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The Chinese smartphone market is already dominated by home grown talent, such as Xiaomi and Huawei, and the market looks set to become an even tougher environment for foreign competitors over the next few years.

Back in July, Chinese authorities insisted that China’s three state-owned wireless carriers, China Mobile Ltd, China Unicom Ltd, and China Telecom Corp, reduce the amount that they spend on promotional handset subsidies. In total, the three carriers have a target of 40 billion Chinese yuan (US$6.5 billion) to cut from their budgets over the next three years, as the big three have, apparently, been overspending on subsidies and advertising.

China Mobile Ltd, which is the largest of the big three, is set to begin brining its handset subsidies down well within the three year time table. The company told investors that it would lower its subsidy budget from 15.6 billion yuan in the first quarter of this year, to 6 billion yuan in the second quarter, a cut of over 60 percent.

“Those handset OEMs that rely on operator channels will likely be adversely affected (in the) long term (if they do not) diversify their channel focus,” – Jasmine Lu, Morgan Stanley

This change in policy will have an impact on all smartphone vendors, including Chinese OEMs who operate through the big carriers, such as Lenovo, Huawei, and ZTE. However, more expensive foreign manufacturers, such as Samsung and HTC, could face an even tougher time. We have already seen smaller OEMs nabbing market share from the bigger global brands this year, due to their lower price points, and in China the big players are now facing shrinking profits to make up for the lack of subsidies, or risk losing sales to cheaper vendors.

Smartphone Market Share Q2 2013 to Q2 2014

We’ve seen a growing trend towards smaller vendors this year, and the new Chinese subsidy cuts could apply further pressure to premium device manufacturers.

Xiaomi, which recently overtook Samsung for the position as China’s largest manufacturer, could be the only vendor to actually benefit from the new budget restraints. The company does most of its business through online retail, rather than through China’s public carriers, meaning that its prices will remain unaffected.

“We believe the new policy could lengthen the handset replacement cycle, thus reducing the total pie,” – Jasmine Lu

Furthermore, Xiaomi makes a lot of its revenue through software services rather than hardware sales, which puts less pressure on profit generated from repeat hardware sales. Xiaomi could secure its place at the top of the Chinese market, once these budget cuts are fully implemented.

China is currently witnessing a big market shift, and this new change in handset subsidies could lead to the rise, and fall, of some new local and foreign companies.

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