Telco 2020 How Telcos transform for the "Smartphone Society"

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1 Competence Center InfoCom 1 Alexander Mogg, Alexander Dahlke, Peter Wimmer, Christian Hoffmann Telco 2020 How Telcos transform for the "Smartphone Society" Competence Center InfoCom

2 2 Telco 2020 How Telcos transform for the "Smartphone Society" 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".

3 Competence Center InfoCom 3 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. Welcome to the "Smartphone Society" a glimpse of the future Snapping your fingers is all it takes to silence the smartphone alarm, getting digital assistant Siri to answer your mails before you even get out of bed, commenting on the first Facebook postings of the day while brushing your teeth and switching on the espresso machine. A doppio, if you don't mind. Since your girlfriend is still away on business, you will have to make do with the hologram projected onto the table by your mobile for small talk over coffee. Five minutes later, your phone opens the car door. As you climb in, you tell the voice control the name of the business partner in Korea who you want to talk to on the way to work both of you speaking your own language, interpreted simultaneously and appearing on the headup video display. In short, the digital transformation is turning our day-to-day lives upside down.

4 4 Telco 2020 How Telcos transform for the "Smartphone Society" 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?

5 Competence Center InfoCom 5 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 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.

6 6 Telco 2020 How Telcos transform for the "Smartphone Society" 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 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.

7 Competence Center InfoCom 7 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. What industry CxOs think the results The interviews were revealing. Top managers are clearly in broad agreement about the course the market will take. But they are very uncertain about their own relationship with end customers, their ability to cope with the digital transformation and about consolidation scenarios. The resultant strategic and timing considerations are equally unclear. At the same time, our interviews highlighted the different opportunities opening up for telcos. Depending on how they position themselves, incumbents can indeed stand up to new competitors and succeed in a game whose rules are changing beyond recognition.

8 8 Telco 2020 How Telcos transform for the "Smartphone Society" 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 Given the upheaval on the communications market, we expect to see a decline of 1% to 2% a year until 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.

9 Competence Center InfoCom 9 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 Telefónica, 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.

10 10 Telco 2020 How Telcos transform for the "Smartphone Society" 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. Personalization of service suites and the customer experience The more complex our service environment becomes, the more important consumers will place on personally tailored, functioning offerings that meet all their needs. For providers, this means giving every user a platform on which they can bundle their apps, information, entertainment, shopping and communication services, and where they can also find someone to help them with any questions or problems that crop up. This service suite must be structured in such a way that it can be custom-tailored, irrespective of what devices and networks users choose or where they happen to be. In the future, customers will expect to be able to take an ongoing call seamlessly from their office phone to their mobile and have it put through to the handsfree device in their car automatically as soon as they turn on the ignition. To put that another way, service suites must work in the background; they will not always be visible. But what should a successful personalized suite look like? Let's take entertainment as an example: Premium and basic packages for different target groups young people, families, over-50s simplify the task of communicating and picking the right services. Each package will include standard content such as an app store, access to 3D Internet TV and preinstalled links to important networks and programs. Telephony and broadband Internet access will likewise be preinstalled. Switch on, go shopping, communicate immediately: that will be the value proposition. Personalized but free add-on services such as videotheques (along the lines of BBC's iplayer), secure single sign-on facilities across mobiles, tablets and the TV, and a firewall or cloudbased storage will complement the standard-issue functions. Customers will select these functions either in a service configurator or, on the basis of past usage patterns, the provider's "recommendation engine" will suggest them itself (e.g. "customers who chose, often choose "). Exclusive add-on functions will allow users to further personalize the service suite, creating a genuine "wow factor" that boosts customer retention and enriches the brand experience. Variations on the theme of the Apple Store's Genius Bar, where specially trained staff provide live help for customer problems, would be conceivable in a service cosmos that combines offline and online support. Premium services such as links to American Express-style concierge services for local cultural offerings, and maybe a personal rendition of "Happy birthday to you!" by Lady Gaga or at least her hologram in the customer's living room, will set the bar for providers of OTT environments, services and consumer goods.

11 Competence Center InfoCom 11 Staunch defense of relationships with end customers The battle for customers will be won not with services alone, but with every aspect of the ecosystem. Communication devices, too, will have a crucial role to play partly because they often clinch a decision whether or not to sign a telco contract. Unlike the situation today, telcos will no longer determine which handset manufacturers succeed merely by displaying their devices in their showrooms. Instead, global brands will sell their own smartphones, tablets and Internet TV devices directly or via retail partners. Apple has been showing how this can work ever since it launched the iphone in Google is strengthening its position with rapid dissemination of the Android operating system and the acquisition of Motorola's mobile communications arm. Together with HTC, Facebook plans to launch its own mobile phone called Buffy starting in spring Following its Kindle Fire, Amazon is also said to be working on a smartphone. Microsoft has teamed up with Nokia to develop the Lumia family if devices in an attempt to relaunch its own operating system. For now, however, it is unlikely that these moves by OTTs will trigger a power struggle in the device segment. The telcos still have a dominant 45% share of distribution channels in Europe. The billions that telcos pay in sales premiums give them huge clout in retail and reseller channels. Not only that, they massively subsidize consumers' handset purchases to the tune of more than EUR 20 billion a year in Europe alone. That's the kind of cash the fab five would first have to splash to keep pace with telcos' forthcoming assault on the market. To reach the mass consumer market, over-the-counter prices have to be below EUR 100. And up to now, Amazon alone has dared to venture into this territory, with the Kindle. So there are a number of reasons to believe that, for the time being, telcos, OTTs and device manufacturers will continue to coexist more or less peacefully. "We quite simply depend on each other to an incredible extent," underlined Google CEO Eric Schmidt, as recently as the 2011 G8 Summit. It is nevertheless a fact that OTTs and device manufacturers possess powerful weapons their SIM technology, operating systems and seamless integration in app stores with which to herald a "changing of the guard". Technologically, it is already possible to use apps or the operating system to install a "soft SIM" on the handset that allows users to choose the best or lowest-cost network. In many places, Internet access is already available via WLAN, and often free of charge. Alternatively, telcos that cannot use their infrastructure to full capacity due to regulatory requirements or simply a lack of end customers will themselves make Internet access available. Google Voice, Skype and WhatsApp give us a foretaste of how Internet groups are already co-opting a portion of telephony revenues. To date, however, the incumbent telcos still have control of the contracts safely in their own hands. Irked by this, some OTTs and device manufacturers are already discussing the possibility of opening their own distribution channels to ship phones and tablets with hardwired "e-sim" cards.

12 12 Telco 2020 How Telcos transform for the "Smartphone Society" 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. Cost-efficient broadband network build-up When relationships with end customers are eroded, cost efficiency and bandwidth become critical if a company is to remain competitive. Only those telcos that have suitably dimensioned infrastructures will be able to defend their market position in the long run, or at least to engage in successful cooperation with larger players. In the years ahead, a lot of money will have to be spent to ramp up the optical fiber and LTE networks. Why? Because OTT services are cranking up the volume of data traffic on ever more powerful smartphones, tablets and TVs. Between now and 2016, mobile data traffic will multiply tenfold, with video content acting as the biggest driver. By 2020, the OTTs' video offerings will account for more than half of the total data volume. That's why on the one hand the fab five need the telcos' broadband networks as the platform for their business model. Even though Google is now laying the first of its own optical fiber networks, only the telcos can guarantee general quality standards for networks at present. On the other hand, telcos have not yet found a way to tap into monetizing this exponential traffic increase. First attempts for monetization are tiered price plans and speed-step down tariffs that some European mobile operators deploy. But OTT Players and telcos can enter a cooperation, with positive impact for both parties as countries such as Japan, China and Russia show. Japan's specific cultural characteristics (language, collective mentality), industry structures (high-tech clusters, keiretsus) and state sponsored broadband program mean that ecosystems have developed around powerful telcos such as NTT, NTT Docomo and Softbank. These companies cooperate with Japanese chip, mobile phone, gaming and industrial companies on their own B2B2C platforms (such as mbanking) and OTT services (i-mode, Internet holdings).

13 Competence Center InfoCom 13 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.

14 14 Telco 2020 How Telcos transform for the "Smartphone Society" Realignment and radical streamlining of operating models The different infrastructure strategies will leave the telco market and telco companies more fragmented than ever. For strategic and financial reasons, telcos must therefore undertake wide-reaching realignment and resizing of their operating models. If they want to offer cost-efficient broadband access, market players need an efficient network company (a "NetCo") and a flexible, customer-centric sales and service company ("SalesCo"). In addition, corporate services ("HQ") must oversee the interaction between the various units in order to set the right priorities for strategy, innovation, partnerships and talents. A separate OTT service group should be attached to HQ and be tasked with committing to selective cooperative ventures and investing in the lucrative but risky OTT game. This separation is necessary if due provision is to be made for different markets, response times and investment cycles that differentiate core telco access businesses from new OTT businesses. While the NetCo operates anonymously in the background, rather like a utility, the SalesCo acts as a brand (portfolio) and has daily contact with its customers. SalesCos are allowed to stir things up, but NetCos simply have to work for all parties including third-parties. To optimize network capacity utilization and quickly achieve payback on investments, activities can be bundled locally in a NetCo. This NetCo should then plan, build and operate nextgeneration broadband networks as efficiently as possible: on its own, by sharing networks with rivals, by outsourcing them to an equipment supplier, or by simply acting as a wholesale customer for partner networks. Network capacity can then be marketed to the internal SalesCo and other, external SalesCos, depending on strategic, regulatory and market positioning requirements. In most cases, this will mean observing the rules of network neutrality: providing wholesale access offerings that are player-, device- and service-independent, but that generate higher revenues than today. However, by no means every provider will be in a position in the future to set themselves apart through their product offerings or sales and service constellation. Depending on the market and target group, SalesCos must offer a top-class mix of proprietary and partner products. In B2C business, the latter may include services from the fab five. In B2B business, the mix could just as well include IT services from companies such as SAP and IBM. Whatever pieces ultimately make up the puzzle, the overall brand experience will be critical to the success of the SalesCo. This experience is delivered by top products, commensurate advice at the point of sale and compelling customer service. Moreover, the door to new distribution partners with strong brands and innovative concepts of their own selling via post offices, gas stations, utilities, OTTs, IT service giants or whatever is wide open. Traditional telco channels appear to be core components of the existing business model. But this approach should be re-assessed. Does a SalesCo really need a store on every corner? Or might it not be better to "do an Apple" and run exclusive experience stores flanked by various other distribution channels? Do call centers really have to be kept in-house?

15 Competence Center InfoCom 15 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. Financial resources to drive digital transformation and intelligent consolidation If undertaken properly, digital transformation and intelligent consolidation are evidently worth the trouble. They can enable European regional groups to eliminate the typical 15% conglomerate discount. But it doesn't end there. Boldly pruning their portfolios would also enable them to free up a further cash, also by aggregating ShopCos and CallCenterCos at the European level and selling them. Less aggressive but equally intelligent moves, such as cooperative ventures, can likewise create significant financial leeway. France Telecom and Deutsche Telekom are seeking to save billions through procurement joint ventures and network cooperation in international markets. In some cases, these arrangements also involve local partners such as "3" in the UK. This kind of "co-opetition" model a balanced mix of cooperation and competition will probably be a wise path to tread when preserving cash for the battle with the major OTTs. This is all the more important given that telcos especially those in Europe have little room to maneuver as the forthcoming wave of market consolidation approaches, let alone throw money at attacks on the OTTs. The ten biggest global players are groaning under net debts totaling a staggering EUR 252 billion. Interest payments and dividend guarantees place tight restrictions on what they can do with combined cashflows of EUR 69 billion. Nevertheless, virtually every decision-maker sees further consolidation of the European telco sector as unavoidable, especially in order to realize economies of scale in the costly access business. Within national markets, underweight players will club together. More than one landline supplier and one cable provider per country is hardly likely to survive. In the mobile segment, two or three might make it a view substantiated by the interviews we conducted. Cable and mobile communication firms will merge to be able to offer integrated access. Something like 220 of today's 300 niche providers are likely to disappear; of the 25 major cable players in operation today, only half will still be independent in 2020.

16 16 Telco 2020 How Telcos transform for the "Smartphone Society" 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 (Telefónica/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. Telefónica, for example, acquired VoIP provider Jajah formerly a Deutsche Telekom minority investment in 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)?

17 Competence Center InfoCom 17 From Access Minus to OTT three scenarios for the future A company's strategy will be determined by its power to activate the five levers described above. We see three realistic scenarios emerging from telcos' efforts: Access Minus, Access Plus and the OTT Game. Access Minus Companies that adopt this strategy do not operate a fully-fledged access business but act primarily as wholesalers. In extreme cases, they merely make their data network available to other companies SalesCos and content providers and operate solely on the B2B level, maintaining no contact with end customers. Incidentally, more than 50% of OTTs see this scenario as the most likely future development for today's telcos, according to a study by Nokia Siemens Networks (NSN). Other telcos will complement wholesale activities with their own branded business and so will need at least a lean SalesCo to complement their NetCo. The SalesCo will facilitate direct customer contact and provide a platform on which the service suites of other content providers can run. 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.

18 18 Telco 2020 How Telcos transform for the "Smartphone Society" 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. The bottom line What role will telcos play in 2020? Will they be mere data pipes? Broadband access and platform service providers? OTT service groups even? Whatever the future holds, all companies are called on to refocus and realign and to do so fast. All three scenarios will see some telcos playing their part successfully. As we have seen, none of the fab five will cover the entire ecosystem. Nor will any one player dominate the entire market, even in its core business. Given the right strategy, telcos can therefore consolidate their position at crucial links in the value chain. We believe that observing five golden rules will help them to do this. Quickly acting on Rules 1 and 3 alone will deliver significant value growth.

19 Competence Center InfoCom 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 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.

20 Amsterdam London 20 Telco 2020 How Telcos transform for the "Smartphone Society" Barcelona Madrid Beirut Manama Beijing Milan Berlin Moscow Brussels Mumbai Bucharest Munich Budapest New York Casablanca Paris Chicago Prague Detroit Riga Doha Rome Dubai São Paulo Düsseldorf Seoul Frankfurt Shanghai Gothenburg Singapore Hamburg Stockholm Hong Kong Stuttgart Istanbul Tokyo Jakarta Vienna Kuala Lumpur Warsaw Kyiv Zagreb Lagos Zurich Lisbon Authors Alexander Mogg Partner and Head of Competence Center InfoCom Alexander Dahlke Partner Peter Wimmer Partner Christian Hoffmann Principal CONTACT Phone: Roland Berger Strategy Consultants 02/2012, all rights reserved

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