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