The Mobile Phone Industry in the UK - Case Study Example

Table of Contents Page Introduction 1 Plan of the paper 2 2 Methodology 2 2. Theoretical concepts and issues 3 2.1: A brief history 3 2.2 Induced Innovation 5 2.2.1 The Technology Push Model 5 2.2.2 The demand pull model 6 2.3. Evolution theories 7 2.4 Path-dependent theories 8 2.5 A summing up 8 3. The mobile phone industry in the UK 9 3.1. Market Size 9 3.2 Market Penetration 9 3.3 Market Structure 10 3.4 Technology trends 11 4. Matching theory with evidence 12 4.1 Some common strands 13 5. Conclusion 13 6. Bibliography 15 ******* The mobile phone industry in the UK: A case study in the economics of technological change 1. Introduction The almost universal ownership of personal mobile phones in the UK (Keynote, 2005) coupled with high-decibel advertising have today made almost every Briton aware of such terms as 2G or 3G. The terms refer to technology – 2G stands for second-generation technology while 3G stands for third-generation technology. Mobile phone owners (and/or users) also know that they now have the option of upgrading their mobile phone service from 2G to 3G – an improvement that would allow them to not only make and receive calls (voice-service) but also enjoy many other non-voice features such as ‘log onto the office network, surf the Internet, order and pay for goods, manage … investments on the stock markets, check the weather or find the nearest Italian restaurant.’ (mPhone Ltd, n.d.). This is an example of technological change or technological innovation. What factors prompt firms to spend on research and development and develop new technologies, new manufacturing processes or new products? What are the determinants of technological change at the firm level? What are the determinants of the rate and direction of technological change? What is the relationship between market structure and technological change? What role does technological innovation play in driving economic growth? How does the rate of technological change enhance the global competitiveness of different economies? These are some of the questions that the subject ‘economics of technological change’ deal with. In this paper an attempt has been made to try and answer some of the above questions in the context of the empirical evidence provided by the mobile phone industry in the UK. Since the subject ‘economics of technological change’ is vast, growing and highly complex (see, for example, Verspagen & Werker, 2003 for an interesting insight to the state of current research on the subject), this paper makes no claim of being either a very rigorous or a very comprehensive attempt at answering these questions. Instead, it is more of a learning exercise where an attempt has been made to study the industrial and market dynamics of the mobile phone industry in the UK with a view to understanding some of the basic economic issues involved in technological change and innovation. As a result, the paper concludes not with a set of unambiguous answers to any set of rigorously stated questions but instead with a few theoretical questions each of which can perhaps be the point of departure for separate dissertations. 1.1. Plan of the paper Section 2 discusses the state of theoretical knowledge in the subject so as to try and identify some of the more important economic theoretical concepts and issues that are relevant for understanding or explaining technological change in any industry. Section 3 goes on to take a brief look at the mobile phone industry in the UK in terms of the size of the market, number of players in the market, the structure of the market, the rate and direction of technological change in the industry and some forecasts regarding the industry in general and technological change in the industry in particular. Armed with this information, Section 4 makes an attempt to revisit the concepts and issues discussed in the first section to identify which of them are relevant for understanding technological change in the personal mobile phone industry in the UK. That is, the third section tries to match theory with the evidence. Finally, Section 5 concludes by raising some theoretical issues that arise from the matching of theory with factual evidence as discussed and analysed in the fourth section. 1.2. Methodology To be honest, any attempt to build a quantitative model of technological change in the mobile phone industry in the UK based on relevant statistical industry data will be a far too ambitious project for this researcher given his present state of knowledge and expertise. Hence, this paper has consciously eschewed any attempt to adopt a rigorous, quantitative methodology. Instead, it has restricted itself to a general, qualitative discussion of the subject. After all, it must be remembered that this is more of a learning project than any ambitious attempt to add new knowledge in this particular field. But then, unless one tries to know what is the present state of knowledge, how can one begin to generate new knowledge? This is the only consolation given the limitations of this dissertation! 2. Theoretical concepts and issues Even a very brief and sketchy survey of the literature on the economics of technological change forces one to agree with Granstrand (cited in Verspagen & Werker, 2003, p.2) that ‘technology has historically penetrated the economy far more than it has penetrated economics.’ In fact, the more one dives into the subject the more does the desire grow to tear one’s hair in frustration due to what appears to be utter chaos and confusion. It is almost impossible to find even a single unambiguous theoretical assertion. There are far too many schools of thought and far too many debates over far too many issues. Perhaps Ruttan sums it up best when he writes: The theories and models of technical and institutional change available to us at the present time are not well articulated. In attempting to understand the generation and adoption transfer of new technology and institutions, we are confronted with a kit of loose tools and a body of generalisations. (Ruttan, 2001, p.61). 2.1. A brief history Historically, the relationship between economics and technology has been a subject of investigation even in the works of the early masters such as Adam Smith, Ricardo or Karl Marx. However, it was not until the early part of the Twentieth Century that this subject began to be treated within a modern theoretical framework. The German economist, Joseph Schumpeter, was one of the first to take up the issue within the paradigm set out by the new orthodoxy in economics – the neo-classical, maginalist school of thought. Responding to the static character of the then prevalent marginalist theories, he adopted a dynamic approach and identified technological innovation as one of the most important engines of economic growth (see Kyn, 1966 for a lucid exposition of the central themes of the Schumpeterian logic). It turns out that, since then, and till the 40s, many of the issues discussed by economists writing on the subject of the relationship between economics and technological change are the same ones that are being grappled with today (Stoneman, 1983, p. 151). Which means the jury is still out on these issues! However, just as time, the process of knowledge acquisition too, never stops. Since then there has been a paradigmatic shift in the way technological change has been treated by economists. To quote Ruttan again: In the early 1950s both technical and institutional change were treated by economists as exogenous to the economic system – as “manna from heaven”. By the 1990s both technical and institutional change were seen as largely endogenous – as induced by changes (and differences) in the economic environment. (Ruttan, 2001, p.61) This marked a major step forward in the understanding of the economic aspects of technological change because today, intuitively, one can see that there is a strong relationship between technology change or innovation and competitive market structures and the resultant fight for market share by different firms. Even the layman, the non-economist consumer of various products and services, will often be found to say that firms introduce new products and services to stay in business and survive. The job of the professional economist is to formalise this intuition and build a rigorous theoretical model to explain in greater detail why this is so and perhaps predict the rate and direction of technological change given likely changes that will take place in the economic environment and vice-versa. But, more on this later (see Section 2.2). Moreover, intuitively, it is also possible to see that there is some kind of two-way relationship between technological change and changes in the economic environment. As the professional economist puts it ‘Technological change has relevant effects on industrial dynamics and industrial dynamics has effects on the rate and direction of technological change.’ (Antonelli, 2003, p. 81) If this be so, it seems obvious that technological change must be treated as an integral part of the economic system – as integral as say factor endowments or output markets. Earlier, it used to be believed that technological change came from outside the economic system as a kind of ‘shock’ to the system and had the effect of extending outwards the production function of the entire economy. In the modern approach, technological change is seen to be arising from factors within the economic system and to be working at the level of the firm. Of course, within this broad approach there are differences and presently there are at least three different schools of thought (Ruttan, 2001, Geocities, n.d.) regarding the sources and effects of technological innovation. These three approaches are known as: (a) Induced innovation – technology push and demand pull, (b) evolutionary theory and (c) path-dependent theories. Some commentators, however, merge (b) and (c) above and consider both to be part of evolutionary theories (Verspagen & Werker, 2003). Following Verspagen & Werker, the first theoretical paradigm is represented by the works of such theorists as Griliches, Kamien, Mansfield, Scherer, Schmookler and Stoneman while the second paradigm is represented by the works of economists such as Dosi, Freeman, Pavitt, Soette and Nelson and Winter (Verspagen & Werker, 2003). 2.2. Induced Innovation This school of thought is essentially based on the neoclassical framework under which attempts are made to build explicit models primarily based on the assumption that firms carry out production along the production function. Such models also make several other assumptions about the nature of knowledge and technology acquisition. Scholars have pointed out several difficulties with such assumptions about knowledge and technology acquisition and so far no one seems to have proposed ways to remove these difficulties such that they find general acceptance. Critiques have also pointed out that there are several reasons why, in reality, resource allocation for technology innovation is unlikely to be optimal although the neoclassical framework assumes that once firms reach equilibrium, resources are automatically optimally allocated. (Geocities, n.d.). Notwithstanding these difficulties, two types of linear models have been postulated within this basic framework – the technology push model and the demand pull model. 2.2.1. The Technology Push Model In theoretical models of this genre it is postulated that new technologies leading to either new production processes or new products emanate essentially from advances in pure science. New scientific discoveries go through a process of application and development to ultimately diffuse into the economy and firms within the economy to finally appear in the market as new production processes or new products. Thus, in such models technological innovation is seen essentially as exogenous. The proponents of this school, while accepting the desirability of considering the endogeneity of technological innovation, admit that their models attain this objective only to a ‘limited degree’. (Stoneman, 1983, p.151). Generally, and this is a big generalisation since changes in the assumptions underlying such models can lead to widely divergent outcomes, analyses done by using these models conclude that the adoption of new technologies by firms would lead to a fall in their cost structure and would shift their marginal cost curves downwards. In competitive market structures, output prices will remain the same leading to higher output and employment. That is, although under certain conditions there is ‘no guarantee that technological change will not lead to technological unemployment’ still there is no need for any pessimism on this count (Stoneman, 1983, p.159). Incidentally, there are scholars such as Richard Day who have argued that irrespective of the sources or processes of technological change, diffusion and adoption by firms, innovation and introduction of new technologies almost invariably lead to rising unemployment of unskilled labour. (Day, 2004, p.113). Be that as it may, given their various limitations and the partiality of approach, it is quite clear that such models certainly do not qualify to be called general theories of the economics of technological change. 2.2.2. The demand pull model In such models it is postulated that economic growth (demand) influences inventive effort (Geocities, n.d.). In such models instead of the marginal cost curve shifting downwards, it is postulated that the demand curve and the marginal revenue curve shifts outwards. Again, the results are the same when competitive market structures are concerned – total industry output increases and price declines. (Stoneman, 1983). Although scholars have provided empirical evidence to support various hypotheses emanating from these models it is, however, generally accepted that such models are too simplistic and there is certainly a need for a more comprehensive theory that integrates both approaches and helps us to understand ‘how demand and technological opportunities interact with each other and with the institutions that form part of the innovative process.’ (Geocities, n.d.). Moreover, these models seem to ignore other supply-side factors such as the impact of relative factor endowments and prices although as Ruttan points out ‘As of the mid-1980s the tests in agriculture, both in the United States and abroad, provided conclusive evidence that changes (and sometimes differences) in relative factor endowments and prices exert a pervasive impact on the direction of technical change.’ (Ruttan, 2001, p.108). 2.3. Evolution theories The essential idea behind evolutionary theories such as that of Nelson and Winter is that firms begin to search for new technologies when their profits fall below a certain threshold. If a new technology is found to be profitable, it is accepted, profits are reinvested and successful firms grow faster than unsuccessful ones. (Ruttan, 2001, pp.110-111). The crucial difference between this approach and that of the induced innovation school is the way technology is conceptualised. Instead of assuming that once a new technology is developed all firms can appropriate the new technology with equal facility, evolution theories emphasise that a firm’s own knowledge and skills play an important role in the adoption of new technologies and that the push for technological innovation does not come from outside but from the firm’s own desire to maintain a certain level of profitability. Although there are some scholars who do not see much difference between evolutionary economics and “normal economics” (Verspagen & Werker, 2003), researchers working with empirical evidence on the history of successful and unsuccessful firms tend to agree with the evolutionary approach. Foster, for example, emphasises that limits are fundamental and that ‘In the world of business, limits determine which technologies, which machines and which processes are about to become obsolete,’ and it is these limits which tell firms when they need to develop new technologies to remain profitable and successful. (Foster, 1986, p.32). That is, firms must continually search for new technologies since there is a limit beyond which no technology will yield profits. These scholars also emphasise the role of the S-curve and how because of the S-curve ‘without continuous research and development [by firms], enduring growth is not possible.’ (Kumar & Siddharthan, 1997, p. 86). For example, Kumar & Siddharthan write: The argument runs as follows: all firms would like their growth curves to be exponential so that they grow at a compound rate. On the other hand the sales curve of a product is not exponential but is ‘S’-shaped, or logistic, characterised by three stages, the first denoted by high technological change but very low growth rate, the second indicated by very high growth rate and stabilising technology, and the third by declining growth or even negative growth resulting in an actual fall is sales and the standardisation of technology. (Kumar & Siddharthan, 1997, p.86). Foster too uses the S-curve extensively to support his main argument that firms must continually seek to innovate if they have to remain successful. He cites the examples of several successful companies such as IBM, Procter & Gamble, Monsanto and others to forcefully argue that continuous innovation is the key to long-term success and survival. (Foster, 1986). 2.4. Path-dependent theories Theorists belonging to this group look at technology as a system. The key concept behind the path-dependent models is that ‘technical change is an on-going process of accumulation of knowledge,’ and innovative firms utilise the progress made by others to make progress themselves. Though their ideas are similar to the evolutionists, they put a lot of emphasis on the assertion that evolution of technologies is path-dependent, i.e. history affects the present and the future leading to institutional rigidities. They explain the specialisation of certain economies in certain specific technologies by claiming that path-dependency leads to certain economies getting locked-into certain specific technological paradigms. (Geocities, n.d.). 2.5. A summing up Our review of the main strands of thought on the economics of technological change shows that from a theoretical point of view much work still needs to be done before we can have some kind of convergence of the various ideas, all of which seem valid in their particular context. There is clearly a need for a more rigorous, comprehensive and holistic approach if a general theory of technological change has to find wide acceptance. As Ruttan puts it ‘A more rigorous approach to the development of a general theory of the sources of technical change will be required to bridge the three [discussed above] “island empires”.’ (Ruttan, 2001). 3. The mobile phone industry in the UK The year 2004 may well prove to be a landmark of world-historic proportions. In that year, for the first time ever, the number of mobile phones around the world, at 1.5 billion, overtook the number of fixed landlines. (Keystone, 2005, p.21).1 The UK was not left behind in this explosive growth of mobile phone usage. Since the first mobile phone call was made in the UK on 1 January, 1985, there has been a period of exponential growth in mobile usage and today the market is becoming increasingly saturated. In keeping with global trends, in 2004, for the first time mobile voice and data revenues, at 12.3 billion pounds, overtook fixed-line voice revenues. (Ofcom, 2005, p.2). 3.1. Market Size Keynote, citing research done by the Centre for Economic and Business Research and published in 2004, says that if handset sales and additional distribution revenue are factored in, the total impact of the mobile phones industry on the UK economy was 19.4 billion pounds. This amounted to around 1.9% of gross domestic product (GDP). The value of the mobile phones market, measured by total operator revenue, increased by 13% between 2002/2003 and 2003/2004 to 13.97 billion. The rate of growth has been declining gradually since 2001/2002, following a sharper drop in growth on the preceding year. However, on the whole, since 1999/2000, the market has more than doubled in size. 3.2. Market Penetration The mobile phone market is following in the footsteps of other industries and sectors where high rates of technological change have continuously brought down prices and thereby enhanced accessibility. While in the early days mobile phone ownership and usage was mainly restricted to the highest earning groups in society, with the continuous fall in prices of handsets and tariffs, mobile phone penetration in the UK today stands at over 78.1%. In 1995, penetration stood at just 6.1%. By 2001, this figure had risen to 62.7% and the following year it was 72.4%. In 2004 the figure had reached 78.1%. Today, in terms of social grade or income group, the penetration is 86.2% in the highest income group, A, 82.2% in B, 81.7% in C1, 77.8% in C2, 74.5% in D and 61.6% in E. This means that except for the lowest social grade, the penetration level for all other social grades are more or less comparable at well over 70% and even in the lowest social grade, a large majority are either owners or users or have access to mobile phones. This is the reason why secular growth of the industry by acquisition of new customers is unlikely in the short term. The market has reached saturation point and any further revenue growth must come from higher average revenue per user (ARPU). 3.3. Market Structure The mobile phones market is dominated by a handful of players. Barriers to entry are high for new entrants due to high costs of setting up networks, licences and brand building. Although the rapid advances in digital technology is lowering technology costs, the cost of marketing is far too high for those wanting to compete, even on a ‘no-frills’ basis. In the past, these entry barriers made it difficult for new entrants to compete in the UK market and, so far, it has been dominated by international players with deep pockets and expensively assembled networks. However, in recent years competition has increased with Hutchison 3G entering the market with heavy backing of its parent, Hutchison Whampoa. Competition has also increased with the entry of virtual operators which can thrive without having their own network. Virgin Mobile, with a market share of 4%, is the only mobile virtual network operator (MVNO), i.e. an operator which sells its services by forming an alliance with another operator which has its own network, is the only MVNO so far to have established itself as a major player in the UK market in the same league as the main operators – Vodafone, O2, Orange, T-Mobile and Hutchison 3G. However, British Telecommunications (BT) is also adding to the competition in the mobile phones arena, with increasing influence as a virtual operator and its planned launch of Project Bluephone. These seven companies along with Nokia and Sony Ericsson – major handset manufacturers with subsidiaries registered in the UK – are the main players in the market. The presence of all these players means that the mobile phone industry is now more competitive than ever. In fact, with reference to the situation in 2004, Ofcom has said: In terms of competitive market structures, mobile is strong, with five competing operators, and several more virtual network operators. In almost all aspects, the mobile sector displays the hallmarks of a vigorously competitive market. (Cited by Keynote, 2005) 3.4. Technology trends Although Bell Laboratories introduced the idea of cellular communication as early as 1947 with portable phones for police use, it took another twenty years for AT&T and Bell Labs to propose a cellular system to the Federal Communications Commission of the US. Such a system comprises many small, low-powered broadcast towers, each covering a cell a few miles in radius and collectively covering a larger area. However, it was not until another six years had past before the first mobile cell phone call was made by Dr Martin Cooper, a former general manager for the systems division at Motorola in April, 1973. He is considered to be the inventor of the mobile handset (Bellis, n.d.). It took a few more years before the first commercial mobile phone service started in Japan in 1979. In the US the first commercial service started in 1984. All these were based on the first generation mobile technology. By 1987 cellular phone subscribers exceeded 1 million in the US and the airwaves became too crowded. This forced the mobile phone companies to develop a new technology that could tackle this problem. The Advanced Mobile Phone Service was the first commercial mobile standard approved in 1978 which remained in operation till the pressure on the airwaves led to the development of the TDMA-IS-54 standard, which came to be recognised as the second-generation mobile phone technology. This technology was commercialised in 1991. Then came the Global System for Mobile Communications (GSM) standard which was an improved version of the TDMA standard and is therefore, sometimes referred to as a 2.5G technology, i.e. a technology that is in-between the second and third generation technologies. Though created in 1987, it took a few more years for the GSM technology to be commercialised and it was approved in the US only as late as 1995. Third generation mobile phone technology hit the markets in just another 5 years and by 2000 this new technology began to be commercialised. Today even as 3G technology remains still in its infancy, newer technologies such as WiFi and WiMax technologies and smartphones have begun to threaten the 3G technology. This brief history shows how technological change in the mobile phone industry has been accelerating over the years with each new technology taking a lot less time to come to the market and get commercialised. While the pre-first generation technology reigned for a full three decades (1947 to 1978), the transition from first generation to second generation took only about 14 years while the transition to 3G took even less time – a mere 9 years. And today, in just a little more than 5 years, even before the 3G technology has begun to become the most widely used technology, newer technologies are threatening its dominance. While the early mobile phone technology came into existence due to on the one hand, the accumulating technical advances in radio and electronics technology, and, on the other hand, demand side factors such as the need for mobile phones to be used by such agencies as the police, the 2G technology came into existence due to demand pressures on the limitations of the existing technology. The development of 3G technology has again come about because of demand side pressures caused by saturation of the market and the need to provide more value-added services to customers in a bid to increase average revenue per user. 4. Matching theory with evidence Our brief survey of the mobile phone industry in the UK shows that it is difficult to fit the evidence to any single theoretical model that we have discussed above. If there is evidence of technology push and demand pull, there is also evidence of technology evolution and path-dependence. While in the early stages, supply side factors such as technology push seem to provide the correct framework for understanding technical change and innovation, later it appears that demand side factors such as increasing demand as well as supply side constraints such as technological limitations were the sources of technological change. When it comes to 3G and newer technologies, again we find that both demand side factors (market saturation and the need to increase average revenue per user to ward off falling profits and coming into play of the S-curve) as well as technological limitations (the inability of 2G technologies to provide anything other than voice services) are the drivers of technological innovation. 4.1. Some common strands The history of technological change and market development of any new product seem to be following a general trend that can be noticed in most sectors of the economy. The rapid penetration of mobile phones during the last five or six years -- the doubling of the market since 1999/2000 and the increase in penetration from around 6% in 1995 to nearly 80% in ten years -- have been possible mainly because of two factors – the growth in consumer disposable income (Keynote, 2005, p.9) and a sharp drop in real prices of mobile phones (Keynote, 2005). Hughes commenting on the automobile industry wrote ‘It was this growth in consumer income, combined with the large decline in the real price of the automobile, that made the rapid growth in automobile ownership possible.’ (Cited in Ruttan, 2001, p.430). Similar examples can be found from most other sectors indicating that one long-term impact of technological change is certainly the lowering of real prices of products. The chief reason for this is summed up by Ruttan with the words ‘The fundamental significance of technical change is that it permits the substitution of knowledge for resources, or of less expensive resources for more expensive resources, or that it releases the constraints on growth imposed by inelastic resource supplies.’ (Ruttan, 2001, p. 619). 5. Conclusion The attempt to match theory with reality shows that at present there is no single theory that can claim to capture most of the significant or important aspects of the reality represented by the mobile phone industry. The most important question that this raises is to what extent is the neoclassical approach relevant to studying the economics of technological change? Does it have the power to cover all aspects and all issues and provide some kind of a general theory of the economics of technological change? If it does, how is it that despite its prevalence as the reigning theoretical orthodoxy in economics for nearly 100 years, we still do not have even a workable theory that is more or less widely accepted and can be used to (a) satisfactorily explain the sources or engines of technological change and innovation, (b) predict the rate and direction of technological change and its concomitant impact on the economic environment – especially on such variables as employment, and (c) satisfactorily incorporate the role of the state and other public non-profit institutions in scientific and technological inventions – if technological change is somewhat exogenous and its point of departure is scientific inventions then the state and non-profit but public institutions certainly have a big role to play (Ruttan, 2001, p.602, Antonelli, 2003) – and in that case any general theory of the economics of technological change must be able to satisfactorily incorporate their role? It does seem therefore, that just as information and communication technology is bringing about a paradigmatic shift in the global economy, similarly there is need for a paradigmatic shift in the economic theory of technology. To paraphrase Granstrand, there is no doubt that the time has come for technology to penetrate economics far more than it has penetrated the economy! ******** Bibliography 1. Antonelli, Cristiano 2003, The economics of innovation, new technologies and structural change, Routledge, London. 2. Baxter, Jenny (ed.) 2005, Keynote market report: Mobile phones 3. Bellis, Mary n.d., Selling the cell phone: Part 1: History of cellular phones. Retrieved on January 21 from http://inventors.about.com/library/weekly/aa070899.htm/ 4. Day, Richard H. 2004, The divergent dynamics of economic growth, Cambridge University Press, Cambridge. 5. Foster, Richard 1986, Innovation: The attacker’s advantage, Summit Books, New York. 6. Geocities n.d., Economics of the firm: Technological change. Retrieved on January 18, 2006 from http://uk.geocities.com/balihar_sanghera/fmtechnological.html/ 7. Kumar, Nagesh & Siddharthan, N.S. 1997, Technology, market structure and internationalisation – Issues and policies for developing countries, Routledge, London. 8. Kyn, Oldrich 1966, Innovations-entrepreneurship-credit in the theory of J.A. Schumpeter, English translation from Hospodarske noviny, No. 34. Retrieved on January 19, 2006 from http://econwpa.wustl.edu/eps/dev/papers/0509/0509019.html/ 9. mPhone Ltd, n.d., The latest mobile phone technology. Retrieved January 21, 2006 from http://www.mphone.co.uk/3g_phones.html/ 10. Office of communications, 2005, The communications market 2005. Retrieved on January 19, 2006 from http://www.ofcom.org.uk/research/cm/cm05/#content/ 11. Ruttan, Vernon W. 2001, Technology, growth and development – An induced innovation perspective, Oxford University Press, New York. 12. Stoneman, Paul 1983, The economic analysis of technological change, Oxford University Press: Oxford. 13. Verspagen, Bart & Werker, Claudia 2003, The invisible college of the economics of innovation and technological change. Retrieved on January 20 from http://edata.ub.unimaas.nl/www-edocs/loader/file.asp?id=780/ ******* Read More