Upwardly mobile

When someone gets around to writing the full history of mobile telephony, the chapter on the industry's development in China in 2001 will undoubtedly be one of the most dramatic. Rarely has a business grown so quickly. In the first seven months of 2001, the number of mobile phone subscribers in China grew 42 percent to 120.6m people. China has now overtaken the US as the largest mobile phone market in the world.

However, the central lesson emerging from the industry's rapid rise has been less surprising: that size does not necessarily equal profitability. The country's two licensees, China Mobile and China Unicom, have become addicted to subscriber growth at the expense of margins.

The extent of the trend was revealed when China Mobile (Hong Kong) released its financial results for the first six months of 2001. Subscriber numbers during the period rose 67 percent year-on-year but net profit increased only 4.8 percent. More worryingly, average revenue per user (ARPU), a measure of how much each subscriber spends in a month, fell 36 percent year-on-year, from Yn247 to Yn158.

As subscriber numbers have grown, operators have increasingly been forced to woo less wealthy users. The fall in China Mobile's per-subscriber revenue was partly due to an influx of new users opting for cheaper pre-paid cards rather than post-paid contracts. These pre-paid subscribers spend on average only Yn78 per month, less than half that of contract users.

China Unicom's first half results revealed a similar trend. Operating profit fell by 16 percent year-on-year, at a time when subscriber numbers increased by 58 percent.

The fall in per-subscriber revenues has coincided with a savage increase in telecoms competition at the grassroots level. Even though China Mobile and China Unicom are officially the only licensees in the country, China Telecom, the dominant fixed-line operator, has quietly set up its own, extremely low-cost service, known as Xiaolingtong, to compete with them.

The service, based on Japan's Personal Handy phone System (PHS) technology, piggybacks on the existing fixed-line network, using small base stations. It can cost as little as Yn20 per month and, although it is meant to be limited only to small cities, is gradually spreading through districts of the bigger metropolises, according to Duncan Clark, managing director of BDA (China), the telecoms and technology consultancy.

China Mobile and China Unicom's responses to such competition have been haphazard at best. Local marketers have offered bargain rates even though these often violate official policies. In August, branches of both companies launched a promotional offer of one-way billing, or calling party pays services, in Shandong province.

This was despite repeated assurances to investors by the regulator, the Ministry of Information Industry, that China planned to stick with its current billing system, under which both calling and receiving parties pay for calls.

Worried that such unexpected policy shifts could undermine revenues, investors have knocked down the share prices of China Mobile and Unicom by more than 40 percent in the past 12 months.

Clark says the management of Chinese telecoms companies needs to be reorganised to inject financial discipline throughout the network. Currently, he says, the depth of understanding of more sophisticated industry concepts such as ARPU and customer acquisition costs go no further than the companies' management in Hong Kong and Beijing and their investment banking advisers.

"I use the analogy of the First World War; the guys in the trenches are just focusing on pushing back and forth to the next trench, while the generals are sipping wine supplied by the investment bankers in Hong Kong and talking about the weather," says Clark.

The situation is made worse by a thinly staffed regulator unable to keep up with rapid developments in China's giant telecoms market. "Again, there's this fire-fighting mentality: 'Okay, calling party pays has broken out in Shandong, so send the boys up'," says Clark. "It's in effect a game of 'Whack-a- Mole' where you hit the target on the head in one area and it just pops up somewhere else."

To be sure, both China Mobile and China Unicom have started trying to offer more value-added services. Both have launched their own mobile internet brands. Simple data services, such as text messaging, have ballooned. China Mobile alone hosted 1.3bn short messages in the six months to June.

However, both companies will have to try harder to show they are serious about sustaining margins or they will risk alienating increasingly hostile international capital markets, on which they have until now been heavily reliant for funding. Even now, China Unicom plans to return to the market in late 2001 or early in 2002 to raise another US$1.8bn to pay for additional network purchases from its parent.

In addition, while the pair are currently insulated from competition, the market is expected to be opened up to more licensees over the next couple of years. The government is believed to be considering consolidating the Chinese telecoms industry into four full-service providers based on China Mobile, China Unicom and the northern and southern operations of China Telecom.

China Telecom, with its current extensive network, could prove to be a formidable competitor for China Mobile and China Unicom. Both will need to begin evolving more quickly if they are to ensure their current record performances do not become consigned to the history books.