Latest US Department of Commerce action limits Huawei’s ability to source components – again
The US Department of Commerce (DoC) has added another wrinkle to the sanctions announced in May of this year, targeting Huawei. After putting the Chinese company on the Entity List in 2019 because of national security concerns, the DoC followed up those restrictions with new sanctions aimed at limiting Huawei’s ability to design and manufacture its own smartphone chips.
The new sanctions, announced on Monday, August 17th 2020, add additional Huawei affiliates to the existing Entity list. Further, the new order now requires any company acquiring US technology, with the goal to provide that technology to Huawei as the true end client, to now also apply for a license to do so.
The new sanctions are likely to significantly impact Huawei’s smartphone business for the rest of 2020 and most of 2021. There appear to be no quick remedies for this situation and Huawei is running out of options.
Limiting access to chip alternatives
In May, the DoC changed the rules under which Huawei can manufacture its own chips, the Kirin family of processors. The new rules stipulate that companies manufacturing Huawei designed chips now also fall under US jurisdiction, if they use US technology and software in their manufacturing and testing processes. The most obvious, and direct, result of this sanction was TSMC’s decision to not produce any new Kirin chips. The last of the already produced, or in process, components need to be delivered to Huawei by September 15th this year. For new components to be allowed to proceed, TSMC would have to apply for a special license from the DoC.
One way for Huawei forward appeared to be to buy chips from other manufacturers and use them in smartphones instead of Kirin chips. Purchasing more supply from Qualcomm appeared one possible way for Huawei to move forward. Other options could have been, potentially, Samsung and MediaTek.
However, the latest rule change seemingly eliminates the option for Huawei to buy chips from another vendor. Now, vendors transacting with Huawei directly, or as an intermediary, are also under US jurisdiction if the solution in question contains US technology and software.
Example: Qualcomm would need a license from the US government to sell chips to an ODM, if the assembled products would be Huawei smartphones. Qualcomm also needs a license to directly supply Huawei.
Expired Temporary General License
The difficulty US companies will face in attempts to get a license from the US government is illustrated with the fact that the Temporary General License (TGL), which had been renewed every 90 days since last year, was allowed to expire on August 14th.
For the smartphone market, TGL was important, because it allowed Google Android updates to reach existing Huawei smartphone users even though new Huawei phones could no longer come with Google Mobile Services (GMS) pre-installed.
The Mate 30 series, launched in September last year, was the first to not include GMS. Since then, Huawei has been trying to create developer buy-in for its own Huawei Mobile Services, the company’s replacement APIs for the missing Google services.
In response to the latest sanctions, Huawei has announced that the company will continue to provide software updates to existing devices. Also, applications already installed on devices should continue to receive updates, according to Huawei. However, Huawei likely has to increase its role in providing software updates for existing devices. How the monthly security updates for Android, released by Google, will reach Huawei devices is not clear now. Even if Huawei is able to provide updates in some way, based on Android Open source, the sanctions provide another level of uncertainty for end-users and channel partners alike.
The combined effects of the new, even stricter sanctions, and the non-renewal of the TGL do not leave Huawei with many open alternatives to negate the impact on its business.
Huawei had been able to avert the impact of the year-long sanctions so far, claiming the Top global smartphone OEM spot in Q2 2020. This position is now under more direct threat than ever.
Change in administration
Hoping for a change in administration at the White House after the elections in November is not a credible option for Huawei. Even if the current president is not re-elected, the administration will be in place until the end of January 2021. After that, there is no guarantee that a new president would be able to reverse these sanctions instantly, providing instant relief.
These severe restrictions are likely to be in place until at least January – almost two quarters of being cut off from US technology components. Even if restrictions are then swiftly removed, the supply chain needs to be re-engaged, because suppliers are unlikely to defer potential business until sometime in 2021, when other OEMs can utilize their components right away.
Focus on domestic market
One of the clearest results of the initial sanctions has been the inability for Huawei to install Google Mobile Services on new handsets. As a result, Huawei increased its focus on its home market. Huawei products in China are based on Android Open Source and use Huawei's AppGallery as app store and do not rely on Google’s mobile framework.
Huawei has made up a decline in overseas shipments by increasing domestic shipments. Huawei’s domestic shipment share increased to 59.1% in 2019 from 51% in 2018. In Q2 this year, Huawei’s domestic smartphone shipments reached 75.6% of the company’s total. Huawei’s brand increased at home after the US sanctions, driven by a compelling product line up like the Mate and P-series flagships. Huawei is the only brand in China able to compete with Apple in the flagship segment.
Huawei also built out its high-end product line-up with Nova and Honor devices. These phones compete with local brands OPPO, vivo and Xiaomi. These brands saw their shipments decrease in China, especially in the middle- range and high-end segments.
While the company has been able to grow shipments in China, even this is now under threat from the latest sanctions. Huawei should be able to maintain its position in China for the rest of this year. Without intervention, Huawei will be faced with chip supply shortages in 2021 for all markets.
Years of growth set to disappear in Europe
In Europe, the Google ecosystem is indispensable for smartphone users. The first set of sanctions against Huawei last year impacted Huawei immediately – shipments declined after the sanctions were announced. Even though shipments in Europe recovered after the initial decline, the uncertainty of the situation caused carriers and consumers to look beyond Huawei. Still, Huawei was able to navigate a difficult situation well and maintain shipments to a large extent.
For Huawei, Europe is the most important overseas market. Around 20% of Huawei smartphones are shipped to Europe. During the last few years, Huawei managed to build a strong brand reputation in Europe, and its market share grew from 18% in Q1 2018 to 25% in Q1 2019. Western Europe is an important market for Huawei high end flagship devices, while Eastern and Central Europe are volume markets for its mid-range and low-end smartphones.
Since May 2019, Huawei market share in Europe declined 16% YoY, from 25% in Q1 2019 to 21% in Q1 2020 – illustrating Huawei’s ability to stay in the market. Huawei was able to do so by re-launching existing devices with slightly adjusted specifications, like the Huawei P Smart 2020, or new color and material options, like the P30 Pro with new back cover design at IFA 2019.
In Eastern Europe, including Turkey and Russia, users are less reliant on Google services. This helps explain Huawei’s continued growth in the region, while Western Europe showed a sharper decline.
Figure 1: Huawei's market share in Western and Eastern Europe
At the same time, Huawei focused on growing the Huawei Mobile Services (HMS) ecosystem in Europe - investing in developer programs for European developers and content providers to grow the number of available apps and services on AppGallery for European users as replacements for missing Google services. This is a long term process and cannot close the many existing gaps in app availability.
Because of the current multi-tiered sanctions on the company, Huawei's market share will further decline in Europe. This turbulent environment will benefit Samsung sales in all price ranges, but especially in the high-end devices sales.
Xiaomi has successfully grown its brand recognition in Europe in the last two years and is positioned to take share in the mid-range and low-end segments. Oppo expanded aggressively in Europe to escape the competition from Huawei in their domestic market. Vivo and Realme are also eyeing the European markets – making life difficult not only for Huawei but also other existing smartphone brands, like LG, ZTE, TCL and others.
Huawei’s smartphone shipments to decline to 117 million units next year
Supply restrictions of application processors is expected to have a significant impact on Huawei's smartphone shipments - the impact is expected to be more pronounced next year than this year.
Even if the supply of chips to Huawei stops immediately due to sanctions, Huawei will be able to continue smartphone production through this year and into early next year by using existing inventories. Most of the smartphones produced during this period are expected to be shipped to the Chinese domestic market, where the impact of US sanctions is negligible. Huawei’s overseas business will contract significantly.
While the US pressure on China is expected to continue at least through the US elections in November, we revised our smartphone shipment forecasts for this year and next year, assuming that the current level of sanctions on Huawei will be maintained until early next year.
-Current level of sanctions (restrictions on semiconductors supplies to Huawei) continued until January 2021.
-Until the second quarter of next year, Huawei will be able to rely on existing inventory.
-Cooperation in chip development and production with Huawei's Chinese local semiconductor company (using Chinese-made chips for low-priced models)
-In the first half of next year, the US will ease some sanctions against Huawei, and suppliers, including MediaTek and Qualcomm, start supplying to Huawei.
Based on the above scenario, smartphone shipment forecast by OEM this year and next year is as follows:
Huawei's smartphone shipments are expected to decrease significantly from 185m this year to 117m next year. This is because, as mentioned above, production volume will inevitably decrease due to the limited supply of chips until the first half of next year. If processor supply is available from the second half of next year, shipments to the Chinese market will surge while overseas sales are expected to take some time to recover. In addition, shipments are highly likely to fluctuate depending on Huawei's current processor inventory. At present, Huawei's exact component inventory is unknown. Over the past year, Huawei has found a way to circumvent US sanctions. Huawei can do so again by expediting the removal of US technology and software from its supply chain and by cooperating with Chinese application processor manufacturers and foundries.
Huawei's decline in shipments is expected to have a negative impact on the Chinese domestic market, as Huawei had a 48% share in China in Q2 2020. Huawei smartphone users show strong loyalty to Huawei. As a result, some consumers are expected to extend the replacement cycle of existing smartphones, instead of jumping to a different brand. Vivo and Oppo will be able to replace Huawei in mid-range and high-end segments while Xiaomi is well positioned in the low-end segment.
These OEMs will also be able to fill Huawei’s portfolio position in overseas markets as well. Oppo is expanding further in Europe by strengthening relations with European operators. Xiaomi is also strengthening its expansion in overseas markets beyond Asia Pacific.
Samsung Electronics, which competes with Huawei in almost all regions, is also expected to be a beneficiary. As a result, we increased Samsung's smartphone shipments for next year significantly from 275m to 293m. In addition, in the Middle East, Africa and South America, where Huawei's market share is high, other Chinese OEMs will be able to replace Huawei.
The US sanctions against Huawei are unlikely to be resolved in the short term. If the political situation changes, the level and persistence of sanctions are likely to change quickly, so the 2021 outlook was not modified by assuming the worst-case scenario. In addition, if the supply of processors from MediaTek and Qualcomm does not resume in the second half of next year, as we assumed, shipments of Huawei next year may drop even below half of our forecast, as chip inventory runs out and production stops. OMDIA will continuously monitor the situation and continue to revise its outlook according to changes in the situation.