The iPhone in China: Will Apple Connect with the World's Biggest Mobile Market?Published: September 16, 2009 in Knowledge@Wharton
Global launches can be rocky, as Apple knows well. Last year, the company introduced its iPhone in India, but instead of the throngs of consumers seen at launch events in the U.S., the journalists assigned to cover the rollout reportedly outnumbered the customers. According to experts, the problems included a lack of marketing and a price tag set too high for Indian consumers. Now, as Apple prepares for an October launch of the iPhone in China in cooperation with service provider China Unicom, many are wondering if it will face similar hang-ups in the world's largest cell phone market, which has more than 700 million subscribers.
"I don't think Apple or Unicom should assume it's going to be a slam dunk," says Wharton management professor David Hsu.
China Unicom, the country's second-largest mobile phone operator, officially announced on August 28 that it had signed a three-year, non-exclusive agreement with Apple to sell the iPhone 3G and 3GS models in China. Company chairman Chang Xiaobing told reporters in Hong Kong that China Unicom would subsidize the device, but neither Apple nor China Unicom has released specific details about price or terms of service. The company did say it would forego Apple's traditional revenue-sharing model and would instead pay on a wholesale basis.
Excitement about the launch is building. In image-conscious China, the iPhone is considered sleek and fashionable. BDA China, a Beijing-based advisory firm that covers China's telecom and technology sectors, forecasts the iPhone will take 10% to 15% of the Chinese smartphone market in the next few years.
Still, Apple has considerable obstacles to overcome in China, Wharton experts say. Unlike its U.S. launch in June 2007, the iPhone faces stiff competition in China from a variety of touch-screen devices. The Chinese version of the handset is also somewhat crippled: The first batch to come out in October will reportedly have no Wi-Fi function, the result of government mandates that were rescinded in May after production had already begun. Perhaps the iPhone's biggest hurdle is China's thriving grey market, which has already smuggled more than a million iPhones into the country. Experts say the trick will be to price it right: low enough to drive sales, high enough to maintain its exclusive edge.
Well-heeled Gift Givers
When Apple launched the iPhone in India last August, one reason it didn't initially gain traction was the absence of any marketing buildup -- or "big splash" -- like the device had when it was first launched in the U.S. So far, that's not been the case in China. Philip M. Nichols, a Wharton professor of legal studies and business ethics, noticed on recent trips to China that the hype was starting to build. "You cannot go into [French supermarket chain store] Carrefour in Beijing right now without getting iPhone advertising right in your face," says Nichols, who visited twice in August. "They are really advertising the heck out of it."
Nichols is not sure how much the advertising will translate into sales. "We think of China as a never-ending fountain of revenue, but there are far more people in China who cannot afford this technology than there are those who can."
The iPhone will likely appeal to well-heeled Chinese, says Wharton management professor Marshall Meyer, who studies China and visits often. "There's this upper crust of people who have a lot of money and they want the latest accessory. The iPhone is the latest accessory."
The Chinese penchant for style does not always favor the most expensive item, however. Wharton marketing professor John Wesley Hutchinson learned this from a project that one of his students did in the late 1990s in China about Windows CE, a stripped-down version of Microsoft Windows designed for handhelds and other devices. At the time, devices with Windows CE were arguably the most functional but somewhat "clunkier" than others in terms of style, Hutchinson recalls. The study found that Windows CE devices got "surprisingly strong competition from lower-priced, not necessarily as functional ... but stylish" competitors. "One of the big lessons that came out of [the project] was that in the Chinese market, while functionality is important, style is actually more important."
The student's project also highlighted the importance of China's gift-giving market, Hutchinson notes. "You give good gifts to your boss [for example], so there are price bumps related to that." If priced too low, the device might not make a good gift; priced too high, it might be out of a gift-giver's range. His conclusion: "The consumer market in China can be quite different from the U.S. in unexpected ways."
Price was a considerable sticking point when the iPhone made its launch in India. At the time of the launch, the 8GB version cost $710 while the 16GB iPhone was priced at $825. The reason for the steep price tag is that in India, unlike in the U.S., cell phone service providers do not subsidize handsets. In the U.S., the iPhone is sold exclusively through AT&T, which subsidizes the phone in exchange for a long-term contract. Most mobile phones in the U.S. are subsidized by carriers, that lock customers into contracts in order to make back the subsidy over time.
But in countries like India, where the average revenue per user (ARPU) for cell phone subscribers is considerably lower than in the U.S. and users tend to rely on prepaid phone cards, carriers cannot recoup the cost of the device through contracts. Similarly, in China, a large percentage of mobile users use prepaid phones and SIM cards that can be transferred easily from one phone to another.
China Unicom has not announced whether the iPhone will be sold with a contract or not, which would certainly affect its pricing. In Hong Kong, for example, the price of a 3GS iPhone ranges from $5,388 to $6,288 Hong Kong dollars ($695 to $811 in U.S. dollars) because the phones are sold unlocked, meaning they are not attached to a contract with a carrier.
Apple may also be at a slight disadvantage in China because of its partnering with China Unicom. "In the U.S., Apple managed to land a deal with AT&T," notes Kartik Hosanagar, Wharton professor of operations and information management. "In contrast, in China, Apple could not get a deal with China Mobile, which has the largest share of the market.... So an important factor is that the share of the market that Apple is getting through China Unicom is much smaller." China Mobile had 497.7 million customers at the end of July, while China Unicom had only 141.1 million. China Unicom, however, is the only one of China's three telecom operators to operate the W-CDMA technology that the 3G iPhone uses, according to BDA China.
It is not clear how China Unicom's second-place status will affect iPhone sales because the company hasn't revealed what special services or subsidies it might offer, or if the phone could be unlocked. Since Apple's agreement with China Unicom is not exclusive, other carriers or companies could theoretically sell the iPhone. And, as has already been proven in China's grey market, a hacked iPhone will function on any of China's mobile networks.
In fact, one of the biggest question marks concerning iPhone sales is how much the grey market may have already dampened demand. BDA China estimates that more than 1.5 million iPhones have been smuggled into China so far, and many run on GSM networks operated by China Mobile.
The iPhone also faces a host of competing devices in China. China Mobile is expected to partner with Beijing-based Lenovo, Texas-based Dell and Taiwan-based HTC to launch a range of smartphones based on Google's Android operating system. Rumors are that Canadian firm Research In Motion, which makes the BlackBerry, and California-based Palm are in talks with China Telecom to offer their devices. All will have to compete with the current giant, Finland-based Nokia, which captured 67.3% of China's smartphone market in 2008, according to Beijing-based CCID Consulting. According to CCID, 97% of China's smartphone market in 2008 went to just five brands: Nokia, Motorola (based in Shaumburg, Illinois), Dopod (of Shanghai), Amoi (based in Fujian, China), and Samsung (Seoul, Korea).
Mark Mechem, a consultant who works in Shanghai, says the Nokia E71 is a favorite smartphone choice in China. While attending a dinner event in Shanghai earlier this year, he says he was "surprised to find eight of the 11 people at my table ... were all using the E71." Now, he adds, people are looking forward to the iPhone's release.
Wharton marketing professor Jehoshua Eliashberg wonders how the iPhone will stack up against competitors. Although future versions of the iPhone in China (beginning in 2010) are expected to be Wi-Fi enabled, the device is not expected to have Wi-Fi when it launches in October. Not having Wi-Fi capability could be a disadvantage, given the growing importance of Internet access to Chinese cell phone users. According to a BDA report published on August 12, "China now has 15 million users of smuggled Wi-Fi handsets, accounting for 80% of all smuggled phones. Purchasers ranked Wi-Fi as the second-most important reason for their choice of a smuggled phone, after cheaper prices." BDA forecasts that sales of handsets with Wi-Fi capability could climb from 800,000 today to 5.2 million units by 2013.
According to a report by BDA, Beijing had originally banned Wi-Fi in order to promote the domestic WAPI (WLAN Authentication and Privacy Infrastructure) standard. The Ministry of Industry and Information Technology (MIIT) changed its policy in May, approving Wi-Fi enabled phones as long as they also provided for the WAPI standard. That was after the iPhone went into production, however. Motorola released the first dual-capacity handset, the A3100, after these rules were changed. Since Beijing has allowed dual WAPI/Wi-Fi, more global vendors have decided to enter the market. BDA says there are currently 10 models undergoing MIIT's license tests, including devices from LG, Nokia, Samsung, Yulong and ZTE.
Eliashberg notes that the iPhone will also have to be functional in terms of inputting Chinese characters --- an important consideration for Chinese mobile users, who like to text. And iPhone applications will have to be adapted to the Chinese market. "I don't think the most popular applications in the U.S. will be the most popular in China," he says. "I think that in order to enhance the likelihood of succeeding, [Apple] is going to have to redesign the applications."
The competition is all the more difficult for Apple since the brand is not as well known in China as it is in the U.S., Eliashberg points out. Apple's iPod, for example, has not been as popular in China as in the United States because mainstream Chinese tend to choose lower-end MP3 players, according to CCID. Apple opened its first store in Beijing in July 2008, but the "cult" that surrounds Apple in places like the U.S. has yet to grow strong.
Wharton marketing professor Z. John Zhang is more optimistic. Zhang, who uses an iPhone himself, says people have been using iPhones in China for the past two years and the Chinese-language software installs and works well. "Without any marketing inside China, Apple has managed to sell a large number of iPhones" through the grey market, he notes. Apple could actually use the grey market to its advantage by capitalizing on the iPhone's existing popularity, Zhang adds. "They can say, 'We know you love the product.' That's not something they could do when they initially launched the product [in the U.S.]."
Pricing It Right
Zhang sees price and brand maintenance as Apple's biggest challenges. "It would be very tempting to lower the price and sell to a lot of people. If you do that you'll lose the brand equity you have up to this point," he says. Once the iPhone is widely available in China, "that's probably going to destroy the exclusivity somewhat. They have to manage that transition process well ... [so as] not to destroy the brand image and cachet that is associated with the phone."
Hsu agrees that Apple's challenge is marketing the phone at the right price. "They're going to have to figure out [whether] this [is] going to be a high-end, exclusive product, or are they going to scale down like in the United States and sell it at Walmart?"
Zhang thinks Apple and China Unicom should keep the price of the iPhone above 1400 yuan (about $205) to maintain its allure. The price is high -- about a month's salary for a recent college grad. "The iPhone is not meant for the mass market and I'd be surprised if it is sold as a mass market product," says Zhang. "It will most likely target high-end, image-conscious users. Even in that case, there is surely a potential for price wars if you are not careful, as competition is more than happy and willing to drag Apple into the mud."
Hosanagar agrees. "[Apple is] not just managing its revenues in one market; it's managing its brand as such. Apple's margins on the iPhone are just fantastic; I don't think that Apple would want to compromise on that."
Both Zhang and Hosanagar point out that if the phone is priced too low, a reverse market could occur. "If the iPhone is over-subsidized in one market, especially with no contract, clearly people would buy a lot of it in one market and ship it to another," Hosanagar says. "So the question is: How will it work in China? To what extent will China Unicom subsidize the phone? Is there a price point that clearly works?"
In India, Apple has continued to struggle to sell the iPhone, largely due to price, Hosanagar says. "My sense is that Apple has learned a lot of things from India. I look at the U.S. and India, and in terms of success, they were polar opposites. China will probably be somewhere in between."