Three is the magic number.
Source: Investors Chronicle
Vodafone was out to impress this
week. Its annual results presentation was, as usual, accompanied by a
demonstration of the latest gadgets and services. But this time around there was
some added spice - for the first time, Vodafone was able to show live
third-generation (3G) services in action. The assembled journalists and analysts
were treated to video downloads, videophones and data services for business
users. Here, at last, was proof that all the money spent on 3G licences would
result in real services, real revenues and, hopefully, real profits.
But behind the tantalising possibilities of video downloads and interactive
gaming, mobile operators' top priority for 3G may be something far more
familiar. Voice calls still form the bedrock of the mobile industry and,
according to research from telecoms consultancy Analysys, by 2009, voice calls
will still represent 66 per cent of mobile revenues.
That's because the number of voice minutes carried by the networks is set to
increase dramatically. According to figures from Analysys, mobile voice minutes
in western Europe will increase by 57 per cent to over 1,300bn minutes per year
by 2009. And the problem for the operators is that the existing
second-generation networks are filling up rapidly, especially in urban areas,
increasing the number of "service unavailable" messages that users receive.
So this is where 3G networks will come in, providing more voice capacity for
operators at lower costs. "One of the key opportunities is to significantly
increase voice revenues, and to take significant revenues from the fixed-line
operators," says Mark Heath, of research consultancy Sound Partners. According
to Dr Heath, the cost per minute of a 3G network is around one-fifth of the cost
of a second-generation network, presenting the opportunity to reduce prices
dramatically to a level that competes with the fixed-line players. "They key
issue," he says, "is whether the operators are going to seize the opportunity."
But while the voice opportunity presented by 3G is enormous, the risks are also
significant. Until now, the mobile sector has been characterised by pricing
discipline among key players. Small tariff differences exist, but none of the
major operators significantly undercuts the others. By reducing some prices
dramatically - for example, by offering large 'bundles' of minutes for a fixed
price - operators may lose out on revenues without achieving the required
increase in volumes.
A new generation of costs
New entrant 3 has attempted to attract users with low rates for voice bundles,
but with limited success. None of the operators has an interest in provoking a
price war, and those operators owned by fixed-line companies (such as Orange and
T-Mobile) have an added incentive to slow the rate of fixed-to-mobile migration.
While virtual network operators (including Virgin and Tesco) may like to offer
much lower call charges, they rely on the prices charged by their suppliers
(network owners such as mmO2 and T-Mobile).
There are also extra costs attached to dramatically increasing the number of
minutes carried over mobile networks. According to research from Morgan Stanley,
the initial 3G roll-out programmes in western Europe have concentrated on
breadth, rather than depth, of coverage, so that initial services can be rolled
out quickly. The consequence is that the networks are not designed for handling
the increased volumes of voice traffic that dramatically lower prices would
attract. The cost of upgrading these networks to handle the extra traffic would,
according to Morgan Stanley's estimates, prove detrimental to the operators'
free cash flow.
Despite this, a UK price war is possible. Unlike most other countries, the four
leading players have very similar market shares, so they have to work hard to
maintain their positions. And two of those four, Vodafone and mmO2, have no ties
to fixed-line operators, so they have little incentive to slow the rate of
fixed-mobile migration. Also, the terms of the UK 3G licences mean that there is
more capacity available to the UK operators, so more of a risk that they will
have surplus capacity.
Given the uncertainty over 3G voice revenues, the operators will have to look
elsewhere if they are to justify the GBP22.5bn that was spent in the UK alone on
3G licences. Both investors and customers will be waiting for the exciting,
non-voice services that were promised. The camera phones, photo-messaging
services, music downloads and games that are available on existing networks are
all designed to get consumers into the habit of buying data services over their
Consumers won't notice the switch to 3G immediately. Both Vodafone and mmO2
stress that the move to 3G services will be an evolution rather than a
revolution. However, 3G networks will give the operators more capacity, allowing
the gradual introduction of more advanced services. Photo-messaging will become
video-messaging, football score updates will be accompanied by a video of the
goal, and synthesised or polyphonic ringtones will be replaced by real music.
"In entertainment, the biggest area is personalisation, and music is the core
area of that," says Eden Zoller, analyst at telecoms consultancy Ovum.
"Ringtones are still popular, as are the new polyphonic ringtones. We are also
looking at truetones, which is real music as a ringtone, rather than a
"In information services, sport is the biggest content strand. It accounts for
about 60 per cent of premium content revenues of information services."
According to Analysys, non-messaging services will account for over half of
mobile revenues by 2009 (see chart, above). Of those services, entertainment and
information are expected to be the most popular. In the industry, 3G is often
said to stand for girls, gaming and gambling.
Profits - a tough call
But it's not clear who will profit from 3G services. The operators are the most
obvious beneficiaries. In the first place, they'll be able to charge customers
for the airtime taken in delivering the services. The greater the capacity taken
up by the services, the more the operator can change, so a video download will
cost more than a photo one.
But charging by capacity alone is unlikely to satisfy the operators, or to pay
back the billions that were spent on the licences. A video download, for
example, will attract both a charge for the capacity taken in delivery, and a
charge for the content itself. It's the destination of the content charge that
will be hotly contested.
The content owners themselves will be keen to get their slice of the pie. Music
publishers, for example, will want a slice of the revenues that come from
ringtone downloads, and football clubs will want money every time a fan
downloads a video of one of their goals. They already take a portion of revenues
from existing services, but they're getting more demanding. "Music publishers
get 15 per cent on a ringtone at the moment, but they're looking for up to 50
per cent on a real tone," says Wayne Pitout, chief executive of content
For their part, operators have been working hard to ensure that customers see
them as the primary source of content. Portals such as Vodafone Live! are
designed to provide everything that the discerning mobile user needs. Content
bought through their own mobile internet sites will give the operators a bigger
cut of the premium content charge.
Operators will face stiff competition, though. Handset manufacturers, such as
Nokia, are keen to promote customer loyalty by offering content that is unique
to their phones.
Content still king
More threatening than the handset manufacturers are the content aggregators.
These companies sign up content from the owners, and deliver it to mobile users,
either directly or through partnerships with operators. Either way, they
represent a middle man that has the power to take revenue from both the
operators and the content owners.
The direct model, in which the aggregators advertise directly to consumers and
deliver their services through messages, is becoming more popular. "Direct will
be our primary source," says iTouch's Wayne Pitout. "We are teaching the market
how to buy direct, rather than through Vodafone Live and other menu structures."
It's easy to see why he's so keen. Under this model, of the GBP1.50 that a
customer pays for a ringtone via SMS, the operator will take 55p, the content
owner will take 9.5p and iTouch will take 85.5p.
Unfortunately for Mr Pitout, competition will be intense. There are already
three UK-listed content aggregators: iTouch, Monstermob and Stream. There is
also competition from overseas aggregators, such as Buongiorno and Index. The
first evidence of a price war emerged this week when Monstermob warned that
margins will be hit by an advertising campaign designed to counter aggressive
marketing by rivals, and by investment in new products. Its shares dropped 23
According to Ms Zoller, the aggregators that will succeed are those that offer
something extra. She says that those offering technology platforms, management
services or even an international element will be best-placed. In that light,
iTouch looks strong, with operations in the UK, Ireland, Australia and South
Africa, and trials in two further countries. Mr Pitout hopes that scale will be
a winning factor when it comes to dealing with the content owners.
But, even once they've signed up distribution deals with content owners, the
aggregators will have to rely on the operators to dictate the speed of migration
to 3G. And that may not be as rapid as some would like. The experience in Asia,
and from 3 in the UK, is that the roll-out of 3G services is a tricky process. 3
pays about E600 to connect each subscriber, but revenues have so far been
At its annual results last week, mmO2 painted a cautious picture of its roll-out
plans. In Germany, for example, it has already covered 25 per cent of the
population with its 3G network, in accordance with its licence conditions. "We
won't build out any more in Germany until we're sure of the revenue stream,"
said chief executive Peter Erskine. The UK launch will only be in major cities.
So while Vodafone has been out to impress this week with its 3G handsets and
datacards, dramatically higher revenues may be some way off. And even when those
revenues do eventually arrive, there will be a feeding frenzy involving the
operators, virtual operators, handset manufacturers, content owners and middle
men. True, the network owners are better-placed than the rest - but the rivals
won't be far behind.
The Asian example
While European consumers are getting excited about camera phones and
photo-messaging, Japanese users are already getting to grips with videophone and
TV downloads. 3G was first launched in Asia in 2002, with mass-market launches
in 2003. Initial news on the usage front is encouraging for the operators. In
Japan and Korea, video telephony, video-on-demand and music-on-demand have
proved popular. TV downloads accounted for 32 per cent of 3G revenues for Korean
operator SK Telecom in the final quarter of 2003.
But while consumers are enjoying the new toys, the operators are suffering. 3G
services have, so far, been a financial disaster. "The two main Japanese
operators have launched 'all-you-can-eat' data plans, capping the potential
revenues," says Mark James, telecoms analyst at Nomura. "Cash costs and
amortisation costs are also rising, pushing down margins." NTT DoCoMo, Japan's
largest operator, warned that revenues will fall this year due to pricing plans,
while competition for new 3G subscribers is pushing handset subsidies up. If
European operators are to avoid the same fate, they'll have to maintain pricing
discipline, and persuade consumers to spend more for 3G handsets.