Future of Telcom in China............................
telecoms-mag.com
The Chinese telecom market is one of the most attractive in the world in terms of its enormous size and still untapped potential. On the other hand, it is probably one of the most unpredictable and risky markets for a foreign telecom operator to enter. The implications of investing significant amounts of capital in a country where the political ideology means that a foreign corporation cannot exercise control or ownership over its investments are enormous. In this highly unpredictable market, on what basis can operators plan their business strategies?
CHINESE TELECOM HISTORY
For years, the sole operator in the Chinese telecom market has been the Ministry of Posts and Telecommunications (MPT). It operates under the auspices of the State Council and remains responsible for telecom policy, strategy, and regulation. In 1993, the Directorate General of Telecommunications was spun off from the MPT as the national network operator, but in practice the MPT continues to exercise direct control, in particular over the interprovincial network. At the provincial and municipal levels, the MPT's local Posts and Telecommunications Administrations (PTAs) retain autonomy in planning and operating their local networks.
In March 1994, a more significant threat to the MPT's monopoly came about when approval was given to establish a second national telephony network under the name of China United Telecoms (Unicom). Unicom's strategic ambition is to install a national trunk network based on the private network infrastructure of two of its parents, the Ministry of Railways and the Ministry of Power Industry, and at the same time to build up its local loop access and fixed telephony subscriber base. However, in order to generate the cash flow required to build both the long-distance and local loop infrastructure, Unicom has initially focused on rolling out mobile cellular services, based on the pan-European global system for mobile communications standard (GSM), which can generate significant profits in a relatively short period. To obtain GSM infrastructure equipment, Unicom has entered into a number of joint ventures with key Western manufacturers including Motorola, Nortel, Siemens, and Ericsson. Unicom and the MPT are also adopting code division multiple access (CDMA) as a second digital cellular standard.
To gain access to key switching and transmission technologies for the fixed network infrastructure and the expertise necessary for network management, Unicom signed a long-term strategic alliance with GTE Corporation in January 1995. At first, the MPT tried to obstruct the interconnection of Unicom's cellular networks to their local and trunk networks but, in mid-1995, the Chinese State Council intervened to require an interconnection agreement between MPT and Unicom. In doing so, the State Council elucidated the nature of the relationship between Unicom and the MPT. Although competition had been introduced in order to expand and improve China's telecom infrastructure and services, there remained an essential element of cooperation.
FUTURE ONE
Many analyses of the future growth of telecom in China predict a rapid but essentially teleological increase in demand for telecom over the coming years. In this scenario, in addition to economic and demographic growth in China, consumption patterns of mobile and fixed telephony services in urban areas quickly begin to resemble those of more advanced nations, particularly the United States. A significant change in the rate of consumption might lead to not just significant but explosive demand, which the MPT and Unicom would be unable to cope with alone.
From 1992 to 1995, the Chinese economy as a whole grew by an average of 12 percent per annum. It is likely that it will continue to grow at 9 to 10 percent per annum for the foreseeable future, with some of the richer coastal provinces enjoying a real GDP growth of up to 20 percent per annum. The first ever purchasing power (PPP) figures prepared for China have put per capita GDP in China at more than $2000. If economic growth continues, China would certainly catch up with many Western countries in terms of PPP over the next 20 years. Taking into account the income variations between the richer and poorer regions in China, income per capita in richer provinces is now high enough to allow a sizable increase in mobile cellular telephony services; currently there are approximately four million mobile cellular subscribers, mainly businessmen. Real income growth among the middle-income earners in China is likely to fuel further rapid growth in the number of mobile cellular subscribers. Equally, the rise in GDP per capita will have a significant impact on the number of fixed telephony connections.
Current demographic trends in China should also have a positive impact on the overall growth of the telecom market in China. The population in China is currently growing at 1.2 percent and is likely to continue to increase at a similar rate. More importantly, an increasing proportion of the population will tend to live in urban areas, as people move from rural districts into cities to secure better jobs. It is possible that this will lead to an increasing Westernization of demand for telecom (for example, a constant growth in demand for mobile cellular services, connection of every household to a fixed telephone line, and 65 lines per 100 people overall penetration).
The Chinese telecom market model aims to estimate this demand. For this model, calculations of the potential mobile cellular and fixed telephony markets (from 1996 to 2016) have been based on the following assumptions:
ú A stable population growth based on today's pattern (1.2 percent growth). The proportion of Chinese living in urban areas is expected to increase from 26.2 percent in 1993 to 52.2 percent in 2016, with a corresponding decrease in rural population.
ú A U.S. growth figure of 2 percent per annum has been assumed. Growth in China is assumed to average 10 percent. By the year 2016, per capita income in China will reach 88 percent of that in the United States using PPP.
ú It has been assumed that, as the purchasing power of the urban population in China approaches that of the United States, the number of potential mobile cellular subscribers will also increase at a rate proportional to the rate of increase in per capita GDP adjusted for PPP. Thus, when income per capita in China reaches that of the United States, the penetration rate of mobile cellular services in Chinese urban areas will be equivalent to that of the United States. The target penetration rate includes business use and increases at the same rate as that forecast for the United States, that is, 6.7 percent in 1993 to 40 percent in the year 2016. (The United States has been chosen because of its geographical similarities with China.)
ú For fixed urban connections, the same assumptions as above have been applied, except that the average OECD number of lines per 1000 people (650) has been used as the penetration rate (which includes business use). This rate is assumed not to grow in the future as the average number of persons per urban household is higher in China (approximately 3.5) than the average OECD figure (approximately 2.5). Affordability is thus determined by the growth in GDP per capita relative to that of the United States.
ú For fixed rural connections, the number of rural house holds is used, not the total population, which is used in urban areas because the primary aim in China is to ensure that each household has one telephone line. Therefore, the number of potential households that can afford fixed telephones in their homes is assumed to increase as household incomes pass a threshold of $12,000 per year. The dis- tribution of income is assumed to be normal, which implies that as the average income per households reaches, say, $10,000, 50 percent are able to afford a line. Affordability is thus determined by the growth in GDP per capita relative to this threshold. The number of households in rural areas is estimated by assuming an average of 4.5 persons per household. The number of households thus increases as the total population increases, but decreases as urbanization takes place.
ú This model reveals that China should become the largest mobile cellular and fixed telephony market in the world by the year 2016. Explosive growth is mainly driven by a constantly increasing PPP equivalent in 2016 to 88 percent of the U.S. figure. The number of potential mobile cellular subscribers and fixed telephone connections is expected to reach approxi- mately 252 million and 586 million (421 mil- lion urban lines and 165 million rural lines), respectively. On this basis, the mobile mar- ket (mainly limited to urban areas) is expected to grow at 30 percent per annum, and the demand for urban and rural fixed telephony is expected to grow at 16 percent and 12 percent, respectively. It should be noted that until the rural market reaches maturity in 2009 (when all households pass the threshold income point), it is expected to grow at 17 percent.
It is questionable whether only two operators, the MPT and Unicom, would be able to satisfy such enormous demand alone. In other words, there could be an important capacity constraint in China over the next 15 years or so, given current Chinese legislation allowing only these two national operators to build infrastructure in China. The capacity constraint is likely to be less of an issue for mobile cellular systems than fixed telephony, as GSM manufacturers such as Motorola, Ericsson, Nokia, Siemens, Nortel, and Philips will continue to enter into joint ventures providing technology and capital to develop the necessary infrastructure for the rapidly expanding networks. For fixed telephony, satisfying demand is more problematic. The real constraint in terms of network expansion and customer connection will be the local loop. In dense urban areas, the two operators can continue installing cable into homes, but in suburban and rural areas the problem with cable is more acute, since it takes time to dig roads and pavements, constraining their ability to meet the potential explosive demand. Hence, wireless local loop systems could be the preferred option for suburban and rural areas.
Today, there are several radio local loop systems emerging using both analog and digital radio transmission technologies. The digital wireless local loop systems employ both TDMA and CDMA access technologies and vary in terms of range, data capability, availability, maturity and overall bandwidth requirements. In order to select the right wireless local loop system, Chinese network operators would need to take into account cost per subscriber, range, spectral efficiency, cost of technology, service capability, development flexibility, availability, maturity, and regulatory issues.
As the existing telecom infrastructure develops in China, there will also be a number of other business issues that affect the choice between wireline access and wireless access technologies in the local loop. Some of the key business issues affecting the choice include
ú Operational cost (driven by cost of service provision, repair, maintenance, and cessation);
ú Number of lines supportable by a single employee;
ú Sophistication of network management system;
ú Ease of integration of radio equipment management system with existing network management system;
ú Ease of configuration/reconfiguration;
ú Ease of integration of configuration system with customer management system;
ú Service capability of radio system;
ú Upgrade path and options from day one deployment;
ú Physical space required for remote equipment.
Similarly, given the enormous number of potential subscribers, billing and operations management will require considerable attention. It is expected that as the Chinese economy develops, people's expectations of service quality will go up, creating further pressure to raise standards. Modern fixed radio access systems typically have greater network management sophistication than traditional copper pair networks, thus yielding operational cost advantages in terms of routine testing and fault location. The existence of active electronics at the customer end supports the ability of remote testing of the network interface and thus enables rapid fault detection, resulting in both lower operational costs and a higher grade of service.
Finally, the explosive growth presented in this scenario is an extremely attractive challenge for the two Chinese telecom operators, yet the magnitude of the future market in China is highly sensitive to the economic performance of the country as a whole. If GDP growth were 1 percent lower per annum, this would imply a reduction of 20 percent in number of potential cellular and fixed urban subscribers by the year 2016. However, maturity in the rural market for fixed connections would only be delayed by one year, that is, 2010. Other forces such as urbanization and penetration rate are also very important factors in dictating the size of the market but are themselves largely influenced by economic growth. Bearing these factors in mind, a reduction of 20 percent may even be conservative.
FUTURE TWO
In this scenario, we examine the consequences of growing economic and political divergence between provinces, which leads to increasing local autonomy and eventually the breakup of China as a single nation. Each of the 30 new states becomes responsible for building its own telecom infrastructure. The scenario challenges assumptions about the way the demographic, economic, and political future of China will unfold and, in particular, the perceived wisdom that China will remain a single, integrated, and homogenous telecom market.
In 1992, per capita income in rural areas averaged $1342 per annum, while in urban areas the figure was $3308. Instead of the economy growing evenly over the next 15 years, this disparity might well grow wider, as patterns of industry and trade continue to diverge: The richer provinces might industrialize rapidly while the poorer provinces remained largely dependent on agriculture. This could mean increasing disaffection among rural populations and potentially an unprecedented exodus from the countryside in the coming years. It is likely that the better educated Chinese would move to the cities first, further constraining the ability of the poorer provinces to build industries and infrastructure to improve stagnant local economies. Economic disparities between provinces, rapid urbanization, and dereliction of the countryside would lead to social problems, which many provincial governments may feel are more appropriately and urgently addressed at the local level rather than being left to national policy. Liberalization of markets may be needed in richer provinces while the command economy remains elsewhere. In these circumstances, the State Council would find it increasingly difficult to adopt equitable policies in what would become increasingly disparate provinces. In time, the result could well be a confederation of Chinese states, as has happened in the former Soviet Union.
The key outcome of such a breakup would be that Unicom and the MPT would find it difficult to operate as discrete, homogenous players in a market of 1.3 billion people. Instead, they would be forced to compete in a range of diverse smaller markets, ranging in size from 10 million to 100 million inhabitants. The two operators would no longer be viable as single companies, finding their assets and operations divided between the various provinces. Some of the poorer provinces might merge their shares of the assets of Unicom and the MPT to form locally controlled, autonomous "state telephone bureaus" (STBs). However, some of the richer states (for example, Beijing, Tianjin, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, Sichuan) would be likely to see some advantage of competition in their telecom market and so would allow the provincial Unicom and MPT businesses to continue operating substantially intact. Notwithstanding the actions of the various provinces, both Unicom and the MPT would, at the very least, have to reconsider their organizational structures in light of the new environment.
In such circumstances, instead of facing up to only one competitor in the domestic Chinese market, the new, smaller operators would probably face far greater competition. As well as STBs, foreign competition would be likely, and many new local entrants might spring up to compete in niche markets, including those of paging and two-way messaging services (for example, using POCSAG, ERMES, and other proprietary standards) and localized cordless and cellular-based applications (for example, using PHS, DECT, and GSM/PCS standards). The new provincial operators are likely to be increasingly sensitive to local needs. Rather than competing by offering enormous volume of limited services, it may become more important to offer service variety through, say, broadband technology to provide Internet access, video-on-demand, and other interactive and high value-added applications. A reassessment of the provincial strategic alliances would be necessary, in light of local telecom needs and with a view to ensuring access to appropriate technologies as well as capital.
There would also be important implications for operators' organizational structures. Currently, the MPT and Unicom are organized to compete in a massive, national market, but locally responsive companies might be more advantageous. In certain cases, the now autonomous local companies may attempt to re-establish links with their former colleagues so as to enjoy the benefit of scale-operating efficiencies and better access to capital. Alternatively, they may feel it is better to become "transprovincial" organizations, sensitive to local needs. This raises further issues and questions: How would such organizations be coordinated and controlled? How would information be shared? What sort of trade-offs would need to be made? What capabilities and competencies would need to be built?
Resolution of these issues impacts on the choice of network architecture: centralized or decentralized. A centralized solution might employ a number of high-speed ATM switches linked to all regions via broadband SDH links, the high-speed switches being used to switch all the calls originating in the country. A more decentralized approach would perhaps select a number of switches in each state, thus introducing further redundancy and resilience in the network. In the event of disintegration, the regional STBs would still end up with a network comprising its own switching and transmission capabilities.
FUTURE THREE
This scenario challenges the assumption that the technology flow into China from foreign companies will continue unabated, and we examine some of the outcomes that might ensue. Such a scenario could develop for a variety of reasons and could result in an international ban on exports of Western high technology, including telecom equipment.
Technology transfer from the West is vital to the Chinese telecom industry. Because of the massive demand for telephony services in China, the majority of the two operators' revenues is invested in network construction, leaving only a small amount for technological research and development. This is perhaps more of a problem for Unicom than it is for the MPT, which has been in existence for a longer period. However, Unicom is well-positioned to form strategic alliances with foreign telecom manufacturers, since it is more flexible and less bureaucratic than the MPT.
A ban on the transfer of technology would hit the Chinese telecom industry very hard. In the initial months of a technology ban, the viability of Unicom as an independent concern might be questioned, given its enormous reliance on foreign support. Instead of continuing its development as a relatively autonomous business unit, Unicom might be obliged to fall back on substantial state support. Notwithstanding this, an enormous slowdown in the rate of network rollout is probable, since it is unlikely that Chinese-made digital exchanges and transmission lines would be manufactured fast enough. Many projects might prove difficult to complete without foreign technological assistance, and existing systems that suffered breakdowns or problems might prove difficult to repair.
Given the fact that neither operator, and Unicom in particular, has paid much attention to building its own technology base, each would be obliged to marshal its technological expertise as quickly as possible, initially by consolidating the implicit knowledge gained over years of cooperation with foreign partners and subsequently by systematically investing more in their own R&D facilities. However, given the complexity and cost of telecom research and development, building such capabilities from scratch would be expensive and time-consuming. Large amounts of revenue would be diverted from infrastructure investment, further slowing down the rollout of networks.
Should Unicom survive the initial impact of a technology ban, it is likely that it would be more susceptible to competitive pressure from the MPT. The MPT would be more resilient, given its larger size, and have a better established infrastructure and better political backing. In a competition to develop an indigenous telecom technology capability, Unicom would be likely to lose out to the MPT in attracting the best scientists and building the best facilities.
Nonetheless, it is important to remember that the ongoing opportunity costs of being excluded from the largest telecom market in the world would also be significant for foreign telecom manufacturers. Many foreign companies might lobby their governments to lift the ban as soon as possible. In this case, a technology ban might prove more symbolic than real, causing an initial setback to Unicom rather than total catastrophe.
If this were the case, both operators would still want to reconsider their dependence on foreign technology and their current approaches to joint venture. They might decide to invest more of their profits in R&D in both fixed and mobile network technologies and dedicate more resources to learning from joint venture partners. They might also consider cooperating with both Chinese and foreign telecom firms to develop key technologies such as ATM, synchronous digital hierarchy (SDH), digital exchanges, and TDMA- and CDMA-based cellular technologies. The nature of contracts with foreign partners could be more carefully considered. Research might be sponsored at international institutions so that Chinese staff could learn abroad, while foreign scientists could be employed or sponsored in Chinese laboratories.
The MPT should give thought to its current methods of working with incompatible systems and standards imported from different countries. Unicom, on the other hand, might take advantage by building an integrated system based on an SDH transport mechanism and ATM switching technology and by increasing its expertise in internationally approved open standards.
Simon Learmount is a director at International Group, a consultancy specializing in the healthcare industry. Behrooz Rashidzadeh Remmer is a consultant at Scientific Generics, a business technology consulting firm based in Cambridge, England. Dr. Remmer is responsible for business development in the communications division. He can be contacted at telelphone +44 1223 875200, fax +44 1223 875201, or by e-mail at bremmer@scigen.co.uk.
This paper is based on a project carried out at the Judge Institute of Management Studies, University of Cambridge. The authors would like to thank Henri-Jean Bourgeois, Ying Li, Ji-ou Liu, Rene Voogt, and Tony Cooper for their contributions. |
