As recently as 1996 IBM was the best-selling brand in the China personal computer market. However, Chinese manufacturers have surged ahead since then and analysts now doubt whether foreign vendors will be able to recover lost ground.
Beijing-based Legend Group is now the undisputed market leader. Its 17.9 per cent market share of unit shipments in the fourth quarter of last year was greater than the combined 15.4 per cent market share of the top three foreign vendors ?IBM, Hewlett-Packard.and Compaq. Founder (with a 3.9 per cent market share) and Great Wall (2.4 per cent) are also competing strongly.
Domestic firms surge
Other international vendors are also seeking to make their mark. Taiwan's top personal computer maker, Acer, wants to expand considerably its current one per cent share and expects the mainland to become its second largest market after the US over the next decade. Acer has recently built a large plant in Guangdong province, assembling computers and manufacturing motherboards. Apple Computer, which planned to launch its popular iMac PC in the second quarter of 1999, also has its eye on increasing market share.
For the time being domestic brands appear to have the upper hand. Overall, the top four local brands – Legend, Tontru, Founder and Great Wall – increased shipments by 65 per cent in the first nine months of last year. This compared with an increase of only 14 per cent registered by the top four foreign vendors.
Overall, Chinese brands captured 74 per cent of unit sales in 1998. Competition in the low-end of the market has been particularly fierce, with many household electronics firms launching PC products. About one-third of the market is held by ‘white boxes' or unbranded PC makers, typically priced 10 to 20 per cent lower than branded models. While a clampdown on imported components helped to narrow the price gap between branded and unbranded products last year, the downward trajectory of white box prices is now expected to resume.
Until now foreign vendors have relied on the power of their brand's reputation for quality and reliability, but there are signs that they are recognising the need to compete more keenly in price terms. The shift in strategy is influenced by the growth of the mid- and low-range PC markets where pricing is of greatest concern to users. The Ministry of Information estimates that China sales of PCs will rise 25 per cent this year to reach 5.1m units, with other groups forecasting 1999 growth as high as 35 per cent.
Earlier this year both IBM and Hewlett-Packard launched mid-range computers priced around US$1,000. IBM began the price war in March with its Aptiva home computer priced at Yn8,999 (US$1,080). In April HP followed with the introduction of its Brio range aimed at middle and low-end business users with prices beginning at just Yn7,999. A survey of 8,000 urban residents reported in China Electronic News in January revealed a median price of Yn7,000, which people thought reasonable for a home PC.
HP was reported to be directing the bulk of its 1999 Asia-Pacific marketing budget to China. In order to achieve a target of 100 per cent growth in PC sales, it planned to spend four times as much money on advertising as it did in 1998. HP was estimated to have spent about US$ l m on advertising in the first half of 1998 compared with US$1.81 m spent by Legend.
The China Electronic News survey revealed that newspaper advertisements were the most consulted form of information when buying a home PC. They were consulted by 31 per cent of respondents. Computer magazine adverts were important to 27 per cent of buyers, while word-of-mouth and exhibitions accounted for 18 and 14 per cent respectively.
Ms Marsha Wang of IBM China concedes that "domestic PC brands have certainly been bringing pressure to bear on international brands, especially price pressure." Mr. Daniel Suen, marketing manager at Hewlett-Packard China, also admits that his firm has still "not had a breakthrough with regard to domestic vendors."
A permanent loss?
Will price-cutting work as a strategy for foreign vendors? Mr Jared Peterson, China research director for IT and media research firm IDC, believes that foreign vendors will not be able to recoup losses in market share.
"The trend may flatten out but the advantages of local products are very strong in terms of distribution – a factor which is becoming increasingly the name of the game in the PC market, especially in low-value systems where prices are comparable with high-end TVs. The only way that foreign vendors could compete is by tremendous localisation," he says.
Dr Peng Fu of Advanced Forecasting-HuiCong (AFHC) is rather more upbeat about the prospects of foreign vendors. "They will be able to recoup these losses [in market shared to some extent, but not completely," he comments.
Localisation of channels is the key. "Many foreign vendors… [notably IBM and HP] have set up factories in China in order to reduce production costs and rearranged their channels to make them closer to their clients," Fu observes. More than 80 per cent of the 3.9m PCs sold in China in 1998 were made locally – including Chinese brands, clones and locally-made foreign brands. The proportion is expected to rise to 88 per cent by 2002.
"Domestic brands will lose their advantage over price and channel somewhat and foreign brands may win consumers by their high quality and reduced price, but domestic brands will still maintain advantages on price," adds Fu.
HP's Suen believes his firm's recent price cuts will be the start of a new phase in the China PC market: "We are a reputable brand with an aggressive pricing level, in a market where not all local vendors will be able to cut prices," he comments. "The market is becoming more and more 'commoditised.' In the past foreign vendors had better quality but the differential is becoming less and less." HP's Shanghai PC manufacturing facility was reported in early 1999 to be gearing up to achieve a production level of 50,000 to 60,000 units a month.
Peterson of IDC agrees that the reliability gap is narrowing. “It’s not that difficult to make a computer and many are made up of the same stock components,” he comments. “In some cases the fact that the packaging may be rougher is the only real difference between local and foreign vendors.”
Hewlett-Packard also plans to enter the home PC market later this year, a sector where price competitiveness is particularly important. A recent AFHC survey reveals that more than half of home PC users have a monthly income level of between US$120 and US$361. This puts into context the Peterson of IDC agrees that the reliability gap is narrowing. "It's not that difficult to make a computer and many are made up of the same stock components," he comments. "In some cases the fact that the packaging may be rougher is the only real difference between local and foreign vendors." extent to which a PC costing US$1,000 is a considerable outlay for such families. But with home PCs now exceeding 30 per cent of total PC sales, the market is reaching a critical lift-off phase and is one which major vendors cannot afford to ignore.
While domestic manufacturers have so far concentrated on low-end products, they are keen to position themselves for the expected lift-off of the internet in China this year. The number of internet users doubled in the final five months of last year to reach 2.1m by January and could hit 10m by the year-end.
Legend targets the internet
Legend launched its first modem at the end of last year and has also developed a new generation of home PCs with multimedia and online translation functions. In March the firm agreed to work with Microsoft, the US software giant, to make internet access available via television sets. Production of set-top boxes, fitted with Microsoft's Venus software, is expected to begin in the second half of this year. One Chinese internet service provider was reported in April to be offering a free multimedia PC in return for signing up for a three-year period – hoping to attract at least 100,000 customers.
But some believe that Legend could be vulnerable to a price war. The Chinese computer company posted relatively modest profits last year of US$26.3m, with average profit margins of less than three per cent. Devaluation of the yuan could have a significant impact on the firm whose computers, analysts believe, are 60 per cent made up of imported components. The company also has considerable foreign currency debts which would be exacerbated by a devaluation. The company hopes to address its exchange rate risk by developing more components in-house as well as exploring new export markets.
Despite thin margins, Legend has responded to Hewlett Packard and IBM's price-cutting. It cut the price of its mid-range Tianhe 640 by Yn2,000 to Yn15,000 (US$1,800) while introducing price cuts ranging from 10 to 13 per cent on its home computers which are priced at Yn8,000 upwards.
Another key factor in capturing market share is distribution, an area where domestic brands are also believed to hold an advantage. "If you just use your own chain, the number of cities you can cover is very limited," says HP's Suen. "Legend's wide coverage is due to its large number of branch offices which allow it to manage a very large number of resellers."
Legend, which was floated on the Hong Kong stock market in 1994, is now aiming to achieve 20 per cent market share this year. It boasts a distribution network of around 200 service centres, which is crucial in being able to provide after-sales service. About 60 to 70 per cent of Legend's customers buy their computer to further their children's education. Many of these parents have little idea how to use a computer, let alone install software or deal with problems that may arise.
But the way is not blocked for foreign vendors to catch up with domestic competitors, says AFHC's Fu. "Theoretically, foreign brands are very likely to be able to close the gap in distribution networks."
IBM is developing an extensive distribution network, he argues, consisting of around 70 first-tier distributors, and value-added retailers supported by more than 300resellers and 70 speciality stores. For business desktop and the Aptiva home PC series, users are able to purchase directly from IBM. IBM's Wang claims that the number of domestic distributors will exceed 700 during 1999. At the same time it is paying attention to overseeing the training of distributors and managing price competition between them.
Tuning into channels
Suen describes distribution as one of HP's core strengths. "Unlike Singapore or Hong Kong you cannot cover the market from one or two distribution points, you have to develop good channel partners. We are also looking for channel competency, resellers that are able to add value in terms of services, solutions, applications and software."
Meanwhile Compaq has tackled logistical problems in getting its PCs to market by splitting its channels into two groups. One handles value-added resellers that sell to large enterprises while the other handles consumer sales.
Dell Computer is trying to develop a direct sales approach to distribution. While it accounted for only 1.2 per cent of the China PC market in the fourth quarter of 1998, Dell claims to have achieved a more than 200 per cent growth in sales in the first quarter of this year.
"Dell is not only the manufacturer, it is also the distribution channel," says Dell vice chair-man Kevin Rollins. "We can cover 15 major cities and 80 secondary cities, which gives us access to about 90 per cent of the market coverage in China."
Dell established manufacturing and customer service facilities in Xiamen last November and is concentrating on marketing its Dimension XPS T series aimed at home and small business customers.
But whatever the claims of individual vendors, "it is tricky to develop successful channels and nobody has the patent on the perfect channel," comments Peterson. "Manufacturers spend most of their time on channel development."
In addition, security systems of international brands tend to be better than those of domestic vendors, stresses Fu, who believes that this will continue to give them an edge in competing for custom from enterprises and professional users.
"Banks often tend to buy foreign brands, but also the prestige factor of a foreign brand such as IBM can be attractive to domestic users," says Peterson. Corporate buyers are still extremely important customers, and finance firms accounted 32.2 of the overall IT spend in 1998, according to IDC.
He believes that foreign vendors will continue to be competitive in PC servers, note-books and the high-end corporate segment of the PC market. Marsha Wang of IBM notes that the market share of the IBM Netfinity server has exceeded 35 per cent.
Compaq is also competing strongly here. In April the firm signed an agreement with seven government ministries and departments including the Foreign Ministry, the Ministry of Labour and the Ministry of Science and Technology. Seven PC servers were supplied free as part of the agreement. Late last year HP launched the Jornada 428, its first hand-held computer specially designed for Chinese language speakers.
Growing services market
While the high-end market is usually characterised by higher profit margins, this is less true in Chiria. The average selling price of a PC server on the mainland was US$3,800 in 1998 compared with US$4,100 in the rest of the region.
IT services is another rapidly growing sub-sector where foreign computer firms may be able to compete. PC hardware sales reached US$12.31 bn in 1998, accounting for 85.9 per cent of China's total IT market, compared with services turnover of only US$845m. But the value of IT services grew by 50 per cent in 1998, well above the over-all market growth of 27.8 per cent predicted by IDC for the 1998-2003 period.
"Guarantees are quite liberal, but in some cases manufacturers might not be able to live up to their promises," says Peterson. The top brands have a similarly high level of service, he adds, but quality in the second tier is less good.
AFHC's Fu also believes that localising. support services will become increasingly important as foreign brands battle for market share. IBM has been doing well here and he describes its `Blue Express' service package as "very effective and impressive". Blue Express is a distribution joint venture which IBM set up in partnership with the Ministry of Railways in 1995. IBM holds a majority stake.
IBM's Wang also highlights the firm's focus on software developed in partnership with Lotus, such as ViaVoice voice recognition technology. In this sense she believes that IBM's strategy is "totally different from those domestic PC manufacturers who only reduce price to expand their market shares." IBM's PC 300GL series, which incorporates voice recognition technology, was launched on the China market in April 1999.
IDC's Peterson believes that the impact of the recent price cuts should not be overstated. "It's part of the process of continual price-cutting. It's not going to make a tremendous difference – the local vendors can match these prices and go much lower," he says.
The ability of foreign vendors to leverage economies of scale based on their global networks is limited by market barriers such as import tariffs. Many computer products are subject of 15 per cent tariffs as well as being liable to 17 per cent value-added tax. The cost of VAT cannot be reclaimed and so must be passed on to end-consumers.
But that is not to say that China accession to the WTO would knock back domestic vendors. Import tariffs on computer products have already been coming down throughout much of the 1990s. In early 1999 Legend denied that it would be much affected by WTO-entry, claiming that it and other domestic vendors had already coped with the effect of tariff reductions. It also claimed that foreign computer makers with China-based manufacturing were operating on a level playing field with domestic firms.
One thing is for sure – the IT market in China is too large for international vendors to ignore. IDC data revealed China to be the fifth largest buyer of personal computers in 1998 after the United States, Japan, Germany and Britain and could expand to feature in the top three by 2002.
Compaq shipments hit by corporate restructuring
Compaq has been finding it tough to raise its market share. Indeed IDC figures show its PC shipments falling 16 per cent in 1998 when the market grew at more than 30 per cent. Its market share fell from 6.7 per cent to 4.3 per cent over the year.
Analysts believe that part of the problem was caused by restructuring made necessary by Compaq's absorption of Tandem and Digital in the last two years. In addition a crackdown on smuggling is believed to have cut the number of Compaq computers brought into China through ‘grey channels' at a time when the firm's mainland-based manufacturing from its Shenzhen plant was suspended. The closure followed Compaq's merger with Digital.
The Shenzhen plant resumed operations in March and the firm plans to invest more than US$30m in the e-commerce and systems integration sectors in the next two years. It has recently received government approval to set up a China-based holding company.
Compaq denies a slump in its China business. Mr. Henry Tse, managing director of Compaq China, points out that shipments of Compaq's PC servers and portable notebook computers grew 44 per cent and 146 per cent respectively in 1998. The firm's high-end Armada family of notebook computers was launched on the mainland market in April. IDC figures, he says, showed Compaq PC servers ranking second in terms of market share, while its sales of notebook computers climbed from fifth rank in 1997 to third last year.