There was a time, about a decade ago, that Cisco (CSCO) executives would comment that Huawei was so good at copying (aka appropriating) Cisco’s technology that it even replicated bugs in the software. What was once a joke has morphed into a juggernaut in the communications-equipment marketplace that shows no sign of abating.

Huawei has pushed itself onto the world stage of equipment OEMs for carriers worldwide in wireless, IP-broadband, core networks, software, and services. According to market research firm Informa, Huawei is now the number three supplier of wireless infrastructure equipment, trailing only Ericsson (ERIC) and As you can see in the graph below, Huawei has been growing like a weed and nothing suggests that it will be slowing down anytime soon.



As you can see from this second graph, part of the reason for Huawei’s success is that it’s willing to operate at a lower margin level than its competitors and willing to accept a lower level of cash generation as well. That is the result of much more aggressive pricing, yielding market share gains.



Huawei doesn’t break out its revenue by market segment, but there’s a pretty good chance that 2009 results will look much like the past several years.

One of the only areas for wireless infrastructure spending this year has been China’s 3G build-out. To no one’s surprise -- with the apparent exception of the CEO of Nokia (NOK) -- the bulk of the 3G contracts from China’s three primary carriers went to the “home team” -- Huawei and ZTE.

However, there’s another factor at play in Huawei’s success and it will be extremely difficult for its competitors to counter. 

In May of last year, there was an article in The Economic Times of India that Reliance Communications (RCOM.NS), the largest CDMA service provider in India, procured a 10-year, $750 million loan from the China Development Bank for the purchase of GSM equipment.

What made this unusually interesting was that it was buying the equipment from Huawei. Would the financing have been available were Reliance buying equipment from Ericsson?

Obviously, we won’t know the answer to that question, but it’s interesting given another recent event.

Huawei has just won a contract to supply Norwegian wireless carrier Telenor (TEL.OL) with LTE (long-term evolution) equipment, beating out incumbents Ericsson and Nokia Siemens Networks. This is the largest LTE award to date in Europe.

In commenting on the contract, Ragnar Kårhus, head of Telenor, said about Huawei, “It was a combination of technical quality, reliability in terms of handling a large-scale equipment replacement operation, and commercial terms that was the deciding factor” [emphasis mine]. One can only wonder to what degree, if any, the China Development Bank played a role?

So what does this mean going forward? Generally speaking, wherever Huawei is involved, competitors will have to be much more aggressive on contract pricing. That, in turn, will translate to lower margins and reduced levels of cash generation.

Cisco CEO John Chambers highlighted the point on a recent conference call. Responding to a question seeking further detail on guidance for lower gross margins, Chambers highlighted the “brutal” pricing they’re seeing in emerging markets.

He said that if Cisco had been more aggressive it would have won more business in those regions. As he noted, “it's a nice way of saying, we'll probably be more aggressive in the next quarter or two…”

Despite its perceived restriction to emerging markets, investors should expect the discounting genie to follow Huawei around the globe. Their business model works as evidenced by their growth rate. Consequently, there’s no reason to limit its success to specific geographies.

The telecommunications equipment suppliers dabbled in vendor financing in the 1990s much to its dismay. Buying business started out well but finished with a thud.

Consequently, I don’t expect a replay of that disaster. However, as the wireless industry stands on the cusp of its LTE upgrade cycle, the competition will be pushed like never before.

Cisco’s business model obviously leaves it with plenty of room to maneuver, but investors tend to dislike anything with declining margins. That tends to make for declining multiples on earnings.

Alcatel and Ericsson are far more at risk given their current fundamentals. Alcatel hasn’t seen “earnings” in some time and Ericsson lacks much in the way of flexibility. Either way, Huawei is going to be turning up the flames.