08 Tuning in: TV equals telcos triple value

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1 RECALL No 16 Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos triple value Tuning in: TV equals telcos triple value Once considered yestertech by the industry, television is now becoming the central element of many telco strategies. Operators in mature and emerging markets alike are benefiting from the revenues and new customers TV attracts, making this a must-have element in any telco s product lineup. Digital television is rewriting the rules of the game for telecoms operators. Long considered marginal to their business, successful players now view pay-tv as a critical element of their go-to-market strategies for the residential segment. Borrowing tactics from the attacker s playbook, first movers in their field are finding they have a critical advantage. The key is to reconceptualize their business model, selecting the appropriate strategy for their market context. Myth and reality Several commonly held beliefs related to telcos and TV have proved a myth as full convergence gains momentum. The first is that TV is not a telco business. Actually, it is or should be. A recent McKinsey survey in Europe revealed that over 60 percent of consumers seek tripleplay offers (voice, data, and TV) and consider TV the prime element of the three. In some markets, TV is in fact the key attribute on average, with around 2.5 times the relative importance of the second most valued element (excluding price), and is indeed the one that best differentiates the offer. Research also shows that interest in pay-tv has exploded across all markets, both in developed and emerging economies. For example, telco-driven TV-based bundles make up over 65 percent of the revenue pool in one Latin American country, and analysts expect these revenues to grow at a rate of over 9.5 percent annually through to Another fallacy is that TV produces marginal revenues. Again, this is untrue. While currently still small in terms of revenues, bundles that prominently feature TV attract a full half of all broadband customers and are responsible for an outsized proportion of gross subscriber additions (Exhibit 1). Experience shows that adding TV to a bundle increases upselling opportunities and boosts customer retention. Industry forecasts seem to confirm this trend: TV and related IPTV service revenues are expected to see the fastest growth in the telecoms industry (20 to 40 percent CAGR versus 1.9 percent in traditional telecoms services). This has provided a new tool for telcos to consolidate revenue growth by leveraging their current client base to generate upsell and retention (with a combined upside of up to 35 percent in direct margin). A further misconception is that TV s only real use to incumbent telcos is as a defensive strategy in cableheavy mature markets. In reality, non-cable players are aggressively offering television, including mobile operators and satellite companies. One satellite operator in the UK Sky, using its traditional TV offering bundled with fixed voice and broadband for the home has succeeded in entering the triple-play game and claiming a growing share of the broadband market over the past five years. Vodafone has also launched TV services over IP since 2009 as a strategy to enhance its fixed value proposition on top of ADSL. The compatibility of its platform with the Xbox 360 (in selected countries) has made this even more attractive over the last two years.

2 60 01 Although small in stock, TV-driven bundles account for a large share of gross Although addssmall in stock, TV-driven bundles account for a large share of gross adds Retail segment Indexed TV Other 100% Small in stock Share of revenues 5 95 relevant to customers Share of broadband customers crucial for the future Share of gross adds (in bundles) SOURCE: Analyst reports; McKinsey DISGUISED EXAMPLE Multiple strategies being applied Players have taken a variety of strategic approaches to digital TV depending on their specific market context. Some who are competing in markets with fully developed triple-play alternatives, where the importance of pay-tv is high, view a successful TV strategy as a clear make-or-break necessity and are investing heavily to make it happen. They purposely differentiate their products from other current offerings by employing a multiplatform strategy that enables fast penetration and makes advanced features available. Other players in markets where the importance of pay- TV is lower e.g., due to the high quality of free-to-air channel offerings but many triple-play alternatives exist are investing in creating strong, competitive TV operations as part of their larger portfolio of businesses. Winning companies in this position focus on achieving fast me-too offerings and making use of platforms characterized by low cost-to-serve performance. Operators who compete in markets where pay-tv is important but that do not yet have fully developed triple-play alternatives often view TV as a possible adjacent business to their current portfolios. Still others, facing limited triple-play alternatives and little need for pay-tv, basically see television as an upselling tool that can help them retain customers and sell premium broadband services, thus selectively investing in the most attractive customer segments or geographies. Rethinking the telco business model Telcos that have been able to quickly develop a TV-atscale business tend to take a number of steps outside the box that defines the traditional business model (Exhibit 2). Acting like true attackers, they have reframed several elements of their residential segment business model, adopting similar strategies along five dimensions: their infrastructure, product development roadmap, go-to-market model, operations, and their organizational capabilities. Infrastructure. Telecoms players can choose from various types of technology to add TV to their offerings: IPTV, satellite (direct to home), digital terrestrial television (DTT), or over the top (OTT). Several telcos have started to consider OTT as a way in, either to complement existing offers or as a stand-alone disruptive offering. The key driver behind technology adoption is related to how well technologies match the need for functionalities (number of channels, interactivity, and advanced services such as HD and video on demand VoD), qual-

3 RECALL No 16 Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos triple value Many telcos have already launched TV operations, with significant penetration Many telcos as have a percentage already of launched broadband TV subscribers operations, with significant penetration as percent of broadband subscribers Customer base penetration by TV service TV customers as percent of broadband customers Portugal Telecom Romtelecom 1 Magyar Telekom Belgacom Telekom Slovenije KPN TeliaSonera Swisscom O2 Czech R. TPSA Svyazinvest British Telecom Telecom Italia France Telecom Telefónica Time since TV launch 1 Direct to home only Years SOURCE: Screen Digest; operator Web sites; press clippings; McKinsey ity of service, coverage, and economics (including initial investment and subscriber acquisition costs). Satellite requires significantly less up-front investment and lower customer equipment costs. This, however, entails higher annual transmission costs per channel for renting satellite transponder capacity. In terms of product capability, satellite allows high definition and a large number of channels but has limits regarding some advanced features that require using on-demand features, such as VoD. In most markets, satellite is the legacy platform for pay-tv, frequently associated with premium offers in content and streaming definition, i.e., HD availability (e.g., Digital+ in France and Spain, Sky in Germany and the UK). Telcos, in contrast, have been electing satellite as the service provision platform for the mid-/low-end segments (because it can achieve the requisite economies of scale) or for areas with no fixed access infrastructure that can handle IP or OTT TV services. Satellite is a new technology for most telcos. They can either use a greenfield approach to build the infrastructure or acquire it from wholesalers that provide end-to-end solutions, which reduces time to market. Alternatively, some telcos have set up commercial partnerships with established satellite players. If fiber and copper platforms are used to deliver video services via IPTV, they can be leveraged in parallel for triple-play services: voice, broadband, and TV. This requires significantly higher up-front capex alongside high customer premises equipment (CPE) costs. However, such an investment allows the distribution of an unlimited number of HD and SD channels, and full interactive services. This solution is often pursued by telcos when there is potential for significant featuresbased differentiation an attractive option in high-density (and competitive) areas where there is a strong business case for extensive up-front business investment. Finally, OTT video services have gained market acceptance and play a variety of roles depending on the market and TV strategy. In some areas, OTT may be the key service for providing non-linear content and advanced TV services to complement rich free-to-air channel services (such as BT with Vision in the UK). In other geographies, it may also supplement satellite offerings with interactive services such as VoD, EPG, and others. Telcos often end up selecting a combination of technologies to serve different customer segments (low/mid/ high) and regional areas (with fixed coverage versus without). A strategic mix of this kind helps operators optimize their reach and economics.

4 62 It is always vital to establish the accompanying backend IT systems, such as CRM and billing, in addition to customer support systems for both remote and on-site services. When integrated, these systems need to generate a seamless customer experience one single point of contact for sales, activation, installation, billing, and after-sales service similar to the practice of the most cable players on the market. Product development. TV product content and structure need to be aligned with a telco s overall strategy. A zerobase redesign of the products and services the company offers is crucial to manage consumer and ARPU growth in parallel. Understanding consumers TV preferences as well as their total multiplay requirements allows a telco to develop offerings to satisfy its different segments and maximize impact along both dimensions. The process should be based on structured market research that provides deep insight into the usage patterns and key buying factors of both existing pay-tv users as well as prospective customers. McKinsey can use these insights to simulate the different potential structures for maximizing total revenues and margin contribution of the product. This process also enables a telco to define the best product bundles to capture and develop the complete household. Go-to-market. One clear hurdle many telecoms players struggle to overcome involves raising awareness of their pay-tv product on a broad scale. In one market, research into consumer purchasing patterns showed that the two biggest hurdles at the launch of an IPTV program are lack of consumer awareness and getting shoppers to move from considering the offer to actually purchasing it. An attacker mindset requires a dual approach: strong above-the-line market communication to make consumers aware of the new offer, together with an effective below-the-line commercial push to maximize effectiveness and acquire as well as win back consumers. A powerful marketing campaign is vital to position the product at the heart of the offering. Contrary to the other (voice and broadband) products, TV can provide significant differentiation via exclusive content, unique applications, or a distinctive user experience, and communicating these features to the market is key. An attacker-like below-the-line commercial effort needs to be developed in parallel. It is not easy to recover customers who have churned by selling TV via a call center, but a direct sales force focused on win-back and customer acquisition can be highly effective and efficient. A corresponding tactic requires different sales strategies depending on the region, with specific scripts and varying types of promotion, differentiating consumer types (upsell, win-back, and acquisition) a critical capability that telcos typically need to build from scratch. Door-to-door sales can represent up to 40 percent of pay-tv sales and is therefore key for competing with cable players. This channel is particularly relevant for sales in high-rise buildings. Many telcos typically outsource their door-to-door sales capabilities but need to find new partners for it as their traditional retail partners will not have the skills required. Operations. Highly upgraded home installation and networking capabilities are essential for telcos to handle the complexity of new TV technologies. To deliver high-quality service, telcos will need to interlink sales, field installation and maintenance, customer care, and equipment purchasing into one seamless process. Accomplishing an end-to-end approach will require a strong sales force, highly skilled technical staff focused on quality of service, call centers capable of resolving issues the first time every time, and significant investments in CPE. Telcos should consider CPE purchasing a strategic function, placing strong emphasis on both reliability and driving costs down. Telecoms players will likely already have many capabilities they can tap into to build a successful pay-tv operation. Retail channels typically represent roughly half of pay- TV sales, so telecoms players often start with an advantage compared with established cable players in terms of retailing density. Their key task is to retrain channels and establish the right incentives so that the new pay- TV offering is not neglected vis-à-vis traditional and higher-volume voice and data products. Players can also leverage their remote channels for customer service and telesales. It is particularly important to upgrade support systems and retrain operators so they can provide a single point of contact to customers for all elements of the offering (voice, broadband, and TV). Fixed operators that already have residential offers can use their existing field forces to install and provide on-site customer support for TV. As with retail and remote channels, operators need retraining to support

5 RECALL No 16 Consumers, Convergence, Connectivity, and the Cloud Tuning in: TV equals telcos triple value 63 On the path toward TV leadership in Portugal: MEO case study Portugal Telecom (PT) is an impressive story of an operator that used pay-tv to turn around its operations as its wire-line business encountered significant challenges. By the end of 2007, PT was facing several hurdles in its wire-line business, including fixed-mobile substitution due to a highly competitive mobile market, slowing ADSL penetration growth, a restrictive regulatory environment fostering the emergence of attackers, and strong cable competition from the consolidation of a new pay-tv competitor, ZON, with a triple-play offering and significant household penetration. In this context, PT envisioned a strategy leveraging the importance of TV in the customer s choice of operator as well as the unmet demand for advanced TV services. PT assumed an attacker-like mindset and focused on making TV a core element of its residential segment business by launching a disruptive TV offering. It utilized the unique advantages of an IPTV platform with non-linear TV and interactivity to create MEO. Its rich VoD range has DVD-like features and a catalog of over 2,500 movies, including high definition. As a result, PT enjoyed growth levels that significantly exceeded expectations, achieving doubledigit household penetration in less than a year. Equally important, over 50 percent of IPTV customers are new to PT. The new brand has also propelled its flagging broadband business to first place in the market in terms of net subscriber additions. Three years after it launched MEO, PT has captured around 30 percent of the pay-tv market share. MEO continues to be at the core of PT s residential offering, acting as an engine for fiber penetration by offering various features that significantly differentiate its value proposition, including: Continuous improvement of the user interface, such as an electronic programming guide Remote control of the set-top box via mobile hand set or PC and access to the VoD library from a PC Multiroom personal video recorder for customers with more than one set-top box Gaming, karaoke, and other interactive applications and service areas Access to personal photo folders Customized content and features for children in a walled garden called MEO Kids. PT will be a strong competitor to TV Cabo within 3 to 6 months Sep 2007 We want to achieve critical mass in TV Oct 2008 We want to be leaders in TV and we are not going to apologize to anybody for that July 2009 We are on the path toward leadership on the pay-tv market July 2010 June Launch of video on demand, set-top boxes, and advanced TV services Nov Spin-off of TV Cabo April Commercial launch of MEO IPTV and MEO Satellite Dec MEO leads in client satisfaction April Launch of MEO Kids Oct 500,000 MEO customers Feb Launch of 3-D Nov Launch of MEO Jogos and Music Box Nov SAPO available in MEO May Launch of MEO Fibra 2010 July Launch of widgets Number of IPTV and direct-to-home subscribers and market share Thousands 1% % % % 830 SOURCE: Operator investor relations presentations; press clippings

6 64 a more sophisticated portfolio. This especially applies if satellite is chosen as the infrastructure technology, requiring installation of a dish, set-top box, and inhouse cabling separate from the existing fixed voice/ data infrastructure. Organization. TV should be perceived as part of the core business rather than as an add-on. A firm case for organizational transformation is the result, evolving the corporate mindset from being a telco toward that of a media company. A clear organizational priority should be assigned to pay-tv to drive the necessary focus and transversal collaboration. To achieve this, senior managers ideally the CEO should adopt TV as their key responsibility, allocating the best resources in the resi- dential organization to this field. Driving TV as a media business also requires specific organizational skills, which will probably need to be hired in. The same talent will also devise strategies to enable the most efficient use possible of the corporation s content offering as a business lever. Convergence at the end user is pushing the boundaries of traditional media, providing telcos with the opportunity to promote a one-stop media shop proposition and elevating their position in the value chain as a result. Pay-TV can become the central element in this mix, serving as a powerful driver of growth. Armando Cabral is a Director in McKinsey s Lisbon office. armando_cabral@mckinsey.com Rodrigo Diehl is a Principal in McKinsey s São Paulo office. rodrigo_diehl@mckinsey.com Patricia Ferruz Aguilar is a Principal in McKinsey s Madrid office. patricia_ferruz@mckinsey.com Miguel Fonseca is an Associate Principal in McKinsey s Lisbon office. miguel_fonseca@mckinsey.com