Secrets of the Shanzhai – How Counterfeiters can Beat Apple to Market
In my last post, I described the Shanzhai bandit phone manufacturers which have successfully beaten Apple to market with a fake version of its own product, the iPhone 4G. Shanzhai also managed to introduce an imitation iPad called the iPed simultaneously with Apple’s international launch. The Shanzhai enjoy tremendous advantages over traditional brands in the areas of time-to-market and cost-of-production. Many people are quick to dismiss the Shanzhai as a nuisance that should be suppressed through stricter enforcement of intellectual property rights legislation. But others such as Dr. Hau Lee of Stanford University have made a practice of studying the techniques of the Shanzhai. Why? Because the Shanzhai have achieved unparalleled levels of supply chain efficiency particularly in the areas of product design, development and distribution. Although, some of these efficiencies are achieved by circumventing established laws, there is value in understanding the techniques that enable the Shanzhai’s success.
The Stanford University Graduate School of Business and the Hong Kong University of Science and Technology recently published a research note on the Shanzhai’s remarkable supply chain efficiency. The Wall Street Journal and New York Times have also published articles recently explaining the techniques used by these counterfeiters to achieve such aggressively low price points and ultra-fast time-to-market. In the post below I have summarized the learnings I acquired from these various sources, but I would encourage you to read the original articles as well.
The Shanzhai mobile phone manufacturers operate in the Shenzhen Special Economic Zone in the Pan-Pearl River Delta region of mainland China. The heavy concentration of mobile phone supply chain participants is a key enabler to Shanzhai success. Within a 20km radius there are 30,000 different companies which specialize in either producing finished products (handsets) or individual components (batteries, cameras, screens). The Shanzhai have learned to collaborate amongst this network of contract manufacturers, component suppliers and product distributors through a system of mutual trust and informal contracts.
- Production – The Shanzhai typically outsource manufacturing to 3rd parties. Small assembly workshops situated in a residential apartment or commercial office building are a common model. These workshops contain only the bare minimum equipment necessary to assemble the phones. Another popular model is to use the full-scale assembly facilities of contract manufacturers. Many of these EMS providers will gladly run a second night-shift of assembly activities to accommodate a Shanzhai request.
- Sales & Distribution – The Shanzhai leverage low cost distribution channels such as shops in small villages. Consumer electronics retailers and mobile network operators are not used for retail distribution. Inventory is typically sold quickly to wholesale distributors, which carry the inventory and product obsolescence risk in the supply chain. Because the Shanzhai do not retain a sales force, do not lease retail space and do not stock finished goods they can achieve extraordinary sales cost advantages.
- Quality Assurance – No testing is performed on the Shanzhai phones. Poor quality or recycled materials are often sourced for components. Consequently, the phones may emit excessive radiation or experience battery explosions while in use. Faulty mobile phones are among the leading complaints submitted to the Chinese Consumer Protection Agency.
- Licensing – Shanzhai typically do not complete the government-required licensing processes for mobile phones. As unregistered products, the counterfeit handsets are also not subject to 17% Value Added Taxes (VAT) or income taxes.
Mobile phones manufactured by global brands such as Nokia, Samsung and Motorola typically require 4-6 months from concept to launch. A complex cycle of market research, product design, components sourcing, prototype development, regulatory approval, quality assurance and production assembly is required to effectively deliver a new handset to market. Shanzhai manufacturers, however, are able to reduce time-to-market considerably, often launching cloned devices in as few as 45 days. The Shanzhai achieve these accelerated timeframes by eliminating several steps in the product development lifecycle:
- No market research is performed. Instead feedback from distributors with local market knowledge is leveraged to identify features.
- Product design is obviated because the handsets are typically clones of major global brands.
- Testing and quality are omitted as there are no warranties or aftermarket service requirements.
- Government licensing and regulatory approvals are circumvented.
No doubt, the most significant factor in accelerating time-to-market has been the advent of the System-On-a-Chip designs produced by MediaTek. In 2005, MediaTek introduced a SOC which merged the functions of several previously independent processors onto a single chip. The design was disruptive and revolutionary because it eliminated the most complicated aspect of hardware design for mobile phones. Many of the functions typically required of hardware components became software-driven functions. MediaTek ships SOCs already fitted onto circuit boards for $15. As a result the purchaser only need to acquire a battery, camera and device casing from third parties in order to assemble a finished product. MediaTek has become so successful with its SOC that its platform is used in 40-50% of Chinese mobile phones – Shanzhai and branded.