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Telecom Evolution: Impact of Economic Cycles, Consolidation & Managed Services

Source: Wall Street Journal

 The other day when I saw this graphic in WSJ it reminded me, of a time when I was starting out in the field of Telecom as a junior engineer, the world look so brilliant. I could go work for so many Operators – wireless and wired! The world was going wireless, GSM was new to India and Industry captains were predicting a multi-fold growth. While in the US it was CDMA vs GSM – two very strong contenders that were changing the way the world was communicating, while the cola wars were dominating the rest of the news and Billy Joel singing – “we didn’t start the Fire” !  

  
 Economic Cycles:

 
  

 
 
 There have been 13 ‘‘official’’ recessions in the US since 1945. Expansions have become gradually longer, and contractions shorter and milder. One reason is that we know better how to deal with downturns through macro-economic policies, and how to mitigate their negative effects through social policies. Looks like I sound contradictory to my own thoughts, it feels like we have been in a recession forever! But stats tell another story! Overall aggregate economies there are cycles for various asset classes and industries. These volatilities are interrelated in various reinforcing and offsetting ways. The swings of the economy as a whole are a composite of the moves of its various sectors and firms.

Just as in the case of investment portfolios, the aggregate volatility of the overall economy should be lower than the average of the industry volatilities. Some industries are more cyclical than others. Telecom used to be less volatile than the economy as a whole. It grew steadily, with long planning horizons hardly ruffled by the business cycle. One company, AT&T, accounted before its divestiture in 1984 for 83.2% of network activity and equipment manufacturing, and provided stability, planning, and an industry-wide umbrella. Its stocks with their steady dividends were treated by investors like bonds. The equipment industry, being globally stratified, was almost as stable as the carriers. But today, in sharp contrast, the telecom sector may well have become more volatile than the economy as a whole, more like the construction business and less like water utilities.

If we look at US telecom industry data going back to its inception in 1875 access lines increased each and every year for over a century, interrupted only briefly in the 1930s, when the line count fell for three years of the Great Depression. Even under the extreme economic conditions that then existed, lines rose on average by 0.5% per year over the decade of the 1930s. The average annual growth rate throughout the 20th century, from 1920 onwards, was 3.7%. During the post-WWII period, there were 11 recessionary years with negative GDP growth. In each of those 11 years, telecom line growth was positive – above average four times, and below average four times. Similarly, the volume of actual calls (local plus toll) rose throughout the 20th century, with only minor dips in 1929–1932. Even over the 1930s, average call volume rose by 2.5% per year. US average annual growth over the century was 4.2%. In each of the 11 recessionary years the number of calls grew; in eight of those years it grew above average; in two cases growth was below average, but not by much. The historical data also show that a third dimension of growth, telecom industry revenues, rose every single year, on average 8.4% from 1920 until the end of the century, with the exception of three Depression years. Of the 11 post-WWII recession years, only two witnessed below average revenue growth.

Thus, one cannot observe a direct correlation of telecom industry indicators – both of absolute numbers and of growth – with the overall economy for the 20th century. The state of the economy most likely played a role, but other factors tended to be stronger along with new technologies such as fax, online services, and the narrowband and broadband internet and today the impact of one phone that changed the Industry – iPhone. 

Let us look at the various economic theories that impact the general state of Telecom. 

The monetarist view : Cycles are caused by flawed monetary policy that causes instability. For example, if a central bank changes interest rates incorrectly, consumers and businesses get wrong signals and their expectations lead to reactions that set off instabilities. This theory

Doesn’t fully explain what happened to the telecom industry.

The Keynesian perspective:  The key drivers of the economic cycle are fluctuations in the aggregate demand. Aggregate demand in turn is affected by the expectation of market participants which often become self-fulfilling. Government must increase or reduce its own demand in order to dampen these private sector variations.

The overall economy slowed down after the economic meltdown in 2009. But one cannot blame a drop in real consumer demand for wireless and the internet on the downturn. The usage of telecommunications in terms of minutes of voice, data communications, and wireless kept raising with double-digit growth rates. True, the growth rate in the internet subscribership was not been as torrid as before, but it still increased and followed by a healthy growth in broadband internet subscribership. Overall, one would expect telecom, as an essential service, to be less volatile than the economy. However, it experienced a much more pronounced boom–bust cycle.

Real business cycles theory (RBC): This theory is a supply side story. For RBC advocates, cycles are mostly caused by random shocks and their impact on total factor productivity, and on flawed government policies in response. The internet was a positive shock, while Housing bust was a negative one. For RBC advocates, causality does not run from consumption to output but the other way around. The RBC theory therefore rejects explanations based on consumer psychology such as ‘‘exuberant irrationality’’. RBC proponents believe that there is really nothing that governments can do about a cycle since it is based on random events.

How does this perspective fit telecommunications? Empirical studies show that single shock rarely triggers downturns of the economy. But a shock can topple an already weak structure. In telecommunications, several shocks occurred in the early 2008 and added their impact cumulatively. Local competition failed; long distance competition, on the other hand, worked only too well, lowering prices and profits; Wall Street became irrationally depressed when stocks declined from their unrealistic heights; governments extracted future expected profits by auctioning access to a vital resource, spectrum; regulators, protective of incumbents’ ability to generate low-price service in high-cost areas, slowed down competitors; etc. But most of these events are not the kind of exogenous, technology oriented shocks that affect productivity, as hypothesized by RBC advocates. They are endogenous financial and institutional variables of the sector itself.

Lag and accelerator models: Small changes in demand can lead to large expansion and investment. Where there is an adjustment lag, unanticipated shifts in demand can generate cycles of investment spending. These lags induce oscillation in the same way that slowly reacting bathroom shower controls induce cycles of hot and cold water. The famous ‘‘cobweb’’ cycle is a model of such overshooting. Industry examples are cattle, airline services, and office space – and now telecommunications.

Here, investments take a long time to get on line, and disinvestments may take even longer. The lumpiness of investments in telecommunications coupled with an even slower regulatory and court system, makes the feedback loop very slow.  

The Austrian theory:  This view is focused on overcapacity, created for some reason – whether due to exuberance, excessive bank lending, monetary policy, optimistic projections of demand, or other factors. After an adjustment lag there is eventually a downturn. The pattern is one of boom, overcapacity, price war, bust, and shakeout. Periodic bursts of innovation generate a swarm of small new firms, and once their product fetches a high price that attracts entry, which expands output and lowers price. This goes on for a while. Industry growth rate then slows below that of individual firms, and a shakeout, winnowing and consolidation, occurs. This instability is exacerbated by the cost characteristics of network companies – high fixed-cost, low marginal cost, and network effects – which quickly cast aside firms that are smaller, or operate at higher cost, or whose products or processes are less innovative.

Network effects: The RBC theory discussed earlier assumes constant returns to scale. That is, if one increases the capital and labor inputs of the firms proportionately, their outputs would grow by the same proportion. An increase in usage leads to greater utility of the product and to increased demand. And that, in turn, increases productivity and real wages and enables further consumption. Growth of other network participants is factored in as part of the value of the product, and leads to still further growth. At some point, however, the expectations of further growth decline, for example as saturation occurs. This leads consumers to reassess the value of the service, which in turn may reduce demand, creating some negative network effects, thereby reinforcing the downturn in demand.

Credit cycles: Credit constraints and economic activity intertwine. If credit limits are tied to asset valuations, a rising stock market leads to an increase in collateral values and hence to an expansion in credit, to still higher valuations, and to further extension of credit. The opposite is true for the period of contraction. Hence, financial markets may increase industry volatility. Investors exacerbated rather than moderated the boom–bust cycle of the telecom industry. And the more recent investment boom let into multiple broadband platforms suggests that the same may happen in the future.

Adding up all the theories of the proverbial blind observers of the elephant, each of these theories appears to get something right for the telecommunications case, but without painting a full picture. Low interest rates encourage investment. Demand growth slowed. Investment and regulatory lags prevented smooth adjustment. Network externalities and lumpiness in investments amplified the swings. Corporate and Wall Street malfeasance at first attracted excessive investment then repelled it when it was exposed. The regulatory process added delay and uncertainty. Industry managers miscalculated. Economies of scale and network externalities created strong incentives for growth strategies, at the expense of profitability. Financial markets encouraged this strategy.

The multiplicity of factors and the absence of a single primary cause has led many observers, as mentioned, to subscribe to a theory of the ‘‘perfect storm’’. Yet the causes of the telecom industry’s recent volatility are not random but fundamental, structural, and inherent, and will remain so for the foreseeable future.

 

Consolidation:

  

The most recent news about AT&T and TMO is probably the largest consolidations in the recent times, but it is neither the first nor the last. The process of consolidation as per the graphic started around 1986 onwards and mark my words will last until we end up with two uber-operators that will compete with each other and allow a Darwinian struggle. Again as operators are reduced to just ‘fat’ pipes, they are looking for opportunities to monetize it as much as possible. Most North American and European mobile markets are mature and static, with a handful of operators typically competing for each other’s customers. With cellphone penetration rates exceeding 100 percent, there is little room to grow and slim prospects of overtaking entrenched leaders.

With Western operators cutting costs in mature markets, the bigger deals are seen coming in Africa and the Middle East, where mobile phone penetration remains low. The regional operators Bharti Airtel and Reliance Communications of India, Etisalat of Abu Dhabi, Qtel of Qatar, Zain and Orascom have all built their groups through acquisitions.

 But here, too, big cross-border deals remain difficult amid disagreements on price. Bharti and Reliance both bid unsuccessfully for MTN, the largest African operator. Vivendi of France tried and failed to buy Zain Africa. Orascom is fighting in court with France Télécom over their joint Egyptian business. Indian operators may also be distracted this year by that country’s coming series of auctions for third-generation licenses and the backlash with handling of 2G licenses.

Some analysts say they see lagging or midsize competitors like Sprint Nextel in the United States, Telecom Italia, KPN of the Netherlands and TDC of Denmark as potential takeover candidates. But the T-Mobile takeover by AT&T is a class act that seemed to happen out of nowhere, but a perfect marriage as both share a common family of technologies.

The numbers of prepaid customers have not been increasing rapidly enough. In order to retain existing customers and attract new users, it has become necessary to design novel pricing plans that would boost revenues, while also satisfying consumers. Next-generation technologies are being developed and tested in order to cater to the need for enhanced speed and capacity. A number of services and applications are increasing the use of mobile phones in areas such as healthcare and banking industries in order to improve their efficiency and effectiveness. These services would require better quality of service and capacity requiring more investment into those tech refreshes.

However, new participants are not in a position to invest in next generation infrastructure as a result, they may have to merge with other prominent market players who have the necessary funds to deploy next generation infrastructure. Certain mobile virtual network operators (MVNOs) that become bankrupt due to the existing competition typically opt to merge with other major telecom participants as well.

 But in this environment, which is ripe for consolidation caution is still the rule!

 Here is a Timeline chart till today for Telecom Consolidation – http://goo.gl/BGSQk

 

 



Managed Services:

  

 
 
 
 Outsourcing of Telecom Networks and managed services appears to be a strong trend in the Telecom world. However, is this really providing valuable benefits to the organization …… or just a perception?

 

 

Today we stand at a place in history in the US where only 3 National operators will remain by the end of next year. How have we progressed in time, what has changed with the way we interact with our cell phones. Today, I wouldn’t dare go out of my home without my cell phone, it is more important than my wallet, with NFC coming to all phones I will not need my wallet anymore, maybe a money clip with IDs!’

The main perceived benefits seem to be:

§  Increased efficiency

§  Access to a broader and deeper knowledge pool

§  Clearer visibility of, and more control over, capital and operating expense

§  Allows the operator to focus its efforts on serving the customer better rather than the management its technology infrastructure.

Cost is definitely one reason for outsourcing and potentially an increase in quality as someone else has suggested in this discussion. The buyer however needs to take into consideration the total cost of the project and have a contingency element to cover any cost of quality issues that may arise. I have had personal experience of where an new supplier came on board to maintain a network who needed a lot of hand holding by both my employer’s company and also another incumbent supplier to bring the new supplier’s level of quality up to scratch. On paper the new supplier’s offering had been very good.

Another key reason for outsourcing can be the opportunity to reduce the numbers of staff that the network operator has. By outsourcing the network operation the operator can TUPE across staff into the new supplier’s business. This potentially reduces the operator’s exposure to redundancy costs and also enables it to have a more flexible service provision.

KPIs and SLAs can certainly be introduced but they do not ensure quality levels. When putting KPIs together, irrespective of commodity, it would be suggested that there is a risk and reward element rather than using them as a stick to beat the supplier with. If you try to shift all the risk on to the supplier by introducing high penalties then you could well find that the KPIs and SLAs have a negative impact rather than the positive one you were hoping for.

Outsourcing is often seen as the panacea to a company’s problems however if you are not prepared to put in the time and effort to manage and build the relationship with the supplier then the company could end up with more problems than ever before.

There are potentially bad outcomes often overlooked or ignored in the planning and honeymoon stages. Remember to keep in mind that:

§  It takes time for an outsourcing company to learn the inner workings/processes of an operator, so there will be an inevitable teething period in the meantime.

§  Depending on the business model of the outsourcing firm, IBMs model was to bring in employees from the Indian operations. And although hardworking/diligent/professional workers there were undeniable language, communication and cultural barriers which most certainly hindered efficiency. Both these cons counteract the perceptions that the outsourced model is more efficient.

-          Lack of ownership/accountability within an outsourcing company.

-          Definitely a valid point too often given little attention is this, as an employee that is outsourced will not have the same feeling of belonging within the organization or job satisfaction.

The outsourced model has certainly taken hold for network operators, even more so since traditional telecoms services such as Voice/SMS are becoming less and less profitable. But the perceived merits of the outsourced model are yet to be proven in my opinion. Some of them are stated below -

Embarq outsourced its Network Operation Centers (NOCs) to Nokia Siemens Networks (NSN).  

Sprint had paid Ericsson $5 billion over seven years to manage its CDMA and iDEN wireless networks as well as its fixed-line network.  

Alcatel-Lucent has joint ventures with Indian operators Reliance and Airtel for mobile and fixed networks, respectively.  

LightSquared, a wholly owned subsidiary of Harbinger Capital has a $7 billion network deployment and maintenance contract with NSN. 

WiMAX rural operator Open Range has an agreement with IP backhaul vendor Harris Stratex to run its NOCs. 

 

Today we stand at a place in history in the US where only 3 National operators will remain by the end of next year. How have we progressed in time, what has changed with the way we interact with our cell phones. Today, I wouldn’t dare go out of my home without my cell phone, it is more important than my wallet, with NFC coming to all phones I will not need my wallet anymore, maybe a money clip with IDs!’

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  1. May 5th, 2011 at 18:33 | #1

    I don't think that outsourcing is the answer! In my experience, it is often done to save money but the company is sacrificing quality in the meantime.

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