China's Business Model Innovators

Posted by: Steve Hamm on June 02

The impression of China is of thousands of super-efficient electronics companies cranking out components and products with cheap labor. But there’s some really interesting business model innovation going on within the Chinese supply chain mega-machine. One such innovator is a company out of Shenzhen called Cogo Group. I met Jeffrey Kang, the founder and CEO, a couple of days ago when he passed through NYC on a tour aimed at explaining his company to New York equities analysts and money managers. In spite of a stellar financial performance, its stock is trading in the $13 to $14 range, down from a peak of $22. Cogo is a new kind of middleman. It started off as an electronic components distributor, but now it’s also an R&D source for both its customers and suppliers.

Here's how the business works. Cogo, with about 500 employees in China, is a semi-virtual company that focuses on two things: sales and R&D. The company is the middleman between about 50 semiconductor companies and about 1200 manufacturers of cell phones, telecommunications equipment, and consumer electronics products. Its suppliers include Broadcom, SanDisk, and Matsushita, and its customers include Huawei, ZTE, TCL, Lenovo, and Alcatel. It works with customers to find out what capabilities they're looking for in their upcoming products. Then it designs electronics modules for them that incorporate chips from more than one supplier. Cogo outsources the manufacturing of the modules to specialists.

This model works for customers because the Chinese market is so fragmented and fast-changing. More than 1000 of Cogo's customers are fairly small, and they benefit from having modules designed and manufactured via a middleman that they can design into their products. Cogo provides them with economies of scale. This way they get to market quickly, and get help with R&D. The semiconductor suppliers can concentrate on designing and manufacturing large volumes of chips, and leaving Cogo to do some of the customization that their end customers (and Cogo's customers) need.

Here's the really interesting part: Cogo charges its customers for components, not its design services. "Our main value is in our design, but we give away the design for free," says Kang.

About 225 of the company's employees are designers and engineers. Kang says he hires the best talent available and pays above market rates.

The model works. The company's revenues have shown a 50% compound annual growth rate for the past five years, and it forecasts a 30% CAGR for the next five years. Its operating margins range between 12% and 13%.

China has a unique business environment, so I don't see this model working elsewhere. Still, it's fascinating to see how some sharp people have sized up the China situation and come up with an unusual business model that seems to fit to a T.

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