By Ming Shuliang

From Caijing Magazine

China’s massive telecommunications sector and the world’s largest population of mobile phone customers stand at the threshold of the 3G era.

Now, the telecom operators responsible for investing in and developing 3G (third generation) mobile services are wondering whether China will embrace the technology, or stumble at the doorstep.

China officially adopted 3G standards January 7, capping nearly eight years of debates, when the Ministry of Industry and Information Technology awarded 3G licenses to the nation’s dominant telecom operators China Mobile Communications Corp. (HKSE: 0941), China Unicom Ltd. (HKSE: 0762), and China Telecom Corp. Ltd. (HKSE: 0728).

Each telecom will base a new network on a separate 3G standard. And each standard will require specific equipment for transmitting and receiving mobile services touted as faster and superior to those available through current 2G (second generation) systems.

According to State Council statements and the licensing announcement, the government chose to support three, separate networks to promote balanced market competition, China’s homegrown 3G technology, domestic consumption and telecom investment.

But questions remain. Some wonder how the domestically developed 3G technology can succeed if two foreign technologies are introduced to create market balance. Others say operators may be sacrificing profits for the sake of spurring domestic consumption. And the most common question is also the broadest: “What will 3G bring to China?”

Since China is the first country to simultaneously introduce three, separate 3G standards, the government’s licensing process has been something of an experiment in market building.

To foster competition, decision-makers chose to award a license for the strongest 3G technology to the weakest telecom, and vice-versa.

Access to the mature, Japanese technology called WCDMA (Wideband Code Division Multiple Access) was granted to China Unicom, the smallest of the three operators.

China’s market leader China Mobile won TD-SCDMA (Time Division-Synchronous Code Division Multiple Access), also known as TD, a domestic technology that’s been undergoing local market tests for months but has yet to be formally launched nationwide.

And the country’s No. 2 operator got the middle-rung technology, as China Telecom was licensed for CDMA2000 (Code Division Multiple Access 2000).

Some argue that China Mobile lost its competitive edge in the assignments, where were designed to create a level playing field. The telecom giant is stuck gripping a pistol, the argument goes, while its competitors are armed with rifles.

“Despite TD’s well-received market response, the technology is still in its infancy,” China Mobile Vice President Lu Xiangdong said recently at the company’s internal meeting.

To protect its massive market share, China Mobile is now promoting its own cell phones and prepaid service plans among existing 2G customers. The strategy is aimed at binding current customers and minimizing client churn tied to the 3G introduction.

“Our strength lies in our 2G business,” Lu said.

Adopting separate standards is also expected to disperse the industry’s resources, said a source with China Mobile’s sales department.

“Market forces will eventually guide firms to make decisions based on profits,” the source said. “Equipment providers will invest in a network that is most profitable.”

Meanwhile, smaller operators China Telecom and China Unicom have set ambitious goals for 3G. China Telecom Director Wang Xiaochu said his company’s target is 100 million users, while China Unicom said it’s aiming at a 30 percent share of China’s 3G client base.

Domestic Technology

But China’s interest in 3G goes deeper than tapping a vast consumer market. Adopting the mobile phone technology also gives the country a chance to promote TD, which was developed by Chinese researchers. TD’s original purpose was to reduce the country’s dependence on Western technology.

During the final stages of discussion prior to their issuance, some experts suggested awarding TD licenses to all three operators. China Mobile liked the idea.

Yet issuing only TD licenses would have undermined the technology’s growth and development cycle, said Lu Tingjie, a professor at Beijing University of Posts and Telecommunications. Moreover, he said, a politicized licensing process would have invited international criticism.

Besides, Lu said, China can improve its balance of trade with other countries by adopting foreign technology that requires telecom equipment imports. And some say debates over 3G standards overlook the fact that the next step in mobile technology – 4G – is right around the corner.

“3G cannot achieve much success in China,” said a source from China Mobile’s marketing sector. “Given a lack of revolutionary advancements in 3G’s network speed, bandwidth and efficiency, many believe 3G is only a transitional technology leading to 4G.”

Indeed, the major telecoms have already voiced plans for so-called 3GPP Long Term Evolution (LTE), a pre-4G technology in its infancy. China Mobile’s Lu said the system may be commercially launched in just four years, leaving 3G in the dust after a brief lifespan.

Telecom Investments

China’s latest investments in 3G stand apart from the telecom scene in the rest of the world, where markets have been torn by the world economic crisis. Goldman Sachs has predicted that the worldwide telecom market will shrink 15 percent in 2009.

China’s licenses are expected to spur investments worth 280 billion yuan over the next two years, said Li Yizhong, the minister of industry and information technology, at a December meeting.

China’s growth is “good news for firms in the industry, including telecom operators, equipment providers, mobile phone manufacturers, operating systems providers and content providers,” said Wang Qindai, CEO of Hurray! Holding Co. Ltd. (NASDAQ: HRAY), a telecom service provider.

UBS analyst Wang Jinjin said combined investments by China Mobile, China Telecom and China Unicom will reach 100 billion yuan in 2009.

3G Investments by Major Operators, 2009

China Mobile started testing TD networks in eight cities in April 2008, prompting the other operators to place huge equipment orders in the second half of 2008 to speed preparations for 3G licenses. Equipment providers such as Huawei Technologies and Ericsson were major beneficiaries.

“Heated market competition raised capital input in many sectors,” said a China Mobile source. “When competitors started large-scale promotion and network-building, market forces will pressure other players to boost spending for marketing and networks as well,” the source added.

Domestic Consumption

The government also hopes 3G will increase domestic consumption to offset a decline in China’s exports and slowing overall growth for the nation’s telecom industry.

The telecom industry grew 7 percent over the first 11 months of 2008, down from 11 percent for the same period 2007, as fixed-lined and mobile phone customer bases moved closer to their limits.

As information highways and conduits for culture, Lu said, mobile networks can have the same economy-boosting capacity evident in infrastructure building. Evidence can be found in the GDP growth posted when new technologies were introduced to the fixed-line sector in early 1990s and the mobile phone sector in 2000.

But there are among telecom operators. Some say such predictions are dangerous since 3G technology’s returns have been unsatisfactory in other countries.

“Where’s the business?” asked Sinolink Securities analyst Chen Yunhong. “Networks can be built quickly. But what business can we bring to the market?”

A wireless network, for example, merely replaces a fixed-line network and has been called a limited market innovation.

Hutchison Whampoa Ltd. (HKSE: 0013), a prominent Hong Kong telecom, has yet to enjoy a profit increase from its European 3G investments, which began in 2003. Market speculators predict China’s 3G business will follow in the footsteps of the European market and get a cold reception, at least in the short term.

Europe’s 3G technology relies on wireless broadband services, while China Mobile and China Telecom have chosen to launch networks with wireless cards for notebook computers.

China Unicom, the only telecom that’s dared to predict profits from the new 3G market, plans to break even after the first year and turn a profit in the second, said company Chairman Chang Xiaobing.

But analyst Chen thinks Chang is too optimistic. “This goal is easy to achieve if they transfer revenues from their GSM (2G) network to the WCDMA network,” Chen said. “But it’s a tough goal if they only count on business from WCDMA.”

Meanwhile, some analysts say current macroeconomic conditions have cast a dark shadow over the 3G market.

“Average citizens will save on these (3G) non-essential expenses,” said UBS analyst Wang Jinjin.

Yet optimists see long-term profits. Wang of Hurray! said it will take two years to see economic benefits because time is needed to launch networks, popularize 3G phones and build the large customer base needed to create 3G “user crowds.”

“Only when the user scale reaches a level of 30 to 50 million will the positive effects of commercialization emerge,” Wang said.

Launch Phases