Strategic breakout in UK telecommunications: the case of Kingston Communications

Transcription

1 Strat. Change 11: (2002) DOI: /jsc.573 Strategic breakout in UK telecommunications: the case of Kingston Communications Colin Turner Department of Economics and Business Studies, Huddersfield University Business School, UK The progressive liberalization of the UK telecommunications sector has necessitated a strategic repositioning by its incumbent operators, British Telecommunications (BT) and Kingston Communications (KC), as they face up to increased competition within their traditional market places. This repositioning has stimulated a process of strategic breakout, a framework derived from the author s on-going examination of changes in the European telecommunications sector. Amendments in the regulatory framework governing the industry has enabled firms to move into geographic and product markets from which they were previously excluded. However, they still face a residual regulatory framework that sustains a commitment by them to their base market principally through universal service obligations. Such a scenario has the potential to create conflict and undermine strategic focus. This paper seeks to explore this conflict through the strategic repositioning of KC since its licence was last reviewed in July After exploring the process of strategic breakout, the framework is then applied to KC highlighting how the process, when interacting with the residual regulatory framework, creates the potential for strategic conflict. Copyright 2002 John Wiley & Sons, Ltd. The nature of strategic breakout in telecommunications Strategic breakout refers to the reactions of regulated telecommunications businesses to changes in their prevailing regulatory framework. Such changes grant these enterprises greater commercial freedom in return for some diminution of position within their * Correspondence to: Colin Turner, Department of Economics and Business Studies, Huddersfield University Business School, University of Huddersfield, Huddersfield HD1 3DH, UK. c.turner@hud.ac.uk present market. In telecommunications, the regulatory change that has stimulated the process of strategic breakout has been driven by a number of interrelated factors (BT, 1999): Technological change: The emergence of new technologies extends the reach of the firm or enables it to overcome constraints upon its prevailing business model: Customer pressure: Where change is customer driven and more is demanded from the enterprise and its product and service offerings:

2 18 Colin Turner Competitive pressure: Wherechangeis driven by commercial compulsion. The basic strategic response to regulatory change has tended to be two-pronged (see the Breakout Matrix in Figure 1): Offensive strategies: Businesses seek to exploit the opportunities of markets (both geographic and product/service) from which they were previously excluded. In line with the conventional productmarket matrix (as adapted in Figure 1), this strategy could involve leveraging existing products to new markets, new products to existing markets or a combination of these actions. Defensive strategies: Enterprises seek to defend their positions within existing markets from new entrants. The firm may seek to utilize existing loyalty to sustain its position through aggressive marketing spend or new pricing/product strategies as a means of extracting maximum value from those customers that it is obliged to service. Ultimately the aggressiveness of such actions is a direct derivative of the threat of potential entrants and the consequent risk of churn. The options for the business within the context of the process of strategic breakout are shown indicatively in the breakout matrix in Figure 1 (derived from Ansoff, 1965). The strategic direction taken by the business will depend on its ambitions and capabilities with respect to new opportunities The strategic direction taken by the business will depend on its ambitions and capabilities afforded to it by regulatory change. The changing environment of the business, the desire of reach and the dynamics of technology, all influence the path of strategic change taken by the enterprise. In the telecommunications sector, breakout has stimulated consolidation as firms reach into new geographic and product markets. This has been affected not only by a freer global market for communications but also by the shift towards mobility and the growing convergence between the respective value chains of Present Market New Present DEFENSIVE OFFENSIVE P r o d u c t New DEFENSIVE OFFENSIVE Figure 1. The strategic options for breakout: the breakout matrix.

3 Strategic breakout in UK telecommunications 19 the telecommunications, information technology (IT) and content sectors (Turner, 2000). Evidently the breakout concerns for the larger operators such as BT are going to be markedly different from those that exist for a smaller alternative operator such as KC. This suggests that a core influence over the form and nature of breakout is the scale of the business and its consequent strategic ambitions as well as the ability of managers to cope with change and conduct effective regulatory relations to ensure that the prevailing controls are compatible with the enterprise s ambitions. Kingston Communications (KC) and the UK telecommunications market Kingston Communications occupies a unique position within the UK telecommunications market. In 1911, when the UK s then privately owned telecommunications operators were nationalized to form what would eventually become BT, Kingston-upon-Hull s local operator was allowed to remain independent. KC came into being in 1987 when the service ceased being a division of the local authority (Kingston-upon-Hull City Council), though the company remained in public ownership (DTI, 1987). Over time KC has become a diversified communication business covering a whole array of activities from the core service provision offered to residential and business markets through (respectively) its KC (Hull) and Torch Telecom divisions through to interactive television, satellite technology and call-centre services. KC s network-centric business model is based upon adding value to the core network through the application of new technologies, the development of innovative services and applications and the extension of its reach (KC, 2000). The increasingly diverse array of businesses in which KC is involved are based on generating traffic (especially the valuable bandwidth-hungry form) for the network infrastructure that enables the enterprise sufficient economies of scale to compete effectively on a national basis. All businesses owned by KC have to fit with this core strategic paradigm. Any business units that fail to exhibit a good enough strategic fit are disposed of, as KC has done with its mobile and software subsidiaries. The position of dominance that KC has over the Kingston-upon-Hull market continued despite the liberalization of the UK market and privatization of BT since The prevailing regulatory framework excluded KC and BT from each other s market while extending these rights to new alternative operators, though in practice no operator (in terms of either telephony or cable services) entered the Kingston-upon-Hull market. This allowed KC to sustain its dominance in the Kingston-upon-Hull area notably in terms of the market for the provision of exchange lines, the local retail market and the interconnection market (Oftel, 1998a). Despite the isolation and protection of its base market, the process of competition in the UK has evidently affected KC. This has been most apparent in terms of the entry of KC into the business services market via its Torch subsidiary. By the beginning of 1998, the prevailing regulatory framework governing KC was looking increasingly anachronistic. KC wanted to develop a national presence and extend the range of its products whilst the Office of Telecommunications (Oftel), the industry regulator, was concerned that the lack of competition within Kingston-upon- Hull was restricting the technological development of the city. The result of these twin pressures was the March 1998 consultative document Delivering the benefits of the information age to customers in Hull, which set out to review the telecommunications licences of KC and Kingston-upon-Hull City Council. In July 1998, after extensive consultation, Oftel s regulatory review recommended that:

4 20 Colin Turner KC should be given permission to offer cable TV services through its network. KC should be granted a national licence. BT should be able to enter the Kingstonupon-Hull market (subject to safeguards over its activities). KC would continue to decide the price of local phone calls (Oftel 1998b). These changes were coupled with obligations within the licence to not only meet universal service obligations for its home market but also committed KC to sustaining a physical presence in Kingston-upon- Hull. The strategic breakout of Kingston Communications The environmental factors shaping the telecommunications industry and pushing the process of regulatory change were challenging the KC business model. The move towards a bandwidth glut (essentially excess network capacity) when combined with the convergence of the telecommunication value chain with those of the IT and content sectors, shifted the source of value away from the network towards content (Cairncross, 1998). This has been complemented by the fragmentation of the converging value chain. On a micro-level, the value chain is splintering with new layers developing (for example, services dedicated to specific markets such as residential and business) with specialist operators active within each layer. This splintering has placed pressure upon telecommunication operators to redefine themselves within a particular niche. Consequently, the ability of any single operator to operate across all places within the converged value chain (effectively as a communications conglomerate) is diminished thereby creating opportunities for smaller operators to flourish. In responding to the new opportunities created by regulatory reform, KC has repositioned itself to become an increasingly niche player offering advanced business-to- KC has repositioned itself to become an increasingly niche player business (B2B) services. This is reflected in the core offensive elements of its breakout strategy. The regulatory commitments placed upon KC prohibit a purely focused strategy upon a niche segment. The enterprise has to guarantee specified services in its home marketplace, which it cannot by law ignore. The consequence of which is the development of a parallel defensive strategy. The pattern of the process of strategic breakout for KC is reflected in Figure 2. Offensive strategies The major thrust of KC s offensive strategy lay in expanding its business communications services (via its Torch subsidiary) to leading UK regional business hubs through its plans to build a nationwide fibre optic network. This connected (initially at least) the four major business centres of Leeds, London (via its alliance with COLT), Birmingham and Manchester. To further support these moves, KC intends to seek access to 1000 of BT s exchanges across the UK to enable it to offer broadband business services over this network nationwide. This offers a possible platform for further alliances to strengthen the business on a national and international level. KC has also pursued an acquisition strategy that added scale or capabilities to its B2B services business. The second aspect of its offensive strategy has been the move by KC into the area adjacent to its Kingston-upon-Hull base, the East Riding of Yorkshire. Here there is a degree of brand loyalty and recognition towards KC derived from the large number of former residents and commuters to Kingston-upon- Hull. KC seeks to use this to develop synergies with the thrust of its defensive strategy mentioned below. The most recent figures

5 Strategic breakout in UK telecommunications 21 Present Market New Present P r o d u c t New DEFENSIVE Price cuts in incumbent Market place DEFENSIVE New service offerings such as Interactive TV to incumbent market and existing business users OFFENSIVE Moves into area adjacent to incumbent market place (East Riding) OFFENSIVE Entry into national broadband business services Figure 2. Kingston Communications strategic breakout matrix. suggest a 51% penetration rate (the percentage of residences passed by the network that actually decide to access its services) amongst dwellings passed by the rolled-out KC network. This expansion will continue with another 36,000 homes targeted within the East Yorkshire area. In addition, KC is rolling out its interactive TV service into this market. Defensive strategies At the centre of its defensive strategy is aggressive price-cutting to raise the barriers to entry and deter the defection of existing customers to new entrants. Under the terms of its new licence, KC has the right to set its own prices while BT has had its right to achieve aggressive entry into Kingston-upon- Hull curtailed. BT can only offer in Kingstonupon-Hull what it offers nationally. KC exploited the strong degree of local loyalty and sense of uniqueness within its defensive strategy. The aim of the defensive strategy is for KC to own its residential customers through effectively locking local users into its networkasaprecursortoextractinggreater value through its planned emergence as a one-stop shop for communications services within its incumbent market. This is reflected in the second element of KC s defensive strategy namely the move to offer broadband services (notably interactive television) to residential users in Kingston-upon-Hull. Given the cost of the strategy (an estimated 1 billion) and the need to acquire to new competencies to support its effective execution, KC s breakout occurred through the following mix of strategic options (Capron and Mitchell, 1999): An initial public offering (just over 50% of KC was floated) increased the level of internal resources available to the enterprise by nearly 400 million. A further 100 million through a share placing with institutional investors later supplemented this. KC also developed a number of alliances to support the breakout strategy and achieve operational efficiencies in its execution. The enterprise has developed alliances with YES TV (which offers an interactive television platform), SKY TV (to offer broadcasting content), Blue Square (to offer on-line betting) and the BBC (for local content services) to support the deployment of its interactive television service. On the infrastructure side, the

6 22 Colin Turner enterprise has developed an alliance with COLT to create a national broadband network. Acquisitions have been low-key with just two purchases being made. Both of these acquisitions were communications solution providers, (Milgo solutions and Ultralink Systems) and made to complement KC s offensive B2B strategy. KC has also been acquiring staff with the necessary experience of the national telecommunications market. The changing strategic focus of KC From the breakout process it is evident that two major and distinct businesses have emerged within KC each with a different strategic focus. A residential business based upon offering telecommunications services to households at low cost to a narrowly focused market based in and around Kingston-upon-Hull. A B2B services division offering focused differentiated services to enterprises nationwide. It is apparent that the degree of overlap between these businesses is not likely to be great as they differ in terms of both product offering and market focus. According to KC s network-centric business model, synergies between the respective businesses will be achieved through the development of a national broadband network and efforts to generate traffic for this infrastructure. Recent trends suggest that such developments may be more apparent than real. With the value of the network being increasingly based on the content delivered and with the content demands of both markets being markedly different, there is every reason to suggest that synergy could be at a premium. KC also sees synergies derived from the existence of core skills and competences that mutually support the development of both businesses. The existence of such complementarities are open to question for finding synergy between the respective business units are likely to be undermined by two fundamental concerns. The first is that despite the fact that both units are selling communication services they are targeted at different markets that requires different skills and competences. Thus the method of marketing and sales would be different for each business unit. This is driven by the fact the B2B division is based on selling premium services whereas the majority of the residential market is offered services that, over the short term at least, extend little beyond basic telephony. The second issue is that KC could overestimate the transferability of competences between businesses (Collis and Montgomery, 1995). The implication from KC s strategy is that it can leverage its resources with equal effort between the distinct units. This need not necessarily be thecase.forexample,whilethereisevident and proven demand for broadband in the B2B market there remain serious concerns over the desire for such services within the residential marketplace. Furthermore there is little feasibility that these markets (and the respective strategies for each) would be capable of being integrated due to the characteristics of each market. In the residential market, the lowcost strategy is necessary due to increased competition in terms not only of fixed telephony but also of cable operators and broadcasters entering this segment, and because KC has little unique content to differentiate its products. The B2B business has to compete on a differentiated strategy as its The B2B division has to compete on a differentiated strategy lack of scale compared to its major rivals prohibits a low cost strategy. According to Collis and Montgomery (1998), strategy must start with a vision of how an enterprise s resources differentiate it from its competitors. As mentioned, in KC s network-centric

7 Strategic breakout in UK telecommunications 23 business model, strategy is based upon the value provided or created by the development of a broadband network. This core element of KC s breakout strategy is clearly open to dispute. The fact that the content offered is largely undifferentiated from its rivals plus the overcapacity of bandwidth, means that KC cannot compete through the physical capacity of its network. The technology it employs is both generic and non-proprietary which means that the ability of KC to differentiate itself will be limited. Though many of these issues existed before the change in its licensing conditions in 1998, they are likely to be accentuated as a result of the breakout process as KC focuses on its B2B division with the residential business being used as a cash cow to fund it. Increased competition within the home market when combined with the need to generate revenues for the B2B strategy intensifies the need for the aggressive defensive strategy. There is clearly no incentive for KC to offer minimal services according to the terms of its licence or to let the home market suffer from benign neglect. To do either could result in KC contravening the terms of its licence or undermining the logic of its offensive strategy. KC s progressively more conglomerate appearance goes against current trends within the industry where success is increasingly based upon focus. Examples would include Vodafone in mobile communications and Cable and Wireless in business communications. Many conglomerates find it increasingly difficult to compete effectively within all markets. This is due to a lack of strategic focus and the inability to manage new technologies and diverse geographical bases. Further, the traditional activities of a telecommunications conglomerate are developing as businesses in their own right. The result is that synergies between the different units are increasingly at a premium with the result that the business and its management become increasingly complex. In KC s case, this is compounded by the particular links between itself and the City of Kingstonupon-Hull. Conclusion In responding to the process of regulatory change, organizations have to consider a range of strategic actions that accommodate both regulatory commitments and exploit new opportunities for business development. The experience of Kingston Communications highlights a fundamental problem faced by firms subject to regulatory frameworks that act as a significant constraint upon choices of corporate strategy. Degrees of strategic change are often limited and the ability of the enterprise to achieve a particular strategic focus is curtailed. Furthermore, the conglomerate structure of the business and the demand for funds has unsettled some investors who desire a clarity of focus for KC that has been achieved by other operators. Ultimately the reconciliation of these demands depends upon a redefinition of the regulatory and corporate strategy interface. A core aspect of successful strategic change for these enterprises is the management of effective regulatory relations. Until this can be reconciled to the satisfaction of all stakeholders, the apparent conflict at the centre of KC s breakout strategy will remain. Biographical note Colin Turner is a Principal Lecturer in Business Strategy at the University of Huddersfield. He has undertaken extensive research and consultancy within the field of telecommunications. References Ansoff I Corporate Strategy. Penguin: London. British Telecommunications BT Communications Report 1998/99. London. Cairncross F The Death of Distance. Orion: London. Capron L, Mitchell W The impact of relevant resources and market failure on the four modes of business change. University of Michigan Business School Working Paper, May. Collis DJ, Montgomery CA Competing on resources: strategy in the 1990 s. Harvard Business Review, July August.

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