Research Brief Little Smart, Big Plans: PHS Storms Ahead in China Abstract: Based on personal handyphone system technology, Little Smart has emerged as one of the fastest-growing services in the telecom sector, but new mobile licenses in China will temper its expansion. By Bertrand Bidaud, Ann Liang and Andrew Chetham Recommendations Vendors of limited mobility solutions should take advantage of this rapidly growing segment before it begins to slow down in 2004. Vendors should expect growing competition and market slowdown to affect margins after 2004. After 2004, vendors should offer China Telecom and China Netcom solutions to manage their user base over multiple technologies fixed lines, wireless local loop and third-generation (3G). Publication Date:8 August 2003
2 Little Smart, Big Plans: PHS Storms Ahead in China Introduction A technology seldom used in other parts of the world has created one of the fastest-growing services in the rapidly expanding Chinese telecom market. The number of subscribers of Xiaolingtong, or "Little Smart," doubled to more than 13 million during 2002. The service accounted for 38 percent of China Telecom net subscribers add for the first five months of 2003. Little Smart uses personal handyphone system (PHS) technology and is regarded neither as pure fixed wireless local loop (WLL) or as a true cellular service. It's sold as a low-mobility, low-cost mobile service. It doesn't support roaming. The service is especially attractive to fixed services carriers because it fills a licensing gray area. The carriers that offer Little Smart, China Telecom and China Netcom, don't have mobile licenses. Yet, the government has allowed its rapid expansion, in competition with existing cellular services offered by China Mobile and China Unicom. From a seemingly small niche service that provides a cost-efficient solution for basic communications in rural areas, Little Smart has taken center stage position in the emerging competition between all of China's carriers. For a detailed analysis of Little Smart, see "Wireless Local Loop: Cellular in Waiting?" TCPS-WW-FR-0141. China Telecom and China Netcom expect to be granted mobile licenses when the 3G licensing announcements are made probably not until early 2004. In the meantime, for these carriers, Little Smart represents a way into the market and an avenue for subscriber growth as public switched telephone network (PSTN) connections slow, as outlined in "China's Booming Telecommunications Market Could Lose Speed," TELC-WW-DP-0295). Key Issues for the Future How Quickly Can Little Smart Grow? Until recently, the combined effect of government control of the competitive environment and China Telecom's concern that it would cannibalize its own future cellular business has led the carrier to focus on rural areas. In particular, until recently, Little Smart was not deployed in the main provincial cities, let alone in Beijing or Shanghai. But this is changing. As 3G licensing has been delayed, China Netcom and China Telecom are keen to move Little Smart from a defensive service (to curtail cellular expansion) to a more offensive one (to take business away from cellular operators). The strategy is shifting. A milestone was reached when the service was launched in a district of Beijing on 10 March 2003. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 8 August 2003
The move to the cities seems to lift one of the last hurdles for the development of Little Smart. The Ministry of Information Industry (MII) has indicated it would neither encourage nor oppose it, against what China Mobile and China Unicom requested. Yet, the move to the cities has also highlighted the weakness of the services. Cellular operators (China Mobile, in particular) reacted by cutting the rates of the cellular services through special promotional efforts to thwart the main competitive advantage of Little Smart. But even more important than the launch of the service in the cities, it could give operators new freedom to manage their service portfolios, which would help not only sustain the growth of Little Smart but also possibly accelerate it. The number of Little Smart subscribers reached more than 13 million at the end of 2002. Gartner Dataquest expects this number to climb to slightly more than 29 million at the end of 2003, with the momentum accelerating thanks to the move to more urban areas. Potential Regulatory Hurdles Uncertainty has followed Little Smart since its inception. As the service has gained in scale and popularity, the uncertainty has decreased but not disappeared. For instance, distributors have reported that new Little Smart users have been asked to sign an agreement with China Telecom acknowledging that the carrier will not be liable for any potential closure of the Little Smart network. The service owes part of its success to government policy not as a result of a government decision but of a laissez faire attitude exploited by China Telecom and now China Netcom. Government policy might include compensation for the delay in issuing mobile licenses to these carriers. Because Little Smart is not classified as cellular service, it is not subject to the same constraints in particular, rate control as Global System for Mobile Communication (GSM) or code division multiple access (CDMA) services. This gives Little Smart a significant tariff advantage, and it has used this advantage to spur its growth. With a leadership change at MII, new policies will be formulated. While Gartner Dataquest does not expect Little Smart to be closed down, or even deployment to be regulated (a possibility until recently), MII policy could undermine Little Smart's development in several ways. One such policy change (and one that is overdue) that would have a negative impact on Little Smart would be for MII to grant freedom to mobile operators to set their own tariffs. In this case, the tariff advantage enjoyed by Little Smart would be reduced. China Telecom and China Netcom could possibly follow with lower rates that Little Smart, but a price war is unlikely, as the two carriers want also to develop a profitable cellular business alongside their fixed-line business. 3 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 8 August 2003
4 Little Smart, Big Plans: PHS Storms Ahead in China Considering how capital-intensive the first few years will be, China Telecom and China Netcom will need all the revenue they can get from the mobile service to justify the investment. Their long-term interest is not to lower the rates of cellular services. Migration to Data Services The launch in Taiwan of a similar service (by First International) illustrates the potential competitiveness of Little Smart as a mobile data service. Gartner Dataquest estimates that 14 percent of average revenue per user (ARPU) was generated by data services at the end of 2002. In mainland China, these value-added services haven't been launched yet on a large scale. Technical feasibility is not the main issue market demand is, and all the more that the service is targeting the low-end segment rather than early adopters of technology. The first step will be to develop short messaging on a large scale. Other value-added services such as e-mail, mobile information and wireless Internet are not expected to play a significant role for the next two years. What Happens When Full Licenses Are Awarded? Gartner Dataquest believes that 3G service in China should not only be understood as a high-speed cellular data service, but also as a plain new spectrum that will be used to grow the voice market beyond its alreadyextraordinary size. Therefore, the potential overlap between 3G service and Little Smart is real. The commitment of China Telecom and China Netcom to the service will be tested once the licenses are handed out. There is a risk of capital drought: Developing a mobile service that can compete with one offered by more mature competitors will be expensive. Gartner Dataquest believes that China Telecom and China Netcom will want to exploit the value and current user base of Little Smart to improve its competitiveness but will primarily focus investments on the cellular service. Under such a scenario, the growth of the service will slow significantly from the second half of 2004 onward. We do not expect the service to be closed or investment to disappear in the mid term. The awarding of cellular licenses to China Telecom and China Netcom will allow them to provide intercity roaming and thus raise the value of the service in the eyes of consumers. Gartner Dataquest expects China Telecom and China Netcom to promote this service to move upmarket. Nonetheless, we do not expect the carriers to push roaming aggressively because it may cannibalize their own cellular service and would test the limit of the Little Smart network. Gartner Dataquest expects that high-spending Little Smart users will be offered an attractive migration scheme to move to the new 3G services, and they could potentially generate more revenue for the carriers. Therefore, for the initial years, we expect that the two services will be complementary in the following manner: Little Smart will target low-end users by offering a higher-priced competitive service. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 8 August 2003
5 What Does the Near Term Hold? High-end Little Smart users will be migrated to 3G services. Gartner Dataquest's outlook for the next 12 months is as follows: We expect China Telecom and China Netcom to promote Little Smart aggressively, which will result in subscriber growth climbing nearly 100 percent. A new focus will be on the large cities, not just Tier 1 regions such as Beijing, Shanghai and Ghangzhou, but also (and mostly) Tier 2 areas. We expect China Railcom to introduce a similar service, but as a late entrant, the carrier will have a difficult time gaining traction. We expect Short Message Service (SMS) on Little Smart to be a growth driver in 2003. What Will the Market Look Like in 2005? Gartner Dataquest expects to see the following market conditions in 2005: Subscriber growth will have slowed significantly as China Telecom and China Netcom will have started to migrate high-end Little Smart users to their 3G service. The carriers will segment the two services to minimize cannibalization. Little Smart will be focused on acquiring new mobile customers, while the 3G service focuses on ARPU growth and the acquisition of China Mobile and China Unicom subscribers. Initially, China Telecom and China Netcom wireless subscribers will be mostly from Little Smart, but corporate focus and investment will be on the 3G service. Little Smart's value-added service will be available nationwide, but it will generate less than 15 percent aggregate ARPU. The focus of Little Smart service deployment will be in the western portion of the country. Competition between China Unicom and China Mobile will focus on the high-end market segment, leaving Little Smart relatively untouched by the initial commercial launch of 3G service. What Will the Market Look Like in 2007? Gartner Dataquest expects to see the following market conditions in 2007: Little Smart service revenue will decline as subscribers migrate to 3G service. Little Smart service will remain most popular in the western part of the country. The service will be discontinued in some Tier 1 and Tier 2 cities. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 8 August 2003
6 Little Smart, Big Plans: PHS Storms Ahead in China Gartner Dataquest Perspective Little Smart's strong momentum will continue until the end of 2004. Significant growth potential exists in large cities in the short term and most remote areas in the longer term. But Gartner Dataquest believes that from 2005 onward, the momentum will be limited as carriers focus on their new 3G services. Key Issue Who are the key players in the public network service marketplace, and how do they differentiate themselves in terms of market position, image, strategy, product and focus? This document has been published to the following Marketplace codes: TELC-WW-DP-0579 For More Information... In North America and Latin America: +1-203-316-1111 In Europe, the Middle East and Africa: +44-1784-268819 In Asia/Pacific: +61-7-3405-2582 In Japan: +81-3-3481-3670 Worldwide via gartner.com: www.gartner.com Entire contents 2003 Gartner, Inc. and/or its Affiliates. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice. 116640