Home saturation

A saturated Chinese market
means that domestic handset vendors have little choice but to expand overseas, writes
Zhang Dongming.

China's handset glut shows no sign of easing.
Coming on top of an already slowing subscriber market and chron-ic oversupply caused by
too many producers, the Sars outbreak has pushed China's hand-set mountain above the
20m mark. GSM handsets make up the balk of this total but, relative to a subscriber base of
some 10m, the estimated UDMA inventory of 3m-3.5m is proportionately even
higher.
Foreign vendors such as Motorola and Nokia have a safety valve in that they
export more than half of their China production. Domestic firms tack these export channels
and, in most cases, do not have the experi-ence in international business to offload their
excess Inventory. Ironically, the export quota imposed on foreign vendors was a govern-
ment requirement in the form of a 1999 circular by the State Council. This requirement was
supposed to protect domestic vendors from the larger-scale manufacturing capabilities of
their foreign competitors,' however it is now proving a blessing for the foreign ven-dors.
Faced with an increasingly saturated domestic market, major domestic vendors are joining
their foreign competitors and baking to overseas channels for new
growth.

The competitive landscape
The temporary retail slump
caused by Sars has played a role. but the fact is that inventory build-up would have been a
problem anyway. Simply put. there are too many players ehuining out too many phones.
China cur-rently has 37 licensed handset manufactur-cr5. Of these, 29 have received GSM
manu-facturing licenees and 20 have received UDMA manufacturing licences from the
Ministry of Information Industry, including the newest UDMA licensee, Nokia.
Over
the past year, domestic players have continued to gain market share from foreign vendors
and sealed up production dramati-cally. As a result, production volume between January
and April 2003 stood at 51 .7m handsets, a 67 per cent increase over the same period last
year. For the whole of 2002, China produced 131 .3m handsets, of which 57.~m were
exported.
To complicate matters, the inventory comprises both monochrome and
colour handsets. At the beginning of the year, hand set vendors had anticipated a
replacement sales rate of more than 50 per cent in the shift from monochrome to colour. As
a result, most new models launched this year have colour screens, For example, TCL
launched 15 new models in April. most of which are colour handsets. With slowing sales
and growing inventory. prices are dropping one weekend in late June, some domestic ven-
dors in Beijing slashed their colour handset prices by 30 per cent.
Some less
successful vendors are looking in other directions, such as contract manu-facturing.
instead of developing their own brands. Following slowing handset sales in the first quarter
of this year, Haier is con-templating handset contract manufacturing for more stable
revenue growth. Haier recently won a contract to produce a Nokia model for both the
European and Chinese markets. Nokia will provide designs and core components and
Haier will assemble hand-sets on its production lines. In addition. Haier has signed a deal
to manufacture handsets for Korean-based Sewon. For companies that have become
relatively successful and have established their own brands, it is of strategic importance to
build up channels in overseas market so as not to become too dependent on the home
market.
Seeking to duplicate the overseas sales successes of domestic
equipment vendors such as ZTE and Huawei, the top domestic handset vendors are
forming plans to target the global market.

TCL, the number four handset
maker in 2002 in China after Motorola, Nokia and Siemens, has pursued a gradual
approach to tap overseas markets. In 2002, TUL exported 196,000 handsets, mainly to
Southeast Asian countries. such as Vietnam and the Philippines. In June this year, TUL
announced it would soon start selling handsets in Thai-land, while India, Singapore and
Taiwan are next on its list. Next year, TCL expects to export to the European and North
American markets. TCL is believed to be the world's 12th largest phone manufacturer and
has stat-ed its intention to become the fifth largest in the next three years.
Bird, the
sixth largest manufacturer in China last year. has also been active in its efforts to expand
overseas. In June, it set up a subsidiary in Hong Kong as the launch pad for its overseas
operations. Bird plans to launch seven models in Hong Kong in the third quarter of 2003
and then to enter other Southeast Asia markets, including Thailand, the Philippines.
Malaysia. Indonesia and Singapore. In November 2002, Bird also formed a 50-50 joint
venture with its long-standing French partner Sagem. which will sell to both local and
international markets.
Kejian. the ninth largest vendor in 2002, has attempted to
build up its international brand with sports-driven marketing efforts, such as sponsorship of
Everton football club in the English Premier League. The team's Chinese midfielder Li Tie
ensures high tele-vision ratings at home and good publicity for the brand. Kejian has
recently launched handsets in Hong Kong and Macau and its engagement of Taiwanese
pop-singer Gigi Leung as celebrity endorser will help expand acceptance of the brand in
these two markets.
Smaller domestic players, such as Nan-jing Panda and
Xiamen-based Amoisonic, also have plans to expand overseas.
While Southeast
Asian markets are the first logical step for domestic players to test the export market, they
are also highly saturated. In Taiwan, local original equipment manufacturers and original
design manufac-turers are lobbying the government in Taipei to block handset imports
from the mainland. While Chinese manufacturers may enjoy some immediate success in
Southeast Asian markets. challenging established brands such as Nokia in Europe or
Motorola in North America will be much more difficult.
First, handset distribution is
very different in those markets from China, operators are much more involved in
subsidising handset sales and setting specifications. such as ensuring that users of
mobile data platforms have the same experience when using mobile data services.
Chinese vendors are less expe-rienced in working directly with operators and established
vendors, and they face entrenched relationships between the two.
Second, while
the core technology may be the same, domestic vendors are not as sophisticated or
experienced in the manufacturing process as their major foreign com-petitors. This
impacts on reliability in 2002, about 6 per cent of domestic brand handsets sold in China
had to be returned for repairs compared with 3 per cent of foreign branded handsets.
Domestic firms also face a disadvantage of scale in terms of market feedback on product
standards and features.
Third, while pricing is traditionally an advantage for
Chinese companies, it is not necessarily the case for handset production. With most
handset manufacturers making fewer than I m units a month, domestic ven-dors simply
cannot achieve the economies of scale of foreign vendors. Furthermore, as domestic
vendors have to purchase chipsets, handset designs and other key components from third
parties for SKD semi-knocked-down) and CKD (eomplete-knoeked-down) production,
there is a basic cost structure for domestic production that they will not be able to overcome
in the near term.
Given these challenges, it will take a long time for domestic
vendors such as TCL and Bird to be able to pose a meaningful threat to the likes of Nokia
and Motorola in their home markets. But with market saturation in China, they have no
alternative but to embark on the journey.

Zhang Dongming is a research director at BDA, a research and consulting firm focused on telecoms and technology in mainland China (www.bdachina.com).