Huawei may have been the first Chinese company to be affected by the U.S.-China trade war, but its main Chinese rival, ZTE, is now also suffering. The two Chinese tech giants are facing severe challenges in the U.S., where legislators have banned companies from selling spare parts, products, software and technology to Chinese phone manufacturers. Federally subsidized U.S. telecommunication operators are also barred from buying equipment from suppliers who could threaten national security. For Huawei, this problem may also be a relief, but not for ZTE whose high hopes for the U.S. market is now severely threatened.
Two tech giants hit one after another
“Some things are easier to let go. The problem between China and the U.S. is not something I can articulate or resolve,” said Eric Xu, one of Huawei’s rotating CEOs, at an analyst meeting. For Huawei, this problem may also be a relief as it means Huawei will no longer worry about the American market and just focus on doing what they do best.
If the series of setbacks experienced by the Chinese tech giants in the U.S. have helped Huawei lower their unrealistic expectations, then what ZTE has experienced is nothing short of a devastating blow. As the most successful representatives of globalization among Chinese tech companies, Huawei and ZTE are the world’s only two telecom giants that operate in both telecommunications equipment and smartphone industries. Huawei is currently the world’s largest manufacturer of telecommunications equipment and the third largest smartphone manufacturer. ZTE is the world’s fourth largest manufacturer of telecommunications equipment and the fourth largest smartphone vendor in the U.S.
The two Chinese tech giants have been hit severely by the sanctions posed by the U.S. government, which were spurred from trade tensions and technology competitions between China and the U.S. Whether ZTE can survive the crisis depends on their negotiations with the U.S. government, and also on the negotiations between Chinese and U.S. government.
Two severe hits in two days
On Monday, the U.S. Commerce Department announced that the U.S. would impose a technology ban on ZTE for seven years, as ZTE violated the U.S. sanctions against Iran on technology sales. Until 2025, American companies are barred from selling parts, goods, software and technology to ZTE. On Tuesday, the Federal Communications Commission (FCC) unanimously passed a resolution barring federally subsidized U.S. telecommunication operators from buying equipment from suppliers who pose a threat to national security, which includes Huawei and ZTE.
Huawei adopting a more nonchalant attitude
Let us examine the second resolution.
The popularization rate of telecommunications services in the U.S. is far lower than that in China due to lower population densities in the United States. Due to costs, private companies offer little or no services in remote and sparsely populated areas, especially in the Midwest. The federal government provides nearly $9 billion a year in subsidies to encourage small local operators to build basic infrastructure and maintain telecommunications networks in these remote areas.
Huawei has been unable to partner with major U.S. carriers since the U.S. congressional investigation in 2012, but in remote areas, small local operators with low margins are still buying telecommunications equipment from cost-effective options like Huawei. For example, the Huawei NE40E router is used by operators in eastern Oregon. A small local operator said that by buying Huawei products, they were able to recuperate $150,000 in cost savings.
The U.S. telecom equipment market is worth $30 billion a year. As the U.S. government took various measures to block Huawei and ZTE, the U.S. market is now occupied by two Nordic telecoms giants, Ericsson and Nokia, whose global market share have been gradually won over by Huawei and ZTE. According to market research firm Dell’oro, less than one percent of mobile and fixed-line devices in the U.S. now comes from Huawei. The FCC decision means that Huawei and ZTE will likely lose even their smallest share of the U.S. telecom equipment market.
Huawei has continuously been met with obstacles since it entered the U.S. market a decade ago. Its technology and asset acquisition attempts were repeatedly rejected, including the 3com deal in 2008, the 3 Leaf and 2 Wire deals in 2010, and the attempt to acquire Motorola’s network infrastructure unit in 2011. In 2010, Huawei was forced to give up its $6 billion contract with Sprint. Its most recent smartphone sales contract with AT&T was also canceled by AT&T, and its partnership with Best Buy ended ahead of schedule. The list goes on.
The U.S. is the world’s second largest mobile phone market with more than 200 million units sent out by manufacturers to a year. Huawei has repeatedly launched its Mate flagship smartphones series equipped with Amazon’s Alexa as voice assistance in the U.S. which will finally have to come to an end. After years of frustration, Huawei’s top executives have experienced expectations to disappointments, from rekindling of hope to now take things as they are. For Huawei, the U.S. market is like the Castle by Franz Kafka, it is right within reach but still a futile pursuit of an unobtainable goal.
ZTE gets on America’s nerves
If the serial setbacks that the U.S. government imposed on Huawei prevented it from entering the U.S. market, then the consequences for ZTE are much more devastating. ZTE is likely to not only lose the U.S. market, where it sells millions of smartphones, but also lose competitiveness in its core business in the global markets.
Violation of the U.S. government’s sales sanction was the fundamental reason for the severe punishment. The U.S. government has posed technical sanctions against Iran, North Korea, Syria, Cuba and other hostile countries, banning any manufacturer that uses U.S. technology from selling equipment to these countries. In reality, as core technologies (chip, systems and components) are mostly in the hands of U.S. giants, most multinational corporations all have to bide by their rules.
Yet ZTE decided to test this rule.
In May 2017, the U.S. government fined ZTE $1.2 billion for violating U.S. restrictions on sales of internet equipment and smartphones to Iran and North Korea. This was the highest penalty that the U.S. government has ever imposed in relation to any sanctions.
According to U.S. media reports, due to improved relations with Iran during the Obama administration, the Iranian government provided information on business transactions between Chinese companies and Iran during the U.S. sanctioned period. ZTE is among the list of involved Chinese companies.
In March 2016, an American ZTE employee provided the U.S. government with the company’s internal confidential documents. A document named “Report Regarding Comprehensive Reorganization and the Standardization of the Company Export Control Related Matters” contained specific export orders that violated the U.S. sanction, including building wireless communication networks for Iran and exporting mobile phones to North Korea. The report became a key piece of evidence during the investigations.
The U.S. government has again imposed a technology ban on ZTE, citing ZTE’s failure to comply with the earlier plea deal and failure to punish those directly responsible for exports to Iran. Although ZTE has reorganized management and fired four executives directly responsible for the export, it didn’t punish the 35 employees involved according to the settlement agreement. Instead, ZTE gave them a bonus, and provided false statement to the U.S. government investigators.
Grim prospects for ZTE Smartphones
Why did ZTE plead guilty and agree to pay $1.2 billion to the U.S. government for a settlement? The $1.2 billion is almost two years of profit for ZTE (4.57 billion yuan or $723.52 million in 2017), which is equivalent to working for the U.S. government for two years for free.
This is because of the notion that ZTE cannot survive without the U.S. market. ZTE is the fourth largest smartphone vendor in the U.S. with a market share of more than 10 percent, only after Apple, Samsung and LG. ZTE has more than 10 million units of smartphones shipped in U.S. each year. The strong growth of the U.S. market has become the biggest source of hope for ZTE, which has seen a sharp decline in other markets (with 43 million units shipped globally last year, down 17.3 percent from the previous year).
ZTE’s low to mid-range phones are mainly sold in the U.S. through sales agreement with operators, including three of the four major U.S. operators. Through sponsoring NBA teams and other marketing methods, ZTE expanded its brand awareness and overtook the market shares of HTC, Motorola and other manufacturers.
However, the carriers market is most vulnerable to policy changes due to their relationships with the regulatory bodies. Under the direct intervention of the government, America’s second-largest carrier AT&T was forced to withdraw from its agreement with Huawei to sell the Mate 10 in January of this year. This is why Richard Yu was enraged during the release conference.
At the U.S. Senate hearing in February this year, six top U.S. intelligence chiefs from FBI, CIA, NSA and three other agencies suggested that American consumers should avoid Huawei products and services, and support operators to boycott Huawei. They also criticized ZTE at the hearing.
Under such political backdrop, even if U.S. operators do not immediately stop cooperating with ZTE, the likelihood of them placing future orders are severely jeopardized. That means ZTE’s shipments, which rely heavily on carrier channels, could be hit hard. According to an insider from one of the four major U.S. operators and one of ZTE’s main clients, executives have been evaluating the political risks of cooperating with ZTE and coping measures starting earlier this year.
Cutting off ZTE’s supply chain
The U.S. government’s ban on U.S. companies from selling parts, goods, software and technology to ZTE may be more serious than the decline of shipments to the U.S. market. If ZTE does not reach a settlement with the U.S. government in time, ZTE’s supply chain could suffer a devastating blow. This pertains to both mobile phone and telecommunications equipment businesses.
Although ZTE is already one of the giants in China’s technology industry and the fourth largest provider of telecomunnications equipment in the world, the indispensable core technology has always been in the hands of U.S. companies. In 2016, the U.S. government imposed a temporary technology procurement ban on ZTE, forcing ZTE to plead guilty and finally reached a deal when ZTE agreed to pay a sky-high fine.
According to Reuters, 25 to 30 percent of ZTE’s components come, including all core components, are from U.S. suppliers. ZTE’s core components, including mobile phone chips, baseband chips, RF chips, memory chips, screen glass, operating systems, optical components and others, are all from U.S. technology giants such as Intel, Qualcomm, Broadcom, Micron, Oracle, Google, and Corning. It is nearly impossible for ZTE to find equally competitive alternatives in the short term, as there are no alternatives. It is also unclear whether ZTE can continue to use Google’s Android system.
ZTE’s production of smartphones and telecommunications equipments will be paralyzed without components made by core U.S. suppliers. The procurement ban will directly affect U.S. technology companies, and may cause share prices of small spare parts suppliers to fall sharply. As long as the ban is in place, they cannot cooperation with ZTE. It is worth mentioning that Qualcomm just survived a hostile takeover with the help of the U.S. government, and is now relying on the U.S. government to advance the deal with NXP Semiconductors.
Huawei was more cautious in handling the Iran sanction.
In 2011, Huawei publicly announced that it would no longer undertake business with Iran, and only provided maintenance for existing products. Huawei also offered to invite the U.S. congress to Huawei headquarters in Shenzhen to investigate alleged links between Huawei and the Chinese government. When business contacts between ZTE and Iran was exposed in 2016, the U.S. Commerce Department asked Huawei to also provide information concerning communication technology exports to North Korea, Iran, Syria, Cuba and Sudan during the past five years. It conducted another investigation on whether Huawei violated U.S. embargo or sold products containing American technology to these countries. 
China as the biggest rival
While the U.S. government has seemingly justified reasons for punishing ZTE, but it is under the backdrop of intensifying trade frictions between China and the U.S. Earlier this month, U.S. President Donald Trump announced punitive tariffs on 1,300 Chinese goods worth $50 billion. Immediately, the Chinese government launched retaliatory tariffs on American imports. It seems like Trump is using tariffs as a weapon to pressure the Chinese government to further reduce existing tariffs on U.S. goods and open the Chinese market.
In the eyes of the U.S. government, China is not only the world’s second largest economy after itself, but it is also the only rival likely to pose a threat in the technology sector in the future. The rapid rise of Chinese technology companies in the global market could challenge U.S. dominance in global technology. That is exactly why the U.S. government started a trade war and a ban on Chinese companies acquiring U.S. ones, especially in the technology sector.
Last month, the U.S. government vetoed Broadcom’s proposal to acquire Qualcomm. The proposal was worth of hundreds of billions of dollars, highest in the history of the semiconductor industry. The core reason for the ban was the concern that the acquisition could affect Qualcomm’s R&D, weaken U.S. advantages in the field of communications and mobile processors, and bring opportunities for Chinese rivals such as Huawei.
On the other hand, Qualcomm’s acquisition of European-based NXP Semiconductors didn’t pass the first check by the Chinese Ministry of Commerce (MOFCOM) either. The deal could change the future of the global car chip industry. Of the nine government regulators around the world, only the Chinese government did not approve this proposal. If the Chinese government intercedes with the U.S. government for ZTE, the latter may use the approval as an exchange.
In 2016, the U.S. government suspended the ZTE procurement ban under the active coordination of MOFCOM, and gave ZTE a buffer period to reach a settlement agreement. If ZTE wants to overcome its biggest survival crisis, it may again need to turn to the Chinese government to improve future prospects of U.S.-China trade talks.
China’s rapid rise in the telecommunications and technologies sectors inevitably threatens U.S. advantages in the areas of politics, economy, military, and many other fields, including the technology industry that is determinant of a country’s future competitiveness. The U.S. has taken continuous measures against ZTE and Huawei, two major Chinese telecom giants, in attempts to curb China’s overtake in the future of the telecommunications and technology industries.
ZTE’s punishments and penalties serve as a warning for Chinese enterprises that are eager to go global, and help the Chinese tech industry see the gap between China and U.S. in core technologies. In order for Chinese companies to overcome the current dilemma and to rid of U.S. constraints, they need to devote to the R&D of 5G communication, integrated chips, display screens, artificial intelligence, autonomous driving, cloud computing and other core technologies. Chinese companies can build up their own technology giants. The research and development of chipsets by Huawei-owned semi-conductors company HiSilicon is a great example..
Fortunately, the amount of support for new technology offered by the Chinese government is unprecedented in China and in the world. Silicon Valley only became the center of technological innovations with the support of the U.S. government and decades of effort from the industry. It will take years for China to become self-sufficient in core technologies as Rome was not built in a day. Manufacturers should avoid arrogance, play by the rules, and never become complacent.