China's Cell Phone Pirates Are Bringing Down Middle Eastern Governments

In the latest installment of Butterfly Effect, we examine China's cheap knockoff cell phones. After being forced out of China and India, Chinese counterfeiters brought their product to the Middle East, where the sudden availability of information had unintended consequences for the region--and for China itself.

Egyptian woman on cell phone

1. Enter The Shanzhai

In 2004, a Taiwanese electronics firm named MediaTek unveiled its latest product--a cell-phone-in-a-box aimed at manufacturers, equipped with everything they needed to make the guts of a working phone on one chipset. Write some software, add features, and snap a plastic case on the front and you've produced a new model. It was an immediate hit with China’s notorious counterfeiters, the shanzhai.

In 2004, MediaTek sold 3 million of its chips; six years later, its sales had soared to 500 million, more than a third of the worldwide market. Nearly half of those went to shanzhai. The sudden ability to design, manufacture, and ship millions of dirt-cheap handsets in total secrecy led to an explosion in Internet-enabled devices in China. “Five years ago, there were no counterfeit phones,” the sales manager at a Chinese component manufacturer told The New York Times in 2009. “You needed a design house. You needed software guys. You needed hardware design. But now, a company with five guys can do it.”

After conquering China, smuggled shanzhai phones made spectrum so valuable that India’s telcos allegedly bribed government ministers to get their hands on it for $40 billion less than it was worth, triggering an ongoing scandal that might bring down the government. Once India cracked down, however, the shanzhai were forced to look for new markets further afield, to the Middle East--where the glut of cheap phones would help enable the Arab Spring.

2. “Nckias” And “Blockberrys”

The key to the cheap phones was the combination of MediaTek’s chipsets and the vast component bazaars of Shenzhen. While MediaTek’s engineers focused on adding software features such as touchscreen recognition and instant messaging to their chips, shanzhai tricked out basic models with speakers, telescopic photo lenses, and flashlight-strength LEDs. Before long, “Nckias” and “Blockberrys” began appearing across Shenzhen and Shanghai.

With their tiny production runs, shanzhai could manufacture a thousand phones, seed the local markets, see if they caught on, and then crank out some more. Established players like Nokia were soon crying foul, even as they scrambled to keep up. Development cycles collapsed from 9 to 12 months to as little as three months. Instead of knockoffs, the counterfeiters were churning out innovation and forcing large companies to play catch up.

The research firm iSuppli expects China’s gray-market mobile phone shipments to rise to 255 million this year, up 12% from 2010. Shanzhai phones are a leading reason why China’s mobile Internet users more than tripled from 50 million to 180 million between 2007 and 2009, according to a report by the Boston Consulting Group. Chinese teenagers fall asleep every night instant messaging friends via QQ on their shanzhai phones.

3. India's Broadband Scandal

What proved to be the fatal flaw in MediaTek’s chipsets is that they don’t support 3G, a much trickier set of technologies. After both the iPhone and Android smartphones arrived in China, the phone bandits began looking for new customers who didn't mind the outdated technology to keep shanzhai phone production churning.

India, with its low PC penetration, high fixed-broadband costs, and proximity to China, was a natural fit. In 2009, shanzhai phones began flooding the market, offering “good functionality at a fraction of the cost of established brands,” according to BCG. The sudden infusion of handsets sparked a brutal price war among carriers like Bharti Airtel and Reliance Communication, which drove the cost of calls down to $.006 per minute even as the companies collectively raced to sign up 20 million new subscribers per month.

That they could afford that race to the bottom may have something to do with the strange way India’s mobile spectrum was auctioned off in 2008. A last-minute rule change in the auction declared that licenses would be granted on a first-come, first-served basis to anyone with completed paperwork and $355 million in cash. Teams sprinted through the building and down stairs to reach the official clerk--a haphazard process that netted only $2.7 billion in licensing fees and may have left $39 billion on the table, according to outside auditors.

An investigation eventually followed, resulting in the April indictments of India’s former telecom minister, two other officials, and six telecom executives charged with criminal conspiracy, forgery, and fraud. The New York Times has described the burgeoning scandal as “India’s equivalent of Teapot Dome.”

4. The Arab Spring

Today, the shanzhai market has moved beyond China, and even India. Of the 235 million greymarket MediaTek chipsets  shipped last year, 140 million were bound for overseas (Mediatek sold many more for regular market phones). These graymarket phones have captured half the Ghanian market, for example, and last fall, The National--the state-financed newspaper of the United Arab Emirates--warned “some analysts believe China’s bandit phone makers may now be targeting the GCC region,” referring to the Gulf Cooperation Council and its members: the UAE; Qatar; Kuwait, Saudi Arabia, Oman, and Bahrain.

A few months later, half its members were embroiled in the turmoil of the Arab Spring. Although no one has drawn a straight line between the appearance of shanzhai phones in the region and the protests that followed, The National presciently noted at the time that “these cut-price clones are not only saturating markets such as India but are starting to appear on the streets of Los Angeles and are thought to be being targeted at the Middle East region, too, which has large numbers of consumers in cities such as Cairo as well as high-end users in countries such as the UAE.”

And while they’re not equipped to run Facebook or Twitter, the current list of features for MediaTek’s phone includes everything else a budding revolutionary needs to evade or expose government repression, including video cameras, Skype, and Bluetooth--just the thing for sharing government crackdown videos over your State Department-sponsored mesh network--all for as little as $50.

The irony is that the Arab Spring has triggered a paroxysm of repression within China (sparked by the rumblings of a “Jasmine Revolution”) which has made life harder for its cell phone bandits, who were previously hiding in plain sight. But China's crackdown can't put the phones back in the box: China's cheap and easy manufacturing has helped usher in mass cell phone ownership in places where it once was a luxury. And with phones comes the free exchange of information that causes revolutions. If Beijing is looking for a cause of the uprisings that has them so scared, it's in the cheap alternatives that fuel China's economy.

[Homepage image: Getty Images; top image: Flickr user sierragoddess]

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