The media’s coverage of the Huawei story looks like a politically-orchestrated car accident in slow motion. The media bills the story as a front in a US-China trade war, but this is wrong. Other than a few mobile phones on Amazon, Huawei sells little in the United States. The fear that Chinese information technology can be abused is not new; it dates to 2005, and many reports have been published about it. The story of Huawei is not one but four stories. This research note investigates the Huawei effect on the global telecom industry and how it impacts the rollout of 5G.
1. The arrest of Meng Wanzhou - Journalists try to sensationalize a banal trade violation.
The ratings-driven media tries to make nearly every story about Trump, including the Canadian arrest of Meng Wanzhou, CFO of Huawei, for a charge of selling sensitive equipment to a hostile government via its affiliate. That Trump was in Argentina meeting the Chinese prime minister as part of the G20 proceedings is not causation but coincidence. The reality is that both Canada and the US have long prohibited its patented technology being sold to countries such as Iran, North Korea, Syria, and Cuba. This is governed by the international 1996 Wassenar Arrangement for international security, proscribing the export and sale of nine categories of conventional weapons and “dual use” technologies. As such, the tech companies of some 40 nations abide by a set of trade and contract rules. In fact China’s Ministry of Commerce Ministry of Commerce (MOFCOM) has similar rules which restrict trade on sensitive security good and services.
2. There is a historical link between telecommunications and national security
The history and development of telecommunications is closely linked to national security. Many Western counties require that critical infrastructure used by the government, military, and public safety providers must be built by companies from NATO countries. Just as NATO countries do not buy military aircraft from China, restrictions are placed on critical infrastructure and communications equipment from the country. By the same token, China buying US-made equipment for its mission-critical functions would be suspect by the Chinese government. AT&T‘s contract for the First Responder Network Authority (FirstNet) forbids the use of Chinese-made equipment in the network. In the United Kingdom, once Everything Everywhere (EE) merged with the incumbent BT, the core network equipment from Huawei was removed from the Emergency Services Network (ESN). Motorola Solutions builds and runs Denmark’s public safety networks (SINE) without Chinese-made technology.
3. The Chinese dominate an increasingly share of the mobile telecom value chain.
While some countries restrict Chinese-made components in networks, the prevalence of Chinese made goods and services in key economic sectors is advancing. "Made in China" once meant junk, but no more. In 2015 the Chinese government launched the “Made in China 2025" plan and targeted 10 global industries which the country should dominate in 10 years (including information technology, pharmaceuticals, robotics, automobiles, strategic manufacturing etc.). The Chinese have succeeding on executing their plan to date, gaining market share for everything from phones and mobile services to telecommunications infrastructure for smart cites. The China effect on global innovation is a force to be reckoned with.
Many are concerned about an addiction to Chinese technology whether because it’s better and/or cheaper in a world that’s increasingly digitized and in which where complex business models, processes and systems are essential for society to function. Some politicians do not want to base security and robustness in networks on diffuse trust concepts with nations with ambiguous relationships. All the same, it’s politically challenging to discuss security, the emergence of Chinese-made technology, and the decline of infrastructure equipment from Western countries.
4. Politicians are starting to focus on resilience on the telecommunication market.
Historically network infrastructure was built and operated by national telecom companies, and the equipment often came from national or regional producers. At that time, the networks and services were a closed circuit so to speak and were governed by a monopoly regulatory authority. Given America’s military prowess, resilience was a key goal of networks, but this concern did not drive decisions in Europe in the same way.
As the telecommunications market has been liberalized, competition re-emerged. We have gone from countries having a single government monopoly to having multiple national and regional networks that both compete and interconnect. New telecommunications companies frequently base part of their network on infrastructure from the incumbent. We have also gone from a world in which people bought voice to one in which people buy data. We have gone from a world where we bought one service from the incumbent to a world in which alternative providers such Skype, WhatsApp, and Netflix provide services on top of another’s telecom infrastructure.
Technological development coupled with increasing competition has meant that citizens and businesses have gained access to unique infrastructures and a huge range of services. It has also allowed the market for infrastructure to grow, while the prices of equipment have fallen sharply. The world has benefited from telecom market liberalization, and modern telecommunications infrastructure, together with digitization, have created a paradigm shift that people and businesses enjoy.
However, in a strange contradiction, exploding competition has led to a re-regulation of networks. This has been particularly severe in the EU with its mandatory reselling obligations and price controls under the guise of roaming and net neutrality. This regulation has reduced profitability and lowered investment to the point that the gap between current investment and the level of the EU’s connectivity goal is €150 billion. Regulatory pressure has driven Europe’s telecom provider away from European vendors and into the arms of the Chinese.
To cut costs, Europe’s telecom operators switched from European suppliers such Ericsson, Nokia, and others to Chinese suppliers Huawei and ZTE. Suffering a major drop in sales, Western network providers have consolidated. This contraction redoubles the benefit for Huawei which uses these dynamics to gain a foothold in many countries, grow its market share, and reinvest in its business. Low price is not the only reason companies select Huawei; its products have improved considerably in quality, and state-owned Chinese banks have financed Huawei and its customers with favorable terms. Concurrently, there is a concern that as companies like Nokia and Ericsson lose business, they cease to have the global scale necessary to be a state-of-the art equipment provider.
In any case, it’s rational that nations start to focus on resilience and vet the companies that supply infrastructure and services.
There is nothing new in the nation's desire for security of supply.
Stability, resilience, scale, and local production are political touchstones in trade policy, though these concepts can be manipulated for a particular interest. Telecommunications is just one industry that can be singled out; transportation is another. Consider how the EU gave massive subsidies to Airbus to create a European alternative to Boeing. In an effort to catch up with the US and East Asian countries which are spending three times as much, the EU will target €20 billion ($24.36 billion) to artificial intelligence by 2020. Global positioning systems or GPS is yet another area. Even though the US invented the satellite-based navigation system and it’s available worldwide for free, Europe launched Galileo; China, BeiDou, Japan, QZSS; Russia, GLONASS; and India, IRNSS. These navigation solutions have a prominent role in defense for their respective nations.
These are but a few examples of industries and applications that governments will guide, if not control, in the name of stability, resilience, scale, and local production. The fear of becoming too addicted to other countries’ goods has existed for many years and has nothing to do with the arrest of Meng Wanzhou.
The political announcements.
Huawei's story has gained attention as many countries have announced that they are "beginning" to focus on resilience in the telecommunications sector. Some journalists misunderstand these messages, thinking that the Huawei CFO’s arrest is somehow a retaliation for China’s growing market power rather than the protocol for violating an international treaty. To put it another way, the telecom value chain is so vast that if one wanted to spy on end users, there are many other touchpoints than just the Chinese-made ones.
All the same, the political fear of losing one’s national champions (if not global firms such as Nokia and Ericsson) to the Chinese is not unfounded. In the EU, the decline of the telecom sector has meant massive job losses, reduced research & development budgets, and less investment—not a great set of factors for a region that wants to win in 5G. For politicians, it is easier to play the security policy cards in order to play the industrial policy cards. While the EU has criticized Trump's "America First" policy, it pursues the very same thing when it comes to agriculture among other industries. In practice, the EU protects many sectors through its industrial policy.
European Commissioner for Digital Single Market and Vice President of the European Commission Andrus Ansip recently questioned whether the prevalence of Chinese equipment in European telecom operators’ networks was optimal. The statement caused much debate at the boards of directors across Europe's telecom companies as it creates uncertainty—will Huawei equipment be allowed today? What about the future? Are some products allowed and not others? The question is imperative as today’s 4G networks in Europe already have Chinese equipment, and 5G will be an evolution, incorporating 4G elements, which are not necessarily distinct.
Ansip should also take a hard look at the regulatory policies he’s supported for the last four years. Has innovation, economic growth, and employment improved as he promised? Or have his policies been gifts to the Chinese?
Strand Consult warned for years of the detrimental regulatory trends in the EU, so what’s happening now is not a surprise. The EU has made a four lane highway for the Chinese to Europe. Huawei files more than twice patents for digital communications than all of Germany, a country once a powerhouse in this area.
The consequences for telecommunications companies.
It’s likely that countries will follow America’s lead when it comes to limiting Chinese equipment in network. This has been the status quo for years, not only in the US. United Kingdom, Australia, and New Zealand are moving in the same direction. The protections for public safety network will likely be extended for enterprise and consumer networks.
Strand Consult explores this and other regulatory challenges as part of its strategic research and training with Next gen telecom policy and regulation - Workshop for leaders in the telecommunications industry. Networks are part of a long, complex value chain. Security threats are not isolated to network equipment. The political system needs to consider the users, devices and services, as well the market composition of incumbents, challengers, and backhaul providers. Security requires political attention in a world in which operators use network sharing and where they outsource parts of there business to technology and managed services companies.
Some incumbents may have Chinese technology for their core network, an investment typically related to 10 percent of capital expenditure (CAPEX). Other operators, frequently challengers, build their operations on top of the incumbents’ networks. In practical terms, they do not control the network technology. However, any government mandate to force switching out Chinese technology will have political as well as financial consequences. Many of these operators have good agreements with Chinese suppliers and agreements that have often included funding. These purchases were frequently approved by the local country government. Full or partial bans on Chinese equipment can have consequences for operators' investment.
Naturally countries that think ahead can avoid this problem. The US never allowed such equipment in networks in the first place. However other countries were more eager to ink sweetheart deals with Huawei, which frequently were negotiated by a former top telecom professionals from the local country hired by the Huawei.
It’s not only politicians that are concerned about this problem, but customers and shareholders. Companies need to vet their suppliers when it comes to security, and this will sharpen the demands for providers of telephony and data connections. The pressure from government, shareholders, and customers about security will likely grow and operators should emphasize this fact to regulators.
Margins and investment at European operators are already depressed, and any requirements to use non-Chinese tech will impact the rollout of 5G in Europe, which is already behind. It shows the downside of EU regulation which mainly focused on lowering prices, while minimizing the importance of security, innovation, and consumer choice. Europe could have had a different outcome today had price not been micromanaged by Brussels. Allowing companies to invest, compete, consolidate, and innovate are important for the entire telecom value chain and firms’ choice of network vendor.
As information and communications is increasingly delivered by the internet, it is important to understand how this drives the market structure of the various players in the value chain. The rise of Huawei and ZTE in infrastructure equipment has paralleled the growth of Alibaba, Tencent and Baidu.
The European Commission and other pan European bodies focus on the areas where they can play a positive role, namely cybersecurity, something that can be difficult for each of the 28 EU nations to ensure. Network security has not had the necessary attention it deserves in the EU. The EU recognizes this, and it upgraded the European Union Agency for Network and Information Security (ENISA) to the Cybersecurity Agency for this reason. Europe needs a hard look at security, what it will cost, and the trade-offs. Decisions to improve security are necessarily and are likely to be costly for the telecom industry and negatively impact the rollout of 5G in Europe.
The recent Huawei CFO story have created more confusion than greater insight. Strand Consult’s interviews with operators in the US, South America, Europe, Africa and Asia attest to the difficulty of the situation. It also demonstrates the folly of avoiding regulatory assessments and cost-benefit analyses in making new regulation. Security is frequently an afterthought in regulators’ zeal to shape the market to deliver their preferred outcome.
Strand Consult has described many of the challenges in deploying 5G infrastructure in its research project How to deploy 5G: Best practices for infrastructure, regulation and business models and its reports Understanding the GDPR and Its Unintended Consequences and Net Neutrality in EU after 1 Year: Unintended Consequences for operators, content providers, and consumers. To learn more about these challenges, please contact us.