Source: Company accounts; STL Partners analysis
Telecoms operator strategies have been centred around transformation, yet change has been slow. STL Partners believes CFO resource allocation models are limiting telco agility and innovation – the goals of transformation.
Telecoms operators have been investing capital in ‘scarce’ spectrum and fibre networks to provide value to customers and keep competitors out – they have been “building moats”. At the same time, third parties have been breaching these moats and diverting value away from telcos by providing network-independent “differentiating services” to telco customers. Telco revenues and margins are declining as net debt – due to capital expenditure – continues to rise.
STL Partners mapped out the relationship between financial and commercial models, revealing that telcos are classic “Moat builders”, making money from capital investment in infrastructure and investing little in R&D. Telcos are are radically out-invested in service innovation by tech players. Internet giants and tech players typically start out as “service differentiators”, keeping capital investment light and instead focusing on flexible operating expenditure to drive service innovation. Increasingly, “service differentiators” are investing capital in cloud computing infrastructure, to construct “moats” to protect their services – giving them cheaper distribution and better customer experience than smaller competitors.
Business owners within operators recognise the need for their organisation to become more agile, more flexible, more innovative which implies having resources that can be (re)deployed quickly, but they find it hard to secure budget owing to the huge and slow capital investment programmes involved in upgrading networks. Finance departments at the same organisations want to deploy resources efficiently to maximise returns – and capital investment in the existing business model (infrastructure that drives connectivity revenue) has a much stronger ROI than speculative operating expenditure in platforms and services that have (so far) proved unsuccessful. The result is status quo: the same financial model drives the same commercial model at a time when returns for core services are reducing every year.
Greater telco investment is needed in platform and service innovation to capture value and ensure future growth: There is a need to increase R&D and other operating expenditure, while limiting pure “infrastructure” spend (i.e. capital investment in 5G, fibre and other network improvements should reduce). CFOs could look to market capitalization as validation of this requirement. The market capitalization of seven internet giants’ (Google, Apple, Facebook, Amazon, Microsoft, Tencent, Alibaba) is bigger than 165 telecoms operators combined – the market assessment is that:
Service innovation + moats = Revenue + profit growth = Future value creation
In other words, telcos’ current business models (financial and commercial models) are not deemed to be strong value creators according to the capital markets.
In future, CFOs need to balance short-term (investor) requirements for yield now and the longer-term growth prospects of the business and ensure that resources are gradually shifted from capital investment into operating expenditure (service innovation). CFOs play a key role in changing the status quo.