US-China business: the necessary reinvention of Huawei
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When Meng Wanzhou returned home to China at the weekend, the presumed heiress of technology group Huawei pledged to harness the lessons of almost three years in legal limbo in Canada to the benefit of her company.
“All the frustration and difficulties, gratitude and emotion, steadfastness and responsibility,” she told a flag-waving welcome crowd on the tarmac at Shenzhen airport, “will transform into momentum for moving us forward, into courage for our all-out fight.”
Huawei will need all the momentum and courage it can muster.
By agreeing to a deferred charges deal over allegations of violating US sanctions against Iran, Meng averted the threat of a lengthy prison sentence and closed a chapter that she said had turned her life upside down. But her company expects to remain a target of US prosecution and sanctions for years to come, and is only just figuring out how to do business under that pressure.
The US has banned the use of Huawei equipment by the federal government, barred American companies from selling to Huawei without an export licence, and prohibited the supply of any semiconductors designed or manufactured using US technology or equipment for use in any Huawei gear. That amounts to an almost total blockade of chip shipments to the Chinese company.
The impact on the group has been brutal. In the first half of this year, revenues fell by almost 30 per cent compared with the same period last year, the largest ever drop.
As the restrictions have begun to derail Huawei’s traditional business, the group is now in a scramble to try to reinvent itself. The company is turning away from the development and sale of telecommunications network gear and smartphones into areas less dependent on foreign chip supplies — such as cloud services and software for smart cars.
The group is also doubling down on its own research and development in an effort to escape the stranglehold of American sanctions. It is investing heavily to be a leader in the emerging 6G technology so that other companies are dependent on its patents — rather than Huawei relying on technology imports from the US.
“In the current climate, the best way to describe the atmosphere within Huawei and the way we go about things, is like a huge collection of start-ups,” says Henk Koopmans, the company’s head of research and development in the UK.
At stake is not just the fate of one of China’s most prominent and successful companies, but the broader technological competition between Beijing and Washington. Chinese officials are clear that Huawei has been a vital part of the country’s network of innovation.
“Many have viewed Huawei as the only possibility for China to make a breakthrough in semiconductors and telecoms,” says a local government official in Shenzhen, the technology industry hub in southern China that is Huawei’s home. “So Huawei must survive. It is a national mission.”
The sanctions on Huawei have had a stark impact on both of its main businesses — smartphones and telecoms infrastructure.
Its smartphone sales dropped by more than 47 per cent in the first half of this year compared with the same period last year. Last week, rotating chair Eric Xu predicted that in the full year, the company will lose up to $40bn of its $50bn smartphone business, a slide that analysts estimate will drive the share of the consumer business in Huawei’s total revenues from 42 per cent earlier this year to just over 30 per cent.
“Huawei’s component bottlenecks are now starting to bite,” says Ben Stanton, a smartphone analyst at research group Canalys. “Stockpiles are running low, and its volume will almost certainly continue to fall each quarter.” Noting that Huawei’s smartphone arm has retreated to its Chinese home market, he adds that its strength in previous overseas strongholds such as Europe “has completely evaporated”.
In the network gear business, the decline is happening more slowly, partly because product cycles are longer.
Dell’Oro, a telecom-focused research firm, said in a note earlier this year that although Huawei can no longer procure custom application-specific chips for its telecom products, it was assuring analysts that it had enough inventory to keep the infrastructure business running in the near term.
In response to these losses, the first big push has been to strengthen Huawei’s software capabilities so that it is less dependent on producing hardware that it will struggle more and more to deliver without access to chip supplies.
Xu told reporters last week that while China was achieving encouraging results in its efforts to develop its own semiconductor industry, it would take “a rather long time” until Huawei’s supply challenges could be fully addressed.
The main software-driven business Huawei is rushing to build is cloud services. Some of the functions in a telecoms network traditionally performed by base stations can be transferred to software processes in the cloud with newer technology. Moreover, Huawei is rapidly developing new cloud services, which it offers to companies and government departments. Last week, the company announced plans to invest $100m in the next three years for small and medium-sized businesses to develop on Huawei Cloud.
According to Canalys, Huawei’s cloud business grew by 116 per cent in the first quarter of this year to take a 20 per cent share of a $6bn market in China, behind Alibaba Cloud but ahead of Tencent. “Huawei Cloud’s results have been boosted by internet customers and government projects, as well as key wins in the automotive sector. It is a growing part of Huawei’s overall business,” says Matthew Ball, chief analyst at Canalys. He says that while about 90 per cent of this business is in China, Huawei Cloud has a stronger presence in Latin America and Europe, Middle East and Africa compared with Alibaba Cloud and Tencent Cloud.
There are limits on Huawei’s cloud business, however. In July, Chinese media reported that the company was considering selling a part of its server business that runs on x86 central processing units after Intel’s export licence for providing Huawei with that component expired. Servers are indispensable for cloud companies because they are where the hardware data is stored and much of the computing needed for cloud services is performed. Huawei and Intel both declined to comment, but industry experts say processor supplies are a headache for Huawei.
“Selling the server business is highly likely,” says Ben Sheen, semiconductor research director for network and communication infrastructure at research firm IDC. “The CPU is a central component, and if Intel cannot ship, Huawei is in big trouble.”
As in the network gear business, providers of cloud services such as Amazon Web Services or Google try to boost performance by improving their software. If Huawei can achieve the same, it will be in less urgent need to get new processor supplies.
“In smartphones, your revenue share goes down very quickly if you don’t have the latest chips. In cloud, you can keep running a decent business for much longer, and maybe even expand your revenue if you invest in software differentiation,” says Jue Wang, an associate partner in the technology practice of Bain, a consulting company.
Although companies such as Intel and AMD release new CPUs every year, the majority of cloud service providers’ servers run on processors two to five years old. The cloud companies increasingly generate new revenues by investing in new AI services and tools — even if their servers run on older chips. “But eventually you will need new ones — you cannot offer cloud services without CPUs,” Wang says.
One of the fields where Huawei finds it relatively easy to pick up new business is helping to digitise industries that have been laggards in the adoption of information technology. It is offering telecom, IT and software tools to Chinese companies in sectors such as coal mining and port operations, enabling them to lower costs and enhance security. Driven by these operations, Huawei’s enterprise business revenues grew by 23 per cent last year and 18 per cent in the first half of this year.
“The enterprise business will likely continue to be a growth point for Huawei,” says Ethan Qi, an analyst at Counterpoint Research, who forecasts revenues in that segment to increase by up to 15 per cent a year in the next few years.
Still, Huawei frets that this is not enough to offset the death blow the US sanctions are dealing to the smartphone business. The new industry verticals “may not even be able to compensate for those lost revenues in 10 years”, Xu told reporters last week.
Frustrated in its main markets, Huawei is making some striking bets on new areas. One of the biggest is in electric and autonomous vehicles. Huawei made its first R&D foray into vehicles in 2014, but now the company is drastically cranking up commitment, with plans to form a 5,000-strong R&D team and investment of $1bn in the segment this year.
The company says it will not build cars itself, but its engineers are clearly looking into everything short of that. “Initially, we just thought we would help the car connect, but after a while we realised that we can also help make it more intelligent,” says a Huawei official.
A vehicle released by Chinese automaker Beiqi at the Shanghai Auto Show this year featured an entire in-car electronics solution developed by Huawei. For this shift, the company is harnessing strengths built over years in its telecoms hardware business — executives say experience in designing base stations that can withstand extreme weather conditions comes in handy because temperature controls are a key requirement in electric vehicles.
“They have refocused their teams in the research centres they run in Europe: In the past, those were 3G and 4G-facing, and now they are focused on [advanced driver-assistance systems],” says Jean-Christophe Eloy, chief executive and president of Yole, a French technology research and consultancy firm.
A large portion of the chips required in automotive electronics are manufactured with more mature processing technology, which does not need to be imported. “Much of that technology is available in China,” Eloy says. “Focusing on automotive therefore can also help them get away from their chip supply problem.”
But Huawei has its sights set far beyond keeping the business running in the near term: If anything, its ambition to be a tech pioneer has grown even stronger. Ren Zhengfei, founder and chief executive and Meng’s father, is letting some of Huawei’s researchers off the leash to focus on basic science and explore technology breakthroughs even without a clear understanding of its potential business applications.
“We will not demand you to put down your quill and join the troops,” Ren told R&D staff at a meeting in August. He added that the research team at HiSilicon, Huawei’s chip design unit, would be kept even though the US sanctions have robbed the Shenzhen-based operation of the chance to manufacture its advanced chips.
“We allow HiSilicon to continue to scale the Himalayas,” Ren said. “The majority of us others will stay down here to grow potatoes, herd livestock and keep sending provisions to the climbers, because you can’t grow rice on Mount Everest.”
‘Seize the patent front’
Last year, Huawei invested Rmb141.9bn ($22bn) in R&D, almost 16 per cent of its revenue.
The driver behind this focus on high-end research is the urge to become less dependent on foreign technology — while also laying the groundwork for growing intellectual property royalties.
Already in 5G, Huawei is one of the most significant owners of patents, forcing rival network gear makers such as Ericsson or Nokia to make certain payments to Huawei even if the Chinese company is excluded from 5G contracts in many western countries.
Exhorting research staff to seek global technology leadership at the August meeting, Ren said: “We research 6G as a precaution, to seize the patent front, to make sure that when 6G one day really comes into use, we will not depend on others.” Elaborating on the potential uses of 6G for the first time, Ren said the technology might, beyond telecom’s traditional realm of connectivity, be used for sensing and detection — functions with potential for use from healthcare to surveillance.
That expectation has grown out of the results of the “collection of start-ups” approach touted by UK research head Koopmans. Ren’s encouragement for Huawei to pursue basic science is instilling what he hopes will be a start-up mentality in many of the company’s own R&D staff.
In addition, it is also tapping into a growing number of start-ups in which it invested in recent years. Engineers at the Centre for Integrated Photonics, a start-up based in Ipswich, eastern England, which Huawei acquired in 2012, recently developed a laser on a chip that can direct light into a fibre-optic cable — an alternative to established telecoms technology that sends pulses of infrared light through the cable. The researchers built the chip themselves, using Indium Phosphide technology instead of mainstream silicon-based semiconductors where US-owned tool technology gives Washington a stranglehold and which Huawei is struggling to obtain.
Koopmans says one future use of the technology could be transferring data from sensors on the skin measuring blood oxygen content in remote healthcare services. “And all this photonics activity came from a really researchy background where we never knew if a product would ever see the light of day. But this is how we are doing things now — reutilise our R&D capabilities in a non-monolithic way.”
Ren is not short on ambition for the group’s R&D operations, but acknowledges that they might not provide short-term results.
“Some theories and papers may not be put to use until one or two hundred years after they were first published,” he told R&D staff, reminding them that the significance of Gregor Mendel’s genetics discoveries was not understood until decades later. “Your paper may even have a fate like van Gogh’s paintings — nobody showed interest in them for more than 100 years, but now they are priceless,” he said. “Van Gogh starved.”
Additional reporting by Nian Liu in Beijing and Qianer Liu in Shenzhen