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Keeping 3G Costs in Check

When the bottom dropped out of the mobile infrastructure market three years ago, it was as though the industry woke up from a dream. Profits disappeared, "vital" projects were put on ice, and all of sudden the industry's top priority became figuring out how to drastically reduce its cost structure.

In particular, it became clear that 3G base stations – whatever you think of 3G technically – would have to get much, much cheaper.

And cost reduction remains a priority for vendors today. For example, speaking on her company's last investor conference call, Lucent Technologies Inc. (NYSE: LU) CEO Pat Russo made it clear that cutting costs is an essential part of Lucent's wireless business plan. "We're doing an awful lot of work on cost reduction on the product side [of 3G]," she said. "And we'll keep on finding ways to reduce costs."

A quick review of Lucent's figures shows why this is so important. Revenues for Lucent's Mobility Solutions division for the second quarter 2004, ended March 31, were $951 million, pretty much flat versus the previous quarter, when revenues were $960 million, and down from the year-ago quarter, when revenues were $1,095 million.

Operating income, on the other hand, jumped significantly, from $249 million a year earlier and $172 million in the first quarter, to $378 million. The point is that in a flat market, cost reduction is the key to sustainable profitability.

The good news is that cutting costs doesn't have to mean slashing jobs. Instead, technical innovation combined with new business models adapted from other global industries, such as car manufacturing and consumer electronics, will deliver the best results.

Adam Jahr, Lucent's director of UMTS product management, explains that the company's role is shifting towards integration of second-tier OEMs and optimizing the supply chain. "Cost reduction is the design priority for us," he says.

This focus on cost is not unique to Lucent: It is happening, in varying degrees, across the industry.

In a recent Unstrung Insider report, called "Open Base Stations: Cutting the Cost of 3G Networks," I examined a number of ways in which OEMs can cut the cost of developing and building 3G base stations. In particular, I looked at the case for outsourcing vital RF components and baseband silicon as a way to speed development cycles, optimize R&D spending, and reduce the overall base-station bill of materials.

On the RF side – the most expensive part of a base station – the market is moving toward integrated transceiver/amplifier/filter modules with digital baseband interfaces. These modules are traditionally developed at least partly inhouse, but they are now increasingly being designed and manufactured by specialist suppliers such as Andrew Corp. (Nasdaq: ANDW), Powerwave Technologies Inc. (Nasdaq: PWAV), and Remec Inc. (Nasdaq: REMC).

On the baseband side, OEMs are moving very quickly away from using ASICs (application-specific integrated circuits) to systems based on programmable architectures using DSPs (digital signal processors), FPGAs (field-programmable gate arrays), or parallel processors.

Names in the frame here include the usual suspects – Agere Systems Inc. (NYSE: AGR.A), Altera Corp. (Nasdaq: ALTR), Analog Devices Inc. (NYSE: ADI), Freescale Semiconductor Inc., Intel Corp. (Nasdaq: INTC), Texas Instruments Inc. (NYSE: TXN), and Xilinx Inc. (Nasdaq: XLNX) – and a few startups claiming vastly superior price/performance/flexibility metrics, such as PicoChip Designs Ltd. and Morpho Technologies.

For OEMs, moving from their vertically integrated businesses to models based on partnerships won't happen overnight. But by adopting an outsourced approach that allows them to focus on core competencies, the smartest industry players will once again achieve sustainable profitability in a market characterized by fierce competition and relentless pressure on prices.

— Gabriel Brown, Chief Analyst, Unstrung Insider

The report – Open Base Stations: Cutting the Cost of 3G Networks – is available as part of an annual subscription to the monthly Unstrung Insider, priced at $1,350. The annual subscription includes 12 monthly issues. Individual reports are available for $900.

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