In this class, I talk about my interview with Huawei about their 2019 financial results. And a bit about the disclosure of fraud at Luckin Coffee.
- #6 Basics of Huawei
- #10 More on Huawei
Concepts for this class:
- Digital Superpower #1: Dramatically Improve the User Experience
- Money Wars
- Hyperscaling vs. Blitzscaling
- Competitive Advantage: Economies of Scale
- Linked Businesses
Companies for this class:
- Luckin Coffee
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.
Note: This content (articles, podcasts, website info) is not investment advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. Investing is risky. Do your own research.
Welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy. And today we’re gonna talk about my interview with Huawei Management about their 2019 financial results, which was a pretty unbelievable year for them. And we also gotta talk about Luckin Coffee, which has recently announced that it turns out there were a large amount of fake sales, which surprised absolutely nobody. Anyway, so we gotta talk about that. So today’s going to be a little bit of a grab bag of big events because it just turns out a lot happened in the last week with regards to Digital China, Digital Asia. So that will be the subject for today. But first, if you haven’t subscribed, please do so. You can go over to jeffthousen.com and there’s a free 30 day trial. Try it out. See what you think. Get dramatically more content as well as a sort of structured course. plan to move you up step by step into Greater levels of expertise, which is the whole point which is why it’s called a class Okay now before we get into the subject for today I sent out some emails in the last couple days basically laying out the course outline for those of you that are subscribers and This is something been working on actually for a long time this idea that, you know, to lay out a path, to lay out, this is what you should do this week, this month, next month, next month. Here’s the ideas you wanna go into, here’s the lectures you should listen to, here’s the articles you should read, and then we go from, you know, easy first steps to level two, to level three, to level four, and basically laid out the pathway through level four, which is probably about nine to 10 months in terms of, you know, moving forward, advancing your knowledge, and we’ll do more than that, but… It took me a while actually to get enough content put together that we could lay that out. It’s kind of a huge amount of content. So those of you that are members, subscribers, you should have gotten that email in the last day. I think for most people you want to start on easy, you know, first steps, which is level one. It’s the box in yellow on the left side of the slide. And I made it really sort of straightforward, just a couple things. I mean, you listen to a little… talk on what to do for the first steps, you start a journal, and you do two basically podcasts, and that’s it. So I made the first steps relatively straightforward, not too daunting. And then as you get up to level two, level three, it will get more complicated, but you’ll get used to the process. So that was the goal there. And yes, for those of you who do martial arts stuff, the steps, the levels in the process, the colors do match the black belts, blue belts, yellow belts, things like that. So. Anyways, you should have gotten that. If you haven’t, send me an email and I will send it to you, or you can log in at the website and just look up course outline. Course outline or learning goals, and it will pop up. Learning goal, level two, level three, level four. For most people, you wanna start on first steps. Okay, let’s get into the subject for today. And we gotta start with luck in coffee, cause this is… It was crazy. It came out on Thursday of last week. I sent out in the daily update lesson for Friday, basically a little article about this, which was, look, nobody was surprised. Nobody. And we’ve covered Luckin in this class. We’ve talked about Luckin versus Starbucks, sort of what their strategy was, some of the good stuff, some of the bad stuff. And there’s some good learning goals in there. For those of you doing that, it would be, it’s learning goal eight, which was Luckin versus Starbucks, and that’s within level three in terms of the course outline. And I really talked about three ideas. I talked about demand purification, and I talked about digital superpower number one, and then I talked about money wars versus hyper scaling versus split scaling. And here’s what I like. Well, let me go through the history view for those of you who aren’t. familiar, which is, you know, most people. But here’s kind of the key factoids in the history of this company. Now, Thursday, here’s what they said. This is from CNBC. Basically, Luckin disclosed on Thursday, which was four days ago, that an internal investigation has found that its chief operating officer fabricated 2019 sales by about 2.2 billion UN, which is $310 million. Now, if you look at their 2019 numbers, that’s like 40 to 50% of their sales. So it’s not a small percentage. It’s a big part of it. In response, shares dropped dramatically, 80% down. Massive wipeout of their market value. The chief operating officer and several employees who reported to him were charged with this and Luckin’s gonna take legal action. Okay, we’ll talk about how much that’s true. You remember when Tiger Woods, you know, it came out that Tiger Woods had been sleeping around quite a bit. You know, he had this sort of really pristine image, Tiger Woods, good guy, amazing golfer. And then, you know, it kind of comes out that, oh, it turns out he cheated on his wife. And it was like two women. It was like two women, oh, Tiger Woods cheated on his wife. And… one of the women was a porn star? And that was sort of one of the initial news stories about this. And the one thing you could conclude immediately was, okay, we don’t know what’s going on, we know it’s a lot more than two. Because when somebody cheats, there’s a long path between, hey, this person’s gonna cheat on their spouse. And hey, they cheated with a porn star. That’s not step one to step two. By the time you get to porn star, you are way down a path. It’s like if someone goes to Vegas and they say, oh, I went to Vegas last week and I lost $50,000. The one thing you know is that’s not the first time they went to Vegas. Nobody loses 50,000 the first time. You go to Vegas, you win a little, you lose a little. then you go again, you win a little easily. And then maybe you lose a couple hundred. And then maybe you lose a couple thousand. But there is a long process before you get to the fact of, oh, I went there for the weekend and I lost 50K. So when they say, look, 40 to 50% of our sales were fabricated, that is a long way down the path of behavior. That’s not one incident. Like if they’d said, oh, it’s 3%, okay, maybe that’s the first incident. Now this is… This is well into a process of certain types of behavior before you get to the 40% number. So that was sort of my first conclusion. Okay, this is tip of the iceberg. There is a lot more going on and has been going on for sure. And they said it happened all within two quarters, a second quarter and third quarter of 2019. Okay, it’s too big. It’s the Tiger Woods analogy, no way. And then it turns out, oh. Tiger Woods have been doing this for years and years and blah, blah, blah. Okay. So that was what happened last week. You go back to the history, 2018, January, Luckin really launched in, I mean, it kind of got started at the tail end of 2017, but it was really January, 2018. This company started to go. I had been writing for years. I mean, literally years about this idea of why doesn’t Starbucks have a competitor in China? because a lot of stores, they say they are their most profitable stores anywhere. And generally, if you make profits in China or really anywhere, keep it quiet. I mean, don’t tell people it’s going to attract people. And China is a very competitive place. And it’s not that hard to open a coffee shop. So, you know, I kept wondering, look, when is someone going to take this company on? And January 2018, I was actually up. at the Meituan headquarters. I was visiting, Meituan has their headquarters in sort of northeastern Beijing. You go north outside the fourth ring road, and there’s a new area up there, and they’ve got their nice headquarters. I was up there visiting them and sort of talking with management. As I was walking out, I noticed all these people with blue cups walking around the business park. So I sort of followed them, and there was one of the first Luckins was there because this was a digital first company. So they tended to open in areas with lots of digitally savvy people, like people who work at tech companies. So that’s kind of how it got on my radar and then everyone started emailing me, hey, you know, Starbucks finally has a competitor. Did you hear about this? And I started looking into it. And they grew incredibly rapidly. So there were two things that they did that I thought were cool. Number one is they sort of reimagined. how you serve coffee. You order it on your phone, it’s digital first, they don’t take cash, they don’t take credit cards in the store or on the phone, and then you order the coffee and you pick it up and you walk away. So one, they’re trying to sort of purify the experience, make it very convenient, which is a big thing in digital. And I liked that. And then… they were changing the cost structure of the business model because if you look at Starbucks, what’s their biggest cost item? Well, it’s staff and it’s real estate. Well, they’re getting rid of the real estate because in theory, 90% of their business should be, you order it on your phone, you walk down to a little, almost like a booth, and you just pick it up and go away, but you don’t sit down. And you really don’t wanna deliver either because that’s kind of expensive for coffee. So that was the model was order and pickup. So you get rid of the real estate that changes the cost structure. And it also makes you a lot more scalable. It’s a lot easier to open a thousand of these things. If you’re just, you know, almost creating these little boots as opposed to full stores where you have to get the good real estate, you have to get the best locations, that sort of thing. So I kind of liked that they were rethinking the demand side. I liked that they had a bit of an innovative business model. And I liked that their management was so aggressive, that this was not some sleepy company. They were swinging for the fence. You know, they were opening thousands of these things very quickly, and in the first year of operations, they opened 2,000 of these outlets. Not, you know, Starbucks outlets are different, so it’s not really apples to apples, but I liked that they were raising money aggressively, opening aggressively, going, going, going, and you know, that’s swinging for the fence. which is what venture capitalists and entrepreneurs in the tech world are good at. They swing for the fence and they either hit it over the fence or they strike out and that’s it and they move on to their next business. Win big or fail fast. And so that’s what Luckin looked like to me. It looked like a win big or fail fast model using a digital tool to come on quickly. So I kind of thought that was all interesting. And the concepts I gave you in learning goal number eight, I talked about this digital superpower. This is my own little list, digital superpowers. Lots of digital tools coming, they come every day. Most of the time they’re just normal upgrades. You used to have tellers and now you have ATMs. Okay, that’s great. You used to have people key in the item when you go to the grocery store, now they scan it with the scanner. Those are just tech upgrades. They’re not game changers. Every business does needs, but every now and then a digital tool emerges that changes the game and puts everyone else out of business if they don’t adapt. So I look for digital tools that are like that. And one of the digital superpowers I call, uh, transforming the user experience on my list of digital superpowers. This is number one. Does the tool so transform the experience that the previous offering is obsolete. I would say Mobike did this. When you could suddenly rent a bicycle with your phone that was just anywhere on the street, hop on, ride five blocks, hop off, leave it, never think about it again. That was a dramatic upgrade from a traditional bike rental business where you have to go down and leave your credit card or your driver’s license and money. And that model basically… was put out of business. So I would say, mobile was a digital superpower in terms of transforming the user experience. I didn’t think Luckin really was, I thought it was more like the scanners. It was nice that I could order the phone, you know, the coffee on my phone, but I could, Starbucks was still okay. So I didn’t think they had that, but I thought it was interesting. And then the third concept I talked about was money wars versus hyper scaling versus blitz scaling, which is more of a tactic. Most of what I’ve been talking to you about over these months, I would put in the category of strategy, of business model, of the structures you build into a business, like a viral business model, like a platform business model. These are kind of the structures, that strategy. Well, there’s also this idea of tactics. You know, a lot of stuff is not about your strategy. You’re just doing stuff every day. You’re offering promotions. You’re coming up with new types of food to sell at your restaurant. you’re responding to your competitor. You know, there’s just back and forth tactics. And you have to do those every day. Money wars, hyperscaling, blitzscaling, these are basically tactics. This is like, look, I’m gonna go out to the venture capital market, I’m gonna raise a bunch of money, and I’m gonna open these stores fast and give a lot of cups of coffee away for free as a way of driving sales quickly. Now that’s not a strategy, I can’t keep doing that forever, but it can be a pretty powerful short-term tactic. And that’s clearly what Luckin was doing, very aggressive growth, raising money very aggressively, and then using that money to open lots of outlets and to give away a ton of cups of coffee. That’s a good short-term tactic. And it’s especially good when you have a new business that’s just being created and you have to get adoption. So that was kinda to me how I looked at Luckin early on. I liked… I like the business model. I like that their management was very, very aggressive and they were basically engaging in hyper scaling. There’s a little difference between hyper scaling and blitz scaling and money wars, but I won’t go into that all again. That’s learning goal number eight, if you wanna learn more about that. Okay, so that’s a good tactic. A lot of venture capitalists do that. Fine. Now what happens? So we go forward and Somewhere around the end of 2018, so about 11 to 12 months into this, they raised in July-ish of 2018, they did a venture capital round, in theory at a $1 billion price tag. People always say it’s a valuation, it’s not a valuation. If you can get someone to assess your business at $1 billion, it doesn’t mean you’re worth that. It just means that’s what you got people to pay. So that’s the price they were… you know, the market price them in at. That’s not the same thing as valuation, which is what people always say. Okay, so they raised money, they called it the billion dollar, the unicorn coffee company. Somewhere around end of 2018, I started to get pretty suspect. This is all interesting. But, you know, we go back to the consumer view. Are you getting adoption? Are people showing up? You’re building big, you’re raising money, you’re opening stores, you’ve got this business model that’s pretty scalable and a little cheaper, and you got a lot of promotion, okay, that’s fine. Are people buying coffee or not? You know, it’s like, did you throw a big party and nobody showed up? You know, you promoted your movie, you had billboards everywhere, and nobody went to the theater, right? You gotta kinda build it and they will come. which is what the strategy is, okay, sometimes people don’t show up. So, you know, December 2018, I spent a whole day, I walked down from Peking University down to Junggwonsun, and I just spent the day visiting Luckin Coffees all over the area, and I would just sit there and count the people coming in, either to sit down or to pick up coffee they had ordered online, and then I would walk to the nearest Starbucks and I’d sit there and I’d count. I did it all day long. And my takeaway was there is very little traffic happening here. Now, maybe that’s just one part of town. Maybe it’s who knows, but you know, that was the point was like, all right. I’m, I’m, I’m losing faith. You know, there’s nothing wrong with that. That’s not a criticism. You know, most businesses you come up with a new idea, you pitch it. And most of the time it doesn’t work. People don’t, you know, new things that people love are actually pretty rare, which is normally why you look for product market fit before you start scaling aggressively. Now they kind of did it in reverse. They started scaling aggressively before they really had proven demand. And this other company I’ve been writing about Haiti, which is basically it’s the Starbucks for tea of China and they have fruit teas and cheese tea. Cheese tea is really good by the way. And they you know you go to any one of those and there’s lines out the door. And they still have you know when I visited them year and a half ago they had about 200 outlets now they’re up to about 400. They’ve been growing slowly based on overwhelming demand. That’s a very different. business strategy then we’re going to build big and hope everyone shows up. Okay, so I was kind of dubious and the number I was waiting for was what happens when they run out of cash. And what they did at the end of 2018 is they raised another round and they said this round was priced at two billion and they closed the round. Okay, that one was like, oh… You know, there’s a certain point, businesses that have trouble are often failures. And there’s nothing wrong with having a business failure. Failure is common in business. Very few companies succeed. So failure’s okay. There’s a difference between failure and fraud. And when businesses fail, what they’re supposed to do is close up their doors, let everyone go, apologize to their investors, and move on to the next idea. But often what they do is they start to engage in fraud when they fail. And you can see the tip over. So that was kind of when I was like, oh man. Either they’re doing better than I think they are, or they’re starting to shift to the dark side maybe. I didn’t know. And then they announce after that we’re going public in July, which was six months later. And they go public in mid-2019. Okay. You know. Who knows? We looked at the numbers when they went public and they were terrible. If this fraud happened in Q2 and Q3, this would be right in the middle of that is when they went public. And these numbers, they’re losing money on every cup of coffee sold. And then the other number I was waiting for was when can the founders sell their shares? That was in November of 2019. So I figured we’d know the truth shortly after that. That lockup period expired November 2019. One to two months later, the short sellers started issuing their reports. This company has massive structural problems. And boom, one to two months later, hey, half the sales are false. Well, 40%. Okay, so, you know, there we are. That’s kind of the story. The founders probably got their money out. The venture capitalists and early private investors probably got their money out. And the public investors got worked. And the employees. You know, many have probably had shares and probably gonna lose their jobs. And that’s… You know, that is what it is. And we’ll see this play out in terms of now it’s in the legal and the regulatory world, and it’s going to be brutal. And we’ll see what happens. And maybe people will go to jail. Maybe they won’t. But, you know, the story looks like it’s coming out. And I think, you know, back to the Tiger Woods analogy, we only know the tip of the iceberg. We don’t know what else was there. We don’t know if this was a failure. that then went fraudulent or if it was that way the whole time, which is possible. We’ll see. I’ll read you just a little bit from an article I wrote just before they went public. And the article was called The Only Number That Matters for Luckin Coffee. This was right around the time they went public. And I was pretty blunt. Here’s what I think. I said, delivery doesn’t really matter. This business model that Luckin has done. The economics are not awesome if people are coming into the stores and sitting down, and the economics are also not awesome if people are delivering because a cup of coffee is $2 to $3 and delivery is $1. The model that works is order on your phone and people come down and just pick it up at a little almost kiosk and take it away. That model was cool. So delivery doesn’t really matter. Store openings and capital raisers don’t really matter long term. That’s a short term tactic. It’s hyper scaling. New retail and digitization don’t matter much. Everyone talks about new retail in China, which can be very powerful. I basically argued, look, this doesn’t matter that much for ordering coffee. It’s not a digital superpower when you buy a cup of coffee. If you go to the supermarket and you go to an Alibaba fresh hippo supermarket. the experience is dramatically different than a regular supermarket because they’ve digitized it. If you buy a cup of coffee, it’s pretty much the same. So that doesn’t really matter. I said, look, the only question that matters is how much traffic is lucky in getting at its pickup locations. That’s pretty much it. And because their whole business model was predicated on, there is a big opportunity out here, which is Chinese consumers drink very little coffee, which is true. average Chinese consumer per capita, you’re talking three to five cups per year. If you look at somewhere crazy like Italy, it’s like 500. If you look at the US, it’s like 300. So if they move the needle from three to five cups to even 20 cups, that’s a venture capital like return. You’re getting 10 times your money. So it is a huge opportunity, big opportunity. They went after it very aggressively, raised aggressively, opened aggressively. And if they had moved the needle on consumption, they would hit that thing out of the park. However, usually when something is low like that, when someone tells you, oh, consumption is low, that’s a big opportunity. No, not really. That usually when consumption is low, it means that there’s something important stopping it. It’s not like Chinese consumers had never tried coffee before. So when that number is two to three cups, five cups of coffee, you don’t conclude, oh, that’s a huge opportunity. You conclude, man, there’s some real big barrier there. I’m going to have to knock down to make this happen. What is the barrier? When people say, oh, you know, it would be a great opportunities if we sell makeup to men, because look, you know, makeup purchases by men are very, very small. Men don’t wear a lot of rouge. That’s a big opportunity. No, that’s the first conclusion is there’s something going on there that they either don’t like it, they’re not getting it. There’s some big barrier happening. that would be very, very difficult to overcome. Now, if we could overcome it, bam, big opportunity, but you gotta assume there’s something there stopping it. If something hasn’t happened in the world, there’s usually a reason why. So that would be the question was, why aren’t Chinese consumers drinking coffee? Which they aren’t. It is growing, but it’s very, very slow. 5% a year, 8% a year, it’s not 100% a year. Anyways, that was basically my take. We’ll see what’s going to happen with Luckin. I sort of stopped paying attention to this company about a year ago when I suspected they had moved over to the dark side. But we’ll see. Now it’s going to be in the world of lawyers and regulators, which is another, you know, there could be a good turnaround play here. There could be a small, good company that comes out of this. But there’s going to be a lot of pain between now and then. But the key concepts you should keep in mind for Luckin, just to bring this full circle, the learning goals that matter for Luckin, this was under learning goal eight, was digital superpower number one. Does this digital tool or business model or service transform the user experience such that existing competitors, traditional approaches, are becoming obsolete and unacceptable? Like Mobike. I would say for coffee, it didn’t happen. for new retail and other spaces, definitely happening. So that’s number one. Number two, think about money wars versus hyperscaling versus blitzscaling. I’m not gonna go into blitzscaling. As a tactic that is in fact particularly powerful, we see it a lot in digital, where you’re using money as a weapon in the short term, you’re gonna lose money. You’re gonna spend a huge amount of money on marketing and you’re gonna lose that, but it’s gonna be a strong tactic against someone who can’t match you. So that was kind of the other idea to think of for Luckin is money wars, hyperscaling, Digital superpower number one. Okay, let’s move on to Huawei. Now a couple weeks ago, I got a call from Huawei Management, would I like to come out and interview their vice president for global communications, who is Carl Song, about their 2019 financials, which were just released a couple days ago. And that was pretty cool. So I like to talk to management, I learn a lot. I mean, I really only have two sources of information I use. I don’t actually read the news very much. I mostly read annual reports, 10Ks, and I like to talk to management. I find that’s sort of direct source information without anyone in between. So I said, that’s great, and I had to sign an NDA and be embargoed, and I couldn’t talk about… you know, their financials. I couldn’t even mention that I had done the interview up until they released the numbers a couple days ago. So I am officially free of the NDA and embargo as a couple of days ago. I thought I’d talk about it. So I went out to their office here in Bangkok. They have a pretty big facility here in Bangkok. It’s, you know, really in, for those of you in Bangkok, it’s up at Rama 9, you know, really nice part of town, big office. So I went up there and I met with them. and basically got a heads up on what their financials for 2019 were. And then I, we talked about that. I know I also talked about, you know, Carl’s background. And I think this is, this is worth thinking about. You know, my audience here, the people I’m talking to, whether you’re an MBA student executive, I’m talking to people who are probably going to work at companies. So. A company like Huawei, you can learn a lot from thinking about the people that run that company. Who they are, where they came from, how did they get where they are in life? So a guy like Karl, think of what he’s gone through in the last year. If you’re head of global communications for Huawei, Think of the just roller coaster they went through. I mean, you’re handling, you know, this was the ultimate crisis management situation, which is something most executives, we all need to learn how to do that. What happens when you’re running a company or you’re a VP or you’re head of communications or you’re CEO and you have a crisis on a random Tuesday morning and you get the call at 4 a.m. Hey, we’ve got a problem with our cars. We’re going to have to do a big recall. Hey, there’s a press report saying so and so did this. Crisis management is one of those skills you really do need as an executive, because that’s who’s in the hot seat. And in terms of crisis management, it would be hard to find a more dramatic example of crisis management when you’re running a company like Huawei and the U.S. government basically cuts you off from U.S. tech and openly talks about you every week. I mean, it’s going to be an unbelievable Harvard business case one day. So a guy like Carl, he was right at the center of that. So I wanted to talk to him about that. which he could to some degree and then certain things they tell you, yeah, we can’t talk about that right now, but I says it will come out. So I want to know about who he was and how he came to be where he was. And, and then also to talk about the financials because, you know, they had a massive hit to their business when they got the tech band and it played out in lots of ways. And that’s, um, you know, all of that finally. At least we can get a snapshot of that by looking at all the numbers for 2019 together, because it’s kind of been this rolling thing. So, you know, the 2019 numbers were something that, you know, a lot of people had been waiting for, myself in particular. So anyways, I went out there and, you know, met with, well, Carl was actually in Shenzhen, so we had to do it through a… video conference, but they had a nice sort of studio set up because here’s the thing about Huawei, they’re really good at telco. So anytime you meet with them, you get like amazing wifi and you get amazing video conferences. Like they have these cars that take people around and in all of their town cars, they have wifi that’s really fast because they’re a telco company. So you’d expect them to be good at that. And we talked to him about sort of what was going on and I’ll give you sort of my take on their financials in a minute. But I also kind of wanted to talk about Huawei as a topic because it’s become very, very political and every time I write about this, you know, I generally get attacked in some form. Not attacked, sniped at. It’s usually with some sort of political thing, you know, that… Oh, this is US, China, this and, you know, in many ways, Huawei has somewhat become a symbol. I think they would use the word pawn within a greater argument between the US and China. And, you know, I don’t really focus on it very much for a couple of reasons. One, it’s not my skillset. I don’t really talk about US, China trade. I don’t talk about the political economic issues going on. And even, you know, Huawei is a symbol of that. I don’t talk about it very much. One, well, one, I don’t have any particular expertise in that. My expertise is in business strategy. So I try not to talk about things. I don’t think I’m really know what’s going on. I think the political aspect is dramatically overrated. I think it’s kind of the go-to framework for thinking about this stuff, and I don’t find it terribly useful most of the time. I think the dynamics that are going to impact Huawei… and Ericsson and Nokia and the smartphone makers, because Huawei does telco and smartphones and other consumer devices. So that’s Apple, that’s Samsung. I think the political aspects are a minor factor for the most part. I think the competition is the predominant factor and I think the changing technology is the biggest factor. Telco is moving very fast. The world we’re going to live in in five years is going to be so different than today. And it doesn’t matter what politicians say. It’s going to change anyways. And there’s going to be certain companies that do it and certain companies that don’t. So politics is part of it. It’s a factor. I just think it’s a minor factor most of the time. Now, the entity list ban was a big political event. So that I would say is an exception. But that’s kind of quieted down. And there could be another big move coming. So I keep an eye out for that. aspects are very very small. No, I don’t say small. I think they’re minor compared to the other factors where I do feel I have expertise. And then maybe the third reason I don’t talk about it is my goal here is not to give you a hot take on whatever Trump said last week or whatever the US-China news is, my goal is for you to get smarter. And as soon as you shift the topic from business strategy into political issues, everything becomes more emotional. And I find that’s not really great for learning. I think the emotional aspects, the anger which comes, it kind of overrides your brain a little bit. I don’t learn anything when I’m angry. You know, if I’m calm and rational and thinking about a business question, I learn a lot. If my blood pressure goes up because it’s political this or that, I think, you know, almost like it, I feel like it shuts down my brain. So whenever I’m teaching, like this is kind of actually funny, like I’ve probably taught three or 4,000 students over the last nine years. You couldn’t find a single student I’ve ever taught who could tell you what I think politically about anything. Like I would be staggered if you could find one person who has any even real idea of what I might think about a subject politically, how I vote, any of that. I mean, I keep it really quiet. harmful to the process of teaching and learning when you move into that sort of subject so I stay out of it and I stick on these sort of more clinically analyzed issues like strategy, competition, technology and I steer clear of that. That’s always been kind of my approach. Perhaps I’m wrong but I don’t think so. And here’s one last thing, now get off this subject. About 50% of the people who read my stuff and listen to me are in China and about 50% are in outside of China, a lot in the United States and Europe. Any particular topic I would talk about, exactly 50% of the audience would get mad on one side or the other. because there’s a lot of this US-China stuff going on in the US and people get very upset about it. But it also people get very upset in China. They have very strong opinions on both sides and the opinions are not the same. And so it’s I kind of hear both, which is interesting. OK, I think that’s a bit of a tangent, but I did want to kind of talk about that because that comes up with Huawei almost immediately. All right, let’s talk about their financials and we’ll talk about Carl. Now Carl, very interesting man. Chinese guy, comes out of China, very highly educated, and comes out of an engineering type background. which is pretty common now. I mean, you meet just a ton of smart people coming out of Chinese universities, and then they will typically go abroad and get some other degrees. Well, he went to Paris and France, which was interesting, and he became fluent in French. So he speaks English, Mandarin, and French. And upon graduation with engineering type background. And upon graduation, just pretty much through a friend, as far as I can tell, he gets a job at Huawei. And Huawei, I’ve written a lot about their culture. I think it’s one of their biggest strengths. I think their HR policies are really impressive. And they have this very clear career path where good people are identified early through sort of systematic performance assessment. Those people are given more opportunities. They move them around the world. and they really cultivate people. And especially in China, people jump jobs all the time. It’s one way of staying ahead of cost inflation is you keep jumping jobs and you up your salary, but it’s also just kind of the way it is. You see a lot of, well, almost every resume you see in China, it’s one year, one job, one year, one job. Huawei keeps their people for a long time. And so, you know, he goes and they put him in, interestingly enough, they put him in Western Africa, which is, you know, where people speak French. And he would start to develop their business there, sell a lot of base stations. You know, there’s no 5G in Western Africa. You’re talking 2G and 3G. But they’re building out, they’re doing government contracts. Ren Zhengfei comes to visit and, you know, they drive for hours. This was a story he told. They drive for hours to the North and then Ren Zhengfei, because he’s testing their coverage. and he’s looking for somewhere remote, and then he’s saying, okay, let’s test it there. So there’s a long history of Huawei going into places like Africa, the Himalayas, pretty much everywhere in the world to create coverage. And there’s a lot of great stories about this. There’s a book, a couple of books about Huawei, which are published by Huawei. One is called Pioneers, one is called Explorers, and it’s just full of these crazy stories of how they brought telco to the parts of the world that didn’t have it. So he starts out in West Africa. Obviously, speaking French was a big part of that. I assume he does well, because then they move him to France. And I think he oversaw the whole French business for a while, or at least he was in the top management. And then around 2017, they move him to the United States to oversee the US business, which obviously started to become more and more political during this time period. And Somewhere last year, when all of this starts to bubble up, he goes from being head of the United States for Huawei back to doing global communications in Shenzhen. and bam, then everything starts happening. Then you’ve got the ZTE issue happened, the entity blissed out. So he’s kind of been in the center of this, which is pretty amazing situation. And the company has really been in battle mode. This is their phrase, battle mode. You know, since last year, people are working unbelievable hours. They are, you know, fighting everything. They’re very open about we’re fighting for survival. You know, we’re the airplane flying in the sky that got shot up. And they have this picture of the bomber from World War II all over the campus with bullet holes all throughout it. And they say, you know, we took two shots through the engine, one of which would be operating systems and the other would be semiconductors. So this whole company is in battle mode and that includes global communications, which is, you know, become very very aggressive. Well yeah I mean aggressive is the right word in the last year. Where Ren Zhengfei never did interviews. For 20, 30 years, this guy never did interviews. And they wouldn’t have a lot of press out there. And now they’re bringing thousands of people to campus. Ren Zhengfei is doing interview after interview. They’re bringing out their senior management. People don’t know who runs Huawei. They know who runs Apple. They don’t know who runs Huawei. Most people don’t know those. Well, they’re bringing those people out. So that’s sort of full court press in a lot of areas. And there’s going to be a lot of good executive lessons in how you respond to something like this from their story. All right, let’s talk about their financials and the concepts I want you to, we’ll get back to the class subject because that’s me chatting a bit here, you know the concepts I want you to keep in mind. We talked about Huawei in two learning goals, number 10 and number 6, and both of these are in level 3. So those of you looking at the course outline, You go from first steps to level two, to level three, to level four. Huawei is in level three. We start talking more about their business and we start talking about a key con, several concepts that underlie them. And the concepts we talked about, or I talked about, were competitive advantage based on economies of scale and linked businesses. Those are kind of the two ideas that I’m going to sort of touch on here. And I think they’re both important. But. Okay, so their financials come out, and we were all looking for a couple things. They have their consumer business, which is smartphones, anything a consumer might have in your hand, smart TVs, AI assistance. I have a pair of smart glasses from Huawei, which are like these. These Gentle Monster, which is a South Korean fashion company for glasses that have, you know, you put them on and it plays in your ear through the glasses. It’s kind of funny, it syncs to your phone. All of that sort of handheld stuff. Then they have their carrier business, which is a B2B business. They sell it to Vodafone and all the mobile carriers around the world. So one business is B2B, one business is B2C, and then they, as part of that, have cloud and AI. And what they’re really putting together is a complete end-to-end solution for smart networks. That it starts with what’s in your hand, your smartphone. IoT devices all throughout your city, all throughout your home, all throughout your car, all of that is sort of on the ground stuff. Then it’s the connectivity piece, which is 5G, that’s their telco, and then it connects to the cloud, which is software and AI. So it’s sort of end to end one solution that they’re trying to put together. And the devices and the telco piece, which is 5G, is a big part of that right now. Okay, when the entity list ban, the entity band, the tech band hit in May. It really hit them in a lot of places. Suddenly you couldn’t get semiconductors, suddenly their smartphones. There’s a lot of components that go into making a smartphone and suddenly hundreds of those that they needed they couldn’t get. So they ran around trying to plug all the holes in their supply chain. And it turns out they did that pretty well for telecommunications. They got their base stations completely free of US tech within a couple of months. On the consumer devices like smartphones, it turned out to be more difficult. And I think they struggled with that a lot more. And the two holes that were a problem were the operating system, which is Google, Google Mobile Services, GMS, and semiconductors. And how they’re gonna get that is a bigger question. But they ran around a lot of short-term crisis management and there was a lot of speculation, how is this gonna play out in their financials? And you could sort of see a couple things happening. You could see maybe foreign carriers like telco companies in Italy aren’t gonna give their contracts to Huawei anymore and they’re gonna go with Nokia or Ericsson. So there was a lot of full court pressing out there to keep those contracts. You could see their smartphones in Europe not sell because you can’t, if it doesn’t have Google, if it doesn’t have YouTube, if it doesn’t have Facebook, that’s kind of hurts the smartphone. So people thought that would be an issue, but everyone was wondering how is this going to impact their business? But there’s another side to this which people didn’t talk about. which is it’s not just how does it impact their current business, but what was the strategic response that Huawei was gonna do because that would also have an impact on their financials. Are they gonna dramatically ramp up their marketing expense? Are they gonna dramatically ramp up their R&D? Are they gonna stockpile semiconductors like crazy because that would hit their cash position? Their response was gonna impact their financials as well. So within the financials, we’re gonna see the hit going to see their response play out. And my take on this, having looked at the numbers, is basically there are four lessons here in terms of their financials. And I think this is what the press is not getting right. So I’ll give you what the press is saying, then I’ll tell you my take. So first thing I took away. Now MSN, when they talked about the results last week, here’s their quote, Chinese tech giant Huawei sales revenue of 2019 rose 19% year on year to about $121 billion US. So they were up about 20% overall sales from 2018. 2018, their revenue was about $100 billion. 2019, $120. And their profit increased about 5% to 6%, which was $0. If you look at their 2018 numbers, their revenue went up by about 20%, their profits went up by about 25%. You look at the numbers that they just released, their revenue went up by about 20% again, but their profits only ran up 5%. So they said, okay, it looks like their profits took a decent hit. I think that’s basically not right. My take on this was, look, this company took a body blow. There is no way around it. This was about as big a hit as you can take as a private company. When one of the two most powerful governments of the planet tries to shut you down. That is, I mean, that doesn’t happen to businesses. Like, when has this ever happened? So they took an absolute body blow. Their financials come in. And when I compare their financials and telecommunications carrier business, their financials, even after the body blow, look better than that of their competitors. Ericsson and Nokia had a worse year than Huawei did in Telco, and they didn’t take the hit. That’s kind of crazy. If you look at the carrier business, the telco business, their revenue was about $41 billion. and the growth in their carrier business was about 4%. So basically in 2019, their revenue from carrier went from literally 40 billion to about 42. Okay, fine. It’s not bad. And actually, Carrier doesn’t grow very fast. Carrier is a pretty stable, flat-growth business. Now compare that to Ericsson for 2019. Ericsson, they’re big competitors in Nokia Ericsson. Ericsson’s total revenue for 2019 was $22 billion. So about 53% of what Huawei made. And their growth was a little higher. Their growth rate has been about 5% to 8% over the past couple of years. So in 2019, Ericsson’s revenue, about $22 billion. And that was up about $1 billion. So Huawei is dramatically bigger. And they’re increasing faster. Even with the blow. Now Nokia’s a little bit better. Nokia’s total revenue was $25 billion and their growth has been going up a couple percent or falling a couple percent over the last couple years. So again, they’re smaller and they’re not growing as fast in overall sales. Okay, and that’s actually not the worst part for them. If you go back just six or seven years, like go back to 2012. 2012 total revenue for Huawei, not their telco business, the whole company, which was $121 billion this year. In 2013, total revenue for Huawei was $40 billion. They went from $40 billion in revenue to $120 billion in seven years. And their carrier business back then was about $27 billion compared to about $42 billion today. Now, that’s pretty awesome in terms of performance, but look at Ericsson. Ericsson in 2013, their total revenue was 35 billion. So in the same time period, Huawei overall business, all of their businesses goes from 40 to 121 billion. Ericsson goes from 35 to 22. That’s really, really bad. I mean. And Nokia, pretty much the same story. The same time period, their revenue goes from 17 billion to about 25. So it is just dramatically different performance over these companies over the past eight years. My takeaways, Huawei had a… Huawei had a… a massive hit in 2019, but despite that, they are still growing faster than either of their competitors in absolute revenue in terms of carrier. The profits are pretty much better and their growth rate is higher and over the past eight years Huawei’s carrier business has grown to about double the size of either of its competitors. Now if you had to choose between having one of those two problems in life, which one would you want? So let’s not you know this whole take of oh, they took a big hit. They’re going down. Yeah, well relative to what? You know, so that was kind of my first take is let’s all keep this in perspective The consumer business was a bit of a, I think, a bigger hit. This is sort of point number two. Look, the consumer business also took a pretty big hit, and I thought the management did a reasonable job of repositioning fairly quickly. But they probably took a bigger hit. The chairman, Eric Hsu, in the press release in the press conference last week, he basically said the sanctions has caused their consumer business to lose about $10 billion in overseas markets. Okay, that’s a pretty big hit. And most of that, they’re overseas markets when you’re talking revenue. They don’t sell in the United States. They’re pretty much banned. So when they talk about international revenue, you’re usually talking Europe. They basically took a big hit in Europe in terms of revenue. And that happened in July, happened in August. That’s pretty tough. And what they did, I think they did the one thing they could do, which was they dramatically ramped up their sales in China. And in China, they surged their smartphone sales in China, and they shot up to over 40% of the China market last year. Well, end of last year. That’s pretty amazing. So overall, their revenue for the consumer business ended up at about $66 billion. That was up 34%. So, I mean, that’s pretty great. I mean, what else can a management team do but respond to the hit you take, reposition? And they did that pretty decently. If you compare that to say a smartphone competitor like Xiaomi. You know, if Huawei is making about $66 billion in revenue on their consumer business, Xiaomi is about 30, so about half. Xiaomi is growing at 17 percent. Huawei is growing at 30 plus percent. Huawei usually makes operating profits of about 10 percent generally. Xiaomi is more like 5 percent. So even that is kind of better than their competitor. But I put the global smartphone consumer business as a bit of a wash. They took the hit. They repositioned as best they could, which was a shift to China. And overall, smartphone business globally was pretty stable. If you look at the end of 2019 versus the start of 2019, it’s really three big players dominate global smartphones, which is Samsung, Huawei, and Apple. And then the one people don’t talk about is BKK, which is when you hear OPPO, Vivo, OnePlus, that’s all one company. So that’s probably the biggest company, but they’re kind of a mix of different. So pretty much the market looked the same at the end of the year. Year on year growth in smartphones globally was about 2%. End of 2019 and start of 2019. Looks pretty similar. All the players pretty much where they were at the beginning. So here is my takeaway from all of this. This is kind of my so what. You know, when I look at, okay, let’s say MSN. Here’s their take on the Huawei financial results. Quote, Huawei reports smallest profit jump in three years as US ban takes toll. Wrong. That’s, it’s off target, not it. Here’s more, the US ban on Huawei appears to have taken its toll on its 2019 profits. The Chinese company’s annual report revealed that its net profit for the year was 62.7 billion yuan, which Reuters noted was the lowest increase in three years at 5.6%. Yeah, this is totally wrong. Here’s what I see. I see a strategic change at the company. I see a big pivot. from fairly aggressive growth, which has been their strategy for the last five years, to long-term survival. I think that’s what happened in July. I think management sat down, the whole idea of, hey, let’s go for growth. Hey, let’s go for profits. I think they pushed that to the side and said, our new approach, survive, survive long-term. And that’s what I see when I look at these numbers. And if you read Ren Zhengfei, his writing, he’s been writing for… 30 years, you can go back and read his thoughts on human resources and the role of the enterprise in 1992. You know, the thing he’s always talked about is the goal of Huawei, the purpose of Huawei, is not to make money. It is not to have a big payday for its founders. It’s not to go public. This is the goal of Huawei is long-term survival as a technology company, which is actually quite difficult and most companies don’t. I mean, most tech companies fade very quickly. His goal is survivability. And he actually has a pretty clear strategy. as far as I can tell for how to do that which is serve your customers very very well because they provide the cash flow that keeps you going. Take that cash and basically serve them better than anyone else. Go where others won’t go. Do for your customers what others won’t do. Total dedication to your customers. Take that cash, use it to grow because scale is your best defense long term. You’ve flooded into research and development. You’ve flooded into scale. That gets you size. As you get bigger as an equipment manufacturer, which was their story from 1990 to 10 years ago, once you get scale, you can make things cheaper than others because you get economies of scale. You’re cheaper than others. That’s a good position to be in the market. You’re also outspending others on research and development because you’re bigger. That helps you stay at the front of the technology curve. And then you also basically reinvigorate and re-energize your culture as much as you can because your people are your only real asset over decades. That was kind of their playbook and they followed it pretty systematically. So when I look at Huawei in the last six months, that’s what this looks like to me. I think they are following this playbook right now. And I put it as four bullet points. Bullet point number one. focus on stable, predictable revenues, not high growth, not high profits, but stable, predictable revenues, because these cash flows are what are gonna keep the lights on and keep the 194,000 employees working day after day. And in terms of Huawei, the two stable sources of cash for them are the carrier business internationally, the telco business internationally, and smartphone sales in China. That’s the thing they can count up. They may sell a lot of phones in APAC or in Europe this year. They may not. Smartphone sales swing all over the place. But their telco business, which is not sexy, it doesn’t grow at 20% or 30%. It grows at 3%. But the telco business where you’re selling to Vodafone or whoever, that’s multi-year contracts that give you a lot of stability. You know the money’s coming next year, the year after year, the year after year, because people don’t swap out every six months. But people do change their cell phone every six months or every year. They may have bought your Huawei phone last year, they may not buy it this year. So focus on the stable revenues which is international carrier and China smartphones. Which it looks to me that’s like what they did. Point number two, flood that money into R&D. Absolutely flooded into R&D. One, because you can’t count on US technology anymore. You have to have other sources of semiconductors, operating systems, all the little mechanical components that go into smartphones and smart homes and all of that. You have to become independent of that. And also because you need to, that’s how you beat your competitors over the long term. You outspend them. So one of the numbers that came out of the financial results last week was Huawei’s spending on R&D in 2019 was $18.5 billion. That is absolutely stunning. They have never spent that much on R&D before. They usually spend about 10%, which let’s say you’re, 10 to 15%. So if they had 100 million, 100 billion of revenue, 10 to 15 billion dollars, they jacked that up to 18.5. And they’ve said that they’re gonna jack that up even more to above 20 billion this year. So they are absolutely flooding money into R&D. And that’s gonna have a big impact on a company like Ericsson and Nokia that can’t spend anything like that. Ericsson’s revenue was $22 billion. We are gonna see a scenario in the next year probably where Huawei is spending more on research and development in Telco than Ericsson has revenue at all. And in fact, if they hit $20 billion, which I think they will, that will make them the third largest company in terms of R&D spending on the planet. Only basically Amazon and Alphabet, Google, will spend more on them and R&D once they hit that number. That, I mean, that’s pretty amazing. So that’s kind of what I’m looking at when I see this. The third point is they’re reinvigorating and reenergizing their culture. So they’re into battle mode. Everyone’s focused, everyone’s working crazy hours. You know, this is kind of their core resources, their people, there are 194,000 people of whom 40, 45% of them like work in R&D. It’s absolutely insane how many people do this. And they’re all like engineers. So, you know, they’re sort of, they’re becoming a lot leaner and meaner than they were a couple years ago. When they kind of become rich. A lot of their management are very rich. A lot of their engineers are wealthy. You know, they’re sort of throwing off that and becoming leaner and meaner. It’s kind of like Rocky II. Remember that movie when Sylvester Stallone becomes successful and he loses the eye of the tiger? It’s like their eye of the tiger moment, for those of you who are old enough to remember that analogy. And then point number four. Basically, stay alive, survive, and use this playbook to grind away at their competitors year after year with your superior scale and your greater dedication at the culture level. That’s their play. I think that’s exactly what they’re doing. I think that’s why they kind of did the pivots that they’re doing. And I think we’re seeing that in their financials. And it’s pretty impressive. We’ll see if it works, you know. Things could change. We could have another political bombshell. There’s rumors that that might happen. If that happens, then we’ll have to look at this all again, but that’s kind of how I see it playing out. There’s a guy out of China named Duncan Clark, who some of you may know, he wrote the book Alibaba, the house of Jack Ma built. He used to work at Alibaba in the early days. We crossed paths in China. He’s a pretty good dude. He had a little comment on this. There was an article in The Economist that basically, I think got it right when they saw the results. They said, quote, indestructible. Huawei reports resilient results. Neither American sanctions nor COVID-19 seem able to slow its rise much. I think that’s pretty close to the truth. And anyways, Duncan forwarded this out, and he had the little quote where I think he said, Huawei is the T1000 of this space, for those of you who have never terminated. It just can’t be stopped. Eh, funny. Anyways, that’s kind of what I see when I look at this company. But in terms of our sort of key learning goals, think about this idea of economies of scale. Telco equipment is a lot about economies of scale, consumer products, consumer devices. It’s a lot about, look, if you’re bigger, you have more engineers, you’re generally cheaper because you get scaled that way and you can flood more into R&D, which is also a game of economies of scale, and that plays out over the long term. You may go up or you may go down, but five years into the future, you’re probably going to be cheaper and with better technology than your competitors, which is pretty much what you see. I mean, it took Huawei a good 20 years. to catch Ericsson. And then it took another 8 to 10 years to really pull away from them, which is what we’re seeing now. Okay, where do we think we’re going to be in 5 to 10 years? Really? That’s kind of how I’m thinking about it. The other learning goal for today, and then I’ll sign off here, is linked businesses. We’ve talked about this in the past. The idea that when you have two separate businesses, that actually can give you a lot of advantages. The analogy I’ve used is if you’re a movie studio, life is actually pretty hard because you have to make hit movies every year. And if you have a hit movie, you make a lot of money. Oh, great. But if you have a bomb, there’s no cash coming in the door. So that makes it hard when you plan for spending on future movies because you don’t know how much money you’re gonna have. So movie studios are kind of live in this hit and miss business model where a company like Netflix has stable revenue because of subscriptions. So what they do is they dramatically outspend the movie studios on content. because they know how much money they’re gonna have three years from now, so they can flood money into content and creating movies and TV shows. And that’s turned out to be a real advantage. Disney does pretty much the same thing because they have their movie studio, which is hit and miss, but they have their theme parks, which are pretty stable. So they flood the money from the theme parks, that’s their linked business, into movies. And that really gives you an advantage in making movies. Well, smartphones are kinda the same. Like, if you’re Apple and you have your ecosystem, it’s a little different because you’ve locked people in. But most smartphone makers like Xiaomi, OPPO, Vivo, definitely HTC, they boom and bust every year based on how good was your phone. Very hard for them to flood money into R&D. And also most of their money they have to use on marketing to promote this year’s phone. So that’s kind of what you see in smartphones, but. Huawei doesn’t have that problem because they have their carrier business. So they have predictable revenues out of carrier and they flood that into R&D that supports their smartphone business even if they boom and bust. So they can outspend the pure play smartphone companies like Xiaomi year after year which is pretty devastating. In fact, if you look at the three top smartphone makers, Apple, Huawei and Samsung, They all have linked businesses. Apple has their ecosystem, which generates a lot of stability, because they’re not just selling handsets, they’re selling handsets plus the ecosystem. Huawei has their carrier business, and then Samsung is a conglomerate. So all of them have linked businesses that they can use to play these cashflow games, and I think that’s a lot of why they can keep out spending people on R&D and other things. Vivo, Oppo, Xiaomi, they don’t have that. It’s a pretty tough business. So that’s the other sort of key concept for today. linked business models which is pretty powerful and digital. Alibaba is a ton of linked businesses. Tencent is as well. So it’s an important idea. Okay I think that is enough for today. I did kind of go on and on. Sorry about that. Everybody have a great week. Stay safe. Mask up. Wash your hands. All of that stuff. And if you haven’t subscribed go over to JeffTowzen.com. Sign up. It’s great fun, you should sign up, give it a try. Anyways, have a great week and I will talk to you next week.