PRINT THIS PAGE Wireless sends out positive signals
03/01/2007. Source:Scottish Equity Partners (SEP). Keith Dyer, Editor, Mobile Europe
To read the financial press, the mobile industry looks at a glance to be in a state of consolidation and low growth, says SEP. Behind these headlines, however, is a wellspring of optimism. Expectations for stellar industry performance may have been premature, but by no means were they unfounded. To read the financial press, the mobile industry looks at a glance to be in a state of consolidation and low growth. Vodafone is under constant threat of shareholder revolt, announcing huge losses and being forced to sell its Swedish, Japanese and perhaps US subsidiaries and holdings. The US market has seen tremendous M&A activity among the major operators including the once mighty AT&T being bought by SBC, a “Baby Bell” and once a subsidiary of the national US monopoly. And on the infrastructure side, Lucent and Alcatel are conducting the first of the mega mergers (if you don’t count what was left of Marconi heading off to Ericsson).
But behind these headlines is a wellspring of optimism. Expectations for stellar industry performance may have been premature, but by no means were they unfounded. According to FierceWireless, the wireless industry’s daily email newsletter, while three years ago the sector was ‘stunted by cautious optimism’, since then there has been an overall resurgence and the industry is poised for strong growth.
The evidence for this includes handset sales increasing from 650m units in 2004 to over 800m forecasted units in 2008. Moreover, the sales of enhanced data phones tripled in 2005 to circa 100m units and this is expected to double again in 2006. 3G and equivalent technologies represent a significant percentage of handset sales and are expected to be 'mainstream' by 2008.This growth is being driven by finally getting consumer acceptance of the new advanced handsets and enterprises going mobile in a big way, as Blackberries becomes the ‘de rigeur’ executive accessory.
Nowhere was the buoyant outlook more obvious than at the mobile industry’s annual gathering of the clans, 3GSM, which this year moved from Cannes to Barcelona. The event, which began ten years ago as a few table-top displays outside a conference discussing a digital cellular technology called GSM, has outgrown the festival town on the Cote d’Azur, and needed somewhere that reflected its growing size and ecosystem. In 2006 50,000 delegates flocked to the Fira de Barcelona where nearly 1000 companies were exhibiting.
But still, revenue growth for most major mobile operators is in single figures, due mainly to pressure on voice margins. Allied to this, data revenues, which were supposed to provide a high growth, high margin replacement for falling voice revenues, have stubbornly refused to reach the uptick of the growth curve.
Most operators will break out data revenues as a percentage of overall revenues, and the average is in the mid-teens. But that figure includes SMS text messages. The suspicion is that non-SMS data usage, that is browsing, music and video downloads, video and picture messaging, gaming, ringtones, the whole gamut of data activity, only accounts for low single figures of revenue.
Failure to launch
And to blame for this? The failure of 3G to date to capture the public imagination, and to deliver the experiences necessary to lift those data ARPUs. 3G promised to deliver consumers a true mobile internet experience, touching broadband speeds, and drove operators in some countries to spend billions merely on spectrum licences, and operators in all countries to spend billions on network rollouts.
Yet from a consumer point of view, for the past three years the launch of 3G has been underwhelming. In most markets, 3G was launched with a limited range of handsets, which, because of the increased radio functionality plus the need to support multimedia platforms, were much bigger than consumers had grown used to, with much shorter battery life. Added to that, the data rates were far more limited to almost fixed line dial-up rates by the limited processing power available on the handset.
Despite the prevalent view that the industry tends to overhype its technology, most operators (excluding 3, which as a stand alone 3G operator had no choice) launched 3G services almost on the quiet. Most chose to offer the same services they offered through their existing data portals (Vodafone live! T-Zones, O2 Active etc) but now “with added 3G.” The result was such a low profile seeping into the market that many people are still unaware 3G is available.
One reason for this may be that, despite the seeming imperative to drive data usage, the existing battle for customer acquisition remained around voice and SMS deals and packages.
Mike Baker, CEO of Zinwave, a company dedicated to providing a means of delivering good radio network access within large buildings and difficult spaces, says that operators with large 2G networks were simply not motivated to drive 3G uptake. In the early days while promising to the operator more network capacity and lower costs per call in the long term, in the short term the equipment was just too expensive and immature.
“There are two camps, those who take 3G as matter of life and death, and those who view it as an extension of 2G,” says Baker. “So 3, for example, is reliant on making 3G a success and will do anything to make it so. Other operators were more relaxed as they viewed it as an extension to 2G. They wanted people on 3G because it freed capacity and was going to be cheaper but they didn’t care too much because if customers didn’t move to 3G, they still had them on 2G. They decided they don’t have to over-invest to make coverage fabulous everywhere, whereas 3 has got to make sure it’s great everywhere.”
3G take two
But now, following widespread service launches throughout 2004 and 2005, there is a feeling in the industry that 3G has now truly arrived and is poised for mass adoption. According to the Global Mobile Suppliers Association, there are now 355 devices on the market compatible with WCDMA (the standard for all GSM-compatible networks), from 41 suppliers. There are also now 108 WCDMA operators in 47 countries.
Stuart Paterson, a Director in Scottish Equity Partners’ Information Technology group, is in the camp that thinks that 3G has moved into a second phase. He says that ‘3G part two’ is about, “Getting the user experience right, the equipment to work at the speeds expected while still being cost effective.”
“Until the size of the handsets and the battery life were at least comparable with 2G handsets then operators couldn’t hope to sell them in large volume,” Paterson says. “As can be seen by the phenomenal success of Motorola’s pink RAZR’ handset, cell phones are a fashion item, and from a user’s perspective better voice quality and slow content access are irrelevant in the buying decision.”
Dave Evans, CTO of SurfKitchen, a company which develops software that helps operators and phone manufacturers manage the user interface on a mobile phone, says that the corner has now been turned at the device level.
“The technology itself is much more established and the handsets are more appealing, more capable and with a battery life closer to what customers are used to. There’s now a greater push for 3G phones because the phones are appealing. You can see that in 3’s customer acquisition figures - when they had an appealing 3G phone such as the LG phone then they took a huge leap,” Evans says.
The second aspect of 3G phase two is the upgrade of the 3G network itself to what some say is 3.5G (or what 3G was expected to be in the first place). Handset and base station processing power has finally caught up allowing true broadband access. Most 3G networks are now scheduled for a software upgrade called HSDPA (High Speed Downlink Packet Access) which will increase data rates on the downlink to something truly akin to the multi megabit domestic broadband user experience. HSDPA will be followed by HSUPA, which will provide similar capacities on the uplink, meaning a user can send, as well as receive, large files. The GSA says there are now 23 commercial HSDPA networks, with 96 operators committed to the technology.
Sanjay Jha is vice president of CDMA Technologies at Qualcomm, a company that dominates the chipset market for phones based on CDMA technology (including 3G phones).
He says that HSDPA is unusual for a technology in that the handsets are ready before the networks are. Although this may be overstating the case somewhat, Qualcomm does have 45 handsets being developed using its HSDPA chipset, compared to 80 W-CDMA 3G handsets. LG and Samsung have HSDPA phones available, and there are also data cards from Option and Novatel Wireless on the market. Jha thinks that “by the second half of 2006, there will be an interesting range of HSDPA devices.”
Behind closed doors
Although HSDPA brings a solution to the capacity side of the network, and handset vendors have been able to produce 3G handsets that conform to 2G models of functionality and usability, challenges still remain. Jha himself highlights one of them. “In my opinion the number one 3G problem is indoor coverage. In every single technology deployment the biggest single issue has been indoor coverage, but in 3G’s case this is somewhat accentuated because it operates at the higher 2.1GHz frequency.”
SEP’s Paterson adds, “When 3G handsets start to look indistinguishable from 2G handsets, driving wider adoption, at that point we will begin to see the limitations of 3G coverage, especially in-building.”
The problem for 3G is that the higher the frequency of a radio wave, the shorter distance it travels and the harder it finds it to penetrate buildings. And 3G operates in most countries at 2.1GHz, compared to 900MHz or 1800MHz, for 2G networks.
In-building coverage matters for two main reasons. The first is simply that most mobile calls are actually originated and, for that matter, received inside a building. The second is that mobile operators are keen to substitute fixed line usage for mobile, both in people’s homes and at work, and to do so they must bring reliability and call quality somewhere near fixed line levels.
Consumers may accept the odd dropped call whilst in a train or their car as inevitable, but will be less tolerant at home. Added to this is the threat of fixed-mobile convergence (FMC), as landline operators such as BT attempt to use Wireless LAN coverage and dual-mode cellular/WiFi phones to encourage single-handset usage, in effect “stealing” the mobile operators’ voice minutes whenever the user is within range of a suitable WiFi access point.
Chris Cox, Marketing Manager for ip.access, says, “The big thing we see is the battle for subscriber residential revenue. Providing coverage and capacity in the home will allow mobile operators to own the end user device, by delivering high speed data and low cost calls to people in their homes.”
Guillaume d’Eyssautier, Chief Executive Officer of picoChip, a developer of base station chip solutions and software reference designs, says that a home 3G base station, linked to an IP network through DSL or similar broadband connection, would let users use their 3G phone whilst at home or on the move. This has driven the recent strategy by mobile operators such as BT, Carphone Warehouse and Orange of bundling voice and broadband access together. The race is on to meet customer demand for better mobile coverage, more service convenience and lower costs. From the operators point of view there is also the huge advantage of the technical and operational synergies in providing voice and data - be it fixed or mobile - on one bill.
“The big advantage is that you can use the 3G phone while on the move and at home using a single handset and number - and not involve the cost and power consumption of a dual mode WiFi/cellular call,” says d’Eyssautier.
“A 3G/wifi home base station connected to broadband also adds data, allowing the operator to provide better services over 3G in the home. It means they can increase coverage and capacity and customer loyalty and see the cost of calls reduce. Fixed line operators are delivering VoIP over Wifi phones to attack this market from the other side. This is a cost-effective way to counter that threat but is more complicated for the user who will have to use two handsets or a more expensive wifi/3G handset with limited battery life.”
Home base stations (called pico-cells in the industry) are a way to provide mobile coverage in smaller buildings, but for larger buildings there is an argument that multiple pico-cells become uneconomical. For larger buildings, and buildings with awkward corners where radio coverage cannot reach, distributed antenna systems (DAS) may provide an answer. A DAS works by siting a base station in, typically, the basement of the building in question. That base station is then connected via the existing Ethernet fibre in the building to remote antennas, which feed radio coverage out into the building.
Zinwave’s Baker says operators have not made a policy decision yet on whether to adopt the picocellular or DAS model. Up until now, he adds, if there has been a problem with coverage the operators’ response has been to add another tower outside. But with 3G, and the threat of VoIP to their voice revenues, that model is no longer viable. So the change will come, Baker says.
Remote control
But beyond issues of network coverage and capacity, there still exists basic usability issues around mobile phones. If mobile operators are basing their business cases on users making video calls, taking videos and sharing them, sending pictures, watching TV over mobile, using the phone to send and receive email, play games and download and listen to music, there is still a large argument for making all of that easier for users to access and use. Paterson says, “That’s the big challenging area for mobile operators. The answer is to increase simplicity for the user by making handsets intelligent, so operators can sell more stuff and make more money.”
It does not always have to be 3G that provides the content and the extra operator revenue as another SEP portfolio company Radioscape is showing with the launch in the UK by Virgin Mobile of ‘Mobile TV’ handsets. These new handsets rely on a mobile version of broadcast FreeView Digital TV to deliver live high quality news, sports and music to the handset using established digital broadcasting technology saving expensive 3G spectrum for customer specific voice and data traffic.
“SurfKitchen is another company that has added more intelligence into the handset to make 3G work better,” says Paterson. “So, for example, a handset which is on-network will have the top ten ringtones downloaded to it in the background at an otherwise idle time, and then the user is prompted to listen to them and click to buy if there’s one he likes. For operators wanting to change a handset’s menu or promote content, it is attractive for them to customise a handset remotely. Certainly O2 found a far greater download rate using “push” technology such as this rather than rely on a user browsing to a particular piece of content on its portal.”
Dave Evans, CTO of SurfKitchen, says the industry is moving away from a browsing model, which relies on a user to “surf” as he would on his home PC to particular sites and content, to a client-server model.
“Client/server on-device exposure brings an end user into a service and delivers that service in a quicker, less latent way. You get content in a managed way so you are not worried about the cost and if it’s working. As we move forward I think operators are moving to defined client-server applications on devices, and moving browser activity off-net.”
Evans’ argument is that the industry is now starting not just to bring technology into the market, but making it easier to use. Certainly, one area where the operators have already trodden this path in is MMS (multimedia messaging).
Francis Schmeer, Chief Marketing Officer of messaging systems provider Empower Interactive, says that when MMS was launched it was hard to find on phones, and harder to use. There was also a case of MMS being a technology in search of a need, he says, as opposed to voice and SMS which seemed to meet pre-defined needs.
Schmeer argues that the lesson from MMS is that operators need to focus on “consumer benefits”, rather than promote technology. He warns, “Consumers don’t care about networks, whether they are using a 3G, MMS or SMS network. They are more focused on their own needs.
“At 3GSM this year we were inundated with mobile TV and video plays, although screen sizes are still small, and the usage model and users’ willingness to pay is still not clear. But I wouldn’t be too negative because at the end of the day this stuff is exciting. My personal opinion is that you can’t ignore what brings the money, voice, SMS, and MMS, and continued investment in that infrastructure is something we still have to focus on.”
With 3G a reality, but with increasing competition in data and voice delivery from other platforms, there remain investment opportunities across the value chain.
“Venture capitalists and smaller companies are highly valuable because they allow for innovation and experimentation. There’s still a tremendous amount of growth in developing markets - take Vietnam, where there are 92 million people, and 10% penetration with an 80% growth rate - so vendors must be global players and you can’t just fund development from Western Europe or Asia,” Schmeer says.
SEP’s Paterson concludes, “The investment cycle always goes a lot slower than people expect. 2G took ten years. After all that initial hype, 3G has taken about eight years to go mainstream. But people are demanding Blackberries and data cards and the like, driving more capacity on the network, and innovation in services and devices can only drive that further.
“The performance of 3G handsets on points such as improved voice quality and lower cost of call delivery as well as greater functionality means that 2G phones will eventually fade out. Maybe 3G didn’t take the market by storm like everyone expected, but now it is taking over by stealth. And with mobile TV, radio, music and video still at the earliest of stages, there are clearly great opportunities for companies that can help operators solve the entwined challenges of coverage, capacity and consumer user experience as well as extracting more revenue.”
Keith Dyer is editor of Mobile Europe, which has provided news and analysis of mobile operators’ business and technical strategies since 1990. www.mobileeurope.co.uk
Scottish Equity Partners (SEP) is one of the largest independent private equity groups in the UK, and is currently investing from a venture capital fund in excess of £100 million, which is backed by leading UK and European institutional investors.
With offices in Glasgow and London, SEP is one of the most active venture capital investors in the UK and has a strong investment track record. Typically, we invest between £500,000 and £5 million or more, in financings of up to £30 million, in early stage and growing companies in the information technology, healthcare & life sciences and energy related technology sectors. For more details visit www.sep.co.uk
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