Just ask the folks at China Unicom and Apple. When China Unicom recently began offering Apple's iPhone for as much as $1,172, the company sold a measly 5,000 units its first weekend, according to Reuters. By contrast, when the iPhone 3GS was released in the U.S. earlier this year, it sold more than 1 million units in its first weekend. At full price, the phone flopped.

Part of the reason is that since 2007, the Chinese market has been flooded with iPhones sold in other countries and then modified, or "unlocked" so they work on other networks, before being sold for as little as $650. In other cases, Chinese consumers had already purchased low-priced, repurposed used phones.

But much of the blame lies with a burgeoning gray market for copycat phones, often made to look like the real thing but sold for a fraction of the price. "Anyone who'd buy an iPhone from China Unicom is insane," says Charlie Wolf, senior analyst at Needham. Fewer than 5 percent of Chinese can afford China Unicom's iPhones, says Neil Mawston, an analyst at consultant Strategy Analytics.

Knockoffs Make Up 13 percent of Handsets

Lackluster iPhone sales dealt a blow to China Unicom, which hoped the iPhone would boost subscriber growth the way it helped AT&T , the exclusive U.S. iPhone provider. It was also bad news for Apple as it tries to forge ties to wireless carriers in new countries, beyond the 64 where the iPhone is already sold.

The gray market extends well beyond China, however. In Africa, Eastern Europe, Latin America, and even the U.S., handset clones are on the march. Gray market phones may resemble the real thing but don't carry warranties, and their makers often don't pay licensing fees to such component makers as Qualcomm. Gray market phone shipments from China are up 43.6 percent, to 145 million units, this year, according to estimates by consultant iSuppli. They now constitute 13 percent of the global legal handset supply. In contrast, worldwide unit shipments of legitimate cell phones will decline 8 percent this year.

Many knockoffs are made in small factories across Asia. "You have all these little workshops, and they do some extremely creative things" to adapt phones to local markets, says Frank Meehan, CEO of cell phone maker INQ, which supplies carriers such as Hutchison Whampoa. "There are hundreds of them [in China), and they are springing up in India." (continued...)

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