The evolution of mobile communications in Europe: The transition from the second to the third generation

ARTICLE IN PRESS Telecommunications Policy 32 (2008) 436– 449

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The evolution of mobile communications in Europe: The transition from the second to the third generation Lucio Fuentelsaz, Juan Pablo Maı´cas , Yolanda Polo ´n de Empresas, University of Zaragoza, Gran Vı´a 2 50005 Zaragoza, Spain Departamento de Economı´a y Direccio

a r t i c l e i n f o Keywords: European mobile communications 2G 3G Regulation Market structure

abstract This paper analyses the evolution of the mobile communications industry in the European Union. The research focuses its interest on the different roles played by the regulator in Europe and in other regions of the world (mainly the US). The diffusion of GSM was extraordinarily fast in Europe, mainly due to the adoption of a unified standard from inception. This rapid diffusion has resulted in an important competitive advantage for European operators. Interestingly, while the regulator acted similarly in the case of UMTS, the development of the latter has faced many problems and, presently, its diffusion is still low (about 5% in the EU). The paper also offers basic information on market structure that may be useful for extracting some preliminary conclusions about the degree of rivalry within the industry and the differences that can be observed between European countries. & 2008 Elsevier Ltd. All rights reserved.

1. Introduction Mobile communications have received considerable attention in recent years. It has attracted growing interest in the academic community and it is becoming increasingly common to find research articles that analyse, for instance, its diffusion (Gruber & Verboven, 2001a, 2001b), the key variables of the industry (Gruber, 1999), the strategy followed by the operators in terms of licence acquisition (Whalley & Curwen, 2003, 2005) or competition in different markets (Doganoglu & Grzybowski, 2007; Kim & Kwon, 2003; Valletti & Cave, 1998). There are several reasons that justify interest in the study of the sector. From a social point of view, its relevance is unquestionable, insofar as this activity has meant a redefinition of the communications sector (mobile handsets have become commodities). It has also originated new forms of business (m-commerce, sms, etc.) and has substantially changed users’ habits. From an economic point of view, its growth in the last few years has been very important and its use is nowadays universal. As a consequence, mobile telecommunications’ penetration rates are higher than those of fixed communications in the majority of developed countries. Furthermore, a thorough knowledge of this industry is also important from a public policy point of view. The regulator’s need to assign a scarce resource—such as the radio spectrum—originated a heated debate about which was the most efficient way to manage it. An additional question in the wireless communications industry is regulatory activity and how much it interferes in both the spectrum allocation process and the competition that has taken place in the market. For the original digital technology, the US authorities chose to distance themselves from the process and let the market determine one (or several) specific standards (Gandal, Salant, & Waverman, 2003). On the contrary, in the EU, the regulators chose to impose a common standard (the so-called GSM, or global system for mobile communications), which was heavily criticised

 Corresponding author. Tel.: +34 976 761000; fax: +34 976 761767.

E-mail addresses: [email protected] (L. Fuentelsaz), [email protected] (J.P. Maı´cas), [email protected] (Y. Polo). 0308-5961/$ - see front matter & 2008 Elsevier Ltd. All rights reserved. doi:10.1016/j.telpol.2008.04.008

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at first.1 In retrospect, no one can doubt that this decision was inspired. After all, it has become a main European strength, so that nowadays GSM is the most extended standard in the world (with the main exception of the United States). The most important consequence of adopting this strategy in Europe is that the mobile industry has spread throughout the continent in a very short period of time, achieving penetration rates never reached by other technologies before. On the contradistinction, and in the same period of time, the US penetration rate hardly reaches 50%.2 Another interesting aspect that has deserved considerable attention in recent years has been the launching of the third generation technology (UMTS, universal mobile telecommunications system). The differences in the systems used by European countries to allocate the licences and the huge amounts of money paid for them has been at the centre of debate for some time. However, and in spite of its promising possibilities, the development of UMTS has not been as rapid as expected and, at the beginning of 2006, GSM is still the dominant technology in the mobile world. In this context, this paper attempts to offer a panoramic view of the current situation of the sector in the European Union (EU), analysing both GSM and UMTS evolution and addressing the structure of the different national markets and some of their consequences in terms of competition. Taking into account that one of the aims of European Governments has been to foster rivalry within the industry, this analysis should be of interest to assess to what extent the regulator has achieved its purpose. The main contribution of the paper is to compare the two generations of mobile communications technologies in order to show their most important differences in terms of evolution, regulation and success. The remainder of the paper is organised as follows. Section 2 presents the history and evolution of the industry in Europe. The most relevant dates and key events in the second-generation technology and also in the incipient UMTS are highlighted. This section also emphasises the differences between the EU and the US in terms of standard setting. Section 3 analyses in detail the sector’s current market structure and tries to infer some consequences in terms of firm rivalry. In the next section, the article offers a brief discussion about the learning that can be obtained from previous experience and its consequences from the point of view of public policy. Finally, the main conclusions of the paper are outlined in Section 5.

2. History and evolution of mobile communications 2.1. Industry chronology: from its origins up to 2G The earliest applications of mobile communications date back to the 1920s (Gruber & Valletti, 2003), but the credit for the first mobile phone is attributed to Martin Cooper who, when working for Motorola in 1973, made the first public call placed on a portable cellular phone in the US (Hamil & Lasen, 2005). However, it was not until 1979 that the first commercial program, developed in Tokyo by the Japanese mobile operator NTT DoCoMo, appeared (Gruber & Valletti, 2003). In any event, most of the pioneer initiatives took place in the United States at the beginning of the 1980s, which gave this country an initial advantage. The commercial origins can also be dated to the US in the early 1980s, when the first analogue systems appeared. In this process, the FCC approved the AMPS (advance mobile phone system) as a common standard. The introduction of such a common standard had two main objectives: to allow interstate roaming and handset compatibility. The scenario described remained intact until 1994, when the FCC ‘‘in comparison to its policy of the early 1980s in the AMPS cellular bands did not mandate a specific standard for the PCS bands.3 Carriers were free to choose whatever standard they wished [y]. Market forces led to this outcome’’ (Gandal et al., 2003, p. 327).4 In the meantime, different systems appeared in Europe, which were usually incompatible.5 This restricted the take off of the technology and made roaming impossible. This unusual situation was also unacceptable from a commercial point of view in an area that was advancing towards integration under the EU’s political guidance. When the demand started to grow in a significant way, it was obvious that there was a need to adopt urgent measures to avoid the predictable growth of the industry becoming mired in a bottle-neck because of the restrictions inherent to the analogue systems. These limitations, imposed by analogue technologies, were also detected in other regions such as Japan or the United States, where there was a unanimous agreement about the necessity of changing towards digital systems in order to deal 1

For a more detailed discussion about this matter, see Gandal et al. (2003). It is should be pointed out that some authors not only attribute this delay in the US sector to the presence of alternative technologies, but also to the pricing policy followed by the regulator (Gruber, 1999). The argument is that the calling party pays system has allowed the EU to consolidate the industry faster. 3 Free market advocates argue that competition will best guarantee better technological systems (possibly an industry accepted standard), and reduce the risk of lock-in to an inferior government-promoted technology (mandatory standard). A counterargument is that free markets may also lead to lock-in to inferior outcomes, thereby necessitating government intervention to cope with this network externality (Gruber & Valletti, 2003). 4 The operators in the United States are free to offer 2G technology from the four available standards: CDMA/IS95, GSM, TDMA and IDEM. This instability in technology has been a brake on the takeoff of 2G, so much so that the first generation system, AMPS, remained the most popular mobile technology all through the 1990s. 5 For instance, the UK introduced the total access communications system (TACS) and Germany developed C-Netz. RC2000 and RTMS were the systems for France and Italy, respectively. The only exception to this incompatibility comes from Scandinavia, which developed the nordic mobile telephone (NMT) system that allowed roaming among these countries. Probably, the success of NMT was one of the reasons why GSM was especially successful in Scandinavian countries. 2

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with the huge expected growth in the number of users and the introduction of new services, especially those that had to do with data transmission. However, and although this initial picture could suggest the opposite, the development of digital technology has taken place mostly in Europe, mainly due to the interest in solving the problems encountered in the first stages of the industry (Haug, 2002a). With this matter in mind, the Confe´rence des Administrations Europe´enes de Postes et Telecommunications (CEPT), took place in 1982, decided to set a new digital standard and created a working group to develop a mobile network without boundaries inside the continent. This group was in charge of establishing the specifications of a new mobile technology that, first of all, had a pan-European nature and allowed roaming throughout the whole continent; secondly, the technology had to be digital, to obtain the highest benefit from the available spectrum capacity; and finally, it had to be able to take advantage of the array of services that were being developed at that time (Haug, 2002b). The group was called Group Special Mobile (GSM). Two years later, the European Commission expressed its official support for the GSM group and, in 1985, several countries signed an agreement by which they complied with this standard. In 1986, a subset of the permanent GSM group was constituted in Paris and dictated the technical specifications required to manage and coordinate the different aspects of the standards (Hillebrand, 2002). At that time, there was a need to clarify the commercial aspects before the new system could start. Consequently, the industry was close to the launch of the new digital mobile era. The next and decisive step took place in December 1986 when, in the European Council, the Heads of State agreed on the adoption of GSM as the digital mobile communication standard in the EU. As a consequence of this summit, a directive was drawn up which forced the member states to keep the 900 MHz band spectrum for future mobile telecommunications development. Between 1986 and 1987, the development of GSM specifications went through an especially productive period,6 that concluded in September 1987 with the signing of a Memorandum of Understanding subscribed to by 14 operators from 13 European countries (Hillebrand, 2002). This agreement enshrined the compromises of the operators in unfolding the GSM infrastructure on certain dates, which constituted another large step lending credibility to the creation of the digital mobile industry at the European level (Temple, 2002). A transfer of responsibilities took place in 1989 (Haug, 2002a). As a result, the function of elaborating the GSM specifications was passed from the CEPT permanent group to ETSI (European Telecommunication Standard Institute). The CEPT Groupe Spe´cial Mobile became the ETSI Technical Committee GSM (Hillebrand, 2002). In addition, the spectrum (focused initially on the 900 MHz band) was widened to cover the 1800 MHz band (Haug, 2002c) when some of its licences had already been adjudicated (e.g., UK). The new bandwidth provided the GSM with a higher capacity and it is now present throughout the European Member States. Without entering into technical aspects that would distort the spirit of this section, it can be concluded that the transfer from the 900 MHz band to the 1800 MHz band was an advance that led to a higher capacity and a greater amount of available services. Retrospectively, there is no doubt that the decisions taken by the CEPT were very risky, especially when setting a unified standard that completely eliminated the market as a mechanism to allocate resources. Nonetheless, the subsequent evolution of events confirmed that this choice had many more welfare or social benefits than the alternative of letting the market determine the standard. To sum up, the introduction of a completely new system, based on digital technology, involved important advantages in comparison with the analogue era. Among others, the following can be highlighted:

 A more efficient usage of resources (radio spectrum).  Taking advantage of costs related to microelectronic technology.  The possibility of offering roaming throughout the continent. This was not only desirable politically and commercially but also a necessary step in the process of European integration.

 The exploitation of scale economies among equipment providers.  The distribution of the expected high costs of research and development among the European members. As a result of the aforementioned arguments, the first deployment with limited services took place in 1991. However, in the same year some problems arose in the GSM world when the expected date for the commercial take off, July 1991, could not be achieved because of the complexity of the process of making the terminals compatible. This entailed a series of delays and, in addition, a crisis of trust in the standard’s viability. Nevertheless, a solution was reached that made enough terminals available in 1992 and so the definitive GSM take off was finally possible in a selected number of European countries. In spite of the problems, Germany had already started a GSM concession in 1991 (the D2 licence). At the end of 1993, GSM technology had over one million users (Hillebrand, 2002) and coverage in the main cities. By then, the MoU had been signed by 70 operators in 48 countries and more than 25 roaming agreements had been put into practise. An example of the development of the new standard lies in the fact that Telstra, the incumbent operator in Australia, decided to 6

There were several key decisions taken at this period. The most important was the adoption of the radio electric interface.

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90% 80% 70%

CDMA GSM iDEN PDC US TDMA W-CDMA

60% 50% 40% 30% 20% 10% 0% Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Mar-06 Fig. 1. Technology standards evolution (% of total users). Source: EMC (2006).

implement GSM and to sign the MoU, which marked the beginning of the GSM’s expansion outside Europe (Hillebrand, 2002). In recent years, the evolution of GSM has taken place in the data field. One of the new standards is that known as GPRS (General Packet Radio System),7 by means of which GSM has been provided with packet communication capabilities, mainly those which allow an efficient access to the Internet, other IP networks, and multimedia services (Dupuis, 2002). Today, GSM is a consolidated reality and a standard that does not generate any discussion. As a consequence, at the end of 2005, 675 operators had signed up for the MoU (representing 210 countries) (see http://www.gsmworld.com) and GSM had become the dominant technology throughout the world with the main exception of the United States. At the same time, this was the starting point for the leadership position of the mobile industry that Europe still holds (see Fig. 1).

2.2. Evolution towards UMTS in the European union: The third generation licence assignment In spite of the apparent reliability of second-generation technology (2G), the high growth of the industry and the increasing presence of the mobile as a commodity encouraged the development of a new technology (UMTS), that partially substitutes for GSM, to offer both a wider range and a higher quality of services. Initially, the third generation (3G) was not conceived as a new range of services, but as a tool that would allow the operators to optimise their networks. Moreover, it was not designed with the purpose of immediately substituting for 2G; instead, it was thought of as a complement to GSM, offering new services (mainly multimedia ones) that did not previously exist. The attempt was made to follow the successful European path through the second generation when it came to facing the challenges associated with 3G. As a consequence, the strategy followed lay in replicating the conditions that gave the industry its previous strength and consistency. Therefore, the path traced by the second generation in Europe was re-taken and materialised in the following steps:

 One only standard, UMTS.8  Use of the same frequency band in the Euroarea.  Objectives established by the political authorities regarding third generation network diffusion and its coverage. These objectives were formulated essentially in terms of the percentage of the population to be reached in a given number of years. 7

The GPRS system has been called 2.5G technology (Whalley & Curwen, 2005). In the migration, from 2G to 3G two fundamental standards were proposed: the UMTS, also known as Wideband CDMA (WCDMA) and CDMA 2000. Both used codes that came directly from the CDMA version for the second generation, called CDMA-One. Europe chose the first of them saying that this would mean equality of terms with the second generation CDMA equipment providers and the operators, while CDMA2000 would concede the third generation a competitive cost and time to take advantage in the market (Gandal, 2002). 8

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However, leaving aside remarks related to the choice of platform on which 3G would be built, the most relevant—and also controversial—aspect is the vortex resident in the mobile licences award process. The debate centred on the choice of the mechanism for assigning the new UMTS licences. Many states chose an auction system designed ad hoc, sometimes with the active participation of recognised economists.9 As a result, some Governments obtained much higher than expected receipts, which may have had consequences for the stability of the sector.10 Especially significant are the cases of Germany and the United Kingdom,11 whose licences were awarded at an exorbitant price. Both countries received more than 6000 million euros for each of the licences they granted. Meanwhile, other countries chose beauty contests as a mechanism for allocating their licences. Some governments were criticised for making this choice, insofar as they were turning down the chance to earn a great amount of money (Gruber & Valletti, 2003). Furthermore, they were criticised for considering that there is ‘‘y difficulty of specifying and evaluating criteria for a beauty contest that makes this a time-consuming and opaque process that leads to political and legal controversy, and the perception, if not the reality, of favouritism and corruption’’ (Binmore & Klemperer, 2002, p. 76). Contrary to auctions, this mechanism is said to be less sensitive to interference from external lobbying and more efficient for allocating resources because licences gravitate toward those who value them most highly. As for the quantities paid for the licence acquisition, the question that arises is whether it is possible to obtain sufficient returns from this investment. A former Telefo´nica Mo´viles planning and control manager illustrated this by saying that if half of the British population between 15 and 64 years old (40 million people) became UMTS users, the firms would have to earn between 20 and 25 euros per month (per user) to recover what they invested in 10 years, or between 15 and 20 to get it back in 20 years. These quantities do not take into consideration the resources needed to build the network and it is difficult to know whether for example, Martin’s prediction in the United Kingdom of 80% coverage reached in 10 years will be fulfilled (Martin, 2000). However, the aforementioned reasoning is not completely accepted within the economic community and should be clarified: the licence payment is considered as a sunk cost for the firm12; thus, it should not have any influence on long-run pricing strategies (this argument contradicts some Governments’ worries that the 3G disaster will be transferred to consumers in terms of higher prices and, consequently, welfare losses). In this sense, a company tries to maximise its profits by equalling its marginal income to its marginal cost, so a licence will not have an impact on the increasing costs because its price is unchangeable (Wolf, 2000). In this context, telecommunication operators will choose the prices that maximise their profits, independently of the cost incurred in the past (Klemperer, 2002a). In any event, what cannot be denied is that the continuous delays in the launching of 3G confirm the difficulties that firms’ managers had in making the necessary investments to start to operate the technology. However, this is not the only explanation for the delay. Experts also mention the crisis that affected the sector after the 2000 stock market crash or the scarcity of handsets for the new technology. This situation opened a debate about the viability of UMTS. The existence of enough demand to allow defraying the costs which the operators incurred has been questioned. With the aim of mitigating the consequences of this process, some solutions have been proposed. One of them has been to reduce the price of licences in order to promote the UMTS market. It was France which initiated this practise, cutting the starting price of its licences to an eighth. Next, the European Commission urged the Governments in the EU to follow the French example with the purpose of impelling the launch of this technology in Europe. The counterargument to this practise comes from those who argue that there is no reason to subsidise this industry, to the extent that operators go to auctions voluntarily. However, the strategic character of the sector and the hopes placed on in it within the EU seem to endorse this type of support.

9 The most significant case is the United Kingdom, where the economists Ken Binmore and Paul Klemperer led a team whose objective was the design of the auction that would make the concession of 3G licences possible. For a detailed vision of this case, see Binmore and Klemperer (2002). 10 The delay caused in the launching of the UMTS technology has opened a debate among politicians, operators and economists about the convenience of the allocation system of the licences for 3G. Paul Klemperer, one of the advisers on the design of the auction carried out in the United Kingdom, has been a staunch defender of this system. He uses three basic arguments to justify this method’s attraction (Klemperer, 2000): ‘‘(a) A well designed auction is the most precise method to locate the resources in the uses in which they are more valuable, (b) the systems based on the beauty contest are less transparent and give way to opportunist behaviour related to favouritism and corruption and (c) an auction can raise staggering sums of money to support public finances’’. Originally, these arguments seem to have been unanswerable but the crisis in which the sector has been immersed and the delay in the 3G commercial launching, have questioned the decision of choosing the auctions as a way of managing the licences. Some people, like Jacques Chirac, have pointed out that ‘‘the auction system has contributed remarkably to the telecommunication sector’s crisis’’. Others, including a a Finnish Minister have gone further saying that ‘‘this is the biggest industrial mistake since the Second World War.’’ According to Klemperer (2002b), these critics assume the following matters as real: (1) the operators paid for the licence more than they thought they could afford. (2) These expenditures have compromised investing in infrastructures and development of 3G technology and (3) they have destroyed these companies’ market value. Klemperer (2002a, 2002b) refutes this line of argument, insisting that the operators go to the auction without pressure and they bid according to the expectations of a very attractive future business. Questions like the winner’s curse or overbidding are threats that are more to do with auctions themselves, but it is in the operators’ hands to manage these risks. Moreover, Klemperer (2002b) further refutes this reasoning postulating that, in the last resort: ‘‘The main effect of the license fees was simply the transfer ofr $100 billion from shareholders around the world to certain European Governments. This was both equitable, since the companies were buying a public asset that they valued this highly at the time, and efficient, since such a lump sum transfer is much more than most forms of taxation’’. 11 The licence auction for the United Kingdom has been called the biggest auction ever (Binmore & Klemperer, 2002). 12 This is true when the auction is articulated in once-and-for-all-lump-sum payments and not in a royalty system.

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120% Penetration EU

Growth

100% 80% 60% 40% 20%

06 2Q

05

05

4Q

04

2Q

4Q

04 2Q

03

03

4Q

02

2Q

4Q

02 2Q

01

01

4Q

00

2Q

4Q

00 2Q

99

99 4Q

2Q

4Q

98

0%

Fig. 2. GSM penetration rate and growth in the EU (15) (*: with the exception of Luxemburg; source: GWM, 2007).

Another solution that enables more flexibility in the sector has its origin in the European Commission and consists of the possibility of transferring the licences. Some countries have accepted this initiative and have approved regulations that allow the transfer of spectrum usage rights. European members such as Spain, Italy or Austria, have considered this possibility (El Paı´s, 2003a). An additional proposal emanated from the operators themselves, who suggested establishing a payment system which taxes the profits obtained through the new technology once it is working, so that its future will not be compromised. They were intimating a type of royalty system. On the positive side, this type of payment mechanism encourages entry and reduces risk for the operators. On the negative side, its use is susceptible to the generation of further distortions and, consequently, new welfare losses. Furthermore, there would be a clear incentive on behalf of the operators to renegotiate the royalties if demand expectations are not satisfied. One of the latest initiatives, which has been approved by the European Commission, is the shared use of the UMTS networks. Using all the physical infrastructures enables a reduction of costs and accelerates the launch of the new 3G services (El Paı´s, 2003b). This measure has been put into practise, for instance, in the United Kingdom, where T-Mobile and O2 share the third generation network infrastructure, an agreement that has been subscribed to in the same terms and with the same participants in Germany (El Paı´s, 2003c).

3. Market structure and competition in the European mobile communications industry 3.1. 2G technology at the beginning of the 21st century This section briefly describes the market structure in the mobile communications industry. More precisely, it centres on its horizontal configuration, analysing both the number of firms that operate in each country and their relative sizes. This picture will also allow inferences to be made about the expected level of competition in the different national markets, an aspect that constitutes one of the sector’s biggest concerns (Gruber, 2005). First, Fig. 2 shows GSM penetration rates and growth in the EU from the end of 1998, when technology diffusion hardly reached 25%, to the end of 2005, when the EU average was above 100%. This figure confirms that, in less than a decade, the industry life cycle passed from its introduction to its maturity. A second aspect that deserves some attention is that the industry is clearly an oligopoly. There are some reasons that theoretically justify this marked oligopolistic character. On the one hand, telecommunications has traditionally been considered as a natural monopoly. On the other, the radio spectrum is considered a scarce resource. Thus, the high infrastructure cost needed to develop the service, together with radio spectrum constraints, implies that the number of companies that can compete efficiently in this type of market is limited. As a consequence, these markets are quite stable, with a number of operating companies that fluctuates between three in Spain, France or Portugal and four in Germany, Greece, Italy, the United Kingdom (five, with the recent incorporation of Hutchison Whampoa) and Sweden. Table 1 presents some basic information about the different European countries, including the penetration rates at the end of 1998 and 2005, the number of operators in each country and the date when each firm started its commercial activity. Table 1 also shows the market share of each operator at the beginning and at the end of the period considered. These figures confirm the high level of concentration in most of the countries. Except for the United Kingdom, there are two dominatnt operators which jointly possess market shares above 70%. One of them emanates directly or indirectly from the

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Table 1 Basic data for European operators Country

Penetration rate (4Q98) (%)

France

20

Germany

Penetration rate (3Q06) (%)

No. of operators

Operator

Starting

Market share (4Q98) (%)

Market share (3Q06) (%)

77

3

Orange SFR Bouygues Telecom

July-92 December-92 May-96

50 38 13

46.5 36.1 17.4

15

101

4

T-Mobile Vodafone E-Plus O2

July-92 June-92 May-94 October-98

36 47 16 0

36.9 35.6 14.7 12.8

Greece

19

122

4

Vodafone Panafon Stet Hellas (TIM) Cosmote (OTE) Q-Telecom

July-93 July-93 March-98 Third quarter-02

52 34 15 0

35.3 19.9 37.1 7.6

Italy

36

133

4a

TIM Vodafone Wind Blu 3 (Hutchison)

April-95 October-95 March-99 May-00 Second quarter-03

70 30 0 0 0

40.2 32.2 18.8 – 8.8

Portugal

29

118

3

TMN Vodafone Optimus

October-92 October-92 September-98

45 47 8

44.2 35.7 20.1

Spain

19

103

3

Telefo´nica Mo´viles Vodafone Amena

July-95 October-95 January-99

65 29 7

45.8 30.6 23.6

Sweden

47

112

4

TeliaSonera Tele 2 Vodafone 3 (Hutchison)

November-92 September-92 September-92 Second quarter -03

53 31 16 0

44.3 34.4 16.8 4.6

United Kingdom 22

114

5

Vodafone O2 Orange T-Mobile 3 (Hutchison)

July-92 January-94 September-94 September-93 First quarter-03

37 31 17 15 0

23.5 25.0 21.9 24.1 5.5

Source: GWM (2007) and EMC (2006). a Blu left the market in the last quarter of 2002.

former PTT, the other is usually13 the operator which launched the mobile network at about the same time. The deviation from perfect competition that can be observed confirms that the desire of European regulators and national Governments to introduce true competition into the sector has not been totally achieved. Undoubtedly, one of the key questions at this point is why the sector does not reach the desired level of competition. The literature has explained this situation through the structural characteristics of digital sectors in general and of telecommunications in particular. Some authors suggest that the natural inertia associated with these industries is difficult to reverse and confers a clear market power to one or a few companies (Arthur, 1989, 1996; Shapiro & Varian, 1998). The reason for this is the presence of network effects (Katz & Shapiro, 1985) or switching costs (Klemperer, 1987).14 In a more general context, the literature also talks about the advantages of being the pioneer in the market (Lieberman & Montgomery, 1988). This set of arguments, applied to communication operators, could fit the following sequence: the companies that operated as a former fixed monopoly would acquire an initial advantage because of—among other

13 OTE in Greece constitutes an important exception to this profile. See zu Knyphausen-Aufseß, Krys, and Schweizer (2002) for a more detailed explanation of the OTE case. 14 There is a growing stream of research that tries to analyse the impact of network effects and switching costs (with the risk for the consumer to be locked-in) in the mobile communications industry. See, for instance, Kim and Kwon (2003) or Doganoglu and Grzybowski (2007) for the case of network effects, and Lee, Kim, Lee, and Park (2006), Shi, Chiang, and Rhee (2006), and Grzybowski (2008) for switching costs.

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10% 9% 3G Penetration

8% 7% 6% 5% 4% 3% 2% 1% 0% Dec-04

Mar-05

Jun-05

Sep-05

Dec-05

Mar-06

Fig. 3. UMTS penetration rate in the EU (15) (*: with the exception of Luxemburg; source: EMC, 2006).

factors—their installed user base or their previous experience.15 This situation is bolstered by inertia, which leads to situations in which it would be difficult for the installed base of consumers to leave the incumbent operator(s) and switch to other rivals with a smaller presence in the market. Moreover, newcomers to the industry take the incumbent operator as the reference point when making their purchasing decisions. As a result, the established companies reinforce their position, reducing the expected performance of new entrants. In the literature, this phenomenon is called winner-takes-most (Liebowitz, 2002; Shapiro & Varian 1998). In spite of this, empirical evidence shows that, articulating the adequate mechanism, it is possible to conceive of a sector in which competition is present. If Table 1 is observed again, it can be seen that the United Kingdom has four operators (five with the recent entry of Hutchison), all of them with similar market shares (about 25%, or 1/n), which a priori suggest that rivalry will be higher than in other countries. 3.2. Third generation mobile technology In spite of the optimism shown at the beginning of the 21st century, the stockmarket crisis, together with several technical problems, rendered the development of 3G difficult. Although most countries expected 3G to start operating in 2001–2002, the commercial launch of 3G typically took place at the beginning of 2004 or later. As a result, the penetration rate of this technology, despite initial expectations, is still low, only reaching 5% by March 2006 (see Fig. 3). Section 2.2 highlighted the importance of the method of awarding the licences, basically the dichotomy between the beauty contest and the auction system—or a hybrid of the two.16 In Europe, both mechanisms have been equally used, although with different results (see Tables 2A and 2B). The initial information that can be taken from Tables 2A and 2B refers to the number of licences granted. For most of the countries, this figure is higher than that of the second generation. The reason for this is mainly technological. Just as the substitution of analogue by digital technology enabled a higher number of operators to make efficient use of the spectrum, a similar phenomenon occurs when the transition between 2G and 3G is considered. An additional argument for the increasing number of licences resides in governments’ interest in introducing competition into their respective markets (Gruber & Valletti, 2003; Whalley & Curwen, 2003). Furthermore, some repeated patterns can be observed in every country. The nations that have chosen an auction system have always offered at least one additional licence to those they had assigned for 2G. This is obviously an indispensable condition for the auction to run efficiently and an initial guarantee for its success (Klemperer, 2002c). Some of the main problems derived from a bad design are related to collusion or entry deterrence, and the number of bidders and licences are especially important to solve these problems. However, this is not the only question that should be considered in the auction process, as the Italian situation shows.17 15 Notice that this effect happens even though the mobile operator has developed its activity in a liberalized market from the beginning. In this sense, the operator that emanates from the old state monopoly would benefit from its installed fixed telecommunications base. It can be said that there is a reputational effect that would encourage potential users to move towards the former monopolist to the detriment of other alternatives. 16 France adopted a hybrid system in which licensees are chosen through a beauty contest but are charged a high fee. Italy has also adopted a hybrid system, selecting, through a beauty contest, the players that are admitted to an auction at a second stage (Prat & Valletti, 2000). But both systems could be assigned to auctions or beauty contests depending on their spirit. 17 The Italian design was not robust because entry into the auction was difficult (Klemperer, 2000a). Moreover, from the beginning, the debate in Italy was not very clear and transparent (Prat & Valletti, 2000). The result was a per capita revenue 40% lower than the one obtained in the UK.

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Table 2A 3G mobile operators in Europe (award method: auction)

Germany

Licences

Winners

6

T-Mobile O2 Vodafone QUAM (Group 3G)a MobilComa E-Plus Total

Italy

5

8.490 8.440 8.420 8.410 8.390 8.340

Cost per capita (h)

Licence award

Commercial deployment

Shareholders

615

August-00

May-04 June-04 May-04 – – June-04

Deutsche Telekom (100%) Telefo´nica (80%), others (20%) Vodafone (100%) – – KPN Mobile(100%)

211

October-00

May-04

Vodafone (76.9%), Verizon (23.1%) – Telecom Italia (56%), Free float (44%) Enel (100%) Hutchison Whampoa (78.3%), Sanpaolo-IMI (5%), Cirtel (12.9%), others (3.8%)

50.490

Vodafone

2.448

IPSE 2000a TIM

2.442 2.417

– May-04

Wind 3 (Hutchison)

2.427 2.427

October-04 March-03

Total United Kingdom 5

Fee (million h)

Vodafone 3 (Hutchison) Orange UK O2 UK T-Mobile UK Total

12.161 9.940 7.036 6.825 6.716 6.671

623

April-00

March-04 March-03 July-04 – February-04

Vodafone (100%) Hutchison Whampoa(100%) France Telecom (100%) Telefo´nica (80%), others (20%) Deutsche Telekom (100%)

37.188

Source: Klemperer (2002a), Prat and Valleti (2000), /http://umts-forum.orgS, European Commission (2002), Credit Suisse (2006). a Operators that have abandoned the market.

On the contrary, in a beauty contest Governments impose a number of criteria. Candidates’ offers are then evaluated by a committee that selects the plan that best fits those criteria. In the case of European Governments, the criteria have included financial resources, reliability and investment in research, as well as more specific criteria such as the speed of network rollout, the requirement for geographic and/or population coverage, pricing, quality, technology and competitiveness (Prat & Valletti, 2000). This system does not condition the number of licences offered and these are established on the basis of competition requirements or bandwidth capacity constraints. As a consequence, among the group of countries that chose a beauty contest system, some offered one more licences compared with those that were operating in the second generation (Spain, Portugal), while in others (France, Finland) the number of licences was the same as in 2G. Another matter that takes on a special importance is the earnings obtained from the licences, both in absolute and relative terms. Undoubtedly, the countries that chose an auction system have received higher amounts of money. Again, the United Kingdom and Germany are paradigmatic examples of the success of the auctions. Fig. 4 completes the information gathered in Tables 2A and 2B by showing the relation between the total amount collected by the different countries and the per capita price paid.18 The last column in Tables 2A and 2B show the opening character that the industry seems to exhibit, at least in its introductory phase. In second-generation technology, national markets were overloaded with domestic companies and it was relatively infrequent to find operators that were present in more than one market (Vodafone and Orange are the only clear exceptions to this assertion). 3G is completely different. Industry growth expectations, together with the consolidation and maturity of a growing number of telecommunications operators, have caused all of them to be immersed in an expansion process that is observed across the whole continent. This phenomenon could be qualified as an Europeanisation of the industry. Thus, a number of major operators (like Vodafone, Orange, T-Mobile or Telefo´nica Mo´viles) play a part to some extent in almost every country.

18 Notice that quantity of money collected per inhabitant is calculated exclusively on the basis of the initial payment made by the license acquisition. It does not therefore include amounts paid afterwards, like royalties or any other kind of tolls. For instance, Spanish operators initially paid out a quantity for the acquisition of a 3G license and promised to pay a toll for the use of radio electric space periodically. Therefore, for the Spanish case, the take per inhabitant should be corrected, adding somehow the payment method of this subsequent toll.

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Table 2B 3G Mobile operators in Europe (award method: beauty contest)

Spain

France

Licences

Bidders/winners

Fee (million h)

Cost per capita (h)

Licence award

Commercial deployment

Shareholders

4

Telefo´nica Mo´viles Vodafone Amena Xfera

130 130 133 130

13

March-00

May-04 May-04 October-04 N.A.

TEF (92.5%), Free floata (7.5%) Vodafone (100%), France Telecom (100%) Telia Sonera (29.4%), ACS (35%), Mercapital (20%), Others (15%)

Total

523

Orange France SFR

619 619

31

May-01b

July-04 June-04

Bouygues Telecom

619

Orange (100%) Vodafone (43.9%), Vivendi Universal (56.1%) Bouygues (83%), JCDecaux (10.5%), BNP (6.5%)

3

Total Portugal

Sweden

4

4

N.A.

1.857

TMN Vodafone Portugal Optimus

100 100 100

OniWayc

100

Total

400

Vodafone Sweden SUN AB

0.011 0.011

Orange 3 (Hutchison)

0.011 0.011

Total

0.044

40

December-00

April-04 May-04 June-04

–

0

December-00

July-04 March-04 N.A. May-03

Portugal Telecom (100%) Vodafone (100%) SonaeCom (46.3%), 093X (25.7%), France Telecom (20.2%), Maxistar (2.8%), DGT (5.0%) –

Vodafone (100%) Tele 2 (50%), TeliaSonera (50%) France Telecom (100%) Hutchison Whampoa (60%), Investor (40%)

Source: Klemperer (2002a), Prat and Valleti (2000), /http://umts-forum.orgS, European Commission (2002), Credit Suisse (2006). a As of April 2006, Telefo´nica has launched a takeover bid to completely buy its mobile operator (so far, approximately 7.5% of the shares are quoted on the Spanish stock market. b In the case of Bouygues Telecom, the licence was awarded in May 2002. c By Order of the Minister for the Economy of 13 January 2003, the OniWay licence was repealed.

Therefore, several mobile service providers, whose activity was traditionally local, have transcended their borders by moving into other EU markets. This strategic scope allows a classification of firms that depends on the number of countries in which the operator is present (see Table 3). This new configuration places Vodafone and Orange one step ahead of the rest of European operators, given that they are present in most of the States of the EU: the European Commission (2002) described these operators as pan-European. Next, there is a group that includes several companies derived from the former fixed incumbents, like O2,19 T-Mobile, Telefo´nica Mo´viles or Telia Sonera (and also Sonera before the merger with Telia). These operators are present, on average, in a number of States that range between four and six and the European Commission (2002) identifies them as cross-Europeans. The rest of the firms only operate in their local and adjacent markets (regional players, like Tele 2 or Telia—before the merger with Sonera) or only in local markets (local players, like Amena20 or TMN). Finally, there is a special company that emanates from outside the EU (external player: Hutchison Whampoa, from Hong Kong). Whalley and Curwen (2003) propose a similar categorisation and classify the operators in terms of the licences—both 2G and 3G—they acquire. However, these authors go one step beyond and try to explain the true evolution of the industry in terms of consolidation or fragmentation.

19 20

O2 was created as the mobile operator of BT but the mobile firm spun off from BT in November 2001. Recently (January 2006), it was acquired by Telefo´nica. France Telecom acquired Amena in July 2005.

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60.000

700

Auction

Fee (mill. ) Cost per head ( )

50.000

600

500

mill€

40.000 400 €

30.000 300 20.000 200 Beauty Contest

10.000

0

100

Germany

Italy

United Kindgdom

Spain

France

Portugal

Sweden

0

Fig. 4. Total fee and cost per head (UMTS licences). Source: European Commission (2002). Table 3 Operators typology before and after 3G Type of player

Description

Before 3G Number

After 3G Company

Number

Company

Players present in the majority of 2 the EU countries 4 Players present in four to six EU member states with one or two big markets without any regional focus

Vodafone Orange T-Mobile O2 TIM Telenor

2

Vodafone Orange T-Mobile O2 TIM Telenor Hutchison Whampoa KPN TeliaSonera Telefo´nica Mo´viles

Regional

Players present on adjacent markets limited in number

3

KPN Tele 2 Telia

2

Tele 2

Local

Players present in one member state only

8

Telefo´nica Mo´viles Sonera Amena TMN Boygues Radiolinja TDC Telering

6

Amena TMN Boygues Radiolinja TDC Telering

External

Player not present in EU

1

Hutchison Whampoa

0

–

Pan-European Cross-European

8

Source: European Commission (2002).

The origin of 3G was supposed to provide a real opportunity for consolidation. Nevertheless, the evolution of the sector did not confirm this assumption and fragmentation seems to be the dominant pattern. The difficulties associated with the launching of 3G would partially explain why almost all incumbents have been forced to reformulate their ambitious plans for expansion, and also the slowing down of investments or the return of licences (Whalley & Curwen, 2005). Interestingly, the acquisitions of O2 by Telefo´nica and Amena by France Telecom, together with rumours about further corporate movements, could re-open the debate about the globalisation of the industry. The consolidation of the sector has probably not finished yet and the coming years will be crucial to its final configuration.

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4. Discussion The previous sections have revealed an asymmetric and relatively unexpected evolution of the 2G and 3G technologies. The global success of GSM led to the prediction of a similar trend for UMTS, which has not been confirmed by the evidence. Although the determinants of the success of a given technology are complex, there are some differences between 2G and 3G that can, at least partially, justify this asymmetric behaviour. One of the key factors of the GSM evolution derives from the way in which the standard is finally settled (globally regulated vs. open market). This decision has had a substantial impact ‘‘on prices, penetration rates, service and feature availability, new technology development and deployment and coverage of 2G services in the EU and the US’’ (Gandal et al., 2003). Undoubtedly, the adoption of a common standard in the EU can be considered a great success, contrary to the strategy followed in the United States, where regulators allowed the market to determine the standards (Gandal et al., 2003). At the launch of UMTS, the European authorities tried to replicate GSM conditions. Unfortunately, this replication does not seem to be enough to guarantee the rapid success of the new technology. The very different situations at the beginning of the 1990s and the 2000s—origins of GSM and UMTS, respectively—can probably partially explain the progress of both technologies. The conditions for the development of GSM were optimal for achieving important diffusion and success. As a consequence, at the end of the 1980s there were only about eight million mobile subscribers throughout the world (four million in Western Europe) while a decade later this figure was close to 800 million (250 million in Western Europe) (http://www.coleago.com). On the other hand, UMTS did not face the same positive circumstances. It is true that European countries also reached an agreement about the UMTS technological standard, in a similar way as they have done for GSM, but this new technology exhibited several difficulties that made its subsequent launching difficult. For instance, it seemed as if UMTS did not consider GSM as a competing technology. At the inception of GSM, a user compared the utility of acquiring a GSM mobile with the utility of not acquiring it. At the inception of UMTS, the comparison took place between the utility of having a GSM handset against the utility of acquiring a UMTS. Arguably, the net balance is completely different in the two comparisons. In the first case, it is reasonable to think of a positive balance. However, the advantages of UMTS compared to GSM were not as clear for the customers. At the date of launch UMTS handset and technology policy was not well implemented, so that it was not possible to exploit properly all the services associated with the new technology. Nowadays, UMTS handsets offer a clear additional service over GSM especially in terms of multimedia services. Moreover, UMTS has faced several problems that have delayed its diffusion. It is well known that one of the arguments that justified the delay in the launching of UMTS was the scarcity of handsets. Additionally, the huge amounts of money paid for the licences have limited the investments in infrastructure that were necessary to compete with GSM. Coverage in the main cities has suffered continuous delays, which constituted an added difficulty for the takeoff of UMTS. UMTS has not only competed against GSM, but has also had to confront the appearance of new players—such as the mobile virtual network operators (MVNOs)—that distort the initial conditions. Likewise, the appearance of alternative technologies—such as VoIP—further hinders the generalisation of UMTS as a mass technology. 5. Conclusions This paper has examined the history, evolution and configuration of the mobile telecommunications industry in the EU, in both second- and third-generation technologies. The history of 2G in Europe is characterised by the joint effort of the different countries with respect to important decisions such as the standard that technology should follow. The main consequence of these supranational policies is that GSM has been consolidated as the main standard throughout the world (with the main exception of the United States). Undoubtedly, the success of this industry cannot be questioned in the light of the data: 2G has reached penetration rates without precedent in history. The euphoria in the sector was so important that the amount of money that firms paid for the 3G licences was, retrospectively, the result of an unjustified overestimation in expectations. As a consequence of the process of licence award and of some additional factors like the 2000 stock-market crisis (which particularly affected the ICT sector), the commercial launching of 3G was delayed, which raised doubts about whether its journey was going to be as stellar as that of its predecessor. Beyond this appreciation of third-generation’s future, the paper has also offered some discussion about one of the recurrent topics in the sector: the extent to which competition has been achieved in the market. It has been observed that there are important differences between the European countries analysed in this research. This paper concludes that there is a group of countries that have achieved a reasonable level of competition while in others liberalisation has not satisfactorily increased rivalry. Within this context, the case of the United Kingdom is of special interest. The British telecommunications regulator is constantly promoting measures that try to favour intervening in users’ transit decisions, with subsequent effects on competition. Among those measures, the early introduction of number portability or the presence of four operators from the beginning of the GSM technology may have been especially relevant. It is precisely at this regulatory level where the UK mobile telecommunications sector seems to be a step ahead of the rest of the EU members. Another important phenomenon is the sector’s transformation in terms of spatial competition. The market has progressed from pre-eminent local markets in 2G to a clearly global industry in 3G, with a few companies (mainly

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Vodafone and Orange, but also firms like T-Mobile, TIM, Telia-Sonera or Telefo´nica Mo´viles among others) operating simultaneously in several countries. In summary, the coming years would seem to be extraordinarily important for the industry’s future. Together with the doubts that surround UMTS technology, it is necessary to consider further elements that can condition its definite take off, such as the role of mobile virtual network operators (MVNO) or voice and data solutions through the internet (VoIP). A thoroughgoing analysis of MVNO or VoIP would be of interest in order to better understand the future evolution of the industry. Unfortunately, such analysis goes beyond the objectives of the present paper.

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