The Delta Perspective

February 2012

The Future of Telecoms: New models for a new industry

Authors Juan Jos Ro - Partner - jri@deltapartnersgroup.com Andreas von Maltzahn - Principal - avm@deltapartnersgroup.com James Ong - Manager - jo@deltapartnersgroup.com

KEY HIGHLIGHTS
The telecoms industry of the future will look very different from what it is today and operators are at a strategic crossroads, needing to decide what strategic models to adopt to best address fundamental shifts in revenue mix and margins. Key developments will include: 6 connected devices per household by 2020 with Internet everywhere Explosion of data related services (current 50% of market to more than 70%) New wave growth (9% CAGR) will outstrip traditional services growth (3% CAGR) Eroding margins with New wave services (<30%) compared to traditional services (40% to 70%) Sitting on the fence is not an option as wait-and see operators will see costs explode and revenues start to stagnate. At one end of the spectrum, operators can adopt a utility model focused on efficiency or go all out in a high-risk but potentially high returns model to compete in different parts of the value chain. Ultimately, there is no one size fits all model and operators have to decide and act now on which path best suits their strategic direction and capabilities. Regardless of the model chosen, transformation is necessary for operators to stay relevant. This paper outlines the challenges and opportunities ahead for those who recognise the urgency and who are resolved to act.

Overview
By 2020, the telecom industry will look radically different from today Few industries will have to re-invent themselves as much as the telecom industry must in the next 10 years. The explosive demand for internet and related services is shaking up the industry. New wave services at lower margins are replacing traditional connectivity services. 12 billion internet-enabled devices are expected by 2020, ranging from cars to household appliances, TVS and, of course, phones - Fundamental shift in revenue mix: The rise of non-traditional services The industry shift toward data results in current cash cows like voice and messaging declining sharply in importance. Growth is in new services, like mobile broadband, Cloud and ICT services, M2M, social media and m-advertising. Telecom operators need to reinvent themselves to compete against a new breed of agile and unpredictable competitors like Facebook, Apple and Google that are redefining customer relationships - Fundamental shift in margins: Revenue growth at riskier margins Telecom operators have benefited from high-margin products in the past like voice (40%) and SMS (70%). In the future, new services being chased for growth like internet connectivity, IT-services and M2M have the risk of tighter margins (<30%) The global telecom industry is at a crossroads, requiring the right strategy Each time an industry faces an expected shake-up, industry players need to be clear on their strategic intent. Should they adopt a high-risk, high-investment approach to compete with Apple and Google in the expansion of the value chain? Or should they take a low-risk strategy of purely focusing on dumb connectivity, but at world-leading efficiency? Or something in between? Two key questions emerge: - What part of the value chain will drive new revenue? - What business model will support the strategic direction? To be a utility or to be like Google? What are the strategic options? We have identified 4 strategic options for telecom operators: - Non-optimised utility: Offer commoditised connectivity products - Optimised utility: Offer the best dumb pipe with best-of-breed infrastructure and chase long-term wholesale contracts - Basic operator: Expand incrementally into new tried-and-tested parts of the value chain to offer new services and drive new revenues - 2.0 operator: Expand transformationally by taking risks to chase higher rewards in both known and as yet unknown new parts of the value chain How much to invest? From limited, tactical CAPEX to transformational investments Each strategic option will require different investment areas and hence different levels of CAPEX. While the Optimised Utility will limit its investment to tactical CAPEX, Basic Operators will also need to focus in strategic CAPEX, while the 2.0 Operator will need to higher levels of transformational CAPEX Sitting on the fence is not an option Traditional telecom operators need to take a stand on the two main forces reshaping the industry. However, to date, many operators have taken either a wait-and-see attitude or have embarked on timid attempts at expansion or transformation This paper argues that such operators will lose out in the future. They will see costs explode and revenues start to stagnate. We will outline the challenges and opportunities ahead for those who recognise the urgency and who are resolved to act.

1. What will 2020 be like?

Data growth and associated growth in new services like ICT, M2M, Cloud and media will drive the bulk of new revenues for telecom operators. As this comes at the sacrifice of having to accept lower margins, operators need to decide how far to go and how.

1.1 By 2020, the world will be increasingly connected, with Internet everywhere
Imagine a world where the telecom industry touches all aspects of daily life: Your car: Every car on the road knows where every other car is, how fast it is going and where it is going, so cars can pretty much drive themselves... Your money: Cash transactions become a quaint novelty and the value of mobile payments is equal to Japans Gross Domestic Product today... Your health: A sachet of pills pops up on your doorstep without you having to ask, thanks to an application in your mobile device that detects it is time to replenish your medication and has proactively alerted your family doctor... Your personal tastes: Things like advertising posters and restaurant menus are digitised and offer you personalised information based on demographics and purchase history... A fantasy? Such a world may not be as far-fetched as we might think today. By 2020, nearly all individuals and most electronic devices are expected to be connected to each other via the internet, revolutionising the way people interact with their environment. The number of connected devices (excluding mobile handsets)1 is expected to reach 12 billion. That works out to around six devices per household, ranging from your TV to your household appliances. More than half of households will have broadband connectivity, supporting all sorts of services, from tele-presence to remote health diagnostics and perhaps even virtual reality. With relatively short technology and handset replacement cycles, 10 years is quite a long time. Practically every device will be 3G/4G enabled, and 5G will be incipient, enabling high-speed broadband to everyone on the go. While only 25% of all devices are expected to support ultrafast mobile broadband via Long Term Evolution R10 (LTE-A), there will be a significant gap between developed and emerging markets, in a remaining Digital Divide. Developed markets will have LTE device penetrations of 50% to 60%, driving the capability to deliver services previously constrained by bandwidth. In contrast, most emerging markets are set to have less than 10% LTE enabled handsets in circulation, so they will support mobile internet everywhere but at lower speeds. With the large number of connected handsets, homes and data devices, mobile traffic is expected to increase more than 100-fold from the current 1 exabyte to more than 127 exabytes by 2020.

By 2020, data connectivity is expected to be so advanced that almost everyone and everything will be connected to the internet.

GSMA

FIGURE 1-1: KEY FIGURES IN 2020

Note: 1 1 exabyte = 1 billion gigabytes Source: Pyramid, GSMA, World Bank, IMS Research, UMTS Forum, Jefferies, Pike Research, Delta Partners analysis

1.2 Customer behaviour will shift fundamentally, with new competition along the value chain
The consumer of 2020 is going to have many things vying for his attention, and he will demonstrate little loyalty to brand, platform, provider, device or content unless they serve his immediate needs with a service that reflects the brand promise. He will continually modify his consumption of services, influenced by the increasing amount of choice in terms of service providers, suggestions by companies like Google and the feedback from social networks.

Loyalty for brands from consumers will decrease. Moreover, customers will expect real time, dynamic brand responsiveness and advertising

Understanding today how best to react to these trends is key for telecom operators to build a sustainable future for themselves. Shifts in customer behaviour The brand is dead, long live the brand The digital revolution will change key paradigms in branding and advertising. Loyalty for brands from consumers will decrease significantly in the years to come. At a time where digital media and social networks like Facebook, Google+ and Twitter will allow everyone to access all information with interaction anywhere, customers will expect real time, dynamic brand responsiveness and advertising. Furthermore, increased social interaction will magnify any gap between brand promise and brand delivery and have an immediate effect in churn. These dynamics will increase the challenge of loyalty as not even the global, international incumbents (e.g. Vodafone) will be able to leverage brands to achieve superior retention rates vis a vis competitors. Mobile takes reins from xed connections Customers will continue to shift more usage from fixed towards mobile internet-on-the-go platforms. Today, these platforms include handsets, laptops and tablets, but the world of 2020 will likely see a much wider range of next-generation devices e.g. Heads Up Displays (HUDs) embedded into wrap-around glasses (already available in NTT DoCoMo development labs). This trend can be observed already, with mobile broadband in particular exploding. In several emerging markets, like Indonesia and Malaysia, mobile broadband usage surpasses fixed broadband. Also

in developed markets, use of social networks like Facebook and Twitter on mobile phones has grown 10-fold from less than 5% three years ago to more than 50% today. This will not imply by any means the disappearance of fixed networks. Indeed network topologies will rely more and more on Wi-Fi and FTTH/GPON, FTTB as mobile networks simply will not be able to handle the data traffic volumes and speeds required by customers due to a constraint in spectrum/more spectral efficiency mobile technologies. To reach out to this consumer, advertising profiles also will change. Today, there is a disconnect between the proportion of time spent on mobile phones and the internet (33%) versus the proportion of advertising dollars spent on these two media types together (20%). As mobile usage increases, this gap will close and potentially even be skewed in favour of mobile advertising, given its unique advantage of being able to target a customer on the move and based on the customers specific profiles. WhatsApp? Shift from traditional services to new VAS/Media services Customers will find themselves using more data services in all aspects. Currently, this is most evident in messaging. Many users are moving to instant messaging services (e.g. KPN is already experiencing a decrease in SMS usage due to a 70% WhatsApp penetration). Customers also are using their mobile phones less for traditional phoning iPhone users have demonstrated that only about a third of time spent on their phone is for voice and messaging, with the rest spent consuming content and other services. However, customers may not always be aware that they are using data services. For example, with the iPhones iMessage service, messages are delivered seamlessly both via SMS and instant messaging using the same messaging client. When voice over LTE (VoLTE) networks are eventually launched, customers will not differentiate between voice delivered on an IP network and a traditional 2G/3G network if basic issues like voice quality and handovers between networks are addressed. New competition in the supply of services: The assault by Apple, Google and other OTT players In terms of supply, there will be a fundamental change in the data value chain versus the voice value chain, with telecom operators facing a double impact of customer ownership dilution in both. In the voice value chain, operators will no longer have a monopoly over the direct relationship with the customer. In the data value chain, operators will be dis-intermediated by Over-the-top (OTT) content generators or aggregators like Google, Apple and Skype. Operators will face an attack on two fronts from device manufacturers like Apple or from OTT providers like Google and at all levels of products and services (including their traditional voice and SMS): Voice: Traditional voice to software VoIP base clients like Skype, Viber or potentially even software based SIMs Messaging: SMS to proprietary and third-party instant messaging clients Data and applications: Enterprise services to public cloud services or proprietary device cloud services Content: Walled garden content to third-party stores and user-generated content

Network topologies will rely more and more on Wi-Fi and FTTH/GPON, FTTB as mobile networks will not be able to handle requirements on data traffic volumes and speeds

FIGURE 1-2: SHIFTS IN CUSTOMER BEHAVIOUR AND NEW COMPETITION

Source: Appsfire, KPN, Delta Partners analysis

1.3 The global telecoms market will move away from core telecom products
More than half of all incremental revenues in the global telecoms markets will come from new revenue streams
The lead up to 2020 will be an exciting time for the telecoms market. Doomsday scenarios about the market collapsing and voice being completely free are unlikely to materialise. Two-thirds of the market is still expected to come from core telecoms products (fixed and mobile data and voice, SMS and basic mobile VAS). Hence, operators who choose to focus on only this part of the value chain do still have a future, albeit with much lower growth prospects. The overall mix of the global telecoms market is expected to change significantly, with new products and services (IT services, M2M and others, like applications, mobile advertising, m-health and m-payments) driving more than half of all incremental revenue growth. They are expected to grow at 9% annually compared to only 3% for traditional telecom services. Data services will explode, increasing from a share of 52% of the market to 72% by 2020. The bulk of this growth will be driven by mobile data, M2M and cloud computing. The strategic challenge for operators is to choose how far to go: Stick to the traditional revenue stream and grow organically with less risk? Tap into higher growth in new services, which bear higher risks and require significant internal change and new capabilities?

FIGURE 1-3: FUNDAMENTAL SHIFT IN ADDRESSABLE TELECOM MARKETS

Source: Pyramid, Machina, IDC, GSMA, WITSA, IE Research, IDATE, PWC, Delta Partners analysis

FIGURE 1-4: 2011A AND 2020 GLOBAL TELECOMS MARKET

1.4 The shift in the revenue mix towards non-traditional services may also transform margins
As operators experience changes in product and revenue mix, their overall margin (EBITDA) mix will also evolve. Telecom operators have traditionally enjoyed margins of 40% to 50% in fixed voice and data, with margins going up to as high as 70% for SMS.

As operators experience changes in product mix, they will experience pressures on margin due to uptake of lowmargin products

Margins are expected to experience increased downward pressure due to two trends. First, with substitution, uptake of high-margin products will migrate to lower-margin products: From higher-margin fixed and mobile voice to fixed and mobile data (VoIP, instant messaging, social networking) From higher-margin SMS to mobile data (instant messaging) Mobile data in particular often has only an average margin of 20%. In fact, margins can range from -10% on heavy-user dongles to 40% on smartphones. Operators are likely to review their data monetisation and optimisation strategy given the disproportionate amount of traffic that dongle broadband generates. Secondly, although new services will experience high revenue growth, they typically have significantly lower margins (although since they are markets in formation, long-term margins may still improve): IT service margins range, on average, from 3% (hardware) to 30% (managed convergent services) and 40% (certain software packages), depending on the part of the value chain Cloud computing services (XaaS) typically have margins of 15% or less, as seen in global players like Salesforce.com M2M services can have average margins of 25% due to lower average revenues per SIM compared to traditional services

FIGURE 1-5: MARGIN THREATS FROM REVENUE MIGRATION

Overall mobile voice margins are not expected to collapse, however, despite OTT VoIP and the introduction of VoLTE. There are three reasons: OTT VoIP operators will still find it difficult to compete with the telecom operators due to factors like numbering, call quality and ease of use VoLTE services will be still controlled by the telecom operators, who will resist the commoditisation of voice for as long as possible; moreover VoLTE will be available only in LTE-covered areas, which will most likely be focused in specific zones, overlaying a traditional 2G/3G macronetwork nationwide The glide paths of circuit-switched voice mobile termination rates are expected to plateau within the next few years

1.5 With these fundamental shifts in the market, operators need to ask themselves how to best respond
The changes in the telecoms market are gaining traction and represent only the tip of the iceberg in the type of evolution that can happen in an industry that is so dynamic. In 2000, Nokia was the market leader with a 30% share, with its most advanced phone feature being SMS chat functionality. Fast forward 10 years, and smartphones today have the same processing speeds (circa 1.5GHz) as that of full computers back in 2000. Nokia has lost ground to other manufacturers, like Apple, HTC and Samsung. To prepare for coming changes, operators need to identify the appropriate business model to take them into the next decade and to avoid a fate like Nokias.

FIGURE 1-6: KEY QUESTIONS THAT OPERATORS NEED TO ASK THEMSELVES

2. What must operators decide now?

There are 3 key business models operators can adopt: the Optimised Utility, the Basic Operator or the 2.0 Operator model
Operators need to be ready for the fundamental shift in the market by deciding which markets to address and which business model best suits them. Operators can evolve into utility operators or they can play further up the value chain. Moving up the value chain brings about higher rewards and the ability to deal with market black swans but also carries higher levels of risk. Integrated leading operators working across multiple markets are best positioned for value chain expansion thanks to their larger customer bases and cross-platform synergies. Financially, remaining a non-optimised operator is not an option. Generally, the most financially rewarding - and riskiest - is being a 2.0 operator.

2.1 Choose now among four potential business models

There are four business model scenarios which operators can adopt or find themselves in 2020: A. Non-optimised operator: Offers commoditised connectivity products B. Optimised utility operator: Forgoes the resale market, focuses on building best-of-breed infrastructure and secures long-term wholesale contracts C. Basic operator: Moves beyond connectivity with expansion into some new products and services, yet avoiding new, yet-to-develop markets D. 2.0 operator: Transforms itself and expands its portfolio to include most advanced products and services, exploring markets under formation such as M2M, sophisticated m-advertising, applications, etc.

FIGURE 2-1: POTENTIAL BUSINESS MODEL OPTIONS

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The non-optimised operator is not a conscious option per se but could be the default scenario that many operators may find themselves in if they do not take a conscious decision towards any of the other alternatives. If operators want to build the right foundations for value creation, they need to decide now what markets to address and business model to adopt that would best position them to respond to the evolving marketplace.

Different models can also help operators shield themselves from disruptive innovation or black swan type of phenomena

Option A (Non-optimised utility) is not a real option: An escalating cost structure will leave such operators unable to respond effectively to the known threats of margin dilution and increased competition. Option C (Basic operator) will bring about higher reward from a cost and revenue optimisation perspective. In the short-term, either option, if executed properly, may be sufficient to respond to the known threats in the short to medium term. In the long term though, there are black swans, whose type and magnitude of threat may not be apparent at this point in time. Just as smartphones revolutionised the telecoms industry in a matter of three to four years, it is likely these disrupters will be hardware or technology led. Examples of these include: Hardware Swans: E.g. a prevalence of software-based SIMs such that operators are replaced at the point of sale by device manufacturers and subscribers can easily change providers or have multiple operator profiles on their phones. Technology Swans: E.g. white space technologies become mainstream and Super Wi-Fi mesh wide area networks become a reality, replacing the need for mobile networks. E.g. Peer-to-peer ad-hoc mobile networks or sponge networks become a reality such that mobile networks can be bypassed completely for establishing a multi-hop call.

FIGURE 2-2: ABILITY OF BUSINESS MODELS TO ADDRESS REWARD OPPORTUNITIES AND THREATS

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These disrupters will be best mitigated by an operator using Option B (Optimised utility) or Option D (2.0 operator). These operators either would not play at the customer level (i.e. avoid market risk as much as possible) as in the case of the Optimised utility or would have a much wider and deeper customer relationship coupled with a diversified product portfolio offered via the 2.0 operator.

2.2 The business models need to be assessed in terms of the presented opportunities, ease of capture and financial implications
While Option D (2.0 operator), if successful, would bring higher rewards than Option C (Basic operator) and in turn Option B (optimised utility), the higher rewards also would present a higher level of risk. Operators will need to evaluate which option suits them by assessing the following areas: i. Opportunities from value chain expansion ii. Ease of capturing the opportunities iii. Financial implications i. Opportunities from value chain expansion Operators are now focused on basic connectivity and VAS, which will constitute almost two-thirds of the telecoms market in 2020. To be able to address the last one-third, operators will need to move along the value chain beyond telecom products and services to more applications/content/ media-based solutions. Operators have traditionally been more at ease with providing connectivity but are recognizing that for certain opportunities, the growth potential could lie primarily outside connectivity. For example, M2M pure connectivity revenues are estimated to be only 2% of the total addressable revenue which could include solutions for the embedded M2M modules. Even in todays environment, many operators have already made strong forays into transforming themselves into Option D 2.0 operators operators: SK Telecom has transformed more than 2,000 homes to incorporate them with interconnected devices like smart meters and such appliances as televisions, refrigerators, washing machines, and air-conditioning units, allowing residents to monitor and adjust household energy consumption according to peak demand or outside temperatures. Telefonica has formed a joint venture with MasterCard to offer mobile financial services to around 65 million Vivo consumers in Brazil, allowing them to make payments, transfer funds as well as purchase good online using a mobile device. SingTel has its own App Store called App Zone and launched Skoob, Singapores first e-book service offering 39,000 local and international titles. Moving into new products and services is not easy, and there will inevitably be setbacks and failures. For example, five years after launching its online store Pixbox for music and movies, Telefonica closed the store in May this year. Operators need to do an internal assessment on whether the potential opportunities justify the risks. 12

FIGURE 2-3: EVOLUTION OF OPPORTUNITIES WITH THE DIFFERENT OPTIONS

ii. Ease of capturing the opportunities An operator needs to assess how easily it may capture the opportunities available, given its market, positioning and capabilities. Operators in emerging markets will have an edge in executing the opportunities of being a basic operator as these markets would usually be less sophisticated in terms of customer requirements. Emerging markets also tend to be populous, so the core telecom markets are already huge versus many other developed markets. Competition would usually range from those operators who are less established to those who are more so. In such markets, an operator who is optimised even in the core telecoms products would already be above most of the competition. In addition, emerging markets tend to be less penetrated by the global OTT players, which often focus on markets with banked populations in order to make transactions via credit cards, so the substitution threat is somewhat smaller. For a 2.0 operator, developed markets will be more conducive as the higher value chain offerings like E-commerce and higher order IT services tend to serve a more tech-savvy audience. Some services, like cloud computing, also require a good fixed infrastructure, which is typically pervasive in developed markets. In terms of the other operator characteristics, being a leading operator with integrated operations over an international footprint would put an operator in the most advantageous position for the following reasons: Emerging versus developed market: Developed markets operators may find it easier to capture the ICT and Pay TV opportunity due to more advanced infrastructure and demand, whilst emerging market operators tend to benefit from higher margins in traditional services. International versus domestic: International operators would be able to use different markets as test beds. Integrated versus xed or mobile only: Integrated operators would be able to offer crossplatform services and leverage network synergies like off-loading. 13

FIGURE 2-4: STRUCTURAL SUCCESS FACTORS FOR OPERATORS TO CAPTURE OPPORTUNITIES

Many operators have recognised the benefits of being a leading operator with both mobile and fixed operations as a long-term strategy and as such have embarked on M&A. Some recent examples include: Acquisition of fixed assets or vice versa to transform into an integrated operator (e.g. Megafon of Nakhodka Telecom, France Telecom of Congo Chine Telecom). Consolidation to gain or increase market leadership/positioning (e.g. Vodafone-WIND merger, AT&T-T-Mobile merger, PLDT-Digitel acquisition, Tele2-Network Norway acquisition). Nonetheless, operators have also recognised that given their individual strengths and characteristics of markets they operate in, some business model options are more attractive than others. For

FIGURE 2-5: EXAMPLES OF DIFFERENT OPERATORS ADOPTING DIFFERENT BUSINESS MODEL OPTIONS

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example, LightSquared in the US has clearly stated its ambitions to be a pure wholesale operator and hence recognises the benefit of focusing on being an efficient dumb-pipe without any distractions of trying to launch new services.

Alternative models will translate into the risk/reward profile of operators, as well as profiles of revenue growth, investment requirements, AFCF, ROIC and ROE

On the other hand, a player like SingTel operates in a country ranked 2nd on the Network Readiness Index with a highly competitive mobile and broadband market. As such, it recognises that it needs to expand into ICT services and leverage its strong enterprise customer base to maintain a competitive advantage. iii. Financial implications Financially, staying a non-optimised operator is not an option. With the impact of stagnant revenue from being uncompetitive and escalating costs (both OPEX and CAPEX), the free cash flow of such an operator could drop by half from existing operations. Being an 2.0 operator would be the most financially rewarding. EBITDA margins may drop by 2% to 3% as lower-margin products make up a bigger share of total revenue, but overall cash flow could more than double if executed successfully thanks to a much larger revenue base. For an optimised utility operator, the financial proposition to shareholders would be quite different. Revenue, margins and cash flow will drop as a wholesale model is pursued rather than a retail one. However, a wholesale model typically comes with longer-term contracts with established clients that provide a stable and predictable cash flow that can be used as collateral for securing greater leverage. For example, while a typical operator may have a capital structure of 50:50 debt to equity ratio, a utility operator bears less volatility and risk from the retail market and hence may be able to secure a ratio of 70:30, achieving a much higher return on equity.

FIGURE 2-6: FINANCIAL IMPLICATIONS OF THE VARIOUS OPTIONS (INTEGRATED OPERATOR)

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2.3 Operators have adopted different business models and have taken steps to transform themselves
To have a strategy to strive for the different business models is not sufficient. Steps need to be taken to execute transformation plans throughout the organisation to ensure the right key success factors are put in place. These key success factors span commercial, technical and organisational considerations. Key success factors: Optimised Utility operator (Option B) An optimised utility operator need a solid network efficiency strategy to effectively deal with data explosion with a best-of-breed cost structure for differentiation. Cost efficiencies can be achieved with a focus on technology mix and roadmap optimisation (macro/micro/pico/femto cell NW planning) or traffic management strategies (off-loading, connection management, dynamic QoS, etc). Differentiated network wholesale services form the main bulk of the product portfolio.

Key success factor for the 2.0 Operator: organise yourself to be able to fail repeatedly but cheaply

Further to that, this approach relies heavily on the capital structure of the venture to ensure higher ROE. It is key to focus on commercial efforts that allow for the closing of multi-year, multi-million/ billion contracts with the companies that serve the end customer (e.g. other telco operators, Google, Apple, Salesforce.com, Sierra Wireless). These contracts would serve as collateral to finance the network and operations, reducing the level of required equity into the business and increasing ROE. Key success factors: Basic operator (Option C) Basic operators need to be able to evolve from a traditional individual-focused business to also delivering device-focused businesses like M2M (albeit only from a connectivity standpoint). With a wide range of opportunities available, such operators need to be able to assess and prioritise these opportunities. A focus on product is required, with necessary investments in the service delivery platforms to achieve best network in speeds and lowest possible cost per unit of data. Key success factors: 2.0 operator (Option D) 2.0 operators participating along the advanced value chain need a strong ability to expand into non-telco services like media, with a strong ROIC understanding for investments outside their core competencies. They need to be able to face more agile competitors (OTTs, Apple, IBM, etc.) in evolving or fast-growing markets. To succeed in these environments, operators need to meet the appropriate market demands and show an in-depth understanding of the customer, with extended service delivery capabilities across multiple platforms. Innovation and building up new capabilities are critical to achieve these objectives. Traditional operators need to learn how to organise themselves to foster innovation (generally a new organisation at arms length from the traditional telco) and how to be able to fail multiple times at a cheap cost, given that these are industries in formation. Finally, strong partnership capabilities will be required to accelerate time-to-market and mitigate internal capability gaps.

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FIGURE 2-7: RISKS, REWARDS AND IMPLICATIONS

3. Aligning future strategy and business model choice with todays investment decisions
It is critical to understand shareholder appetites for the level of investment, apart from the obvious need to formulate strategic intent around business focus, M&A, organisation and business lines. In times of tight credit, shareholders might be reluctant to approve large-scale investments with uncertain returns. Understanding which investments to target is key for an operators overall strategy. Broadly speaking, we see three levels of investment types: Tactical CAPEX Utility operator (10-12% of revenue): Mainly refers to adding capacity to the existing networks as well as certain coverage expansion in those markets where this is still required. As emerging-market operators mature, their tactical CAPEX levels as % of sales should come down to more reasonable levels in line with Western standards, typically around the 12-15% benchmark. Those operators who are just looking to build out an efficient utility model can limit most of their investment to this type of CAPEX Strategic CAPEX Basic operator (12-17% of revenue): Typically refers to CAPEX over and above what is required by todays business, really building the next wave, the next opportunity or the next revolution in the offering. This can include 3G/4G type of investments beyond standard upgrades. It involves really building a competitive advantage through accelerated roll-out above and beyond what competitors are doing or what todays market may typically

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Operators should not underestimate the level of transformation required to execute what could be a radical change in their strategic direction

need. This may force operators to push up their CAPEX spend in key markets to 20-30% for the next couple of years (as a % over sales). Operators looking to build a strategic edge in the data space in their top markets would fall under this category Transformational CAPEX 2.0 operator (15-20% of revenue): Broadly refers to CAPEX investment going beyond the pure expanded access networks, looking to significantly upgrade the whole sourcing of local and international connectivity, from submarine cables to satellite to huge backbones to regional metro rings to fixed-fibre networks. This would put any operator in a position to fully transform the local market and position it for a transformational evolution towards the fully integrated, high data business model in the future. The biggest problem with this is that this could push up CAPEX/sales in selected markets past 20% of sales (not referring to start-up situations). This could be a tough sell in todays environment of tight credit and increasing shareholder demands for cash flow and growing dividends. Yet for those looking to transform the landscape, new investment models are being developed looking towards joint/shared build-outs and investments, infraco JVs combining strategic players with financial investors and even whole new build-lease models where vendors or independent third parties (as happened in the towers space) could potentially play a role

As operators look towards the 2020 model they want to target, they need to define today what their CAPEX targets will look like and how they will finance the necessary infrastructure investments independently or together with other partners.

4. The transformational program

Operators should not underestimate the transformational program required to execute what could be a radical change in strategic direction in order to pave the road to 2020. The process 2 encompasses change across the entire organisation. There are generally 8 steps1 that need to be achieved to transform an organisation: 1. 2. 3. 4. 5. 6. 7. 8. Establishing a sense of urgency in the organisation (it needs to be done, our survival is at stake) Forming a Core Transformation Team where all the key top executives are present Creating a Vision for the change (what is the end goal?) and the strategies that will support it Communicating and living the Vision Empowering others to act on the Vision change the systems/obstacles for change and encourage risk taking, non-traditional ideas and actions Planning for and creating short-term wins Consolidating improvements and producing more change Institutionalising new approaches

Many operators are expected to announce their transformation during 2012 as they take steps (similar to those outlined above) to building a strong foundation to ready their business for the future challenges. Any transformation journey usually takes between 18 and 24 months, depending on the level of change required, the size and the specific situation of the organisation. A transformation program usually consists of the elements shown in Figure 4-1:

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Professor Kotter (Harvard Business school)

5. Conclusions
FIGURE 4-1: ILLUSTRATIVE TRANSFORMATIONAL PROGRAM

The future of telecoms is not all bleak, and telecoms markets are not expected to become completely commoditised, with connectivity prices going off a cliff. It will however be a significantly different world with Internet everywhere by 2020. With fundamental shifts in customer behaviour towards mobile and data-centric services, and new competition along the value chain, operators will experience a shift in margins from highmargin to low-margin products. Operators will need to decide now on how they want to react to this shift in terms of sticking with traditional revenue streams with less risk or higher-growth services with more risk.

Lead the market. Decide now and implement in a consistent manner

Out of the four potential business models discussed, remaining a non-optimised operator is not an option. Operators have the choice of being an optimised utility player or expanding further along the value chain. While value chain expansion offers significant opportunities, these come with more risks. Operators need to determine both their internal appetite for these risks and their relative ease of capturing these opportunities given their current market positions. Financially, 2.0 operators are likely to represent the most attractive option, with many integrated operators like Telefonica, SK Telecom and SingTel taking the lead in this space. However, there are also players like LightSquared in a utility model that have gained traction in the wholesale space. Ultimately, there is no one size fits all model. Operators have to decide and act now on which path best suits their strategic direction and capabilities. Regardless of the business model chosen, the window of opportunity is closing for operators to assess their capability gaps and ensure the necessary transformational key success factors are in place. Once the decision is taken, operators will need to design a transformational program that draws the path from where they are today to where they want to be. They will need to establish building blocks, strategic initiatives, business model implications. From then onwards, as in most instances in business, execution will separate success from failure.

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