Smartphone commoditization has hit Taiwan’s HTC (TPE: 2498) hard. The top handset maker by volume in the US in 2011, HTC cratered over the next two years, posting its first annual loss in 2013 as Samsung (KRX: 005930) and low-cost Chinese brands chipped away at its market share. By 2014, HTC was no longer one of the top ten handset brands by shipments and held a pithy 1.5% share of the global market.

Analysts warned of HTC’s impending demise and suggested a buyout to increase its competitiveness. Going private would allow HTC to pursue strategies without an immediate payoff, but which would bear fruit in the long run, such as a push into lower-end handsets, they said.

HTC rejected the idea of a buyout. But it has cut costs, introduced cheaper handsets and is expanding into new product categories.

Following these moves, the Taoyuan, Taiwan-based company has returned to profitability for three consecutive quarters. Its fourth-quarter profit rose 49% to $14.8 million over a year earlier, beating analysts’ expectations of $10.4 million. Revenue increased 12% to $1.5 billion from $1.35 billion a year earlier. In the final three months of last year, HTC also posted its first quarterly sales growth since 2011.

HTC is forecasting an annual revenue increase of 30% this year.

Reading between the numbers

Aggressive cost cutting has driven HTC’s improved performance, industry experts say. A key part of that strategy has been outsourcing production of its non high-end handsets. In May 2014, chief financial officer Chang Chialin confirmed that contract manufacturers were making some HTC smartphones. He said the company’s outsourcing volume was below 50% of total shipments, but declined to specify the actual figure.

Compal Electronics (TPE: 2324) is handling a large portion of HTC’s orders. In 2014, the Taiwanese OEM made 2 million smartphones for HTC and may ship as many as 6 million this year, says Arthur Liao, a downstream analyst at Fubon Securities in Taipei. Compal also makes handsets for many other leading vendors including Sony (TYO: 6758) and makes Microsoft’s (NASDAQ: MSFT) Surface tablet.

“Outsourcing has improved the cost structure of HTC’s mid and low-end devices,” CK Lu, a principal research analyst at Gartner in Taipei, told VR World in an interview. “It’s an important part of their strategy to boost profitability.”

But there are limits to the benefits of outsourcing for HTC, because it still produces its premium smartphones in-house. Those high-margin devices are the company’s bread and butter, not lower-end handsets.

At the same time, HTC’s financials may be shakier than they appear. The New Taiwan dollar’s fall against the greenback was an important contributor to recent profitability, says Jeff Pu, an analyst at Yuanta Securities in Taipei.   “HTC was lucky that the NTD depreciated sharply,” he says. “Otherwise, they might have posted a loss in the fourth quarter.”

New product lines

As HTC tries to gain ground against its competitors, it is rapidly rolling out new product categories: tablet computers, action cameras, wearable devices, even a virtual-reality headset. The purpose of that diversification is to provide new sources of revenue and position the handset maker as a stronger consumer brand, analysts say.

“You can’t grow producing smartphones alone,” says Lu of Gartner. “The market is too saturated. HTC is the only major vendor without something else.”

Tablet computers are an odd place for HTC to start. Not only are the devices plummeting in popularity among consumers, but HTC’s previous foray into the tablet market in 2011-2012 was a flop. Its overpriced Flyer and Jetstream tablets each lasted less than a year.

Yet HTC is the producer of the new Nexus 9 tablet, which was released in October 2014. Reviewers have compared the device unfavorably to the iPad Air 2 and Samsung Galaxy Tab S 8.4, criticizing the Nexus 9’s poor battery performance, screen resolution and camera. Sales peaked for the Nexus 9 “in the first few days,” says Pu of Yuanta Securities, adding: “It’s going to be a disappointment.”

The “Re” waterproof action camera shows better potential. Also unveiled in October, the tube-shaped device features a 16-megapixel sensor, a wide-angle lens and HD video recording capability. Since the device connects to smartphones wirelessly, it will be able to live stream directly to YouTube under a planned partnership.

The Re camera is selling well, HTC says. In December, it forecast sales of 20,000 units of the device by the end of 2014, with strong momentum carrying into 2015. Jack Tong, president of HTC North Asia, said at a product launch in February that the Re camera was performing well enough to boost the company’s overall first-quarter revenue.

HTC is competing with GoPro (NASDAQ: GOPRO) and Sony in the nascent action camera sector. Sander Research forecasts that market will grow 16% annually through 2018.

At this week’s Mobile World Congress in Barcelona, HTC is taking its new product categories a step further with the launch of the Grip fitness band and Vive virtual-reality headset.

Grip is HTC’s first wearable device. The GPS-enabled fitness band was co-developed with the American sportswear company Under Armour, which supplies wearables to the US military. HTC is positioning the device as a fitness wearable rather than a smartwatch, but it does have email, message and phone functions. Grip is also compatible with both Android and iOS devices.

The Vive virtual-reality headset, which uses technology from the US game developer Valve, is the more intriguing of HTC’s two new gadgets. Vive provides a panoramic high-definition view and tracks body and head movements as the user walks. HTC says Vive’s mobility distinguishes it from Samsung’s Gear VR and Google’s cardboard virtual-reality goggles, which users engage from the confines of a chair.

But unlike the Samsung or Google devices, HTC’s virtual-reality headset works only with PCs and consoles. HTC says it plans to make Vive compatible with mobile devices in the future.

A developer version of Vive will hit the market in spring and the device will be launched for consumers during this year’s holiday season.

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Taiwanese technology companies are poised to tap the fledgling wearable devices market on the back of their hardware prowess and ties with Apple, whose highly anticipated smartwatch is expected to spur mass consumer adoption of the gadgets.

Wearables track information for health and fitness purposes, such as the number of hours slept, steps walked or calories burned and are equipped with small motion sensors to take photos and sync with mobile devices. In addition to smartwatches, other common wearables include connected fitness bands, glasses and fabrics.

Thus far, devices from global brands including Samsung (KRX:005930) , LG (KRX:066570) and Sony (TYO: 6758) have failed to generate a devoted following. Consumers are put off by their limited functionality, analysts say. “People are asking themselves, ‘why would I want to put on this watch?’”says Amy Teng, a principal research analyst at Gartner in Taipei.

But many industry experts believe Apple’s smartwatch will solve that conundrum, creating a viable new product category as the iPad did for tablet computers. The research firm IDC forecasts wearables shipments will triple on year to 19 million in 2014 and reach 112 million by 2018. Juniper Research is more bullish, predicting shipments will rise from 27 million this year to 116 million by 2017.

“Without Apple’s involvement, manufacturers would think twice about investing heavily in an unproven product category,” say Jeremy Huang and Jessica Hsu, senior analysts at the Market Intelligence & Consulting Institute (MIC), a research house affiliated with the Taiwanese government.

Benefiting from Apple

While Apple remains tight lipped about details of its forthcoming smartwatch, several Taiwanese manufacturers are involved in the production of the device, market insiders say.

The most prominent of them is Quanta Computer (TPE: 2382), the world’s largest contract PC manufacturer. Quanta is a major supplier of Apple’s (NASDAQ: APPL) iMac computers and has also produced its iPods in the past. Quanta’s mobile device team is the primary manufacturer of the Apple Watch, according to Taipei-based Fubon Securities (TPE:2881).

Arthur Liao, a downstream analyst at Fubon, believes the Apple Watch will not be a major source of earnings for Quanta, contributing just 5-6% of overall revenue, but will help the company to move beyond hardware manufacturing. “Quanta wants to use the Apple Watch to get a foothold in cloud computing and the Internet of Things (IoT) ecosystem,” he says.

Liao believes Kinsus Interconnect Technology, a Taiwanese maker of electronics components, is in the Apple Watch supply chain because of its ability to mass produce curved printed circuit board (PCB) components required for the device’s flexible display. “Kinsus is the only company with both the advanced technology and production capacity to meet Apple’s requirements for these parts,” Liao says. “Winning this order from Apple will help Kinsus reaffirm its position in pioneering technology.”

Homegrown wearables

Taiwanese firms are also keen to gain a foothold in the burgeoning wearables market with devices of their own. At Computex, more than three-fourths of the 59 wearable exhibitors were from Taiwan, compared to six at the 2013 show.

Among those exhibitors was Acer (TPE: 2353), the No. 4 PC maker globally, who unveiled a hybrid fitness band-smartwatch called the Liquid Leap. The device has received a mixed reception. Wareable, a site dedicated to wearable device reviews, describes it as “a multi-tasker doing nothing particularly well.”

Asutek (TPE: 2357), the world’s fifth-largest PC manufacturer, launched its Android-powered ZenWatch earlier this year in the US and Japan and plans to roll out two additional smartwatches in 2015 in a bid to become a dominant player in the wearables market.

Consumers in the US and Japan have responded well to the ZenWatch, Asutek chief executive Jerry Shen said, in remarks to the audience at a December product launch for the device in Taipei. Shen did not reveal sales figures, but added that the ZenWatch would be released in China, Hong Kong and Europe in the future.

The Taipei-based startup JoyRay Technology, meanwhile, is focusing on wearables for children. Its open-platform Jumpy smartwatch, which can run Android or iOs, is slated for release later this year. Founder and chief executive officer Jerry Chang worked in Foxconn’s smartphone business group for more than eight years before leaving in December 2013 to launch JoyRay. As Chang’s ties with the world’s largest contract electronics maker remain strong, Foxconn will produce the Jumpy watches.

Chang had the idea to found JoyRay when he observed the fascination of his young son with one of the Foxconn smartwatch prototypes he showed the boy. “I realized there was tremendous potential in the children’s smartwatch market,” Chang says.

Jumpy faces a slew of global competitors, but Chang believes the device’s large screen, detachable watch head and varied apps will help it to stand out. “Most kids use smartwatches for two weeks and then lose interest,” he says. “Jumpy will keep kids engaged with educational, exercise, and entertainment apps that will be regularly updated and encourage interaction between kids and between parents and kids.”

Proceeding with caution  

Despite the steady rollout of new wearable devices, some industry observers remain skeptical about the products’ viability. Gartner found just 40% of wearables users between 2011 and 2014 replaced a wearable device at the end of its lifecycle. That low replacement rate does not augur promise for wearable technology, Gartner principal analyst Amy Teng says, adding that wearable devices could follow a similar trajectory to tablets.

Tablet shipments surged after the introduction of the iPad in 2010. But as vendors flooded the market with devices over the next few years, consumers felt little reason to upgrade to newer models that differed scantly from their predecessors. As a result, tablet shipments fell for the first time in 2014.

Taiwanese tech firms should look to integrate wearable technology into a larger service platform, say Jeremy Huang and Jessica Hsu of MIC. They offer Disney’s $1 billion MyMagic+ technology as an example. A key part of that technology is the MagicBand, a bracelet linked electronically to an encrypted database of visitor information. Within a Disney theme park, it serves as an admission ticket, hotel key, credit card or debit card. If the technology is successful, it may spread to airports, malls, museums and zoos, analysts say.

For now, Teng urges prudence on wearable technology. “We all want this market to continue to grow, but the products are still at an experimental stage,” she says. “Consumers have to be convinced of their value.”

Photo: Jumpy smartwatches for children. 

Photo by: JoyRay

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Successful tech startups are rare in Taiwan. They have traditionally been perceived as risky, making it difficult for entrepreneurs to secure early-stage funding. Capital is typically deployed toward later-stage investments by large corporations and venture capitalists seeking short-term financial gains or to complement their existing businesses.

Similar attitudes also exist in China but investor interest in startups is moving in tandem with China’s soaring technology stocks. This year, China’s own tech giants Alibaba (NYSE:BABA) and Tencent (HKG:0700) are taking advantage of their rising share prices to buy up startups at high valuations. Their buying spree is expected to last two years, analysts say.

Meanwhile, startup culture in Taiwan is also changing as the island looks to diversify an economy long over dependent on the manufacturing of technology hardware. 500 Startups, a California-based accelerator and seed investment fund in technology companies, sees strong potential in Taiwan startups and has invested in five so far.

VR World caught up with 500 Startups’ partner and Greater China investment head Rui Ma during her November visit to Taiwan to discuss the country’s nascent startup scene and how it compares with that of its massive neighbor across the Taiwan Strait.

VR World: What do you think are the most important differences between the startup environments in China and Taiwan?

Rui Ma: The ecosystems are completely different. China is a huge market and is the most active region outside of Silicon Valley. It has thousands of startups, 1,200 professional angel investors and hundreds of funds. The number of angel investors is still a fraction of what it is in the US, but it has really improved from three years ago.

China is creating generations of successful tech entrepreneurs. You see startups that grow into successful businesses and whose former employees go on to form new companies. Take Alibaba, for instance. Former Alibaba employees have created 130 startups.

In Taiwan, you have talent, and you have capital – although it tends to be deployed in later-stage investments – but you don’t have local heroes like Jack Ma who can act as mentors for the next generation. Taiwan has had many successes in tech but those have come in hardware manufacturing, often as OEMS or ODMs. The big Taiwanese tech companies haven’t created many employees within their organizations knowledgeable about running a startup.

VR World: China’s economy has been growing much faster than Taiwan’s. How is that impacting startups?

Rui Ma: Taiwan’s economy has been fairly stable, stagnant even. You see a lot of tech businesses in Taiwan that in order to grow should go into another line of business. They have been around five, ten or fifteen years. But they have no appetite for risk. When you consider Taiwan’s economic situation, it’s rational in a certain sense.

In China, you just can’t do that. You have to go to grow to break even. Salaries are going up at 20% a year. The cost of living is rising rapidly. You are almost forced to grow in China.

VR World: How important is government support to Chinese startups?

Rui Ma: China has government support for entrepreneurship coming from the highest levels. President Xi Jinping says innovation is part of “the core of the Chinese dream.” In May, nine Chinese government departments said they would help 800,000 university students start their own businesses between 2014 and 2017. That’s not the main force that creates a successful startup culture, but it helps to shape cultural perceptions, and I think it is having an impact.

It’s still risky to be considered an entrepreneur in China, but to go to work for a startup has become much more mainstream, and overall, I believe it’s seen as more acceptable to fail in China than just a few years ago, more so than in Taiwan, where there is still a real hesitancy to acknowledge failure.

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Chinese smartphone brands are vying for market share in neighboring Taiwan, where international brands and the island’s own HTC (TPE: 2498) have historically been dominant.

While the Taiwan market is small, its cultural similarities with China makes it a logical choice for ambitious Chinese smartphone makers like Huawei Technologies (SHE: 002502). and Xiaomi Inc., who are in the midst of international expansion. Xiaomi has an 11% share of Taiwan’s handset market and Huawei 2%, according to IDC, a market-research firm. Chinese brands are searching for new growth opportunities overseas as their home market – the world’s largest for mobile phones – becomes increasingly saturated, analysts say.

“Chinese brands can use Taiwan as a stepping stone to other global markets,” says Sophia Chen, a handset analyst with the Market Intelligence & Consulting Institute (MIC), a research firm affiliated with the Taiwanese government.

Upgrading ‘Made in China’

In the Taiwan market, where they are newcomers, Chinese smartphone vendors must build brand awareness and counter the stigma that their products are of dubious quality. To that end, they are offering both inexpensive feature-packed mobile phones and flagship high-end handsets to Taiwanese consumers.

This year, Shenzhen-based Huawei, the world’s fifth-largest smartphone manufacturer by shipments, aims to double its 2013 Taiwan sales to 200,000 units. In July, it launched the Honor 3C, a 4G LTE-enabled handset in partnership with the Taiwan carrier Chunghwa Telecom (TPE: 2412). Priced starting at $564 (NT$16,900), the device competes in Taiwan’s premium handset market.

The high-end market will be difficult for Huawei to penetrate, says Alan Chen, an analyst at TrendForce, a Taiwan-based market research firm. “Made in China means low and mid-priced products to Taiwanese consumers,” Chen says. “Taiwanese consumers are very brand conscious. They are likely to choose a comparable Samsung phone instead.”

But high-end handsets may help Huawei build brand awareness in Taiwan, says Carlos Peng, an analyst at Fubon Securities in Taipei. “Huawei wants to show Taiwanese consumers that as a Chinese brand it is capable of producing a high-end smartphone that in theory can compete with HTC, Samsung or LG,” he says. For that reason, Huawei is content to sell premium handsets in small numbers for now, he adds.

Oppo, which was founded in 2004 as a manufacturer of Blu-ray video and MP3 players, is another Chinese brand targeting Taiwan’s premium handset market. Oppo launched its flagship 4G Find 7 in the third quarter through Chunghwa Telecom at a cost of $566 (NT$16,990). The Dongguan-based firm says it expects overseas revenue to comprise more than 50% of its total sales by 2017.

Oppo is touting the Find 7’s camera, which features a Sony camera module designed for taking selfies. Oppo may have a niche market opportunity with selfie fans, as no comparable product exists on the Taiwan market now, says Joey Yen, a research manager with IDC in Taipei. But if an international or Taiwanese competitor launches a similar product, Taiwanese consumers will choose that device over Oppo’s, she says, adding: “Taiwanese consumers still have reservations about the quality of Chinese brands.”

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China has long been paramount to Taiwan’s technology hardware firms. It first offered them a low-cost manufacturing base for electronics components sold to global brands like Apple (NASDAQ: APPL), and later, as some transitioned into branded consumer electronics, a huge market that shares geographic and cultural proximity with Taiwan.

The key Taiwanese firms in Apple’s supply chain have flourished. Hon Hai Precision Industry (TPE: 2317), also known as Foxconn, is the world’s top contract electronics maker and Apple’s largest supplier. From April to June, Hon Hai’s profits rose for the third consecutive quarter to $673 million ($NT20.19 billion) . Taiwan Semiconductor Manufacturing Co (TSMC) (TPE:2330) is the largest contract chip maker globally and produces the microprocessors in Apple’s smartphones and tablets. TSMC posted a record net profit in the third quarter of $2.51 billion (NT$76.3 billion).

But as China’s own companies move up the value chain, Chinese wages rise and the renminbi appreciates, many Taiwanese tech firms see their competitive advantages eroding.

Chinese firms have a strong edge in their home market, the world’s largest for technology products. Beijing provides its companies with low-interest loans, generous subsidies, government procurement and even judicial protection.

“Support from the Chinese government is the greatest asset Chinese tech firms have,” says Avril Wu, an assistant vice president at TrendForce, a Taiwan-based market-research firm.

Beijing also restricts foreign investment in the telecommunications sector, which is an oligopoly dominated by the state-owned carriers China Telecom (HKG: 0728), China Unicom (HKG:0762) and China Mobile (HKG: 0941). Beijing’s support, along with aggressive marketing and retail distribution strategies, have helped Chinese brands Lenovo (HKG: 0992), Huawei (SHE:002502) and Xiaomi grab smartphone market share from global competitors including Samsung and Taiwan’s HTC (TPE: 2498).

Losing in China

Two years ago, Ray Yam, who then headed HTC’s China operations, said the firm’s goal was to be one of the top two handset vendors in China by revenue by 2015.

At this point, that seems unlikely. HTC has flagged badly since 2011, when it sold one in ten mobile phones worldwide and was the global leader in Android smartphone shipments. In China, it has just a 5% share of the handset market, according to TrendForce.

“HTC’s new models lack innovation and outstanding features,” says Vanessa Zeng, a senior analyst at Forrester Research in Beijing. “Compared with domestic brands, its products are a poor value and its brand is not clearly defined. So HTC is losing from the standpoint of both retail channels and end users.”

Fu Cong, a 30-year-old account manager with a news distribution provider firm in Shanghai, bought an HTC smartphone in early 2013 and is unsatisfied with its performance. “It became very slow after a year of use,” he says. “I don’t see any clear advantage for HTC now either, since it is more expensive than domestic brands but uses the same Android operating system. I will consider buying a domestic brand in the future.”

HTC will struggle to gain traction in China, says Wu of TrendForce. Chinese brands better understand China’s consumers and equip their handsets with in-demand software and services, she says, adding: “HTC wants to position themselves as a premium brand and keep prices up to maintain profitability, but they have neither the resources nor wherewithal to do effective marketing. They are a hardware-oriented company.”

Chips on the table

MediaTek (TPE: 2454), Taiwan’s largest chip designer, also faces tough competition in China. MediaTek posted record profits of  $420 million (NT$12.55 billion) for the quarter ending in June, as smartphone and tablet computer chip shipments rose. But Deutsche Bank downgraded its shares in September, citing unexpectedly tenacious competition in the China market.

US chipmaker Qualcomm (NASDAQ: QCOM) is China’s top mobile phone chip supplier, with a 50% share of the baseband market, compared to number two MediaTek, which has 25%, according to a Credit Suisse report. Qualcomm also holds 80% of China’s burgeoning 4G Long Term Evolution (LTE) chip market, according to data compiled by Digitimes.

“MediaTek is having trouble developing a power-efficient 4G chip,” says Wu of TrendForce. “They are going to try to grab market share by undercutting competitors’ prices, which will hurt profitability throughout the industry.”

Meanwhile, local competition is intensifying, buoyed by funding from China’s state coffers. The Beijing-backed private-equity firm Tsinghua Unigroup acquired local chipmakers Spreadtrum Communications and RDA Microelectronics a year ago for $1.78 billion and $907 million, respectively. Spreadtrum is China’s second-largest chip designer and RDA its third-largest.

In September, Intel (NASDAQ: INTC) took a 20% stake in Unigroup for $1.5 billion. Intel aims to penetrate the mobile chip sector by allying with Chinese rivals dominant in that industry as growth slows in personal computers. This investment also gave both Spreadtrum and RDA access to the Intel Architecture for future system-on-a-chip projects.

Still, MediaTek is likely to hang on to its strong position in the Chinese market for now, says Arthur Liao, an analyst at Fubon Securities in Taipei. “Chinese firms are becoming more aggressive in the production of mobile chipsets, but it will be hard to threaten MediaTek in the next two to three years,” Liao says. “But in the long term, China intend to dominate the market.”

Ceding ground slowly

Indeed, Beijing has set its sights on the semiconductor industry. While China is the top consumer of chips in the world, accounting for 45% of global demand, imported integrated circuits comprise 90% of that consumption, according to the consultancy McKinsey & Company. To strengthen the competitiveness of domestic semiconductor firms, the Chinese government is forming a special task that aims to boost their revenue at a compound annual growth rate of 20% until 2020. Beijing could pour up to $170 billion (1 trillion renminbi) into that project over the next five to ten years, McKinsey says.

China also intends to develop a world-class chip packager and tester. Taiwan’s Advanced Semiconductor Engineering (ASE) (TPE: 2311) is currently the world’s number one chip packager.

Ultimately, China seeks to build a team of semiconductor national champions and will move aggressively to acquire other companies in pursuit of that goal, says Jeff Pu, an analyst with Yuanta Securities in Taipei. In September, China’s largest chip packager and tester Jiangsu Changjiang Electronics Technology, flush with funding from Beijing, bid to acquire the Singapore chip packager and tester Stats Chippac Ltd. (STAT) (SGX:S24) . “China wants to use acquisitions to leapfrog up the value chain of chip packaging, which has a low entry barrier,” Pu says. “Chinese firms could be competitive with ASE in one to two years.”

Liao of Fubon Securities believes TMSC, with its superior technology, will dominate chip making for the next two to three years. After that, he says, it may have to contend with formidable Chinese competitors.

But because of the strength of its global distribution network and importance in Apple’s supply chain, Foxconn will remain the world’s preeminent contract electronics manufacturer, Liao says.

Increasing automation will also help Foxconn keep costs down and reduce the possibility of worker unrest at its factories, says Pu.

Still, for most of Taiwan’s technology hardware companies, rising Chinese competition will be difficult to manage without government support, particularly given the lengths to which Beijing goes to strengthen the hands of its own firms.

Worryingly, amidst political gridlock between the ruling Kuomintang and opposition Democratic Progressive Party, the Taiwanese government appears unable to act on behalf of Taiwan’s technology industry, wrote Kirk Yang, Barclay’s Asia Pacific ex-Japan head of technology hardware research, in a report published in June. Yang said more projects like the Hsinchu Science Park, which was established in 1980 and became a center for global semiconductor manufacturing, are needed if Taiwan’s technology firms are to remain global leaders.

Unfortunately, that type of support from the beleaguered Taiwanese government is unlikely to be forthcoming, says Pu. “I don’t think that’s where their priorities are,” he says.

Image credit: Matthew Fulco

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