Death bell tolls - 3G R.I.P

Added: (Wed Aug 14 2002)

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Death bell tolls - 3G R.I.P?


Datamonitor - London, 16 August, 2002 - Operators' capital expenditure on building and subsidizing 3G services simply can’t keep going as it is, according to independent market analyst Datamonitor (DTM.L). Telefonica and Sonera axed their German joint venture, Quam, writing-off over €8 billion in the process. Orange in Sweden is lobbying the government to ease off on license requirements. Several first and second tier operators look increasingly likely to delay 3G service launches. Any kind of venture funding for small content houses has all but dried up. Uptake of any mobile data services so far has been shockingly low. There are no handsets - well, none that work - and it's clear that no consumer is prepared to pay more than around €250 for any sort of advanced device. According to Datamonitor, low uptake will cause a cash-vacuum and that won’t service the billions of dollars of debt in license and infrastructure costs.

It is a crisis, a long drawn-out death! - No financier, VC or enterprise would consider investing in something with payback "somewhere in the next three to eight years"

Optimists in the industry say all this is a setback, but not a crisis. Recent industry announcements talk of ‘the 3G sweetspot’ and in the same breath state that 'it will take between three and eight years for 3G license holders to break even'. This isn't reassuring in the slightest, and should be seriously worrying operator shareholders.

“This is hardly a ‘sweetspot’ - It's a 'long, drawn-out, death',” says Datamonitor mobile telecoms analyst Nick Greenway. “No financier, VC or enterprise would consider investing in something with this kind of payback period - besides, operators will not be around if it takes them any more than three years to gain some sort of return. With junk status ratings; share-prices with possibly another 10% to fall; industry Rights Issues looming; massive over-expectation of potential MMS revenues and discussion of technologies capable of leapfrogging 3G altogether, it could be the beginning of the end for some.”

License holders- its cheaper to abort 3G plans, despite the sunk costs

Within the next 12 months, some license holders may shelve 3G aspirations, possibly having to treat the cost of licenses as a write-down. Despite the sunk costs of licenses and infrastructure, it will still prove cheaper for them to abort 3G plans, rather than to try and foster a market by subsidising the handsets and services required. Of interest is what happens with the licenses. Telefonica and Sonera have retained their license despite pulling the plug on Quam. It still has residual value as an asset on the balance sheet. However, all it takes is a couple more shaky operators and licenses may become available at knock-down prices as part of debt-restructuring plans. Operators who decided to concentrate on advanced 2.5G services may get another bite of the cherry. But will they want it?

Give it away now - there’s more sense in abandoning the market altogether than rolling out a service on top of giant sunk costs

Investing billions of Euros in 3G licenses and infrastructure isn't a decision that anyone would like to make in today’s market, but rolling a service out on top of such giant sunk costs makes less sense than abandoning the market altogether.

It's becoming clear that no consumer is prepared to pay more than around €499 for any sort of advanced device - most will pay no more than €250. Considering that most devices in the offing (such as Sendo's smartphone) are priced at around €1,200 at unsubsidised retail value, subsidies of between €500 and €800 look necessary. “Do the maths - if a European operator with 12million subscribers wants even half of them to have a 3G handset, the cost of subsidy will exceed €3 billion. Of course in reality, around 65% of those customers will be pre-pay and as such, not an initial 3G data-service target, but the point is implicit,” says Greenway.

Add to that the cost of service development, deployment and marketing and it starts mounting up. “Operators’ original 3G business plans had been looking to fund some of this from the increase in existing customer revenues. However, uptake of any mobile data services so far has been shockingly low. Even though GPRS handsets are being sold at a moderate rate, the percentage of those actually signing up to a GPRS tariff is abysmal,” adds Greenway.

SMS continues to be a success story, so much so that demand for innovative services outstrips operator abilities in tracking, provisioning and billing. MMS however, has already suffered the same fate as other mobile acronyms - over-hype. While few doubt the value of this application, predicted uptake and revenues have been massively inflated, not least as it is likely to cannibalise existing SMS revenues. The handsets just aren’t available right now, with only two camera-phones on the market and about another one or two models in the next few months. In the run-up to Christmas, consumers are far more likely to demand handsets with radios and MP3 players, according to Datamonitor. Business models with this extent of exposure to fragile consumer confidence (not only in the US, but also in Europe if interest rates start rising towards the end of the year) will come under even heavier pressure when consumer expenditure drops off.

Dis-Content providers and several dedicated start-ups on their last legs

Unless operators can offload more of their costs to content providers, the chicken and egg scenario of data-service subscribers and services will continue unabated.

However, while content providers lamented the lousy margins proposed by operators up until 6 months ago (especially in Europe, where these might have been as low as 20%), the introduction of i-mode services has gone some way towards fostering a change. The operator industry is tending towards a margin of 15% on consumer services.

Any kind of venture funding for small content houses has all but dried up, with only a few investments remaining in messaging technology. Several dedicated start-ups are on their last legs; the real-world media groups are tightening belts and cutting back anything that's online or unprofitable - especially things that are both - and the industry is looking more than expectantly to Hutchison 3G to blaze a trail out of the mire.


No handsets - well, none that work
All this would be enough of a problem, even if anyone had made a successful 3G handset. But so far, no one has really managed to integrate the circuitry required for 2G (inc 2.5G) and 3G to exist on the same silicon wafer. In effect, all prototype 3G handsets at present comprise ‘two handsets in one’ under the bonnet.

Nobody has even properly managed to make these double-chip 2G/3G combinations work successfully. Hutchison 3G hopes to be the first major European 3G player to bring a service to market, hoping to launch in late 2002. It recently admitted, however, that its dual-mode handsets cannot currently hand-over calls between 2G and 3G networks, meaning that the user has to ring back. This is serious: if you pay €499 for a phone, you'll be justifiably annoyed about having to re-dial your call every time you move from one network area to another. According to Hutchison, the problem won't be fixed until mid-2003, but they are by no means the only ones.

This hybrid phone naturally incurs a correspondingly larger BOM (bill of materials) for manufacturers, but they are in no position to absorb this through additional efficiencies in production - they’re sailing as close to the wind as possible already when it comes to making margin on handsets.

And the walls come tumbling down

According to Datamonitor, some operators will follow Telefonica/Sonera and pull out; others may go bust or be acquired. Parent companies of smaller operators might have painful decisions to make, with respect to allowing a slide into receivership, the sale of a going concern (which no one will want to buy unless some debt is written off) or injecting yet more cash. One thing is clear - British Telecom’s decision to divest O2 is proving to be wiser by the week.

Greenway concludes:

“This is not to tar all operators with the same brush. Some show more prudence than others and have rather healthier balance sheets and some have not been subject to such massive license costs, such as in Norway. MVNOs may yet have their day. With no revenue streams, 3G operators may have no option but to lease capacity to brands like Manchester United, AOL Time Warner or Disney.

However, if governments do not revise contractual obligations, we may well see a grey market for 3G licenses before 2002 is out.”

Ends

Notes for Editors:

This analysis is based on current industry trends and in-house modelling techniques used in Datamonitor’s Enterprise Mobility strategic planning program (SPP). Information on the range of research can be obtained by visiting www.datamonitor.com

To arrange an interview with analyst Nick Greenway, or for further information please contact:

Krishna Rao
Tel: (+44) 20 7675 7271
Fax: (+44) 20 7794 7016
krao@datamonitor.com

Datamonitor plc is a premium business information company specializing in industry analysis. We help our clients, 5000 of the world’s leading companies, to address complex strategic issues. Through our proprietary databases and wealth of expertise, we provide clients with unbiased expert analysis and in-depth forecasts for six industry sectors: Automotive, Consumer Markets, Energy, Financial Services, Healthcare, Technology. Datamonitor maintains its headquarters in London and has regional offices in New York, Frankfurt, and Hong Kong.