1 by Raul Katz Paul Kocourek Decio Mendes Gary Neilson Telecommunications Service Providers A New Operating Model
2 1 Telecommunications Service Providers A New Operating Model In the last two decades the structure and nature of the telecommunications industry have been transformed. AT&T s breakup in 1984 launched an intensely competitive market in long distance and gave birth to the Regional Bell Operating Companies (RBOC). Shortly thereafter, the wireless market emerged. Over the next ten years, these three industry sectors (local, long distance, and wireless) rapidly expanded and consolidated. We witnessed the long distance wars, the relentless spread of wireless, and the Incumbent Local Exchange Carriers (ILEC) moves to lock in local customers with an expanded range of services and features. Then the forces of deregulation and increased price competition took hold as the Telecommunications Act of 1996 relaxed the barriers between local and long distance, and wireless penetration reached 50% of the U.S. population. 1 Add to this the profound and accelerated impact of the Internet on telecommunications capital investment, and you have the makings of a revolution. But as the marketplace has transformed over the past twenty years, the operating models of the industry s leading players have not leading to an increasing disconnect between competitive market imperatives and telecommunications service providers ability to respond. The cycle of expansion fueled by deregulation and expanding voice and data traffic came to an abrupt halt in April Companies and investors who had bet on a build it and they will come philosophy have been sorely disappointed. And the ability of telecommunications companies to return their cost of capital has been seriously handicapped 2 (see Exhibit 1). Still, absent changes mandated by regulation (e.g., structural separation of the RBOCs wireline and wireless businesses) or engineered for financial reasons (e.g., spinning off wireless subsidiaries), the operating model of most telecom companies dates back to the time of Ma Bell. It is our view that telecommunications companies need to transform their operating models (defined as the sum of organization structure, business processes, management systems, decision rights, and culture) to compete effectively in the current competitive climate. If they do not, their continued viability may well be at risk. The Need for Change While each segment of the telecommunications industry contends with its own unique competitive dynamics, three Exhibit 1 U.S. Telecommunications Players 2002 WACC vs. ROIC Source: Company reports; Shuper (2003); Booz Allen Hamilton 1 Between 1995 and 2001, U.S. wireless operators drove penetration from 25% of the population to 50%. 2 R. Katz and C. Junqueira, Managerial Strategies and the Future of ROIC in Telecommunications, Columbia University Program on Telecommunications Recovery, March 2003.
3 2 Exhibit 2 High Performance Operating Models Share a Common Architecture common trends have emerged across the wireline and wireless sectors: Slowing growth: For the first time since the Depression the number of access lines in the U.S. has contracted as a result of broadband and wireless substitution. In the first quarter of 2002, basic access line growth declined 2.8%. Meanwhile, incremental wireless penetration has slowed. The last two quarters of 2002 show clear signs of a falloff in subscriber growth. Severe price-based competition: Pricing in all segments basic landline, long distance, wireless, enhanced data has been consistently declining. Since 1995, the average price per wireless minute has fallen from 56 per minute to 11 per minute. 3 Similarly, long distance pricing has slipped at a compound annual rate of 6% over the past eight years. High customer acquisition costs: The cost to acquire a new customer in the U.S. wireless market has climbed to $360, the highest in the world. A new retail DSL customer costs a Local Exchange Carrier approximately $350. These trends have exerted tremendous pressure on the telecommunications industry s operating margins, which have fallen from a healthy 45% in 1995 to an expected 33% in Meanwhile demand for nextgeneration services (e.g., 2.5G, DSL) drives continued capital expenditures across the industry. Total capital spending by wireless carriers is expected to reach $23.3 billion in 2003, which is slightly higher than 2002 s total. Across the entire telecommunications sector, capital investment may be down as a result of significant reductions on the part of the ILECs, but at 23% of sales, it is still above the threshold of 20% required to generate sustainable returns on any investment. 4 To make matters worse, the cost of capital has never been higher as both the equity and debt markets have turned away from the telecommunications sector in recent years. Margin pressure, competitive intensity, and shifting customer needs all expose the deficiencies in carriers current modes of operation and organization. The New Telco Operating Model To a greater or lesser extent, the concerns described above apply to every telecommunications company. The question on the minds of industry executives is: How do you overcome these barriers and develop a new operating model for success? How do you leverage legacy strengths, while aligning structure, processes, measures, rewards, and decision rights behind the right strategy moving forward? While organizational configurations will continue to differ across the telecommunications sector, the basic elements of the New Operating Model are consistent and enduring (see Exhibit 2): Profit-accountable business units formed around distinct market segments and value propositions Separate, market-efficient support services that provide internal clients with responsive, competitive offerings 3 11 /min at the end of D. Endicott, Is Low Telecom ROIC Here to Stay, and How Long Will Investors Bear This? Columbia University Program on Telecommunications Recovery, March 2003.
4 3 Lean and strategically focused corporate centers Alliances and partnerships with best-in-class external service providers to leverage scale, access expertise, and increase flexibility Connective rules and tools that measure, inform, and motivate organizational elements to work together in executing the firm s strategy. Moving from organizational concept to operational reality takes applied effort and fierce commitment applied effort across the entire enterprise and fierce commitment from the very top. The move to a new operating model is nothing short of a transformation. In the case of the telecommunications industry, there are three competitive imperatives driving this transformation (see Exhibit 3): 1. Improve the cost structure. The immediate priority for companies across the industry is to rein in costs. If growth was agenda item no. 1 in the 1990s, the turn of the millennium has pushed efficiency front and center. In a carrier s bid for continued relevance and viability, operational excellence and economies of scale are the base requirements for competition. 2. Create customer intimacy. Telecommunications providers need to address new customer requirements for tailored and integrated products and services. Bundled offerings, unified billing, and single channel customer service require major changes in organizational structure and systems to promote cross-functional cooperation. If improving cost structures are the base requirements for telcos, customer intimacy will be the prime point of competitive differentiation. Exhibit 3 Telecommunications: The New Operating Model Imperatives 3. Enhance organizational alignment and adaptability. To strengthen operating economics and business unit linkages, telecommunications service providers will need to change the way they are organized to do business. The full gamut of organization levers from structure to management systems to business processes to roles and responsibilities will need to be adjusted, even overhauled. Competitive Imperative #1: Cost Restructuring The case for cost restructuring in the telecommunications industry is readily made and well understood. Stagnant growth and increased price pressures have eroded margins and returns on invested capital industry-wide. Some carriers have already responded by slashing capital expenditures; others have squeezed specific functional areas for cost savings. Both tactics are short-term palliatives, however, and could seriously hamper long-term growth. For example, indiscriminate reductions in customer care staff can result in customer dissatisfaction, hence increased churn, hence higher acquisition costs. How do telecommunications carriers find sustainable solutions to the cost-restructuring imperative? How do wireline and wireless carriers quickly shift their focus to achieve step-change reductions in cost and capex levels? Functional Organization Structure Many in the industry use the immediacy of the costrestructuring imperative to justify their maintaining a functionally oriented organization structure. Indeed, it is true that a disciplined and tightly run structure organized around such functions as sales, customer service, marketing, network operations, IT, finance, and legal and human resources generally results in very low operating costs. Scale functions are consolidated in stand-alone cost centers or shared services units allowing companies to reap significant economies. The danger, however, with a functionally oriented organization structure is that it leads to a functionally driven operating model. Such models do not encourage customer focus. Instead, they often reward silo behavior as the managers of each function set their sights on their individual goals and financial targets, rather than enterprise objectives or customer requirements. Operating decisions tend to be budgetdriven, and cross-functional coordination is a challenge. Moreover, functional models require the hands-on involvement of senior management, often the COO or CEO, since true P&L responsibility can reside only at the top of the organization.
5 4 Shared Services To reduce costs and hone business unit focus, a number of telecommunications companies have introduced shared services in recent years (e.g., AT&T, Verizon). In fact, companies across industries ranging from aerospace to electric utilities to consumer products are turning to shared organizations to improve the cost efficiency and effectiveness of their administrative and technical support services. 5 When a company chooses to organize around shared services, it consolidates support services from headquarters and business units into a single organization. Rather than functioning as an arm of the central hierarchy with costs allocated to the rest of the organization (the support services model employed by most of the telecommunications industry), a shared services organization collaboratively plans requirements and pricing with its internal corporate and business unit customers. The fundamental principles of shared services noted in Exhibit 4 introduce marketlike discipline and appropriate incentives to the provision of internal support services. Transparent pricing and the contestability of services act to improve the quality of service rendered while limiting service demanded to that which the business unit customer is willing to pay for. No longer a free good, internal support services are now market-priced products with costs and benefits. Corporate and business unit customers make trade-offs accordingly, with an explicit understanding of the true economic impact of their choices. The service providers become not only vendors to the internal customers, but also expert advisers on what services would best suit the business needs of the customer and whether they should be sourced internally or externally. Still, many companies have stumbled in implementing shared services. Many that claim to have implemented these models have not realized the desired benefits. In such cases, we often find that companies are misusing the term shared services to refer to centralized and fully insulated staff support functions rather than independent, market-focused, accountable service providers. Shared services, it should be emphasized, is not just a new name for cost center. Outsourcing The commercial give-and-take of the shared services model, combined with the external benchmarking and internal cost transparency that characterize it, provide a solid, organic foundation for outsourcing. Increasingly, telecommunications carriers are embracing these new supplier relationships to not only lower costs, but also to enhance flexibility, access expertise, and free up inhouse resources to focus on core business capabilities. Telecommunications outsourcing began with peripheral, nonstrategic activities such as logistics and facilities management. But as outsourcing has taken hold among telecommunications players, its reach has spread into areas that are closer and closer to the core, according to research conducted among service providers. 6 Today, business process outsourcers (BPOs) are providing complex end-to-end services for missioncritical operations such as call centers, data centers, IT applications development (e.g., administrative and ERP systems), and billing. Vertical thinking (i.e., own or control every link in the supply chain) has given way to virtual thinking (i.e., create a flexible web of supply relationships and focus exclusively on what you do best) as telecommunications companies grapple with the imperative to restructure costs. Generally speaking, outsourcing is becoming increasingly prevalent in asset-intensive functions (e.g., IT, billing) where separation from the corporate core is possible (i.e., operations rather than planning and development). Activities that require standards setting or close integration with corporate planning are easier to perform in-house. Exhibit 4 Shared Services Principles Rest on Market-Like Mechanisms Shared Services Principles Price Transparency Business Management Market Responsiveness Best Practices Proliferation User Governance Service Culture Each service has its price. The business unit determines how much, if any, it wants at that price. The service is managed as a business, not a fixed overhead. It exists to serve internal customers. Service levels are determined by what the users want, not by what support staff thinks they need. Internal and external best practices are continually identified and, if appropriate, incorporated. Users have the dominant voice in setting standards and processes for commercial interaction. Support services exist to serve the business needs of the users, proactively as well as reactively. 5 P. Kocourek, V. Couto, P. Hyde, and L. Dunn, Getting Shared Services Right: Capturing the Promise, Booz Allen Hamilton, S. Eikelman, Outsourcing Options for Mobile Network Operations, Booz Allen Hamilton, 2002.
6 5 While network operations have been regarded by most carriers as too strategic to outsource, our research indicates that network outsourcing has significant potential scale benefits, especially if the BPO manages multiple networks (e.g., expert staff, warehouse consolidation, equipment maintenance) Carriers are beginning to consider various outsourcing alternatives from the outright transfer of network functions to the BPO to the reengineering of processes and the redefinition of boundaries between carrier and outsourcer. Of course outsourcing presents risks. In cases where the outsourcer enjoys a virtual monopoly, it will often raise transaction charges such that the aggregate economic cost of outsourcing (i.e., transaction plus production costs) exceeds the cost of keeping the function in-house. In such areas (e.g., systems integration, ancillary IT services), some telcos are weighing whether to bring the services back inside the company. 7 Sharing Infrastructure Another option that telecommunications companies have been considering to leverage scale is sharing infrastructure, particularly network resources. Both the wireless and wireline segments of the industry have examined this possibility; indeed, a number of wireless carriers in the U.S. and Europe have networksharing agreements (e.g., T-Mobile/Cingular, German wireless carriers). Our economic analysis indicates that wireless carriers can save an estimated 48% in access network costs. This figure obviously depends on the degree of cooperation and the regional synergies of the particular networks. Competitive Imperative #2: Customer Intimacy In addition to responding to mounting cost pressures in the immediate term, telecommunications carriers need to enhance their customer responsiveness dramatically. In conducting market assessments in the telecommunications sector, we at Booz Allen find wide and consistent agreement among both business and consumer customers on the need for greater integration of products and services. In the enterprise market, customers value the opportunity to build a relationship with a one-stop supplier of telecommunications services. They want a package of solutions that wraps systems and connectivity requirements around information technology with a single bow. In the consumer market, customers are looking forward to product and service bundles, unified billing, and a single customer sales and service channel. They want a seamless experience, which puts great pressure on carriers to reorganize their operating model. They need to build and cement linkages between business units that have been growing apart for years. The telecommunications industry is not the first to tackle the challenge of customer intimacy. The retail banking, consumer goods, and automotive industries have all tried in recent years to deepen the penetration of their existing customer base. Telcos are fortunate, actually, in that consumers are not only willing; they demand a more penetrating and full service relationship. They want one-stop shopping. They want bundled offerings. Building a customer-centric service organization, in our experience, requires repositioning the business around a seamless continuum of tailored solutions. So, for example, a bank needs to transition from a provider of transaction services to a partner in wealth creation. Telcos need to shift from a carrier mindset to a full-service provider model. The telecommunications company of the future will provide tailored bundles of products and services to anyone, anytime, anywhere, anyhow. The experience of other industries suggests that the critical enabler to achieving this new strategic position is organization structure and the corresponding business processes. First, telcos need to understand the full range of customer requirements (e.g., define segments, value propositions, product sets). Then they need to modify their internal processing architecture to reflect a market rather than a product orientation. Each market segment will have its own differentiated set of economics. This new customer-centric and solutions-oriented operating model will: Optimize overlap in service/product coverage Provide for effective management of pricing and cross-selling Integrate across all points of contact, both in sales and care Generate a holistic view of product development In every industry where solutions plays have worked, there are three key success factors. First, customers desire, perceive, and are willing to pay for true solutions. Second, the solution bundles 7 R. Katz and B. Sarma, The Importance of Scale and Scope in Driving Telecommunications Industry Structure, Columbia University Program on Telecommunications Recovery, 2003.
7 6 Exhibit 5 Customer-centric Operating Model for Telecommunications Providers are a combination of strong underlying positions and capabilities, not an attempt to hide a suboptimal offering within a broader package. Third, successful companies acknowledge (rather than deny or ignore) the inherent tensions between being customer-centric and internally disciplined and efficient. 8 This tension is especially pronounced in asset- and scale-intensive businesses where it is necessary to heed the needs of the production plant be it manufacturing facility or the network as well as those of the customer. Our client experience in a range of service industries suggests there are four design principles that telecommunications service providers should keep in mind in building a customer-centric organization: Differentiate the customer experience via new, open and transparent customer interfaces Redesign distribution and customer management around a solutions approach Develop a segment-aligned delivery model that genuinely differentiates economics by segment Pull away from competitors by getting execution right the first time (a bundle handicapped by poor delivery is worse than no bundle at all) Putting these design principles to work results in a fundamental transformation of most telecommunications carriers operating mode. No longer are companies organized around functional areas; instead, customer segments are the primary axis (see Exhibit 5). This customer-centric organization structure represents a major departure from the current models prevalent in the telecommunications industry today. It will require redefining roles and responsibilities at nearly every level, as well as processes and procedures. It also fundamentally alters the operation of the business, as P&L responsibility no longer needs to reside at the top of the organization. Rather it can roll up to customer segment heads. While dislocating over the short run, the reward of such a structure is an increased focus on what is ultimately a carrier s greatest asset the customer. Competitive Imperative #3: Organization Alignment and Adaptability We ve established that telcos need to dramatically change their operating economics and deliver an integrated product to the customer. These competitive imperatives are, in turn, driving the need for a new operating model among telecommunications carriers. To support this new operating model, many telcos will need to restructure their organizations to foster both 8 D. Sharma and R. Katz, Customer Solutions: From Pilots to Profits, Booz Allen Hamilton, November 2000.
8 7 alignment with strategic objectives and adaptability as these objectives shift in a constantly changing competitive environment. Telecommunications companies need to optimize organizational effectiveness to cope successfully with rapid, often unanticipated, market and technology developments. Our experience suggests that most carriers should focus immediate efforts on improving the effectiveness of four key organizational areas: Product Development Speed to market is critical and will only become more so as the telecommunications industry continues to evolve. To optimize the product development process, telcos need to reduce organizational tensions and promote cross-functional collaboration. We find that most companies stumble in getting new products and services to market because of their own intrafunctional roadblocks. Marketing, sales, finance, network operations, and engineering cannot seem to cooperate in launching new ideas and integrated solutions in a timely manner. Moving from functional organization structures to a customer-centric model will help break down this silo behavior. However, telecommunications service providers also need to address nonstructural organizational attributes. In particular, they need to redefine roles and responsibilities to establish clear ownership of critical end-to-end processes and design new incentive mechanisms to foster true accountability for results. Customer Care Customer services costs can represent up to 20% of a telco s total operating expenses. Moreover, poor customer service is a key driver of the unacceptably high churn rates in the industry. So, enhancing customer care operations is clearly a priority. We find that most telecommunications customer care organizations suffer from two major weaknesses: 1. Lack of effective coordination between customer care, marketing, and billing. The result? Marketing rolls out new products and services before IT has implemented the requisite billing system changes and before Customer Care is prepared from a procedural, staffing, and training standpoint to support the new offerings. Customer dissatisfaction is the direct outcome. Higher operating costs are an indirect impact as staff scramble to develop work-around processes and custom services to accommodate the new products and service in the short to medium term. 2. One-size-fits-all approach fails to optimize customer demand. Most telcos have historically subscribed to the conventional wisdom that one-size-fitsall solutions result in the lowest overall costs. However, our recent client work across industries suggests that this logic is outdated and faulty. In practice, this approach typically overserves a service provider s least profitable customers, while underserving the most valuable customers. Again, the result is dissatisfied customers and higher than necessary costs. Telecommunications customer care organizations need to migrate from one-size-fits-all to fit-forpurpose customer service solutions tailored but efficient service delivery solutions for customer segments (defined according to cost-to-serve and ability-to-serve). By assessing and addressing customer needs and priorities, companies can provide a set of affordable yet responsive solutions. 9 Retail Sales and Distribution As telecommunications shift to a new operating model, they need to focus special attention on customer touch-points, not only customer care operations, but also retail sales and distribution. The telecommunications industry has boxed itself into a retail distribution model that is increasingly out of sync with customers needs. 10 The symptoms of this dysfunction are obvious: uneconomic companyowned stores in the wireless sector; telcos inability to distribute bundled products through common channels, and numerous supply chain inefficiencies. In designing a new organizational structure for the retail channel, telecommunications carriers need to accommodate: The migration toward a multi-product channel that can distribute and support bundled offerings The differentiation of the carrier-owned store based on customer segment (i.e., business versus consumer) to complement and support an overall customer-centric organization model A redesigned retail supply chain that minimizes working capital requirements through business process simplification 9 V. Couto, G. Neilson, F. Jones, E. Alvarez, and others, Attacking Overhead Costs from Both Sides: Optimizing the Supply and Demand for G&A Services, Booz Allen Hamilton, D. Endicott, A. Clyde, N. Hodson, and J. Harrison, Lifting Wireless EBITDA Margins by Redefining Retail Distribution, Booz Allen Hamilton, 2003.
9 8 The Corporate Center As telecommunications carriers delegate P&L responsibility and, consequently, business strategy decisions to customer-focused business units and centralized support activities to shared services organizations, what remains in the corporate center? The right answer is a significantly stripped-down set of clearly defined functions that revolve around strategic leadership. However, telco corporate centers have traditionally presided over functional and geographic organizational structures that require hands-on, day-to-day management and oversight. The transition to a lean, strategically focused structure represents a dramatic break from the past. The corporate center must shift its focus from running the business to developing the capabilities necessary to support the new operating model. Roles, responsibilities, and relationships within the organization will necessarily change. 11 Role of the executive team: Telecommunications carriers need to move away from staff-heavy executive bodies and toward leaner, business-focused managing structures and systems (i.e., Executive Committee). Business unit heads must step up and play a more active role in driving the corporate change agenda. Corporate functional leaders must support the business units more effectively and efficiently, while also driving change across the enterprise within their own areas of responsibility. Exhibit 6 Lessons of Successful Operating Model Transformations Relationship between the CFO and the business units: In the current business climate, the CFO is taking on greater accountability and authority. Traditionally focused on reporting and control functions, the CFO is now also responsible for connecting capital markets requirements directly with business unit operations and raising red flags whenever and wherever significant risks exist. He or she is now called on to provide an independent perspective on the performance of individual businesses, actively challenging line management s decisions in some cases. CFOs are identifying and focusing on the billion dollar decisions, testing the business cases for large investments and allocating restructuring resources. At some telcos, the CFO will need to have direct line authority and control enough of the corporate budget to take failsafe actions to make plan. 12 Putting the New Model into Action Conceptualizing a new operating model for telecommunications carriers is one thing; designing and implementing it is another. Putting this new telecommunications operating model into action will transform the way telecommunications companies conduct business. It will encompass and alter the full gamut of organizational levers from structure to measures to incentives to processes to management systems and responsibilities. This change cannot be incremental; it must be dramatic. It cannot be business unit-specific; it requires a top-down and enterprise-wide vision. It cannot be led by middle management; it has to be driven by the CEO. Fortunately, telecommunications service providers can learn from the example of other industries (e.g., basic manufacturing, automotive, financial services) that have already confronted significant threats to their operating model and transformed their organizations to meet new competitive requirements. Companies that effect successful transformations apply many of the same lessons learned (see Exhibit 6). In our experience, operating model transformations work best when the top management team works collectively and in offsite mode. Corporate officers, business unit heads, and functional leaders convene for a series of working sessions to hammer out the strategic direction and overall objectives of the new operating model. At this point in the process, many companies make a fatal mistake. They hand these strategic objectives 11 M. Moran, G. Neilson, and S. Hedlund, The View From the Top: Rethinking the Roles of Senior Management, Booz Allen Hamilton, I. Heinz, J. Neibuhr, W. Schirra, and V. Couto, The New CFO Agenda: Setting the Pace for Value Generation, Booz Allen Hamilton, 2003.