China's Local Cell Phone Boys Get Tough

Multinationals lose ground in the fastest-growing market

It was a multinational's idea of a nightmare. In early August, Motorola Inc. announced that it was expanding its 10-year-old collaboration with Eastern Communications Co., a state-owned Chinese manufacturer and distributor of telecom equipment. Two weeks later, Hangzhou-based Eastcom launched its own digital cell phone--and undercut Motorola's rival StarTAC model by $120. "We used the Motorola brand to start business as a distributor," says Wang Zhongxiong, Eastcom's director and CFO. "Now, we want to create our own brand."

Who can blame them? China is the world's fastest-growing cellular market: It is adding 1.5 million users a month--and is forecast to reach 44 million by yearend. Until now, foreign companies such as Motorola, Ericsson, and Nokia have had the technology--and 80% of the market--to themselves. But that's changing fast. Besides Eastcom, three other mainland companies have already launched phones that operate according to the GSM standard. Some two dozen more will join the fray this year. Within two years, predicts Wang, the $4 billion handset cellular market will be split evenly among locals and foreigners. He wants Eastcom to have 8% of it.

MANY COLORS. Eastcom is putting a lot into this gambit. The $700 million company spent more than a year developing its first mobile phone at its Los Angeles R&D center. It comes in five colors, includes Chinese songs for its ringer, has a Chinese-character keypad, and will retail for $146. Eastcom plans 10 more models over the next year. It will triple its R&D staff in China and the U.S., to more than 100, before yearend. Beijing intends to help on the R&D side, too.

So far, so good. While heavy investments drove first-half profits down 24%, sales were up 21%. The market is impressed. Eastcom's yuan-denominated shares, listed in Shanghai, are up 58% this year.

Eastcom has spent heavily to hire U.S.-educated Chinese engineers away from the likes of Sony Corp. and Motorola. From Motorola, Eastcom has picked up valuable experience in production, quality control, and testing. Technological exchanges with Lucent Technologies Inc. have also been critical. Lucent now supplies chip sets for the latest GSM digital systems. It also helps Chinese companies design their phones, cutting the two-year development time by 60%.

A change in the market also helps. Growth is no longer driven by high rollers but by ordinary folk who are less smitten with foreign brands. The same pattern already has hit the pager market. It is now divided evenly between Chinese companies, with Eastcom a major player, and foreigners, led by Motorola.

NO HARD FEELINGS. Although stunned by the challenge from its own supplier, Motorola insists that it does not resent the strides Eastcom is making. Jason Chen, vice-president and a general manager at Motorola Greater China, says the company wants to keep collaborating with Eastcom.

As upstarts multiply, "Not everyone's going to be successful," says Zhou Zhenhong, managing director at Lucent Microelectronics (China) in Shanghai. "But a big chunk of the market will definitely be supplied by domestic companies." The ones that survive, that is. A glut of phone handsets may be building. Producers of switches, such as Shenzhen-based Zhongxing Telecom and Jinpeng Group of Guangzhou, also are moving into cell phones, as is Konka, a Shenzhen TV manufacturer. "If too many companies jump in, it will bring pricing down to the dirt," says Chen. To avoid the supply gluts that have crippled other industries, Beijing may soon assign production limits to local manufacturers.

To veteran China hands, that's a familiar sign. "That's standard practice," says an analyst in Beijing. "First try to limit the competitors and then offer special financial packages to the Chinese companies." It won't be the first time that multinationals have pioneered a mammoth growth market in China--only to watch it vanish into the hands of local players.

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