Apple, Samsung Face China Telco Freeze-Out

| About: Apple Inc. (AAPL)

Cost-cutting pressure is putting a squeeze on China's 3 big telcos, creating an unusual set of conditions that could claim smartphone giants Samsung (OTC:SSNLF, Seoul: 005930) and Apple (NASDAQ:AAPL) as victims. The latest signs of trouble for the world's 2 largest smartphone makers comes in the form of an article in the English language China Daily newspaper, calling on China's big 3 mobile carriers to stop offering packages with Samsung and Apple smartphones, and instead only offer models from domestic manufacturers like Lenovo (OTCPK:LNVGY, HKEx: 992), ZTE (OTCPK:ZTCOF, HKEx: 763; Shenzhen: 000063) and Huawei. Further evidence of the pressure the telcos are feeling comes in an unrelated report which has the trio denying reports that they're preparing massive layoffs.

The bigger story is that China's 3 telcos are seeing profit growth slow sharply or even contract as their mobile market matures and most of the country's 1.3 billion people now have service. What's more, the trio of China Mobile (CHL, HKEx: 941), China Unicom (CHU, HKEx: 762) and China Telecom (CHA, HKEx: 728) are all spending billions of dollars to build new 4G networks, and millions more to promote 4G services by selling handsets at subsidized prices.

Like many large state-run companies, the 3 telcos all count Beijing as their biggest stakeholder, and thus are somewhat obliged to follow directives from the central government. Most recently, the government has ordered the trio to cut their costs by trimming promotional spending (previous post). That means they'll need to cut back their practice of purchasing bulk volumes of phones from different smartphone makers and then offering those phones for cheap prices to consumers who agree to long-term service plans.

Now it appears the government is guiding the telcos specifically to reduce their buying from foreign smartphone makers, based on signals coming from the state-owned China Daily, which often functions as a government mouthpiece for a foreign audience. A new headline on the front of its business page proclaims "Smartphone subsidy cuts to lift local firms", and goes on to say the telcos should end their practice of subsidizing phones from foreign manufacturers like Apple and Samsung (English article).

The story quotes an analyst with an unnamed telecom research organization in Beijing, which could easily be one of the many quasi-government bodies that advise the government. Such bodies wield huge clout in formation of government policy, and in this case, it's quite easy to see why Beijing might want to force the telcos to give most or all of their subsidy dollars to the domestic manufacturers.

While Apple and Samsung focus on the higher end of the market and are both quite profitable, the same isn't true for the growing number of Chinese firms that have piled into the market over the last 2 years. Most of those, including Lenovo, Huawei and Xiaomi, are squarely focused on the mid- to lower-end of the market, and have been locked in a nonstop stream of price wars that are rapidly eroding their margins.

Against that backdrop, it's not difficult to understand why Beijing might want to use the telcos as a policy tool to support struggling domestic smartphone makers. Many observers might argue such a move represents discrimination against foreign firms, and China has recently been accused of similar discrimination after a series of anti-trust investigations targeting mostly foreign firms (previous post).

I mentioned the denial of plans for massive layoffs by the Chinese telcos at the top of this post, so I'll briefly return to that in closing, which again shows the pressure the carriers are facing to cut costs. Those reports are brief, with the carriers collectively denying any plans to lay off some 300,000 workers (Chinese article). Such cuts do seem unlikely, since Beijing leaders are worried about growing unemployment as China's economy slows. But cutbacks to subsidies for Apple and Samsung phones seem far more possible, and could easily begin later this year.

Bottom line: China's 3 telcos are likely to trim their bulk purchasing of Apple and Samsung smartphones as part of a Beijing campaign for them to cut costs and support domestic manufacturers.

Disclosure: None.

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