Managing Director & Partner
Two paradoxes surround value creation in the telecommunications industry. First, value is generally migrating toward the top of the stack where content and communities reside (think Netflix and Facebook). But companies such as Netflix depend on broadband and mobile connectivity and, therefore, on operators that have the financial resources to expand their networks.
The connectivity of the entire stack, in other words, depends on the health of telecommunications operators. And operators continue to face regulatory scrutiny, especially in Europe, as well as pricing pressure everywhere and challenges relating to network modernization and the overall customer experience.
Second, the world is going mobile, but mobile-only operators are struggling to create value. For example, in the five-year period from 2007 through 2011, the top three value creators (and four of the top five) in the industry were mobile. But most recently, from 2011 through 2015, only one mobile-only operator broke into the top ten—at ninth place. It’s not going to get easier. The mobile upgrade costs of integrated operators are substantially lower than those of mobile-only operators, which, in many cases, must lay new backhaul fiber to accommodate the higher bandwidth.
The 2016 TMT Value Creators Report
The resolution of the second paradox is easier than the first. For the foreseeable future, we will live in a hybrid fixed-mobile world, and operators that serve the highly competitive mobile-only side must find ways to offer fixed services, or they will suffer. This explains why, from 2011 through 2015, the cable industry and integrated operators1 outperformed their mobile-only peers. (And it’s not just mobile operators that are underperforming but also the companies that lease towers and other mobile infrastructure to operators. Quite recently—in our 2008–2012 ranking—three of these companies were in the top ten in telecommunications value creation. However, none of them is in the top ten this year.)
Finding a value-creating way through the first paradox is more demanding. How can operators prevent all the value in the stack from being sucked upward to companies that ride on their infrastructure? In markets where regulation is restraining investment, operators need to seek relief. (See “The Importance of Regulation.”) But that will not be enough. They also need to fundamentally digitize their networks to remain cost-effective and to build platforms on which they can create new growth businesses.
Even within restrictive regulatory environments, operators can outperform their peers. So regulation should not be an excuse that operators use to avoid making all the strategic and operational moves at their disposal.
Still, the regulatory environment does matter. Europe and South America generally are playing catchup with North America and Asia in creating a digital market that will facilitate commercial activity. (See Five Priorities for Achieving Europe’s Digital Single Market, BCG report, October 2015.) Despite challenges related to the “digital divide,” cord cutting and thinning, and network neutrality, the US regulatory environment has several positive features, related, for example, to spectrum and local-loop competition.
In our view, the following are priorities for national regulations:
The median of the top ten performers’ average annual TSR from 2011 through 2015 was 25%. (See Exhibit 1.) Multiple expansion was the largest driver of TSR—a sign that investors support companies’ strategic and operational moves. But this occurred in a low-interest-rate environment. If rates rise, many operators will have a more difficult time boosting TSR through multiple expansion.
Margins of six of the top ten declined over the five-year period, and sales growth contributed 5 of the 25 percentage points of average annual TSR.
Dividends contributed just 3 percentage points to average annual TSR. This suggests that the best telecommunications operators have discovered how to create value in ways other than simply returning cash to shareholders, which was a popular default strategy in the industry not so long ago. In the 2008–2012 period, dividends underpinned one-third of the top ten’s 16.1% annual TSR.
Speed, Speed, Speed. In a survey of consumers in 18 countries, high fixed download speeds ranked as the most important fixed-mobile feature in 11 countries and among the top three in 16 countries. In particular, cable companies benefited from this insatiable demand for fixed-broadband speed. The industry’s five-year annual TSR was 19.1% compared with 10.6% for both integrated and mobile-only operators. Cable operators also profited from relatively low upgrade costs, given the deep penetration of fiber in most of their networks and the variety of technology levers, such as Docsis 3.1, to add bandwidth without ripping up existing infrastructure.
The five-year value creation view is somewhat tempered by one-year performance. In 2015, a flat to down year for most equity indexes, four of the seven cable companies we tracked generated negative TSR. Overall, the cable industry’s one-year median TSR dropped from 19% to –1.1%. It’s too early to say whether the one-year performance is a blip or early evidence that cord cutting and thinning are starting to affect operators materially. Stay tuned.
Convergence Is King. Fixed-mobile bundles have taken off in countries such as France, Portugal, and Spain, where market penetration already exceeds 50%, according to the 18-country convergence survey. In 13 of the 18 countries surveyed, more than 60% of household decision makers were interested in or already had a fixed-mobile bundle. Fixed-mobile convergence (FMC), in other words, is a global consumer trend.
Many operators are working to offer FMC to their customers. For example, when BT Group, the number six telecommunications value creator, recently bought EE, the UK’s largest mobile operator, it reentered the wireless arena it had once vacated. Vodafone and Liberty Global have announced a Dutch joint venture to compete against KPN, the integrated incumbent. The venture combines Liberty Global’s cable and internet business, Ziggo, with Vodafone’s mobile network. And Deutsche Telekom has launched its Magenta One quadruple-play offer in numerous countries. As of mid-2016, Deutsche Telekom had signed up 2.5 million German customers and 1.1 million customers outside of Germany for the service.
Maturity Matters. Telecommunications companies in mature markets generated a median five-year annual TSR of 14.4%, compared with 8.9% in emerging markets. To generate revenues in emerging markets, operators need to rely on taking market share from their competitors (without creating price wars), encouraging greater usage, and running their businesses efficiently.
These headwinds might be stronger than those faced by operators in mature markets when growth slowed. Network upgrades, which are necessary in order to meet rising demand, are costly. There is limited available spectrum to purchase, and operators in emerging markets—where the penetration of fixed lines and cable is much lower—generally do not have the same opportunity to build profitable fixed-mobile bundles.
Their performance may have differed over the past five years, but the challenges facing cable and telecommunications operators are similar. In order to strengthen their existing businesses, operators should digitize their value chains end to end. (See Exhibit 2.) They need to reinvigorate their B2B businesses, which are especially vulnerable to digital attackers. To spur new growth, they should drive disruptive digital innovation in adjacent areas if they can exploit sources of competitive advantage. (For a study of one operator’s moves, see “Deutsche Telekom’s Turnaround.”)
For Deutsche Telekom, 2012 was a dark year. Revenues, profits, the number of fixed lines, and the share price were all falling. The operator made several difficult decisions, such as eliminating jobs and reducing overhead, but simultaneously began to work on modernizing its front and back ends and turning around its mobile business.
Since 2012, net revenues have grown by 6% annually, the number of TV subscribers has increased 35% overall, and 28 million consumers, most of them in the US, have signed up for mobile service. Deutsche Telekom’s stock has risen 10% annually since the end of 2012.
A cornerstone of this transformation was a series of bold moves. On the revenue side, the company’s Un-carrier strategy and its bold and relentless execution in the US have contributed to growth and value creation. In Germany, regaining mobile market leadership and launching converged fixed-mobile bundles have been important factors. On the cost side, Deutsche Telekom expects eventually to save about €1.2 billion annually by creating an all-IP pan-European network—which it calls its “superior production model.” The model is replacing hundreds of legacy platforms with virtualized and centralized network functions and is built on digital, customer-centric, and efficient processes. This new model will enable Deutsche Telekom to launch new products that take advantage of its integrated mobile- and fiber-network strategy. In addition, it has ongoing efficiency initiatives in operations and support functions.
Deutsche Telekom is also building cloud, security, and smart-home businesses and is creating a digital connected-channel experience for consumers.
Operators have begun to implement elements of digital transformation. Tele2, for example, an integrated European operator is moving its network and IT functions to the cloud with network function virtualization (NFV). In France, SFR has deployed 4 million Wi-Fi hotspots, enabling the carrier to offload a significant share of its mobile traffic. Several carriers are working on data analytics applications that will help them monetize the movement and whereabouts of their customers.
There are three fundamental pieces of an end-to-end digital transformation: modernizing the network, embracing customer-centricity, and creating a digital culture and mindset.
Modernizing the Network. One of the most effective ways for telecommunications operators to start an end-to-end digital transformation is to modernize how information is transmitted over networks and how networks operate.
Other innovations in network operations include small cells, automation (such as self-optimizing networks), and data analytics that dynamically manage network traffic.
Embracing Customer-Centricity. Retailers do it. Airlines do it. Hotels do it. Even banks do it. Yet most telecommunications operators struggle with it—or worse, do not even have a clear view of how to make it happen.
We are talking about creating compelling customer journeys and offering customers a connected-channel approach. Telecommunications operators are competing against digital attackers, such as WhatsApp and Snapchat, that understand, engage with, and delight their customers.
Customer-centricity requires active change management. Connected-channel retailing, for example, requires technical skills to manage an online and mobile presence, data analytics skills to understand customer behavior, automation capabilities to create seamless service, and inventory management capabilities to ensure the availability of “click and collect” purchases.
Soft skills are needed, too. The best connected-channel retailers train their store and call center personnel to perform a full range of sales, service, and follow-through activities. They also create common metrics so channels are not fighting one another for revenue credit.
The payoff for operators is tangible. Strong connected-channel performance can yield revenue increases of 3% to 5%, reductions in churn of 2% to 4% and in cost to serve of 15% to 30%, and improvements in customer satisfaction scores of 15% to 30%.
Creating a Digital Culture. The success of an end-to-end digital transformation rests more with leadership and people than with hardware and software. Leaders must be comfortable changing the core of their organizations, and they must play an active role in leading the change.
At the same time, operators need new ways of working. For example, SVN technologies require changes to organizational structure, capabilities, and behavior that reach across the value chain. Virtual development and operations teams need to work seamlessly across organizational boundaries. Open-source architecture teams and joint commercial and technical teams need to move customers systematically to new offerings.
The IT function must play a critical role in facilitating this transition. It needs to embrace greater technological openness and flexibility by creating accessible application programming interfaces, or APIs, by allowing greater integration into the network, by storing information in data lakes, and by encouraging agile development. Along the way, the IT function needs to start viewing itself as a source of value rather than a cost center.
Nowhere is the need for customer-centricity more apparent than in the B2B market. To succeed with business customers, it will not be enough just to offer connectivity. Revenues from connectivity are generally flat or declining. Meanwhile, Amazon Web Services has started to offer network functionality as a service, providing load balancing, firewalls, and routers on the cloud. Even B2B customers that are not yet comfortable with cloud-based network services have much higher expectations of the telecommunications operators than they did five years ago. At the same time, the procurement staffs of large commercial customers have become much savvier negotiators.
Operators can play a highly valuable role in B2B—especially with midsize companies—but only by transforming their operations so that they can compete against OTT and cloud companies able to create a compelling customer experience. The back end of operators often suffers from inflexible legacy infrastructure, while on the customer-facing front end, their user interface, pricing, and sales skills often lag behind the market.
The goals of disruptive digital innovation are to create new revenue streams, barriers to entry, and sources of value creation. It’s a game of disrupt or be disrupted. Operators seek these goals in different ways: acquisitions, partnerships, incubation, and corporate venturing. They need to embrace a strategy of open innovation to tap into the positive powers of disruption. Executives should think broadly about how they can leverage their assets and strengths to create a new growth trajectory for their business. (See “Finding Adjacent and New Growth.”)
Where can cable companies and telecommunications operators find sources of adjacent and new growth? Outside of Japan and South Korea, operators have had only modest success expanding into new lines of business. But to drive top-quartile returns, operators typically need to generate more top-line growth than that afforded by the core business. Consequently, they need to find adjacent businesses to enter. In so doing, they need to leverage at least one of the following assets: