The Chinese Telecom Industry: On The Road to Stable Growth?

Yuanzhe (Michael) Cai, an analyst with Parks Associates of Dallas, TX

For China Business Intelligence.

Part I

The Chinese telecom market has witnessed remarkable growth in the past five years, thanks to the economic and industry reforms of the Chinese government.

The number of fixed-line and mobile users increased from 111 million in 1998 to 421 million in 2002–almost four-fold growth in five years. The compound annual growth rates (CAGR) for fixed-line, mobile, and Internet users between 1998 and 2002 were 25%, 72%, and 130%, respectively. In 2002, China passed the United States to become the No. 1 mobile market in the world, and China Mobile and China Unicom currently rank as the No. 1 and No. 3 largest mobile carriers in the world.

The accelerated telecom industry reforms during the past decade also completely changed the competitive landscape of the Chinese carriers market. Before 1994, the Ministry of Posts and Telecommunications (MPT) was responsible for both the administration and operation of the posts and telecom industries. It provided telecom services through its operational arm, China Telecom. Challenged by proliferating private networks and pressured by dissenting consumers and several powerful Ministries, the Chinese government officially embarked on its deregulation process in 1994 by introducing a new competitor – China Unicom – to the telecom services market.

However, China Unicom could hardly compete with China Telecom because of the close tie between the MPT and China Telecom. Four years later, the government decided to separate the administrative and operative duties of the MPT; the administrative functions were merged into the new Ministry of Information Industry (MII) and the operational arm, China Telecom, became a telecom carrier independent of the MII.

Subsequently. the MII took two large-scale industry reshuffling actions targeting the monstrous China Telecom. The first reorganization in 1999 stripped the mobile, paging, and satellite businesses from China Telecom and made the Company primarily a monopoly of fixed-line networks and services. The second split happened in May 2002, when China Telecom was split geographically; 30% of its network resources and ten subsidiaries in north China were merged into China Netcom Group, and the 21 subsidiaries in south China retained 70% of the networks and formed the new China Telecom Group.

Through these reforms, China's telecom industry has changed from a highly regulated market dominated by the monopolistic China Telecom into a market featuring limited competition–all in less than ten years.

Currently there are six major telecom carriers in China%G—%@China Mobile, China Telecom, China Netcom, China Unicom, China Railcom, and China Satcom, ranked in the order of market share. None of the carriers has a market share of more than 40%, and in each business segment, including the fixed-line market, at least two carriers are competing with each other.

Despite such remarkable progress, many analysts and observers think that the Chinese telecom market is murky and difficult to decipher.

Part II

Despite such remarkable progress, many analysts and observers think that the Chinese telecom market is murky and difficult to decipher. Especially in 2002, the declining CAPEX (capital expenditures) of Chinese telecom carriers has prompted debate on the future prospects of the Chinese telecom market.

Although some analysts continue to believe that the Chinese telecom market is still a land of gold, others argue that the growth of telephone users will soon reach a ceiling and opportunities in the Chinese telecom market are disappearing. In addition, critics are uncertain of the government's future reform and deregulation plans.

Within China, various topics are being debated with great intensity. Such topics include the effectiveness of the second industry reorganization in 2002, the relationship between the MII and telecom carriers, the necessity of stipulating a telecom act, the gray areas of current regulations, conflicts of interests between state and public ownership of listed telecom carriers, issues of interconnection and universal service funds, the timing of third-generation (3G) commercialization and its relationship with granting new mobile licenses and selecting 3G standards, etc.

Such confusion by and large stems from two transitions that the Chinese telecom industry is currently experiencing. The first transition is from limited competition to effective competition, which calls for less direct government influence, more market-oriented decisions, and perhaps the introduction of new carriers.

This is not an easy task to achieve because the six major telecom carriers are majority-owned by the Chinese government and hasty deregulation may damage the interests of state ownership. Moreover, deregulation is a complex task: the MII, policies and regulations, management systems of current telecom carriers, and industry structure all have to be changed.

Many times government officials want to make progress, but given the formidable challenges of restructuring, they don't know how. Once again, the Chinese government has decided to take the "middle way" balancing the interests of parties affected by the reforms and developing the market through restricted competition. The process is likely to be slow, and confusion is inevitable.

The second transition is from a period of explosive growth to a period of mature growth. As the user bases for these services have grown larger, the growth rates for fixed-line and mobile users, which peaked in 2000, have declined. China's fixed-line and mobile services markets are now entering a mature growth stage, and accordingly, the CAPEX of telecom carriers will stabilize.

In fact, Chinese telecom carriers' aggregate fixed asset investment peaked at about $32 billion in 2001 and declined by more than 20% to about $25 billion in 2002. There is no reason to panic about such a decline. China is a country where the telecom infrastructure and service provisioning were not able to satisfy even the rudimentary communication needs of individual and enterprise consumers until the mid-nineties.

During the past several years, major Chinese telecom service providers were focused on catching up with network infrastructure constructions -- on average they spent about 50% to 70% of their total revenue back into fixed asset investment, whereas that percentage is usually less than 20% in most developed countries.

Intensive customer recruitment followed the heavy network constructions, and now that the customer base has reached a respectable level, naturally the Chinese carriers will shift focus towards generating more revenue through new and better services. Such a shift, coupled with the effect of decreasing equipment prices, has contributed to the decline of CAPEX. Nonetheless, they will continue to invest at a steady pace, at around $24 billion per year for the next three years.

The Chinese telecom market still promises tremendous opportunities for international telecom carriers and equipment vendors, but given the transition to more stable growth, it is extremely important for these companies to have a holistic and objective perspective of the market. Moreover, they have to understand which market segments promise the best growth opportunities.

Part III

Before China's reentry into the WTO, only foreign equipment vendors were allowed to invest in the Chinese telecom industry, and international telecom carriers were banned from accessing the market.

China's WTO accession has changed that scenario: China's telecom carriers market will gradually open to foreign investors, in the order of value-added services, basic mobile services, and basic fixed telecom services.

Geographically, the Chinese government will first open the market in three super-sized cities -- Beijing, Shanghai, and Guangzhou, then 17 big cities, and finally the rest of the country.

The basic guideline is to first open the most competitive markets and then the less competitive ones. In 2001, AT&T established Shanghai Symphony, the first sino-foreign telecom carrier joint venture, and the Company began providing services in 2002.

The latest news says that SK Telecom and China Unicom will soon establish a wireless-Internet joint venture to support China Unicom's advanced data services based on the CDMA1X platform.

More partnerships like these may appear in 2003, as foreign investors are now allowed to invest up to 49% in value-added service providers and 35% in basic mobile service providers in 17 cities.

One caveat is that foreign carriers have to find a partner in order to provide telecom services in China, for the WTO schedule stipulates a maximum equity stake of 50% for foreign investment. Therefore it is important for interested companies to start early shopping for Chinese partners with the best experiences and relationships, preferably one of the six major telecom carriers.

In addition, foreign investors have to understand issues such as the mindset of the Chinese government in terms of further reforming the telecom industry, China's fulfillment of WTO commitments, the competitive landscape and growth opportunities in different service markets, and the characteristics and strategies of the major Chinese telecom carriers.

For equipment vendors, the most important thing is to identify where the money is going, especially now that the CAPEX of Chinese telecom carriers is stabilizing. Different markets will see different growth patterns. Broadband Internet market will be a red-hot spot for investment in the next couple of years. The broadband services market has been experiencing spectacular growth -- according to the MII, China's broadband users grew by 230% to 6.6 million in the second half of 2002.

Moreover, foreign equipment vendors have to understand two important trends:

1) Chinese telecom carriers are undergoing a major mindsetchange, shifting their focus from network construction to service provisioning, from backbone to edge networks, and from fixed CAPEX to success-based or variable CAPEX (e.g. CPEs);

2) Chinese equipment vendors have dramatically increased their R&D capabilities and competitiveness in the past decade, and foreign vendors need to identify the best strategies to cooperate with these indigenous vendors -- they have to balance their competitive and cooperative strategies according to specific situations.

In order to understand the complex Chinese telecom market and the implications of these two transitions, Parks Associates recently published Chinese Telecom Market: Overview and Analysis. This comprehensive report identifies opportunities for international service providers and equipment vendors by analyzing the current competitive landscape, the regulatory changes in the service market, and future strategies of the dominant carriers.

The report provides detailed analysis of different market segments such as fixed-line, mobile, and broadband Internet. Its unique Chinese perspective clarifies the Chinese government's thought process and agenda on economic reforms and helps readers understand key success factors of doing business in China.