Special report | A Survey of Telecommunications

Cutting the cord

Mobile phones are everywhere, thanks to falling prices, rising quality and clever marketing

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HERE is a cautionary tale about a telephone giant and a management consultancy. In the early 1980s AT&T asked McKinsey to estimate how many cellular phones would be in use in the world at the turn of the century. The consultancy noted all the problems with the new devices—the handsets were absurdly heavy, the batteries kept running out, the coverage was patchy and the cost per minute was exorbitant—and concluded that the total market would be about 900,000. At the time this persuaded AT&T to pull out of the market, although it changed its mind later.

These days 900,000 new subscribers join the world's mobile-phone services every three days. In eight countries more than a third of the population own mobile phones; among Scandinavian men in their 20s the figure is almost 100%. Almost everywhere ownership is growing relentlessly, and sometimes exponentially. In both France and the Netherlands, for example, the number of mobile phones doubled during 1998. The tipping point seems to be somewhere between 15% and 20% of the population. Below that, people regard mobiles as expensive toys for business people, so it takes a long time to reach that point; but from there on, growth takes off.

The most obvious reason why mobile phones are becoming so popular is that quality is going up at the same time as prices are coming down. The Yankee Group, a consultancy based in Boston, Massachusetts, calculates that worldwide wireless prices decreased by an average of 38% between the fourth quarter of 1996 and the first quarter of 1999 (see chart 2). In three cities prices came down by more than 50%: Tel Aviv (70%), and Hong Kong and Rome (62%). Falling prices also make it likely that people will use their mobile phones more, because the price premium over fixed-line phones becomes narrower.

If mobile phones now offer a better deal, much of the credit must go to increased competition. Around the world governments have used the wireless industry to shake up the monopoly-ridden world of telecoms, either creating a wireless rival to the incumbent or encouraging competition between several cellular companies. For an illustration of what competition can do, compare the Asia-Pacific region with Latin America. In Asia-Pacific, where competition is the norm and six of the nine biggest markets have at least five cellular operators, prices have been plummeting. In Hong Kong 2,000 people a day take advantage of “number portability” to switch from one of the area's nine operators to another.

In much of Latin America, by contrast, prices have remained exorbitant—as much as ten times the cost of a local call—because governments have been reluctant to take on the established monopolies. Where competition has been introduced, the market has surged: when Chile allowed in new operators in 1998, prices fell by 40% and the number of customers doubled.

The World Bank notes that the same pattern holds around the world. In the Middle East and North Africa it is Lebanon, where competition is most intense, that has the lowest prices (7 cents a minute against a regional average of 40-50 cents). Charges in Norway have dropped by 60% and in Germany by 70%. Europe, the continent with the most competition, also has the the fastest growth in mobile-phone use.

Other forms of liberalisation have helped too. Japan's love affair with mobile phones dates from the repeal, in 1994, of an absurd law which forbade Japanese people from owning cellular handsets, forcing them to rent them at a prohibitive $1,000 a year instead. But the other big force behind the spread of mobile phones is technological innovation. Digital networks, for example, can carry three to six times as much traffic as analogue networks, making room for data as well as voice, and also providing better reception, greater security and a host of useful features such as caller identification, call forwarding and three-way calling. Some of them are being rendered even more powerful by a range of compression algorithms to squeeze many conversations into a given frequency (eg, time-division multiple access, or TDMA, and code-division multiple access, or CDMA).

Improvements in both battery and radio technology have shrunk phones so they will fit into a shirt-pocket, and stretched standby time from a few hours to several days. The rapid increase in the number of base stations has filled in many gaps in service. And the relentless decline in the cost of integrated circuits has made handsets both smarter and cheaper. A top-of-the-range phone now costs about $350, compared with $1,000 four years ago.

Cash in advance

The biggest boost to the market in the past couple of years, however, has come from the introduction of pre-payment. Pre-payment allows people to buy telephone time off the shelf in the same way that they buy sweets. This is popular with consumers because it allows them to ration the amount of time that they—or, often more to the point, their children—spend on the phone. It also removes the need to sign a contract with a cellular company—something that sits uneasily with the free-floating culture of mobile phones. Telephone companies like it too, because it reduces their credit risk, improves their cash flow, and gives them access to new groups of subscribers.

The idea has spread like wildfire. In Italy, for example, mobile phones were slow to catch on until what locals call “Mafia phones” (no contract, no trace of the user) came along; then penetration zoomed past 40% of the population. Pre-paid phones now account for about 30% of new users in France and three-quarters in Britain. In Asia, where carriers are struggling with bad debt created by the recent financial crisis, pre-payment is behind the wireless industry's rebound, accounting for 70% of new users in Thailand last year and 100% in Malaysia; in Latin America, where fixed-line phone bills can be arbitrary, pre-payment is one of the main attractions of cellular; and in the United States, where about 30% of applicants for wireless services are rejected because of poor credit ratings, pre-paid has the potential to turn the market upside down.

Cellular companies are improving their marketing in other ways, too. Alan Knott-Craig, the boss of Vodacom, South Africa's largest cellular network, points out that his company allows retailers to keep a share of the revenues generated by any handset they sell. This not only persuades the most unlikely outlets to sell mobile phones; it also encourages them to subsidise the phones. Most companies are getting better at targeting specific groups of consumers. In Japan, NTT DoCoMo is making some phones with larger handsets for elderly people. American operators have started offering free service in the evenings and weekends—prime teenage gabbing time—to capture the youth market. New World Telephone, a Hong Kong company, sells pre-paid cards with pictures of “Winnie-the-Pooh and friends” to attract the pre-school crowd.

Many people in the wireless business are convinced that it is only a matter of time before the term “mobile phone” becomes redundant, because there will be no other sort around. This is a little optimistic, not least because fixed lines represent such a gigantic investment. But the momentum is undoubtedly with wireless. Since 1996 the number of people signing on for cellular has exceeded that for fixed-line service every year, and the gap is widening. Many young people see no point in paying for a fixed line when their lives are so peripatetic.

Now the mobile-phone industry is raising its sights, talking about “exceeding 100% penetration”. The idea is that mobile devices can be used not just to allow people to communicate with data banks or with machines, but also to allow machines to communicate with people or with other machines. Car companies are already beginning to fit cars with wireless devices that can tell the rescue services where they are if they crash or break down. Wireless is already used to monitor expensive equipment in isolated places, a technique that may one day be applied to more basic equipment such as parking meters. NTT DoCoMo estimates that by 2010 only a third of its 360m customers will be people: the rest will be cars (100m), bicycles (60m), portable PCs (50m), motorcycles, boats, vending machines—and even pets .

Selling phones to boats and pets must be an exhilarating challenge. But what really excites the wireless industry at the moment is the creation of an entirely new breed of smart phones.

This article appeared in the Special report section of the print edition under the headline "Cutting the cord"