China restructuring must not kill golden goose

By Tony Brown

The long-awaited restructuring of China’s telecoms market finally seems to be on the horizon, after the ruling State Council agreed last month to split up second-ranked mobile operator China Unicom and create three new integrated telecoms firms.

Under the plan, Unicom would merge with second-ranked fixed-line operator China Netcom and continue operating its GSM networks, while its struggling CDMA operations would be sold to fixed-line leader China Telecom. Mobile market giant China Mobile would buy out small fixed-line operator China Tietong (formerly China Railcom), giving the firm its own limited fixed-line infrastructure.

The timing of the restructuring remains unknown, though many observers say it will most likely occur in 4Q08, and the government has also not fully worked out how to execute the restructuring.

Nonetheless, the goal of the plan is twofold: to create three integrated operators that would operate with greater efficiency than is being demonstrated by the lopsided mobile and fixed-line markets, and to create significantly more competition as China moves toward fixed/mobile convergence (FMC).

The restructuring will probably be followed by the equally as anticipated 3G-licensing process, in which China Mobile will most likely be awarded a TD-SCDMA license and a WCDMA license, while China Netcom/Unicom receives a WCDMA license and China Telecom receives a CDMA2000 license.

Some analysts have said that a key objective of the National Development and Reform Commission, which devised the restructuring plan approved by the State Council, is to make sure that China Mobile’s strength is not compromised by the plan.

However, although the restructuring plan itself does not seriously affect China Mobile, it is clear that the firm will be massively disadvantaged if it is forced to offer the homegrown TD-SCDMA. Even if China Mobile is granted a WCDMA license in addition to a TD-SCDMA license, the government would almost certainly force the firm to focus on TD-SCDMA. (China Mobile has since announced plans to roll out TD-SCDMA in eight cities).

After all, the government has not poured hundreds of millions of dollars into developing TD-SCDMA just to allow China Mobile to put the technology at the back of the store. The government is going to want it front and center.

The idea has long persisted that China Mobile would be the best outfit to operate TD-SCDMA, because of its market strength. The firm added more than 7 million net subscriptions in January, out of total market net adds of 8.9 million, taking its subscription count to 376.4 million in a market of 540 million.

However, those who say China Mobile would not be overly burdened by TD-SCDMA are ignoring the realities that a TD-SCDMA rollout would place on the operator. Sure, China Mobile has extremely deep pockets, but the burdens imposed by TD-SCDMA – such as the new and unproven nature of the technology and the lack of global economies of scale of TD-SCDMA handsets – make its deployment an uphill struggle.

A lesser-quality service combined with expensive handsets could enable rival operators in the newly restructured market to bite back hard against the long-time market king.

China Telecom looks to be the main threat, if the restructuring and 3G licensing proceed as planned and the firm finally gets its hands on a full mobile license, albeit not the WCDMA license it would most like.

China Telecom will seek to bolster its dwindling fixed-line business by aggressively turning around Unicom’s struggling CDMA operations, almost certainly offering heavily discounted tariffs and discounted quadruple-play services.

And China Unicom will also probably be reinvigorated by finally being released from the burden of operating dual GSM and CDMA networks and will finally be able to launch a concerted attack on its longtime nemesis.

Although remaining at a clear financial disadvantage to its bigger rivals, Unicom should be able to use the significant global economies of scale generated by WCDMA to offer much more competitively priced handsets than anyone else. It should also be able to offer the widest and highest-quality range of 3G handsets in the country, given the supply of WCDMA handsets from multiple international and local vendors.

In addition to the disadvantages caused by TD-SCDMA deployment, the industry restructuring would leave China Mobile with a far weaker set of fixed-line assets than either of its rivals.

China Telecom is the runaway broadband-market leader, and even the underperforming Netcom has more than 21 million broadband subscriptions, and both firms have already launched commercial IPTV services.

In comparison, and even allowing for the fact that China Mobile has deployed some of its own fixed-line infrastructure, China Tietong remains a poor cousin in the fixed-line market and cannot compete as anything more than a niche operator.

Therefore, although some people still see China Mobile as a behemoth that cannot be budged from its pre-eminence, it is fair to say that the combination of burdening the firm with TD-SCDMA and the industry restructuring will place huge competitive pressures on the firm.

Given that China Mobile is one of the country’s flagship companies and that the government is eager to see it become a serious player in the global telecoms market, it will be interesting to see how the government reacts if China Mobile starts struggling.

The government might well end up caught between a rock and a hard place, with its commitment to seeing a successful TD-SCDMA rollout and a more balanced domestic telecoms market conflicting with its grand vision of China Mobile as a global giant.

Sooner or later, the government is going to have to make some difficult choices, because it cannot have its cake and eat it too on these strategic issues. It will have to decide whether China Mobile is to be a domestic guinea pig for TD-SCDMA or a global giant.

It really does look like, after years of allowing China Mobile to establish an unhealthily dominant position and of pursuing a hard-headed approach to TD-SCDMA development in the face of all available logic, China’s regulators will finally have to sit down to a banquet full of consequences.