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Fighting smart Strategy options for telecoms operatorsA report from the Economist Intelligence Unit

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Fighting smart Strategy options for telecoms operators

Preface

F

ighting smart:Strategy options for telecoms operators is an Economist Intelligence Unit white paper, sponsored by Amdocs. The Economist Intelligence Unit bears sole responsibility for the content of the paper. The Economist Intelligence Units editorial team conducted the research and wrote the report. The findings and views expressed in this report do not necessarily reflect the views of the sponsor. The analysis in the report is based on interviews with senior executives of telecoms network operators and independent industry experts, as well as on desk research. The following individuals were interviewed for the study: l Okan Alper, division head for Internet and community, Turkcell l Hannes Ametsreiter, CEO, Telekom Austria l Francis Deprez, senior vice-president of group strategy and policy, Deutsche Telekom l Sertan Eratar, divisional head, Turkcell l Colin Giles, global head of sales, Nokia l Michael Hecker, vice-president of strategy and corporate development, MTS l Bertrand Kan, global head of TMT, Nomura l Chris Lane, head of group strategy, Vodafone l Guy Middleton, head of corporate communications, 3 UK l Jan Ogren, vice-president of network planning, Ericsson l Tushar Rao, analyst, Capgemini l Scott Richardson, strategy adviser, Clearwire l Russ Shaw, head of mobile, Skype l Morten Karlsen Sorby, head of business development, Telenor1 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

l Lin Sun, independent analyst on Chinas telecoms market l Tim Whitley, chief strategy officer, BT l Richard Windsor, analyst, Nomura The author of the report was Iain Morris and the editor was Denis McCauley. Our sincere thanks go to the interviewees for sharing their insights with us. May 2010

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Fighting smart Strategy options for telecoms operators

Executive summary

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he rising importance of the Internet and data services, combined with the gradual decline of the much older voice business, is creating threats and opportunities for telecoms network operators in almost equal measure. While data traffic revenue could more than compensate for the decline of voice, the networks needed to support them are costly to build. In the mobile broadband market, levels of usage are also putting a huge strain on capacity and threatening profitability. Perhaps the biggest threat to operators, however, comes from the so-called over-the-top players that the formers own networks have allowed to flourish. Although these companies, through their online services, are attracting new users to the networks, they often play a bigger role than operators would like. The worry is that customers will develop closer relationships with the Internet companies than with operators, and that the latter end up being seen as little more than a utility servicea dumb pipe. Were that to happen, the commoditisation of services would accelerate and revenue would come under even greater pressure. Network-based operators do not often disappear, but a combination of low revenue-growth prospects and large, unavoidable capital outlays needed to deploy nextgeneration networks will spell real financial trouble for many players. A central premise of this study is that the spectre of a dumb pipe future is overstated for all but the most hidebound of operators. The latter have numerous assets that should allow them to compete and partnereffectively with Internet companies. But operators urgently need to take action on several fronts. For a start, they need to work out how they can build a compelling customer experience, either in partnership with Internet companies or working against them. Given the likelihood that service prices will continue to fall, they also need to explore ways of restraining capital intensity and bolstering efficiency as they build out newer networks. At the same time, they must consider adapting their pricing practices so there is a closer connection between usage and retail ratesand do this without scaring off customers. Meanwhile, they have to think about ways of defending their traditional voice business without simply blocking Internet companies. Finally, they have to take a lead role in developing new opportunities in industries like energy, healthcare and publishing. Arguably no operators have yet found the grailthe business model which will enable them to achieve all the above, ensuring a profitable future even while the threats from Internet players and other non-traditional competitors multiply. But there are no shortages of experience and best practice3 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

for operators to call upon. Based on interviews with a range of senior operator executives and industry experts, as well as extensive desk research, the Economist Intelligence Unit has identified five sets of strategy options, or strategy typologies, which operators should explore in seeking the optimal business models to take them forward: Smart pipe: By partnering with Internet companies rather than competing against them, operators can bring their own unique capabilities to content and applications development and stave off the threat of commoditisation. A smart-pipe strategy makes sense in markets where Internet companies are well-established. Even where the latter have less power, for example in Russia, operators such as MTS successfully partner with some online firms while also competing aggressively in the content and applications market. Efficient pipe: By carefully monitoring competition and demand, efficient-pipe operators are controlling the pace of next-generation network deployment. They are also using technologies such as femtocells, and sharing networks with rivals, to lower their capital and running costs. Greater automation of business processes could bolster profitability for numerous telecoms organisations, and especially thoselike Germanys Deutsche Telekomthat remain encumbered by their origins as stateowned monopolies. Pricing pioneer: Astute operators are examining new pricing models that better reflect actual network usage and guard profitability. Sophisticated schemes based on time-of-day usage and speed could meet with particular success. The UKs Vodafone has been trialling such a scheme in Spain. Depending on the regulatory environment, charging content companies for providing a higher-quality service could give rise to an entirely new wholesale opportunity. Defender of the realm: An extension of the smart-pipe strategy, this approach recognises that partnering with, rather than blocking, innovative Internet companies is one of the best means of attracting and retaining customers. For example, while mobile operators generally fear the impact of third-party VoIP (voice-over-Internet Protocol), one or two have realised there is more to be gained from partnering with VoIP providers than blocking them which, among other things, makes operators unpopular with their own customers. The UKs 3 has been able to attract more profitable customers through a deal with Skype, while Verizon hopes a similar arrangement will help it to capture a bigger share of US smartphone customers. Transformer: This strategy focuses on identifying new revenue opportunities in areas such as energy, healthcare and publishing. Deutsche Telekom, for example, is targeting 1bn in sales from intelligent networks by 2015. These opportunities look most attractive to operators having both business-toconsumer (B2C) and business-to-business (B2B) operations, and especially those that have already developed an IT-services capability. Operators should take a leading role in demonstrating the benefits of smart grids, e-healthcare and e-publishing, for example, to their customers.

The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Introduction

On the one hand, weve never had so many opportunities. On the other, weve never faced so many risks. Hannes Ametsreiter, CEO of Telekom Austria, the countrys largest network operator, neatly sums up the position of operators emerging from the recent recession. A surge of interest in broadband services, particularly in the mobile-phone world, should create enormous opportunities for the companies that own and run the networks. Mobile data revenue alone is forecast to rise from US$257bn this year to US$420bn in 2014, according to Pyramid Research, an analyst firm. Yet all that growth cannot happen without enormous investmentall the while that operators core voice businesses are going into decline. The biggest threat to operators arguably emanates from the Internet players that broadband networks have allowed to flourish. In the old voice-only days, ownership of the networks equalled full control of the service delivered to customers. But the rise of the Internet has brought about a disintermediation. Operators now see many companies competing to provide a service over their lines and build a relationship with their customers. As broadband has developed, a handful of theseGlobal mobile revenue, 2010-14(US$ bn) 800 700 600 500 400 300 200 100 0 2010Source: Pyramid Research.

Mobile voice

Mobile data 800 700 600 500 400 300 200 100 0

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Fighting smart Strategy options for telecoms operators

companies have grown into some of the most powerful brands on the planet. Although online content still generates far less revenue than data access, many operators fear becoming dumb commodity pipes. They are concerned about having to bear the cost of rolling out next-generation networks. And they worry about losing touch with their customers. The purpose of this study is to examine how telecoms operatorsoffering fixed services, mobile services or a combination of both (integrated operators)will seek to address these threats over the next half-decade. Based on lessons learned by companies in different parts of the world, it also identifies potentially successful operator strategy typologies. This paper argues that operators still have an opportunity to compete with the Internet giants in particular markets. It shows that they can avoid being tagged as dumb pipes by collaborating with those companies and contributing their own unique skills and resources to application development. The study also demonstrates that there are various means by which operators can become more efficient, and argues that investments in infrastructure can be contained, while carefully managed adjustments to pricing systems can safeguard the profitability of mobile broadband services.

The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Key points

n Insteadofstrugglingtocompetewithover-the-topplayers,manyoperatorsseedeeperpartnerships withthesecompaniesastheanswer. n PartneringshouldcapitaliseontheoperatorsvaluetoanInternetcompany.

Smart pipe

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perators appear less tormented by the prospect of being dumb pipes than in years past. Some of the biggest, for example, are no longer fiercely protective of their own Internet portals. Chris Lane, head of group strategy at Vodafone, a UK-headquartered mobile operator, says its portal, Vodafone Live!, was created partially because there were no third-party alternatives for getting users onto the mobile Internet, and that it might not even exist ten years from now. Yet Live! was once seen as the archetypal walled garden, by which operators hoped to prevent customers from using third-party services. Other operators, meanwhile, have stopped trying to be actual content providers. We used to employ a lot of people involved in generating or buying content, confirms Guy Middleton, head of corporate communications for 3, the UKs youngest mobile operator. Now we focus on Internet communications apps and getting the most relevant Internet apps working well on phones. Few operators have entirely given up on having a presence for content and applications. But insteadMobile websites' share of UK mobile Internet users(%) 60

2007

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Note. "Share of users" refers to the percentage of users who have accessed these sites on a mobile phone during each year. Source: Morgan Stanley, The Mobile Internet Report, December 15th 2009.

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The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

case study

MTS and the three-way pipe

Michael Hecker, vice-president of strategy and corporate development for MTS, Russias largest mobile network operator, describes the companys strategy as a three-pronged affair: smart pipe, content pipe and dumb pipe. Smart pipe involves partnering with other companies to provide the best possible user experience to the customer. One example of that is a deal with a Russian social-networking site called Odnoklassniki (translated as classmates), which gets about 12m users daily. That has brought a huge increase in data access usage and revenue, as well as customer loyalty, because with an MTS phone a customer has the Odnoklassniki experience on mobile for the first time, says Mr Hecker. Content pipe extends MTSs role in the value chain. It operates a portal called Omlet.ru that takes a share of revenue from the sale of music and videos to customers. MTS aims to make Omlet.

ru the iTunes of Russia and the Commonwealth of Independent States (CIS). Helped by its retail presence of over 3,000 stores, the operator has a more powerful brand than Apples in this region. Moreover, because Omlet.ru is loaded with Russian content, it may hold greater appeal to the typical Russian consumer than a more international, English-language storefront such as iTunes. Another advantage we have is control of the billing and payment relationship in a country where credit cards are not widely used as a payment tool, notes Mr Hecker. Sales on Omlet.ru helped MTS to earn Rb13.2bn (US$21m) in content revenue in the third quarter of 2009exceeding even the Rb10.2bn (US$325m) it made from data-traffic revenue (although much of the content revenue was generated by the sale of ringback tones and other add-on services). Even so, as MTS expands its networks in Russia, particularly after recently gaining permission to provide 3G (third-generation) services in Moscow, the dumb pipe, access-revenue part of the business may be the one that matters most.

of struggling to compete with over-the-top playersindustry shorthand for Internet firms delivering their own video and other content over operator networks many see deeper partnerships with these companies as the answer. (See chart on the previous page for an indication of how quickly operators Internet presence has declined in the UK.) We put in a lot of effort and had good usage and lots of turnover, but at the same time it didnt necessarily generate much margin or prove to be critical to our customers, says Mr Middleton of 3s online music business. He now believes there is greater value in partnering with the likes of Spotify and others. To proponents of the operator portal, this approach might appear to be admitting failure and accepting a role subservient to over-the-top players. But partnering with the most exciting Internet companies is, at the very least, a means of attracting new customers to data-based tariffs. More importantly, partnering should capitalise on the operators value to an Internet company. Nokia, for example, is willing to share revenue from sales on its Ovi online store with operator partners because it realises that operator-integrated billing eases the payment process for many consumers, according to Colin Giles, Nokias head of global sales. Moreover, Internet companies agree with operators that the best services are made possible by collaboration. The experience weve built with Verizon is better than the over-the-top one, says Russ Shaw, head of mobile for Skype, a VoIP provider. Working with it and being deeply integrated into the handset is another step forward in terms of customer experience. Two operators focused on enhancing this customer experience are Vodafone and Deutsche Telekom, Germanys dominant telecoms service provider. Once seeming intent on preventing customers from using services other than its own, Vodafone is now trying to enable the use of applications across different third partiessuch as Facebook, Google and Windows Live Messengerthrough 30, its suite of mobile Internet services. Deutsche Telekoms My Community works in a similar way, allowing a customer to choose a contact before deciding whether to communicate via a call, text, online chat or

The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

social network. These are services an Internet company could not provide and a user may highly value. Either an over-the-top player has had to create a closed environment, as has Apple, or a customer has had to commit himself to one social network, and were saying thats not necessary, says Francis Deprez, senior vice-president of group strategy and policy at Deutsche Telekom. It is not only by providing services across multiple platforms that operators can make a different type of contribution to the customer experience. Deutsche Telekom has been introducing technology that allows services to be run across multiple devices, for instance allowing IPTV1 content to be screened on a smartphone. As customers store more content on our digital network, and as they use it across more devices, they will be more inclined to stick with us as a provider, maintains Mr Deprez.

Operators do not have a good track record in competing on such technological innovation.Bertrand Kan, analyst, Nomura

Not another app storeOperators have not entirely stopped competing against over-the-top players. The app store (applications store) offered by Apple has sparked countless imitations, including from operators. Vodafones 30 service has an app store at its very heart, and earlier this year Vodafone clubbed together with other companies to unveil the Wholesale Applications Communityan operator-led initiative to challenge the dominance of Apple. Bertrand Kan, global head of TMT at investment bank Nomura, is sceptical about the operators move. The operators do not have a good track record in competing on such technological innovation, he maintains. Yet as competitors operators also have considerable strengths. Mr Ametsreiter of Telekom Austria believes that intense co-operation in the app store market could produce the biggest platform in the world, working across multiple handsets and operating systems and with a large community of developers. Morten Karlsen Sorby, head of business development for Telenor of Norway, also notes that operators often store more information about customers than is typically available to firms such as Google. If privacy concerns can be overcome, that information could be used to create more tailored and relevant applications and advertising. Also, operators are used to dealing directly with customers. Google doesnt know anything about proper retail and after-sales service, stresses Mr Lane of Vodafone. In markets with a rich and distinctive culture, where US software giants are not as relevant, national operators may also have a big advantage over Internet companies. For example, the local knowledge of Turkcell, Turkeys largest mobile provider, is helping it to build an app store of particular relevance to the domestic consumer. Google is a great company but it doesnt know the Turkish market intimately as we do, claims Okan Alper, division head for Internet and community for Turkcell. Notwithstanding international business concerns about China, and Googles high-profile withdrawal from the country, cultural idiosyncrasies mean that Chinese operators can play a bigger role in applications than operators in other parts of the world, notes Lin Sun, an independent analyst. Apple needs to work hard with China Unicom [one of the countrys three main mobile providers] to produce a Chinese version of the app store, he says. Otherwise the potential value of the iPhone will fall. Elsewhere, competing with the likes of Google and Apple will be far more difficult. Although they must partner with these brands as well as software companies, operators also need to prevent any one organisation from becoming so powerful that it is able to dictate terms, as Apple has sometimes appeared to do. Ultimately, however, there is a major consolation should they fail. Even if our customer relationships weaken, the need for infrastructure will definitely be there, says Mr Sorby of Telenor. The Economist Intelligence Unit Limited 2010

TV delivered over Internet protocol, the communications technology that underpins the Internet.1

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Fighting smart Strategy options for telecoms operators

Key points

n Operatorsneedtoexplorewaystocontaintheinitialexpenseoftheirnetworkinvestmentsandextract more efficiency from their businesses. n Business process modernisation, closer integration of fixed and mobile units, sharing of network components and using advanced technologies in high-demand areas can all help improve efficiency.

Efficient pipe

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hile many hate to be called dumb pipes, operators have excelled at running very large and profitable businesses out of providing basic connectivity. Yet due to their origins as state-owned monopolies, many of the worlds biggest operators labour under significant constraints, says Nomuras Mr Kan. When products commoditise you need to have free rein to control costs and headcount and drive your bottom line, he says. A lot of operators cannot easily do that. Besides being so encumbered, operators are also being forced to spend heavily on network infrastructure to serve the demand for increasingly sophisticated services. Beyond the upfront investment, the operational savings that can be realised from the use of new network technologies are very significant, believes Mr Kan. Recent data, for example, suggest that there is a cost-per-megabyte reduction of 50% in moving from 3G to HSPA (high-speed packet access, a so-called 3.5G technology) and another 50% reduction in going from HSPA to LTE (long-term evolution, sometimes considered a 4G technology). Yet operators need to explore ways to contain the initial expense of some of their network investments and extract more efficiency from their businesses.Mobile broadband cost of ownership in comparison with WCDMA(Total cost of ownership per gigabyte as % of WCDMA) 100 90 80 70 60 50 40 30 20 10 0 WCDMA HSPA HSPA+ HSPA+ MIMO LTENote. Assumes 10Mhz bandwidth, 10 year depreciation, and a greenfield case. MIMO = multiple input, multiple output. Source: Nokia Siemens Networks.

100 90 80 70 60 50 40 30 20 10 0

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The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

You dont have to provide nationwide [fibre] coverage right away to make it work.Francis Deprez, senior vicepresident of group strategy and policy, Deutsche Telekom

In a mobile, or cellular, network, core and backhaul refer to those parts of the network connecting the caller in the originating cell to the user in the destination cell.2

One option is further modernisation of business processes. According to Mr Deprez of Deutsche Telekom, the entire telecoms industry lags other sectors of the economy when it comes to automating areas like customer care and order management. He believes that next-generation IT (information technology) systems will help Deutsche Telekom to raise its operating margin (before depreciation and amortisation) to 35% by 2012, from its 2009 level of 31%. Closer integration of fixed and mobile units can also help operators to realise savings. Deutsche Telekoms One Company project in Germany and eastern Europe is intended mainly to ease the crossselling of fixed and mobile products. But by moving to shared systems for customer relationship management and other IT functions, the operator also aims to lower its costs. Mr Deprez says other savings can be realised by using shared core and backhaul network infrastructure.2 Russia-based MTS is also hoping to realise US$5m of cost synergies by merging its core and backhaul networks with those of Comstar-UTS, a local fixed-line operator in which it recently took a 51% stake. There is little that can be shared, however, in the last mile to the end-userthe costliest part of the network to build. Mr Deprez acknowledges that as service prices continue to fall, capital expenditure must be kept under control. The only way to do that is to be a lot more demand- and competition-driven, he says. Deutsche Telekom is not only focusing the roll out of its fibre-optic network on areas where there is strong competition from cable-TV providers, but is also examining the level of customer interest in bandwidth-rich offerings in particular neighbourhoods. You dont have to provide nationwide coverage right away to make it work, states Mr Deprez. Operators are taking a similar approach in the mobile sector. By using more advanced technologies to supplement older ones in high-demand areas, they can limit the roll out of next-generation networks,cabinet, not the home. If, in future, the demand for bandwidth forces BT to be more ambitious, an upgrade would make the overall project more expensive than if BT had built to the home in the first place. Second, the Conservative Party has indicated that, should it win the forthcoming general election, it will force BT to make its underground ducts available to rival infrastructure providers. Such a move would weaken BTs investment case considerably. The biggest concern, perhaps, is about revenue potential. A rich TV service would help, yet BT Visionthe operators IPTV offering is dwarfed by the TV services of Sky, a satellite operator, and Virgin Media. BT is collaborating with UK broadcasters on Project Canvasaimed at creating an open platform that allows content companies to provide services for the TV. This could certainly attract new customers to broadband, and challenge the pay-TV incumbents, but the revenue model remains unclear. Indeed, Mr Whitley believes that Canvas will help to ensure that the enormous consumer benefits of Internet-connected TV are not restricted to paying customers, and that BT Vision would be able to offer bundles that are extremely competitive in comparison with existing pay-TV providers. No wonder it is so fiercely opposed by Sky. The Economist Intelligence Unit Limited 2010

case study

BT, fibre and IPTV

Tim Whitley, chief strategy officer of BT, says the investment case for the companys fibre-optic network plan is based on the need for higher bandwidth in the market, as services like catch-up TV, video-on-demand and multi-room HDTV (high-definition TV) take off. Yet, for many years the company resisted a rollout, prompting criticism from industry observers that the UK would end up lagging its European peers on broadband capability. A major factor in this change of approach has been the willingness of Ofcom, the UK regulator, to grant BT more control over the wholesale pricing of its fibre-optic network than it enjoys with copper. Another has been the activity of Virgin Media, a cable rival, which has upped the pace and marketing of its own high-speed network deployment. Both developments led to a commitment from BT in 2008 to spend 1.5bn on rolling out a fibre-optic network to about 0% of UK homes. Not all observers are convinced by the plan, however. For a start, the project mainly involves building fibre only as far as the street11

Fighting smart Strategy options for telecoms operators

thereby containing investments. Clearwire, a wireless Internet service provider (ISP), is one US operator whose investor make-up encourages such a strategy. For our cable [TV] shareholders, were really a broadband mobile overlay. For Sprint Nextel [a mobile operator and co-owner], were an overlay to the 3G network, says Scott Richardson, a strategy adviser to the operator. Through careful planning, Vodafone is also hoping to contain capital expenditure when it comes to G (fourth-generation) network construction. For regional areas, you can easily put 00MHz digitaldividend spectrum [airwaves set to become available when analogue TV signals are turned off] on top of your existing GSM (900MHz) network, says Mr Lane. LTE at 2.GHz is more about capacity in hot spots, he adds, so you dont have to build a layer that provides coverage across entire cities. In-building technologies such as WiFi and femtocells can further reduce the need for external network construction. That would also give operators a fixed-broadband backhaul network with a lower operating cost than mobile, says Tushar Rao, an analyst with Capgemini, a consultancy. He estimates that the marginal cost per gigabyte of traffic on a femtocell is only US$2.40, compared with US$9.50 for expanding HSPA in a capacity-constrained area. Increasingly, operators are also sharing backhaul and cell-site infrastructure to lower their costs. When two operators are of equal size and determined to cover the same areas, this looks especially attractive as a cost-saving measure. Greater sharing could do much to aid the profitability of Chinas operators, believes Lin Sun, although intense rivalry means that they still resist such schemes. Last year, the Ministry of Industry and Information Technology found that a lot of money was being wasted on telecoms infrastructure, he says. It has asked operators to share facilities like wire poles and conduits for laying cable, but the extent of sharing is still quite limited.

Wheres the revenue uplift?While the efficiency incentive for building next-generation networks is clear, the revenue case is not. In the fixed broadband market, strong triple-play (voice, Internet, TV) competition from cable companies seems to make fibre rollout critical. But Analysys Mason, a market research company, maintains that operators already making money from copper-line broadband services will not be able to make much more from fibre-optic connections. Mr Sorby of Telenor believes that operators need to offer premium TV content to be profitable with fibre. Even then, the business case is not strong because operators must share TV revenue with producers. (Operators typically keep only about 30%, according to Analysys Mason.) Of course, operators might be able to strike favourable arrangements with the best content partners if they have an infrastructure edge over their rivals. Turkcell touts its 3G lead over competitors as an important factor in this respect. That provides economies of scale for us to deliver digital content to our customers, and its helped us to strike exclusive deals, says Sertan Eratar, a senior divisional head at Turkcell. Mr Richardson of Clearwire says the poor quality of video services on 3G networks should persuade application providers to partner with the company, which mainly utilises WiMAX broadband wireless technology. However, although this could pull customers away from rivals with less capable networks, it would not necessarily get them to pay more. Implementing LTE does not necessarily mean we will be able to charge a higher price, says Mr Ametsreiter of Telekom Austria. Nevertheless, in the mobile world, at least, operators are considering new ways of charging customers for usage.12 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Key points

n Introducing greater complexity in the form of tiered pricing could backfire on operators, especially in less developedmarkets. n Fair-usage policies that target bandwidth hogs may prove effective in some markets, while traffic shaping could be used to base tariffs on speed.

Pricing pioneerhe widespread introduction of flat-rate, all-you-can-eat data tariffs has generated huge consumer interest in mobile broadband. While traffic has soared, however, revenue has not. Capgemini reckons that the average price per megabyte of data usage in the Netherlands fell from 0.84 in 2005 to 0.13 in 2008, while in Germany it dropped from 0.33 to as little as 0.001 over the same period. With margins coming under pressure, operators are urgently rethinking their pricing practices. One option gaining in popularity is a move towards tiered pricing. Put simply, this would give customers a certain allocation of megabytes for a set monthly fee, which would be stepped up for bigger allowances. There is almost as much resistance to tiered pricing as there is support for it, however. We havent seen that many initiatives because customers would probably see it as favouring certain applications over others, says Mr Rao of Capgemini. Mr Shaw of Skype puts it more simply: It would make for a horrendous customer experience. In younger markets, where there is still unused capacity on networks, a rush to greater pricing complexity could be counterproductive. Indeed, in countries such as China there is arguably a call for more simplicity and greater usage of flat rates. Pricing schemes were so complicated at first that no one could understand them, explains Lin Sun. Operators are now starting to increase data-volume allowances and offer lower rates. No doubt, users will have to be offered various band options and be able to move easily between them if tiered pricing is to work. Yet any operator introducing tiered pricing unilaterally is likely to lose customers to its rivals. Another issue is that only about 5% of users are responsible for consuming as much as 50% of capacity, according to Mr Lane of Vodafone. There are plenty of users that have signed up for 5gb bundle plans using only 600 megabytes a month, and they are highly profitable, he says. Do you want to disturb the message today for the sake of the 5%? Fair-usage policies that target peer-to-peer file sharers and other bandwidth hogs could be a solution. But there also needs to be a greater level of pricing sophistication than pure usage-based schemes. These could include so-called traffic shaping, where operators charge more for usage during busy periods. A customer using 10 gigabytes between midnight and pm is actually a very low-cost user, whereas someone that uses 1 gigabyte between pm and midnight is a high-cost user, explains Mr Lane. The Economist Intelligence Unit Limited 2010

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Do you want to disturb the message today for the sake of the 5% [of users on unlimited plans]?Chris Lane, analyst, head of group strategy, Vodafone

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Fighting smart Strategy options for telecoms operators

Estimated impact of increased usage on EBIT of a sample Europe mobile broadband operator, 2009-12(EBIT margin, %) 60 50 40 30 20 10 0 -10 2009 2010 2011 2012Note. EBIT = Earnings before interest and tax. Source: Capgemini, Mobile broadband in Europe: Profitability challenge or next growth engine?

1gb average usage/month

1.6gb average usage/month

2.4gb average usage/month 60 50 40 30 20 10 0 -10

Traffic shaping could also be used to base tariffs on speed. In Spain, Vodafone has been testing a quality-of-service offer that it hopes some consumers would buy as a bolt-on to their normal service. If speed is important, you could buy a gold-level service that prioritises your traffic over that of other customers, says Mr Lane.

Charging the web companiesIt is not just their consumers whom operators would like to charge. With web-based video content putting a heavy burden on networks, some believe content providers should pay to use the pipes. Otherwise, the volumes of traffic will ruin the networks over time, says Mr Sorby of Telenor. Unsurprisingly, this solution is fiercely resisted by the Internet community on the grounds that it contravenes net neutralitythe principle that operators should not be allowed to discriminate between different types of content on their networks. Demanding that Google pay for a best-efforts service is likely to be unacceptable to many regulators too. But there may be some middle ground. Many of these new technologies have features we can sell to content providers that want faster or safer access, says Mr Deprez of Deutsche Telekom. By ensuring a certain quality of service, we can offer a sort of business-class option. Even this seems likely to meet with opposition in the US, where net neutrality has been enshrined in national telecoms policy. But it might be more acceptable to authorities in markets with healthier levels of broadband competition, such as the UK. Theres no need for legislation, and we think the market will evolve to enable different business models so that traffic which needs priority can be appropriately prioritised, maintains Mr Whitley of BT. Apart from charging the customer a higher fee, there may be no alternative for content companies wanting to deliver a better Internet service. Indeed, some of the collaboration already happening between Internet companies and operators seems to conflict with the strictest interpretations of net neutrality. We made a business decision to work closely with Skype to deliver the huge value1 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

of free Internet calls to our customers, says Mr Middleton of 3. We dont block any VoIP services, but we chose to get behind Skype on 3 and that has resulted in well over 3 million voice minutes on our network every day, he adds. Were open to the Internet but our approach to Skype has been active rather than neutral. Net neutralitys place in the issue of VoIP is explored further in the following section.

case study

African innovation in mobile pricing

It is not just in developed data markets that more sophisticated tariffing schemes are being considered. In Africa, operators dependence on low-income users has given rise to real innovation in the area of so-called dynamic tariffing. One mobile operator that has already introduced pricing based around this concept is Vodacom Tanzania. It has used technology to identify under-used parts of the network and then offer heavy discounts to its customers at off-peak times or in particular locations. The original innovator was perhaps MTN of South Africa, which15

introduced such a mechanism for its ordinary mobile voice customers about two years ago. MTN Zone offers customers variable rates for on-net calls depending on the time of day and location. Through its service, customers can use their phones to check on the discount rates available at particular times. Those discounts can be so high during the early hours of the morning that price-sensitive customers are prepared to stay up to make calls. MTN benefits largely by reducing network usage at busy timesessentially encouraging some of its higher-cost customers to change their behaviour. But MTN Zone also helps the operator to reduce customer churn and generate new revenue. Dynamic tariffing could have similar benefits for mobile broadband operators in more developed markets. The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Key points

n Blocking VoIP is a short-sighted approach, as it will likely meet with a customer backlash. The alternative is toseeVoIPasanopportunity. n Given the generous provision of voice minutes in many flat-rate smartphone packages, VoIP is unlikely to do much revenue damage to mobile operators.

Defender of the realm

A

s most mobile operator revenue still comes from voice services, the need to defend such services is paramount. Competition and regulation have been the traditional challengers to operators dominance in mobile voice, but the biggest emerging threat is typically perceived to be VoIP. By offering a service that bypasses operators normal voice-charging mechanisms, Internet-telephony companies could deal a hammer blow to the mobile businessor so operators fear. So far, the standard mobile operator response to VoIP has been to block it, eliciting howls of protest from the advocates of net neutrality. Indeed, it is mainly concern about the impact of VoIP that has led operators into this particular conflict with the Internet community. If software players take away the voice traffic of a mobile operator, then infrastructure will not be built and there will be no investments by that operator, says Mr Ametsreiter of Telekom Austria. But is VoIP really justification for such high anxiety? The flat-rate smartphone tariffs offered by many operators now include such generous provisions of voice minutes that VoIP can hardly do much revenue damage. The cost of the incremental call is zero, because no one uses a thousand minutes, says Mr Lane of Vodafone. So why go to the hassle of calling someone using Skype? While Skype customers still feel they can save money on long-distance and international mobile calls, much of that business moved to calling cards (as well as fixed-line VoIP) a long time ago. Two other reasons operators might want to block VoIP, however, are cost and customer experience. While the usage of VoIP might not chew into revenue, it could raise costssimply because it is more expensive to carry an IP call over todays networks than it is to support a normal voice call. While Skype claims that a minute of VoIP uses just half the capacity consumed during a minute of web browsing, the impact of heavy migration from ordinary voice to VoIP would be significant. In some European markets, operators are allowing VoIP services but charging customers additional fees for using them. Operators also fear that their relationships with customers will suffer if Internet-telephony companies become the application provider, just as they fear losing out to Internet companies generally. Blocking VoIP, however, is a short-sighted approach. For a start, it is likely to contravene even looser interpretations of net neutrality, and has already landed AT&T in trouble with the Federal Communications Commission (FCC) in the US. More importantly, preventing customers from using services that have proven tremendously popular on the fixed-line Internet is bound to meet with a1 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Comparison of bandwidth consumed by various mobile data applications(Kilobytes consumed per 1 minute of activity) 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 VoIP Call Browsing Audio streaming YouTube streaming Better quality video streamingSource: Chetan Sharma Consulting, Mobile VoIPapproaching the tipping point, 2010 (sponsored by Skype).

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

backlash. This should have been clear to operators from their experiences with walled gardens. The alternative is to see VoIP as an opportunity, which is exactly what 3 did in the UK (see box). By partnering with Skype, it hoped to attract new customers and generate more revenue from data services. But the collaboration also led to a surprising jump in ordinary voice minutes. Its counterintuitive but the 3 customer using Skype has 20% more profit margin associated with him because hes also making more non-Skype calls, sending texts and using data services more, says Mr Shaw. 3s move was deemed to be a slightly desperate one by some analysts, who saw behind it a nothingto-lose approach to boosting low market share. Verizons deal with Skype, unveiled in February this year, could not be interpreted similarly. One of the two biggest operators in the US, with a massive voice business at stake, Verizon is rolling out a Skype service now and intends to include it on its entire

case study

Embracing Skype

The UK operator 3 agreed a partnership with Skype in November 200 to provide the latters VoIP service over 3s network, but at that time it was a fairly niche proposition. Mr Middleton admits it was not particularly well integrated into 3s services initially and that usage did not begin increasing until the last quarter of 200. This was when 3 launched the Skypephone, which fully integrated Skype with the phone address book and featured a button for easy access to the Skype service. Since then, 3 has launched a range of devices supporting Skype and claims to have attracted about 00,000 customersaround 10% of its entire subscriber base. According to 3, mobile Skype1

users generate 0% more voice revenue than non-users and 33% more texting revenue, and they churn 1% less than non-users. While 3 has not even required customers to pay a data subscription to use Skype, customers also tend to be heavy users of 3s other data services. This means that 3s Skype customers are 20% more profitable than its non-Skype customers, the operator claims. A similar Verizon deal with Skype was unveiled in February this year and is now available on six Blackberry devices, two Motorola ones and a handset from Taiwan-based HTC. The US operator is no doubt looking to gain a competitive advantage over AT&T, which still seems resistant to VoIP, in the fight for new smartphone business. But customers will still have to buy a voice and data plan to use the Skype service. If the availability of Skype persuades more consumers to adopt smartphones, Verizon has much to gain. The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

range of smartphones by the end of this year. The deal marks one of the closest collaborations to date between an operator and a web company.

A VoIP standard for the 4G worldAs higher-capacity G technologies such as LTE are deployed, mobile operators are likely to view VoIP in a more positive light. Indeed, when those networks become pervasive, operators will be able to shut down older network systems and move all their voice traffic to all-IP networks. That would lead to big operational savings, says Jan Ogren, vice-president of network planning with Ericsson, a network equipment vendor. Operators would also be able to control the IP voice service and charge for it separately. One obstacle to this vision is current disagreement on the standardisation of the operator-owned VoIP service. The greatest momentum is around a standard called VoLTE (voice over LTE), while rival technologies have also attracted support. VoLTE, however, cannot work unless a network technology called IMS (IP multimedia subsystem) has already been deployed. Many operators have not previously factored this into their network planning. Indeed, Mr Lane of Vodafone says IMS has until now been a technology solution looking for a problem. Even if technical progress accelerates, the LTE networks on which these standards will sit are unlikely to be widespread for many years. Moreover, although operators own VoIP services might offer the highest quality and greatest convenience, it is far from clear that they would prevent customers from demanding access to third-party services. Skype believes that an even closer collaboration with operators could remove the need for VoLTE entirely. Operators will need to spend millions to develop the IP and software capability, says Mr Shaw. There is no reason why we couldnt provide that instead. Few operators are likely to see Skype as an alternative to their own VoIP services, but third-party services like it may need to feature just as prominently in their plans.

As higher-capacity G technologies such as LTE are deployed, mobile operators are likely to view VoIP in a more positive light.

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The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

Key points

n Cloud computing may be just as big a deal for operators as it is for the Internet players and software providerswithwhichitistypicallyassociated. n Machine-to-machineapplicationsofferopportunitiesforoperatorsintheenergy,healthcareand automotive sectors, as do e-readers in publishing.

Transformer

T

he need to find new sources of revenue has already forced fixed and mobile operators to go far beyond their roots as providers of voice telephony. In developing countries, operators have filled a gap in the market for money services caused by the lack of banking infrastructure. In developed ones, they have taken advantage of their network capabilities to move into IT. Its a good opportunity for BT because we can leverage existing customer relationships to expand into the IT space, but with a strong focus on networking, explains Mr Whitley. Given the emergence of cloud computing, such opportunities may grow for the right types of operator. Deutsche Telekom has already been offering a dynamic computing service through its IT subsidiary, T-Systems, providing data-centre capacity to corporate customers on a usage basis. Its partnership with SAP, a software provider, means that it can also offer software applications in a service-based manner. Indeed, cloud computing may be just as big a deal for operators as it is for the Internet players and software providers with which it is typically associated. Not only can the operator bring to the table its customer base and distribution power, it can also bundle partner services with connectivity, as in the case currently of Deutsche Telekom. That has additional cost benefits that a pure software player cannot always offer, says Mr Deprez. The introduction of data connectivity to other industries is also creating new roles for operators. In the media industry, operators could take advantage of two developments: the rise of e-reader-type devices and media companies search for a sustainable online business model. Mr Lane of Vodafone suggests an option that customers might prefer to paying for online newspaper subscriptions. Were good at taking hardware and putting it together with service packages and selling it to customers through a 2-month contract. I would not be surprised if we started selling e-readers bundled with subscriptions to The Economist or Financial Times, he says. By delivering subscriptions during offpeak hours, Vodafone could provide such a service cost-effectively. I think were in a good position to help because the newspapers will struggle to do it on their own, believes Mr Lane. How much operators do in the e-reader market will be a topic of considerable debate in coming months. As bundlers of devices, content and services, operators such as Vodafone would be able to remain in control of billing and customer care. Yet Clearwire sees e-readers as a smaller wholesale19 The Economist Intelligence Unit Limited 2010

Fighting smart Strategy options for telecoms operators

opportunity because, in Mr Richardsons view, youre buying a device brand as opposed to a service brand. Critical to both models will be a network that offers broad distribution. According to Mr Richardson, Clearwires still-limited footprint has been one barrier to it doing more deals in the machine-to-machine area. The energy, healthcare and automotive sectors are also ones that operators can serve through socalled machine-to-machine or intelligent-network applications, especially iflike BT and Deutsche Telekomthey already have established B2B and B2C operations. In the healthcare business, this

case study

From zero to a billion

When Deutsche Telekom unveiled its latest strategy update earlier this year, the company talked aplenty about expanding its broadband and data services operations. But a newer focus was also to increase its role in intelligent networks. Still in their infancy, such networks earn operators almost nothing today. By 2015, however, Deutsche Telekom expects them to be contributing 1bn in sales (see chart). What specifically made Deutsche Telekom feel that it had an important role to play was its combination of B2C and B2B operationsthe first through its mainstream telecoms activities and the second through T-Systems, an IT subsidiary focusing on the worlds top 00 multinationals as well as the SME sector. The industries that can really benefit from our contribution are energy, healthcare, media distribution and automotive, asserts Francis Deprez.Growth segments of Deutsche Telekom, 2009 to 2015(Revenue, bn) Mobile Internet4.0

There is particular momentum behind energy. In Friedrichshafen, Deutsche Telekoms T-City project is providing a smart-metering service to the local utility operator that allows real-time measuring of data. Mr Deprez says the utility can use the data to either adapt tariffing or to make suggestions to consumers about consumption. The next step, however, is to provide more intelligence in the grid itself, which would allow energy supply to be more closely aligned with demand. Such projects tend to begin as one-offs, but the platforms developed can then be sold on to other operators. Mr Deprez says the investments around the meters are typically variable costs that have to do with how many customers are signed up and how fast regulation forces Deutsche Telekom to move. He reckons EBIT (earnings before interest and tax) margins from these activities are likely to be around 1520%about the same as those currently generated by IT services providers.

2009

2015 (Forecast)

10.0

Connected home (a)5.0 7.0

Non-access businesses0.8 2.5 6.0 8.0

T-Systems (ext) (b)

Intelligent network solutions (c)0.0 1.0

(a) Double & triple play, home gateway and communication suite. (b) Including cloud services. (c) In energy, healthcare, media distribution, connected car. Source: Deutsche Telekom.

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Fighting smart Strategy options for telecoms operators

would give operators the opportunity to add more value, according to Mr Deprez. You could provide health-metering services to people with chronic illnesses, and use your own distribution outlets to serve them, but also provide the data to the healthcare companies, whether insurers or hospitals, he says. It will be important that operators take a lead in this area if progress is not to stall. Mr Sorby says that the machine-to-machine market, in which Telenor Connexion and Telenor Objects operate, has not developed as fast as he expected two years ago. That is partly down to macroeconomic setbacks, but he also admits that Telenor must do a better job of explaining to customers why these services are beneficial. Ultimately, these new opportunities will be accompanied by the same arguments taking place now about the precise role of the operator. As bit pipes, operators will need to work hard to defend margins. But even if profits are thin, intelligent networks represent an entirely new source of income.

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Fighting smart Strategy options for telecoms operators

Conclusion

O

perators face enormous challenges as the Internet comes of age. Further commoditisation of traditional services, intense rivalry in the broadband market and heavy-handed regulation could all trip them up. But the argument that operators are heading for a grim bit-pipe future is overstated. As this report has shown, operators have numerous assets that Internet companies do not, and options for becoming more efficient organisations they have yet fully to explore. Not the least of these assets are their existing relationships with customers and their ability to provide services over numerous technology platforms. The key efficiency opportunities today lie in the greater automation of business processesand in the longer term in the deployment of next-generation networks. The five strategy typologies for network operators described in this study are not, of course, mutually exclusive. In our view, learning to partner with Internet companies (smart pipe), radically boosting operating efficiency (efficient pipe), perfecting usage-based pricing (pricing pioneer), embracing rather than resisting competing technologies such as VoIP (defender of the realm), and exploring new revenue opportunities in areas such as cloud computing, intelligent networks and machine-to-machine communications (transformer) are all strategies that, even if pursued in isolation, would help operators to counter the existential threats they face today. If pursued in combination, the effect on operators long-term prospects could be magnified.

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The Economist Intelligence Unit Limited 2010

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