The declaration of US President Donald Trump of a national emergency to “protect America from foreign adversaries who are actively and increasingly creating and exploiting vulnerabilities in information and communications technology infrastructure and services” on May 15, 2019 placed the Chinese telecommunication giant Huawei into global focus. The quick decision of the Commerce Secretary to include Huawei in the entity list of the US Department of Commerce as of May 17 is an unprecedented move in the history of global business.
The entity list inclusion means that any goods or services the company is buying from US companies or its overseas subsidiary are subject to specific license requirements administered by the Bureau of Industry and Security (BIS) from now on. In a fast-moving industry like telecommunication in which most equipment life runs from three to five years, the time it takes for the government to evaluate the national security implications of products and issue an export license of equipment essentially means the cutoff of American technologies from the supply chain of Huawei. Considering the historical dominance of US companies in the telecommunication semiconductor business and the software platforms powering smartphones, there is a legitimate concern as to whether Huawei can survive the US sanctions. The case of ZTE in 2018 highlighted the power of such sanctions and the dominant presence of American semiconductor technology in the industry.
The announcement of Google on May 19 that it is stopping to service new Huawei Android handphones and the market news that American chip companies like Intel, Qualcomm, Xilinx and Broadcom has suspended product shipments to Huawei until further notice confirmed the speedy imposition of the sanctions. Even the US government on May 19 issued a 90-day temporary export license to US exporters and allowed them to provide products and services until August 19. The concern over Huawei’s ability to provide reliable products and services lingers, particularly among its overseas customers.
The response of the company is quick as well. On May 21, the company’s reclusive CEO, Ren Zhengfei, gave an extensive interview lasting more than 2.5 hours and declared that the company is prepared for such sanctions early on. It has a Plan “B” to overcome the adverse impacts on its operation, and the company is starting to implement the alternative plan now. Ren declared that the company would lose some growth as a result of the sanctions, but it will still grow at a respectable 20 percent for this year. He predicted the company’s technology leadership in the nascent 5G area could be kept in the face of US sanctions on parts. Furthermore, he said the company would not subject itself to US monitoring, alluding to what ZTE agreed in its settlement with the US government in 2018 after a three-month sanctions that broke the company’s back.
Reports from Nikkei Asia confirmed that Huawei has built a comfortable parts buffer lasting up to a year and the company’s Hi-Silicon fabless semiconductor subsidiary has probably achieved a design capability on par with the industry leader, Apple. While many people expressed doubts about whether the company can genuinely replace US semiconductors suppliers, particularly in the area of Radio-Frequency (RF), Central Processing Unit (CPU) and Field Programmable Gate Array (FPGA) chips, one should not rule out the possibility that the company can successfully source some of these chips from either non-US suppliers or develop them in-house. Hi-Silicon has chalked up an impressive record in chip development; it is the fifth largest and the fastest growing fabless company in the world with 2018 sales of more than USD 7.5 billion. The company’s Kirin processor chip powers all of Huawei’s high-end phones, and its Balong 5G baseband chip is judged one of the best 5G baseband chips in the market along with Qualcomm’s X55.
The challenge in front of Huawei is how to develop a good alternative to parts and services that it is buying from US suppliers at the moment and still keep its industrial technology leadership. Based on its announced annual spending of USD 70 billion on parts, USD 11 billion was sourced from US base suppliers and out of the top 92 key suppliers, US companies accounted for 33. Replacing US suppliers in its supply chain is a daunting task but not insurmountable. All depends on how successful its Plan “B” will work out.
It is impossible for outside observers to pass judgement on the prospect of Huawei at this moment. Plan “B” is a trade secret, and the public will not know about it until all dust is settled. However, there are some signposts in the next six to nine months that can shed light on how Plan “B” will work out.
Everyone is watching the unprecedented sanctions closely: whether the US has underestimated the company as Ren said in his May 21 interview, and whether Huawei is over-confident in its ability to overcome the sanctions?
First is the extension of the sanctions. Will the US use the long arm of legal interpretation on US suppliers? That interpretation means any foreign manufacturers using US machinery will likewise be subject to American sanctions jurisdiction and not allowed to ship those goods to China. The press reported on May 22 that Huawei is checking their parts suppliers from other countries on whether they are using US machinery in the parts produced for Huawei confirmed the possibilities of such interpretation. Whether the US government will adopt the extended interpretation is not clear, because such measures will likely hurt US semiconductor equipment companies as much as Huawei. China buys more than 55 percent of global semiconductor production with more than half of which is destined for domestic consumption and the balance for re-processing to export, while US equipment suppliers control around half of the global semiconductor equipment supplies. The US and China are linked so closely in the semiconductor business that the long-arm interpretation will likely plunge the whole sector into chaos and global semiconductor fabricators will rush to get out of US supply chains if there are alternative suppliers available.
Second is whether the future business of Huawei is significantly affected by the cutoff of US suppliers? Huawei announced its first quarterly sales figure in April in an apparent attempt to improve corporate transparency. The company reported USD 26.8 billion sales in the first quarter, a significant increase of 39 percent from a comparable period last year and driven by its smartphone business. Even with Ren confidently predicting growth, sales figure and new order figure going forward will be closely scrutinized by observers. Business figures are useful parameters to see whether the company’s Plan “B” has succeeded to keep a comfortable parts inventory, successfully produced or sourced replacement parts, kept the confidence of its overseas buyers of telephone gears and smartphones in place and allowed the business to grow.
Third is new product announcement and patent filing. Huawei is the leader in the telecommunication industry, and it filed the most number of Patent Convention Treaty (PCT) patents in the world in the past few years. If the company’s new product announcement and patent filing momentum stay, and the time between commercially rolling out new product and patent or product announcement is short, that could mean the company’s innovation cycle and production cycle are intact.
The fourth is overseas sales of its smartphones under the new operating system. The company sold more than 59.1 million handphones globally in the first quarter of 2019, and foreign markets accounted for slightly less than half at around 29 million units. Huawei handphones run on different operating systems for units sold within China and outside of the country. The domestic operating system has won acclaim among native Chinese users, and local sales will likely not be affected by the US sanctions. On the contrary, the likelihood of nationalism-driven demand will boost Huawei smartphone sales in China unless it is constrained by US parts availability.
The Google cutoff of Android system support means future Huawei phones will no longer receive critical software and security updates. Eighty percent of smartphones in the world run on the Android platform, and Huawei’s overseas products must use an alternative operating system after August 19. Huawei’s point man on handphone said the company would roll out an alternative operating system as early as autumn. How fast the shift is going to happen, and the acceptability of the replaced operating system by foreign customers will materially affect the future sales of Huawei handphones overseas. The company’s compliance with the Chinese domestic censorship requirement means the company cannot merely transplant the local system overseas; it must develop a new operating system providing similar functionality and security as the Android system it intends to replace. Ren admitted that this is a more significant problem than the US parts issue but stated that the company is addressing it head on. The modification and subsequent acceptance of Huawei smartphones abroad is an acid test for Huawei, and any sign of success or failure is a harbinger of Huawei’s survival or not.
The US granting of general license extension was rare in the past, and it showed the entrenchment of Huawei’s products in the global telecommunications industry. Everyone is watching the unprecedented sanctions closely: whether the US has underestimated the company as Ren said in his May 21 interview, and whether Huawei is over-confident in its ability to overcome the sanctions? All these remain open questions in which the next few months will shed some light on.
More importantly, Huawei’s past success and the company’s open defiance against the US sanctions have made it a national champion with a very high emotional value among the Chinese. The Huawei sanctions case has transcended technology and has become a barometer for the broader Sino-US relationship in the future.