It is a typical winter weekday on the third floor of the electronics market on bustling Huaihai Lu in central Shanghai. Phone salesmen lean against glass display cases, passing the time as the weather keeps most customers away. New Nokia and Samsung handsets sit next to local brands and off-market knockoffs.
Springing into action when asked about China’s third-generation (3G) mobile standards, the shop clerks’ recommendations are swift and clear: Go for WCDMA, they say, the standard given to China Unicom, one of the country’s three mobile carriers. While the clerks cede that China Mobile offers the best 2G coverage, they rest their argument for 3G on the wide variety of phones available for WCDMA, the most prevalent standard outside of China. For the shop clerks, when it comes to picking a 3G carrier, handset choice is king.
For users, the answer has been less clear-cut – wide handset choice isn’t reflected in wide subscriber bases. China Unicom introduced 3G services at the end of 2009, lagging competitors China Mobile and China Telecom by a margin of months and millions of subscribers. Even the competitors disappointed, however, with all three carriers attracting a mere 15 million 3G subscribers out of 729 million mobile users in China in 2009.
Analysts caution against reading too much into past performance. "I don’t think we can really judge based on 2009," said Bertram Lai, an analyst at CIMB-GK securities. But in 2010, he said, "it’s make or break time."
At least the market is moving. When 3G was introduced, the Ministry of Industry and Information Technology (MIIT) set a goal of 100 million users in three years – a high target based on optimistic forecasts that some say were meant to convince regulators to support industry players along the entire value chain.
Hidden by even the disappointing subscriber numbers are the real statistics regarding mobile handset usage – and the story they tell is less than impressive. As Richard Robinson, CEO of Beijing mobile game developer Kooky Panda and former vice president of international business development at Chinese wireless value-added services firm LinkTone describes it, "The early adopters of 3G in most markets are users who use it as a means of getting their laptop online."
While data cards contribute to 3G market revenues, the simplicity that underlies their appeal – they are merely a means of getting laptops online – means that they offer none of the value-added services that make handsets so important.
The real question is which operator has succeeded in attracting the most handset substitutions, and which company will carry that success into the future. According to Wang Jing, secretary-general of the TD Forum, an organization that promotes the development of TD-SCDMA, China’s homegrown 3G standard, the data delivery capabilities of all the standards are similar enough to render debate about superior technology moot. "[Success] is fully dependent on the operators, not on the technology," he said.
The answer, therefore, lies in coverage, price, and experience – but the real winners may be suppliers and consumers, not those who operate the networks.
The groundwork for 3G coverage was laid in 2008, with the restructuring of China’s telecom industry. China Mobile, the dominant 2G mobile carrier, was granted a 3G license for the relatively immature TD-SCDMA standard. China Unicom, a distant competitor, merged with pure fixed-line provider China Netcom and was granted a license for WCDMA. China Telecom, another fixed-line only carrier, was given China Unicom’s former CDMA network and a license for the CDMA2000 3G standard.
Coverage has been a matter of simple statistics, with China Telecom grabbing the early advantage. By the end of October 2009, the firm had built 117,000 base stations in 342 cities, 2,055 counties, and 6,000 towns. China Mobile had completed the second phase of its 3G infrastructure with 46,000 base stations across 38 cities, and planned to build a further 42,000 in 200 cities by the end of 2009. China Unicom’s 3G network comprised 80,000 base stations in 285 cities.
Price is a much harder metric to judge, especially as lower prices on handsets cut into the bottom line without necessarily driving higher 3G usage revenues. Furthermore, attracting users to a new standard requires a transformation of the entire payment system for mobile phones.
China’s mobile market has traditionally followed a pre-payment model, with users adding money to their accounts as needed, rather than signing contracts. But within the larger mobile market, the real cream lies in China Mobile’s estimated 100-million-strong 2G post-pay contract customer base. "It’s the most attractive subscriber base in China," said Tucker Grinnan, regional head of telecom and media research for Asia at HSBC. "The real targets for 3G are the existing high-end China Mobile users."
China Telecom and China Unicom recognize that winning the 3G market depends on stealing away some of these customers, but it is no easy task. Upgrading from 2G to 3G with China Mobile involves buying a phone and a data plan and then just swapping SIM cards. Customers switching from China Mobile to another carrier, however, must abandon their 2G numbers. Even while Chinese users are price-sensitive, Grinnan said, "in the absence of mobile number portability, it’s going to be difficult for China Unicom and China Telecom to peel off these high-end customers."
As a result, China’s carriers are engaged in a war of attrition for market share. Once a customer is locked into a 3G handset, he or she is also locked to a specific standard and a specific carrier. Subsidies offered to potential long-term customers come at the cost of near-term profits.
China Telecom’s handset subsidies have proved a hit with the public, helped along by savvy marketing. The firm encouraged users on other networks to purchase phones that would accept two SIM cards: one for 2G access, allowing retention of a previous phone number, and one for 3G access on China Telecom. It also engaged in bundling, enabling customers to take advantage of both fixed-line and mobile 3G offerings at a lower price.
While pushing handset prices down appears to be the common denominator of 3G substitution – to the point that China Unicom is expected to issue debt this year in order to increase its ability to subsidize handsets – it can only go so far. "The service cannot be successful if the operator can only gain the users with free phones," said Meiqin Fang, an analyst at telecom consultancy BDA China.
A more permanent solution to breaking through the user barrier to 3G lies in driving data costs lower – rather than flat rate plans, only staggered monthly plans with limited bandwidth are currently available – enabling a complete 3G user experience. It is the most complicated, but most important, step in winning over China’s 2G masses.
All about the phone
As demonstrated by the exhortations of the shop clerks at the Shanghai electronics market, the basic element of the experience remains the phone. With consumers accustomed to choosing between hundreds of different phones, providing a sufficient variety of 3G handsets will be a key component in attracting users.
But in choosing what services to offer on their phones, China’s carriers have resisted a system that threatens to convert them into simply "dumb pipes" through which more profitable value-added services are transmitted. At the other extreme, a top-down approach in which the carrier dictates the user experience is unsustainable and threatens to squash innovation before it has a chance to occur.
Prior to the 3G rollout, operators’ profit projections came with promises of high-bandwidth, revenue-generating services like video calling and wireless video. Those promises may have been oversold. "In other markets, people have discovered that mobile video has not been that big a driver," said Mark Natkin, managing director of Marbridge Consulting, a telecom and IT research house. The same discovery is likely to occur in China.
Mobile video is limited by the small screen and battery life restrictions of handsets. While these limitations should fade as technology advances, for now the Chinese 3G experience leaves significant room for improvement – improvement that must come through integration of the handset, carrier, and value-added services.
The carriers are aware of what is needed. "The providers and handset manufacturers must combine the advantages of the entire supply chain to adapt handsets and prices to be truly practical and convenient to a variety of users," China Telecom told CHINA ECONOMIC REVIEW in a written statement.
The 3G experience is not a matter of one single application, but rather an ecosystem of handset vendors, mobile carriers, and value-added service providers. "There’s not going to be an enormous change in the content," said Kooky Panda’s Robinson. "People will just be consuming more of it because they are able to get access to it faster."
But delivering that content in a form that appeals to and attracts the average user remains an elusive holy grail.
Perhaps the company whose fate is most tied to the user experience is China Unicom. Although the firm was the last to launch its 3G network, in WCDMA it has what is considered the most advanced standard and the one with the largest selection of global handsets. Yet China Unicom’s weak performance has spurred doubts that it can reel in its competitors. Network aside, many now tie China Unicom’s fortunes to that of its flagship handset, the Apple iPhone.
Unicom has a three-year contract with Apple to distribute the iPhone exclusively, but the first batch of handsets offered came with their wireless internet (Wi-Fi) capability disabled. This effectively hobbled many of the iPhone’s most attractive features and destroyed much of the user experience. Wi-Fi, bundled with a domestic wireless standard, has been approved on future iPhones.
Not only are China Unicom’s iPhones pricey – they cost over US$1,000 while most 3G users pay below US$250 for a handset – but they also face competition from an estimated 1.5 million gray-market, Wi-Fi-enabled iPhones smuggled in from Hong Kong and carrying other carriers’ SIM cards.
Nevertheless, David Wolf, president and CEO of Wolf Group Asia, a Beijing-based communications consultancy, warns against writing the carrier off just yet. "China Unicom is going to have a different strategy altogether: ‘We’re going to give you a choice of experiences rather than choosing to do things our way’."
Wealth of choices
For China Mobile, Marbridge’s Natkin sees the continuing challenge as convincing handset vendors to develop phones for the TD-SCDMA standard. The company has introduced a subsidy program to attract vendors, and the end of 2009 saw a marked increase in TD-SCDMA handsets, with international players like Nokia and Samsung both offering TD-capable phones. China Mobile also has plans to sell Research in Motion’s 3G BlackBerry models. As of January, the carrier offered 80 TD-SCDMA handsets, 65 data cards and 58 netbooks, as well as the OPhone, a smartphone based on Google’s Android operating system that is seen as a direct competitor to the iPhone.
China Mobile hopes to benefit from these increased handset offerings, but BDA China analyst Flora Wu says that the immediate revenues will accrue to the foreign handset manufacturers.
While the three carriers battle for market share, the larger force at work remains the government. The MIIT has abandoned its initial three-year projection of 100 million users for a more reasonable target of 50-80 million, and investment of US$66 billion in 3G development is expected for the same period. This comes after US$21 billion was spent during 2009.
In pitting three different carriers with three different standards against each other, Beijing is looking toward the future both at home and overseas. Through tasking China Mobile with TD-SCDMA, the government has developed a domestic standard to reduce foreign patent royalties and pave the way for a Chinese presence in the global telecom industry. The presence of other standards, meanwhile, is intended to stimulate competition domestically to drive development of new technology and services.
It is, in essence, tying the best jockey to a prize horse with unproven potential, but laying bets on every horse in the race.
"China is moving toward a Korea-style model in terms of how they regulate and manage the telecom sector," said Grinnan at HSBC – which will entail channeling excess cash flows from carriers to vendors. The consequences for Korea were thriving international handset producers like LG and Samsung at the expense of SK Telecom.
While this bodes well for domestic manufacturers like Yulong, Huawei and ZTE, the implications for China’s carriers are less than ideal. Strong profitability and growth aren’t likely to come until better services and flat-rate data plans are in place, but each carrier is simply fighting for customers to support these services if and when they emerge.
If there is a silver lining, it might be that the slow rate of 3G development has put China’s carriers in a stronger position for more advanced technologies. "3G is just one milestone," said Benjamin Joffe, CEO of the Asia-focused research consultancy Plus Eight Star. "China is a whole generation behind and should be able to leverage its third-mover advantage."
For now, though, progress hangs on opening 3G to value-added services and content creators so as to offer a unified experience for which customers will pay a premium. Technology alone is not enough. "You can’t stop the consumer," said JP Gan of Qiming Ventures, a China venture capital firm that invests in technology companies. "Consumers are smart; they’re not going to change just because it’s called 3G."