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.
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.
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