BusinessWeek Article Misses the Mark
BusinessWeek Article Misses the Mark

BusinessWeek Article Misses the Mark

BusinessWeek Article Misses the Mark

On 29 May, BusinessWeek ran an article, "Japan: Cheap Cell Phones at What Price" aiming to demystify Japan’s complex carrier subsidy situation. The writer, Kenji Hall, is an astute observer of this country’s mobile scene, but he missed the mark on several key points and it’s worth reviewing these in detail…

"Technology sells. That’s NTT DoCoMo’s 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."

Yes: Not only does "technology sell" but – when successful – it also creates user demand and massive third-party service provider revenues. Yes: The latest phones have brought goodies like 1Seg digiTV and music to mobile; however barcode readers and digital photos have been common for at least four full years now. We also note that universal GPS was mandated by the government as a standard for all new handsets as of 1 April 2007, so it’s not just DoCoMo and the carriers who think their problems can be solved by (expensive) technology. We note with interest the one "gee-whiz" feature that was
excluded from the list above – and which has been central to DoCoMo’s strategy ever since KDDI dropped flat-rate data into the market: FeliCa m-commerce.

"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."

Making sure consumers don’t "get spooked by exorbitant prices" (in any business) is one way to look at it; on the other hand, creating an entire device line-up with a common platform for content and service offerings (which all carriers do here – unlike in Europe or the US) also costs real money up front, which the operators invest for long-term gain.

"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."

Without getting too deep into the math, one point that should be made clear is that Japan’s third-party sales distribution channels, the retail stores, are rewarded with anything between ¥5,000 and ¥20,000+ per unit sold. At any rate, since the total mobile industry value is in the order $90 billion per year, this up-front primer strikes us as one logical way to drive innovation and maintain a lower barrier to entry for consumers.

"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."

If all things are equal, with combined voice and data ARPU being even ‘slightly more’ in Japan, then as a consumer which handset (and indeed service offering) would you rather have? The vastly greater data ARPU in Japan is due to the excellent features of the phones and therefore content offerings available.

According to Chetan Sharma, only the Philippines have a higher percentage of data revenue in overall ARPU than does Japan. Yes: Japanese mobile voice minutes are rather expensive, which is one reason why people opt for email, chat and other data-based communications. However, we often hear overseas visitors wishing for the day when they, too, could have a full-featured Japanese-caliber handset.

"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."

Looking through the telescope the wrong way again. The fact that the government issued three new 3G licenses, at least in part to boost competition, helps illustrate why we find it difficult to see that competition is being stifled when the Japanese market has seen so much innovation in the way of new product and service offerings.

"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."

We disagree. As the operators here are the device makers’ customers, they should certainly be entitled to place handset orders to their specifications, especially since the carriers not only pay for the stock on delivery but assume the B2C sales cost and risk. And it is certainly odd to suggest that it is somehow unfair for the operators "to channel Internet users to Web sites that work best with the phones’ software platforms," since all handsets can easily surf off the carriers’ official decks as well; in any event, what’s wrong with this as a business model?

As for the domestic handset makers being "almost entirely dependent on Japan’s saturated market," it’s difficult to see how that’s the operators’ fault or responsibility. Yes, there are some definite reasons why this happened in the past (non-compatible legacy 2G technology, as the BW article mentions) but with 3G there are indications that this is changing at least for Sharp and Casio, who have struck tidy deals with overseas operators. As for the "single digit margins;" well, it should be noted that the Japanese handset makers also deliver a much wider range of products than just cell phones. They have been able to ship other forms of consumer electronics – think TVs and handycams – into markets overseas and there is no reason why they cannot replicate this success with mobile phones as well. Perhaps most importantly: the operators here have actually helped the makers by the nature of being a strong customer not to mention massive R&D investment with and directly into the
manufacturers to develop the needed technology. But it is the makers who have to build their international business, not DoCoMo!

"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.

It’s true many consumers don’t give a hoot about gadgetry; and they can easily get a no-frills handset complete with an ultra-cheap flat-rate voice package from Willcom or now even SoftBank Mobile.

"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 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.

As we mentioned, consumers do have options for basic handsets and (within carrier networks) flat-rate voice plans. While Sakai-san is complaining about her $115 monthly bill, the article makes no mention of the actual amount of her voice time or whether her company covers some of that for work-related calls (many do). Her bill is over double the monthly ARPU so clearly that single example is not the norm.

"’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."

Hmmmm: Gan-san and eMobile are hardly neutral parties to this discussion!

However, the one thing we will agree with is, "don’t expect the government to make changes overnight." Without dwelling too much on the obvious, the mobile industry in Japan is big business and therefore contributes large tax revenues and provides employment for hundreds of thousands of people. Major, and potentially disruptive, changes will not happen without full consultation and consensus from the key players. This is, after all, Japan.

That being said, it would not surprise us at all if the operators are actually driving the discussion as a way to limit their future costs and risks associated with the current subsidy model. We would also point out that this discussion has been going for some time now, as we recall hearing Nakamura-san, DoCoMo President and CEO, mention they are looking at alternatives to the current sim-locked (and therefore subsidized) business model as far back as November of 2005.

-– Daniel Scuka