Article / 04 March 2015 at 6:34 GMT

#TechWeek: Overseas expansion key for China’s smartphone players

China Watcher / Shanghai
China
  • China offers a significant market opportunity for low-cost manufacturers
  • The mobile ecosystem is an integral strategy for all Chinese tech firms
  • Local manufacturers are likely to target markets such as India and SE Asia

By Neil Flynn

As with most of China’s industries, the mobile tech industry is domestically focused, and is relatively unknown to overseas investors. However, China’s migration to mobile has spawned a huge mobile market, and tech firms are actively transitioning their business models away from PC and towards mobile. As part of #TechWeek, this report will discuss the main hardware firms in China, and why the mobile ecosystem is the key strategy for China’s tech firms.

Low-cost domestic manufacturers

China’s smartphone manufacturers know that they are unable to compete with the luxury appeal of the Apple iPhone and Samsung Galaxy, so they have grown very quickly by developing low-cost Android smartphones.

Away from China’s wealthiest cities, not only are premium smartphones very expensive, but they are often very difficult to buy. The release of the iPhone 6 saw people from China’s western provinces continually queuing to buy two at a time over the space of several days in cities such as Shanghai and Beijing, in order to take the phones back and sell them for three times the purchase price. 

This created a significant market opportunity for low-cost manufacturers, as a significant proportion of China’s mobile user base is unable to afford foreign imports, and this has seen low-cost Chinese smartphone manufacturers grow exponentially over the past few years.

China's Android Smartphone Market Share
Source: Internet Consumer Research Centre

While there are many small manufacturers, I will introduce the four main smartphone companies in the domestic market, who all will likely expand overseas in the coming years.

Lenovo

Lenovo is relatively well-known in the west as it is the world’s largest PC vendor in terms of unit sales, due to its acquisition of IBM’s PC division, including the ThinkPad brand. In China, Lenovo also produces a range of smartphones, covering a much wider price range than its domestic rivals. The cheapest A360e phone retails at RMB 239 ($38), while the high-end K920 retails at RMB 3,999 ($637). 

Lenovo is more likely to enter into western markets before its rivals because it has already established its brand name and operations overseas, through its PC and laptop business.  

Lenovo's Phone Range
The Lenovo Lemon K3 (L) and the S60t (R). Source: Lenovo

Xiaomi

Xiaomi is the most well-known Chinese smartphone manufacturer, and has become the world’s most valuable start-up firm. It offers the Xiaomi 3 and 4 phones, as well as the budget Redmi 1S and the Note. 

The quality of the phones is very good, and given the price, they provide very strong competition for foreign brands. The Xiaomi 4 costs RMB 2,099 ($335) while the budget Redmi starts at RMB 599 ($96). In addition to smartphones, the firm has been developing its smart home products, including TVs and home appliances. 

China’s smart home market is slowly growing as products become more affordable, and with its smart TVs and its partnership with home appliance manufacturer Midea, Xiaomi is set to take a dominant share of the smart home market.

Xiaomi's Phone Range
Source: JD.com  

Coolpad

Hong Kong-listed Coolpad has three ranges of smartphones, from the low-cost 3G phones, the popular Dazen brand, and the high-end 4G phones. Nevertheless, most phones retail for under RMB 1,000 ($159) while the more expensive 4G phones are typically less than RMB 2,000 ($319). Coolpad is relatively small compared to its rivals, but its recent partnership with tech giant Qihoo should see it gain market share within China.

Coolpad Phones
The Coolpad Dazen X7 (L) and the Dazen F2 (R). Source: Coolpad  

Meizu

Meizu has been quietly gaining popularity in China, and has gained a lot of exposure from its partnership with Alibaba. Meizu offers the Blue and MX4 smartphones, which look very similar to iPhones. This would likely be a problem for Meizu when they try to expand overseas, because Apple is notoriously litigious about copyright infringement. With its recent partnership with Alibaba, Meizu will begin to use Alibaba’s YunOS operating system on its phones, instead of Android.  

Meizu Phones
Source: Meizu  

Building the mobile ecosystem

The concept of the mobile ecosystem is the integral strategy for all of China’s tech firms, and 2015 should see this develop even further. The basic idea is that firms want to monetise every aspect of a mobile user’s behaviour. So if a user typically uses his or her smartphone to connect with friends, play games, shop, and watch videos, a tech firm will want to offer all of these services so that it can earn more revenue from each user. 

This allows firms to collect more data about each user, so that advertisements can be more targeted. The three biggest mobile ecosystems are unsurprisingly run by China’s three biggest tech firms: Baidu, Alibaba and Tencent, collectively known as the BAT trio.

Baidu

The main entry point into the Baidu mobile ecosystem is Baidu Search, which has a market share of around 80% in China’s search engine market. In addition, it has the market-leading Maps application, the combined market leading online video platforms in PPS and iQiyi, as well as app distribution and daily deals. 

The one aspect where Baidu is lacking is mobile ecommerce, as Alibaba and Tencent hold dominant positions in the market. However, Baidu is looking to develop its ecosystem further by entering into the healthcare market. The aim is to be able to connect users with doctors, and allow users to book hospital appointments through their phone.

Alibaba

Alibaba has based its mobile ecosystem around its two major shopping platforms Taobao and Tmall. It also has a wide range of services for its users, including the online video platform Youku Tudou. 

However, the most important part of the ecosystem is the Alipay payment system, which is not only widely used throughout the ecosystem, but is used for offline purchases. For example, if I go to my local convenience store, I can pay for my goods at the checkout by scanning a barcode on my Alipay app. This is important for Alibaba, because it has been able to collect 10 years' worth of payment data from users, and is set to launch a credit rating system, with the view to offering personal loans.

Alibaba has been trying to rival Tencent’s social media platforms, and has had varying success with its own Laiwang messaging app, and the Momo and Dingding apps in which it has invested. Tencent’s WeChat has become the best entry point into a mobile ecosystem because it is the most popular messaging app in China. 

Tencent’s QQ instant messaging app (represented by the penguin logo below) has been incredibly popular for over 10 years, and provides another strong entry point into the Tencent mobile ecosystem.

Mobile App Usage
The most popular apps for men (L) and women (R) each hour in China.
Source: iResearch China  

Tencent

Tencent’s mobile ecosystem is focused on its dominant social media platforms, and given that users spend more time on their QQ and WeChat apps than any other app, Tencent has the best entry point into its mobile ecosystem. In 2014, Tencent invested in Alibaba’s biggest online retail rival JD.com, and it has a direct link from both WeChat’s and QQ’s services pages. It has also invested in the Sohu subsidiary Sogou, which is a search engine with a similar market share to Qihoo. 

Tencent has successfully integrated Sogou into its social media platforms, and this has seen the search engine grow, because no other search engine is able to search WeChat accounts.

Tencent has a mobile payment system, but it is much younger than Alibaba’s Alipay, meaning that the quality of its soon-to-be released credit rating system won’t be as good as Alibaba’s. For the time being, Tencent will sell its credit data to third-party financial institutions as opposed to offering loans to users. Tencent is also focusing on education, and its recent partnership with New Oriental Education has seen the launch of an English learning app.

I expect that in 2015, more educational content will be available throughout the Tencent ecosystem, as the firm targets younger users.  

WeChat Services Page
Tencent WeChat’s services page. Source: WeChat  

For 2015, firms are focusing on the closed loop mobile ecosystem. This is a natural stage of the ecosystem development because China’s tech firms have been actively acquiring different start-ups in order to broaden their services. It has got to the stage where most big firms can offer every service, therefore for example, it is possible for a user to solely use Tencent’s services on mobile, without having to use those of Alibaba or Baidu.

Future of China’s mobile industry

The second half of 2014 saw China’s tech giants begin to partner with domestic smartphone manufacturers. Qihoo invested in a joint venture with Coolpad; Alibaba partnered with Meizu, and Baidu has partnered with Lenovo. This is a very interesting strategy because tech firms are now incorporating hardware into their mobile ecosystems. 

Taking the Coolpad Dazen (大神) phone as an example, it’s sold to customers with all of Qihoo’s apps and services preloaded onto the phone as default. Therefore when a user buys the phone, there is no need to download other game distribution apps, search engine apps or security software apps, because the phone already has them installed. 

This will help to build Qihoo’s user base, because users will register for a Qihoo account, and will in time begin to use Qihoo’s services on PC and download other Qihoo apps. The more that a user remains within a mobile ecosystem, the more data the company can collect, meaning that it can monetise the user even more. 

 Chinese smartphone manufacturers are now likely to target overseas markets
such as South-East Asia and India. Photo: iStock

Alibaba and Baidu have followed a similar strategy, but have each expanded on it in differing ways. Not only do Meizu phones have Alibaba apps as default, but they will begin to use Alibaba’s new mobile operating system YunOS. In its fiscal third-quarter results, Alibaba’s management discussed the planned expansion into the smart home concept, and with its smart TV boxes already using the YunOS operating system, we should see further developments to this throughout 2015 based around the Meizu phone. 

One of Baidu’s problems is that it has failed to enter the Chinese e-commerce market, which is a significant revenue driver for its BAT rivals. Nevertheless, it has been making passive investments in e-commerce projects, and its partnership with Lenovo is another example of this. The Lenovo ShenQi phone will be loaded with Baidu’s apps and services, and will be sold directly through Lenovo, with Baidu taking a percentage of the e-commerce revenues.

This year, 2015 should see further investment from tech firms into smartphone manufacturers, as they look to strengthen their closed loop mobile ecosystem. While only certain phone models are currently equipped with the preloaded apps, this will likely be expanded, as tech firms look to expand this new mobile land grabbing opportunity. 

Because China’s mobile population has reached 1.286bn, there is very little scope left in mobile land grabbing, and therefore growth for Chinese smartphone manufacturers will likely slow as they are forced to target the replacement cycle. 

I expect that we will see domestic manufacturers target overseas markets, with South-East Asia and India likely to be the initial targets. This is because the proportion of mobile buyers in these countries that can’t afford a premium smartphone is much greater than in more developed countries such as the US. 

However, one issue that has been raised regarding the overseas expansion of China’s smartphone manufacturers is that their servers are based in Mainland China. The Indian Air Force placed a ban on Xiaomi phones for this very reason because it was discovered that the Xiaomi Redmi 1S budget smartphone was forwarding the carrier name, phone number, IMEI, as well as numbers from the address book and text messages back to servers in Beijing.

Therefore I expect that in 2015 and 2016, we will see these manufacturers building servers outside of China. Once this has happened, I expect to see manufacturers develop new phones for western markets, in order to minimise copyright infringement in these highly litigious markets.

– Edited by Gayle Bryant

Neil Flynn is portfolio manager at Alcuin Asset Management. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform.

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