THE FIRST 3 BILLION IS ALWAYS THE HARDEST

There are 1.7 billion wireless subscribers in the world today. By the end of the year or by early next year, the global wireless population expected to march across the 2 billion mark. That accomplishment alone is cause for celebration in the wireless industry. No technology in the world has reached such levels of penetration in such a short amount of time, and the cell phone is rapidly becoming the single electronic good that a majority of the world's population has in common.

With the first 2 billion almost under its belt, the global wireless industry is looking ahead to the next 1 billion subscribers. But those subscribers won't come from the same geographic outposts as the first 2 billion. With penetration levels in Western Europe and Japan climbing above 90% and two-thirds of the U.S. population covered, the next 1 billion primarily will come from the developing world, in countries spread throughout Latin America, southeast and south Asia, the Middle East and Africa. Some of the statistics for these countries can be staggering. The U.S. — until surpassed by China — was long the world's largest wireless market. With a subscriber base of 200 million the U.S. accounts for 12% of global subscribers. But, if India were to have 200 million subscribers, it would have a penetration rate of merely 20%. China is projected to have nearly 400 million subscribers by the end of the year, and that accounts for only 30% of its population.

“There are six and a half billion people in the world,” said Dave Murashige, vice president of marketing for Nortel Carrier Networks. “We've only covered a third of the globe. But there's still a lot of people we haven't touched yet.”

It's almost a foregone conclusion that many of the world's next 1 billion wireless users will come from three to four specific regions — southern Asia, Africa and the Middle East, Eastern Europe and Latin America. With each of those regions, there likely will be one more powerhouse growth markets that lead the charge. China is currently the world's fastest-growing mobile market, according to In-Stat Research, and is expected to remain so in the years to come. In Africa and the Middle East, Sub-Saharan countries such as Kenya, which are looking to catch up economically and technologically with the rest of the world, could experience fast growth, as well as least one Middle Eastern country undergoing a massive rebuilding — Iraq.

Dave Chamberlain, senior wireless analyst at In-Stat, said Iraq and neighboring Pakistan are expected to have the fourth and fifth fastest subscriber growth rates between 2004 and 2009.

Meanwhile, in Eastern Europe, Russia remains one of the world's most promising markets. In Latin America, there are a host of countries — including Colombia, Brazil, Mexico and Venezuela — that could lead the region's growth, spurred in part by competition between two carrier Goliaths, Mexico's TelMex subsidiary America Movil and Telecom Moviles, the international arm of Spain's Telefonica.

According to Mike Iandolo, vice president of mobility solutions for Lucent Technologies, the countries poised for the most growth usually have a couple of things in common that make them promising.

“We see certain regions around the world where there is a combination of low teledensity and good [gross domestic product], and that kind of combination is what will account for the next billion customers,” he said.

As subscribership builds in each of these regions, the demographic trends, service and device needs and usage behavior of the world's next 1 billion users could be radically different than what the global wireless industry has been used to for the past 22 years.

These issues will force carriers and their vendors to adapt to a different set of rules and challenges for serving the next 1 billion users. For example, while GDP is a good indicator of economic health, citizens in a country with low teledensity initially will be concerned with having a simple lifeline service.

“So far, the concerns of carriers in the wireless industry have had to do with how to compete in a material market,” said Rowland Shaw, director of strategic planning for Ericsson. “But, what about a market that hasn't taken service yet? You are talking about a lower-end kind of user who isn't going to consume as much right away. You're talking about a $50 ARPU in a mature market versus a $20 ARPU in a less established market. Carriers will have to have a low-ARPU business model.”

Eventually, as new markets enjoy fast user growth but produce only low or mid-range ARPU, the industry may come to have less faith in ARPU as an ultimate measuring stick for a carrier's financial success, Shaw said.

“We've continued to harp on ARPU in the business world, but at the end of the day, the other parameters you may use to measure success in these countries are income and EBITDA margins,” he said.

Even $20 per month may be a high figure for some of the markets the next billion will target. Some vendors estimate that in poverty-stricken countries like India, ARPUs could be as low as $2 to $5 per month. Only the sheer volume of potential new customers those countries can bring could raise income to levels those western carriers have come to expect.

One thing is for certain: Lower revenue per subscriber will translate into lower spending on network infrastructure per subscriber. But the basic properties of the radio access network won't change to accommodate the differences in the average income. A base station can only reach so far and can only support so many calls per channel. An individual subscriber still requires an individual handset. The same equipment that built the West's wireless industry — and for which carriers paid a premium — will have to be implemented in the developing world, and carriers there won't be able to afford the prices their Western predecessors paid.

No vendor will admit its network equipment is about to become commoditized, but it might come pretty near close. Base stations will be severely discounted, and average phone prices will be in the $25 range. No vendor is going to sell its equipment at a loss, however. They are all seeking ways of bringing the costs of their equipment manufacturing, engineering and deployment to match their new customers' ability to pay while still keeping their margins intact.

Nortel's Murashige said it comes down to the global supply chain. Products that Nortel made and installed in Europe and the U.S. can be built and installed at a far cheaper price in a developing country — and there's no cost to export those products afterwards. While the core engineering know-how will remain in the infrastructure vendors' labs, basic manufacturing, installation and basic materials can be found in developing countries at a 50% to 60% discount. Some components like cables and tower materials can be bought at fraction of their costs in a developed market. And savings on labor costs are immense, Murashige said.

The networks and handsets that carriers are deploying are based on much of the same technology that vendors developed in the 1990s, and that intellectual capital has already been paid back through sales across the first world. Still, vendors are taking advantage of off-shoring R&D, setting up labs and core technology sites in India and China, applying those cost savings not only to technologies for those emerging markets but to technologies being deployed in the developed world.

“We've moved R&D, we've moved manufacturing to the [developing] world,” said Antti Vasara, vice president of corporate strategy for Nokia. “Cost sensitivity is a global issue. We need to be competitive no matter what market we're in. So we have to be a global company.”

Vendors are also, in many cases, removing themselves from the manufacturing equation — at least in part. Almost every top vendor has a joint venture running with an Asian manufacturer: Nortel with China Putian and LG Electronics, Ericsson with ZTE, and Siemens with Huawei. While most of those partnerships are nominally geared toward developing 3G technology, many are planning to use those ventures as jumping off points into the developing markets of the East where those Asian vendors already have the facilities, the work force and the clout to compete.

For vendors, profiting from the next 1 billion boils down to a simple economic mantra: Drop costs but maintain those precious margins. The overall revenue collected — and therefore profits earned — off any individual base station or handset may suffer, but the sheer opportunity in these new markets will balance out those losses. In China, the overall revenue per subscriber a vendor collects for a newly minted network may be half as much as what it collected for the same network in the U.S. But China has 1 billion more people than the U.S., meaning it will eventually have infrastructure and terminal demands four times greater than the U.S. What revenue per subscriber doesn't accomplish, sheer volume makes up for — at least that's the idea.

In the new global wireless market, vendors aren't counting on infrastructure revenues alone to meet its earnings targets. In fact, manufacturers in the last year have stopped talking like manufacturers and started talking like systems integrators and professional consultants. They're still hyping the new network technology and the latest handset, but they're also promoting their abilities to help carriers run that aforementioned network and launch content over that new handset.

Vendors are changing their business models, and they're doing so not just address new business opportunities. The old business model centering on the manufacture of base stations, MSCs and cell phones simply aren't enough to cut it, said Jorge Fuenzalida, a technology and strategy consultant for InCode, a global wireless consulting group. The industry is extremely healthy right now with about 40% margins on EBITDA, but with the shift of major deployments to the developing world, there's no way those margins can be sustained, he said.

“Those margins are reeling in,” Fuenzalida said. “But when Ericsson or Nortel sells a network to a carrier — especially one in a Third World country — they're finding those carriers don't have the network engineering they need. It's with those services they can make up those margins.”

For vendors, the equipment contracts could be lower in value and the paydays spread further apart. But vendors also might benefit from the inexperience of some carriers in new markets because new operators need them to host applications or even provide managed network services that effectively make vendors the operation wizards behind the curtain.

“In a lot of countries, you've got an entrepreneur from another kind of industry who wants to move into operating a telecom network, but that company is not going to develop the capabilities of a Verizon overnight,” Lucent's Iandolo said. “A vendor will have to be able to manage the service or the network, and at some point, you have to wonder if there is enough operational experience in the world to feed that growing need.”

That shift is already apparent. Most of the big vendors have reported big gains between this year and last in professional services revenue. Last year Nokia reported 25% of all revenue came from professional services, and this year it expects it to account for half of all its sales. Though vendors are lumping all those revenues into the generic category professional services, the amount of work they are offering to do is astounding.

Ericsson claims to have taken over the management of entire networks from operations to billing. Nokia is pushing multiple content and application management platforms that make its old Club Nokia portal pale in comparison. It launched its own wireless provisioning, management and delivery service, Preminet, and has plans for a music download service this year. Qualcomm soon plans to launch its own multicast mobile multimedia service using its MediaFlo technology. While most of those services are now targeting carriers in mature wireless markets, vendors are preparing to pounce in the developing world, establishing operations and sizing up the cultural nuances of a country before wireless makes its first impact.

“Establishing an operational base in a new market very early on is important for a vendor,” Ericsson's Shaw said. “It helps to get to know the market, even if the payoff is not immediate.”

Vendors can potentially — and will undoubtedly try to — offer even more. Many vendors are adopting what InCode's Fuenzalida called “pay by the drink” application services: Instead of selling carriers a server or application, they sell a hosted solution into which operators continue to pay as they grow.

“It's like an ASP model for wireless operators,” Fuenzalida said.

A vendor, for instance, could set up an multimedia messaging system (MMS) hub that only handled interoperability of picture messaging between carriers but also host individual operators MMS services. And as those carriers start outgrowing those kinds of generic services, vendors can tack on more value by creating individually tailored services and applications for a specific operator, which it in turn would host.

While a Cingular or a Vodafone might look on those types of services with suspicion, carriers in the developing world will likely embrace them. Vendors have built up an enormous amount of intellectual and business expertise that Western carriers may share but carriers in developing countries have not, Nokia's Vasara said.

“As network services become more complicated, there's more willingness from carriers to have us take those network solutions over for them,” Vasara said. “It could be something small — we could host a content downloading and provisioning service for them. But we can go all the way to running the entire network, performing everything from planning and installation to day-to-day operations. … Some carriers have decided that they don't want to be in that part of the value chain.”

As the global wireless market transforms, there's a certain expectation that the developed markets will evolve with it. As vendors slash base station and handset costs to sell to emerging carriers, U.S. carriers should be able to enjoy those same cost savings. According to industry experts, however, that probably won't be the case.

“There are so many variables, it's hard to get into any kind of predicative models about the global wireless industry, but I would suspect there wouldn't be much effect on the U.S. market,” said Mark Desautels, vice president of wireless Internet for Cellular Telecommunications & Internet Association. Desautels said there's no competition between carriers in the developing world and those in the U.S. and therefore no point of reference to effect such changes. The U.S. and other developed markets are now focusing on a different class of services and features such as data and 3G networks that are still confined to the mature wireless markets.

“If you sell a base station in India and then turn around and sell the same base station in the U.S. at twice the price, you'll run into trouble,” he said. “Otherwise, there will be little effect.”

In the U.S. carriers are focused on UMTS, EV-DO, IP multimedia subsystem overlays, fixed mobile convergence, multimedia and multicast streaming — premium technologies that are fresh on the shelves and don't enjoy the economies of scale that basic GSM and, to a lesser extend CDMA, now face.

There are still carriers in the U.S. that haven't fully built out their core voice networks. When they do so, they might find that their vendors will, in fact, sell them the same base stations they sold to an India carrier for twice the price. But there's justification behind that cost disparity, Nortel's Murashige said.

“If you need a base station here, you're not going to import it from India,” Murashige said, because the costs would cancel out any manufacturing savings. “U.S. carriers will be getting some of the cost benefits of a mature technology, but there won't be the scale. In India, they're not ordering several hundred base stations, they're ordering tens of thousands.”

On the handset side, consumers in the U.S., East Asia and Europe have come to expect a certain level of technological sophistication: Color screens have become standard on phones, digital cameras are rapidly become standard features and few carriers are selling a device that doesn't at least have Java data functionality. The same economies of scale that allowed the features of $500 phone a few years ago to become packaged in a $200 phone today are the same economies of scale that make the standard grey-screened short messaging service-capable phone of yesteryear the $30 phone vendors now market to the developing world, said Bob Laikin, chairman and CEO of Brightpoint, a global wireless handset distributor.

“Technology sets the curve, and that curve is being reset every 12 to 18 months,” Laikin said. What is new and exciting today becomes a standard technology tomorrow and commoditized the day after. The mature wireless markets and the developing world are evolving on parallel but separate planes. If anything, the U.S. may become a source of refurbished phones to sell into the developing world, but they won't have overlapping markets for some time.

While the geographic markets that will be home to many of the next 1 billion users present many challenges and potential pitfalls early on, they also may evolve at an extremely accelerated rate compared with how mature markets such as the U.S., Western Europe, Korea and Japan developed.

“The one commonality wherever you go in the world is that there is a mobile work force that needs to be connected,” Lucent's Iandolo said. “Beyond teledensity, there will be a much more compressed pace of adoption and a much more rapid embrace of data. These countries may be underserved to begin with, but they also want to compete with the rest of the world.”

Most analysts predict that the day the world hits 3 billion subscribers will be some time in 2009. By then the world's population will be significantly larger, and 3 billion won't be the halfway milestone we think of today. But it may be a mistake to think of the one phone per every one person in the world as the ultimate comparative benchmark. The next 1 billion after 2009 may come even faster than the previous.

In fact, it's likely at some point the industry will exceed 100% global penetration. The more mature markets aren't necessarily approaching a saturation point — In-Stat's Chamberlain still counts the U.S. and Japan among the top 10 growth markets. Some percentage of future subscriber growth still will come out of the most advanced wireless countries in the world. It seems apparent that longtime users in established markets will continue to sign up for multiple wireless devices for individual, household or business usage.

So, while a large number of the next 1 billion wireless users may come from the geographical watersheds we have always expected them to, there is more to the story than what we can see by looking at a map.

“We have to divorce ourselves from the idea of the subscriber as a person and look at where much more of the traffic could be created,” Iandolo said. “You've got countries trying improve teledensity and catch up with data, you've got mature markets where people will be signing up for additional devices, and you've got a lot of machine-to-machine — that's your next billion users right there.”