All That Money on 3G--and for What?

A simpler, cheaper wireless Net standard could win out

Last October, in the heat of Europe's auctions for third-generation wireless-phone licenses, it looked as though Italy's No. 4 carrier, Blu, had blown its future. After two rounds, Blu dropped out of the bidding for a so-called 3G license when the price got too rich--more than $2 billion for each of the five winners.

Yet now that the frenzy has died down and the winners grasp how much 3G mobile services will cost, Blu isn't feeling so blue. It's banking instead on something called 2.5G, a long-planned upgrade to the existing Europeanwide wireless-phone system. The format is set to come online this year, and should offer nearly all the benefits of 3G for a fraction of the cost. If 2.5G is a big hit, it could undermine demand for the high-stakes third-generation system. Indeed, says Nick Jones, a researcher in the British office of consultant Gartner Group Inc., "3G's biggest competitor is 2.5G."

That idea must send shivers through already anxious telecom executives who have bet the farm on 3G. Deutsche Telekom, France Telecom, Britain's Vodafone, Spain's Telefonica, and others collectively have gambled more than $95 billion on 3G licenses in the hope that speedy new networks will ignite the long-promised wireless Internet and stem the decline in voice revenues per subscriber. They'll have to spend $125 billion more to build 3G, figures analyst Durlacher Research Ltd., plus billions on marketing. The combined debt could be so severe--especially if 3G doesn't take off as quickly as hoped--that European telcos may face massive consolidation, or even financial ruin, over the next decade.

Yet 2.5G's imminent arrival isn't entirely unwelcome to the 3G crowd. "Smart operators will milk [2.5G] and minimize [3G] rollouts," says analyst Lars Godell of Forrester Research Inc. in Amsterdam. Most of them also have spent the few millions necessary to upgrade their existing GSM (Global System for Mobile) networks to offer 2.5G, which could tide them over until the third generation is up and running--2003 at the earliest.

As its name implies, 2.5G technology was conceived as a stepping stone from second-generation GSM to 3G. In all the fuss over 3G, though, 2.5G's importance has been underplayed. Its big advancement: Data such as headlines, sports scores, and traffic updates travel in a channel separate from voice calls and flow in and out of a phone anytime it's on. This "always-on" capability, coupled with data speeds two to three times faster than before, will make using the wireless Web easier, even though users will have to buy new phones to take advantage of that benefit.

Such improvements could jump-start the mobile Web. Dutch operator KPN Mobile, for instance, figures new 2.5G services this summer could boost its revenues per subscriber by 35%, says Business Marketing Director Brian Stout. Durlacher Research figures nonvoice services will yield more than $70 billion in revenues for European wireless operators by 2005. The likely moneymakers: instant messaging, games, and business services. "Our whole business model is changing," says KPN's Stout.

For now, the big players express commitment to both technologies. Vivendi Universal CEO Jean-Marie Messier says his company is ready to roll out 2.5G later this year, but will also test a 3G network in Monaco starting in June. Nokia Corp. says it will deliver millions of 2.5G handsets in the fourth quarter, with 3G models set to arrive a year later.

PERVERSE OUTCOME? Not that there aren't problems to be ironed out with 2.5G. Handsets are late and scarce: Only Motorola, Ericsson, and Sagem have delivered any so far. The growing complexity of handsets also poses risks for both 2.5G and 3G. Nokia's 2.5G models are seriously delayed. On top of that, they'll cost $300 to $500, or about twice as much as conventional GSM phones, until prices start to drop in late 2002.

Even so, the problems of 2.5G pale in comparison to the risks of its successor. Experts say 3G technology is so complex that it will likely arrive years later than promised--perhaps not until 2004. That leaves telcos carrying license-fee debts long before they can start recovering 3G revenues. Plus, whatever prices operators settle on for 2.5G data are likely to set a ceiling on what they collect for 3G. In the end, Europe's telcos are banking on a perverse outcome: That 2.5G is so popular, wireless networks will become clogged with traffic and customers will switch to 3G for better performance. In effect, they plan to choke one golden goose to fatten another. Now, they just have to be certain neither one lays an egg.

By Andy Reinhardt, with Stephen Baker in Paris, William Echikson in Brussels, and bureau reports

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