Apple, Samsung Face Rising Challenges in China Market

The world’s biggest phone market is getting a lot tougher for Apple Inc. and Samsung Electronics Co.

China Mobile Ltd., the biggest carrier, is cutting subsidies by $2 billion in a sign the industry is less willing to pay for expensive devices like the iPhone and Galaxy S. That may accelerate growth for Chinese makers Xiaomi Corp. and Lenovo Group Ltd. that offer similar features for lower prices.

The 38 percent cut comes after government regulators were said to tell China’s three carriers to lower marketing expenses, changing a practice that spurred sales of premium handsets to a wealthier population. The order may save the companies $6 billion and further shift the balance of power after Samsung lost the top spot in market share last quarter and Apple failed to crack the top five in sales.

“High-end flagship phones will suffer the most from the regulation due to their prohibitive prices in the China market without subsidies,” said Lydia Bi, a Shanghai-based analyst at researcher Canalys. “Samsung and Apple, as the two major high-end flagship phone makers, have the most to lose.”

China Mobile investors supported the move, with shares rising to the highest in six years yesterday in Hong Kong trading. Lowering subsidies should be positive for profit, Chief Financial Officer Xue Taohai said in Hong Kong this week after the company announced its fourth-straight drop in quarterly net income.

Apple Deal

China Mobile will spend 21 billion yuan ($3.4 billion) to offset the costs of phones for customers this year, compared with the 34 billion yuan the carrier planned to spend, Taohai said. The company already spent 15.3 billion yuan in the first half.

Teresa Brewer, a spokeswoman for Apple, declined to comment. Adam Yates, a spokesman for Samsung, didn’t respond to a request for comment.

The carrier in December agreed to offer the iPhone after six years of negotiations. Cupertino, California-based Apple said iPhone sales rose 48 percent in the country in the quarter ended June 28.

Yet Apple wasn’t among the top five vendors during the second quarter, according to separate research from Canalys and International Data Corp.

Apple, one of a number of U.S. technology companies excluded from some state purchases as tensions between the countries escalated over assertions of hacking and cyberspying, said it’s shifting mainland Chinese users’ data to servers run by and China Telecom Corp., a move that may address concern by government officials that the information could be a security vulnerability.

No Access

The data is encrypted, so state-controlled China Telecom, the country’s third-largest wireless carrier, won’t be able to access it, Apple said in an e-mailed statement.

State-run China Central Television last month questioned the security of Apple products, reporting that iPhone software may result in the leak of state secrets. Apple rejected those claims.

Xiaomi became No. 1 in China by shipping 15 million devices in the second quarter, giving it 14 percent of the market to pass Samsung, which had 12 percent, Canalys said. Xiaomi wasn’t even among the top five vendors a year earlier.

It was the first time Suwon, South Korea-based Samsung wasn’t No. 1 since the fourth quarter of 2011, according to Canalys.

According to IDC, Lenovo was the top vendor with 12.5 percent of the China market, with Samsung ranking fifth.

‘More Receptive’

“Chinese consumers are starting to be more receptive of the higher-end phones produced by Chinese vendors,” said Tay Xiaohan, a Singapore-based analyst with IDC.

China’s State-owned Assets Supervision and Administration Commission told the national carriers to cut costs because they overspent on subsidies and advertising for devices such as iPhone, people familiar with the matter said last month.

China Mobile, China Unicom (Hong Kong) Ltd. China Telecom were told to cut spending on subsidies and advertising by a combined 40 billion yuan, or about $6.4 billion, in three years, the people said.

Subsidies for high-end phones can reach $750 at China Mobile. For example, the carrier’s website offers the 16-gigabyte iPhone 5s for 5,288 yuan, without a contract.

Rebates, Subsidies

The company offers a rebate of 4,656 yuan, or 88 percent of the total cost, to subscribers of its most expensive data package costing 388 yuan a month.

Less-expensive phones don’t need subsidies to be attractive, and Xiaomi sells most of its phones without carrier assistance. The marquee Mi 3 phone starts at 1,499 yuan on the company’s website.

Because Xiaomi sells most of its phones by the Internet, the company sees no negative impact from China Mobile’s subsidy cuts, said Tony Wei, a spokesman for the Beijing-based company. Representatives from Lenovo and Huawei Technologies Co. didn’t respond to requests for comment.

“There is no reason to buy an unsubsidized Samsung at the high end because they are so much more expensive but not that much better anymore than domestic Chinese models,” said Shaun Rein, managing director for China Market Research Group in Shanghai.

Eroded Profitability

Carriers are keen to reduce the subsidies that have eroded profitability. China Mobile yesterday reported that net income fell 7.8 percent to 32.5 billion yuan in the second quarter, according to figures derived from six-month results.

China Unicom, the No. 2 carrier, will reduce selling and marketing expense as a percentage of revenue in the second half of this year, President Lu Yimin said Aug. 7.

“We will control our overall handset subsidy toward the high-end models in the second half,” Lu said.

China Telecom won’t report first-half financial results until Aug. 27. The company will supply a forecast for full-year phone subsidies at that point, Jacky Yung, a spokesman, said in an e-mail.

— With assistance by Edmond Lococo

(Updates with Apple shifts customer data to China Telecom servers in 10th paragraph.)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE