This is an excerpt from D2D Newsletter Issue #18 – For a copy of the complete report, please e-mail me or DM me on Twitter.

Perhaps the biggest change to the shape of the hardware industry will be the emergence of China’s customers and suppliers.

For as long as I have been visiting China (my first trip to China was 30 years ago this August), global IT companies have been looking for major growth from China. In many senses, they succeeded. Cisco, Alcatel, Ericsson, IBM, EMC, Intel and many others have done incredibly well there, building a major presence. On the other hand, the China growth story has always been somewhat mixed. Sales took longer than expected. The required investment has always been larger than anticipated. And today, a variety of political and market factors raise further questions about the future. I think it is safe to say that China’s demand for IT products is going to remain robust for a long time. Their webscale companies are a major force. And the country still has lots of gains to be found through further digitalization of the economy. But as we have seen over the past 30 years, it is going to remain a very competitive marketplace.

A big part of that disappointment is that many Chinese companies have emerged to compete, not just for domestic demand but as true global rivals. The most obvious example of this is Lenovo. Depending on how you count it, Lenovo is now the biggest, computer vendor.

Less well-understood is the role of Huawei and ZTE as major sellers of enterprise IT vendors. These companies are known as formidable suppliers of Telecom equipment. But they are also among the largest vendors of equipment for enterprises. There is not a lot of hard data about this, so just like China, Inc. ‘surprised’ the mobile industry, I think there are a lot of people who are going to be surprised to face off against these companies in selling enterprise switches and servers. Anecdotally, ZTE is one of the largest buyers of Ethernet switches to power what is probably their leading position for switch sales. Huawei is a Top 5 buyer of Intel’s server chips, and probably a Top 3 vendor of storage systems.

There are many reasons for their success. Competitors will say they win by price alone, but that is not true. They do have the advantage of a very low cost of capital, but even that may be changing. Both Huawei and ZTE are much more innovative than they are given credit for. Perhaps most importantly, they have succeeded by finding new sales channels. In particular, they have partnered with their many telecom operator customers to push sales of enterprise gear throughout the emerging markets.

When Huawei and ZTE began selling telecom gear, they adopted a strategy of “Using the Countryside to Surround the Cities” (an old Maoist guerilla strategy). That is to say they focused first on selling to periphery markets in emerging markets. Then over time they gradually moved into more developed markets. They seem to be employing the same strategy for sales to the enterprise. I noticed recently that Huawei hosted a data center power conference – in Ethiopia. That may seem like an incredibly remote sales center, but it is just the start. We have seen this playbook before.

Most importantly, these companies realized that in many emerging markets, the leading IT distribution partner for ordinary enterprises is the telecom operator. If you are starting a business in Morocco or Tanzania, there is not a lot of IT talent readily available. And since all businesses need phone lines and Internet connectivity, the telecom operator is a natural first-stop on the IT trail. Both Huawei and ZTE seem to be building partnerships through their existing relationships with the Telecom operators.

One of the (many) interesting facets of this path is that it is somewhat future proof. As businesses in emerging markets move to the cloud (or just start in the cloud), they are going to go to those same telecom operators to provide hosting, collocation and a whole range of Infrastructure as a Service (IaaS) offerings. In the US, the telecom operators are struggling to find a cloud strategy. In emerging markets, there is far less choice for enterprises. If you visit a Huawei booth at a trade show (note: MWC is coming up), you will find a whole range of cloud and enterprise services being pitched to their telco customers.

To tie things up even more neatly, it is also important to note that Chinese companies have taken strongly to a whole host of open source initiatives. Unburdened by years of legacy practices and industry habits, the Chinese hardware ecosystem is able to fully utilize many of the emerging hardware trends in ways that established US peers can only do at the risk of cannibalizing their cash cow product lines.

Of course, this is not a foregone conclusion. There are plenty of potential hindrances and outright roadblocks ahead. Nonetheless, I think it is safe to say that China’s hardware industry is going to be an important force shaping the future of the industry.

Side note on Taiwan

I think it is important also to touch on the related subject of the Taiwan-based hardware manufacturing ecosystem. This ecosystem is centered around a group of Taiwan-based companies that design and assemble so much of the world’s hardware. Strictly speaking, much of this work is actually done in and around Shenzhen, but Taiwan’s economy has long been heavily reliant on selling into the PC complex.

The end of PC growth has brought some important changes to this ecosystem, and Taiwanese companies have adapted to the age of mobile with varying degrees of success. Many have been able to shift into sales of mobile components, and more importantly sales of IP (intellectual property) bundled into hardware. For instance, Mediatek’s use of reference designs has been a major factor in their success selling mobile basebands. Similarly, the shifting tides of enterprise hardware are going to be reflected in Taiwan as well. In particular, the webscale companies have gone direct to Taiwanese design houses (ODMs) to build their white box systems. This has actually been a big boon to contract manufacturers there. Companies like Accton and Hyve are offshoots of Taiwanese contract manufacturers, moving up the value chain to provide design services to the likes of Amazon and Facebook. It is not a glamorous business, but it is a few points more of margin than they could expect as PC assemblers.

In my opinion, the Taiwanese IT complex is going to become one of the major proponents of further growth of highly abstracted, white box equipment sales. This ecosystem’s existence is the key enabler allowing webscale companies to build their own equipment. That means the ecosystem’s prospects are largely tied to the fate of white box hardware, a future which is very much in question.