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Telefonica O2 and e-Plus merger: a new 4th network operator makes little sense

April 17, 2014

Today the FT reported that in order to overcome objections to the proposed take-over of E-Plus “Telefónica has offered to equip a new German mobile competitor with spectrum”.  This is similar to the offer by Hutchinson 3 in the context of its take-over of Orange Austria. In the event there was of course no new network based entrant in Austria, the aim of the Telefonica O2 and E-Plus tie up is to take costs out of the industry by reducing the number of mobile network operators. At this stage of the industry life cycle consolidation at network level is expected. This is driven by high prices paid for spectrum and continuing high LTE capex while revenues remain flat or in decline. When free cash flow declines, capital has to be taken out of the industry simply to get back to returns that are not below the cost of capital.

The FT also reports that Telefónica promised concessions for MVNOs. Competition remedies at wholesale level in the form of a reference wholesale access price offer – similar to what was agreed to by Hutchison in Austria – are a much more effective remedy. This is particularly true for Germany which already has a vibrant MVNO market. Indeed E-Plus pioneered the multi-band MVNO strategy and hence concessions at wholesale level are likely to be impactful. Given the competitive MVNO market in Germany, regulating wholesale prices provides an effective insurance against retail price increases, which might otherwise result from the tie-up.

If indeed wholesale price regulation ends up as the key remedy, and this in Europe’s largest mobile market, we are one step closer to the structural separation of the European mobile industry into NetCos and ServiceCos.

Written by Stefan Zehle, CEO, Coleago Consulting

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Elimination of EU roaming charges implies a move towards regulated wholesale rates

April 11, 2014

On the 3rd of April 2014 the European Parliament voted (with some amendments) to adopt the Commission’s proposal to end roaming charges in the EU by the end of 2015. This was part of a wider vote in support of the Commission’s proposed regulation for a “Connected Continent”, the term used for the telecoms single market. The regulation must be approved by parliament and the European Council. With this, the Commission also moved a step closer to regulated wholesale prices and hence the structural separation of mobile networks into NetCos and RetailCos.

In essence the Commission wants EU consumers be able to use their mobile phone within all EU countries in the same manner as they would at home. “…Further reforms in the field of roaming should give users the confidence to stay connected when they travel in the Union without being subject to additional charges over and above the tariffs which they pay in the Member State where their contract was concluded.”

However, the problem with this is that most consumers chose domestic tariff plans with bundled minutes and data plans, so that within the bundle the incremental cost of usage for consumers is nil. Selling bundles also makes sense from a mobile operator’s perspective because most costs are fixed. In contrast, in a roaming situation an operator’s costs (the wholesale rate an operator has to pay to the visited network) are proportional to usage – i.e. variable. The Commission and the Parliament appear to be aware of this problem, and the adopted text states that operators “may, notwithstanding the abolition of retail roaming charges by 15 December 2015, apply a “fair use clause” to the consumption of regulated retail roaming services provided at the applicable domestic price level, by reference to fair use criteria. These criteria should be applied in such a way that consumers are in a position to confidently replicate the typical domestic consumption pattern associated with their respective domestic retail packages while periodically travelling within the Union.”

Much will depend on how the “fair use clause” is written. If we take at face value the text “consumers are in a position to confidently replicate the typical domestic consumption pattern associated with their respective domestic retail packages while periodically travelling within the Union”, this may mean that customers on large minute and data bundles can use these freely at any time across the EU. Alternatively the EU would have to define what “periodically travelling within the Union” means. Does it mean 30 days a year, or 180 days, or how much? Assuming the Commission does not want to place limits on how much Connected Continent consumers are allowed per year, there will be no time limits. Taken to an extreme, a mobile user could shop around for the cheapest SIM-only deal in Europe regardless of his or her country of residence. A prime example is EU parliamentarians who shuttle between their home country, Strasbourg, Luxembourg and Brussels.

The fair use provision is designed to address the problem that it is ultimately impossible to regulate retail prices without regulating wholesale prices. The Commission appears to be aware of the difficulty in defining “fair usage” and the implication for operators’ margins. The adopted text states: “In addition, the Commission should by 30 June 2015, in advance of that final abolition of retail surcharges, report on any necessary changes to the wholesale rates or wholesale market mechanisms, taking into account also mobile termination rates (MTR) applicable to roaming throughout the Union.” This is the real bombshell because it heralds EU regulation of wholesale prices.  In the same way as the EU has driven the regulation towards lower MTRs this may happen to wholesale prices.  The target might be a Reference Wholesale Access Offer, for example with the €0.002 per Mbyte of data rate imposed on Hutchison 3 Austria to allow their acquisition of Orange Austria to go ahead.

In regulating mobile tariffs, the EU is focusing only on roaming charges, whereas international call pricing is also highly unbalanced. In most cases international calls are not included in a mobile minute bundle and charged at a premium. This leads to oddities. For example, for a UK mobile subscriber with a bundled minute plan the incremental cost of a call to a UK mobile numbers is nil. Hence for a call to a UK number that is roaming in Poland, the marginal cost to the caller is nil and, according to the EU roaming charges cap, the called party pays no more than €0.07 per minute to receive the call. The marginal revenue to the UK operator is €0.07 per minute. However, if a UK mobile user calls a Polish mobile number the price paid is substantially higher. For example, Vodafone’s standard to Europe call price is £1 a minute (€1.20). In other words, Vodafone’s incremental revenue is 17 times higher, although costs are the same.

The Commission also proposed that for European fixed calls “operators will have to charge no more than a domestic long-distance call for all fixed line calls to other EU member states. Any extra costs have to be objectively justified.”  Will the same principle be applied to mobile operators? If yes, the scenario where a consumer buys a SIM in one country and uses it in another becomes practical. In this scenario, where within the EU distance and geography no longer matter for mobile retail prices, the retail activity of a mobile operator might evolve into what is in effect a pan-European MVNO with an “always best connected” value proposition, regardless of the access network used. Under these circumstances, who will then want to bid for spectrum and invest in networks?

Either way, we are moving to a situation where the EU mobile industry is subject to extensive price regulation. And yet, the EU Directorate General for Competition is totally focussed on preserving competition at network level and in-country consolidation of mobile operators is hard to achieve. This makes little sense. Now that the cost of calling has come down, perhaps Neelie Kroes can afford to make a call to Joaquín Almunia (Vice President of the European Commission responsible for Competition Policy) and attempt to sync policies.

Written by Stefan Zehle, CEO, Coleago Consulting

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How the Telefonica Deutschland / E-Plus merger could play out

April 9, 2014

This week it was reported that the European Commission and the German telecom regulator (Bundesnetzagentur) are applying pressure to Telefonica regarding their planned takeover of KPN’s subsidiary E-Plus in Germany.

We think on balance the deal will get approved but both parties will need to make significant concessions to get it done. This will be especially the case with regard to spectrum holdings and as we saw in Austria commitments to support virtual operators and branded resellers (i.e. wholesale access). There is always a chance that the concessions are so onerous that they may effectively destroy the deal.

The combined entity will have approximately a 39% mobile customer and 32% mobile service revenue market share in Germany, so the European competition authorities (and the German telecom regulator) will no doubt review it very carefully. Revenue market share figures would of course look much lower if the fixed and mobile markets were combined and no doubt KPN/E-Plus and Telefonica Deutschland will be arguing for this. They have a point, given the recent €7.7bn deal by Vodafone to acquire Kabel Deutschland and the fact that Deutsche Telekom sells fixed and mobile services effectively under one brand.

Regarding spectrum, the combined entity will on the face of it have a whopping 64% of the 1800MHz and 54% of the paired 2100 MHz bands, so it is likely that regulators will require a sale or handback of some of the holdings in these core bands.  In the less scarce 2600MHz band, it holds 42% of the spectrum. A similar situation was seen in the UK with regard to 1800MHz spectrum when EE was created from the merger of Orange and T-Mobile. It is possible that the other German operators will lobby to have “excess” spectrum handed back rather than sold so that the merged entity does not benefit. Some of the excess spectrum is due to for renewal in 2016 and the merger will reduce competition for these frequencies.

By contrast, in the very scarce and more valuable sub 1 GHz bands, it holds 33% of the 800MHz and 29% of the 900MHz spectrum, so there should be less of an issue here.

Clearly the deal is going to require significant concessions.  It makes sense for the competition authorities to scrutinise these deals to ensure that monopolies are not arising and customers have enough market choice.  Yet at the same time, telecom operators need to generate acceptable returns in a fiercely competitive and mature market. A difficult balancing act for the competition authorities.

By Scott McKenzie, Director, Coleago Consulting and former supervisory board member of E-Plus

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Consolidation in the European mobile industry is inevitable, but what path will it take?

April 7, 2014

It has been pointed out many times that the EU with around 100 mobile operators, serving a roughly similar size population as the USA, is hugely fragmented compared to the mobile industry in the USA. The historic reason is easy to understand, but the fight put up by Directorate-General for Competition of the European Commission to halt in-country consolidation is harder to understand.

In the model used to analyse the impact of mergers on retail prices, the Competition Directorate, assumes that retail prices will always go up as a result of a merger between two MNOs in the same country. It does not assume that the efficiencies brought about by a merger would, at least in part, be passed on to consumers in form of lower prices or better service in terms of coverage or access speeds.

Network sharing is encouraged under EU rules as long as it is limited to the Node B and RNC and excludes spectrum and the core. A great deal of cost sits in the RAN, and hence RAN sharing could be termed “merger lite”. With LTE, it is efficient to deploy the technology in as wide a band as possible. Hence significant additional savings could be brought about if spectrum is shared.  This reduces competition at network level, but also delivers consumer benefits in form of higher access speeds.

The transactions now awaiting approval by the Competition Directorate are the O2 and Eplus tie-up in Germany, Hutchison’s takeover of O2 in Ireland and, if the acquisition of SFR by Altice fails, then also the Bouygues – SFR take-over in France.  The conditions the European Commission attached to the Hutchison 3 take-over of Orange Austria may serve as an indicator as to the conditions that might be imposed to allow these deals to go ahead. Among other conditions, Hutchison Austria had to publish a wholesale access price reference offer for MVNOs. By regulating wholesale prices, the Commission in effect bought insurance against sharp increases in retail prices because it would allow MVNOs to undercut these.

The conditions imposed on Hutchison Austria may be a first step towards the structural separation of the mobile industry into Netcos and Retailcos. In a world where mobile network operators share much of their network and perhaps spectrum, these mobile operators start to look more like MVNOs on a shared network. Structural separation may not be a “horror scenario” for mobile operators if returns on invested capital can increase as a result.

Looking at what business mobile operators are actually in, it seems that they are to a large extent hire purchase phone vendors. Comparing SIM only postpaid tariffs with postpaid plans that include a “free” smartphone, it appears that the price for SIM only deals is 50% below plans with a bundled handset. Therefore roughly 50% of a mobile network operator’s business is not about running a network but about selling phones on credit. Other than marketing and selling phones and SIMs, customer care and billing are a big cost bucket attributable to the retail activity of an MNO.

Retail activities are scalable, i.e. can be done profitably at different volumes. In contrast the Netco activity is not scalable because costs are fixed. Netco returns are a function of network utilisation. By structurally separating retail and wholesale activities in exchange for being allowed to merge networks including spectrum, MNOs might see lower costs and as a result higher returns, all the while prices at retail level may not move or even decline.

Barriers to entry and exit in the Mobile Netco activity are extremely high. We are now in the maturity stage of the industry life cycle, and it is normal for consolidation to take place. Furthermore, regulators have hastened the need for consolidation because they took billions of Euros out of the industry through spectrum auctions. This had the effect of dramatically reducing returns to investors. And yet, the Directorate responsible for telecoms, DG Connect, ceaselessly points out the benefit to European industry of increased investment in mobile broadband networks. How can the policy objectives of DG Connect and DG Competition be delivered simultaneously?

From the industry perspective, if structural separation allows returns to increase despite increased competition at retail level, then structural separation might be the way forward. Competition might drive down margins in the retail activity, but this is not problematic because in contrast to the Netco activity reducing capital or even exiting the retail activity is possible.

The proposed consolidation in Germany is most interesting in this regard. Eplus pioneered a multi-brand wholesale and MVNO strategy precisely because E-Plus was sub-scale. As can be seen by leafing through some older KPN investor presentations (KPN E-Plus Seminar, Delivering profitable growth, Sep 2006), this resulted in lower subscriber acquisition costs and higher EBITDA. The strategy brought about a flourishing MVNO and reseller activity, thus increasing consumer choice. This means within Eplus the set-up exists to take the concept forward to full structural separation.

From the mobile industry perspective a further benefit of consolidation at network level would be that governments can no longer pit competing operators against each other in spectrum auctions, such as the forthcoming second digital dividend. High spectrum reserve prices would finally be seen for what they are: a tax on the mobile industry that ultimately has to be paid for by the consumer. Furthermore it may be better to be in a regulated industry with reasonable returns rather than in an industry with wafer thin returns, high investment needs and continued technology risk.

Written by Stefan Zehle, CEO Coleago Consulting

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Wi-Fi offload won’t reduce the need for more mobile spectrum

February 5, 2014

During the Wi-Fi Offload Summit in Frankfurt on Jan. 23, a number of interesting developments in the Wi-Fi space were presented. A key question for mobile operators is whether Wi-Fi offload reduces the growth in mobile broadband (HSPA and LTE) traffic and thus the need for more mobile spectrum.

Research presented by Deutsche Telecom from tests in Hamburg and Rotterdam showed that when Wi-Fi is advertised and available free of charge in a particular area, this immediately generates substantial Wi-Fi traffic but does not reduce the volume of mobile data traffic. Towerstream Inc. presented conflicting evidence from its outdoor Wi-Fi offload network in New York.

From other findings presented, it is clear that both Wi-Fi and LTE traffic are increasing dramatically. Perhaps what is at work here is the Jevons paradox, which proposes that as technology progresses, the increase in efficiency with which a resource is used tends to increase (rather than decrease) the rate of consumption of that resource. The increasing availability of free Wi-Fi coupled with a rapid uptake of smartphones and cheap tablets would underpin this theory as one feeds off the other.

The growth in Wi-Fi is also driven by the desire of shops and malls to engage with shoppers on their in-store Wi-Fi networks. There is marketing value for retailers to have shoppers on their Wi-Fi network as soon as the shopper walks into the store. EE in the U.K. is turning this into a small business line, equipping supermarkets such as ASDA with a Wi-Fi infrastructure. Rather than identifying shoppers at the checkout when they swipe their loyalty card, ASDA hopes to be able to identify and engage with shoppers from the minute they are within the store’s Wi-Fi coverage. For example, coupons could be sent to a handset at the beginning of the shopping trip and can be used right away rather than languishing at the bottom of a shopping bag. This is just one of the many marketing benefits of free in-store Wi-Fi.

The simultaneous growth in Wi-Fi and LTE traffic may also be explained by the fact that Wi-Fi has other uses compared to cellular. The proliferation of TV Anywhere apps turns tablets and laptops into TV outlets, and in Canada, Bell has launched the first wireless TV proposition. TV over Wi-Fi creates a surge of Wi-Fi traffic in residential areas. Other devices in offices, public indoor spaces and outdoors rely increasingly on Wi-Fi connectivity because it is cheaper and more flexible than cable connections. This all takes Wi-Fi capacity in cities and raises the Wi-Fi noise floor.

In regard to the rapid adoption of tablets, all are Wi-Fi-enabled, but few are 3G (HSPA) or LTE-enabled. As people take these tablets out of their homes they will look for Wi-Fi access, thus increasing Wi-Fi hotspot usage. However, smartphones have a personal hotspot feature and where tablets are not in Wi-Fi coverage, we are seeing “cellular on-loading” from Wi-Fi devices.

Having paid for a shiny new LTE device, some customers would prefer to pay another €10-20 a month rather than having to faff about with logging onto Wi-Fi. Asking smartphone users to choose between LTE and Wi-Fi is the antithesis of a ubiquitous mobile broadband experience. However, Wi-Fi 2.0 with SIM-based authentication increases the ease of Wi-Fi access and may even be transparent to the user.

Another factor which determines the amount of LTE vs. Wi-Fi traffic are the policies for applications set in smartphones. For example, which bearer is allowed or preferred for which application. Some apps do not work via LTE; for example. FaceTime on the iPhone. In the U.S., the first version of the iPhone 5 with iOS 6 did allow FaceTime over LTE. This came as a bit of a shock to cellular operators as AT&T blocked FaceTime over cellular on most plans, but subsequently changed the policy. What cellular operators really want is to be able to set policies dynamically based on the app, the location, time of day and perhaps even the type of customer.

Nevertheless, most mobile operators have some Wi-Fi offload strategy. The focus is not so much on relieving congestion in busy areas but to deliver an “always best connected” value proposition. In short, LTE and Wi-Fi complement each other. The growth in Wi-Fi does not reduce the need for more cellular spectrum to serve the growth in mobile broadband traffic.

Written by Stefan Zehle, CEO Coleago Consulting

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Could mobile operators become the prime real estate landlords for the digital economy?

January 22, 2014

Finally it is here: The mobile data equivalent of toll-free numbers. Last week AT&T unveiled a “Sponsored Data service”, meaning that their customers are able to use participating services without eating in to their data allowance. AT&T will treat Sponsored Data traffic no differently to regular data traffic, thus providing digital retailers and OTT service providers with an efficient way to communicate and trade with their customers.

Coleago has long argued that with the growth in the digital economy, sellers of physical and digital goods and services are looking for the mobile data equivalent of a toll-free number. In the past many businesses encouraged consumers to trade with them over the phone by publishing toll-free numbers. The growth of online shopping with mobile devices provides impetus for extending the concept to mobile data. The message from retailers to consumers is “it does not cost you anything to visit our digital store”.

The good news for mobile operators is that this provides an additional revenue stream. But the concept could be taken further. In Europe, North America and other markets where most people purchase their smartphone from mobile operators, these operators can control what consumers see on the screen of their new smartphone when they take it out of the box and switch it on. A smartphone screen provides the digital real estate for sponsored apps.  Apps placed on the home screen would be the most valuable, and the giants of ecommerce such as Amazon may have the scale to pay to have their app on the home screen. EBay, travel and financial sites and many other e-tailers may also be interested in sponsoring apps placed on subsequent screens.

Of course users can delete and move smartphone apps. However, judging by how many people do not bother or do not understand how to change their browser home page, it is likely that many of the preloaded apps will stay where they were first placed. This effectively means that mobile operators become landlords in the digital economy.

Written by Stefan Zehle, CEO, Coleago Consulting

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Hong Kong’s hybrid approach to 3G spectrum renewal creates a “freerider” problem for the incumbents

December 19, 2013

Hong Kong’s Office of the Communications Authority (OFCA) has decided to adopt a hybrid approach to the renewal of incumbents’ 3G spectrum. OFCA will distribute two thirds of the spectrum to the incumbents through an administered allocation process and the remaining third will be put up for auction. The incumbents have the opportunity to reacquire the spectrum through the auction but it also opens up the opportunity for a new player (and many are speculating the China Mobile Hong Kong is the primary candidate) to acquire the spectrum.

When incumbents value spectrum one of the most significant sources of spectrum value attributed to spectrum in an auction is the ability to block new market entry. This “blocking value” can be very high for incumbents, especially in mature markets, as a new player seeking to win share to drive economies of scale often sparks a value destroying pricing or commission war – the experience of Three entering the UK market is a good case in point.

China Mobile may place a high strategic value on gaining access to 3G spectrum in Hong Kong and so the cost of blocking in the auction could be high. All the incumbents have an incentive to block new market entry. However, in an ideal world an incumbent would prefer “freeride” and rely on another incumbent to pay any premium for market entry. This creates a coordination problem for the incumbents and this risk is that they fail to “reach agreement” through their bidding strategies as to who will take the responsibility for blocking. The result may well be that new entry occurs despite all incumbents being heavily incentivised to avoid it.

Written by Graham Friend, Managing Director, Coleago Consulting

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