The Value-Added Telecom Services Market Ripens

Foreign companies considering whether to invest in China’s rapidly growing telecom value-added services market must understand the regulatory environment.by Christine Kahler and Weizhen LiChina’s relatively young telecom industry has grown rapidly since 2001, fueled by rising incomes and cheaper technology. From 2001 to 2009, total telecom services revenue more than doubled, from ¥357 billion ($43.1 billion) to ¥842 billion ($123.3 billion), according to the PRC Ministry of Industry and Information Technology (MIIT). Even during the economic downturn, industry revenue grew 7 percent in 2008 and 3.9 percent in 2009. These figures obscure an even more interesting development, however: China’s value-added telecom services (VATS) sector is growing much more rapidly than the telecom industry overall and makes up an increasingly large share of total telecom industry revenue. (VATS are services that add value to basic telecom technologies by enhancing the form or content of customer data, such as through e-mail services, or providing for its storage and retrieval.)

Revenue from China’s VATS industry exceeded ¥192 billion ($28.2 billion) in 2009, up 12.8 percent over 2008. In 2008, VATS industry revenue grew more than 18 percent, after growing 34 percent in 2007. VATS revenue as a percentage of China’s overall telecom industry revenue has risen steadily from 13.3 percent in 2005 to 22.8 percent last year. The number of mobile phone users in China increased last year by more than 100 million to nearly 750 million, and 384 million people accessed online data using their mobile phones.

China’s VATS market opens to foreign investment

China’s developing VATS market has become more accessible to foreign investors over the last decade. When China joined the World Trade Organization (WTO) in 2001, it agreed to open the following VATS to foreign providers:

• Electronic mail;
• Voice mail;
• On-line information and database retrieval;
• Electronic data interchange;
• Enhanced/value-added facsimile services (including store-and-forward and store-and-retrieve services);
• Code and protocol conversion; and
• On-line information and/or data processing (including transaction processing).

China’s large population and improving regulatory landscape have fueled foreign-investor interest in the country’s telecom market since China joined the WTO. Though opportunities for foreign companies have been somewhat limited by strict regulation and the dominance of China’s state telecom companies (see Key Domestic Players in China’s Telecom Industry), some foreign providers have successfully marketed their services in China.

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Key Domestic Players in China’s Telecom Industry

The PRC government embarked on telecom reform in 2008, with the aim of boosting competition in the domestic telecom industry and encouraging companies to develop innovative services through industry restructuring. Existing companies were merged to form three major telecom corporations—China Mobile Communications Corp., China Telecommunications Group Corp., and China United Telecommunications Corp. (China Unicom). Before the restructuring, telecom companies offered either landline or mobile services. Now each company offers all types of telecom services and operates in the basic services and value-added telecom services (VATS) markets.

Though China has tens of thousands of VATS enterprises, the three major corporations control the telecom networks. Foreign investors that want to enter China’s telecom market will need to cooperate with one of the three major players or their affiliated companies, which have been seeking partnerships with foreign investors to gain access to new technologies that will optimize their business models and strengthen their competitiveness.

—Christine Kahler and Weizhen Li[/box]

Foreign companies enter China’s VATS market

In 2001, AT&T, Inc. partnered with two Chinese companies and established the first foreign-Chinese telecom joint venture (JV) in China (see Case Study: China’s First Foreign-Invested Telecom Enterprise). Since then, many more telecom—and VATS—companies have entered the country.

• SK Telecom  A South Korean company with experience in developing value-added services, SK Telecom signed a cooperation agreement in 2001 to provide CDMA consulting services to Unicom Horizon Mobile Communications Co., a wholly owned subsidiary of China United Telecommunications Corp. (China Unicom). In 2002, SK Telecom and China Unicom signed a memorandum of understanding to establish a wireless Internet JV, and in 2004, the two companies established UNISK, in which SK Telecom owned a 49 percent stake. In 2006, SK Telecom became the first foreign company to participate in the development of China’s TD-SCDMA network, which uses China’s national standard for third-generation mobile telecom technology.
• SoftBank Mobile Corp.  A large Japanese telecom service provider, SoftBank first entered China’s telecom market in 1995 through an investment in Unitech Telecom, Inc. In 2004, SoftBank acquired Japan Telecom, which earlier the same year had established a branch company in Shanghai, Japan Telecom China Co. Ltd. That company focused on providing international and domestic VATS services to multinational corporations, including end-to-end Internet-protocol virtual private network (IP-VPN) services. SoftBank currently has investments in China’s VATS market and is involved in a JV with China Mobile and Vodafone Group Plc to develop new technologies and application services for mobile phones.
• Research in Motion Ltd. (RIM)  RIM launched its BlackBerry service in China in 2006. In 2007, the company introduced the BlackBerry smart-phone and its related technologies into China through local partners. RIM and China Mobile Communications Corp. negotiated for eight years before the PRC Ministry of Information Industry— the precursor to MIIT—approved the license to use the VATS technology in China. At the end of 2009, China Mobile and RIM announced they were developing TD-SCDMA and TD-LTE smart-phone technologies, which offer enhanced Internet-based technology.

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Case Study: China’s First Foreign-Invested Telecom Enterprise

In 2001, AT&T Inc.; Shanghai Information Investment Inc., an investment body of the Shanghai Municipal Government; and Shanghai Telecom Corp., a subsidiary of Beijing-based China Telecommunications Group Corp., established the first Sino-foreign telecom joint venture (JV) in China, Shanghai Symphony Telecommunications Co. Ltd. (SST).

• 1994  AT&T signed a memorandum of understanding with the Shanghai Municipal Government to discuss the possibility of conducting telecom services in designated areas in Shanghai.
• 2000  AT&T completed the examination and approval process and found a local partner, Shanghai Telecom. The two companies and Shanghai Information Investment jointly established SST.
• 2001  SST received PRC Ministry of Information Industry approval to provide certain telecom services.
• 2002  SST introduced its first product, AT&T Managed Data Network Service, into China.

Upon its establishment, SST was restricted geographically, but China’s implementation of its World Trade Organization commitments has allowed SST to expand beyond the original geographic and service limitations.

In 2008, SST provided communications support for the US Organizing Committee at the Beijing Olympic Games. At the end of 2009, SST had 400 clients operating in a variety of industries in northern, eastern, and southern China.

—Christine Kahler and Weizhen Li[/box]

Challenges for foreign investors

China has gradually loosened restrictions on foreign investment in the telecom industry. The central government has eliminated geographical restrictions on foreign-invested VATS operations, but regulatory requirements still present significant hurdles. Under the country’s regulatory regime, and in accordance with China’s WTO commitments, foreign-company ownership is capped at 50 percent in VATS ventures (and an even more restrictive 49 percent for basic telecom services). To invest successfully, foreign companies must understand VATS regulations and complicated administrative procedures.

According to PRC law,

• A foreign company must have registered capital of at least ¥1 million to operate within a province or administrative region and ¥10 million for national-level or cross-provincial operations;
• Cross-border telecom services must be kept separate from services provided within China and require special approval from MIIT’s International Communications Entry and Exit Administration; and
• Projects that involve domestic and foreign investors are subject to more complicated examination and approval processes, making it difficult for foreign companies to attract Chinese partners.

China is still drafting its long-awaited Telecom Law, and rules and regulations that govern the industry could change. Currently, investors that want to set up a JV should consult three regulations that govern foreign investment in the VATS industry: the Regulation on Telecom Services (2000), Administrative Measures on Telecom Services Licensing (2001, revised in 2009), and Administrative Regulation on Foreign-Invested Telecom Enterprise (2001, revised in 2008). Taken together, these regulations outline a four-step application process for foreign investors and their domestic partners (see China’s Four-Step Application Process for Foreign Investment in VATS)

An area for growth: 3G’s rise in China

Third-generation (3G) networks support advanced telecom mobile wireless technology, such as simultaneous use of speech and data services, at higher transfer speeds than basic telecom networks. China’s 3G networks incorporate technologies used by the three major domestic telecom companies in China: CDMA 2000 for China Telecom, WCDMA for China Unicom, and TD-SCDMA for China Mobile.

Unlike earlier technologies, 3G technology’s growth is largely the result of the growing VATS market rather than the expansion of basic voice services. The focus will be on developing China’s 3G VATS platform and integrating VATS into the mobile network.

As China’s major telecom operators complete the construction of new 3G networks and systems, 3G services and subscribers will likely grow significantly. In March 2010 alone, China’s 3G users increased by about 2 million to 18 million people, according to MIIT. In April, MIIT and seven other PRC ministries and major agencies announced plans to invest ¥400 billion ($58.6 billion) to construct more than 400,000 3G base stations and increase China’s total number of 3G subscribers to 150 million by 2011.

The expansion of 3G technology offers new opportunities for service providers. Foreign providers that have established operations overseas will likely find opportunities to share their experience and help with content delivery and cost efficiency in 3G networks in China. These may include investments or operations in technical support, network solutions, integration services, and multimedia and entertainment development.

China’s VATS market develops

Developing the VATS industry is a priority for the PRC government, and China’s efforts to upgrade telecom services and technologies have opened up more investment opportunities for foreign companies. Companies should consider how the industry’s trajectory may be affected by China’s broader development plans: The PRC leadership’s desire for investment to be spread more evenly throughout the country may create VATS opportunities for investors willing to venture beyond China’s wealthier coastal regions. For example, the PRC National Development and Reform Commission and the Ministry of Commerce in 2008 jointly released the Catalogue of Encouraged Industries for Foreign Investment in the Central and Western Regions, which opened a number of industries to foreign investment in western China, including VATS.

Rapid growth in China’s VATS market offers more investment opportunities, and new technologies may expand the role that foreign companies play. For example, China Mobile plans to introduce a fourth-generation (4G) wireless mobile standard in China in 2010. Whether 4G technology will be successful in China is unclear, but companies operating in the VATS industry should track such developments for potential business prospects.

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China’s Four-Step Application Process for Foreign Investment in VATS

To apply for a value-added telecom services (VATS) joint venture (JV), the major domestic and foreign investors must complete a four-step process–a much more complex and onerous process than the one a wholly Chinese-owned VATS provider must undergo. (The “major domestic investor” is the Chinese company that contributes the greatest share of investment and owns at least a 30 percent stake in the JV; the “major foreign investor” is the foreign company that contributes the largest share of foreign funds and at least 30 percent of total investment.)

The major domestic investor submits all documentation–including documentation provided by the foreign investors. To apply for VATS operations within a province or administrative region, the documents are submitted to the local branch of the relevant authority, which forwards the document to the central-level agency for approval. To apply for cross-provincial or national-level VATS operations, the documents are submitted to the central-level agencies directly.

Step 1: Obtain a business assessment letter

To obtain a Foreign-Invested Telecom Business Assessment Letter, the major domestic investor must submit an application to the PRC Ministry of Industry and Information Technology (MIIT) that includes:

• The investment total for the JV;
• The registered capital of the companies and how much each will invest; and
• The types of VATS services the JV will provide and the duration of the intended partnership.

In addition, the domestic investor must submit proof that it has sufficient funds and staff resources to carry out the proposed business operations and that the operations will meet MIIT’s examination and safety requirements for the industry.

The major domestic partner must also submit proof to MIIT that the major foreign partner

• Qualifies as a legal person;
• Possesses licenses for basic telecom services operations in countries and regions where the company is registered;
• Has the available funds and staff resources to carry out the proposed business operations; and
• Has a good reputation and experience conducting telecom service operations.

Once the major domestic investor has submitted all documentation, MIIT has 90 days to process the application and release the results. If it approves the JV, MIIT will issue a Foreign-Invested Telecom Business Assessment Letter; otherwise, MIIT will reject the application and provide a written explanation. For VATS business license applications submitted at the local level, the local telecom administrative office will make a decision within 60 days. If it approves the application, it will forward the application to MIIT, which will make a final decision within 30 days. If MIIT approves the application, an assessment letter will be issued. Foreign-invested projects that require National Development and Reform Commission (NDRC) examination and approval should be sent to NDRC for approval before the assessment letter is issued. This step may extend the full application processing time to 120 days.

Step 2: Obtain a business approval letter

After receipt of the assessment letter, the major domestic investor must submit the letter, its company contract, and its company rules to the PRC Ministry of Commerce (MOFCOM) or the local commerce administrative office for business operation approval–a process that typically takes 90 days or less. If approved, MOFCOM or the local commerce office will supply the enterprise with a Foreign-Invested Telecom Business Approval Letter.

Step 3: Obtain a telecom service business license

To obtain a Telecom Service Business Operations License, the domestic investor must forward the business approval letter to MIIT, along with

• An application report for VATS operations signed by the company’s legal representative that includes the types of services to be approved, the coverage of the services, and general company and contact information;
• Copies of the applying investors’ business licenses;
• Basic information on the new JV, including its staff, operating venue, and facilities;
• Annual financial accounting or capital verification report for the applying investors;
• Established company rules, shareholding structure, and information about shareholders for the JV;
• The business outlook, implementation, and technological development plan for the telecom service operations;
• Planned measures to provide subscribers long-term, quality service;
• Planned measures for protecting information;
• Proof that the major investing companies have good reputations; and
• A letter of commitment signed by the company’s legal representative that promises the company will conduct its services legally.

If the application materials provided by the applicant are incomplete, MIIT will request supplemental or revised application materials within five days of receiving the application. After receiving the application materials, MIIT has 60 days to approve or reject the application. Following approval, MIIT will issue a license that is valid for five years; following rejection, MIIT will issue a written explanation for the rejection.

If the enterprise operates cross-regional services, it must file the following materials with the local telecom administrative office after it has received an operating license:

• A description of the local branch responsible for local business operation, including the name and contact information of the branch;
• Copies of the operation’s license;
• Copies of the local branch’s business license, its established operation rules, and other related relevant materials; and
• The company’s local business development plan.

Local telecom administrative offices will then issue a receipt of filing within 15 days and inform MIIT. VATS operations cannot begin before these documents are filed with local administrative offices. If the submitted materials are incomplete, local telecom administrative offices will inform the company within five days of receiving the materials. The telecom service provider must begin providing the services within one year after the license is issued or note in the application documents if it will be unable to provide these services within one year.

The Administrative Regulations on Foreign-Invested Telecom Enterprises require foreign-invested cross-border telecom services providers to acquire special MIIT examination and approval conducted through the Administration of International Telecom Entry and Exit.

Step 4: Register with the PRC State Administration for Industry and Commerce (SAIC)

As a final step, the major domestic investor should present the approval letter and MIIT operation license to SAIC to register the foreign-invested enterprise(s). Registration information is contained in the following PRC regulations:

• Law on Chinese-Foreign Equity Joint Ventures
• Implementing Regulations for the Law on Chinese-Foreign Equity Joint Ventures
• Interim Provisions on the Acquisition of Domestic Enterprises by Foreign Investors
• Provisional Rules on Foreign-Invested Enterprise Investment in China
• Administrative Measures for the Establishment of Partnership Enterprises by Foreign Enterprises or Individuals within China

—Christine Kahler and Weizhen[/box]

[author]Christine Kahler and Weizhen Li are manager and research assistant, respectively, Business Advisory Services, at the US-China Business Council in Washington, DC.[/author]