The word "shanzhai" has several meanings. Originally it meant a fortified mountain village, but these days it mainly refers to small, illegal factories that churn out copies of famous-brand mobile phones. In the era of relatively simple 2G phones, the industry was huge, but now everyone wants a fancy 3G smartphone, and they're a bit too hard to fake, leaving an uncertain future for this hidden industry.

Illegal but massive
Shanzhai mobile phones started to become popular in 2004, when 2G phones were still standard.

"The most important reason for me to buy a shanzhai mobile phone was the low price compared with the big brands, generally just around 1,000 yuan ($154.61). Shanzhai mobile phones were so popular in the past and many of my friends had them," Guo Yang, a young office worker in Beijing, told the Global Times.

Statistics from market research firm All View Consulting show that China produced 600 million mobile phones in 2009, of which 145 million were shanzhai models, taking nearly 30 percent of the domestic mobile phone market.

"Every year, mobile phone manufacturers spend millions of dollars researching consumers' preferences and developing products. But imitation of famous brands in design and function saves a lot of costs for shanzhai mobile phone manufacturers.

So they can provide very competitive prices. Also the imitation of famous brands can secure buyers," said Luo Qijun, an analyst at IT market research company eShip Consulting.

Luo added that in the early stages of their development, most shanzhai phone manufacturers just copied popular mobile phone models. But with the development of mobile phone chip technology, some were able to design their own products, bringing many new ideas to the industry.

Thirst for functions
"The boom in the shanzhai mobile phone market was closely related to a Taiwan-based mobile phone chipset company – Mediatek. The company developed a low-cost mobile phone chipset, which allowed for incorporation of different functions, such as Bluetooth, MP4, voice command and cameras, into different designs," Luo said.

"This allowed customers to choose which functions they wanted and gave ample space for shanzhai phone manufacturers to apply their imagination in phone design," he added.

Mediatek's success was based on its leading position in SOC (System on Chip) technology. It created a "turnkey solution," integrating all the functions that mobile phone manufacturers required on one chip. The success of the shanzhai phone industry contributed greatly to the company's $3.52 billion revenue in 2009, up 21.7 percent from $2.90 billion in 2008.

"Most shanzhai mobile phones are produced by small factories. The Ministry of Industry and Information Technology (MIIT) regulates that every mobile phone manufacturer must obtain a telecom network access license before selling a product. In order to obtain that license, every mobile phone manufacturer must send sample products to MIIT's labs to test their safety, electromagnetic compatibility, radiation and other aspects," said Mao Jun, an engineer at the China Telecom Testing Lab of the MIIT.

"But shanzhai mobile phones don't have these tests and network access licenses. In other words, shanzhai mobile phones are illegal products that might harm people's safety and health," he added.

However, "No one cares whether shanzhai mobile phones have network access licenses," Li Jiangang, a shanzhai mobile phone retailer in Zhongguancun, Beijing, told the Global Times.

"What people care about is price and function. Due to the low prices, some consumers even criticized the huge profits of famous mobile phone manufacturers."

Fall in 3G
However, new generation mobile phones have not done so well in the 3G era in China.

Mediatek announced in its 2011 first-quarter results that revenue was NT$19.87 billion ($690.69 million), down 39.3 percent year-on-year. Its net profit was NT$3.06 billion, down 72.3 percent year-on-year.

"Shanzhai mobile phones are not as popular as in the past. More and more people like 3G smart phones. Last year, I could sell at least 20 shanzhai mobile phones in one day, but now just 5 or 6, " said Li, the shanzhai phone retailer.

"In the 2G era, users cared about functions. But now, no one talks about Bluetooth and cameras; consumers are fascinated by software applications, like Angry Birds and Facebook. Shanzhai mobile phones can't support these applications well," Li added.

The problem in the 3G era is related to the shanzhai business model, said Guo.

"The turnkey solution is not valid in the 3G era. Now the competition is in mobile phone operating systems (OS), between Microsoft's Windows Mobile, Apple's iOS and Google's Android. The three giants can call on a huge number of application developers for their OS to attract manufacturers and users. The whole industry has changed, and chipset manufacturers can't dominate the industry anymore," Guo said.

"Shanzhai phone manufacturers are very weak in research and development. In the 2G era, they relied on the turnkey solution.

Their 'research and development' is only in designing the shell of the phones or combining provided mobile phone functions.

Also, Mediatek was not well prepared for 3G. In order to enter the 3G mobile phone chipset business, it signed a patent licensing agreement in 2009 with Qualcomm, owner of the widely used technologies WCDMA (Wideband Code Division Multiple Access) and CDMA (Code Division Multiple Access). This made its advantage in price disappear," Guo said.

He believes the change in the industry has also had an impact on distribution channels for mobile phones.

"3G relies more on telecom operators' services and networks. Mobile phone OS developers and manufacturers have closer cooperation with telecom operators. Telecom operators have become one of the most important distribution channels. However, shanzhai mobile phone manufacturers don't have the capabilities to cooperate with telecom operators," Guo said.

Bumpy road ahead
"Most shanzhai mobile phone manufacturers will be eliminated by the market. Those who want to stay in the industry will have to establish their own brand and innovation capability," Xiang Ligang, a telecom expert, told the Global Times.

"3G has made people's expectations for mobile phones more diversified. Smart and dazzling phones have become fashionable. And the drop in smart phone prices has squeezed the market for shanzhai mobile phones," Xiang said.

But there is still a need for cheap mobile phones.

"Shanzhai phone makers can put more emphasis on rural areas, where consumers are more sensitive about prices and care less about applications. But in the long run, they still need to face the ruthless tide of the market," said telecom engineer Guo.