Why Apple and China are Simply Incompatible

The Beijing Olympics begin in two weeks. But for Apple, the China games have already begun. The company opened a shiny new Apple store in Beijing Saturday -- the "first of many" in China, according to an Apple official. The race is on.

But is this an event Apple can win?

China is a coveted market. But so far, things aren't going well. Apple has less than 8 percent market share in China for media players, and far less than 1 percent of either PC or cell phone market share.

Although Apple has successfully launched the iPhone in more than 70 countries, China isn't one of them. The company has not yet been able to reach a deal with any Chinese carrier.

Apple's second biggest hit in China, the iPhone, isn't authorized. One Chinese analyst estimates that some 1 million Apple iPhones are currently operating on just one Chinese carrier -- China Mobile -- with a smaller number on other carriers. Most Apple "Authorized Resellers" in China sell black-market iPhones, and many even offer illegal cracking services -- a process that reportedly takes less time than activating an iPhone 3G in California.

Apple's struggle to sell iPhones legitimately in China is part of a larger problem: China is simply incompatible with Apple. Here's why.

Apple is a mass-market luxury brand

Cheap, high-volume mass-produced electronics do well in China, and low-volume luxury brands do well in Beijing and Shanghai. But Apple products fall into a third category: high-volume luxury.

Most Apple products are far too expensive for China. A 2.4 GHz Intel Core Duo MacBook available at the new Apple store, for example, costs about the same as the average city-based Chinese worker earns in a year: $2,000.

But it's more than just price. Apple succeeds because customers love the products and the brand. But in China, brands mean little to most potential customers, and hardware even less. Chinese consumers prize value above all.

The rest of the world's love of the Apple brand has enabled Apple to get favorable terms with carriers around the world. But this hasn't helped much in China. Apple initially demanded a big two-digit percentage of carriers' wireless revenue as a condition for granting its coveted exclusivity deal, according to reports (one company says Apple demanded 30%). The Chinese carriers were apparently unimpressed by the value of Apple's brand compared with the value to Apple of access to Chinese consumers. They appear to have forced Apple to drop its demand for any share of wireless revenues.

China has an authoritarian government

One-party rule in China actually affects product quality. One example is that Apple will probably be required to disable the iPhone's Wi-Fi feature in order to comply with the Communist Party's strict Internet control and censorship rules.

There is no Chinese iTunes

For reasons it refuses to divulge, Apple does not offer a Chinese version of iTunes. The reasons probably have something to do with concern by the music labels about rampant music piracy in China. Regardless, Apple sells iPods and will soon sell iPhones in market where it believes it cannot offer the "other half" of the value: a music store.

Worse, China Mobile has a thriving music download business. China may be the first country in which the carrier, not Apple, sells the music that people listen to on their iPhones.

China is number one in intellectual property theft

Apple's whole business model is based on creating value through exquisite design, superior branding and the sale of creative intellectual property (IP) -- then defending its rights against the IP thieves, pirates and counterfeiters.

How will this formula succeed if China doesn't enforce intellectual property laws?

The music piracy rate in China is between 90 and 99 percent, depending on whom you ask. China is the global epicenter of intellectual property theft in general, and of Apple IP theft in particular -- especially iPhones and iPods.

Fake iPhones, and phones that steal Apple branding; illegal iPhone unlocking services; trade in illegal movie and music files; all appear to be tolerated and even government-protected activities in China.

Chinese courts, which are not independent from the Communist Party, are typically hostile to foreign companies trying to squeeze Chinese companies who are stealing IP. The Chinese government has traditionally viewed Chinese IP theft as a win-win. It simultaneously builds Chinese know-how and Chinese manufacturing, but has the added benefit of damaging foreign competitors.

In the past year, the Chinese government has cracked down on some counterfeiting. But this shift may be part of a wider effort to improve its reputation in advance of the Olympic Games. It remains to be seen what will happen when the games are over and the spotlight comes off Beijing.

Chinese carriers don't like Apple's revenue-sharing terms, and most Chinese customers don't like Apple's prices or care that Apple is a premium brand.

And Apple has to compromise on the Apple experience for customers in China. The iPhone will probably have no iTunes and no Wi-Fi.

Yes, Apple must and will do business in China. But the company's pristine new Apple store masks the very messy reality of a company like Apple trying to do business in a country like China.