China and Korea crack down on device subsidies July 11 2014

High end smartphone makers could suffer as China demands lower subsidies, and Korea mandates discounts for low end plans

By Caroline Gabriel

Handset subsidies are one of the most contentious issues in the traditional mobile operator model. Carriers bewail the way they eat into profits but many attempts to ditch the practice have failed because of consumer attachment to the low upfront fee for a high end device. Some operators are devising new approaches, notably by providing instalment payments on smartphones, as in T-Mobile USA's 'Uncarrier' scheme. But in many Asian countries, the decisions are further complicated by government regulation of the issue.

In China, the authorities recently told the three mobile operators that they must slash their marketing expenditure, particularly their high levels of spending on subsidies (as well as advertising), to boost uptake of new 3G and 4G services. The SASAC (State-owned Assets Supervision and Administration Commission) told China Mobile, China Unicom and China Telecom that they must reduce their combined marketing spend by CNY40bn ($6.4bn) over the next three years.

This could create yet another problem for Apple, whose Chinese market share has fallen in recent months despite finally netting a distribution deal with China Mobile, the largest cellco. With no low cost model to offer, Apple is heavily reliant on carrier subsidies to make its iPhones affordable, although it has also embarked on some financing deals of its own.

According to a research note from analysts at UBS, around 60% of handsets sold in China are subsidized, and a shift in this pattern will mainly impact the high end of the market, which accounts for about 20% of sales. Apple has about one-third of this high end segment in 2013. By contrast, reduced availability of subsidies should increase the speed of expansion by lower cost, often local vendors such as Xiaomi, Lenovo and Coolpad.

The three operators, especially China Mobile, have repeatedly complained about the impact on their profits of subsidies, which has been felt since the carriers introduced 3G services with their accompanying more expensive devices. Mobile started selling the iPhone at the start of this year and its CFO, Xue Taohai, says this is one reason why subsidy costs will rise by 29% this year.

In nearby South Korea, the three main cellcos have repeatedly landed in hot water with the authorities over excessive subsides, and earlier this year, all three were suspended from signing new subscribers for at least 45 days, for violating caps on subsidies.

Now the government and the regulator, the Korea Communications Commission (KCC), have introduced new rules, which apply to low end handsets too. The KCC says it will move away from its current subsidy cap of KRW270,000 ($265) per device. Instead, it will reflect the fluid nature of the market by adjusting the subsidy cap every six months based on market factors including competition. The ceiling will always be in the range of KRW250,000 to KRW350,000.

The government has also introduced additional new rules in this sensitive area, requiring operators to offer subsidies for low cost plans as well as the expensive deals attached to costly smartphones. The size of the subsidy will be dependent on the cost of the monthly contract. Carriers will also be mandated to offer discounts to new subscribers who wish to continue using their old devices; to those who were not offered a subsidy when they signed up; and to users of smartphones more than two years old.

The ministry of trade said the changes aim to prevent cellcos from attracting customers to the most expensive monthly plans with top end smartphones at low upfront cost.