China design houses change direction

A new approach is to add manufacturing and create turnkey solutions as competition heats up with Taiwanese original design manufacturers.

By Amy Wang, Contributing Writer -- Electronic Business, 7/2/2007

China's vaunted independent design houses are shifting direction, churning out turnkey solutions instead of just designs. The move puts them squarely in the original design manufacturer (ODM) camp and, for the first time, in direct competition with Taiwan's ODMs.
 
TechFaith Wireless Communications Technology is a case in point. Founded in Beijing in 2002, it grew to become one of the leading independent design houses in China, specializing in handset application software and chip solution development.
 
At present, the company has 2,400 employees, 90 percent of whom are engineers. While that may sound like a recipe for success in the Chinese market, in the first three quarters of 2006 the company watched its profits and revenues head decidedly in the wrong direction. Revenues began to climb again after shifting to an ODM model. 

The upturn in fortunes is more focused on the business model than the market sector. For the most part, Chinese independent design houses have focused on the handset market, one of the leading consumer sectors within China. Some also have expanded into the MP3 and MP4 markets. That approach worked well in 2004 and the first half of 2005, until Taiwanese semiconductor suppliers began offering low-cost chipsets and turnkey solutions to Chinese handset OEMs. That particularly hurt independent design houses in the low end and middle tier of the handset market.
 
Taiwan-based MTK, for example, won business from Lenovo and Konka Group at the expense of Chinese independent design houses. The Chinese handset OEMs adopted MTK's solutions and ended their relationships with the design houses because of better pricing and reduced time to market.
 
China's design houses responded in force. TechFaith Wireless began changing its business model in 2006 to look more like an ODM. The company redefined its business scope as three areas: smart phone, feature phone and application software with focuses on the export market and China's high-end market. It also put emphasis on the smart phone and 3G handset products, which were mainly exported to the overseas market. The company is now exploring how to capitalize on overseas markets.
 
According to Defu Dong, TechFaith's Chairman and CEO, the company began expanding internationally last year and posted good returns. "We ended the year with 16 international customers compared to 7 in 2005, with 66 percent of our revenue coming from international customers compared to 64 percent in 2005. Revenue from international markets was 38 percent in 2006 compared to 5 percent in 2005," said Dong. "In terms of new technology, our TD-SCDMA effort is on track. EDGE, HSDPA and EVDO handsets were launched in the fourth quarter. Importantly, we continue to make inroads with tier-one customers and expect to achieve sustained profit and revenue growth in 2007."
 
In the Chinese market, TechFaith works directly with China's telecom operators to provide customized 2.5G, 2.75G and even upcoming 3G handsets. The company has developed TD-SCDMA based handset to focus on China 3G market.
 
Behind the changes
Mobile operators need independent design houses to develop new handsets to win new business, but they also have limited manufacturing capacity. That makes turnkey products far more attractive than design solutions offered by design houses. China's design houses have begun capitalizing on the shift. For the last quarter of 2006, TechFaith posted net revenue of (US) $29.1 million, compared with $24.1 million for the same period of 2005. Although the net revenue of the fiscal year 2006 was $80 million, down 12 percent year over year, the company expects revenues to rise this year with sales of smart phones, custom-feature phones and a global ODM service. TechFaith expects 80 percent of its revenue will come from ODM services, with only 20 percent from design services.
 
TechFaith is hardly alone in shifting to the ODM model. Other Chinese design houses such as Holy Group (Hangzhou), Yuhua Communications (Shanghai), Longqi Communications (Shanghai) and Yulong Communications (Shenzhen) also have adopted the ODM business model.
 
All of these companies believe there is a growing market for custom-feature handsets for specific operators, which will get a boost from a shift to 3G. But because custom-made handsets usually do not have huge volumes, the ODM model will far outperform the design house model. ODMs also are better equipped to expand globally because they offer a comprehensive service, from design to manufacturing.