In Five Years, How Did Huawei Go From Working for the Carriers to China's Biggest Phone Company?

In Honor's third year as an independent brand, phone makers can no longer afford to look only at the home market.

2011 was probably the most important year in China's phone industry.

That August, Lei Jun — who had started several companies and spent years as an investor — held a launch event in Beijing for a phone called Xiaomi. It was the company's first product, and the outside world was deeply skeptical of a phone priced at 1,999 yuan. But more than a thousand fans had already turned up to cheer it on, all of them early users of MIUI, Xiaomi's custom Android system. Launch events that rallied fans like this became ordinary over the next five years. At the time it was the first of its kind.

Two months earlier, OPPO — a brand spun off from BBK Electronics in its early years — had hired Leonardo DiCaprio, echoing his image from that year's blockbuster Inception, to advertise its new phone, the OPPO Find, around the world. BBK's own phone brand, vivo, launched its first smartphone in November 2011.

What they had in common: all of them ran Android, and all of them were pushing their own brands.

Of the companies that reacted that year, Huawei drew the least attention. Also in November, Huawei launched a phone called the Honor U8860. Starting a new brand was this huge telecom-equipment maker's first try at a consumer business. Back then Huawei's phones mostly turned up on flyers in China Telecom and China Unicom stores, jammed in among offers of money back on your phone bill.

By December 2013, Honor had gone from a company working for the carriers to an independent phone brand.

Walk into a phone store today and you'll see fewer and fewer foreign brands besides Apple. OPPO and vivo are now the top two in the Chinese market. Lenovo and Xiaomi have each held the number-one spot here, then been pushed out of it.

Huawei is the odd one out. It has never been the best-selling brand in China, yet its overseas business keeps it the world's third-largest phone maker, behind only Samsung and Apple. In the third quarter of this year, Huawei's smartphone operating profit reached US$200 million, or 2.4% of total global smartphone revenue, making it the most profitable Android phone maker in the world.

The phone makers that were doing carrier business alongside Huawei — ZTE, Coolpad, Lenovo — have each ended up struggling. ZTE sold only 15 million phones in China last year, far behind Xiaomi, OPPO, vivo and Huawei; Coolpad was bought by LeEco this year; and Lenovo has cut its phone brands down to Motorola alone.

How did Huawei do it?

At the start, making phones just meant working for the carriers

Huawei's phone business began in 2003 with PHS handsets, or Xiaolingtong — easy to build, and barely profitable. Because it never made money, Huawei's management considered selling the business off in 2008. Earlier that year, Lenovo had sold its own phone business (and bought it back the next year).

The turn came in 2010, when Huawei worked with China Telecom to launch an Android phone, the C8500.

By Huawei's account at the time, this phone, running Android 2.1, sold more than a million units in China within 100 days of going on sale. In that year, a million was a remarkable number.

The original iPhone, released in June 2007, took 74 days to hit a million. The first Android phone to pass a million was the Motorola Droid (Milestone) in 2009; Samsung didn't have its own million-selling smartphone, the Galaxy S, until the summer of 2010.

Put side by side, though, Huawei's C8500 was plainly a different kind of "million-seller" from Motorola's or Samsung's.

The C8500's screen was under 3 inches, with a lower resolution than a few-hundred-yuan MP4 player of the day. The "C" in the model name came from CDMA, China Telecom's network standard. The phone was really a custom device Huawei built for China Telecom.

Around 2010, Android smartphones had only just reached the market. Samsung and HTC both started at the high end.

The carriers, who controlled phone sales, went looking for manufacturers to build cheap Android phones.

ZTE, Huawei, Coolpad and Lenovo were the carriers' biggest partners then. In these deals the carriers were in charge. What they asked for was typically a 4-inch screen (large by the standards of the day), a 1GHz processor, 256MB of memory, a 5-megapixel camera, a price of 999 yuan — more like a spec sheet from an electronics mall than anything a phone maker puts out today.

In this arrangement, phone makers only built phones to the carriers' requirements. They could not really decide the hardware or software design, and they could not really reach consumers.

Even the preloaded software was chosen by the carriers, who then sold the phones through outlets across the country, bundled with new numbers and calling-plan discounts.

That was the start of Huawei's smartphone business. Huawei's annual reports from 2009 to 2015 show that its consumer business, which includes phones, passed 20% of revenue in 2011 and kept growing fast.

Learning from Xiaomi, building an internet brand

Huawei was also the first big company to copy Xiaomi's model wholesale. The timeline below lines the two up point for point.

Timeline of learning to build an internet brand

2010.08

Xiaomi releases its custom Android system, MIUI.

2011.08

Xiaomi releases its first Android smartphone; the "Mi Fans" appear.

2011.10

The Xiaomi online store opens, selling Xiaomi phones and accessories.

2011.11

Honor's first Android phone, the U8860, is released.

2012.02

Huawei starts calling Huawei and Honor fans the "Hua Fen."

2012.03

The Huawei Mall opens, selling phones, routers and other consumer products.

2012.07

Huawei releases Emotion UI 1.0, its custom Android system.

2013.12

Huawei announces that Honor will become an independent brand, run entirely as an internet brand.

Xiaomi's internet model changed how the phone industry worked at every level.

The first step was online promotion and online sales.

Next came software differentiation. Xiaomi shipped a new MIUI build every week, adding features and fixing problems, and leaving a window open for users to send in feedback and ideas.

In production, Xiaomi set its pace by numbers gathered online. Weekly pre-order figures, social-network figures, even scalper prices decided how many units Xiaomi ordered from its factories.

The newest chips and technology in Xiaomi's phones were still expensive at launch, so controlling volume and pace this way meant that by the time a phone went on open sale at scale, falling chip and materials prices had already opened up more room for profit.

So Huawei, too, acquired a name for its fans, the "Hua Fen," built its own online mall, and got its own phone operating system, Emotion UI. To give the brand a separate identity in people's minds, it simply spun off its internet phone brand, Honor, to run on its own — and Honor's products copied Xiaomi's high specs at low prices, right down to the 1,999-yuan price.

The process produced some extreme things too.

On phone and gadget forums on Baidu Tieba, in Weibo comment sections, in the comment fields of phone news sites, the reply you saw most often ran something like, "Huawei's phones are pretty good, great value for money." They all shared one trait: counting punctuation, they ran to about 17 characters, and the content was nothing but praise for Huawei.

Given the scale of the effort and the number of marketing accounts involved, these people who turned up in unison to praise Huawei later came to be called "the navy".

Such aggressive marketing drew criticism, but from 2013 on, Huawei's weight as a phone brand was settled.

It uses the internet model, but it's still a traditional hardware business

For Huawei, product sales were quickly remade along internet lines. The difference lay in how the money got made.

Xiaomi worked out its thinking early. Vice President Lin Bin has said more than once that Xiaomi's hardware doesn't have to make money: selling phones, TVs and other products to users isn't the end point but an entrance, and the software and services users buy afterward are where Xiaomi really wants to earn.

To give phones more video and games to consume, Xiaomi licensed mobile games including Sword and Fairy World (《仙剑世界》) and War of the Kings (《列王的战争》), and put US$1 billion into video content, linking an iQiyi membership deal into Xiaomi TVs. From 2014 Lei Jun also began investing in "ecosystem chain" companies, hooking other smart hardware into the control app on Xiaomi phones. Many internet brands later borrowed the idea.

Huawei didn't do this. Nearly all of the annual revenue at its sub-brand Honor comes from hardware sales; ads in the app store and inside EMUI are its only service income. The software services it built for its phones exist, in the end, to sell more hardware.

OPPO and vivo also stayed out of investing in software services. They did develop better selfie and audio software, but that too was ultimately about selling phones. Like Huawei, both companies earn their main software revenue from the app stores built into their phones.

This sent Chinese phone makers down two completely different roads. One, represented by Huawei, OPPO and vivo, chases hardware profit and treats selling hardware as a complete business. The other, represented by Xiaomi, treats the phone as an entrance to internet services, stripping out its own hardware margin and using higher specs and lower prices to get people to buy that "entrance to internet services."

Having chosen not to be an entrance, Huawei also gave up the carrier channel to raise its margins on phones. In August 2014, Yu Chengdong said publicly that Huawei would cut its carrier-customized models by more than 80% in the second half of the year, to no more than 10 models in all, and that carriers as a sales channel would be squeezed down to 20%.

Without the large run of low- and mid-range models built to carrier order, the average price of a Huawei phone rose. According to IDC, and against the general decline in average Android smartphone prices, Huawei's global average smartphone selling price rose year on year in 2015 from US$176 to US$213.

Seen from today, China's three biggest smartphone makers — Huawei, OPPO and vivo — have all ended up on the side that chases hardware profit.

It's hard to say Huawei's phones stand out in any way, but they rarely go wrong either — which suits a smartphone market moving from innovation to maturity

Unlike the Android of 2008, an early system full of problems, there is now less and less room to win users over by optimizing Android software.

Once phones are as mature and everyday as household goods, a "unique new feature" isn't necessarily what matters most.

Independent analyst Horace Dediu put it this way when writing about competition in mature markets:

"In a niche market, the biggest motivation for early adopters is buying a flawed early product, because they want to be ahead of the trend. There's a gulf between selling to early adopters and selling to the mass market, because the two groups' expectations and behavior are completely different. The auto industry crossed that threshold (of product immaturity) long ago. Carmakers are used to promising nothing about the future, and there isn't much differentiation in their products beyond a different color or shape. But because the market is mature, people's quality expectations for cars have become very high. So the strongest competitors in that market, like Toyota and Volvo, don't win through differentiation. They win by balancing high product quality, performance and customer satisfaction, in order to attract millions of mass-market consumers."

Mature smartphones today are much the same.

In hardware design, the gap between Huawei's phones and Apple's iPhone is no longer as obvious as it was in 2010.

All these signs point to a new phase, in which people replace phones they already own. Lu Junkuan, an analyst at the market research firm Gartner, told QDaily that competition in the smartphone market has changed: it is no longer about performance and price as it was early on. Most consumers now weigh more factors when they buy a new phone, including after-sales service and brand.

These shifts work in Huawei's favor.

Huawei's hardware has yet to develop a style or design language of its own, and its custom EMUI system is hard to call distinctive. But both are very mature. Its software engineering team also dealt relatively early with the Android habits that drain batteries, such as apps launching themselves in the background and waking the device too often.

For an ordinary consumer, a Huawei phone may have nothing unforgettable about it, but it has never had a large-scale failure that wrecked the user experience.

Phone makers of the same period fared worse. Meizu added models so fast that its R&D couldn't keep up, and users ran into crashes again and again; Xiaomi, for a while, began tucking ads into the corners of MIUI.

QuestMobile data for January to September this year shows that 33% of Huawei owners chose Huawei again when they changed phones, better than Xiaomi and second only to OPPO and vivo.

Lenovo, Coolpad and ZTE, which worked for the carriers alongside Huawei in the early years, each came in under 5%.

Making its own processors gave Huawei lower costs

If OPPO and vivo won more profit by building up their brands and their sales networks, Huawei is more like Samsung: it cuts costs by making its own core components.

Samsung has gone further at saving money this way. On some models the processor, camera, display and memory are all made by Samsung. So was the curved display that helped the S7 Edge sell so well.

Huawei has so far made only the processor. But that is the most expensive part of a phone.

In building a smartphone, the three costliest parts are usually the display, the main processor and the baseband processor (the thing that lets you get online and make calls). Take the iPhone 6: its hardware plus assembly cost US$227. Of that, the display took $41.50 (18%), the main processor $37 (16%) and the baseband processor $27.50 (12%). The last two together made up 28% of the cost of the phone.

Then there are patent royalties, above all to Qualcomm, the largest maker of phone chips. The amount depends on the phone maker, but the usual reckoning is that a maker pays Qualcomm the phone's price × 65% × 3%. A phone selling for 1,000 yuan owes 19.5 yuan. For low-end phones with thin margins to begin with, that is a heavy cost.

In the years when phone makers sold only in China, how much of this royalty was actually collected is hard to say. But as Chinese companies moved into markets abroad, the royalties had to be paid. In the third quarter of this year, Qualcomm's revenue jumped by US$700 million, with a better outlook for the full year, mainly thanks to OPPO, vivo and the new licensing agreements it signed with them.

Huawei spent years pushing its own processors forward. In 2012 its HiSilicon K3V2 was used in four Huawei phones for the first time. With an outdated manufacturing process and software compatibility problems, using its own processor was, at that point, nothing but a burden.

But sticking with its own processors in mainstream models drove the chip business's development in turn. From the Kirin 910 in 2014, Huawei combined the main processor and the baseband processor, and its performance gradually closed on its rivals. Today its processors are a selling point that draws some buyers in.

In the end, what decides growth for Huawei and every other Chinese phone maker is who can replace Samsung overseas

In 2014, Samsung's smartphone sales fell for the first time and its profits collapsed. It looked as though it was about to become the next Nokia.

At the time Samsung really did look hopeless. Its high-end line faced the large-screen iPhone. It had mid- and low-range lines as well, but to protect its margins it had to keep those models clearly below the Galaxy S and Note series.

Samsung's "mid- and low-range" phones, at 1,000 to 3,000 yuan, went up against the main products of Chinese phone makers. Running the same Android, Samsung found it harder and harder to persuade users to pick it over a rival product that worked better.

By last year Samsung had dropped out of the top five in China.

At the end of 2014, this chart of phone sales trends, drawn by the independent analyst Horace Dediu, roughly captured what the outside world then expected of the market: Samsung falling fast, Chinese makers catching up fast.

That isn't what happened, of course. Samsung is still the world's largest phone maker. If not for the Note 7, its quarterly profit would still exceed that of every other Android maker combined. And the Note 7's effect won't last forever.

The forecast missed because Chinese companies failed to break into markets abroad. They only took Samsung's share inside China.

As the Chinese market itself approaches saturation, which company keeps growing depends directly on whether it can take Samsung's share overseas. Huawei has gone the furthest so far, winning a sizable share on the strength of years of work with European carriers and on its brand.

Figures from the market research firm Kantar put Huawei's share in Europe behind only Samsung and Apple. Among Europe's five biggest phone markets, Huawei's third-quarter share in Italy reached 27.3%, above Samsung's 24.7%, making it the largest phone brand there by market share. In Spain, another major market, Huawei's 23.3% share came very close to Samsung's, trailing by 0.9 percentage points.

But in markets where the carriers are less powerful, such as Indonesia, Thailand and Vietnam, OPPO is the brand closest to Samsung. And in India, said to be the next China, the brands eating into Samsung's share fastest are Xiaomi, OPPO and vivo.

A new round of competition has begun.

Cover image: Wikipedia