Japan

in the World
Telecom Market

by Louis Ross

With domestic monopolies being privatized the world over, and global competition encouraged, the international telecommunications industry will change drastically in the near future. The recent World Trade Organization (WTO) Global Telecommunications Plan, approved in February, will also play a major role in liberalizing the world's domestic telecom markets. More than 65 countries have approved the plan, agreeing to open their telecommunications markets to international competition.

US long-distance telecommunications firms, which already hold about 30% of the $600 billion global telecom market, are perceived as the big winners from the WTO agreement. Asian (including Japanese) telecom firms, on the other hand, are seen as likely to suffer. Or maybe not.

Japan's telecom trade surplus
It's true that deregulation of the world's telecom markets will mean an end to the domestic sanctuary of Japanese firms described in my previous article. [See "Japan's Telecommunications Market: Where It's Been, and Where It's Going," June 1997, page 31.] As Japan's telecommunications market becomes more competitive, Japanese firms will increasingly need to succeed in overseas markets in order to survive.

In other words, the traditionally secure domestic revenue streams will fall prey to competition, and overseas income sources will become more important. This is one reason that the Japanese government - concerned about the competitive position of Japanese telecom firms relative to the large multinational foreign firms, which are increasingly linking up to form strategic global alliances - is promoting overseas expansion.

The Japanese government realizes that the "weak link" in the Japanese information/communications (I/C) food chain is telecommunications. Even though from 1980 to 1987 Japan's share of the total OECD (Organization for Economic Cooperation and Development) telecommunications equipment market doubled (from 17% to 34%), the competitive strength of Japanese companies overseas remains low since the major Japanese suppliers were content to produce equipment for NTT based on Japan-only standards.

Traditionally, the Japanese government has nurtured the domestic telecom market via "controlled competition." The ministries and the private sector have formed obligational close relationships and nurtured a closed group of Japanese-only suppliers. This served as the crux of a system in which NTT provided the demand (annual procurements of around $190 billion), set the specifications, and relied on Japanese electronics firms to produce the equipment. Japanese telecom/electronics companies developed electronic (then digital, and now ATM (asynchronous transfer mode)) switches based on Japanese standards that generally were not used in foreign markets. There was no economic incentive for them to adopt world standards, since the bulk of their orders came from NTT.

Given the current climate of deregulation, however, and the need for Japanese telecom firms to become internationally competitive, this traditional approach may become somewhat altered. Deregulation, and an increasing anxiety about falling behind, will be the catalysts.

But is Japan really in danger of falling behind? Are Japanese telecom firms truly weak in overseas markets? Interestingly, although US firms are acknowledged leaders in most strategically important areas of the I/C industry, the US has actually run a trade deficit with Japan in this industry since the late 1980s. In 1994, this deficit was almost $12 billion.

Japanese dominance in certain high value added I/C components - such as facsimile equipment and copiers, optical fiber, and advanced telecommunications equipment like routers, bridges, and ATM technology - has helped generate the nation's impressive surplus. In emerging wireless terminal-related technologies, Japanese firms specialize in many key components and capabilities; flash memories and flat panel displays, in particular, are two high margin, fast-growing technologies in which an American presence is scant or nonexistent.

In other areas, too, Japanese firms are setting the standards in key hardware that will play a crucial role in the development of multimedia/telecommunications-related equipment. Japan's trade surplus in the I/C area seems likely to continue, and Japanese firms stand well positioned to take advantage of the expected integration of computers and telecommunications.

Asia's developing telecom markets
Asia represents a large potential market for Japanese telecom firms. The Asian telecommunications market is ready to explode, and Japanese as well as foreign firms are gearing up to meet the challenge. In 1998, world growth of cellular phones (new installations) is expected to be about 25 million lines, and for fixed phones that figure may surpass 90 million lines. Of this total, Asia should account for nearly 55% and 70% of the growth, respectively. With the penetration rate for cellular phones in many Asian countries still quite low (3% or less), the potential for growth is huge.

Substantial capital expenditures are needed to set up a cellular-based system, however, which increases the cost of the service itself. In light of this reality, the development of PHS (personal handyphone system) technology by Japanese companies offers a good example of a low-cost system that can easily be converted later into a system providing digitalized, wideband communications directly connected to homes as per capita incomes rise. Japanese firms would then be able to market the hardware for such systems, including advanced multimedia integration of video and audio in one unit.

In line with the Japanese investment boom initiated in the early 1990s, capital expenditure increases are planned by both electronics and telecommunications firms throughout Asia to construct a stronger telecommunications infrastructure and develop advanced networks. Asian telecom firms, however, are relatively weak in regard to competitiveness, which will most likely lead them to form alliances with large foreign firms. One such example is the Mitsubishi/NTT/DoCoMo interest in Asia Pacific Mobile Telecommunications Satellite - a partnership that will offer an inroad into the Asian satellite-based communications market when the planned satellites become operational (by 1998). NTT and DoCoMo have already joined hands to provide domestic satellite telephone services in Japan.

In the early 1990s, many Asian countries significantly opened up their domestic telecommunications markets - either by establishing their first publicly-owned telephone company (and encouraging foreign investment and joint ventures), or by developing plans to privatize their public phone companies. Many of these same nations signed the WTO pact and (at least formally) have agreed to open their domestic telecom markets to competition. These countries wish to stimulate the expansion of network construction, but since many of them lack the required technology and capital, they will be dependent on foreign firms for some time to come.

The initiative to develop an internationally competitive Japanese telecom industry has been delayed by the lack of NTT expansion into overseas markets. NTT was prohibited by the Japanese government from aggressively entering these markets since Japan decided, for whatever reason, to remain the only major country to separately license domestic and overseas telephone services. NTT invested just $400 million overseas from 1987 to 1993 - compared to British Telecom's $10.4 billion and AT&T's $9.2 billion. But NTT has released only a fraction of its overseas investment capability, and with the new regulatory climate, NTT's investments are likely to increase exponentially over the next decade.

Asia's future standards
Japan has been making a strong effort to influence standards in the Asian region. In 1994, at the Asia Pacific Telecommunications meeting held in Thailand, Japan's Ministry of Posts and Telecommunications (MPT) proposed unification of Asia's now-numerous communications standards. The Japanese government has been aggressively promoting the PHS standard, and the MPT and Japanese industry hope to establish it as an Asian standard.

Kiyohisa Ota, first vice president and head telecom/industrial electronics analyst at Merrill Lynch Japan, feels that the Japanese PHS strategy for Asia is sound. "The PHS system is suitable for wireless local loop communications in less developed countries that can't afford expensive cell[ular] phones," Ota comments. Also, PHS requires relatively low capital expenditures, and lines can eventually be routed into homes to provide direct digital links capable of being expanded into a wider band digital network.

The separation of the PHS and cellular/CDMA (code division multiple access) markets will make it easier for Japan to influence standards in both markets. In many potential Asian markets, this appears to be a reasonable strategy. The projected demand for analog and digital cellular handsets represents about one-quarter of the world telephone demand, and when these markets take off in Asia, that share should continue to expand.

The unexpected growth of the PHS market in Japan, and the fact that Hong Kong, Singapore, Australia, and Indonesia are considering adopting PHS to supplement their cellular standard, bodes well for Japanese manufacturers. The Japanese government has assisted with limited subsidies to Asian nations, such as Vietnam and Indonesia. Now, with the groundwork laid - as domestic deregulation continues and foreign barriers to entry come down - Japanese firms should be able to entrench Japanese standards by investing huge amounts of capital (or even giving the technology away).

If you want to establish a world standard in the next century, quipped one Japanese businessman, "just give it to China for free." That is basically what Japan is doing with PHS.

Louis J. Ross is a Strategist, Assistant Vice President, Research Department, at Merrill Lynch Japan (Tokyo). He has followed the relationship between capital markets and the funding of high- technology industries both in the US and Japan for over five years.

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