Enter the Dragons

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Illustration by Charis Tsevis for Fortune

Almost overnight China’s phonemakers came to dominate their own market. Now they’re looking farther afield—with claws out.

The air is electric inside the stark-white modernist lobby of OnePlus. Pods of murmuring guests shuffle across the floor as a pair of receptionists, clearly overwhelmed, type furiously at their desks. It’s 11 a.m. on a Saturday. This level of activity is not the norm for a corporate building in downtown Shenzhen, China’s fifth-largest city. For OnePlus, a young electronics company that expects to sell a staggering 1 million smartphones in its first year, it’s business as usual.

The company was founded by 40-year-old Pete Lau and 25-year-old Carl Pei, who decamped from a top Chinese phonemaker, Oppo, just four subway stops down the road. The pair quit to start their own shop, with plans to sell a single $300 phone. It seemed foolhardy. “Thirty thousand smartphones sold was to not get fired,” says Pei, who is the company’s director of global efforts. “Fifty thousand was acceptable. One hundred thousand was a dream. Now we’re trending toward 1 million.”

The nearly overnight success of OnePlus may at first appear extraordinary, but it’s only the latest chapter in a story that has been years in the making. Low-priced, high-tech mobile phones have become objects of desire for many of the 1.36 billion people in China, even though income per capita—after adjusting for purchasing power—is less than a fourth that of the U.S.  In 2012, China passed the U.S. as the world’s largest smartphone market. Since then its number of annual phone shipments has doubled, to about 400 million—enough for every man, woman, and child in the U.S. and Canada with tens of millions to spare.

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Samsung and Apple AAPL , the global leaders in mobile phones, have made no secret of their desire to command the world’s largest smartphone market. But as demand exploded in the country, local companies sprang up to meet it. “Now you see the proliferation of 400 brands in China,” says Neil Shah, a director at Counterpoint Research. “It’s a gold rush.”

In 2011 just two of the top 10 smartphone makers in China were Chinese, according to market researcher Canalys: Huawei and Lenovo. In 2014 eight of the top 10 were Chinese; Samsung and Apple were the only foreign holdouts. In just three years the cast of leaders completely reshuffled as China’s smartphone market more than quadrupled. Today six of the top 10 smartphone brands worldwide are Chinese, according to Strategy Analytics, even though many of them sell only in China—proof of the enormousness of that market relative to the rest of the world.

OnePlus Cell Phone
Loud, proud, and with phones that elicit a “Wow”: The latest smartphone success story from China is Shenzhen’s OnePlus.Photo: Courtesy of OnePlus

China’s newcomers are now looking to expand beyond its borders. Xiaomi, a Beijing startup valued at $45 billion, is plowing money and people into nearby India. ZTE, in Shenzhen, revealed plans to double its market share in three years in the U.S.  Huawei, also in Shenzhen, traveled to the IFA electronics trade show in Berlin to unveil its newest flagship phone, the Ascend Mate7. In almost every corner of the globe, Chinese phonemakers are present and ready to make a sale.

“China is one of the important global markets, but overseas revenue will occupy more than 70% of the total smartphone business,” says Lv Qianhao, ZTE’s head of handset strategy, citing common industry estimates. “That’s what we will target.”

We’ve seen this film before. In the 1970s electronics from companies in rapidly industrializing Japan-flooded Western markets. Goods from Sony SNE , Matsus-hita, Sanyo, Sharp, and others first imitated and undercut, then improved upon and outmuscled products from domestic manufacturers like RCA, GE GE , and Zenith. In the 2000s, gadgets from South Korean makers—Samsung, Hyundai HYMTF , LG—repeated the exercise on their Japanese forerunners: undercut on price, outpace with innovation, profit.

For years Chinese phonemakers served in the shadows as manufacturers for Nokia and others. Everything changed after Google introduced Android in 2008. The inexpensive and customizable mobile operating system, an answer to Apple’s status-quo–shattering iPhone, made it possible for any electronics company with some savvy to develop a worthy alternative. In no time Chinese companies shifted their strategies from churning out white-label devices for others to building brands for themselves.

We are now facing a new era in consumer electronics, a Chinese era, studded with a new generation of wily entrepreneurs and clever engineers armed with lessons learned from those that came before. Yes, some copy Western ideas, sometimes to a T. (Nearly everyone wears black onstage in emulation of Steve Jobs.) But many are genuinely innovating as they race to become the next Nokia of the ’90s: affordable, high tech, global.

Says Richard Liu, managing director at Morningside Venture Capital in Shanghai and an early Xiaomi investor: “This is probably just the beginning of the wave.”

Meizu

Meizu was the first Chinese phonemaker to emerge as a brand in its own right. Based in Zhuhai, a leafy coastal city near Hong Kong, Meizu is led by Jack Wong, a high school dropout and onetime factory worker who is often described as temperamental and reclusive. With no marketing budget, Wong used the power of online buzz—he was a frequent presence in web forums—to create one of China’s most popular MP3 players in the 2000s.

Four days after Apple introduced its iPhone in 2007, Wong boasted that Meizu would build an iPhone killer called the M8. The phone turned out to be too much like Apple’s distinctive device, and Meizu, under pressure from its muse, pulled it from stores. But Wong’s company managed to create millions of fans and put a Chinese smartphone on the map.

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The Chinese are on the move, ZTE sponsors NBA teams.Photo: Pichi Chuang—Reuters

Today Meizu is trying to expand within China to better position itself for entry into other Asian markets. Though the company builds some of the best-reviewed smartphones in China, it remains outside the country’s top 10 brands. In a cramped conference room in Meizu’s headquarters last summer, marketers Arnold Pei and Gaven Zhang outline a new strategy. Arnold scribbles on a whiteboard:

2013 used to be:

1. one cellphone

2. 2,500 RMB ($400)

3. profit first

4. family business held by Jack Wong

2014 going to be about:

1. four cellphones

2. sell 1,000–3,000 RMB ($160–$480)

3. market share first

4. hire a lot of people

5. move from hardware company to mobile Internet company

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Huawei shines at the 2015 consumer electronics show.Photo: Robyn Beck—AFP/Getty Images

The most important part of Meizu’s strategy is the shift in focus from profits to market share. “The problem is, our phones are great, but no one knows about us,” a Meizu marketing consultant told me at a glitzy event for its new MX4 phone last fall. Not for long: In February, Alibaba invested $590 million for a minority stake in Meizu, giving the e-commerce giant a foothold in the handset market and Meizu a better shot at expansion.

Xiaomi

Lei Jun doesn’t look much like a disrupter. He’s middle-aged, for one. He’s as likely to be photographed in the uniform of the corporate establishment—dress shirts and trousers—as the jeans and T-shirts of the startup world. For years he worked at a Chinese Microsoft competitor and eventually took it public. He also worked as a venture capitalist. Part company man, part folk hero, Lei is the founder of China’s highest-profile mobile contender, Xiaomi, a Beijing company with a naked desire to upend its entire industry.

In the late 2000s, Lei became obsessed with smartphones. He studied their design, operation, and business. He carried around several dozen in a backpack. Sensing opportunity, Lei used his connections in China’s venture capital scene to recruit partners, including the former head of Google’s mobile-search operations in China. They settled on the name Xiaomi—“small rice”—and got to work designing their first phone. The Mi1, made by the same Taiwanese contract manufacturer that makes the iPhone, went on sale in October 2011 for 1,999 renminbi ($330).

Xiaomi epitomized the lean startup. It sold phones only online—forgoing store costs and retailers’ cuts—and spread its story by winning over Chinese enthusiasts eager for a national champion. “They found an innovative way to sell phones without spending any marketing dollars,” says Richard Liu, the early investor. Even today Xiaomi spends far fewer marketing dollars as a percentage of sales than Samsung or Apple. “We have the world’s top operational efficiency,” Lei, 45, told Fortune this past summer.

The Chinese press likes to call Xiaomi the “Apple of China,” but beyond the aesthetic imitation, it’s a poor comparison. Apple devices sell at premium prices; Xiaomi’s sell at low prices. Apple operates hundreds of its own brick-and-mortar stores; Xiaomi sells its wares only online or through carriers. Yet both companies are able to generate a rush of excitement with every new release. In January, Xiaomi declared that the first shipment of its answer to the $975 iPhone 6 Plus, the $370 Mi Note, sold out in three minutes.

Xiaomi’s overnight success—it ended 2014 as the top smartphone maker in China, ahead of Samsung and Apple—has not come without criticism. In October, Apple design chief Jony Ive said that Xiaomi’s work amounted to “theft.” Similarly, Meizu’s Wong once wrote in a company forum that Lei copied Meizu’s “phone design, production, supply chain, marketing, and even financial operation.” (A Xiaomi spokeswoman denied it.) Whatever the case, it’s difficult to deny that there is strategic advantage in the fast follow—especially in the technology industry.

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ZTE

Lv Qianhao, ZTE’s handset strategy chief, is a round-faced man who delivers his English in forceful bursts. He’s unequivocal in his analysis of his company’s problems from its downtown Shenzhen headquarters. “ZTE is famous for low-priced products,” he says. “It is not famous for the latest innovation.”

In contrast to Xiaomi, ZTE has never professed a desire to reinvent its industry—just itself. The company, one of China’s two telecom-equipment champions along with Huawei, is the world’s ninth-largest phonemaker. But it desperately seeks to shed its image as a maker of cheap, no-name phones.

ZTE needed a better brand, Lv concluded. In 2012 the company introduced a new line called -Nubia, sold exclusively online, that won buzz when China’s first lady, Peng Liyuan, was photographed using one. In a bid for better visibility, ZTE also became the official smartphone of the New York Knicks as it tries to sell premium phones in the U.S.

Lv likens ZTE’s situation to a horse eating a patch of grass that is surrounded by encroaching desert. “If he doesn’t move, the grass will become less and less, the desert larger and larger. Alas, one day there will be no grass for this beautiful horse. The horse will die,” he says. “If it only focuses on entry-class products, ZTE will become this horse.”

Huawei

Huawei, like ZTE, churns out enough smartphones to be a major player in its home market. But all the company cares about is being “China’s most global brand.” Five years ago the company couldn’t crack the global top 10 brands in mobile-device sales, according to Gartner. Today it’s one of the world’s largest smartphone makers, behind Samsung and Apple.

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Top, A customer examines a product in a Xiaomi showroom in Beijing. Bottom, The Xiaomi store’s design is strikingly similar to an Apple store in Hong Kong, bottom.Photos, top: Lam Yik Fei—Getty Images; bottom: Gilles Sabrie—The New York Times/Redux

The road to global dominance has occasionally been rocky. Two years ago Huawei made headlines after the U.S. House Intelligence Committee labeled the company a security threat, in part for its ties to China’s military. (Huawei’s founder, Ren Zhengfei, left the People’s Liberation Army in 1983.) Huawei denies the committee’s assertion but remains barred from bidding on large U.S. telecom contracts.

But there’s no ban on consumer phone sales. Huawei is carefully managing its exposure as it expands into new markets. It sponsored 30 soccer teams, including top club A.C. Milan. It launched a smartphone line sold online in the U.S. and elsewhere, the Ascend Mate2. And last year it cracked Interbrand’s list of 100 top global brands, sandwiched between Corona and Heineken.

Its strategy has begun to pay off. When Huawei launched its Ascend Mate7 “phablet”—a phone approaching the size of a tablet computer—in Berlin this past fall, some bloggers proclaimed it better than Apple’s new iPhone 6. It was exactly the kind of response the company was looking for. “When we launched Mate7, our clear target was the Galaxy Note 4 and iPhone 6 Plus,” says Shao Yang, vice president of marketing for Huawei’s consumer group. The buzz was no small triumph for a company that two years ago was recognized by less than 25% of U.S. consumers.

Next Steps

The great challenge facing China’s phonemakers is that their global expansion will pit them against the same multinational tech giants they bested in their favorable home market. But they can’t look back. The Chinese market is saturated; at this year’s Consumer Electronics Show, some 300 vendors from Shenzhen alone showed up.

It’s also slowing down. After several quarters of triple-digit growth in smartphone shipments, China saw it slow to 15% in the third quarter of 2014, estimates IDC—a sign that phone-makers must begin to transition from appealing to first-time buyers to persuading existing owners to upgrade.

And then there are the legal hurdles lying ahead. With the exception of Huawei, ZTE, and Lenovo, Chinese phonemakers hold relatively few patents, putting them at risk of lawsuits that could be costly and slow expansion. In December an Indian court ordered Xiaomi to stop selling handsets after Ericsson complained that Xiaomi wasn’t paying royalties on its wireless patents. “The injunction is simply an indicator that we’ve grown up and have quickly reached the stage that took other companies many years to get to,” says Hugo Barra, the executive in charge of Xiaomi’s global division. He added that the suit wouldn’t slow Xiaomi’s expansion in India.

At the airport in Shenzhen, I run into Jerry Zhao, a 25-year-old product manager at OnePlus who is working on strategic partnerships. He’s wearing tight jeans and a T-shirt and speaks in the kind of rapid-fire English you hear in New York. When I met with Carl Pei, he told me that OnePlus hired a lot of ABCs—American-born Chinese. Zhao is one of them. Six months earlier he left a Wall Street job to ride the mobile wave in China.

As we talk about the industry, he pulls out his phone. “You want to see something?” he asks, grinning. He calls up an internal chart measuring brand popularity. The OnePlus line is a hockey stick, soaring above those for ZTE, Coolpad, Huawei, and others. OnePlus is doing really well, he says, swiping through charts. “We are killing it.”

The race is on. In January, Apple posted record earnings, fueled in part by a 70% increase, year-over-year, in sales in greater China. Meanwhile, Samsung has vowed to reinvigorate its mobile efforts after posting lackluster sales of its own—a result of increased pressure from Apple and Xiaomi.

The thing about overnight success? It tends to stir the sleeping giants.

Illustration at top by Charis Tsevis for Fortune

This story is from the March 1, 2015 issue of Fortune.

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