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The utility factor: are telecom operators in a low-margin utility business, or can they command the returns of value-added service providers?
Telecommunications International, Jan, 2005 by Ouida Taaffe
The telecom industry has seen steep price falls since deregulation. It is also undergoing a profound technological shift. In the place of multiple switched networks, such as ATM or Frame, dedicated to different services, IP networks are being implemented that will, essentially, be uniform. This will mean that the industry moves away from being a purveyor of dedicated circuits and services reliant on engineering know-how to one where software plays an increasingly important role.
In this new world, the question for telcos is whether the services they have traditionally offered will cease to pack a margin punch and whether, if so, they can move into services that do have real clout. The ground has already started to shift.
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"In my mind, they have no choice but to think of alternative business models and alternative revenue streams," argues Jean-Herve Jenn, president of Convergys' information management group, EMEA. The market, however, does not seem over-confident on the ability of the telco industry to make the adjustment.
"Telecom relates to the transfer of bits/bytes or analogue waves of voice and data and as such is as much a utility as electricity or gas, albeit a little more complicated," argues Morten Singleton, director of telecom research at West LB in London. Singleton points out that many people in the industry talk about the extension of the telco value chain, but he is not sure that this is a realistic assessment of the actual trend. "In my view these are media/entertainment services being offered over telco infrastructure," he says. Other financial analysts agree. "I think they are utilities. They have been trying to develop VAS for many years, but most of these efforts have stayed close to their core business," says Henk Doorenspleet an analyst with Rabobank in Amsterdam. "Mobile is not much different to fixed," he adds. "There is a 'time shift' with mobile, but their current turf of minutes will continue to be commoditized, to be offset by SMS, MMS and other data, which are also, in essence, utility products."
If the downbeat comments from outside the industry sound rather bleak for the operators, they have yet to concede defeat. "I don't see us as a utility provider," says Mark Ellison, head of strategic marketing and business development at Colt. "Not at the moment. When the word utility is mentioned, 'commodity' also comes up and that brings me out in a cold sweat," he says, cheerfully. Ellison argues that features that mark out utilities such as the provision of full 'on demand' services, are still some way off. However, though the "sophisticated changes in ordering and provisioning" that he believes would be necessary to allow that will not happen soon, the level of competition in the market is such that pricing to business customers has already been much simplified. "Sometimes the market [drags you down the utility route]," says Ellison. "If you are asked to provide bandwidth on demand, you have to. If we don't someone else will." Ellison does not pretend that the market is easy. "It is true that the value of our carrier business will shrink as prices shrink, then it becomes more of a liability. We will have to offset that with value-added services," he says.
This does, of course, beg the question: what is a utility? "The economic definition of a utility is an organisation supplying a public good that is costed at marginal price, based on capacity, meaning, in practice, almost zero. This is already the case for fixed voice and increasingly so for wireless," says Louis-Francois Pau, professor of mobile business at the Rotterdam School of Management. "So, at a utility, income is derived from the management of assets. In the case of telecom, this will be returns from CRM, interconnect fees and so forth, but not from the ownership of physical assets," he adds. Pau points out that the typical margins in gas and electricity are around 16 per cent gross." Telcos can make money on margins like that if they are lean and efficient and don't over-invest," he adds.
As telcos are forced to consider their options, there are, Pau believes, a number of different scenarios that could develop, in particular the specialisation of operators around vertically-defined service functions, though he is cautious on calling the longer-term outcome. "What the European telecom landscape will look like five years from now very much depends on policies and regulation. If, indeed, vertical consolidation is promoted in the interests of European competitiveness, positive things may happen. However, if the traditional view of getting size and clout--and having indirect government influence at operators--prevails, it won't move that fast," he says, adding that the telecom industry lacks flexibility.
That does not mean, however, that telcos are entirely devoid of savvy. One of the fields that operators could move into, is, for example, Pau argues, retail banking. "Mobile operators have prepaid income, which gives them a capital base," says Pau. "However, what is much more interesting from a transaction perspective is the way in which they handle their revenue streams, whether prepaid, or postpaid. They are much more efficient than banks because they capitalise on more up-to-date IT technology in their back offices."
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