Nextel and the Orphan-Standard Syndrome

The biggest issue involving Nextel's(NXTL Quote - Cramer on NXTL - Stock Picks) future does not have anything to do with its current performance, which is pretty darn good by most comparative measures. So the debate about Nextel has often split in two.

Many observers are impressed by the good current subscriber growth and the high average revenue per subscriber. Yet the long-term prospects of the company have little to do with the current performance. There is no doubt that Nextel is a very shrewdly managed operator -- but the fundamental standardization problem plaguing the operator is about to rear its ugly head.

Nextel is a relatively big player in the U.S., with its subscriber count about to top 8 million. But it is also the only sizable operator in the world using the standard called iDEN, integrated digital enhanced network, the global implementation of which has hit a brick wall as efforts to set up iDEN operators in countries like Israel founder.

The raw numbers for digital mobile-telephony subscriber bases are something like this: global systems for mobile communications (GSM) 560 million, code division multiple access (CDMA) 100 million, time division multiple access (TDMA) 80 million, iDEN 10 million. This is the core problem of Nextel. No amount of good management can change the manufacturing dynamics of the industry.

The overwhelming sales-volume advantage of the three leading digital standards means that they consume more than 20 times the research and development expenditure that iDEN does. The only company in Nextel's corner is Motorola(MOT Quote - Cramer on MOT - Stock Picks), which shoulders both the iDEN infrastructure and handset development costs on its own. This is not a happy situation.

Orphan standards are always problematic. This is doubly true when the development of that standard is dependent on a single company, and it's even more true when that single company is cutting more than 20% of its workforce while embarking on a cost-saving and restructuring program to return to profitability. For all practical considerations, Nextel is an all-Motorola operator from base stations to phones. As mobile phones become increasingly complex, though, most consumers will demand a variety of different handset brands, causing problems for Nextel.

So far, iDEN handset development has kept pace with the rest of the industry, which is a credit to Motorola. The phones have a special feature that enables subscribers to place radio calls to each other at no cost -- a nifty advantage for many professional users. Professional users aren't that focused on phone brands, but the U.S. phone industry is increasingly dependent on consumers, not professionals. Perhaps this is why Nextel has started missing its quarterly subscriber addition targets -- an ominous new trend that may accelerate next winter. As long as the U.S. mobile-phone market was being driven by professional users, Nextel went from strength to strength. The rules are changing now, though.

The phone industry is entering a highly demanding transition phase. Mobile networks will be upgraded to handle packet-switched data, and mobile handsets will acquire this feature, as well as a suite of other stuff, including color displays, Java software support, new messaging software solutions and XHTML (extensible hypertext markup language) browsing. iDEN phone development kept up with the competing standards as long as the overall phone industry was coasting along with few major technology innovations. Now the cost of R&D is spiking up, demanding extensive, interlocking product-development projects weaving display, packet data and software advancements together. I doubt that Motorola can handle both the infrastructure and handset upgrades while still focusing mostly on GSM and CDMA development.

The economies of scale rule all electronics manufacturing in high-volume industries. If Nextel succeeds in the long run, it would be a unique development, going against all past trends in the IT industry. Twenty-to-one scale disadvantages become insurmountable the moment an industry hits a transition period. There is little doubt that there are too many operators in the U.S. Something's gotta give. Nextel's past performance gives us no guidelines about its future outlook; for that, we need to look at the bigger picture.