Telefonica and Sonera axed their German joint venture, Quam, writing off over E8 billion in the process. Sweden is lobbying the government to ease off on license requirements. And several first- and second- tier operators look increasingly likely to delay 3G service launches.

Optimists in the industry say all this is a setback, but not a crisis. Recent industry announcements talk of the 3G sweet-spot and in the same breath state that it will take between three and eight years for 3G license holders to break even.

But this isn’t reassuring in the slightest, and should be seriously worrying operator shareholders – three to eight years is hardly a sweet spot. It’s a long, drawn-out, death. No financier, VC or enterprise would consider investing in something with payback somewhere in the next three to eight years.

License to lose

Besides, operators will not be around if it takes them any more than three years to gain some sort of return. With junk status ratings; share-prices with possibly another 10% to fall; industry rights issues looming; massive over-expectation of potential MMS revenues and discussion of technologies capable of leapfrogging 3G altogether, it could be the beginning of the end for some.

Within the next three years, some license holders may shelve 3G aspirations, possibly having to treat the cost of licenses as a write-down. Despite the sunk costs of licenses and infrastructure, it will still prove cheaper for them to abort 3G plans, rather than to try and foster a market by subsidizing the handsets and services required.

What will happen to these licenses? Telefonica and Sonera have retained theirs, despite pulling the plug on Quam. It still has residual value as an asset on the balance sheet. However, all it takes is a couple more shaky operators and licenses may become available at knockdown prices as part of debt-restructuring plans. Then, operators who decided to concentrate on advanced 2.5G services instead may get another bite of the cherry.

This all sounds rather implausible. Investing billions of Euros in 3G licenses and infrastructure isn’t a decision that anyone would like to make in today’s market, but surely rolling a service out on top of such giant sunk costs makes more sense than potentially abandoning the market altogether?

Give it away now…

Actually, no! It’s becoming clear that no consumer is prepared to pay more than around E499 for any sort of advanced device, and most will pay no more than E250. Considering that most devices in the offing (such as Sendo’s smartphone) are around E1,200 at unsubsidized retail value, subsidies of between E500 and E800 look necessary.

Do the math – if a European operator with 12 million subscribers wants even half of them to have a 3G handset, the cost of subsidy will exceed E3 billion. Of course in reality, around 65% of those customers will be pre-pay and as such, not an initial 3G data-service target, but the point is implicit.

Now add the cost of service development, deployment and marketing and it starts mounting up. Operators’ original 3G business plans had been looking to fund some of this from the increase in existing customer revenues. However, uptake of any mobile data services so far has been shockingly low.

Even though GPRS handsets are being sold at a moderate rate, the percentage of those actually signing up to a GPRS tariff is abysmal. SMS continues to be a success story, so much so that demand for innovative services outstrips operator abilities in tracking, provisioning and billing. MMS however, has already suffered the same fate as other mobile acronyms – over-hype.

While few doubt the value of this application, predicted uptake and revenues have been massively inflated, not least as it is likely to cannibalize existing SMS revenues. The handsets just aren’t available right now, with only two camera-phones on the market and about another 3 or 4 models in the next few months.

In the run-up to Christmas, Datamonitor believes that consumers are far more likely to demand handsets with radios and MP3 players. Business models with this extent of exposure to fragile consumer confidence (not only in the US, but also in Europe if interest rates start rising towards the end of the year) will come under even heavier pressure if consumer expenditure drops off.

Dis-content providers

Unless operators can offload more of their costs to content providers, the chicken and egg scenario of data-service subscribers and services will continue unabated.

However, while content providers lamented the lousy margins proposed by operators up until six months ago (especially in Europe, where these might have been as low as 20%), the introduction of i-mode services has gone some way towards fostering a change. The operator industry is tending towards a margin of 15% on consumer services.

But any kind of venture funding for small content houses has all but dried up, with only a few investments remaining in messaging technology. Several dedicated start-ups are on their last legs; real-world media groups are tightening belts and cutting back anything that’s online or unprofitable – especially things that are both – and the industry is looking more than expectantly to Hutchison 3G to blaze a trail out of the mire.

No handsets – well, none that work

All this would be enough of a problem, even if anyone had made a successful 3G handset. But so far, no one has really managed to integrate the circuitry required for 2G (inc 2.5G) and 3G to exist on the same silicon wafer. In effect, all prototype 3G handsets at present comprise ‘two handsets in one’ under the bonnet.

Nobody has even properly managed to make these double-chip 2G/3G combinations work successfully. Hutchison 3G hopes to be the first major European 3G player to bring a service to market, hoping to launch in late 2002. It recently admitted, however, that its dual-mode handsets cannot currently hand-over calls between 2G and 3G networks, meaning that the user has to ring back.

This is serious: if you pay E499 for a phone, you’ll be justifiably annoyed about having to re-dial your call every time you move from one network area to another. According to Hutchison, the problem won’t be fixed until mid-2003 – and the same will be true for other operators.

This hybrid phone also incurs a correspondingly larger BOM (bill of materials) for manufacturers, and they are in no position to absorb this through additional efficiencies in production – they’re sailing as close to the wind already, when it comes to making margin on handsets. So more charges for operators…

And the walls come tumbling down

Operators’ capital expenditure on building and subsidizing 3G services simply can’t keep going as it is. Low uptake will cause a cash-vacuum and that won’t service the billions of dollars of debt in license and infrastructure costs.

So what’s the net result? Some operators will follow Telefonica/Sonera and pull out; some may go bust or be acquired. Parent companies of smaller operators might have painful decisions to make, with respect to allowing a slide into receivership, the sale of a going concern (which no one will want to buy unless some debt is written off) or injecting yet more cash. One thing is clear – BT’s decision to divest itself of O2 is proving to be wiser by the week.

This is not to tar all operators with the same brush. Some show more prudence than others and have rather healthier balance sheets and some have not been subject to such massive license costs, such as in Norway. MVNOs may yet have their day.

With no revenue streams, 3G operators may have no option but to lease capacity to brands like Manchester United, AOL Time Warner or Disney. And if governments doesn’t revise contractual obligations, we may well see a gray market for 3G licenses before 2002 is out.

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