The end of the soft cell

Oftel has ruled that the cost of calls to mobile phones should be reduced. But will consumers simply pay in other ways? Charlotte Ricca-Smith investigates

The British love a bargain - think of January sales, package holidays and family packs of processed chicken. Our attitude towards mobile phones tells a similar tale. With handsets being sold at knockdown prices, or even offered for free, it is little surprise that more than 47 million people in Britain now own a mobile. We take these subsidised prices for granted, and mobile phone manufacturers rely on them. But the days of the cheap mobiles are numbered. The network operators Orange and Vodafone have already increased the prices of many of their handsets by around £40 - and this is only the beginning.

The move follows the decision of telecoms regulator, Oftel, to reduce the cost of making a call to a mobile by up to 60 per cent, over the next three years. The first 15 per cent decrease was implemented on 24 July, which Oftel expects will save the customer around £220m. Its main focus has been the excessive cost of calls made from landlines to mobile networks, which proved a cash cow for wireless operators, offsetting their outlay on subsidising customers.

But with the connection charges already cut, and further annual discounts to follow, operators face losses of up to £2bn. Unsurprisingly, the four mobile giants - Vodafone, Orange, T-Mobile and O2 - have fought Oftel every step of the way; Gavin Darby, the chief executive of Vodafone UK calls it "fundamentally flawed". But after a year-long battle, the High Court pronounced Oftel the victor in January. David Edmonds, the director general of Oftel, hopes that the operators "will now behave in the interests of all those UK consumers who call mobile phones". However, a spokesperson from T-Mobile said consumers should be wary of seeing this new ruling as a good thing.

"The competition commission did not suggest mobile phone operators weren't entitled to recoup their investment, just not in this way," a spokesman said. "One result will be that subsidies will disappear and the cost of buying a new handset will go up considerably." Indeed, according to Orange, Oftel has actively encouraged the operators to find alternatives to fill this substantial revenue hole. A reduction in subsidies was just one of its suggestions, as was increasing the cost of calls abroad. So while some consumers may save money in one area, others end up paying more elsewhere.

And it isn't just the buying public who will be hard hit by subsidy cuts. The manufacturers also rely heavily on these operator handouts to shift phones. Mobile sales have decreased sharply over the past few years: last year 17 million were sold in the UK compared with 28 million in 1999, and figures for the first half of 2003 show little growth. The manufacturers are desperate to find new ways to sell new phones. The answer? Upgrades.

According to the 2003 Mobinet study of 5,600 mobile phone users around the world, one-third of users plan to upgrade in the next year. That's a lot of potential sales - but only because they are under the illusion that they will pay very little for the privilege. Had they been told that a new phone could cost them up to £250, the number would undoubtedly be lower. Which is bad news for the manufacturers.

Nokia is already feeling the pinch, and has revealed losses of $127m in the first quarter of 2003. It plans to lay off about 2,000 people this year. And Sony Ericsson is having even worse financial problems.

According to Peter Richardson, the vice-president of research at the venture capitalist group SoundView Technology, these companies have only managed to maintain the subsidy bubble this long because they have played on the operators' desire to attract new customers.

"It is very disingenuous to expect operators to subsidise their products," he says. "I can't think of any other market where the first party steps in and pays part of the price to make the product more attractive to the end user."

But with few new customers to attract, the incentive to subsidise has gone. Which spells trouble for 3G licensee Hutchison, which is attempting to penetrate the UK market with 3. So far sales have been dependent on massive subsidies, and the future of 3G networks could be in jeopardy if such price cuts can no longer be offered.

O2 has already delayed its 3G plans until the end of 2004, but 3, having spent £4.4bn securing the licence and hundreds of millions more building the network and marketing its services, has little choice but to battle on with 3G, because it has no other wireless licence.

It aims to gain one million subscribers by the end of the year, but so far has achieved only about 12 per cent of that target; which is why 3 is one of the few operators keen to keep handset prices low.

Vodafone, by contrast, sees subsidies as a manufacturer conspiracy. Although the company declined to talk about this "sensitive issue" in detail, one source suggested that the manufacturers have had it easy till now. "They have to take more responsibility for the price of their phones," the Vodafone source explained. "It is because of cheap handsets that customers expect a new one each year. But it really doesn't matter to us what handset they use - just what they use it for."

New uses are top of the operators' agenda. While voice calls still generate around 85 per cent of their revenue, competition, and now Oftel's regulations, are driving down charges. As a result, the operators are focusing on creating new services, such as picture messaging and games. For your benefit? Don't be daft. It's so they can charge more for them. Downloading ring tones is expected to generate £2.5bn in revenue, which is why operators' aim is for data to account for 25 per cent of their profits by 2005. That way, they may claw back some of the £22bn invested in 3G licences. And, of course, offering these services keeps the user tied to the network - something that's key to an operator's success.