Hard Cell

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Cong Qihua, a former farmer who migrated from impoverished Anhui province to seek a better life selling vegetables from a stall in the outskirts of Shanghai, is, in his own way, upwardly mobile. Back in Anhui, he made about $120 a year. Today he and his wife make that much in a month. Still, the pace of his days is not so different. He has no reason to dash about, like many of his fellow Shanghainese, with a cell phone pressed to his ear. "Why would I need one of those things?" asks Cong, who is in his 50s. "It's hard for me to figure out how to use them. I can't read. Besides," he adds, "I can't afford one."

China's 1.3 billion population helped the country to rocket from backwater to the world's biggest mobile phone market, with nearly 200 million subscribers, in just a few years. (The U.S., in second place, has about 150 million.) But now, the law of large numbers is working against the country's cellular duopoly, China Mobile and China Unicom. Earlier this year, China's heady subscriber growth rate started to sag; after surging 60% in 2000 and 88% in 2001, growth this year is projected to fall to 40%. Suddenly China isn't the world's hottest market—that's India, where annual growth this year is expected to top 80%.

Cong is one of the reasons why China may be maturing before its time. Less than 15% of the population subscribes to cellular service, which suggests plenty of room for expansion. But carriers have already picked off the low-hanging fruit—nearly half of the residents of the country's wealthy coastal cities have mobile phones, analysts say. Now, China Mobile and China Unicom must fight for customers who, like Cong, are a harder sell. "The demographics are shifting to farmers and laid-off public-sector workers," says Shiv Putcha, an analyst for the Yankee Group, a Boston-based research firm, "none of whom represent ideal target markets for cellular services." Indeed, while existing customers have average monthly incomes of $200, potential customers only make $81 a month—close to the urban national average—according to a survey of Chinese living outside the largest cities by Credit Suisse First Boston (CSFB).

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The trend is already reflected in the amount of money customers are paying for monthly service. China Mobile's average revenue per user in September was $14.25, less than half the level of 1999 and far lower than the $60 to $80 users pay in the U.S. and Japan. That translates into lower overall profitability, and once-bullish analysts are growing more cautious about the prospects for China's mobile sector. Both CSFB and Goldman Sachs recently downgraded shares in China Mobile and China Unicom, which have fallen 21% and 34% respectively on the New York Stock Exchange this year.

Vast untapped market or no, China is proving vulnerable to the same woes plaguing cellular operators in more developed countries throughout the world, including cell phone-crazy Japan and Hong Kong where once-torrid growth rates have tapered off. Chinese carriers have already joined the parade of telcos worldwide that have slashed investments in their networks. China Mobile, which controls 70% of the market, is cutting capital spending this year by almost 20% to $6.5 billion. The company says it will spend even less, $5.3 billion, in 2004.

To a less-receptive consumer add another complication: cut-throat competition. In an effort to grab market share, China Mobile and China Unicom are already circumventing government price regulations through handset subsidies and other backdoor give-backs. According to CSFB analysts, China Unicom even appears to be cannibalizing its existing customer base of GSM subscribers because of incentives designed to attract users to its new high-speed wireless network, based on a transmission technology called CDMA.

Making matters worse, China's two huge fixed-line operators—China Telecom and China Netcom—have jumped into the fray by offering a cheap alternative to cellular service via a wireless technology first introduced in Japan in the 1990s. Called the Personal Handyphone System in Japan but renamed Xiao Lingtong (Little Smart) in China, the service doesn't allow callers to roam outside their area code and reception is often poor. But per-minute charges are about 1 and only the caller pays, compared with the 5-a-minute charge assessed both caller and receiver by the established mobile carriers. Although fixed line operators China Telecom and China Netcom are technically prohibited from competing in the wireless arena, their Xiao Lingtong services have garnered about eight million customers, and both are reportedly considering expansion into the key Beijing market if regulators do not object.

In the long run, China remains a key global market. "We may not reach the (penetration rate) of Hong Kong," says Peter Lovelock, director of Beijing-based consultancy MFC Insight, "but there is no reason we can't get to 40%." Already, one-fourth of the world's cellular phones are sold here, and there are still plenty of customers like Shanghai high school student Song Yuyun. "Out with the old, in with the new," she said recently as she examined a sleek new phone to replace her older model. "I should be coming into some money over Chinese New Year." If only China's silent majority had the same expectations.