Power of the people: A sleeping tech giant awakens
By Michael Kanellos
Staff Writer, CNET News.com
July 9, 2002, 4:00 a.m. PT
BEIJING--It's one of the few words that can perk up a high-technology executive these days: China.
Companies have attempted to tap the country's enormous potential for years, but it has become a far more attractive target recently as the rest of the world remains mired in economic problems. Now, the People's Republic of China has become one of the leading strategic opportunities for Intel, Nokia, Hewlett-Packard and virtually every other multinational.
"The PC penetration rate is below 5 percent. This is still very much a growth market," said W.T. Tan, president of Intel China. "China is still in love with technology."
A rapidly expanding economy, combined with a huge population that views both employment in and products from the industry as one of the most direct routes to success, has created a situation where double-digit growth still thrives and will likely continue for several years.
Just as important are tax breaks, a competitive educational system, and low labor costs that are transforming the nation into one of the key stops in the product development chain. The average worker in China makes about 3,000 yuan a month, the equivalent of $365, according to various sources.
"Today there is a lot of low-end assembly, but 10 years from now you will probably see a copy of today's Taiwan," said Jun Tang, president of Microsoft China. "First they will build up the manufacturing part, and eventually people will design products out of China."
For large companies, the process is well under way. A number of major tech companies manufacture products or maintain significant research and development centers here. Microsoft's Beijing lab, for instance, came up with some of the intellectual property behind the MPEG-4 video-streaming standard.
Local companies have also gained in strength and are expanding beyond the borders. Haier, a Chinese consumer electronics conglomerate, and network equipment manufacturer Huawei Technologies have begun to export branded products to Europe and the United States. Legend, the largest local PC manufacturer, commands 26 percent of the market and is inching into cell phones and the export market.
Semiconductors will also become a huge industry. Nearly 200 chip designers have sprung up in the past few years, said F.C. Tseng, deputy chief executive of Taiwan Semiconductor Manufacturing Co., the world's largest chip foundry. Consequently, foundries--which make chips for companies that don't have factories--are proliferating on the mainland, and TSMC plans to open facilities there to compete with locals such as Grace Semiconductor and Semiconductor Manufacturing International.
"They are getting into communications and consumer products," Tseng said of the mainland Chinese, including their own standard for next-generation mobile phones.
Historical high
The high-tech opportunity in China exists largely because of a confluence of historical circumstances.
During the Cultural Revolution of 1966-76, "there was no law," said Cedric Chao, partner with Morrison & Foerster, an international law firm based in San Francisco. But in 1979, Deng Xiaoping set the country on a course of economic reform and stability.
While political reform until recently has been fairly slow, the country's economy adapted rapidly to market forces.
Today "99 percent of consumer prices are dictated by supply and demand," said Lawrence J. Lau, professor of economic development at Stanford University. The government owns 70 percent of the stock on the Chinese exchanges, he added, but private enterprise is responsible for 65 percent of the gross domestic product.
The economy has grown by 10.9 percent a year since 1979 and will continue to expand by 7 percent annually for the next several decades regardless of economic conditions outside the country, according to studies by Lau. With $450 billion invested in it each year, China will surpass Japan as the world's second-largest economy by 2020, he predicts, and its GDP will equal that of the United States by 2035.
Anticipating this growth, the government has funded research and adjusted its laws to provide a fertile environment for intellectual property. Legend, Linux developer Red Flag Software and other companies were created through funding, research, and often personnel from the state-run Chinese Academy of Sciences, which recently developed a prototype of a 150MHz processor compatible with Windows. Hundreds of universities with strong tech departments have been created.
The Chinese public has responded in kind. The country is the largest consumer of cell phones in the world, with 167 million customers and another 4 million to 6 million new subscribers each month.
The demand for personal computers has slipped since 2000, when consumer shipments grew 82 percent, but it is still relatively strong. PC shipments are expected to grow 18 percent annually on average through 2006, according to market researcher IDC. Server revenue will grow 12.7 percent annually through 2006.
A budget box with a Cyrix processor and a DOS operating system sells for $472 (3,800 yuan) while a locally made Pentium 4 computer with a screen runs about $968 (8,000 yuan).
Popularity of the Internet will continue to fuel PC sales as well. Last year, China surpassed Japan and became the country with the second-largest number of people using the Net, according to Hsin-Mao Huang, CEO of the BNI Media Group.
"In China, unlike the rest of the world, the TV content is still quite limited," Huang said. "So the Internet has much more influence than compared with the U.S."
Import and export
For now, the bulk of China's high-tech production will probably serve the local market, which alone is huge and growing faster than other regions. That is why Lau and others liken China to 19th century America rather than other Asian countries, which depend mostly on export businesses.
"Eighty percent of our semiconductors get imported from outside," said Dai Haibo, CEO of Shanghai Zhangjiang High-Tech Park Development Corp., an industrial park catering to semiconductor manufacturing that counts Applied Materials and Lam Research among its tenants. "In 20 years if we have 20 more production (sites) we still won't have enough."
In this boom, foreigners will likely profit. In five years, half of Zhangjiang's tenants will be Chinese companies and the other half will be outsiders, but a projected 70 percent of the park's output will come from overseas manufacturers.
Exports will grow as well because of low labor costs. A notebook costs $25 less to manufacture in China than in Taiwan, said Carter Tseng, CEO of Microtek, a major scanner manufacturer. Scanners cost $8 less to produce.
Nearly every Taiwanese manufacturer has or is investing in factories on the mainland, said David Lin, CEO of Lite-On, the second-largest optical drive manufacturer worldwide. Taiwan produces about half of the world's notebooks and one-third of its desktops annually, so a large portion of U.S. hardware will inevitably come from the mainland in the future.
Last September, Dell Computer shifted its Japanese manufacturing to China. Microsoft's Xbox is built, but not sold, here. Intel also assembles Pentium 4s, chipsets and flash memory in China for worldwide consumption.
Government obstacles
The enthusiasm, though, is tempered by risks and bureaucratic stumbling blocks. Chinese law imposes tariffs, restricts foreigners to certain sales regions, mandates sales caps, and forces some companies to enter into joint ventures with Chinese companies, among other restrictions.
Government officials also need to be courted. Establishing personal connections within the bureaucracy, hiring locals, and working closely with regional universities and companies are often crucial to success.
"You need to deal with the government a lot more" than in other countries, Intel's Tan said. "On the positive side, the government is totally aware of how important IT is to the country."
And the barriers are dropping. Membership in the World Trade Organization is forcing the Beijing government to redraft laws in the next four to six years, and Chinese officials--especially younger ones--have become increasingly serious about enforcing them, said Jian Daning, director of the Shanghai Waigaoqiao Free Trade Zone, an industrial park run by the government and created for foreign corporations.
"Many previously nationalistic requirements will have to be changed," noted Jian, who said he is on the youthful side of a ministerial generation gap in Beijing. "The changes will be rapid. There will be a lot of changes in the next three to four years."
Getting products through customs, for instance, used to take 72 hours. When the government learned that Malaysia could process imports and exports in eight hours, it set a goal of processing goods through customs at ten hours in general and six hours for IT products.
China also understands tax benefits. Nortel Networks, Intel, IBM and other companies inside Waigaoqiao don't pay income taxes for the first two years of operations and half the standard 15 percent for three years after that. Last year, the park accounted for industrial output worth $10 billion, with 80 percent of the volume coming from IT companies. All are excluded from export and VAT (value added tax).
In addition, government officials are seeking advice from their foreign business partners. Nokia CEO Jorma Ollila, Ericsson CEO Kurt Hellstrom and Matsushita Electric Chairman Yoichi Morishita all serve on the Business Leaders Advisory Council to the mayor of Beijing, a position that requires them to visit the capital at least once a year.
Microsoft, in particular, has become more attuned to local politics. Piracy prosecutions and the use of Taiwanese translators on the Mandarin versions of Windows have rankled Chinese consumers in the last decade. In late 1999, the company's former general manager, Juliet Wu, wrote a tell-all book about Microsoft's business practices in China that became a best-seller.
Since then, Microsoft has worked to better ingratiate itself. A meeting two years ago between Microsoft CEO Steve Ballmer and Premier Zhu Ronghi led to the creation of Censoft and Wicresoft, two new software services companies owned jointly by Chinese companies and the Redmond, Wash., giant. Censoft began operations in April while Wicresoft will open in July, Microsoft's Tang said.
The logical conclusion
So where will all this activity lead? First, foreign companies will begin to face increasing competitive pressure as Chinese industries mature even as they benefit from the growing market.
Semiconductor makers in particular could suffer from a mad rush by companies to build factories on the mainland to reduce shipping costs and to appease the Chinese government by investing in the country. The market faced similar issues when a glut of chips occurred after Japan entered the semiconductor market in the 1980s and again when Taiwan and Singapore joined the industry in the '90s.
"From a supply point of view, you probably don't need these new facilities being built in China," TSMC's Tseng said.
PC companies will also increasingly engage in price wars. Since last year, Dell has cut prices and marketed more heavily to consumers with inexpensive PCs to gain market share. Legend, in turn, has vowed to take more business of its own.
Unlike previous tech manufacturing giants, however, China may not face pressure from price reductions. Manufacturing costs will remain low because more than half of the population still works in the agricultural sector.
"China will enjoy a huge advantage for years to come in low labor costs," Lau said. If history is any guide, the lower labor costs will translate directly to lower PC prices in the West over time.
Taiwan and China may become less distinguishable from one another, at least economically. Taiwanese companies have invested billions of dollars in China and employ more than 300,000 people here, according to statistics from the Committee of 100, a Sino-American leadership group.
Taiwan provides the expertise in this relationship and China the workers. "It is only a matter of time before Taiwan rejoins the motherland," said Ronnie Chan, chairman of the Hang Lung Group, a large Hong Kong real estate concern.
Taiwanese executives generally are far less enthusiastic about reunification but openly acknowledge that their future dictates a binding relationship with the mainland, with business leading the way. "The politicians are not heading up the dialogue, but they are keeping their eyes on it," said Paul Hsu, a senior partner at Lee and Li, a Taiwanese law firm.
The freer flow of information and rising income will inevitably have an effect too. If global history is any guide, the result may be a thriving middle class that eventually leads to political reform.
"We think that bringing in more and more technology opens that country up," Intel President Paul Otellini said in an interview earlier this year. "It is the Chinese equivalent of glasnost. Long term, that has to be good." 
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