While the focus has been on international companies setting up their own design centers in China, an emerging local industry is paralleling the growth of captive operations.

The Chinese independent design houses (IDHs) have until now focused primarily on handset design, but some are beginning to expand into other areas--notably, consumer electronics such as MP3 and MP4 players.

The evolution from manufacturing to design is a natural one. Design services typically command higher margins and higher salaries than manufacturing, so it's an attractive sector for both entrepreneurs and engineering students. And it's poised for continued growth. One source estimates that China graduates 300,000 engineers a year, many of whom will go into electronics.

Still, it is early days for China's nascent design sector. The country produced 240 million

handsets last year for both domestic and international customers: one-third for the local market and two-thirds for export. Of those 240 million phones, only about 10 percent were designed by Chinese firms, according to Pday Research, a Beijing-based research firm that focuses on the handheld- and wireless-products markets.

Most of the domestic IDHs are located in Beijing, Shanghai or Shenzhen, where 80 percent of China's mobile-handset and digital consumer electronics production occurs.

Classification

For the most part, China's IDHs fit into one of four categories:

1. Those setting out on their own. Such companies are often founded by a designer or business manager who used to work for either an international or a domestic OEM in China and sees an opportunity to go it alone.

2. Those started by returning entrepreneurs. Another category of company is typically set up by Chinese engineers or managers returning from education or work experiences in Europe or North America and looking to start their own business.

3. Those with roots in distribution. This type of company emerges from a services unit of a component distributor to pursue a business opportunity in electronics design services.

4. Joint ventures. These companies are typically formed with the help of a foreign OEM, component supplier or design firm that takes an equity stake in the local company.

The 10 Chinese IDHs profiled in the chart on page 30are representative of the four categories. The list is not a ranking of the top industry players. The lack of reliable, independent financial data for many of these companies precludes such a ranking.

Squarely in the setting-out-on-its-own category is Techfaith Wireless Communications Technology. It was founded in 2002 by a group of Chinese engineers and businesspeople who previously worked for Motorola Mobile Communications.

Techfaith has four offices, split between Beijing and Shanghai, in part to keep its projects separated and to protect the interests of its technical-design-platform partners, which include Texas Instruments, Skyworks, Philips and Qualcomm.

It's typical for an IDH to base its designs on one system platform in order to satisfy the business interests of the platform supplier, although a few companies have a multiplatform strategy. Design platforms from Analog Devices, Infineon, Philips, Qualcomm, Skyworks and Texas Instruments are all well-known in China.

There is nothing parochial about Techfaith's business strategy. It is one of only a few Chinese IDHs that engage in both GSM and CDMA handset designs. And the company recently released an MP4-enabled TV handset design solution.

In the same category is Shenzhen-based Ginwave Technology. It was founded in 2002 by design engineers and sourcing executives from Konka Group, a leading domestic handset and TV maker. The company builds all of its designs on the Infineon platform.

Konka initially was Ginwave's top customer, but the IDH has since broadened its customer base to include China's Telstar and Qiaoxin. The design firm has been also in discussions with Motorola and Nokia, according to Hailing Li, president of Ginwave Technology.

Li believes Motorola and Nokia are looking to outsource more designs to third parties in order to reduce costs. The need is particularly acute at the low end of the handset market, he said, because both Motorola and Nokia lost market share in China in 2003 because of a focus on the high end. They reversed the slide in 2004 as a result of a more-balanced marketing approach but are still looking to cut costs, and Chinese IDHs have a design cost advantage, according to Li.

Chinese returnees are another important driver for the emergence of the Chinese IDH sector. For example, James Wu, founder of Shanghai-based Yuehua Teltech, was an executive at semiconductor equipment maker Applied Materials Inc. and at NASA in California. He specialized in RF design and portable communications terminals.

Wu saw a handset business opportunity in China back in 2000 and jumped at the chance to start his own company. Domestic demand and manufacturing demand were growing at a 30 to 40 percent clip annually, and there was virtually no local design capacity at the time to support that growth.

Wu persuaded 10 Chinese engineers and businessmen who had deep semiconductor knowledge and design expertise in Silicon Valley to move back to Shanghai in 2001 to form Yuehua Teltech.

One of Yuehua Teltech's products is a Qtopia-based Linux embedded smart phone, launched this year, that integrates an MP4 media player. The company owns patents for polyphonic ring tones, a GSM/GPRS protocol stack, Layer 1 core software and applications in games, TCP/IP, WAP, USB and digital still cameras.

Distributors, too, are moving into the independent design space. In some cases, the IDH is spun off into an independent entity by its parent. In others, it remains a business unit of the mother company.

Solution-based BOM

"In many cases, distributors are selling ICs one part at a time, [while a] design house sells a solution-based bill of material. This is more productive," said Zhengfeng Gao, chief technology officer of Linpo Electronics Technology, a Shanghai-based semiconductor distributor.

Linpo grew 150 percent in 2004, to $60 million, and much of that growth was design-driven, according to Gao. About 25 percent of the company's revenue comes from MP3 and set-top-box designs, he said. Linpo employs 20 design engineers. By combining a design with traditional component distribution, "we can better deliver design to purchase," said Gao.

For the customer, that means fewer middlemen. Typically, Chinese EMS providers and OEMs have to manage three contacts: distributors, IDHs and IC suppliers. They can spend a lot of time going back and forth between their suppliers and distributors, because suppliers' reference designs are often too general to be applied directly to a customer's design. "Our design lab integrated the functions of the three parties, which allows the customer to talk to only one contact person," said Gao.

Linpo plans to expand design services to LCD-TV products and automobile audio/video systems, and eventually to spin out the business to form a separate company.

Like Linpo, Simcom Shanghai, a subsidiary of Sunrise Group, also has a distribution background. Sunrise Group owned Sunrise Technology Hong Kong, a leading regional distributor, but sold that business to Avnet Inc. in 2001. It now focuses on LCD module and handset design and logistic services, and it operates through four separate companies in Shanghai and Hong Kong.

Representing the joint-venture model, Shenzhen-based Huawei Technology, the top-ranked indigenous Chinese telecom equipment manufacturer in terms of revenue, set up a joint-venture IDH in Shanghai in 2002 called Cosmobic Mobile Systems with partners NEC Corp. and Panasonic Mobile Communications. The venture focuses on 3G handset designs as well as value-added distribution for NEC and for Panasonic Mobile Communications' RF modules and components.

NEC and Panasonic license their 3G core technology and protocol stacks to Cosmobic, which enables the venture to deliver customer applications to third-party handset makers. In return, NEC and Panasonic benefit through greater Chinese-market penetration of their products, thanks to Huawei's market presence, strong relationships with Chinese mobile operators and skills in low-cost engineering design.

Techno Science Technology R&D Co. switched to an IDH business model after many years as an EMS-ODM in the MP3 and audio market. The company now focuses on design solutions for embedded hard-disk-powered media players such as MP3 and MP4 products, according to Mingcheng Zhu, Techno's project director. The company builds its design on Freescale Semiconductor Inc.'s IMX21 microcontroller family and is a strategic-solution developer for Freescale.

CEC Wireless is a joint venture between China Electronics Corp. (CEC), a state-run company with four handset business licenses, and Cellon International, a San Jose, Calif.-based IDH. Set up in 1999, CEC Wireless has engaged in GSM and wideband-CDMA handset design using the Philips design platform and chip set. With technical and management enhancement, CEC Wireless has served handset makers such as CECT, Eastcom, Haier, Konka, LG Electronics, Qiaoxin and Siemens. CEC Wireless estimates its 2004 revenue at $85 million, a figure that would make it the top IDH in China.

This tier-one Chinese IDH is planning an initial public offering to raise funds that it will use, in part, to penetrate foreign markets. It is not alone: Techfaith Wireless launched an IPO on the Nasdaq (CNTF) last May, raising $141 million. That same month, Longcheer Group, based in Shanghai, had an IPO on the Singapore stock exchange and raised $14.9 million.

Observers suggest that the IPO trend will continue, most likely starting with Ginwave Technology, which has announced intentions to sell shares to the public this year.

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