus, the technology developments in China now offer new markets within e-commerce for American companies. For example, Alibaba partnered with Kroger to sell Kroger’s Simple Truth brand products on the e-commerce’s firm virtual storefront. Though China once needed to mimic Western products for its development, the growth of entrepreneurship and e-commerce opens new markets for Western companies as seen with Kroger. Thus, the China’s occasional theft of technology and imitation of Western products now allows U.S. companies to benefit from the new markets created by original Chinese technology. U.S. companies now have greater access to Chinese consumers in part to U.S. companies such as Samsung expediting China’s path towards its own technology industry.

      https://www.reuters.com/article/us-kroger-alibaba/kroger-partners-with-alibaba-in-china-grocery-sales-venture-idUSKBN1KZ256
      https://www.wired.co.uk/article/how-china-became-tech-superpower-took-over-the-west
      https://www.investopedia.com/articles/investing/032515/chinas-silicon-valley-zhongguancun.asp

  2. Max says:

    I do see the message this article is trying to convey to readers. In this political climate, there is much focus with the trade war going on with China and other countries. I believe that part of the reason Trump has launched a trade war with China is because of their “unfair” trade practices. The article is also trying to dispel an idea held by some people that China is not an innovative, technologically advanced country that just copies our tech and manufactures our goods and just steals our tech. The author is also trying to show that our economic relationship with China is not that simple and that our relations with China has changed over time. Today, we live in a complicated, modern, globalized economy, where it is not easy to make economic assumptions. Companies may have their headquarters in one country, be a legal entity of another country, have operations in another country and sell most of their products to a people of another country. Don’t be too quick to point figures. If there is any theft going on China, US companies are also facing many benefits, having access to sell their goods to the world’s largest markets. China is not completely a manufacturing focused economy anymore. Places like Shenzhen have come from being a rural fishing village, to a city of manufacturing to one of the most prosperous urban regions on the planet with many innovative companies popping up here and there.

  3. Jonathan says:

    After reading this article, this does not appear to be theft to me. It stated that Samsung itself appears happy to sell pieces of obsolete technology to smaller entities as long as it doesn’t disturb their own ongoing development, which it does not seem to have done. Much of this seems to just be a side effect of globalization, as a single company can have auxillaries, such as factories and distribution centers in many other nations. It is almost inevitable that some of this technology can leak out and be adapted by other people. It also doesn’t appear that patents are being violated, as many of the phones being made are simply using older pieces of phones that are now not available in more developed markets.

    An example of more blatant theft would be in the Chinese counterfeit market, where factories compete to make more accurate replicas of popular shoes and clothing for a fraction of their normal price. Here we see Chinese entities blatantly stealing designs from other countries, not just buying old pieces and developing on them.

    Ultimately, the value chain for the US will not be massively damaged by the cell phones being manufactured. The cost to assemble an iphone is relatively low, and most of it is likely represented in the initial components and transportation as it is shuttled around the world to be assembled. There is no way that a tiny Chinese company selling outdated technology could pose a threat to the massive multinational corporations that dominate the electronics world.

    • Mike says:

      Some of the counterfeit products come out of the factories that make the real deal … in which case they are not counterfeit, but their manufacturers are not adhering to the terms of their license, which surely mandates that 100% of output must be sold through to a specific wholesaler or retailer. Illegally.

  4. Pat DiTondo says:

    In considering whether or not China is “robbing us blind” I think it is helpful to understand what we mean by robbing. I think this article does a strong job of showing that China is not simply “copying” the technology of the rest of the world, and that natively produced Chinese technology is now on par with anywhere worldwide. This is typified in Shenzhen, which may be the most advanced center of consumer electronics manufacturing worldwide. ( https://www.youtube.com/watch?v=SGJ5cZnoodY) However it seems to me that some of the American resentment towards China’s “theft” arises from the special restrictions that the Chinese government places on foreign companies operating in China. By virtue of its fantastic growth China has tremendous bargaining power with international corporations which allows it to extract deals favorable to Chinese political/social/economic goals. I think of the example of the “Great Firewall” that seems to have basically created an entirely separate internet in China, while locales like the EU may fine Facebook and Google it is China that places especially heavy barriers to entry for its massive market. These rules do not only apply to internet companies, but is also present within the auto-manufacturing industry. (https://www.nytimes.com/2018/04/25/business/china-auto-trade.html)

    Perhaps the anger espoused towards Chinese trade practices is misplaced, often focusing on the physical products of Chinese industry or the fiscal barriers to entry that the Chinese government imposes rather than looking at the ways China insulates itself from the globalized marketplace. In the context of globalized value-chains and IP that is extremely difficult to give a geographic location to it seems like it would be a more productive endeavor to try and ensure that all countries are exposing themselves equally to the global marketplace.

  5. John Schindler says:

    This article dispels the notion that China is “stealing us blind” in the ways that it articulates the more complex globalization of companies and the roll these companies play with China. The writer dispels the claim that in the automotive industry, companies are being “’forced’ to hand over tech”, and also notes that China is just as technological advanced as we are. It is important to note that in consumer goods today in a globalized marketplace, most parts to these goods are imported from foreign countries. China is not forcing us to hand over tech, as companies like Samsung feel free handing over their old tech. China did not “steal us blind,” but their entrepreneurs located this opportunity and realized the market potential that lied within these back yard cell phones. China is not “stealing us blind” because they play a key role in global value chains and much of the aspects of this global value chain are parts and labor from inside Chinese borders.

  6. Mike says:

    In the background is a peculiar ideology: the White House seems to equate a trade imbalance with being robbed. But if the world has triangular trade, there’s never a bilateral balance, even if overall trade is balanced. The initial White House economic advisors have all been shown the door. The current crew, Kudlow and Navarro, are yes-men, not advisors, because the President does not want advice. And Lighthizer at USTR made his career filing antidumping suits against Japanese steel producers, a good lawyer of the hired gun type. He does what the client asks.

    From another angle, if American companies such as General Motors were worried about technology theft, they could have simply stayed out of the market. In fact, GM from the start began setting up R&D facilities in Shanghai (called PATAC). Why? GM understood that for a whole variety of standard business reasons, it makes sense to produce cars where they are sold. Less foreign exchange risk, better PR (cars are after all a consumer good), and more responsiveness to local conditions (that consumer thing, again). Yet their joint venture partner has never made money in their own automotive business. First, they never needed to: they made lots of money helping GM run local manufacturing operations. Second, technology is embodied in teams of people, not blueprints. That takes several model cycles to develop. Having a JV partner doesn’t let you do that, you can poach an engineer here and there, but you can’t poach a 200-person design team, and even if you do, they won’t know how to work in the new corporate environment – different software, different suppliers, different customers, different factories and equipment.

    Geely is most of the way there, 16 years after they began building cars, but they never had a JV partner, they learned by doing. Could a company steal a particular piece of software? Perhaps, but then they can’t get updates, and software companies do a good job of making sure updates are needed. Not all bugs are accidental. Can you steal a set of blueprints? Perhaps. But that doesn’t tell you how to actually make that car – different parts come from different suppliers, and your own suppliers generally can’t duplicate them, parts and production systems are co-developed so a supplier can’t make things that reflect state-of-the-art, because each supplier’s state-of-the-art is different. Then there’s a time gap: turning blueprints into product isn’t quick, because of the need to source parts and tooling. At a car company, that’s done contemporaneous with doing the design, it’s not a sequential process. Anyone stealing blueprints would thus need roughly 2 more years to actually start production. As a fashion good with shifting infotainment systems, it’s not generally a viable business practice to be out-of-date.

    So GM may complain, and there are things they keep very proprietary (software, but especially future product plans, such as styling and cost/pricing). But losing blueprints may handicap rather than help a rival.

    [corrected spelling: USTR Lighthizer not “Lighthouser”

    • Di Aeschliman (Deedee) says:

      This discussion raises the interesting point that more important than US and China trade relations are the investment relations and significant long-term bilateral investment opportunities that exist between US and Chinese businesses.

      American companies have a great incentive to invest in offshore operations and markets in China in order to assess China’s large and increasingly wealthy consumer class, who have continuously exhibited increased demand for western imports. Especially as US companies are mostly exporter of services and high-end goods, US companies’ sales in foreign markets benefit greatly from setting up local infrastructures in these foreign markets. Telsa for example recently invested $5 billion to build a new factory in Shanghai, as Elon Musk has a vision of accessing the world’s potentially largest market for electric vehicles.

      On the other hand, Chinese businesses have a strong desire for American capital (Chinese inbound investments) and assets (Chinese outbound investments) due to their incentives to acquire western technology capabilities. In fact, the pursuit of Western high-tech assets is supported by China’s political program to finance the industrial upgrade and development of its tertiary sector and become a global leader in technology.

      While it is arguable that western companies like GM have gained much in investing in China and that local manufacturers face difficulty in trying to replicate western technology blueprints, it is also important to note the inherent risks that American investors face when entering a joint venture in a foreign country where enforcement of intellectual property law still lags behind those of most mature economies. It is not so much the wanting to acquire western tech assets that is the problem, as global value chains ultimately promote the diffusion of technology and the benefits that all parties derive from it; the problem lies in how these western tech assets are being acquired by Chinese firms, particularity state owned enterprises. That is not to discount China’s own feats in technological innovation and some of its state of the art manufacturing capabilities, particularly in manufacture assembly.

      To address these issues, China showed some effort to institutionalize its markets and intellectual property laws. For example, despite the ongoing trade war, China has stated that it will allow full foreign ownership of automakers within five years. This is an important milestone, as such a measure would scrap previous stipulations that required foreign automakers to work through state-owned partners, which had the consequence of forcing foreign automakers to share their technology immediately with potential competitors.

      Ultimately both China and US companies have much to gain by participating in the global value chain. However, there is a conflict of interest as both parties also desire to obtain control over the global value chain’s most profitable segments. It will be interesting to see how things play out moving forward, especially taking into consideration the trade war. So far there has been a drop in foreign investment worldwide, particularly Chinese investments in the US, which plummeted 90% this year as of the end of the second quarter. In the long run however, I believe that it is unlikely for these decreased investment trends to continue, as both US and Chinese businesses will benefit greatly from bilateral investments.

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