Japan: Cheap Cell Phones at What Price?

Subsidizing fancy handsets with high service fees is routine. It also stifles competition and hurts some clients. Tokyo regulators are seeking a way out

Technology sells. That's NTT DoCoMo's (DCM) rationale for ordering manufacturers to stuff cell phones with every gee-whiz feature possible. The latest handsets don't just e-mail, browse the Internet, and take digital photos; they double as global positioning systems (GPS), anti-theft alarms, bar code readers, music players, TVs, and portable gaming gadgets. The downside to all the high-tech goodies is that such handsets cost more than $600 each to make.

Then why do Japanese consumers rarely pay more than a couple of hundred dollars for a new cell phone? Because DoCoMo subsidizes the cost of every handset on its network. Japan's No. 1 wireless operator is willing to lose more than $300 per phone to make sure that consumers won't get spooked by exorbitant prices.

DoCoMo's rivals KDDI (KDDIF) and Softbank (SFTBE) spend as much as $70 more per phone than DoCoMo, according to the companies' own estimates. The fight over customers is so fierce that, for new subscribers, operators will even offer their year-old models for as little as a penny. The tab for subsidies alone can set the operators back some $16 billion a year.

The Government Checks It Out

Sounds like a bonus for the common man, right? Not necessarily. The operators recoup their spending by charging consumers steep prices for air time. Though Japanese wireless operators earn only slightly more from each customer per month than their U.S. counterparts in average revenue per user—or ARPU—Japan's per-minute connection fees can be more than five times higher.

Now the government is asking whether the subsidies do more harm than good. Since January, a 10-member panel appointed by the Internal Affairs and Communications Ministry has been looking into the matter as part of a broader industry regulatory review. It's too early to say what the mobile-business study group will recommend, but the committee might end up siding with critics who blame subsidies for stifling competition in the market.

The controversy over subsidies fits into the bigger question of whether Japan's operators wield too much control over the $90 billion industry. It's no secret that Japan's operators dictate to tech manufacturers what features to build into their handsets. But doing so allows operators to channel Internet users to Web sites that work best with the phones' software platforms, say analysts and executives. Meanwhile, cell phone manufacturers are almost entirely dependent on Japan's saturated market—70% of Japanese own a cell phone—and are either saddled with losses or barely scraping by on low, single-digit profit margins.

Reforms Haven't Helped Much

It's not clear whether government officials will adopt the aggressive reforms needed to bring real change. In late 2005 it issued new wireless licenses, and last October imposed new rules letting consumers switch carriers without changing their phone numbers. Neither move has done much to upset the old order. DoCoMo, which has dominated the industry for more than a decade, has forfeited some ground—but not much. Its market share is still 54.4%, while KDDI has 29.1%, and Softbank, which bought Vodafone's (VOD) Japanese business last year, has 16.4%.

One big challenge will be balancing what's good for businesses with what's good for consumers. Says Ovum Managing Director John David Kim, "The government can give manufacturers and operators a break, but consumers will pay for it. Or it can penalize the operators for the benefit of consumers."

The problem is that it's not always easy to distinguish between the two. DoCoMo says subsidies are one way of keeping Japan's 97 million finicky, tech-loving cell phone users happy.

"In a market where it's common to find cell phones sold at low, subsidized prices, we think setting handset prices at several [hundreds of dollars] would severely limit sales," the company wrote in response to questions from the panel.

Operators Hooked on Subsidies

While experts concede that high-end handsets have helped Japan become a leader in mobile Internet use, they say subsidies only benefit a small percentage of consumers who feel they must have the newest phones. Consumers who don't give a hoot about gadgetry might be better off if they could choose a package consisting of lower connection charges and low-tech phones, says Jeffrey Funk, a professor at Hitotsubashi University's Institute of Innovation Research.

"Subsidies have become like a drug that the operators can't quit," adds Funk. And some executives worry that the operators' influence is already stifling the industry's organic growth. "Freer competition would lower the bar for new entrants," says Masaki Kinoshita, chief executive of Future Mobile, a Tokyo maker of wireless software and solutions.

That has regulators concerned that Japan Inc. won't be able to go global with its know-how in speedy third-generation (3G) wireless technology. In fact, Japan's lack of global penetration in cell phones, mobile content, and software has consumed the communications ministry's panel discussions since day one.

Japan already knows what it's like to be odd man out. Its decision to go with a unique second-generation wireless technology, rather than the CDMA and GSM standards used elsewhere, turned out to be disastrous for handset makers such as Matsushita Electric Industrial (MATSF), Sharp (SHCAF), and Toshiba (TOSBF). Those companies dominated at home but got creamed overseas by competitors Nokia (NOK), Motorola (MOT), and Samsung Electronics (SSNGY).

Key Problem: Opening the Market

The hope is that through the elimination or limiting of subsidies, consumers will have more options. Wakako Sakai, for one, would support anything that might lower her phone bill. A year ago, she got a sleek white Sanyo (SANYY) phone for just one cent when she signed up for KDDI's service. But for someone who only makes calls, sends e-mail, and occasionally goes online to check the weather, the phone's features are excessive—and she pays for it. Her monthly bill regularly tops $115. "I wish there were more alternatives," says Sakai, 31, who works at a Tokyo publisher of English-language textbooks. "I would switch if I could get a better deal."

There might have been options if the government had followed through on plans approved last year to force operators to open their networks and lease their excess bandwidth to newcomers, known as mobile virtual network operators (MVNOs). But regulators haven't decided how it could be done, and would-be MVNOs say talks with the operators have gone nowhere. Some say all the attention on subsidies distracts from other important issues.

"Getting rid of the subsidies will be treating the symptom," says Eric Gan, chief financial officer of eMobile, Japan's newest wireless service provider. "You're not dealing with the cause. You have to lower the entry barriers for newcomers to come in and utilize the (operators') facilities—maybe lower access charges, or tower-sharing, or MVNO, or roaming." With this many issues at stake, don't expect the government to make changes overnight.

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