Handset hell

China's mobile-phone market, with around 320m subscribers and adding 4m-8m monthly, is the world's largest, and probably most competitive. Dozens of puny local manufacturers are already battling it out with muscle-bound giants like Motorola, Nokia and Samsung. Despite the scrum, large rewards shimmer.

"This is a large and growing handset market. If you want to be a big global player you have to be here," says Ted Dean, managing director of telecommunications and technology consultancy BDA China in Beijing.

Manufacturing is a free-for-all now that anybody can make handsets. They only have to pass basic technical tests to move from factory to shop counter – after the Ministry of Information Industry scrapped its licensing system. Retreats and blood seem certain.

Many are struggling. Siemens, for one, appears to be wavering. "Siemens' biggest problem in China is probably scale – it doesn't have enough new models, not enough scale in promotion and distribution. Last year they tried tying up with Bird [a serious Chinese player]. They are not large enough to sustain deeper, broader distribution channels on their own," Dean says.

Alcatel quit last year, handing its global handset business over to Chinese market-leader TCL, and got back to focusing its core network infrastructure business. Having the French giant's know-how has not turned TCL into a world-beater but it helped the bottom-line. "They have Alcatel's sales and marketing channels in Europe," notes Paul Waide, telecoms consultancy Pacific Epoch's editor in Shanghai. "Their imports are in dollars, their exports are earning euros,"

So why no takers for Siemens' handset business, which apparently has been on the market for 18-months or so? "Would a Chinese company want to pick up the cost-structure in Germany?" Dean asks, hardly expecting an answer.

Had TCL gained a great boost from taking on Alcatel's handset business, buyers might be queuing up – if they did not have empty pockets. Chinese handset players' margins are slim; many earn little more from mobile phones than from their mainstay white goods and televisions, which do not gobble-up R&D budgets that handsets do in the gadget-driven, short-cycle mobile market.

Mobile phones are more like washing powder inside the washing machines – or FMCG (fast-moving consumer goods). Consumers need constant reminding to buy this brand or that of washing powder, shampoo or cola – or phones, which means big marketing bills.

Too big for many local players. "The industry is hypercompetitive now," Waide says. "Margins are getting hammered – unless you have massive marketing budgets like Nokia, Motorola, Samsung or Amoy, you can't compete."

Yet, just after the new century dawned the sun seemed to shine on the local boys, going from zero to controlling half the market by 2002. But that was an aberration.

Phones went from being just phones to sexy consumer-electronics items, with color screens, internet access, radio, and cameras. Only a few – like Sony, Samsung and Sharp – continually excel in pleasing fickle consumers with electronics.

But Motorola and Nokia struck back, pouring huge sums into marketing, opening design shops to tweak products for local tastes and expanding their finely-tuned distribution channels into the sunrise markets of interior cities and towns, where consumerism is beginning to get a grip. "They have made a huge comeback in 2004," says Johnny Chan, regional hardware analyst with JP Morgan in Hong Kong.

Still down the curve
Local manufacturers are still learning about distribution and inventory. Their cheap prices turned Chinese consumers on, but their quality turned them off. "A lot of Chinese consumers realize the quality of the local brands is pretty poor [and] the failure rate for the local brands is fairly high," Chan adds.

Gimmick laden, they also face competition from something that looks like a mobile phone, but technically is not. Personal Handy-phone System (PHS), or Xiaolingtong, is super-cheap, the price of a low-end mobile. PHS handsets are small, and work fine – unless the user is moving faster than bicycle speed.

For fixed-line operators China Telecom and China Netcom, Xiaolingtong has been a godsend, allowing them a taste of the mobile action. Xiaolingtong subscriptions accounted for about half the 60m lines they hooked up last year.

PHS may be growing the overall market, but that does not make it easier. "You need to be really big and innovative to make the handset business work," Dead says. "And even when you are really big it's still very tough – even Nokia has seen the margins fall."

Aside from Motorola and Nokia, Panasonic, NEC and Samsung should stand their ground, probably Sony Ericsson too. On the Chinese side, Bird, TCL, Amoy, and perhaps DBTel, look safe.

In the longer term though, Chinese manufacturers seeking higher margins will need to win customers in Europe and North America. They will not come cheap.