China's handset glut shows no sign of easing. Coming on top of an already slowing subscriber market and chronic 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 experience in international business to offload their excess Inventory. Ironically, the export quota imposed on foreign vendors was a government 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 vendors. 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 putting out too many phones. China currently has 37 licensed handset manufacturers. Of these, 29 have received GSM manufacturing licenses and 20 have received UDMA manufacturing licenses 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 dramatically. As a result, production volume between January and April 2003 stood at 51 .7m handsets, a 67 percent increase over the same period last year. For the whole of 2002, China produced 13.3m handsets, of which 57m 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 percent 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 vendors in Beijing slashed their colour handset prices by 30 percent.
Some less successful vendors are looking in other directions, such as contract manufacturing, instead of developing their own brands. Following slowing handset sales in the first quarter of this year, Haier is contemplating 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, TCL exported 196,000 handsets, mainly to Southeast Asian countries, such as Vietnam and the Philippines. In June this year, TCL announced it would soon start selling handsets in Thailand, 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 television 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 manufacturers 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 experienced 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 competitors. This impacted on reliability in 2002 – about 6 percent of domestic brand handsets sold in China had to be returned for repairs compared with 3 percent 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 vendors 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 (complete-knocked-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.