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More and more mobile phone and device vendors have been turning their attentions to the enormous Chinese market over the last year….and with good reason. At the start of 2009 there were more than 650 million cell phone users in China. By 2020, that number is expected to grow to one billion or more, which will be larger than the combined markets of the US, Europe and Japan. That means there is a mindboggling amount of money to be made, or lost, selling phones to the Chinese for years to come

It is no surprise then that all the major players in telephony are trying to get larger stakes in the Chinese market as the global recession makes it harder to make money in Europe and the US. However, there are certain strange realities to selling electronics in the nation that actually manufactures the majority of the devices designed by US, European and Asian companies, and is understandably proud of their rising hi-tech expertise. It has caused such companies as Dell to resort to designing smartphones just for China and has even caused the iPhone juggernaut to hit a speedbump. Apple struggled for ages to get into the Chinese market only to have their golden goose lay an egg.

Why have only 5000 people in China bought the iPhone since it debuted there? Simple…it’s because so many people in China already owned “iPhones”, or versions they liked better.

Counterfeiting has become a serious issue in China, so serious it is posing a real threat to efforts by such companies as Apple and Dell to enter the Chinese market…and the problem is spreading through Asia.

Learn more after the jump.

Counterfeit electronics have always been big business in China, even back in the days they were low quality, underpowered knock offs. These days they are often as good or if not better then the brand name devices they are mimicking, are much cheaper, and just as importantly to many Chinese buyers…they are 100% Chinese.

According to Gartner, Chinese manufacturers without production licenses will produce a whopping 150 million handsets this year. To put this in perspective, LG is the third largest handset maker in the world and they will produce only 117 million phones in 2009. That means the three top cell phone vendors in the world are Nokia, Samsung and Shanzhai, the Chinese Phone Black Market.

Shanzhai started to become a money spinner in 2005 when a Taiwanese company called Mediatek, which still produces the electronics components of almost all Chinese black market phones, developed a circuit board that could easily and cheaply combine the functions of multiple chips, thus eliminating the need to develop custom chips. Like a Pokemon character, if you want more features in a Shanzhai phone, just load different predesigned software elements on the chip. No name companies often with only a couple employees can buy a Mediatek chip preloaded with selected software, pick up other counterfeit components cheaply and then hire a factory to assemble them, often for a percentage of the sales.

Therefore while a Shanzhai brand like a “Hi-Phone” may look like an iPhone, it will also include added features that are popular in China, such as dual SIM cards and advanced camera attachments…and cost $100 dollars rather than over $1000 dollars for a newly released iPhone 3GS.

Things really exploded in 2007, when in the interests of boosting the economy, Chinese regulators said companies no longer even needed a license to manufacture a cell phone. Shanzhai now produces about 20 percent of the phones sold in China, most being “enhanced” counterfeit versions of Western or Korean brands.

The problem is no longer isolated in China and has been reportedly spreading across the border to such countries as Pakistan.

Shanzhai versions of popular handsets are appearing throughout Pakistan, usually for between 5000 and 10000 Rupees (Between 60 and 120 dollars) while the originals sell for more than four times as much.

Just as in their domestic markets, the Shanzhai phones sold in Pakistan and now other parts of Asia carry more features than the original versions (such as expanded internal memory or higher megapixel cameras) and often have hardware customized for local tastes.

In Pakistan the problem was made worse by the Government attaching new tariffs to legally imported electronics last year. Therefore, the number of licensed Cell Phones imported into Pakistan last year dropped by 75 percent and the number of Shanzhai phones crossing the border skyrocketed, often driving legitimate third party vendors out of business.

The Pakistani government lowered the tariffs this year, from 750 Rupees to 250 Rupees, but the damage was done and consumers have found they like the lower costs and larger feature sets of the Shanzhai counterfeits. In July to September of 2009 about 60 million dollars worth of licensed Cell phones were sold in Pakistan, down from nearly 85 million dollars worth in the same period last year.

It is reported that not only are the Shanzhai phones cutting into imported device sales in Pakistan, but also strangling legitimate Pakistani ventures to produce cell phones for local use.

Counterfeit phones are poised to become even larger issues in the coming year as more and more companies spend big to try and break into the incredibly lucrative Chinese market. At the same time, the Shanzhai phones themselves will also be spreading into new markets, cutting into the sales potential of legitimate vendors and license holders in markets throughout Asia, Russia and the Middle East. Shanzhai phones are even hurting legitimate Chinese vendors since they pay no taxes and can undercut any price.

It’s only a matter of time before this problem will have to be confronted by the Chinese Government as well as international trade boards to ensure the continued healthy growth of mobile telephony in Asia.

(Sources: The New York Times, WSJ, Reuters, ProPakistani)