Japan: Cheap Cell Phones at What Price?

Subsidizing fancy handsets with high service fees is routine. It also stifles competition and hurts some clients. Tokyo regulators are seeking a way out

by Kenji Hall

Technology sells. That's NTT DoCoMo's (DCM) rationale for ordering manufacturers to stuff cell phones with every gee-whiz feature possible. The latest handsets don't just e-mail, browse the Internet, and take digital photos; they double as global positioning systems (GPS), anti-theft alarms, bar code readers, music players, TVs, and portable gaming gadgets. The downside to all the high-tech goodies is that such handsets cost more than $600 each to make.

Then why do Japanese consumers rarely pay more than a couple of hundred dollars for a new cell phone? Because DoCoMo subsidizes the cost of every handset on its network. Japan's No. 1 wireless operator is willing to lose more than $300 per phone to make sure that consumers won't get spooked by exorbitant prices.

DoCoMo's rivals KDDI (KDDIF) and Softbank (SFTBE) spend as much as $70 more per phone than DoCoMo, according to the companies' own estimates. The fight over customers is so fierce that, for new subscribers, operators will even offer their year-old models for as little as a penny. The tab for subsidies alone can set the operators back some $16 billion a year.

The Government Checks It Out

Sounds like a bonus for the common man, right? Not necessarily. The operators recoup their spending by charging consumers steep prices for air time. Though Japanese wireless operators earn only slightly more from each customer per month than their U.S. counterparts in average revenue per user—or ARPU—Japan's per-minute connection fees can be more than five times higher.

Now the government is asking whether the subsidies do more harm than good. Since January, a 10-member panel appointed by the Internal Affairs and Communications Ministry has been looking into the matter as part of a broader industry regulatory review. It's too early to say what the mobile-business study group will recommend, but the committee might end up siding with critics who blame subsidies for stifling competition in the market.

The controversy over subsidies fits into the bigger question of whether Japan's operators wield too much control over the $90 billion industry. It's no secret that Japan's operators dictate to tech manufacturers what features to build into their handsets. But doing so allows operators to channel Internet users to Web sites that work best with the phones' software platforms, say analysts and executives. Meanwhile, cell phone manufacturers are almost entirely dependent on Japan's saturated market—70% of Japanese own a cell phone—and are either saddled with losses or barely scraping by on low, single-digit profit margins.

Reforms Haven't Helped Much

It's not clear whether government officials will adopt the aggressive reforms needed to bring real change. In late 2005 it issued new wireless licenses, and last October imposed new rules letting consumers switch carriers without changing their phone numbers. Neither move has done much to upset the old order. DoCoMo, which has dominated the industry for more than a decade, has forfeited some ground—but not much. Its market share is still 54.4%, while KDDI has 29.1%, and Softbank, which bought Vodafone's (VOD) Japanese business last year, has 16.4%.

One big challenge will be balancing what's good for businesses with what's good for consumers. Says Ovum Managing Director John David Kim, "The government can give manufacturers and operators a break, but consumers will pay for it. Or it can penalize the operators for the benefit of consumers."

The problem is that it's not always easy to distinguish between the two. DoCoMo says subsidies are one way of keeping Japan's 97 million finicky, tech-loving cell phone users happy.