From Manufacturer to Innovator : China is the New Kid on the Block

GDP Levels, China vs. W. EuropeSelect Years, CE 0 - 1820

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Millions International 1990 $

China Western Europe

GDP Levels, China/India/JapanSelect Years, CE 0 - 1820

0

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0 1000 1500 1600 1700 1820

China

India

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Millions International 1990 $

GDP Per Capita, China vs. …Select Years, CE 0 - 1998

10

100

1,000

10,000

100,000

0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998

China Western Europe United Kingdom United States India Japan

Number of Years to Double Per Capita GDP

ChinaChina

KoreaIndonesia

JapanU.S.

U.K.

70

60

50

40

30

20

10

0

Number of Years

1780-1838

1839-86

1885-1919

1970-88

1966-77 1987-961978-87

Modern Greater China: Educated Population

Percent Workforce with Secondary Education or Better

TaiwanHong Kong

South KoreaMainland

JapanThailand

100

80

60

40

20

0

Year 2000Year 2020

Mainland China’s Six Major Economic Districts

Economic District Core CitiesPopulation (Millions)

GDP (US$ Bil.)

North East 3 Provinces Dalian & Shenyang 107 119

Beijing & Tianjin Beijing & Tianjin 91 112

Shandong Qingdao & Yantai 91 104

Changjiang Delta Shanghai & Suzhou 138 234

Zhujiang Delta Shenzhen & Guangzhou 86 116

Fujian Xiamen & Puzhou 35 48

548 733

Taiwanese Electronics CompaniesEstimated Capital Investments

14.1 13.3 12 10.5 8.8 7

2.6 3.7 5.2 6.8 8.6 10.5

0

5

10

15

20

2001 2002 2003 2004 2005 2006

US$

b

In Taiwan In Mainland

China - Manufacturing

02010099989796959493929190

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0

14.0

13.0

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Value Added, billions Employees, % of Labor Force

Manufacturing, Value Added (L)

Manufacturing Employment as a % of Total Labor Force (R)

Note: SOE Reform Began

0%

10%

20%

30%

40%

50%

60%

1997 1998 1999 2000 2001 2002 2003

China - Speedy Move Up Tech Ladder

HT / Exports

HT / Manufacturing

Share / Global IC

Share / Global R&D

Science and Technology ProfileChina & U.S., 2004

Metric Unit China U.S. Ratio

Scientists and Engineers in R&D Per million people 584 4,099 7

Scientific and Technical Journals Number 11,675 163,526 14

Expenditures for R&D Percent of GDP 1.09 2.80 3

High Technology Exports US$ Millions 68,182 162,345 2

Royalty and License Fees Receipts in US$ Mill. 133 44,142 332

Patent Applications Filed Number 118,970 184,750 2

Trademark Applications Filed Number 6,252 292,464 47

Locations of China High-Tech CentersBy Market Capitalization of Technology Firms, 2004

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Jinan

Fuzhou

Beijing

Kunming

Shanghai

HangzhouChangsha

Guangzhou#

Hong Kong#

Shenzhen

#

Taipei#

Taoyuan

#

Hsinchu#

T̀ ai-chung#

Kao-Hsiung

#

Nanjing

#

Zibo

#

Tianjin

China High-Tech Centers’ ProfileBy Market Capitalization of Technology Firms, 2004

High-Tech Center Province Specialized IndustriesBeijing Beijing Computers, SoftwareFuzhou Fujian ComputersGuangzhou Guandong Pharmaceuticals, ComputersShenzhen Guandong Computers, PharmaceuticalsHong Kong Hong Kong Biotechnology, SemiconductorsChangsha Hunan Computers, SoftwareNanjing Jiangsu SoftwareJinan Shangdong Communication SoftwareZibo Shangdong PharmaceuticalsShanghai Shanghai Semiconductors, PharmaceuticalsHsinchu Taiwan SemiconductorsKao-Hsiung Taiwan SemiconductorsTai-chung Taiwan SemiconductorsTaipei Taiwan Computers, SemiconductorsTaoyuan Taiwan ComputersTianjin Tianjin Pharmaceuticals, BiotechnologyKunming Yunnan Biotechnology, PharmaceuticalsHangzhou Zhejiang Semiconductors, Pharmaceuticals

China – Global R&D PresenceForeign R&D Centers in China, 2004

High-Tech Center Province Specialized IndustriesBeijing Beijing Computers, SoftwareChangsha Hunan Computers, SoftwareFuzhou Fujian ComputersGuangzhou Guandong Pharmaceuticals, ComputersHangzhou Zhejiang Semiconductors, PharmaceuticalsHong Kong Hong Kong Biotechnology, SemiconductorsHsinchu Taiwan SemiconductorsJinan Shangdong Communication SoftwareKao-Hsiung Taiwan SemiconductorsKunming Yunnan Biotechnology, PharmaceuticalsNanjing Jiangsu SoftwareShanghai Shanghai Semiconductors, PharmaceuticalsShenzhen Guandong Computers, PharmaceuticalsTai-chung Taiwan SemiconductorsTaipei Taiwan Computers, SemiconductorsTaoyuan Taiwan ComputersTianjin Tianjin Pharmaceuticals, BiotechnologyZibo Shangdong Pharmaceuticals

China – Six Economic Districts

Economic District Core CitiesPopulation (Millions)

GDP (US$ Bil.) Major Industries

North East 3 Provinces Dalian & Shenyang 107 119 Heavy Industries

Beijing & Tianjin Beijing & Tianjin 91 112 Software, IT

Shandong Qingdao & Yantai 91 104 Farming, Energy

Changjiang Delta Shanghai & Suzhou 138 234 Finance, Computers

Zhujiang Delta Shenzhen & Guangzhou 86 116 Electronics, Processing

Fujian Xiamen & Puzhou 35 48 Food, Electronics

China’s Top Exports

2003 2004 Percent(US$ Billions) (US$ Billions) Change

Electrical Machinery & Equip. 89.0 129.7 45.8Power Generation Equip. 83.5 118.1 41.7Apparel 45.8 54.8 19.7Iron & Steel 12.9 25.2 96.0Furniture & Bedding 12.9 17.3 29.1Optics & Medical Equip. 10.6 16.2 53.6Footwear & Parts 13.0 15.2 17.4Toys & Games 13.3 15.1 13.6Mineral Fuel & Oil 11.1 14.5 30.2Inorganic & Organic chemicals 10.7 13.9 29.8

Commodity Description

China’s Top Imports

2003 2004 Percent(US$ Billions) (US$ Billions) Change

Electrical Machinery & Equip. 103.9 142.1 36.7Power Generation Equip. 71.5 91.6 28.2Mineral Fuel & Oil 29.3 48.0 64.2Optical & Medical Equip. 25.1 40.2 59.8Iron & Steel 25.6 28.4 10.9Plastics 21.0 28.1 33.4Inorganic & Organic Chemicals 18.7 27.8 48.4Ore, Slag, & Ash 7.2 17.3 141.0Vehicle & Parts 11.8 13.1 11.2Copper 7.2 10.5 46.3

Commodity Description

0201009998979695949392

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US$ Billions Percent Change, Year Ago

Value - LGrowth Rate - R

China - High-Tech Exports1992-2002

Scientists & Engineers in R&DTop 10 Countries by Per Mil. Population, 2003

Rank Country NumberPer MillionPopulation

1 Japan 648,778 5,0952 Finland 26,378 5,0593 Sweden 40,534 4,5114 Singapore 19,737 4,1405 Norway 18,811 4,1126 U.S. 1,201,233 4,0997 Switzerland 26,762 3,5928 Russian Federation 501,621 3,4819 Denmark 18,816 3,476

10 Australia 66,775 3,353

50 China 705,689 54572 India 167,414 157

0200

9896

9492

9088

8684

8280

2.2

2.0

1.8

1.6

1.4

1.2

1.0

25

20

15

10

5

0

-5

-10

Millions Percent Change, Year Ago

Science Research Workers - LGrowth Rate - R

China – Science Research Labor force1980-2002

GermanyJapan

U.S.U.S.+Japan+Germany

China

350

300

250

200

150

100

50

0

55

50

45

40

35

30

25

20

15

Thousands Percent

NumberPer 100,000 People

Engineering GraduatesBachelor’s Degrees, 2004

20032002

20012000

19991998

19971996

19951994

19931992

1991

100

80

60

40

20

0

-20

-40

Percent Change

China - LHong Kong - LTaiwan - R

China – Patent GrowthU.S. Patent and Trademark Office, 1991-2003

China – Patents Per 100,000 PeopleU.S. Patent and Trademark Office, 2003

Country PatentsPatents Per

100,000 PeopleU.S. 87,901 30.27Japan 35,517 27.92Taiwan 5,298 23.44Germany 11,444 13.89Korea 3,944 8.21U.K. 3,627 6.04Hong Kong 276 4.05India 341 0.03China 297 0.02World 169,028 2.68

20032002

20012000

19991998

19971996

19951994

19931992

19911990

10

8

6

4

2

0

Number

ChinaKoreaJapanU.S.GermanyIndia

Patents Per US$ Billion of GDPU.S. Patent and Trademark Office, 1990-2003

20032002

20012000

19991998

19971996

19951994

19931992

19911990

50

40

30

20

10

0

Number

ChinaKoreaJapanU.S.GermanyIndia

Patents Per US$ Billion of Industrial ProductionU.S. Patent and Trademark Office, 1990-2003

02010099989796959493929190

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100

0

100

95

90

85

80

75

Value Added, billions Employees, millions

China - Manufacturing

Manufacturing, Value Added (L)

Manufacturing Employment (R)

Note: SOE Reform Began

China - Manufacturing

02010099989796959493929190

500

400

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14.0

13.0

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Value Added, billions Employees, % of Labor Force

Manufacturing, Value Added (L)

Manufacturing Employment as a % of Total Labor Force (R)

Note: SOE Reform Began

0%

10%

20%

30%

40%

50%

60%

1997 1998 1999 2000 2001 2002 2003

China - Speedy Move Up Tech Ladder

HT / Exports

HT / Manufacturing

Share / Global IC

Share / Global R&D

China – Top 10 Car Manufacturers2004 Q1

Rank Car Manufacturing Company1 Shanghai Volkswagen2 First Automobile Group Volkswagen3 Shanghai GM4 Tianjin First Automobile Group Xiali5 Chang-An Automobile6 Guangzhou Honda7 Qi-Rui8 ShenLong Automobile9 Beijing Hyundai

10 First Automobile Group Automobile

China – Car Market Explodes2002-2003

Percent Change

2002 2003 2002-200312 32 166.7%

Production 3,250 4,440 36.6%Sales 3,249 4,370 34.5%Production 1,090 2,010 84.4%Sales 1,090 1,970 80.7%Exports 3.5 4.7 34.0%Imports 7.8 14.4 84.0%

Purchase Share of the World 5.7% 7.5% 31.6%

Trade (US$ Bill.)

Chinese Car MarketDomestic Car Manufacturing Company

Total Car (Thou.)

Passenger Car (Thou.)

China – Mobile Phone vs. Wired Phone2003-2004

Phone Market 2003 2004

Percent Growth

2003-2004Wired Phone Users 312.4 315.6 1.0%Mobile Phone Users 334.8 339.8 1.5%Wired Phone Per 100 People 24.9Mobile Phone Per 100 People 25.9

China – Mobile Phone Market2002-2003

Percent Change

Chinese Mobile Phone Market 2003 2004 2002-2003Production (Millions) 186.5 233.4 25.2%Sales (Millions) 178.4 230.4 29.1%Exports (Millions) 95.3 146.1 53.2%Users Share of the World 20.0%Production Share of the World 35.1%

China – Mobile Phone Market Share2004

Others26%

Motorola12%

Nokia12%Samsung

10%Ninbo Bird

10%

Konka6%

TCL Mobile8%

Sony Ericsson

3%Dbtel Technology

5%

Guanzhou Soutech

4%Amol4%

China – Mobile Phone Market Share2002 vs. 2004

2002

Chinese Brands

24%

Foreign Brands

76%

2004

Chinese Brands

37%

Foreign Brands

63%

Top 250 ICT* FirmsRanked by Employment Size

Rank Country Firms

Revenue, US$ Mill.,

2003

Net Income, US$ Mill.

2002

Employment, Thousands,

20021 U.S. 139 937,910 -99,184 3,5252 Japan 39 656,382 -20,603 2,3663 EU 33 535,484 -105,339 2,2964 Germany 5 153,213 -21,212 7525 France 9 98,636 -25,551 5006 U.K. 8 101,419 -44,991 3467 Korea 4 86,657 8,483 2818 Netherlands 3 42,492 -17,473 2179 Canada 7 41,073 -4,396 19310 China 3 29,556 7,083 192

OECD 228 2,306,194 -215,757 8,861Total 250 2,421,327 -205,404 9,422

*ICT: Information and Communication Technologies

China – Top Ten Corporations*By Total Assets

* Financial institutions are excluded

Rank Company Industrial Category Total Assets (US$ Bil.)

1 China Petroleum & Chemical Oil/Gas 386.22 China United Telecommunication Telecommunication 143.23 Baoshan Iron & Steel Co. Iron/Steel 60.34 Huaneng Power Intr Inc. Electric Utilities 48.75 China Southern Airlines Co. Airlines 38.96 China Eastern Airlines Co. Airlines 36.17 Sinopec Shanghai Petrochem Chemicals 25.48 Maanshan Iron & Steel Iron/Steel 22.99 Sichuan Changhong Electric Home Electronics 22.2

10 SP Power Development Co. Electric Utilities 21.1

China – Top Ten Corporations*By Market Capitalization

* Financial institutions are excluded

Rank Company Industrial CategoryMarket Cap (US$ Bil.)

1 Petrochina Co. Oil/Gas 82.32 China Petroleum & Chemical Oil/Gas 50.03 China Telecomunication Telecommunication 23.84 Huaneng Power Intr Inc. Electric Utilities 15.35 Baoshan Iron & Steel Co. Iron/Steel 10.46 China United Telecommunication Telecommunication 9.77 China Yangtze Power Co Ltd. Electric Utilities 8.98 Aluminum Corp of China Iron/Steel 7.89 Sinopec Shanghai Petrochem Chemicals 5.0

10 Semiconductor Manufacturing Electrical Comp. & Equip. 4.9

China – Top Ten Corporations*By Sales

* Financial institutions are excluded

Rank Company Industrial CategorySales

(US$ Bil.)1 China Petroleum & Chemical Oil&Gas 42.42 Petrochina Co Ltd. Oil&Gas 30.43 China Telecom Corp Ltd. Telecommunications 11.84 China United Telecommunication Telecommunications 5.85 Minmetals Development Co. Distribution/Wholesale 5.26 Baoshan Iron & Steel Co. Iron/Steel 4.47 Sinopec Shanghai Petrochem Chemicals 2.98 TCL Corp. IT Products 2.89 Sinopec Zhenhai Refining Oil&Gas 2.8

10 Huaneng Power Intr Inc. Electric Utilities 2.3

20152010200520001995199019851980

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20

0

Millions

China – Population of Young Adults Population of 20-24 Year-Olds, 1980-2015

China

India

Western Europe

United States

20152010200520001995199019801970

100

90

80

70

60

50

40

30

Percent

ManWomanTotal

China – Literacy RateAdult Literacy Rate, By Gender

China – Urban & Rural PopulationAs Percent of Total Population, 1950 - 2030

20302025

20202015

20102005

20001995

19901985

19801975

19701965

19601955

1950

100

80

60

40

20

0

Percent

Urban Population Rural Population

0200989694929088868482

70

60

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Percent

AgricultureManufacturing & ConstructionServices

China – Labor Force TransformationEmployment Structure, 1982-2002

Foreign Students in JapanBy Country of Origin

China, 64.7%

S. Korea, 14.5%

Taiwan, 3.9%

Malaysia, 1.8%Thailand,

1.5%

Other, 12.2%

Indonesia, 1.4%

(70,814 students)

(15,871 students)

(4,235 students)

(2,002 students)(1,641 students)

(1479 students)

(13,466 students)

Hong KongMexico

CanadaTaiwan

JapanKorea

ChinaIndia

80

60

40

20

0

Thousands

1

2

34

5 6

7 15

Foreign Students in the U.S.Rankings and Country of Origin

China + Taiwan + Hong Kong = 100,850

Table of Contents• Overview of Foreign R&D into China• Overview of China’s R&D • Case Study of Foreign Vendor R&D in China • The Outsourcing Trend

Foreign investment continues to flood into China

40.3 40.746.9

52.7 53.560.6

0

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70

1999 2000 2001 2002 2003 2004

US

D B

illio

nChina FDI Growth 1999-2003

Different waves of foreign investment

Outsourcing of Design & ‘True’ R&D

Software Outsourcingto China (mainly from

Japan)

‘Showcase’ R&Din China

Relocation of Production Capacity

to China

First wave: Relocation of production capacity to China

Beijing:Nokia JVEricsson JV

Guangdong Dongguan: Nokia Factory

Sichuan Leshan: Motorola Semiconductor JV Hangzhou:

Motorola System JV

Tianjin: Motorola WOFE

Dalian Ericsson JV

Nanjing: Ericsson JV

Shanghai: Alcatel JV

Suzhou:Alcatel WFOE

Relocation of Production Capacity

All major telecom equipment manufacturers have established manufacturing capacity in China to leverage the cheap labor in China and get closer to the local market

Second wave: ‘Showcase’ R&D

• Foreign vendors set up R&D centers in China in the late 90’s to meet the government’s requirement for technology transfer to the local companies

• Many of those R&D centers were “show” R&D, focusing on localization of software and customer services

• The R&D centers also help foreign vendors show their commitment to China and serve as good PR/GR

Symbolic R&Din China

Third wave:China as regional software outsourcing hub

Korea, 2%

Others,5%

Japan,67%

HK, 11%

Taiwan,4%

US, 11%

• Japan is China’s largest software export market representing over 60% of total export value.

• Outside Japan, demand from U.S. and Korea is likely to develop as the industry matures.

65%

15%

0%

60%

11% 10%

67%

13%

0.5%0.6%

16%11% 11%

2%

4%

0%

20%

40%

60%

80%

Japan HK US Taiwan Korea

2002 2003 2004

Mainland China’s Software Exports to Key Markets as % of Total Exports

China’s Software Export Breakdown in 2004

Software Outsourcing

Current wave:Outsourcing of design and ‘real’ R&D to China

Outsourcing of Design and ‘Real’

R&D to China

CompetitionCompetition • Increasing competition in the domestic market for items such as handsets is forcing foreign vendors to launch more models to capture market share.

• Foreign vendors have to rely on local design houses and ODMs for some products

ProductsProducts • A growing consumer electronics market is driving demand for outsourcing in China

• Foreign vendors have to design their consumers products here to better suit consumer demand

Local demandLocal demand • Domestic demand is an important long-term driver for R&D outsourcing in China.

• Manufacturers, such as Motorola and Nokia, wants to increase their R&D to better suit taste of local customers

Table of Contents

• Overview of Foreign R&D into China• Overview of China’s R&D • Case Study of Foreign Vendor R&D in China • The Outsourcing Trend

Background to China’s R&D• National high-tech initiatives – 1980s/1990s

– Spark Program (1986): S&T advances applied to agriculture– ‘863’ Program for High Tech R&D (1986): political initiative to gain technological parity

with West– Torch Program (1988): established 53 High Tech Development Zones (HTDZs)

including Beijing’s Zhongguancun corridor; offered state funding, loans, tax benefits– National New Products Program (1988): supported R&D in new high-tech products– National Science & Technology Diffusion Program (1990): support to SOEs to

commercialize R&D– National Basic Research Priorities Program (1991): Basic research initiative– ‘973’ National Basic Research Priorities Development Program (1997)

• Selected Legal Reforms – 1982 to Date– Trademark Law (1982, revised 1993, 2001, 2002)– Technology Contract Law (1987)– Patent Law (1984, revised 1993, 2000, 2001)– Copyright Law (1990, revised 2001)– Product Quality Law (1993)– Law on Promoting the Transformation of Science & Technology Achievements (1996)

Huawei and ZTE are creating a pool of talent for foreign vendors to tap

0

100

200

300

400

500

2001 2002 2003 2004

HuaweiZTE

Million USD

• ZTE is known as the “Huang Pu / Whampoa Military School” of handset engineers in China as the first domestic vendor to invest heavily in handset R&D

• Huawei currently has a 24,000-strong global workforce, with over 46% of these employees working in R&D.

• ZTE has about 22,000 employees, of which over 37% focus on R&D.• Huawei and ZTE invest about 10% of their annual revenues in R&D.

– In its IPO prospectus in 2004, ZTE committed to invest about 40% of proceeds, c. USD 140 million, in 3G-related R&D.

– In 2004, Huawei’s R&D expenditure totaled USD 480 million, up 25% from USD 385 million the previous year.

Annual R&D Spending

Balancing act: Self-confidence/internationalism vs. protectionism/nationalism

• Protectionist tendencies– Technology as leapfrogging tool– National security concerns– Call for government intervention / subsidies to assist

struggling vendors, research institutes– Examples:

• WAPI: Wireless LAN Authentication and Privacy Infrastructure (shelved in Apr 2004)

• China’s self-confidence / ability to operate on global marketplace

– Increasing weight of China in global market– Rise of homegrown vendors

• Equipment• Handsets

– Growth in private sector telecom, technology and media companies, driven by consumers, not government policies/direction

Table of Contents

• Overview of Foreign R&D into China• Overview of China’s R&D • Case Study of Foreign Vendor R&D in China • The Outsourcing Trend

R&D Focus of Selected Foreign Vendors• Focus areas include semiconductor design, mobile network

solutions, MMI technologies and software development

• Microsoft Research China, Beijing: One of 4 global research centers (est. 1998). Includes Advanced Technology Center (ATC) (est. 11/2003). Voice recognition is a key focus. Targeting 80 engineers and developers in its first year.

• Intel China Lab: application research and product development in Beijing, Shanghai and Shenzhen. Focus includes Human-computer interface (HCI) technologies, computer architecture, system software, assembly and translation technology and embedded system tools, wireless technology, others

• China investments total over €2 billion. Focus areas include speech & handwriting recognition, IPv6, location based services,multimedia technologies.

Selected wholly owned foreign R&D in China

Language processing, speech & handwriting recognition, pervasive computing, mobile computing, multimedia, and e-business technologies & solutions

$ 1.2 millionEquipment investment in last five years

BeijingIBM

Information technology study regarding computer, internet, distant access and Chinese-application related voice recognition

$ 50 millionBeijingIntel

Voice recognition, image and picture technology, Multimedia technology

$ 80 million BeijingMicrosoft

Semiconductor device and process modeling and simulation, chip design, advanced material research, software development, personal communication product design development, most advanced mobile communications network solutions, PowerPC application and development, man-machine interaction technologies in future hardware and software applications

$ 300 million BeijingMotorola

Technology HubsInvestmentsLocationCompanies

Selected wholly owned foreign R&D in China

Technology HubsInvestmentsLocationCompanies

Communication software: Access network, mobile system and consumer terminal

N.A.ShanghaiEricsson

Next generation(3G,4G) mobile communication, GSM top end application, Chinese voice recognizing/compounding, natural language processing, digital TV and PC application software and display tube basic technology

$ 500 millionIn future 5 years

BeijingPanasonic

Speech & handwriting recognition, mobile IPv6 technology, Mobile internet, Mobile locating, SCTP Protocol, ROCH & HSPA technology and multimedia

*Euro 2.3 billion

BeijingNokia

Chinese Language processing technology, OCR recognition and Voice recognition, IMT-2000 technology and LSI technology

$ 4.4 millionBeijingFujitsu

Nokia increased R&D activity in China to better service domestic demand in its largest market

Nokia’s 10 major markets by net sales

2002 EURm

2003 EURm

2004EURm

531748768Spain

1 3421,003884Italy

9251,886909UAE

570938Russia

7738051,091Brazil

5391,0621,364India

1,8492,2971,730Germany

3,1112,6932,261UK

2,8022,0132,660China

4,6654,4753,416USA

• China has overtaken UK and Germany to become Nokia’s No. 2 market and is in process of overtaking US

• Nokia has set up two R&D Centers in Beijing and Hangzhou respectively

• Beijing handset R&D will design 40% of Nokia’s new handset models launched globally.

• The number of employee in Hangzhou3G R&D center has increased to 500.

• Nokia is also in discussion with local handset design house Techfaith to outsource some low-end model design

Headquarters Manufacturing Subsidiaries

Technical and R&D Center

Beijing - China Headquarters- R&D Center- JV

Dalian Neu-Nokia JV

Hangzhou 3G R&D center

Dongguan Factory

Key Locations of Nokia in China

Motorola is the first mover in conducting real R&D in China

• Motorola is the 5th largest foreign company in China in 2004 in terms of revenue.

• Motorola is the 2nd handset vendor in China in 2004 with 14.1% market share.

• Motorola is the first foreign handset vendor who design handsets specifically for the China market back in 2001.

• Importance of Chinese market for Motorola– Revenue from domestic sales in China was

USD 4.67 billion in 2003.– Exported products totaled USD 4.09 billion in

2003.– Plans to increase the revenue to USD 10 billion

in 2006

Key Locations of Motorola in China

Headquarter Manufacturing Subsidiaries

Technical and R&D Center

Shanghai R&D Center

Suzhou IC Design Center

Hangzhou Mobile System JV

Sichuan Chengdu: -R&D center-Telecom Solution center

Beijing: - NEA Headquarters- Personal communication center and the headquarters of telecom solution

Sichuan Leshan: - Semiconductor JV

Tianjin WOFE

Ericsson is also increasing R&D in China

• Importance of Chinese market to Ericsson– Revenue from Chinese market

was RMB 15.8 billion and export RMB 7.4 billion in 2004.

• R&D– R&D staff planned increase to

600 in 2005 from 500 in 2004 – Plan to invest USD 0.5 billion

in R&D in China to expand market share

– Has also setup a global 3G system manufacturing center in Ericsson Nanjing.

Ericsson Has Strong Legacy in China’s 2G Market

Key Locations of Ericsson in China

Headquarter Manufacturing Subsidiaries

Technical and R&D Center

Shanghai Software R&D Center

Beijing: - China Headquarters- Beijing JV

Dalian JV

Nanjing Panda JV

Guangzhou JV

Consulting Co.

Chengdu R&D centerChengdu R&D center

Table of Contents• Overview of Foreign R&D into China• Overview of China’s R&D • Case Study of Foreign Vendor R&D in China • The Outsourcing Trend

Design houses and ODMs are helping domestic vendors to bridge the R&D gap

OS/Stack

Software

Hardware

IntegrationManufacturing Post ProductionChipsets

Base

Ba

nd

Des

ign

& C

odin

g

PCB

Layo

ut

Des

ign

& C

odin

g

Dis

trib

utio

n

Mar

ketin

g &

Bra

ndin

g

Test

ing

RF Su

b-Ass

embl

y

Des

ign

APP/MMI

Software

Exte

rnal

D

esig

n

Fina

l Ass

embl

y

ZTE

DaxianODM (such as Pantech)

SoutecDesign House (such as Cellon)

Chipset Vendors(such as TI)

Vendors can get products quickly into the market by outsourcing designs to ODMsand design houses

Profile of Key Design Handset Houses and ODMs

• PalmOne• T-Mobile• Verizon• Audiovox

• Siemens• Philips• Other domestic

handset vendors

• NEC• In discussion with

Nokia• Haier and other

domestic handset makers

Customers

• 900

• 800

• 500 - 600

R&D Staff

• Independent design house in China

• Plans for Nasdaq listing

• Contract manufacturer based in Taiwan

• Designer of handheld devices and smartphones

• Independent design house

• Spun off from Philips• Has big labs in China

and France

Key BusinessCompany

Techfaith

Software Outsourcing: China’s linkage with other Asian regions

• China to Japan:– Leading Chinese software outsourcing firms (i.e.

DMK and Sinocom) target Japan.– Japanese firms (i.e. NEC, Fujitsu, and NTT Data)

have established software development centers in China, which export software back to their corporate parent.

– Japanese companies have also made strategic investments and set up JVs in China. The JVs conduct software outsourcing primarily for Japan.

• China to Korea– Korea currently attracts limited software

outsourcing from China with most software development still conducted domestically. However, growth potential is significant as Korean companies seek to reduce costs to stay competitive.

• China to Hong Kong and Taiwan– Software outsourcing to Hong Kong and Taiwan

makes up a small share of China’s total industry, but Hong Kong firms in particular do outsource to China.

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Customer Linkages: Software outsourcing companies

• NEC Software, Nomura, Daiwa, HP, SUN, IBM, and Hitachi

• Leading Japanese vendors

• GE, IBM

• NEC, NTT Data, Hitachi, GE, Mitsubishi Electronics, Nomura Research Institute, and Fuji Xerox

Major Customers

• The largest independent software outsourcing company in Beijing

• DMK was the first Chinese company to pass the SEI-CMM Level 5 Assessment (March, 2003).

• DHC was ranked 1st in export value in China’s 2002 software exporters list

Market Position

• USD 33.7 million• 76% from software

outsourcing

• Almost all of DHC’s software revenues are from Japan.

• 92% of SinoCom’soutsourcing comes from Japan.

• Sinocom does BPO for Sun’s technical support (6% of total revenues).

• Focus on software outsourcing

• Primarily target Japan market

Key Business

• USD 14.7 million• 90% from software

outsourcing

• USD 12 million • 95% from software

outsourcing

2003 RevenuesVendors

DMK

Investment Linkages: Japan -> China Software outsourcing investments

• Company focuses on both SI activities in China as well as outsourcing for its parent company, NEC Japan.

• NEC Solutions, a recent consolidation of previous NEC SI and NEC CASS, has close to 1,000 employees

• The main function of the JV is to complete software projects outsourced by NTT Group in Japan.

• The JV has recently started looking at conducting SI activities for companies in China as well.

• NTT Data established a joint-venture subsidiary with DHC in Beijing, employing about 100 software developers.

• JV exports software back to Japan• Fujitsu conducts outsourcing activities through its local joint-venture subsidiary, Beijing Fujitsu Software (BFS), which was established with CS&S in 1992.

Investments Business Scope

China’s Growth and Challenges to It

Short- and Mid-Term Challenges: Growth, Productivity, and Employment

l Chinese and U.S. economies share a problem and an opportunity:

– rising labor productivity (LP)

l LP a problem in near-term: – employment growth = GDP growth - LP growth– corollary: for given GDP growth, the higher is LP growth,

the less is employment growth– China’s annual GDP growth (1998-2003) 8-9%, annual

LP growth ~7%: hence, job creation 1% of labor force ~ 7-10 million annually

l 7-10 million is appreciable, yet modest relative to total unemployed/underemployed ~ 168 million

Short- and Mid-Term Challenges: Growth, Productivity, and Employment

l LP also an opportunity: major longer-term contributor to economic growth and social progress, boosts wages, drives demand for labor, raises profitability of capital

l in longer-term, short-term tension between rising LP and increasing employment can be mitigated by appropriate policies – trimming swollen bureaucracy in China (and in U.S.!) might be

moderated in consideration that these jobs are relatively low-productivity yet socially valuable

– increasing investments in China’s health services and improving serious air and water pollution problems: enhance quality of life without much effect on LP

l GDP growth of, say, 7% with LP growth of 3% may be preferable toGDP growth of 9% and LP growth of 7%!

From Manufacturing to Innovation

1. Manufacturing Power

started in ~ 1985

2. Consumption Power

started in ~ 1995

3. Innovation Power

started in ~ 2005

Lower Manufacturing Cost

Greater Market

Lower R/D Cost

Three Major Reasons that Companies go to China

Driving Forces Behind the Innovation

- R/D Spending Increase Steadily

- Large Talent Pool Available

- Government Push

- Market Demand

R/D Expenditure in ChinaR/D Expenditures

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20,000

25,000

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Series1

- Growth rate >15% 2001-2004- 1.35% of GDP (greater than India and Brazil)- Will be Close to US today in about 15 years

Large Talents Pool Available

•More than 2200 University/College in China

•Graduate Students : - 326,000 entered in 2004 (MS/PhD ~ 4/1)

- 820,000 in school (MS/PhD ~ 4/1)

- graduated 151,000 in 2004 (MS/PhD ~ 5/1)

•College Students : - 4.47 million entered in 2004

- 13,335 million in school

- graduated 2,391 million in 2004

Backflow of Oversea Trained Talent Started

Government Push (Examples)

• 863 Project (Ministry of Science & Technology)

- Recommend by 4 Scientist and Signed by Deng Xiaoping in 1986

- National High-Tech R/D Program to Accelerate the High-Tech

Development to Boost Innovation Capacity

- Four Major Tasks : 1. Develop Key technologies for the construction of China’s

information infrastructure

2. Develop key biological, agricultural and pharmaceutical technologies to improve the welfare of the Chinese people

Government Push (Examples)

3. Master key new materials and advanced manufacturing technologies to boost

industrial competitiveness4. Achieve breakthroughs in key technologies for environmental protection,

resources and energy development to serve the sustainable development of the society

•211 Project (Ministry of Education)

- Build ~100 Reputable Universities for Knowledge Based Economy

in 21Centry; Started in 1995

- Funding Came from Central and Local Government ( ~US $ 2.2B)

- Focus on ~600 Key Areas :

New Technology (42%) & Basic Science (15%)

China Semiconductor Demand Outpaces Domestic Production

10%12%

29%

44%

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Production

Percent Demand Satisfied byDomestic Production

Market Demand (Semiconductor Example)

• > 10 Foundries & IDM Companies Established (e.g. SMIC, Grace, Huahong, Baling, STMicro-Hynix,ProMOS,

Powerchip)

• 13 FABs are set to be built in the next 3 years• Capable of backend IC integration and SW

development• Relatively low development cost, but increasing in

coastal cities• > 500 design companies established, most are small

to medium; many of them established via VC funding & joint venture; Eager to develop IPR& new products

Conclusions Conclusions

• China is into a new era transitioning from manufacturing focus to marketing driven and to innovation; They are certainly the new kid on the block on innovation

• Four major forces are behind this including R/D expenditures, large talents pool, government program push and market demands

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