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NOVEMBER 27, 2000 VOL. 156 NO. 21

Phone Wars: Episode 3G
Japanese rivals are massing for a fresh assault on markets dominated by Nokia and Ericsson. The battleground: third-generation mobile phones
By APARISIM GHOSH Stockholm and Helsinki

Entering the Fray
Outsiders want a piece of the action, too
Role Model: NTT DoCoMo's stunning success with the i-mode offers valuable lessons for all of Japan Inc.
Thumbs Up: A look at Japan's mobile-phone culture
Big Screen: Say goodbye to those old phone displays

As a young boy in the 1950s, Takashi Kawada made radio sets as a hobby. "Even in junior high, I was fascinated by electronics and communications," he says. "I always wanted to get into that world." Now 63, the hyperkinetic president of Matsushita Communication Industrial is experiencing something of a second childhood, bringing a youthful energy to the job of running Japan's leading mobile-phone maker. Where once he marveled at crystal receivers, Kawada is now consumed with a new passion: third-generation (3G) phones. Kawada loves to visit the company's design centers, where he peppers designers with questions and isn't shy about making suggestions. "People say I'm still more of a technology manager than a company president," he confesses sheepishly. His enthusiasm for 3G phones is not hard to understand: What teenage techie wouldn't get excited about a device that combines the functions of mobile phone, TV, radio, video camera, Internet browser, MP3 player—and a dozen other gadgets besides?

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Japanese mobile-phone manufacturers take aim at Nokia and Ericsson in the battle to dominate the coming market for third-generation handsets. Can the Europeans hold the fort?
Entering the Fray: Outsiders want a piece of the action, too
Role Model: NTT DoCoMo's stunning success with the i-mode offers valuable lessons for all of Japan Inc.
Thumbs Up: A look at Japan's mobile-phone culture
Big Screen: Say goodbye to those old phone displays

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EXHIBITIONS: National Treasure
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For Japan's mobile-phone manufacturers, the 3G phone will serve another, more critical function: as a weapon. Companies like Matsushita, Mitsubishi Electric, NEC, Toshiba and Sony hope to use the new generation of phones to grab large chunks of the handset market, worth around $50 billion last year and, according to Nomura Securities, likely to balloon to $76 billion in 2002. Their eyes are fixed on a point around five years thereafter, when sales of 3G devices are projected to overtake those of current-generation mobile phones. "The new technology," predicts Kenshi Tazaki, managing director of the Gartner Group in Japan, "will make Japanese manufacturers big players in the world market."

The Japanese threat is not lost on the companies that dominate today's mobile-phone world. Finland's Nokia, Motorola of the U.S. and Sweden's Ericsson are all keen to expand—or at least maintain—their shares of the market. The most critical battles will be fought in Europe and Asia, which lead the world in the race to embrace 3G technology. These markets are currently the preserve of Nokia and Ericsson, and they'd like to keep it that way.

Brace yourself, then, for Round 2 of the mobile-phone wars: Europe vs. Japan. The Europeans collectively command nearly 40% of the global market, while the top four Japanese manufacturers control, among them, 15%.

The Japanese, you remember, lost Round 1 when they backed the wrong technological horse. In 1993, NTT DoCoMo, Japan's principal mobile-phone carrier, opted for a technical standard called Personal Digital Cellular (PDC), which was incompatible with the Global System for Mobile Communications (GSM), the standard adopted by most of the rest of the world. Japanese mobile-phone makers were so busy competing with one another at home, they took their eyes off the international arena, allowing relative unknowns Nokia and Ericsson—which correctly anticipated the dominance of GSM—to grab the largest slices of the pie. When the likes of Matsushita and Sony eventually turned their attention to GSM markets, they were left to play catch-up with the Europeans.

There's little danger of that twist of history repeating itself. Telecommunications experts predict that most GSM countries will adopt a 3G standard known as Wideband Code Division Multiple Access (WCDMA). This puts the Japanese on the starting line with the Europeans in the 3G race. In fact, the Japanese should have a head start: DoCoMo is scheduled to launch 3G mobile services in Tokyo next May, while carriers in Europe and Asia aren't expected to follow suit until the summer of 2002. The Japanese will have a full year to test and fine-tune products in real market conditions while the European prototypes remain in the laboratory. Tim Storey, Asia telecoms analyst for Goldman Sachs in Hong Kong, says this puts the Japanese manufacturers "ahead of the curve, ahead of the rest of the world." An early start, he adds, will help the Japanese find the "killer applications"—functions that make the phones irresistible to consumers, just as e-mail did for personal computers—ahead of the Europeans.

As if these advantages weren't enough, there is also the matter of marketing muscle: few companies anywhere in the world have gone head-to-head with a Matsushita (better known by its brand names, Panasonic and National) or a Sony and lived to tell the tale. "If you look at every consumer electronics market in the world, there isn't a single other one that isn't dominated by Japanese manufacturers," says Rick Timmons, managing director of sales at J-Phone, Japan's No. 3 carrier. "The mobile-phone market is now a high-penetration consumer market, which is exactly what the Japanese are good at." Neutral judges are equally admiring. "The Japanese have proven themselves masters of the consumer business," says Bertrand Bidaud, head of telecoms research at Gartner Group. "And because all the handset manufacturers are starting on roughly the same level, the Japanese may have an edge."

If the Europeans are feeling edgy about any of this, they're doing a swell job of hiding it. At Ericsson's sprawling campus in Kista, a technology park near Stockholm, Jan Lindgren, vice president for mobile Internet solutions, is guarded when talking about the competition. He acknowledges that the Japanese are formidable opponents, but contends they still have plenty of catching up to do. "We must have respect for them," he says, choosing his words with care. "But there's no need to be afraid." In Nokia's glass palace outside Helsinki, chief technical officer YrjÖ Neuvo is more candid in his estimation of Japanese rivals. "They are very good in some important technological areas, like miniaturization," he says. "And they are very good in lifestyle electronics." Will they be able to use these skills to make inroads into Nokia's European stronghold? They can try, Neuvo says with a wide grin, "but we are determined to fight back."

Outside the headquarters of the two companies, opinion is divided about their ability to withstand a Japanese onslaught. Mats J. Larsson, business editor of Dagens Nyheter, Sweden's leading newspaper, is concerned about Ericsson. He believes the company's weakest link is its inability to produce compact, attractive phones. "They're a company by, of and for engineers," he says. "The trouble is, they make phones that might impress engineers but don't attract consumers." This Achilles' heel was very much in evidence at the launch, earlier this month, of the company's latest model, the T20. The first Ericsson phone targeted specifically at the youth market, the T20 is sold with a strapped woollen lovika, or pouch, handmade in Lapland. The pouch looks youthful enough; the phone, on the other hand, is squat and chunky, suffering in comparision with several Nokia models—and nowhere near as trendy as most Japanese phones. "This was Ericsson's first attempt to be 'cool,'" says Larsson, dismissively. "How can a company like this compete with Sony and Panasonic?" Some industry analysts are recommending that the company call it quits before the fight and sell its loss-making phone division. (Ericsson spokesmen routinely shrug off such suggestions as unworthy of consideration.)

Nobody's suggesting Nokia should back down from a confrontation with the Japanese. In Finland, even hinting at such a thing elicits expressions of incredulity. To understand why, consider the company's impact on the country's economy: Nokia accounts for 4% of Finland's GDP, nearly 30% of exports and 1% of jobs. Ask a Finn about Nokia and, from the sales clerks in Helsinki's giant Stockmann department store to researchers in the country's think-tanks, you consistently get patriotic hyperbole. "Nokia is an extraordinary company," says Pekka YlA-Antilla, director of the Research Institute of the Finnish Economy. "I wouldn't put anything beyond its abilities."

To be fair, neither Nokia nor Ericsson is a pushover, for the Japanese or anybody else. For one thing, they are huge companies: Nokia sold more than 76 million phones in 1999, ahead of Ericsson's 29.8 million. (Matsushita, the leading Japanese phone maker, sold 15.5 million.) Both have a tradition of technological innovation and excellence—and of overcoming adversity. It's hard to believe now, but Nokia was on the verge of bankruptcy in 1991, when it shed a raft of diverse businesses to focus on mobile phones. The company is now a byword for marketing success, and boasts one of the world's most recognizable brand names. Ericsson's engineering expertise is a touchstone of the telecoms industry; the dominance of its infrastructure division, which makes the equipment that forms the basis of mobile- phone networks, more than makes up for its weaknesses in handsets. "We have our own strengths," says Lindgren, simply.

But some visionaries argue that 3G phones represent a technological leap so vast that many of the advantages enjoyed by today's market leaders may soon be worth little. After all, if the technology delivers everything the telecoms experts promise it will (see graphic), 3G handsets will be used primarily as mobile Internet devices, rather than as phones. "A mobile phone is something you press against your cheek, but a 3G device is something you will hold in front of you," says Ulf Lesley, marketing director at Ericsson's 3G division. "Selling a 3G device will be completely different from selling mobile phones." The difference is more profound than that: it calls for a fundamental change in the relationship between product and consumer. For parallels, hark back to what happened when TV sets replaced radios in homes—or when PCs replaced mainframes in offices.

The Europeans know all about the perils of fundamental technological change since they were the principal beneficiaries of the last big shake-up in the telecoms industry: the advent of mobile phones. While manufacturers of fixed-line phones were trying to come to grips with cellular technology, Nokia and Ericsson came out of almost nowhere to become, within a decade, globe-straddling corporations. Lindgren acknowledges that the two companies are on the verge of the next great leap—or inflection point, to borrow from the computer industry lexicon. But it is not, he maintains, a plunge into the unknown. "We are creating this new technology, so we are well prepared for it," he says. Many analysts are unconvinced, however, pointing out that the extent of the change wrought by 3G technology will affect the very rules of the game, leaving existing players vulnerable. "The faster access speed will significantly alter the business model," says Goldman Sachs' Storey, "and Japanese companies will be better prepared."

Their preparations started in 1996, when DoCoMo laid the groundwork on i-mode, its spectacularly successful mobile Internet service. A sort of dry run for 3G, i-mode phones are perpetually connected to the Net, allowing users to browse parts of the World Wide Web, send and receive e-mail, play games and book tickets—among other things. Sometimes described as a 2.5G technology because it acts as a bridge between mobile telephony and the full-fledged mobile Internet, the service has spawned a whole new style of phone usage, particularly among Japan's youth (see accompanying story). The nearest thing the GSM networks have to i-mode is a service known as Wireless Application Protocol, or WAP, launched at the beginning of this year. But WAP users must dial in to the Net; at 9.6 kilobytes per second, the connection speed of a mobile phone is painfully slow, and many users of WAP phones simply give up after a few minutes. "WAP has gone from being a buzzword to a dirty word very quickly," says The Wireless Internet , a September report by Nomura Equity Research. The GSM equivalent of 2.5G technology will begin rolling out next year—again, well behind the Japanese.

To try to make up for the time lag, the two European companies have set up research offices in Japan and routinely conduct market surveys to understand what makes i-mode tick—and, by extension, how consumers might react to high-speed Net access from their phones. "We're trying to learn from i-mode," says Tord Wingren, director of Ericsson's 3G phones unit. "There's no question that they've done some of the right things." Nokia's Neuvo, on the other hand, dismisses the notion that the i-mode experience has given Japanese phone makers deeper insight into the mobile Internet than Nokia or Ericsson possess. Until recently, most of DoCoMo's customers used their phones mainly to send and receive short messages, he points out, and GSM users have been able to do that since 1993. He also suggests the tiny, featherweight i-mode phones might not be suitable for 3G technology because their screens are too small for video images. (Actually, some i-mode phones come with larger screens.) "The phones aren't all that easy to use," says Neuvo. "Japanese consumers tend to be experimental and not afraid to learn complicated instructions, but Europeans want simplicity." Perhaps. But Japanese companies are expert at dumbing down products to broaden their appeal. The fact that Japanese consumers are willing guinea pigs for gadgets has allowed manufacturers to use their home market successfully as a test bed for products ranging from TVs and vcrs to digital cameras and video-game consoles.

The first shots of the 3g war will be fired in May, when DoCoMo launches the world's debut 3G service. For the first six months or so, it will be restricted to Tokyo (Osaka and Nagoya will get 3G services by the end of the year, followed by other major cities in 2002). The choice of phones and applications will be limited, too. The first devices from Matsushita and NEC will provide much faster voice and data transmission than conventional mobile phones, with connection speeds of up to 384 kbps; some models will be equipped with cameras to allow video conferencing. DoCoMo is experimenting with music download services in collaboration with Matsushita and Sony, so expect some phones to double as MP3 players. (Sony will start marketing a pre-3G model this month: the music has to be downloaded into a memory "stick" and inserted into the phone. In the future, the phone itself will be able to download directly from the Internet.)

Some of the players may offer short video clips of sports highlights or movie promotions as early as May. Picture quality will likely be sacrificed at first to keep the data downloads smaller (customers will pay by the data packet, rather than the minute). But low memory capacity means it won't be possible to watch longer films for some time. Matsushita's projections say today's 64-megabyte memory cards will double in size to 128 MB next year, but these will be enough to hold just a few minutes of video. Even the 1 gigabyte (around 1,000 megabyte) cards expected to hit the market in a couple of years will store only 19 minutes of video.

After a year or two of what's sure to be furious experimentation and rapid improvement in the technology, the 3G phone will no doubt come into its own. It will also come in many forms. Expect the market to fragment into multiple categories to suit different requirements and budgets—basic phones for voice-only use, phones with bigger screens for games and video conferencing, phones specializing in data transmission. Size will vary accordingly: the first 3G devices will be larger and heavier than most of today's models, although phone makers rule out a return to the weighty bricks of the early 1990s. Prices are expected to range between $300 and $1,000, but 3G carriers will likely subsidize handsets the way they do now for mobile phones. The most interesting contest will take place at the high end, where models laden with features and functions will be aimed at business users. Profit margins for these devices will be high, and the category will likely attract competition from outside the mobile phone industry. Manufacturers of personal digital assistants like Palm and Handspring will eventually vie for a piece of that action, perhaps in collaboration with some phone makers.

But even as they experiment at home, some Japanese companies have been quietly laying the groundwork for a big push into Nokia and Ericsson strongholds in the GSM market. Matsushita Communication this year sold nearly 15 million handsets overseas, mostly in Europe. Mitsubishi Electric already sells more phones in Europe and China (16 million this year) than in Japan (7 million). Others are seeking alliances with second-rung European manufacturers. Toshiba this month announced an alliance with Siemens to make 3G phones. Toshiba says it needs the German company's experience in making GSM since the first 3G models offered in Europe will be dual mode (GSM and WCDMA).

At the same time, the Japanese manufacturers are acutely aware that they will face increased competition at home. Until now, Japan's market was sheltered by virtue of its unique mobile-phone standard; although Nokia, for instance, makes an i-mode phone, the company hasn't tried very hard to market it. But a universal 3G standard will allow the Europeans to tackle the Japanese on their own turf. With the market nearly saturated—Nomura estimates around 45 million phones will be sold this year—it's likely that one or two of the smaller Japanese phone makers will bow out of the race. The others may need to look overseas in order to achieve the economies of scale necessary to stay in contention. "We have the advantage as the first comer to the 3G market," says Matsushita's Kawada. "But to survive, we have to become one of the top three players in the world." A grab for market share, or a battle for survival? Either way, Round 2 of the mobile-phone wars will produce some gripping handset-to-handset combat.

With reporting by Donald Macintyre and Sachiko Sakamaki/Tokyo and Penny Campbell and Brian Bennett/Hong Kong

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