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China is no longer a copycat

China grows up and evolves its model

24 June 2019
Author: Michael PowerStrategist

China is moving beyond the copycat model into a global leadership role in several industries. Has China experienced its own ‘Sputnik moment’?

On its own account

Since China was capital short and needed to generate a large number of factory jobs for its fast-rising urban population, this previously suspicious-of-foreigners country had little option but to let foreign companies lead the way (and was happier if it was led by Greater China companies from Taiwan and Hong Kong). Before long, a model was developed whereby contract manufacturers like Taiwan’s Honhai – now reputedly the world’s largest employer of factory labour – formed alliances with Western companies like Apple. Apple then designed and specified product for the likes of Honhai to manufacture in China, which it agreed to buy once the product was manufactured and ready for the retail shelf.

Over time, mainland Chinese companies have learned to make such products for their own account, especially in the all-important electronics sector.

Sometimes this happened with Western help. In 2005, Lenovo bought IBM’s laptop division and has improved it into producing arguably the world’s best machines today. In 2014, Lenovo bought Motorola Mobility for its smart phones and is intent on doing the same under the Moto brand name. The Moto G6 is ranked by Londonbased ‘Stuff’ magazine as the world’s seventh best smartphone. In these instances, China did not steal US technology, it simply bought it.

The top ten smartphones according to ‘Stuff’ magazine

1Huawei P30 Pro

2Samsung Galaxy S10

3Huawei Mate 20 Pro

4iPhone XS

5Honor View 20

6OnePlus 6T

7Moto G7 Plus

8Sony Xperia XZ3

9Samsung Galaxy Note 9

10Google Pixel 3XL

Source: ‘Stuff’ website, May 2019.

Elsewhere in the electronics sector, Chinese companies are expanding fast and into virtually every sector, including the previously Apple-dominated niche of high-end mobile phones. Stuff magazine currently ranks Huawei’s P30 Pro as the world’s best smart phone, ahead of Samsung Galaxy S10 and last year's leader Huawei Mate 20 Pro. Apple's iPhone XS comes fourth with Chin's Honor View 20 and OnePlus 6T occupying fifth and sixth place. In fact, Chinese-branded phones now occupy five of the top eight slots, while Chinese-made phones occupy all eight slots. In 2018, in unit terms, Huawei overtook Apple to become the second-largest producer after Samsung. Again, in unit terms, Chinese phone makers account for six of the global top ten in smartphones: Xiaomi, Huawei, Lenovo, ZTE, TCL (bought out of France’s Alcatel in 2013) and Coolpad. Bernstein Research estimates that China make 90% of the world’s smartphones and two-thirds of the worlds smart TVs and computers.

World leading across sectors

Chinese manufacturers are already world leaders in many other consumer electronics categories: Haier is easily the world’s largest white goods manufacturer, Gree leads in air-conditioners, Galanz in microwaves and Zhejiang Supor in cookware. Chinese manufacturers (TCL, Hisense) have a fast-growing presence in televisions.

Huawei has also recently overtaken Nokia and Ericsson to become the world’s largest telecommunication equipment manufacturer, helping to establish China as the best-prepared country in the world for the arrival of 5G.

And China has spread beyond consumer electronics into more sophisticated manufacturing products such as renewable energy: JinkoSolar, JA Solar and Trina Solar lead the world of solar panels, BYD and CATL lead for lithium Ion batteries.

Chinese manufacturers are also clear leaders in many areas of transport, logistics and infrastructure. China Shipbuilding Industry Corporation is the world’s largest shipbuilder: China Railway Group is likewise the largest builder of railway systems, a position born of building most of China’s high speed ‘bullet’ network. ZPMC is easily the world’s biggest manufacturer of port equipment.

One other transport industry which China is destined to dominate is electric vehicles, not least because over half the annual sales in this category are in China. Already, by unit sales, six of the top ten EV companies are Chinese: BYD, SAIC, Faw, Geely, BAIC and Dongfeng.

The one transport area where China is not yet a global player is aircraft. But Boeing – producing the commercial aircraft that are the only non-natural resource category in the US’s top six exports to China – potentially faces stiff competition from 2008-established COMAC when the latter launches its CR 929 model in 2023. COMAC’s Western technology partner is Bombardier of Canada.

China’s industrial progress is no longer just a case of outdoing the Japanese, the Koreans, the Americans and the Europeans by producing smaller, more basic, cheaper versions of someone else’s product, although initially that is what tended to happen, as it did when Japan and Korea and even the US were in their own early stages of industrialisation.

A perfect illustration of the new China is electric car company NIO, which was founded in Shanghai in 2013. Within four years, its show-stopping EP9 broke the Nurburgring lap record – and the EP9 is an electric vehicle.

One can investigate a whole range of new high-profile industries – artificial intelligence, quantum computing, robotics, cloud computing, and biotech – and China is now at the forefront of world research in all of them. In quantum cryptography, it is well ahead of the competition. This research focus reflects the “Made in China 2025” strategy which has identified the ten key manufacturing and industrial areas that China has set out to develop and dominate over the coming decade. These are illustrated below:

Information technology

Medicine and medical devices

Electric vehicles

Numerical control tools and robotics

Aerospace equipment

Ocean engineering equipment and high-tech ships

Railway equipment

Power equipment

New materials

Agricultural machinery

Source: Investec Asset Management.

E-commerce, beyond copycatting

One can even argue that China has begun to invent industries: modern e-commerce, for example. Between Alibaba and Tencent, e-commerce has been interpreted in a way not dreamed of by the likes of Amazon. By creating interconnected ecosystems backed up by easy electronic payment methods, the Chinese duo have created a readily accessible digital world populated with virtually every good or service a person might need. This ecosystem includes fintech, traveltech, healthtech, gaming, media, all aspects of retail and a long list of other products under a single umbrella.

Yes, China has been through a ‘copycat’ phase, but it is quickly growing beyond that to a world where it is much more a leader than a follower. This is captured in a variety of statistics: by 2015, China had outstripped the US 2:1 in patent applications with Huawei now the world’s leading corporate applicant. This is echoed in the same ratio of science and engineering graduates relative to the US: 2:1. In 2014, China overtook the US in numbers of peer-reviewed scientific papers published. In terms of gross expenditure on R&D, adjusted for purchasing power parity venture capital raised and unicorns funded, China is fast catching up with the US.

Figure 2: Patent applications in China have soared

Figure 2

Source: WIPO statistics database, February 2017.

China’s ‘Sputnik moment’

The ongoing saga between the Trump White House and China regarding the export of US semiconductors to China could be a watershed event in the latter’s industrial evolution. Indeed, the New York Times dubbed it China’s ‘Sputnik moment'. Until now – other than commercial aircraft – the most industrial of items that China has been importing from the US have been semiconductors. They are often akin to the ‘secret syrup’ Coca Cola supplies to its bottlers worldwide: Intel chips are still famously ‘inside’ most Lenovo laptops and many of Xiaomi’s cell phones run Google’s Android software.

In 2017, Qualcomm, Broadcom and Micron all got over 50% of their revenues from chip sales to China. Indeed, China-based manufacturers use 60% of semiconductors worldwide. A high percentage are used by contract manufacturers like Quanta, Compal, Wistron, Inventec, Flextronics and of course Foxconn making product for HP, Dell and Apple. China’s 2017 chip imports – including chips sourced from the US, Japan, Taiwan and Korea – totalled $260bn. After crude oil, chips are China’s largest import.

This relationship has been highlighted in the developing trade war between the US and China in that it brought Chinese tech giant, ZTE, one of the world’s leading telecom equipment manufacturers, to the edge of bankruptcy. Though the pretext was the illegal distribution of US technology embedded in microchips to Iran and North Korea, the event has highlighted China’s dependency on the US for semiconductors. China is clearly determined to eliminate this Achilles’ Heel. Chinese public and private chip sector has grown massively in the past 12 months with the intent of reducing – even cutting off – this dependence.

China has now put in place a US$47 billion ‘Big Fund’ to finance semiconductor research and underwrite chip start-up development. It aims to achieve selfsufficiency and parity in semiconductors by 2025.

General risks: The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made.
Michael Power
Michael Power Strategist

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