China Mobile, the country’s biggest telecom carrier, recently announced that it would cut subsidies for smartphone purchases, driven by a directive from the Chinese government to telecom carriers to cut their management and marketing expenses by 20% over the next three years. China Mobile’s planned subsidy in 2014 was $5.5 billion, but now is expected to be around $3.4 billion, a 38% cut. After China Mobile’s announcement, China Unicom followed with an announced cut in 2H. What will be the influence of these subsidy cuts?

First, sales of premium smartphones in China will be impacted. Even with reduced subsidies, Chinese telecom carriers still want to hit their targeted selling volume this year, so they will likely push makers for more entry-level smartphones. Since the subsidy for premium models is much higher than entry-level smartphones, perhaps by 5:1, premium smartphones will likely be deemphasized.

Second, component costs are likely to fall. Subsidy cuts do not mean that telecom carries will give up on the LTE market; instead, they will push component makers to reduce costs, targeting $100 entry level smartphones for example.

Third, NFC demand is likely to increase. Telecom carries will more aggressively expand businesses other than selling smartphones and earning service fees. As telecom carriers serve as a bridge for payment between users and producers, they can take a percentage of purchases. That is why China Mobile is promoting NFC in its 4G smartphones. It is not difficult for phone and component makers to embed NFC in LTE SIM cards. This way, the carrier can provide service and security, but not dedicate any resource to hardware.

Fourth, tier one smartphone brands are likely to increase their investment in emerging markets. According to our latest research, Samsung will be passed by Lenovo in China this year. Lenovo has own sales channel, which lessens the impact of subsidy cuts, and since they receive support from key component vendors for cost reduction, they have aggressive plans for low-end smartphones in 2H. Samsung has found competing with domestic makers in China’s entry-level smartphone market to be very difficult; they will likely focus increasingly on emerging markets such as Southeast Asia, South Asia, and others.

Finally, as they face pressure to launch more low-cost models, smartphone brands will rely more on IDH (independent design house) partners, who can help cut manufacturing costs.