Any US compromise will be too late to stall Huawei’s bid for self-sufficiency

While many countries enjoyed a summer break, there was no let-up for Huawei in its attempts to build up defences against further potential US-inspired sanctions and restrictions. While the past week saw the US government relaxing its stance towards the Chinese vendor somewhat, amid a slightly more positive outlook for broader trade agreements, the situation remains unpredictable for Huawei and its customers, and the supplier’s actions over the preceding weeks clearly show that it is determined to make itself as self-sufficient as possible, and so less exposed to changes in US policy.

So, at the start of August, Huawei duly announced its own operating system, now called – perhaps ironically – HarmonyOS, and also said it would open a major new factory in Brazil for its smartphones. Both of these appeared to be statements of defiance of continuing US threats to freeze it out of the 5G market.

HarmonyOS could appear in smartphones by the end of the year, though Huawei remains reluctant to ditch Android for non-Chinese markets – with the large applications base built around the Google operating system, it will clearly be difficult to sell the Mate Pro handsets in huge volumes, for all their well-priced wizardry, with an alternative OS, especially in western markets. “We have the ability to develop it and the ecosystem, but we prefer Android,” said Huawei chairman Liang Hua recently.

But HarmonyOS is a contingency plan which is likely to do well in China and some other Asian markets, and may prove necessary to activate in the west too, with the US government continuing to flip-flop over its attitude to Huawei, creating uncertainty that damages all stakeholders.

Earlier this year, the Trump administration placed Huawei on its ‘entity list’ – US companies are barred from supplying companies on this list without a special licence, and the attempt to exclude the Chinese giant from buying US components could be effectively extended to US-allied countries (the US government has been pressurizing partner governments to follow its lead and exclude Huawei or ZTE from 5G network contracts, and it could take the same tactic with the entity list, forcing European vendors, in particular, to choose between selling to Huawei or to the USA).

Shortly after the entity list ruling, the US took a step back from imposing a complete ban on Huawei procuring US components, under pressure from US chip providers, and President Trump said licences could be granted to continue to do business with the Chinese firm.

However, the damage had already been done – the softening of approach will not stop Huawei, backed by its government, investing heavily to reduce its dependence on any US parts or intellectual property as quickly as it can, which in the end will reduce the USA’s place in the 5G market while attacking the global nature of the 5G ecosystem.

The most damaging aspect of the fight is the uncertainty, with the US policy on Huawei changing by the week. In the same week that HarmonyOS appeared, Trump said the US would not do business with Huawei. The statement, made to reporters on August 9, did not add much in material terms to existing policies – the USA introduced a ban on Chinese equipment in national infrastructure networks, including mobile, back in 2008. However, the statements put paid to hopes that a more cooperative relationship was being fostered behind the scenes.

“We’re not going to do business with Huawei,” Trump said, though he added: “That doesn’t mean we won’t agree to something if and when we make a trade deal” – a caveat he has uttered before, which contradicts the US claims that its sanctions are related to alleged cyberespionage risks in Huawei kit (charges the Chinese firm denies).

This was followed, on August 7, by the White House publishing rules for a ban on federal purchases of telecoms or video surveillance equipment or services from five Chinese companies, including Huawei and ZTE – the result of the National Defense Authorization Act passed last year by Congress, and now in force. The government has another year to comply with the Act’s broader restrictions on working with contractors that use products or services from the banned firms.

It also seems that the limited reprieve afforded to Huawei after the entity list decision in May has not led to the “timely” issue of licences to supply the Chinese company, which component makers had hoped for and which Trump had promised. Bloomberg sources are reporting that the White House is holding off on granting these licences. Commerce secretary Wilbur Ross said recently that he had received 50 requests for these permissions but decisions on all of them were still pending.

A couple of weeks later, the mood had lightened, though without any concrete measures to ease the way for Huawei’s partners. President Trump said his government would delay imposing threatened 10% tariffs on some Chinese-made goods and consumer electronics, including cell phones, until December 15. This was largely seen as a response to protests from US vendors and consumer groups, who argue that products such as Apple’s forthcoming new iPhone – which use parts and assembly plants in China – would be hit by import duties and those costs would be passed onto consumers.

But as FCC Commissioner Jessica Rosenworcel pointed out in tweet, cellphone tariff hikes have only been delayed, and 25% import taxes are already imposed on 5G antennas, semiconductors and routers.

“We need a thoughtful way to build a digital future. This mix of taxes on consumers and networks is not it,” she tweeted.

This “thoughtful” approach seems unlikely to materialize as the USA and China engage in seesaw negotiations and public spats, with vendors and operators from both countries caught in the crossfire.

Huawei itself is certainly not betting on a more cooperative climate developing.

An internal memo from founder and CEO Ren Zhengfei, reported by Bloomberg, sets out a plan for a complete restructuring of Huawei over the next 3-5 years to reduce its vulnerability to US sanctions. The first priority would be the handset business, which is the second largest in the world, a position that is threatened if it cannot access the Android ecosystem – or create its own parallel universe.

“We have to complete an overhaul in harsh and difficult conditions, creating an invincible iron army that can help us achieve victory,” Ren wrote. “We absolutely have to complete this reorganization within three to five years.”

He said the Chinese market alone was large enough to ensure Huawei’s survival in handsets, but Ren, despite the aggressive language, acknowledged the difficulty of being a global smartphone business without Android. “Two bullets fired at our consumer business group unfortunately hit the oil tanks,” he added.

His views were borne out by Huawei’s interim results, which saw the consumer business growing by 24% year-on-year at the half-year stage, but with that growth largely propelled by the domestic market. Research by Canalys said smartphone shipments in China were up 31% year-on-year, but those to Europe fell by 16% as operators hold back amid fears of supporting a handset without access to the core Google apps at the heart of Android.

The other main aspect of the planned reorganization is to make the rest of Huawei less reliant on US and western technology by building self-sufficiency. Chairman of the board Liang Hua told Chinese journalists recently that only “non-core” suppliers have been allowed back into Huawei’s supply chain – the company has “not seen” licences for key products coming from the USA – which confirmed the Commerce Department’s report that progress had been limited – and he would not speculate when any might be issued

Of course, one certain result of all this uncertainty is that Huawei will invest more heavily in its own self-sufficiency and reduce its exposure to the USA’s hostility. It will be hurt by inability to access US components and innovations, and by the potential for other countries and operators to ‘play it safe’ and avoid Chinese equipment in 5G and other national roll-outs. But it will aim to strengthen its technology leadership and its pricing in the markets where it can play, potentially to the disadvantage of western rivals, which may be hit by retaliatory action, leading to the global 5G world being split into two huge islands.

In the cause of independence from US suppliers, Huawei says it will increase its global R&D budget by 20% in 2019, to a vast $18bn. Some of this is being clearly targeted at countries which are currently strong supporters of Huawei in 5G, but which are also close US allies, such as the UK – aiming for a double whammy of defending an important market and weakening the Trump government’s attempt to create a zone of solidarity against Huawei.

Last year, Huawei invested over £100m ($150m) in R&D initiatives in the UK, where it has been a leading supporter of the country’s national 5G Innovation Center, and of trials with operators including incumbent BT/EE. Speaking in London, Huawei’s president for global government affairs, Victor Zhang, said that the company planned to increase its R&D personnel and investment in the UK, even as it is pulling staff out of its US-based R&D base.

“Our R&D budget for this year will be $18bn, which is a really significant increase. Last year, we invested $15bn. We rank as the fifth biggest company for research and development, according to a report by the European Commission,” Zhang told a TotalTelecom conference. “That’s good news for the UK. Our commitment to investment and our ongoing activities in the UK will not change. We are committed to the UK on 5G but also in terms of the country’s fibre network roll-out.”

He added: “Last year we invested £112m in the UK and we remain committed to that. While we don’t have the exact figure available at the moment, we believe that figure will increase next year, as our R&D partners have already increased the number of projects that they are working on. We also want to increase the number of people we employ in research and development in the UK.  We now have 400 R&D engineers here in the UK, compared with around 300 last year.”

But Huawei is not flinching from the fact that all this R&D money is a fight for survival. “We will continue investing in the future and enable our survival,” Liang Hua said at a press conference in China to announce Huawei’s interim results. “We are fighting for survival, and at the same time seeking growth.”

For the first half of 2019, sales were up 23% year-on-year to CNY401bn ($58.3bn) with a profit margin of 8.7%, but Hua acknowledged that the second half of the year would be very different, though he did not provide a sales forecast.

The first half results indicated just how hard it will be to break Huawei, since it has been able to turn in far better sales performance than its key rivals despite working under such challenging international conditions – government debates over whether to exclude it from 5G deals have been taking place in many countries in Europe, as well as Japan and others, for the past year, creating continued uncertainty.

So far, Liang Hua said, Huawei has withstood the pressures because it has been “well prepared” – stockpiling components in anticipation of US restrictions and developing its own technology with initiatives such as taking HarmonyOS off the back burner. He said that, since the USA issued the entity list order on May 16, Huawei had “secured 11 5G commercial contracts” to make a total of 50.

He added:  “We have now recovered to 80% of our performance before we were added to the entity list,” he said. Huawei has analyzed its core products and “if we have difficulties continuing supplies of the core products we will have to switch suppliers …. And we may give up some of the non-core products.”

Huawei’s half-year results:

Overall revenue grew 23.2% year-on-year at the half-year stage to reach CNY401.3bn ($58.31m) though much of the growth was concentrated in the first quarter, before the US restrictions were imposed – although Huawei did not release individual quarterly results, analysts said its smartphone growth was almost entirely in Q1, with flat sales from Q1 to Q2.

In its Carrier Business Group, Huawei reported first half revenues of CNY146.5bn ($21.28bn). It shipped 150,000 5G base stations to international and domestic markets in the first half of 2019, and is targeting 500,000 by the end of the year, claiming it has signed 11 additional commercial 5G contracts since the US ban of May.

In its Consumer Business Group, the company recorded revenues of CNY220.8bn ($32.08bn), shipping 118m smartphone handsets. It consolidated its position as the world’s second largest smartphone maker, but largely because of outperforming the market in China itself, where it grew its sales by 31% year-on-year, according to Canalys, in a market which slowed overall.

“Huawei is the only smartphone vendor to show growth in its Q2 handset unit sales [in China]. We grew by 30%. Other vendors are seeing double-digit declines in their handset sales. This says a lot about the quality of our product – if consumers don’t like a product, they just won’t buy it,” said the company.