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Management summary
A battle of giants is brewing in the world of telecommunications. Traditional telcos, with their five billion customers worldwide, are getting ready to take on new Internet-focused rivals offering communication platforms, services and content via smartphones, tablets and Internet-enabled TVs. Right now, the strongest of these are the "fab(ulous) five": Amazon, Apple, Facebook, Google and Microsoft, who serve over three billion customers between them. Traditional telcos and their modern rivals each have a total market capitalization of round about EUR 800 billion. Current public opinion favors the fab five with their superior innovative capabilities, breathtaking growth rates and large cash reserves. But will that be enough to threaten the traditional telcos? The fab five certainly enjoy a number of advantages, including daily "branded contact" with customers, close customer bonds with their easy-to-use, personalized service ecosystems and, increasingly, a willingness on the part of customers to pay for such services. Pureplay broadband access the mainstay of traditional telcos' business today will remain the cornerstone of digital communication in the future for both landlines and mobile communication. While usage and associated data volumes continue to grow exponentially , however, telcos are under the price pressure that inevitably accompanies commoditization while the industry so far has failed to monetize volume growth. So what can telcos do in their battle with the giants? This is the question answered by our global study "Telco 2020 How telcos transform for the Smartphone Society". Our talks with more than 25 top decision-makers representing the entire spectrum of telecommunications revealed that the "right" strategic orientation for each telco will depend on five key levers: 1) Personalization of service ecosystem and the customer experience; 2) staunch defense of relationships with end customers; 3) cost-efficient broadband network build-up; 4) the realignment and radical streamlining of operating models; 5) the financial resources to drive digital transformation and consolidation. Three realistic scenarios emerge from this finding. In extreme cases, telcos will do no more than engage in what can be termed "Access Minus" business, primarily providing network infrastructure as wholesale service providers that have all but been cut off from their relationship with the end customers. Companies with better strategic positions and deeper pockets will develop their own access-centric services and selective over-the-top (OTT) offerings, positioning themselves as "Access Plus" providers. Only a handful of regional telco groups will, through acquisitions, establish themselves as "OTT service groups" capable of competing with the fab five in the complex "OTT Game".
None of these three strategies is inherently right or wrong. Provided they make a convincing job of executing the strategy, even companies that back the Access Minus horse can develop successfully and stimulate hopes of value growth on the stock market. We believe that virtually all telcos can manage this approach, even if some incumbent players currently appear overvalued. Ultimately, though, five golden rules will separate the winners from the losers: 1) Get the core access business right Converged broadband access, personalized service suites, experience-based; 2) Make targeted, realistic "bets" with regard to growth and differentiation (in the case of Access Plus strategies and forward-looking OTT investments); 3) Transform into lean telcos with de-layered operating models and only half of today's workforce; 4) Convince capital markets by presenting them with attractive consolidation and streamlining stories, abandoning secondary activities and committing to cooperative ventures; and finally 5) Act quickly and resolutely. Only then can the industry resume its pattern of value growth and begin offering shareholders attractive returns again despite the erosion of its core business and the best efforts of global rivals such as Apple and Google.
Ubiquitous communication: Ever since the smartphone, tablet and Internet-enabled TV began their triumphal march, we have been online almost permanently, often with multiple devices simultaneously. Worldwide usage data shows that, apart from over dinner and when we are asleep, there is no time when we do not engage in online communication. And that is only the beginning. We are well on our way to becoming a smartphone society, a telecommunicative world that, while perhaps still a distant dream for many consumers and providers, appears inevitable to us at Roland Berger. Customers don't buy access, they buy service ecosystems: In the future, our communication will revolve around social media platforms, dominated by Internet firms such as Apple, Facebook and others that do not even exist yet. The Google+ videotelephony project launched in 2011 shows the way forward for integrated communication environments that, building on a personal or organizational network, set up telephony, messaging, mail, chat or video links at the click of a button. This will naturally affect telcos' revenue streams. Voice over IP (VoIP) telephony is doing away with the need for traditional, landline phones. Free chat apps are replacing profitable services such as text messaging. Even online videotelephony is emerging as a free service, (although it tends to clog up networks). Future data tariffs will only compensate for part of these losses, even after more bandwidth and greater data usage has been priced in. Worse still, young, tech-savvy customers are getting used to interacting from within the service ecosystems set up by over-the-top (OTT) players and are just a click away from the latter's all-in service offerings. These ecosystems are where they come to meet friends, buy music, post news and pay for online purchases. So why should they leave their familiar "home" environment just to communicate?
Usability and service experience the keys to customer acceptance: Separate individual contracts are increasingly giving way to demand for access packages that bundle broadband connectivity for mobile phones and the Internet. As things stand, just 10% of customers buy contracts that combine mobile and landline communication. Yet this figure is expected to rise to 60% by 2020. In the end, customers pick the provider whose digital service suite matches their patterns of usage as closely as possible, and that also supplies attractive handsets. Future offerings will have to function independently from devices and network access, especially at a time when mobile Internet is becoming increasingly important worldwide. Communication is no longer a separate service. It has become an integral part of social networks and other e-service ecosystems that embrace entertainment, shopping and healthcare, for example. Telcos need to compete with the fab five: Amazon, Apple, Facebook, Google and Microsoft are spreading their tentacles and occupying more and more of the service territory. They are offering Internet applications, their own devices and platforms on which customers can (although they rarely do in practice) combine all their online activities even if the service ecosystem builds barriers to other ecosystems. In the future, customers will be willing to pay for simple, fast access to these ecosystems. Pure-play broadband access will remain the cornerstone that even the fab five will have to use. But given the forecast ubiquity of optical fiber networks and highspeed wireless connections, it is increasingly being regarded as an interchangeable commodity. As a result, price pressure is growing.
Personalization: Ease of use based on intuitive access to a familiar ecosystem, one-stop shopping and customer services will become core requirements, precisely because the market is flooded with so many disparate devices and offerings. The fab five already attach great importance to personalized recommendation marketing ("I like", "Amazon Recommendations" and "Google Search", for example). Future telco offerings will have to be personalized to the same degree, including apps to answer everyday questions, from "What's on TV?" to "Is the freeway clear?", not to mention the availability in the cloud of personalized content that is independent of specific devices.
Telcos have some fundamental rethinking to do our motivation for this study
Telcos need to understand each and every one of their five billion customers, their networks and their preferences, rather than trying to supply the masses with one-size-fits-all infrastructure products. The good news is that no-one has as much information as the telcos do. The bad news is that no-one does as little with it. They scarcely seem able to use this knowledge to personalize sales and services. Not so the five Internet players. Amazon (300 million shoppers), Apple (over 250 million iOS installed), Facebook (845+ million users), Google (over one billion search engine users, 200+ million "Androids") and Microsoft (over 660 million Skype users) dominate the OTT game. They have our data and they are not afraid to use it. Consistent personalization makes them indispensable. They are our daily companions because nearly all of us use their services. They also beat telcos on finance and innovation a fact that stock markets have rewarded with considerable increases in their share prices in some cases. Tellingly, not a single European firm appears on the list of most valuable internet business brands. Nor do many people expect to see them there any time soon, as the digital transformation undermines the position of traditional telcos. Revenues and profits are in decline even as companies have to invest more just to compete. If the telcos continue to rely on their existing strategies and business models, revenues will drop by as much as 20% and EBITDA by as much as 40%. The lost profit will find its way to the fab five, other OTT providers and cable companies. At the same time, European telcos will need to invest a total of more than EUR 600 billion by 2020. Most of this will be required by today's core business, on optical fiber networks and LTE, driven by political requirements and competition from cable operators with their 100+ megabit connections. In the short term, this will lead to a considerable increase in investment levels for some players. Others will attempt to spread their investments over a longer period, but in so doing lose valuable time in the competition for shares in the broadband market. In a shrinking market, telcos can only cope with these losses if they consolidate intelligently.
They must slim down their various network, sales and service business models, abandon secondary activities and use M&As or cooperative ventures to penetrate fast-growing markets. All of this leaves little money and less time to "bet" on new strategies and business models. Worse still, the experts we spoke to do not believe that the traditional telcos have the innovative capability required to engage in a competitive battle with the fab five. Prompted by the upheaval in the market and competitive landscape, Roland Berger took a closer look at the future role firms will play, expectations with regard to their business models and the necessary consolidation. To prepare our study "Telco 2020 How telcos transform for the Smartphone Society", we interviewed more than 25 decision-makers representing the entire telecoms value chain all over the world, including six of the ten global leading telcos, equipment providers, Internet market leaders and investors. The participating companies post combined annual revenues of around EUR 400 billion about a third of the global industry total. Half of our interviewees were board members or CEOs who take these changes into account in their decisions day in, day out.
Current market figures and expectations for Europe suggest that two issues are key with regard to telcos' future strategic orientation: 1. Access will remain the backbone of most telcos' business. 2. To be equipped for growth markets, many telcos will also offer Access Plus services, covering everything from the marketing of access-centric platforms to mostly regional OTT services. Access will remain the major source of revenue and hence the core of every telco strategy in the long run. In 2015, we expect to see revenue totaling some EUR 300 billion in Europe. Around two-thirds of this amount will be attributable to mobile communication, partly because LTE networks will have substituted as much as 10-20% of landline Internet connections. Due to their experience with infrastructure, their heavy investment in more efficient broadband access networks and the savings permitted by leaner business models, telcos can continue to generate EBITDA margins of as much as 35% to 45% by delivering access alone.
Having said that, this core business area will stagnate until 2015. Given the upheaval on the communications market, we expect to see a decline of 1% to 2% a year until 2020. Activities such as hosting, data storage and security services all of which build on access are the exception to the rule. These cloud technologies are enjoying double-digit growth. They are attractive to telcos because they upgrade "mere" access, allow to capitalize on their networks, help to retain customers, their data and their applications, and so allow companies to gain a foothold in the OTT segment.
In adjacent business lines that rely on the telcos' network and IT service platforms, it makes sense to cooperate and place selective bets in order to grow and cultivate a distinctive value proposition. To what extent telcos succeed, however, will naturally depend on their own capabilities, their potential to become market leaders and whether the markets they serve follow local or global rules. Regional telco groups such as Telefnica, Vodafone and Deutsche Telekom and national champions such as Telecom Italia, KPN and Swisscom are setting their sights on similar areas of growth: payment services, advertising, energy services, smart home services and healthcare services ("e-health"), to name but a few. To take the latter segment as an example, many patients may not yet be able to imagine having, say, their blood pressure measured by a mobile service provider. Yet Telecom Italia is using precisely this kind of remote monitoring system to save older patients the hassle of spending time in hospital and to save the national health system money. E-health may not be a large market. But given that healthcare is heavily dependent on national legislation, it seems a sensible niche to occupy as global OTT players are unlikely to be interested in developing suitable offerings for each and every country. European telco groups might even have the chance to establish a European standard although there is as yet no sign that telcos plan to prioritize such opportunities in collaboration with healthcare partners. On the other hand, payment services and advertising business force national incumbents to line up against international competitors. Payment by mobile phone is regarded as a market that has so far been neglected but could be worth billions. Things are slowly beginning to move. Japan's NTT, for example, is already in possession of bank licenses in Europe. Deutsche Telekom, Vodafone and O2 have come together to form the "mpass" joint venture a payment system for online purchases by mobile phone. OTT players are also joining the fray, as evidenced by the Google Wallet, Facebook's "Credits" and the eBay subsidiary PayPal. Telcos that go beyond access-centric services and platforms will encroach on the OTT turf that the fab five have made their own. In the short term, TV promises to deliver the most revenue and will be a necessary weapon in local competition. In the long term, however, traditional telcos will scarcely be able to hold this ground as they simply cannot keep pace with global OTTs such as Facebook and Google+ or portals such as iTunes, YouTube, Netflix and Hulu particularly as local content providers can easily make use of their own platforms. Telcos face the same dilemma on the subject of music libraries, online games, app stores and e-commerce stores. They may stand a better chance in sectors with a more local focus, such as special regional areas of e-commerce. Alternatively, they might follow the example of Japan's telecommunications company Softbank and invest in a portfolio of potential future OTT market leaders another way of betting on the future.
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Theoretically, then, the options range from pure-play access business with telcos operating more or less as anonymous wholesale providers in extreme cases to engaging in handto-hand combat in the OTT boxing ring. According to the results of our interviews, the best strategy for a particular operator depends on five key levers: the personalization of service suites and the customer experience; staunch defense of relationships with end customers; cost-efficient broadband network build-up; the realignment and streamlining of business models; and the financial resources to drive digital transformation and consolidation.
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In our interviews, the Chief Strategy Officer of one national telco group added the following observation: "The biggest threat comes from Apple and Amazon. They will offer handsets plus e-SIMs and will walk off with our customer relationships." Contracts and billing could be handled via iTunes or Amazon accounts. The telco would thus become anonymous, a mere wholesaler of network capacity with no end-customer relationship of its own. The apps are already here, and soft SIMs and e-SIMs are on the way. It is a matter of when, not if. OTTs still lack a sales and service presence on the ground in urban areas. Apple, for example, sells only 14% of all iPhones via its 350 stores; the rest are sold primarily by the telcos. In 2011, the company opened just 40 new stores worldwide not exactly a powerful distribution network. By comparison, Orange has 850 stores in France alone. "The big OTTs will continue to need our local service and support," agreed a CEO at one European mobile network operator. That is why we believe the telcos will stay in control of a large proportion of contracts for the time being. Around 80% of contracts are today sold directly to end customers. By 2020, the figure will still be 50%, compared to 30% for smaller telcos.
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China and Russia manage and protect their telcos and OTTs through state-led infrastructure development and to great effect: Tencent, Baidu and China Mobile are among the Top 10 in their sector worldwide and VimpelCom and Yandex are not far behind. These countries have given their national ecosystems a chance to position themselves effectively against the fab five. However, a maze of regulatory prescriptions and political interests is ensuring that there is no clear pattern to network expansion in Europe. The fab five have a free hand when it comes to European infrastructure. While German policy primarily focuses on moderate consumer prices, various countries give precedence to industrial policy considerations, national welfare or national security. This being the case, we envision three possible broadband expansion scenarios, described below. Infrastructure champions: Expansion of privately owned network infrastructure is advancing fastest in countries such as France and Switzerland, where favorable regulatory terms wholesale prices, co-investment obligations and quality of service specifications, for example offer financial protection to companies that invest in networks outside already well-developed conurbations. In most cases, national market leaders assert their dominance, ultimately ending up with market shares of over 50% even in heavily cabled areas. This policy encourages monopolies, but also drives the rapid development of next-generation networks. Network cooperation: The situation is different in countries such as Sweden and the Netherlands, where regulation focuses above all on consumer prices and competition. In these markets, a lack of subsidies for private players investing in broadband network deployment effectively limits expansion to densely populated areas. Market leaders, local governments and utilities apply cooperative models to develop and use networks. Next-generation networks take longer to build as a result, giving cable operators a temporarily strong position. Conversely, the telco market leader's nationwide market share is shrinking to between 35% and 40%. Public broadband network: In countries such as Australia, developing the broadband network is a public work that is funded by floating the market leader's network subsidiary on the stock exchange, stumping up money from infrastructure funds or setting up a government-owned network company. Public access is controlled by the government, which involves telcos solely as its partners. The latter effectively become bandwidth resellers and capture correspondingly low market shares and margins. In most cases, only the mobile communication network is developed by private enterprise. These three scenarios have varying consequences for landline, mobile communication and cable providers. Ultimately, only market leaders and cable companies are bound to invest in optical fiber. Mobile communication firms are going the way of long-term evolution (LTE) and by 2015, will have substituted up to 20% of the landline broadband network. Alternatively, they will copy landline niche providers who do not own networks but rent access from other providers and then market it.
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Or would it be enough to provide excellent service to VIPs and outsource the rest? Does the company have to run its own e-commerce outlets? Or might partnerships with online shopping platforms, electronic retailers or even device manufacturers be more effective? Telcos that rigorously and swiftly farm out everything apart from their true core business can cut costs by as much as 12%, investment spending by 6% and the workforce by 50%. In return, they become more agile, engender a more entrepreneurial spirit and can realize the value of each part of the company. When that happens, they at last end up with fair valuations: three to four times EBITDA for NetCos, seven or eight times for SalesCos and twenty times for OTT service groups.
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On a European level, regional groups are realigning their portfolios. They are jettisoning minority interests (e.g. Vodafone/SFR), exiting from weak market positions (e.g. Orange Switzerland) and scaling back peripheral activities (Telefnica/Endemol) to reduce their debts, buy back shares and regain strategic room to maneuver. Conversely, cooperative ventures and mergers will be stepped up among regional groups as in the case of VimpelCom and Orascom. The chief strategist at one European telco group goes so far as to forecast that, in Western Europe, "three or four large groups at most will survive and be able to compete in the global arena." Even the 15 market leaders in smaller countries will be taken over to optimize regional footprints. Of course, there is always the risk that transactions will fall at political hurdles or due to antitrust concerns. The protracted debate surrounding the consolidation of the artificially created German cable landscape is a case in point. Especially among regional groups, free cashflow will be plowed back into promising future developments: to accelerate growth plans for B2B2C platforms (such as payment, advertising and e-health), say, or to place relevant strategic bets in the OTT game. Telefnica, for example, acquired VoIP provider Jajah formerly a Deutsche Telekom minority investment in 2009. Deutsche Telekom in turn then acquired web hoster Strato and payment provider ClickandBuy. Both have reorganized their innovation activities and set up OTT service groups. But how serious are the telcos about Access Plus in reality? One thing is for sure: the fact that OTT players are valued at five times higher multiples than telcos makes it expensive for the latter to diversify into OTT activities. Nor, with the exception of Softbank in Japan, are there any examples of firms doing so successfully. That said, Softbank is a pretty impressive success story; its 900 affiliates, forming softbanks internet segment already contribute 10% of revenue and 16% of profits. And the group even has a presence on the fast-growing Chinese market, where it now owns a stake in Renren (the country's biggest social network), Alibaba (a global e-tailer) and Ustream (China's foremost live video portal). In India too, Softbank has launched a joint venture for mobile Internet incubation with Bharti Airtel. Regional OTT partnerships and investments are beefing up telcos' knowledge of the Internet business. They are also giving incumbents an early insight into how this business might dovetail with their own core business. In treading this path, regional groups the only players big enough to step into the OTT ring are making a clear statement of intent: They will not give up their acquired privileges without a fight. Telcos desperately need a level playing field, however, as OTT groups are already expanding into the infrastructure business. Google, for example, is currently laying optical fiber networks in Kansas City, is part of the US broadband program and plans similar forays into Europe. Showing true vision, Google is also investing in satellite operator O3b with the aim of delivering high-speed Internet access to the "other 3 billion" people in developing countries. "Our mission is to make the world's knowledge available to everyone," a Google spokesman said. So how are the telcos responding? Waiting and seeing (again)? Acting in concert? Engaging in "co-opetition" (competing in some areas and collaborating in others)?
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In this scenario, telcos fade into the background but can still survive as brands if they deliver outstanding quality. Lack of coverage and poor voice quality are, after all, the main reasons why customers switch providers. Every fifth Internet user in the industrialized world is willing to pay more for access in return for a guarantee of top network and service quality. Access Minus works best if the company keeps its NetCo and SalesCo separate, focuses on investing in network expansion, spins off its SalesCo or seeks long-term partnerships for it with virtual network operators, resellers or OTTs (Verizon/Google) and distributes the cashflow it generates to shareholders.
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Access Plus The name says it all: Companies adopting this model go beyond access business, positioning themselves as service providers and complementing the SalesCo and NetCo with a third element, a "telco innovation factory" charged with developing and marketing new services. The latter will primarily consist of access-centric services that use the existing network and IT platforms in the e-health segment, for instance or regional OTT-related offerings such as TV. Such services will be embedded in partners' service suites or, depending on the extent to which the "Plus" aspect is to be emphasized, on proprietary platforms that integrate third-party services. Some of our interviewees nevertheless question whether many telcos will really be able to handle this business. "The industry lacks knowledge, good people and speed," says a CEO from one of Europe's telco heavyweights. To make this strategy succeed, incumbents must first master their core business and see adjacent business lines as bets on the future. But they must not make the whole company and its infrastructure revenue too heavily dependent on such bets. OTT Game This scenario is feasible for regional telco groups commanding sizable customer franchises, making them attractive for global partnerships. Companies that go down this road see their service suites as the primary communication gateway in their customers' online life. "The big telcos have what it takes to create their own OTT platforms," says one board member at a leading Asian telco. Rather than producing all the content themselves, they will, for example, partner up with gaming and credit card firms to provide entertainment and finance offerings. As brands, they will be so strong that groups outside the industry and large OTT players will willingly cooperate with them and place their content in the telco's ecosystems, aiming to reach end customers via the resultant B2B2C partnerships. Since it was the telcos themselves that ramped up the networks, they have close ties to customers and can use their steady stream of access profits to constantly improve their ecosystems.
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1. Get the access strategy right broadband, personalized, experience-based: Expanding LTE and FTTH networks, providing converged access offerings and optimizing personalized service suites will safeguard telcos' core business and maximize their cashflow. 2. Place realistic Access Plus bets that promise growth and set the telco apart: The key is to invest selectively but consistently in B2B2C platform services and regional OTT services. Even so, telcos will succeed only if they are realistic about their market position and enter into partnerships that genuinely make sense. Beyond that: Steer clear of risky bets! 3. Transform into a lean telco and cut today's workforce in half: Telcos should split themselves up into a SalesCo, a NetCo and corporate services (HQ) and make the remaining core activities as cost-efficient as possible even in comparison with consumer goods, service and OTT champions. 4. Convince the capital markets with Access Minus, Access Plus or more: Digital transformation and intelligent consolidation can guarantee shareholders annual returns of 10% and more, on a par with top utilities. To write a compelling investor story, it is vital to be the first to align with the appropriate core business. Units that do not fit in should be sold or committed to joint ventures in order to eradicate their conglomerate discount of 15%. 5. Act quickly to gain first-mover advantage, especially with a view to OTT: Customer demands, communication technology and competition are all developing faster than ever. All of which creates an environment in which telcos can no longer afford the luxury of sluggishness, strategic inertia or blind spots. Stock markets currently put a value of EUR 810 billion on Europe's telco industry (5.3 x EV/ EBITDA). Sticking to today's strategy will see that value erode to EUR 570 billion (4.1 x) by 2020 destroying nearly 30% of their market capitalization in the process. The underlying root causes are obvious: After 2015, revenue will decline by 7% triggered by the emerging e-SIM, further regulatory cuts and two-fisted competition. Hence, EBITDA is expected to slump from EUR 155 billion to just EUR 140 billion. That does not have to happen. If telcos do their homework with respect to broadband access strategy, transformation into a cost efficient lean telco, and to consolidation they have a real chance not just to stand up to the fab five, but also to grow in enterprise value caused by strongly improved earnings. Our interviewees anticipate a development that would still raise the industry's valuation to EUR 745 billion (4.4 x) by 2020 almost a third more than if they stick to their current strategic direction. Roland Berger is slightly more optimistic: Based on the assumption of fruitful regional consolidation, from which regional groups would reap the greatest benefits, we expect the telecommunications industry to be worth EUR 795 billion (4.6 x) in 2020. Telcos would thus virtually retain their value and as result grow EBITDA clearly above EUR 170 billion and all this, despite heavy revenue losses in their core business. Not bad for an industry taking guard against the likes of Apple, Google and Facebook.
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AUTHORS Alexander Mogg Partner and Head of Competence Center InfoCom Alexander Dahlke Partner Peter Wimmer Partner Christian Hoffmann Principal