Pick-up in mobiles still looks uncertain

Consolidation has further to go in a sector that has contracted by about 40% this year

Scratch beneath the surface of yesterday's weak manufacturing output data and it is the mobile phone industry that is to blame again for the decline.

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Scratch beneath the surface of yesterday's weak manufacturing output data and it is the mobile phone industry that is to blame again for the decline.

This is no surprise since all the major mobile phone companies have been making dramatic cutbacks. They have also been moving handset manufacturing away from Europe in favour of cheaper countries in the Far East; outsourcing, or pulling out of it altogether. Indeed, Ericsson, which has already announced thousands of job losses, is still trying to sell the two UK mobile phone production plants it is pulling out of in Carlton, Nottinghamshire, and Scunthorpe, Lincolnshire.

What has surprised some, though, was how severely growth is slowing in the industry, making it increasingly difficult to forecast the timing of any likely improvement. In the short term, the prognosis is not good.

National Statistics said yesterday that the optical networking and mobile phones sub-sector fell by 22 per cent in April, after a 36 per cent drop in January. Since the beginning of the year, the sub-sector has contracted by around 40 per cent. While NS will not separate out the performance of optical networking from mobile phones, the corrective action being taken by the mobile phone giants acknowledges the gloomy trend.

Most of the mobile phone companies warned of the upcoming deterioration at the start of the year, when they radically scaled back their growth forecasts for handset sales.

The range in the market varies as much as 380 million to 500 million, although most seem to be forecasting around 470 million of sales. Gartner Dataquest is forecasting half a billion sales in 2001, up from around 415 million last year. Previous forecasts had been for about 550 million.

Against those downgraded expectations, most analysts seem to be taking pessimistic short-term views. It is not difficult to see why, given that the evidence is still very fresh.

Only last week, Alcatel, the French telecoms business, added its name to the increasing list of those exiting mobile phone handset production. At the beginning of this week, analysts at Dresdner Kleinwort Wasserstein, who are predicting 470 million handset sales this year, warned that investors should "brace themselves" for further bad news from the world's leading handset makers.

The bears do have a point. Mobile phone handset penetration is now very high among many European countries, meaning that the mobile phone makers are having to rely increasingly on the handset replacement market for growth.

To make matters worse, the mobile phone operators recently all cut subsidies on the cheap pay-as-you-go mobile phone deals as part of their plans to focus on quality customers. The days of growing customer bases at any cost seem truly over.

Peter Knox, an analyst at Commerzbank, said the handset market had slowed for two main reasons: "It's the increasing penetration of West European markets. As a result of that, the level of subsidies being offered by operators has been reduced because the marginal user is sometimes not that lucrative." He is forecasting handset sales this year of 475 million and predicts Nokia will weather the storms better than most.

There is also the problem that the new mobile phone service, known as GPRS or 2.5G, will not live up to expectations and will not give the industry the stimulus it was seeking.

The service offers users an always-on internet connection as well as faster transmission of data. It aims to be a quicker and more reliable version of WAP, the first way of accessing the internet over mobile phones.

But only BT Cellnet and Vodafone have launched a GPRS service in the UK, and it is too early to tell yet how well it is going down among consumers. However, GPRS is unlikely to get off to a flying start just because both had just one handset to offer customers.

Ben Wood, an analyst at Gartner Dataquest, said: "There clearly is a pause for breath in the marketplace in terms of the volumes of terminals being sold. Part of that can be attributed to the uncertainty surrounding the technology being pushed into the marketplace."

Moreover, many consumers are likely to be inclined to be cynical about GPRS because of disappointing experiences with its WAP predecessor. "If the operators don't make GPRS work, where's the money going to come from for 3G investment?" said one analyst who did not want to be named.

Worse still, the early signs for third-generation, or 3G, mobile phone services, are not good. Japanese phone companies, including NTT DoCoMo, had to delay 3G launches because of software glitches, while similar problems forced BT to postpone its own 3G offering on the Isle of Man. A 3G service might not appear in the UK on a commercial scale until 2003-04.

That said, many analysts remained adamant that mobile phones will be very much back in vogue in the not too distant future, driven by services such as GPRS and 3G.

"Moving into next year, I think the handset business will normalise, and I would expect a recovery back to reasonable growth next year," Mr Knox said, adding: "There's been a hell of a crunch, but I do believe 2001 is a dip year, not the start of a structural decline."

There is also the very valid argument that the mobile phone operators have invested so much money in 3G licences that they will have to find ways of making it pay, and that will involve consumers buying the new handsets.

Manufacturers and operators "have to make GPRS work and make sure it's a commercial and operational success," Mr Knox said. Indeed, the arrival of the new handsets is also expected to perk up demand.

While there is likely to be a variety of GPRS mobile phones in the shops in time for the crucial Christmas period, many predict that the more eye-catching designs will not be on offer until next year. The first of the eagerly awaited mobile phones to come out of the Sony/Ericsson tie-up will not be on the market until early 2002. Similarly, mobile phones combined with personal organisers are not expected to appear in volume until next year.

While many analysts are forecasting an upturn in the mobile phone market next year, there are still too many unknowns at this stage to bet the ranch on the timing or size of any upswing.