PacTel Cellular Takes a Gamble on Technology : Telecommunications: Mobile phone companies are adopting new systems. The Southland’s biggest carrier has decided to go its own way.

Jeffrey R. Hultman, president and chief executive of PacTel Cellular, likes to tell his employees that they are pioneers in a “100-year business.”

Taking a long-term view keeps a decision such as which of two competing cellular phone technologies to adopt from seeming quite so daunting, he says. Even so, Hultman and other cellular industry executives are grappling with the biggest technological transition in the industry’s brief history.

The change involves modernizing the nation’s cellular networks with second-generation digital technology that will allow cellular companies to squeeze calls onto an already cramped wave band.

For PacTel Cellular, the nation’s second-largest cellular phone company, the change comes at a crucial time. In Los Angeles, the Irvine-based company’s largest market, the carrier that converts to digital first could capture the lion’s share of subscribers, who are tired of network congestion.

The industry, including PacTel’s local rival, Los Angeles Cellular Telephone Co., has endorsed a new technology standard to improve and expand service in the coming decade. But PacTel Cellular has chosen a different path.

The conversion to digital is expected to cost cellular phone suppliers hundreds of millions of dollars per market over a period of years. That’s why the decision over which flavor of technology to select is critical.

PacTel Cellular, a subsidiary of San Francisco-based Pacific Telesis Group, packs a lot of clout in the industry. So Hultman’s decision to buck the industry’s choice and instead champion a technology developed by a little-known San Diego company may compel the rest of the industry to follow, some analysts say. But if the choice is wrong, PacTel risks losing its leadership position in the fast-growing Los Angeles area, where it has 57% of the market. And the industry may lose its hope for a nationwide compatible network.

“I don’t know if the technology will work yet,” Hultman said. “And we never want to get into a standards fight with the rest of the industry. But we will put this technology out in the marketplace and let the market decide if it is better.”

With about 10% of the nation’s cellular business, PacTel has gained prominence in the young industry.

“The industry is so new that everything can still be very experimental on the management side,” said Stuart Crump, co-author of a book on cellular phones and editor of Cellular Sales & Marketing in Washington. “There’s a lot of risk taking, sort of like being an early airline operator, and PacTel has a reputation for doing that.”

Hultman said he was skeptical when officials from Qualcomm Inc., a San Diego start-up, approached him late last year and told him their digital technology--known as code division multiple access, or CDMA--would allow PacTel to squeeze 20 times more callers onto the existing network.

After all, just a few weeks earlier and at Hultman’s recommendation, the Cellular Telecommunications Industry Assn. voted unanimously to adopt a digital technology called time division multiple access, or TDMA, ending a two-year dispute over industry standards. Because it emerged so late, CDMA was not considered.

TDMA extracts three to seven times more capacity from the existing analog system by slicing a frequency into a number of time slots. The transmitter bursts a signal for a call for a given period of time and then alternates to another call, dropping the first one for a split-second. The caller can’t notice the gaps between the call signals because they are so short. In effect, several calls are handled simultaneously on the same frequency.

But CDMA systems, first developed by the military to protect radio communications, spread a number of call signals across the available frequency spectrum simultaneously and assign a unique binary code to each signal. The signals are sorted from the background noise by a receiver that knows the code. The method uses the airwaves as efficiently as a skyscraper uses real estate, Qualcomm claims.

Hultman’s decision to back the CDMA standard--although he says the company still has the option of switching to TDMA--received some key support three weeks ago when American Telephone & Telegraph Co., Ameritech Mobile Communications and Nynex Mobile Communications Inc. said they would develop CDMA systems. AT&T; makes cellular phones; Ameritech Mobile and Nynex Mobile are cellular arms of other Baby Bell companies.

“I give (Hultman) a lot of credit for being farsighted and open-minded enough to listen,” said Harvey White, Qualcomm’s chief operating officer. “They were the first ones to really make a commitment and give us an audience.”

Norm Black, spokesman for the Cellular Telecommunications Industry Assn., said the industry will begin producing TDMA equipment next year. He cautions, however, that any further disputes over standards could delay industry growth and raise the cost of digital cellular equipment.

Some industry observers say PacTel and others who support CDMA are hurting the industry by not being team players and endorsing the industry standard.

“What is disturbing is that certain companies (that support CDMA) are so willing to pursue a panacea that isn’t proven and wasn’t part of the testing process that arrived at a standard,” said Eric Lissakers, director of planning and development for Ericsson Radio Systems, a Richardson, Tex., cellular phone manufacturer. “They are looking at a rainbow instead of the planned evolution of a standard.”

Mark Buford, a spokesman for Northern Telecom Inc., a Canadian telecommunications manufacturer, said his company has endorsed TDMA but continues to explore CDMA as an alternative. He said any changes could result in higher development costs and a delay in the conversion to digital.

For its part, the Federal Communications Commission ruled in 1987 that carriers do not have to follow a particular standard, so the choice between technologies could be made on a market-by-market basis.

But PacTel’s Hultman argues that the advantages of CDMA technology are too big to ignore. He says the technology will lead the nation closer to a third-generation system--a concept the industry has dubbed the Personal Communications Network (PCN)--that could make cellular as commonly used as today’s wire-line telephone system.

PCN would allow customers to place calls on pocket phones that would be lighter than current cellular portable phones. Several companies in England already provide pocket phone service. Nynex Corp. in New York plans to install a rudimentary version of a pocket phone system within the year.

PacTel Cellular inaugurated its service during the 1984 Summer Olympics in Los Angeles, when Mayor Tom Bradley made the first call to members of the Olympic Torch Relay team on the road near Dallas.

At the time, the company had only 2,500 customers waiting for service and 16 cell sites--the transmitters that send and receive radio signals from cars and forward them to telephone switching stations--that covered 3,200 square miles in central Los Angeles and northern Orange County.

Today, Pactel has more than 170 cell sites covering 10,000 square miles in five Southland counties. Of the company’s 443,000 subscribers, about 170,000 are in Los Angeles, estimates Herschel Shosteck, a cellular market researcher in Silver Spring, Md. About 40% of PacTel’s Southern California customers are in Orange County.

The company’s growth in Southern California reflects the enormous popularity of cellular phones in the land of car-crazy commuters and clogged freeways. And growth has been brisk in PacTel’s other California cellular markets: San Francisco, San Diego and San Jose. PacTel provides cellular service in more than 20 cities, including Atlanta.

With 30 million potential subscribers in its coverage areas, PacTel Cellular is second only to McCaw Cellular Communications of Kirkland, Wash.

Nationwide, the number of cellular subscribers is expected to rocket from 3.5 million last year to at least 18 million by 1995, Shosteck estimates. About 10% of the nation’s cellular phone subscribers are in greater Los Angeles, the nation’s second-largest market after New York City.

PacTel has grown to more than 1,300 employees, including 535 in Orange County, and plans to add 300 more employees by year-end. Three weeks ago, it began moving its headquarters staff to new quarters in Irvine.

Meantime, the standards battle has pitted PacTel against its local rival, LA Cellular, in a race to be the first to convert to digital. LA Cellular, jointly owned by McCaw and Atlanta-based BellSouth Corp., started service in Los Angeles in March, 1987, and now has 43% of the market.

LA Cellular and PacTel executives say the quality and timing of implementing digital service could reshuffle the local market share.

Hultman says PacTel could install a CDMA system in Los Angeles as early as the second half of 1991. That schedule could keep PacTel in the running to be the nation’s first carrier to convert to digital service.

Time is of the essence, particularly in Southern California, where the popularity of cellular phones could overload the present network in late 1991 or 1992.

“Los Angeles has one of the most difficult systems around as far as perceived quality problems,” said Shosteck, the Maryland market researcher, who regularly surveys industry dealers about quality of service in major U.S. markets. “Part of this is due to the capacity problem.”

PacTel officials acknowledge that a crowded network helps make service poor in Los Angeles. And the city’s skyscrapers and mountains don’t help.

But PacTel claims that only 1% to 3% of its calls are dropped; LA Cellular claims a comparable rate. Shosteck’s quarterly poll on cellular phone quality shows that LA Cellular received better quality ratings than PacTel in nine of the last 12 quarters.

The carriers can boost network capacity by building new cells and subdividing the coverage area into smaller cell sites, but eventually the costs become prohibitive.

Both companies have been spending heavily to improve their networks.

LA Cellular says it has spent more than $230 million on network improvements since 1987. But the investment has taken its toll on the firm’s bottom line, with losses totaling $33 million over the past three years, said company President Michael Heil.

PacTel spent $30 million to upgrade its network in 1989 alone and roughly $200 million since the company was started. Its financial results, however, are well above the industry average. The company reported earnings of $55 million last year, up from $15 million in 1988. Revenue jumped 47% to $453 million in 1989.

But industry analysts say profits mean little at this point, because every company must reinvest some of those profits in its network for years to come.

Overall, the industry invested $4.5 billion in network improvements from 1984 to 1989, while generating a scant $3.3 billion in revenue, according to the Cellular Telecommunications Industry Assoc., a Washington-based trade group.

Alf Humphries, cellular analyst with Hanifen Imhoff Inc., an investment banking firm in Denver, estimates that the cellular industry will begin making a profit on its cumulative investment sometime in 1993.

“This business is difficult because it requires a lot of reinvestment,” Humphries said. “The network has to be replaced every three to five years, but once the profits start coming in they will be very good.”

For cellular phone customers, however, the switch to digital networks won’t mean improved sound quality or lower prices, at least not for a while.

Digital cellular phones won’t sound any better than the current analog phones, neither of which match the quality of standard home or office phones.

And the digital phones aren’t expected to drop below the current average price of about $300. That’s because cellular providers will pass on to customers the cost of their sizable investments in new equipment. Cellular phone prices have dropped sharply over the years, from $2,000 in 1984.

Although digital service could give carriers the network capacity to begin widespread penetration among consumers, it could also present them with a potential obstacle to growth.

Some industry watchers say that widespread use could prompt state regulators to reconsider regulatory action taken earlier this year. In June, the California Public Utilities Commission decided against regulating service rates after determining that cellular phones are more of a discretionary than an essential service for most customers.

The PUC decision gave PacTel Cellular and other service providers relief from pressure to reduce their rates, which have remained at $45 a month plus 45 cents a minute at peak times since 1984. In Orange County, the rates result in an average monthly bill of about $140, making it one of the most expensive markets in the nation, according to PacTel Cellular figures.

“PacTel is making (at least) a 40% return on investment, and that level is far in excess of what would be allowed for wire-line carriers,” said Frederick R. Duda, a utilities commissioner and the lone dissenter in the panel’s June decision. “At some point, I believe closer rate regulation will happen.”

Don Harris, vice president of corporate development for PacTel Cellular, disagrees. He said the industry will remain intensely price competitive as long as carriers are allowed to set their own rates. He adds that the decision also enables the company to expand more quickly.