Who'll Survive the Cellular Crisis?
europe.businessweek.com
Facing a laundry list of woes, the industry is in turmoil as it's spending billions on new networks. The future belongs only to the strongest
In 1947, to help police departments keep in touch with patrol cars as inadequate radio frequencies got jammed up, AT&T engineers designed the first cellular network. Their solution: special transmitters that hand off calls to each other like so many footballs being passed from player to player. It required half a century of innovation for this technology, cell phones, to reach mainstream America. And then, it took the country by storm.
During the late 1990s, the number of cell-phone users in the U.S. more than doubled every two years -- and wireless stocks grew as hot as those of many dot-coms. Sprint PCS (PCS ) shares rose five-fold from 1998 to mid-2000. And AT&T Wireless (AWE ) raised a record $10.6 billion in its April, 2000, initial public offering.
A lot has changed since then. Like the dot-coms, cell-phone stocks have taken a plunge: The Philadelphia Stock Exchange Wireless Communications Index has dropped 30% in 2002 alone. And when it comes to signing up new customers, the law of diminishing returns has started to take hold: Nearly half the U.S. population, or about 130 million people, already own mobile phones, and the remainder won't be as easy to convert.
CASCADE EFFECT. In fact, growth in new-user sign-ups has tapered off from the breakneck pace of 50% annually in the late 1990s to what analysts project will be a 15% to 20% rise in 2002, and no more than that in 2003. To some extent, numerous surveys have found, slower growth in demand reflects consumer disillusionment with just about every aspect of cell-phone service -- its reliability, quality, and notorious customer service.
Whatever the cause, the cooling off in demand threatens to cascade through the industry: The big six U.S. cell-phone carriers -- Verizon Wireless, Cingular Wireless, AT&T Wireless, Sprint PCS, VoiceStream, and Nextel Communications (NXTL ) -- are engaged in a fierce price war that imperils their timetables for becoming profitable, not to mention their efforts to whittle down their mountains of debt. Sprint alone owes $16 billion -- and has $179 million in cash.
As the carriers have begun to cut costs, wireless-equipment makers -- companies such as Lucent (LU ), Nokia (NOK ), and Ericsson (ERICY ) -- have been left with a market that's bound to be smaller than they had anticipated. Handset makers have been insulated so far, but they, too, face a nagging uncertainty. They'll soon introduce advanced phones to the U.S. market that will run on the new networks the carriers are starting up over the next year or two. But the question then will be: Will Americans embrace these snazzy data features -- and their higher costs -- with the wild enthusiasm that Europeans and Asians have? Or will they limit their usage to plain old voice calls and dash the industry's dreams of riches?
SOBERING CONSEQUENCES. In short, the U.S. cell-phone business has arrived at a crossroads. The carriers argue that they see plenty of upside, thanks to the 25%-plus share of the U.S. population they still hope to capture and the glitzy services they'll soon roll out. If they're wrong, or if their timing is off by a year or two, the consequences could be sobering: Debt-laden carriers could face wrenching consolidation, some equipment makers might have to exit the business, handset makers could enjoy a far smaller bonanza -- and cell-phone stocks could take up permanent residence in Wall Street's dungeon.
Long before the outcome is clear, the industry will have to adopt a new mindset. "In the old days, it was all about connectivity," says Andrew Cole, an analyst with wireless consultancy Adventis. "Build the network, and customers will come." From now on, the stakes will be higher. The new mantra: Please customers, or you may not survive.
In the U.S., at least, cell-phone service has been an industry in search of a payoff ever since its beginning in the 1970s. Carriers borrowed huge sums to build networks, then spent up to $500 a head to attract customers they had to keep in the fold for two years just to recoup the cost of acquiring them. As cell phones grew in popularity, though, more carriers entered the fray. They cut prices, stole customers from each other -- and, for the most part, never made money.
STARK OPTIONS. To work their way out of this box, the carriers are banking on a couple of key notions. One is that they'll continue to attract large numbers of new subscribers. They also plan on reaping much more revenue per customer once cell phones are widely available that have color screens and can browse the Web and play games over a fast connection. Suddenly, though, growth in subscribers has declined more steeply than anyone expected. And it will be a year, at best, before it's clear whether U.S. consumers will buy advanced cell-phone services -- which could increase their monthly bills 25% or more.
That leaves the six major providers with stark options: Make the two-pronged strategy work, or look for a merger partner. For now, most are spending heavily on service upgrades in hopes that the market will support them all. They don't have much choice, really -- customer dissatisfaction is rising rapidly. Cell-phone service is far superior to what it was a decade ago, but now that it's widely used, it's often compared unfavorably with regular phone service.
In fact, U.S. cell-phone networks are among the worst in the world, notes Adventis' Cole. He estimates that they contain one-third fewer cellular bay stations -- also known as cell towers -- than networks in Britain, for example. The result is too much static, too many "dropped calls" in the no man's land between stations -- and irate customers. Carriers often blame communities for opposing new towers and forcing operators to wage time-consuming and costly court battles.
FASTER ANSWERS. At the same time, however, they're spending huge sums to address the problem. Much of Sprint PCS's $3.4 billion in capital outlays this year will be for new stations. And in fact, the new high-speed, high-capacity nationwide networks due to roll out later this year should help ease the calling-capacity crunch that has caused many consumer complaints.
In the meantime, some companies are using better training and organization to keep customers happy. The nation's largest rural operator, Alltel (AT ), recently reorganized its call centers so that a customer's query goes to the first operator who's available anywhere in the country, instead of the first one available in the customer's home area. That should cut waiting time to one minute from three to five minutes previously, says Kevin Beebe, Alltel's group president for communications.
Even a small changes like that can pay off big on the bottom line. Service providers who have higher overall customer-satisfaction scores keep subscribers for two months longer, on average -- and get $11 more per head in monthly revenue, according to quality experts J.D. Power & Associates.
COOPERATE OR DIE? Of course, such steps are just a stopgap measure until the payoff from advanced services arrives. Sprint PCS predicts that by 2006, data services such as mobile e-mail access and text messaging will generate more of its revenues than voice calls. Williams Capital Group is more conservative but still optimistic: It estimates that data services will contribute 15% of operators' 2005 revenues, up from less than 2% today.
Neither prediction may come true, however, unless carriers enable two-way text messaging between their systems -- similar to what they currently allow with voice messages. Even now, many carriers view this degree of cooperation with suspicion. But that's foolish -- and "not the way to grow the industry," says Lew Chakrin, executive vice-president for corporate strategy and development at AT&T Wireless. "Any data service ought to be sent and received by anybody," he adds. Some carriers expect such cooperation to begin this year.
Even with cooperation, smaller companies will have a hard time surviving and could disappear in as little as 18 months if the industry consolidates. Last October, AT&T Wireless acquired the 77% it didn't already hold of TeleCorp PCS, which serves 14 states and Puerto Rico, for $4.7 billion in cash and debt. In a year or two, some analysts believe, the top six could consolidate down to three, with Verizon Wireless leading the way, says Charles Pluckhahn, an analyst with investment bank Stephens.
Indeed, some players "have business models that, in the cold light of day, really don't make any sense," says Stephen Carter, CEO of Cingular Wireless. "We just have to wait for them to run out of money."
"HIGH-WATER MARK." Consolidation among carriers would mean more bad news for the companies that make equipment for wireless networks. In their heyday, these outfits doubled in size every year. Today, their outlook is glum. In 2002, operators' spending on equipment will be flat to down 10%, vs. 2001, when they spent $50 billion. "All our customers are [rethinking] their business plans," says Cindy Christy, chief operating officer for mobility solutions at Lucent (LU ).
In this slowdown, the best strategy for the equipment makers is to be patient -- and push the products that still sell well: Gear for high-speed wireless networks. AT&T Wireless will spend $5 billion in 2002 to upgrade its network -- "the high water mark of our spending," says Chakrin. That's good news for Nokia and Ericsson, which will do the job for the company. There's also some money to be made -- though less -- on software-intensive network upgrades at Sprint PCS and Verizon Wireless.
An alternative is to look beyond the U.S. -- at China, for instance, where demand for cell-phone service is still skyrocketing. The only other option for equipment makers is to tighten their belts and put faith in the calling habits of Americans, who spend 75% more time on their cell phones each year, according to the Cellular Telecommunications & Internet Assn., an industry group.
A WILD CARD. Indeed, if growth doesn't revive at carriers by sometime next year, the weaker players in wireless equipment might have to leave the business. Nokia and Ericsson have already taken market share from Nortel (NT ), Lucent, and Motorola. By yearend 2002, the two European companies should control nearly 70% of the worldwide wireless infrastructure market, up from 40% in 1999, according to analysts at J.P. Morgan.
Despite their market-share gains, Nokia and Ericsson won't see much revenue growth in wireless equipment this year, though income from deals such as the AT&T Wireless upgrade should keep them out of the red. But Nokia, in particular, should do just fine in handsets. Analysts figure that cell-phone sales should grow by 5% to 15% in North America, vs. last year's 76.8 million total units.
The wild card in that projection, however, is how popular the advanced services that U.S. carriers roll out will be. For the first time ever, in 2002 more than half of global handset sales will be driven by customers replacing their old phones with enhanced ones -- rather than by first-time buyers. In the U.S., replacements will also account for the lion's share of the market.
INVESTOR BEWARE. Price resistance could be an issue: The new phones will cost about $50 more on average, and tapped-out carriers won't provide much higher subsidies, so consumers will shoulder most of the increase. That helps account for the modest projections for cell-phone sales -- and for analysts' predictions that any or all of the second-tier phone makers -- Motorola, Samsung, Siemens, and Sony Ericsson, a joint venture between Sony and Ericsson -- could exit the business, leaving it to market leader Nokia.
For investors, the byword in every sector of the business should be caution for now. There's little question that, one day, most of the U.S. will have wireless connections -- and surfing the Net or sending instant messages via cell phone will be taken for granted. And no doubt, the leaders in each sector of the business will prosper.
What remains unclear is when that day will be -- and which companies will be around to see it. So, many analysts suggest that wary investors avoid the sector -- or, if they're willing to take some big risks, try to pick the survivors and plan to hold on to them for what's sure to be a long and rocky ride. |
