CDMA growth in China

The FT this morning has a profile of the innovative management of China Telecom, the CDMA carrier in the PRC.

From what the article says, the Ministry of Information Industry's grand reorg of the Chinese telecommunications services sector — reallocating mobile licenses and consolidating weak operations with strong ones — seems to be having the desired effect. Competition is intensifying and firms are investing heavily in rolling out 3G infrastructure, both depressing profits.

In the reorg, China Telecom inherited the 2G CDMA operations run by Great Wall (a People’s Liberation Army affiliate) that became part of China Unicom. CT has been rolling out EV-DO, but many assumed that with its US technology it would be at a disadvantage compared to China Unicom (with GSM/W-CDMA) and China Mobile (the dominant carrier, using China’s home-grown TD-SCDMA).

However, the FT says that China Telecom has the highest growth of the carriers, jumping from 28m to 44m subscribers. (By comparison, China Mobile has 500m). To quote FT:

Analysts say China Telecom has established itself as the best run of the three telecoms operators.

“They are much more of a pragmatic, commercial animal than the political animal of China Unicom,” says Duncan Clark, chairman of BDA, a telecoms consultancy in Beijing.

The article credits the company’s research lab (China Telecom Shanghai Research Institute), and a company-wide innovation initiative that encourages workers to be more innovative in developing and packaging mobile services. The company runs an annual internal innovation contest, while engineers are sent to the provinces to work with regional marketing reps to understand the market.

Obviously it will be a while before China Telecom threatens China Unicom (142 million subscribers), and it seems unlikely to directly challenge China Mobile. Still, Qualcomm (and the global cdma2000 ecosystem) are fortunate to have drawn such an innovative ally in the world’s largest mobile market.

FUD against EV-DO in China

W-CDMA supporters in China are running a campaign of fear, uncertainty and doubt (FUD) against EV-DO efforts there, in a rehash of their strategies from the 2G CDMA wars.

In the great 3G reorg of China last year that created three mobile operators, China Unicom got GSM/W-CDMA, China Telecom got CDMA/cdma2000 and China Mobile got the homegrown TD-SCDMA. On January 7, all three were awarded their 3G licenses after more than five years of delay.

In a story on China Unicom’s plans to sell the iPhone in China, Forbes included some commentary on China’s three-way fight for 3G market share:

Unicom was given a WCDMA (Wideband Code Division Multiple Access ) license. China Mobile, which holds a commanding 74% share of domestic subscribers, obtained TD-SCDMA (Time Division Synchronous Code Division Multiple Access), a homegrown 3G standard based on spread spectrum technology that is different from approaches used in the West). And China Telecom was allowed to develop CDMA 2000 (a hybrid 2.5 or 3G technology which built on code division multiple access, or CDMA, technology used worldwide.
…
Among the three, China Unicom's WCDMA is regarded as the leading 3G approach. What's more, it's the only 3G technology used by the iPhone.

This sort of FUD marketing strategy is a classic technique by a dominant player to marginalize competitors. IBM in the 1970s was credited with inventing the strategy for the tech industry, and of course Microsoft used it against open source software or other rivals in the 1990s.

Perhaps cdma2000 1x is a 2.5G technology ala EDGE. The fights between GSM and CDMA camps over what should count as “3G” caused a fair amount of disagreement.

But certainly EV-DO — as fast as W-CDMA’s HSDPA — is a 3G technology. This year China Telecom has issued a series of tenders for procuring EV-DO equipment. The company is preparing a new round of handset tenders and can brag about superior data performance.

So to say China Telecom is only developing “2.5G” is a lie. The claim about W-CDMA being the leading technology is true from an adoption sense, if not from a standpoint of technological performance.

I wasn’t there, so I don’t know where the reporter got the bad information. The Chinese equipment suppliers are the least likely suspects, since leading firms like Huawei and ZTE provide equipment to all three of the major standards: W-CDMA, cdma2000, and TD-SCDMA.

However, based on the bitterness of the GSM vs. cdmaOne (or W-CDMA vs. cdma2000) fight, the most likely suspects are those who want to commercially weaken cdma2000 and China Telecom. That leaves either rival operators (China Unicom, China Mobile) or foreign W-CDMA equipment providers such as Nokia and Ericsson.

CDMA success brings Chinese royalty gripes

Taking a page from their Korean counterparts, in the face of rapidly growing sales, Chinese cellphone manufacturers are airing complaints through local propaganda organs in hopes of lowering their contractually obligated CDMA royalties.

Last year, a reorg of China’s telecommunications industry brought dominant landline provider China Telecom the opportunity to offer 3G mobile services using Qualcomm’s cdma2000. On Wednesday, China’s official Xinhua news service reported good news for Qualcomm and its local licensees:

Under the stimulation of China Telecom's large investment and procurement this year, the growth of China's CDMA cell phone market will be great, said an industrial insider. Competition will heat up as many GSM mobile phone manufacturers are entering the CDMA field, he added.

China's CMDA cell phone market rebounded in the end of 2008 despite gloomy market conditions. According to statistics released by market research firm Sino-MR, sales volume of CDMA handsets topped 1.29 million during December 2008, up 33.6 percent year on year and 183 percent month on month, marking a five-year high.

However, the report ended with a complaint about the royalty rates

Insiders with China Telecom consider China an important market for CDMA business and expect Qualcomm to realize the market condition and give more supportive pricing. Qualcomm refused to comment.

When in 2000 Irwin Jacobs negotiated government permission for CDMA to be used in China, Qualcomm granted Chinese manufacturers the best rates in the world — around 2.65% as opposed to 5% for other makers. (Qualcomm neither discloses nor confirms its royalty rates).

In fact, this deal has brought continued griping by Korean manufacturers paying list price. The Korea Times has run one-sided stories since 2004 airing selective leaking by the unhappy manufacturers. For example, it ran a March 2004 story (no longer on their website) entitled “Qualcomm's Royalty Policy Angers Korean Chip Makers”:

U.S. chipmaker Qualcomm’s royalty policy has angered Korean manufacturers of code division multiple access (CDMA) phones as it charges lower rates to China than to Korea.

A local CDMA phone maker contends that Qualcomm gives a “subsidy” to Chinese exporters as it collects as low as 5 percent of handset prices in royalties from them. But the rate is 5.75 percent for Korean makers.

Korean cell phone producers, which pay a fixed 5.75 percent for export and 5.25 percent for local sales to the San Diego-headquartered firm, shoulder higher royalty burdens in both domestic and global markets.

According to a contract between Qualcomm and one of China’s leading handset manufacturers, which The Korea Times obtained exclusively, the royalty rates are 2.65 percent for local sales and 7 percent for offshore shipments.

However, the contract says the export royalty will be cut to as low as 5 percent after the three years immediately following the license effective date.

The deduction ranges from 5 percent to 6.5 percent, depending on quarterly export volume, but the Chinese firm is entitled to enjoy the low rates “if more than 100,000 such subscriber units (handsets) are sold in the applicable calendar (year)” in overseas markets.

The KT report said that Chinese manufacturers signed a 10-year agreement in “early 2001,” which would mean these deals will be expiring in 2011.

A review of Qualcomm’s 2001 press releases reveals this May 21, 2001 announcement:

Qualcomm Incorporated … today announced that it has signed a commercial license with ZTE Corporation, a leading manufacturer of telecommunications equipment in China. Under the terms of the royalty-bearing license agreement, Qualcomm has granted ZTE a license under Qualcomm's CDMA patent portfolio to develop, manufacture and sell cdmaOne™ and third-generation (3G) CDMA2000 1x/1xEV network equipment. The license grants ZTE the right to use Qualcomm's technology and integrated circuits to make and sell cdmaOne and CDMA2000 equipment in China and worldwide. ZTE becomes the first company in the People's Republic of China to enter into a commercial license with Qualcomm.

Additional manufacturers signed licenses in July and November, with the latter including Huawei. Another 17 Chinese firms signed in January 2002.

The Xinhua story seems designed to help Chinese manufacturers (or China Telecom) pressure Qualcomm to lower royalties on the current deals, or at least when the licenses come up for renewal in two years.

Interestingly, there is no complaining about the GSM royalty rate, which is also secret. One report estimated the rate at 2-10%. However, data from the various Sendo-related lawsuits put the number more like 10-13%, suggesting that single-digit GSM royalties are only available to firms with big enough patent portfolios to negotiate a cross-license. Thus far, only a few Chinese manufacturers have enough patents to possibly put them in the latter category.

China will/won't allow cdma2000

Back in November 2000, I needed a case to teach political risk. So I wrote one about Qualcomm's on-again, off-again relationship with the Chinese government and state-owned carrier China Unicom — the one that eventually allowed Unicom to offer cdmaOne 2G mobile phone service in China. (My teaching case “Qualcomm in China” was used to flesh out the China portion of Dave Mock’s Qualcomm book).

Last month, the Chinese government unveiled a master reorg of telecommunications carriers is realigning six companies to three, each of which will have a wireline and mobile operation. China Unicom will be broken up, and its CDMA operations sold to China Telecom (the dominant wireline carrier) while its GSM network will be sold to China Netcom. One estimate places the value of the CDMA network at $13-15 billion.

But after that, nobody can agree on what’s happen — which exactly makes the point of the original case that a lack of policy transparency creates high risk and uncertainty for Western firms operating in China.

Among the disputed predictions that are the source of so much speculation:

• Will it create real competition for China Mobile, which with nearly 400 million subscribers is the world’s largest cell phone operator? An expert interviewed by the FT said “There will be no way to create a real three-way fight – China Mobile will still be the big one standing alone” but the market pummeled China Mobile shares on the assumption that it will have real competition.
• Supposedly having three carriers means three 3G licenses will be issued, solving a long-standing problem in Chinese telecom policies. Some say (as has been long predicted) it will happen in time to showcase Chinese wireless technology for the 2008 Olympics, but others say it won’t happen until 2009.
• Many say it clears the way for every carrier to deploy TD-SCDMA, but TheStreet speculates that all three types of 3G will be deployed: TD-SCDMA with China Mobile, W-CDMA with China Netcom and cdma2000 with China Telecom. With this plan, CT would have a huge time to market advantage because the cdma2000 upgrade is faster and cheaper, while China Mobile would deploy the least proven technology (one it has been trailing for several years).
• Reportedly one expert claims that China will skip 3G to 4G (see the comments on this post). It would certainly make sense technologically — allowing China to skip a generation of infrastructure development and giving its manufacturers a huge leg up on 4G equipment deployment. The problem is that the comment is attributed to Willie Lu, a prolific wireless researcher who is well connected and well trained (although a lousy webmaster), but a 4G promoter based in America who speaks for himself and not the Chinese government.

So will there be a TD-SCDMA? Will Qualcomm make any money from it? As with a year ago, everything is still up in the air.

Qualcomm is notoriously secretive in disclosing its royalty terms, which makes it difficult for researchers like me but also leaves it vulnerable to accusations of violating the non-discriminatory part of RAND patent licensing terms. One report I thought curious was an account Friday that claimed that China Telecom signed a deal with Qualcomm to pay CDMA royalties at 4%.

Reviewing my notes from the Qualcomm in China case, it’s clear that report is wrong. The list price for QCOM’s patents is known to be in the 4-5% range. I reported back in 2001 that on behalf of Unicom and its suppliers, the Ministry of Information Industry (MII) negotiated Irwin Jacobs down to 2.65% for handsets and 1% for infrastructure. So there’s no way the MII-led reorg will cause China Telecom to pay 4% royalties for Unicom’s existing 2G network.

China's 3G plans

In February 2001, I made my first (and thus far only) visit to China, to research Qualcomm’s efforts in China. The result was an MBA teaching case “Qualcomm in China,” published in two parts by Ivey Business School (A and B) and in a slightly different form by the Asian Case Research Journal (DOI: 10.1142/S0218927502000257 and DOI: 10.1142/S0218927502000269). This case is the basis for the China market entry discussion in the 2005 book The Qualcomm Equation.

When I finished the visit (and the research), the one thing I was itching to follow up on was China’s plans for its own 3G standard, TD-SCDMA. It was obviously a big issue: direct efforts by the Chinese government to delay 3G deployment and protect access to its market to help Chinese firms develop a national (and nationalistic) technology, to help Chinese firms gain privileged market access and (as with DVDs) pay less in foreign patent royalties.

Also interesting was the role of Siemens. By then, it was already an also-ran in the global mobile phone industry and thus were transferring technology to the Chinese in hopes of gaining market access; since then, they sold their handset business to BenQ (a business that then went bankrupt) and transferred their infrastructure to a joint venture with Nokia.

I really wanted to follow up on this — it was a top goal of mine, since this was obviously the next big standards battle, both in terms of market size and also as a technology policy issue. But I lacked the funds, time and language skills to pursue it, so put it aside to do “someday.”

This week I’m attending DRUID, the main European academic conference on the economics of innovation. I was fortunate to meet Hui Yan (or as they would say in Singapore, YAN Hui), a doctoral student of my friend Prof. Bent Dalum at Aalborg University in Denmark. Hui spent 4 years working for mobile phone companies in China, including Motorola and Nokia.

Hui is doing her dissertation on TD-SCDMA development and policy, focusing on the complex interactions between the Chinese government, domestic operators, domestic manufacturers and foreign manufacturers. At the DRUID conference on Wednesday, she presented a paper summarizing her findings thus far. She describes the long complex path that the Chinese government has taken in nurturing and protecting TD-SCDMA.

Today, China has no 3G service, while more than 450 million subscribers are using 3G in 134 countries worldwide. GSM carrier China Mobile once hoped to roll out WCDMA service in 2004. As with CDMA carriers in Japan and Korea, China Unicom could presumably upgrade from cdmaOne to cdma2000 at any time it wants.

Hui reports that both major carriers would prefer to use the upgrades to their existing technology (presumably because they prefer proven solutions than relying on the unproven new technology.) However, she reports that China’s MII has again delayed 3G another year to 2008 (or later) so that TD-SCDMA will be viable before any 3G licenses are awarded. Writing as from a Chinese perspective, she laments that this “Chinese” technology only has 7% of its patents held by Chinese firms, versus 66% by the three big European manufacturers (Nokia, Ericsson, Siemens).

As with the rest of the world, 3G is being pushed by manufacturers looking to sell multibillion dollar infrastructure upgrades; in this case, this is the shared interest of foreign and domestic manufacturers, even if they prefer different technologies. Meanwhile, absent proven demand for 3G services, the Chinese carriers would prefer to just keep growing their market penetration.

Technorati Tags: 3G, CDMA, China, TD-SCDMA

How much will Qualcomm make from TD-SCDMA?

Qualcomm had partial success selling CDMA to China, as I recounted in a teaching case called “Qualcomm in China” (that later was used to flesh out the China portion of Dave Mock’s Qualcomm book). Alas, for Qualcomm, cutting the royalty rate in China for Chinese manufacturers has brought a nonstop round of threats (and bluster) from Korean manufacturers and their allies in the press and the government.

For years, Chinese telecommunications officials have been vowing to introduce its own 3G technology that has a different set of patents than the Qualcomm’s cdma2000 or the Euro-Japanese W-CDMA. Now the goal is to have a live network in time for the Beijing Olympics. On Tuesday, unstrung reported that the country’s largest carrier, China Mobile, plans to let a $3 billion contract for TD-SCDMA equipment, with European firms hoping that local partnerships will give them a slice of the business. For most carriers, not having a license would be an impediment, but I guess being a state-owned enterprise means never having to say you’re sorry.

The idea that China could design a CDMA technology that doesn’t overlap Qualcomm’s hundreds of CDMA patents seems implausible. On the other hand, as with any other question of foreign IPR in China, it’s not clear how many patents have been granted in China and how (or if) they would be enforced by the courts.

Western firms have agreed to pay Qualcomm royalties on TD-SCDMA, but the intentions of Chinese firms are far less certain. One possibility is that Chinese firms will pay a lower rate domestically but close to a standard rate for export. This would be consistent with Qualcomm’s 2G policy. I don’t think it really matters whether it’s because Qualcomm has less patents granted or whether its patents are less enforceable. I would rule out two other motivations: that vendors have their own patents has not swayed Qualcomm in the ongoing W-CDMA disputes, and a claimed lower ability to pay has not led it to cut royalties in India below its standard 5% rate. (I never quite understood the “ability to pay” argument for a percentage royalty, since cheaper phones pay lower royalties).

Qualcomm doesn’t seem to be saying much about TD-SCDMA royalties, and I’m sorry to say I didn’t think to ask about it at last week’s annual meeting. I wrote the earlier “Qualcomm in China” cases because the twists and turns of Qualcomm’s 2G efforts in China struck me as an ideal illustration of the concept of political risk. Given the impact that uncertainty had on Qualcomm’s stock price nearly a decade ago, my surmise is that they’re waiting until things are resolved before commenting.

Technorati Tags: China, patents, Qualcomm, TD-SCDMA