Could Sanctions Harm ZTE’s US Smartphone Ambitions?

Nothing riles the often fragile relationship between China and the US like a heated spat over sanctioned technology, and the latest clash over ZTE’s Iranian reexports is attracting fire from all sides.

ZTE, which makes smartphones and telecommunications equipment, allegedly breached US sanctions by selling US-made goods to Iran, according to a statement released on Monday by the US Department of Commerce.

Since then, Chinese officials have leapt to the aid of the local telecommunications equipment maker and smartphone vendor. A statement from the Chinese Ministry of Commerce website expressed their “resolute opposition” to the move, noting that the new license requirements would “severely” affect the operations of ZTE.

Diplomatic gymnastics aside, the sanctions have the potential to threaten a movement at the heart of ZTE’s current mobile operations: a two-year long push to put handsets in the hands of American consumers.

A Break In ZTE’s Supply Chain

While the latest restrictions won’t stop ZTE from shipping handsets to the US, they have a significant impact on the technology used in them. ZTE has made no secret of the fact that their latest high-end handsets are designed in the US, for the US.

Last year saw a handful of energetic Chinese smartphone sellers throwing off ‘made-in-China’ stereotypes by releasing high-end smartphones. At the beginning of 2015 ZTE initiated a brand overhaul and began selling handsets to the US. Previously the company had sold handsets in the US under white label agreements, meaning the ZTE phones were branded under other names, mostly carriers.

ZTE’s Axon was their enthusiastic high-end debut, defined by a significant upgrade in component quality. The phone was designed and tested in the US with the help of foreign teams, including Blackberry. The company branched out to sponsor five NBA teams among a series of decadent marketing commitments designed to push the new brand in the US market. In November, Senior Director of Strategic Marketing at ZTE, Andrew Elliot, told Technode that the company had tested every stage of the phone’s development, including the name, with 5768 American consumers.

And it worked. The company’s market share in the US almost doubled to 8.2 percent in 18 months. In a symbolic display, the Axon was even released in the US before China.

But as the company faces a lockout from US  technology companies, they are also facing a lockout from the current, and potential, high-end components that helped them build their US flagship brand.

One of the major US tech companies that will be affected by the latest US ruling is Qualcomm. Qualcomm provides the MSM8994 Snapdragon 810 chip used in ZTE’s Axon. Under the new restrictions Qualcomm would be required to apply for a license to sell to ZTE, which would likely be turned down.

ZTE’s Relationship With US Consumers

The latest case with ZTE brings to mind the riff between Huawei and the US government. Huawei’s telecommunications business was blacklisted in the US over spying allegations. While the two cases are markedly different, it’s worth noting that Huawei’s handset business has made healthy gains in the US market despite the previous damage done to their brand. Like ZTE, Huawei has managed to encroach on Samsung and Apple’s high-end domain, notwithstanding a slowing smartphone market.

While consumer sentiment may not be harmed by ZTE’s latest sanctions, a dip in quality components could. The latest restrictions will also likely drive ZTE to search out new suppliers, further promoting the Chinese government push to localize and control core technologies.

The US sanctions against Iran, many of which were recently relaxed, are designed to halt the development of Iranian nuclear programs by locking them out of trades involving US technology.

According to the US Department of Commerce ZTE “planned and organized a scheme to establish, control, and use a series of ‘detached’ (i.e., shell) companies to illicitly reexport controlled items to Iran in violation of U.S. export control laws.” ZTE has a registered company in Iran, and was allegedly utilizing shell companies to export goods that include US technology from China to Iran.

ZTE has suspended trading this week in reaction to the news. The company has not responded to a request for comment at the time of publishing but released a statement noting they are “working expeditiously towards resolution of this issue.”