Innovation networks in the informal economy: the case of shanzhai 山寨 innovation
Julia Seidel
1496255
MA Asian Studies: Politics, Society Economy
Supervisor: Dr. Rogier Creemers
Abstract
This thesis is about shanzhai 山寨 as an innovation system. Shanzhai innovation is a
phenomenon that takes place in the informal telecommunications sector in China. The
production process of shanzhai mobile phones is embedded in a dynamic system of different
actors that each take over a specific role in the production process. Through the network,
actors acquire knowledge and information from each other and technology is shared openly.
This interactive learning process accelerates the innovation process of new products and
designs. The shanzhai network creates a wealth of knowledge and resources for mobile phone
producers. This approach may enable businesses to grow and become innovative firms. The
rapid growth of the internet company Xiaomi can be attributed to the characteristics of
shanzhai innovation in their business model. To what extent shanzhai innovation can become a model for innovation will be analyzed.
Acknowledgments
I would like to thank my thesis supervisor Dr. Rogier Creemers for his valuable and
constructive support while writing my thesis. I would also like to thank my family for their
love and support during my studies. I am grateful for the smart and inspiring people I have
Contents
1. Introduction ... 5
2. Literature Review: The Informal Economy ... 7
2.1. The Informal Economy: a definition ... 7
2.2. Innovation Networks and the informal economy ... 8
2.3. The Informal Economy in China ... 10
3. Introduction Shanzhai ... 13
3.1. Historical context of Shanzhai ... 14
3.2. Shanzhai as a cultural phenomenon ... 15
3.3. The development of shanzhai businesses in the mobile phone sector ... 17
3.4. Technological progress ... 19
3.5. Shanzhaiji production and the innovation network ... 20
3.6. Description of Shanzhaiji ... 22
3.7. Defining shanzhai innovation ... 24
3.8. The difference between shanzhai and counterfeit phones ... 25
4. Shanzhai innovation in the case of Xiaomi ... 27
4.1. User-centeredness ... 27
4.2. Network orchestration ... 28
5. Discussion ... 29
6. Conclusion ... 32
1. Introduction
Through the economic and social reforms, the informal economy has evolved into an
important factor in China’s economic development. It is an essential source of employment for many social groups, and it is a place where constant innovation is a necessity for
businesses to survive. Shanzhai innovation is a phenomenon that takes place in the informal
economy in China. Foremost, the production of shanzhai mobile phones has attracted much
attention. Shanzhai mobile phones are often critiqued as being counterfeits. However,
shanzhai mobile phones are created in a dynamic production process that results in unique adaption and innovative features. In this environment, businesses share their technology
openly and can freely adopt innovations from others. These networks enable the innovation
process to accelerate and allow businesses to be extremely flexible and adaptive to new
trends. To what extent these dynamics can be scaled up and expanded to larger networks
poses an interesting question.
The research question of this thesis is whether shanzhai innovation can be a model for
small-sized businesses to grow. It will be investigated how shanzhai innovation has translated
into a business model for growing mobile phone company Xiaomi.
The analysis is divided into the following sub-sections. The first section of this thesis will
start by reviewing the characteristics of the informal economy before introducing the
theoretical framework of the Innovations Systems Theory. The second section will analyze
the cultural implications of the shanzhai phenomenon. Shanzhai is a diverse social, political
and technological phenomenon. In order to understand what implication the popularity of
shanzhai may have on its innovation system, the historical and cultural background need to be taken into account. The third section will explore the economic and political factors that
Further, the innovation networks of shanzhai businesses will be analyzed. It will become
clear that consumers and producers motives play an essential role in the production process.
The fourth section, will analyze Xiaomi’s business model concerning the characteristics of
shanzhai innovation. The final section will discuss what potential shanzhai business have to
become integrated into a formal environment. It will be argued that shanzhai innovation can
be beneficial for companies to expand, however, further social and political reforms are
necessary to enable the growth of shanzhai businesses. The final section will offer the
2. Literature Review: The Informal Economy
The goal of this section is to provide an overview of the different debates surrounding the
informal economy in China. Before going into depth by discussing the informal economy in
China, the different approaches in studying the informal economies of developing countries,
in general, will be given. The informal economy has played a significant role in China’s economic reforms. Informal networks continue to be an important source of employment and
industrial development.
2.1. The Informal Economy: a definition
In recent years, the informal economy in developing countries has become a field of
inquiry in terms of economic development and innovation. The informal economy can be
described as a part of the economy that is unrecognized and unregulated by the government.
Defining and measuring the informal economy is difficult, because informal work is neither
legal nor illegal. Owners of micro- and small-scale businesses as well as self-employed
individuals or people employed by informal businesses count towards the informal economy
(Becker, 2004). People are likely to be involved in informal and formal work relations
simultaneously. Informal work consists of a range of different economic activities, this can
include workers such as taxi drivers, street vendors, manufacturers or domestic workers
(Charmes, 2016; Xin, 2001). Workers are, therefore, less likely to receive employment
benefits or any other form of compensation apart from their wage (Charmes, 2016). “Casual employment, kinship or personal and social relations rather than contractual arrangements
with formal guarantees” characterize business relations (International Labour Organization, 1993). Thus, informal or casual contracts make employees and businesses vulnerable to
Four dominant schools of thought have evolved that each describes the emergence,
the composition and role of informal economies from a specific perspective (Becker, 2004;
Chen, 2012). The various schools of thought can be summarized in the following way (Chen,
2012); the Dualistic school of through sees the informal sector as a distinct part of the
economy. The informal economy is created by a mismatch of between people’s skills and the structure of the formal economy. The Legalist approach ascribes the emergence of the
informal sector to an unfavourable bureaucratic system for entrepreneurs. People tend to
avoid the cumbersome bureaucratic process that is involved in formalizing their
business. Further, the Voluntary school of thought argues that entrepreneurs in the informal
sector deliberately want to avoid regulations, such as taxation and controls, by staying in the
informal sector. Finally, the Structuralist approach argues that the informal economy is a
result of formal businesses taking advantage of the informal sector to reduce their costs. For
instance, by outsourcing parts of the production or service components for informal
enterprises, legitimate companies can lower the costs for their production. It can be said that
the fundamental differences lie in what factors either motivate or drive people into the
informal sector. Moreover, it can be said that people are motivated to operate informally to
reap benefits, or their economic, political and social situation does not allow them no to seek
formal work. It will become clear that when looking at a specific context, a mix of different
factors contribute to the reasons why people work formally or informally. To investigate how
the informal economy, despite possible constraints, can be innovative, can be done by
analysing the informal innovation networks.
2.2. Innovation Networks and the informal economy
Innovation is seen as the diver of economic growth. However, in the context of the
informal economy, it is still understudied (Charmes, 2016). Analyzing the process of
economy (De Beer, Fu & Wunsch-Vincent, 2016; Fu, Diez & Schiller, 2013). The National
Systems of Innovation theory, assumes that knowledge is the fundamental resource of a
modern economy (Lundvall, 2010). The theory focusses on how flows of technology and
information are distributed within a network of people, enterprises and institutions (OECD,
1997). The government plays a central role in creating a framework in which interaction can
take place between the public and private sector, research institutions and the government.
The ongoing learning process can thereby lead to the creation and diffusion of innovations
(Johnson, 2010). Hence, innovation takes place in contexts where information and knowledge
can be exchanged and integrated effectively.
The theory has previously been applied innovation networks in the formal economy,
but has become a tool to analyse the dynamics of informal networks as well (Fu, Diez &
Schiller, 2013). The network that will be analysed in this thesis is centred on the mobile
phone industry in Shenzhen. A range of different actors, such as suppliers, designers,
integrators, retailers, financiers etc., constitutes the network that will be analysed. Actors’ roles may be informal and formal and can consist of government institutions. Informal
institutions are an important factor of informal economies (Harris-White, 2017). In this case,
the government plays a direct role in shaping the economic, political and societal conditions
of the informal economy. Nevertheless, the governments’ influence cannot be seen as
supportive of the informal economy. Moreover, a lack of government support leads informal
actors to create alternative institutions that substitute for government institutions (Tsai, 2018).
In the informal economy people acquire their skills through ‘learning-by-doing' and
by copying from others. Innovation occurs through adopting or improving goods and services
(De Beer et al., 2016; Fu, Diez & Schiller, 2013). The approach of “open innovation” is is
helpful in explaining the reasons behind this process. “Open innovation” describes the way
This also includes that they make their technologies available to others and collaborate with
firms in their environment (Chesborough, 2006). “Open innovation” can be seen as an
ongoing trend in the mobile phone industry in China. For specific industries it can be more
beneficial for businesses to invest less in their internal research and development and instead
engage with other companies in the sector to collaborate and exchange (Lee, Lee, Song &
Kim, 2008).
The network is formed by informal and formal business relationships. Research has
shown that business relationship in the informal economy are closely linked to maintaining
social relations. Actors that are dependent on each other, sustain their ties by building trust
through personal favors (Fu, Diez & Schiller, 2013, p. 638). This is a crucial strategy for by
businesses to gain more certainty in an informal environment. To make a comprehensive
analysis of the innovation process actors and their roles need to be identified. However,
informal relations make the network more difficult to analyse as social relationships may be
hidden from outsiders.
2.3. The Informal Economy in China
Since 1978 the Chinese government has implemented a series of economic and social
reforms. The informal economy plays a unique role during the economic transition of a
state-led economy towards a market-driven economy. Since the 1990s the state-sector became
increasingly privatized, which decreased the employment opportunities in the public sector.
The informal economy became a reservoir for workers that were laid-off from the state
sector, because many of the laid-off workers that did not find re-employment in the private
sector became small-scale entrepreneurs (Hurst, 2009).
While the structural adjustments were still ongoing in the private sector, entrepreneurs
had to seek support to set up a business through private or informal networks. These private
institutions (Ibid.). For instance, state-run banks were not able to provide the necessary
financial support to private entrepreneurs. Therefore informal banks were created would
satisfy the demand of private entrepreneurs need for credit. It can be said that the self-reliance
of the private sector on its own institutions is still relevant and small and medium sized
businesses still acquire much their funding through private channels (Allen, Qian & Qian,
2005; Tsai, 2018).
Next, to laid-off workers, informal migrants constitute a large part of the informal
economy. Since the household responsibility system was implemented, people from rural
areas migrated to the cities to seek employment. Internal migrants took on low- or unskilled
work in the manufacturing industries in urban areas (Xin, 2001). Even though migrants may
have been employed at a formal company, their contracts were often flexible and temporary.
Their chances of obtaining residential status in the cities they reside are low. The household
registration system hinders rural migrants from obtaining an official status in urban areas.
As a result, people are left in a so-called ‘floating status' without proper access to
social welfare or protection. Self-employment became a viable option for many migrants.
Since they cannot access the public welfare systems in the cities, they are better of being
self-employed rather than staying in a work relation with a formal employer (ibid.)
There are several competing views on how informal work affects economies as a
whole. It can be said that the effects of informal work have yet to be fully understood and
gathering reliable data and accounting for informal work is difficult (Charmes, 2012). On the
one hand, the growth of an informal economy has pointed towards a mismatch between
government intervention and the economy. For instance, missing state regulations can lead to
unfair competition for the formal economy. By undercutting prices and evading taxation, the
informal economy can potentially weaken the economy as a whole. This development can
2011; Stan & Ștefănescu, 2018). Not only could this lead to destabilizing economic growth, but it can also have adverse effects on social equality. Moreover, people may be stuck in
informality without access to social welfare. This lack of support leaves them in an
economically and socially disadvantaged situation from which they cannot escape (Jütting,
Parlevliet & Xenogiani, 2008).
On the other hand, it has been argued that the informal sector’s contribution to a country’s GDP is often underestimated due to a lack of clear definitions (Charmes, 2016). The informal economy can contribute to the economy in a way that it satisfies the demand for
cheaper goods. Especially among social groups that have a lower income, the informal
economy provides products and services at a lower cost (Becker, 2004). It is argued that the
low prices are not only a result of cutting taxes or labour costs, but they are also created
through the ingenuity of products and production processes. In that matter, the informal
economy may be the driver of innovation and economic growth (Harris-White, 2017;
Kraemer-Mbula & Wunsch-Vincent, 2016). The informal economy is an environment in
which businesses have to “operate under extreme conditions of survival, scarcity and
constraints.” (Kraemer-Mbula, Wamae, & International Development Research Centre 2010, p. 138).
Informal employment China is deeply interwoven with the formal sector and both
sides are dependent on each other. Through the economic and social reforms, informal
networks became an indispensable of the development of the private sector. Informal
institutions bridge structural shortcomings of the government and migrant workers make up
the majority of the workforce in urban manufacturing. It has be questioned to what extent
informal businesses are able to translate their innovation system to a formal environment.
To sum up, it can be said that the informal economy constitutes an important part of
different economic activities count towards the informal and formal economy. Throughout
the transition period, the informal economy has been a buffer against economic shocks
caused by the reforms. Informal work relations make up a large proportion of the
manufacturing jobs in urban areas. On the one hand, the economy benefits from the informal
sector through low labour cost and un-bureaucratic relations. On the other side, tax evasion
and under regulation can harm formal businesses and undermine government control.
Several perspectives on how to define informal economy and its characteristics have
emerged. Thereby each approach captures an important aspect of the informal economy, but
rather than selecting one approach over the other, it is more useful to analyse the informal
economy from a holistic perspective. The National Innovation System theory allows us to
study the informal economy from the perspective of an innovation system that revolves
around the exchange of knowledge. Through this approach, networks in the informal
economy can be identified and innovative processes captured. With regards to China’s
informal economy it can be argued that shanzhai has become one of the most dynamic and
innovative phenomenon. It is necessary to analyse shanzhai from a broader perspective,
before going into depth with its innovative practices.
3. Introduction Shanzhai
In this section, shanzhai will be introduced from a popular and cultural perspective.
Shanzhai has various definitions in different contexts. Before going more in-depth whit shanzhai innovation and the informal economy, is important to understand what shanzhai entails in a cultural and historic context. It will become why shanzhai has become such an
3.1. Historical context of Shanzhai
The word shanzhai derives from the Chinese novel 水滸傳 commonly translated as
the ‘Warriors of the March' or ‘The Water Margin'. The word shanzhai is generally referred to as “mountain fortress” or “stronghold” in English (Sin, 2016). This story is seen as one of the four great classic novels of Chinese literature. The outlines of the story are said to date
back to the early Song period and have been passed on in various variations and storylines
(Han, 2016). The gist of the story is that men, who become outlawed by society, find shelter
in a mountain fortress. They are located far away from any government control and live by
their own rules. From their base, the bandits surge out to fight crime and corrupt government
officials on behalf of the weak. Even though their acts were often brutal, and they attacked
the government, they were rehabilitated by the emperor and served him in the imperial army
(Sin, 2016). The heroic legends of the bandits fighting for justice captured people's
imagination. However, people's admiration for the rebels' culture and lifestyle would not stay
without controversy. Throughout the centuries, the novel received critique from official sides.
The stories were even blamed for causing chaos and leading to society's decay. The novel
was officially censored for glorifying the gruesome acts of the bandits and for legitimizing
their self-righteousness. This critique did not seem to influence the popularity of the novel
among society. The opposite occurred when the government banned the stories; it made
people were even more captivated by it (Sin, 2016).
Historically, the stories of the self-righteous bandits became part of common folklore.
The ‘hero-bandits' found their way into contemporary popular culture through television and cinema. First, the legends were featured in series and movies produced outside of mainland
China. The TV series later became popular in China in the early 2000s (Cui, 2012). This way,
However, this popularity would only be a prelude to the trend that would develop the years
after.
3.2. Shanzhai as a cultural phenomenon
The height of the shanzhai phenomenon was arguably in 2008 when ‘shanzhai’ became
the word of the year. Yang (2016) argues that the reasons why shanzhai became such a huge
trend at this particular moment in time all leads down to the combination of the following
factors; The technological advancement of mobile phone production in Shenzhen, the
immense popularity and growing demand for cheap, alternative phones and the rise of online
forums, where shanzhai became a hotly debated topic. The rise of online culture and the
spread of “user created” content created a platform for shanzhai to grow and evolve its
cultural potential. Especially in online forums, people found a place to express their
discontent or mock dominant cultural values (Zhang & Fung, 2013; Xu, 2017). When the
traditional media caught on to the trend, shanzhai became a phenomenon beyond the internet.
Shanzhai established itself as a popular phenomenon and many people wanted to become part of it. People participated by labelling themselves or others as a part of the
shanzhai-spirit. Hence, anything that was seen as a knock-off or ironic re-creation of something
popular would qualify as ‘shanzhai' (Chubb, 2015; Yang, 2016).
It can be said the media coverage pushed the debates about shanzhai onto a new level.
The phenomenon itself soon became a widely discussed topic, where people questioned the
values of an imitation culture and debated whether this form of entertainment could be linked
to grass-roots political protest. In some debates surrounding shanzhai in relation to the
spin-offs of cultural festivities were seen as an attempt to counter the dominant cultural values by
deconstructing and appropriating them (Zhang & Fung, 2013; Zhang & Zhang, 2011).1
1The Shanzhai Gala was one of these cultural events. The goal of the Shanzhai Gala, was arguably to create an alternative entertainment show to the CCTV Spring Festival Gala. Lg
Shanzhai ranges from various tech-products to clothing brands, food, artists and debates about cultural values. In relation to shanzhai as innovation, it can be said that proponents
have made use of the popularity to gain more acceptance for shanzhai as an innovation
system. In many articles describing the production of shanzhai phones, the historical myth is
used as a tool to explain the reasoning and culture behind the shanzhai networks (Huang, Tse
& Ma, 2009; Lindtner, Greenspan & Li, 2015). The way in which informal businesses are
portrayed as ‘shanzhai’ shows that proponents of shanzhai try to establish a link between the
production process and the cultural phenomenon. By attaching shanzhai to historical
background and in line with the cultural values, it may lead to positive public image and help
shanzhai innovation to become more acceptance in society in general (Lee & Hung, 2014; Huang et al., 2009).
However, it is debatable whether this popularity is beneficial for shanzhai businesses.
Debates about the meaning of shanzhai have led people to disregard the imitation culture and
question its cultural value. It can be said that shanzhai is trapped in a discourse on whether it
can be seen as a legitimate cultural product or whether they should be disregarded as silly
imitation (Cui, 2012). This debate is still ongoing and arguably complicates the ascendance
of shanzhai innovation into the formal economy. In the next chapter, the background of
shanzhai businesses in the mobile phone sector in Shenzhen will be described.
the founder of the Shanzhai Gala was assembled a crew of amateur actors and performers that were supposed to perform a knock-off version Spring Festival Gala, that would appeal to people that could not take part in the New Year’s ritual of viewing the Spring Festival Gala together with their families (Chubb, 2015).
3.3. The development of shanzhai businesses in the mobile phone sector
In the early 2000s, a new type of bandit mobile phones was invented. These mobile
phones were not only knock-offs from their original counterpart, they were equipped with
special features that would enhance the mobile phone itself. These mobile phones were
named Shanzhaiji (山寨机) and were the first products associated with the contemporary
Shanzhai phenomenon. The trace of Shanzhaiji leads to Shenzhen, a city in southern China
which is known for its large manufacturing sites and often referred to as the “Silicon Valley
of Hardware” (Wired UK, 2016). Shenzhen’s environment is often compared to an “open
source ecosystem” and is seen as the optimal place for the development of new technological
products (Bunnie’s Studios, 2014). In this section, the developments that shaped the
emergence of Shanzhaiji in Shenzhen will be reviewed. Subsequently, the way in which
businesses produce and innovate their mobile phones will be analysed in the next section.
Shenzhen became the first Special Economic Zone (SEZ) in 1980 and has since then
flourished into becoming a manufacturing hub. By gaining a special economic status,
Shenzhen became an attractive place for foreign investors (Lu & Tao, 2012). Moreover,
political pragmatism and economic experimentation paired with a low-wage labor force
turned Shenzhen into an integral part of the global manufacturing supply-chain (Bach, 2017;
Lüthje et al 2013). Shenzhen has been a role model in many regards for China's economic
and political reforms and it can easily be said that shanzhai is a result of this development.
The economic, political and technological conditions in Shenzhen created an environment in
which Shanzhaiji could enfold.
In the course of the reforms of opening up, foreign investment started flowing into the
SEZ. Several manufacturing companies were opened that started to produce electronic parts
and hardware. These manufacturing plants were mostly subcontractors of international
electronic components for their clients. Fast-paced production at a low cost seems to be the
desired outcome of subcontracting and Shenzhen manufacturers were able to fulfil this (FHI
Mobile Limited, 2013). The hierarchy between the manufacturers and the international
corporation is clearly defined. The subcontractors are specialized in the production and
assembly process, the design knowledge and ownership of the product lies in the hand of the
international corporation (Hu, 2008).
Next, to the large production sites, small local businesses also settled in Shenzhen and
they started producing electronic components. These were sold on electronic markets
throughout the city. A popular place to buy and sell electronic parts is the Huaqiangbei (华强
北) area (Wired UK, 2016; Yu Jia, 2008). With the rapid development of the city, the markets have grown into major shopping malls. All kinds of manufacturers and service providers can
be found there and they offer quick and cheap access to all kinds of technologies (Tocha,
2018; Wired UK, 2016). The environment in which developers, producers and vendors are
working is described as an open innovation environment where people can easily negotiate
access to other people's technology and knowledge (Lindtner, Greenspan & Li, 2015). In
these spaces, informal and formal businesses co-exist and the boundaries between informal
and formal are blurry.
The transformation of the city demanded laborers and these predominantly came from
the surrounding rural areas. They were either recruited to work in factories or people decided
to migrate to the city to seek employment (Lindtner, Greenspan & Li, 2015). With little or no
formal education, these workers are succumbing to low wages and harsh working conditions.
The migrant population plays an important role in the development of shanzhai products.
While they take part in the production and they were initially also the largest target groups of
worked in factories of large cell phone producers by day and assembled their own
counterfeited mobile phones by night. This earned them the nickname of “moonlight
workers” (Hennessey, 2012). It can be assumed that migrants that previously worked in large manufacturing companies may have switched to work in the informal sector (Xin, 2001). As
we will see in the following section, the production process of shanzhai phones is more
sophisticated than what migrants assembling mobile phones by night. It involves several
actors in a network of designers, system integrators, suppliers and vendors.
3.4. Technological progress
A key turning point for the production of mobile phones was the import the MTK
chip. The chip integrated multimedia functions, a software platform and application software
(Li, 2015, p. 141). Independent Design Houses (IDH) became an important part of the
production process of shanzhai phones. The IDHs specialized in the integrating the MTK
chips and in adding additional functions to them on demand (Dong & Flowers, 2016, p. 239).
This made the production process shorter and lowered the entry barriers for smaller handset
producers to produce mobile phones (Li, 2015; Yang, 2016; DCCC, 2015). Businesses
without extensive previous knowledge of the mobile phone industry were able to produce
their own phones and sell them for a fraction of the price of branded phones.
Initially mobile phone manufactures had to acquire an official license. The
telecommunications sector was strongly regulated by the state. Only a limited number of
licenses were issued and sold to manufacturers. While more and more informal businesses
entered the mobile phone market, officially licensed mobile phone manufacturers were
confronted with strong competition. Attempts on breaking down on shanzhai manufacturers
were futile, as the number of informal producers had grown out of proportion. As a result, the
licensing system was abandoned in 2007 (Liao & Chen, 2011). The reasons why the licensing
developments in the mobile phone industry and that deregulation has been a step to support
more competition in the telecommunications sector.
Altogether, economic, technological and political factors enabled shanzhai innovation to
evolve and manifest itself in the manufacturing culture of Shenzhen. The establishment of the
SEZ attracted international manufacturing companies to operate in Shenzhen. At the same
time, more and more migrants came to seek employment in the city. The migrant workforce
created demand for cheap and alternative phones. With the innovation of the MTK chip costs
and production time was lowered, which ultimately led to abandoning the regulatory system
on mobile phones production. The following section will explore more closely at the
production of Shanzhaiji and the innovation process.
3.5. Shanzhaiji production and the innovation network
Research on the production process has shown that a network of different actors comes
together to produce a Shanzhaiji (Dong & Flowers, 2016; Wallis & Qiu, 2012). The shanzhai
business has a central role in coordinating and outsourcing the production steps to
contractors. The IDH is responsible for the design of the MTK chips. This includes the
placement of components of the mobile phone such as battery, antenna and camera on to the
circuit chip (CNOEM Phone, 2015). Other materials and parts are also outsourced and
produced by external suppliers. The assembly of the mobile phone is also likely to take place
at an external manufacturing business (Dong & Flowers, 2016). The finished product is
distributed to wholesalers and retailers before it is sold to the customers (Dong, 2014).
The network consists of formal and informal relationships. Often these businesses only have
few employees which makes it easily manageable for people to communicate directly with
their network. The short lines of communication make the development and adaptation of
products fast and flexible. In addition, people within the network know each other well. This
系) in the Chinese context (Fu, Diez & Schiller, 2013; Wallis & Qui, 2012). Guanxi is a social system of giving and paying back favours and are an integral part of maintaining and
establishing business relations.
Within the network, businesses collaborate on several levels. The environment can be
described as an “open source ecosystem” that includes sharing design and the materials that are used in the production process of a product. This “open source” ecosystem, also called
gongkai (公开), enables businesses to trade their knowledge and technologies with each other
(Bunnie's studios, 2014; Lindtner et al, 2015). Moreover, businesses can build on other
businesses expertise, research, and development (Hu et al, 2011). The close and often
informal links between entities contribute to the sharing environment and make it easy for
new businesses to enter the market and become part of the ecosystem. However, smaller
shanzhai businesses may depend on intermediaries to negotiate prices with other actors (Dong & Flowers, 2016). Sourcing Agents can support up-starting firms or smaller
businesses to begin their production. The Sourcing Agents do not only provide smaller firms
with necessary contacts but are also a source of funding. Since acquiring financial support
from banks often not an option to these small businesses (244).
In this sharing, yet competitive and fast-paced environment, businesses are under the
pressure to produce something that stands out from other products and meets the price-quality
expectations. Lowering the costs can partly be achieved through avoiding taxation and not
performing official product test. Further, shanzhai businesses only invest little in product
promotion, since it is the responsibility of the retailer to promote and sell the product (Dong
& Flowers, 2016; Hu et al, 2011). Low entry barriers for new businesses and a lack of official
Shanzhaiji initially had a confined consumer base. This group was constituted of migrant workers that sought connectivity to stay in touch with relatives and acquire information about
new employment possibilities. This social group was not able to afford the branded phones
and the demand for an alternative was high. Large phone companies often overlook this
market segment, referred to as “bottom of the pyramid” and do not produce for that niche (Dong & Flowers, 2016). Shanzhai businesses filled the gap by making phones that were
affordable and reflected upon the specific needs of this group. It was necessary for shanzhai
businesses to maintain close contact to their consumer group. That way businesses are able to
catch up on trends and design phones that met the needs of their buyers (Wallis & Qiu,
2012).
3.6. Description of Shanzhaiji
Shanzhaiji can broadly be placed into two categories. On the one hand, Shanzhaiji assimilate the design of a branded phone that customers find appealing. It is, however,
enhanced with features that the original does not have. An example of this adaptation is the
Dual-SIM card system that was integrated into shanzhai phones. It is a SIM-card holder that
could be used for two SIM-cards. This was especially useful for migrant workers that
travelled in and out the Special Economic Zone for work. Later, this feature became so
popular that international mobile phone producers picked it up and started implementing it in
their phones (Chubb, 2015; Dong & Flowers, 2016) Another popular feature was the volume
enhancing speakers. The Shanzhaiji came with an additional set of speakers so that users
could listen to music on their phones in noisy surroundings. This was popular among
construction workers that wanted to listened to music during work. On the other hand,
Shanzhaiji producers can innovate phones by mixing and matching them with features that are normally not associated with the functions of mobile phones. For example, phones with
handy for people that had to scan paper money to make sure that the money is not fake.
Another shanzhai phone was disguised as a cigarette box (Bunnie's studios, 2009).
These adaptations go beyond the normal usage of a mobile phone and many of the Shanzhaiji
that were invented are extraordinary combinations of everyday objects and mobile phones. In
this regard, the options are limitless. In many cases, it can be argued that the technology used
in enhancing copies and combining objects is not cutting-edge technology. Dong (2014)
terms this type of innovation a “catch-down” innovation. This type of innovation is seen as
only improving existing innovation. It is also limited to less advanced types of technology
and does not operate with high end or technologies that are more sophisticated.
All in all, it can be said that Shanzhaiji evolves out of a complex production process
that requires different actors to work together closely by building formal and informal
relationships. Up-starting and growing shanzhai businesses benefit from the network around
them, but it is seemingly difficult to study as informal connections remain hidden from
outsiders, because business owners run the risk of being exposed and shut down by officials
(Lee & Hung, 2014). Further, Shanzhaiji fulfil the demand of a niche market.
User-centeredness plays an important part in the innovation and design process. Businesses have
exclusive insights into the needs of their target group and easily become aware of the trends
in the mobile phone sector. Therefore, it can be said that shanzhai businesses that are able to
incorporate customer feedback effectively are more likely to succeed. At the early stages, the
network of shanzhai businesses was close-knit and confined to the city. With the
implementation of further reforms and the opening of the telecommunications sector,
shanzhai networks also started to take shape outside of Shenzhen.
One of the most debatable issues surrounding shanzhai innovation is the question
it will become clear that consumer-centeredness also plays a crucial role in driving shanzhai
innovation.
3.7. Defining shanzhai innovation
The range of bandit mobile phones is immense. For some phones, the resemblance with
the original is strong. Even the operating systems have the same functions and design as the
original. Shanzhai is often seen as counterfeiting and bandit phones are labeled counterfeit
and shanzhai interchangeably. Regardless of whether a product has additional features or not.
From the perspective of a consumer, it there are different motivations for purchasing a
counterfeit or a shanzhai phone. This section will look at why shanzhai innovation
distinguishes itself from counterfeiting and how it achieved this through user-centeredness.
3.7.1. Counterfeiting
Shanzhai is often translated as "copy" or "counterfeit" in English. Whereas ‘copy' and ‘counterfeit' are different words in Chinese, namely, fuzhi (复制) and weizao (伪造). The word fuzhi refers to an object that is the replica of the original. In the realm of creative
production, this word does not have a negative connotation (Han, 2016). Instead, creating a
copy that matches up to the original is seen as a work of art in itself. In the context of mobile
phones, emulating the design and software of a branded phone can be done with such
accuracy that it is not easily detectable for the untrained eye. Often only small irregularities
give away that it is not an original phone. Producing these types of phone is called
counterfeiting. Weizao (伪造) has been the standard way to describe counterfeit goods that
increasingly circulated in China since the 1980s (Yang, 2016).2
2A counterfeit is an unauthorized copy that appears to be valid but is illegal. The negative consequences of counterfeiting are manifold and there have been several debates on fighting
3.8. The difference between shanzhai and counterfeit phones
It has to be said that the production process of shanzhai and counterfeit phones may be
very closely related. Moreover, businesses may be producing both types at the same time. By
looking from the perspective of producers and consumers’ motivations, a difference between
shanzhai and counterfeiting can be established.
As discussed in the previous section, shanzhai phones incorporate imitative and
innovative features. While producers of counterfeit phones aim to make the best copy,
Shanzhaiji producers want to stand out from the rest. Therefore, Shanzhaiji producers interfere with the original creatively and playfully. This includes showing off their products
as being overtly fake and different (Qin, Shi, Stöttinger & Cavusgil, 2017). Research on the
motivation of consumers to buy shanzhai products reveals a difference between the
motivation of buying a shanzhai and counterfeit phone. Consumers intentionally buy
shanzhai in order to make use of the additional features (Cordell et al., 1996).
Moreover, the functionality and new features are the primary motivators for people to buy
a Shanzhaiji. Unlike buyers of counterfeit goods where the intention is to take on a particular
social status (Qin, Shi, Song, Stöttinger & Tan, 2018). Price and quality play important roles
in both categories. Consumers of counterfeit and shanzhai products take into account that the
quality of the products is inferior to the original. The technology can be unstable, and the
features of shanzhai product may not perform reliably. Buyers seem to be satisfied with the
counterfeiting in China. Counterfeiting is a growing global phenomenon that affects domestic and international businesses. Counterfeit goods can damage the reputation of a brand leading to a loss of consumer trust in the original product.
In some cases, counterfeits can have severe consequences for consumers. For instance, when users are tricked into believing they are using a genuine product, while the counterfeit product may be inaccurate or faulty in its functions. This can expand to affecting the
economy as a whole and even impair country’s trade relations (“frontier economics”, 2017; Cordell, Wongtda & Kieschinck, 1996).
price-quality trade-off. They are aware of purchasing a lower quality product, in which they
risk buying a low-functioning or fraudulent device (Ming, 2014; Qin et al., 233).
What makes Shanzhaiji stand out further is the practicality of features that are directly
aimed at a specific type of user. While large mobile phone producers generally cater their
products to a vast range of consumers from different social and economic backgrounds, it can
be assumed that they have less direct contact with their vast consumer base. Phone producers
that copy branded phones, may be more attentive to the trends of their target and respond by
copying phones that are in high demand. At this point, shanzhai clearly distinguishes itself
from the original brand and the counterfeit good because the products target a much smaller
demographic of consumers. Shanzhai producers have to understand the needs of their target
group, which in return binds the consumers to the product.
With increasing popularity, Shanzhai producers were forced to invent creations that
would make them stand out and catch the attention of their customers. Shanzhai became a
creative expression of the producers where the playful features stood in the foreground.
Moreover, these products do not only represent the shanzhai businesses themselves but are
also a representation of the consumer’s identity. The identification with shanzhai from a
producer and consumer perspective has made shanzhai into its brand3. Some shanzhai
businesses advertise their product being ‘shanzhai’, and buyers and sellers of shanzhai seem to take pride when buying these products. They stand out for being domestically designed
and produced and are framed as a form of ‘Chinese innovation’ (Lindtner & Li, 2012; Wallis
& Qiu, 2012). This way of framing is one of how shanzhai businesses can increase the
popularity of shanzhai phones and acceptance among Chinese consumers.
3According to Kotler (1991), “name, term, sign, symbol, or design, or combination of them which is intended to identify the goods and services of one seller or a group of sellers and to differentiate them from those of competitors” can define a brand. (as cited in Keller, 1993, p. 2)
Overall, it can be said that shanzhai innovation does itself apart from counterfeiting and
imitative productions. The shanzhai network does not only have the capability to transfer
technological knowledge between entities, but it is also a communicative system between
producers and consumers. Without the external input from consumers, shanzhai innovation
would not have been successful. Paying attention to users’ needs makes people feel
connected and they purchase the product with a sense of pride. Nevertheless, shanzhai
innovation will continue to be under scrutiny, as shanzhai phones will continue to imitate
features of higher end technology.
4. Shanzhai innovation in the case of Xiaomi
In the following section, it will be discussed how shanzhai innovation may operate in a
larger business network. This will be done by looking at the internet company Xiaomi.
Xiaomi has grown from a small niche, user-centred and software developing business to a
high-end mobile phone and smart device producer. The company orchestrates the ecological
chain of its mobile phone production and is at the interface between manufacturers, designers
and consumers (Mobile Internet, n.b.)4. Xiaomi's development from selling inexpensive
smartphones to becoming a leader domestic smart device production will be explored more
closely.
4.1. User-centeredness
The company was founded in 2010 started to sell an operation software for smart phones
called MIUI. From the start, user-centeredness was at the core of Xiaomi’s product
development. The first customers were only a smaller group of technologically experienced
4 Xiaomi is known for its competitively priced high-end mobile phones and these phones the company offers a range of lifestyle products including smart TVs, Mi Band, Mi Air Purifier and Mi Electric Scooter (Xiaomi Global Community, n.d.). Domestically, Xiaomi is already the largest producer of mobile phones while it is becoming increasingly popular in international markets as well (Xiaomi Corporation, 2019).
users. When users installed MIUI they were able to give feedback on the operating system
(Shirkey, 2015). The users' expertise was used to improve the software and customize it to
the users’ needs in the next update. These updates were launched on a weekly basis, so that users would quickly experience an improvement (Wong, 2014). Much appeal was found in
this model constant feedback and users became known as "Mi Fans" or mifen (米粉). Xiaomi
continues to nurture its user community by publishing the latest information on updates and
products online and users can engage by posting questions and by sharing their experiences.5
Through this interaction, Xiaomi is able to communicate with its users and binds people to
thei products through engagement (Kline, 2017). This kind of two-way communication plays
an important role in shanzhai innovation. The extensive engagement with its users makes
Xiaomi stand out from other mobile phone companies.
4.2. Network orchestration
After gaining expertise in the field of operating systems, Xiaomi moved on to producing
mobile phones. The company has launched almost 20 smart phone models in high-end and
low-price categories over a short period of time (Mi Phones, n.d.).
Xiaomi's mobile phones are produced through collaboration with Independent Design
Houses (IDH) and Original Design Manufacturers (ODM) in Shenzhen. While IDHs take
over designing the mobile phone, ODMs offer already finished produced mobile phones.
These phones are then optimized with the software and labelled by Xiaomi (Joseph, 2019).
By outsourcing the design and manufacturing Xiaomi reduces the costs for production
(TechDesign.com, 2016). In addition, the company builds on the expertise of IDHs and
ODMs to manufacture phones. These companies conduct their own research and
5Mi Global Community: For more insight on online forums hosted by Xiaomi visit: https://c.mi.com/oc/forum-1898-1.html
development, which shortens the production cycle of a smartphone and allows Xiaomi to
release more phones in a shorter period of time.
The collaboration of Xiaomi with different partner companies is further enhanced through
diversifying the product range. Xiaomi outsources the development of other smart devices by
collaborating with companies that are specialized in the area. Xiaomi is mainly involved in
the final design stage and labelling of the product. These companies benefit through the
collaboration by gaining access to distribution channels and market insights (Wang, 3 May
2019). Thereby Xiaomi builds a network where technological knowledge and market insights
are exchanged. It can be said that one of the main successes of this network collaboration is it
that Xiaomi's was able to cut costs for consumers.
5. Discussion
From the perspective of small or medium sized business, operating in a shanzhai
environment can be beneficial to secure resources and advance technological knowledge and
market insights. The strengths of this innovation system lie the capability to absorb and
implement new technology at a high pace and subsequently create products that respond to
the demand of consumers. It can be said that even though, the shanzhai network is partly
based on informal or social relations, shanzhai businesses are very competitive and
market-driven. The price-quality trade-off is significant for producers and customers and therefore
creates a strong incentive to advance existing technologies and push innovations. It can
therefore be advantageous for the development of the mobile phone industry to integrate the
economic output of the informal sector.
In the current context, businesses may face several obstacles in becoming formal. This
includes for example, access to subsidies and obtaining financial services from conventional
banks. Small businesses may further be discouraged to transition into the formal economy by
needed. Since many skills that are obtained in the informal economy are acquired through
learning by doing, it may be difficult to train employees for higher skilled working processes
when the resources are not available within the network. Consumers’ demand plays a central role product development in the shanzhai innovation system. One of the drawback for
growing businesses could that the products do not appeal to a wider consumer segment. To
what extent businesses are able to adapt to the needs of a larger consumer base is debateable.
In terms regulating shanzhai innovation it is unclear whether the government will be able
to implement policies that could encourage businesses to formalise. The restrictive policies
towards migrants settling in urban areas such as Shenzhen can be seen as the greatest social
barrier towards formalisation of networks. Further, the question remains to how informal and
social relations that are partly in place to protect businesses from government interventions
can be translated to a formalised environment.
Currently, the unregulated modes of entry to the mobile phone market push down prices
and marginalize producers’ profits. It can be said that fierce competition may create a race to the bottom in mobile phone manufacturing. Technological advancement is likely to
exacerbate this process. Hence, businesses may be discouraged to take greater risks in
expanding when they face increasing competition from below.
In addition to the structural and regulatory obstacles, the acceptance of shanzhai
innovation in the current social and political context is still debateable. Legitimacy plays an
important role for growing businesses as it can secure the access to resources and societal
support in the longer term (Rutherford & Buller, 2007; Lee & Hung, 2014). Research has
shown that, customers, financiers and employees are more likely to endorse a company when
they have a certain level of trust in a company. Businesses are more likely to expand their
production and hire new employees when they have a certain degree of certainty that they
phenomenon, people purchased shanzhai products with a sense of pride for shanzhai being
domestically produced. However, at the same time the value and significance of shanzhai
have been consciously under scrutiny. One of the mechanisms employed by supporters of
shanzhai innovation has been to obtain greater legitimacy by framing shanzhai from a historical and cultural perfective (Lee & Hung, 2014). It can be said that framing shanzhai is
an ongoing process, but its outcomes can not be fully anticipated.
User-centeredness and network orchestration are two of the main characteristics of
Xiaomi’s business model and it overlaps with the practices of shanzhai innovation. Xiaomi was able to create a competitive edge by integrating user feedback and quickly responding to
the needs of the target group. Xiaomi has adapted its user-centeredness model to its
crowdfunding platform. On this platform, customers can directly fund products they want to
buy (Techkou.net, 2019). Thereby Xiaomi able to foresee trends and can enter collaboration
with producers and integrate the products in its product range. It can be said that while the
company continues to grow and expand to new markets, user-centeredness may become more
challenging.
It can be said that at the early stages of Xiaomi’s mobile phone production, shanzhai innovation has played an important role. Xiaomi gained its expertise from external
contractors and build phones through collaboration. Xiaomi continues to build on
collaborations as it strives towards becoming an IoT company that integrates smart devices in
its online network. Therefore, Xiaomi constantly enters new collaborations with companies to
enhance its smart devices range (Mobile Internet, n.b.). Collaborating has the advantage that it lowers the costs of developing a new device and increases the amount of products available
to consumers. Xiaomi thereby sets the standards, but under which conditions knowledge and
There have been some drawbacks in which companies misused the Xiaomi brand name to
market their product (Techkou.net, 2009). Just as other smart phone producers, Xiaomi is not
immune to its products being counterfeited. How the company responds to its technology
being appropriated is unclear. It can be said that in order to sustain the brand a certain amount
of protection of its innovations and technologies needs to be upheld. Furthermore, Xiaomi
faced production shortages of its smart phones devices. The shortage is said to have been
caused by mismanagement of the production process (Li, 2019; Wang, 17 March 2019).
While Xiaomi is currently able to reap the benefits of collaboration with partners, these
collaborations may become obsolete as the companies mature themselves. It can be said that
the shanzhai innovation approach may shift towards a more closed system of collaboration.
6. Conclusion
This analysis has shown that shanzhai innovation is an important part of China’s
telecommunications sector. By applying the National Innovations Systems Theory,
innovative capacity of shanzhai networks has been made visible. Building these networks
through formal and informal business relations creates a dynamic knowledge and technology
transfer that enables innovations. In addition to the relations between actors, shanzhai
products are enhanced through the incorporation of customer feedback. Producers are
motivated to stand out from counterfeited phones by inventing combinations of features and
gadgets that appeal to the customers. It can be said that shanzhai innovation has a competitive
advantage for small to medium sized business operating in a local environment. It has
become clear that shanzhai businesses in the mobile phone industry face several constraints
that are typical for businesses in the informal economy.
The case of Xiaomi describes how shanzhai innovation can be a possible approach for
businesses to expand. Xiaomi has been successful in resembling a shanzhai innovation
Establishing a user community to gather input and expertise and trends have been the
fundament of Xiaomi’s success. Through the implementation of a collaborative network, Xiaomi had to invest less on internal research and development. This has lowered the costs
for its devices and created an advantageous price-quality trade-off for its consumers. Xiaomi
continues to be the interface between consumer input and device manufacturers as it expands
its product range. The discussion has shown that the growth of the company may impede the
shanzhai approach to the extent that Xiaomi may not be able to incorporate the needs of a larger and diversified customer-base. Further, challenges in the supply chain have shown that
Xiaomi may have to shift away from depending too much on external collaborations.
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