CHIPS: China Repeats Flawed R&D Model With Qualcomm

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Bottom line: China should abandon its model of trying to develop proprietary technology through government-backed initiatives, and focus instead on supporting leading private companies like Huawei to develop such products.

Qualcomm JV developing special server chip for China

China has started down a familiar but flawed path to creating its own cutting edge-technology, with reports last week that a joint venture backed by US telecoms giant Qualcomm (Nasdaq: QCOM) is developing a special microchip for the China market for use in computer servers that power the Internet. The effort looks strikingly similar to previous ones that typically saw China work with big foreign companies to develop technologies to compete with existing global products and standards.
Foreign companies often agreed to such efforts to maintain access to the huge China market and win favor with Beijing, even though the technologies they created were often redundant and inferior to western-developed counterparts. Such efforts mostly resulted in billions of dollars of wasted investment for products that nobody wanted and were later quietly retired.

China’s desire to become a leading developer of global technologies is understandable, since such technologies often bring big licensing fees from makers of products like smartphones, PCs and networking equipment. But rather than resort to this kind of strong-arming model that often results in failure, China should continue its separate, more forward-looking approach of supporting the creation of private sector leaders that take a more market-oriented approach to developing new technologies.

Qualcomm is the world’s leading maker of chips used to power smartphones, and has a near monopoly on the high end of the market. That fact, combined with some unconventional licensing practices, led many of China’s smartphone makers to complain to Beijing about high prices and unfair business tactics. As a result, one of China’s anti-trust regulators last year levied a record fine of nearly $1 billion on the company and ordered it to change its ways. (previous post)

In a bid to improve its image after that conflict, Qualcomm established a joint venture early this year to make server-based chips with the local government in Guizhou, one of China’s poorest provinces in the interior southwestern. Now a Qualcomm executive has disclosed that the new joint venture will develop a new type of server chip just for China, the world’s biggest Internet market with around 700 million users. (Chinese article)

The special made-for-China chip will be for servers used to host web sites, and is being optimized for enterprise data storage and use in data centers. The Qualcomm executive, President Derek Aberle, pointed out the venture decided to make the special chips because requirements for servers in China are higher than those for ones used in the United States and other western markets.

Massive China Market

The costly process of developing such special “made for China” chips is economically feasible due to the market’s large size, theoretically guaranteeing a major customer base for such products. But history has shown that such products are often only reluctantly embraced by domestic manufacturers, who would usually prefer to buy western-developed products that are often more mature and reliable.

Previous examples of problematic made-for-China technology exist in a number of areas, including PC operating systems and wi-fi equipment. One of the most high-profile cases involved the 3G wireless standard known as TD-SCDMA, which was developed in China in partnership with Germany’s Siemens (Frankfurt: SIEGn).

But problems with the technology due to its newness caused TD-SCDMA to remain largely unused. The only major carrier to adopt the standard was China Mobile (HKEx: 941; NYSE: CHL), which only did so reluctantly after being ordered by China’s telecoms regulator. Even then, China Mobile only half-heartedly promoted its problem-prone 3G network, resulting in billions of dollars in wasted investment for technology that was never widely adopted outside of China.

While it’s too early to say if the new Qualcomm chips will follow a similar fate, the historical odds certainly aren’t in its favor. Instead of employing this kind of government-led approach, Beijing should stand back and let its vibrant and more commercially-focused private sector do the job of developing such new technology. It could assist in that effort by promoting these companies with policies like grants, subsidies and other incentives to reward innovators that create successful new technologies.

A strong example of that approach is homegrown telecoms giant and leading innovator Huawei, which was nurtured with preferential policies in China’s oldest special economic zone of Shenzhen, and has gone on to become a global powerhouse in networking equipment and smartphones. That prowess was on display just last week when Huawei sued global heavyweight Samsung to protect its intellectual property, demonstrating the success that China can enjoy when the government provides indirect incentives for domestic private companies allowed to operate independently.

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