The Cheap iPhone Challenge in China (CHL, AAPL, CHU, CHA, S, VZ, VOD, T)

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The chairman of China Mobile Ltd. (NYSE: CHL) has said that the world’s largest mobile carrier, with more than 610 million subscribers, does not have a timetable to begin offering the iPhone from Apple Inc. (NASDAQ: AAPL) to its customers. At the same time, he did say that he hoped Apple will produce a new LTE-compatible phone and that China Mobile has already received a “positive answer” on that issue from Apple. Then why is China Mobile still hoping for a new iPhone?

Currently the only Chinese carrier for the iPhone is China Unicom (Hong Kong) Ltd. (NYSE: CHU), the second largest of the big three carriers, with about 155 million subscribers. China Telecom Corp. (NYSE: CHA) is the smallest of China’s large carriers and has been been in talks with Apple to produce a cheaper version of the iPhone for the Chinese market.

Whichever company gets the nod from Apple, it is very likely that the iPhone will be the company’s 3G model, not the 4G-LTE model that Apple is expected to introduce with its next iteration of the phone, the iPhone 5. China Telecom uses the CDMA network, similar to that of Verizon Wireless and Sprint Nextel Corp. (NYSE: S). Verizon Wireless is joint venture between Verizon Communications Inc. (NYSE: VZ) and Vodafone plc (NASDAQ: VOD).

China Mobile uses a home-grown version of CDMA known as TD-SCDMA, which is only available in China. China Unicom uses GSM technology, similar to AT&T (NYSE: T), and that is probably the reason the company got Apple’s first contract in China.

Apple has been resisting China Mobile’s efforts to get a version of the iPhone for its network. The cost of developing the iPhone for a network technology that is expected to give way to the faster 4G-LTE network probably isn’t worth the investment at this point. China Mobile is expected to begin rolling out its 4G-LTE network next year.

The request/requirement for a cheaper version of the iPhone is probably a result of China Unicom’s poor earnings report for its first-half of 2011. The country is moving toward adoption of 3G networks where the iPhone 4 is a strong contender. But the large subsidies that Apple demands (and gets) put a lot of pressure on China Unicom’s profitability. First-half profits were down more than -9% year-over-year.

Apple still hasn’t confirmed that the iPhone 5 will operate at 4G-LTE speeds. The company is wary of the reduced battery life that is a side-effect of the higher speed networks. iPhone users have become accustomed to eight hours or so of battery life, and cutting back on that may lead to dissatisfied customers, not something that Apple is used to.

Interestingly China Mobile currently supports about 8.5 million iPhone users on its 2G network. These are users who got their hands on unlocked versions of earlier models of the iPhone.

Will Apple release an 4G-LTE compatible iPhone? Of course. The issue is when. And for China Mobile the issue is will Apple release interim versions of the iPhone that are compatible with the company’s network. The answer to that is probably not, mainly because Apple probably stands to get a bigger share of the Chinese market by putting out a cheaper phone rather than a one-off phone. Besides, China Unicom’s experience indicates that Chinese versions of the iPhone may have to be sold at lower prices than Apple is used to.

If Apple succumbs to the pricing pressure and makes a cheaper iPhone for China, other carriers in other countries will demand the same phone. Can Apple reasonably deny that request? Not unless a future version of the iPhone is worlds better than anything else on the market.

The negotiations between Apple and the Chinese carriers are a precursor to negotiations Apple will face with other carriers around the world. New CEO Tim Cook faces a big decision here. And history may not provide much of a guide.

Paul Ausick