China Mobile Needed Apple

 | Dec 24, 2013 | 9:30 AM EST
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Apple (AAPL) and China Mobile (CHL) had been stuck in negotiations for at least six years. So why did the two companies finally announce a deal today that would result in the world's largest mobile phone operator (763 million subscribers) selling Apple's iPhone for the first time?

I think the two companies finally have a deal not because of anything that's changed at Apple. The new, relatively cheaper iPhone 5C isn't anywhere near cheap enough to be a game changer.

It's what has changed for China Mobile that counts. The company has lost market share to its conventional domestic rivals over the last two years, with its share of the Chinese market falling to 62% in October 2013 from 64% in October 2012 and 67% in 2011.

And the company is facing a new wave of competition from unconventional rivals. New regulations have opened the mobile phone market to private companies to operate virtual mobile phone networks. The big news is that Alibaba Group, the still-private Chinese operator of Internet marketplaces, has filed for one of the new licenses. Given that Alibaba has even more economic clout in China than (AMZN) does in the United States, it's only understandable that China's mobile phone incumbents are running in fear. (In 2012 Alibaba had $170 billion in gross merchandise sales to Amazon's $92 billion.)

Alibaba isn't the only unconventional competitor, either. Tencent Holdings (TCEHY in New York and 700.HK in Hong Kong), owner of the monstrously popular WeChat service, is siphoning off wireless customers to its chat service and is viewed as a likely applicant for one of the new virtual network licenses.

With these trends in the market and with new competitors in the wings the last thing China Mobile needs is to operate at any kind of avoidable handicap in any market segment. Would you want to go into this battle with a sales force that has to tell its wealthiest prospects that it doesn't offer the iPhone?

And frankly, China Mobile faces some negative cash flow trends that makes having a high-end product to get heavy data users into its stores and onto its website really, really important.

China Mobile projects that a capital-spending budget of $31 billion this year -- and roughly the same in 2014 -- as it builds out its 4G network. It has to spend the money or risk being left behind by competitors that will use their own 4G networks to sell more-profitable Internet, gaming and video services. But to make that buildout pay, China Mobile will have to attract a very high percentage of China's most-profitable wireless users. Yes, as analysts have been quick to point out, probably only about 100 million Chinese can afford the highest-end smartphones, but those are exactly the users that China Mobile and all other network operators need. In its 760 million customers, China Mobile has only 176 million 3G users (none of whom can use an iPhone on the company's 3G network). China Mobile needs to add more 3G and then 4G users to make its capital spending plans work and to counterbalance the erosion in revenue as users shift to over-the-top services such as WeChat and whatever Alibaba has in mind.

In the third quarter of 2013, China Mobile reported just 8% subscriber growth overall. Its 3G subscribers grew by 124% year over year. But those new 3G users didn't have enough heavy spenders to counter the erosion in use among the rest of the company's subscribers. ARPU -- that's average revenue per user -- fell 1.5%.

The iPhone is part of a potential solution to problem. And from China Mobile's point of view, the iPhone will work even if the high-end users it draws into its real and virtual stores wind up buying a 4G smartphone made by someone other than Apple.

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