Lack of New Bells and Whistles Slows Cell-Phone Sales

Cell-phone makers are losing the fuel that was supposed to fire their next growth stage.

Consumers were expected to begin trading in their old phones for new handsets in huge numbers, which would more than make up for the fact there were fewer new customers out there. But they're not replacing their phones as readily as expected, mostly because of a delay in technological advances as well as macroeconomic factors. Consequently, forecasts for industrywide handset sales this year are progressively decreasing.

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Earlier this month, Motorola (MOT Quote), the No. 2 cell-phone manufacturer, disclosed that it now expects industry handset sales for 2001 to come in at the low end of its previously announced 525 million to 575 million unit range.

Finland's Nokia (NOK Quote), the world's largest maker of handsets, projects that 550 million units will be sold in 2001, while Ericsson (ERICY Quote) of Sweden, like Motorola, projects sales of 525 million to 575 million units. However, those figures may well be trimmed when the two companies release their fourth-quarter results in the next week.

Some analysts doubt even these figures are realistic. "The industry is going to have a tough time doing 500 million units. I still think 525 million is not a lay-up," says Todd Koffman, an analyst with Raymond James.

He adds, "The industry is relying on an accelerating replacement rate. It's not obvious that will happen."

Reliance

Of course, there still are areas that need new cell phones, China and Latin America chief among them. But in much of the world, cell-phone penetration has reached high levels, particularly in Europe where about 62% of the population has some kind of cell phone. So cell-phone makers can't depend on new subscribers for their growth, forcing them to push replacement phones.

The bottom line is that handset manufacturers grow only when people are buying more handsets. That's an obvious point, perhaps, but one that bears repeating as companies and analysts take down their estimates for handset unit sales in 2001. Those downward revisions will put pressure on the shares of players like Nokia, Motorola and Ericsson as they deal with this new environment.

Nokia has one of the most optimistic forecasts for replacement handsets, with 50% of the industry's users replacing their cell phones in 2001, which it sees rising to a rosy 70% to 80% in the next few years.

In contrast, Motorola last week pegged the rate at 44% to 46% in 2001. At the same time, Johan Carlstrom, an analyst at Swedish investment bank Handelsbanken, lowered his replacement rate estimate to 44% from 52% but predicts it will rise next year to 50%.

The Bear

Vivian Mamelak, an analyst with Arnhold & S. Bleichroeder, is much more bearish, predicting a downward trend in the replacement rate, from only 38% in 2001 to as little as 30% in 2003. At the same time, her estimate of industry-wide handset unit sales for 2001 is 431 million.

It all comes down to technology.

Mass-market consumers make up about 55% of cell-phone users, according to Mamelak's estimates, and they don't replace their phones nearly as often as businesspeople and wealthy consumers. "You can argue that businesspeople replace their phones every two years," she says. "To say that consumers do the same thing is a bit of a stretch."

So far, the main drivers behind replacement have been functional and technological upgrades. Consumers have been attracted by smaller, more lightweight and more stylish phones, with longer battery lives. "Technology is an important driver, but new models with attractive sizes and colors, new screen savers and games are much more important for driving the market," says Carlstrom at the Swedish investment bank.

Even so, technological advances have hit a plateau, with many consumers reluctant to replace their phones until a technological leap occurs. That leap would be to nothing less than an upgrade to 2.5 generation or third generation cellular services, which give users the ability to easily receive and send data -- not just voice -- via phones.

Slow Motion

That leap will be a long time coming. The evolution to so-called 2.5G and 3G services is a more costly and time-consuming endeavor than originally thought. Japan is furthest ahead, with plans in May by NTT DoCoMo, Japan's largest mobile phone company, to become the first carrier in the world to offer 3G service.

Europe is also making strides, with GPRS (general packet radio service), a 2.5G technology, set to take off in the second half of this year, after a delay. Carlstrom says there won't be mass introduction of GPRS-ready phones in Europe until the third or fourth quarter, with a ramp-up in purchase in 2002.

The U.S. is furthest behind, however, with the installation of next generation technology starting only this year.

"Data is expected to be a driver, but that's been a bit of a bust," says Mamelak at Arnhold & S. Bleichroeder. WAP, or wireless application protocol, enables mobile devices, such as a phone, to load and display information from the Internet, but consumers have yet to embrace this technology.

It doesn't help that there are few data services currently available. "There's no real killer app," bemoans Mamelak. "It's not just having the technology in place but having the applications."

The cloudy macroeconomic picture doesn't help either. "There's been a lot of worry, rightfully so, that the first half of the year is very uncertain," Carlstrom says, citing a potential slowdown in the U.S. economy that could affect other parts of the world.