Working Paper The Dynamics of Innovation in the Wireless Telecom Industry during two Eras of Technological Convergence, 1995-2015 This project has received funding from the European Union Horizon 2020 Research and Innovation action under grant agreement No 649186 INNOVATION-FUELLED, SUSTAINABLE, INCLUSIVE GROWTH Henrik Glimstedt Stockholm School of Economics 09/2017 May
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Working Paper
The Dynamics of Innovation in the Wireless Telecom Industry during two Eras of Technological Convergence, 1995-2015
This project has received funding from the European Union Horizon 2020 Research and Innovation action under grant agreement No 649186
INNOVATION-FUELLED, SUSTAINABLE, INCLUSIVE GROWTH
Henrik GlimstedtStockholm School of Economics
09/2017 May
1
THE DYNAMICS OF INNOVATION IN
THE WIRELESS TELECOM INDUSTRY DURING
TWO ERAS OF TECHNOLOGICAL CONVERGENCE, 1995-2015
Henrik Glimstedt
Stockholm School of Economics
May 22, 2017
This project has received funding from the European Union Horizon 2020
Research and Innovation action under grant agreement No 649186
2
ABSTRACT
This paper traces the changing dynamics and strategies of innovation in
wireless infrastructure industry, covering three major phases: (1) massive
adaptation of wireless services in the 1990s and the Internet Cries, (2) the
smartphone revolution and the trends to commoditization of wireless systems and
(3) search for new profitable growth in services, cloud and Internet-of-Things. It
analyses the development of the specific industry character: role of open industry
standards as pathways for innovation, the continuous leadership of vertically
integrated incumbent system integrating vendors, the regionalization of
communication markets, and the development of telecom regulations. It shows
how the equipment industry’s continuous massive R&D efforts (i.e. 3G, HSPA,
HSPA+ and 4G wireless systems) enabled the smartphone revolution, whilst the
intensive competition among wireless operators trickled down to the incumbent
equipment vendors in terms of a lethal mix of requirements for high-performing
equipment and very competitive pricing, a combination which undermined
vendor’s margins. In the process, industry incumbents shared new generations of
technologies with new innovative Asian entrants through the open standards
regime, leading to more global and heated competition. As the competition
developed from “regionalized and moderate” to “globalized and intensive”, both
European incumbents and Asian entrants explored services and software as new
areas of profitable growth. In particular, the paper analyses how the industry
players, in stiff competition with the ‘IT giants’ and platform leaders of the
Internet economy, are seeking leadership in cloud and Internet-of-Things through
the launch of the 5th Generation wireless services, to be standardized in 2020. To
explain the competitive outcomes in the different periods outlined above we need to
link two levels of the analysis:
• Firm Level Sources of Competitiveness
o Strategic commitments and business models
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o Governance of internal resource allocation and the social
organizational integration of knowledge, capabilities and resources
within the company, as well as with external suppliers and partners
o Financial resource commitments
• Standards and the Industry Architecture
o Governance of wireless standard setting processes, regional and
global
o Governance of and business models for knowledge integration of
evolving technologies within generations of standards
o Short-term and long-term impact of industry architecture on firm-
level performance
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Introduction
On February 22nd 2016, Hans Vestberg, then the CEO of Ericsson entered the
stage at the annual World Mobile Congress in Barcelona. In his keynote address,
“Partnership for Innovation”, Vestberg focused on how collaboration and new
ways of working spurs innovation and creates new solutions, especially
partnerships between Ericsson and the two tech giants Cisco and Amazon should
foster innovation-based growth. In his presentation, Vestberg stressed that the
partnership would add further muscularity to Ericsson’s far-reaching ambitions
to become a leader not only in the 5th Generation. In turn, this would strengthen
Ericsson in its role as integrator of other rapidly advancing IT-technologies, such
as cloud computing and sensors, into what the industry calls the Internet-of-
Things (IoT from hereon).1 Few could question Ericsson’s role as one of the long-
term sponsors of the visions of the connected society. It was one three leading
competitors, sponsoring the long-term evolution of mobile broadband technology,
Under the bold heading of 50 Billion Connected Devices, the company have
persistently advocated a strategy for connecting machines into wireless networks.
The hype around IoT at did not surprise the people that continuously watch
and discuss the evolution of the mobile telecom business. The buzz surrounding
IoT connects to a bigger drama that now impact and shape the wireless telecom
sector globally. To get a glimpse of these current affairs, we need to appreciate
the real impact of the smartphone revolution on today’s telecommunications
sector. Whilst the vision of digital wireless services included the notion of
wireless data and internet access from the mid-1990s, it was the introduction of
smartphone that unlocked promise of 3G mobile networks. According to research
by the international wireless industry association, the average adoption rate for
developed markets of 84% is approaching saturation whereas the number of
1 As the CEO one of the three undisputed world leaders in mobile communications systems,
this was far from Vestberg’s first address at the WMC. His presentation would however become
his last one in this capacity as the CEO of Ericsson. About nine months later, he was asked by
Ericsson’s chairman of the board of directors to step down. There were issues regarding
Vestberg’s generous compensation package, the lackluster performance of the stock and the
company’s future competitive position against its competitors. Whilst the disappointing trends in
revenues and profit margins in the current 4G markets clearly undermined Vestberg, the board
was also concerned about his ability to chart a course and drive execution for revitalization of
Ericsson in the next generation of communication technologies.
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users still are growing at higher pace in Asia, Latin America and Africa (GSMA
2017, 12). Smartphone adoption is accelerating across the developing world; there
were 3.8 billion smartphone connections at the end of 2016, accounting for more
than half of total connections (excluding M2M) worldwide. Adoption rates have
reached 65% of the connected base in developed markets. Smartphone
connections in the developing world reached 47% of the total connections base by
the end of 2016, largely due to growth in Asia Pacific and Latin America (GSMA
2017, 12). In Sub-Saharan Africa, the take-off is imminent. Market research for
Nigeria, for example, indicates that over 80% of all internet users rely on
smartphones as their sole on-ramp for access to the Internet (Ericsson 2015b, 7).
The growing number of smartphones and other advanced devices drive the
increasing the use of ‘data intensive’ applications, particularly video streaming,
on mobile networks. This has amounted to an explosion of data traffic. The
growing number of smartphones and other advanced devices (e.g. tablets) are
increasing the use of data-intensive applications, such as video streaming, on
mobile networks. Cisco (2017) estimates that smartphones generate massive
amount of data traffic compared to feature phones2. The increasing use of mobile
broadband-enabled smartphones will generate an explosion of data traffic, with
volumes forecast to grow at a CAGR of 57% to 2019, an almost tenfold increase,
with volumes to grow at a rate of ca 50% over the next five years – a more than
seven-fold increase – approaching 40 EB per month by 2020. This is equivalent to
a global average of 7 GB per subscriber per month (GSMA 2015, 14f)
One the smartphone technology diffused, mobile network operators invested
continuously in infrastructure to update their network and deploy new
technologies. To meet demand for mobile data, furthermore, operators stepped up
their investment plans, particularly by adding more capacity to the mobile
networks. The mobile CAPEX is a good indicator of the level of investment
performed by mobile operators. One the one hand, operators have rolled out more
3G/HSPA equipment as a short term solution. By doing so, their networks can
accommodate more data traffic without reducing the cost efficiency of the
2 In 2016, the typical smartphone generated 48 times more mobile data traffic (1,614 MB
per month) than the typical basic-feature cell phone (which generated only 33 MB per month of
mobile data traffic. (Cisco 2017)
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networks. Operators have also moved onto the next technological stage by rolling
out cost-effective network equipment. New network technology generations such
as HSPA+ or LTE, that is 3.5G and 4G, more than halve the cost per gigabyte
with their increased capacity per site, still relieving network capacity
constraints.3 According to a report by IDATE, the consultancy, there has been a
pattern of uneven development. Generally, the most recent technologies were
deployed most broadly in the North American, Japan and South Korean markets.
In those markets, LTE deployment reached between 70 and 95%. In the large
European markets, i.e. UK, Germany, Italy and France, CAPEX investments
have, however, been almost flat over the past few years in Europe. One direct
consequence of the lack of investment has delayed the LTE take-off (IDATE 2015,
7).4
As the smartphone became widely used across large parts of the populations
throughout the world, the sheer growth of demand for wireless services has been
stunning, However, the financial well-being of mobile operators are suffering
from the widening disconnect between the demand-side developments, that is the
market penetration of data intensive smartphones, and the revenues that
operators can command on the supply-side. While most operators are managing
to grow their top line with mobile data, there is a treacherous undercurrent. The
usual economies of scale, it seems, malfunctions in the following way: mobile data
ARPUs are not delivering the same financial margins as voice (which relies on
quality service [latency] rather than high bandwidth as for data transfer). A
significant share of smartphone customers became unprofitable because mobile
data offers are mainly structured around bundled, flat-fee plans. Operators were
lacking, under the current bundled business model, capabilities to transform
increasing demand into revenues and profits. The increasing data traffic per user
3 HSPA+ and LTE are expected to support three to five times as much traffic as HSPA (7.2
MBit/s) with the same spectrum, reducing cost per gigabyte by 40 to 70 percent compared with
the currently implemented network (Grijpink et al, 2016, 23). 4 As also noted by IDATE Consulting (2016), the contrast between EU5 and other regions is
even more striking when taking into account the respective size of the markets. CAPEX per
population (pop) ratios display the amount of money spent per inhabitant (EUR/inhabitant).
CAPEX per pop ratios are much higher in Asian countries and in the USA than in EU5. It is the
highest in Japan with more than 100€ per pop per year, whereas the USA and South Korea are
respectively at EUR 80 and EUR 60 per pop per year. Europe again falls behind with a widening
gap towards the USA during the 2008-2014 period of time at less than EUR 40 per pop in 2014.
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has not matched the ARPU, the average revenue per user. Since 2010, this
disconnect has developed into global problem, although it is most pronounced in
the European market: “Although the emerging mobile data arena will prove to be
a sizeable growth engine for most telecom operators…”, McKinsey reported, “…
preserving its long-run profitability could become a significant challenge and
priority for operators.” (McKinsey 2012, 3)”
For the period between 2006 and 2014, research by Research Center on
Regulations in Europe shows, the average price tariffs in the OECD countries
steadily declined with around 50% for the period, or almost 2.2% per quarter
(Genakos, Valletti, and Verboven 2015, 14). Operators in countries with a low
degree of market concentrations reduced tariff prices at a somewhat higher pace
than in in countries typified by competition between many smaller operators
(Genakos, Valletti, and Verboven 2015, 16) . Adding to this toxic situation, top-
line growth slowed down around in 2014. Western Europe, according to Ovum, an
London-based market intelligence group, expects see very limited revenue growth
in the period between 2016 and 2018. By 2019, Western Europe will experience
revenue decline also in real terms. For all other regions, revenue CARGs will be
modest, or around 2%. Central and Southern Asia and Africa is predicted to grow
faster than average, at of 5.1%, 4.5%, and 3.6%, respectively, through 2019
(Ovum 2015, 11). At the heart of this un-development is the increasing cut-throat
competition on data plans for smartphones, which on average is 50% lower in
Europe compared to other developed markets .
With shrinking market cap and average return on capital employed for
major European operators, such as Vodafone (UK), Organge (Fr) and Telefonica
(Sp), telecom CEOs began to look consolidation through M&A. In 2012 and 2013,
European authorities gave the green light to minor attempts to consolidate in
smaller regional markets but also a more significant merger, i.e. Telefónica’s
2014 takeover of E-Plus in Germany, which stimulated a slew of merger
proposals. European competition authorities however struggles to strike a
balance between protecting the regional operator’s business while also protecting
their customers. In 2016, Brussels for example decided to block the much-
anticipated merger of O2 and the UK branch of Hutchison’s Three. As
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emphasized of independent industry analysts, FT reports, the collapse of the deal
leaves both operators in a precarious situation (Financial Times, May 11, 2016).
This is an unsustainable situation that threatens both the long-term health of
the telecoms industry.
Trickling down of cost-pressure to wireless infrastructure equipment vendors
No other group of actors in the mobile communication industry, most observers
agree, feels the operator’s dire situation more deeply and profoundly than the
four leading full-service manufacturers of mobile systems – Huawei, Ericsson,
NSN, ZTE and Samsung. To meet operator’s seemingly endless demand for
capacity Since the coming the second generation digital services 1990s,
equipment vendors have engaged in continuous innovation in new generations of
radio access technology and core system products to meet the operator’s
seemingly endless needs for high capacity at constantly lower costs. Yet, the
development of operating margins in key product areas, such as radio base
stations, suggests that wireless connectivity has been put on a trajectory towards
commoditization in a maturing market.
Network capacity expanded primarily through innovation. Between 2006
and 2015, the R&D investments by Huawei, Ericsson, Qualcomm and their peers
in evolved and new generations of wireless infrastructure technologies resulted in
major increases in network efficiencies. Especially new network and spectrum
technologies such as 3G HSPA+ and 4G LTE technologies opened up large
amounts of capacity to the operators. The equipment vendor’ brought those
innovative were brought to the market at high cost. Ericsson, which is most
heavily specialized in wireless equipment, is a case in point. With 1/3 of the
workforce (or 21,400 employees) in research, Ericsson’s R&D spending 2012 at
32.8 billion kronor ($4.9 billion), and accounted for 14.4 percent of the Stockholm-
based supplier’s sales. On average, Ericsson R&D/sales ratio amounted to 15% of
its revenues on R&D between 2006 and 2015. In real terms, R&D expenses have
increased from 27bn in 2007 to 36bn SEK in 2015 (Ericsson 2015a). Huawei has
consistently increased the proportion of funds invested in R&D relative to
turnover. R&D/Sales ratio for Huawei --where almost half of its workforce is in
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R&D-- was 13.7 percent in 2012. Since 2013, the Chinese vendor reports that
R&D spending growth at a higher pace than its revenues. These levels are typical
to the industry. On average, the industry leaders --Huawei, NSN Networks
(Nokia-Siemens-Alcatel-Lucent) and Ericsson-- allocated on average 14,6% of
their annual incomes to R&D between 2011 and 2014. The average combined
R&D-spending by the leading equipment vendors 2011-2014 reached $57,7bn in
total. In broad strokes, the equipment vendors have to different degrees focused
their R&D-efforts in four areas:
• spectrum efficiency and radio access/antenna technologies,
• IP systems (i.e. core/edge routers and Ethernet switches),
• network virtualization, data center technology and software defined
architecture (i.e. decoupling of network hardware, functions and
control
• signal processing technologies (i.e. software algorithms and ASIC
architecture).
Despite the R&D intensiveness, the equipment vendors increasingly experienced
a profit squeeze. Particularly in the European wireless markets, operators began
to take full advantage of the rivalry between incumbent equipment vendors and
low-cost entrants (i.e. Huawei). The unusual combination of high R&D-cost and
falling revenues naturally undermined the financial results of the equipment
vendors. Huawei, the tremendously successful company that gobbled up markets
shares with promptness for the decade in all parts of the global market except in
the US between 2006 and 2016, experienced the benefits of double-digit growth.
Still, the operating margin has remained below 15% between 2012 and 2015. In
the same period, Ericsson posted operating margins between 6 and 8%, with a
jump up to 12% in 2016 due to aggressive cost-cutting (through implementation
of the Profit Plus initiative). For the sector, the combined operating margin
averaged at 7,3% between 2009 and 2015 (Xerfi Global 2016, 58).
What thus typifies the vendor sector is commoditization of wireless
connectivity and the high pressure on R&D to deliver spectacular technological
advances. Without these cost-saving innovations, the demand from today’s data
hungry end-consumers would not have been possible to meet neither
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economically nor in technical terms. Research by independent analysts, such as
Analysys Mason (2013) and Booze Allen (2013), shows that, for investments in
latest LTE equipment, the ToC per unit of network capacity has decreased with
no less than 95% compared to investments in 2.5 or early 3G technologies.
Published reports by Telenor points in the same direction: the operators are
increasingly getting a ‘bigger bang for the buck’.
Diagram 1: Figure 1: Development of Network Spending per Gigabyte, 2009-2015
Adopted from: (Spilling 2016)5
Peter Laurin, senior vice president and head of Ericsson’s global sales to
Vodafone, confirmed in an interview with the author that network cost efficiency
have increased between one hundred and two hundred times between 2006 and
2016, depending on site utilization (Larurin 2016). Even if being great news for
the customer, who enjoys the benefit of dirt-cheap data plans, it is however a far
more troublesome development for the equipment vendors. For each invested
Euro in R&D –it seems-- the financial returns to innovation shrinks even further.
Internet-of-Things: the Light in the Tunnel
So, here we are at a juncture in the evolution of the mobile communication
business where means and ends do not quite match -- at least not for equipment
manufacturers. No wonder that Ericsson and its peers spent so much time on IoT
at the MWC. As the stakes got higher, the participants of the MWC were not only
looking for answers concerning how big the pie will be, but also what companies
5 Telenor presentation by Rolv Olof Spilling, CTO, https://www.telenor.com/wp-