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Shanzhai (Bandit) Mobile Phone Companies: The Guerrilla Warfare of Product development and Supply Chain Management.

By: John Rediehs, Malini Seelan, Rama Paidi

Table of Contents


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Case Analysis

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Introduction Shanzhai (Bandit Cell Phone) is shaping the entire thought process of development, marketing, and technology in the largest cell phone market in the world. A market that has long been dominated by the corporate players like Nokia, Samsung, and Sony now face a tenacious domestic threat defined by a grassroots culture spreading within China. Shanzhai companies as they are referred to in this case study have gained a steady market share in the recent years on the big corporate players. By understanding their domestic market and their contract manufacturing history with the big players in the market, Shanzhai companies arose out of the culture to revolutionize the Chinese cell phone market. In this paper we will be analyzing several steps in the Shanzhai manufacturing process and business model. By highlighting several interesting and unique Shanzhai business strategies, we hope to gain the insight to apply these strategies elsewhere in the business world. Case Analysis Shanzhai companies are uniquely Chinese; they are a blended subculture of shameless counterfeiting, ruthless competition and social beliefs. Shanzhai companies tend to bend the rules or flat out ignore them in a pursuit to maximize profit, experimentation, and optimal output. In translation Shanzhai companies operate with surprising efficiency and at extremely low costs. With this ability to cut costs and offer similar products based off the corporate brands at a lower price, the Chinese market was prime for growth. Currently, the Chinese market has over 900 Million mobile phones users with over a billion individuals for market growth. Due to the geographic and socioeconomic situations in China many groups are left out of the market or cannot afford the Global brand phones. Shanzhai companies fill this void offering niche market phones that are produced for the needs and wants of that particular market. They also are able to offer a far cheaper phone than similar products of the global brands with the same or virtually the same abilities. Shanzhai mobile phone manufacturers went after the ignored markets, offering very low prices and fast response to user demands to grow their base. Shanzhai companies emergence in the Chinese market has been a very competitive force in the developing telecommunications industry in China. Their innovative and unique business model has led to strong competition for global brands in China and other developing nations. Many of these larger corporations have the ability to learn from the practices of the Shanzhai mobile phone companies. Initially Shanzhai companies starts out as copycats. After become economically viable and successful in 2

the market they build their core competency. Shanzhai proponents acquire key know-how, especially in R&D and new product design, and then begin developing value added services or differentiated products to solidify or expand their customer base. Scaling up quickly while simultaneously creating barriers to entry and developing strategic core competences. A common modus operandi involves targeting lower-end mass segments in order to build scale and market share via large-volume sales, then raising entry barriers by developing further advantages in areas such as cost control, pricing, and supply chain stickiness, or by building cohesive ecosystems with industry partners. Not only was the business model unique but also were the phones and their manufacturing process. The Traditional companies like Nokia and Samsung invested heavily in Research and development and it required a broad range of expertise including electrical, mechanical, software engineers and industrial engineers. They developed a prototype based on extensive market research which they tested and refined several times before finalizing the end product. They also applied to certification and approval of the international telecommunications standards and for the NAL (Network access license) which usually costs about ($30,000 - $40,000). The development time was about 4-6 months. The Shanzhai companies had a simple conceptual design process. Their market research was simple and they relied on the input from distributors and local sources. They outsourced the design to local design houses and did not perform quality inspections. They often bypassed the required government approvals. Companies like MediaTek introduced turnkey solutions such as the chipset (SOC- System on Chip) provided integrated functions into one chip which was previously provided by multiple chips. The manufactures only had to source components such as camera, battery and exterior housing. The chip provided functions for basic communication, was blue tooth ready, had Touch screen support, Interface for camera etc. If the manufacturers needed extra functions they paid an extra fee to access the software drivers for those functions. Shanzhai mobile phone makers could now quickly and easily develop new models. The time taken for a Shanzhai company from conceptual design to mass production was as short as 45 days. In general they took about 8 days to analyze and copy a new model (from a branded company) including the circuit board, software and the structure. The main circuit board and the software design together with the purchase of accessories took about another 10 days. Mass production of the cell phones can be setup in about 22 days. The production of Shanzhai phone was usually outsourced to small assembly workshops which could be setup in a residential apartment, 3

commercial office depending on the scale of operation. Small assembly plants may have fewer workers as small as 10 people and the team may produce more than thousand phones every day. After understanding the competitive advantages in manufacturing and design we must get a full look of the challenges that face Shanzhai companies in the present and the future. Recommendation/Suggested Implementation Two particularities of Shanzhai phones have raised customer and government wariness. One is low quality and attendant physical safety issues. Exploding batteries can cause injury or even death. The possibility of high radiation levels led the Chinese Ministry of Industry and Information Technology to issue a warning against Shanzhai phones in March 2009. Quite apart from the physical risks, the lack of after-sales support has contributed to making faulty mobile phones the number one customer complaint in China. Shanzhai manufacturers have also bypassed the mainstream obligation of equipping phones with a unique International Mobile Equipment Identity (IMIE) number. This number prevents stolen phones from accessing the network and also allows security services to track mobile phones. Shanzhai firms tend to shun IMEI because the testing costs $20,000-$50,000 and takes six months. While China has tolerated the sale of IMEI-less phones, India and Taiwan banned the use of such phones in 2009, with the Taiwanese instituting a fine of $9,000 per violation.

Conclusion Now that we get a full overview of the Shanzhai companies we begin to see that Shanzhai companies modus operandi usually involves such careful study and adaptation of an existing business model that they are perceived to be taking something belonging to an incumbent whether they are acting in breach of its IP rights or not. At the same time, Shanzhai companies can offer instructive insights and viable business model to operate in local markets, in-particular how existing strategies can be adapted to work more efficiently in a Chinese context. This is especially true for foreign companies, which are often unfamiliar with Chinas sometimes unusual operating environment. Key takeaways include these: Underestimate low-cost competitors at your peril. With the right business model and strategy, some Shanzhai companies can and do evolve into major-league players. 4

Always drive change instead of being driven by change. Companies need to be constructive destructors and game changers. Do not just react to market change; change the market. Get out of your comfort zone. Learn from the Shanzhai players and become a fearless experimenter. Companies that are able to work successfully in China must first develop a clear understanding of its complex markets, appreciate the diversity of the local customer base, and come to terms with relatively poor IP rights protection. Those who can come to terms with the subtleties of Chinas multi-tier customer segments, understand their tastes and preferences, and create distinctive products that meet local needs will benefit from the Shanzhai mind-set when serving Chinas emerging breed of consumers. On one hand, Shanzhai companies can be formidable competitors. On the other hand, they could become potential business partners or even acquisition candidates. The key is to keep an open and humble mind.

References links: uctInnovationinChineseMarket_EdTse.pdf