After years of rumors, a massive restructuring of China’s telecoms industry and the launch of third generation (“3G”) mobile telephony are almost a reality. Three mobile networks will pit three reorganized telecoms operators and three competing wireless technologies against one another. Among them will be China’s own proprietary 3G mobile technology — TD-SCDMA (Time Division-Synchronous Code Division Multiple Access) — which, following a series of delays, is now well into its trial phase. China Knowledge at Wharton spoke with experts about the long-awaited Chinese standard and what 3G and telecoms restructuring will mean for the industry.
According to these experts, a telecoms battle is taking shape. China Mobile’s current undisputed dominance may be threatened, as three telecoms operators battle it out in a market where competition in mobile and fixed-line telecoms (formerly distinct areas of operations for carriers) can be combined in new ways. Moreover, the new environment should offer rich opportunities for makers of telecoms equipment, software manufacturers and venture capital and private equity investors. Nevertheless, analysts caution that Chinese 3G will be subject to a constraint familiar elsewhere: a shortness of user demand.
Ringing the Changes
Although China has yet to issue any 3G licenses, the government’s restructuring plan, formally announced in May, is confirmation that 3G technology (which allows for features such as internet access and video phone facilities, for instance) is on its way, says Deng Zhongyuan of Analysys International, a Beijing consultancy working in the telecoms, media and technology fields. Though the process is not yet complete, under the plan three giant telecoms carriers will all be equipped with both wireless and fixed-line networks. China Telecom, the country’s biggest force in fixed telecoms, acquires a mobile network based on the 2G CDMA standard from China Unicom. This leaves Unicom, which currently plays second fiddle to China Mobile in the mobile market, with a wireless network constructed on a different 2G standard (GSM). To this it adds a fixed-line network purchased from China’s fixed-line number two, China Netcom, which will cease to exist. China Mobile, meanwhile, will absorb China Tietong, China’s third force in fixed telecoms.
While there has been no formal announcement of which 3G standards operators will adopt, it is commonly understood that China Unicom will be awarded WCDMA, the most widely used global standard, while China Telecom will upgrade to its nearest competitor, CDMA2000. China Mobile will receive a license for the bewilderingly named TD-SCDMA, shortened by those in the industry to “TD”.
Difficulties in bringing China’s home-grown standard to commercial readiness have been widely blamed for delaying the launch of 3G. China Mobile is believed to be unhappy about being laden with the least mature technology. Nevertheless, against a background of strong government support for the domestic standard, the company finally launched commercial TD trials in mid-2007, and plans to have networks in 38 cities by June 2009.
China’s home-grown standard is often portrayed as a means for domestic firms to avoid forking out enormous sums in royalties to foreign patent owners. However, according to analysts, this is only part of the story. More ambitiously, this is an attempt by the government to stimulate China’s telecoms and IT industries (and thus the economy) and improve manufacturers’ domestic technological standing, Chinese experts and industry sources say. As one telecoms analyst notes, Chinese manufacturers (or “vendors”) of telecoms equipment such as Huawei and ZTE to date have been in a constant struggle to catch up with Western makers, who had a significant head start in mobile technology. By developing a domestic standard, China hopes to give itself an opportunity to catch up with or even get ahead of their Western competitors, he says.
A manager working in TD-SCDMA equipment at a major Chinese vendor draws a parallel with the Indian government’s successful efforts to push the nation to the forefront in IT services. China wants to kick start China’s Information Technology and Communication (ITC) industries in a similar way, he says. He also points to another motivation for the industry restructuring and launch of 3G: The government aspires to sponsor a more competitive environment, improving service for subscribers while cutting prices.
Indeed, the industry makeover is seen as an attempt to challenge China Mobile’s domination in the Chinese telecoms scene. The world’s largest wireless carrier in terms of users, it dwarfs China Unicom by more than two to one. It is also increasingly powerful in comparison to fixed-line carriers China Telecom and China Netcom, whose user base has fallen while that of mobile carriers has grown, as young users and rural dwellers bypass fixed-lines in favor of wireless. In the first half of the year alone, the company added 45 million new subscribers, raising the total to 415 million, and in the second quarter earned over twice as much as its three rivals combined. Beijing has spoken of the Chinese telecoms industry’s “serious imbalance in its competitive structure”.
“My impression is that the State Council just felt that China Mobile got too big for its own good and needed to be brought down a notch,” says Paul Denlinger, a private consultant with long experience in Chinese ITC. “Among consumers and partners it had acquired a reputation for arrogance. This is why it was saddled with TD-SCDMA. My belief is that the State Council believes that because China Mobile had become too dominant and powerful, Unicom and Telecom had to be brought up to compete with CM and level the playing field.”
Three Telecoms Kingdoms
Denlinger, speaking for many, believes China Telecom is the greatest beneficiary of the industry shakeup, and Analysys International’s Deng agrees that China Telecom will become far more competitive post-restructuring. Meanwhile, China Unicom, though blessed with the strongest global mobile standard (WCDMA), will lag somewhat behind the big two due to weaknesses in human resources and elsewhere, Deng and others believe.
One reason for the projected rise in China Telecom’s fortunes is the speed and cheapness with which the second generation CDMA technology it is acquiring can be upgraded to 3G. Furthermore, China Telecom’s newfound potential for combining fixed and mobile services to offer comprehensive packages poses a further threat to China’s number one, Deng says, “It will be able to make better use of its fixed line network advantage.” By drawing on its user base, China Telecom will be able to offer combined mobile and fixed deals to family and corporate clients. It might offer its fixed-line customers discounts on the condition that they allow China Telecom to cater to their broadband and mobile telecoms needs. Used as it is to dealing with individual customers, China Mobile must start paying more attention to group clients, Deng advises. Up to this point, the company doesn’t seem to have come up with an answer, he says, though its TD-SCDMA tariff proposals (which include differentiated fees for corporate, family and other subscriber groups) reflect the emphasis it places on the problem.
How the competition will play out in the long run is hard to tell. Deng predicts China Mobile will remain top dog in the wireless arena for the next three to five years: It has many strengths, after all, not least its massive user base. And China Telecom must confront challenges of its own. “The initial, most obvious learning curve will be about moving into mobile,” says Denlinger. “Building a mobile infrastructure is a major undertaking.” Nevertheless, if China Telecom does a good job of combining mobile and fixed services, Deng believes it can become a very strong competitor to China Mobile not just in the overall market, but also on China Mobile’s home turf, the mobile market.
TD’s Trials
Even more dangerous than the threat from retooled adversaries, however, is the challenge posed to China Mobile by its receipt of the 3G standard with the least mature 3G technology and the most poorly developed industrial chain, Deng says.
Results from trials in ten cities have been uneven, he notes. According to media reports, spotty coverage has been the top complaint: One technology blogger wrote this month that “there seems to be a growing consensus that TD-SCDMA apparently sucks eggs.” However, in contrast to the tone of much commentary, Deng says that overall, the technology’s performance has been “comparatively excellent,” and no worse than WCDMA and CDMA2000 at similar stages in their development. Nevertheless, even small problems (such as loss of signal, or inability to send short messages) could be magnified in the future hurly-burly of competition, he stresses, and must be solved quickly. Failure to do so could have a significant adverse effect on customer satisfaction, and thus on TD’s future.
Handsets pose another problem. Wang Jianzhou, China Mobile’s chairman and chief executive, made waves recently with a statement that owing to problems with handsets, China’s standard lagged “a few years behind” the other technologies. Judging from consumer feedback, handset problems lie in the areas of choice, quality, price and performance, he said. Others agree that TD’s severest problem lies in poor handsets. Though cheap, the handsets produced thus far are very “simple.” Due partly to insufficient market research, large Chinese vendors do not understand users’ needs, one analyst says.
Other challenges may lurk. According to an industry source, quality problems could arise in the future in part due to the inexperience of many of the new factories that have sprung up in the TD-SCDMA industrial chain. Moreover, most vendors are contending with delays in delivering the chipset, which is made by Chinese manufacturer Datang Mobile. If big Western names such as Motorola and Ericsson showed more interest, it might help to alleviate TD’s problems, he says, but they have not done so. Analysts cite resistance to a new competing standard and the fact that foreign vendors’ competitive advantage lies elsewhere as reasons for low foreign levels of engagement.
Skepticism about TD’s ability to make the grade beyond China’s borders is another factor. Indeed, taking TD abroad is going to be, “an extremely difficult problem” says Analysys’s Deng, especially since 3G has already reached the marketplace in developed countries.
Still, Denglinger thinks China’s government will judge TD’s success according to a different set of criteria than those common in the West, where typically each generation of technology must be profitable to be valid. “This is a multi-billion dollar learning lesson for the Chinese government,” he says. “Ultimately, mobile communications is considered a strategic industry by the Chinese government, which means that Chinese companies should control the technology and own as much of the revenue as possible,” he notes. “What the Chinese government is most interested in is 4G. This is where the government will seek to control key technologies. In 3G, there will be significant opportunities for equipment vendors as the Chinese learn about the technology value chain and technology standards. I expect the Chinese to try to learn about the whole value chain, and then try to completely replicate it in 4G with local producers and manufacturers.”
Deng, however, believes that it is far from certain that China’s development of TD will put it in a good position to compete in 4G. That will partly depend on how much energy China Mobile puts into getting TD right, he says. Even so, China’s delayed launch of 3G leaves it still lagging developed nations. This means that by the time the earliest 4G networks begin to emerge, which may happen during the next three-to-five years in some developed countries, China will remain behind. At the earliest, 4G will not reach China for seven or eight years, Deng estimates.
“But at this point, even so, TD has definite development potential,” he adds. After all, the Chinese market on its own is blessed with a huge population. TD could also make inroads in developing countries if Chinese carriers invest in or buy out local operators and establish networks built on the Chinese standard, Deng says.
Opportunities for Vendors and Others
Even if TD is limited to China’s domestic market, China’s 3G launch and industry restructuring promises valuable new opportunities for equipment makers, who provide the core systems, base stations and terminals (handsets) that make mobile telecoms possible. “The market is much bigger,” says the manager at the Chinese TD-SCDMA equipment vendor.
It will also bring renewed competition, as foreign makers (including Ericsson, Motorola, Alcatel-Lucent) and domestic players Huawei and ZTE compete for their slice of the market. According to Deng, since China is a member of the WTO the playing field is essentially level, although local players will still have a slight home advantage. Furthermore, analysts indicate that the two big Chinese vendors’ capabilities are now generally competitive with those of foreign equipment makers.
In terms of the competition between the two biggest Chinese vendors, Deng and others say that on paper ZTE has greater capability in TD-SCDMA and CDMA2000, while Huawei is stronger in WCDMA. How this struggle plays out, however, won’t be determined purely by technical capabilities. Tactics will also play a role, he observes, making outcomes hard to predict. And, as the Chinese manager points out, whereas ZTE prefers not to put all its eggs in one basket, Huawei is known for its aggressive competition and willingness to slash prices. Indeed, rumors persist that Huawei has won a larger-than-expected share of China Telecom’s CDMA2000 tender thanks to a very low bid. If true, that would be much to ZTE’s consternation.
For major handset makers such as Nokia, Sony-Ericsson and Samsung, meanwhile, 3G will bring new opportunities in China, says Denlinger. Such global giants will welcome the opportunity to try out their application services on Chinese users, while Apple’s iPhone will be the most high-profile beneficiary, he predicts. And 3G will open up new avenues for venture capital and private equity. “Most of the major opportunities will come from services which are generated from 3G technologies,” he says. “3G will help mobile change from a mobile phone platform to a mobile computing platform. And with faster download times, there will be another round of services. Venture capital and private equity will go after these opportunities.”
Deng adds software makers to the list of possible beneficiaries from 3G. At the same time, however, he cautions that 3G services face constraints in China. Some of these are regulatory. For instance, whereas Japan’s NTT DoCoMo has done a good job of offering mobile banking services, the same is not true in China, where carriers are forbidden by law from offering a range of banking options services independently of banks. Mobile banking is only possible via cooperation with banks, but costs are prohibitive and carriers are unenthusiastic.
More fundamentally, Deng says that user demand for 3G in China, as in the rest of the world (with the notable exceptions of Japan and Korea), is in fact not very great. Carriers will try to fit foreign ideas to the Chinese context, but past experience in China proves that this will be a hit-and-miss process. Moreover, outside of China’ top-tier cities, lower consumer spending power will hold back demand. In the short-term, he predicts, demand for 3G data services will not be very apparent.
