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A tough call

Should the mobile phone industry entice existing customers with more expensive lines for higher profits or go after first-time consumers with lower-priced commodity products?


Cell phone industry at crossroads: Go high or low?

By Corey Grice and Michael Kanellos
Staff Writers, CNET
August 31, 2000, 4:00 a.m. PT

SAN FRANCISCO--Kristen Phelan is debating whether she needs email on her cellular phone, and the fate of a multibillion-dollar industry hangs in the balance.

"A lot of the newer phones come with Internet and email. I don't think I need all that," Phelan said at a downtown retail store where the 26-year-old talent agent recently mulled her vast options. "This time I am doing some research."

Phelan offers a fairly typical example of second-time-around wireless shoppers who are scrutinizing their choices as never before. What they decide will determine the future of the global mobile phone industry, which will soon face a difficult question that is inevitable for all consumer electronics businesses, from personal computers to television sets: Does it try to entice existing customers with more expensive lines for higher profits or go after first-time consumers with lower-priced commodity products?

Hundreds of millions of people already own mobile phones, and their ranks are projected to swell to more than 1 billion in just a few years. At the same time, however, those numbers reflect a shrinking pool of first-time buyers--meaning that Nokia, Motorola, Ericsson and other major manufacturers face the not-so-simple task of selling replacement phones to people who already own one and are often locked into a lengthy subscriber contract.

"It has a dramatic effect on the growth rate," said Ashok Kumar, a wireless semiconductor analyst with investment bank U.S. Bancorp Piper Jaffray. "This year, all the cell phone makers have over-forecasted the market. It is going to get much more competitive. You are going to see profit-margin erosion."

The dilemma mirrors growing retail trends throughout the international economy, from cars to clothing. Especially in the United States, consumers have gravitated toward either extreme of the markets, showing they are willing to pay for name-brand products but are looking for bargain-basement prices as well.

For the phone industry, the issue is complicated further by constant changes, including upgrading to digital network systems from analog, preparing for high-speed wireless Internet access, and the inevitability of falling prices for phones and service. In recent months, the industry has seen some signs that mobile phone profits and sales may be slipping.

Industry shakeout on the horizon
To many within the business and beyond, that can eventually mean only one thing for some key players: an industry shakeout. Only the largest manufacturers are likely to support a product line with dozens of models that span the range of consumer demand.

"You're going to a see a percentage of high-end users, particularly business customers, that want Internet browsing and other advanced features," said Matthew Adams, vice president of research at Epoch Partners, a technology investment bank. "But the real market opportunity will be in the lower end with simple text messages and text browsing."

Many companies will be hard-pressed to spend the research and development dollars necessary to create a broad product line with devices intended for high-end customers, new subscribers and everyone between. Already, some smaller handset makers, including Qualcomm, have exited the business, and analysts say others may eventually have no choice but to follow suit.

The alternative is a relatively stripped-down product offered at a much lower cost aimed at the mass market. But that would mean smaller profit margins and a need to acquire vast market share to increase revenues.

None of this, of course, means that the cell phone market is withering away. Wireless phones and other devices are widely touted as the next great technology market opportunity, particularly for mobile Internet access. As wireless Net access becomes more popular, many consumers are expected to upgrade their purchases.

"The replacement market is increasingly important to us," said Keith Nowak, a spokesman for No. 1 handset maker Nokia. "As you get into the replacement markets people are more savvy; they want more features."

Replacement sales are expected to represent 77 percent of all handset sales worldwide in 2007, up from 37 percent last year, according to a study released this month by The Strategis Group, a communications market research firm. A July report by research firm Cahners In-Stat Group found the average life span of a wireless phone dropped recently to about 25 months from 32 months. Analysts say these numbers represent the maturity of a market, but also present new challenges.

Those looking for clues to the mobile phone market's future might find some lessons in the experiences of the personal computer industry. If history repeats itself, wireless phone makers will likely discover that the replacement market grows at a much slower rate, produces lower profit margins than original products, and creates buyers who are more knowledgeable and particular about their purchases the second time around.

"The importance of brand becomes that much more of a factor," said Bryan Prohm, a wireless analyst at Dataquest, a market research firm. "Now is the time to really lock up consumers to gain their loyalty."

Clues to the future
Feature-filled phones often sell for more than $200, generating greater profit margins than the low-end handsets that frequently are free with entry-level plans subsidized by service carriers such as Cellular One, Verizon Communications and AT&T Wireless. But in many consumer electronics markets, replacement buyers typically cling to older technology that they have already paid for unless particularly compelling new products emerge.

Still, frontline troops in the wireless sales wars say there is hope the second time around.

"In my experience, it's much easier with current users to sell them a phone," said Behzad Parsa, an account executive at a San Francisco ePhones retail store. "People trade in mainly because of the size and the battery life. The analog phones were like bricks. They want a smaller, lighter phone that's easier to carry."

see CNET report: Cell phone safety As seen in the PC business, markets based largely on replacement sales begin to mature and often consolidate around a few major providers, economists say. Price competition then drives profit margins lower, and unit shipments level off from the headier early days.

PC makers saw tremendous growth in the 1980s. In the '90s, however, the business market became a replacement market, while a similar shift is under way in the home market, according to International Data Corp. and other research firms.

The PC market dealt with a similar maturation problem in a variety of ways. On one hand, these companies promoted the Internet and digital music to drive consumer sales. These companies also rapidly moved into the more profitable server and workstation markets.

On the other hand, they rapidly cut costs and adjusted their business models to encourage replacement. PCs costing less than $1,000 emerged, sparking sales. Profit margins shrunk, while companies resorted to rebates and low-cost strategies to maintain growth rates.

Wireless evolution
Several similarities to the PC sector may portend a comparable fate for the wireless industry and major manufacturers such as Nokia, Motorola and Ericsson--similar to the PC industry's "Big Three" of Dell Computer, Compaq Computer and Hewlett-Packard.

The biggest PC players have expanded their market share in recent years, although some low-cost competitors such as Emachines have seized some of the market. The five largest PC makers accounted for two-thirds of all computer sales last year, according to IDC, up from about half of the market in 1994.

The wireless phone market has seen some similar encroachment from low-cost manufacturers. Qualcomm and others were forced out, in part, by the success of a handful of Korean and Japanese handset makers including Samsung, Kyocera, Matsushita and others, analysts have said. Although these competitors also make high-end, feature-packed phones, their lower-end handsets often are among those that are given for free to consumers under subsidized service activation plans.

Adding to the significance of the changing wireless market, handset sales already outpace worldwide annual personal computer sales. Most analysts predict that about 400 million mobile phones will be sold this year; just 120 million PCs were sold last year. The trend is expected to make mobile phones and other wireless devices and future "information appliances" vitally important to the growth of the Internet.

In addition, the Internet appears likely to play a similar role in the wireless industry as it did in the PC sector. The rise of the Net led to new PC sales as consumers demanded computers capable of surfing the Web. Thus, the Internet's popularity drove replacement PC sales, some of which now come bundled with high-speed cable or digital subscriber line (DSL) modems.

Other analysts caution against direct comparisons between the PC industry's evolution and the increasing replacement sales in the wireless business.

"Mobile phones are not durable goods," said Kelly Quinn, a wireless analyst at the Aberdeen Group. "They're not made to last 20 years."

And if phone customers do find the need to buy again, the most powerful factor in their decision may be one that's all but impossible to overcome: habit.

"I'll probably get a Nokia," Phelan said in deliberating her choice for a new handset. "That's what I had before, and that seems to be OK."  

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