The 9 billion pound gamble

The man who founded Orange is trying another high-tech phone business. Is 3 one risk too many for Li Ka-shing? Scott Payton and David Bowen report.

by Scott Payton and David Bowen
Last Updated: 31 Aug 2010

It was one of Stephen Byers' more satisfying days as a cabinet minister.

On 27 April 2000 he had something exciting to tell the world: mobile operators had just paid the British Government a cool £22 billion for licences to run the hottest new technology on the planet - third-generation (3G) mobile networks that promised to turn the humble cellphone into a video conferencing, entertainment and internet marvel that soon nobody would be able to do without. This, Byers said, was 'good news for business, the consumer, the economy, and the taxpayer'.

No wonder he was pleased: the Government had said it would have considered £3 billion a great result. Twenty-two billion was beyond its wildest dreams.

But for the mobile operators who stumped up the cash, it was not long before everything started to unravel. The internet boom turned into a technology backlash, and those 3G licences started to look like an awful waste of money.

Fast-forward to 2003, and only one of the UK licence winners has so far got a 3G service running. What's more, the company is new in the mobile market - the spawn of a British government plan to increase competition.

In March, fellow 3G licence-holders Orange, T-Mobile, Vodafone and mm02 looked on while 3 (as the young contender is called) launched the first 3G services in the UK and Italy, with the aim of capturing a large chunk of the mobile market from under the noses of incumbents. The multi-billion dollar question is: will 3 succeed?

There is massive scepticism certainly, but also a feeling that maybe, just maybe, 3 will pull it off. 'When you're talking about 3, you need to remember it's a company backed by two of the richest men in the world,' says a source close to the business. These are, furthermore, the men who launched another mobile company in the teeth of fierce competition and sold it for $22 billion. Orange was no lemon.

Li Ka-shing, or 'Superman' as the Hong Kong media has labelled him, was born in the Chinese province of Chaozhou in 1928. When he was 12, Li and his family fled to Hong Kong in the wake of the Japanese invasion of China.

Li began work at 15 to support his family, and set up his own plastics business, Cheung Kong, at 21. Fifty-four years later, Li's business empire now employs more than 150,000 people in 41 countries and covers a wide range of activities from ports, via retail, to telecoms.

In 1994, Li invested in Orange, a new mobile operator in the UK. In the early stages of Orange's life, many analysts predicted that it would fail. 'After 18 months of operation, everybody seemed to be writing it off,' says an insider.

But within six years, under the stewardship of Canning Fok, one of Li Ka-shing's most trusted executives, Orange grew to become one of the most successful mobile operators in the world.

Its winning formula was to offer customers clearer, fairer pricing structures than incumbents, wrapped in a memorable, stylish brand. 'Orange went into a market dominated by firms offering comically bad value to customers,' says a source close to the firm. 'It succeeded because it offered customers an attractive alternative.'

Timing was another key factor. When Orange first appeared in 1994, there was plenty of room for expansion in the mobile market - the company enjoyed rapid growth for six years.

By 1999 it was time for Li and Fok to cash in on their shrewd investment.

They sold Orange to German company Mannesmann for $22 billion.

The sale of Orange came as mobile technology seemed to take a new direction.

The belated take-off of SMS (see p51) seemed to prove that handsets had a far greater future than simple transmitters of voice. The concept of mobile data, though embryonic, was the new buzz - the next stage for the apparently unstoppable internet rocket. The acronym of the time was WAP - a technology that would bring websites to our mobile phones, allowing us to read news headlines, book a train ticket, order a book and so on.

It was in this atmosphere that telecom companies apparently went mad, bidding seven times more for 3G licences than the UK government expected - with similar extravagance in other countries. Their logic was simple: mobile data was the big new thing - you only had to look at the success of SMS to see that - but it was equally clear that WAP was an interim technology. The real rewards would go to companies that brought together two technologies of the future: mobile data and broadband (very fast) access.

Byers captured the sentiment of the time when he declared that '3G has the potential to transform everyday life, opening up full-scale multi-media access to millions of people. 3G users will be able to surf the net, download e-mails, music and high-quality pictures and hold video conferences all on the move.'

Li and Fok saw the 3G licences as a chance to repeat the success they had with Orange. Their firm paid £4.4 billion for the UK licence alone (although this cost was ultimately shared with other backers), and a total of £6.4 billion for eight 3G licences across Europe. (Add on the cost of execution to date and the total is more like £9.5 billion.) It soon looked like a mistake. First, the internet bubble burst, with the last big float (of the aptly named Lastminute.com) in March 2000, followed within weeks by the first big collapse (of the equally appropriately named Boo.com). The trickle of failures turned into a tsunami - few dot.coms survived and, more importantly, the whole technology sector was pushed into deep recession.

Second, WAP was launched, and was a disaster. Companies launched media blitzes implying that WAP would bring all the wonders of the web - colourful graphics, convenient shopping, free music and so on - to customers' mobile phones. In reality, internet-based services using WAP were slow, short on content and often fiddly to use.

Throughout 2001-02, the 3G licences looked increasingly farcical. Some analysts urged companies to give the licences away rather than throw good money after bad. A few European firms took this advice, and all the others put their plans for a 3G rollout on hold. Except for 3.

Hutchison 3G, as the operation was then known, set about building its network, recruiting staff, securing distribution channels and making deals with content providers and handset manufacturers. Appropriately, the first 3 flagship store opened on the third day of the third month, 2003.

But as some inside 3 freely admit, the service had a shaky start. Launches in the UK and Italy were hit by technical glitches. Worse, the first handsets to go on sale were awkward to handle, and ate batteries. In Italy, a disillusioned 15% of early customers took their handsets back.

There was more bad news: the firm's advertising was widely seen as failing to make an impact on the UK public. 'The launch campaign was incredibly bewildering,' says a senior industry source. 'It totally failed to give potential customers a reason to sign up to 3's service.' The problem, say critics, was that 3's pre-launch brand-building campaign, designed to cultivate curiosity, was too enigmatic.

Communications problems such as these, combined with high prices, were reflected in low early sign-up rates. By the third week of May, 3 had attracted just 25,000 subscribers in the UK. If it didn't improve on that fast, the firm would fall far short of the 1 million subscribers it had pledged to sign up within 12 months. What to do? Slash the prices. In June, handsets were heavily subsidised, and voice call packages were introduced that dramatically undercut those offered by incumbents - in some cases by 50%.

This meant that 3's extra functionality was being thrown in for free: for a while, 3 was by far the cheapest provider of standard mobile voice calls, and as a result, sign-up rates improved considerably. By 21 August, 3 had won 155,000 users - still desperately short of its 12-month target, but a great improvement on previous performance.

'What's the killer application of 3G? It's still voice!' declared 3 spokesman Edward Brewster, referring to the greater capacity for voice offered by 3G networks. Then in the autumn things started to get bloody; the incumbents began to match 3's deep price-cuts.

So what is the future for 3? That depends on which factors turns out to be most critical. Here we borrow the so-called scenario planning developed by Shell and others: provide best-case and worst-case scenarios, in the reasonable expectation that reality might be somewhere between the two.

SCENARIO ONE - THE SUCCESS STORY

Hutchison's financial stamina helps 3 to outlast rivals in a cut-throat price war. As a result, 3 builds up a strong customer base. Meanwhile, new 3G mobile handsets become much easier to use, batteries last far longer, and interactive services - such as cashpoint finders and football clips - become faster and more polished. 3's head start in launching a 3G network keeps the firm a step ahead of its rivals. The 3 brand is established in the collective psyche as the leader in 3G mobile. Rivals seem old and tired by comparison.

In 2010, 3's share of the UK mobile market reaches 14%. Hutchison sells the company. Li and Fok make more billions - some of which they plan to use to invest in a 4G mobile network.

Why this could happen

Hutchison has confounded the critics before. 'It would be very foolish indeed to write these guys off,' says a source close to the company. 'It's not the Hutchison way to walk out on things.' As well as Li and Fok, other characters from the Orange success story have returned to the Hutchison fold to make 3 work, including Bob Fuller, 3 UK's chief executive, and Colin Tucker, its deputy chairman. 'Hutchison is a savvy company,' says Neil Anderson, a senior analyst at Ovum. 'I do not think it is heading for disaster.'

Hutchison has enough cash to keep 3 going until 2010, according to equity research firm Nomura. And that's plenty of time to make a nice big dent in incumbents' market share. As it is already proving, 3 can tap into Hutchison's massive resources to fund deep price cuts in an attempt to lure customers away from its rivals. It is highly possible that Hutchison will have more stamina in a price war than encumbents.

As Nomura points out, between a fifth and a quarter of all UK mobile users switch operators each year. So if 3 proves attractive to customers, it can win a healthy market share in a short time.

Few people suggested that SMS would take off. But it did (see p51). If the company can come up with a unique, genuinely useful 3G service, it could win customers in droves. There is, for example, considerable potential for location-based services such as restaurant-finders and local maps - if the services are fast and easy to use. There is also potential for business-to-business applications - an engineer on call may find it useful to point a videophone at equipment to ask for a second opinion. This is already starting to happen in Italy (see Scenario two, opposite).

A high-quality videophone turns everyone into a television cameraman (just as the web has turned so many into publishers). So there must be opportunity there. It matters little that we cannot imagine where the killer applications lie. Who, a decade ago, would have predicted that the big successes of the web would include auctions held by individuals, or a system to get old school friends back together?

There are signs that 3's customer base is a potent money-spinner. The company surprised many analysts when it revealed that in July, UK customers spent an average of £45 a month - much higher than the usual mobile spend (3's rivals tend to get £25-£35). 'By July, we were winning between 10,000 and 15,000 new customers a week,' 3 spokesman Edward Brewster says. 'And these are high-spending customers.'

SCENARIO TWO - THE TALE OF DOOM

Despite spending millions on subsidised handsets and heavily discounted voice calls, 3's deals are matched at every stage by rivals. This, coupled with the fact that videophones fail to capture the public imagination, means that 3 falls short of its target of 1 million UK customers by the end of its first year. In 2004, other operators launch their own 3G services.

The company looks around for other niches, trying to borrow from the Italian experience, and also that of Japan's successful iMode network.

But they do not play in the UK market. Hutchison decides that its window of opportunity has now closed. It no longer has a unique service to offer customers, and its existing customer base is not a large enough foothold.

Li and Fok sell 3 to an incumbent.

Why this could happen

Lars Godell, senior telecoms analyst at Forrester Research, believes that 3 is doomed to failure. The fatal problem, he says, is that the company is an unknown player in a near-saturated mobile market; a market dominated by powerful established companies. '3 has many disadvantages, including poor brand recognition and a small customer base. Its costs are higher (than that of rivals), while revenues are smaller.' Forrester estimates that fewer than one in 200 European mobile users will try 3G services this year - with just 10% of users moving to the technology by 2007. All this is hardly good news for Li Ka-shing's company, in the short to medium term at least.

The feature that truly sets 3 apart from its non-3G rivals is the ability to make video calls. Users of a 3 handset can record and send a 12-second video clip of themselves to fellow 3 users or, even more whizzily, conduct a live video call with them. Quirky, yes, but a killer-application? Many analysts think not.

'We've had the bloody video phone for years,' says a well-placed observer, referring to the fixed-line video phones that have been available for some time.

'We have one sitting in the bowels of our office, gathering dust. Once in a blue moon, some-one feels obliged to haul it out for an international video conference, but that's about it.' One industry insider goes even further. 'I don't think most people want their phone to be a graphical device. The limits of a technology like the phone are part of its appeal. Similarly, the low-tech nature of SMS is part of its appeal. When I'm on the phone or sending a text,' he adds, 'I don't want to show my face to the person at the other end - or to see their face, for that matter.'

The assumption that what works in one country will work in another is always dangerous. The relative success of 3 in Italy is largely due to cultural and social factors. Japan's iMode phones, which share much of the capability of 3G, are an even more local phenomenon. The need for private communication devices in an overcrowded country; long train commutes; a national obsession with cartoons - all these have run in iMode's favour but tell us nothing about its likely success elsewhere. Too often, it seems, technology just doesn't travel.

WHAT IS 3G ANYWAY?

2G GSM: Global System for Mobile communication.

The standard that Europe and many other parts of the world have been using for mobile phone calls for years. It's great for voice calls and text messaging, but not for most data functions - WAP internet services on GSM are slow and limited.

2.5G GPRS: General Packet Radio Service.

Allows data (text, pictures, etc) to be sent up to 10 times faster than via GSM. What's more, unlike GSM, GPRS is 'always connected'. This means that data can be sent and received without the tedious hold-up while the handset connects to a data service. Mobile operators across Europe now offer GPRS services.

3G UMTS: Universal Mobile Telecommunications Systems.

A completely new mobile communications network that, in theory, allows data to travel more than 30 times faster than via GSM. This allows for real-time video calls and faster downloading of e-mail, video clips and web pages - as well as offering greater capacity for voice calls.

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NEW TECHNOLOGY HITS AND MISSES

What makes a technology work? History shows that there are no simple

answers - timing and cultural, technical and other influences all play a

part.

Technology/date: FAX - 1970s onwards.

Description: Text transmission using phone line and special equipment.

Success or failure: SUCCESS Idea patented in 19th century but took off

about 1980. Japanese pushed it to overcome their problems with writing

script on computer keyboards.

Comment: Ultimate slowburn, with eventual take-off for a specific

cultural reason. Its security (it can carry signatures) gives it an edge

over the otherwise victorious e-mail. Expect it to be around for a

while.

Technology/date: VIDEOTEX - 1970s onwards.

Description: Text service delivered to the television by phone line or

cable. In the UK, Prestel.

Success or failure: FAILURE People not prepared to pay for text. Closely

related (free) teletext services succeeded in Europe, as did (paid for

but subsidised) Minitel in France.

Comment: Nudged out by similar but superior or cheaper technologies

(teletext, online services, web). Might have succeeded if these had not

emerged. A mystery: why did teletext succeed in Europe but not the US?

Technology/date: FULL BROADBAND NETWORK - Orlando. Mid-90s.

Description: High-speed service trial to 4,000 homes, incl. video on

demand, interactive shopping, games

Success or failure: FAILURE Most-used service was selling stamps.

Viewers not interested in video on demand. Expensive technology

overtaken by the low-cost web.

Comment: Orlando was seen as proof that people did not want interactive

services; actually, it suggests that it takes time for us to get used to

new ideas. Video on demand is now available on cable, and seems to be

used.

Technology/date: SHORT MESSAGE SERVICE (text messaging). Mid-90s

onwards.

Description: Ability to send short text messages (160 character limit),

common to all GSM mobile phones.

Success or failure: SUCCESS The first SMS in the UK was sent in 1992.

Last year, 16 billion texts were sent. A sleeper technology that was

huge with kids long before their parents caught on.

Comment: One the experts missed. SMS is very basic, but it's cheap,

ubiquitous and, most importantly, people find it useful and fun. 3 could

learn plenty from the huge growth of texting.

Technology/date: ADSL - Mid-90s onwards.

Description: Cut-price way of providing high-speed internet connection

down a standard phone line.

Success or failure: SUCCESS Initially seen as a stopgap before we all

had fibre-optic cable to our houses. Instead, asymmetric digital

subscriber line has become the dominant broadband technology.

Comment: A triumph of ingenuity over mega-buck investment, which has

allowed us to see that there is huge demand for broadband internet.

Technology/date: iMODE - Late-90s onwards.

Description: Japanese high-speed mobile data service.

Success or failure: SUCCESS Japanese like downloading cartoons and

playing games, and want visual devices that do not disturb neighbours or

fellow-commuters.

Comment: Ultimate cultural success for very specific reasons. Some

lessons for fast mobile elsewhere, but they must be picked carefully.

Technology/date: INTERACTIVE TELEVISION - Late-90s onwards.

Description: True interactive TV runs on cable; other versions simply

offer choice of many channels, or a return path by phone line.

Success or failure: JURY STILL OUT - UK is the only major country with

interactive TV. Simple services, such as pushing a button to vote, are

popular, but interactive ads, enhanced content, e-commerce etc, are very

slow to take off.

Comment: One question is whether interactive TV will find its niche(s)

before cheaper broadband internet meets it coming the other way. Another

is whether the living room is the right place for an interactive device.

</pre>

 

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