Winning in China

Can Motorola hang on to its top spot as local rivals come on strong?

It's a wild night at the old Exhibition Center in Shanghai. The Soviet-style palace, dating from the glory days of Moscow's friendship with the People's Republic, is the unlikely setting for a gala launch of new cellular phones from Motorola Inc. Outside the hall, white Motorola balloons flutter in the brisk winter air, while purple and red spotlights project the company's logo and Chinese slogan, Nihao Moto (Hello Moto), on the building's pillared facade. Inside, hundreds of guests listen to popular tunes, watch movie trailers, and play games--all on shiny new Motorola phones. Then it's time for a banquet of Kung Pao chicken, shark fin soup, and other Chinese delicacies, while fashion models showing off Motorola handsets strut across the stage to a steady rock beat bouncing off the vast arched ceiling.

Quite a show--and a symbolic leap into the future for the American high-tech icon. The January event marked the first time Motorola has launched a new global product line in Asia. The choice of China should come as no surprise. As the world's largest cellular market, with 200 million subscribers, China is the marketing fixation of every company in the industry. And Motorola was a China pioneer. Current Chairman Christopher B. Galvin first visited Shanghai as a rising exec and met with Jiang Zemin--then a little-known local party functionary, now China's President--in 1986. The U.S. giant has been diligently nurturing the Chinese market ever since, investing $3.4 billion in manufacturing and research and development facilities there, more than any other Western company.

That commitment has paid off. Motorola sells more cell phones than anyone else in China: nearly 17 million in 2002, according to market researcher Adventis Corp. Last year, Motorola manufactured telecom and other equipment valued at some $5.7 billion in China, selling roughly $2 billion worth abroad--making it one of China's top exporters. Some 20% of the company's $26.2 billion 2002 revenue came from China, according to brokerage Bear, Stearns & Co., and Motorola executives confidently predict sales will continue to increase at double-digit rates.

Even more important, analysts say Motorola is profitable in China. And its China business is growing faster than that of any other region--big news for a company that has been languishing in the red and is expected to eke out just a small profit globally for 2002. "China has been great for Motorola," says Mike S. Zafirovski, the company's president and chief operating officer, who flew into Shanghai for the big bash. "It's very much a bright spot for our company."

But no number of sultry fashion models, flashing billboards, or plates of Kung Pao can hide the fact that the bright spot may soon start to dim. Archrival Nokia has poured $2.4 billion into China and has a giant complex making cell phones and components near Beijing. And Korea's Samsung Electronics is benefiting from looser regulations following China's 2001 entry into the World Trade Organization. Even more ominous for Motorola is new competition from local Chinese handset makers. They had less than 3% of the market as late as 1999 but today control some 26%, according to Adventis. Meanwhile, Motorola's market share fell to 28% last year, from 31% in 2000.

Motorola is in little immediate danger of losing its lead in China, but there's no denying its local rivals are coming on strong. Many Chinese companies plan to double or triple their capacity, flooding the market with millions more handsets and driving down prices on the low-end phones that have provided Motorola and its multinational rivals the bulk of their China sales. In the past year alone, the average price of a phone in China fell by 15%, to $170, according to Beijing-based Norson Telecom Consulting. "If the local guys get too much market share, that could put huge pressure on Motorola," says Bear Stearns analyst Wojtek Uzdelewicz.

That's pressure the company can't afford. Outside China, key customers for Motorola's networking gear--wireless operators such as Europe's T-Mobile International and Verizon Communications in the U.S.--have slashed spending dramatically. Motorola's infrastructure business throws off so little profit that company executives have been open about wanting to sell it. Its semiconductor unit, although recently reorganized, isn't doing much better. And in the U.S., Motorola's largest market for cellular phones, subscriber growth has begun to tail off, as nearly half of all Americans already carry phones. The bottom line: Investors have pushed Motorola shares down 60%, to $9.50 a share, over the past two years. No wonder China, the source of 30% of its handset sales, is a beacon for the company. "This is our most important market," says Scott A. Durchslag, Motorola's corporate vice-president for strategy and business development.

Yet Motorola has made some recent missteps in that critical market. The company made headlines with its promise to build a $1.5 billion semiconductor plant in Tianjin to make phone-handset chips, even though others in the semiconductor industry questioned whether the fab was needed. The facility was supposed to be one of the most advanced chipmaking factories in China. Today, the building is complete, but because of slack global demand for chips--and a glut of production capacity--the company has been slow to ramp up manufacturing. "We're in small production," says Joe Steinberg, Tianjin-based vice-president and general manager of Motorola's China chip division. "We're not adding capacity. It's prudent to wait until we have something tangible" in terms of demand.

The chip plant is crucial to Motorola's plans to deepen its roots in China. The company already employs some 1,300 Chinese engineers doing research for products such as mobile-phone handsets, semiconductors for PCs and speech software. Motorola is also hiring more local designers, since China's millions of cellular subscribers are growing increasingly savvy and trend-conscious. "The Chinese have become very knowledgeable about phones," says Brian Holmes, Motorola's senior director for product marketing in China. "They do their homework."

So Motorola is putting more of an emphasis on models with flair. Consumers and analysts have criticized Motorola's Chinese phones as technology winners with ho-hum design, especially when compared with the gee-whiz models sold by local rivals. TCL International Holdings, a Hong Kong-listed manufacturer in Guangdong province, features a diamond-encrusted handset. Eastcom, a state-owned enterprise near Shanghai, sells a $425 phone that's covered in specially treated fish skin. To fight back, Motorola has introduced a faux-diamond-studded handset of its own. And it is hoping mainland consumers will fall for phones that can better handle Chinese-language text messages and can double as karaoke machines or e-books--features local rivals have a hard time matching. "In the past, Motorola's reputation was more for good quality. Now it's much more trendy," says Tim Chen, Beijing-based chairman of Motorola's China operations.

These days, Motorola is stressing the idea that its phones are fun. Of the 20-plus new models that Motorola will launch in China this year, at least a dozen will be phones that can send and receive photos, says Brian Lu, Beijing-based vice-president and general manager of Motorola's Greater China handset group. Lu vows that such products will tame the ambitions of Motorola's local rivals. "It will be difficult for [Chinese handset makers] in the long haul," he says. "They don't control the technology. They don't control the R&D. They own only a very small piece of the value chain."

Yet the Chinese may be stronger than Lu thinks. Take Ningbo Bird Co., a Chinese mobile-phone manufacturer that is currently ranked No. 6 in China but is growing at a torrid pace. Ningbo Bird last year made more than 7 million phones and has just opened two new factories that boost its capacity to 20 million phones annually. Not bad for a company in only its third full year of mobile-phone production. "We want to be No. 1 in China," declares Ma Sitian, the company's deputy general manager. And even though Ningbo Bird initially relied on France's Sagem for its system designs, it now has technology partnerships with others, including LG of South Korea and BenQ of Taiwan.

The ability to buy technology off the shelf has helped Ningbo Bird to prosper even without a vertically integrated manufacturing and R&D operation like Motorola's. Furthermore, Ningbo Bird is boosting its own R&D capabilities and designed 15% of the phones it made last year--although none of them has the advanced features that Motorola claims will set it apart. Still, with all of its new capacity, Ningbo Bird will be looking to markets beyond China, starting in Southeast Asia. "The competition will be even more intense, so we have to export," says Ma.

That's what should scare Motorola the most. Virtually every product made in China--from sneakers to DVD players--quickly drops in price as manufacturers gain scale and low-paid workers churn out goods by the container-load. At the same time, even as demand for cell phones continues to climb in China, the rate of growth is slowing. So, like Ningbo Bird, other Chinese rivals will begin selling their phones abroad, potentially hurting Motorola's sales worldwide. With 1 billion mobile users today, most of the world's wealthiest people already have phones, says Ross O'Brien, Asia-Pacific director for telecommunications consultant Pyramid Research. Expanding the number of users will now require ever-more drastic price cuts. "You have to take the market down a notch," O'Brien says. "This is where China's vendors have the upper hand."

Team Motorola is determined to avoid that trap. To stay ahead of the game in China even as its handset business comes under increasing pressure, Motorola has hatched a strategy that executives dub "Two plus three plus three." The "two" refers to Motorola's primary operations in China, manufacturing and R&D. The first "three" refers to the businesses Motorola wants to expand there: semiconductor production, broadband equipment, and digital-trunking networks (the mobile-communications systems used by police, taxi drivers, and delivery fleets). The final "three" refers to targets Motorola has set for yearend 2006: $10 billion worth of production in China, purchases of $10 billion worth of components in the country, and $10 billion in direct or indirect investment by Motorola and its partners. In short, the company wants to cut costs via local sourcing and boost its strength in new areas where there are fewer worries about Chinese rivals flooding the market with me-too products.

A critical part of Motorola's strategy is to show Beijing its commitment to the Chinese economy. That's especially important given that local rivals are usually government-owned and have good guanxi, or connections, with local officials. Motorola, though, contends that it is as Chinese as any of its rivals, with more than 10,000 employees in the country--roughly the same number as Ningbo Bird. "We take pride in viewing ourselves as a very local company in China," says COO Zafirovski. And since Motorola isn't blind to Beijing's desire to boost China's science and technology prowess, it recently announced a $100 million expansion of an R&D center in the capital. Chinese officials appreciate the effort. "There is a lot of trust on the Chinese side because Motorola has put a lot of investment into the country," says Craig Watts, an analyst with Norson Telecom Consulting.

Motorola is even prepared to work with the companies that are eating away at its top position in handsets. The company has agreed to sell chips for cell phones to TCL and Eastcom. As a bonus, if Motorola can get local manufacturers on its customer list, the Tianjin chip fab might see enough business to get the production lines running full-bore. "The market will come back by the end of 2003," Chen says.

Motorola's Chinese adventure has been a great success so far, even as local rivals nip at its heels. Motorola "is well established," says Duncan Clark, an analyst with Beijing-based telecom consultant BDA China Ltd. "It will take some time to dislodge them." Given the threat to Motorola's market share in China, though, the company has to keep moving--especially in light of its history elsewhere. Bear Stearns estimates that since the mid-'90s, Motorola's market share in handsets has slipped from about 50% to 30% in the U.S. and from more than 30% to less than 10% in Europe. In the context of those setbacks, China is the gamble Motorola has to win.

By Bruce Einhorn in Shanghai, with Dexter Roberts in Tianjin and Roger O. Crockett in Chicago

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