SMARTPHONES: ZTE Joins Chorus of Smartphone Trouble Signals

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Bottom line: Beijing should note the latest trouble signal from ZTE in the smartphone sector, and take steps to prevent future similar boom-bust cycles by encouraging more responsible investing incentives by local governments.

ZTE cautious on China smartphone market
ZTE cautious on China smartphone market

The latest trouble signal from China’s overheated smartphone sector came last week from telecoms stalwart ZTE (HKEx: 763; Shenzhen: 000063), which said it would remain cautious in the world’s largest market even as it announced ambitious new sales targets for the rest of the world this year. The company’s relative caution in its own home market comes amid a looming shakeout that is just the latest in a series of boom-bust cycles that have become all too common in China’s business landscape in the last 3 decades.

While market forces play a large role in these bubbles, regional governments looking to spur economic growth may also share some responsibility by offering incentives that encourage local firms to enter unfamiliar areas where the chance of failure is high. Such failures often result in big financial losses and mass layoffs, negating any economic benefit they were supposed to create.

Markets should always be the central force dictating what products companies make, and new product development is a critical part of any company’s long-term survival. But to reduce the severity of these boom-bust cycles, government officials should take a more hands-off approach to company product development decisions and leave such matters to commercial forces.

ZTE is one of China’s leading global smartphone brands, but is surprisingly weak in its home market that is the world’s largest, accounting for about a third of worldwide sales. In last year’s third quarter the company was the ninth largest brand in the global marketplace, where it competes with top names like Apple (Nasdaq: AAPL), Samsung (Seoul: 005930), LG (Seoul: 066570) and Sony (Tokyo: 6758). But it was also just ninth in China where many of the big global players are absent, finishing behind far lesser known homegrown brands like Zopo and Elephone.

The company’s caution is with good reason, as it tries to steer clear of the current price wars that have ravaged China’s smartphone market for much of the last 2 years. In an interview last week, the company’s smartphone chief announced an ambitious target of boosting ZTE’s smartphone sales by 25 percent this year to 70 million from 56 million in 2015. (Chinese article)

He added the company’s China smartphone sales of 15 million units last year was a disappointment. But he was quick to add that ZTE must still learn from others before it can ramp up its China sales, reflecting a conservative stance due to the market’s cut-throat competition.

The co-founder of OnePlus, China’s fifth largest brand, was even more direct in another recent interview, predicting a looming sector shakeout that would get worse before getting better. Other signals of the looming shakeout include a growing number of bankruptcies among the many factories that make smartphone components and finished handsets for the major brands.

Me-Too Investing

The rampant competition stems from a China market that is crowded with homegrown players who have rushed to cash in on the sector’s rapid growth even though many have little or no related experience. The field of current brands covers a wide range of companies, from home appliance specialist Gree (Shenzhen: 000651) to heavy equipment maker Sany (Shanghai: 600031), and Smartisan, a brand founded by a man famous for his English teaching skills but little or no experience in telecoms products.

This kind of piling into new and unfamiliar product areas is quite common in China, and most recently occurred in the sector making panels to produce solar power. That boom saw China rise to manufacture more than half the world’s solar cells in just a few years. In that instance a wide range of traditional manufacturers piled into the sector, encouraged by government-linked incentives like cheap or free land for factory construction, and cheap loans from local state-run banks and other lenders.

The solar sector is now paying for that rapid boom with an ongoing bust that has seen many producers go bankrupt, resulting in big headaches for local governments that must now deal with the huge piles of unpaid debt and thousands of lost jobs. The smartphone sector looks set to undergo a similar retrenchment that will eliminate the large amount of excess capacity, much of it for cheap, low quality models that would have difficulty competing outside China.

Beijing should take note of this latest boom-bust and take steps that could try to prevent such cycles from happening in the future. An important step would be rejigging growth targets to encourage smarter and more targeted incentives from local governments, aimed at promoting higher quality manufacturing investments rather than simply growth at any cost.

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