Gravy train from China slows

Market no longer a respite from North America for telecom equipment vendors.

Who knows how these things get started?

Was it the slowdown in demand for telecom equipment in other markets that made China seem so hot? Maybe it was that magic number: a largely untapped market of 1.3 billion potential customers. Or perhaps it was the rented police motorcades with their flashing lights and sirens, which whisked wide-eyed executives from their hotel suites to meetings with senior government officials that made the difference.

However it happened, telecom equipment makers have been betting on China to deliver bullish growth in the years ahead, especially with the sluggish markets in North America and the rest of the world because of sharply reduced carrier spending and shrinking economies. But there are signs that equipment vendors could be headed for a rude awakening if they expect the high rates of growth seen in recent years to continue.

These days, the growth of China’s telecom equipment market is slowing as capital expenditures have fallen by nearly one-third, and analysts see no sign of a bonanza for foreign equipment makers.

“This year there is a decline in the equipment market in China, that is very clear,” says Bertrand Bidaud, vice president of telecommunications, Asia-Pacific, at Gartner.

But how can a market often described as one of the world’s fastest growing telecom equipment markets be experiencing a slowdown in growth? The slowdown is the result of several factors. On one hand, the Chinese market is not as large as some might think and competition has grown fiercer, both from overseas and domestic equipment vendors. In the midst of growing competition, the country’s dominant fixed-line carrier was restructured earlier this year and slowed its capital-expenditure spending. Together, these factors have helped put the screws on equipment vendors already faced with tight profit margins from sales in China.

“Chinese carriers have been very adept at squeezing costs out of the system and playing vendors off each other,” says Duncan Clark, managing director of telecom consultancy BDA China.

In addition, signs of slowing growth have begun to emerge in some parts of China’s telecom market. Rural areas in the country, where the overwhelming majority of Chinese live, saw a dramatic slowdown in demand for fixed-line services earlier this year, with growth dropping by 41% compared with the previous year, according to China’s Ministry of Information Industry (MII).

Perhaps the greatest effect on equipment spending has come from dominant fixed-line carrier China Telecom, which in May split into two separate entities: China Telecom and China Netcom.

The new China Telecom operates services in 21 provinces in southern and northwestern China and holds 70% of the national trunk transmission network assets owned by the former China Telecom. China Netcom combines the former operations of China Netcom, Jitong Communications and former China Telecom operations in 10 northern provinces.

This restructuring has occupied the attention of both companies and has helped put the breaks on growing Chinese telecommunications equipment spending. By the end of September, capital-expenditure spending by Chinese telecom companies reached $11.6 billion, a drop of 31% compared with the same period last year, according to MII.

Capital-expenditure spending in 2001 totaled $31.8 billion, up 15.3% from 2000, it says.

“The restructuring of China Telecom had a major impact,” Bidaud says.

“China Telecom is still the major purchaser of equipment in China, and the restructuring pretty much meant that the year was lost for equipment vendors,” he says.

Nevertheless, the outlook for equipment spending and subscriber growth in some sectors of China’s telecom industry remains healthy, even if expected growth rates will be slower than in previous years.

Indeed, sales of synchronous digital hierarchy and wavelength multiplexing optical transport equipment in the Asia-Pacific region is expected to almost doubled between 2002 and 2004.

But questions remain as explosive wireless subscriber growth in recent years has given way to maturing markets and more complex challenges, such as growing market segmentation.

“I think the key question, say in the mobile area, is where are the next 100 million mobile users coming from,” Clark says, noting that China still holds significant potential for growth.

Untethered opportunities

Mobile telecom is one area where equipment vendors continue to win large deals from Chinese carriers. In October, many companies, including Ericsson, Lucent, Motorola and Nortel, signed deals with China United Telecommunications (Unicom) to upgrade its Code Division Multiple Access network to the CDMA2000 1X standard. The announcement of the latest CDMA equipment deals, which are valued together at more than $1.2 billion, will see Unicom expand the capacity of its national CDMA network from 15.2 million to 30 million subscribers.

The deal, which was signed in New York, represents one of the largest single packages of telecom equipment deals that Chinese carriers awarded this year. Its announcement was made to achieve maximum political effect, timed as it was for the day before the arrival of Chinese President Jiang Zemin in the U.S. for a meeting with President Bush.

The rollout of CDMA in China has long been a political issue between the U.S. and China. Various political disputes between the two countries helped delay the launch of CDMA services in China from the mid-’90s until this year, despite the U.S. Department of Commerce’s lobbying efforts, Clark says.

“CDMA has been a political football between the U.S. and China,” he says.

Unicom and the country’s largest mobile operator, China Mobile Communications, operate networks based on GSM. When Unicom received its CDMA license and announced plans to launch a service based on the mobile-communications technology, there were those within the company who saw little sense in offering comparable services based on two different technologies.

“There was resistance and there still is resistance within Unicom,” Clark says.

Unicom’s CDMA service, which covers 330 cities, has gotten off to a rocky start. Launched in January, Unicom had attracted 800,000 subscribers by April, including 440,000 subscribers of an existing CDMA network that Unicom acquired from Great Wall Telecom, a company linked to the Chinese military. During the same period, Unicom added 6 million subscribers to its GSM network, raising questions whether the provider would be able to meet its targets of 7 million subscribers by year-end.

Slow CDMA subscriber growth has continued to plague Unicom. By the end of September, the company put the number of its CDMA subscribers at 2.3 million, still far short of its stated target but closer to analyst expectations of between 3 million and 4 million subscribers by year-end.

Unicom has blamed slower-thanexpected CDMA subscriber growth on a shortage of affordable mobile phones that support the wireless standard. Perhaps hoping to avoid a repeat of that problem when Unicom launches its CDMA2000 1X service by year-end, the company announced in September a deal with Samsung Electronics – which BDA estimates has been losing handset market share to domestic competitors – for 700,000 CDMA2000 1x handsets and said the two companies would collaborate on development and marketing of CDMA phones.

Revenue on the rise

One bright spot for Unicom’s CDMA network is subscriber revenue, which remains higher than its GSM service. For its third quarter, ended Sept. 30, the carrier reported that average monthly revenue per user (ARPU) for its CDMA subscribers was $17.8 billion, more than double the $8.5 billion it earned on average from subscribers of its GSM network.

One main reason for the lower ARPU for GSM customers is the growing number of prepaid GSM subscribers, according to Unicom. Prepaid cellular services let customers pay in advance for a certain amount of mobile telecommunications access, which can be used for either voice or short messages.

Of the 9.1 million new GSM subscribers that Unicom reported during the first three quarters of 2002, 7.5 million, or 82%, were prepaid customers, which typically generate less revenue for carriers than postpaid subscribers. That brings the number of Unicom’s prepaid GSM subscribers to 18.01 million, or nearly 50% of the company’s total 36.1 million GSM subscribers, the company says. Unicom does not offer a prepaid option for its CDMA service.

On the horizon

Looking ahead, Unicom’s CDMA service should receive a boost from the rollout of CDMA2000 1X technology, which offers higher data access speeds and should help attract more subscribers if the experience of carriers in South Korea and Japan is any indication, observers say.

In addition, Unicom has no plans to upgrade its GSM network to General Packet Radio Service capability, which will help to differentiate the carrier’s GSM and CDMA services.

“We see [CDMA2000] 1X being a compelling offering,” Clark says, adding that it is still too early to tell exactly how Unicom’s CDMA2000 1X service will be received and what its future prospects are. “Unicom could still mess this up.”

Even if Unicom’s CDMA2000 1X service fails to win over Chinese subscribers, there will be plenty of other opportunities for equipment vendors in the coming years, analysts say. Growth in equipment spending might be slowing in China compared with previous years but they see no sign to an end of spending on telecom equipment in the foreseeable future as China advances its development plans.

Lemon is a correspondent with IDG News Service’s Taipei bureau.