The new Silicon Valley?

If you had asked a Hong Kong resident what neighbouring Shenzhen was good for 10 years ago, you would probably have got the reply, “It’s where I get my fake handbags and DVDs from.”

Ask someone the same question today and you would probably hear a very different refrain. “Ah yes, that’s where I developed my smart handbag.”

In this context, smart does not just mean elegant, but WiFi-enabled as well. For it was in Shenzhen that a hardware incubator called Haxlr8r (pronounced “hackcelerator”) helped an American couple to develop Everpurse – a clutch bag with a built-in battery and docking station for smartphones.

Shenzhen has become a mecca for the “makers” – with entrepreneurs now gaining increasing prominence as the inventors of smart gadgets. Once known as the factory city of the world, Shenzhen has been metamorphosing into its tech hardware capital as well.

In doing so, it is eating into Taiwan’s once dominant share in electronics manufacturing and innovation. Earlier this month, the Economic Observer published a lengthy feature examining Shenzhen’s transformation. It concluded: “All the fields originally dominated by Taiwan’s manufacturing industry have now been transferred to Shenzhen,” although it did acknowledge that in some respects, “many industries in Shenzhen are driven by Taiwan”.

The newspaper attributed part of the city’s success to Invest Shenzhen, a government body set up in 2011 to foster its efforts to move up the tech value chain. Its general director Chen Zhaozhao tells the newspaper that the main aim is to attract more of the world’s largest tech companies and make sure they “feel proud of opening their R&D centre in Shenzhen”.

In 2013, R&D accounted for 4% of Shenzhen’s economy. This compares with 4.4% in Israel, and China’s average of 2%.

Moreover, hardware designers and engineers working close enough to Shenzhen’s factories can get their most imaginative ideas into up-and-running hardware prototypes far quicker because the components are close at hand. These prototypes can also be cheaper to make than those developed in the West. This helps developers sell more realistic business proposals on crowd-funding sites such as Kickstarter.

As a result Shenzhen is benefiting from a cluster effect both in terms of the sheer magnitude of electronics factories surrounding the city, as well as the hardware start-ups. Haxlr8r moved its headquarters from Silicon Valley to Shenzhen last year. Other hardware incubators include Highway1 and Seeed Studio (which has the motto, “Innovate with China”) have also set up shops in Shenzhen.

Typically, these companies offer would-be inventors hardware kits, plus seed capital in return for an equity stake. Others, like PCH International, which started life as a components sourcing platform for overseas companies, offer an end-to-end service for hardware designers and manufacturers.

Another major advantage propelling Shenzhen’s rise as a tech hub, ironically, is its shanzhai culture. The term originally referred to the defensive strongholds built by regional bandits in early twentieth century China, but then came to refer to pirated goods.More recently still, the meaning of shanzhai has mutated again into a positive term describing the information-sharing culture among many of Shenzhen’s newest tech firms. The information exchange that once helped counterfeiters to pirate goods at lightning speed is now being used to churn out innovative prototypes and devices at very low costs.

As such, Shenzhen has been able to steal a march on Taiwan in its production of more mainstream products like smartphones and tablets. As the Guardian wrote earlier this year, “The phones that fuelled the Arab Spring were soldered on the backstreets of Shenzhen.”

Global estimates vary, but Taiwan’s Market Intelligence & Consultancy (MIC) said the island shipped roughly 230 million smartphones in 2013. This gave Taiwan a global market share of 24.1%, down from 29.7% in 2012. And by 2018, MIC believes Taiwan’s market share will drop below 20% for the first time. Almost 70% of current shipments relate to Apple’s iPhone and in the short-term, at least, analysts forecast the launch of the iPhone 6 will provide an end-of year boost to exports.

By contrast, China has seen its market share in smartphones explode. Many have been sold domestically, but increasingly to emerging markets where price is a key consideration too.

In 2011, China was producing about 70 million smartphones per annum. In 2012, this tripled to roughly 208 million and in 2013 it shot past Taiwan to produce 350 million, although some analysts believe the actual figure could be closer to 500 million if the legions of small manufacturers are taken into account.

The same picture is evident in tablet shipments. Taiwan shipped roughly 120 million tablets in 2013 according to MIC figures, up from about 96 million in 2012. China shipped about 100 million in 2013, triple its 2012 shipments, which were in turn almost quadruple its 2011 shipments. (Research firm IDC estimates that 44% of the tablets sold globally this year will be made in Shenzhen, with the lowest priced at $48.)

Chinese manufacturers can thank Taiwanese firm Mediatek and Chinese counterpart Rockchip for their increased presence. Together they have provided the low-cost chips which have reduced the entry barriers for Chinese electronic firms in the smartphone and tablet business. Rockchip is an ARM licensee and until 2014 was using the British firm’s computing architecture for the majority of its products. ARM-based dual and quad-core processors also power Samsung and Apple products. However, in May Rockchip forged an agreement with Intel to use the latter’s quad-core chipsets for entry-level Android tablets. This marked a major step forward for Intel, which has been largely shut out of the ARM-dominated tablet and smartphone market. Intel began its global fightback in 2013 when it established its China Technology Ecosystem in Shenzhen to build an industry chain for non-branded, white-box producers alongside 14 domestic tablet manufacturers. It is now hoping to ride on China’s coat tails and build up market share in the low-end of the tablet – and potentially smartphone – market.

The Wall Street Journal reports that Intel’s customers have been impressed by the resources the US giant is pouring into Shenzhen. It cited the example of a tablet-maker called Hampoo, whose boss Star Wang comments: “We had some technical issues, and Intel sent an engineer to stay with us for a month and a half, working late until 10:30pm or even midnight, to solve the problems. When we had a component shortage, Intel went to talk with suppliers to ensure we would get the components we needed.”

Wang says he will shift all his chip purchases to Intel. With more orders like his, the Santa Clara-based firm says it hopes to have installed 40 million Intel chips in Chinese-produced tablets by the end of 2014, quadruple the figure for 2013.

Intel’s China President Yang Xu tells the Economic Observer that Shenzhen is becoming a “global centre for innovation in intelligent devices”, revealing that Intel’s Shenzhen R&D team won an internal bid against their Taiwanese equivalensts to produce a keyboard for the firm’s Ultrabook. The Taiwanese team had proposed a 3.5mm thick keyboard, while the Shenzhen team had pitched a 3.7mm version. However, the Shenzhen unit could produce the keyboard at far lower cost, and their production cycle was two months faster than in Taiwan. As a result, Shenzhen now leads the entire production process for this Intel product.

Cost is still one of Shenzhen’s big attractions for hardware start-ups. And while they have risen considerably in the past 10 years, a local engineer’s salary is still roughly one-tenth the cost of a similar role in Silicon Valley.

And news broke on Thursday that Intel might be about to raise the stakes on its China bet considerably. Reuters reports that Intel is close to buying a stake in the Chinese-government affiliated mobile chipmakers Spreadtrum Communications and RDA Microelectronics, in what it described as “its latest move to catch up in a smartphone chip industry led by Qualcomm”.

Citing sources closes to the deal, Reuters said Intel could spend around $1.5 billion for a 20% stake in the chipmakers’ parent, Tsinghua Unigroup.

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.