InterDigital Inc (IDCC)

[jimmylee]

New Cost Pressures coming for the phone Manufacturers:

Nov. 30--The wireless industry is embarking on a new era, with open networks and more choices for customers arriving as soon as next year. But the consumer revolution comes with a price -- one that may ultimately slow the pace of change.

As major companies such as Verizon Wireless and Google start championing open phone networks, the wireless market is evolving to give consumers greater say in selecting a handset and loading it with applications. For the independent software developers creating those programs, which could range from music sharing to social networking, the potential for tapping millions of mobile phone users appears lucrative and rapidly approaching.

It's a different story for major handset manufacturers, whose long-standing and complicated marriage with wireless carriers will take far more time to change. The prevailing business model for the wireless industry has brought costs down for users through carriers' heavy subsidies of handset prices.

Therein lies the challenge for phonemakers: Without the carriers, there are no subsidies. And without subsidies, manufacturers will have to ask customers to pay much more for their handset than what they've been accustomed to for years.

Sharp rise in costs

"We can't subsidize our handsets ourselves," said Nokia spokesman Keith Nowak.

If phonemakers start selling many more non-subsidized phones directly to consumers, say, at retail electronics outlets or their own stores, costs would go up sharply. Roger Entner, senior vice president of the communications sector at IAG Research, said subsidies vary widely, but $250 is an approximate figure. In theory, a consumer wanting to purchase a phone from a manufacturer would thus pay not only $250 more to make up for the cost of the carrier's subsidy, but the additional markup for the phonemaker to generate a profit. These days, Entner said, 80 percent of Americans spend less than $100 for their phones.

"You have the challenge that 80 percent spend less than what the device costs," Entner said. "That is a major inhibitor."

Another hurdle is that bypassing the carrier also means giving up the technical support that service providers otherwise offer for the phones they sell. Verizon has said that aside from verifying network compatibility, it won't be responsible for subscribers' issues with outside devices. Customer service is a sticking point for consumers such as Toby Herr, who visited a Verizon store on Michigan Avenue to hunt for a camera phone with a Web browser for under $125.

"When I have a problem, I want it fixed that day," said Herr, 64.

The current relationship between service providers and phonemakers limits consumers' choices of phones and carriers. In many cases, phonemakers sign exclusive contracts with carriers so that certain models are available only through a particular wireless company. This is the case with Samsung's Juke music phone, for example, which is serviced exclusively by Verizon. In other instances, the manufacturers make multiple versions of the same phone to meet the specifications of each carrier, as Motorola did for its new Razr 2.

The carriers' "current business model is really to pick and choose and validate which handsets ultimately make it to their retail outlets and which don't," said Mark McKechnie, an analyst at American Technology Research. "They're like a gatekeeper."

The U.S. model developed because the driver of early growth in the wireless industry came from the carriers, who were eager to sign up as many subscribers as possible and subsidized the cost of handsets for consumers, said Ed Snyder, an analyst at Charter Equity Research. The power rested with the service providers, who were able to request phones to be customized for their networks. The partnerships between carriers and manufacturers also developed to accommodate the alphabet soup of competing technologies -- CDMA, GSM and IDEN -- that proliferated.

Some consumers are willing to pay much higher prices for the phones they want. James Simms, a Verizon subscriber on the fence about switching to AT&T so he can get Apple's iPhone, studied the similar LG Voyager at a Verizon store. The 33-year-old Chicagoan didn't blink at the Voyager's $299 price tag because he already spent that much on his current phone last year. The reason for this year's purchase?

"My phone doesn't fit in my tight jeans," Simms said. "Sleeker is better, right?"

Analysts and industry players say Simms' demographic remains a niche market, one likely to grow as networks open up but unlikely to unseat mass-market practices in the short term.

Technology aficionados

Nowak of Nokia pointed out his company operates two flagship retail stores in the U.S., including one on Michigan Avenue, for "that technology aficionado" who will happily purchase a device for hundreds of dollars that isn't tied to a specific carrier. Nokia's N95, which features a five-megapixel camera, costs $699 at the Chicago location.

Carriers such as "AT&T and Verizon meet the demands of the majority of consumers," Nowak said.

As for smaller manufacturers hoping to get into the handset business, high entry barriers will likely prevent boutique designers from entering the industry. Snyder pointed out that the high technical standards and required economies of scale for cell phones distinguish the industry from other consumer electronics.

"You have to supply this thing in millions of units at a small failure rate," Snyder said. "That makes it very difficult for Joe Blow to get in and supply it on a large scale."

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