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    China Business
     Apr 13, 2006

China and the art of (standards) war
By Indrajit Basu

In the afternoon of January 10, Huang Ju, China's vice premier, made a videophone call from the Science and Technology Innovation Achievements Exhibition that was then being held in Beijing. For the residents of Bijie county, to whom this call was made, it was a simple call from the vice premier that conveyed New Year greetings. But for the global telecom industry, it was an end to several years of anxious waiting.

"I am impressed with the quality of the call," Huang said, and with those words he put the Chinese government's official stamp of


approval on the locally developed third-generation (3G) technology that was used for the demonstration. China's operators and global equipment makers had been waiting for years for Beijing to roll out 3G licenses and make a final decision on the technology that it would use for 3G services, expected to start in mid-2006.

The video call also ended another uncertainty: whether China would adopt its "home-grown" 3G technology standard, known as time division-synchronous code division multiple access (TD-SCDMA), and not the globally accepted and European-backed wideband code division multiple access (W-CDMA) or the US-backed CDMA-2000. According to global technology experts who assisted China in developing TD-SCDMA, "development of this technology was a prestige issue".

On its face, this statement might seem curious. There are many sources of prestige for countries - strong economies, five-star hotels, powerful militaries, gold medals at the Olympics - but technical electronics standards, which are mostly invisible to the devices' users? After all, what difference does it make whether a mobile phone is GSM (global system for mobile communications), CDMA or some other standard, as long as it works?

Clearly, something important is going on here, because the TD-SCDMA case is not an isolated example. Over the past several years, China has been making a systematic effort to develop its own standards in a host of other areas ranging from mobile phones to next-generation digital video discs (DVDs) to digital television to nanotechnology, and even trying to wrest control of the personal-computer (PC) operating system standard away from Microsoft by openly supporting Linux.

Evidently, China's government considers the development of indigenous technical standards a strategic priority. To understand why, we have to discuss two business concepts: first-mover advantage, and the experience curve.

First-mover advantage refers to the fact that the first company to develop a new product or technology has the greatest chance of becoming the dominant player as that industry develops and consolidates - basically because it has a head-start both in terms of the product or technology itself and in terms of consumer identification. While being first certainly does not assure long-term success (how many MITS Altair computers have you seen on the market lately?), empirically, first movers have a greater chance of hanging around for the long haul than their imitators.

The experience-curve concept, developed by Boston Consulting Group beginning in the 1970s, states that the more often a task is performed, the lower will be the cost of doing it. Mathematically, when unit cost is graphed versus cumulative output, the curve slopes gently downward and to the right. The experience curve helps to explain first-mover advantage - first movers, having been around longer, have the ability to offer a product at a lower price relative to their competitors.

How does this relate to electronics standards? Simple: a new type of mobile phone, or color TV, or whatever, is subject to the two phenomena above, just like any other product. Whenever the need for a new standard arises - for example, when innovations in lasers, optics and digital technology created the necessary foundation for digital audio discs in the 1970s - the companies that develop that standard first can dominate that industry for years or even decades afterward, as they race down the experience curve ahead of competing firms.

At the moment, most of the first movers are US, European or Japanese firms. But China would dearly like the first movers of the future to be Chinese. And the easiest way to make sure that happens is to promote indigenous technical standards, which - because China's market is so huge and growing so rapidly - the global electronics industry cannot afford to ignore, even if they perceive that losing control of standards will undermine their long-term interests.

There is another factor as well: license fees for intellectual property rights (IPR). Although it would be easy enough, in most cases, for a country to reverse engineer and copy standardized technology from abroad, the world trade system makes it difficult for countries that do this to export the products to the country where the technology originated. And modern production technology is so efficient that IPR fees can make up a shockingly high percentage of the cost of the product.

For example, China manufactures the preponderance of the world's DVD players. But DVD is a standard that requires special decoder chips - the rights to which are owned by the DVD license holders - to manufacture. And while Chinese firms could (and probably do) sell their players within China without paying the license fees, attempting to do so abroad would expose them to lawsuits from the license-owning firms. Since license fees can make up as much as half of the production cost of a low-end player - which gives the Chinese electronics industry an overwhelming incentive to develop, and favor, its own standards over all others.

What we are seeing now is the early stage of a high-stakes struggle over technology standards that will last for many years, and analysts are beginning to discern the patterns.

"The Chinese government is establishing high-technology standards that differ from international standards," said Dennis Fernandez, of Fernandez & Associates, a California-based intellectual-property consulting firm. "In effect, foreign high-technology intellectual property rights are not only losing value, but the high-technology standards [that China is creating] are also incompatible with international high-technology standards, [which consequently are] making entry into China's market difficult for foreign companies with intellectual property rights in high technology."

The impact of China's determination to set its own standards and its incompatibility with international standards emerged as a public issue in early 2004, when chip giant Intel came in direct conflict with a Chinese security standard for wireless chips. That January, China suddenly declared that to be able to continue selling integrated circuit chips in the country, all chip vendors' technologies needed to comply with China's newly issued Wireless Authentication and Privacy Infrastructure (WAPI) security standard for wireless local-area networks (WLAN) technology, or else face a ban. That came as a blow to Intel, which realized that its popular Centrino chips were not compliant with the Chinese WAPI standards. The company declared in March 2004 that it had no other alternative but to withdraw from the Chinese WLAN equipment market.

But the battle wasn't over: China suspended the new standard because of pressure from the US government, Intel and other multinational firms. "Had the Chinese not suspended the standard due to international pressure, Intel would have lost the entire Chinese market for its now-popular Centrino chipset," said Fernandez.

Despite this early round apparently going to overseas companies, clearly China's ability to stop a company "as big and strong as Intel from profiting in its market" still looms large on the minds of other technology companies, and many are worried.

Eugen von Keller, head of the Beijing office of the German management consultancy Roland Berger, believes that the prospect of China one day setting the standards for mobile phones, TVs, computers and, indeed, almost everything else is an alarming one for the West. "Companies like Siemens, for example, are already not only manufacturing all their standard phones in China, but have as well put all [their] research and development into China," he said. "The standards will be set [in China], and the consumers will decide on what applications they want to have - the Chinese consumers, not the Germans."

Undoubtedly, there is a growing school of thought that says the Chinese believe their market is so large that they will ultimately be able to force adoption of their standard, and eventually use this structural advantage to take control of the industries in question.

"Technology vendors that misjudge the impact of China's standards revolution could find themselves at a significant disadvantage, with their position in the market increasingly overtaken or encroached upon," said Clarence Kwan, national managing partner of the Chinese Services Group at Deloitte & Touche. "China is able to use the lure of its massive markets and spectacular growth as leverage in the standards war. Global technology and telecommunications companies need to review China's standards initiatives and collaborate, where appropriate, with Chinese companies in standards development."

Indeed, whether the rest of the world is prepared or not, it is already clear that China is using its massive markets and spectacular growth as leverage in the standards war. Markets for the country's electronic-information products have grown from $20 billion in 1999 to more than $85 billion (estimated) in 2005, and according to Vice Minister of Information Industry Lou Qinjian, China's output of several categories of home-made electronic and information products already ranks first worldwide. With consumer-electronics products such as color TV sets and mobile phones witnessing scorching growth, "China has become the world's second-largest consumer-electronics market next to the US," said the minister.

According to the statistics of the Ministry of Information Industry (MII), China produced, sold and exported respectively 82.8 million, 80.4 million and 39.7 million sets of color TV sets in 2005, up 13.02%, 10.69% and 43.36% from the previous year. The output of mobile phones has increased just as dramatically. China manufactured 303 million mobile phones in total in 2005, some 40% of the world's production. The MII predicted that the number is likely to exceed 340 million this year. Statistics for most other electronics products show similar increases.

What is China's viewpoint on the standards issue? One might well ask the obvious body, the China Electronic Standards Institute (CESI), which made an interesting argument in a 2003 paper. The CESI said the country has been forced to develop its own standards solely because developed foreign countries, through their own non-tariff trade-barrier tactics, have made it imperative for the country to "change its economic stance from defensive to offensive."

The CESI argued: "During the Chinese World Trade Organization [WTO] membership negotiation process, we were generally concentrating on tariff reduction. However, besides tariff[s], intellectual property barriers have long been established. This scenario has become more serious within the WTO framework. Examples are [the] cigarette-lighter case in Wenzhou [1] and the license fee levied on DVD players. These cases had sounded the alarm for us. It made us aware that under [the] WTO, Trade Related Intellectual Property Security [TRIPS] rules can be used to protect intellectual properties in trade.

"On the other hand, [the] Trade Barrier Treaty [TBT] can be used under the mask of standardization, patents and intellectual-property rights to obtain most world trade advantages. For that, we should research and develop countermeasures. We need to learn from the foundation of the developed countries. We should set our strategy on forming standards and Intellectual property laws within the framework of [the] WTO."

The CESI added: "First, we need to use the patent system to promote our technological advancement. On one hand, we have to have technology breakthrough[s] at the entrepreneur level. We should enable them to apply for timely patents. On the other hand, the government should help companies to innovate, and to apply for patents. Technology barriers are also a race in technology between countries. Due to technology barrier standards, health inspection and quarantine procedures are full of high-tech and intellectual property [issues]. To pay high prices for license[s] is just a short-term solution for the immediate market. For the long term, we should elevate our technology R&D [research and development] level. Owning our own IP is the only way we can cross over the technology barriers set by the developed countries."

That is why Peter Read of Fusion Consulting, a business intelligence consultancy with expertise on the Asia-Pacific markets, feels that China is just trying to save its turf from global dominance. "One of the primary motives behind developing these home-grown standards is to give Chinese companies an advantage in the domestic market in the face of the unrelenting ingress under WTO reforms of foreign companies, with in many cases more market experience and business savvy than their Chinese counterparts," he said.

"In addition to that, the Chinese leadership has been conscious for years that global economic leadership will increasingly be driven by intellectual as opposed to material property, which does not sit well with China's rapidly growing role as the factory of the world. With the domestic market and business as opposed to [the] state becoming more significant in the economy, home-grown standards are one very effective way to redress the balance to some extent and ensure the long-term future success of [the] Chinese economy."

Paul Lee, who heads the technology, media and telecommunications group at Deloitte Research, too feels that the fear that Chinese standards would dominate the high-tech industries in the future is unwarranted. "Their overriding ambition is to achieve top level economic growth," he said. "Like any government in a developing country, China wants to reduce dependence on foreign companies and cultivate its own technology industries. It wants to move its economy away from low-tech commodities to high-tech products based on its own intellectual property so that it products can fetch a premium in the global marketplace."

According to Lee, there's also an economic imperative. As the world's largest producer of consumer electronics, Chinese companies would also like to reduce their royalty payments to foreign vendors. Besides, developing home-grown standards is also "prestigious".

"That China is a low-cost manufacturer is well-known ... defining and owning new global standards also increases the pride and prestige of China's high technology industry as it progresses to leading innovation in high technology," said Lee.

Nevertheless, he said, it is also true that as China's markets grow and its standards take root, "Chinese firms will be better positioned to disrupt global IT markets."

The most likely pattern for the future is that China will first mass-produce in its home market, and then export its new technologies to neighboring developing-country markets in Southeast Asia, the Middle East, and other countries that do not have technologies to call their own.

"Chinese products and standards will start at the low end, but will steadily improve to eventually compete in every country and market segment around the world," said Lee. Like Clarence Kwan, Lee said technology vendors who fail to anticipate this long-term trend will find themselves at significant disadvantage.

So what lies ahead? Will China's standards, with the great mass of the Chinese market behind them, grow so overwhelming that they begin to influence the development and use of technologies worldwide?

"No one knows," said Lee. "But China is too important to be ignored." Therefore Lee suggests that global technology companies must formulate a China-centric strategy, the central theme of which should be "collaboration and partnership with standard setters".

In that context, Siemens' decision to partner with Datang - a Chinese telecom company - jointly to develop the TD-SCDMA technology is a good example. Experts say Siemens took a risk by sharing its technology, but gained the first-mover advantage in the world's largest telecommunications market in return. And taking that cue, now even Japanese telecom companies have started partnering with Chinese companies to develop fourth-generation (4G) mobile-phone technology.

According to Lee, the other elements of the China strategy should be competing selectively, focusing on areas where standards are harder to mandate; specific innovation for the Chinese market; and entering those segments of the Chinese markets where standards have yet to take root, to establish early control.

"Companies that do not follow these rules may find themselves locked out of the world's largest growing market or worse, unable to compete in a global marketplace increasingly defined by standards that originate in China," Paul Lee warned.

Chinese standards initiatives at a glance

Technology

International standard

Proposed or adopted Chinese standard

Notes

Digital television (DTV)

Advanced Television Systems Committee (ATSC);High Definition Television (HDTV);Standard Definition Television (SDTV);Digital Video Broadcasting-Cable (DVBC)

Digital Multimedia Broadcasting-Terrestrial (DMBT); and Advanced Digital Television Broadcast-Terrestrial (ADTBT)

Though the ATSC has been seen primarily as the American standard setter for DTV, many countries have adopted the standards set by the group. DVBC is the European standard, which China has chosen to adopt until its proposed standards are ready for deployment.

Mobile telephony

Wideband Code Division Multiple Access (WCDMA - European); Code Division Multiple Access 2000 (CDMA-2000 - US)

Time Division-Synchronous Code Division Multiple Access (TD-SCDMA)

China has its own globally approved standard for 3G and as the world's largest market for mobile communications, is well positioned to take a lead role in defining the 4G standard. TD-SCDMA phones have the capability of being dual mode, thus able to handle other 3G technology based phones such as WCDMA and CDMA-2000. Major companies involved include: Siemens AG, Agilent Technologies, Huawei Technologies, Motorola, Nokia, LG Electronics, and many other cell phone manufacturers.

Wireless Local Area Networks (LANs)

Existing 802.11 Security Standards Including: Service Set Identifier (SSID); Media Access Control (MAC); Wired Equivalent Privacy (WEP)

Wired Authentication and Privacy Infrastructure (WAPI)

After months of dealing with the newly adopted security standard for Wi-Fi chips within China, Intel decided in 2004 it would not ship Wi-Fi chips to China once the standard was adopted. China decided to suspend adopting the standard.

Video discs

Digital Versatile Disk (DVD)

Enhanced Versatile Disk (EVD)

Development of the EVD technology was triggered by high royalty costs for the DVD technology. Chinese companies are constrained by hefty DVD royalties, which range from US$15 to $22 on players that today often retail for less than $60. A consortium of China's leading makers of DVD players holds the EVD patents and collects royalties. EVD is currently based on MPEG-2, but a switch to AVS is expected - allowing Chinese manufacturers to produce state-of-the-art video players based entirely on Chinese technology standards.

Home networking

Digital Home Working Group (DHWG)

Intelligent Grouping and Resource Sharing (IGRS)

China's Ministry of Information Industry uses IGRS rather than the established DHWG which includes Intel, Microsoft, Sony and Samsung. The IGRS currently has 15 member companies with 11 newly applying.

Radio Frequency Identification (RFID) tags

Electronic Product Code Network (EPC)

Undecided

China established a working group to draft and develop national standards for RFID tag technology. Some reports indicate the group is adhering to international standards, while others suggest the group is planning to go its own way. The rumor is that China will likely set a different standard than EPC.

Audio/video compression

Moving Picture Experts Group (MPEG) 4; H.264

Audio Video Coding Standard (AVS)

China is developing its own standard technology - AVS - for compressing audio and video. AVS is competing with MPEG-4 and H.264 to replace the current worldwide compression standard, MPEG-2.













































































































































Sources: Osama Hussain, University of the Pacific, McGeorge School of Law; Dennis Fernandez, managing partner of Fernandez & Associates, LLP; "Changing China" (research paper), by Paul Lee of Deloitte Touche Tohmatsu.

Note
1. This referred to a 2002 case in which the European Union, in an apparent response to soaring numbers of imported Chinese cigarette lighters, adopted an EU-wide standard for cigarette lighters that included a patented technology. This confronted the Chinese cigarette makers with a choice between developing their own substitute for the technology, which would result in lost sales opportunities during the development phase assuming a competitive substitute was even possible, or paying the license fees to use the EU technology, which would result in a loss of cost competitiveness.

Indrajit Basu is a Kolkata-based equity analyst turned journalist with more than 12 years of experience in business/finance and technology journalism. Besides writing for Asia Times Online, he also writes for US-based publications, as well as IT companies.

(Copyright 2006 Asia Times Online Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)


 


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