Sales of handsets will still increase this year, but not by as much as last year.

If a cautionary tale emerged from the most recent round of earnings announcements from handset manufacturers, that was it. Starting with

Motorola

(MOT)

Jan. 10 and extending to

Ericsson

(ERICY)

Jan. 26 and

Nokia

(NOK) - Get Report

Jan. 30, investors were thrice-buffeted by repeated slashings of the handset forecast.

Tuesday's Coverage

Getting a Handle on the Wireless-Handset Slowdown

Previously

Why This Earnings Season Has Been So Brutal

Earnings Burned Investors, but the Tech Fire Remains

With No Catalyst, Stocks Rumbling and Stumbling Through February

The diminished growth will cut into the anticipated handset revenue for the handset makers, unless they manage to ramp up their market share. In turn, some of those handset makers with significant wireless network equipment divisions may try to rely on those operations to pick up some of the slack, despite some delays in upgrades to next-generation wireless networks.

The three biggest players in the handset business -- No. 1 Nokia, No. 2 Motorola and No. 3 Ericsson -- all trimmed 2001 sales estimates. Motorola maintained its range of 525 million to 575 million units but acknowledged that sales would likely come in at the low end. Ericsson was more bearish, reducing its estimate to between 500 million and 540 million units, from 525 million to 575 million.

And you knew things were really bad when Nokia, which issued a bullish pronouncement for itself and the industry at the beginning of December, essentially fell in line with Ericsson, shrinking its forecast to a range of 500 million to 550 million units, from 550 million.

Darn Yuppies

The largest percentage of people, especially in Western Europe, who already own phones is widely cited as a reason for weaker demand. "The penetration rates are pretty high in many countries," says Herve van Caloen, a portfolio manager with

Simms Capital Management

. Taking estimates down "shouldn't be much of a surprise."

He's right. The so-called penetration rate in all of Europe is close to 60%, with percentages in Scandinavia and Finland much higher.

"Once you reach a certain level of penetration, growth has to come from replacements," van Caloen adds. But current users of cell phones have yet to

replace their old phones as fast as some analysts and the industry counted on, primarily because of delays in technological advances.

After all, it has been a longstanding expectation that wireless networks would now be upgrading to the so-called second generation, which is capable of carrying data traffic, as well as voice. However, there have been delays in the move to the GPRS (general packet radio service) network in Europe. Consequently, technology is at a standstill and there is little reason to buy a new phone.

"Technology is remaining state of the art longer than most of us anticipated," notes Marc Patterson, vice president of managed-access services at

Infonet Services

(IN)

, which manages corporate networks for customers like Nokia, Ericsson and

AOL Time Warner

(AOL)

. "There isn't a whole lot of technology or innovation that's occurring to make our lives easier."

Taking License

Blame the technological impasse on the costs of building new wireless networks and the dearth of data applications for mobile phones.

Most people already know that spectrum licenses for third-generation networks in Europe were prohibitively expensive, with many telecommunications companies, large and small, buckling under the weight of expansive debt burdens. And before these concerns start making money, they still have to spend massively to build the proper networks.

But another issue is the absence of applications for use on GPRS networks. "There's no application out there to compel the consumer to get a GPRS handset. You don't have handset demand because you don't have application demand," Patterson explains. "There's a lull right now until the next great application comes along." That next great application will be the availability of video, he thinks.

Handset-sales growth will slow as long as that lull lasts and eat into the top line, or revenue. But Nokia can avoid that fate if it succeeds in its stated desire to aggressively take further market share.

"Nokia's strategy is to make a land grab from its weak rivals in the next two quarters while Motorola and Ericsson are treading water," says Todd Bernier, an analyst at

Morningstar.com

. (His firm does not rate stocks or perform underwriting.)

Challenges in Europe from

Siemens

(SMAWY)

and some Japanese manufacturers may thwart that plan, however.

Even so, for Nokia, as well as Motorola and Ericsson, it makes sense for them to concentrate more on their network infrastructure businesses, where the rewards will be greater, as long as network upgrades happen.

"What Ericsson has done and what I expect Nokia to do more of is to

outsource commodity components and focus on the network," Patterson says. "I would look for Ericsson and Motorola to play up their relationships with the next-generation infrastructure. There's demand for building wholesale changes in infrastructure. They want to create a perception of stability."

But don't totally write handsets off. Growth of anywhere from 23% to 36% is still healthy, while there may yet be a spike when data services kick in. "Right now is the end of one cycle, voice, only," says Peter Baughan, an analyst at

Harding Loevner Management

. "The market is making a mistake in thinking that a slowdown in voice is a slowdown in overall demand."