European commission proposal ignores the fundamentals: We need to create an environment that attracts capital into the EU telecoms sector

The European Commission’s adoption of regulatory proposals for a Connected Continent announced by Neelie Kroes on the 11^th of September 2013 are as polemic as can be expected from a politician. The headline grabbing proposal deflects from the failings of member states to adopt sensible policies with regards to developing the telecoms sector. In its opening paragraph the proposal declares that “The overarching aim is to build a connected, competitive continent and enabling sustainable digital jobs and industries; making life better by ensuring consumers can enjoy the digital devices and services they love; and making it easier for European businesses & entrepreneurs to create the jobs of the future.”

To achieve these objectives substantial investments are required. Only 12 days prior to the Commission’s proposal, on Thursday 05 September 2013, PwC published a detailed analysis which showed that mobile operators cannot make adequate returns on capital employed. For the past three years the return on invested capital (ROIC) made by Europe’s telcos was below the cost of capital of around 8%-9%. In the mobile sector this is in part due to the high spectrum licence fees charged by national governments.

And yet with statements such as “It is also essential that citizens … are protected from unfair charges and practices such as roaming rip-offs and opaque contracts” the Commission conjures up an image of ultra-profitable telecoms operators which fleece consumers.

What the European telecoms sector needs most is a climate with the regulatory certainty which is favourable to investment. Only investment in the sector will achieve the Commission’s aim – which we all agree with – of excellent fixed and mobile internet connectivity and communication without borders within the EU.

Furthermore, the Commission proposal contains contradictions. Vice President Neelie Kroes said “The aim is to gradually make the telecoms sector a “normal” economic sector with limited ‘ex ante’ rules and responsibility shifting to ex-post regulation” and then demands that “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.”  “Normal” economic sectors do not “objectively justify” prices based on cost but charge what the market will bear. The image of the Coca Cola bottle in the proposal is a fine example. The price per litre of Coca Cola varies hugely between a discount supermarket and a beach club on the Cote d’Azur. And yet, nobody suggests regulating prices for Coca Cola.

On the positive side, the proposal highlights member states’ regulatory failings and tardiness in allocating spectrum for LTE.  This, with a call for a European authorisation for telecoms operators – and by implication European telecoms regulation – is a very positive development. This is a prerequisite for the much needed consolidation in the EU telecoms sector which will then give investors a chance to earn adequate returns.

Written by Stefan Zehle, CEO of Coleago Consulting

Misguided approach to EU intervention on roaming charges

In her speech on the 9 July 2013, Neelie Kroes, Vice-President of the European Commission responsible for the Digital Agenda, reiterated her assault on roaming charges within the EU. There is talk of regulatory intervention to eliminate roaming charges within the EU.

While mobile operators may earn good margins on roaming, a mandated elimination of roaming charges is ill conceived because mobile operators in different EU countries face different costs. One of the most significant investments made by mobile operators is in buying spectrum.  For example, for the 800MHz digital dividend spectrum, operators in Denmark paid €0.30 per MHz per head of population (€/MHz/pop) whereas in France, operators paid €0.67/MHz/pop i.e. 123% more.  Some cash strapped EU countries set high reserve prices for spectrum €0.58/ MHz/pop in Italy vs. €0.10/MHz/pop in Denmark. Coupled with differences in deploying 4G LTE coverage, this translates into hundreds of million euro differences in capex.

Furthermore there are significant differences in the timing of spectrum allocations and hence the deployment of LTE which translates into huge cost differences for mobile data. Assuming investors like to earn similar returns, these cost differences will result in different wholesale and retail prices. Therefore it does not make sense to mandate the same retail prices regardless of the country in which the traffic occurs.

If the EU and its member countries are really so keen on a single telecoms market, why not start by allowing operators regardless of their country of operation to select a national telecoms regulator of their choice to regulate them.  I suspect the Danish regulator would attract quite a few “customers” whereas the Italian and Greek regulators might go out of business. The resulting reduction in regulatory costs could be passed on consumers in form of lower retail prices.

Written by Stefan Zehle, CEO, Coleago Consulting

Towards a single EU telecoms market

In a speech delivered at Mobile World Congress 2013, Neelie Kroes, European Commissioner for Digital Agenda, called for the creation of a single telecoms market in the EU. Kroes iterated that it would be of great benefit to the European telecoms industry as well as consumers. There are numerous aspects to this, but mobile telecoms and notably spectrum allocation is most notably one of the focal points.

In recent times, common EU policy has led to the harmonisation of mobile spectrum and technology in the form of GSM at 900MHz and 1800MHz. One could argue that it is this which kicked off the global boom in mobile communications as a result of delivering low equipment prices (terminals and network) as well as international roaming. The benefits to both the European industry and users are undeniable. Mobile communications is now a global business and with the inclusion of multiple LTE bands on chipsets, harmonisation is perhaps a little less important from the technology perspective, but it still matters from a business perspective.

Spectrum allocation mechanisms and prices paid by operators are driven by national policy objectives. Some governments (e.g. Finland) rightly think that spectrum should be made available to operators as cheaply as possible since ultimately this generates the greatest benefit to society. Others (e.g. Ireland and Greece) focus on immediate cash generation. Views on competition may also differ. The 800MHz auction rules in France are a good illustration of a government ensuring the survival of the 4th entrant, whereas in the highly competitive UK market, competition does has not been a big issue in the recent spectrum auction.

These policy differences result in very different costs for mobile operators and yet there is an assumption that prices, notably wholesale prices should be standardised across the EU. Clearly there is a contradiction.

Another key point in pushing for an EU wide approach to telecoms regulation is that cross-border mergers should be made easier in the EU. The fragmentation of telecoms services provision within the EU is a barrier to the single market. An innocent bystander might ask a whole series of questions which demonstrate that the current EU mobile and fixed regulatory environment is unsatisfactory, for example:

—Why is it that a call on a mobile network within a country tends to be included in the bundle whereas a call to a neighbouring country is usually priced at a premium?

—Austria has a smaller population than Bavaria, so why does T-Mobile run Austria as a separate business from its German operation?

—Why are mobile numbers portable within a country but not within the EU?

The current structure of the EU telecoms industry and markets are an artefact of national telecoms regulation. Faced with competition from global OTT players who are not bound by national regulatory regimes, it is the European telecoms companies who suffer. Both industry and end-users would greatly benefit from a truly EU wide approach to telecoms policy and regulation.

Written by Stefan Zehle, CEO, Coleago Consulting

The end of geography and roaming in telecoms

Today most people are familiar with services such as Skype. Effectively a location independent mobile service, with Skype it does not matter where people call from nor does it matter where the called party is located. Geography has become irrelevant. By the end of Q4 2012, it was anticipated that roughly 50 per cent of international call traffic is likely to have taken place via Skype and similar services rather than traditional carrier traffic.

More and more people are installing Skype on their handsets or using Facetime on their iPhone, and they are getting used to the fact that calling from their mobile phones doesn’t necessarily have to involve the mobile operator. What’s more they also get video telephony. Increasingly people use WiFi on their smartphones, both at home, at work and in public places. The introduction of WPA2 as well as SIM based authentication which allows automatic connection to a WiFi network without signing in makes it easy for users to route their traffic via WiFi and opt out of traditional telephony.  Operators such as Rebtel in Sweden and Republic Wireless in the USA focus on this opportunity – these mobile operators that use WiFi offload “push” their customers to make calls using Skype like services.

The trend away from making standard mobile voice calls is accelerating with the adoption of LTE. For example, in contrast to older versions of the iPhone, the new iPhone with Apple’s iOS 6 upgraded FaceTime from a WiFi only feature to a cellular feature. AT&T Wireless was the first to allow customers to use FaceTime over LTE if they signed up to their new shared data tariff plan.

During 2013 we will see the start of a fundamental reshaping of mobile telecoms service offerings driven by new services based on the IP Multimedia Subsystem (IMS), the evolution of mobile wholesale as well as regulatory trends. Some operators may go all the way and break the link between the mobile telephone numbers and geography. After all it seems somewhat archaic that in a world where distance does not matter, mobile operator tariffs are still based on location and distance. Location is not an issue with Skype or FaceTime and this is one of the reasons for the success of these OTT operators.

Some operators have already introduced services based on IMS, for example in Canada the Rogers One Number service allows the seamless switching between a smartphone and computer. It allows mobile operators to leverage the proliferation of free WiFi connectivity to in effect extend their network coverage world-wide.  This allows mobile operators to fight back against OTT services such as Skype, WhatsApp and FaceTime by in effect becoming themselves an “OTT over WiFi” player.

There are also traditional mobile services that allow users to avoid roaming charges and thus take at least one aspect of geography out of equation that already exists for voice (Truphone, WoldSIM and other) and data (roamline.com, in collaboration with KPN). The business model is built on exploiting the difference between lower wholesale prices paid by MVNOs versus high inter-operator roaming tariffs by offering customer SIMs with multiple numbers in different countries.

The opportunity to take geography out of mobile pricing is not limited to roaming. For example, Turk Telecom launched a service in Germany and Belgium aimed at the Turkish ethnic segment in these countries. Customers are charged exactly the same amount to call numbers in Belgium or Turkey. Turkcell could add the ability to recharge linked accounts (a Turkish person working in Belgium can recharge the prepaid SIM of relatives in Turkey) and make small mobile payments across borders. Smart, of the Philippines is already going down this route, targeting the Filipino diaspora segment around the world.

As a result of these trends in international call pricing as well as roaming, Geography may soon become irrelevant.

Written by Stefan Zehle, CEO, Coleago Consulting

Austrian 2.6GHz spectrum auction results show some consistency with previous auctions but the picture is still confusing

The Austrian regulator RTR concluded the auction of 140MHz of paired spectrum and 50MHz of unpaired spectrum raising proceeds of €39.5 million from the four incumbent operators Telkom, Hutchison, T-Mobile and Orange. The benchmark for the paired spectrum of approximately €0.04 is at a similar level to the results from the German auction which also saw the 4 incumbents secure spectrum but 4 times lower than the Danish auction, another market with 4 existing operators. Whilst relative levels of spectrum supply relative to operator demand is often a significant determinant of spectrum prices achieved at auction it is clearly not the full story.

Austria has one of the most competitive and developed mobile broadband markets in Europe and the need for capacity should have pushed prices higher. However, unusually the RTR attached roll-out requirements to the 2.6GHz band requiring 25% of the population to be provided with coverage with a downlink of 1 MBit/s and 256 KBit/s on the uplink by no later than December 2013. This represents an onerous requirement for operators as it will require them to deploy LTE sooner than perhaps they might have preferred. The coverage requirements will have depressed auction prices. Attaching coverage requirements to the 2.6GHz spectrum is unusual as coverage is usually addressed through lower frequency spectrum bands such as 900MHz and 800MHz as the propagation characteristics of the lower bands are more suited to providing coverage. The mix of strong demand and onerous roll-out conditions mean that the auction results provide little additional insight for regulators and operators who have yet to auction the spectrum.

The relative prices for paired and unpaired spectrum also remains confusing as Hutchison paid less in total for its paired and unpaired spectrum (a total of 65MHz) compared to T-Mobile which only acquired 40MHz of paired spectrum. This outcome is however more likely to be due to the algorithm (effectively a second price rule) used by the regulator to determine the final prices.
The use of second price rules, where the highest bidder wins but only has to pay the amount of the 2nd highest bidder, tends to result in more economically efficient allocations of spectrum but it can lead to interesting variations in price for similar lots. For example Telkom paid 20% more for the same amount of spectrum as Hutchison and T-Mobile paid 40% more on a €/MHz/Pop for its 40MHz of paired spectrum than Orange paid for its 20MHz and the difference is unlikely to be explained in full by differences in spectral efficiencies of LTE in wider bands
As countries such as Switzerland, Spain and the UK prepare to auction spectrum in the 2.6GHz band the Austrian auction provide some insight into the potential value of the spectrum but considerable uncertainty remains.

Theory versus practice in the global versus local operator debate

When the Financial Times reported in January that CEO Vittorio Colao was facing pressure from some shareholders to break-up the global operator it prompted other mobile groups to re-examine the global versus local debate. Some theories suggest that value should be generated by global scale but the reality is that many of the theoretical benefits are not achieved in reality. As is so often the case, realising the benefits of global scale is down to effective execution.

In theory, operators with international scale should achieve significant purchasing economies. In practice, some national operators have managed to get more advantageous equipment pricing and terms than their parent. As a result, some local operators have opted out of the group purchasing process altogether. In the case of securing content deals content owners, in theory, are attracted by distribution partners who can provide the widest distribution or eyeballs for their content. In practice the industry has not embraced exclusive content deals and those that did, such as 3 in the UK, rapidly rejected them. There is also probably little content that is truly global in its appeal and that customers are prepared to pay for. However, global players in general probably do have a stronger bargaining position with some suppliers, particularly equipment vendors.

International operators make great play of their ability to leverage learning and experience across their operations. In practise, cumbersome group structures often fail to disseminate the learning effectively and may actually stifle local innovation and slow down decision making. For large groups with a mix of developed and developing markets the learning from developed, increasingly data centric markets is of less relevance for voice centric developing markets. Indeed operators in Africa and other developing markets are sometimes confronted with re-charges for group services that are of little relevance or benefit. Indeed local operations should have a better understanding of their customers and competitors than those sitting centrally. Whilst the benefits of technological innovation can be replicated across markets the same is not necessarily true of propositions and tariff structures.

In theory, it should not be necessary to have a large international footprint to create attractive roaming offers (e.g. in the airline industry, the Star Alliance was an early example of how marketing benefits of sharing Airmiles’ eligibility could offset the smaller scale of individual airline operators). In practice however, Vodafone was the first to launch successful ‘passport’ type products in Europe. Of course, Vodafone customers travelling to the US are unable to use Verizon’s CDMA network and so a uniform technology footprint is a prerequisite for realising global roaming benefits. A “roam like home” proposition can be very compelling and is much easier to implement with a global footprint due to billing and accounting issues. The ability to steer roaming customers onto your own network can also deliver significant commercial benefits. In practice a global footprint may well attract higher spending business customers who roam although the benefits will diminish as roaming rates are regulated downwards.

In maturing markets consolidation can often be expected as economies of scale are much easier to achieve at the local rather than global level. Prior to consolidation taking place profits and cash flow can come under significant pressure due to high levels of competition. To act as consolidator an operator will need access to cash to either make acquisitions or to ride out the storm. A global parent with a strong balance sheet can provide a major advantage in mature markets. However the sheer size of a global parent may mean that opportunities in smaller, local markets are missed if the benefits of a consolidation play represent only a rounding error in the parent’s consolidated accounts. Smaller markets may find themselves a long way down the parent’s priority list.

Global players in theory can also benefit from portfolio effects where the “cash cows” in the mature markets can finance the growth of “problem children” and maintain “stars” elsewhere in the portfolio. In theory, capital markets should be able to provide this funding, but, as recent events have shown, capital markets are often far from perfect. The strategic implications of the Boston Consulting Group Matrix for business unit portfolio management may hold true to some extent. However, operators are often reluctant or slow to ruthlessly dispose of underperforming “dogs” which weakens the benefits of a portfolio approach adopted by global players.

A global brand, in theory, should be stronger than a local one when it comes to technology based services. In practice, T-Mobile was less successful in achieving global brand equity compared to say, for example, Vodafone. However, in some markets customers have a great deal of loyalty to local brands. When Vodafone re-branded J-Phone in Japan the customer base deserted in droves. A global player can gain very significant brand synergies through successful sponsorship campaigns such as F1 motor racing or the world cup. When executed successfully a global brand can deliver global brand synergies.

In short, it all comes down to execution. Global scale is not in itself a guarantor of net synergies, however if well managed, a global company can extract significant strategic benefits. With the increasing complexity of the technological landscape in particular, having leverage with equipment and device manufacturers is key to ensuring they get what they need. Smaller operators are more likely to simply get what they are given.