Should the Telecom Industry Diversify or Focus?

Transcription

1 Research Brief Should the Telecom Industry Diversify or Focus? Abstract: A decision framework to evaluate alternative strategies of diversification or focus provides telecommunications companies a structured methodology to pursue growth opportunities. By Mike Harris Recommendations Telecommunications companies must utilize a consistent framework to evaluate, prioritize and measure the success of focus or diversification strategies. Telecommunications companies must carefully manage product and market portfolios to achieve the best-available mix of growth and maturing business. Recognize that bigger is not always better. Large acquisitions and mergers fail more often than not; challenge assumptions of synergy when potential conflicts appear. Publication Date:20 January 2003

2 2 Should the Telecom Industry Diversify or Focus? Crisis and Opportunity The global telecommunications industry is in crisis. One trillion dollars in debt has been accumulated by operators to fund infrastructure expansion and spectrum licenses. Total wireline services revenue grew an anemic 3.5 percent in 2002, while wireless services revenue grew less than 13 percent over the same period hardly the meteoric growth rates needed to fund interest on that debt (see "Telecommunications Services Limp Along in 2003" (TELC-WW-DP-0268) and "Many Challenges Remain for Mobile Communications," (TELC-WW-DP-0270). The result has been more than $100 billion in bankruptcies over the past 24 months. There has been a massive retrenchment in the industry, as companies exited lines of business, geographic markets or joint ventures. All of these recent changes in strategic direction make industry observers, customers and investors question just how telecom companies decide to focus or diversify their interests. Clearly, a broad spectrum of options is available to telecom executives. To simplify this array of options and construct a practical decision-making framework, we have identified the following two fundamental strategies: Diversification A strategy of diversification provides a more predictable, reliable revenue and income stream, as cyclical downturns in one business segment may be offset by a cyclical upturn in another. Focus A focused strategy directs all the company's resources to a narrow field of opportunities markets, products or regions with the intent of dominating that segment and capturing exceptional revenue growth or margins. No company pursues a pure diversification or a pure focus strategy. Issues of risk mitigation, portfolio management and resource allocation across a mix of products and markets must all be considered. Yet, by understanding these fundamental strategies and applying a consistent framework to decisions for investment or divestment, telecom executives can chart a strategically coherent approach to growing the business. Figure 1 depicts the bases on which a company can focus or diversify. Broadly speaking, a company must examine what it provides (its products) and where it provides them (its markets). Providing one product to one small market is as untenable in the long term as providing all products to all markets. The former restricts revenue growth and exposes the company to high risk, while the latter requires more resources than any one company can effectively manage.

3 3 Figure 1 Focus vs. Diversification Full Service: Provide Complete Portfolio of Services Diversified Companies Local/Single Market Segment Market: Where you deliver Global/All Market Segments Focused Companies Portfolio: What you deliver Expert: Do One Thing Really Well Source: Gartner Dataquest (January 2003) Carriers have the opportunity to become masters of their chosen domain. Should carriers emulate Singtel and seek to provide a broad array of regional communications, information, transaction and entertainment services, delivered over a variety of fixed and mobile infrastructures? Or should they emulate AT&T and separate their broadband, wireless, consumer and enterprise businesses to achieve greater focus on each individual market? To help answer these questions, Gartner has developed a decision framework that identifies the fundamental rationale for focus and diversification strategies and enables executives to prioritize their available options against these key indicators of success. After all, there is no single "right answer" for strategic planning. A company shouldn't always focus or diversify but it should have a consistent set of criteria applied to its decision making to guide the process. An empirically grounded, consistent methodology for developing strategy is invaluable. In associated pieces, Gartner examines several examples of focus and diversification strategies employed by communications service providers from around the world. Using the decision framework, we rate the performance of those strategies to measure their efficacy. Most communications service providers employ a mix of focus and diversification strategies, depending on levels of regulatory reform, growth opportunities in different markets and financial resources

4 4 Should the Telecom Industry Diversify or Focus? available. Fundamentally, however, successful companies meet the success criteria identified. Decision Framework Figure 2 Product/Market Life Cycle Companies must consider where their products and selected markets lie along the life cycle. Overconcentration on emerging markets can lead to cash flow problems, as revenue trails investments in research and marketing; overconcentration on mature markets can lead to cash flow problems as operating margins are squeezed by price competition and commoditization. Striking an appropriate portfolio of products and markets along this life cycle is a critical consideration (see Figure 2).Type A customers are early adopters; Type B customers are mainstream adopters; and Type C customers are late adopters of technology. Revenue Adoption by Type A customers only Specialists High focus High revenue growth Initial adoption by Type B customers High revenue growth Margin growth through operational efficiency improvements Mainstream adoption by Type B customers Market consolidation Verticalized penetration Standardization Broad-based services Adoption by Type C customers; Type As have moved on Legacy support Maintain existing customers to sell them newer, highmargin add-on services Emerging Growth Mature Declining Time Source: Gartner Dataquest (January 2003) Of course, in the short term, no firm is so flexible that it can precisely choose its optimal portfolio mix. Inhibitors such as debt load, regulatory constraints and tight capital markets make it difficult to diversify into all desired businesses, for example. But in the long term, communications providers must determine if they will provide: Enterprise vs. consumer-oriented services Regional vs. global capabilities Retail vs. wholesale services Wireless vs. wireline services

5 5 Content vs. transport Applications, hosting, professional services or other services Utilizing a consistent framework and carefully monitoring results with some fundamental benchmarks can provide companies with a decision tool set to be applied to all focus and diversification considerations. Table 1 outlines the strategy for focusing on a narrow range of opportunities. Table 2 indicates the objectives and actions for a diversification strategy. Table 1 Focus Strategy Strategic Objective Actions Required Metrics of Success Examples Compete only in markets with higher gross margins Sustain fast-growing revenue Gain first-mover advantages and capture market share Execute flawlessly on a focused market Source: Gartner Dataquest (January 2003) NPV = net present value ROI = return on investment Reinvest earnings in R&D Emphasize new product development over product management Sustain price premiums over competing, but older, products Exit/divest slowing business areas Spin off from slower growing parent companies to focus resources Closely align product development, marketing and sales for rapid deployment Avoid temptation to rapidly diversify into related areas Ensure supply chain is controlled via tight contractual commitments to avoid delays, problems Closely manage investment/return horizon. Competitor's entry or regulatory obstacles can quickly extend payback period. R&D/revenue ratio should exceed 75 percent of competitors. Accelerated new product introduction cycles Products/services with less than average margin are moved out of portfolio within 12 months. Products/services with less than average revenue growth are moved out of portfolio within 12 months. Market share leader in selected businesses Focused targeting of emerging markets Payback period, NPV or ROI analyses will vary by company and by strategy. The key is to carefully monitor market changes and adjust business case to ensure it still supports the strategy Discounted cash flow analysis should include a high-risk premium for very focused strategies. Teleport Communications Group deployed metro optical services targeting dense, highmargin business services (was acquired by AT&T in 1998). Several wireless operators structured separately from slower-growth parent companies (that is, Cingular, AT&T Wireless) Infonet has focused exclusively on managed packet data services since its origins in Yipes (U.S. metro Ethernet provider) grew revenue 61 percent in 2001, filed for bankruptcy in March 2002, and recently emerged from bankruptcy. It is an excellent example of a focused company with a strong business plan that did not sufficiently manage its investment return horizon.

6 6 Should the Telecom Industry Diversify or Focus? Table 2 Diversification Strategy Strategic Objective Actions Required Metrics of Success Examples Achieve operational efficiency and synergies through increased scale Manage portfolio of products to sustain predictable, growing revenue stream Control supply chain Control distribution channel to maintain price levels and limit competitive inroads Grow ROIC Notes: CDMA = code division multiple access SG&A = sales, general and administrative ROIC = return on invested capital TDMA = time division multiple access Source: Gartner Dataquest (January 2003) Integrate infrastructure, processes and systems for network operations, IT Establish a common brand, marketing campaigns Enter multiple geographies (reduce risk of regional downturn) Diversify into multiple market segments (that is, public sector growth may balance financial services slowdown) Manage technology risk by investing in competing standards (that is, CDMA and TDMA) When diversifying into immature products, controlling supply chain may be critical to ensure sufficient inventory or integrated design Acquire or ally with a consulting/products/services company to pull through network sales Leverage established infrastructure, customer relationships to provide additional services over common distribution methods Quantifiable reductions in SG&A, operations expense Products/markets are arrayed along the life cycle to ensure steady pipeline of growth. Have no revenue and/or profit dependency on a single product or service (that is, no single product contributes more than 25 percent of total revenue) Consistently beat competitors to market Control critical components in the manufacture or creation of products and services Growing ratio of joint sales/proposals (alliance) Costs of sales reduced Revenue-per-client growth ROIC growth Vodafone has equity interest in mobile communications networks in 28 countries across five continents. Tele2 AB manages a portfolio of companies and products across six market areas (geographies). Vodafone acquired Vizzavi for a mobile portal and created the "Vodafone Live!" brand Sprint purchased Paranet; Qwest created Qwest CyberSolutions with KPMG Consulting; SBC acquired Sterling Commerce. AT&T Universal Card a consumer credit card that is also a calling card AT&T managed network services provide additional services to established data network customers Gartner Dataquest Perspective Telecommunications executives are often whipsawed from one strategy to another in search of ever-elusive shareholder value optimization. The problem with pursuing the strategy du jour, of course, is that strategic and organizational change is difficult to implement; the cost in lost efficiency, valuation and jobs can be tremendous. In the past two years, telecom operators and equipment vendors have laid off more than 500,000 people in the United States alone, according to figures from Challenger, Gray & Christmas, an outplacement firm. While the extent of the downturn was largely unforeseen, careful management of diversification or focus strategies would have lessened the blow for many companies.

7 7 Executives should pursue focus or diversification strategies appropriate for their company's particular comparative advantages. In many cases, a combination of the two will be required to support overall corporate diversification, combined with discrete focus within a given market. The key to success is to identify appropriate metrics and then structure implementation and monitoring of progress to ensure performance. By applying a consistent framework to evaluate the merits and performance of such options, employees, customers and shareholders would be better able to align operational tactics and performance expectations to achieve long-term growth. Key Issues How will the worldwide communications market develop, and which forces will drive market growth and future opportunities in which sectors? How will strategic alliances and mergers reshape markets?

8 8 Should the Telecom Industry Diversify or Focus? This document has been published to the following Marketplace codes: TELC-WW-DP-0288 For More Information... In North America and Latin America: In Europe, the Middle East and Africa: In Asia/Pacific: In Japan: Worldwide via gartner.com: Entire contents 2003 Gartner, Inc. and/or its Affiliates. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice