Research Brief Boom and Bust of the China Consumer Electronics Industry Abstract: Demand for consumer electronics has exploded in China in recent years. The strong survive as constant price wars in the industry force many weaker players out of this potentially profitable market. By Dorothy Lai Recommendations Consumer electronics manufacturers should explore new ways of competitive differentiation in an oversupplied and price-sensitive market. China still offers growth opportunity. Multinational consumer manufacturers should partner with local Chinese companies to leverage this opportunity. While it is cost-effective to expand production in China, consumer electronics manufacturers must evaluate their rate of spending on new capacity so as not to exacerbate an already oversupplied market. Publication Date:24 June 2003
2 Boom and Bust of the China Consumer Electronics Industry Introduction Since the 1990s, China's consumer electronics sector has continued to expand rapidly, driven by the increase in the incomes of the Chinese people, which has prompted a wave of rising consumer spending. Many state-owned enterprises (SOEs) as well as private companies have sought to prosper in this environment by manufacturing to meet local demand. China has become increasingly critical to the world's consumer electronics supply chain for low-cost production as well as assembly of products. Meanwhile, China has also offered foreign consumer electronics companies a cheaper alternative manufacturing location coupled with access to what has become the world's largest home market. As a result of the upsurge of domestic producers, as well as substantial foreign investment, China has become one of the world's largest producers of consumer electronics, especially in the color television, audio, video equipment and appliance areas. China has risen in the last decade to become a key exporter of IT products, includingdataprocessingandcommunicationsaswellasconsumer electronics. The "walking out" strategy became even clearer after China's admission to the World Trade Organization (WTO) in 2002. WTO membership gave Chinese-made products lower tariff rates, fewer quota restrictions and easier access to foreign markets. During 2002, China exported $142 billion worth of electronic and electrical products, 38.6 percent more than in the previous year. Table 1 shows the breakdown of China's 2002 electronic and electrical product export business. Gartner Dataquest believes that China produced about $40.2 billion worth of consumer electronics in 2002. We believe the industry will grow 11.5 percent to reach $44.8 billion by 2003. (See "China/Hong Kong Electronic Equipment and Semiconductor Forecast, 1Q03," SCSI-AP-MS-0132, for detailed statistics of the China/Hong Kong forecast.) Table 1 China's Exports of Electronic and Electrical Products in 2001 and 2002 (Millions of U.S. Dollars) 2001 2002 Change (%) 2001-2002 Automatic Data Processing Machines and Units 13,092 20,135 53.8 Lamps and Lighting Fittings 2,474 3,132 26.6 Electrical and Electronic Products 51,315 65,119 26.9 Computer and Telecommunications Products 36,210 54,533 50.6 Total 103,091 142,919 38.6 Source: China customs statistics and Gartner Dataquest (June 2003) 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 24 June 2003
Meanwhile, following heavy investment in the consumer electronics sector, many manufacturers now find themselves in an oversupply situation. Many expanded their production capacities prematurely, well before demand developed. Cutthroat price wars have driven many smaller and weaker companies into negative income territory. While the excessive production is not unique to the consumer electronics industry, many Chinese consumer electronics makers were hurt. As shown in Table 2, the profits of China's top 100 domestic electronics companies declined for the second successive year since 2000. The profits of the top 10 domestic consumer electronics companies declined 0.8 percent while revenue grew 8.5 percent (see Table 3). Shrinking profits and escalating price wars are eroding the strength of China's consumer electronics industry and are forcing many players to exit this potentially profitable market. Table 2 Revenue and Profit Breakdown of China's Top 100 Domestic Electronics Companies (Millions of U.S. Dollars) 1999 2000 2001 2002 Total Revenue 36,767 53,710 60,220 71,342 Change (%) - 46.1 12.1 18.5 Total Profit 2,238 3,247 3,053 2,676 Change (%) - 45.1-6.0-12.4 Source: China Ministry of Information Industry and Gartner Dataquest (June 2003) 3 Table 3 Revenue and Profit Breakdown of China's Top 10 Domestic Consumer Electronics Companies (Millions of U.S. Dollars) 2001 Revenue 2002 Revenue Change (%) 2001-2002 2001 Profit 2002 Profit Change (%) 2001-2002 Haier Group 7,286 8,592 17.9 243 133-45.4 TCL Group 2,553 3,249 27.3 86 166 92.0 Shanghai SVA Group 3,629 2,334-35.7 188 40-78.7 Hisense Group 1,954 2,082 6.5 36 151 315.9 Panda Electronics 2,564 1,754-31.6 118 32-73.2 Sichuan Changhong Electronics 1,284 1,506 17.3 13 113 788.8 Shenzhen Huaqiang Holdings 674 979 45.4 16 7-57.1 Konka Group - 967 - - 28 - Shenzhen Skyworth 607 932 53.7 4 57 1,511.6 Caihong Group 809 785-3.1 36 7-79.2 Total 21,359 23,180 8.5 739 733-0.8 Source: China Ministry of Information Industry and Gartner Dataquest (June 2003) 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 24 June 2003
4 Boom and Bust of the China Consumer Electronics Industry Gartner Dataquest Perspective Gartner Dataquest expects that continuing severe competition and globalization will cause consumer electronics prices to fall further. This clearly spells good news for end users; however, this seemingly neverending decline in pricing will continue to place pressure on the industry as a whole. Gartner Dataquest believes that the entry of China's consumer electronics companies into new markets, aided by the country's accession to the WTO, will present more challenges for global consumer electronics businesses. While most Chinese consumer electronics companies follow a low-price strategy, a few businesses are succeeding by exploring other strategies as well. Some larger Chinese companies are focusing on increasing exports to regions such as South Asia, Eastern Europe, the Middle East and Africa. Of the companies in Table 3 that increased their profits dramatically in 2002 (TCL, Hisense, Changhong and Skyworth), three companies increased their exports to the world market in 2002, as shown in Table 4. Others are expanding their product design, R&D, electronics manufacturing and semiconductor design capabilities. A few others are promoting high-end consumer products such as set-top boxes and digital and flat-panel TVs, while some are expanding to mobile phones and PCs. The trend illustrates that diversity in business models and manufacturing portfolios is the way to succeed in such a challenging market. Table 4 Export Revenue of China's Top 10 Domestic Consumer Electronics Companies (Millions of U.S. Dollars) 2001 2002 Change (%) 2001-2002 Haier Group 424 1,711 303.8 TCL Group 707 1,090 54.0 Shanghai SVA Group 1,152 191-83.4 Hisense Group 63 272 329.4 Panda Electronics 456 16-96.4 Sichuan Changhong Electronics 104 46-55.9 Shenzhen Huaqiang Holdings 16 55 249.6 Konka Group - 476 - Shenzhen Skyworth 11 155 1,336.9 Caihong Group 110 101-8.9 Total 3,044 4,112 35.1 Source: China Ministry of Information Industry, Gartner Dataquest (June 2003) 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 24 June 2003
To compete successfully outside of China, Chinese domestic companies must first perform well at home. They must have a certain level of brand recognition among local consumers. They may initially start attacking competitors by using the low-price strategy. However, as time progresses, they have to face hundreds of local competitors whose sole weapon in this battle for business is price and to compete against powerful multinational companies with superior technology and brand names. To be able to stand out from the crowd, these local players need to balance their products between low price and high quality. We note that many successful companies are changing their low-price strategy once they gain certain market share. Not only do these companies want to become more profitable, but they also want to elevate themselves from being just another low-price vendor. Foreign consumer electronics companies that enter the Chinese market, hoping to grab a slice of one of the world's biggest markets, have often exited the market bruised and disappointed. Entering the market on a mantra of quality and focusing more on the high end, these foreign companies find out quickly they could not compete with the Chinese companies on price, with the opportunities for high-end products still remaining limited. What multinational consumer electronics manufacturers need to do is to partner with better-known Chinese companies. Since many of the Chinese indigenous companies wanted to tackle the foreign markets, foreign manufacturers can exchange their technical expertise for distribution support in China. This type of strategic alliances can be seen in the joint ventures between Haier and Sanyo from Japan and Haier and Sampo from Taiwan. Despite fierce price competition in China, the Haier-Sanyo joint venture did not employ a low-pricing strategy. Because the two companies market similar products in similar markets and want to avoid malicious competition, they cannot price their products at extremely low levels. This partnership helped stabilize pricing. Furthermore, the two companies were able to reduce spending on new production capacity. The joint venture took the benefits of the two and created a more cost-effective manufacturing base for the two companies. For example, Sanyo supplied cellular phones to Haier through an original equipment manufacturer (OEM) agreement, while Haier produced home appliances for Sanyo. The two companies also jointly developed new products to be marketed under their own brand names. This helped save both companies' R&D costs. Finally, although both companies are producing and marketing the same products, the two also benefited from the partnership, as they can use each other's existing distribution channels in China and Japan. Similar arrangement was set between Haier and Sampo for different products and different markets. 5 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 24 June 2003
6 Boom and Bust of the China Consumer Electronics Industry Many foreign companies are using China as a manufacturing base only and are targeting their products to the world's market. However, no matter how inexpensive China seems from a manufacturing perspective, these companies should realize that a moderate pace of spending on new capacity is essential to help them focus on producing higher-margin products. The market changes quickly; expanding too fast may not satisfy current end demand. If the consumers' tastes fluctuate frequently, the extra effort and time to retool production lines will cause a delay to market, causing a bigger problem for manufacturers. If foreign companies want to target the local market, they also need to conduct extensive consumer market research, as local markets are quite different from the world markets. For example, video compact disc (VCD) players took off in China but were never popular elsewhere in the world. Clamshell mobile phones are more popular in China, less so in Europe and Southeast Asia. In addition, they need to know the bandwagon mentality will continue with Chinese manufacturers, with legal and illicit copying set to continue. Most Chinese manufacturers lack proprietary technologies that allow them to differentiate themselves from multinationals and thus appeal uniquely to export markets. Although the Chinese government is pushing hard to encourage domestic enterprises to develop new technologies, such as homegrown processors, TD-SCDMA (a new mobile phone protocol) and the EVD system (a DVD standard), China still needs foreign technological support. Foreign companies can take advantage of this handicap and cooperate with the Chinese companies in exchange for personal connections. However, this is not without risk. Intellectual property (IP) is still a big concern in China. Foreign DVD player manufacturers, such as the 3C (Philips, Pioneer and Sony) and 6C (Hitachi, Panasonic Matsushita, AOL Time Warner, Toshiba and JVC), had much trouble getting the Chinese manufacturers to pay the required patent and royalty fees for the DVD player technologies. The IP issue will continue to haunt foreign manufacturers operating in China. China will remain a low-cost location for consumer electronics manufacturing for the foreseeable future. Its attempts to establish itself as the world's leading electronics manufacturing hub holds promise. As the average income of local Chinese households is set to continue increasing, a market of 1.3 billion people with ever-increasing incomes holds immense business potential. However, drawn-out price wars in the consumer electronics industry in China have taken their toll on company profits. Both Chinese and foreign companies must rethink their strategies when entering a new market. Product diversification, new manufacturing and design expertise, strategic partnerships and service support may be some steps that consumer electronics companies can explore to avoid a continuous oversupply and profit-weak, competitive environment. Key Issue How will electronic equipment production trends affect market growth opportunities? 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 24 June 2003
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