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China's iPhone Fans Find a Way

As Beijing consumers snap up hacked versions of the popular phone, Apple bides its time in striking a deal with authorized cellular operators

Want to buy an iPhone in Beijing? Talk to Liu Yong. Apple's (AAPL) wonder isn't legally available in China, but Liu, who operates an electronics shop in the Zhongguancun neighborhood close to the capital's premier universities, has plenty of inventory and is more than happy to sell you one for about $680.

Don't worry that Apple hasn't authorized any Chinese cellular operator to serve the iPhone; the software in Liu's iPhones is hacked to enable you to use the phone locally. Inputting Chinese characters on the iPhone's touch-screen is no problem either, he says. But buy now, he warns, because prices are heading upward as demand for the world's coolest phone is increasing.

There still is one big problem—if the phone happens to break. Liu, after all, isn't exactly an authorized Apple dealer and nobody selling iPhones in China is either. That's because, according to Apple, iPhones aren't supposed to be sold in China. "If there's a software problem, we can fix it for you," Liu says. "But if it drops and breaks, then you're out of luck."

No Problem Finding Sellers

That has not deterring determined consumers from buying iPhones from rogue dealers like Liu in big Chinese cities like Beijing and Shanghai. With more than 160 million Chinese surfing the Internet, it's easy for people to follow the latest trends in the U.S. Moreover, many upscale Chinese regularly upgrade their phones to the latest high-end model. And there's now nothing more high-end than Steve Jobs' creation. "There is a real pent-up demand for the iPhone," says Shaun Rein, marketing manager at China Market Research Group in Shanghai. "The iPhone is considered by many Chinese to be the best phone out there."

Finding people selling iPhones in Chinese cities, in districts such as Beijing's Zhongguancun or in the big IT shopping centers in Shanghai, is a snap. Da Lin, a Beijing resident, got his first iPhone from Liu Yong just days after its U.S. debut and has since purchased "a dozen or so" for Chinese friends.

Frank, a 30-year-old European businessman who lives in Shanghai and requested anonymity, says that he bought his iPhone about two months ago from an IT mall in the city. A self-described Apple "fanatic," he owns two iPods and two Macs. He says he had a tough time synching his iPhone with iTunes on his computer: "It took me six hours online to find the right way to do it," he says; but there's no beating the envious oohs and ahhs he gets when he shows it to friends. "Every time I go out for dinner and put it on the table, it's in everyone's hands," he says. "Everyone wants to play with it."

Apple Is In No Hurry

The challenge for Apple is how to capitalize on that popularity. Seduced by the lure of 1.3 billion potential customers, other Western tech companies have been focusing on China for years. China, after all, is already the world's largest cellular market, with 528 million mobile users. It's the No. 2 PC market, behind only the U.S. The only country with more Internet users than China is also the U.S. Companies like Dell (DELL), Hewlett Packard (HP), Nokia (NOK), and Motorola (MOT) have made selling in China one of their top priorities.

Apple, though, seems to be in no rush when it comes to leveraging iPhone's popularity in China. The company's Asia-Pacific spokesperson would not comment when questioned by BusinessWeek, but rumors are flying in Chinese tech and telecom circles about Apple having talks with the country's No. 1 cellular operator, China Mobile, regarding the iPhone. Ranie Lei, a China Mobile spokesperson in Hong Kong, says that her company's chairman, Wang Jiangzhou, stated last month that the company was interested in talking with Apple. But Lei adds that she cannot confirm reports that talks have since stalled, reportedly over disagreements about profit-sharing. She called speculation "unfounded."

In the U.S. and other markets, Apple has cellular operators lining up to partner with the Silicon Valley innovator, putting Jobs in a strong negotiating position. In China, though, Apple doesn't have many choices. The government allows only two cellular operators, both of them state-owned. China Mobile is the bigger of the two and with a 70% market share and 369 million subscribers has a thumping lead over longtime laggard China Unicom . By yearend, China Mobile will have increased its subscriber base by 22.5% compared to 2006, according to a November research report from Sydney investment bank Macquarie, and its profits of $11.4 billion will have jumped 28%.

China Unicom Not Too Appealing as Partner

Indeed, in China Mobile, Apple may have met its match. The Chinese company's Hong Kong-listed shares have risen 111% this year, about the same as Apple's. But China Mobile has a market capitalization of $384 billion, compared to just $156 billion for Apple. If the Chinese operator is playing hard to get in talks over the iPhone, "it just highlights the dominance of China Mobile," says Dave Carini, an analyst in Beijing with research firm Maverick China. "They don't need to make deals like this. There is no need for it to make the kind of deal that American and European operators have been making."

No. 2 operator China Unicom probably isn't much of an option for Apple, though. The company has struggled for years, saddled by Beijing with the burden of operating both GSM and CDMA networks. Many people who follow the telecom industry closely believe that there's also a good chance that China Unicom will end up getting folded or merged into one of the country's state-owned, fixed-line operators when China's regulators finally issue the long delayed licenses for 3G service, possibly next year. "I'm not sure that Apple would want to lock itself into a deal with what is clearly the weaker operator in the market," says Carini. "Apple is very conscious of its image."

China Mobile does face some challenges, though. Its average revenue per user is declining, falling 1.5% this year, according to Macquarie, as the company finds budget-minded subscribers in poor rural and inland areas. An alliance with Apple would help the company draw more money from affluent customers in the big cities. In the meantime, dealers like Liu Yong can take advantage of the opportunity to meet the growing demand for iPhones.

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