Updated: Huawei Placed on U.S. Tech Blacklist, Killing Huawei's Consumer Device Business Outside China

[first published May 20, 2019 9:26 AM; expanded with more context May 20, 2019 10:32 PM ET; updated May 22, 2019 3 PM ET after Arm pulled its license; updated with EU carrier and Trump comments May 24, 2019 5 PM ET; Updated again July 31 2020 with Arm, Windows updates; headline changed to “…Outside China” once Arm license was restored.]

How big a deal is this?
By placing Huawei on a U.S. technology trade blacklist, Trump has effectively banned Huawei from building smartphones and tablets for sale outside China. Key U.S. technology providers for phones and laptops include Google, Microsoft, Qualcomm, Broadcom, Corning, and even ancillary companies like Dolby. Arm, a UK company whose designs underpin all mobile processors, briefly pulled its license to Huawei as well.

The impact is enormous: Huawei is – or was – the second largest smartphone vendor in the world, with Huawei’s Consumer Device Business unit brining in over $50 billion in revenues in 2018. Huawei sold 208 million phones last year, with approximately 80 million of them outside China, and its export percentage has been growing. U.S. government pressure has kept Huawei off U.S. carrier shelves, but Huawei and its Honor subsidiary has been the fastest growing brand in Europe, with over 20% market share last year, and as much as 30% today. Huawei sells phones across the pricing spectrum, but most of its phones outside China are in the midrange and higher; flagship phones comprise 30% of its European sales.

ZTE was similarly impacted last year when it was denied access to U.S. technology; it had to shut down until access was restored.

Impact in Europe

The competitive impact in Europe will depend on how long the blacklist status lasts. Key Huawei carrier partners, including Vodafone and EE, are scrapping Huawei phone launches shelves because they cannot sell phones that will not have software support. In the short term, Xiaomi and OPPO, two other Chinese companies expanding in Europe, should immediately pick up sales. Samsung could see a small uptick in flagship sales as well, particularly if Huawei is not able to resume sales and support when the Galaxy Fold and the next Note start shipping later this summer. Lenovo’s rumored folding Moto RAZR phone would also benefit from the lack of competition. Fast-moving local brands like Wiko should also be able to take up some of the slack; Honor’s rise had cut directly into its sales opportunities.

There is also clear harm to the millions of Huawei and Honor customers in Europe and other geographies outside China as Huawei can no longer support the Android phones it already sold. The U.S. Commerce Department has extended Huawei’s access to Android software updates for three months. If the entity designation is not lifted by that date, consumers who already bought Huawei or Honor phones will discover that a geopolitical situation they have no control over has made their phones less secure and without access to new features coming in Android 9.

Impact in the U.S.

Huawei has been effectively banned from selling smartphones in the U.S. already, so U.S. consumers will not see any change on the shelves. Huawei’s innovation in smartphone imaging, silicon, and design has spurred competitive response from companies like Samsung that do sell phones in the U.S., but the direct impact is hard to measure. On the laptop front, Huawei’s MateBook line was sold at Microsoft Stores, Amazon, and B&H, and offers strong competition to premium notebooks from Apple, Lenovo, and Microsoft’s own Surface (Microsoft has now removed MateBooks from its online store. As of May 22, they are still available at retail). If Huawei is kept out of the market for long, it will be a loss for consumers, but sales volumes have been relatively small.

U.S. technology companies that count Huawei as a large customer will lose out on revenue and growth – Huawei’s device sales have been rising rapidly, which ripples throughout its supply chain. Ironically, although Google’s software is crucial to building phones, losing Huawei should not immediately impact Google’s revenues because Google makes money from advertising, not from licensing Android.

The indirect damage could be significant. Huawei is not just a large company, it one of the few Chinese companies with an international brand, and it is a source of national pride for the Chinese. If the Chinese government wants to retaliate for trade restrictions crippling Huawei, it could target Apple. This would not be without cost – Apple is a big employer inside China, drives even more jobs through its supply chain, and its executives have good relationships with the government. However, Apple is also a big target, as 17% of its revenues come from sales inside greater China. Even if the Chinese government doesn’t target Apple directly, Chinese consumer backlash against U.S. companies could be painful. Apple can afford a temporary drop in sales, but any damage to its brand appeal in China could have a terrible long-lasting impact for the company.

Can Huawei build phones without U.S. technology? How does Arm fit in?

Huawei has been planning for the possibility of losing access to U.S. technology since at least last year, when ZTE was shut down under similar circumstances. In recent interviews, Huawei has claimed that it is prepared for this, and has been stockpiling three months of supplies to make devices without new U.S. components, and that its growth will not be affected in a significant way. The last claim was extremely hard to believe even before Arm pulled its IP licenses. Huawei can certainly find non-U.S. alternatives for chemically hardened glass from Corning, SoCs from Qualcomm, and various filters and chips from Broadcom, but it will need to completely redesign its products in order to do so, and that takes time. Without access to an Arm license, Huawei cannot even substitute its own processors and modems for Qualcomm’s (not legally, anyway. It is questionable how aggressive China will pursue Huawei for IP violations in this regard, though sales outside China are definitely out). To build mobile processors without Arm, Huawei will need to start from scratch, it will take years, and even then it will probably fail. [Update: Arm eventually determined that its technology is UK-based, and not subject to Entity List restrictions. It is unclear if this will change as Softbank is looking to sell Arm.]

Is Huawei about to fragment Android?

Even if Huawei can get its Arm license restored – or if it keeps using its designs without paying for it – Huawei will still need access to U.S. software. As Microsoft (and BlackBerry, Palm, and others) discovered the hard way, it is now impossible to build a viable mobile application ecosystem outside of Android or iOS. Huawei claims that it has built its own mobile OS, presumably based on the open source portions of Android (AOSP) for application compatibility. This might be acceptable in China, where Google services are largely absent and alternative app stores abound, but Huawei’s growth is dependent on sales outside China. Everywhere else in the world, Google’s PLAY store, Gmail, and Maps are core requirements to make a smartphone smart. An Android AOSP phone will always be at a competitive disadvantage to Android phones that have Android features, Android security updates, and Google apps and services.

It is worth remembering that software and services were already deeply split between China and the rest of the world due to China’s own laws and policies. China requires forced IP transfer, 51% local ownership, and extensive censorship. This has kept out key technologies and services from Google, Amazon, Facebook, Netflix, Microsoft, and others.

Can Huawei build laptops without U.S. technology?

Not really. There are no viable alternatives to Microsoft, Intel, and AMD. If Huawei had its Arm license, it could build something like a Chromebook running on HiSilicon processors, and this would certainly be an interesting product, but it would not compete with premium Windows and MacOS laptops like Huawei’s MateBook line does today. [Update: Microsoft has somehow avoided having Huawei’s Windows license restricted by the Entity List designation. While this could change in the future, for now Huawei continues to build Windows laptops sold primarily in China, but also parts of Asia and Europe.]

Is this just about trade negotiations?

The U.S. government’s actions against Huawei are motivated by three different factors: national security, sanctions violations, and trade negotiations.

Huawei’s infrastructure business was first targeted by U.S. security agencies well before the Trump administration took office due to fears that the company was owned by the Chinese government and its networking gear could be used to spy on American interests. It is unclear if this fear is based on evidence or conspiracy theories; no evidence has ever been made public. It is at least plausible; networking gear is opaque, and Huawei’s ownership structure leaves room for doubt. During the Trump administration, opposition to Huawei intensified, and even Huawei smartphones became targets – political pressure forced AT&T and Verizon to scrap plans to launch Huawei phones at their stores. While it is certainly possible to put spyware on smartphones running Android, it should also be much easier to detect. No one has ever found indications that Huawei Android phones and Windows laptops have malicious code in them, and no one in the U.S. administration has ever even claimed that Huawei has actually done so.

The U.S. Justice Department claims that, like ZTE, Huawei has violated U.S. sanctions law by secretly selling U.S. technology to Iran. This is a serious accusation, and one that is apparently well documented (Canada arrested Huawei’s CFO, Meng Wanzhou, on these grounds). This may be the technical justification for the inclusion of Huawei on the Commerce Department’s “entity” trade blacklist.

However, in a recent interview, President Trump called Huawei “dangerous from a security, from a military standpoint,” but “Huawei could be part of a trade deal.” It is not clear how Trump could take his own intelligence agencies’ security concerns seriously while also suggesting that they could be waved away if China makes trade concessions. Trump clearly sees the entity list restrictions that he placed on Huawei via executive order as a tactic in the larger trade negotiations. The U.S. Commerce Department is giving Huawei three more months of access to software updates for security purposes, effectively setting a countdown clock for the next round of negotiations.

Will other Chinese companies be banned from using U.S. technology or selling in the U.S.?

Even as recently as last month, the answer was almost certainly no; concerns about Huawei’s infrastructure business and alleged sanctions violations don’t apply to Lenovo (Motorola, ThinkPad), TCL (Alcatel, BlackBerry), OnePlus, CoolPad, or Xiaomi. There are new worries that DJI’s consumer drones could be targeted due to data security issues. However, the trade war seems to be the driving force at work now, and if that gets worse, all bets are off.

To discuss the implications of this report on your business, product, or investment strategies, contact Avi at avi@techsponential.com or +1 (201) 677-8284.