Mobile key is a killer application

The telecoms industry would probably be happier, if it weren't for boring and visionless financiers who have spotted a worrying trend. Over the next six months Europe will gear up to award its third-generation mobile phone licences, which allow internet access and additional services over handsets. But analysts say the high up-front costs of the licences could be difficult to recoup because consumer take-up of these services may not be as enthusiastic as the telecoms companies believe.

The telecoms industry would probably be happier, if it weren't for boring and visionless financiers who have spotted a worrying trend. Over the next six months Europe will gear up to award its third-generation mobile phone licences, which allow internet access and additional services over handsets. But analysts say the high up-front costs of the licences could be difficult to recoup because consumer take-up of these services may not be as enthusiastic as the telecoms companies believe.

There is no online service which would make buying a $900 thirdgeneration mobile phone a "must" for anybody. Rival technologies, which offer similar services cheaper, make the massive spend on licences seem a bigger gamble than anticipated.

Most European telecoms companies have spent the past two years working on their visions for what could be achieved with third-generation mobile telephony. They painted a picture where consumers would abandon PCs, televisions and newspapers and conduct their banking over the phone. They envisaged full internet access, videos, news, share price alerts, shopping and booking ticket on handsets 24 hours a day, 365 days a year.

In anticipation of cash-paying consumers lapping up these services, telecoms companies prepared glowing financial projections, including 80 per cent of customers using data services such as text messaging. On the back of these forecasts, they raised billions of pounds for licences.

They knew buying the spectrum, building the networks and subsidising the third-generation handsets would be expensive. But they pointed to the breathtaking speed with which Europe had embraced mobile phones in the Nineties. Mobile penetration in countries such as Finland now exceeds the number of fixed-line phones, and the rest of Europe is expected to match that over the next three years. Spurred by the dizzy stock-market heights the telecoms sector enjoyed over the past couple of years in anticipation of riches to come, the equity and debt markets were only to happy to cough up for companies to deploy third-generation technology.

Predictions by research company Datamonitor may alarm mobile operators and their financial backers. It says by 2005, third generation will have only 11 per cent of the market. Ordinary mobile phones will have 52 per cent and GPRS, a fast method of sending data over mobiles, will have 37 per cent.

Earlier this year, Finland and Spain sold off their spectrum licences. Instead of holding an auction, they held "beauty parades" which judged each application on its merits and netted the Governments healthy licence fees but didn't set off alarm bells about being excessively expensive.

The auction which raised real concerns was when the UK sold off its spectrum for nine times more than had originally been anticipated, at a whopping £22.5bn. This immediately raised the value of third-generation licences across Europe, to the delight of governments who were elated at the prospect of pocketing billions for licences.

The French government decided on a "beauty contest" but after it became evident how much telecoms companies are actually willing to pay for the spectrum, it postponed the awarding of the four licences from June 2000 until the first half of next year. And the cost of each licence was hiked up to FFR 32.5bn (£2.9bn).

The three incumbents, France Telecom, SFR and Bouygues, complained to the regulatory authorities to no avail. "They don't have a choice," says Stephane Piot, a consultant with Paris-based telecoms consultancy firm Analysys. "I don't see any incumbent saying they won't bid for the licence. Even though the business case for third generation isn't proved and no one knows by how much the average revenue per user is going to increase, there is no way they can afford not to offer the services. It would be very damaging to their brand." In Holland, five licences were auctioned but did not reach the expected prices.

Now it appears auctions work in only some key European markets. Ireland last month announced it is to award four licences in a beauty contest next year but will determine the licence fees later, taking into account developments in Europe.

The Republic is one of the fastest-growing mobile markets in Europe and, no doubt tempted by the result of UK auction, some observers believed an auction would be a better way to sell the licences.

Dublin-based telecoms analyst Jemma Houlihan, from ABN Amro, says: "The beauty contest is the most suitable option for the Irish market, because there won't be as much interest here than in the five key geographical regions in Europe, which are the UK, Italy, Germany, France and Spain. If you control those markets, you control a large portion of Europe."

Most the EU countries seem to agree with these sentiments (see table) and opt for beauty contests. But the fees charged are still high and, combined with the rollout costs of the networks, the upfront costs for any operator are enormous. This applies particularly to the pan-European operators such as Vodafone, BT, France Telecom, Deutsche Telekom and Telefonica, who bid in countries where they already have an involvement. For Vodafone, that is 14 markets.

In the long term, these giants will benefit from economies of scale, but the upfront costs of the service and their ability to recoup the investments are beginning to worry analysts. Credit ratings agency Moody's, for example, warned after the result of the UK auction, which set the tone for the German, French and Italian sell-offs, that the cost could crimp the credit-worthiness of some European telecoms companies and weaken their financial muscle.

Moody's estimates that third-generation development will cost some of the pan-European players such as Vodafone, Deutsche Telekom, BT and France Telecom upwards of 300bn euros (£117bn), with 150bn euros spent on purchasing licences and 150bn euros on network construction.

A report by ABN Amro's London-based European telecoms' team says the returns on broadband investments will in many cases be lower than expected for the wireless companies. "To measure the impact of third-generation systems upon returns, it is instructive to look at the example of a theoretical existing wireless operator in a medium-size European country. Building the company's existing GSM network will probably have cost them 5bn euros on which the company can expect to achieve a mature return of investment of around 40 per cent. Spending on the 3G system is likely to total 12bn euros made up of 7bn euros in licence fees and 5bn euros in network construction overheads.

The report states: "Let us take a best-case assumption that the operator continues to achieve a 40 per cent return on its existing system, and an addition 40 per cent return on its 5bn euros of 3G network spending. Because the company has spent 7bn euros in licence fees, which generates no direct profits, the overall return on total investment (including the fees) will only be 24 per cent - nearly two-thirds below the previous level."

Others say high up-front costs will spur telecoms companies into action to launch new and innovative services to recoup their 3G investments as quickly as possible. They point to the success of i-mode in Japan, DoCoMo's internet-over-mobile offering, which has added 20 per cent to the average revenue per user of customers. This is wishful thinking on the parts of the companies, says Andreas Hoffmann, of German consultancy Mummert & Partner. He says fancy third-generation services, even in the medium term, will not find a mass market. "The corporate market will use high bandwidth applications such as videoconferencing and intranet access. But I can't really see consumers buying themselves expensive UMTS phones, just to send a video-postcard."

He says consumers will go for so-called "thin" data applications such as personalised news services, stock price alerts and general internet browsing. None of these require 3G technology, but an upgraded GSM network with technologies including GPRS (General Packet Radio Systems) and the even further advanced EDGE (Enhanced Data Rates For GSM Evolution). GPRS will make data transfer considerably faster and cheaper than third-generation mobile and EDGE is as fast as a 56kb modem on a PC, meaning it will serve the immediate needs of internet access and e-mail over your mobile phone.

EDGE is expected to be commercially launched around the same time as third-generation mobile services in 2002, but it is expected to be considerably cheaper than third generation. Stephane Piot, of Analysys, says: "The key is to find a killer application for the third-generation mobile that people want to pay for. It has not been invented, but if telecoms companies are successful in developing the mobile phone into an accessory people will carry all the time and use extensively, I am very hopeful the investments will pay off."