Opportunities for Action in Telecommunications. The Myth of the Global Telco

Transcription

1 Opportunities for Action in Telecommunications The Myth of the Global Telco

2 The Myth of the Global Telco Many telecommunications executives believe that their industry is a natural candidate for globalization. After all, the advantage of scale has long been considered a given in telecommunications strategy. The economics, however, argue otherwise. Of the five types of telecom globalization strategies that The Boston Consulting Group has identified among international carriers, three offer limited potential for profit, at best. And two catering to the needs of multinational companies and providing wholesale services for carriers offer opportunities that only a handful of companies can exploit. Telco executives will therefore need to think long and hard before embarking on a globalization strategy. Many may conclude that there are more attractive prospects for growth in their own back yards. One reason we are skeptical about the profit potential of globalization in this industry is that only a small portion of the telecommunications value chain can actually be leveraged by creating a global business. The large, scale-intensive elements, such as network operations and customer service, are inherently local. Another reason is that global backbone capacity, which has been scarce, is now becoming plentiful and inexpensive. Although companies can attempt to increase their profits by sharing procurement and transferring operating skills among countries, the gains will be modest. To understand the limited opportunities for globalization in telecom, it is helpful to examine how economic factors affect the strategies that many companies are pursuing or contemplating.

3 Strategy 1. Diversifying Geographically The simplest and most prevalent globalization strategy is geographic diversification. Telcos with monopolies in mature home markets have often moved in this direction when national regulators have limited the profits they could earn domestically. Investments in overseas telecom markets may grow quickly, are generally not subject to rate-of-return ceilings, and can help offset weak periods in home markets. In addition, profits from such investments can immediately contribute to earnings. Ameritech s investments in central Europe, for example, have boosted earnings considerably. And British Telecommunications international holdings contribute about 25 percent of the company s market value, up from zero a decade ago. The shortfalls of diversification strategies, however, are widely known. The number of truly attractive licenses and incumbent properties has dwindled rapidly, and demand appears to be outstripping supply: witness the recent high prices paid for wireless licenses in South America. In fact, there is growing recognition of a winner s curse : to succeed, bidders must aggressively overvalue the asset. Recent economic upheavals in emerging markets underscore the risks of investing in them. In the future, the case for pure diversification will be hard to make. Strategy 2. Leveraging Operating Synergies A handful of telcos have successfully leveraged the operating synergies among telecom subsidiaries in different countries. Spain-based Telefónica, for example, has created a strong position in South America by sharing knowledge, pursuing scale economies in purchasing, and exploiting traffic linkages between affiliates in the major Spanish-speaking countries.

4 Leveraging operating synergies, however, is easier said than done. An analysis of telecom economics reveals few real opportunities for cost sharing across borders. Finding intercontinental opportunities is even harder. Network-related expenses, for example, are largely a function of local assets and employees; unit costs therefore depend on local, as opposed to regional, operating costs. Retailing costs, including customer service and marketing, tend to be local as well, and they are virtually impossible to share across language barriers. Cost savings in information technology, which are often cited as a rationale for horizontal telecom mergers in the United States, have also been elusive. Even U.S. RBOCs with similar legacy systems have found this to be the case. Achieving synergies in IT between telcos in different countries is a long shot. In addition, telcos have found few opportunities to reduce overhead expenses through cross-border mergers. The reason: a large portion of overhead expenses is tied to the specific regulatory and reporting requirements that are imposed by each national regulatory regime. BCG estimates that an aggressive cost-sharing strategy (for example, using standardized wireless networks around the world) could yield savings of 2 to 3 percent of revenue mostly from increased negotiating leverage with equipment suppliers. Although such savings are substantial, they will not be enough. Strategy 3. Leveraging International Traffic Creating a network that manages international traffic to optimize profits can provide immediate benefits to carriers, but there is a narrow window of opportunity.

5 The long-standing system of bilateral settlement agreements which sets prices for the delivery of international traffic at artificially high levels and guarantees a volume of inbound traffic in proportion to outbound traffic is under tremendous strain. Global carriers can bypass the high costs of the old system and boost revenues from international traffic. The strategy works best when a global carrier with a high share of outbound traffic from multiple markets (including its home market, where it was the monopoly) invests in a new telco in another country with a low share of outbound traffic. Under this scenario, the global carrier can direct to the new telco a much larger share of highly profitable inbound traffic from other markets than the new carrier would have received under the old regime; this increases the new telco s profits. Refiling international traffic through a third country to arbitrage bilateral settlement rates is a variation on this strategy. Globalization strategies in the retail wireless market can follow a similar logic. High cross-border roaming charges produce a strong incentive for telcos to invest in wireless carriers in other countries in order to reduce the cost of serving globe-trotting customers. However, the potential for creating value through this strategy depends on the continuation of exorbitant roaming charges. The cross-border strategies described above have value today, but they rely on arbitrage within crumbling market structures and thus will likely be shortlived. In addition, the emergence of global carriers carriers (see Strategy 5) promises to rationalize the market for international traffic delivery over the next five years.

6 Strategy 4. Serving Multinational Customers Providing integrated telecom services to large multinational customers offers attractive and concrete opportunities for globalization. The largest companies and institutions are looking for an end-to-end network that can deliver consistent, sophisticated services around the world; one point of contact; standardized pricing; global reliability; and a single bill. Serving these customers accounts for 5 to 10 percent of the total world telecommunications market. And the margins in this business seem sustainable because they depend on the scope and complexity of customers needs which few carriers can meet and not on regulation or protected markets. The big question is, how many companies can prosper by pursuing this strategy? Realistically, fewer than 1,000 customers demand such complex networks and elaborate service. What is more, the level of investment required to address their needs is huge: a global network with at least 100 points of presence; localaccess networks or partnerships to provide interconnection in numerous countries; leading-edge products supported in each location; global network management; and a global sales and field service presence. Ultimately, we expect that only three or four global competitors (and perhaps a few regional players in areas such as South America and South Asia) will succeed in this market. Strategy 5. Becoming a Global Carriers Carrier The other area where we see considerable potential, at least in the near term, is the provision of global

7 network capacity to meet the expanding network needs of the telecom companies that are springing up around the world. The continued deregulation of telecom monopolies and the burgeoning demand for Internet access have created a wave of new national and regional carriers, including hundreds of Internet service providers (ISPs). At the same time, IT service companies such as IBM and Unisys are building applications that operate worldwide, but many of these companies do not have their own global networks. Recent advances in fiber-optic transmission make it possible to build new networks with huge capacity and, assuming the capacity is utilized, dramatically reduced unit costs. New global backbone networks are being built to exploit this opportunity. And new satellite networks are planned, such as Teledesic and Hughes Spaceway, which will offer high-speed access and bandwidth on demand anywhere on the globe. In many cases, the fastest route to filling these huge new networks will be selling large blocks of traffic to other telcos. As a result, a wholesale, or carrier s carrier, market is emerging. The hottest part of this market is Internet protocol (IP) traffic for both Internet access and private networks. ISPs in many countries pay dearly for lowquality Internet access: they are often forced to buy connections to the Internet backbone from incumbent telcos at prices based on voice telephony, which are roughly ten times higher than prices for Internet connections. In developing countries, these circuits are frequently overloaded. The new carriers carriers offer a high-bandwidth IP connection to the Internet backbone, which dramatically improves both the economics and performance of Internet access. The fundamental question about this strategy is not whether there is a viable market but how many com-

8 panies can make money in this business and for how long. In contrast to the limited opportunities to serve multinational customers, the barriers to becoming a global carriers carrier are low. In recent years, investors have poured billions of dollars into global fiber-optic networks. For example, Global Crossing emerged out of nowhere two years ago to become an early leader in the race to build a global carriers carrier backbone. Level 3, KPN/Qwest, and GTS (which acquired Esprit) are close behind, and integrated global carriers such as MCI WorldCom are building their own backbones. Such network investments will produce a surge in global capacity. Yet the universality and flexibility of IP technology are likely to turn the newer networks into commodities, triggering the kind of rapid downward price spiral now occurring in the United States, where longdistance rates in major commercial contracts will soon be less than one cent per minute. The global carriers carrier market is a bonanza in the near term, as early entrants capture latent demand and arbitrage opportunities created by the old bilateral settlements regime. But it will likely become a hypercompetitive commodity market in the medium to long term. A Hard Look at Globalization While the idea of globalization is alluring, many telcos have been disappointed. In some cases, their local partners have performed poorly; in other instances, they themselves have failed to establish coherent global operations. Many efforts have resulted in a string of isolated investments with little strategic logic and average returns. Moreover, some of the most successful globalization strategies have been driven by privatization and by international arbitrage opportunities that are now ending.

9 Today s highly competitive telecommunications environment and intense level of investor scrutiny have raised the performance bar for globalization strategies. Before investing heavily to become global, carriers need to take a hard-nosed look at the economic and competitive logic. Does the company have a strategy that will create lasting value and advantage, and can the company outperform the numerous competitors with similar aspirations and deep pockets? We believe that the answer will be yes in only a few instances. Most telcos will be better off letting carriers carriers make global backbone investments so that they can focus on owning customers. To do that, they will need to provide high-quality access, integrate domestic and international services, and seize the opportunities created by the death of distance and the explosion of bandwidth. Craig Moffett Todd Hixon Craig Moffett is a vice president in the New York office of The Boston Consulting Group. Todd Hixon is a senior vice president in the firm s Boston office. You may contact the authors by at: moffett.craig@bcg.com hixon.todd@bcg.com The Boston Consulting Group, Inc BCG

10 Amsterdam Atlanta Auckland Bangkok Berlin Boston Brussels Budapest Buenos Aires Chicago Copenhagen Dallas Düsseldorf Frankfurt Hamburg Helsinki Hong Kong Jakarta Kuala Lumpur Lisbon London Los Angeles Madrid Melbourne Mexico City Milan Monterrey Moscow Mumbai Munich New York Oslo Paris San Francisco São Paulo Seoul Shanghai Singapore Stockholm Stuttgart Sydney Tokyo Toronto Vienna Warsaw Washington Zürich 11/99