Regulator Imposes New Restriction On VNOs

MIIT bans VNOs from all network building

China’s telecoms regulator has made steady moves in the last 2 months to usher in a new era of competition for the nation’s telecoms services sector by breaking the long-running monopoly held by 3 big state-run carriers. The strategy, which will see several dozen new virtual network operators (VNOs) enter the space, is a welcome development and could help China compete with other nations in the future development of cutting-edge telecoms services.

But the Ministry of Industry and Information Technology (MIIT) also needs to be careful to nurture these new companies and avoid putting too many obstacles in their path, or risk seeing the trial program stagnate and fail to produce the desired result.

VNOs look the same to consumers as other telecoms carriers like China Mobile (HKEx: 941; NYSE: CHL), China Unicom (HKEx: 762; NYSE: CHU) and China Telecom (HKEx: 728; NYSE: CHA), providing a wide range of telecoms products and services under their own brands. But unlike the state-run carriers, the VNOs won’t build and own their own telecoms networks and instead will lease capacity from the big 3 carriers.

The MIIT has moved very carefully in its roll-out of the VNO program, aiming to create an orderly new industry that can truly compete with the existing state-run giants. It spent much of 2013 crafting policies to govern the sector, and has awarded two batches of licenses since late last year to 19 firms, including familiar names like electronics retailers Gome (HKEx: 493) and Suning (Shenzhen: 002024).

Those companies are now drawing up business plans and working out other logistical issues, and are expected to start offering service as early as April. The MIIT has indicated it will continue to issue more licenses throughout this year, with the final total potentially reaching as much as 2 to 3 dozen.

Throughout the process, the MIIT has taken a number of key restrictive steps to ensure orderly development of this untested new area. Taken individually, each step looks reasonable and logical, and is designed to ensure fairness and prevent disorder. But too many similar measures, if they continue to come, could create an onerous burden for these new players that could stymie their development.

From the outset, the MIIT required potential new VNO licensees to directly negotiate network-leasing agreements with one or more of the big state-run carriers. Such negotiations are quite market oriented, and acknowledge the fact that each of the 3 carriers has spent billions of dollars to build up massive and state-of-the-art national networks over the last 2 decades. But that move also put the new bidders at a disadvantage, since they had very little leverage to bargain good deals with the big carriers.

Word later emerged that each new VNO would be limited geographically, rather than being allowed to offer service nationwide. That move also was most likely designed to maintain order by preventing the sudden emergence of too many new national competitors all at once. But the condition will also limit the attractiveness of the new companies to potential customers, since many might prefer services providers with national capabilities.

Last week, the MIIT took its latest limiting step by saying the new VNOs wouldn’t be allowed to build their own network infrastructure. (English article; Chinese article) Again, that step looked designed to ensure high standards for networks in the marketplace. But once again, that ban means the new VNOs won’t be able to build the facilities they may need to complement the big carriers’ networks, potentially undermining their ability to provide the best service.

Clearly it’s far too early to say just how the new VNOs will develop, and the MIIT has been relatively efficient so far in creating a new and complex plan to shake up the market. If successfully implemented, such a program could create a new field of vibrant, innovative service providers who could sell their products not only in China but also around the world. The program could also help the nation’s big 3 telcos by forcing them to innovate more, paving the way for a global expansion that many expected much sooner but has yet to unfold.

To ensure the best chances for success, the MIIT needs to find a good balance between regulation and the use of free-market forces to foster development of these new VNOs. While strong regulation is certainly needed, the ministry must also be careful not to make too many rules and other conditions that would create a heavy burden for the new VNOs, potentially undermining their chances for success.

Bottom line: The MIIT needs to be careful not to impose too many limitations on new VNOs, or risk undermining their chances for success.

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