China syndrome: huge volumes squeeze handset margins to US$1.50

In a new research report, Ovum says China’s burgeoning mobile market can be highly lucrative for those handset manufacturers that manage to make an impact,, but at the same time, intensifying competition has driven gross margins per unit to a minuscule US$1.50 - massively down on the US$90 that was the norm back in 2004.

Given the huge competition from both domestic and international brands, the question is "How can a handset manufacturer ensure its survival and potential prosperity in the Chinese market? Well, according to Tracey Chen, a seniopr analyst at Ovum, the answer is making the right connections.

“Some handset providers have focused on volume, others on carving out higher-margin positions,” says Chen. “Handset providers need to set-up appropriate partnerships to execute these strategies.”

According to Chen, three basic types of operator partnerships exist in the Chinese market and handset providers have to find the right balance to suit their needs.

The first type is based upon having the operators control the handset’s user interface and pre-load devices with proprietary applications and value-added services. With this, handset providers stand to benefit from operators’ sales networks and commitments to a minimum number of units purchased. It is the most common form of operator partnership in China, with examples being Lenovo, which jointly launched its LePhone smartphone with China Unicom. The LePhone is targeted at the same segment of consumers as Apple’s iPhone, but comes pre-installed with applications from China Unicom.

The second form of partnership entails cooperation with content and application providers.

One example is Sony Ericsson’s provision of legal music tracks for its music-centered handsets. Another is Nokia’s agreement with popular Chinese video website TuDou, to launch a handset with a pre-installed widget for that portal. “This strategy creates differentiation and a selling point for attracting users in targeted segments. It has already seen some success, particularly in the youth segment,” says Chen.

The third form of partnership is one with which many in the developed markets will be familiar – having the handset provider act as an enabler for third-party developers. Apple, RIM and Nokia have taken this route. However, such a strategy does pose a risk, says Chen. “All the mainland Chinese operators have launched their own application stores, which compete with handset-based offers,” she points out.

A case in point here was China Mobile’s ability successfully to negotiate an agreement with Nokia to ensure that users favoured the operator’s application store. “The operator’s leverage in this case is partly due to aggressive handset subsidies that will prove expensive to maintain. Chinese operators are reluctant to become bitpipes, but with handset providers expanding control of the user interface, it’s hard to imagine this trend being reversed,” says Chen.

The first type of partnership would be more beneficial for weaker brands, Tracey Chen says, but handset providers should strive to develop their products and engage in the second and third types of partnerships.

“The player that controls the user interface will win the lion’s share of margin,” says Chen who is of the opinion that handset providers are currently in a stronger position than the operators.