Brands apart

Mobile handset vendors in China probably couldn’t imagine a better customer than Simon Xue. According to Xue, who works as a digital marketing manager for an advertising firm in Beijing, one year he bought 11 new mobile phones.

“I was young and going out a lot and losing my phones all the time,” he said. “I didn’t feel bad about losing them because it meant I could buy the newest model.”

Xue has since reined in his purchases. He currently owns just two handsets, one a smart phone and the other a cheaper model that he takes with him when he goes snowboarding.

Neither of these phones is made by a domestic firm.

“I prefer foreign brands,” he said. “Through some projects at work I’ve been able to try a lot of the domestic phones. I would say they’re not user friendly and the quality is not as good.”

Domestic outcasts
Xue isn’t alone in his preference for the likes of Nokia, Motorola and Samsung. Though Chinese handset makers once dominated the space, as of the third quarter of 2007, foreign firms held a 69% share of the domestic market, according to Analysys International, a Beijing-based tech research house.

Even China’s technology standard bearer, Lenovo, has felt the pinch. Analysys figures show that Lenovo is the leading local handset vendor by market share. But it recently announced the sale of its handset unit to a group of private equity firms for US$100 million.

Analysts point out that handsets were never Lenovo’s core business, but the fact that a company with genuine brand recognition took the opportunity to sell up is an indication of how challenging a market it has become for local firms.

“I don’t really think the domestic handset makers can come back,” said Dave Carini, co-founder of Maverick China Research, a Beijing-based media, tech and telecom consultancy.

Yet it was only five years ago that Chinese handset makers ruled the roost with a 54% share of the market, according to Analysys. Though these firms did make some gains in the high-end segment, their success was based primarily on the strength of sales of cheap phones in China’s lower-tier cities.

“The Chinese handset makers put a lot of effort into expanding their distribution systems and they hired lots of sales staff,” said Flora Wu, an analyst at BDA China, another Beijing-based tech consultancy. “That was the main reason they achieved dominance.”

But in conquering the provinces and rural areas, these local firms provided their foreign competitors with a blueprint for approaching the China market. Having picked the low hanging fruit of markets such as Beijing and Shanghai, the overseas players released a bevy of ultra low-cost phone models that sold for prices as low as US$30.

They also boosted their distribution channels into the provinces, finding new outlets for phone sales everywhere, from national chain stores to small electronics shops. (See: The Finnish invasion: Nokia’s march to No.1)

“The foreign handset makers learned from the domestic handset vendors and then they beat them at their own game,” said Carini.

Foreigners firms could also rely on their comprehensive product lines as they targeted all sectors of the market, rather than merely harnessing their fortunes to one segment. This approach was backed up by a marketing strategy that covered their entire customer base.

“[Foreign vendors] persuaded high-end consumers to see their products as an identifier of social status,” said Zhang Yanling of Analysys. “They attracted low-end customers with the high performance-to-price ratio of their products.”

In addition, the foreign firms leveraged the prestige of their brands to secure major deals with network operators and provide after-sales services and technical support for their products. Chen Xin, a project executive for an events planning firm in Beijing, noted the availability of after-sales services was influential in her decision to by a foreign-branded phone.

Superior technology
But the real advantage for foreign vendors lies within the phone itself, in the self-developed core technologies they use in their products.

“Chinese handset manufacturers started later than their global competitors in the 2G market and there was a gap between domestic and foreign brands on the core technology,” a spokesperson for Shenzhen-based handset maker ZTE told CHINA ECONOMIC REVIEW.

The spokesperson added that 2G technology was already mature when the Chinese firms began producing handsets. Low market entry barriers meant that competition was fierce on all fronts.

At the same time, domestic firms had to spend money on the core technology they lacked, according to Gao Zhenyuan, an analyst with CCID Consulting, which is under the direction of China’s telecom regulator. Already struggling to widen profits margins, they were splashing out on key components, such as system-on-chips, made by the likes of Spreadtrum in Shanghai or Taiwan’s MediaTek.

“Even if you can copy everything [in a mobile phone], you’re still not going to get as good a price as the person who invented it,” said Maverick China’s Carini.

The TD advantage?
It is partly to redress the balance of all those years sending royalties overseas to the holders of key intellectual property rights that China has developed its own standard for third generation (3G) mobile technology. Some local handset makers see producing TD-SCMDA phones as a chance to catch a break.

“We believe domestic players, including [ourselves] will get fantastic return from the market for our efforts and preparation,” said ZTE. The firm added that its TD-SCDMA mobile phones are ready for use and they are waiting for commercial deployment by China Mobile.

ZTE also refutes claims made by many within the industry that the low quality of TD-SCDMA mobile phones is delaying the issuance of 3G licenses in China. It maintains that the problems are with the TD-SCDMA platform.

Although basing phones on a homegrown technology means handset makers can save on patent fees – and also benefit from government policies that promote TD-SCDMA – CCID’s Gao warns that their advantage may be short-lived.

“Chinese manufacturers will be more competitive at first because TD-SCDMA is a domestically developed standard,” he said. “But CCID predicts that the domination of the TD-SCDMA market by domestic firms will only last one year, then foreign companies will gradually enter the market.”

In fact, foreign firms have already begun to make inroads in TD-SCDMA. David Tang, vice president for Greater China sales at Nokia, said the firm is already developing TD-SCDMA handsets. The Nokia-Siemens joint venture won 15% of China Mobile’s last procurement order for TD-SCDMA equipment.

Analysts also expect consolidation in the domestic handset industry with only the strongest players making the cut. But they will still be unlikely to wrest control of the market from the foreigners.

According to BDA’s Wu, Chinese firms may still have a fighting chance in targeting specific market segments.

“I think the opportunity for domestic handset vendors is as niche market players,” she said, citing Shenzhen-based Yulong, which found success by providing customized dual-mode (GSM/CDMA) handsets for China Unicom.

Beyond handsets
With the higher data transfer rates allowed by 3G and the enhanced computing power, the handsets of the future will increasingly be used primarily to access the internet. In this changing environment, foreign handset vendors are looking for the next growth area in China, and it may not be in mobile phones.

“With 3G, it is more than just handsets,” said Nokia’s Tang. “We are now positioning ourselves as an internet company, so that means devices as well as services and software. And when 3G comes, the bandwidth will be able to launch a lot more mobile internet services. That will mean more opportunities for everyone.”

He sees music downloads, location-based services such as mapping and GPS, and Web 2.0-style social networking services as potential stars of the 3G era.

But Simon Xue remains guarded about the possibility of expanding his mobile phone collection to include a 3G model.

“I’m not really paying attention to 3G,” he explained. “Even if they do launch the 3G service, you don’t know what [the content and pricing] is going to be.”