3G adoption in Asia-Pacific inevitable

April 18, 2005

Asia-Pacific Operators Must Drive Mobile Penetration in Low-Income Segments

For mobile handset vendors, Asia-Pacific is the largest regional market in the world and holds the greatest potential. The region currently accounts for more than 40% of global handset sales and mobile users. Its importance will only increase as subscriber growth and device sales decelerate in the mature markets of Europe and North America.

In a region with striking income disparity, the challenge for network operators is to drive penetration within low-income segments while encouraging high-end migration to advanced data terminals-crucial to growing mobile data revenue and revive flagging ARPU. Vendors must serve the needs of operators and consumers with high volumes and a broad portfolio of products offering customization while defending existing margins.

Mobile operators, vendors and application developers all need an accurate view into future handset technologies for strategic planning. Unlike in Western Europe, where GSM is ubiquitous and all operators are expected to eventually migrate to WCDMA, the disparate standards in use or planned in Asia-from PDC and PHS to TD-SCDMA and CDMA800-make the region much more challenging to segment and predict.

Yankee Group updates its mobile handset forecasts on a quarterly basis. This DecisionNote outlines our forecast methodology and discusses our most recent handset sales by technology figures for Asia-Pacific.

Forecast Analysis

Asia-Pacific Handset Sales Will Peak in 2006

From 249 million units in 2004, we expect handset sales in Asia-Pacific to peak in 2006 at 265 million before slowly declining to 237 million in 2009 (see Exhibit 1). This trend is in line with subscriber growth patterns as the rate of market expansion begins to slow. Annual net additions in the region are already in decline: from 158 million in 2004, we expect only 100 million net new users in 2005.

Exhibit 1.
Asia-Pacific Handset Sales by Technology, 2004 to 2009

Source: Yankee Group, 2005

Although mobile penetration remains below 25% across the region, most Asian markets will reach saturation at a much earlier stage compared to Japan or Western Europe due to relatively low incomes. This is particularly true of China, India and Indonesia, which collectively account for more than 70% of the region's inhabitants. However, average mobile penetration in these three markets is only 17% and will remain below 35% during the next 5 years.

Replacement handset sales will not offset the decline in new user purchases. Replacement rates vary significantly by market and are influenced by different factors. For example, Japanese consumers frequently upgrade their devices in line with trends and to gain advanced device functionalities and access to new data services. In developing and prepaid-dominant markets, replacement cycles are much longer because usage is voice- or SMS-centric, there is no data-driven impetus to upgrade and affordability remains a high barrier.

The region is currently in a major upgrade cycle driven by color screens and the introduction of cameras into mainstream phones. The next major cycle-driven by moving image capabilities-is already under way in Japan and South Korea. But for the rest of Asia, 3G services must first become commercially available and data usage and 3G handset costs must be reduced further.

Handset cost usually represents the greatest barrier to mobile adoption, even with 2G and 2.5G devices. New phone prices need to fall below US$50 to significantly affect penetration. Initiatives such as the GSM Association's (GSMA's) tender for new handsets priced at US$40 are designed to address this. Motorola has already responded with its C114 family of handsets targeting emerging markets, which will retail at around $40 initially and at $30 or less by 2006. The GSMA has already encouraged demand via a special procurement initiative from nine Asian operators.

Little Demand for Advanced Data Services in Most of Asia-Pacific

Japan and South Korea are driving the migration to next-generation networks (WCDMA and CDMA1x EV-DO). WCDMA services are now available in Australia and Hong Kong, while operators in Malaysia, Singapore, Indonesia and Taiwan will launch commercial services in the first half of 2005. But in most of Asia, demand for advanced data services remains nascent. Low penetration levels also mean there is little operator need for the increased bandwidth and greater spectral efficiency of next-generation networks to support voice traffic.

GSM-only devices remained dominant in 2004, but GPRS/EDGE and CDMA 1x unit sales will overtake them this year. Supply will drive this migration because almost all new handsets have GPRS capabilities and vendors will discontinue GSM-only devices shortly. Assuming WCDMA retail prices will fall to current 2.5G-equivalent price points, the migration to WCDMA will also be steady and will account for almost half of total unit sales in 2009. Backward compatibility with GSM and GPRS will ensure that even in countries where WCDMA is not available, 3G handsets will be popular even if their data capabilities remain unused.

Between 2005 and 2009, 1.26 billion mobile phones will be sold in Asia-Pacific. China will account for the bulk of the region's sales with 557 million units, followed by Japan with 252 million units and India with 138 million units. Consumers will buy more WCDMA devices during the next 5 years than any other technology. Combined with GSM/GPRS/EDGE devices, total sales will reach almost 900 million units during the forecast period. The CDMA technology family (cdmaOne, CDMA2000 1xRTT, EV-DO) will account for 567 million, with the remainder composed of PDC, PHS, TDMA and a small number of analog devices.

Recommendations for Vendors

· Provide appropriate and relevant terminals. Asian markets are at different stages of development and suitable handsets must be available at affordable prices. Base product road maps on local market characteristics, consumer preferences and how these will evolve. In-region manufacturers that develop handsets for local tastes will steal market share from the large global vendors.

· Focus on improving usability, cost and utilization of existing features. Adding more elements to mobile devices usually pushes up retail costs without a commensurate return in revenue. Although current 3G users may generate higher than average ARPU, they are early adopters and it remains to be seen whether they will maintain higher averages over time.

Recommendations for Operators

· Standardize technologies. To reap economies of scale and improve interoperability, operators must migrate to either EV-DO or WCDMA. Existing AMPS and TDMA operators must make a decision as soon as possible based on pragmatic market considerations and not vendor financing. Operators that use both GSM and CDMA should dedicate resources to only one technology family.

· Give consumers a reason to upgrade. Many consumers in Asia only replace their handset once every 3 to 4 years. Accelerate natural replacement cycles by providing compelling reasons for consumers to upgrade-through advanced features, attractive data services, innovative design and economical price points.

· Make handsets more affordable. Apart from pressuring vendors to reduce wholesale costs, regional operators can make collective purchases for higher bulk discounts. Expand handset subsidy programs, even if this necessitates aggressive prepaid migration to fixed-term contracts.

Forecast Methodology

Our mobile user forecasts underpin our handset sales projections. We assume each net addition will make a handset purchase and we combine this with replacement handset sales resulting from upgrades, churn, loss or damage. As a secondary check, we assess our figures against guidance from all the major vendors. Because our projections are derived from end-user purchases, they represent unit sell-through or retail sales volume and not sell-in, which describes total shipments by vendors.

To derive handset sales by the different cellular technologies, we evaluate network launch and rollout plans for individual operators and markets, handset availability, average selling prices and socioeconomic factors to model adoption. We apply two distinct categories to replacement handsets: same technology purchases and technology upgrades. The key assumptions here are that most users will migrate to more advanced technologies when they decide to replace their old phones and only a minority of consumers will actively seek the most technologically advanced handsets the moment they become available. We model intertechnology migration based on the likelihood of a user migrating to a higher technology when changing handsets.

Other key assumptions and parameters include:

· In classifying mobile terminals, the higher technology takes precedence. For instance, a tri-mode GSM/GPRS/W-CDMA handset is considered WCDMA.

· No backward migration will occur from a higher technology to an earlier one (e.g., from WCDMA to GPRS).

· Cellular users constitute the total registered base, not just active users.

· We applied replacement rates to total users at the end of the previous year and not the mid-term average, as is standard for ARPU and revenue calculations.

· Our forecasts relate solely to mobile phones and exclude all other cellular access devices such as PC cards or wireless-enabled PDAs.

Lack of visibility into TD-SCDMA handset and network deployments has led us to exclude this technology as a discrete category. Currently, we include it with WCDMA. This may change as a firmer road map from the Chinese government on TD-SCDMA deployment becomes available. We also combined GPRS and EDGE within a single category due to the limited networks and range of EDGE handsets currently available in Asia.

We have not explicitly modeled the gray (informal) market for handsets. Therefore, we may underestimate total unit sales. But gray imports or refurbished, second-hand devices have no bearing on official vendor sales and shipment figures. We believe they will represent a diminishing share of the total handset market in the future.