Innovation and Catch-up in the Chinese Telecommunications industry

Xielin LIU professor

School of ManagementGraduate University of Chinese Academy of Scien

ce (CAS)liuxielin@gucas.ac.cn

outline

A review of theory of catch-up A new framework for understanding catch-

up in China Catch-up in telecommunication industry of

China conclusion

Theory of catch-up

Gershenkron (1962) argued that targeting rapidly growing and advanced technologies is the advantage of catch-up countries.

Using a “window of opportunity” that may arise in the evolution of a technology system to catch-up with appropriate social, industrial and technology policies, a country may catch-up. Otherwise, it will continue to lag behind (Perez and Soete,1988)

Theory of technological regime A new approach argues that the technological regime affects the nat

ure and success of innovative activities of those firms trying to catch-up (Breschi, Malerba and Orsenigo, 2000 ). Technological opportunity, appropriabiity of innovations and cumulativeness of technical advance and the property of knowledge base.

In the case of Korea, Lee and Lim(2001) argue that regimes, in which innovation is more predictable and frequent will give latecomers more opportunity to catch up; such as DRAM and automobile industries in Korea.

In the opposite case, latecomers will have less opportunities to catc

h up; the PC and consumer electronics industries in Korea also illustrate this situation.

Case of China China has make great economic achievement in the last twenty

years. How to understand the catch-up process in China.

Different background and approach for catch up: Japan and China in Japan, limited role of FDI, strong governmental role and social

innovation. More shop-floor processing innovation. China: strong role of FDI important, transition economy, more alliance

and outsourcing strategy.

In the Western literature, Chinese companies are still copy cats rather than innovators. China is country with huge manufacturing capability but poor in science and innovation. Kenny: Chinese companies in NASDAQ, Multinational R&D labs in India and China

Less papers on catch-up in China.

Our paper tries to illustrate how one Chinese industry makes a fast transition from an imitative stage to an innovative stage in the past 20 years.

Why telecommunication industry ?

The industry entered its fast track since 1980s.

It is the fastest growing industry in China and in the world. Even in the dismal period after the bubble of .com collapsed in USA.

Telecommunication industry in China keeps its high growing pace, makes itself the target market of global telecommunication equipment makers, such as Motorola, Nokia and Ericsson, etc.

Outline of Chinese ICT industry

2000 2006 Average annual growth

Fixed phone users

145 million 371 million 21%, 1/4 of the world

Internet users 33.70 million 131 million 31% , 1/10 of the

world

Wireless phone users

85.0 million 449 million 40%

Sales of ICT industry

607 billion 3800 billion(2005)

31%, Number 3 in the

worldSource: 吴邦国在 2006年世界电信展开幕式上的讲话 , 2006年 12月 3日 .

Catch-up in Telecommunication industry of China

Mu and Lee(2005) found that the important factors in the catch-up are the strategy of “trading market for technology”, the knowledge diffusion from Shanghai Bell to R&D consortium and Huawei, and the industrial promotion by government.

The technological regime of telephone switches is featured by a more predictable technological trajectory and a lower cumulativeness.

Question: But why Chinese automobile and other industries with v

ery similar of technological regime, industrial promotion and technological regime, do not show a similar strong trend to catch-up?

Key factors for successful catch-up in China

Existing or imported product or technologies are the starting points for companies in catch-up countries to make the innovation decision. if there is a large gap between the imported products with local demands, the domestic companies will get a strong incentive to innovate.

The design of existing foreign product system can be lead or lock out the late innovator. Totally openness of the product system design can give latecomers more opportunity to make innovation based on the existing product system. Closeness means not easy for latecomers to learn and enter its future development.

If the latecomer company can access to new technology by licensing, alliance or by making themselves, the opportunity of innovation will be more open. The availability can be technical problem. The new technology can come from other industry.

The gap between new foreign product and local market needs:incentive to innovate

Open or close of the new foreign product system design: opportunity to innovate

Availability of new technology and learning capability: capability to innovate

A framework for bottom-up catch-up in China

Five key elements for successful catch-up

Finding mismatch area: innovation in low-end market Technological opportunity: new technology from other

industry or existing industry. Governmental support: market for technology, stage-

skipping. Licensing and outsourcing strategy: role of FDI and

university Innovation strategy: path-following or stage-skipping

Market knowledge: Gap between the existing products and Chinese market needs

Technology opportunity: The redesign possibility of the product The birth of new technology The role of university and GRIs.

Company’s strategy: Cost and market segmentation

Alliance strategy: joint venture, licensing, acquisition, collaboration

Government role: strategy, R&D programs, R&D consortia, standard setting, public procurement

Catch-up and Innovation

Figure 3: A model of catch-up in Chinese industry

Path-following Catch-up in the digital phone switches:

The boom of fixed phone market from 1978, there was a boom for fixed phone market and digital phone switches.

The market was almost monopolized by imported or foreign joint venture products.

Table Main indicator of telecommunication industry in China

Indicator Unit 1995 2000 2001 2002 2003 2004

Investment Billion 199.5 231.4 264.2 210.6 224.6 217.3

Local fixed phone switches

million gate

72.0 178.3 255.7 286.6 350.8 423.5

Long distance fiber

1000 kilometer

110 290 400 490 590 700

User of fixed phone

million 40.7 144.8 180.4 214.4 263.3 312.4

Fixed phone popularity

set/100 people

3.4 11.5 13.9 16.8 21.2 24.9

User of mobile phone user

Million 3.6 85.3 144.8 206.6 268.7 334.8

Mobile phone popularity

Set/100 people

0.3 6.8 11.2 16.2 20.9 25.9

资料来源：根据《中国电子工业年鉴（ 1990 ～ 2005 ）》，中华人民共和国信息产业部网站等所提供的公开信息整理。

Digital phone switches were dominated by foreign JV’ s products

Product type Companymultinationals

Equity share by Chinese partner

Start year of

production

Sales volume (10000

lines)1997

S-1240 Shanghai BellAlcatelBelgian 60% 1986 500

EWSDBeijing International

communicationSiemensGermany 60% 1992 300

AXE10 Nangjing Ericsson

ErikssonSwede

n 43% 1993 80

NEAX-61E/61 Tienjing NEC

NECJapan 60% 1994 70

5ESS Qingdao LucentLucentUSA 49% 1995 150

DMS-100 Guangdong NortelNortelCanada 60% 1995 100

F-150 Jiangsu FujitsuFujitsuJapan 35% 1995 100

Total 1300Source: “Key Industry Innovation” Project Team Report of Ministry of Science and Technology，

But there was mismatches of the products with the market

Most of imported or JV’s products were used in the large city areas and their design were based on market needs in their own main market, did not care much about needs in Chinese market. For example, fixed phone users often access internet via fixed line, this made the phone line very busy, Huawei found that problem and introduced a solution for that.

The prices of their products were usually high, the users in the small cities or rural areas could not afford.

Availability of knowledge

Government’s strategy “market for technology ” to require the foreign JV to transfer some technology (Mu and Lee, 2005).

The spillover of FDI: demonstration, labor turnover and others, e.g.,Shanghai Bell had provided lot of training and maintenance work for the Chinese customers, that is one the important opportunity for Chinese to learn the technology.

Private company: heavy R&D investment.

The invention of HJD-04 domestic digital phone switches Key engineer Mr. Wu had years of experience with Japa

n F-150 system, before that, he was a engineer for computer research.

With government support (Ministry of Post and Telecommunication), the project team (a R&D consortia of government research institute and SOEs) of domestic digital phone switches are familiar with Shanghai Bell technology.

Computer technology had progressed much than the time of development of existing foreign technology engineers thought it was better to apply design structure to digital phone switches.

The new product integrated the advantage of Fujitsu’s F-150(centralized control system), Shanghai Bell’s S1240(distributed control system) and computer design.

The sale of the product firstly by SOE, great Dragon. This is a typical top-down catch up model in the earlier st

age of the innovation.

Open network system for fixed phone switches

The Chinese network system is based on an open No.7 signal system and it opened a time for lots of foreign products to enter Chinese market widely

It also paved the way for the late entrance of domestic companies with new technology.

Late innovators—Huawei and ZTE But the in digital switches market, coming late means got

more. Huawei and ZTE, both late comers, but these two companies with an ownership structure of private companies, aimed the low end market with their own technology.

In 1993, ZTE launched out digital product, ZXJ2000 for rural market; in 1995, Huawei developed its own digital product: C&C08. Both ZTE and Huawei aimed at rural market (small towns and counties) which is neglected by multinationals.

Both of them started earlier to develop product of accessing equipment which can make exchange among different system of digital switches possible.

The sales of telecommunication manufactures in China in billion yuan

Table The sales of telecommunication manufactures in China in billion yuen

1994 1995 1996 1997

Shanghai Bell 5.12 4.54 4.57 5.00

Beijing International Switcher

1.57 1.02 1.72 1.99

Eastern telecommunication of POST

1.55 2.84 3.90 4.63

Shanghai Telecommunication of POST

0.47 0.57 0.61 0.65

Beijing telecommunication of POST

4.89

Huawei 1.28 Na 4.19

Sources: Top100 Chinese IT companies.

Huawei’s market share in switches in China(unit:100 lines)

Sales Market share(%)

1997 4115 20

1998 7000 24

1999 7500 32

2000 16500 35

Path following in GSM and 3G

From 1995 on, the market had undergone a sharp change: mobile telecommunication became the hot products and experienced a fast growing stage. Motorola, Nokia and Eriksson became the main players in the new market.

In GSM system, there is Abic interface between base station controller (BSC) to base transceiver station (BTS) that is not open.

If in a regional system of mobile telecommunication is deployed, all mobile switches, BSC and bases have to be compatible. This makes locked in become possible.

As all of the telecommunication infrastructures were built by foreign companies, it left no space for domestic companies for Huawei and ZTE. Besides, Motorola, Nokia and Eriksson have long experience in GSM than Chinese new comers.

How domestic companies do To earn the new market, especially the CDMA market. C

DMA is one of the technologies to break the GSM monopoly in China.

To get some of GSM marginal market with lot of incremental innovation for Chinese market. Huawei constructed mobile intelligent network for China mobile for users to make prepay phone call possible.

When text message becomes big market for value added service, Huawei quickly established their capability here and get two third of Chinese market for the equipment.

To go global to access international low market. Chinese companies are good at innovation for low-end market.

Stage-skipping in TD-SCDMA

From 1990s on, government had supported research on CDMA in GRIs under MPT. MOST began to support research on CDMA in 1993 and 3G in 1997. But the research basically followed the path of Ericsson and Qualcomm, though had made some progress but no breakthrough. But the research in GRIs provided some basic knowledge for 3G technology.

Chinese companies have already accessed necessary knowledge from Qualcomm via government help. In 2000, in order to get Chinese market share, Qualcomm licensed its technology to Huawei, ZTE, Datang and other companies of base station, switches and handset. This is a action as a result of market for technology, but also the strategy of multinational to enter China 。

Role of overseas Chinese engineering and international standard

In 1994, overseas Chinese, one work for Motorola , the other in University of Texas, Austin developed a new wireless network technology to bypass Qualcomm’s technology. They set up a company called CWILL in the USA and at the same time, they set a Chinese joint venture called Xingwei between CWILL and Research Academy of Post and Telecommunication of MPT.

Based their work, in 1995, a new technology was invented by those mixed research group: a TDD model other than FDD model of WCDMA and CDMA2000. The new technology system is called TD-SCDMA (Time Division - Synchronous Code Division Multiple Access), with characteristic of synchronization, smart antenna and software defined radio, Joint detection, banton handover, high-speed transmission technology for downlink packet data. The main inventor is the overseas Chinese engineer.

In 2000, TD-SCDMA, supported by government, became the third 3G standard in the world.

Alliance with Siemens to develop the product based on the concept

Datang and Siemens signed the contract. The development project is consisted with two parts, base station and end product.

Siemens almost finished the joint development in base station, as for a long time the market is not clear, so Siemens stopped the further development of end products. It is just because this complex joint process, there is a wide distribution of patents in this technology.

Further support by government In 2002, the government supported the new technology.

State Development and Reform Committee, MOST and MII jointly made a strong support for the industrialization of TD-SCDMA.

They supported a TD-SCDMA Alliance so that more companies can join and share the benefits of new technology. Just by a GRI-transformed company is not enough for the hard task. The members of companies in the alliance included Huawei, ZTE, China Putien, Lenove and others. Secondly, the government invested 0.7 billion for further testing and other purposes.

They gave TD-SCDMA a 155m wireless frequency for its future uses. All these methods emitted a strong signal that TD-SCDMA technology is now an authorized technology for future 3G markets.

The paradox of stage-skipping catch-up in TD-SCDMA: financial and technical issues

The technology is still undergoing small scale of testing for further improving. Datang has already spent about two billions Yuan for R&D of TD-SCDMA.

Most of the money came from bank loan. Who will spend more money to finish the testing and improving before the final use is still unclear. The operators and government can not fully decide before all the tests finished.

TD-SCDMA is not compatible with that of WCDMA and CDMA2000. another important issue for its future.

SOE How can Datang as an SOE push that further to the actu

al uses. This can explain why Datang has difficulty to find the financer.

Former experience of digital fixed phone switches is a good example. Though the SOE Great Dragon is the main innovator, but the poor management capability could not guarantee them to spend more money on R&D for further innovation. They just watched how Huawei, ZTE and others took over the market.

Datang may not be the final winner of the TD-SCDMA, even if the government will issue the certification for that.

Loose alliance: though there are many local and foreign companies joining the alliance, this makes future transaction costs very high. It is not easy to coordinate all players and push the technology forward.

Partners of TD-SCDMA. System equipment: Datang, Siemens, UT Starcom. Network equipment: Siemens, Huawei, ZTE. End product chip: TI, Philips, STmicroelectronics; End product: Samsung, LG, Hauli, Lenovo,etc.

At the same time, lot of so called alliance partner are watching and standing by to see the government’s further action. TD-SCDMA is jus

t one of their technology options.

Market issues How big is 3G market will be also a critical for its future. So

me optimistic said that the market value of TD-SCDMA will be about 400 billion. But some researchers pointed out that 3G made no money in other countries. Can Chinese make be an exception?

Even if the government will issue the 3G certification soon, it may not Datang win the market. Other domestic and foreign companies with better marketing and technology power than Datang are ready to supply their production system.

In future’s bidding process, nobody know who will get the most. In digital switches, Great Dragon is the innovator, but Huawei and ZTE won the competition.

Public purchase or market purchase?

Should government or operators decide use of 3G technology for the market.

To adapt strategy for indigenous innovation, it seems that is rational to purchase TD-SCDMA as a main 3G technology provider.

But as a member of WTO, China is also cautious as to favors TD-SCDMA against WCDMA and CDMA2000. So, MII just announced that in order to match the WTO, it is the operators (market ),not the Chinese government, has the power to decide what kind of technology and standards should be used in Chinese market.

Purchase good technology or low technology: which one is good for indigenous innovation in China?

conclusion I tried to expand technological regime to look at the catch-

up experience in China with large market size and open economy.

The mismatch of existing (foreign) product with Chinese market needs, the openness of the product design and the availability of the knowledge (FDI, public research institutes and company’s own R&D) are the most important interactive factors for industry in a developing country to catch-up.

In China, path-following catch-up has proven to be a more appropriate strategy than stage-skipping in progressive industry.

Stages-skipping approach means more risky and need better government-industry-academic cooperation for its final success. It has to play the game with the leading multinationals.

Limitation and next

I did a research on Chinese information processing innovation

Now, telecommunication industry next, automobile industry, biology

industry etc. Then I can have a better theory to

understand the catch-up in Chinese industries.