It's probably too early to declare the death of an ambitious plan to liven up China's stodgy telecoms services sector through the injection of new private sector competition. But the latest reports that these new competitors, called virtual network operators (VNOs), are facing difficulties due to high prices being charged by their suppliers is just the latest sign that the plan from the Ministry of Industry and Information Technology (MIIT) is running into trouble. I've been predicting such trouble all along, and these latest reports are raising serious concerns that the new VNOs will never get a serious chance to succeed.
Before I go any further, we need to backtrack a moment to understand the genesis of this latest obstacle. VNOs are meant to compete with traditional telcos, which in China's case are the state-run trio of China Mobile (HKEx: 941; NYSE: CHL), China Unicom (HKEx: 763; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA). But unlike the traditional telcos, the VNOs don't own any actual telecoms infrastructure and instead have to lease network capacity from the big 3 existing telcos.
Anyone with half a brain can clearly see the potential for problems with this arrangement, since the big 3 telcos are being forced to sell capacity on their networks to a new group of rivals that will steal their business. In that kind of a situation, it's quite understandable that the 3 big telcos would set their prices quite high to prevent these new VNOs from offering service at competitive rates.
In other markets, the telecoms regulator might have avoided this situation by either setting the prices that telcos could charge to the new VNOs, or by letting the VNOs build some of their own infrastructure. But the MIIT has done neither of these, forcing the new VNOs to directly negotiate deals with the big 3 telcos, and also forbidding the VNOs from building any of their own infrastructure.
As a result, the latest media reports are citing VNO executives as complaining that high wholesale prices from the big 3 telcos are preventing them from offering competitive service. Compounding the problem, China Mobile and Unicom have both been offering extremely cheap packages recently to promote their newly launched 4G services.
The telcos are almost certainly offering such packages at a loss -- something they can do since each has big piles of money and steady cash flow to subsidise such service. But that kind of subsidy is much more difficult for these VNOs, since most are newly formed companies that don't have the resources to offer service at a loss over a long period. The high wholesale prices being charged by big 3 telcos are just making the situation worse, since the VNOs would probably have to sell their retail service at a huge loss simply to match the latest prices from China Mobile and Unicom.
China was buzzing for much of last year when word of the VNO plan first emerged, as many held out high hopes for a much-needed injection of new competition into this tightly controlled sector. The plan moved forward at a steady pace, with the MIIT awarding its first set of 11 VNO licences in late December to companies backed by the likes of Internet giants Alibaba and JD.com. Some companies said they planned to launch new service under their own brands as early as this spring.
But since then the news has been almost all negative, with the VNOs running into a steady string of obstacles that have undermined their chances for success. The MIIT placed geographic restrictions on all new licencees, meaning none will be able to offer national service. The prohibition on building new infrastructure and high wholesale prices being charged by the telcos aren't helping either. Unless the MIIT loosens some of those restrictions and steps in to set wholesale prices at lower levels, I could see this plan quickly fizzle and die by the end of next year, as these new VNOs fail to attract many new subscribers for their service.
Bottom line: High wholesale prices and aggressive promotions by traditional telcos are undermining prospects for new VNOs, which are likely to fail unless the telecoms regulator revamps its reform program.