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War of the giants – Observations on the anti-monopoly investigation into China telecom and China unicom

War of the giants – Observations on the anti-monopoly investigation into China telecom and China unicom

Introduction
Li Qing, the vice president of the Price Supervision, In­spection and Anti-monopoly Bureau of the NDRC (Na­tional Development Reform Commission), disclosed in a news interview program of CCTV on 9 November 2011 that the NDRC had launched an anti-monopoly investiga­tion into China Telecom and China Unicom. In the inter­view Li accused the two companies of conducting price monopoly in the broadband market by charging their competitors high inter-network settlement fees while giving huge discounts to non-competitors.

Li also indicated that if such monopoly practice is prov­en, the two companies face a fine ranging from 1% to 10% of their business income of the previous year. China Telecom and China Unicom having annual turnovers of around USD 7,8 billion and 4,7 billion, respectively, the fine could add up to several hundreds of millions USD in total.

The CCTV program drew an enormous amount of media attention and led to general public astonishment. Many had always believed that state controlled or state owned enterprises were exempt from similar government in­vestigations. Now, for the first time in history, they were proven to be wrong.

The Anti-monopoly Law
The Chinese Anti-monopoly Law was enacted in 2008 and defines the following three actions as monopoly:
– establishing a monopoly agreement;
– abusing dominant position in the market; or
– seller concentration, which has or may have the effect of excluding competitors or restricting competitions.

In the current case, the investigation is aimed at the sec­ond action: the abuse of a dominant position.

When the joint market share of two market players reaches 2/3 of the total and their individual share each reaches 1/10 of the total, they will be deemed having a ‘dominant position’. According to Li Qing, there is no doubt that China Telecom and China Unicom have a dominant position in the broadband market, as they more then easily fit these criteria. One of the activities constituting the ‘abuse’ of this dominant position is giv­ing unreasonable differentiation treatment in price and other transaction terms to buyers under similar condi­tions.

China Telecom and China Unicom have supposedly charged competitors such as China Tietong (CTT) and Ca­ble Modem the maximum allowable settlement fee (that is approximately USD 0.16 million/G/month); whereas charging less for ‘normal’ non-competitors, sometimes even half the maximum price. Moreover, the prices ap­plied to internet content providers (or “ICP”) are some­times even lowered further to approximately USD 0,016 million/G/month. Especially the popular ICP users like Sina and Tudou will enjoy this discount as they provide large amounts of traffic interchanges. From a legal point of view, setting off these practices against the anti-mo­no-poly law, it is safe to say that China Telecom and China Unicom are engaging in price monopoly.

Enforcement of the anti-monopoly law
The NDRC is one of the three enforcement authorities designated by the Anti-monopoly Committee of the State Council. The other two authorities are the Ministry of Commerce (MOFCOM) and the State Administration for Industry and Commerce (SAIC). The NDRC is responsi­ble to investigate and punish monopoly practices related to price, the MOFCOM is responsible to approve seller concentration transactions while the other forms of mo­nopoly are subject to the SAIC. We refer to the chart below for an overview of the Chinese anti-monopoly regulatory system.

NDRC’s activism in this field is of a recent nature. The MOFCOM and the SAIC used to be more active than the NDRC. In the past the MOFCOM rejected Tengzhong’s purchase of Hummer, Nokia-Siemens’ acquisition of Mo­torola and Coco-cola’s bid to acquire Huiyuan Juice. The AIC took care of the famous dispute between Tencent and 360. As to the NDRC, its Price Supervision, Inspection and Anti-monopoly Bureau was only established last July and this case has been its first anti-monopoly investiga­tion triggering public attention. In previous anti-monop­oly cases, the Chinese government was quite reluctant to publicly issue any information until the administrative decision was officially made. Therefore, the government now appears to be acting quite unusual – some may even think inappropriate – by going public whilst the investiga­tion is still at the stage of evidence collection.

The question we could ask at this moment is why the Chinese government is acting in this unusual way. What makes this case different from previous anti-monopoly cases? To find an answer to these questions, we need to gain insight into the complicated relationship amongst the telecommunication giants and the background of the investigation.

The long story of the telecommunication giants
The telecommunication industry in China knows three main players: China Telecom, China Unicom and China Mobile. The first two companies currently are the mar­ket leaders. However, China Mobile, as well as the broad­band giant Cable Modem, are of growing concern to them. Although China Telecom and China Unicom seem to have a very firm control over the broadband market today, China Mobile and Cable Modem are likely to catch up with them or even take the lead in the future.

In the paragraphs below we will discuss each of these companies, and will give an insight into the ‘war of the giants’.

China Telecom, a state owned enterprise (or “SOE”) with a registered capital of approximately USD 25 billion, cur­rently dominates the broadband market in 21 provinces, mostly in the southern part of the country. China Uni­com, a state holding enterprise with a registered capi­tal of approximately USD 14 billion RMB, dominates the rest of the geographical market in China. Their respec­tive dominant positions are mainly the result of their extensive data routes (internet backbone) built in the last decade. As such infrastructure construction requires long-term and large capital investment, it is difficult for new competitors to build their own nationwide network. Instead they have to “rent” the routes to provide inter­net access service and pay an “inter-network settlement fee” based on traffic volume in return. Pursuant to ap­plicable legislation by the Ministry of Industry and Infor­mation Technology (MIIT), the inter-network settlement fee is subject to mutual agreement but may not exceed USD 0,16 million/G/month. In practice however, thanks to their dominant position, the pricing power is in hands of China Telecom and China Unicom.

China Mobile is a state owned enterprise mainly en­gaged in mobile communication, having a registered capital of approximately USD 8,2 billion. As a company having more than 50% shares in the mobile communica­tion market, China Mobile in fact has the capital, in house talent and technology to compete with China Telecom and China Unicom in the broadband market. Neverthe­less, it does not have a market position equal to its real strength. The reason for this is the restriction, pursuant to a Circular by the MIIT, from directly entering into the broadband market. Many believe that the MIIT imposed this restriction to avoid destructive competition among the three telecommunication giants. As a result, China Mobile was limited to grabbing a small market share by acquiring China Tietong (CTT) in 2009, which was at that time a small SOE engaged in broadband services.

It is widely believed however that sooner or later the MIIT will lift the restriction and allow China Mobile to fully participate in the competition for the broadband market.

Cable Modem is affiliated to Cable TV and belongs to China broadcasting and TV Group (TVG). Different from the other three telecommunications giants, Cable Mo­dem is under the administration of the State Adminis­tration of Radio, Film, and Television (SARFT) instead of the MIIT. Its cables could be digitally transformed as to transmit both TV signals and internet data, which would enable TVG to enter the broadband market.

In this respect it is imporatant to note the concept of integrating the three networks of telecom, internet and television. When integration would be realized, network resources could be used more efficiently, leading to more diversified media and communication applications. The Chinese government has been proposing integration for over a decade. Many people believe however that in the event of integration, where the three networks are sup­posed to be fully shared and connected, the pricing pow­er of telecommunication companies could be consider­ably weakened and most profits would be generated at terminals such as TV broadcasting. Therefore, although TVG has been pushing for integration with great effort, the three telecommunication giants have been very re­luctant. Due to such deep divergence between the two sectors, very limited progress has been made so far.

The foregoing has shown a growing threat to the lead­ing market position of both China Telecom and China Unicom. In an attempt to exclude China Mobile and TVG from the market, they have consequently been trying to use price differentiation. The effect of such practices is obvious.

Take China Tietong (CTT) as example. Not enjoying any discounts, the costs of the settlement fee would equal 30% of its annual turnover. This ratio would make it quite difficult for CTT to make any profits. Therefore, in order to minimize these costs, it purchased traffic volume at a relatively low price from service providers who did receive discounts. After a nationwide inspection in July 2010 by China Telecom targeting such resale of flows, over 10 million terminal users were disconnected. The inspection led to hundreds of millions of dollars of addi­tional costs for CTT. Many believe that these events trig­gered the current NRDC investigation.

Legalism or politics?
As indicated above, from a strictly legal point of view, the practices conducted by China Telecom and China Unicom clearly constitute monopoly. The public expo­sure on CCTV shows however that there is a big political aspect to the investigations. Recent intense competition amongst giant SOEs and clashes between government agencies (more specifically, between the MIIT and SAR­FT), have made this a politically sensitive issue. This can be further evidenced by the active involvement of the TVG with the investigations and MIIT’s angry response to the interview of Li.

In our view, the television exposure looks more like a strategy by the NDRC to urge the two companies in reaching a settlement with the other giants. In response to the investigation, on 2 December, China Telecom made a public statement, admitting its price manage­ment is not satisfactory and the price differences are too big. The company also promised to properly lower the settlement fee according to the principle of fair trade. China Unicom submitted a settlement proposal to the NDRC on the same day.

We expect that the NDRC’s bark might be bigger than its bite, and that the huge penalty that was threatened in the interview will not be imposed.

China’s political market economy
It is not uncommon for Chinese government agencies to have conflicts with each other. The Chinese market is in fact a political market economy in which both enter­prises and government agencies are pursuing economic interests.

Another example where government agencies clashed with one another was the famous conflict between the Ministry of Culture (MOC) and the General Administra­tion of Press and Publications (GAPP) on the control of the internet gaming industry in 2009. The conflict resul-ted in a disconnection of the famous foreign online game “World of Warcraft” for over three months, causing great dissatisfaction with the general public. The conflict had to be dealt with by the State Council itself as it was partly the result of an unclear re-definition of functions of the ministries involved in new legislation. Eventually the GAPP and MOC seemed to reach a settlement as the game obtained approval from both departments almost 9 months after its application. World of Warcraft, howev­er, never regained its popularity in China since then due to the longterm disconnection.

Foreign investors
Foreign investors are only allowed to enter the Chinese telecommunication market through an equity joint ven­ture with a Chinese partner. There might be foreign in­vestors who think the anti-monopoly investigation into China Telecom and China Unicom might improve their chances of entering the Chinese market. They should however not get their hopes up. As this publication has shown, even the domestic giants China Mobile and Cable Modem have gone through a long period of fighting their way into the telecommuncation market. We therefore do not expect that the investigation will open the market for other domestic telecommunication companies – let alone for foreign invested companies.

Jan Holthuis

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