Troubled Times Ahead for Huawei Smartphones as Trade War Bites Deep

With a despondent backdrop of the COVID-19 pandemic and the U.S.-China trade war, the smartphone market was remarkably resilient in 2Q 2020. Although global shipments were heavily impacted and dropped 17% Year-on-Year (YoY), there was a small uptick Quarter-on-Quarter (QoQ) as global sales were estimated at 281 million units. Samsung and Huawei lead the market, shipping around 54 million units each in 2Q 2020, both experiencing YoY declines. They were followed by Apple, which managed to keep shipments relatively flat YoY and QoQ at 38 million units, with Chinese vendors Xiaomi and OPPO completing the top 5 vendor roster for the quarter.

On the face of it, there seems much to be optimistic about in the smartphone market as countries start to emerge from the pandemic, gradually witnessing supply chains, buyer behavior, and demand returning to some sort of level of normality. With the important 4Q period for smartphone sales also fast approaching, including an expected boost from the long-awaited launch of 5G iPhones, coupled with a quick expansion down the price tiers for 5G smartphones, it points to a market that is gradually coming under control and is on track to partly compensate for the downturn in sales for the first half of 2020. Surprisingly, it has been China—epicenter of the outbreak—that has led the way out of recession, seeing demand recover quickly while fully embracing 5G. In fact, this has been key to the revival of the smartphone market, owing to the vast majority of leading vendors being reliant on China for the bulk of their manufacture and component supply, despite the inevitable adjustments to their roadmaps and shipment projections.

However, while it is not clear what the full extent or lasting ramifications of COVID-19 will be on the mobile device ecosystem, the pandemic is now overshadowed by geopolitical trade wars that are set to become a major impediment to the future development of the mobile devices market, which has intensified in recent months. At the center of the storm is Huawei, which is banned from acquiring parts and software featuring U.S. technologies or selling its products in the United States and closest allies, which notably affects its use of many hardware components and Google’s services on Android. Most recently, the U.S. Department of Commerce updated it policies, effective from September 15, 2020, when trade was suspended with Huawei for companies wishing to sell components that are developed with U.S. technology unless special approval is obtained.

In the short term, Huawei has fought back and retrenched to its own China market to bolster sales in 1H 2020, thus avoiding a significantly worse shipments performance than it may have had otherwise. This owes much to the ban on use of Google Mobile Services on its products, which is not an issue in its home market but problematic outside China, notably affecting sales in Europe. In 2Q 2020, the company managed to improve its smartphone market share in China and certain other regions of the world including Africa and parts of Asia-Pacific through some aggressive sales promotions and fostered strong local support for its 5G smartphones. Huawei has also taken some drastic decisions to keep its smartphone business afloat, notably aggressively building up stockpiles of processor chips and components ahead of the trade ban, possibly keeping enough stock to last for up to 3 years. However, many of its processor suppliers are now no longer able to provide chips under the recent September directive, and that includes producing its own Kirin chipsets, which rely on input from memory chip companies, such as the U.S. company Micron, Samsung, and SK Hynix. Currently, Huawei uses Qualcomm and MediaTek for its low- and mid-range smartphones, keeping the high-end flagships for its own Kirin processors.

With access to chipsets being a fundamental requirement for surviving in the smartphone market, it was thought that Huawei would turn to MediaTek to provide chipsets longer term because it is one of the few companies that could meet demand while having also beefed up its chipsets with the Dimensity series, including 5G options. However, this expectation now falls foul of the September policy change, and MediaTek needs to apply for permission from the United States to supply chips to Huawei, and has been joined in this bid by Qualcomm, Samsung, and the Semiconductor Manufacturing International Corporation (SMIC). The hope is that MediaTek, if not all of the companies listed here, will be able to earn a license and continue to supply chips to Huawei, but this is by no means a foregone conclusion with there being little to suggest that the United States is likely to ease its sanctions any time soon, irrespective of a change in administration.

As a lead global player in the smartphone market, Huawei’s business is valuable to many companies along the supply chain, but it is now being forced to take some drastic decisions owing to the U.S. trade ban if it is to keep its consumer business afloat. While securing supply of advanced components and chipsets is one crucial part of its survival, having access to a smartphone ecosystem is another. The company has addressed the ecosystem challenge by recently making its HarmonyOS a smartphone platform from 2021 (as an alternative to Android), but it is unclear how Huawei would be able to move forward with chipset supply. Its stockpiling of chipsets may help in the short term, but a major issue with this approach is that it will become increasingly difficult over the next couple of years for Huawei to implement innovation on these dated chipsets, thereby creating uncompetitive smartphones using old technology, resulting in a detrimental effect on its market share.

Having already ruled out setting up its own chipset manufacturing lines, the company has few options open to it when sourcing parts for its smartphones:

• Partner with, or increase its relationships with, MediaTek, Samsung, or Qualcomm
• Look to alternative chipset suppliers and manufacturers, such as Chinese chipmaker Unisoc or SMIC

Whomever Huawei is able to choose to supply silicon will not only ultimately depend on the decisions of the U.S. Department of Commerce, but could also put its devices at a distinct disadvantage, although this would undoubtedly be preferential to exiting the smartphone market altogether. Each major chipset vendor works at a variety of price points and technology leadership, notably in terms of 5G, so the choice would either affect Huawei’s device margins or ability to procure cutting-edge semiconductors. Such an outcome could prevent the company from implementing innovation, losing any sort of differentiation it had managed to build in its flagship smartphones through use of its own Kirin chips. In some cases, the use of certain suppliers would result in a backward step in terms of manufacturing process “nodes,” potentially moving back to a 10 nm process rather than onwards to 5 nm, which would have a profound effect on its devices in terms of size, performance, and power efficiency. Its ability to even keep volumes relatively flat YoY would also be at the mercy of the suppliers’ capacity, potentially culminating in a massive reduction in shipments and market share.

In short, Huawei has a real struggle on its hands to stay in the smartphone market in the longer term and rebuild its now tainted brand outside of China. However, this would not be the first time that a major player in the smartphone market has floundered, whether or not through any perceived fault of its own. Indeed, it may actually spell good news to many of its competitors, such as Samsung, Apple, Xiaomi, OPPO, and Vivo, both in China and globally, which are waiting to fill market share left at Huawei’s expense. It can be argued that Huawei’s anticipated descent at the hands of an increasingly restrictive U.S. trade ban will be felt across the whole smartphone market in 2021 and beyond, and will reach a tipping point that could see a fundamental reshaping of the supply chain and chipset market. It is also set to have a significant bearing on the landscape of China's influential smartphone market, potentially blighting 5G innovation at least in the short term.

Whatever the outcome following the latest U.S. government sanctions, the issue could be compounded further by the mooted acquisition of ARM by U.S.-based NVIDIA, which would put even more supply chain strength into the hands of the United States. If this were then added as leverage in the trade war, such an acquisition could potentially harm and disrupt the ability for all Chinese smartphone vendors to gain access to an architecture that is the basis for virtually all smartphone chipset designs, thereby affecting more than 50% of the world’s shipments, stifling market supply and innovation.