Wireless Web Woes

Tony Coyle was sure he had latched on to the Next Big Thing.

In March 2000, the 28-year-old British entrepreneur and his two mates launched a

nightlife information service called Joe London. The company dished out

up-to-the-minute reviews and event listings to cell phones using a technology

that reformats Web pages for mobile devices. But people balked at the slow, clunky system. After just three months

of scant traffic, the founders pulled the plug. "We saw the hype and the

hard landing," Coyle says.

So did a lot of others. Stockholm-based Citikey bored through

$16 million trying to launch mobile-phone city guides across Europe before

cratering last November. CreSenda Wireless, a Los Angeles provider of software

for linking business data from the Web to handhelds, bit the dust in February.

British Internet provider Breathe.com took its last breath in March, partly due

to an ill-advised push into wireless Web services. All faced similar complaints:

Getting information through mobile phones was too darn slow, expensive, and

confusing. "Expectations were out of whack with reality," says Niklas

Savander, general manager of the Internet applications group at phone-maker

Nokia.

These wireless woes strike terror in the hearts of telecom

executives from Stockholm to San Jose. The industry has gambled hundreds of

billions of dollars on the wireless Web becoming a booming success over the next

few years. Now, the problems experienced by Joe London and other startups are

raising serious concerns that the high hopes and big promises were little more

than marketing fluff. Fears are growing that revenues generated from the new

services may not repay the costs of providing them anytime soon.

Nowhere are the stakes higher than in Europe. The Continent’s

largest telephone companies bet their futures on a surge in wireless data

services to propel their growth. Last year, European carriers laid out a

staggering $116 billion to license spectrum for speedy third-generation (3G)

mobile systems, and they will have to shell out another $150 billion over the

next few years to build the networks. With that kind of money on the line, as

well as sky-high usage of cell phones, Europe is shaping up to be the testing

ground of the mobile Internet. If it doesn’t work in Europe, will it

elsewhere?

Going haywire

Investors are worried that the experiment is going haywire.

The stocks of some European telecom companies have dropped 50% or more since

last year. Wireless giant Vodafone Group’s shares, for example, have tumbled

54% from their peak last March. Worse, many companies have borrowed heavily to

pay for their new licenses and have been crippled under the heavy debt loads.

France Télécom, Deutsche Telekom, and British Telecom have $130 billion in

debt among them. The Netherlands’ KPN may be in the worst shape: It took on

$20 billion in debt and now is selling off its stakes in 20 businesses to pay

off its loans.

There’s good reason to be nervous. The original vision of

the wireless Web was the Internet in your hand: From a mobile phone, you could

surf Web pages, scroll through articles in Le Monde, or buy the latest

bestseller from Amazon.com. The potential revenues seemed limitless. However,

recent studies from analysts such as Gartner Group and Jupiter Media Metrix

suggest that customers aren’t jazzed by many wireless applications and don’t

want to pay much for them. Rather, they want low-cost, simple-to-use services.

For example, short messaging, online games, and targeted information based on

your location are proving to be popular. Revenues per subscriber for these kinds

of services will rise by more than $6 a month by 2005, says analyst Lars Godell

of Forrester Research But the increase won’t make up for the decline in voice

revenues caused by fierce price competition. Forrester forecasts a $13 drop in

monthly voice sales per subscriber in the same period. Overall, monthly revenues

per subscriber are expected to fall from $38 today to $31 in 2005.

Worse yet, they may not pay back the massive outlays for

future networks. All told, the huge 3G expenditures will add, on average, $5 a

month per subscriber to the cost of providing mobile service for the next 15

years, Forrester says. Coming up with data services to drive so much incremental

revenue will be tough. If carriers can’t boost their take, they face financial

ruin or massive consolidation.

The math is manageable for some mobile operators, murderous

for others. In countries that auctioned 3G licenses, such as Germany and

Britain, prices went through the roof. In Germany, Telefónica partnered with

Finland’s Sonera to bid $7.6 billion for a license and will spend at least $4

billion more on its network. That $12 billion will be hard to earn back for a

company new to Germany. The venture, called Group 3G, is expected to see

revenues of only $1.3 billion in 2005, says brokerage Sanford Bernstein &

Co. At that rate, Munich-based Group 3G might have to merge with a larger

partner to remain viable, Bernstein says.

US telecom players face less financial risk, if only because

they’re moving to 3G more slowly. Most carriers are rolling out simple

wireless Net services with the radio spectrum they already have. They probably

won’t bid on new licenses for 3G until late this year or next year–and then

they’re likely to be cautious bidders, after the European fiasco. "The

stakes are quite small in the US, but the potential rewards are huge," says

wireless analyst Tom Lee of JP Morgan Chase & Co.

Still, the story is far from what hypesters originally

predicted. In 1999, at the peak of the Internet bubble, analysts forecast that a

half-billion people would use wireless phones to get on the Web by 2003. Based

on those expectations, hundreds of software and content outfits set up shop near

wireless meccas such as Helsinki, Stockholm, and Silicon Valley. Venture

capitalists poured $8.3 billion into more than 400 European and US mobile Net

startups since January, 1999, according to researcher Venture Economics. Even as

late as the first quarter of this year, some $500 million went to nearly 40

companies.

But the first attempts at the wireless Web proved disastrous.

Joe London and others tried to create an experience like surfing the Net from a

personal computer. They used WAP so people could read them from their mobiles.

The result: excruciating waits for simple information. And mobile shopping?

Unthinkable. The hostile reaction was dubbed "WAPlash." By the end of

2000, just 5% of Europe’s 210 million mobile subscribers used WAP services.

Still, the wireless Net isn’t dead. As telecom players and

providers of wireless data refine their approach, they are beginning to find

services for which customers are willing to pay money. The effort should become

easier over the next year as European and US carriers roll out an interim

generation of wireless technology, known as 2.5G, that will move data about

three times faster than today’s pokey 9,600-bits-per-second connections.

Better yet, the data will be "always on," which means it will flow in

and out of handsets whenever they’re turned on. That’s a big improvement

over current networks, which require users to dial in to check a stock price or

sports score. And it’s a proven success, at least in Japan. There, a wireless

Web service called i-mode has attracted 23 million users who each spend an

average of $18 per month.

Impatient startups aren’t waiting for zippier technology.

They’re revising their business plans to take advantage of today’s slower

networks. After Joe London bit the dust, Tony Coyle and his mates ditched WAP in

favor of Short Message Service, or SMS, a simpler technology that allows users

to zap brief notes to one another and is built into every digital phone. In

March, the trio introduced a new service, called mTickets, that lets customers

buy movie and club tickets via PCs on the Web and receive confirmation via SMS

on their mobiles. Then, with phone in hand, users flash the screen at the box

office and breeze in the door.

By Andy Reinhardt with Peter Elstrom and Steve

Rosenbush in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc

True grit

But the very strengths of the Net are also its limitations. Just because

communication is ubiquitous doesn’t mean it’s everything. The last five

years have taught us that in industries such as retailing, manufacturing, and

transportation, physical factors overpower the virtual. E-tailing turns out to

be more about which company is best at moving boxes around rather than who has

glitziest web site or the biggest virtual store on earth. Linking supply chains

over the Net cuts costs and improves response times, but ultimately

manufacturers succeed or fail if they develop good products and figure out how

to produce them at low cost and high quality. Online airline reservation systems

can improve customer convenience and boost the revenue yield per passenger, but

they can’t do anything about long delays caused by runaway congestion, too few

loading gates, antiquated air traffic control systems, and mechanical

difficulties on airplanes.

Even in areas where the Internet can play a central role, the big changes are

not going to come overnight, as investors have found to their chagrin. Some of

the information-intensive industries where the Internet could have its biggest

effect are also the ones where institutional and regulatory barriers are the

highest and vested interests are the strongest. In health care and education,

for example, the possible benefits from widespread use of the web are enormous,

but it’s going to happen in baby steps, over time. What’s more, it’s a

difficult, painful, and slow process to restructure companies and markets.

In the end, it turns out that the speed of Internet time has more to do with

the capital markets than with the pace of technology adoption. The enormous

amounts of venture capital available to startups drove companies to grow far

faster in a few short years than the underlying infrastructure or consumer

demand could support. In fact, the eventual benefits of the web should be

measured over a decade. "People had higher expectations for the next couple

of years than are likely to be realized," says Jeffrey Bezos, CEO of

Amazon.com. "And people have much lower expectations for the next couple of

years than are likely to be realized over the next 10 years." That may help

explain the current confusion about the future of the Internet.

Got Web?

That’s why Internet optimists are refusing to retreat. Analyst Mary Meeker

of Morgan Stanley Dean Witter is urging Net leaders such as Amazon, Yahoo, and

AOL Time Warner to band together in a ‘Got Milk?’-style marketing campaign

promoting the idea that the web is alive and well.

Such webfests, however, aren’t likely to change the minds of burned

investors or restore the once-buoyant expectations for the Net. For instance,

Merrill Lynch analyst Henry Blodget recently reduced his expectations for how

much retail sales will go online to only 5% to 10%, down from 10% to 15% he

envisioned just a few months ago. Even Bradford Koenig, head of the technology

banking practice at Goldman, Sachs, which underwrote many of the hottest Net

IPOs, has lost confidence in pure Internet companies: "The notion of an

Internet company is no longer viable."

But that’s too pessimistic. In fact, part of the problem was that much of

the investment flowed into areas where the Internet is incremental rather than

revolutionary. Take retailing. The hyped consumer dot-coms were supposed to blow

away their brick-and-mortar counterparts. But it turns out that the importance

of information and communication in retailing–the Internet’s forte–is much

smaller than the role of logistics. How much smaller? According to a Softbank

spokeperson, it takes between $15 million and $25 million to build a

top-of-the-line web site. Yet it costs at least $150 million to build a

warehouse and distribution system for a consumer web operation.

All across retailing, the Internet is no longer seen as the 800-pound

gorilla. For example, a year ago, the prevailing wisdom was that old-fashioned

auto dealers were going to be passe. But so far, that hasn’t turned out to be

true. "There hasn’t been the massive shift to buying cars online that we

thought there would be 18 months ago," admits Mark Hogan, president of

e-GM, the auto maker’s online consumer unit.

And there’s growing evidence that shoppers on the Net are supersensitive to

price, according to Austan Goolsbee, an economist at the University of Chicago.

The implication is that any profits e-tailers might make could be short-lived as



competition drives prices down on the web.

Perhaps the biggest surprise is the comparatively limited impact that the Net

may have on manufacturing. To be sure, there is no doubt that e-business has

become an essential part of any manufacturer’s toolkit. The use of the Net can

reduce inventories, take costs out of the supply chain, and eliminate

unnecessary transactions. Collaboration can also speed up product development,

e-marketplaces can lower the cost of components and other supplies, and detailed

info on customers can help customize products to snag bigger orders or even help

determine which customers aren’t cost-effective. At Procter & Gamble, a

web-based information-sharing network makes it easier to collect and evaluate

new product ideas from the company’s far-flung workforce of 110,000 people.

Nevertheless, at the end of the day, manufacturers are still in the business

of making things, not simply moving bits and bytes around. Wheels have to be

bolted onto the car, circuit boards have to be installed in the router–and

that has to be done physically.

To know how this limits the impact of the Net in manufacturing, look at the

example of Cisco, the communications equipment giant, universally regarded as

the poster company for using the web. Some 68% of Cisco’s orders are placed

and fulfilled over the web and 70% of its service calls are resolved online.

Cisco is in the process of linking all of its contract manufacturers and key

suppliers into an advanced web supply-chain management system, dubbed eHub

speeding up the rate at which information about demand is distributed to

suppliers.

According to Cisco’s own calculations, its payoff from its use of the

Internet amounts to $1.4 billion per year, or 7% of sales. If the rest of

manufacturing could even do half as well as Cisco in using the Net, that would

cut an impressive $150 billion from annual manufacturing costs. And yet it is

not the radical reduction in costs that would signal a revolution.

Slow as molasses

While supply chains linked over the Net are more responsive than their

predecessors, they have their limits, too. "The flexibility now being

demanded by customers exceeds the physics of what the supply chain can actually

deliver," says Kevin Burns, chief materials officer for contract

manufacturer Solectron, whose big customers include Cisco and IBM. Now that

companies have switched to web-based models, he notes, they expect to be able to

ramp up or halt production of a product within weeks. But it still takes at

least three months to get a specially designed chip made in a Taiwanese foundry

and around 40 weeks to order an LCD screen.

Obstacles don’t disappear, but it’s easier to see the far-reaching

potential of the Net in industries that are primarily about moving information

rather than goods. Take financial services. In many ways, financial products are

ideally suited to the Internet, since they deal only with information. A recent

Goldman Sachs survey reported that 63% of financial companies had sold their

products through an e-marketplace or a web site, the highest of any industry.

The Internet is already well on its way to transforming financial services.

Online brokers such as E*Trade Group have completely changed how the retail

brokerage business worked. And Net services are now offered by nearly every US

bank and credit union. Bank of America says it’s signing up 130,000 online

customers a month, giving it more than 3 million Net customers. Citigroup has

2.2 million, Wells Fargo, more than 2.5 million.

But as in the case of entertainment, technological and institutional barriers

are slowing down the eventual gains. Consider online bill-paying, widely

anticipated to be the "sticky app" that drives traffic. The benefits

of paying bills on the Net, for both consumers and businesses, could be

enormous. But the technology has proven exceptionally complicated, and it has

hit a wall trying to penetrate the banking industry. Among the problems: Banks

and billers have been unable to agree on how bills should actually appear

online. Still, Bank of America plans to launch a big ad campaign later this year

to promote its bill-paying service.

And then there’s health care. Despite the tangible nature of many medical

services, health care has a very large information component that makes it a

natural for Internet applications. Just shifting claims- processing to the web

could save $20 billion a year, according to the Brookings economists. At a

leading provider of prescription drug care in the US, it costs a matter of cents

to handle a prescription order on the Internet, as opposed to more than $1

through other methods.

Broadband’s promise

But there are enormous institutional barriers. For one, privacy

considerations may slow down the full shift of health-care records to the web.

Moreover, health-insurance companies, doctors, and hospitals are unwilling to

give up control of patient records and insurance payments to a third party. This

reluctance helped frustrate WebMD and Healtheon, which expected to lead a

restructuring of health care by moving many claims, payment, and related

processing services to the Net. WebMD’s efforts to provide real-time payment

capabilities were shunned by insurers and HMOs, who prefer the current

cumbersome process that lets them hold onto the money longer.

There’s also the technology factor. In the long run, realizing the promise

of the Net will depend on the widespread introduction of advanced technologies

such as broadband to the home and high-speed wireless. With broadband

connections over telephone or cable-television lines, consumers will be able to

watch TV-quality video clips of the NCAA basketball tournament or download

crystal-clear music files faster than ever before. What’s more, they’re more

likely to use the Net because they’ll always be connected and won’t have to

spend minutes dialing into the Net each time they want to visit a site.

The problem is that getting the new technologies in place may take longer

than expected. Financially stressed telecom companies are slowing down the roll

out of broadband. The failure of small telecom providers means that subscriber

growth may slow down in second- or third-tier markets. And the prices for

high-speed Internet access may rise.

In the end, the Internet seems likely to revolutionize mainly

communications-intensive industries. If that seems too



limited, remember that almost every breakthrough technology over the last 200
years affected some areas of the economy more than others. The automobile

transformed personal transportation and patterns of housing while little

affecting manufacturing. Electricity radically altered manufacturing practices

and any industry that was power-intensive, while not having an enormous effect

on health care. The Net deserves to be put in such august company.

Michael J Mandel and Robert D Hof with inputs from Linda Himelstein in

Silicon Valley, Dean Foust in Atlanta, Joann Muller in Detroit, and bureau

reports–BusinessWeek