The Chips Are Down for ZTE

Chinese Phone-Maker Removed from US Smartphone Gene Pool

Last week, the US Department of Commerce announced a denial order against ZTE in response to what it called "repeated false statements" to the US government. In early 2017, ZTE reached a deal with authorities in the US for claimed violations of a trade embargo against Iran. That settlement included a $661 million civil penalty and a seven-year denial of export privileges, imposed as a "suspended sentence". The suspension could be lifted if certain probationary conditions weren't met.

The government now believes that ZTE hasn't complied with the probationary terms. This claim points to the company's handling of its employees who were directly involved in the trade violations. The Chinese phone-maker had informed authorities that it would take action against those employees, but the US government alleges that ZTE has done the opposite, continuing to reward them with monetary recognition.

The denial order is significant for ZTE as it will directly hit its supply of components and its supply to customers in the US and elsewhere.

Unlike Huawei, which has also encountered difficulties in the US, ZTE is already firmly established in this market, providing phones and other consumer equipment to all major carriers as well as many mobile virtual network operators. It shipped about 18 million handsets to the US in 2017, including 16 million smartphones, making up about 30 percent of ZTE's global mobile phone sales. It's the fourth largest seller of handsets in the country and has about 10 percent of the market, so this development will disrupt the supply of devices, particularly at the low end of the market. We estimate that 75 percent of ZTE's device sales to carriers in the US are for prepaid services.

In addition to carriers, the other victim is Qualcomm, which can no longer provide chipsets to ZTE. The phone-maker was a major customer for Qualcomm and much of its business will have to shift to other chipset suppliers. A denial of export privileges would, for example, prohibit ZTE from sourcing US components, on which it's highly dependent for its phones and other products.

ZTE could also be banned from using Google's Android operating system as a result of the announcement, which would give the Chinese company very few options when it comes to platforms. Mobile operating systems beyond iOS and Android take up less than 1.5 percent of the market. An option for ZTE could be to reach out to Samsung for its Tizen operating system, although this has a limited scope. Another alternative is to consider Chinese-grown platforms like Alibaba's AliOS or to use the Android source code without Google's mobile services. This would enable it to ship products, but without Google apps they would be hopelessly uncompetitive.

The US government's imposed seven-year ban isn't a short-term sanction — in the tech world, this is essentially a lifetime. ZTE, which has been spending money to build its brand in the US with some success, will have to start over in the year 2025. But the other side of the coin shows there's an opportunity for brands that had been losing share to ZTE such as Alcatel TCL, Blu, LG and Motorola. Another potential contender to take advantage of the manufacturer's woes is Finnish company HMD Global, which has licensed the Nokia brand. However, Nokia is significantly less known by consumers in the US than other markets in Europe and Asia, so its appeal may be diminished. That said, it will be challenging for any phone-maker to form a mutually-beneficial working relationship with the notoriously difficult US carriers.

It should also be noted that many of these manufacturers have Chinese backers, and this could be a problem in light of the current political climate in the US. The Alcatel brand is owned by TCL Communication Technology, HMD Global is supported by Foxconn International and the Motorola brand is used by Lenovo.

There's also a clear contagion risk here to ZTE. Irrespective of the exact implications of the ban, which there still seems to be some confusion about, ZTE will find it extremely difficult to recover from reputational damage, given the avalanche of negative headlines. It's unlikely that mobile phones buyers in large carriers or retailers will be as eager to embrace its products in the near term. In the UK, for example, the National Cyber Security Centre has expressed concerns about all ZTE equipment and services. This is likely to spread further.

One thing is certain, US carriers that relied on ZTE for their low-tier device portfolio will now have to shuffle their business to other handset suppliers. This is a clear opportunity for ZTE's rivals to fill the coming void.

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This entry was posted on April 24th, 2018 and is filed under Devices. You can follow any responses to this entry through the RSS 2.0 feed or you can leave a response.

Posted By Raghu Gopal On April 24th, 2018

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