I spent a lot of time talking to the China handset OEMs once known as the Shanzhai. As I said in my last note, this remains a major but poorly understood block of manufacturers. They ship at least half of the world’s handsets. I think it is worth exploring the nature of these vendors a bit more closely.

I tend to categorize these vendors into three loose buckets. At the top, are the major international brands: Huawei, Lenovo, ZTE and increasingly less familiar names like Coolpad, G5 and Gionee. These companies have established strong-ish brands and wide distribution networks. They tend to do a lot their own sales, and have ties to the major wireless operators. Below that is another tier of branded vendors. These are companies that make low-cost handsets, but are trying to establish their own brands. Typically, they enjoy sales in one region in China and sales to a few other countries where they have relationships with smaller carriers or ‘local kings’ that control some other distribution channel. Below that, there is another tier that likely numbers in the hundreds if not thousands of very small vendors who exist on the margins of profitability. These companies sell largely to a domestic audience or to the very bottom of the emerging markets consumers. These companies care less about quality, brand and distribution. It is important to remember that each of these camps looks at the market very differently. In general, the top tier worry about competing with Apple and Samsung (especially). The middle group worries about being consumed from below, while the bottom group worries mostly about surviving.

The top category sell a range of handsets, and are generally now focusing on the smartphone market where they sell mid and high-range devices priced comparably to the global brands. The other two sell $50 3G smartphones and $10 2G feature phones. The middle category also tend to experiment with other form factors like watches, TV set-top devices, tablets and wearables.

All of these vendors shipped reasonable volumes in 2013. The bottom rung always sees a lot of churn, but as a whole these vendors are doing well.

The many Shenzhen vendors have not been that good at seeing long term trends. When your profit is less than $1 per phone, it is hard to take a long-term view. So they expressed little interest in LTE. But by the same token, they had little interest in 3G and smartphones at first.

During my visit, China Mobile reportedly said that they plan to purchase 100 million LTE smartphones in 2014. That, coupled with the near-term launch of Mediatek’s LTE chipset, suggests that these vendors will soon start looking at LTE much more seriously.

And then there is Xiaomi.

It is hard to talk about China handsets today without mentioning this rapidly growing phenomenon. Initially, Xiaomi stood out for the phones it offered. Their model is to sell high-end smartphones essentially at cost. To the other vendors, especially the ones with global ambitions, this was interpreted as price competition, and they largely responded by lowering prices. However, the industry has now started to realize that the interesting part about Xiaomi is how it makes money. Several people we spoke with said “Xiaomi is not a handset company, it is a mobile Internet company”. Xiaomi is reportedly now very profitable, and it does this through payments from various Internet services including its own. For the big vendors, this is a problem. They have large investments in hardware, but struggle to come up with software of their own. The smaller vendors, can be (have to be) more flexible, and they are now looking for partners who will pay them for app placement.

This is not a new business model. For years, the feature phone vendors took payments for placements, but this essentially ended with the iPhone, and the big OEMs soon had to pay the large app makers to port to their devices or limit availability for a time period. Going even further back, there was a period when the PC makers including Dell and HP made most of their profit from marketing payments form the likes of AOL. It seems likely that we will see the small vendors do a lot more app placement on their phones. I could not find a ready Chinese translation for ‘crapware’, but I suspect there will be one soon.

On a more sobering note, there are some signs of consolidation. During my last visit, one OEM noted that there were so many contract manufacturers vying for his business that they were basically giving away their services at cost, and throwing in design and engineering work for free, just to keep their lines operating. This time, he said his range of suppliers had diminished considerably. Now he really only had a choice of ten battery vendors. Ten is still a lot, but far fewer than what he had a few years back.

Perhaps the most interesting new development in this space is the opening of the US market. Historically, the smaller vendors had all ignored the US. Getting a phone onto a US wireless operator was very expensive, requiring hundreds of thousands of dollars of testing and certification costs, upfront. Now, the small vendors are winning business from MVNOs. For those who do not remember, an MVNO or mobile virtual network operator, is a carrier who ‘rents’ capacity on someone else’s network but brands their service as their own. This trend was very popular a few years ago, when many MVNOs set up to tap into various US demographic niches (i.e. teens, immigrants, sports fanatics). However, almost all of them faded away. Either their niche was too small to sustain custom handsets or they got too big and the physical operators pushed them out or acquired them (or both). Now it seems the smaller MVNOs are coming back, in part because they can now afford custom phones from the small Chinese vendors.

This  is a big change, but left open several questions. If the big carriers still require heavy certification to protect their networks, why do they let the smaller guys use un-certified phones? This is a topic I am going to explore more in the future.