Introduction

By early 1997, more than a dozen personal communications services (PCS) were being turned up in cities around the country. At the same time various forms of SmartPhones were being publicly announced, while others were being shown privately. PCS-like wireless services, such as analog cellular with cellular digital packet data (CDPD), are also actively competing for customers; and the incumbent cellular carriers are feeling the heat of real competition--perhaps for the first time in their corporate lives.

This report from Insight Research analyzes this market as it finally emerges: its size, key players, driving forces, and the expected competition between new PCS players (at 1.9 GHz) and the established cellular providers (at 800 MHz) who do not wish to lose the market they have invested billions of dollars to develop.

Our thesis is that intense competition is about to force some players out of the market. For example, NextWave Telecom Inc., a new wireless carrier formed in 1995 to bid on PCS spectrum, received their Federal Communications Commission (FCC) license to operate in early January. But almost simultaneously with the FCC green light, reports are questioning the company's viability. NextWave presently owes $4.2 billion for the licenses and must pay $274 million quarterly in interest-- which works about to about $755,000 per day just to keep the wolves from the door. This report will not pick the winners and losers; rather we will try to lay a firm foundation for assessing the opportunities and risks in the new competitive landscape.

Much has been written about the market but little is known about:

Market requirements -- who are the users and what will they pay for?

• Market size -- how large will the PCS market become in five years?
  
• Product features -- what do mobile workers really want in a PCS
  telephone?
  
• Competition and pricing -- who are the competitors and which ones
  are likely to survive the difficult competition between technologies?
  
• Standards -- which wireless protocols are expected to be the winners
  and why?

In our analysis, Insight defines PCS as whatever the leading vendors say it is. We have included the new wireless services at the frequencies designated for PCS by the FCC, and we have also included competing services that leading carriers like AT&T Wireless are marketing as PCS to gain a marketplace advantage. For this reason, AT&T's PocketNet Phone, which operates in the 800 to 900 MHz frequency range and combines existing analog voice with a CDPD wireless data service, was included in the study. While this product and similar services are not be digital and do not meet the FCC's definition of PCS, they are included in this report since a major player in this market defines this service as PCS.

PCS Carriers

In order to discuss the PCS carriers and their strategies, the carriers have been segmented into four groups defined by their similar resources and goals. Often, however, they have quite different strategies for achieving them:

• Long distance carriers (AT&T, MCI, and Sprint) -- While they differ in
  many ways, each sees PCS and other wireless services as a way to
  provide local loop services and eliminate the access fees they now
  pay to local telephone companies.
  
• Major local telephone companies (RBOCs plus GTE, Cincinnati Bell,
  and Southern New England Telephone, SNET) -- They are starting
  new PCS services to expand their revenues while defending their
  existing cellular services and preparing for competition in their home
  territories.
  
• New wireless carriers or consortia (like PrimeCo, NextWave, and
  Western Wireless) -- They need to generate positive returns for their
  investors since they just spend millions for PCS licensing. They now
  need to build their wireless infrastructures and attract customers, often
  away from existing cellular services.
  
• Narrowband service providers (like SkyTel or PageNet) -- They are
  exploring how to configure, price, and market the new two-way
  services they now can offer both locally and nationwide.

Key Issues and Trends

Competition between PCS and Cellular

Competition between PCS and the incumbent cellular carriers will be intense after 1997. PCS vendors will be striving to gain enough customers to cover their high fixed costs and to break even while the established cellular carriers will be fighting to maintain market share. The FCC auctions have left most of the PCS frequency winners deeply in debt. Their need to quickly implement a network and gain customers has created a major drain on cash. "Usually four competitors in the market will be able to do a reasonable business. Above four, the additional ones will probably have some difficulty," said Irwin Jacobs, president of Qualcomm, Inc.

Insight Research sees market dynamics and price competition in the wireless markets even more starkly than does Irwin Jacobs, and we predict that by 1998 some wireless carriers and PCS auction winners will seek partners to avoid running out of operating income. The alliances and interoperability agreements being signed now are expected to lead to closer working agreements and potential mergers as competition increases for wireless customers. As the carriers compete, their profit margins will be reduced, and those short of cash are expected to join or merge with adjacent carriers to improve the efficiency of their operations.

Growth of the Market

At least five different wireless standards will compete for customers:

• CDMA (code division multiple access),
• PCS 1900 (called Global Standard for Mobile Communications, GSM, in Europe),
• TDMA (time division multiple access),
• AMPS (advanced mobile phone service) with CDPD, and
• AMPS for voice only and for circuit-switched data applications.

While each standard claims distinct advantages, the regional markets can only support two or three wireless networks. We expect that some carriers and eventually some network standards will be eliminated by the severe competition. The winning standards will be those which can quickly attract a critical mass of customers, not necessarily the ones that are the most technically advanced. Another factor which complicates the competition between wireless protocols is the willingness of some leading equipment
suppliers to offer generous financing packages as incentives. The cash-poor PCS carriers who accept money from suppliers and adopt their products will need to use the same standards as the suppliers' products.

The FCC's and Congress's efforts to increase competition in wireless services will have long-term effects on the market. The FCC auctions and the 1996 Telecom Reform Act sought to broaden competition, and Insight Research expects that after 1997, there will be a consolidation in the wireless business. Less well-financed carriers will seek to sell their licenses or franchises to cover their debts.

As the cellular industry expands into residential markets, Insight expects PCS vendors to concentrate their marketing and sales efforts to almost exclusively target mobile workers through 2000. The advanced features and security offered by digital PCS appeal to mobile workers, and they can justify the initially higher costs of the PCS services based on their greater benefits. Most consumers value low price far more than capabilities for phone services, and analog AMPS services appeal to them. Business users tend to have higher usage rates than consumers; they average over 100 minutes of usage a month, compared with just over half that amount for consumers.

The growth rate for cell phone subscribers will slow when PCS networks begin to compete seriously. Users' average monthly service charges for the newer PCS services are expected to be higher than cellular services.

Cellular services will continue to expand into consumer markets where usage tends to be less. PCS subscriber fees cover the same enhanced services, such as two-way messaging, SMS (short messaging services), caller ID, and call forwarding.

As PCS services become established, rates will gradually decline to attract a wider audience, including consumers. Since the new PCS carriers have significant debt, initially they will have to charge higher prices for their services to cover their debt payments. They will be competing with existing cellular carriers whose networks are often largely depreciated.

Markets Expand from Mobile Workers to Consumers

Following the pattern of sales for analog cellular phones in the 1980s, the new PCS phones will first be sold to the 43 million mobile business workers; penetration of consumer markets will only come later when prices have declined. During the 1996 to 2001 period, PCS sales efforts will primarily be targeting businesses and individual mobile workers, as both groups will pay for the added functionality and security of digital PCS for mobile voice, messaging, and data.

In most of the major cellular markets, there have been two cellular carriers. This year those incumbent cellular carriers are going to be joined by three new PCS carriers offering integrated digital services at a lower cost to the user. Because the new digital infrastructure will take time to build, there may be lots of dead zones since the range of PCS is more limited. Car phones, for example, might be better matched with cellular services because users require wide area coverage. The advantage of low-power PCS phones is that they will potentially run longer, sound better, and cost less.

With the introduction of PCS services, many customers, especially mobile professionals, will want the benefits of these new services but will also need the universal coverage provided by the existing analog AMPS network. At least until 1999, none of the new digital wireless protocols are expected to become the nationwide PCS standard similar to AMPS for cellular services. To get wide-ranging coverage and the benefits of new services, users will have to carry dual mode and/or dual frequency wireless telephones. These devices utilize AMPS or one of the new digital PCS services at either 800 MHz or 1.9 GHz, depending on their location. Nokia, Ericsson, Nortel, and other vendors are already preparing versions of these handsets to enable mobile workers to roam from region to region.

Insight's research suggests such phones are a very necessary step in the transition from the current near universal coverage provided by AMPS cellular services to the new PCS services. Since there is no agreed upon PCS standard, customers who travel will need to have dual wireless mode capabilities to provide coverage and access to the new PCS services.

Methodology of Study

In our study Insight combined research data from carriers, equipment providers, and large users of wireless services. By integrating data from both supply and demand views of the market, we were able to develop a more accurate perspective than is possible to get from any one source. On the supply side, for example, data from carriers tended to focus on the growth of traditional telephone services since that is mainly what the carriers offer. On the demand side, data from users focused on leading edge applications, but it lacked a complete perspective on the vertical segment and its size.

Forecasts in this report are based on real dollars in each year and assume an inflation rate in the US of under three percent in 1996, climbing to four percent for 1997 to 2001. Insight also assumed that the US Treasury Department would continue its policy of containing inflation and that interest rates, such as the prime lending rate and 30-year treasury bonds would remain below nine percent. This economic policy will continue the current period of moderate economic growth without a recession through the year 2001.

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