The frequency isn't fuzzy, the finances are: whatever happened to 'the next big thing'?

Small audiences, few advertisers, big losses. A decade after the first broadcasts, Tim Webb asks when digital will turn into the smart set

Last September, Stephen Carter, the head of media regulator Ofcom, made a joke at an industry seminar in Westminster. Because he had formerly been a shareholder in Digital One, a leading force in digital radio, he told his audience: "I have some understanding of the commercial returns - or not - generated by the digital audio broadcasting [DAB] platform."

Last September, Stephen Carter, the head of media regulator Ofcom, made a joke at an industry seminar in Westminster. Because he had formerly been a shareholder in Digital One, a leading force in digital radio, he told his audience: "I have some understanding of the commercial returns - or not - generated by the digital audio broadcasting [DAB] platform."

Next to him, Ralph Bernard, then chief executive of the radio company GWR (now executive chairman of GCap Media, created by the merger of GWR and Capital Radio), laughed nervously. GWR (and now GCap) owned Digital One, so he knew all about the losses generated by what the radio industry has been heralding for years as "the next big thing".

In a research note entitled "Digital killed the radio star", stockbroker Panmure Gordon estimates that over the past five years, the five main quoted radio groups - Capital, GWR, Chrysalis, Emap and Scottish Radio Holdings - have invested around £100m in digital radio. In return, they have chalked up losses of almost £55m for the same period.

The BBC made its first digital radio broadcasts in September 1995, while the first commercial radio station went digital in November 1999. The industry trumpeted its growing popularity when, last Christmas, sales of DAB radios broke through the one million mark, just two years after the first portable DAB set was launched.

But as Richard Wheatly, chief executive of the Local Radio Company, the commercial broadcaster, points out, this is misleading: "A lot is made about one million DAB sets being sold but the replacement cycle is very slow. It will take a long time to replace the 120 million analogue sets out there."

No one knows how many people actually listen to digital radio. Ratings body Rajar reports that in the third quarter of 2004, the 12 commercial stations that are available only on digital claimed just 4.4 per cent of all radio listening. But there are no reliable figures for those stations that are also available on analogue, or on digital television, or on the internet. As a result, advertisers, which base their spending on who - and how large - a media company's audience is, do not fully trust digital radio yet. Privately, radio executives admit that some stations struggle to sell their advertising slots.

Mr Wheatly, whose company has not gone digital, says that many consumers have yet to be convinced. "Digital radio will be a slow-burn technology," he says. "It has no killer application for consumers. People are not saying 'I have to have this'." Meanwhile, DAB radio sets, while they have fallen in price, still cost over £50.

Even though listening figures are tiny, audiences in the UK are among the highest in the world. But because of this, most global car manufacturers do not fit digital radio in standard models. To compound the problem, most mobile phones cannot yet receive it, and "add-on" services made possible by digital - such as text information - are either limited or non-existent.

Even advocates such as Emap, which accounts for half the market, know the technology has some way to go. Shaun Gregory, managing director of national brands for Emap Radio, insists: "Digital radio will get there. It will just take time. People forget that digital terrestrial television [DTT] had a bad start with ITV Digital. But the BBC is now backing DTT and it's also backing digital radio. So the signs are good. We are not worried about how much we have invested."

Coverage is another problem. There are currently 48 digital radio multiplexes - or chunks of digital spectrum - in the UK. Two of these are national multiplexes, one of which is operated by the BBC, the other by Digital One. The other 46 are local multiplexes that operate in similar areas to the existing local or regional analogue stations. Ofcom estimates 86 per cent of the population are covered by at least one.

But this does not mean 86 per cent of people can listen to digital radio, as most licence holders only have to make a commitment to transmit across 70 to 90 per cent of their area. Because of the cost, most do not go beyond this, particularly in rural areas where they would have to build extra transmitters for small numbers of potential listeners. As a result, most of Wales, northern Scotland, the North-west and parts of East Anglia and the South-west are digital radio "blackspots". As Miranda Carr at Panmure Gordon notes: "Radio companies' definition of coverage is different to most people's."

Typically, a small station may have an annual bill of £50,000 for analogue transmission, while it costs some £300,000 a year to run one digital multiplex. This is prohibitively expensive for many companies, as Mark Thomas, head of broadcast technical policy at Ofcom, admits: "The economics of DAB are less friendly to smaller stations. They tend to be more marginal businesses for whom the costs of simulcasting [broadcasting on analogue and digital] would be daunting. There are usually no peers to share a multiplex."

Ofcom, which is halfway through a comprehensive review of the radio sector, is planning to release three new blocks of spectrum, but it can't wave a magic wand to solve all these issues, particularly the one of cost. Laurie Patten, an analyst at technology consultancy Spectrum, points out that if the regulator over-subsidises digital, it risks alienating companies that have already spent large amounts. "If you intervene too early, you may discourage further investment in multiplexes. This could be damaging."

The future of digital radio is uncertain. No one knows how many people will be listening to it in five years, or when companies will make a return on their huge investments. But as Ms Carr from Panmure Gordon says, the fear of missing out will keep the money coming. "Despite all the problems and the cost, companies will invest in digital because they will lose the commercial advantage if they don't."