The Coming Upheaval In the Chinese Handset Market

The National Development and Reform Commission, China's super-ministry whose purpose is to drive the nation's economy forward, has just issued final approval for four new Chinese consumer electronics companies to begin making handsets, adding to the 80-odd manufacturers already in the market.

You could argue that the last thing China needs is another four mobile handset manufacturers. And you'd probably be right. People far wiser than I have been saying for a long time that there is a major shakeout coming in this market, and that in the end the 80 odd device makers will probably be whittled down to a round dozen or so.

Voting for the Market
I see something very positive in the NDRC's move. The senior economists and policy makers at the NDRC are not stupid - they know that China's mobile handset market - no matter how big it is - cannot hope to support nearly a hundred companies in the business. Frankly, I doubt the entire world, with a billion handsets made each year, could support a hundred handset makers.

The message that the NDRC is sending in this move is that rather than select champions to support and force the rest out of business, they are letting the market decide who will survive. Will this mean cannibalistic hypercompetition among manufacturers? Absolutely. But the thinking is that the companies that DO survive will be better suited to compete both locally and globally than they would if the winners were selected by the bureaucrats.

The Coming Agony
If anything, this move hastens the day when the big shakeout begins. Now, we've already seen some manufacturers depart the market completely. Mitsubishi appears to have packed up and left, Siemens (SI) is gone, its successor BenQ is on life support, and others are on the edge.

Here are the challenges that face the market:

1. 3G is coming (yes, really): Not all companies will find it easy to shift from producing GSM-based phones to producing phones based on 3G, especially TD-SCDMA. Some will never make the shift, relegated to fighting for scraps at the bottom of the mobile food chain.

2. Picky consumers. China's mobile handset buyers - regardless of whether they are first-time buyers purchasing basic handsets, style-conscious fashionistas, or wealthy young executives buying the newest, coolest handheld hypergadget, are expecting more and more from their devices. Delivering handsets with the mix of design, features, and experiences that appeal to consumers is no easy trick, and the chances of getting it wrong are growing. Smaller manufacturers won't be able to afford mistakes - a couple of mediocre handsets, and they'll be gone.

3. Market tempo: Tastes change fast out here, and your average handset owner picks up a new phone every 15 months or so. You have to move extremely fast to keep up with changing demand. Maintaining a reasonable level of innovation and product development will exact a brutal cost on companies, and many - if not most - of the current crop of manufacturers won't be able to keep up.

4. Economies of scale: Being able to sell a given design, feature, or handset across a global market will mean lower prices, even at the high end. The bigger manufacturers will deliver better value for the dollar. Period. At the low end, where economies of scale are everything, the kind of scale that Motorola, Nokia, and Samsung can bring to the party is going to be difficult to match. A lot of companies are going to engage in bloody price wars to try to hold onto the low end of the market, while the big boys can turn out cheap phones at a profit all day long.

5. Retail: Up till recently, phones have been sold in a bazaar-like environment in stores large and small around the country. The war for retail space and for the attention of the consumer is getting intense: the major manufacturers are making large investments in improving the retail experience across the board. This is no longer about how much display space you get - rather, it is about who can make buying the handset more enjoyable. Motorola is way out ahead in China with its flagship stores. Nokia is following, and Samsung will probably do so as well. The question is, can new licensee Fujian Furi or any of the other smaller manufacturers manage the same?

The Winners Will Be...

We can be pretty sure of about ten companies that will make it across the divide: Motorola (MOT), Nokia (NOK), Sony-Ericsson, Samsung, LG (LPL), Sanyo (SANYY), Ningbo Bird, ZTE, and a couple of the larger original device manufacturers [ODM]. Beyond that, it's going to be anybody's guess.

A number of fates await the losers, not all of them dismal. Sure, some companies might go out of business. Others will merge with competitors to form larger players, move into specific niches or vertical markets, or move into other parts of the business: parts, accessories, and specialized devices like cellular modems and Wi-Max receivers. Many will wind up as either subsidiaries of or suppliers to the winning companies.

As the mobile handset market grows and evolves around the world, the value chain is becoming larger and more complex, offering more opportunities in these areas. What the NDRC needs to be looking at is ways to ease the transition of the companies to something new once they've been squeezed out of the handset business.

Here is the ultimate result, and I'd wager this is what the NDRC is betting on: China will be the global center of the mobile handset industry, not just in manufacture and consumption, but in research, design and development as well. If the cost of that is a little creative destruction, that's a price the NDRC is (and should be) willing to play.

Comments

[omooc]

Excellent commentary. I read, some time ago, that what is under development is incompatible with current standards in the west. If so, how does this impact research and development? omooc