China’s Evolution: From Sweatshops to Innovation

Two stories relating to technology and China prompted some dark thoughts, not that I need much help on that front.

First, I read the story about the deplorable working conditions and objectionable treatment of workers who manufacture peripherals and other PC hardware for Microsoft, HP, and other technology mainstays. That item tells us a lot about the China of today, the China whose contract manufacturers have attracted Western patronage with low costs predicated on cheap labor and a lax regulatory regime.

It’s unconscionable that such manufacturers treat their employees so abysmally, but, as Paul Thurrott writes, nothing is likely to change. Microsoft HP, and others will continue to manufacture in China, occasionally dealing with dubious contract-manufacturing partners, as long as the cost of producing goods in China remains low and helps to fatten profit margins.

Corporations are abstract entities, not individual human beings. A corporation, especially one on the public markets, doesn’t think, breathe, feel, or have a conscience. It functions as an amoral business entity, for the purposes of growing revenue, boosting profits, and producing a return on investment for shareholders. As they say in the mob movies, it’s nothing personal, it’s just business.

But the thing is, China won’t always be the place it is today, which brings me to the other story I read, online at the Wall Street Journal. In that piece, John Deng, chairman of Nasdaq-listed Vimicro, makes a convoluted and unconvincing argument that regulatory and other barriers to foreign firms operating in China will somehow be beneficial to worldwide innovation.

I’m not sure I follow his sashaying, weaving logic, but he makes other points that are less disputable. He points out, for instance, that innovation in China heretofore has been done “through collaboration,” in which Chinese companies (like the aforementioned contract manufacturers) have adhered to U.S. and international standards and built business models on the modest foundation of low labor and environmental costs rather than on the elevated pedestal of high-value innovation.

Citing Huawei and Lenovo as examples, he says the situation is changing. Just as Japan and South Korea outgrew their humble manufacturing origins and became innovation powerhouses, Deng sees a similar but even bigger evolution for China. Unlike those countries, China can leverage unique attributes (namely its size, power, and influence) to set its own technological standards. Deng believes it should do just that to encourage the development and growth of indigenous technology companies.

He’d also like to see China get better at commercializing university research and development. He also would like the country to develop improved legal protections for intellectual property.

In China’s earlier (still current) stage of industrial development, the defense of intellectual property wasn’t a priority for the country’s leaders. With most of the innovation being brought into the country by foreign companies — and technology transfer, from Western to Chinese companies, being the strategic imperative — China and Chinese companies weren’t as concerned with the unassailable integrity of intellectual property.

As China innovates, and develops competitive differentiation and business value from those efforts, Chinese companies and authorities will have a newfound appreciation for intellectual property. At that point, China will enact legal and regulatory reforms that will strengthen protections for intellectual property. By then, though, China will have more to protect, and more to lose.

If one views the evolution of China in this context, the country looks like the ultimate honey trap for Western technology concerns. Western companies could not resist what the country offered — low-cost manufacturing operations and a vast market for commodities and consumer goods. Even though these foreign companies knew that doing business in China entailed significant risks, including the loss of valuable intellectual property, they took the plunge because their greed outweighed their fear, the temptation was too great.

In the future, we probably won’t see many stories about execrable working conditions at Chinese contract manufacturers. At some point, low-cost manufacturing sweatshops will move elsewhere, and the bad news coming from China will be on a different scale entirely.

Microsoft’s Consumer Groundhog Day

In so many respects, Microsoft has become its worst enemy. Just consider what’s happening with its overlapping, somewhat contradictory moves with Kin and Windows Phone 7 Series (WP7S).

The two efforts overlap because they both are targeted at consumer demographics. They conflict because they’re built on different platforms. For observers, and presumably consumers, the result is cognitive dissonance, particularly as it pertains to understanding what Microsoft thinks consumers should buy.

Should Microsoft be playing to its weakness, tackling Apple and the iPhone on its own consumer-cool turf? It doesn’t seem wise, does it? Microsoft’s consumer brand isn’t exactly imposing. Very few people not employed directly or indirectly by the company could argue, with a straight face, that Microsoft has an intrinsic feel for the consumer zeitgeist.

Microsoft doesn’t suffer only from an errant appreciation of consumer sensibilities, though that problem is irrefutable. It also is afflicted by a lack of corporate self-awareness: It doesn’t know that it doesn’t know about consumers.

As Microsoft’s executives took to the stage and to the airwaves to tout Kin, I was alternately amused and appalled at how maladroit they seemed in attempting to connect with the social-networking youth market that they perceive as Kin’s sweet spot. Microsoft seemed an aging, leering, out-of-touch lothario hitting a dance club for the first time in decades, trying too hard to sell itself to an audience with which it does not have a natural affinity.

Maybe I’m wrong, and maybe the Kin will find a niche, one big enough to satisfy its corporate masters. But Microsoft’s past performance and initial portents aren’t auspicious.

Meanwhile, I wonder, as do others, about whether Microsoft’s fixation on getting back in the good graces of mobile consumers might cost it whatever patronage it retains in the mobile enterprise. That’s a market segment Microsoft ought to understand, one in which it can leverage assets and strengths many of its competitors don’t possess. But the company’s commitment has wavered, it has failed to execute too many times with diminishing returns from successive iterations of Microsoft Windows Mobile, and now the focus seems completely lost.

That can only be good news for RIM, which, like Microsoft, has a difficult time figuring out the mobile-consumer space and how the younger generation swings. Unlike Microsoft, though, RIM is disinclined to surrender a mobile bird in the hand for one in the bush.

There’s also a good chance that Google is watching intently as Microsoft’s middle-age crisis plays out. Google has enterprise ambitions that encompass mobility and smartphones, and it has a growing ecosystem that can help it exploit chinks in the Microsoft armor.

With the Kin and Windows Phone 7 Series moves, Microsoft might think it has arrested its chronic mobile decline.

But what are they thinking? I realize past performance isn’t a guarantee of future results, but what has changed at Microsoft to lead its executive team (or us) to believe that somehow this time, in this particular foray into the consumer realm, it will be different?

Juniper’s Prudent Ankeena Play

A few commentators have opined that Juniper’s recently announced acquisition of Ankeena Networks was a me-too play, a means for the company to catch up with Cisco Systems in video-delivery infrastructure for mobile and wireline networks.

There’s an element of truth to that assessment, but that’s why I like the deal, said to be valued at less than $100 million. This wasn’t a speculative, damn-the-torpedos, high-risk acquisition, pursued by a vainglorious executive team intoxicated by delusions of grandeur.

To the contrary, this deal fills an identifiable gap in Juniper’s solution portfolio, provides software-based value that enhances the JUNOS profile, and responds to actual customer requirements relating to cost-effective, reliable, scalable, and high-quality video delivery. What’s more, the companies had a prior JUNOS-based technology partnership, giving Juniper added confidence that the deal would work.

Finally, the price was right. Juniper could derive considerable long-term benefits from ownership of Ankeena’s video-delivery software, and the price it’s paying for that opportunity is not prohibitive. The downside to the deal, presuming post-acquisition integration sputters and Juniper fails to leverage what Ankeena offers, is not debilitating, though Juniper is motivated to make this deal work.

This transaction looks like a tuck-in acquisition for Juniper. Risks have been mitigated, and the upside is promising.

Might Huawei Consider Extreme Acquisition?

It’s Friday, and I’m in an expansive mood. Speculation is in the air.

Extreme Networks is going through some difficult times, with executive overhauls, layoffs (reportedly still continuing), and stiff competition that figures to intensify now that HP is bringing 3Com under its corporate roof.

Fortunately for Extreme and its shareholders, the company’s acting CEO, Bob Corey, has an interesting track record. When he’s at a company, it tends to be acquired. Here’s some of Mr. Corey’s history, as recounted late last fall by Eric Savitz at Tech Trader Daily:

*Corey was CFO at Thor Technologies when it was acquired by Oracle in 2005.

*Corey was chairman of Interwoven when it was acquired by Autonomy in March 2009

*Corey was CFO at Forte Software at the time it was acquired by Sun Microsystems in October 1999.

*Corey was CFO of Documentum, until about a year before it was acquired by EMC.

Moreover, according to a Schedule 13D SEC filing last month, the Cowen Group’s Ramius LLC and its subsidiaries obtained significant stakes in Extreme. Not much has been written or said about this transaction, but it warrants attention.

Finally, we know Huawei would like to make acquisitions in the U.S. Recently, Huawei is said to have expressed interest in acquiring Motorola’s network-infrastructure unit. In connection with that bid, and perhaps others, Huawei reportedly has broached a “mitigation agreement” with the U.S. government, similar to the pact Alcatel signed when it acquired Lucent. The objective of the agreement would be to allay American concerns relating to national security.

In the past, Huawei’s acquisitive ambitions in the U.S. have been thwarted on national-security grounds. The Chinese networking company, alleged to have close ties with China’s defense and intelligence agencies, saw its bid for minority ownership of 3Com frustrated a few years ago when Bain Capital was discouraged from pursuing the deal by the U.S. government.

If Huawei can satisfactorily address the national-security concerns of the Obama Administration, it would be able to pursue not only an acquisition of Motorola’s network-infrastructure unit, but of other U.S.-based networking vendors, too.

Extreme might be a logical candidate. The company is available, it has a product portfolio of interest to Huawei (which wants to strengthen its enterprise offerings to counter HP/3Com and Cisco in China and elsewhere), and it has intellectual property (patents) that Huawei might find attractive.

Sure, Extreme has lost a lot of engineering talent in Silicon Valley during its recent struggles. But Huawei doesn’t need engineers. It has plenty of those in China.

While this post is entirely speculative, I would not be surprised to see Huawei make an enterprise acquisition. Extreme wouldn’t be the only option available to Huawei, but it would probably be the easiest to execute in terms of regulatory constraints and integration challenges.

MOFCOM Approves HP’s 3Com Acquisition

Hewlett-Packard Co. yesterday received approval from China’a Ministry of Commerce (MOFCOM) to proceed with its acquisition of 3Com.

As stated in an SEC filing by 3Com, MOFCOM’s approval was the last of the required regulatory hurdles the acquisition had to clear. The parties expect to close the transaction on or about April 12, 2010. HP is expected to make a formal announcement on that date.

Just after 3Com filed its notice with the SEC, Standard & Poor’s said NewMarket Corp. will replace 3Com on the S&P MidCap 400 index.

Fascinating History Behind Huawei’s China Threat to 3Com

Before I dig into the meat of this post, I want to make one thing clear: I have nothing against 3Com. I don’t “hate” the company, as one commenter once charged, nor do I have any personal animosity toward those who lead it.

3Com is an interesting story, though. It’s a company that began its existence as a networking pioneer, an early innovator, and a classic American success story. Over time, it changed tack and reinvented itself repeatedly, variously targeting SMB markets, the enterprise (more than once), consumers, and even mobile devices (it owned Palm for a short time after its acquisition of U.S. Robotics in 1997).

Lately, 3Com has become primarily a Chinese vendor, though it retains an American facade. It made the transformation as a result of its now-defunct partnership with Huawei, a Chinese network-equipment vendor that has grown into a market leader worldwide as a purveyor of wireless-network gear.

What happened during the 3Com-Huawei partnership, which spawned a joint venture called H3C (Huawei-3Com), is fascinating. 3Com might be a microcosm of wider change occurring throughout the technology industry, as the tectonic plates of economic opportunity shift from west to east.

At the time the H3C joint venture was formed, I thought Huawei would get the better of the deal, learning what it could from the American company before moving on to its next conquest. That wasn’t exactly what happened, though.

While Huawei clearly benefited from the relationship, 3Com did, too. Before the H3C partnership, 3Com was adrift, seeking to reinvent itself yet again. The Huawei lifeline came just in time, and it gave 3Com a new lease on life.

After the relationship ran its course when the U.S. government discouraged Bain Capital from pursuing an acquisition of 3Com, with Huawei as a minority stakeholder, 3Com bought out Huawei’s 49-percent stake in H3C. That gave 3Com a Chinese presence, not only government and enterprise customers, but also a large engineering team that gave it a means of developing a broad portfolio of standards-based, cost-effective networking gear that could be sold not only in China but worldwide. 3Com’s “China-out” strategy was formulated, ultimately leading to where it finds itself today.

3Com’s presence in China, and particularly its engineering team, made it attractive to HP, whose pending acquisition of the company awaits approval from China’s Ministry of Commerce (MOFCOM).

Past is prologue, which is why I provided the foregoing historical overview. Now, let’s look at what’s happening how.

3Com filed its quarterly 10-Q with the U.S. Securities and Exchange Commission (SEC) yesterday. There are accounting changes, references to unresolved litigation, and mention of acquisition-related costs and a potential termination fee ($99 million) that could be incurred if the HP deal is derailed; but arguably the most compelling part of the document is a discussion of the competitive threat posed by Huawei.

The reference to Huawei comes just after 3Com’s cites risks related to sales in China. 3Com says: “We are significantly dependent on our China-based segment; if it is not successful we will likely experience a material adverse impact to our business, business prospects and operating results.”

The context here is that 3Com sales through Huawei in China are plummeting, and 3Com is being forced to compensate for the revenue erosion. It’s having a difficult time offsetting the lost revenue, as Huawei not only stops selling 3Com’s H3C gear but sells gear of its own into H3C’s installed base.

Quoting from the 10-Q:

In China, we face competition from domestic Chinese industry participants, and as a foreign-owned business may not be as successful in selling to Chinese customers, particularly those in the public sector, to the extent that such customers favor Chinese-owned competitors.

We expect that a significant portion of our sales will continue to be derived from our China-based sales region for the foreseeable future. As a result, we are subject to economic, political, legal and social developments in China and surrounding areas; we discuss risks related to the PRC in further detail below. In addition, because we already have a significant percentage of the market share in China for enterprise networking products, our opportunities to grow market share in China are more limited than in the past. Our China-based sales region has experienced growth since its inception in part due to the growth in China’s technology industry, which may not be representative of future growth or be sustainable. We cannot assure you that our China-based sales region’s historical financial results are indicative of its future operating results or future financial performance, or that its profitability will be sustained or increased.
Given the significance of our China-based sales region to our financial results, if it is not successful our business will likely be materially adversely affected.

If, as expected, Huawei Technologies, or Huawei, continues to significantly reduce its business with us, our business results will be materially adversely affected if we cannot increase other business to offset the decline.

We historically have and currently derive a material portion of our sales from Huawei, which formerly held a significant investment in our H3C subsidiary. In the three months ended February 26, 2010, which includes results from our China-based sales region’s December 31, 2009 quarter, Huawei accounted for approximately 7 percent of the revenue for our China-based sales region and approximately 4 percent of our consolidated revenue. Huawei’s percentage of our China-based sales region’s revenues has been trending downward from 46 percent during the 3 months ended November 30, 2006, to the current level. This decrease has been accelerating. We expect Huawei to continue to reduce its business with us and we believe that its purchases in absolute dollars will likely continue to decrease significantly. Huawei does not have any minimum purchase requirements under our existing OEM agreement, which expires in November 2010. We believe Huawei has begun to sell, and likely will continue to sell, internally-developed networking equipment with respect to some of the products it formerly purchased from us. We further believe Huawei also has access to other networking equipment vendors that sell products comparable to our solutions. If and to the extent any of these events occur and/or continue, it will likely have an adverse impact on our sales and business performance. In order to minimize any adverse impact on our results from any decreased sales to Huawei, we need to successfully execute on our business strategies including, without limitation,

More on Huawei follows subsequently:

As Huawei expands its operations, offerings and markets, there could be increasing instances where we compete directly with Huawei in the enterprise networking market. As a significant customer of our China-based segment, Huawei has had, and continues to have, access to H3C products for resale. This access enhances Huawei’s current ability to compete directly with us both in China and in the rest of the world. We risk competition from enterprise products that Huawei internally develops and markets or sources from our equipment manufacturer competitors. Huawei has historically sold our networking products to carrier customers (who purchase for themselves and their own enterprise customers). We believe Huawei sells internally developed products to meet carrier demand for these products and it is possible Huawei may also use these products to market and sell more directly to enterprise customers in the future. Huawei is not bound by any contractual non-competition obligations with us. We also sell carrier class products in China through our direct-touch sales force in competition with Huawei and other carrier market equipment providers.

Huawei maintains a strong presence within China and the Asia Pacific region and possesses significant competitive resources, including vast engineering talent and ownership of the assets of Harbour Networks, a China-based competitor that possesses enterprise networking products and technology. We cannot predict the extent to which Huawei will compete with us. If Huawei increases its competition with us, or if we do not compete favorably with Huawei, it is likely that our business results, particularly in the Asia Pacific region and specifically in China, will be materially and negatively affected.

Habour Networks, the Huawei-owned enterprise-networking company mentioned above, isn’t a household name in the West. In China, though, it was a formidable competitor before Huawei acquired it in 2006, at about the time Huawei was considering divestiture of its 49-percent stake in H3C. Harbour had been started by former Huawei executives and engineers, looking to replicate the best practices of their former employer. Some contend it had originally been intended as a “spin-in,” but conflict between the companies ensued, complicating matters.

In 2005, prior to the acquisition, Huawei warned Harbour that it was considering litigation related to alleged IPR infringements. The acquisition, said to be valued at approximately $212 million, negated the need for lawsuits and also gave Huawei a vehicle to compete against its soon-to-be-former joint venture with 3Com.

Siemens apparently had discussed an acquisition of Harbour before Huawei’s successful bid. At the time of the purchase, Warburg PIncus was said to be Harbour’s largest shareholder.

3Com’s sales in China are under full-frontal assault from Huawei and other indigenous Chinese vendors. Many of 3Com’s Chinese customers are government agencies and departments, and they will — following China’s “indigenous innovation” dictates — favor Chinese vendors when they make purchase decisions.

Before the HP acquisition, 3Com could claim to be more Chinese than American, hence having a fighting chance of retaining favor in key accounts targeted by Huawei. Now, though, as the property of HP, 3Com’s loss of business in China is likely to accelerate. That might seem paradoxical to Americans — after all, the assumption is that HP’s brand and corporate heft should boost 3Com’s sales prospects, right? — but different rules apply in China.

Presuming the acquisition of 3Com is approved by China’s MOFCOM — and 3Com and HP still retain hope that the deal will close before the end of April — HP will get a cost-effective engineering team, one that can help it develop competitively priced switches and routers to pressure Cisco’s margins and help it compete for price-sensitive enterprise accounts worldwide. That said, HP should not count on maintaining the substantial market share in China that 3Com built through its H3C joint venture with Huawei.

That, literally, is history.

Cisco Refreshes UCS, but Customers and Channel Wary

Cisco has refreshed its Unified Computing System (UCS) offerings, putting the upgrades in an ostentations marketing box labeled Data Center 3.0.

The new gear puts more meat on the bones of UCS, making clear that Cisco is serious about its pursuit of data-center hegemony. The questions now is, when and to what extent will customers demonstrate more than exploratory interest in Cisco’s vision?

Feedback form customers, channel partners, and analysts suggests that Cisco has many challenges to overcome. Although Cisco claims to have more than 400 UCS customers and says the infrastructure upgrade will result in further patronage, analysts tell Network World that UCS demand seems lukewarm, with deployments taking the form of trials rather than production systems.

Meanwhile, an article at SearchITChannel.com suggests that prospective customers have concerns about integrating elements of UCS with their existing data-center infrastructure. Resellers are said to have reservations about Cisco’s pricing structure, too.

For its part, Cisco counters that UCS is as conducive to incremental upgrades in existing data centers as it is to wholesale deployment at new facilities. Cisco says UCS will interoperate with systems-management consoles and frameworks from BMC, IBM, CA, Hewlett-Packard, and Symantec. The networking giant also says it offers an API and developer toolkit that allows ISVs and partners to integrate offerings into a UCS environment.

Still, many customers with existing data centers are skeptical, even though Cisco argues that UCS isn’t an all-or-nothing proposition suitable only for greenfield data centers.

Illuminata’s Jonathan Eunice seems to have it right when he says Cisco is targeting big-game, high-value deployments of server complexes instead of single, standalone servers. At least at headquarters, Cisco is aiming high, focusing on ambitious data-center consolidation, virtualization, and automation. Field sales representatives and channel partners might be more willing to compromise, though.

Sales, after all, will be the ultimate measure by which UCS will be judged, and not just by Cisco. To quote Eunice:

“I think it’s still in the kicking the tires phase. Cisco is not a traditional vendor in the server space. This is really not even through the first full year of shipment. They have not disclosed a long list of massive sale, whereas you go to HP or IBM they have tons of references for any size sale.”

The next time Cisco does a UCS announcement, it should bring along lots of fresh sales bookings and customer references. The company cannot afford Data Center 3.0 to be perceived as nothing more than a marketing construct.

3Com Concerned About China’s “Indigenous Innovation”

In a DC Velocity article in which a senior executive of the U.S.-China Business Council says conditions for foreign companies doing business in China have reached a new low, a quote from a 3Com spokesperson makes for interesting reading.

3Com is a networking vendor that manufactures nearly all its products in China. Most of its design and development is done there, too. As such, it’s notable that 3Com should have concerns about China’s “indigenous innovation” polices, which are intended to boost the research, development, and manufacture of Chinese companies — relative to foreign competitors — in computing, software, telecommunications, and cleantech.

One might think that 3Com, essentially a Chinese company with an American moniker, wouldn’t have an objection to China’s industrial policy. Nonetheless, 3Com is concerned, as the following paragraph from the DC Velocity makes clear:

Not only does that policy erect unfair trade barriers, it also puts intellectual property at risk, said Misty Rutter, trade compliance director for 3Com, a telecom hardware maker that manufactures almost exclusively in China. Rutter warned that the process of certifying a product’s compliance with the “indigenous innovation” policy exposes design and other intellectual property to Chinese government scrutiny—and potentially, to piracy.

HP’s pending acquisition of 3Com has been held up, awaiting official approval from China’s Ministry of Commerce (MOFCOM). If 3Com has concerns that China’s indigenous innovation might compromise its intellectual property, one can only wonder what HP will make of the situation.

RIM: Not Dead Yet

Let’s wait a bit longer before we summon the coroner to RIM’s bedside. The company isn’t in danger of imminent demise, by its own hand or as a result of the furious onslaughts of its competitors.

In fact, RIM isn’t even seriously ill. Could it benefit from a better diet, more exercise, and a makeover? Absolutely. But we could say that for many former high-fliers who’ve found life in the smart-phone market more difficult than it used to be.

The smartphone market is changing, heading into a period of intensifying competition in established markets and fresh opportunities in emerging markets. Based on the evidence presented yesterday, in the form of RIM’s latest quarterly results, we’d have to say that the company is doing better extending itself into new markets than it is at defending its old turf.

Revenue, earnings, and average sales price per handset failed to meet Wall Street’s expectations, but subscriber growth was robust and margins remain strong. Challenged by Motorola’s Android-based Droid at Verizon, where RIM derives more than 25 percent of its sales, the company seems to have a fight on its hands. The problem will be exacerbated as Apple’s iPhone moves into Verizon and other CDMA carriers.

These are new threats to RIM’s franchise, and the company will have to respond effectively, with new phones, new marketing, better operating-system software, and an improvement in the quality and quantity of applications that run on the BlackBerry. The challenges are considerable, but RIM knows what it’s up against. It’s gearing up for a fight, not for the undertaker.

A bright spot for the company is foreign sales, which appear to have compensated for its struggles in North America. Clearly, foreign sales are a double-edged sword. Many developing markets, where RIM is placing significant emphasis, will offer lower average sales prices and slimmer margins than those to which RIM has become accustomed in North America.

RIM will have to be careful with its brand, too, both in emerging and developed markets. What is RIM’s niche? What are the BlackBerry’s defining characteristics and its unique identity? RIM knew the answer in the past — the BlackBerry was the enterprise-friendly, mobile-email kingpin — but the company is going through a mid-life crisis that must not become a protracted period of introspection.

Tacking Apple on its own terms will be futile — RIM isn’t a consumer-oriented company, despite its best efforts — and it’s doubtful that RIM can match Google’s geek appeal. I still think the enterprise, particularly certain vertical markets, is a strong franchise for RIM, but the company will have to do more than mount a rearguard defense if it wishes to meet the market’s expectations for growth.

As we look ahead, RIM faces many questions, and definitive answers aren’t yet available. Keep an eye on the company, by all means, but it’s too early for a funeral procession. Throughout its history, RIM has repeatedly refuted its doomsayers.