Ted Dean
Cover by Benjamin Hurd
Ted Dean (ted.dean @bdaconnect .com) is managing director of BDA (China) Ltd. (www. bdaconnect. com), a telecommunications and technology consulting and research firm focused on mainland China. This article is based on research from BDA's reports, Broadband Access in China (2001) and China's Internet Data Center Market (2001).
China Telecom's grip on the sector is loosening as reforms open the communications market to competition
Connections among the networks were so inadequate that, through 1999, traffic was often routed through a foreign country rather than directly between one network and another.
China Netcom is seeking to offer its customers an end-to-end solution that is not dependent, at any stage, on services provided by its competitors.
The Year of the Snake did not start auspiciously for data communications and the Internet in China. A February 9th break in an undersea cable left China's Internet users with slow or no connection to overseas websites for more than 10 days. The cable break was an unexpected black eye for China Telecommunications Group Corp. (China Telecom) ahead of its planned initial public offerings (IPOs) in New York and Hong Kong.
As China Telecom prepares for what may be the largest IPO in China's history, it is worth taking a look at where the company stands in an increasingly competitive data communications market. A host of new companies are moving into data communications, operating the networks that support the World Wide Web, Internet protocol (IP) telephony, and the many technologies used to transmit data for corporations and other customers. While China Telecom is a giant today, investors must decide how a business built as a state monopoly may fare in a more competitive market.
China Telecom dominates...
Even after being stripped of its paging, mobile, and satellite businesses in a 1999 government-mandated restructuring, China Telecom remains dominant in fixed-line telephony and data, racking up $20.5 billion in revenues in 2000 in these two businesses. But while the telephony business still provides over 90 percent of the company's turnover, it has fallen victim to the same competitive and technological pressures that have been exerted on incumbent carriers everywhere. For example, IP telephony service from four competing operators has pulled so many customers away from China Telecom in recent years that the company had no choice but to cut its international and domestic direct-dial tariffs in December 2000.
As the fixed-line business threatens to stagnate, China Telecom and its underwriters must look to data communications--a business that grew by some 60 percent in 2000--for growth. Thanks to its existing fixed-line network and the unregulated cross-subsidization from China Telecom's voice business, the company dominates in data as well as voice. Through its data communications arm, ChinaNet, China Telecom is the leading Internet data center (IDC) provider, access provider, and Internet backbone in China.
IDCs provide stable and secure environments for servers holding Internet content and applications, along with bandwidth that links servers to the Internet. While China's IDC market has begun to open to new competition, until recently almost all web content in China was hosted on servers at China Telecom facilities, primarily in Beijing.
In the dial-up access market, the alternative brands of China Telecom and its affiliates create the appearance of competition where in fact little exists. In Shanghai, for example, Shanghai Online, Shanghai Telecom, and Shanghai Global Information Networks Co. offer competing dial-up access services, yet these three services are all run by different arms of the loc al branch of China Telecom. In fact, most dial-up Internet service providers (ISPs) still trace their roots back to China Telecom, and survey data from the fourth quarter of 2000 from iamasia (Interactive Audience Measurement Asia) suggests that over 80 percent of home Internet users access the Internet from a China Telecom ISP.
China Telecom faces more vigorous competition in the broadband access market, but with most competitors just beginning to launch service, the former monopoly remains the leading provider. While leased lines are beginning to give way to more cost-effective alternatives, they remain the most common form of broadband connection, and China Telecom holds 90 percent of the market. Building on its existing fixed-line network, China Telecom is moving to retain its advantage by deploying integrated services digital network (ISDN) and asymmetric digital subscriber line (ADSL) services.
China Telecom's Internet backbone is also the most extensive in China, and the company has some 953,000 km of fiber-optic cables crisscrossing the country. The company also provides more than 70 percent of China's international Internet bandwidth. Roll together this dominance in the access, backbone, and IDC markets, and some industry players estimate that over 90 percent of China's IP traffic runs on China Telecom's network.
...but competitors are gaining
These headline numbers mask the competition that is beginning to appear in the market as fundamental changes reshape the data communications industry. The rise of competition is the result of both regulatory and technological developments and is reflected in the entrance of a wide range of other carriers, newly invigorated ISPs, and cable (CATV) operators.
- Other carriers In the past, Jitong Network Communications Co. Ltd. was the only direct competitor of ChinaNet. But in the last two years, China Netcom Corp. Ltd. (Netcom), China United Telecommunications Corp. Group (Unicom), and most recently China Railway Communications (Railcom) have also launched service, competing with China Telecom as backbone and broadband-access providers. Though these companies still lack the local loop that ChinaNet's fixed-line network provides, they have begun to break China Telecom's grip on the backbone market, creating more room for alternative access and IDC providers.
- ISPs While independent ISPs have struggled to compete in the past, their competitive position has improved with the presence of multiple backbone bandwidth suppliers and the new investment flowing into the sector ahead of China's entry into the World Trade Organization (WTO). In addition, the development of the broadband and data center markets has opened new and potentially higher-margin lines of business.
- Cable operators China's cable companies have long been hindered by antiquated infra-structure and a lack of regulatory support. Recent network upgrades and a regulatory opening to cable operators allowing them to offer telecom services, however, will enable cable companies to compete directly with ChinaNet and other ISPs in offering broadband Internet access and other telecom services. With a CATV network that extends into more than 80 million homes, cable operators have the only last-mile network that rivals China Telecom in scope.
As China Telecom's competitors multiply, new technologies are eroding the company's traditional advantages. No operator will ever be able to match the reach of China Telecom's copper line network. However, fixed wireless networks, upgrades by CATV operators to Hybrid Fiber Coaxial (HFC) networks that support two-way data transmission, and the expansion of fiber-optic metropolitan area networks provide new alternatives.
The prospects for China Telecom's competitors are improving, in part, because the Ministry of Information Industry (MII) is gradually emerging as a more independent regulator. The process of separating regulatory oversight from commercial activities, begun with the creation of MII in 1998, is now beginning to show results. The system is still imperfect, and MII often treats China Telecom as a favored son. Nevertheless, fostering competition is now an explicit goal of telecom regulations, and the anticompetitive practices that helped China Telecom build its position in the marketplace are less and less tenable. This more open environment finally provides enough room for independent players to compete with ChinaNet.
Interconnection woes
The worst of China Telecom's anticompetitive practices was its refusal to interconnect with competing carriers. With most of China's Internet users logging on to the Internet through a ChinaNet ISP, competing carriers must have adequate interconnection to reach endusers. Yet interconnection among networks has been one of the weakest links in China's network infrastructure and a key reason that new entrants into the market have struggled. In fact, connections among the networks were so inadequate that, through 1999, traffic was often routed through a foreign country rather than directly between one PRC network and another. By early 2000, this situation had improved slightly, but even then only 10 Mbps of bandwidth connected Jitong to ChinaNet and 8 Mbps connected China's two academic networks, China Science and Technology Network (CSTNet) and China Education and Research Network (CERNet). This lack of interconnection was primarily the result of resistance from China Telecom, which sought to maintain its leadership by refusing or delaying interconnection to competing networks or charging exorbitant tariffs for those links once they opened.
During 2000, removing these bottlenecks became a major priority for MII, leading the ministry to create network access points (NAPs), first in Beijing and then in other cities, where all of China's network backbones would link together. In a compromise with China Telecom, which had resisted participating in the NAPs at all, the former monopoly manages the NAP facilities. The first of these NAPs, the China Internet Exchange (CNIX), opened in Beijing in March 2000.
Despite MII's efforts to improve interconnection, China Telecom continues to drag its heels in providing the free interconnection that MII requires at CNIX. In Beijing, several rival operators complained that China Telecom had only opened 10 Mbps of bandwidth to the MII-mandated NAP instead of the agreed-upon 155 Mbps--providing less than 10 percent of what MII requires. In Shanghai, China Telecom refused to take part in a NAP organized by the local government. Moreover, representatives of rival backbones in Shanghai have expressed concern that China Telecom would open only limited bandwidth to the soon-to-be-opened NAP sponsored by MII. As long as most of China's data communications traffic runs on China Telecom's network, China Telecom's habit of limiting interconnection will hinder the ability of rival carriers to offer competitive service.
The competitor moving most swiftly to take on these challenges is China Netcom. Founded in 1999 with four state-owned shareholders, the company is unique among China's telecom operators in having a CEO with entrepreneurial experience--Edward Tian was the founder and CEO of AsiaInfo Holdings Inc., a mainland-based systems integrator that listed on the NASDAQ last year.
Since its founding, Netcom has built a state-of-the-art IP-over-Dense-Wave-Division-Multiplexing network that links 17 cities, spanning some 8,000 km. Netcom is working to become a major provider of Internet bandwidth to China's corporate customers, ISPs, IDCs, and even other carriers. The $325 million that foreign investors, including News Corp. Ltd. and Goldman Sachs Group, Inc., recently poured into the company in February of this year is a sign of how far Netcom has come in its first two years.
Yet the company still faces significant challenges as its seeks to win customers and build its business. The most pressing of these hurdles--interconnection with China Telecom and establishing last-mile links to its customers--are common to China Telecom's other competitors and all new telecom firms taking on incumbents.
In establishing last-mile links with its customers, China Netcom is seeking to offer its customers an end-to-end solution that is n ot dependent, at any stage, on services provided by its competitors. Without a copper-wire network of its own, Netcom is looking to a variety of technologies to bridge the gap to endusers. The company is focusing its efforts on building metropolitan area networks in major cities. Through these networks, the company runs fiber-optic cables directly to major commercial buildings and new residential complexes. Netcom is currently running tests of fixed-wireless technologies, another promising alternative.
As it reaches out over the last mile to its customers in different cities, China Netcom has been forced to adapt its strategy to local markets. The company is building on its relationship with the Shanghai government, which is a founding shareholder, to tap into the city's already well-developed broadband infrastructure. In Ningbo, Zhejiang Province, China Netcom has set up a joint venture with the Ningbo Information Port (backed by the local government) to offer broad-band access in the coastal city. And in Beijing, China Netcom is negotiating with the local power company about the possibility of laying fiber-optic lines alongside power lines.
Netcom's efforts to match ChinaNet's reach are beginning to pay off, and Netcom has signed an impressive list of clients. One major, independent IDC in Beijing has entered into long-term agreements with Netcom to use its network to link its facilities across Chin a, and others are following suit. Perhaps most significantly, Netcom reached an agreement with China Mobile Communications Corp. that will soon lead to China Mobile routing some of its data traffic over Netcom's network.
China Telecom, beware
While Netcom is China Telecom's best-known competitor, it is not alone. A conce rt of carriers, access providers, IDCs, and cable operators are shifting the competitive balance against the incumbent. With each new Netcom customer, with each new ISP that links to Netcom, Railcom, or Jitong, and with each new Internet user who logs on through a cable modem, data traffic slowly shifts away from China Telecom. Eventually, a tipping point will be reached, and China Telecom will be forced to face its competition not as a dominant carrier that can deny interconnection to stave off its rivals, but as one of many carriers that must compete on the quality of its service.
With this tipping point rapidly approaching, China Telecom will face the huge task of improving its services. A recent MII report shows the depth of China Telecom's problems--over 70 percent of all customer complaints investigated by MII during 2000 involved the incumbent carrier. At the city level, the competition among various arms of China Telecom signals the company's poor coordination. Across China, provincial branches of China Telecom often act as independent companies, managing their own procurement and negotiating their own deals with customers. For companies that have telecommunications needs in multiple provinces, this can mean entering separate negotiations with not just China Telecom's central office, but with local offices in each province in which they operate. Though China Telecom's IPO will help recentralize the compan y--as IPO proceeds will be distributed by Beijing--improving service quality will require years of management reforms.
Foreign companies knocking
The competition that has emerged to date is still entirely among domestic players. While foreign equipment vendors have done extremely well building China's data communications networks, foreign operators have been left waiting at the gate because MII has banned foreign investment in or operation of telecommunications services until very recently.
China's entry into the WTO should change this. After China's WTO accession foreign companies will be able to take 30 percent stakes in value-added service providers, including ISPs. Two years following accession, basic service providers, including Internet backbones, will begin to open to foreign investment. Assuming China joins the WTO this year, foreign investors will be able to take 50 percent stakes in value-added service providers by 2005 and 49 percent stakes in basic service providers by 2007.
Even ahead of China's WTO entry, the government has begun to open to foreign participation. China Netcom's private placement was a major turning point in the fundraising strategies of China Telecom operators. China Mobile and China Unicom had previously raised capital by listing on overseas stock exchanges, but neither company completed a private placement.
AT&T's recent invest ment in Shanghai is even more significant. In December 2000, AT&T announced a $25 million joint venture with Shanghai Telecom and Shanghai Information Investment (an investment company under the Shanghai government) in which AT&T will hold 25 percent. The joint venture, named Shanghai Symphony, will offer data communications primarily to international corporate customers in Pudong, Shanghai. The deal represents a high-water mark for foreign involvement in telecom services in China, as AT&T will participate directly in the operations of the joint venture.
While both of these investments were approved by the State Council, smaller-scale investments are already moving into the data communications market without the same level of official approval. In particular, IDCs, which lack clear regulatory classification as either a value-added or basic telecommunications service, have attracted substantial investments from both strategic and financial investors. Hong Kong's Pacific Century Cyber Works, for example, holds 42.5 percent of Beijing Centergate, a joint venture that operates a 2,000 m3 IDC in Beijing.
This new openness to foreign players can cut both ways for China Telecom. AT&T's Shanghai investment shows that the company might benefit from a partnerships with foreign companies that can show it how to improve services and expand its business with multinational clients. Yet foreign investment also means more resources behind domestic competitors racing to pull data communications business from the incumbent operator.
Either way, domestic competition and foreign participation are clearly making China's telecom market more competitive. Though good news for consumers, competition translates into uncertainty both for investors in China's publicly listed telecom operators and the operators themselves.
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