Ren confirms Huawei restructure on the cards

An internal memo from Huawei founder Ren Zhengfei has been doing the rounds, suggesting a major business restructure to ensure the business can survive US aggression.

Although it remains the heavyweight champion in the network infrastructure segment, the last two years have been marred with a White House propaganda mission to limit the prospects of the business. Huawei has remained strong in the face of adversity to date, though in a memo to staff, Ren has admitted the damage has been dealt.

Over the next three to five years, Huawei will undergo a major business restructure to ensure it is capable of withstanding continued aggression from the US. This is a preparatory strategy from the Chinese vendor and we suspect the depth or breadth of the strategy will depend on the winner of the 2020 Presidential Election.

Of course, the inadequacies of the business have been highlighted to date. Although Huawei is not as dependent on the US as its domestic rival ZTE, there are areas where the US ban has hurt the giant. Should Trump win re-election, it would be a fair assumption the anti-Huawei campaign will continue though it might not be as aggressive under a Democrat administration.

Irrelevant to the outcome of the election, a restructure is probably needed and has been highlighted here by Ren.

“We have to complete an overhaul in harsh and difficult conditions, creating an invincible iron army that can help us achieve victory,” Ren said in a memo seen by Bloomberg.

“We absolutely have to complete this re-organisation within three to five years.”

Although the existence of Huawei was not in question, the Chinese domestic market is large enough to support it alone, the international success of the business has been called into question as a result of the on-going US/China conflict.

Huawei has largely been a proxy of the trade war, perhaps due to the success of the business on the world stage. ZTE is a more obvious target for US aggression, it is partly state-owned after all, however it does not have the presence of Huawei. Few companies have leapt out from behind the Great Firewall of China and dominated a segment in the same way Huawei has.

This is the precarious position Huawei currently sits in. Valuable relationships with international telcos are under threat thanks to the US bullying allies into line, while its supply chain is looking dented. Some suppliers can be replaced by alternatives, though there are a couple of areas where it is incredibly difficult. OS Android for its smartphones is top of the list due to fact there are no alternatives which can match.

“Two bullets fired at our consumer business group unfortunately hit the oil tanks,” Ren said in the memo.

This might be a reference to the significant damage which has been done to the consumer business. Although it is still in a position of strength, the reference might suggest it is living on borrowed time.

In the first half results, Huawei said its consumer business has grown by 24% year-on-year, though this now looks to be driven by the domestic market. Research from Canalys suggests smartphone shipments in China have increased by 31% year-on-year for the second quarter, though a decline of 16% for the same period was estimated in Europe. Patriotism is fuelling growth in the domestic market, though Huawei’s international reputation has been dented.

What Huawei looks like in a couple of years in a very interesting game to play. However, the turbulent storms of 2018/19 might lead to a stronger company in the long-run.

If US aggression continues its aggressive campaign, Huawei will be forced to completely restructure its supply chain. If it can maintain international relationships and customers throughout this period of restructure, it will have removed reliance on the US and a major weapon of the White House when attempting to bully its way through international relations.

Sources: White House holds off Huawei reprieve after China counter-punch

US suppliers are still staring into the abyss as reports emerge the US Government has halted its special-permissions programme to work with Huawei due to Chinese retaliation.

According to Bloomberg, applications for special-licenses to continue supplying Huawei with US components, products and services are currently on hold, as the US Government ponders the latest counter-move from the Chinese Government; a halt to purchases of US agricultural equipment.

Just as there was a moment to celebrate, dozens of US firms are now allegedly back to square one.

The licenses themselves have proved to be popular, with Commerce Secretary Wilbur Ross suggesting his department had received 50 applications, as of last week. This is not to say 50 companies will be given permission, the US Government has hinted the majority will be turned down, though it is back to purgatory the suppliers go.

Entry onto the Entity List has caused a significant headache for numerous parties around the world. Not only do the US suppliers have to figure out where they are going to recapture lost revenues, but potential customers in other markets have to assess the quality and resilience of the products following a disruption to the supply-chain.

Last month, Ross announced the Commerce Department would start accepting applications for licenses to receive permission to trade with Huawei. That said, no advice was offered on the criteria said applications would be measured against, aside from an ill-defined reference to national security.

What is also worth noting is the mentality of those considering the applications. Refusal would be front of mind, unless the application was compelling enough.

However, this has all been turned upside-down.

We might have been expecting retaliation from Chinese Government, though few would have assumed the White House would snap the olive branch extended to US suppliers who are losing a major customer. This is allegedly what is happening today.

This tit-for-tat trade battle has now entered the realms of finger pointing. Trump has suggested he would loosen controls on Huawei if China increased purchases of US agricultural equipment. China has stopped purchases because the noose is still firm grasped, but the US is not willing to let go because China has not ramped up its purchases.

It’s a Mexican stand-off with private companies, in both countries, feeling the pain of government posturing and flexing, as egos are massaged by enablers and yes-men looking to gain favour with short-sighted and morally-bankrupt politicians.

Looking at the collateral damage, numerous US technology companies saw share price decline following the rumours. Skyworks Solutions, where 10% of revenues are attributable to Huawei, recently reported quarterly earnings with a $127 million hole in the spreadsheets. Total revenues were 16% down in comparison to the same period of 2018, prior to the Huawei headache.

Interestingly enough, there are several companies who have publicly stated they have applied for licences. Micron and Xilinx, two US semiconductor companies, have said the license is key as their role in the supply chain can be replaced by a foreign alternative.

If the rhetoric of the trade-war is to help US companies in the long-run, the very opposite is being done with these two organisations; once they are out of the supply chain, it will be very difficult to get back in. Most likely the only way will be to renegotiate contracts at less favourable rates to convince Huawei to ditch newly found alternatives.

Google is another which will pray for the end of the trade-war and ban on supplying Huawei due to the emergence of Harmony OS, the Chinese vendors in-house OS which could be applied to smartphones and smart devices. The emergence of another contender in the OS segment could lead to Google losing real-estate on millions (if not billions) of devices for its products such as Google Play, Chrome and Google Maps.

Right now, it is difficult to see this trade-war as anything more than a battle of egos. It was supposed to counter nefarious activities of the Chinese Government, creating a platform for US companies to thrive. However, with alternatives being sought and created, the temporary damage could turn permanent very quickly.

US suppliers do not want to permanently lose a lucrative position in the supply chain of one of the worlds’ fastest growing technology companies, though that is the reality some will have to face.

Breaking down the Supply Chain Review Statement

Although there was very little said during the Supply Chain Review statement yesterday, there are some interesting developments worth keeping an eye on.

Speaking to the House of Commons, Secretary of State for the Department of Digital, Culture, Media and Sport Jeremy Wright did as most expected he would and dodged the Huawei decision. Although we were promised a decision by March, the slippery politician has managed to create enough breathing room to get him through to September.

Despite some being disappointed by a lack of clarity on the competitive landscape for UK communications infrastructure, there were a few takeaways.

There’s no avoiding interference from Transatlantic geo-politics

Every politician will tell you decisions are made dependent on what is best for the British people alone, but it is impossible to avoid the US here. The White House and its aggressive policies are causing havoc around the world, including here in the UK.

Fundamentally, without a decision on Huawei there is no clarity for investment and progress into the digital economy will falter.

Wright said a decision on Huawei would be made irrespective of the political influences of the US, but US interference is unavoidable.

“The hon. Gentleman has said that he is concerned to ensure that this should be a decision about the interests of the UK and not the priorities of the US Administration, and I understand that,” Wright said in response to the suggestion the US has too much influence from Tom Watson, Shadow Secretary of State for Culture, Media and Sport.

“I can give him the assurance that decisions we take will be decisions in the best interests of the United Kingdom, but he knows that this is a hugely interconnected sector and it simply is not possible to make sensible judgments about telecommunications without recognising those interconnections.”

With Huawei being placed on the Entity List the performance, resilience and security of its products might be impacted in the future. Wright has said he will not make a decision on Huawei until he has all the facts, and the relationship between China and the US is a huge factor in this.

Kicking the can to avoid irritating the new boss

Despite there being pressure from influential Parliamentary groups and the telco industry to make a decision, it was always highly unlikely Wright was going to say anything until his new boss has taken residence in No.10 Downing Street.

Boris Johnson is the new Prime Minister and he will want to put his own mark on proceedings. The Huawei decision is an important one, not only for UK 5G infrastructure, but because it will impact the relationship with the US. BoJo has already shown himself as somewhat of a pet of the President and will most likely want to nurture this relationship as only he knows how.

Wright does not want to jump the gun on making a decision and potentially irritating the new boss, especially when there is a potential promotion around the corner.

David Guake, the Justice Secretary, has resigned. Education Minister Anne Milton has gone. Chancellor of the Exchequer Philip Hammond has publicly stated he would quit if BoJo won. Rory Stewart, the Secretary of State for International Development, formally announced his resignation over Twitter at 11.18am. And finally, it is highly likely Foreign Secretary Jeremy Hunt, BoJo’s opponent for PM, will be shifted elsewhere.

“The reality is that this statement is just a lot of words to confirm further delay. Why are the decisions now being left in the gift of the new Prime Minister? Is this just another case of putting the Tory party before the country?” SNP MP Alan Brown questioned.

As one of the few politicians who managed to remain neutral during the proceedings, Wright could find himself heading up a new department before too long.

Security framework will make UK more secure

This is perhaps the most encouraging snippet to emerge from a relatively shallow statement overall; security requirements will be heightened for everyone.

“Fundamentally, we must make a decision on the basis of what is in our security interests, but he is also right that if we were to focus solely on one company or country, we would miss the broader important point that our telecoms supply chain must be resilient and secure, regardless of where equipment comes from, because risk may transfer from place to place and our population is entitled to expect that the approach we take puts security at its heart, wherever the equipment comes from,” Wright stated.

Although there are few details available regarding the new security requirements, Wright has suggested there will be a more stringent framework set in place and on-going assessments to ensure standards are being maintained. This will be applicable to every supplier, irrelevant of where they have come from.

To start with, this will be a voluntary scheme for the telcos, but soon enough it will be cemented in place through legislation. This takes time, but it is encouraging that the Government recognises threats can come from anywhere, everyone has a globalised supply chain and cybercriminals are becoming much more capable.

If policies have the position of 100% secure is impossible and everyone is a potential threat, risk mitigation levels should be set higher. This is the best possible means to achieve a resilient and secure network, capable of dealing with threats irrelevant as to their origin or intention.

Vendor diversification is nothing but a smokescreen

It might sound like a wonderful plug, but suggesting the UK is going to encourage diversification in the supply chain is nothing but a distraction to attract PR points for DCMS.

“In addition, we must have a competitive, sustainable and diverse supply chain if we are to drive innovation and reduce the risk of dependency on individual suppliers,” Wright said.

“The Government will therefore pursue a targeted diversification strategy, supporting the growth of new players in the parts of the network that pose security and resilience risks. We will promote policies that support new entrants and the growth of smaller firms.”

During the statement, Wright promised work will be done to enable smaller and more innovative players to contribute to the 5G euphoria. This sounds good and, in theory, addresses a long-standing problem in the telco world, but let’s not get ahead of ourselves.

The telco industry has been attempting to create a more diverse supply chain for years, as well as adapting procurement models to ensure smaller companies can weave through the red-tape maze. There has been little progress to date and intervention from DCMS is unlikely to reap any material changes.

You also have to wonder whether Wright is tackling the challenge head-on. Wright pointed to funding which has been directed towards the West Midlands and other innovation hubs, however this is not the problem which the telco industry has been facing. The limited supply chain is most harmful in places like the access network or core. This is where there are so few suppliers and competition has been impacting the cost of deployment.

Wright might be encouraging diversification and growth for start-ups, but don’t be fooled by this statement; he is not directly tackling the biggest competition challenge the industry faces.

Long-overdue legislative overhaul and Ofcom empowerment

The legislative and regulatory landscape has needed an update for years and Wright is promising one. Not only would this put the security framework into law, it will also ensure Ofcom has the right powers to be effective in the digital economy.

“We will pursue legislation at the earliest opportunity to provide Ofcom with stronger powers to allow for the effective enforcement of the telecoms security requirements and to establish stronger national security backstop powers for Government,” Wright said.

Until the new legislation is put in place, Government and Ofcom will work with all telecoms operators to secure adherence to the new requirements on a voluntary basis.”

Many of the rules which govern the telecoms and technology industry have been written for a bygone era. This is an outcome which is largely unavoidable when you consider the speed at which progress develops nowadays. However, rules need to be brought into the 21st century.

Legislation will offer the Government more influence over commercial communications infrastructure while Ofcom will have its teeth sharpened. It’s a long-overdue update.

Not much said, but potential to progress

Overall, there was little said by Wright in terms of material progress, but there is enough evidence the UK is creeping forward toward contextual relevance. We saw hints of progress yesterday, but realistically, the new Prime Minister and his administration will dictate evolution over the coming months and years.

Apple eyeing up $1bn Intel smartphone chip purchase – sources

Reports emerged about Apple’s interest in Intel’s smartphone modem business a few weeks back, and now the rumour mill is back up-and-running as more sources suggest conversations.

According to The Washington Post, a deal worth $1 billion, including various patents and staff, is entering advanced talks. Apple has always been a business which wants to control its ecosystem and such a deal would take it one step closer to developing critical components for its devices.

Although the Intel smartphone business unit has been viewed as somewhat of a failure in recent years, it is certainly more developed than Apple’s in-house capabilities. This is an area which is a significant focus for Apple and incorporating the Intel smartphone business into its own operations could help save it years of development work.

This is of course not the first push into the semiconductor world by Apple. Not only has it announced plans to open a 1,200-strong research facility in San Diego, but it effectively ended its relationship with GPU firm Imagination Technologies in 2017. Apple said it would begin to phase out Imagination Technologies in favour of its own GPU components.

For Apple, this seems like a logical move considering the squeeze which is being placed on smartphone manufacturers worldwide. There are several reasons smartphone shipments are declining year-on-year, but the increasing price is certainly a powerful factor.

The iPhone has consistently underpinned profits at Apple, though the global slowdown and challenge to market share from Chinese brands threaten this. Apple is regularly being undercut by rivals, while entry into new markets such as India has been challenging because of the price of devices. Owning more elements of the supply chain, especially components, can help the iLeader reduce the price of handsets and become more competitive in the era of innovation mediocrity.

This is also a slight change in mentality when it comes to Apple’s acquisition strategy. Rarely does the iChief go for the big-ticket acquisitions, preferring to swallow up smaller providers in pursuit of innovation, but it does appear context is ruling above in this instance, assuming the reports are true of course.

For Intel, this would appear to be a very satisfactory exit from a challenging segment. Although the team has always had ambitions in the smartphone segment, it has never been able to make it work. The unit has consistently undermined profits and recent R&D efforts have focused on 5G in other device segments. This transaction would appear to be a win-win for both parties.

Ren’s back to tell us how Huawei is starting to ditch the US

Huawei founder Ren Zhengfei appears to be little more than a celebrity spokesperson nowadays, but a recent interview suggests the vendor is just fine with its US shunning.

Speaking to the Financial Times, Ren has once again been called into action to address the tensions between China and the US, as a result of which, Huawei has become a prime target for anyone hoping to inflict damage on the worlds’ second largest economy. The message from Ren is relatively simple; we’re doing OK and we’ll move away from US suppliers.

Such comments will certainly set off alarm bells in the offices of some US semiconductor firms, but it should hardly come as a surprise. The ‘Made in China 2025’ strategy might be unpopular with the US and Europe, but it is by no-means a secret.

‘Made in China 2025’ is an initiative set into action by Chinese Premier Li Keqiang during 2015. Through this initiative, the Chinese Government wants to evolve the perception of the country, ditching the ‘world’s factory’ tagline and moving up the value chain towards higher value products and services. The Government will be contributing $300 billion to the project to enable China to compete with the US.

This plan has been heavily criticised by the US for a number of reasons, but ultimately it all boils down to one; this is a genuine threat to the technological domination of the US on the global scene.

Of course, there are plenty of reasons not to like the idea. Some have suggested it violates the World Trade Organization (WTO) rules on self-sufficiency. Others have said trade secrets have been stolen from foreign companies or unfairly obtained through forced joint-ventures. For ‘Made in China 2025’, companies have to move up the value chain, targeting growth industries such as AI or medicine, and these smarts have to come from somewhere.

However, you always have to bear in mind the end-result irrelevant of path taken to get there. If ‘Made in China 2025’ succeeds, the US will no-longer be the dominant force in the technology world, and other economies could be shattered if China replaces imported goods with domestic.

In the latest interview, Ren is suggesting that even if there is a reprieve from President Donald Trump following the G20 summit last weekend, Huawei will continue to move its supply chain out of the US. Perhaps this is the catalyst which was needed to kick the ‘Made in China 2025’ concept up another gear.

“The US is helping us in a great way by giving us these difficulties,” said Ren. “Under external pressure, we have become more united than ever.

“If we aren’t allowed to use US components, we are very confident in our ability to use components made in China and other countries.”

Although there has been a concession from Trump with regard to the ban facing Huawei, some might view this pardon with scepticism. The President’s opinion seems to change more often than the tides so why would any organization pins its hopes and aspirations on the door of the Oval Office. Instead of a power demonstration, the US seems to have pushed the Chinese further towards autonomy.

While it is far from confirmed, we strongly suspect the huffing and puffing from the White House was little more than a demonstration of power. Huawei’s entry onto the Entity List might have been an aggressive move to gain the upper-hand in trade talks with the Chinese; look what we did to ZTE last year, the US appears to be saying, so play nice or we’ll do the same to Huawei.

But it doesn’t seem to have worked; Huawei is still alive and still OK, if you listen to Ren.

How OK Huawei actually is remains to be seen. Ren has been wheeled out to put a positive spin on the situation, but the picture is rather gloomy. Smartphone shipments are set to decline by 40-60% over the remainder of the year, Google hasn’t said it is once again on friendly terms with Huawei despite Trump’s amnesty, and some have questioned whether China is capable of filling the semiconductor hole created through the China/US vacuum.

Huawei has done a lot to add diversity to its supply chain in recent years, while also moving numerous operations to its own fabless semiconductor company HiSilicon, but can it satisfy its appetite for more specialised components? Huawei works with a number of US firms who have niche operations, Qorvo supplies radio-frequency systems and solutions for Huawei for example, and when it comes to specialised components, the US rules the world.

For certain segments of the semiconductor industry, field programmable gate arrays as another example, and China has not been able to replicate the US success just yet. Despite what Ren says about moving Huawei’s supply chain out of the US, it will still be reliant for some incredibly important cogs.

One way of viewing this situation is that there is a short-term demonstration of power. Without the likes of Xilinx, Qualcomm, Qorvo, NeoPhotonics and numerous other semiconductor businesses, Huawei cannot produce the products it is promising customers. Not yet at least.

But long-term, perhaps this approach is simply forcing ‘Made in China 2025’ to accelerate and eroding the control the US has globally over some very high-value, highly profitable segments. Prior to the trade war, US companies were inside the tent. Admittedly conditions were not perfect, but they were inside not outside.

Perhaps this is the watershed moment; companies are going to be forced out as companies like Huawei increasingly look for domestic suppliers, and once they find them (by luck, convenience or necessity) there is no coming back.

Indian companies to be punished for Huawei business

India is the latest country to be dragged into the US/China conflict as the threat of punishment is directed towards any companies who work with Huawei.

According to the Economic Times, any company found to be supplying components or products to Huawei, or any affiliated company on the US Entity List, could face regulatory penalties. Although the White House has focused on crippling Huawei through placing limitations on US companies, it seems the US Government feels it needs to spread its wings further.

“Any Indian company which will act as a supplier of US-origin equipment, software, technology to Huawei and its affiliates in entity list could be subject to penal action/sanction under US regulations,” said Telecoms and IT Minister Ravi Shankar Prasad in Parliament this week.

Although Huawei’s entry onto the Entity List, a list of companies which US firms are banned from working with, has had a notable impact on the Chinese firm’s business, it seems the consequences have not gone far enough. Huawei has suggested smartphone shipments will certainly take a hit, but the company is still functional, seemingly much to the distaste of US officials.

Last year, the US dropped an economic dirty-bomb on ZTE and it almost destroyed the firm. ZTE’s supply chain was unhealthily concentrated in the US leading to the distress, though as Huawei’s supply chain is much more diversified, the same action has not brought the same result.

Perhaps this is another step to add further distress to Huawei. If the US Government places restrictions on the companies who supply Huawei, irrelevant to their nationality, it might have a better chance of hurting the Chinese vendor.

That said, the impact on Huawei might just be a pleasant by-product of a dispute between the US and India. Like China, Mexico and Canada, India has got its own tensions with the US this time concerning data localisation.

Last month, rumours emerged that India would be the latest target of the US. India currently has laws in place which force foreign companies to store data on Indian consumers and businesses within the borders. There are other countries who have similar laws, but the US does seem to have some leverage over India.

H-1B work visas allow an individual to enter the US to temporarily work at an employer in a specialty occupation. Although there are no official quotas, it is believed Indian citizens account for as much as 70% of the H-1B work visas which are handed out each year. If localisation rules are not relaxed, the US has threatened to curb the flow of visas into India.

What will interesting to see is whether this is a strategy which is rolled out globally for the US Government. If it holds all of Huawei’s suppliers who use US components, products or IP in their products to account, there will be a varied list. This might be a strategy to further cause distress to Huawei, though we suspect it could also be used as a bargaining chip in the larger trade discussions.

Understanding the collateral damage from Trump’s trade aggression

President Donald Trump might be back on friendly terms with China’s President Xi Jinping, but his efforts to kill Huawei’s business produced friendly fire, hitting companies based in allied nations.

This is the unintended and unavoidable consequence of a targeting a single company or country with sanctions and tariffs, the US’ version of an economic dirty-bomb; such are the complexities and wide-spread nature of today’s global supply chains, you are going to cause damage to innocent parties. We suspect Trump does not care, as long as his objectives are achieved, but here we’re going to have a look at the indirect friendly-fire.

The Nikkei Asian Review has broken down Huawei’s latest smartphone, the P30, listing off the individual components of the device and also giving an estimation of cost. Japan supplies the largest proportion of components for the device, 53.2% or 869 parts, while the US supplies 0.9% of the components and South Korea provides 34.4%. Interestingly enough the costs tell a slightly different story.

The financial output from Huawei is an interesting split. It is estimated that a P30 costs $363.83 to manufacture, with 38.1% of the expenditure remaining with Chinese suppliers. The 15 parts supplied by US firms account for $59.36 per device with Micron Technology collecting $40.96 for its DRAM chipset. Japanese suppliers gain $83.71 for every device manufactured, while $28 heads to South Korea and $28.85 to Taiwan.

What is important to consider when you are assessing the friendly-fire is the direct and indirect impact of Trump’s actions. The direct impact is easily measured; by banning US companies from working with Huawei you can see the financial detriment of losing a customer. If you go one stage further, you can see the indirect impact. By taking a shot at Huawei, less devices are being sold, therefore less cash is being paid out to every supplier.

The table below gives an overview of some of the international organizations which have been impacted by Trump aggression towards China:

Company Country Component Supplied Cost
Micron Technology US DRAM $40.96
Samsung South Korea NANDflash memory $28.16
Sony Japan Rear camera $15.15
Sony Japan Front camera $12.16
Skyworks Solutions US Communication semiconductor $8
Sony Japan Rear camera $7.6
Qorvo US Communication semiconductor $3
Alps Electric and Alps Alpine Japan Touch panel $3
Corning US Cover glass $2.7

Estimates courtesy of Nikkei Asian Review

What is worth noting is the aggression towards Huawei is temporarily on hold. At the G20 Summit this weekend, the US and China have made positive statements about getting trade talks back on track, though this would mean Trump would have to stop his campaign of terror against Huawei. Suppliers to the firm will be relieved, but you have to wonder whether the damage has already been done to the smartphone business.

Just like the telcos for networking equipment, consumers will want assurances the devices will continue to work over the lifetime of the product. As Google is a US firm, and therefore subject to the Entity ban, consumers were much less likely to buy a Huawei device when there is no guarantee Android will work as effectively and securely as it should.

The statements from the two Premiers are all well and good, but considering Trump’s opinion seems to change as often as the tides, how can anyone guarantee the effectiveness of the Android operating system over the course of the device’s lifetime? There are other factors to consider here, Huawei’s homegrown OS for example, but this is an unknown factor and consumers rarely trust the unknown en-masse.

This is where we believe the damage has already been dealt; it takes a lot to earn consumers trust but not much to lose it. Huawei has been gathering momentum in the smartphone market for years, and entry onto the Entity List might have set it back to the beginning. Rumours have emerged suggesting the company is preparing for a 40-60% decline in shipments for the remainder of 2019; how long will it take the firm to recapture these customers?

Apple considering a Chinese exit amid international tensions

It seems Apple does not consider itself immune from collateral damage, as whispers about a China exit are becoming louder and more plentiful.

For China, and those Chinese citizens who are dependent on Apple for their livelihood, the news will come as a shock, but this is a development which some have been expected for a while. According to the Nikkei Asian Review, Apple is considering moving 15-30% of its production capacity out of China.

This is a trend which we are starting to see pretty much everywhere. Supply chain management is a very difficult aspect of an international business, and while it might have looked attractive to take advantage of cheap labour in developing markets during yesteryear, it seems a concentration of operations is getting Apple executives twitchy today.

The quoted sources are suggesting diversification of the supply chain is a sensible way to manage some tensions floating back and forth across the Pacific Ocean.

In terms of the clues this development was on the horizon, it is worth looking back a couple of weeks. Foxconn executives have already said 25% of production is already located outside of China, and there is enough capacity to meet the demands of Apple as a customer should tensions have a negative impact on the Apple business. This appeared to be a largely unprompted statement, but perhaps the conversations were already happening behind closed doors.

What is also worth noting is that Foxconn certainly has some incentive to bend to the will of Apple executives; if it doesn’t have the capacity, a smart idea might be to spend some cash buying a company outside of China sharpish. Although not confirmed, Apple supposedly accounts for roughly half of Foxconn total revenues. If Apple wants to move production capacity out of China, Foxconn should quickly learn the moves to the new dance.

For the Chinese employees in the supply chain, this will be a very worrying time. Five million workers rely on Apple’s presence in the country, with Apple only employing 10,000 directly. Interestingly enough, there are now more named suppliers in China than in the US (41 Chinese firms vs. 37 US suppliers). What is worth noting is that China will remain the centre of Apple’s supply chain for the foreseeable future; shifting such a complex and monstrous operation would take a considerable amount of time, investment and planning.

Other countries would of course want to woo Apple, but China is a very attractive base for the iLeader. Not only does it have the necessary infrastructure, it has the skilled workers in place. 90% of Apple’s products are currently manufactured in China and replicating this successful operation will not easily be done elsewhere.

Although this would be a precautionary move from Apple, the threat is genuine. Huawei and ZTE have already shown there are heavy consequences if supply chains are too concentrated in a single market, and due to the aggressive actions of the White House it would surprise few to see retaliation from the Chinese Government.

On the supply chain side of things, Apple has been making other efforts to shift around operations. The firm has been working to move the production of some premium handsets to India in an effort to avoid the 20% import duties in the country. Apple has continued to struggle in India, partly due to the price conscious nature of consumers. Anything which can be done to reduce the price of handsets will be explored to improve market share.

Whatever your thoughts of President Donald Trump, you cannot argue the Oval Office is having a much more profound impact on the technology industry than previous administrations. Perhaps his actions will lead the Chinese semiconductor market grow, while the manufacturing and assembly operations will be spread into other Asian markets. Another couple of years and the segment could almost look unrecognisable.

Don’t ignore Huawei’s ban on buying US components

While everyone is focusing on the ban on selling in the US, the ban on buying US components is a much more interesting chapter of the Huawei saga.

President Donald Trump has dropped the economic dirty bomb on China and it’s dominating the headlines. Although Huawei, or China, are not mentioned in the text, the Executive Order is clearly a move to stall progress made in the telco arena. China is mounting a challenge to the US dominance in the TMT arena, and this should be viewed as a move to combat that.

There are clearly other reasons for the order, but this should not be ignored. The security argument, albeit an accusation thrown without the burden of concrete evidence, is a factor, but never forget about the capitalist dream which underpins US society.

However, although most are focusing on Huawei’s inability to sell components, products and services in the US market, there might be an argument the ban on purchasing US components, products and services is more important, impactful and influential.

“This action by the Commerce Department’s Bureau of Industry and Security, with the support of the President of the United States, places Huawei, a Chinese owned company that is the largest telecommunications equipment producer in the world, on the Entity List,” said Secretary of Commerce Wilbur Ross. “This will prevent American technology from being used by foreign owned entities in ways that potentially undermine US national security or foreign policy interests.”

While we will focus on the ban on purchasing US components, products and services for this article, it is worth noting the ban on Huawei selling in the US will have an impact.

Rural telcos in the US have mostly been against any ban on Chinese companies. In October 2018, Huawei made a filing with the FCC arguing its support for rural telcos is underpinning the fight against the digital divide and a ban would be disastrous for those subscribers. Michael Beehn, CEO of MobileNation, was one of those who argued against the ban, suggesting the cost-effectiveness of Huawei allowed his firm to operate. Without the advantage of nationwide scale, these organizations will always struggle when the price of networks is forced north.

While the US is a massive market, with huge opportunities to maximise profits, not being able to sell in the US is not going to have a significant impact on Huawei. Its customers are the rural telcos not the national ones. Huawei has not managed to secure any major contracts with the big four, therefore it is missing out on something which it never had. Huawei has still managed to grow sales to $105 billion without the US, therefore we believe this ban is not going to be a gamechanger.

However, it is the ban on purchasing US components, products and services which we want to focus on here.

Huawei is not outrightly banned from using US technologies and services, however, those companies who wish to work with the dominant telco vendor will have to seek permission to do so beforehand. The US can now effectively how strategically it wants to twist the knife already dug deep into Huawei’s metaphorical chest.

Although we’re not too sure how this will play out, Huawei’s business could be severely dented by this move.

Huawei recognises 92 companies around the world as core suppliers to the business. It will have thousands of suppliers for various parts of the business, but these 92 are considered the most important to the success of operations. And 33 of them are US companies.

Some are small, some are niche, some are more generic, and some are technology giants. The likes of Qualcomm, Intel and Broadcom all have interests in keeping the US/Chinese relationship sweet, though more niche companies like Skyworks Solutions, Lumentum and Qorvo have much more skin in the game. Firms like NeoPhotonics, who are reliant on Huawei for 46% of its revenues, might well struggle to survive.

Huawei will be able to survive this move, it has been preparing for such an outcome, but you have to wonder what impact it will have on its products and credibility.

HiSilicon, the Huawei-owned semiconductor business, has been ramping up its capabilities to move more of its chip supply chain in-house, while the firm has reportedly been improving the geographical diversity of its international supply chain. According to the South China Morning Post, not only has Huawei been moving more operations in-house, it has also been stockpiling US components in the event of the procurement doomsday event.

A similar ban on procuring US components, products and services was placed on ZTE last year and it almost crippled the firm. Operations were forced to a standstill due to the reliance on US technology. Huawei has never been as dependent on the US, though it seems the lessons were learned from this incident.

The big question is what impact a ban would have on the quality of its products.

Huawei might preach the promise of its own technology and the new suppliers it will seek/has sought, but there is a reason these 33 US companies were chosen in the first place. Either there is/was a financial benefit to Huawei in these relationships, or they were chosen because they were best in class.

Huawei is a commercial organization after all, it wants to make the best products for the best price. There will certainly have been compromises make during these selections, either paying more for better or sacrificing some quality for commercial benefits, and having to make changes will have an impact. Huawei, and its customers, will have fingers and toes crossed there is no material impact on the business.

The other aspect to consider is disruption to operations. ZTE found out how detrimental dependence on a single country can be, and while Huawei has mitigated some of this impact, it remains to be seen how much pain could be felt should the ban be fully enforced. Might it mean Huawei is unable to scale operations in-line with customer deployment ambitions? Could competitors benefit through these limitations? We don’t know for the moment.

The ban on selling in the US might sound better when reeling off headlines, but don’t forget about Huawei’s supply chain. We think there is much more of a risk here.

A look at how US suppliers have been hit by Huawei news

President Trump’s Executive Order and the decision to place Huawei on the US ‘Entity List’ is going to dominate the headlines over the next couple of days, but what will be the impact on US suppliers?

During the ZTE saga last year, where the firm was banned from using US components in its supply chain, several US firms faced considerable difficulty. With Huawei potentially facing the same fate, the next few days will certainly make for uncomfortable reading for some.

Although the main focus of the news has been on the Executive Order banning any Huawei components or products in US communications infrastructure, the entry onto the ‘Entity List’ should be considered as big. This is effectively the commerce version of a dirty bomb, and some might suggest it is being used to disrupt Huawei’s supply chain and dent its ability to dominate the telco vendor ecosystem.

But what is the impact of losing a major customer? What are the realities these US firms will face if the Secretary of Commerce turns down their application to work with Huawei?

Speaking to members of the financial community, it could be pretty severe.

Losing a customer which accounts for 2-3% of total revenues would be a concern but nothing major. For 5% of revenues, this is a headache, but something the spreadsheets could most likely tolerate. When you start getting to 10% the panic button needs to be hit.

A customer which accounts for 10% of total revenues is a major prize. Losing this revenue would result in a complete rethink in how the business operates, as this could effectively wipe out any profit for the year. If you are in the services industry, it isn’t as much of an issue, but when it comes to manufacturing and components, there are so many different implications.

For example, in the first instance you have to consider how this hits budgets, forecasts, resource allocation and manufacturing strategy.

Sales staff are probably the safest here, as the lost revenues will have to be replaced as soon as possible with new customers, but what about the marketing strategy? Do you want to replace the lost capacity with short-term customers (i.e. quicker) or long-term customers which may offer larger orders?

On the R&D side, does a company have dedicated resource working on projects for that customer? What will these staffers do now? Can those projects be re-orientated for another customer?

Finally, on the manufacturing side, there are all sorts of issues. How will the loss of revenue impact the resource recovery plan? How are the manufacturing facilities configured – do you have to close plants?

Another consideration is on your own supply chain and procurement strategies. When supplying products to said customer, you will have to source your own raw materials. Will the loss of this customer result in contracts with suppliers having to be re-negotiated? Will this mean quantity discounts are now impacted?

These are all the considerations when you are losing a customer worth 10-15% of total revenues. Anything above this and you would have to question whether the company can survive, or at least face a major restructure.

Share price of US suppliers to Huawei
Company Share price
Qualcomm -3.18%
Xilinx -4.1%
Western Digital -1.12%
Marvell Technology +0.5%
Seagate Technology +0.43
Texas Instruments +0.045
Skyworks Solutions -4.56%
ON Semiconductor -0.99%
Qorvo -5%
NeoPhotonics -12.9%
Flex -1.13%
Finisar -2.05%
II-VI -2.86%
Maxim Integrated -0.99%
Analog Devices -2%

All share prices at the time of writing (UK: 16:20) – in comparison to market close on 15 May 2019

Looking at Qorvo, executives at semiconductor supplier might certainly have something to worry about. Huawei is features in the ‘top three’ customers for the firm, while on the most recent earnings call, the team discussed the success of Huawei’s smartphone division and in particular the ‘P’ series as a contributor towards a successful quarter. Some have suggested 11% of Qorvo revenues are dependent on Huawei.

Skyworks Solutions, another semiconductor company, has been suffering in recent years. With large parts of the business reliant on smartphone shipments, the global slowdown has been tough. The team work with Huawei on both the mobile and infrastructure side, and while it does work with many tier one firms in both segments, the market is clearly worried about a competitive field and an inability to work with one of the largest telco vendors worldwide.

Both Qorvo and Skyworks supply radiofrequency chips to Huawei, which might have an effect on the Chinese vendors ability to manufacture devices. That said, the supply chain disruption will not be anywhere near as damaging to Huawei as it was to ZTE as it has HiSilicon which manufacturers many of its components.

Xilinx is another which seems to have worn the news quite negatively. The team work with Huawei’s enterprise business unit, helping with video streaming challenges. This might be the smallest business group at Huawei, though the 5G euphoria is set to offer considerable opportunities. Xilinx share price has been recovering after a 17% drop in April, though this has proved to be another set-back.

NeoPhotonics is a company which should be seriously concerned. As a customer, Huawei accounted for more than 46% of the total revenue across 2018. The executive team is relatively open with investors regarding this fact, and this might have been factored into any decision to invest, though this is a massive loss for the business to absorb.

Lumentum is another business which is somewhat reliant on Huawei. While we were not able to nail down specific numbers, the firm supplies fiber optic components to Network Equipment Manufacturers (NEM) and considering there aren’t many of them to supply to, losing Huawei will be a headache.

At Finisar, Huawei described as one of the company’s major customers, though it has seemingly been diversifying its customer base in recent years. In 2017 and 2016, Huawei accounted for 11% and 12% of the annual total respectively, though the percentage is not listed for 2018. This is because the percentage has dipped below 10%, though we were unable to ascertain what the figure now is.

We might have to wait a few weeks to understand the full extent of the impact, and how stringently the US will enforce Huawei’s entry onto the ‘Entity List’, but we suspect there will be some very stressful meetings taking place in numerous offices throughout the US.