Strategic Perspectives on Mobile

Telecommunications:
Industry Evolution and Implications
By Francis Deprez, Bernhard Schmidt, Stefan Schmitgen, and Pal Erik Sjatil
After experiencing a decade of stunning growth and profits, the mobile industry
has reached an inflection point. Will it see a better-than-expected future, or will it
descend into massive value destruction?
The worldwide mobile industry came of age in the decade between 1993 and 2003.
Revenues grew by 30 percent each year, subscriptions increased by 44 percent annually,
and stock performance although a wild ride consistently outperformed the broader
market. The mobile industry currently represents more than 40 percent of the total
telecom market and is expected to reach 50 percent within three years. Moreover,
significant parts of the industry have (in a sense) reached a path of profitable growth,
with 2003 global industry EBITDA (earnings before interest, taxes, depreciation, and
amortization) margins averaging nearly 40 percent, while capital expenditures as a
percent of sales have remained at a manageable 16 percent.
Today, the industry is poised at an inflection point, from which it can either continue to
experience enviable profitable growth, or witness extreme levels of value destruction.
Industry observers and market analysts today still maintain quite positive outlooks for
the mobile market, with subscriber growth forecast to increase by 10 percent annually
through 2007, in line with revenue growth projections of 11 percent during the same
period. However, it appears that there are numerous clouds on the mobile horizon, which
make the future a lot more uncertain than typically anticipated. The structural trends can
be categorized in the following terms:
Customer behavior: As existing customers become more sophisticated, their
needs begin to diverge, requiring operators to abandon their one-size-fits-all
approaches and increasingly differentiate their offerings. The anticipated
adoption of non network-based services mainly focused on mobile data but
also on voice (e.g., VoWLAN) could challenge current customer
relationships. Finally, accommodating the "next billion" mobile users could
prove to be more challenging than the first billion the next billion being
made up of more customers in emerging markets, who have very different
income levels at their disposal.
Technology: The diffusion of alternative wireless access technologies (e.g.,
WiFi, WiMAX, Flarion, etc.) will challenge the straightforward 2/2.5/3G
roadmap. This, combined with the emergence of multi-modal devices and the
decoupling of the network and service deployment layers, could make it a lot
more difficult for existing operators to fill their networks, keep the customer
interface, and to avoid price wars.
McKinsey & Company Mobile Telecommunications Extranet

 Industry dynamics: A wider range of non-mobile players with disruptive

Internet-like business models seem ready to enter the market, and could
become attractive substitutes for current mobile customers. Accelerating
innovation and product development cycles, coupled with shifts in R&D
investment to non-traditional players, could swing industry momentum away
from current operators, and challenge the status quo even more.
Regulatory environment: The expected technology neutrality of regulators,
with the spectrum being maintained as a scarce resource, could lead to more
permissive, more competition-oriented regulation that, again, would
negatively impact current players.
These challenges represent substantial threats to mobile operators, exposing industry
vulnerabilities in the customer, service, and technology areas and highlight the fact that
regulators will most likely do little but enhance competitive dynamics. In order to better
understand the upside possibilities and downside threats in the mobile industry,
McKinsey & Company's Mobile Telecommunications Practice has developed a
perspective that seeks to provide both a "ceiling" and a "floor" for the industry's
potential future. This scenario-driven analysis uses the current state of the industry as its
starting point and then provides the elements that could make either scenario a reality.

Worst Case Value Destruction

In the worst case scenario, mobile operators would face strong competition and
consolidation in a commoditized industry. The realities of such an environment would
likely cause operators to:
1.

Compete away the mobility price premium for voice service in the event that
fixed players partner with third parties in order to roll out fixed wireless and
capture indoor calls through VoWLAN. Furthermore, mobile voice pricing
could decrease anyway, as signs are emerging that operators around the
world are increasingly introducing heavily discounted and flat-rate pricing
schemes.

2.

Fail in attracting the "next billion" users in the developing countries, if

handset vendors continue to focus on high-end devices and decide to not
market low-cost products.

3.

Lose control of the customer relationship and identity if, for example, other
parties from the fixed sector leverage their technology in order to provide the
authentication, authorization, and accounting (AAA) systems necessary in
offering mobile data services.

4.

Be unable to drive data uptake, if content players fail to team up and instead,
launch their own services for security reasons (e.g., digital rights
management).

5.

Generate limited margins for wireless data service, if customers pay only low
fixed rates for data services in a fixed/Internet paradigm (such as those
introduced in Japan within the last year).

McKinsey & Company Mobile Telecommunications Extranet

6.

Be restricted in terms of capacity and technology because they face

unfavorable spectrum and/or licensing policies.

Mobile revenues would face significant pressure if non-mobile players were to take over
sizeable portions of the voice business. For example, in a theoretical case, while
revenues in Europe could decline by 41 percent if prices drop to fixed levels, they would
decline even more by an estimated 67 percent were a disruptive technology such as
VoWLAN to be introduced across the board, thus allowing non-mobile players to
commandeer a significant portion of the market. The further revenue reduction would
result from the additional price decreases created by the switch to VoWLAN, which
could potentially represent up to 60 percent of voice calls.
Revenues would remain flat over the next four years in a worst case scenario (Exhibit 1),
instead of increasing by more than 10 percent annually under current forecasts. Such a
development would lead to huge value destruction in the mobile industry. The key
assumptions behind this value-destroying scenario are not far fetched. For example, if
developing-markets subscriber growth averages just 7 percent per year instead of 17
percent through 2007, there would be 30 percent fewer new subscribers in these
countries. Such a decline could be driven by a lack of low-cost handsets and
infrastructure. Strong competition or regulator intervention could lead to voice ARPU
declines of approximately 35 percent instead of the 10 percent currently forecast for the
developed markets. Instead of doubling as is currently anticipated the ARPU
generated by data and value-added services (VAS) could decline by 20 percent as data is
commoditized.
Ultimately, EBITDA margins would decline by six to eight percentage points and the
industry could forfeit up to USD 200 billion in value. In such a scenario, the winners
would include: consumers, who would pay lower prices; mobile virtual network
operators and service providers with low-priced offerings; new wireless players, who
would acquire parts of the traffic; and Internet players, who would capture the value of
VAS.

McKinsey & Company Mobile Telecommunications Extranet

Exhibit 1:
WORLDWIDE ESTIMATES

In a "worst case" revenue growth could be driven down

to zero for the next four years ...
USD billions revenues

644

NOT ...
423

79

44

27

229

Current
forecasts

Growth in

subscribers till 2007

slows down f rom
17% to 7% in
dev eloping markets
Voice ARPU decline
35% instead of 10%
in dev eloped
markets vs. 2003*
Much slower data/
VAS uptake combined with decrease
in pricing (SMS,
f lat data fees)

USD ~ 200
billion at risk
zero growth for
the next four years
in a pessimistic
"worst case"
scenario

BUT ...
423

144

141
4

"Worst
case"
Mobile
rev enue
2003

Growth
Decline
in mobile in v oice
subARPU
scribers**

Growth
in data
ARPU

Growth
in VAS
ARPU

* Still conserv ative: Mobil e prices d ecreas ed by ~50% i n 6 months in D enmark after Telmor e market entry
** 2003 ARP U
*** Consider ing d isrupti on in Western Eur ope, North Amer ica an d Asia Pacific (sca led- up bas ed on WE and US)
Source: Gartner, Ovum, IDC, McKinsey analysis

13

421

Mobile Disruptiv e VoWLAN/

rev enue WiMA X uptake
after 2007 could lead
2007
to rev enues <USD
300 bn***

BVA-ZZU387- 200 406 14-he-v 6

"Favorable Future" Possibilities

Because the worst case scenario is certainly within the realm of possibility, mobile
operators must act now in order to avoid this outcome, and thus reach a more favorable
future. The key is to effectively resist commoditization by delivering a distinctive
mobile value proposition to customers. A more optimistic view on the future mobile
industry would require a shift in this direction. For example, mobile operators would
offer high-quality access that allows for ubiquitous, spontaneous personalized
communication. A large network of companies would also deliver compelling data
services and third-party content via standardized open platforms. Operators would offer
a trusted, easy-to-use environment (e.g., spam and virus protection) and ensure efficient
and secure control of identity data, as well as be able to apply workable charging
mechanisms (e.g., active usage payments in the "data world"). In order to succeed,
operators must establish stronger relationships with their approximately two billion
customers worldwide. They must work to maintain realistic mobility price premiums in
a seamless, multi-access world and seek to benefit from heavy demand for data services
and the VAS being delivered by mobile players.

McKinsey & Company Mobile Telecommunications Extranet

Exhibit 2:
Mobile operators who react now could create a significant upside for the
industry
USD billions - market value

Main assumptions*

25% higher penetration in developing

+50%

~ 1,725

countries leads to 2.3 billion subscribers

instead of expected 1.9 billion

Voice revenues captured by mobile players

~ 1,150
~ 750

~ 30% higher in developed countries than

expected assuming strong fix ed to mobile
substitution (at price ratio of 2:1) and the
reselling of fix ed minutes

In developing countries voice ARPU is 15%

higher than base case 2007 through
stronger deployment of mobile infrastructure
rather than fix ed
"Worst
case"

Continue "Favorable
future"
"as is"

Data/VAS ARPU is 80% higher than

expected for 2007 (275% vs. 100% growth);
mobile operators control the entire value
chain

EBITDA margin 4-6 perc. points higher

* Compar ed to 200 7 "as is" mod el
Source: McKinsey

16

BVA-ZZU387- 200 406 14-he-v 6

Success could create a significant upside for the industry, potentially boosting total
market value by 50 percent from current projections for 2007 (Exhibit 2). The favorable
future scenario would generate EBITDA margins 4 to 6 percent higher than those
currently anticipated for 2007. Appropriately designed services and handsets should
generate 25 percent higher penetration in developing countries, producing 2.3 billion
subscribers instead of the expected 1.9 billion. Mobile players should also be able to
capture additional voice revenues, which could be roughly 30 percent higher than
expected in developed countries, assuming strong fixed-to-mobile substitution and the
reselling of fixed minutes. A focus on deploying a more robust mobile infrastructure,
which more fully overtakes fixed services in developing countries, would generate voice
ARPU that are 15 percent higher than in the base case 2007. In the favorable future
scenario, data and VAS ARPU would be 80 percent higher than that currently expected
for 2007, with mobile operators controlling the entire value chain.

Forging a Favorable Future

Achieving the favorable future scenario (or at least preventing the worst case scenario
from happening) will require both individual company effort and industry-wide action.
Mobile operators must defend their businesses from the worst case scenario, while
proactively shaping the factors that will enable them to outperform the current outlook
regarding the industry's future.
Avoiding the worst case scenario will require a focus on cost containment (e.g.,
streamlining the organization and implementing lean operations), including strategies for
maximizing economies of scale (e.g., consolidation and the establishment of profitable
reselling partnerships). It will also compel the industry to develop attractive network
products (e.g., integrated messaging service) and to evaluate the cost advantages of
McKinsey & Company Mobile Telecommunications Extranet

migrating to next-generation IP networks. In other words, companies should prepare for

"hard times" by optimizing their operating processes, increasing scale, and by seeking
new network options.
At the same time, achieving the favorable future scenario will mean that firms must
leverage customer ownership with an eye toward increasing their "share of wallet",
which will require operators to strengthen their customer franchises. Such efforts
involve building brand equity and instituting superior customer life cycle management
and quality of service processes. Operators must also improve their retail distribution
positions and strengthen service delivery to maintain customer satisfaction and loyalty.
They must continually innovate in order to offer attractive customer-driven services and
(ultimately) embrace new wireless technologies to enable leveraging of the most costefficient mix of access networks.
How can a company achieve such objectives? The key enablers of the favorable future
scenario require operators to (Exhibit 3):
Manage the customer identity by, for example, leveraging AAA capabilities
and SIM in order to create a trusted environment
Establish the precondition for services-based charging principles (e.g., what
will be the "active party pays" equivalent in the IP/data world?)
Create open standards for service deployment and guarantee interoperability
Manage seamless access to embrace the most efficient technologies, including
roaming and multi-modal handsets.
Exhibit 3:
The key enablers for a "favorable future"
Key enablers

Manage customer identity

Customer identity
Charging principles

leverage AAA capabilities/SIM

and create trusted environment

Playerspecif ic
services/
applications

Create prerequis ites for

services based charging
principles (active party pays in
IP/data world)

Create open standards for

service deployment and
guarantee interoperability

...

OS neutral service deployment platform

Manage seam less access

to embrace the most efficient
technologies,
GSM
including roaming and multimodal handsets
What can
mobile operators
really achieve
individually?

Seamless access integration

GPRS

UMTS

WiFi
?

WiMAX
?

Source: McKinsey

23

BVA-ZZU387- 200 406 14-he-v 6

McKinsey & Company Mobile Telecommunications Extranet

There are two ways in which these key enablers can be put into play. One is that
companies can simply elect to allow the needed changes to take place around them
organically. For example, vendors will set standards for service delivery platforms,
Internet players will set standards for access technologies, and SIM card manufacturers
will establish identity standards together with players from other sectors. However,
allowing other parties to set de facto industry norms will probably cause mobile
operators to lose control of critical elements in the mobile value chain.
The other and preferred method would be for the players to proactively shape the
industry to their advantage. Very large players may attempt to drive standardization by
themselves, in the same way that Microsoft did in the personal computer industry. But
even large mobile operators may not have the wherewithal to pull off such a strategy.
Perhaps a more reasonable approach would be for multiple operators to participate in
strong mobile alliances. But even in this case, mobile players must realize that there are
key competitors outside of the industry that could blunt the impact of such pacts. Firms
can attempt to collectively drive standards via industry bodies and associations, which
may be the only option for achieving success in some cases.
The mobile industry will face significant challenges in the coming decade. The "golden"
days of full-throttle growth and profitability appear to have passed, as new players
utilizing innovative technologies enter the market. Operators must act now to ensure that
they are protected from worst case possibilities as well as positioned to take advantage
of what could be a very favorable future.

About the authors:

Francis Deprez is a Principal in McKinsey's Brussels office, Bernhard Schmidt is a
Manager in McKinsey's Berlin office, Stefan Schmitgen is the European Mobile
Telecommunications Practice leader and a Director in McKinsey's Frankfurt office, and
Pal Erik Sjatil is a Principal in McKinsey's Oslo office.

Copyright 2004 McKinsey & Company, Inc.

All rights reserved.

McKinsey & Company Mobile Telecommunications Extranet