Stumbling toward 3G

After years of false starts, murmurings from Beijing suggest that the long-awaited licenses for third-generation (3G) mobile networks are soon to be released, unleashing a torrent of spending in the world's largest mobile market. Official statements are talking up the demand for advanced services. The China Center for Information Industry Development recently estimated the number of 3G subscribers would increase by 30 million a year over the next four years, creating business opportunities worth from US$24.7 billion to US$37.3 billion.

Given the breakneck speed of mobile take-up in China, and the rapid adoption of data services, the estimate seems reasonable. Today, it is the biggest mobile market in the world, after the number of subscribers grew from 144.8 million in 2001 to 393.4 million at the end of 2005. China's telecom regulator the Ministry of Information Industry (MII) has estimated the number will reach 440 million during 2006.

At the 3GSM World Congress in February, Wang Jianzhou, CEO of China Mobile, the world's largest mobile operator, created a stir when he announced the company had added 42 million subscribers in 2005. Most operators cannot aspire to that number of users in total. Wang also pointed to a willingness among Chinese users to make the most of wireless value-added services (WVAS), with the revenue generated by mobile music last year surpassing the entire revenue of the traditional music industry.

Around 100 million Chinese handset users had access to the mobile Internet at the end of 2005. A survey by global research company GMI last December showed China was leading the world in mobile data use, with 97% of Chinese mobile phone users downloading data, compared to fewer than half of American users.

Catering to this demand, wireless application protocol (WAP) websites have begun popping up, offering a vast array of services. News, online communities, interactive mobile gaming and real-time updates from sporting events, as well as music, ring-tone, picture and video downloads are all available at the push of a button. And with 3G mobile networks just around the corner, many new startups are looking to tap into the expected boom in the advanced WVAS market over the next few years.

An immature market
But as rumors circulate about Beijing's 3G plans, analysts say many of the uncertainties that have stayed its hand until now, such as concerns over the true level of demand for wireless value-added services, have not been resolved (See: Killer content: girls, goals and games).

Norson Telecom Consulting analyst Boaz Rottenberg believes there has been a lot of caution about 3G in China in terms of revenue generation for operators and the chances of advanced services actually being used. "There has been a lot of hype about 3G and I think, with the exception of maybe Japan and Korea, it's not generating the revenues that everybody hoped for," he said. "At the end of the day 3G is just a technology. The question is: will there be popular services that drive data traffic?"

While Chinese users may have a relatively large appetite for data services, MII figures show these services accounted for only US$3.8 billion, or just over 10%, of operators' US$35.8 billion total mobile revenue in 2005. But the gap is narrowing – data accounted for just 1.15% of the US$20.65 billion in mobile revenue in 2001.

Estimates from China telecoms analysts BDA show there is WVAS money to be made. Revenues from wireless value-added services climbed from US$2.6 billion in 2003, including carrier revenues, to US$7.1 billion in 2005. BDA is predicting growth at 37% each year up to 2009, at which point consumers will be spending a total of US$24.7 billion a year.

But voice is the big use now, Rottenberg said. "Value-added services are rising, as are the revenues they are generating. But does that really warrant the heavy investment in 3G networks?"

The answer for operators is, probably not. But BDA's Zhang Dongming points out that even if people did not turn to value-added services in the quantities hoped, 3G still provided a way for operators to deliver voice services cheaper, or capture more profit. "People always think [the killer application] is going to be data or fancy applications but in fact I think it is going to be cheaper voice," she said.

Global ambition
Regardless, Beijing is unlikely to give up the opportunity to exercise a business decision. In China 3G has come to mean much more than simply an advanced communications network – it has become a standard-bearer for the country's global ambitions. A huge amount of capital, both political and real, has been poured into developing a homegrown 3G standard to rival international standards WCDMA and CDMA2000 (See: Tech travels: the road to 3G). Beijing appears willing to leave no stone unturned in its efforts to ensure that the domestic technology, TD-SCDMA, has a future.

But, like many projects in China, 3G is pointed toward the Beijing Olympics – MII promised services would be "up and running by 2008," offering the authorities an international platform on which to showcase China's emergence as a technological power. But Norson Telecom's Rottenberg believes time is running out for Beijing to make a decision. "If the government wants 3G to be available for the Olympics as promised then licenses need to be issued sometime this year, and soon," he said.

So far Beijing has refused to issue a timeline for licensing, and it has not yet made it clear which operators will receive which standards, or even which standards will be issued. As a result, rumors have run rampant, with the suspicion growing that the authorities have yet to make up their minds.

Despite the lack of clear government direction, analysts predicted the Beijing 2008 factor meant the first licenses were likely to be issued in early 2006, with homegrown technology in the front running. This prediction was buoyed by recent government activity. TD-SCDMA was formally set up as the national technology standard for 3G in January, running off its own stand-alone network. In a statement, MII said a series of tests since 2001 had shown the technology to be "mature and ready for manufacturers to move ahead with production."

Licensing is expected to unlock the recent uncertainty-fueled slowdown on telecommunications investment and spark a US$10-12 billion round of spending on telecom equipment. The beneficiaries are likely to include global giants Ericsson, Nokia, Siemens and Motorola. Nokia said that the company expects licenses for 3G mobile networks by June, while Siemens has laid out plans for at least US$1.2 billion in sales in China over the next three to four years from telecom operators building 3G mobile phone networks. Domestic vendors like Datang and AsiaInfo also are well-placed to take a sizeable share.

Battle for licenses
Meanwhile, the foundations of a licensing regime appear to be slowly coming into place. Most analysts now agree that Beijing is planning to grant fixed-line incumbent China Telecom a TD-SCDMA license and China Mobile a license to upgrade its 2G GSM network to the 3G equivalent, W-CDMA.

The hottest debate centers on the future of the smaller fixed-line and mobile incumbents, China Netcom and China Unicom. Whatever happens, China Unicom is unlikely to retain both the GSM and CDMA networks it currently operates. Goldman Sachs is among those who expect the company will be forced to sell or lease its GSM network to China's eventual TD-SCDMA operators, which will then roll out TD-SDCMA along a GSM model. The backup GSM standard would provide TD-SCDMA-based handset users with additional GSM roaming, allowing extended coverage and enhanced quality as the homegrown standard is expanded.

A merger between China Netcom and China Unicom has also been touted, with the new grouping set to receive a CDMA2000 license. Because CDMA2000 evolved from China Unicom's 2G CDMA standard, this pairing makes perfect sense. A further theory making the rounds is that China Netcom will instead receive a TD-SCDMA license along with China Telecom, which means there would be two competing operators on the same standard. Other possible candidates for a TD-SCDMA license are niche players China Satcom and China Tietong.

However, Chen Jinqiao, deputy chief engineer with the MII's China Academy of Telecommunications Research told a business conference in Beijing in February that "China will issue no more than three 3G licenses, which will mean no more than three operators." The picture remains unclear.

Whatever the eventual licensing scenario, a lot is riding for Beijing on the success of TD-SCDMA. Chinese telecom providers were relatively late adopting 2G standards when China's first networks were rolled out, allowing international competitors to move in and control most of the equipment market. Ericsson filled 40% of China Mobile equipment orders, for example, while leading domestic providers Huawei and ZTE claimed less than 3%. The government sees a homegrown 3G standard as a way to ensure domestic vendors can capture a healthy slice of the domestic telecoms market.

But more importantly, Beijing also sees it as an opportunity to make its mark on the world of international standards, reducing China's reliance on foreign-owned technology as the country moves to strengthen the protection of intellectual property rights (See: Political football: business basics kicked to touch).

Accounting firm Deloitte Touche Tohmatsu predicted in a 2004 report that China's standards initiatives would shape global technology, media and telecoms sectors, affecting the ability of foreign companies to compete not just within China, but also "in a global marketplace increasingly defined by standards that originate in China."

Foreign foothold
However, even though TD-SCDMA is considered a Chinese standard, delays in development have given foreign firms, particularly Siemens and Nokia, time to develop a stake and patent rights in the technology. As a result, Norson Telecom's Rottenberg doesn't think domestic companies will see their market share increased as much as the government had hoped. "If it had been done quickly it probably would have been the case," he said. "But because of the delays, you have companies like Siemens investing in this technology and a lot of multinational companies actually own a lot of the patents related to this technology."

Siemens has invested around US$205 million to help develop the standard and Nokia has co-invested US$111 million, while most other major firms have also jumped on the TD-SCDMA bandwagon, including Motorola, Ericsson, Nortel Networks, Alcatel, and Lucent Technologies. "Most players in the market have realized that TD-SCDMA is going to be a technology used in the China market and people who want to be a part of that market are making the necessary plans," Rottenberg said.

Property rights aside, WCDMA is expected to take the lion's share of the domestic market, despite government backing for the homegrown standard. This is certainly how Nokia views it, and the company expects to do well out of WCDMA network equipment sales as a result.

"We have a very good position in 3G WCDMA network supply in the Greater China area, so that puts us in a very good position to win the future mainland 3G market," a Nokia spokesperson explained. "TD-SCDMA will also play a role and you can see the government has given great support to the technology's development. But for Nokia, we also have a very strong IPR portfolio in TD-SCDMA."

Still too early
According to Wang Xueqing, manager of the macroeconomic research institute at the National Development and Reform Commission (NDRC), foreign ownership of the homegrown standard is a threat. He believes 2006 is still too early to release the licenses.

Of particular concern is the fact that American giant Qualcomm owns around 80% of patents for all CDMA technologies, on which TD-SCDMA is based. "That means Chinese companies can only get a little profit while Qualcomm controls nearly the whole China 3G market and industry," Wang said. "It's a threat to national security for the core technology of the nation's telecommunications to be controlled by a foreign country."

Even if TD-SCDMA can be deployed in the near future, there is widespread suspicion that it won't receive wholehearted support from Chinese vendors and operators. In a report in May 2004, Norson Analysis said that Huawei and ZTE, China's only heavyweight equipment makers, were spending more on WCDMA and CDMA2000 product development than on the local alternative. Only one company is backing TD-SCDMA, and that is the standard's inventor Datang Mobile, a company that was spun off from the official Chinese Academy of Telecommunications Technology.

And the operators themselves are in a behind-the-scenes battle with Beijing as their commercial aspirations butt up against the government's political desire. China Mobile's chief executive Wang Jianzhou made his company's wishes clear earlier this year, telling investment bankers in Hong Kong that WCDMA was China Mobile's preferred 3G standard.

Fixed-line uncertainties
The picture is less clear-cut for fixed-line operators China Telecom and China Unicom. Some see TD-SCDMA as the guarantor of their future while others like Roger Cui, the chief telecoms analyst at telecom consulting firm Analysys, say they are keen to avoid the domestic standard trap, despite their desperation to secure a mobile license (See: Falling revenues: is 3G the solution?).

"What they want most is not 3G but a mobile license," Cui said. "If they just build a 3G network it will not make sense for them, the competition will be cruel. But in this situation, they cannot just get a 2G or 2.5G network. All Chinese carriers are owned by the central government so they sense they have a duty to fulfill the government's strategy."

In a January report into licensing, Norson's Rottenberg argued that as the first major user of TD-SCDMA technology, the strategy would come at a heavy cost for China Telecom. Not only did it face extra costs and lower user confidence in its network, its existing "mobile" client base of fixed wireless Xiaolingtong service subscribers are also the least likely to adapt to wireless value-added services. "After the dust has settled and the first wave of China's 390 million mobile users has moved to 3G, China Telecom will likely find itself a distant third in subscriber numbers," the report said.

"It's going to cost China Telecom a lot of money to build those networks and the return for that investment is not going to be very high," Rottenberg added.

Unhappy prospects
All may not be lost for China Telecom, though, as Beijing's strategy could well be undermined by doubts over the commercial viability of TD-SCDMA. The clearest warning bell is that the development of commercial test networks is woefully behind schedule. Originally slated for completion in the second half of 2005, the government did not announce the roll-out of commercial test networks until February this year and these won't be completed until August.

Though small-scale field trials have already been conducted – by China Mobile and China Netcom in Beijing with equipment vendors TD-Tech and Datang Mobile, and by China Telecom in Shanghai alongside wireless vendors ZTE and Ericsson – they have not involved real users with real phones in a commercial situation. The latest trials will be the first to test for specific glitches, such as the network's ability to support multiple 3G handsets in one room and a base station's compatibility to connect calls from different operators' handsets.

A recent Goldman Sachs report was skeptical of TD-SCDMA's prospects, claiming that early test results had shown the technology to be unstable, and that there was a chance that full stand-alone commercial deployment will not happen at all. "If TDS is still not ready by end-2006, even with its earlier licensing, then we believe WCDMA licenses will likely also be given to China Telecom and China Netcom, and a bundled WCDMA+TDS will be deployed," the report concluded.

The theory has its advantages as the two standards are very similar and all WCDMA developments, and users, in theory at least, could easily be switched to TD-SCDMA when the technology was ready.

But Norson Telecom consulting analyst Chris Han said if the government wanted to give the homegrown standard every chance of establishing a reasonable market presence, it had to wait until it was commercially ready to issue licenses, and that depended on the results of the current testing regime. "Issuing a TD-SCDMA license before the technology is confirmed is dangerous as Beijing will not be able to wait for too long before issuing licenses for WCDMA and CDMA2000," he said.

Complicating matters, the foreign standards are already commercially viable and the networks close to deployment. "China Unicom will take four months from licensing to get its CDMA2000- EVDO networks up and running, and Telecom Mobile will get its networks up even faster – in fact, you can already use the network in parts of Shanghai and Beijing, provided you can access a network card," said Han. "That is why Beijing said no more tests. They were not building test networks, they were building the network."
Han is referring to a February crackdown on unauthorized WCDMA trial networks after the government discovered Chinese telecom operators had built close to 90 WCDMA networks in over 30 Chinese cities, with more than 800 WCDMA base stations, despite authorization only for eight. The rampant network construction fueled fears of a repeat of the time when fixed-line operators developed a huge illicit market for Xiaolingtong services by constructing networks in the absence of clear regulation, eventually forcing Beijing to grant licenses. Han said a repeat scenario would have given WCDMA an even greater head-start over the homegrown standard.

Leveling the field
If China Telecom fails to establish a market for TD-SCDMA, as expected, the government's 3G aspirations would take a major hit. But even then, there is still a possibility that the homegrown standard will emerge with its reputation intact – China Telecom could get the WCDMA license and leave China Mobile stuck with TD-SCDMA.

"If the rumor is true, there will be a better balance between the carriers," Analysys' Cui said. "China Mobile, which is the strongest, will have the worst license, and China Telecom, which has less mobile operating experience, will get the best license, so there will be a balance. I think this rumor is reasonable."

This solution will enable Beijing to give China Telecom what it most wants, namely a mobile license. It would likely lease or buy China Unicom's GSM network, which it would use to develop a new customer base and slowly convert its Xiaolingtong users to a real mobile network as it deployed its 3G WCDMA network. Meanwhile, China Mobile would maintain and grow users on its existing GSM network, switching them at such time as its TD-SCDMA network was ready. Given that most existing 3G services can be run on 2G and 2.5 networks, it is unlikely to see a mass exodus of subscribers in the meantime.

For Beijing, handicapping its strongest mobile operator could be the only way to ensure the success of TD-SCDMA. As Pacific Epoch Managing Director Sage Brennan points out, it's a decision that has transcended business and become lodged firmly in the political domain.

Reading newspaper and analyst reports from 2002 and 2004 gives an uncanny feeling of d?j?-vu. Analysts seem to make a living out of proclamations that 3G licenses are on the verge of being issued while the government is not slow to proclaim the commercial viability of TD-SCDMA. But as the rest of the world slowly turns its attention from 3G to fourth-generation mobile networks, China is in danger of getting left well and truly behind.

If the government is to honor its promise of 3G in time for the Olympics, it is time it stopped hedging its bets and announced some concrete plans. Failure to do so will be the surest sign yet that all is not well with Beijing's 3G ambitions.