Hot Game: Musical Cell Phones

Eyes will be on Nokia and Motorola as the MP3 player becomes the must-have wireless phone accessory.
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Next year, cell phones will learn how to carry a tune.

Picture phones with pretty screens certainly caught the fancy of the mobile phone shopper in 2004, sending handset sales surging a projected record 20% over a year ago. But cell-phone makers have a couple of new tricks in store next year to keep the beat going.

By far the biggest feature coming to handsets in 2005 will be music. Yes, the long-awaited union of cell phones and digital music players, like

Apple's

(AAPL) - Get Report

iPod, will soon be upon us. Like heat added to hotness, the fast-growing popularity of portable MP3 players figures to be a major component of the already-strong mobile phone market.

Analysts and gadget lovers alike are enraptured by the promise of this divine gift from the tech gods.

"MP3 phones are going to be much bigger than camera phones," says Charter Research analyst Ed Snyder.

Korean phone makers like No. 2

Samsung

and

LG

are expected to introduce music phones in the U.S. in the coming months. And handset king

Nokia

(NOK) - Get Report

, which has dabbled in MP3 phones, recently partnered with music software developer

Loudeye

(LOUD)

, signaling a bigger push toward tunes.

But the greatest anticipation is centered on

Motorola's

(MOT)

joint development with Apple. Motorola signed an agreement in July to use Apple's iTunes software in a line of digital music phones that is expected to be unveiled sometime next year.

Speculation has also cranked up on the possibility that Apple will lend some of its design skills to fashion an iPod phone with Motorola.

So why will the curtain rise on music phones in 2005?

Among the reasons why next year will be big for music phones is that telcos had pushed, almost exclusively, for camera phones in the hopes that subscribers would swap snapshots and drive up data service revenue. But that strategy didn't go exactly as planned. Now the next big hope is that MP3 phones will inspire customers to sign up for new faster third-generation wireless service to download songs.

Charter analyst Snyder says he sees few barriers for adding music players to phones, adding that it's both easier and cheaper than adding cameras.

Unlike cameras, which required expensive parts, most of the basics for a music player are already inside cell phones, says Snyder.

"Adding MP3 capability to a phone is inexpensive because the phone already includes most of the functions needed," says Snyder, "like audio interface, a power amplifier and a headphone jack."

One of the major shortcomings phone makers have encountered with music is limited memory capacity and a cumbersome music navigation system, say analysts.

But technology rolls along, and advances in flash memory easily allow more than an hour's worth of songs to be stored on removable cards. And with Apple's iTunes software, there's great hope that some of the much-praised music organization features will be worked into new phones.

Though 2005 will likely be a big year for MP3 phones, the music phone contribution to huge sales volumes probably won't come until 2006, say analysts. Since 2004 was such a phenomenally strong year for phone sales, demand may take a bit of a breather next year.

New markets like Asia and South America certainly contributed to cell-phone sales growth in 2004, as did the so-called replacement segment, where users traded up from their old phones for new color-screen, clam-shell camera models.

Sanford Bernstein analyst Paul Sagawa sees the MP3 phone trend not as an overnight success, but growing over the coming years as 3G takes hold and hard disk storage becomes available in phones. He expects total phone sales will grow somewhere between 10% and 12% next year.

"Long term," says Sagawa, "I expect most phones above entry level will have both camera and MP3 by 2006."

Snyder sings a more optimistic tune. While he expects phone sales to cool off a bit from 2004 levels, he says 2005 sales volumes will hit 14%.

"MP3 phones, if designed and promoted correctly," he says, "could certainly fuel the fire next year."