Mobile market will drive the growth of the industry: broad service changes required.

The wireless business in the United States is like a shark: If it stops moving forward, it will die. (And, of course, it tends to take a bite Out of anything in its way.)

With the worldwide slowdown in wireless revenues and the collapse of telecommunications companies, however, it seems that now is a good time for wireless providers to take stock of the industry and make the changes necessary to stay healthy and competitive. And, in fact, this is exactly what several new reports are recommending for wireless service providers. But while analysts feel that consolidation is inevitable, they also stress that providers must keep their technology programs moving forward, or risk being gobbled up by larger, swifter, and hungrier competitors.

The first, and perhaps most important, point is that mobile operators who do not embrace public wireless LANs are in danger of extinction when wireless WANs (high-speed wireless or 3G) become prevalent. The home market for wireless networking is exploding and, though still relatively small in dollar terms, is expected to be attacked by Microsoft at about the time you read this--always a sure sign of its technological importance. (See the August issue of CTR for a discussion of Redmond's plans, available at www.wwwpi.com.) But industry observers feel that for mobile providers, the key to effective penetration of the WWAN market, at least initially, is via public WLANs.

Wireless Latte, Please

"Public WLAN services will help educate users on WWAN data usage, thus increasing their usage and adding to overall data ARPU [average revenue per user] incrementally while helping to alleviate the decline in voice ARPU," Donald Longueuil, an analyst with Cahners In-Stat/MDR, said in a recent research report. Longueuil feels that mobile operators who ignore the rise in public WLANs--in places like airports, coffeehouses, and hotels-- do so at their own peril, and risk being overtaken by competitors who either develop such technologies in-house or get them through strategic acquisitions. "Every mobile operator could achieve increased wireless data revenue if they implement a WLAN solution properly," Longueuil notes. "But to do this, they must start now, either by growing organically or by purchasing a WLAN service provider. Delaying entry into the market will likely prove detrimental in the long run."

While public WLANs are still in their infancy in the United States, In-Stat predicts that there will be approximately 5,000 so-called "hotspots" at the end of 2002 (worldwide) and approximately 41,000 at the end of 2006. Although private, non-telecom companies own the majority of public hotspots today, In-Stat says, that majority will shift to mobile operators by 2006. By that year, companies that offer combined WLAN and WWAN services will see nearly $700 million more in revenues than if they offered WWAN alone.

For mobile operators, public WLANs can serve as both a carrot and a stick. On one hand, they entice users to buy new phones that can take advantage of wireless networking services. On the other, they habituate users to the speed and convenience of such services, making going back to slower data rates particularly unappealing. (Pricing plans will also likely be structured to make going back especially uneconomical.) In particular, public WLANs can serve as an effective starting point for users who are just getting their feet wet with high-speed wireless.

"Offering WLAN services today will enable mobile operators to experiment with broadband services, to combine them with their GPRS and CDMA 1 x RTT offerings, and migrate users to WCDMA when it becomes available," Longueuil notes in his report. "If they delay in implementing WLAN technology, competitors will get a [head start] over mobile operators, covering all the hotspots and competing head-on with their future services."

Korean Food For Thought

The absence of a foothold in this market might prove particularly damaging in an economic and technology climate where consolidation is already taking place, and is expected to continue. For a preview of what might happen in the United States, and in Europe before that, it is helpful to examine the wireless industry in Korea, which is widely considered to be at least three years ahead of the European market (and hence four or five years ahead of the United States).

Over the past 18 months, the number of mobile providers in Korea has shrunk from five to three. Much of this consolidation, analysts contend, is the result of the elimination of economically unsustainable phone subsidies, which are common throughout Europe and the United States.

Strand Consulting, a research firm based in the U.K., says that the subsidy ban, introduced in June of 2000, had a dramatic, nearly instantaneous effect: "Nine months later, the two largest Korean mobile operators merged with the two smallest operators, bringing the number of operators down from five to three," the firm said. "Three mobile operators is unusual in a country with a mobile penetration of 61% and around 30 million mobile subscribers--but together with the subsidization ban this has paved the way to three financially healthy mobile operators." Strand feels that such consolidation of mobile operators will be "a necessary step for many European countries, where there are simply too many operators competing for customers and basically not making money." In Korea, all three mobile operators are now the black; two out of the three had reported several years of losses prior to the ban.

Why was the ban effective? Strand feels that government regulators were concerned that mobile operators did not have the necessary capital to upgrade their networks to 2.5G, mostly because the companies were losing tens of millions on the subsidies as well as their related marketing programs. "For a start, the operators marketing expenditure was immediately halved: this was simply the money they were spending on the actual subsidization," Strand reports. "When you have a market with around 30 million mobile users, suddenly not having to subsidize each and every mobile phone adds up to a lot of money-and as all three mobile operators are effected by the ban, none of them can now use the price of the mobile phone as leverage to get new customers." With the phones no longer a drag on revenues, the providers were able to devote capital to network upgrades.

But how were such capital expenditures recouped? With the phones no longer subsidized, how did the Korean operators move into the black when the very services they were offering required expensive (and now much more expensive) new phones?

Interestingly, and tellingly for U.S. and Europeans mobile providers, the answer is stratification. Strand reports that all three Korean mobile operators went for the same solution: Split their subscription offerings into sub-brands, specifically targeted at different age and gender segments of the mobile users. "We are not just talking about different price plans here, as we have seen in Europe, but actual brands with their own portals, marketing, content and services offerings and of course price plans, for pre-teens, teens, young adults, women, and so on."

The results have been dramatic. Strand reports that in the two years since the ban on phone subsidies, more than 9 million mobile customers have switched to 2.50 mobile phones, and ARPU has risen dramatically as the new mobile services and content in the different sub-brands is used regularly by almost all mobile users. Meanwhile, the mobile operators EBITDA margin rose to between 30 and 40%, where it had been in red figures for two of the operators only the year before. "The unique combination of the sub-brands, and the vast amount of content and mobile services offerings that the sub-brands can offer, have been instrumental in getting the mobile users to discard their 2G mobile phones and buy the new non-subsidized 2.50 mobile phones," the firm said.

Could such a strategy work in the United States? The U.S. regulatory climate makes a government-mandated elimination of phone subsidies highly unlikely, if not impossible. However, stratification of service levels is already occurring in terms of pricing, with socalled family plans, unlimited calling to users of the same service, unlimited wireless data usage for business customers, and so on. Stratification of content is more difficult--at least from a technical perspective -- without higher-speed data services and phones, which have yet to become widespread. But mobile operators who begin offering public WLAN access--which requires a much lower level of capital expenditure than do WWAN services--might be able to begin tailoring content to specific user segments.

According to recent research, wireless usage is expected to double in 2006 from last year's levels. In a report from the Yankee Group, a survey found that while just three percent of U.S. consumers use their mobiles as their only phone, 26% of mobile users' minutes are already being displaced from wire-line to wireless, and 45% of mobile users indicated substitution. (According to the report, 50% of Americans own cell phones.) But the Yankee Group feels that the industry must undergo consolidation, and eliminate at least two major operators, before adequate financial returns can be achieved.

Moving to WLAN

Like the mobile market, the WLAN sector is poised for explosive growth. According to Gartner Dataquest research, the penetration rate of wireless LANs into the professional mobile PC installed base will grow from 9% in 2000 to almost 50% by the end of 2003, and it is expected to surpass 90% by 2007. Gartner indicates that worldwide WLAN shipments are on pace to grow 73% in 2002, with revenues set to increase 26%.

Andy Rolfe, principal analyst for Gartner Dataquest's worldwide telecommunications and networking group, is the author of a new report titled Wireless LAN Equipment: Worldwide, 2001-2007. The report says WLAN revenue will reach almost $2.8 billion in 2003, up from $2.1 billion in 2002.

But like the mobile market, Rolfe expects considerable consolidation in the WLAN market; there are currently 70 vendors offering WLAN equipment "The market is already far too crowded, and we expect to see significant failures, withdrawals and consolidation over the next two years," Rolfe says. "By 2005, apart from mobile PC vendors offering bundled or integrated wireless LAN, we do not expect there to be more than 6 or 7 significant adapter vendors. There will be a larger number of infrastructure vendors that survive, due to the greater differentiation in products."

One WLAN equipment provider that probably won't disappear anytime soon is Microsoft Corp., which has just introduced nearly a dozen new WLAN products for the home. In October Redmond will begin selling its own branded base stations, wireless USB adapters (desktop and notebook), and Ethernet adapters based on WiFi (802.11b). The devices will include parental controls and 128-bit encryption by default.

WLANs and mobile phones in some ways face the chicken-and-egg scenario: Users are not likely to begin buying and using phones with WLAN features until WLANs are publicly available, and WLANs are unlikely to become widespread until there is a decent installed base of phones and PDAs that can use them. But with 30% of notebooks expected to come equipped with WLAN adapters by 2004 (according to Gartner), it may be portables that spur the growth in early adoption of public WLANs.

Perhaps more than any other single company, Intel has the power shape the wireless market at the hardware level. The chipmaker is to set to include wireless support in its new mobile CPU (code-named Banias), and Intel has announced its intention to add radio functions to the rest of its chips (see this month's Top Tech story). With the PC now becoming little more than a glorified home appliance, the mobile market is well positioned to drive the recovery--and the future growth--of the industry.