Telecommunications

Telecommunications

1. Introduction

The telecommunications industry is a fast growing sector. According to the International Telecommunication Union (ITU), industry revenues have steadily increased to reach an all-time high of $1.37 trillion in 2003. There are 1.2 billion fixed telephone lines, and 1.3 billion people carry mobile phones of decreasing size and increasing complexity. Around 665m people now have access to the internet. Consumer spending on telecommunications is growing faster than spending in any other category.

Globally, one person in five now has a mobile phone; in parts of Europe and Asia, where mobiles are most popular, around 80% of the population - or everyone between the ages of 10 and 80 - carries one. America is a laggard, with mobile-phone penetration at around 50%, but it is catching up. Nokia has become the world's largest handset maker, with nearly 40% of the market. Today's most advanced mobile phones are tiny. They are, in effect, pocket computers, and include all kinds of new features such as still and video cameras, colour screens, internet access and games.

Mobile telephony is growing fastest in the developing world, where many people's first phone is a mobile. Wireless networks can be established more quickly and cheaply than wired ones, because there is no need to run a wire into every subscriber's home. Mobile phones are booming in China, which now has more than 200m subscribers - a larger number than any other country - and is adding new ones at the rate of 5m a month. But mobile penetration is still low, at only 18%, so this growth will continue for the rest of the decade. There is also vast scope for growth in India, where penetration is just 1% but mobile phones are at last taking off. According to Telecompetition, a market-research firm, China and India will account for 60% of new mobile subscribers between now and 2010.

Another booming region is central and eastern Europe, where mobile telephony provides a way to bypass fixed-line infrastructure from the Soviet era. Once a mobile network is up and running, all that subscribers have to do is buy a handset. Pre-paid cards and the sharing of handsets among many users have brought telephony within almost universal reach.

2. What are the problems in the sector?

Despite all these good signs, over the past couple of years, fraud, bankruptcy, debt and destruction of shareholder value have become widespread in the industry. Dozens of firms have gone bankrupt, including Global Crossing, 360networks, Williams Communications, Viatel and WorldCom, whose bankruptcy last year was the biggest ever. Hundreds of thousands of workers in the industry, and particularly at telecoms-equipment makers, have lost their jobs.

3. What caused the problems?

Although the industry has continued to grow, it has not done so in the manner, and above all not to the extent that those in the industry expected. Telecoms is an infrastructure-intensive business, and because infrastructure takes a long time to build, telecoms firms have to predict  future demand. However, demand was overestimated in the late 1990s.

The rise of the internet persuaded many investors that demand for data-network capacity across continents was about to explode. Since 1997, internet traffic has roughly doubled every year. Much of the industry, however, was convinced that traffic was doubling every 100 days. Dozens of firms rushed to build new fibreoptic networks in America, Europe and Asia. But apart from a brief period in 1995-96, the figure was simply wrong.

As upstart firms spent on vast infrastructure investments, the incumbents in many countries tried to transform themselves into global operators. They expanded their existing networks and bought stakes in foreign operators, running up debts in the process. Meanwhile, European firms thought that the expected increase in demand for fixed-communications capacity would be accompanied by a similar increase in demand for mobile capacity, and paid 109 billion ($125 billion) for licences to operate 'third-generation' (3G) mobile networks. They, too, took on debts and they were wrong as they overestimated demand.

Around $150 billion was spent building unnecessary telecoms networks in America and another $50 billion in other parts of the world.

When it became clear that the predicted explosion of demand was not going to happen, operators frantically cut their prices. Equipment-makers' sales collapsed and their share prices tumbled. Companies started to use illegal means to avoid bankruptcy and keep investors. WorldCom set a new record for accounting fraud, misclassifying capital expenditure as operating costs and overstating profits by $11 billion. When it was found out, the company crashed spectacularly.

3. SMS

Texting first took off among cost-conscious teenagers. More than one billion text messages are now sent every day around the world, at an average cost of around 10 cents. Ringtones and screen logos can also be delivered by text message, but cost more. All these messages add up to a huge industry that generates about $40 billion a year.

The average mobile-phone subscriber sends 30 messages a month, though in some countries the figure is far higher (250 messages a month in Singapore) and in others lower (seven messages a month in America).

Outside America, the success of texting has been a godsend for operators. Text messages, which are limited to 160 characters in length, require minuscule amounts of network capacity and are hugely lucrative. Text-messaging now accounts for 20% of some operators' revenues, a windfall that has helped to make up for declining revenues from voice calls.

4. WAP

The trouble began with Wireless Access Protocol (WAP), a simple form of web-browsing designed for mobile phones, which was introduced by operators worldwide from 1999. WAP was described as a mobile version of the internet, when in fact it was nothing of the sort. Establishing a connection on a WAP phone and downloading any of the limited content available took far too long, and mobile handsets had tiny monochrome screens, which further heightened users' frustration. No wonder WAP was a flop.

5. 3D technology

Yet the industry went on making the same mistake, promoting technologies rather than creating useful services using those technologies. In 2000, this obsession with new technology caused Europe's mobile-phone industry to get carried away in buying licences to operate third-generation (3G) mobile networks, which can support higher voice capacity and faster data downloads than existing 2G networks. European operators agreed to pay a total of 109 billion ($125 billion) for 3G licences.

It soon became clear that paying so much for 3G licences had been a huge mistake. As their share prices collapsed, mobile operators wrote down the value of their 3G licences. Some even handed the licences back to the governments from which they had bought them, rather than commit themselves to building expensive new 3G networks.

But whereas 3G has so far proved an expensive mistake, text-messaging has been a spectacular success, showing that consumers are prepared to use their phones for more than just voice calls after all. Texting took off unexpectedly, without any marketing by operators, but it has now become a core part of their businesses. For users, the appeal of texting is that it is a simple, quick and unobtrusive way to send someone a message, usually for less than the cost of a voice call.

There are now promising signs that mobile operators have learned from the failure of WAP and the success of texting. The industry has devised a new plan to encourage customers to adopt data services and thus, it hopes, make a smooth transition to 3G. The breakthrough is that operators are now talking about services, not technology as customers are more interested in services than technology.

The basic idea is the same for all of them: subscribers get a fancy handset with a large colour screen and usually a built-in camera. The phone is pre-configured with menus and bookmarks offered only by that particular operator, making it easy to download games and access news and other information. As well as being able to send and receive text messages, subscribers with camera phones can also swap photos. All of these services are bundled together for a monthly fee. .

6. DSL services

Just as their voice businesses have declined in an intense competition with mobile operators, however, a new market has opened up for fixed-line operators: broadband internet access. By installing special equipment at telephone exchanges, operators can supercharge old-fashioned telephone wires and turn them into fast broadband pipes, using digital subscriber line (DSL) technology. Subscribers in Europe and America typically pay around $50 a month for a DSL connection, so this provides a valuable new source of revenue for fixed-line operators. Around the world, DSL is booming and has become the dominant means of providing broadband access to homes and small businesses.

Indeed, the technology can help to dissuade customers from giving up their landline telephones, since it uses an existing telephone line which can still be used to make calls. Fixed-line operators are now repositioning themselves as broadband operators.

Embracing DSL requires incumbent fixed-line operators to do the same as mobile operators: to switch from a predominantly voice-based business to one in which voice and data are equal partners. That entails a learning process for operators and, as with mobile data services, it means pricing and marketing broadband to appeal to the widest possible audience.

Although broadband is growing fast, in most places this is not fast enough to offset the decline of voice, which accounts for 70-90% of most fixed-line operators' revenues. If they can move a significant proportion of their customers over to broadband, however, operators should be able to offer a range of new data services.

7. What is the future of the sector?

For the past couple of years, telecoms operators have concentrated on restructuring debt, cutting costs, backing out of bad investments, cleaning up balance sheets and trying to hold on to their customers. New management has been installed almost everywhere.

New opportunities for the industry seem to lie in exploiting three main trends.

1. The most visible growth area is the continuing rise of mobile phones, which have overtaken fixed-line phones to become the most widespread communications devices on earth. Their number is expected to rise from 1.3 billion today to 2 billion by 2007, and they are being increasingly used to do much more than make phone calls, providing new opportunities for wireless operators and equipment makers.
2. The second trend is the growth of high-speed or 'broadband' internet access, which is booming in many parts of the world. This offers a valuable new market for fixed-line operators to compete with mobile operators.
3. A third promising area is in the corporate-telecoms market. As large firms look for ways to cut costs and move operations overseas, many are adopting new internet-based technologies that can interconnect regional offices cheaply and securely and allow voice and data to flow over the same network. Many operators are now overhauling and simplifying their networks to ensure they can implement such 'next-generation services' quickly and efficiently.

All three areas involve difficult transitions for telecoms operators. But the mobile-phone industry cannot rely on subscriber growth forever. Eventually everyone who wants a mobile phone will have one, as has already happened in parts of Europe and Asia, at which point a new source of growth will be needed. The continued health of the mobile-telephony industry depends on being able to deliver data services alongside voice calls, revenues from which are flat or declining. Creating and delivering multimedia services to mobile handsets is, however, proving to be a lot more complicated than simply providing telephony. Similarly, fixed-line operators offering broadband internet connections are having to work harder to provide both data and voice services than voice services alone. And in the corporate market the operators face a new challenge: the increasing overlap between telecoms and information technology (IT). If they are to offer next-generation services such as Internet hosting or call-centre outsourcing, network operators must improve their expertise in IT or form partnerships with systems integrators. Equipment vendors also face problems as mobile, broadband and next-generation services require new equipment.

In short, there are still opportunities in telecoms - but not where they were during the boom. The experience of the past couple of years has demonstrated that there is more to being a telecoms operator than simply owning a network. The best prospects revolve around providing complex services, not merely capacity. Transformation seems to more important than construction. Only by embracing this new reality will the industry find a way out of its troubles.

Source: The Economist: A Survey of Telecoms Oct. 11 2003