The telecommunications market: The dawn of a new era

Transcription

1 Allianz Dresdner Economic Research Working Paper Nr.: 66, June 1, 2006 Author: Werner Heß The telecommunications market: The dawn of a new era Content Abstract 1. Introduction 2. Networks, providers and markets an overview 2.1 Network infrastructure: More bandwidth, more competition, more convergence Box 1: Regulating VDSL networks: yes or no? 2.2 Market players: Various forms of vertical integration with differing interests 2.3 Dynamic market growth 3. Fixed-line market facing profound changes 3.1 Lack of competition in the German broadband market Box 2: DSL business models still no bitstream access in Germany 3.2 Voice over Internet Protocol: Revolution in voice transmissions 3.3 Triple Play: More bandwidth higher sales? 4. Mobile telephony: New growth in the wake of higher sales per customer 4.1 Pressure on providers is growing 4.2 Setting the sights on new sales sources 5. The megatrend: Convergence 5.1 The Next Generation Network flexible applications at falling cost 5.2 Decoupling the stages in the value-creation chain will intensify competition 6. Outlook Literature 1

2 Abstract In the eight years since the German telecommunications market was opened to competition in 1998, it has witnessed very dynamic development, with average annual sales growth just under 6½ %. By the end of the decade, however, we expect average annual growth to have retreated to 3 %. The continued decline in traditional fixed-line telephony and the difficulties currently being experienced on the mobile communications market, where it is proving impossible to sustain the sales increases of recent years in the face of threatening market saturation and price pressure from lowcost providers, will both contribute to curbing the dynamism. Nevertheless, mobile communications remains a growth market, benefiting from the increased popularity of cellular phones. The same applies to broadband-related business. The services that have been facilitated by VDSL (triple play) are, in particular, likely to keep market share losses in fixed-line services in check. The number of households with broadband access in Germany increased more than five-fold between 2001 and 2005, from almost 2 million to over 10 million, which represents around 30 % of all households. The most widespread form of access is DSL, which accounts for 97 % of connections. However, the market for broadband communication is still a long way away from being truly competitive. It would therefore be wise to promote both intermodal competition between the various forms of broadband technology, and competition on the market for DSL access (intramodal competition), thus enabling Germany to catch up with other countries in terms of broadband coverage. This is a fundamental precondition to facilitating the spread of Voice over Internet Protocol (VoIP). The increasing acceptance of VoIP will have a considerable impact on the development of innovative infrastructures and services, and will lead to radical changes in the telecommunications market. The main advantage of IP telephony is the huge increase in productivity for voice connections. It may therefore be expected that cost pressures will force most network operators to switch to IP technology over the next few years. Unbundling DSL and telephone connections will provide a major stimulus for VoIP market opportunities. Converting network infrastructures to IP technology also allows customers to watch television via the internet (IPTV), which in turn enables the Triple Play business model for bundling voice and internet services along with television and video services over a single connection, although this requires considerable bandwidths with a high quality of service right down to the end customer. Cable television networks, traditional telephone networks and mobile communications networks all represent viable platforms for Triple Play. Provided they can offer appropriately up-to-date infrastructure a process requiring billions of euros in investments cable network operators and DSL providers in particular will become direct competitors in the battle for Triple Play customers. This competition is, however, unlikely to be particularly intense for the time being. In the medium to long term, established telecommunications groups will see their sales and earnings figures being increasingly affected by successful Triple Play marketing strategies. After all, the pressure on the 2

3 traditional fixed-line telephony is increasing due in part to the cheaper VoIP offers, and also to competition from mobile communications. Although the mobile communications market is still witnessing a clear growth trend, the sector will have to prepare for harder times in the next few years, for two reasons in particular: Firstly because prices for mobile communications services are facing increasing pressure from low-cost providers, and secondly because mobile communications companies are seeing dramatic declines in their profit margins due to the reduction of the fees payable by fixed-line providers for fixed-tomobile calls, but also as a result of pressure from the European Commission to lower international roaming charges for consumers. Faced with this predicament, the mobile communications sector is searching for new sources of revenue. Technical innovations are one option that are being considered in this respect. Whilst the mobile communications industry has concentrated predominantly on voice communication over the past few years, increasing attention is now being paid to the transmission of information in the form of text, images and multimedia. The bundling of mobile communications and television is also offering new prospects. On the basis of market research and experiences in other countries, we believe that a monthly surcharge of around 10 would be acceptable for television via cell phones. In addition to using supplementary services to increase revenues, mobile communication companies are also pinning their hopes on mobile communications replacing the fixed line. According to estimates, the proportion of all telephone calls attributable to mobile communications in Germany is set to more than double by the end of the decade, from the current 16 % to between 40 % and 50 %. In an attempt to buck this trend, fixed-line operators are coming up with solutions to combine mobile and fixed-line communications. The aim of this fixed-mobile convergence (FMC) is to offer person-specific telecommunications services independent of network infrastructure. The integration and replacement of existing public telecommunications networks (fixed-line, mobile and data networks) using IP technology will play a key role in this process. This concept, known as nextgeneration network (NGN), will allow voice, data and multimedia services to be transmitted over a single network, thus rendering the current practice of separate networks redundant. This would open up substantial potential savings for network operators. Users would, above all, benefit from the increased application possibilities and convenience offered by NGN. The convergence of different technologies, channels of communication, and media is leading to changes all along the value chain in the telecommunication market, which together will bring about fundamental changes. Over the next few years, the vertical network-oriented value creation structure that still dominates will gradually be replaced by a horizontally integrated structure. The value creation levels will be separated from one another and services will no longer be provided dependent on specific network access technologies, instead they will be based on an integrated access 3

4 platform. Consequently, competition on the market for telecommunications services will also become more intense, as market entry barriers for alternative providers become lower. The structure of value creation will also change as the convergence progresses. The value added by the networks business will decline and the services on offer from network operators account for a greater proportion of end-customer sales. The changes in the value creation structure will cause the telecommunications market to become more fragmented. This means that the power of the customer will increase, and thus content and customer benefit will take priority over technology. In the long term, the trend towards convergence will also mean a merging of the telecommunications sector and IT, the media, and consumer electronics (market convergence). In principle, this trend will lead to a new definition of electronic services and applications. In the future they will have to be seen increasingly as a combination of content production (music, film, and publishing), content editing (online, internet, and media services), content distribution (telecommunications), and content presentation (end device industry). This is why an increasing number of strategic partnerships can be expected in the future between telecommunications and media companies, but also with financial services providers. The consolidation within the telecommunications sector will also continue. Ultimately, it is necessary to achieve economies of scale in the use and expansion of the network infrastructure as well to set standards. 4

5 1. Introduction It is unlikely that another market is experiencing a more profound change than telecommunications. Whilst the driving forces behind the changes in the last decade were in particular digitalization, deregulation, privatization, and globalization, the current challenge is to bundle as many telecommunication services as possible in a single package for the end customer. In order for this to be possible, data networks based on Internet Protocol and traditional telephone networks have to be converged into one highly efficient communications network (Next Generation Network). This convergence process makes innovative electronic services possible and thus also opens up lucrative business opportunities for new market participants. At the same time, the core business of established telecommunications groups is shifting, as they gradually transform from technology providers to service providers. So the transformation process continues. This paper provides an overview of important structural and technological developments which are set to shape and change telecommunications in the coming years. Following an overview of the network infrastructure, the providers in the sector, and the structure and development of the telecommunications services market as a whole, we focus on the fixed-line business. It is currently experiencing a renaissance with the rapid proliferation of broadband technologies, but in the longer term is faced with dramatic change through the convergence of voice and data services. The mobile communications market is heading for harder times in view of saturation trends and aggressive competition. Providers are therefore attempting to tap new sources of revenue through technical innovations and the increase in the proportion of mobile communications in the total volume of telephone calls made. The spotlight is thus increasingly on the integration of fixed line and mobile communications, but also on the general trend towards the convergence of different technologies, channels of communication, and the media which is triggering a drastic structural change in the telecommunications market. 2. Networks, providers and markets an overview The telecommunications business largely consists of providing telephone, data, and internet connections for the transportation of voice, data, and digital content. This is based on an extensive global telecommunications network. In line with the different network levels and the variety of products on the supply side many companies are acting with contrasting interests and different degrees of vertical integration. In the eight years since liberalization in 1998, the market for telecommunications services as a whole in Germany has seen extremely dynamic development. 5

6 2.1 Network infrastructure more bandwidth, more competition, more convergence Telecommunications networks comprise several hierarchical levels. These levels include international networks, national wide area networks (transport networks), the regional and local distribution level (connection networks), and the local access level (access networks). Transport and connection networks are often grouped together under the term backbone. They consist of fiber optic cables with high bandwidths 1, which are able to cope with the heavy data traffic (comparable with highways for street traffic). In contrast, the access network has pairs of copper wire connecting each individual participant s access point to the local exchange. Known as a local access line or local loop, this is divided into two sections from the local exchange or the central office to the feeder distribution interface, and from there to the end device (see Chart 1). DSL technology (Digital Subscriber Line) was developed to enable the existing pairs of copper wires to be used for broadband data exchange as well as telephony; this uses normal telephone lines to transfer data up 250 times faster than a traditional ISDN connection. The standards ADSL (whereby download speed is higher than upload) and SDSL (with the same speed for downloading and uploading) transfer data at 1 to 3 megabits per second (Mbit/s). The latest ADSL2+ technology uses the existing copper cables with up to 25 Mbit/s. The next new standard VDSL (Very High Speed Digital Subscriber Line) allows data transfer of up to 50 Mbit/s via normal telephone lines. However, the speed decreases the longer the line. The realization of VDSL connections therefore requires substantial investment in fiber optic cables to bring the technology closer to the customer. Deutsche Telekom is planning to extend the fiber optic network in 50 cities beyond the central offices (approx. 2,000 meters away from customers) up to the feeder distribution interfaces (approx. 300 meters from the customer), so that copper cable will only cover the remaining few meters to the customer. As soon as the DSL improvements reach their limit in future, the access network will need to replace the pairs of copper wire with fiber optic cables (Fiber to the Home FTTH). 1 Bandwidth refers to the transmission capacity of a connection. The bigger the bandwidth, the more information units can be transferred within a certain period of time. In general, the forms of technology classified as broadband are those with transfer rates above ISDN technology. These include in particular fixed line technologies such as Digital Subscriber Line (DSL), Fiber-to-the- Home (FTTH), and internet access via cable modem or electric cable (Powerline Communications, PLC). However, mobile communications technologies such as Universal Mobile Telecommunication Systems (UMTS), Wireless Local Area Network (WLAN), and Worldwide Interoperability for Microwave Access (WiMAX) are also classified as broadband. 6

7 Chart 1 Use of glass fibre and copper in connection network Local exchange with main distribution frame app m Feeder distribution interface app. 300 m End customer Glass fibre Copper c able ADSL-connection Backbone Glass fibre Glass fibre for VDSL Copper cable VDSL-connection Glass fibre to the home FTTH-connection Source: Bundesnetzagentur. Despite the fact that all of Deutsche Telekom s around 7,900 central offices are equipped with fiber optic cables, around 20 % of them are currently offering limited or no DSL services for technical and economic reasons. This rises to 40 % in some areas of the east German states. A possible DSL alternative to close this gap with a wireless solution for the last mile is the relatively new wireless technology WiMAX, which is characterised by relatively high transfer speed and a theoretical range of up to 50 kilometers. Box 1 Regulating VDSL networks: yes or no? The planned expansion of the fiber optic network has for some time been the subject of a controversial discussion between the European Commission, the German government and Deutsche Telekom. The reason for this is the current regulation policy. As the former monopolist, Deutsche Telekom is subject to regulation by the Federal Network Agency. This means that it is obliged to offer its existing networks to competitors at prices fixed by the regulating authorities. Deutsche Telekom is no longer willing to accept this for the new network. Its 3.3 billion investments in a new VDSL network are subject to the proviso that that fixed prices will not apply at least for a certain period. Deutsche Telekom says that it is in its best interests to cooperate with other companies that wish to use its network, but wants to conduct bilateral negotiations with these companies itself, and not be forced by regulation to open up the network. On the other hand, Deutsche Telekom s competitors fear a monopoly with the new network and are in favor of regulation. 7

8 In accordance with European law, Deutsche Telekom is protected against regulation only if it is offering new products via the VDSL network which cannot be realized with other forms of technology. The draft amendment to the Telecommunications Act (Telekommunikationsgesetz TKG) submitted by the government allows only new markets to be exempt from sector-specific regulation. Telekom believes that the offers enabled by the new network, such as high-resolution television and extended internet applications, constitute a new market. It is up to the Federal Network Agency to decide whether or not this is the case in a market analysis. However, it has already indicated that it does not intend to loosen the regulation of the telecommunications market in favor of Deutsche Telekom. Instead, the Federal Network Agency believes that opening up the monopoly network is exactly what is needed for investments and dynamic market growth. However, its examining competence is, in practice, restricted, because the European Commission can veto its decision, and therefore has the final say. The Commission has also announced that it will not accept a new monopoly by Deutsche Telekom. Whilst access network operators hold supremacy over the local loop, connection network operators do not have this key final part of the network up to the customer. They take over their customers telephone or data traffic in the nearest local exchange, and channel it through their network via preselection or call-by-call. They pay the relevant access network operator a fee fixed by the regulatory authorities for use of the local loop. Both access network operators and connection network operators use the transport network operators lines and services. These establish and operate backbones across Germany and internationally, and sell their line capacity to other telecommunications companies. The creation of interoperability between various network systems makes it possible for the same telecommunications services to be offered via different networks. and thus to enter for alternative network systems into infrastructure competition with the Public Switched Telephone Network (PSTN). Television cable networks are a prime example of alternative networks in the access area. In contrast to Germany, many other countries use the cable network much more for access to the internet, in addition to DSL (see figure 5). But in Germany, too, the cable network represents a potential alternative platform for telecommunications and internet access, as almost 70 % of households are connected to the cable network a very high proportion by international standards. It is true that some cable network operators are currently preparing their networks to be an alternative broadband option to DSL, but the upgrade is hampered by the fragmentation of the network into different levels each with different owners. As the cable network operators have no direct access to many end customers the local loop is often owned by building cooperatives or other operators who have no interest in network upgrade they are currently testing various types of transmission technology (including WiMAX) to reach their end customers directly. 8

9 Other possible access networks in competition with PSTN are Wireless Local Loops (WLL), and the low-voltage electric mains which can transmit telecommunication signals via Powerline Communication (PLC). The mobile communications network comprises in particular the mobile distribution network and the access network. The mobile distribution network enables the wired transfer of signals between the fixed facilities of the mobile communications network, primarily via fiber optics (sometimes via the same connection networks that also transport the traffic from the fixed line access networks). The signal is not actually transmitted wirelessly until the local loop of the access network (also known as air interface ), (Stellung) between a mobile communications antenna and the mobile end device. Second and third generation mobile communications networks are currently in operation in Germany. Second generation networks (2G) are capable of transferring data, but are still geared more towards voice transmission. The most important 2G standard is GSM (Global Systems for Mobile Communication). The third generation was introduced gradually; first of all an interim standard (2.5G networks) was created with GPRS (General Packet Radio Service), which enabled package-based data transmission in the mobile distribution network. The introduction of 3G networks suitable for data transmission aimed to increase data transmission speed and also eliminated the problem of capacity for voice transmission. The most important 3G standard is UMTS (Universal Mobile Telecommunications System). In addition to the public telephone network, a large number of data networks have been /laid over time, and integrated into a worldwide network the internet. This is made up of different subnetworks and computers that exchange data at central junction points. The technical basis is a universal protocol available on every computer, known as Internet Protocol (IP). This is an accumulation of rules that set important standards for data transmission on the internet and make sure that the information to be transmitted is divided into individual data packages, thus enabling it a smooth passage through the network. The overlap between telephone and data networks is continually increasing due to the digitalization of voice transmission. A convergence between the two network worlds, based on Internet Protocol is to be expected in the long term (Next Generation Network). 2.2 Market players: Various forms of vertical integration with differing interests The companies active on the telecommunications market can be roughly grouped into network operators, and service and content providers. There are many different types of network operators. In many European countries, the former monopolists (incumbents) among them maintain a dominant position, as is the case with Deutsche Telekom in Germany. It is the market leader in all major market segments (infrastructure, voice transmission, internet services, and mobile communications). Since Deutsche Telekom is the only company to have a nationwide infrastructure at the level 9

10 of local access, all fixed line competitors have to rely on its existing infrastructure if they want to serve customers nationwide too. The some 200 competitors who operate their own fixed line infrastructures include long-distance and data network operators such as BT Ignite, Colt Telecom, and mediaways, which target solely corporates, national long-distance and access network operators such as Arcor, which are also active in the private customer market, and regional and local access network operators such as Hansenet and NetCologne. Known as city carriers, their business models are predominantly based on renting local loops from Deutsche Telekom. Moreover, cable television network operators are increasingly offering internet and telephone service in addition to television. Along with the fixed line providers in Germany, there are four mobile communications network providers; T-Mobile, Vodafone, E-Plus, and O2, which have also built up UMTS networks in addition to their GSM networks. They are thus competing with fixed-line providers in the broadband access market. Other player include Mobile Virtual Network Operators (MVNO), who use third party networks, but present themselves to customers like network operators (see Chapter 4.1). Aside from companies with their own network infrastructure, there are many providers without their own network, such as debitel or MobilCom. These service providers and resellers purchase or rent network capacity from fixed line or mobile communications network operators, and sell it on to their customers, bundled with their own basic or value-added services. There is only a thin line distinguishing service providers from network operators, as service providers are increasingly investing in their own network blocks too. In the course of the convergence of voice and data communication, the internet service providers in particular are increasingly penetrating the traditional telecommunications areas, whilst on the other hand, the established telecommunications groups are increasingly offering internet and IT services. 2.3 Dynamic market growth Revenue on the telecommunications services market in Germany has climbed consistently since the beginning of liberalization in 1998, from over 44 billion to around 68 billion in 2005 (see Chart 2). This represents average annual growth of almost 6½ %. The market segment with the highest revenue remained fixed line access services with over 36½ %. These comprise revenues by network operators (including valued-added services), resellers of voice services, and internet service providers without networks. The fixed line business has been showing clear signs of a recovery since 2002, after years of decline. This is a result of revenue growth from the marketing of broadband services (see Chapter 3.1). 10

11 Chart 2 EUR bn 80.0 Telecommunication services turnover in Germany e Other Cable TV Carrier services (Interconnection) Rental lines Mobile telephone service Fixed line services Source: Bundesnetzagentur. Conversely, the second-largest segment, mobile communications services, with a market share of almost 34½ %, has recorded uninterrupted growth since 1998, which in comparison with the telecommunications market as a whole, is well above average at almost 14 % per year. The same applies to the carrier business, whose market share in the period under review increased by 7½ percentage points to over 11½ %, which represents average annual increase of 23½ %. The carrier business comprises connection and access services provided in fixed line and mobile communications networks for the interconnection of their networks. The TV cable network operators and leased line business account for a relatively small share of the telecommunications market with just under 4½ % and 1½ % respectively. Other telecommunications services (11½ %) includes in particular data communication and radio transmission services, trunked radio, wireless data, and paging services. The next two sections present the key structural and longer-term developments in the fixed line business (see Chapter 3) and in the mobile communication market (see Chapter 4). 11

12 3. Fixed-line market facing profound changes The classical telephony business of the major fixed-line providers is clearly running out of steam. Whereas the number of fixed-line call minutes (via dialed analog and ISDN connections) virtually doubled between 1997 and 2002, reaching 355 billion, it has been declining since 2003 (see Chart 3). In 2005, the volume of narrowband traffic was down to 337 billion minutes. Between 2001 and 2005, Deutsche Telekom lost almost one third of its call minute volume, while its rivals boosted their volumes by a total of 56 %. Chart 3 in bn. 400 Fixed-line call minutes in Germany: Severe losses for Deutsche Telekom e Deutsche Telekom Competitors Source: Bundesnetzagentur. There are two main reasons for the decline in fixed-line call minutes. The first is increasing competition from mobile telephony. For five years now, the number of mobile telephones has exceeded that of fixed-line channels, and it is also rising much faster (see Chart 4). The second is that internet traffic is shifting away from narrowband telephone connections to broadband technologies (see Chapter 3.1). The growing number of broadband connections is helping to turn internet telephony into a mass market (see Chapter 3.2), and that, too, is putting increasing pressure on classical fixed-line telephony. To combat early signs of falling sales, the established providers are pinning their hopes on the Triple Play" business model (see Chapter 3.3). 12

13 Chart 4 in millions 80 Telephone market in Germany: Mobile connections exceed fixed network channels Fixed network channels Mobile connections e Source: Bundesnetzagentur. 3.1 Lack of competition in the German broadband market The number of broadband connections in Germany has risen dramatically. Between 2001 and 2005 it soared more than fivefold, from just under 2 million to over 10 million. In other words, some 30 % of households now have a broadband connection. The most widespread form of broadband technology in Germany is DSL, which accounts for 97 % of all connections. Only 2 % of all broadband connections are linked via TV cable. Other technologies, such as satellite or PLC, do not play a significant role at present. Despite a number of measures adopted to open it up, the broadband communications market is still far from being competitively organized. In nearly all countries, the former monopolies dominate the DSL market, since they are the main owners of the fixed-line system. In Germany, Deutsche Telekom has by far the largest share of the DSL market, i.e. 43 %, followed by United Internet (17 %), Arcor (11.5 %), AOL (10.5 %), Freenet (6.5 %) and Hansenet (just under 5 %). Given this level of dominance, government broadband sales campaigns which promote DSL in preference to alternative broadband technologies are somewhat questionable in terms of competition policy. Indeed, some people even see them as subsidization of old monopoly structures. Empirical studies show that competition between different broadband infrastructures (intermodal competition) is a key prerequisite for the widespread distribution of broadband connections. After all, intermodal competition leads to a race among the infrastructure providers, who all want to be the first to dominate the market. The providers are therefore keen to expand as quickly as possible, which ultimately accelerates the spread of broadband. Against this backdrop, it is hardly surprising that the number of broadband connections per 100 inhabitants in Germany which has very little 13

14 intermodal competition is lower, at 10.2, than the OECD average (11.8 as at June 2005). Germany is thus close to the bottom of the league table, far behind the leaders South Korea, the Netherlands and Denmark (see Chart 5). The kind of infrastructure competition that could be triggered above all by the cable network would, then, be welcome. It should be promoted in order to boost the number of broadband connections in the country. Chart 5 Broadband internet connections: Germany lagging far behind % of population South Korea Ne the rlands De nmark Sw itzerland Canada Finland Be lgium Norw ay Sweden Japan USA UK France Austria Luxembourg OECD Australia Germany Italy Portugal Spain Greece ,8 22,5 21,8 20,3 19,2 18,7 18,2 18,2 16,5 16,4 14,5 13,5 12,8 12,5 11,8 11,8 10,9 10,2 10,0 9,9 9,3 DSL Cable, other 25,5 Source: OECD, as of June Intensification of intermodal competition between the different broadband technologies is not the only factor here. Competition in the market for DSL connections (intramodal competition) should also be encouraged. The technical and regulatory arrangements for this vary according to the extent to which the former monopoly is obliged to provide upstream services for its competitors. The more comprehensive these upstream services are, the less opportunity rival providers have to compete on the strength of higher-quality services (see Box 2). 14

15 Box 2 DSL business models still no bitstream access in Germany DSL resale The business model with the most comprehensive upstream service for a DSL connection is DSL resale. Competitors buy in the entire range of products from Deutsche Telekom, and then resell those services in an unmodified form to end users in their own name and for their own account. The reseller is unable to change the technology underlying the service. DSL resale enables competitors to offer one-stop broadband access without having to build up an extensive infrastructure of their own. In this sense, of course, resale does encourage competition. But it does not allow competition for innovations, since providers have to use the products supplied by Deutsche Telekom. Subscriber line rental Under the fully free-standing subscriber line business model, competitors rent the entire subscriber line and sell only their own services to the end user. This gives competitors much more freedom, but it also forces them to invest heavily in their own infrastructure. It is hardly surprising, then, that competition based on subscriber line rental is still relatively limited. Line sharing Line sharing is based on the fact that ISDN and DSL lines use different frequency bands. This means that Deutsche Telekom can still handle telephone traffic, while a competitor rents only the frequency band for data transmission. That competitor can also change the technology of the DSL connection (which is not the case in DSL resale). The prerequisite for line sharing is, however, that the end user still has a telephone connection provided by Deutsche Telekom. Bitstream access Bitstream access is not yet available in Germany. With this upstream product, the network operator provides broadband transmission capacity (e.g. via DSL) between the end user and a defined point of interconnection in the competitor s network, enabling that competitor to take over the datastream (bitstream) and to offer its own products to end users on that basis. In other words, bitstream access (like line sharing) enables competitors to control their relationship with the end user directly (they can offer their products in a different form from the network operator) and also means (unlike line sharing) that they can offer one-stop connections and broadband services. The advantage of bitstream access is that it allows competitors to enter the market gradually. It puts them in a position to offer broadband access independently of the telephone connection without having to invest immediately in extensive infrastructure, which is the case with the subscriber line rental model). The key factor in the further spread of broadband connections and the promotion of competition in the German DSL market remains consistent regulation of upstream products by the Federal Network Agency. The agency s decision in summer 2005 to reduce charges for line sharing and subscriber lines is a key prerequisite for greater competition. 15

16 3.2 Voice over Internet Protocol: Revolution in voice transmissions The continuation of this regulatory policy will boost the DSL market and help Germany to make up further ground on other countries in the provision of broadband access. This, in turn, will pave the way for voice transmission via the internet so-called VoIP (Voice over Internet Protocol) to become a mass market. The increasing use of this technology will have a significant impact on the development of innovative infrastructures and services, and will trigger sweeping changes in the telecommunications market. IP technology makes it possible to split the production of voice transmission between a number of different market players: competitors can offer telephone services without needing the infrastructure of a network system. It is hardly surprising, then, that (above all) Internet Service Providers, new special providers like Skype and software companies like Microsoft are now seeking to gain a share of the telephony market by offering lucrative VoIP services. The established network operators, who generate most of their sales with traditional telephony, face serious falls in their market share if they do not adjust to the new competitive environment. The incumbents must find strategic answers to the new technology not merely by adapting their network infrastructure to offer VoIP, but also by providing additional services, such as Triple Play (see the next section). The main advantage of VoIP is that it allows enormous productivity increases in the manufacture of voice traffic. In conventional technology, a telephone call occupies a line, which cannot then be used for other purposes although its capacity is by no means being fully utilized by the voice traffic. In IP technology, on the other hand, the voice traffic floats along as a series of data packages in the larger data stream. However, it only takes up the network capacity it needs, which means that a large amount of capacity is still available for other applications. Network capacity is, then, used more efficiently, significantly reducing the price of the individual transmission. VoIP thus offers many established telephone companies, too, the opportunity to reduce their costs. Calculations have shown that the British provider BT, for example, could cut its network operation costs by more than 40 % if it switched entirely to VoIP. Prices for voice traffic could then be reduced accordingly. It therefore seems likely that cost pressures will force most network operators to move over to IP technology in the coming years. Deutsche Telekom, for example, plans to make the full transition from conventional telephone technology to the Internet Protocol by the year Fixed-line operations face their biggest upheaval since the telephone was first invented. The shift to IP-based telephony is now inevitable. However, two major obstacles still have to be overcome before it becomes a mass market in Germany: 16

17 The number of broadband connections must be increased, since they are indispensable for VoIP. As mentioned above, there were only 10 broadband connections per 100 of the population in Germany in mid-2005 (see Chart 5). An even more important factor in improving the market outlook for VoIP is the possibility of renting a DSL connection independently of a telephone line. Customers who exclusively wish to use VoIP do not need a conventional telephone line. All they need is a DSL connection. In Germany, this technology has so far been based exclusively on upstream service products provided by Deutsche Telekom, which still offers them only in conjunction with its telephone lines. This is a further factor that makes it very difficult for IP telephony to replace conventional technology in Germany. The much-discussed bitstream access technology is the only way out of this impasse (see Box 2), since it would allow companies to offer a stand-alone DSL connection. It is up to the Federal Network Agency to force Deutsche Telekom to uncouple DSL access from its telephone lines. In view of the current situation, experts expect IP telephony in Germany to have an approx. 30 % share of the private fixed-line market by Triple Play: More bandwidth higher sales? The conversion of the network infrastructure to IP technology will also enable companies to offer so-called Triple Play. This technology provides customers with voice, internet and video services via a single line, but it requires significant bandwidth with a high degree of reliability all the way through to the end user. Triple Play will mean that TV via the internet will be able to seriously challenge the classical channels of cable, satellite and terrestrial aerial. Three platforms are currently available to provide Triple Play (see Chart 6): the TV cable networks, the conventional telephone networks, and the mobile phone networks (see Chapter 4.2). 17

18 Chart 6 Triple Play platforms Cable-TV network Telephone network/dsl Mobile network Telephony VoIP Analog ISDN VoIP Mobile telephony Internet Broadband internet Broadband internet Mobile broadband internet (UMTS) TV TV IPTV Mobile TV Source: Bundesnetzagentur. Cable network operators who intend to expand their core business (the transmission of broadcasting signals for TV and radio) to include broadband internet and voice telephony will have to make their networks, which are currently designed to carry only TV transmissions, return-channel compatible. Today, some 53 % of German households are linked to the TV cable network, and the potential is just under 70 %. Although approx. 6 million households (18 %) were in a position to be equipped with a return channel at the end of 2005, only 240,000 customers were using the internet via a cable modem. By the end of 2007, approx. 45 % of all connectable households could be able to use TV, internet and telephony services via cable. However, telephone network operators who wish to add broadband internet services and internet TV to their core business (classical fixed-line telephony) will have to modernize their networks, which are currently equipped with conventional DSL connections. Relatively high bandwidths (i.e. higher than ADSL2+ or the even faster VDSL standard) are needed to transmit moving images and several parallel TV programs to households in very high definition (HDTV). If they modernize their infrastructure and that will mean investments running into billions operators of cable networks and DSL providers will become direct competitors in the battle for potential Triple Play customers. Customers will have to decide whether they wish to use a DSL connection or a TV cable as their central telephone, TV and internet link. The provider of the mode selected by the customer will generate sales from all three segments. There is much more at stake here for DSP providers than for the cable network operators, for two reasons. First, by entering the telephone and internet segment, the cable industry is attacking a market which is approx. ten times the size of the TV market which the telephone and internet providers are targeting with their entry into the TV market (probably in mid-2006). And second, the cable operators are adding 18

19 to their range of services two activities which generate high average sales, while the telecommunications providers will be gaining only one single service (IPTV) with relatively low average sales. In the first instance, however, the competition for Tripe Play customers is unlikely to be very intense. The cable network operators scope for expansion is limited at least in the medium term by the limitations they face in modernizing their cable networks. And on top of that, the market potential of TV via DSL (IPTV) will probably be quite limited in the early stages due to the wide range of free TV channels currently available. Transmission rights are a further problem. In the medium term, the additional business segments of DSL providers will probably be high-quality pay TV or individually accessible TV services. According to estimates, the western European market for Triple Play services will grow from just under EUR 1.5bn in 2005 to EUR 7.5bn in the year That corresponds to average growth of over 40 % per year. Most of the sales will probably come from the DSL infrastructure (see Chart 7). The number of German households using TV via DSL at the end of the current decade is put at approx. 1.4 million, i.e. some 8 % of DSL customers. Chart 7 Triple Play sales in Western Europe: DSL-infrastructure still dominant 10 9 EUR bn e 2006e 2007e 2008e 2009e 2010e DSL Cable Source: Solon Management Consulting. Before the fixed-line operators can make themselves more attractive to the market by offering Triple Play and other content-oriented services, a number of legal issues (in media law) have to be clarified, e.g. whether and to what extent telecom companies operating in the TV market are subject to broadcasting regulation. Is IPTV a new telecom service, or is it TV? Where fixed-line operators face excessive restrictions on their services under broadcasting legislation, the government should step in to deregulate the market. Otherwise, investment in VDSL infrastructure will carry too high a risk. The fact that providers are keen to be exempted from regulatory control as they develop Triple Play and other broadband services is quite understandable. However, Deutsche Telekom s insistence 19

20 that its proposed VDSL network should be temporarily freed from regulatory supervision (see Box 1) is equally controversial. In business terms, an infrastructure provider should have an interest in allowing competitors to use its network, since this creates demand for upstream services which in turn helps to finance new infrastructure. Furthermore, as past experience with DSL connections has shown, competition would boost demand for higher bandwidths and thus accelerate the spread of the new access technology. That would significantly reduce the investment risk for Deutsche Telekom. If, on the other hand, Deutsche Telekom succeeds in its demand for temporary exemption from regulation, it could (at least initially) refuse access to competitors who wish to use the VDSL network for their own products. And if, beyond that, products based on VDSL technology force current ASDL products out of the market as seems likely competitors would not merely be excluded from a future market development: they would also be unable to compete in offering products that are currently available. If the market develops sluggishly and it then seems necessary after all to allow rival providers to offer VDSL connections, that option would still be open to Deutsche Telekom. In other words, then: Deutsche Telekom could play a decisive influence in the starting date and extent of any competition. And it is precisely this decision that is the ultimate responsibility of competition and regulatory policy. In the present case, it should be a fairly simple one. Not only is it in Deutsche Telekom s own business interest to grant access to the network: the opening of the network is the only way to encourage investment and promote dynamic market growth. In the longer term, IPTV could seriously challenge existing TV transmission channels especially if it proves possible to combine exclusive content and attractive prices with technological innovations that conventional TV cannot provide. In those circumstances, Triple Play would have the potential to become a profitable business model. However, if products are to succeed in the Triple Play market, they do not merely have to be constantly developed and refined: they must also and above all be positioned in the market. This latter factor places significant demands on sales and customer support activities. All told, then, the established companies face massive technological and organizational upheaval as they make the transition from classical telecom providers to multimedia providers. Over the medium- to long-term horizon, the successful marketing of Triple Play products will play an important part in the sales and earnings of the established network operators. After all, their previous core business fixed-line telephony is coming under increasing pressure, not just from less expensive VoIP services, but also from mobile telephony. 20

21 4. Mobile telephony: New growth in the wake of higher sales per customer The German mobile telephony market has continued to grow dynamically in recent years. However, that growth has not been as dramatic as it was in the second half of the 90s. While the number of mobile phone users rose by around 66.5 % per year on average between 1995 and 2000, the expansion rate slowed to only 9.5 % in the period (see Chart 8). In 2000 only 58 % of the population had a mobile phone. By 2005, though, the penetration rate had reached 96 %. Over the next few years, the margins in mobile telephony will come under pressure from various sides (see Chapter 4.1). The main motor of future growth will be greater use of mobile phones (see Chapter 4.2), while increases in the penetration rate will prove less significant in view of the current high level of ownership in western Europe (see Chart 9). Chart 8 in th ousan ds Number of mobile phone users in Germany 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, e Source: Bundesnetzagentur. In Germany, it will be possible to increase the number of mobile phone customers only by expanding use in special segments (above all children and senior citizens), and by raising the number of customers who have more than one SIM card (i.e. a second mobile phone). According to a forecast by Solon Management Consulting, the number of mobile phones in Germany will rise from its current 79.2 million today (2005) to around 100 million by the end of the decade. The latter figure would mean a penetration rate of 120 %. Over the same period, sales generated by mobile telephony services are expected to rise by an average of just under 5 % per year. That would be a significant slowdown compared with the average annual growth rate of 14 % in the period