Driving the agility flywheel: the stepwise journey to agile

Agility is front of mind, now more than ever

Telecoms operators today face an increasingly challenging market, with pressure coming from new non-telco competitors, the demands of unfamiliar B2B2X business models that emerge from new enterprise opportunities across industries and the need to make significant investments in 5G. As the telecoms industry undergoes these changes, operators are considering how best to realise commercial opportunities, particularly in enterprise markets, through new types of value-added services and capabilities that 5G can bring.

However, operators need to be able to react to not just near-term known opportunities as they arise but ready themselves for opportunities that are still being imagined. With such uncertainty, agility, with the quick responsiveness and unified focus it implies, is integral to an operator’s continued success and its ability to capitalise on these opportunities.

Traditional linear supply models are now being complemented by more interconnected ecosystems of customers and partners. Innovation of products and services is a primary function of these decentralised supply models. Ecosystems allow the disparate needs of participants to be met through highly configurable assets rather than waiting for a centralised player to understand the complete picture. This emphasises the importance of programmability in maximising the value returned on your assets, both in end-to-end solutions you deliver, and in those where you are providing a component of another party’s system. The need for agility has never been stronger, and this has accelerated transformation initiatives within operators in recent years.

Concepts of agility have crystallised in meaning

In 2015, STL Partners published a report on ‘The Agile Operator: 5 key ways to meet the agility challenge’, exploring the concept and characteristics of operator agility, including what it means to operators, key areas of agility and the challenges in the agile transformation. Today, the definition of agility remains as broad as in 2015 but many concepts of agility have crystallised through wider acceptance of the importance of the construct across different parts of the organisation.

Agility today is a pervasive philosophy of incremental innovation learned from software development that emphasises both speed of innovation at scale and carrier-grade resilience. This is achieved through cloud native modular architectures and practices such as sprints, DevOps and continuous integration and continuous delivery (CI/CD) – occurring in virtuous cycle we call the agility flywheel.

The Agility Flywheel

agility-flywheel

Source: STL Partners

Six years ago, operators were largely looking to borrow only certain elements of cloud native for adoption in specific pockets within the organisation, such as IT. Now, the cloud model is more widely embraced across the business and telcos profess ambitions to become software-centric companies.

Same problem, different constraints

Cloud native is the most fundamental version of the componentised cloud software vision and progress towards this ideal of agility has been heavily constrained by operators’ underlying capabilities. In 2015, operators were just starting to embark on their network virtualisation journeys with barriers such as siloed legacy IT stacks, inelastic infrastructures and software lifecycles that were architecture constrained. Though these barriers continue to be a challenge for many, the operators at the forefront – now unhindered by these basic constraints – have been driving a resurgence and general acceleration towards agility organisation-wide, facing new challenges around the unknowns underpinning the requirements of future capabilities.

With 5G, the network itself is designed as cloud native from the ground up, as are the leading edge of enterprise applications recently deployed by operators, alleviating by design some of the constraints on operators’ ability to become more agile. Uncertainty around what future opportunities will look like and how to support them requires agility to run deep into all of an operators’ processes and capabilities. Though there is a vast raft of other opportunities that do not need cloud native, ultimately the market is evolving in this direction and operators should benchmark ambitions on the leading edge, with a plan to get there incrementally. This report looks to address the following key question:

Given the flexibility and driving force that 5G provides, how can operators take advantage of recent enablers to drive greater agility and thrive in the current pace of change?

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Table of Contents

  • Executive Summary
  • Agility is front of mind, now more than ever
    • Concepts of agility have crystallised in meaning
    • Same problem, different constraints
  • Ambitions to be a software-centric business
    • Cloudification is supporting the need for agility
    • A balance between seemingly opposing concepts
  • You are only as agile as your slowest limb
    • Agility is achieved stepwise across three fronts
    • Agile IT and networks in the decoupled model
    • Renewed need for orchestration that is dynamic
    • Enabling and monetising telco capabilities
    • Creating momentum for the agility flywheel
  • Recommendations and conclusions

The Telco Cloud Manifesto

Telco cloud: A key enabler of the Coordination Age

The Coordination Age is coming

As we have set out in our company manifesto, STL Partners believes that we are entering a new ‘Coordination Age’ in which technological developments will enable governments, enterprises, and consumers to coordinate their activities more effectively than ever before. The results of better and faster coordination will be game-changing for society as resources are distributed and used more effectively than ever before leading to substantial social, economic, and health benefits.

A critical component of the Coordination Age is the universal availability of flexible, fast, reliable, low-latency networks that support a myriad of applications which, in turn, enable a complex array of communications, decisions, transactions, and processes to be completed quickly and, in many cases, automatically without human intervention.  The network remains key: without it being fit for purpose the ability to match demand and supply real-time is impossible.

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How telecoms can define a new role

Historically, telecoms networks have been created using specialist dedicated (proprietary) hardware and software.  This has ensured networks are reliable and secure but has also stymied innovation – from operators and from third-parties – that have found leveraging network capabilities challenging.  In fact, innovation accelerated with the arrival of the Internet which enabled services to be decoupled from the network and run ‘over the top’.

But the Coordination Age requires more from the network than ever before – applications require the network to be flexible, accessible and support a range of technical and commercial options. Applications cannot run independently of the network but need to integrate with it. The network must be able to impart actionable insights and flex its speed, bandwidth, latency, security, business model and countless other variables quickly and autonomously to meet the needs of applications using it.

Telco cloud – the move to a network built on common off-the-shelf hardware and flexible interoperable software from best-of-breed suppliers that runs wherever it is needed – is the enabler of this future.

 

Table of Contents

  • Executive Summary
  • Telco cloud: A key enabler of the Coordination Age
    • The Coordination Age is coming
    • How telecoms can define a new role
  • Telco cloud: The growth enabler for the telecoms industry
    • Telecoms revenue growth has stalled, traffic has not
    • Telco cloud: A new approach to the network
    • …a fundamental shift in what it means to be an operator
    • …and the driver of future telecoms differentiation and growth
  • Realising the telco cloud vision
    • Moving to telco cloud is challenging
    • Different operator segments will take different paths

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Telco edge computing: How to partner with hyperscalers

Edge computing is getting real

Hyperscalers such as Amazon, Microsoft and Google are rapidly increasing their presence in the edge computing market by launching dedicated products, establishing partnerships with telcos on 5G edge infrastructure and embedding their platforms into operators’ infrastructure.

Many telecoms operators, who need cloud infrastructure and platform support to run their edge services, have welcomed the partnership opportunity. However, they are yet to develop clear strategies on how to use these partnerships to establish a stronger proposition in the edge market, move up the value chain and play a role beyond hosting infrastructure and delivering connectivity. Operators that miss out on the partnership opportunity or fail to fully utilise it to develop and differentiate their capabilities and resources could risk either being reduced to connectivity providers with a limited role in the edge market and/or being late to the game.

Edge computing or multi-access edge computing (MEC) enables processing data closer to the end user or device (i.e. the source of data), on physical compute infrastructure that is positioned on the spectrum between the device and the internet or hyperscale cloud.

Telco edge computing is mainly defined as a distributed compute managed by a telco operator. This includes running workloads on customer premises as well as locations within the operator network. One of the reasons for caching and processing data closer to the customer data centres is that it allows both the operators and their customers to enjoy the benefit of reduced backhaul traffic and costs. Depending on where the computing resources reside, edge computing can be broadly divided into:

  • Network edge which includes sites or points of presence (PoPs) owned by a telecoms operator such as base stations, central offices and other aggregation points on the access and/or core network.
  • On-premise edge where the computing resources reside at the customer side, e.g. in a gateway on-site, an on-premises data centre, etc. As a result, customers retain their sensitive data on-premise and enjoy other flexibility and elasticity benefits brought by edge computing.

Our overview on edge computing definitions, network structure, market opportunities and business models can be found in our previous report Telco Edge Computing: What’s the operator strategy?

The edge computing opportunity for operators and hyperscalers

Many operators are looking at edge computing as a good opportunity to leverage their existing assets and resources to innovate and move up the value chain. They aim to expand their services and revenue beyond connectivity and enter the platform and application space. By deploying computing resources at the network edge, operators can offer infrastructure-as-a-service and alternative application and solutions for enterprises. Also, edge computing as a distributed compute structure and an extension of the cloud supports the operators’ own journey into virtualising the network and running internal operations more efficiently.

Cloud hyperscalers, especially the biggest three – Amazon Web Services (AWS), Microsoft Azure and Google – are at the forefront of the edge computing market. In the recent few years, they have made efforts to spread their influence outside of their public clouds and have moved the data acquisition point closer to physical devices. These include efforts in integrating their stack into IoT devices and network gateways as well as supporting private and hybrid cloud deployments. Recently, hyperscalers took another step to get closer to customers at the edge by launching platforms dedicated to telecom networks and enabling integration with 5G networks. The latest of these products include Wavelength from AWS, Azure Edge Zones from Microsoft and Anthos for Telecom from Google Cloud. Details on these products are available in section.

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From competition to coopetition

Both hyperscalers and telcos are among the top contenders to lead the edge market. However, each stakeholder lacks a significant piece of the stack which the other has. This is the cloud platform for operators and the physical locations for hyperscalers. Initially, operators and hyperscalers were seen as competitors racing to enter the market through different approaches. This has resulted in the emergence of new types of stakeholders including independent mini data centre providers such as Vapor IO and EdgeConnex, and platform start-ups such as MobiledgeX and Ori Industries.

However, operators acknowledge that even if they do own the edge clouds, these still need to be supported by hyperscaler clouds to create a distributed cloud. To fuel the edge market and build its momentum, operators will, in the most part, work with the cloud providers. Partnerships between operators and hyperscalers are starting to take place and shape the market, impacting edge computing short- and long-term strategies for operators as well as hyperscalers and other players in the market.

Figure 1: Major telco-hyperscalers edge partnerships

Major telco-hyperscaler partnerships

Source: STL Partners analysis

What does it mean for telcos?

Going to market alone is not an attractive option for either operators or hyperscalers at the moment, given the high investment requirement without a guaranteed return. The partnerships between two of the biggest forces in the market will provide the necessary push for the use cases to be developed and enterprise adoption to be accelerated. However, as markets grow and change, so do the stakeholders’ strategies and relationships between them.

Since the emergence of cloud computing and the development of the digital technologies market, operators have been faced with tough competition from the internet players, including hyperscalers who have managed to remain agile while building a sustained appetite for innovation and market disruption. Edge computing is not an exception and they are moving rapidly to define and own the biggest share of the edge market.

Telcos that fail to develop a strategic approach to the edge could risk losing their share of the growing market as non-telco first movers continue to develop the technology and dictate the market dynamics. This report looks into what telcos should consider regarding their edge strategies and what roles they can play in the market while partnering with hyperscalers in edge computing.

Table of contents

  • Executive Summary
    • Operators’ roles along the edge computing value chain
    • Building a bigger ecosystem and pushing market adoption
    • How partnerships can shape the market
    • What next?
  • Introduction
    • The edge computing opportunity for operators and hyperscalers
    • From competition to coopetition
    • What does it mean for telcos?
  • Overview of the telco-hyperscalers partnerships
    • Explaining the major roles required to enable edge services
    • The hyperscaler-telco edge commercial model
  • Hyperscalers’ edge strategies
    • Overview of hyperscalers’ solutions and activities at the edge
    • Hyperscalers approach to edge sites and infrastructure acquisition
  • Operators’ edge strategies and their roles in the partnerships
    • Examples of operators’ edge computing activities
    • Telcos’ approach to integrating edge platforms
  • Conclusion
    • Infrastructure strategy
    • Platform strategy
    • Verticals and ecosystem building strategy

 

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Telco ecosystems: How to make them work

The ecosystem business framework

The success of large businesses such as Microsoft, Amazon and Google as well as digital disrupters like Airbnb and Uber is attributed to their adoption of platform-enabled ecosystem business frameworks. Microsoft, Amazon and Google know how to make ecosystems work. It is their ecosystem approach that helped them to scale quickly, innovate and unlock value in opportunity areas where businesses that are vertically integrated, or have a linear value chain, would have struggled. Internet-enabled digital opportunity areas tend to be unsuited to the traditional business frameworks. These depend on having the time and the ability to anticipate needs, plan and execute accordingly.

As businesses in the telecommunications sector and beyond try to emulate the success of these companies and their ecosystem approach, it is necessary to clarify what is meant by the term “ecosystem” and how it can provide a framework for organising business.

The word “ecosystem” is borrowed from biology. It refers to a community of organisms – of any number of species – living within a defined physical environment.

A biological ecosystem

The components of a biological ecosystem

Source: STL Partners

A business ecosystem can therefore be thought of as a community of stakeholders (of different types) that exist within a defined business environment. The environment of a business ecosystem can be small or large.  This is also true in biology, where both a tree and a rainforest can equally be considered ecosystem environments.

The number of organisms within a biological community is dynamic. They coexist with others and are interdependent within the community and the environment. Environmental resources (i.e. energy and matter) flow through the system efficiently. This is how the ecosystem works.

Companies that adopt an ecosystem business framework identify a community of stakeholders to help them address an opportunity area, or drive business in that space. They then create a business environment (e.g. platforms, rules) to organise economic activity among those communities.  The environment integrates community activities in a complementary way. This model is consistent with STL Partners’ vision for a Coordination Age, where desired outcomes are delivered to customers by multiple parties acting together.

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Characteristics of business ecosystems that work

In the case of Google, it adopted an ecosystem approach to tackle the search opportunity. Its search engine platform provides the environment for an external stakeholder community of businesses to reach consumers as they navigate the internet, based on what consumers are looking for.

  • Google does not directly participate in the business-consumer transaction, but its platform reduces friction for participants (providing a good customer experience) and captures information on the exchange.

While Google leverages a technical platform, this is not a requirement for an ecosystem framework. Nespresso built an ecosystem around its patented coffee pod. It needed to establish a user-base for the pods, so it developed a business environment that included licensing arrangements for coffee machine manufacturers.  In addition, it provided support for high-end homeware retailers to supply these machines to end-users. It also created the online Nespresso Club for coffee aficionados to maintain demand for its product (a previous vertically integrated strategy to address this premium coffee-drinking niche had failed).

Ecosystem relevance for telcos

Telcos are exploring new opportunities for revenue. In many of these opportunities, the needs of the customer are evolving or changeable, budgets are tight, and time-to-market is critical. Planning and executing traditional business frameworks can be difficult under these circumstances, so ecosystem business frameworks are understandably of interest.

Traditional business frameworks require companies to match their internal strengths and capabilities to those required to address an opportunity. An ecosystem framework requires companies to consider where those strengths and capabilities are (i.e. external stakeholder communities). An ecosystem orchestrator then creates an environment in which the stakeholders contribute their respective value to meet that end. Additional end-user value may also be derived by supporting stakeholder communities whose products and services use, or are used with, the end-product or service of the ecosystem (e.g. the availability of third party App Store apps add value for end customers and drives demand for high end Apple iPhones). It requires “outside-in” strategic thinking that goes beyond the bounds of the company – or even the industry (i.e. who has the assets and capabilities, who/what will support demand from end-users).

Many companies have rushed to implement ecosystem business frameworks, but have not attained the success of Microsoft, Amazon or Google, or in the telco arena, M-Pesa. Telcos require an understanding of the rationale behind ecosystem business frameworks, what makes them work and how this has played out in other telco ecosystem implementations. As a result, they should be better able to determine whether to leverage this approach more widely.

Table of Contents

  • Executive Summary
  • The ecosystem business framework
  • Why ecosystem business frameworks?
    • Benefits of ecosystem business frameworks
  • Identifying ecosystem business frameworks
  • Telco experience with ecosystem frameworks
    • AT&T Community
    • Deutsche Telekom Qivicon
    • Telecom Infra Project (TIP)
    • GSMA Mobile Connect
    • Android
    • Lessons from telco experience
  • Criteria for successful ecosystem businesses
    • “Destination” status
    • Strong assets and capabilities to share
    • Dynamic strategy
    • Deep end-user knowledge
    • Participant stakeholder experience excellence
    • Continuous innovation
    • Conclusions
  • Next steps
    • Index

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Telco 2030: New purpose, strategy and business models for the Coordination Age

New age, new needs, new approaches

As the calendar turns to the second decade of the 21st century we outline a new purpose, strategy and business models for the telecoms industry. We first described The Coordination Age’, our vision of the market context, in our report The Coordination Age: A third age of telecoms in 2018.

The Coordination Age arises from the convergence of:

  • Global and near universal demands from businesses, governments and consumers for greater resource efficiency, availability and conservation, and
  • Technological advances that will allow near their real-time management.

Figure 1: Needs for efficient use of resources are driving economic and digital transformation

Resource availability, Resource efficiency, Resource conservation: Issues for governments, enterprises and consumers. Solutions must come from all constituents.

Source: STL Partners

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A new purpose for a new age

This new report outlines how telcos can succeed in the Coordination Age, including what their new purpose should be, the strategies, business models and investment approaches needed to deliver it.

It argues that faster networks which can connect tens of billions of sensors coupled with advances in analytics and process digitisation and automation means that there are opportunities for telecoms players to offer more than connectivity.

It also shows how a successful telecoms operator in the Coordination Age will profitably contribute to improving society by enabling governments, enterprises and consumers to collaborate in such a way that precious resources – labour, knowledge, energy, power, products, housing, and so forth – are managed and allocated more efficiently and effectively than ever before. This should have major positive economic and social benefits.

Moreover, we believe that the new purpose and strategies will help all stakeholders, including investors and employees, realign to deliver a motivating and rewarding new model. This is a critical role – and challenge – for all leaders in telecoms, on which the CEO and C-suite must align.

To do this, telecoms operators will need to move beyond providing core communications services. If they don’t choose this path, they are likely to be left fighting for a share of a shrinking ‘telecoms pie’.

A little history 2.0

Back in 2006, STL Partners came up with a first bold new vision for the telecoms industry to use its communications, connectivity, and other capabilities (such as billing, identity, authentication, security, analytics) to build a two-sided platform that enables enterprises to interact with each other and consumers more effectively.

We dubbed this Telco 2.0 and the last version of the Telco 2.0 manifesto we published can be found here – we feel it was prescient and that many of the points we made still resonate today. Indeed, many telecoms operators have embraced the Telco 2.0 two-sided business model over the last ten years.

This latest report builds on much of what we have learned in the previous fourteen years. We hope it will help carry the industry forwards into the next decade with renewed energy and success.

Other recent reports on the Coordination Age:

Table of contents

  • Executive Summary
  • Introduction
  • Industry context: End of the last cycle
    • The telecoms industry is seeking growth
    • Society is facing some major social and economic challenges
    • Addressing society’s (and the telecoms industry’s) challenges
  • The Coordination Age
    • Right here, right now
    • How would the Coordination Age work in healthcare, for example?
  • New opportunities for telcos?
    • The telecoms industry’s new role in the Coordination Age
    • Telcos need an updated purpose
    • This will help to realign stakeholders
    • A new purpose can be the foundation of new strategy too
    • Investment priorities need to reflect the purpose
    • New operational models will also follow
  • Conclusions: What will Telco 2030 look like?

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Digital Services: What is Your Digital Business Worth?

Introduction

When Hewlett Packard’s then-CEO (Carly Fiorina) defended HP’s infamous acquisition of Compaq in 2002, she offered a number of arguments as to why the deal made sense. Firstly, the combined entity would now be able to meet the demands of customers for “solutions on a truly global basis.” Secondly, she claimed that the firm would be able to offer products “from top to bottom, from low-end to high-end.” Lastly, but perhaps most importantly, the merger would generate “synergies that are compelling.”

‘Synergy’ is a straightforward concept: the interaction of two or more entities to produce a combined effect greater than the sum of their parts. Synergistic phenomena are ubiquitous in the natural world, ranging from physics (e.g. the building blocks of atoms), to genetics (e.g. the cooperative interactions among genes in genomes) and the synergies produced by socially-organised groups (e.g. the division of labour).

In the business world, ‘synergy’ refers to the value that is generated by combining two organisations to create a new, more valuable entity. Synergies here can be ‘operational’, such as the combination of functional strengths, or ‘financial’, such as tax benefits or diversification. Traditionally, however, investors have been deeply sceptical of synergies, in terms of both their existence and the ability of M&A activity to deliver them. This was the case with the HP-Compaq merger: the day the merger was announced HP’s stock closed at $18.87, down sharply from $23.21 the previous day.

Recently, ‘synergy’ has also become an increasingly familiar term within the telecommunications industry, owing to activities in two distinct areas. These are now discussed in turn.

Fixed-Mobile Convergence: How tangible are the synergies?

Fixed-mobile convergence (FMC) is a hot topic, and numerous substantial M&A transactions have occurred in this space in recent years (especially in Europe). Figure 1 charts some of these transactions, including publicly available synergy estimates (reflecting cost savings, revenue benefits, or both), below:

Figure 1: Fixed-mobile convergence driven by synergy value

Source: Vodafone, Analysys Mason, STL Partners
* Synergy run-rate by 2016; ** Revenue synergies only

With synergies estimated to account for over 10% of each of these transactions’ valuations, and in the case of Vodafone/KDG nearly 30%, they are clearly perceived as an important driver of value. However, there are two key qualifications to be made here:

  1. Discounted Cash Flow, or ‘DCF’, is theoretically sound but less credible in practice: Each of the estimates of ‘synergy value’ in Figure 1 were constructed using DCF techniques, which attempt to forecast future cash flows and ‘discount’ these to their overall value today (e.g. because one can save cash and earn interest) . Although theoretically sound, there are several problems with DCF in practice.
  2. Certain FMC synergies are more tangible than others: Whilst cost-centric synergies, such as economies of scale (e.g. combined call centres) and access to mobile backhaul, are tangible and easier to quantify, revenue-centric synergies (e.g. quad-play and upselling) are less tangible and more challenging to quantify

These qualifications mirror those raised in the ‘Valuing Digital: A Contentious Yet Vital Business’ Executive Briefing, which discusses the challenges telecoms operators are facing when seeking to generate formal valuations of their digital businesses.

Recap: Digital businesses are especially challenging to value

As telecoms operators’ ambitions in digital services continue to grow, they are increasingly asking what the value of their specific digital initiatives are. Without understanding the value of their digital businesses, telcos cannot effectively govern their individual digital activities: prioritisation, budget allocation and knowing when to close initiatives (‘fast failure’) within digital is challenging without a clear idea of the return on investment different verticals and initiatives are generating. However, telcos face significant challenges across three areas when attempting to value their businesses:

  1. There are challenges in valuing any business (analogue or digital): Although DCF has its drawbacks (see above), any quantitative ‘model’ is necessarily a simplification of reality
  2. Traditional approaches to valuation (e.g. DCF) are inadequate for digital businesses: DCF is especially inappropriate when valuing early-stage digital businesses due to their unique characteristics
  3. The potential for digital services to generate ‘synergy value’ presents further challenges for valuation: Synergy value presents additional conceptual and practical challenges when digital businesses are held within telecoms operators. Figure 2 outlines these below:

Figure 2: Conceptual and practical challenges caused by synergy value

Source: STL Partners

Therefore, telcos (but also the broader technology ecosystem in general) need a new set of tools to answer questions in two key areas. For example:

  1. How should telcos model the market value of their digital businesses?
    • Introducing ‘proxy models’
    • What are the advantages and disadvantages of proxy models?
    • How can a proxy be built to account for issues around limited data availability?
    • Case studies: example valuations of high-profile but privately-held initiatives
  2. How should telcos think about the ‘synergy value’ generated by their digital businesses?
    • What is a useful framework for thinking about synergy value?
    • How are some telcos using clinical trials to assist in the ‘measurement’ of synergies?

 

  • Executive Summary
  • Introduction
  • Fixed-Mobile Convergence: How tangible are the synergies?
  • Recap: Digital businesses are especially challenging to value
  • A Digital Valuation Framework
  • ‘Net synergy’ has four components: benefits and costs, to and from the core
  • Benchmark data theoretically leads to conservative valuations
  • How to Build a Proxy Model
  • What is a ‘Proxy Model’?
  • Proxy models have several advantages over DCF, but they also have data availability challenges
  • Case Study: SK Telecom’s MelOn could be worth $1bn+
  • How to Measure Synergies
  • The Theory: Clinical trials reduce the synergy problem
  • Case Study: A leading European MNO works with its OpCos to run clinical trials
  • Conclusions and Next Steps
  • STL Partners and Telco 2.0: Change the Game

 

  • Figure 1: Fixed-mobile convergence driven by synergy value
  • Figure 2: Conceptual and practical challenges caused by synergy value
  • Figure 3: MTN Mobile Money Uganda, Gross Profit Contribution, 2009-12
  • Figure 4: ‘Net synergy’ across four categories
  • Figure 5: ‘Net synergy’ as a component of digital business value
  • Figure 6: Facebook monthly active users vs. valuation, Q1 2010-Present
  • Figure 7: Proxy model output – SME SaaS providers (financial driver)
  • Figure 8: Total VC Investment by Geography, 2010-13
  • Figure 9: Example operational and financial ‘Emerging Market Discounts’
  • Figure 10: Proxy model output – Digital Music (operational driver; South Korea)
  • Figure 11: Correlation vs. Causation

 

The Internet of Things: Impact on M2M, where it’s going, and what to do about it?

Introduction

From RFID in the supply chain to M2M today

The ‘Internet of Things’ first appeared as a marketing term in 1999 when it was applied to improved supply-chain strategies, leveraging the then hot-topics of RFID and the Internet.

Industrial engineers planned to use miniaturised, RFID tags to track many different types of asset, especially relatively low cost ones. However, their dependency on accessible RFID readers constrained their zonal range. This also constrained many such applications to the enterprise sector and within a well-defined geographic footprint.

Modern versions of RFID labelling have expanded the addressable market through barcode and digital watermarking approaches, for example, while mobile has largely removed the zonal constraint. In fact, mobile’s economies of scale have ushered in a relatively low-cost technology building block in the form of radio modules with local processing capability. These modules allow machines and sensors to be monitored and remotely managed over mobile networks. This is essentially the M2M market today.

M2M remained a specialist, enterprise sector application for a long time. It relied on niche, systems integration and hardware development companies, often delivering one-off or small-scale deployments. For many years, growth in the M2M market did not meet expectations for faster adoption, and this is visible in analyst forecasts which repeatedly time-shifted the adoption forecast curve. Figure 1 below, for example, illustrates successive M2M forecasts for the 2005-08 period (before M2M began to take off) as analysts tried to forecast when M2M module shipment volumes would breach the 100m units/year hurdle:

Figure 1: Historical analyst forecasts of annual M2M module shipment volumes

Source: STL Partners, More With Mobile

Although the potential of remote connectivity was recognised, it did not become a high-volume market until the GSMA brought about an alignment of interests, across mobile operators, chip- and module-vendors, and enterprise users by targeting mobile applications in adjacent markets.

The GSMA’s original Embedded Mobile market development campaign made the case that connecting devices and sensors to (Internet) applications would drive significant new use cases and sources of value. However, in order to supply economically viable connected devices, the cost of embedding connectivity had to drop. This meant:

  • Educating the market about new opportunities in order to stimulate latent demand
  • Streamlining design practices to eliminate many layers of implementation costs
  • Promoting adoption in high-volume markets such as automotive, consumer health and smart utilities, for example, to drive economies of scale in the same manner that led to the mass-adoption of mobile phones

The late 2000’s proved to be a turning point for M2M, with the market now achieving scale (c. 189m connections globally as of January 2014) and growing at an impressive rate (c. 40% per annum). 

From M2M to the Internet of Things?

Over the past 5 years, companies such as Cisco, Ericsson and Huawei have begun promoting radically different market visions to those of ‘traditional M2M’. These include the ‘Internet of Everything’ (that’s Cisco), a ‘Networked Society’ with 50 billion cellular devices (that’s Ericsson), and a ‘Cellular IoT’ with 100 billion devices (that’s Huawei).

Figure 2: Ericsson’s Promise: 50 billion connected ‘things’ by 2020

Source: Ericsson

Ericsson’s calculation builds on the idea that there will be 3 billion “middle class consumers”, each with 10 M2M devices, plus personal smartphones, industrial, and enterprise devices. In promoting such visions, the different market evangelists have shifted market terminology away from M2M and towards the Internet of Things (‘IoT’).

The transition towards IoT has also had consequences beyond terminology. Whereas M2M applications were previously associated with internal-to-business, operational improvements, IoT offers far more external market prospects. In other words, connected devices allow a company to interact with its customers beyond its strict operational boundaries. In addition, standalone products can now deliver one or more connected services: for example, a connected bus can report on its mechanical status, for maintenance purposes, as well as its location to deliver a higher quality, transit service.

Another consequence of the rise of IoT relates to the way that projects are evaluated. In the past, M2M applications tended to be justified on RoI criteria. Nowadays, there is a broader, commercial recognition that IoT opens up new avenues of innovation, efficiency gains and alternative sources of revenue: it was this recognition, for example, that drove Google’s $3.2 billion valuation of Nest (see the Connected Home EB).

In contrast to RFID, the M2M market required companies in different parts of the value chain to share a common vision of a lower cost, higher volume future across many different industry verticals. The mobile industry’s success in scaling the M2M market now needs to adjust for an IoT world. Before examining what these changes imply, let us first review the M2M market today, how M2M service providers have adapted their business models and where this positions them for future IoT opportunities.

M2M Today: Geographies, Verticals and New Business Models

Headline: M2M is now an important growth area for MNOs

The M2M market has now evolved into a high volume and highly competitive business, with leading telecoms operators and other service providers (so-called ‘M2M MVNOs’ e.g. KORE, Wyless) providing millions of cellular (and fixed) M2M connections across numerous verticals and applications.

Specifically, 428 MNOs were offering M2M services across 187 countries by January 2014 – 40% of mobile network operators – and providing 189 million cellular connections. The GSMA estimates the number of global connections to be growing by about 40% per annum. Figure 3 below shows that as of Q4 2013 China Mobile was the largest player by connections (32 million), with AT&T second largest but only half the size.

Figure 3: Selected leading service providers by cellular M2M connections, Q4 2013

 

Source: Various, including GSMA and company accounts, STL Partners, More With Mobile

Unsurprisingly, these millions of connections have also translated into material revenues for service providers. Although MNOs typically do not report M2M revenues (and many do not even report connections), Verizon reported $586m in ‘M2M and telematics’ revenues for 2014, growing 47% year-on-year, during its most recent earnings call. Moreover, analysis from the Telco 2.0 Transformation Index also estimates that Vodafone Group generated $420m in revenues from M2M during its 2013/14 March-March financial year.

However, these numbers need to be put in context: whilst $500m growing 40% YoY is encouraging, this still represents only a small percentage of these telcos’ revenues – c. 0.5% in the case of Vodafone, for example.

Figure 4: Vodafone Group enterprise revenues, implied forecast, FY 2012-18

 

Source: Company accounts, STL Partners, More With Mobile

Figure 4 uses data provided by Vodafone during 2013 on the breakdown of its enterprise line of business and grows these at the rates which Vodafone forecasts the market (within its footprint) to grow over the next five years – 20% YoY revenue growth for M2M, for example. Whilst only indicative, Figure 4 demonstrates that telcos need to sustain high levels of growth over the medium- to long-term and offer complementary, value added services if M2M is to have a significant impact on their headline revenues.

To do this, telcos essentially have three ways to refine or change their business model:

  1. Improve their existing M2M operations: e.g. new organisational structures and processes
  2. Move into new areas of M2M: e.g. expansion along the value chain; new verticals/geographies
  3. Explore the Internet of Things: e.g. new service innovation across verticals and including consumer-intensive segments (e.g. the connected home)

To provide further context, the following section examines where M2M has focused to date (geographically and by vertical). This is followed by an analysis of specific telco activities in 1, 2 and 3.

 

  • Executive Summary
  • Introduction
  • From RFID in the supply chain to M2M today
  • From M2M to the Internet of Things?
  • M2M Today: Geographies, Verticals and New Business Models
  • Headline: M2M is now an important growth area for MNOs
  • In-depth: M2M is being driven by specific geographies and verticals
  • New Business Models: Value network innovation and new service offerings
  • The Emerging IoT: Outsiders are raising the opportunity stakes
  • The business models and profitability potentials of M2M and IoT are radically different
  • IoT shifts the focus from devices and connectivity to data and its use in applications
  • New service opportunities drive IoT value chain innovation
  • New entrants recognise the IoT-M2M distinction
  • IoT is not the end-game
  • ‘Digital’ and IoT convergence will drive further innovation and new business models
  • Implications for Operators
  • About STL Partners and Telco 2.0: Change the Game
  • About More With Mobile

 

  • Figure 1: Historical analyst forecasts of annual M2M module shipment volumes
  • Figure 2: Ericsson’s Promise: 50 billion connected ‘things’ by 2020
  • Figure 3: Selected leading service providers by cellular M2M connections, Q4 2013
  • Figure 4: Vodafone Group enterprise revenues, implied forecast, FY 2012-18
  • Figure 5: M2M market penetration vs. growth by geographic region
  • Figure 6: Vodafone Group organisational chart highlighting Telco 2.0 activity areas
  • Figure 7: Vodafone’s central M2M unit is structured across five areas
  • Figure 8: The M2M Value Chain
  • Figure 9: ‘New entrant’ investments outstripped those of M2M incumbents in 2014
  • Figure 10: Characterising the difference between M2M and IoT across six domains
  • Figure 11: New business models to enable cross-silo IoT services
  • Figure 12: ‘Digital’ and IoT convergence

 

Connected Home: Telcos vs Google (Nest, Apple, Samsung, +…)

Introduction 

On January 13th 2014, Google announced its acquisition of Nest Labs for $3.2bn in cash consideration. Nest Labs, or ‘Nest’ for short, is a home automation company founded in 2010 and based in California which manufactures ‘smart’ thermostats and smoke/carbon monoxide detectors. Prior to this announcement, Google already had an approximately 12% equity stake in Nest following its Series B funding round in 2011.

Google is known as a prolific investor and acquirer of companies: during 2012 and 2013 it spent $17bn on acquisitions alone, which was more than Apple, Microsoft, Facebook and Yahoo combined (at $13bn) . Google has even been known to average one acquisition per week for extended periods of time. Nest, however, was not just any acquisition. For one, whilst the details of the acquisition were being ironed out Nest was separately in the process of raising a new round of investment which implicitly valued it at c. $2bn. Google, therefore, appears to have paid a premium of over 50%.

This analysis can be extended by examining the transaction under three different, but complementary, lights.

Google + Nest: why it’s an interesting and important deal

  • Firstly, looking at Nest’s market capitalisation relative to its established competitors suggests that its long-run growth prospects are seen to be very strong

At the time of the acquisition, estimates placed Nest as selling 100k of its flagship product (the ‘Nest Thermostat’) per month . With each thermostat retailing at c. $250 each, this put its revenue at approximately $300m per annum. Now, looking at the ratio of Nest’s market capitalisation to revenue compared to two of its established competitors (Lennox and Honeywell) tells an interesting story:

Figure 1: Nest vs. competitors’ market capitalisation to revenue

 

Source: Company accounts, Morgan Stanley

Such a disparity suggests that Nest’s long-run growth prospects, in terms of both revenue and free cash flow, are believed to be substantially higher than the industry average. 
  • Secondly, looking at Google’s own market capitalisation suggests that the capital markets see considerable value in (and synergies from) its acquisition of Nest

Prior to the deal’s announcement, Google’s share price was oscillating around the $560 mark. Following the acquisition, Google’s share price began averaging closer to $580. On the day of the announcement itself, Google’s share price increased from $561 to $574 which, crucially, reflected a $9bn increase in market capitalisation . In other words, the value placed on Google by the capital markets increased by nearly 300% of the deal’s value. This is shown in Figure 2 below:

Figure 2: Google’s share price pre- and post-Nest acquisition

 

Source: Google Finance

This implies that the capital markets either see Google as being well positioned to add unique value to Nest, Nest as being able to strongly complement Google’s existing activities, or both.

  • Thirdly, viewing the Nest acquisition in the context of Google’s historic and recent M&A activity shows both its own specific financial significance and the changing face of Google’s acquisitions more generally

At $3.2bn, the acquisition of Nest represents Google’s second largest acquisition of all time. The largest was its purchase of Motorola Mobility in 2011 for $12.5bn, but Google has since reached a deal to sell the majority of its assets (excluding its patent portfolio) to Lenovo for $2.9bn. In other words, Nest is soon to become Google’s largest active, inorganic investment. Google’s ten largest acquisitions, as well as some smaller but important ones, are shown in Figure 3 below:

Figure 3: Selected acquisitions by Google, 2003-14

Source: Various

Beyond its size, the Nest acquisition also continues Google’s recent trend of acquiring companies seemingly less directly related to its core business. For example, it has been investing in artificial intelligence (DeepMind Technologies), robotics (Boston Dynamics, Industrial Perception, Redwood Robotics) and satellite imagery (Skybox Imaging).

Three questions raised by Google’s acquisition of Nest

George Geis, a professor at UCLA, claims that Google develops a series of metrics at an early stage which it later uses to judge whether or not the acquisition has been successful. He further claims that, according to these metrics, Google on average rates two-thirds of its acquisitions as successful. This positive track record, combined with the sheer size of the Nest deal, suggests that the obvious question here is also an important one:

  • What is Nest’s business model? Why did Google spend $3.2bn on Nest?

Nest’s products, the Nest Thermostat and the Nest Protect (smoke/carbon monoxide detector), sit within the relatively young space referred to as the ‘connected home’, which is defined and discussed in more detail here. One natural question following the Nest deal is whether Google’s high-profile involvement and backing of a (leading) company in the connected home space will accelerate its adoption. This suggests the following, more general, question:

  • What does the Nest acquisition mean for the broader connected home market?

Finally, there is a question to be asked around the implications of this deal for Telcos and their partners. Many Telcos are now active in this space, but they are not alone: internet players (e.g. Google and Apple), big technology companies (e.g. Samsung), utilities (e.g. British Gas) and security companies (e.g. ADT) are all increasing their involvement too. With different strategies being adopted by different players, the following question follows naturally:

  • What does the Nest acquisition mean for telcos?

 

  • Executive Summary
  • Introduction
  • Google + Nest: why it’s an interesting and important deal
  • Three questions raised by Google’s acquisition of Nest
  • Understanding Nest and Connected Homes
  • Nest: reinventing everyday objects to make them ‘smart’
  • Nest’s future: more products, more markets
  • A general framework for connected home services
  • Nest’s business model, and how Google plans to get a return on its $3.2bn investment 
  • Domain #1: Revenue from selling Nest devices is of only limited importance to Google
  • Domain #2: Energy demand response is a potentially lucrative opportunity in the connected home
  • Domain #3: Data for advertising is important, but primarily within Google’s broader IoT ambitions
  • Domain #4: Google also sees Nest as partial insurance against IoT-driven disruption
  • Domain #5: Google is pushing into the IoT to enhance its advertising business and explore new monetisation models
  • Implications for Telcos and the Connected Home
  • The connected home is happening now, but customer experience must not be overlooked
  • Telcos can employ a variety of monetisation strategies in the connected home
  • Conclusions

 

  • Figure 1: Nest vs. competitors’ market capitalisation relative to revenue
  • Figure 2: Google’s share price, pre- and post-Nest acquisition
  • Figure 3: Selected acquisitions by Google, 2003-14
  • Figure 4: The Nest Thermostat and Protect
  • Figure 5: Consumer Electronics vs. Electricity Spending by Market
  • Figure 6: A connected home services framework
  • Figure 7: Nest and Google Summary Motivation Matrix
  • Figure 8: Nest hardware revenue and free cash flow forecasts, 2014-23
  • Figure 9: PJM West Wholesale Electricity Prices, 2013
  • Figure 10: Cooling profile during a Rush Hour Rewards episode
  • Figure 11: Nest is attempting to position itself at the centre of the connected home
  • Figure 12: US smartphone market share by operating system (OS), 2005-13
  • Figure 13: Google revenue breakdown, 2013
  • Figure 14: Google – Generic IoT Strategy Map
  • Figure 15: Connected device forecasts, 2010-20
  • Figure 16: Connected home timeline, 1999-Present
  • Figure 17: OnFuture EMEA 2014: The recent surge in interest in the connected home is due to?
  • Figure 18: A spectrum of connected home strategies between B2C and B2B2C (examples)
  • Figure 19: Building, buying or partnering in the connected home (examples)
  • Figure 20: Telco 2.0™ ‘two-sided’ telecoms business model