For 50 years, China Telecom had been the monopolistic operating arm of former Ministry of Post and Telecommunications (MPT). Although China Unicom was created in 1994 to play a similar role to that of MCI in the US in the late 1970s, competition remained stifled. With the support of MPT, China Telecom was still the only licensed international telecoms service provider. They blocked Unicom's interconnects to the national network and limited the business scope of Jitong, China's cable television networks and other potential competitors.
On April 28 of this year, the Ministry of Information Industry (MII), MPT's successor, issued a regulation permitting China Telecom, China Unicom and Jitong to conduct a 26-city, six-month internet protocol (IP) telephony trial. This trial is now underway. IP telephony may hold the key to China's rapidly growing its tele-density rate beyond the March 1999 level of 1 1.22 percent.
After the trial, IP telephony will probably be opened in more regions and to more competitors, such as China's cable television networks. The trial, along with other structural reforms outlined below, should make China's telecoms playing field more level and create tremendous opportunities for foreign equipment, technology and service suppliers.
The opening of this market was preceded by a substantial amount of grey market activity by internet service providers, computer shops and local cable television networks – and a major lawsuit brought by the now-famous Chen brothers in Fuzhou, Fujian province.
In September 1998 Mil banned the provision of IP telephony. In spite of the ban, the Chen brothers continued to offer IP phone services through their computer store. After China Telecom had the police detain the Chens and seize the equipment, the Chens filed suit, lost in the trial court, but, amazingly, won on appeal. The appellate court accepted the Chens' argument that their activity was not covered by China's criminal law, but was at most an administrative matter. The appellate judge was said to be a wangchong, or net worm.
However, the Chen brothers' saga continues. On re-trial in the lower court, the Chens lost again but they are appealing this latest decision. Meanwhile, MII continues to crack down on other unlicensed IP telephone operators. Whatever the final result for the Chens, their case clearly has forced MII to open up the IP telephony market.
According to a recent China Economic Times article, China's IP telephony market (including equipment and services) will reach Yn l OObn by 2002. ChinaByte on July 20 reported that more than 35,000 IP telephony cards had been sold in Guangzhou since the IP telephony trial began and that the number is growing by an average of 1,000 per day.
During the trial period, China Telecom, Unicom and Jitong are issuing IP phone cards that are similar to scratch-off lottery tickets. They can be used only within the service area of the issuing company and are not interchangeable. Face values are Yn50, Yn100, Yn200 and Yn500. To access the service, a user enters the local access number of the vendor, account number, password, area code and phone number. The phone charges are then deducted from the account.
The map shows the access numbers, technology suppliers and cities in which the three companies are permitted to operate IP telephony services.
During the trial period, all three service providers are required to charge the same rates. The charts compare current IP phone service rates with rates for Beijing's fixed-line switched circuit service. The latter rates reflect price reductions that MII announced in preparation for the IP telephony launch.
What is IP telephony?
IP telephony is more efficient and less expensive than traditional circuit switched telephony, which accounts for the vast majority of today's telecoms traffic. Traditional telephony requires fixed bandwidth (a circuit) that is composed of unrecoverable or unused band-width (silence). IP telephony digitises speech into data, compresses it and divides it into packets of data, which are transmitted over the internet and reassembled at the receiving end. The unused bandwidth is recovered and made available to others.
1 Calling party dials local access number and connects to a gateway computer (or local Point of Presence) in the central office ?17900 for CT, 17910 for Unicom and 17920 for Jitong.
2 Transmitting gateway computer converts the analog voice signal into digital signals and breaks into data packets.
3 Data packets are passed from the gateway to the long distance network using Internet Protocol for delivery to the distant gateway.
4 Distant gateway converts data packets back into analog signals.
5 Distant gateway transfers call to local network for delivery to called party.
Opening up the market
IP telephony is regulated by MII's Telecom Management Bureau, headed by Zhang Chunjiang. The bureau's responsibilities are to:
-maintain fair competition
-promote universal service and protect public interest
-approve and issue telecoms and information service licences, and supervise service quality and prices
-write the access and interconnection rules among telecoms networks, allocate and manage telecoms network numbering and regulate internet domain names, addresses and related international internet coordination
-set standards for telecoms network equipment access .and interconnection for the public switched telephone network (PSTN)
-coordinate construction and operation of specialised governmental and private telecoms networks
-manage the PSTN control and directing centre, international telecoms gateway bureaux, and Internet Security Supervision and Control Centre
-draft telecoms development plans, policies and measures.
In addition to encouraging IP telephony and competition in that area, MII has been taking additional drastic steps to open China's telecoms service market.
At the end of 1998, China Telecom had one million workers, fixed assets of approximately US$72bn, and managed a network with about 87m fixed-line subscribers and 25m mobile subscribers. In contrast, Unicom still had only a small foothold in the wireless market and an even smaller one in the fixed-line market.
In order to make China's telecoms market more competitive, China Telecom was ordered earlier this year to split its assets into four separate operating companies – fixed-line, mobile, satellite and paging. The restructuring is scheduled to be completed by the end of this year.
MII now intends that Unicom have a significant share of the telecoms market, possibly up to 30 percent. In addition to allowing Unicom to offer IP telephony, Unicom has been granted its own, long-sought international internet gateway. Unicom is now the third commercial entity to have this tremendous competitive advantage, along wits China Telecom and Jitong. The Chinese Academy of Sciences and Ministry of Education have international gateways fog their non-commercial activities.
Unicom's uncertain future
In February 1999 MII bolstered Unicom's leadership by appointing Yang Xianzu, former MII vice minister, as Unicom's chairman. Other appointments included Wang Jianzhou, former MII director general of planning, as Unicom's executive vice president, and Shi Cuiming, the former chairmar of China Telecom Hong Kong and director general of MPT's finance department, a! Unicom's vice president. The former president of Unicom, Cao Guixing, became Unicom's vice chairman.
In addition, the State Council has hander Unicom the assets of the newly formed China Railways Communication Co. (the communications network of the Ministry of Railways) and Guoxing Paging (the main land's largest paging entity, formerly 98 percent owned by China Telecom).
Unicom's new leadership must immediately address two major issues: the recently banned China-China-Foreign (CCF) join venture formula that has provided 70 percent of Unicom's capital (about US$1.4bn), and raising sufficient capital, which had been in short supply even before Unicom had to find a way to fund the re-purchase of foreign interests in CCFs.
The CCF formula had been the investment vehicle that foreign entities used to skirt China's prohibition of foreign ownership, management and operation of telecoms networks. In this model, a foreign company joint ventures with a Chinese enterprise that produces telecoms equipment and that joint venture, as a ‘Chinese legal person,’ obtains an interest in a telecoms network by means of a second joint venture. The latter joint venture is thus between two Mainland firms. However, because of the great sensitivity to foreign ownership in this area, foreigners do not get ownership interests in assets of the service provider, but rather a consulting arrangement tied more or less directly to the revenues of network.
In July MII started to issue notices to foreign companies to terminate the CCFs. To solve its capital shortage and to buy out its CCF partners, Unicom announced a US$1bn public offering in Hong Kong and/or New York for this October. Even with its newly acquired assets and the proceeds of any public offering, Unicom faces the possibility of lawsuits from some of the 40 foreign parties to the CCFs which have stated that they are not happy with the terms of the buyout. Moreover, the public offering may not be possible with such enormous, unresolved liabilities. Recent reports indicate that it will be delayed significantly, although the amount may be increased.
The Chinese government recently approved the formation of China Cable TV Network Group Company (Netcom). Netcom is building a broadband, IP protocol-based backbone network that will link 15 Chinese cities in the first phase. This net-work may ultimately provide IP telephony to China's 80m cable television subscribers. The Yn300m investment comes from the State Administration of Radio, Film and Television (SARFT), the Ministry of Railways, the Chinese Academy of Sciences and the Shanghai municipal government. Netcom's success in large part will depend upon MII granting a licence for this service. This approval may come prior to the end of this year.
SARFT has been attempting to break into the telephony business for several years, and at times there has been open, verbal warfare over this issue between SARFT and MPT/MII. Last year the Radio, Film and Television bureaux in Leshan, Sichuan province, and Zibo, Shandong province, attempted to use local cable television networks to offer telephony services far below China Telecom's prices. Such services have not yet been approved and exist in a grey area.
Opportunities for foreigners
The April US-Chinese negotiations indicate that, upon accession to the World Trade Organisation, China will allow foreign ownership of up to 49 percent in basic telecoms services and 51 percent in value-added services. However, foreign investors are already permitted to own up to 35 percent of internet service providers.
Subject to a determination by the Chinese government as to whether IP telephony is a basic service or a value-added service, foreign investors may already have a vehicle to enter the IP telephony market. In addition, this past March, AT&T reached an agreement with the Shanghai municipal government and Shanghai Telecommunications Administration to provide value-added telecoms services in Shanghai's Pudong district.
Unicom's capital spending plans indicate the size of the opportunity for foreigners. According to Yang Xianzu, Unicom's chair-man and president, this year Unicom alone will invest Yn2bn (US$241 m) to complete its IP telephony trial and build up a data and computer network covering as many as 90 additional cities.
Equipment and technology opportunities include applications, last-mile IP telephony technology, firewall support, next generation IP switching, customer billing solutions, voice-over IP tools and multimedia phones.
Foreign companies should be aware that localisation has already become an issue in IP telephony as it has in China's information technology sector in general. Local suppliers, some of which even obtained US Federal Communications Commission approval for their equipment, have been shut out from the IP telephony trial.
These considerations have prompted China to establish an IP standards study group comprised of 17 Chinese entities that has begun to consider standards for allaspects of IP, including IP telephony. Jiang Lintao, chairman of this study group, stated that the study group was considering standards as to gateway, network protection, coding, access equipment and telephone interconnections.
After the six-month trial, it is likely that more IP phone service providers will be authorised. The number of participants is likely to remain relatively small, although some observers predict that this market may become much more fragmented, similar to the paging market which has 2,800 operators. In any case, prices will continue to drop as technology improves and competition increases. The long-term shape of China's IP telephony market will be clear only when China finally enacts its long-awaited telecoms law and related regulations.
This article was written by Warren H. Rothman and Jonathan P. Barker of Rothman, Barker & Associates Inc. For further information, please contact them at 711 Van Ness Avenue, Suite 440, San Francisco, CA 94102. Phone: + +1 (415)292-5045, Fax: ++1 (415) 292-5578. Web site: http://www.rothmanbarker.com. 1999 Rothman, Barker & Associates Inc. All rights reserved.