Research Brief Chinese Cellular Phone Vendors Are Catching Up Abstract: Cellular phone manufacturing is becoming a major driver for electronic equipment growth in China. By Chang-Soo Kim Recommendations Cellular phone vendors in China need to be aware of and prepare for increased price competition in the near future. This will arise because of an expected increase in inventory from a rapid production ramp-up and from lessening demand caused by severe acute respiratory syndrome (SARS). Domestic and foreign cellular phone vendors based in China should concentrate on reducing time to market, improving distribution and improving quality and reliability to succeed in the Chinese cellular phone market. Successful vendors must be able to change their production quickly to meet fast-changing consumer preferences in China and to reinforce their position in China's vast cellular phone market. Publication Date:12 June 2003
2 Chinese Cellular Phone Vendors Are Catching Up Introduction Cellular Phones The Biggest Contributors to China's Electronics Industry The Chinese cellular phone industry has experienced high growth in demand since the introduction of cellular services. Carriers have deployed countrywide Global System for Mobile Communications (GSM) and code division multiple access (CDMA) networks. Because of this, demand for mobile terminals has exploded. As a result, the mobile communications manufacturing industry is leading China's overall communications sector. China has 37 licensed handset vendors, and another dozen potential vendors are waiting in the wings, pending a relaxation of government licensing restrictions, which will likely take place before year-end 2003. Most of the license holders are solely domestic; however, the bulk of production is from licensed joint-venture companies. Basically, foreign manufacturers had to partner with the domestic companies to be permitted to produce in China. Table 1 lists the top 10 domestic companies in China. Table 1 Top 10 Domestic Companies' Cellular Phone Sales to End Users in China, 1999-2002 (Thousands of Units) Rank Company 1999 2000 2001 2002 Growth (%) 2001-2002 1 TCL 18 221 1,140 5,501 382.5 2 Bird - 850 2,300 2,812 22.3 3 Xiaxin - - 45 1,100 2,344.4 4 Haier - 190 800 750-6.3 5 Eastcom 12 267 120 730 508.3 6 Kejian 5 310 1,220 704-42.3 7 DBTEL - - 15 600 3,900.0 8 Konka - 85 175 400 128.6 9 Legend-Xoceco - 473 140 400 185.7 10 Capitel - 150 200 361 80.5 Source: Gartner Dataquest (June 2003) China produced about 109 million units in 2002. This about 22 times the number of units produced in 1998. Cellular phone production revenue in 1998 was $1.1 billion, representing only 1.8 percent of China's total electronic equipment production revenue. In 2002, cellular phone production revenue grew 13.4 times to $14.5 billion, representing 11.1 percent of China's total electronic equipment production. These growth figures illustrate the importance of the mobile phone industry to China. Government Support in the Mobile Communications Industry China announced its "Promotion Plan for the Development of the Mobile Communications Industry of China" under a decree of the State Council in 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 12 June 2003
January 1999. Accordingly, the Chinese government has a plan to promote the development of an independent domestic manufacturing base for mobile terminals to allay foreign dominance of the terminal business in China. Furthermore, the plan promotes exports and strictly controls illegal activities such as the contraband trade of cellular phones and their components. Under the policy, the government urged the domestic cellular phone vendors to advance themselves in sectors such as the design of cellular phones, application software, and design of core chips and protocols. In addition, the policy encourages the cellular phone component industry to mass-produce core components such as liquid crystal displays, lithium ion batteries, nickel metal-hydride batteries, layer-built resistors, condenser accessories, layer-built inductors and printed circuit boards. The government support can also help domestic companies to master cellular phone technology and expand their skill sets to incorporate MP3, PDA or digital still camera functions to next-generation cellular phones. However, domestic cellular phone vendors still rely heavily on global manufacturers for key components and software. Most domestic vendors have also been shielded from heavy investment in R&D, with the exception of TCL and Xiaxin. This situation will evolve with further technology transfers and deeper participation and integration of global vendors in the Chinese market. However, it should also be recognized that global manufacturers approach "knowledge transfer" with caution, given the risk of loss of intellectual property and commercial know-how through poorly defined or undersupervised cooperation agreements. Chinese cellular vendors will continue to rely on second-tier South Korean and Taiwanese original design manufacturer cellular vendors. The partnership with South Korean and Taiwanese cellular manufacturers will, for the most part, remain strong for at least another two years. 3 Gartner Dataquest Perspective The proliferation of cellular vendors active in China indicates that the handset price wars are set to intensify and continue for some time. The heavy discounting by local brands marks efforts by vendors to increase market share and, in some cases, to dispose of old inventory. Such strategies are suitable for a limited time, since at some point vendors must achieve critical economies of scale to put their businesses on a sustainable footing. Inevitably, the smaller handset vendors with weaker brand equity, smaller volume, fewer in-house design or distribution resources and poor profitability will be absorbed by the larger players or go out of business. The influx of new handset vendors obtaining manufacturing and sales permits in China, and the removal of restrictions on domestic sales, will accelerate this process. This influx of new handset vendors will be in addition to the current joint ventures. The influx will be a gradual rather than sudden process as the government progressively loosens regulatory controls and preferential local industry policies in line with its commitments to the World Trade Organization (WTO). 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 12 June 2003
4 Chinese Cellular Phone Vendors Are Catching Up The increasing commoditization of the handset business worldwide has allowed local vendors in China to exploit consumer electronics business models and pull together the necessary components, software, design and integration skills to stage an accelerated drive into a business that has traditionally been characterized by high entry barriers. Owing to the rapid growth of the domestic cellular phone market in China, the manufacturing of cell phones has also dramatically increased. We predict China's share of worldwide cellular production will rise from 24 percent in 2002 to 40 percent in 2007. This growth is likely to arise from the healthy local market, aided by foreign vendors' investment. Most foreign vendors are considering China as their production base to cut their manufacturing costs and to serve this important market. Being a local manufacturer has its advantages and benefits. The domestic vendors in China have built a strong sales network and are sensitive to local consumers' preferences. Furthermore, local vendors can quickly develop new products to adapt to consumer trends in China. Finally, local vendors have a competitive edge in their strength in local marketing and after-sales service. The major challenge facing the global cellular manufacturers in China is to match the efficiencies and economics of the Chinese-brand distribution networks. This is especially true as cellular market growth moves out of the urban areas to rural China, where local brands carry as much weight as the major international brands. However, while the domestic cellular phone vendors of China have recently made dramatic leaps, Chinese domestic cellular phone suppliers do not have direct access to core cellular phone technology. This could put them at a disadvantage. Chinese suppliers use imported components to build their phones. This includes important items such as baseband integrated circuit chips and displays. Furthermore, most domestic suppliers do not have their own design facilities. Numerous foreign cellular phone vendors are planning to invest in the Chinese cellular phone industry. Not only could they produce phones for the world market at a low cost, but they could also expand their market in China and Asia/Pacific. Foreign capital invested in the Chinese cellular phone industry during the past three years totaled more than $10 billion. Major companies such as Motorola, Sony-Ericsson, Nokia, Samsung Electronics and Sanyo have established joint ventures with the local companies in China (see "Will 100 Handset Vendors Bloom in China?" TCMC-WW-FR-0130). In particular, Motorola plans to invest $10 billion to build a cellular phone production base in China in 2006. In addition, it also plans to purchase $10 billion worth of cellular phone components in China starting in 2006. Nokia has already invested $1.2 billion in the first Beijing Xingwang project and will invest $1.2 billion in the second project. At year-end 2003, the Chinese government's protection policy for domestic vendors will end. At that time, most foreign vendors will still need to work closely with their Chinese partners to maintain their market share. 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 12 June 2003
5 However, other foreign vendors will end their cooperation with domestic vendors and participate directly in the Chinese domestic market, and the market will become more price-competitive. While domestic phone manufacturers are gaining shares in the domestic second-generation (2G) phone industry, they also are already investing and accelerating their R&D of third-generation (3G) mobile communications systems. The government is also keen to develop its telecom industry and minimize royalty payments to overseas patent holders such as Qualcomm, Ericsson and Nokia. The 3G market will become a new competing ground for domestic and foreign companies. Domestic vendors will no longer have a price advantage because of the changes in government policy, whereas the foreign companies will not yet be able to determine which standard the Chinese consumers want. Basically, cellular phone design is undergoing some fundamental changes to meet the function and performance requirements for 3G and 2.5G mobile voice and data. Cellular phone specifications affect the semiconductor components and these, in turn, determine the viability of cellular phone architectures. Opportunities exist for semiconductor vendors that can provide components to support or enable these new architectures economically, either through highly integrated stand-alone chips or modules. Continued demand for mobile phones in China depends on gaining new subscribers and on the handset replacement market. Important factors in the development of the market include: China Mobile's general packet radio service China Unicom's high-quality CDMA service expansion China Telecom and China Netcom's joining in the market The positive effect of China's WTO membership on China's economic growth The boost the 2008 Olympic Games in Beijing will give to China's economy Conclusion We predict that about 19.9 percent of China's population will have cellular phones in 2003, equivalent to approximately 53 million net new connections in 2003. China's cellular phone penetration rate was only 16 percent in 2002, and demand has recently been affected by SARS. However, domestic and foreign vendors continue to increase their production by expanding capacities. Hence, problems of increasing supply and inventory are rising in the cellular market, and this can be expected to trigger a fierce price war among cellular vendors in the Chinese market this year. Phone manufacturers learned early on that they could not compete in 2003 Gartner, Inc. and/or its Affiliates. All Rights Reserved. 12 June 2003
6 Chinese Cellular Phone Vendors Are Catching Up China based on price alone. When domestic vendors cut prices, the global suppliers were able to more than match the discounts and offer higher functionality, foreign-branded devices. Domestic vendors then moved upmarket and leveraged their own market knowledge and distribution resources to challenge the global vendors where they were weakest. This is a critical time for global handset vendors to take stock of the challenges they face and respond to evolving market conditions. Local phone manufacturers are getting stronger in the market, and foreign vendors will need to recognize the following developments in China: Chinese consumers prefer fashionable designs, localized features and customized attributes; local vendors view the appearance of the product as absolutely critical in customer buying decisions. Local vendors regard mobile handsets as consumer products, rather than specialized high-tech communications devices. New distribution channels will evolve after the debut of local brands. As government protectionism will be phased out soon, it will be interesting to see how the industry plays out. But one thing for sure, domestic Chinese phone manufacturers cannot be ignored even in the world's market during the next few years. Key Issue What is the electronic equipment production forecast for Asia/Pacific? This document has been published to the following Marketplace codes: SEMC-WW-DP-0293 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. 115457