In this class, I discuss my visit to Huawei and some lessons learned from lunch with rotating Chairman Guo Ping.

You can listen here or at iTunes or Himalaya.

• Competitive advantage: Learning advantages
• Competitive advantage: Economies of scale

Companies for this class:

• Huawei

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I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

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Welcome, welcome everybody. My name is Jeff Towson. I teach at Peking University and this is Jeff’s Asia Tech class. Now the topic for today is three lessons from having hot pot with Hua Hui Chairman Guo Ping. Now those of you who are followers, you noticed I mentioned a week or so ago that I was heading out to Shenzhen to have hot pot and… some beers with the rotating chairman, Guo Ping of Huawei. We did that a couple of days ago, it was great. Those videos are coming out shortly. But I thought I would talk about just sort of lessons I took away from that, things I didn’t know that I thought were pretty important. And then also to start talking about Huawei and some of the strategy issues that feed into that company, which has become a very important company. It’s always been an important company in terms of business and technology and now it’s increasingly a political situation. So I’m talk a little bit about that but that’s not really my area. OK so that’s going to be the topic for today’s three lessons from Hotpot with Huawei Chairman Guo Bing. And first of course if you haven’t subscribed please do so. You can go over to JeffTowson.com and sign up there. There’s a 30 day free trial, so please join the class, get involved, I really do appreciate those of you who have subscribed and sort of made that commitment. Also over at iTunes, you can subscribe to the podcast that’s free, so anyone can get that anytime. Okay, now onto the class. So last week I flew out to Shenzhen, which is kind of one of my favorite places. I mainly cover digital giants, tech companies. So I don’t really go to that many places. A lot of time in Shenzhen, Hangzhou, Beijing definitely, which is a ton of companies there. Increasingly Singapore, as I move sort of further down into Asia. Those are kind of my major cities. There’s not really that many tech companies outside of those. Even Shanghai doesn’t have really that many. But Shenzhen is awesome. One of my favorite places, very green, sort of. a little bit tropical which is kind of the thing I like about Bangkok as well. So fly into Shenzhen, head out to the Huawei headquarters, I mean this is where they’re based, they’re a huge deal in Shenzhen. And interestingly like their headquarters is like right next to Foxconn, so there’s actually freeways you can go and they have signs on the freeway turn right for Huawei, turn left for Foxconn. Anyway so go out to their headquarters which is amazing. And you know that Huawei has been, you know, they’ve traditionally been a telecommunications equipment manufacturer. So they make, you know, the routers you put into buildings, into offices, into hotels, wireline. Then over time, they moved into mobile. And then from that telco business, they moved into other businesses. Their biggest one is consumer business, smartphone, smart devices, things like that. And increasingly, they’re moving into enterprise business, things on the web. I’m sorry, the cloud. So they’re kind of slowly putting together the whole package, which would be connectivity, 4G, 5G, wireline, mobile, connecting to the devices in your hands, smartphones, smart homes, smart TVs, things like that, although they don’t make TVs. And then the other part of the piece is the cloud. So that whole sort of end-to-end solution is what they’ve been building over time. And they’re the market leader in telecommunications. They have been since about 2012, 2013 when they sort of matched Ericsson for the first time at about, back then it was about $33 billion in revenue. Huawei finally caught Mark Ericsson and then they’ve surpassed them since then. They also started smartphones in mid-2000s which has now grown where they’re basically number two or number three, although this year is a bit funky, but generally they’re number two or number three after Samsung. So number one in Ericsson, I’m sorry, number one in telecommunications, number two or three in smartphones, and probably gonna be number one fairly soon. So, you know, they’re really doing spectacularly well, and while their revenue was about equal to Ericsson in 2012, 2013, you look at it today, you know, before the whole US situation happened, they were at about $100 billion of revenue, which is really four to five times Ericsson, so they’re just, they’re. They’re way ahead in terms of just pure revenue scale. That’s not the same thing as profitability, but when it comes to R&D spending, who’s bigger is what matters. Okay. So you fly out to their headquarters, and it’s a pretty great headquarters because for, you know, their core business has always been selling to carriers around the world. So Vodafone, you know, Verizon, whoever, you know, all around the world, So that’s B2B type sales. So you bring out a lot of government officials, you bring out a lot of CEOs, Vice Presidents as part of the sales process. So as a result of this, they have a pretty nice come visit our campus process they have developed over many years. You know, they pick you up at the airport, they take you in, they have their own hotel. The campus is absolutely beautiful. And one of the quirky things is the founder Ren Zhengfei. he really loves European architecture. He just loves it. So when you go into the hallway headquarters, it’s all sort of like French style and statues of I don’t know what these Italian or French. I don’t know what statues are. But I mean, it looks like you’re kind of in a chateau and then you walk out back and it’s all grass and lakes and there’s literally French chateaus, you know, around and their new R&D center, which is up in Dongguan. So 30, 45 minutes away. That’s called Europe Town. I don’t know if that’s the official name. That’s what everyone calls it. And it’s basically built like five or six European cities. So there’s Vienna, there’s Marseille, and there’s a train that takes you through them. And it’s like castles and stuff. And it’s crazy. I mean, it kind of sounds Disneyland-ish. but it’s really not, like it’s really nice. And I guess the other thing Ren Zhengfei really likes is coffee. So in every one of these little Europe town squares, there’s coffee places everywhere. Now that’s also good because you’re doing your R&D there and everyone hangs out and drinks coffee and that’s probably pretty good in general. So anyways, kind of an amazing place. So I go in there and sort of meet up and we had planned this ahead of time. We had talked about what we were gonna talk about and… I was sort of, I guess, the first sort of influencer. I kind of said before, I don’t really like that term, but whatever you want to call that role, sort of the first one to be invited to come talk to their chairman. Now this is rotating Chairman Guoping because they do rotate their chairman and CEO fairly regularly. So everyone talks about Ren Zhengfei, the founder, but he’s pretty much been retired for quite a while. He’s not running day to day. So it’s that day to day team that I really wanted to talk to. Who’s making the decisions? Who’s dealing with the issues? What’s their strategy? Things like that. So we talked about it and they said, well let’s have a meeting, we’ll video it, we’ll put it up, all that stuff, fine, fine, fine. I said, look, I don’t wanna do that. Well, I wanna do that, but I wanted to do it like that. I wanna go, let’s go to a restaurant down the street, let’s go to a bar, let’s get a bunch of beer, let’s sit and just talk. Like. And we’ll talk about the real business questions, not these standard, you know, if you read the interviews, it’s always the same 10 questions over and over. It’s pretty boring. Let’s talk about the real strategy questions. And well, they said, well, I can’t go to a bar, but all right, so fine. Let’s have hot pot. Like, cause hot pots awesome. Like it’s, it’s like the greatest thing in China is hot pot. Let’s have hot pot. Let’s have some beers. And they sent that up to Mr. Guo and he basically came back and said, absolutely, we’re going to do that. Like he was very enthusiastic about that because I think he’s getting bored of answering the same questions as well. That’s a guess, but I think that’s true. Okay. So that was kind of the idea. We go, we sit down. Um, this is a logo up on video, stuff like that. And we just, you know, we talked for about an hour and a half about everything. And, you know, obviously had to defer on a couple of questions. Like everyone wants to know about semiconductors. not gonna give me an answer on semiconductors because they’re keeping their cards close to their chest on that one. But talked about sort of the early years of Huawei. I mean, one of the things about Mr. Guo is he was the fifth employee of the entire company hired back in 1988. So I wanted to talk a lot about the early years and sort of the path and then also jump forward. What’s gonna be five years from now? What’s that gonna look like? I’m not as much interested in all of this sort of. current events happening week to week. I don’t generally follow that stuff anyways. I kinda wanna see further down the road what’s gonna happen and also just sort of talked about his life, how he ended up there, you know, any regrets he’s had, advice he’d give to young professionals, MBAs about how to think about life, how to think about business. You know, and he was very open about all that stuff, very enthusiastic, fun guy to talk to, like really fun. and also to talk about my takeaways. And then in the middle of it, he kind of says, great, let’s go hiking on, I asked him a question like, what are some lessons you’ve learned? And he says, well, I exercise a lot more now. Because he had some medical issues years ago. And so he’s really into exercise. He said, I just did a half marathon, and we’re all going hiking this Saturday. It’s gonna be seven to 10 hours hiking in the Shenzhen Mountains. You should come. I kind of deferred a little bit. I’m like, look, I’ve actually got flights set and I’m due back in Bangkok. And yeah, that didn’t work. He’s like, no, no, no, no, you changed the flights. I’m paraphrasing, but that’s basically what he said. I deferred again and he basically blew through my deflections. So I ended up flying back into town on Friday and then hiking up in the hills for about three to four hours. They did like seven to 10 hours. And I said, that’s crazy. I don’t need to do, you know. 10 hours of hike. I’ll do three to four. That’ll be great. And then I’m going back to the hotel and I’ll, you know, I’ll watch the Avengers and chill out or something, which was a pretty good Saturday really. Okay. So that was kind of the crazy day. And then in between this, I ended up going to Jingdong’s new East base in Chongqing, which I’m going to write a lot about and talk about that. But we’ll skip that for today. Okay, so let’s talk about And you kind of have to get a sense for Huawei as a company that it’s really these two core businesses, the telecommunications equipment business and the consumer business, which is smart phones, smart devices. And neither of those are great businesses. Like if you’re looking at businesses that are attractive, businesses where… You can build a competitive barrier where you can make an inordinate sort of return on invested capital. Neither of those businesses are like that. They are both actually pretty tough businesses. Now I generally tell my students, look, if you don’t have a competitive barrier, if you’re not protected, then you’re basically in an endless marathon where you’re continually running every day. And that’s your only story. You don’t really even need any strategy. Your game plan is we get up and we do an operational marathon. where every day we run, run, run, we try and get more efficient, we try and get more effective, we try and improve our ops, and that’s the game we play. And if we fall down and stumble, other people catch us. But there’s no way to sort of cross the finish line in that sort of game. Now other businesses like Coca-Cola, Facebook, pretty much anything Warren Buffett invests in, they have competitive barriers such that you can kind of take it easy and make a lot of money and you don’t have to work that hard. You have some… advantages in those. Well, smartphones, if you don’t have an ecosystem, which Apple does, but most smartphone makers don’t. Smartphones and telco equipment, those are both tough businesses and they’re both global. You can’t just be the smartphone maker for Indonesia or the US. It’s a global game. You have to win everywhere. And telco equipment is kind of the same. You have to, there isn’t a… telco equipment maker that only sells in Europe and another that only sells in Asia. No, it’s a global competition, and you’re gonna get three to four to five winners globally, and everyone else is too small to play that game. So they’re in two tough businesses, and they do joke about this in their interviews and stuff, that if they had known this was such a tough business back in the 80s and 90s, they probably would have chosen another one. They just didn’t know any better. Okay, so, 1988. Huawei gets founded by Ren Zhengfei in Shenzhen. Shenzhen back in 1980s is really boom town. I mean, this is the first part of China that opened to the world. The early wave of entrepreneurs like Ren Zhengfei, like Wang Shi, the guy who founded Vanka. A lot of these companies, these were sort of ex-government people who all sort of left that world to go and become entrepreneurs. Because prior to that, the only job you could really get was as government. I mean, that’s what you could do. So they all sort of jumped ship from government, a lot of sort of crazy activity in the boom years of Shenzhen. And within that, you know, Ren Zhengfei started Huawei. The rumor is, or what people say is, he had 21,000 renminbi to found the company, which was, you know, not a couple thousand dollars. And they chose the name Huawei. And the story, which may or may not be true, is, you know, it turns out Huawei was not a great name. and they wanted to change it, but they didn’t have enough money to refile the paperwork, so they had to stay with it? I don’t know, I think that’s true, but I’ve never really confirmed it. Okay, so they start in the early 80s, and they did what most businesses did back then, is they did importation. You become an agent, you become a contract manufacturer, they basically cut a deal with a Hong Kong company to import PBX machines. So routers that you put into, let’s say a hotel, where one phone line comes into the hotel and then you can break it up into 50 or 60 lines for the rooms and that’s the PBX machine does that. Okay so that’s what they did, they had the Hagen Kong Company. And they started out and Mr. Guo was employee number 5 and I kind of asked how did that happen. He says well you know he was from Jiangxi. He was a masters in computer science so he had a college degree. And he wanted to go into business as well. So he moved down to Shenzhen. And he actually said he wanted to go to Shenzhen University. That’s where he wanted to go. He met with them. And I guess there was a problem with his Hukou. You have to have a local registration. Even if you have a Chinese citizen card, you have to have a local registration to work city by city. It’s still an issue today having your Hukou. And met with, I guess, the professors there. And they said there was some issue with the Hukou. But what they could do is they said you should talk to this guy Ren Zhengfei who’s founded this company you maybe go work for him and that could work out this situation. So somewhere in the way he got handed off to Mr. Ren, met with him, ended up becoming the fifth employee of Huawei. So I asked him kind of you know what was that like those early days and he says you know I was just flying around his his sort of area was Zhejiang which is you know around Shanghai that part of China. And he would go up there and basically sell PBX machines and install them and handle the problems and do the wiring and do whatever. And he didn’t have any training in that. He was obviously a smart guy, but he just kind of learned how to do it. And he would go around putting these things in hotels or office buildings or whatever contracts they could get because they were a very, very small company. The telco equipment business was all being done by the international giants and ZTE, which was much bigger back then. You know, Huawei was the tiny little player on the margins, sort of surviving on these small little contracts. And he said, you know, his big contract was like a 300 room hotel, and for that he had one assistant as a helper. But, you know, that was kind of how they started for the first couple of years, and it was really sort of, you know, their focus was not making a ton of money, their focus was survival. And that really became core to their identity, even today. You know, their primary goal as a tech company has never been, let’s go public. Let’s get a big payday. Let’s make big profits. Their goal has always been survival long term. How do you survive as a company long term? And Mr. Wren talks about this a lot, that they study other tech companies who survive and how do they survive. So that’s kind of turns out to be relevant when we’re talking about today and they get hit by the US. Well, you’re hitting a company whose primary strategy is survival. so and knows a lot about scraping by and getting by on nothing. So that’s you know pretty tough really. Okay so that was kind of the early years running around and then the first big event happens in 1990 1991 when basically the Hong Kong company cut off their contract for whatever reason cuts them off and it’s kind of like their first tech ban. I mean it was really a tech ban, not unlike, well, not too dissimilar to the current situation of the US cutting off their tech supply. This is not the first time they’ve had their tech access cut off in their supply chain. They dealt with this early on and as a result of that they started to build their own PBX machines and do it themselves. invest 10% of their revenue every year into R&D. And this idea that, look, we can’t be dependent on other companies because you can get cut off. So they sort of started developing their own PBX machines. I think they took about 11 months to build the first one and then to start to sell that. And ever since then, they’ve always spent at least 10% on R&D. Now it’s closer to 15%. So when I say they have $100 billion in revenue last year, Keep in mind 15% of that, 15 billion is going into R&D every year compared to say Ericsson, which I think their revenue is about $30 billion this year. They’re outspending them by four to five to one every year forever. And that’s a huge deal when you’re in the tech business. Okay, so that’s kind of the early years. We talked a lot about when they started developing their own products, how many of those were failures. you know, a lot of them where they spent a lot of money, a lot of time, and then the machine was no good or the market didn’t want it or didn’t sell. A lot of failures in the 90s. That’s really kind of, you know, the story. All right, so that’s kind of early Huawei, which I thought was interesting. And within that, they also sort of built up their initial culture. And I’m gonna talk about, you know, they are ultimately not a tech company. Tech comes and goes, tech can be copied, tech becomes obsolete very quickly. Now their big strength is not technology, their big strength is human resources. They are a big company that is very good at mobilizing and incentivizing engineers. And as tech comes and goes, the company continually recreates itself every three to five years. That’s the nature of surviving long-term as a tech company. So I’ve been saying this for a couple months, like, They are not going to win with technology. Yeah, their 5G is probably a year or two ahead of Ericsson and Nokia. That’s not the key thing. The key advantage they have over Ericsson, Nokia in telco is their culture. It’s their human resources strategy. That’s their big strength. Anyways. Okay. So that gets you to Huawei in the late 1990s. They start going international very early on. They were really one of the first Chinese companies to go international. had a lot to do with the fact that they were a small player in China and they were on the periphery. They were going for these small hotels and office buildings and they were going out to third tier cities because they were a very small player. But they got a lot of fast growth because it turns out in the 90s, China was kind of a boom town and you could get by pretty easily. Okay, so they start going international early on and they start competing in the Middle East. They start competing in Africa. And they’re known as having a very aggressive culture that can, you know, compete with anyone anywhere. They will go anywhere. They’ll go to the, I mean, they have all these crazy stories, which I’ll talk about those in a later class. There’s books of stories about all the crazy stuff they do of putting routers on in the Himalayas and you know, Mount Kilimanjaro and all these crazy places that they would go to that no one else would go to. So this sort of, this sort of battle mode, culture, this sort of we will take more pain than anyone culture. It really plays out in two divisions. It plays out in their sales division and it plays out in their R&D division. That’s what the center of their human resources strategy is about is those two divisions. They will sell more aggressively. They will compete with anyone anywhere in terms of getting sales, getting contracts, and they’ve put more money into R&D than anyone. So that’s where the culture thing plays out. Okay. 2004 they enter Europe. That was a bit of a stretch to fight their way in there. 2005, their international sales in terms of revenue surpasses their domestic sales for the first time. They also started launching smartphones. 2010, I believe, 2009. And they sort of grow slowly by slowly, bit by bit, step by step. And you can kind of see the game plan, which is We have this very aggressive culture in R&D and sales and marketing. We start to fight, fight, fight, and step by step we grow. And as you grow a little bit, you start to get scale advantages. One advantage is if you’re a manufacturing company and you’re a little bigger than your competitor or a lot bigger than your competitor, you can usually be cheaper. You have a cost advantage that comes with size and you also have a spending advantage in R&D. And that’s kind of been their process is every year we get a little bigger than our competitors. We are therefore cheaper and we can outspend people on R&D. If we do that well and effectively that should get us more market share which would make us even a little bit bigger. There again we can increase our spending on R&D and we can be cheaper. So it’s a bit of a virtuous cycle that plays out over really decades. And that has been their game forever. It’s a game of scale. both in smartphones and in telco equipment. Get bigger, get bigger, get bigger. There aren’t any real natural competitive advantages. So we have sort of two things we do, which is we get economies of scale within R&D and some manufacturing, and then we get sort of what we call a production advantage, which is about the more you have accumulated experience in a field, you can usually do things cheaper. And I’ll talk about those in the next part. But that was really kind of the… The first takeaway, I think, from this meeting was… Number one, and so I said there’s gonna be three lessons from my hot pot with Mr. Guil. Number one, this company has always been about survival. It’s about being tough, it’s about living lean, being frugal, it’s about thinking long term. That is very different than a lot of what we see in the tech world, especially a lot of these new IPOs coming out of Asia, which are pretty dodgy, honestly. So survival was always their goal, and they built a human resources strategy against that that has turned out to be their biggest strength, not technology. Because in the 30 years they’ve been doing this, the tech has changed so much. 2G, 3G, 4G, 5G. Everyone’s talking 5G right now. I guarantee you in five years we’ll all be talking 6G. The two core businesses they are in, telco and smartphone, smart devices, those are both tough businesses. Those are not businesses where you break out, get a strong advantage, and you’ve won. Those are business where it’s a long hard slog and you fight day after day, day after day, day after day, and slowly over time you build up some scale advantages, which I’ll talk about in a sec. And then the third one is, look, human resources has always been their core strength. And that’s sort of the next topic. All right, I wrote an article a couple months ago called, basically, Huawei is going to beat Trump with human resources, not technology. And it talked about this idea that I don’t really know what the point of the US tech ban was. I don’t know what it’s supposed to accomplish, because what it does accomplish is Fairly clearly is sort of refocusing and reenergizing this culture and convincing them they need to be independent and sort of have multi-channel supply chains and now maybe there’s other goals because I don’t do politics. I don’t understand why people do what they do in that world. But from a business sense, it was pretty clear what the response was going to be almost immediately. So you know. Back to that core point, look, Huawei’s strategy has always been about survival. If you go back and Ren Zhenfei is really interesting because I think he wants to be a human resources guy at heart. He’s been writing about human resources since like the early 90s. He has all these papers you can read. And here’s a quote from him from an article he wrote in 2001. He says, being big and strong temporarily is not what we want. What we want is the ability and resilience to survive sustainably. Here’s some of his other articles he’s written or talks he’s given. 1998, how long can Huawei survive? 2000, this is 2000 articles. Survival is fundamental to an enterprise. 2001, Huawei’s hard winter. I mean, he’s been talking about this for decades. So, and thinking about, you know, how do companies survive and really what they study, I think is why companies fail and how to avoid those things. So. My take on the strategy that came out of all that thinking was basically the following four points. This is my interpretation of what their strategy for long-term survival is. Number one, satisfy your customers better than your competitors and no matter what it takes, because ultimately that’s your lifeline. That’s where your cash comes from. That’s the key to everything. So they will do anything to satisfy their customers. And the stories are crazy. Point two, the other activities that people tend to talk about like technology, oh 5G. That’s just the means to the end. You can copy tech, you can buy it, especially in China and developing economies. So technology is only the means to the end. That’s a second tier priority. Number one priority is satisfying your customers. Number three, if your customers are satisfied, that’s how you grow. And that’s how you begin to get economies of scale, which is absolutely critical. As you get bigger as a manufacturer and a investor in technology through R and D and M and A, as you get bigger, in theory, if you are well run and well managed, your unit costs should decrease. Doesn’t necessarily mean you’re going to be lower costs than everyone, but you will at least be the low cost producer in your market. No one’s going to be cheaper than you. Now hopefully you’re cheaper than everyone else, but no one’s gonna get under you on price and then come to your customers and say, come with us, we’re 10% cheaper. You wanna be the person no one can get under. Point four, superior scale also gets you the resources where you can then outspend your rivals on tech, IP, and next generation products. I think that’s their game. I think it’s serve the customers no matter what. and slowly get bigger and bigger and slowly grind your competitors down with your lower costs and your greater R&D spending. And that when I look at 1995 to 2013 when they finally caught Ericsson, that’s what that looks like to me. And then 2012, 2013, today they’ve just kept getting bigger and bigger in smartphones. They’re moving up from number five to number four to number three to number two. They would have been number one this year except for the issues. And Telco, they’re so much bigger than that. I mean, they’re literally, their overall revenue is about four to five times bigger than Ericsson and Nokia, but that’s also smartphones. So if you just look at the Telco business, it’s about twice as big. So they’re just continually pulling ahead, pulling ahead, and now imagine where they’ll be in five to 10 years, right? And I’ve sort of been saying this for months, is like, if you take out the politics and it’s just a business case, I don’t know how you beat them. I don’t see anyone on the field right now who can beat them. Now if a Google or someone or an Amazon or something like that were to jump in, that could be an issue. But I don’t see how the current competitors can beat them. I just don’t. Okay. Now against that game plan, it’s not about the tech. It’s about your people. It’s about your culture. It’s about your human resources strategy. And they have a very unique culture. There’s a couple of companies in China that just have really vibrant. cultures, one of them is Alibaba. Everyone at Alibaba is different. The other one is Huawei. Everyone is like, oh my God, those people work really hard. Even in China’s like 996 culture, even people who live in that culture look at Huawei and they go, oh my God, those people work really hard. It’s an engineering-based company, so their core resource is really engineers. But not engineers doing engineering. What they like to do is take engineers and turn them into managers. So they have these sort of teams. That’s the, you know, if Huawei is like an army of battalions, lots of battalions. Well, each battalion is basically a small team led by an engineer turned manager. That’s kind of the unit you want to look at. And they have about 190,000 people now. Actually, I think the last time I looked last week was 194,000 people. So how do you motivate and get 194,000 people to really. work hard and be all in and continually just outwork people. Well, here’s another quote from Mr. Wren, quote, resources can be exhausted, only culture endures. Huawei does not have any natural resources to depend upon. What we do have is the brain power of our employees. This is our oil, our forest and our coal. Human ingenuity is the creator of all wealth. I mean, you can really see how he’s been building this systematically for Now, they’ve been doing this for a couple ways is, they talk a lot about, okay, how do you create value in an enterprise? And they say the value is all created when you serve a customer, and therefore you get a check, right? So that’s where the value comes from. Who creates that value? Which employees contribute the most such that the value of the firm is continually created? So they wanna know who’s, creating the value, but then they also talk about, okay, once the value is created, how is it distributed? And they want it to go back to the people that create it. So they don’t have a lot of, they don’t have public shareholders and the company, you know, most of the value goes back to… either people who own shares in the company, this employee stock ownership program, or through salaries or through bonuses. But generally speaking, you can think of it’s about a ratio of one to four. For every dollar that comes into the firm, you have to pay your cost of goods sold. So let’s say gross profit, when you get to the gross profit number, three out of $4 in that gross profit ends up going back to the people who create the value. That could be by salaries, it could be by benefits, it could be by employee ownership, a lot of things, but only one dollar of that goes to people who don’t create the value, and that would include ex-employees. If you’re an ex-employee and you leave, and you still have shares, one, you have to sell those back. There are some exceptions, but you’re supposed to sell those back, and if you don’t sell them back, you’re an exception. They don’t want the money going to those people. They want three to four dollars for every, let’s say five created. They want that going to the people that are currently creating the value today. And that’s kinda how they look at it. So it’s sort of very similar to 3G Capital, Jorge Paulo and this group out of Brazil that has sort of pioneered this idea of meritocracy and partnership, where the company should rerun on a strict meritocracy. Doesn’t matter how long you’ve been here, doesn’t matter what degree you have, doesn’t matter who you know, it’s all about performance. That’s the meritocracy part and also partnership. The wealth that is created all goes to the people that create the wealth. Now that’s kind of what Huawei is doing, they’re just doing it at a huge scale, 194,000 people. So, you know. What they’re very good in this system, there’s a system of appraisals, there’s bonuses, they give opportunities to people that they think are the most effective, they give bonuses to them, they move their salaries up, they give them titles, they reward them in lots and lots of ways through their assessment program, but then they also have their ESOP, their Employee Stock Ownership Program, where those shares you can buy in if you’re one of the designated employees, you can buy in on an annual basis to buy shares. They set the book value for the entire firm. It happens once a year You can buy in and that’s where you’re supposed to create most of the wealth in your life They don’t like their employees to have other sources of income they want all their income to come from the ESOP and their salaries and bonuses and The deal is if you do that if you commit if you’re all in and you’re one of the people that are part of the ESOP You will become wealthy. That’s kind of the deal So it’s meritocracy plus partnership at a very large scale. And it’s actually pretty complicated. I mean, it sounds easy in theory, but there’s a lot of complications like, how do you treat new employees? People who just come in, young men and women just after college, you wanna make sure that these people have a career path where they can also create wealth for themselves and the company. Well, that’s difficult if you’ve got a lot of shareholders or you’re already post IPO, or you’ve got the management is sort of entrenched up there and you know they’re not going anywhere. So for the new employees to have the same path, you have to move out the older employees. You have to create space for them to grow. So that’s a sort of a problem. For the more senior employees, well, these people are probably already pretty rich. How do you get them to keep contributing, even though they’re already wealthy? How do you get them to move out of those top positions that are pretty comfortable to sit in? How do you open up the space for the younger? But also the problem with senior people is, if you want top performers, if you want people to go all in, it can’t be just about the money. These are like world-class athletes or world-class mountain climbers. You have to keep giving them new mountains to climb. So you have to say we’ve done well in telco. Now we’re going into smartphones. Now we’re going into enterprise. Now we’re going into smart cities. The best people will leave if you don’t give them new mountains to climb. This is kind of an Apple problem. That the top people don’t want to work at Apple. Like why would you? What, we’re just gonna make yet another iPhone? No, they want new adventures. They want new things. So you’ve gotta give both the senior employees and the younger folks real big mountains to climb. You have ex-employees, you have Huawei veterans. You definitely want to reward them for the contributions they’ve made in the past. But you don’t want them to weigh down on the system. At a certain point, they have to leave. And Huawei does do this. When you leave the company, you have to sell your shares back to the company. If you’re over 45 or if there’s a widow situation, there’s exceptions. And then you’ve got this problem of famous founders as well. You know, famous founders, even if they don’t have huge ownership, they can sort of dominate the firm and they can be too famous. And you really want not to have that effect. You don’t want them sitting at the top forever where this is always going to be Mark Zuckerberg’s company for the next 50 years. And I think Huawei and Alibaba in particular were very good at having the famous founders step aside. Ren Zhengfei stepped out, Jack Moss stepped out, and the new crop of managers is making their own name for themselves. And I think they’re very good at that. So famous founders can be a problem as well. So when you get into this sort of meritocracy plus partnership, how do you do that at a big scale? I think Huawei’s done exceptionally well. And that lets you continually recreate your technology. You continue this constant game of getting bigger, getting bigger, run your competitors into the ground, step by step by step. Okay, if that’s Huawei as I’ve just described it, what is the effect of the US tech ban on them when Trump said, okay, you can no longer buy semiconductors, you can no longer use Google Play Store, and we’re gonna try and shut down your contracts around the world? No, I mean, ironically. Okay, you know, the supply chain was an issue. They had to restructure their supply chain. They’ve pretty much done that in telco already. Their telco base stations are already independent of US tech. Smartphones, it’s actually a bigger deal that’s sort of still playing out. But probably the biggest impact of all of this was you reinvigorated their culture. right because they had an issue where there were so many wealthy people at the top that this was something that the management talked about that like what we’re getting fat and lazy we’re not lean and mean like we used to be in the nineties uh… we’re too wealthy were too successful our main competitors aren’t running neck-and-neck with us anymore we don’t have a major competitor threatening to take us down every six months that we have to fight off the main competitors are kind of in and they’re in our our rearview mirror now being lazy and successful is a problem. Well, it turns out the tech ban really reinvigorated and refocused the whole culture. And so now they’re all in battle mode and everyone’s working like crazy. So to some degree it’s probably helped them as much as anything. I think looking back in three to five years, this is gonna be a huge gift to them. that they’re gonna develop new tech which they’ve never developed on their own. They’re not gonna be dependent on semiconductors or operating systems out of the West anymore. And they have reinvigorated their culture. I think that’s probably the five year story. Now between then it could be pretty rough, but I think that’s probably where it’s going, but we’ll see, it keeps changing. Okay, so that’s kind of the HR story, I think for Huawei as I see it right now. Let’s talk a little bit about some competitive advantage stuff, and then I think that’ll be it for today So let’s talk a little bit about competitive advantage now for those of you who are in my classes at PK UNC You know I talk about competitive advantage like all the time I mean, this is my obsession in life is the intersection of digital and competitive advantage it’s you know Michael Porter meets Jack Ma and I kind of just said look they had two core businesses here telco and smartphone slash smart devices, consumer business. And both of those are not terribly attractive businesses. There are some advantages to getting bigger, that’s true. You can get some scale advantages, but like the Huawei smartphone business does not have like the massive competitive advantages of say the iPhone in the US. Now the iPhone in the US is really two products. It’s a handset, you know, a smart device. which you buy and it’s pretty expensive, and it’s the ecosystem. Okay, the ecosystem has all the competitive advantages. This is the lock-in. There’s network effects, there’s locking in of customers. You have all your friends on your connections, you have all the music you’ve purchased on iTunes, you have your stuff on the cloud. There’s a lot of sort of very strong competitive advantages, mostly on the ecosystem side. The handset itself, No, it’s the software where the competitive strength is. So what Apple’s doing is the software side of the business. They have a lot of competitive barriers and they have a lot of what we call consumer surplus. That they have all this free stuff they’re giving you and they’re not really charging you for it. They’re making their money by monetizing the handset. We sell you the phone for $700. So it’s kind of this interesting paired business model. But if you take away the ecosystem and it’s just the handset, there’s not really a lot of competitive strength there. Every year you have to sort of fight and release a new smartphone that’s got better screens and new tools. And if you’re successful, people buy your phone. And if not, they buy someone else. And if you ever want to know if someone has a competitive advantage, you just look at market share over one to two years. And if you see the market share swinging wildly, it kind of tells you by definition. You don’t have a competitive barrier because clearly people are taking part of your business month by month and you’re taking it back. It’s a free for all. The iPhone in China doesn’t have any of that. This is the Achilles heel of Apple in China is their big competitive strengths are not there. That people aren’t using their software in China. They buy the handset because people think they’re cool, not as cool as they used to be. But no one’s using the software. One, a lot of it’s not. allowed in China. But do everyone’s using WeChat. We’re using you know there’s not one app store. There’s tons of app stores in China. There’s a bunch of them. Everyone’s using different software, different app stores and really WeChat is almost becoming the de facto operating system anyway. So they don’t have any of their ecosystem in China for the most part. So you know Apple in China is a lot more like Apple in the US in 1980. where they have an Apple II and they make a lot of money and then they have the Mac and no one buys it and they crash and burn. You just win year by year or you lose year by year. So okay, that’s smartphones in China and Asia is nobody’s really controlling the ecosystem. They’re not controlling the software. It’s basically a handset game. It’s not that different than selling smart TVs or selling washing machines or any of that. It’s a… It’s a consumer electronics business, which is not a terribly great business to be in. And if you look at the telco business, it’s actually got some strengths in there. Yes, you’re coming up with new routers every year, you’re coming up with new technologies, and when you put equipment in with a carrier, they are not going to rip all of that out in one year. A person can buy one smartphone this year and a completely different one next year and just download WeChat and you’re good to go. Okay, major carriers don’t swap out their whole telco network every year. And so there are some switching costs, although there’s a lot of common standards. So it’s a bit of a mix. But generally speaking, these are businesses that don’t have dominant competitive advantages. No, the game you’re playing is if you don’t have a dominant competitive advantage, generally the game you’re playing is go for scale. And that makes you generally more efficient. it generally makes you more effective and at a certain point you do get some sort of advantage. So there’s sort of two that I like to think about. Well there’s really three but let’s say two in this case. If you’re going to have a competitive advantage it means you’re doing something that someone else can’t really do terribly easily. You’re hard to replicate. And how that plays out in the money is that therefore when you raise your prices five or ten percent. People stay with you. They don’t say, oh, what 10% I’m switching. Because there’s a little bit of a friction there. So, you know, when your accountant calls you up and says, I’m raising my fees 10% this year, you don’t say, I’m out of here. Because, oh, we have to migrate all the accounts and this person knows my business. There’s, now if they come up and say, we’re raising 50%, then you say, okay, it’s worth it, I’m out of here. So you can generally squeeze in a premium on the revenue side, let’s say five or 10%, which will, let’s say if you have a 20% profit business, that’s doubling your profits. That’s pretty impressive. So you either have a bit of strength on the revenue side, the demand side, which would be like a switching cost, or you have a bit of a strength on the cost side, which is, look, we’re both selling the same telecommunications equipment at the same price point. So neither of us has a lot of strength there. but I can make stuff cheaper than you. So I have a sort of a cost advantage, and the net result is the spread between your revenue and your cost is greater than your competitors. The revenue minus cost for the competitors, 20%, for me it’s 25%. I’m getting that 25% either because I can nudge up the price for the same product or I can drop the cost for the same product such that I’m making 25% and you’re making 20%. against the same invested capital so your ROIC is greater. You’re looking at ROIC and you’re looking at market share as evidence of a competitive barrier of some kind. On the cost side you can put these into two buckets. You can put them into fixed costs and variable costs or what they would call economies of scale and scope or production cost advantages. The difference basically is Economies of scale, it’s a fixed line item. You have a factory, I have a factory. My factory is three times bigger than you. Running the factory is to a large degree a fixed cost. There are some variable costs, but it’s more fixed cost. Such that when my volume is three times bigger than yours, my per unit costs are lower. You take roughly the same fixed cost structure, you divide it by three instead of one. My per unit costs are cheaper. That would be sort of economies of scale, economies of scope. So you see this a lot in manufacturing. You see it in any business that has a lot of fixed costs to it, like logistics, large retail, like shopping centers or furniture stores, mobile networks, carriers can get this effect going. You’re looking for businesses with large fixed costs. So if you look at the telecommunications business of Huawei, what you’ll see, you look at their income statement. you will see large fixed cost spending on research and development and pretty much their manufacturing base, which is gonna be operating expense plus ongoing capex, maintenance capex, growth capex. So that’s where they are really going for scale and this is kind of what I just talked about. As they got bigger and bigger than Ericsson in the telco business, they were able to be cheaper than them on a per unit basis because of that cost, that per unit cost. and they were also able to outspend them on R&D as 15% of their revenue. So those are the two hammers you keep just pounding your competitor with because you have a fixed cost advantage. So we would call either of those economies of scale sort of fixed cost advantages, and definitely Huawei was sort of moving in that direction year after year, decade after decade. The other type of cost advantage you can have is what we call production cost advantage, where it’s just a variable cost. We’re both making cars, you buy steel, I buy steel. Now if we’re buying on the same market, open free market, we both pay the same thing, neither of us has an advantage. We’re a restaurant, you’re buying milk and coffee, I’m buying milk and coffee, neither of us have, those are variable costs and neither of us have an advantage in those. Now you can get some variable costs, production cost advantages, and one of the ones people talk about is what they call the learning advantage, that You know, back in the Henry Ford days of the Model T, you know, he discovered that, well, it was Bruce Henderson at Boston Consulting Group did a lot of studies on this about learning advantages. As you get a cumulative sales, not sales per year, but cumulative sales over years, your cost structure does decrease per unit because your organization learns how to do things better and better and better in lots of subtle ways. that don’t really show up on one line item. So there’s this idea of cumulative learning being an advantage. And we saw that in things like Model Ts. And then we also see there’s a different type of learning. Let’s say we’re making one Model T car or one base station or one table. Well, table’s not complicated enough. You are gonna see a certain cost advantage emerge as one player does more and more volume. be 5%, 10%, 15%. There’s another type of learning advantage if you’re in an industry where you’re continually launching new products, where Steve Jobs, iPad, iPhone, iPod, PC, when you’re in a business that continually needs new products, certain organizations get better at launching the next product and can do it cheaper and more effectively than others. And Apple definitely did that in the 2000s. They haven’t done it in a while, but they did it for a good 10 years under Steve Jobs. Okay, Huawei is definitely getting an advantage there, that they’re getting better and better as a learning organization at building the same thing cheaper and cheaper over time. They’re also getting better at launching the next thing because the nature of their business is always new product and the old tech becomes obsolete. You got to launch the new one. You got to launch the new one. So you’re seeing them sort of develop some real strength as a learning organization and that plays out as a cost side. competitive advantage. Now that whole question of learning advantage, I’m writing a lot about this right now. It’s being changed as companies used to learn by people, but increasingly they’re learning by data and they’re learning by AI. And companies are starting to build new models of learning as a combination of human and machine. And we’re starting to see this in some companies and it’s pretty effective. How do you build a competitive advantage as a learning organization as human plus machine? Anyways, that’s pretty fun stuff. But kind of the two ideas today to put in the concept tool chest toolkit are to think about cost side competitive advantages based on fixed costs, which would be economies of scale versus variable costs, which would be production cost advantages. Okay. So those are kind of the two ideas for today. Now I guess we’ll finish up here. I’ve been talking longer than I thought I was gonna do. So what are the three lessons from my hot pot with Huawei chairman Guo Ping? I’d say three main ones are that this company has always been focused on long-term survival, and that is a different strategy than most technology engineering-focused companies. And when long-term, we’re talking decades. That is a different strategy. And that’s a good game. Whenever you’re competing against a different objective than others, that can really be interesting. Number two, because their core two businesses, telecommunications and smartphones, smart devices, have never really had really terribly strong competitive advantages, they had to focus on human resources as their core strength. And I think they’ve done that. They have a very well thought out HR strategy. that they’ve built. They’ve really built it for over decades. It’s very, very impressive. So think about Huawei as a human resources company, not a tech company. And I think you’re closer to the mark. And so the third one I haven’t talked about yet, which is it looks like everything I just said is changing. So, you know, their telco and their consumer business are changing in a fairly significant way. Because Telecommunications used to be about connecting people and buildings, right? Your phone calls my phone. Now your mobile phone calls my mobile phone and we exchange voice and some data. Well, that is changing and we’re seeing the rise of sort of intelligent networks where suddenly telecommunications don’t just connect people, they connect everything to everything. I am connected to the door. to my computer, to my business, to my bank, to my healthcare provider, to the street, to the car, everything is becoming connected to everything. So telecommunications is becoming sort of ubiquitous connectivity of everything in life. That’s a very different business than calling people on the phone. It’s also becoming increasingly intelligent because the communications network is starting to integrate with the cloud. and AI and big data. So the network itself is becoming more and more intelligent. That changes a lot of this business. So when I look at Huawei today, I see them halfway between the business they’ve been in for the last 30 years and a new business that’s emerging, which I sort of call intelligent networks at scale, where suddenly everything in the world, business, society, life, government, culture is all becoming intelligent network based. That is the infrastructure of the modern world that’s being built right now. And Guo Ping really talked about this when I asked him where did he see the business going. He kept saying look we are building intelligent infrastructure. That’s the game we’re in. Okay when you start talking about that business a lot of the stuff I just said changes. There are very powerful competitive advantages in the data and the software world and Intelligent networks at scale looks like a different business to me in many cases. So I think that’s sort of where we’re going in three to five years, which is what I’m spending a lot of my time thinking about. So all of this may change fairly quickly and that is point three is get ready for intelligent networks at scale as the next big game. Anyways, and I think that’s it for today. It’s end of the year. My voice is going. So I’m going to go take a walk in Bangkok and relax a little bit. Given that we’re about two months into this, this is about the ninth lecture, any feedback you have would be really appreciated. I’m gonna sort of iterate this product, try and get it better and better. And so any feedback you can have, please put it in the comment section. Feel free to email me anytime, jefferytowson at gmail or info at towsongroup.com. Send me your thoughts, I really do appreciate that stuff. And those of you who have been sending me emails, it’s fantastic, thank you so much for this. and I’m trying to incorporate your feedback. And I think that’s it for the year. So this is the end of 2019. Please sign up, subscribe, sign up on iTunes, join the class, and hopefully we’ll keep doing this week after week, month after month through 2020. And the discussions, you can already tell that the discussions are getting more detailed. We’ll imagine where we’re gonna be in six months. When you are already the expert on Huawei, Alibaba, Tencent, these companies, and you already have a fairly robust toolkit for how to think about these companies and take them apart. So the discussions are going to get more and more detailed and more and more fun. Anyways, that’s the plan for the year. Everyone, happy 2019. Have a great end of the year. Happy holidays to everyone. And I will talk to you in the new year.