Getting sleek

The PMG approach may change the way we think about handsets and mobile communications

by Brian Modoff, Michael Thelander and Daniel Kaplan, Deutsche Bank Securities, Inc.

Beginning last year, the major handset suppliers began incorporating more functionality into their high-end handset models in what we like to call the Swiss Army Knife approach to handset design. Now, most high-end - and even some mid-tier - handsets have a built-in camera, Personal Information Management (PIM) applications, larger color screens and perhaps a special large keyboard to input text. In addition, these handsets typically support simplistic games and other forms of entertainment, utilizing the BREW or J2ME platform. Although these devices do everything under the sun, they also come with a much higher sticker price and lots of extra size and weight - not ideal when you go to the gym.

The "commoditization" of the handset is another recent, and less desirable, trend in the industry. At the end of 2002, handset suppliers and wireless operators were aggressively discounting a vast selection of handsets, including some of the latest models, in an attempt to entice consumers to activate a new account, switch operators or upgrade their phones.While these offers can have a positive impact on unit sales and subscriber growth, their impact on bottom-line profitability is detrimental in the near term and unsustainable in the long term. In order for this industry to regain its strength, the underlying growth for handset sales needs to be driven by real demand and not by artificial stimulants, such as aggressive subsidies. Ultimately, if handset subsidies continue, consumers will grow accustomed to receiving heavily discounted prices before they consider upgrading their current mobile devices.

While the battle for the consumer rages in the retail stores and in the operators' kiosks, the industry faces the prospect of flat or even declining average revenue per user (ARPU) growth. Such factors include service contracts with more voice minutes, plans that allow the monthly rollover of unused minutes and special promotional offers that are aggressively priced in order to attract new subscribers. Differentiation among the mobile operators is seemingly a function of which operator can provide the most voice minutes for the lowest price, and perhaps throw in a handset for free. While great for the consumer, it is an unhealthy scenario for the operators, which must balance their growth prospects with the strength of their balance sheets and the requirements of their investors.

Mobile Data - The Long and Winding Road

Mobile data has the potential to become the saving grace of the industry, although industry consolidation is a separate endeavor that can also have a meaningful impact. As we discussed in our 3G report (The Rise of the Empire, Even Rome Had Its Bad Days, May 2002) and in our weekly "Signals to Noise" newsletter, we are staunch supporters of mobile data and the impact it can have on the wireless industry's growth. We recognize, however, that mobile data in its various forms will not become an overnight success story as some predict. Instead, we are of the opinion that mobile data usage will ramp up slowly over time, much like Short Message Service (SMS) grew in the mid- to late 1990s, as operators take a more cautious and pragmatic approach to introducing data services into their overall offerings.

Ask a handful of carriers, industry consultants and OEMs what the killer data application is and you will get a handful - perhaps two handfuls - of answers. Some will claim it is richer messaging (video postcards). Others will tell you it is location-based applications. Some will even claim it is games or m-commerce transactions or banking or gambling orŠ you get the picture. Even voice will remain a primary application in next-generation networks as new services evolve.

To paraphrase former Supreme Court Justice Potter Stewart, we can't define what the killer application is, but we'll know it when we see it. We do not believe there is a real need for any one particular killer application, or any one particular device, for that matter. Allow us to switch to the PC industry for a minute to demonstrate our point. Which killer application or operating system do you believe drove the growth of the PC industry: Microsoft Office, games, Windows, Netscape/Internet Explorer or online trading? In actuality, the PC industry grew thanks to contributions from all of the above applications. One of the biggest inhibitors of mobile data is sticker shock, especially among the more cost-cautious youth market. The $500 phone with an integrated camera or AM/FM radio may attract interest from the 20-something-and-under crowd, but we doubt that there will be many takers. Consumers with deeper pockets can afford such luxuries, but they represent less than 30% of the overall market. Even worse, those deep-pocketed consumers are unlikely to take advantage of the wireless gaming applications and multimedia messaging services that generate data traffic and ultimately increase an operator's overall ARPU, and in particular, its data ARPU. Bottom line, a Catch-22 situation has developed in the industry.

A Potential Paradigm Shift

Now, a private company, IXI Mobile, is seeking to change the way we think about handsets and mobile communications in general. IXI is a software provider that works with its partners to deliver its vision of mobile data. IXI offers what it calls a Personal Mobile Gateway (PMG). The PMG, which is available either as a stand-alone device the size of a mint box or as a device that can be integrated into a traditional handset, acts like a server/router between the mobile network and a host of "Sleek" devices (IXI's term) that all communicate via Bluetooth with the PMG. Each device is very inexpensive and designed to perform specific applications. For example, the device could be a text-messaging device, a gaming device, a Bluetooth camera or an extremely small handset that is designed to resemble a piece of jewelry or to fit unnoticed in a shirt pocket. One of our favorite ideas is a sports watch that could utilize GPS technology (housed in the PMG) to track and report distance traveled and split times (ideal for the jogging enthusiasts who want to know how far they really ran).

The PMG houses cellular (GSM/GPRS and CDMA) and Bluetooth modem chips, sufficient memory, the software that handles the routing between the personal-area network (PAN) and wide-area network (WAN), as well as an applications server, which allows the Sleek devices to be thin clients of the PMG. The back-end server provides functions such as device authentication and activation, monitoring/billing and application fulfillment.

In our view, the potential benefits are numerous, including the following:
  • Faster time to market for the Sleek devices vs. smart phones (months vs. years).
  • Much lower costs vs. smart phones, due to the higher costs associated with integrating multiple functions into one device (smaller size and form factor = higher cost).
  • The inexpensive and trendy Sleek devices are ideal for a virtually untapped consumer market - the price-sensitive youth.
  • Mobile operators benefit, since they do not need to offer subsidies for the relatively inexpensive devices.
  • Carriers can generate additional revenue by charging a premium for certain data transmissions, since the PMG - along with a back-end server - helps them identify the type of data (picture vs. text) being transmitted.
  • Subscribers can own multiple devices (the same phone number is assigned to the PMG) and then select the appropriate device to take with them. Work, play or even a night on the town could warrant a different device - you could even color coordinate the device with your purse and shoes.
The year 2003 could represent the dawn of a new era in mobile communications when a handful of entrenched companies no longer dictate the selection of communications devices available and the functions these devices support. Instead, the introduction of the PMG clears the way for a wide range of new entrants, including sports franchises, jewelers, fashion designers and game device manufacturers, who can relatively quickly and inexpensively introduce their own sleek device specifically designed and targeted to a particular application and clientele. While consumer demand and acceptance is the determining factor of any new technology or concept, it appears to us that many of the remaining pieces are already falling into place with the announcement of several strategic partners and launches by some major wireless operators throughout the world. Only time will tell whether or not a new paradigm in the wireless industry has emerged.

Brian Modoff, Michael Thelander and Daniel Kaplan are research analysts with Deutsche Bank Securities, Inc. The above comments should not be considered a recommendation concerning the purchase or sale of any security mentioned herein.