VOIP: A CASE STUDY OF CHINA'S INTERNECINE PROFIT

UNCLAS SECTION 01 OF 02 BEIJING 013684

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STATE PASS USTR
USTR FOR STRATFORD/WINTER/MCCARTIN/GRIER
USTR FOR MCHALE/WINELAND
TREASURY FOR OFFICE OF INTERNATIONAL INVESTMENT
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E.O. 12958: N/A
TAGS: ETRD EINV ECPS PGOV ASEC WTRO CH
SUBJECT: VOIP: A CASE STUDY OF CHINA'S INTERNECINE PROFIT
WARS

REF: STATE 12988


1. (SBU) Summary: In an informal interview during the June
14-16 China VoIP Conference & Expo in Beijing with Dr. Kan
Kaili, Director of the Policy and Development Institute of
Information Industries at Beijing University of Post and
Telecommunications, he likened the profit wars between
China's major telecom players as an internecine fight
guided by the bottom line, profit quotas, and the need to
please both Beijing Central Government officials and
company headquarters. End Summary.



2. (SBU) In a candid analysis of the future of Voice Over
Internet Protocol (VoIP) in China, Dr. Kan, a very
influential Stanford PhD and former Deputy Director of the
Economic and Technological Development Research Center for
the now disbanded Ministry of Post and Telecommunications,
said that VoIP is alive and well and being exploited by
China's major telcos as just another tool to increase
profit margins or in some cases to meet monthly profit
quotas. In essence, what the consumer wants really has
nothing to do with Chinese telcos' business practices.

The Landscape
--------------


3. (SBU) China Telecom, which has more than 244 thousand
employees, is the largest fixed service telecommunications
provider in China with USD 21.20 billion in revenue and
around 202 million customers in 2005. The company provides
services in the west and south of China, including the
municipalities of Shanghai and Chongqing, the provinces of
Guangdong, Jiangsu, Zhejiang, Anhui, Fujian, Jiangxi,
Sichuan, Hubei, Hunan, Hainan, Guizhou, Yunnan, Shaanxi,
Gansu and Qinghai and the autonomous regions of Guangxi
Zhuang, Ningxia Hui and Xinjiang Uygur. Its main rival,
China Netcom, was formed after a 2001 decision to split
China Telecom and break its monopolistic hold over China's
fixed line phones services. China Netcom provides services
in the north of China, including Beijing, Tianjin, Hebei,
Henan, Shandong, Liaoning, as well as in Shanghai and
Guangdong. The company, with more than 138 thousand
employees, had USD 10.90 billion in revenue in 2005. China
Telecom controls 70 percent of the backbone network while
Netcom controls 30 percent.


4. (SBU) China Telecom and Netcom are state-owned
enterprises (SOE) and parts of their companies are listed
on the New York Stock Exchange. Dr. Kan said that the
creation of the State-owned Asset Supervision and
Administration Commission (SASAC) has made SOEs more
powerful and it is understood that these companies can
engage in whatever business activities they wish without
fear of antagonizing a ministry such as the Ministry of
Information Industry (MII). (Note: While the power of
these companies is well known, MII still regulates the
industry and determines when and who, for example, will
receive 3G or VoIP licenses. The great power of SASAC over
the SOEs was exemplified when they shuffled the presidents
of all the telcos like a deck of cards. End Note.)

VOIP: Just Another Tool to Make Money
--------------


5. (SBU) VoIP currently remains unregulated in China and is
neither legal nor illegal. Nevertheless, to date, the
Chinese Government has exhibited policies and practices
that are stifling the growth of any non-domestic VoIP
providers. A recent decree that halts the issuance of VoIP
licenses until 2008 serves as an example of how much power
a company like China Telecom can wield over the legal and
regulatory environment. In the meanwhile, China Telecom
and Netcom are using VoIP to boost their own revenue

BEIJING 00013684 002 OF 002


streams. Dr Kan explained that both companies are not only
encroaching on each other's territory but each provincial
branch is also encroaching on its own siblings'
territories. For example, when the general manager of a
provincial China Telecom branch sees that his branch will
not meet that month's profit quota he will have no qualms
about going north to try to get more business by
undercutting calling rates from a province that Netcom
controls. This is done by using VoIP to offer cheaper
domestic calling rates and services than Netcom's fixed
lines network. Meanwhile, the rivalry does not stop there
because that same branch will also try to take business
away from another province that China Telecom already
controls. Dr. Kan said that the low cost of VoIP
technology has given regional companies another tool to
increase their revenue streams or meet pre-set quotas. He
added that while this may look like chaotic business
practices, everybody is making money so the powers that be
in Beijing are happy with the status quo.

The Future
--------------


6. (SBU) In answering a question about the future of VoIP,
Dr Kan said that VoIP is widely available and popular in
China and that in the end MII will have no choice but to
legalize it. He exemplified this by pointing out that up
until 1999 IP telephony was illegal in China but in a
manner similar to VoIP was widely available. The
government then had no choice but to legalize it and he
predicted that VoIP will follow the same path. He
concluded by wondering if American companies could really
survive in such a business environment in China.

Randt