Cell Phones: Europe Made The Right Call

Its single digital standard gives it the clout to shape the next generation of wireless gear

These should be triumphant times for Qualcomm Inc., a scrappy pioneer of digital cell-phone technology. After struggling for more than a decade, the San Diego company has sold the world on the merits of its cellular technology. Revenues will exceed $3 billion this year--a tenfold increase in four years. And in June, Europe and Japan decided to adopt Qualcomm's technology as the basis for much more powerful phones--"third generation" machines--that should be available early in the next century.

But for Qualcomm, the victory is bittersweet. The company's top officers say the Europeans have tweaked the technology in a way that will reduce Qualcomm's royalty streams from its patents and make its phones less attractive overseas. Qualcomm officials have offered the Europeans a variety of proposals and compromises in which both sides might prosper, but Chairman Irwin M. Jacobs says its suggestions have fallen on deaf ears: "Our contributions were either tabled or ignored."

Qualcomm's travails are part of the global struggle to settle on standards that will make a cell phone usable throughout the world. More than 10 years ago, European officials decided to implement a common digital standard, known as GSM (global system for mobile communications). While America is a tangle of competing phone standards, bred by its laissez-faire philosophy, European governments helped to create a united front led by such giants as L.M. Ericsson and Nokia Corp. That alliance has soared to global dominance.

Now, as Qualcomm is discovering, Europeans may call the shots for the next generation of cell phones, which will be able to cruise the Internet and deliver live video in as little as three years. Qualcomm is crying foul and is asking Washington for help. But now and in the near future, Europe rules the world's radio waves. The outcome is already evident in China, the world's fastest-growing cell-phone market, which increasingly takes its technology cues from Europe.

For the U.S., the costs of playing second fiddle are now painfully obvious. Dataquest Inc. figures that cellular subscribers worldwide spent upwards of $37 billion on handsets last year. That number will shoot past $55 billion in 2001. Washington-based market researcher Strategis Group says most of that growth will be in phones built to Europe's GSM specs--further enriching Nokia and Ericsson. Of the 98.6 million digital cell phones produced last year, 58% were GSM, according to Dataquest.

PARTY CIRCUIT. Europe's success has already bloodied Motorola Inc., which pioneered two-way radios, pagers, and cell phones. The Schaumburg (Ill.) company has fallen far behind Nokia in Europe and Asia. Even in North America, Motorola's market share has crumbled, falling from 60% in 1994 to 34% today, according to Herschel Shosteck Associates Ltd. in Wheaton, Md.

The picture for Motorola and other U.S. manufacturers could grow even darker as the world migrates to third-generation, or 3G, cellular phones. (The first two generations were analog and current-style digital.) In third-generation phones, data transmission will be front and center. Most of today's cell phones transmit at a top rate of 9.6 kilobits per second, but 3G phones will send data at up to 2 megabits per second--faster than the direct connections many people have at work, and easily fast enough to surf the Web and download software or movie clips. Eventually, product developers predict, 3G phones will even manage videoconferencing.

The phones are based on a technology called "code division multiple access," or CDMA. Concocted by the U.S. military and commercialized by Qualcomm, it spreads specially coded signals across a slice of radio spectrum, allowing many users to share the same scarce communications bandwidth. You can think of a CDMA network as a multilingual cocktail party: There are many conversations in progress, in different languages, and listeners can focus on one and ignore the rest.

It's no surprise, then, that both Europeans and Asians embraced CDMA for the third generation. But Qualcomm wants a standard that would be "backward-compatible" with its existing CDMA system. It felt slighted when in late January, the European Telecommunications Standards Institute (ETSI) endorsed a 3G CDMA standard that bypasses key Qualcomm patents and is incompatible with existing networks that use Qualcomm's CDMA technology. "They want a technology that lets them protect their home turf," says Jacobs. "Then they'll build that up and continue to export." Nothing would stop Qualcomm from making and selling phones based on Europe's new standard. But the company would suffer diminished patent revenues and lose its economies of scale.

GREAT LEAP? The Europeans say they weren't trying to dodge Qualcomm's patents--they simply focused on the best technology. "We wanted to make a major leap forward in terms of capability," says Ake Persson, vice-president for marketing and sales at Ericsson Mobile Systems in Stockholm. "The standards group was not prepared to sacrifice that just to make the systems backward-compatible."

The truth may lie somewhere in between these two views. Certainly, Qualcomm is not without blame for its current predicament. The company has a reputation for setting license fees much higher than those the GSM group imposes on its members. "This has been spoiling the whole thing from the beginning," says Thierry Laurent, senior vice-president for communications products at U.S. chipmaker VLSI Technology Inc., an impartial supplier to all camps.

Nonetheless, Qualcomm's tale of woe dismays U.S. trade negotiators. Qualcomm executives note that voting power in ETSI is based on a company's sales. So Qualcomm ended up with only one vote. Last November, when Qualcomm finally got a chance to put forth its ideas formally, its proposal was the last item on the agenda--and the meeting was adjourned before Qualcomm could make its presentation.

Fifteen years ago, the situation with Europe was reversed. The U.S. had just one cellular standard, and Motorola was in the driver's seat worldwide. With seven different analog standards, Europe looked more like America's own Wild West.

To impose order, European governments and industry adopted a common digital standard--GSM--in 1992 that, for the first time, enabled a mobile executive to roam with a cell phone from Stockholm to Seville. Since then, GSM has exploded, last month passing the 100 million-subscriber mark. Four new customers are now switching on a GSM phone every second, or 5 million a month. The result--manufacturing economies of scale and low prices--has prompted most of Asia, and even the U.S., to embrace the standard.

In the U.S., meanwhile, Washington encouraged competition. "Consumers are best served when the marketplace determines the standards it prefers rather than government-affiliated standards bodies like ETSI," says Federal Communications Commission Chairman William E. Kennard.

As America moves into third-generation phones, the market will be further split into four different technical standards. There's no way out, since today's service providers must assure backward compatibility with their customers' current telephones.

ULTIMATUM. Qualcomm insists that it has the resources and the legal right to build on its success. To do so, it's banking on its CDMA patents. On Aug. 5, Qualcomm delivered an ultimatum to ETSI: It would withhold intellectual-property rights unless ETSI agrees to a standard compatible with both European networks and American digital networks. Qualcomm also demanded that the standard be chosen on technical merit. If Europe attempts to force Qualcomm to grant a license to its patents, Jacobs may request a World Trade Organization filing.

Washington seems prepared to back Qualcomm. The likely outcome is that ETSI, to preserve the peace, will shoot for an accommodation that will reduce market-entry barriers for Qualcomm.

Meanwhile, the International Telecommunications Union has until next year to certify ETSI's proposal as a global standard. So there is plenty of time for negotiation. Europe is likely to weave some of Qualcomm's favorite technical specs into the new 3G standard. With that, Qualcomm will be able to boost its royalty revenues, which may give the company some satisfaction. But it won't be enough to give Americans the upper hand in the third generation.

— With assistance by Catherine Yang

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