The Huawei Way

In just 18 years, Huawei has grown from a corporate midget into a mighty global contender in one of the world's key industries. In 1988, when the Chinese company was founded by Ren Zhengfei, a former People's Liberation Army officer and a current Communist Party member, it essentially resold imported telecom gear for the domestic market. Nobody outside China paid much attention to the firm. Today, everybody does--and not only for commercial reasons. Huawei has become a major manufacturer of wireless phone and networking equipment, with offices in 41 countries. The company competes with multinational big boys--Northern Telecom, Alcatel, Lucent, Cisco Systems--and wins business from the world's top network operating companies, mostly by significantly undercutting the prices of its competitors in the equipment business. Huawei's sales jumped to more than $4 billion in the first half of 2005, 85 percent higher than the same period a year before, and more than half its orders (by value) come from markets outside China.

So why do some Western politicians and business executives furrow their brows when Huawei comes calling? Perhaps because Huawei, like many fast-growing Chinese companies, is a little too close to the Chinese government, and a little too obsessed with acquiring advanced technology. While Huawei already has an R&D operation in India, for instance, the Foreign Investment Promotion Board has been sitting on its application for a $60 million expansion in Bangalore to develop software for its equipment for months. At the same time, Huawei has applied for a license to bid as an equipment supplier for large-scale Indian telecom projects run by state-owned service providers MTNL and BSNL. But the Telecom Ministry, likewise, has blocked that application. According to press reports, India's Intelligence Bureau suspects that Huawei has ties to China's intelligence apparatus and military, and even performs the debugging sweeps for the Chinese Embassy in India. (Huawei says that's not true.)

Political conservatives in Britain expressed the same security concerns about Huawei last spring. In April, the company won a $140 million contract to build part of British Telecom's "21st Century Network," a major overhaul of its equipment. But when rumors began circulating that the Chinese company might then bid on Marconi, a landmark electronics and information technology firm that was being put up for sale, a Conservative Party spokesman sounded the alarm. The Tories asked the British government to consider the implications for Britain's defense industry of a Chinese takeover of Marconi. In the end, Huawei didn't make an offer, and the Swedish telecom giant Ericsson is in the process of buying Marconi.

Like China National Offshore Oil Corporation, Lenovo, Haier and other Chinese corporate juggernauts, it's hard to know quite what to make of Huawei. Is it a security menace bent on doing Beijing's bidding, a legitimate international telecom competitor, or a corporate house of cards, all market share and PR releases but no profits? It's hard to answer those questions. CEO Ren refuses to talk with journalists, and there are persistent rumors that the firm is actually run by the People's Liberation Army. The company denies that, and has long claimed it no longer has any ties to the government. Huawei's books are audited by a well-known accounting firm (KPMG), but few of its financial numbers are made public. Opaque bookkeeping has also frightened analysts: an August report by the Thailand-based consulting company MWL argues that Huawei may rely on "unsustainably low prices and government export assistance" to make sales. The report adds that some customers "should be wary of making it a primary supplier for now."

Huawei has also been dogged by accusations of intellectual-property theft and corporate espionage. In 2003, Cisco sued the company in a U.S. court for copying computer codes used in its routers, machines that connect online networks. According to court documents, Huawei even copied Cisco's model numbers to make it easier for customers to switch to cheaper Huawei versions. Cisco eventually dropped the suit--but only after Huawei pulled the contested products from the market and agreed to alter their design codes. Neither company will reveal other details about the settlement.

The story of Huawei's rise--from its murky finances and purported government links to its rapid move into global markets thanks to bargain-basement prices--is a window on the aspirations and operations of China Inc. Many Chinese companies are beginning to compete in the global market with Western heavyweights, raising the questions: do they really have the innovative instincts and management expertise to become legitimate multinationals, and is Beijing now more a help or a hindrance to their ambitions? In April, the computer maker Lenovo, which is partly owned by the Chinese Academy of Sciences, the country's top research body, signed a $1.75 billion deal to buy IBM's personal-computer manufacturing unit. Two months later the Chinese oil company Cnooc, 70 percent of which is owned by the state, bid $18.5 billion to acquire the American firm Unocal. Fears that U.S. politicians would block the deal and a higher bid by Chevron forced Cnooc to pull out. Still, analysts say, the trend is clear: as the domestic Chinese market becomes more competitive, major Chinese firms are determined to become global players, whatever the cost.

Huawei certainly aims to convey at the very least an image of sophistication. The company's dazzling headquarters, located on the outskirts of Shenzhen, the 25-year-old boomtown across the border from Hong Kong, is affectionately called "Huawei base" by the 16,000 people who work there. The grounds are perfectly manicured. The training center, with its stone-and-wood facade, was designed by renowned British architect Norman Foster. In a massive exhibition hall 3G, mobile phones play Ang Lee's film "Crouching Tiger, Hidden Dragon." After work, employees relax in a massive swimming pool and hot tub. According to management, Huawei has spent more than $500 million hiring foreign firms like PriceWaterhouseCoopers and Hay Group (which specializes in human resources) to modernize the company's business practices--including accounting, pay packages and leadership training for corporate executives. The result, says chief marketing officer Xu Zhijun, is that Huawei "is a Chinese company with a Western management system."

The combination of a strong work ethic and modern business practices is helping Huawei to alter customer perceptions of China Inc. in overseas markets. When Huawei salesmen first approached British data-services company Fibernet three years ago, the firm had been using merchandise built by Cisco, Ciena and Marconi, according to Fibernet marketing director Nigel Pitcher. When Pitcher visited Huawei headquarters, he expected "to be underwhelmed by a Third World sweatshop operation." Instead, he says, he was "bowled over" by "the most modern manufacturing facility that I have ever seen."

Huawei has benefited from being in a strategic industry. Over the past 20 years, there has been a massive release of pent-up demand in China for better communications. When Huawei began selling fixed-line hardware in 1988, China had only about 3 million land-line phones, says Duncan Clark, managing director of the Beijing-based research firm BDA China, most of them in government and corporate offices. Today the country has 259 million land lines, as well as 335 million mobile-phone subscribers (more than the entire population of the United States) and 100 million Internet users, up from fewer than 200,000 in 1997. As Li Chenye, senior partner at the Beijing-based management consulting firm Strategic Decision Resources, says: "When the market is growing at 15 percent a year for 15 years, it's good for every business."

But market forces are not the only catalyst for Huawei's growth. Beijing has taken a very active role in boosting both the country's communications infrastructure and the domestic telecom industry. While India has largely left the private sector to fend for itself, Beijing has used strong central controls to nurture favored local firms. Huawei, Li says, has received a slew of advantages, from government R&D funding to tax breaks and export credits.

More important is the easy line of bank financing Huawei and other companies receive. In 2004, Huawei got a $10 billion credit line from the state-owned China Development Bank and $600 million from the Export-Import Bank of China to fund its global expansion. That, analysts say, has helped Huawei undercut competitors' bids by as much as 70 percent and offer vendor-financed loans. In April, the consulting firm MWL reports, Nigeria received $200 million in loans from the China Development Bank to buy Huawei equipment. "Beijing sees that Chinese high-tech [firms] are weak compared with larger Western corporations," Beijing consultant Li says, "so they want to help." Adds Clark of BDA: "It's a Wal-Mart vacuum-cleaner approach. They're just sucking up the market."

One of China's long-term goals in the information-technology industry is to develop its own technical standards, so it can stop paying royalties to foreign firms. In 2004, Beijing announced that some wireless-network products sold in China would have to conform to WAPI, a standard that had been developed by Chinese enterprises. A WAPI rollout would not only have required an overhaul of Western imports, but Chinese firms might have been able to claim intellectual-property rights and charge proprietary license fees rather than pay them, as Huawei and other Chinese tech firms have done for years. Western corporations and governments, including the United States, staunchly objected to the proposed Chinese standard, and the implementation has been "indefinitely delayed." But China is still keen to develop its own intellectual property for technologies ranging from Internet protocols to data protection, a recent American Chamber of Commerce report stated.

Huawei's success highlights Beijing's efforts to move up the technology value chain. The R&D operations of some Chinese firms are partially funded by the government, and Huawei has received more than $9 million in research funding from Beijing since 2003. As important, Beijing has been pouring money into science education. Chinese universities are graduating more engineers than the United States by a factor of "three or four or five," Clark says, a trend that has helped Chinese companies improve "not only in manufacturing but in research and development." Indeed, at Huawei headquarters, scientists and engineers (half of them with master's degrees or Ph.D.s) churned out 2,300 new patent applications last year. And they work cheap. While starting engineering salaries in Japan are $20,000, salaries for Chinese engineers just out of college have fallen by roughly one third over the past five years--to $8,500 a year--as universities churn out graduates more quickly than jobs are created.

Some industry insiders accuse Huawei of catching up by infringing on copyright and stealing industrial secrets. In addition to the IP dispute with Cisco, Huawei came under fire in 2004 when an employee was caught taking photographs of circuit boards inside Fujitsu networking equipment afterhours at a Chicago trade show. Huawei's Xu calls the incidents "misunderstandings," and adds that they are "all about how Westerners and Americans view China. They think that China can't create this technology. They think the only way we could do it is by stealing." But experts say copying is part of China's corporate culture. "There was reverse engineering [at Huawei] in the beginning," BDA's Clark points out, though he notes that if Huawei's transgressions were widespread, more competitors would have sued. And with newer technologies like optical telecom transmission, adds Duncan, "everyone is starting in the same place."

A more persistent problem may be the fact that, like most large Chinese companies, Huawei's finances remain murky. While Huawei claims to hold assets totaling nearly $5 billion, analysts say it is impossible to determine the company's financial health. "As with Chinese government figures," the recent MWL report states, "Huawei's reported financial data generally shows what Huawei wants it to show that it's growing impressively, succeeding with international expansion and prospering financially." The problem is that substantial liabilities could be lurking behind the rosy sales numbers.

As worrisome, little is known about Huawei's top management. CEO Ren's steadfast refusal to talk with journalists has fueled the speculation that the company is actually run by the PLA, a claim management denies but which it has not been able to shake. "When you have a company which has absolutely no transparency," says Jason Kindopp, an analyst at consulting firm Eurasia Group, "it will make you think twice about going into a long-term relationship."

Chief marketing officer Xu, however, argues that Huawei is transparent enough. The company, he says, is "100 percent employee-owned" and has no relationship with the military. He says the firm has two short-term aims--to reduce product prices further by cutting profit margins (already, Xu says, 15 percent to 40 percent below Cisco's) and to increase R&D spending. There's little doubt that Huawei will do both, with or without Beijing's help.

The biggest question--for Huawei and China Inc.--is whether company executives and technocrats will learn to play by global rules. With sales surging, Huawei has time to clean up its books. If it doesn't, it's a good bet the company has something to hide.