SAP Strategy Profile: Enabling Telcos to Operate at ‘Internet Speed’

Summary: Our top-level review of SAP’s vision of how it will enable telcos to ‘operate at internet speed’ against Telco 2.0 principles and the six key opportunity areas identified in our strategy research report, ‘The Roadmap to New Telco 2.0 Business Models’. We also challenged SAP to build a Proof of Concept implementation of a complex multi-sided business model with a leading European mobile operator within one month. How did it go? (February 2012, Foundation 2.0) Six Opportunity Areas within the Telco 2 Platform
  • Below is an extract from this 17 page Telco 2.0 Report. The report can be downloaded in full PDF format by members of the Telco 2.0
    Executive Briefing service here.
  • Additionally, to give an introduction to the principles of Telco 2.0 and
    digital business model innovation, we now offer for download a small selection of
    free Telco 2.0 Briefing reports (including this one) and a growing collection of what we think are
    the best 3rd party ‘white papers’. To access these reports you will need to become a Foundation 2.0 member. To do this, use the promotional code FOUNDATION2 in the box provided on the sign-up page here. Your Foundation 2.0 member details will allow
    you to access the reports shown here only, and once registered, you will be able to download the report here.
  • We’ll also be discussing business model innovation at the Silicon Valley (27-28 March) and London (12-13 June) Executive Brainstorms.
  • To access reports from the
    full Telco 2.0 Executive Briefing service, or to submit whitepapers for review for inclusion in this service, please email contact@telco2.net or call +44 (0) 207 247 5003.

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Executive Summary

SAP’s new vision for telcos –  ‘operating at internet speed’ –  aligns well with certain Telco 2.0 principles and is supported by an interesting new set of tools, processes and pledges. To be more precise ‘operating at internet speed’ means driving change fast enough to match internet disruptors such as Google, Apple and Facebook.

This sounds great (and would truly be a boon for operators) but we have heard this all before and from just about everybody.  Vendors making this claim need to be prepared to prove it. The Telco 2.0 team, together with a leading European Mobile Operator and a team of configuration experts from SAP, got together to build a Proof of Concept implementation of a complex multi-sided business challenge.

The results were impressive and within a period of a month:

  • we defined the challenge and business model impacts in a 2-day workshop;
  • we developed a software implementation through three weekly iterations;
  • we deployed a complete reporting toolkit to measure performance against key metrics; and
  • all without writing a single line of software, just configuring SAP software.

The exercise convinced the Telco 2.0 team that operating at internet speed is not beyond the grasp of mobile operators, but it requires both a change in working practices and approach to partnering with key vendors. The barrier is organisational.

Based upon the success of the exercise, we will shortly be launching “The Telco 2.0 Challenge” to the wider Telecommunications Industry, and we’re now looking for more operators who’d like to set a new Telco 2.0 challenge. To find out more please email us at contact@telco2.net or visit SAP’s stand at the 2012 Mobile World Congress in Barcelona.

Introduction

The Telco 2.0 team was recently invited by the leadership team at SAP’s Telecommunications Industry Group to review its vision of the evolution of Telco business models and the capabilities required to support this vision.

SAP is a world leader in enterprise application software with a turnover in 2010 of €12.5bn serving in excess of 170,000 customers in over 120 countries, including over 1,000 telco customers. SAP software has long been present in telecom operators’ finance and supply chain departments. Recent acquisitions such as Highdeal (real-time rating), Sybase (database, device management and mobile payments) and Business Objects (customer insight) together with in-house product developments such as In-Memory Computing and Cloud Computing position SAP to serve more and more of telco computing needs.

At the heart of SAP’s vision for telecoms operators is that they should be able to operate with more dynamism and flexibility. SAP aims to support telcos both internally and externally: internally  SAP enables marketing, product and pricing teams to deliver a customized experience and quickly rollout and test new services; externally SAP enables enterprise customers and 3rd parties to integrate communications services and telco data services into their own.

Much of the SAP vision is aligned to key aspects of Telco 2.0 thinking. In this report we map the key aspects of the SAP vision to the Telco 2.0 future growth areas for telcos.  SAP also has many years experience of working with many other industries and therefore is well positioned to assist cross-industry collaboration which of course is essential to successful two-sided business models.

This report examines the SAP vision in the context of two-sided business models, and specifically against the Six Telco 2.0 Opportunity Types identified in our recent research report The Roadmap to Telco 2.0 Business Models. It examines the tools and pledges made by SAP to support business model innovation and implantation. Finally, it examines some of the specific features within the SAP software and their applicability to telcos.

Sponsorship and editorial independence

This report has kindly been sponsored by SAP and is freely available. SAP provided input to questions asked by STL Partners’ analysts and were given the opportunity to comment on working drafts. Research, analysis, and the writing and editing of the report itself were carried out independently by STL Partners. The views and conclusions contained herein are those of STL Partners.

Analytical Framework: The Six Strategic Telco 2.0 Opportunity Areas

The most recent of these research reports, ‘The Roadmap to Telco 2.0 Business Models’ – describes the transformational path the telecoms industry needs to take to carve out a more valuable role in the evolving ‘digital economy’, and outlines six key opportunity areas in which telcos can create new value. We have used this framework to analyse SAP’s vision at a top level.

These opportunity areas sit themselves within the context of Telco 2.0’s ‘two-sided’ telecoms business model concept, in which telcos remodel their businesses to serve both traditional ‘downstream’ customers (individual and business end-users consuming traditional telco services) and ‘upstream’ customers, or ‘merchants’ who instead use telco assets in new ways to achieve business goals such as improving business processes or services. This concept and the accompanying opportunities are described in depth in The $125Bn ‘Two-Sided’ Telecoms Market Opportunity report (see also page 14).

Figure 1 – The Six Telco 2.0 Opportunity Types

Six Opportunity Areas within the Telco 2.0 Platform
Source: STL Partners

The six opportunity areas are in summary:

a) Core Services

  • Redefine the customer experience for telecoms via:
    • Improvement of core product portfolio (voice, messaging, connectivity, TV/media), more engaging and ‘smarter’ marketing and DRM, leveraging of online sales channels, enhanced customer interaction and care
    • Engaging differently with existing customers is important, to create loyalty and retain the customer base, and also to build the base for up-selling and providing new services. A key part of the re-engineering required is to improve customer data access, both to enable analytics and internal performance improvements, and to make it possible to enable appropriate external use of this data in the Personal Information Economy.

b) Vertical Industry Solutions

  • Extend from telecoms into IT and networking for corporate clients via ‘verticalised’ solutions.

c) Infrastructure Services

  • Expand and extend wholesale and corporate offerings from network to infrastructure:
  • Provide infrastructure services such as mobile offload, data centre capabilities etc. to other operators and to corporate customers.

d) Embedded Communications

  • Integrate voice, messaging, and connectivity services into those of third parties:
  • Communications-enabled business processes, voice and messaging integrated with games (for example), M2M and embedded mobility connectivity.

e) Third party business enablers

  • Make (latent) telco capabilities available to third-party service providers:
  • Identity & authentication; marketing & advertising; payments; customer care.

f) Own-brand ‘Over-The-Top’ (OTT) services

  • Develop network-independent applications and services:
  • Copy internet players and provide valuable applications and services ‘OTT’ – could be free or paid-for.

The Roadmap also outlines a number of generic principles for success, which at a top level may be summarised as:

  • Unlocking the value and power of telco customer data is essential to both improve the design and delivery of existing services;
  • Telcos need to fundamentally improve their flexibility and operational capabilities to innovate and react;
  • changes enabling horizontal and ‘upstream’ partnerships will be essential to enable new business models;
  • and a list of seventeen principles for disruptive innovation.

SAP’s Telco Vision: ‘Operating at Internet Speed’

Dynamism and Flexibility lies at the heart of SAP’s vision for the Telco of the future. This future telco is a different organization from the one most of us is familiar with today. The Telco2.0 team took away four strands from this vision:

  1. ‘Sensing at internet speed’:  According to SAP, tomorrow’s telco “knows” what its customers are experiencing and is able to make sense of this knowledge.  To be fair, telcos have already made great strides in expanding real-time analytics beyond network management for customer segmentation and applying different rule sets for support and promotions. However, Internet best-practice, particularly in optimizing all aspects of customer experience, is still a distant aspiration.
  2. ‘Thinking at internet speed’:  In SAP’s vision, the telco of the future is able to assimilate, evaluate and act much, much more quickly than is typical today.  Part of this is down to better information, part down to better mechanisms for enacting decisions… and part is down to the decision-making processes and tools that support these.
  3. ‘Acting at internet speed’:  For the major and successful online players, real-time A-B testing of new propositions and continuously evolving these propositions in response to customer behaviour is second nature.  Telcos do this already… for their websites, but not for their services.  Introducing new packages, policies, services, on a targeted basis, several times a day is pure fantasy for operators (particularly where they have market power and may require regulatory approval for any new service).
  4. ‘Collaborating at internet speed’:  Exposing capabilities and assets to third parties for them to integrate into their own services is common on the web (at least common for the likes of Amazon, Google and Facebook).  They have spawned veritable industries around these capabilities.  Here again, we are seeing some isolated successes from telcos, but still so much work to do.

Ultimately, in SAP’s vision, this becomes a continuous process rather than a one-off sequence.

Mapping the SAP vision to Telco2.0 opportunity growth areas

All the Telco 2.0 opportunity growth areas require a step change in the organizations’ ability to adapt and change. Indeed, this is one of the underlying strategic imperatives for change in the digital economy. There is a however a certain degree of applicability for each strand to each growth opportunity as the diagram below highlights.

Figure 2 – Mapping the Internet Speed vision against the Telco 2.0 opportunity

Mapping the Internet Speed Vision Against the Telco 2.0 Opportunity
Source: STL Partners

For instance, the relatively asset intensive infrastructure services are slower moving than own-brand services. Similarly core services require less collaboration than with vertical industry solution and third party enablers.

However, in some instances, high speed sensing, thinking and acting may be required in these asset intensive services. For example, mobile offloading (an infrastructure service) requires real-time sensing and acting in it’s operation.

Equally, for some telcos, collaborating in OTT services may require more dynamism as some partners will need sensing information in near real-time…

To access the rest of this 17 page Telco 2.0 Report in full including…

  • Mapping SAP’s solutions to telcos in practice
  • Support for Multisided business models
  • Configurable by business people, not constrained by IT
  • Tools, processes and Pledges
  • Supporting Vertical Industry Solutions and ‘Embedded Communications’
  • Making Sense of Customer Data
  • Advanced Device Management
  • M-commerce
  • Conclusion
  • STL Partners and the Telco 2.0™ Initiative

…and the following report figures…

  • Figure 1 – The Six Telco 2.0 Opportunity Types
  • Figure 2 – Mapping the Internet Speed vision against the Telco 2.0 opportunity

…members of the Telco 2.0 Executive Briefing service can download it in full PDF format here.

Additionally, to give an introduction to the principles of Telco 2.0 and digital business model innovation, we now offer for download a small selection of free Telco 2.0 Briefing reports (including this one) and a growing collection of what we think are the best 3rd party ‘white papers’. To access these reports you will need to become a Foundation 2.0 member. To do this, use the promotional code FOUNDATION2 in the box provided on the sign-up page here. Your Foundation 2.0 member details will allow you to access the reports shown here only, and once registered, you will be able to download the report here.

We’ll also be discussing digital business model innovation at the Silicon Valley (27-28 March) and London (12-13 June) Executive Brainstorms.

To access reports from the full Telco 2.0 Executive Briefing service, or to submit whitepapers for review for inclusion in this service, please email contact@telco2.net or call +44 (0) 207 247 5003.

Digital Entertainment 2.0: Report and analysis of the event

Digital Entertainment 2.0: A summary of the findings of the Digital Entertainment 2.0 workshop, 8th November 2011, held in the Guoman Hotel, London.

Digital Entertainment 2.0: Event Summary Analysis Presentation

Part of the New Digital
Economics Executive Brainstorm
series, the Digital Entertainment 2.0
workshop took place at the Guoman Hotel, London on the 8th November
and looked at how ‘personal data’ will revolutionize advertising, payments and
customer experiences.

Using a widely acclaimed interactive format called ‘Mindshare’ the event enabled  specially-invited senior executives from across the communications, media, banking and technology sectors to.

This note summarises some of the high-level findings and includes the verbatim output of the brainstorm.

More information: email contact@stlpartners.com, or phone: +44 (0) 207 247 5003.

DOWNLOAD REPORT

Extracted example slide:

Digital Entertainment 2.0: Event Summary Analysis Presentation

M-Commerce 2.0: Report and analysis of the event

M-Commerce 2.0: Event Summary Analysis. A summary of the findings of the M-Commerce 2.0 Executive Brainstorm, 10th November , held in the Guoman Hotel, London. Part of an international research and events programme, run with the support of the World Economic Forum, the Brainstorm explored the principles of personal data in the context of ‘M-Commerce 2.0’ – creating mechanisms that put the user in control of their data, helping the individual to generate value from that data, reducing friction and transaction costs in day-to-day ‘B2B2C’ commercial processes.

M-Commerce 2.0: Event Summary Analysis Presentation

 

 

Part of the New Digital Economics Executive Brainstorm series, the M-Commerce 2.0 event took place at the Guoman Hotel, London on the 10th November and looked at how ‘personal data’ will revolutionize advertising, payments and customer experiences. It also explored the “Great Game” between the leading Internet players and the telcos. Using a widely acclaimed interactive format called ‘Mindshare’ the event enabled specially-invited senior executives from across the communications, media, banking and technology sectors to explore opportunities to create new services and experiences from unlocking the value of ‘personal data’. The agenda is shown in appendix A.

The Brainstorm is part of an international research and events programme run with the support of the World Economic Forum. M-Commerce 2.0 supports the World Economic Forum’s ‘Re-thinking Personal Data’ project, which promotes the concept of user-centricity within the context of building ‘trust frameworks’.

This note summarises some of the high-level findings and includes the verbatim output of the brainstorm.

More information: email contact@stlpartners.com, or phone: +44 (0) 207 247 5003.

DOWNLOAD REPORT


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M-Commerce 2.0: Event Summary Analysis Presentation

CDN 2.0: Report and analysis of the event

CDN 2.0: Event Summary Analysis. A summary of the findings of the CDN 2.0 session, 10th November 2011, held in the Guoman Hotel, London

CDN 2.0: A Summary of Findings of the CDN 2.0 Session Presentation

Part of the New Digital Economics Executive Brainstorm
series, the CDN 2.0 session took place at the Guoman Hotel, London on the 10th
November and looked at the future of online video, both the star product telcos
rely on for much of their revenue and the main driver of their costs.

Using a widely acclaimed interactive format called ‘Mindshare’, the event enabled
specially-invited senior executives from across the communications, media,
banking and technology sectors to discuss the field of content delivery
networking and the digital logistics systems Netflix, YouTube and other online
video providers rely on.

This note summarises some of the high-level
findings and includes the verbatim output of the brainstorm.

More information: email contact@stlpartners.com, or phone: +44 (0) 207 247 5003.

DOWNLOAD REPORT


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CDN 2.0: A Summary of Findings of the CDN 2.0 Session Presentation

M2M 2.0: Report and analysis of the event

M2M 2.0: Event Summary Analysis: A summary of the findings of the M2M 2.0 session, 10th November 2011, held in the Guoman Hotel, London

M2M 2.0: Event Summary Analysis Presentation


Part of the New Digital
Economics Executive Brainstorm
series, the M2M 2.0 session took place at
the Guoman Hotel, London on the 10th November and reviewed real-world
experience with M2M projects from operators and other actors. Using
a widely acclaimed interactive format called ‘Mindshare’, the
event enabled specially-invited senior executives from across the
communications, energy and technology sectors to.

This
note summarises some of the high-level findings and includes the verbatim
output of the brainstorm.

More information: email contact@stlpartners.com, or phone: +44 (0) 207 247 5003.

DOWNLOAD REPORT

Extracted example slide:

M2M 2.0: Event Summary Analysis Presentation

Appstore 2.0: Amazon Vs Apple & Google

Summary: Amazon is probably the Internet’s best retailer. As it launches its own AppStore, we provide a detailed analysis of its digital media business and pick out the key opportunities it offers to content owners, network service providers and manufacturers.

Below is a major extract from this 18 page Telco 2.0 Analyst Note that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service and the Telco 2.0 Dealing with Disruption Stream using the links below.

                            Read in Full (Members only)        To Subscribe

‘Growing the Mobile Internet’ and ‘Fostering Vibrant Ecosystems: Lessons from Apple’ are also key session themes at our upcoming ‘New Digital Economics’ Brainstorms (Palo Alto, 4-7 April and London, 11-13 May). Please use the links or email contact@telco2.net or call +44 (0) 207 247 5003 to find out more.

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Introduction

For Amazon, the world of downloading and streaming brings both threats and opportunities: threats in that a large proportion of its current business is at risk of being cannibalised; and opportunities in that a significant element of its cost base associated with the storing, shipping, picking and packing of physical goods could be automated and reduced further.

Amazon’s key strengths are the size of its customer base; its ongoing relationships with all the major content owners in all the key categories (Books, Music, Movies/TV and Games); and most importantly, Amazon is the most highly skilled retailer on the Internet. Amazon’s Achilles heel is that it has very little control over next generation devices, apart from the Kindle, whether Tablet or Mobile phone.

In this note, we examine:

  • Amazon’s current performance;
  • The rising costs of physical distribution;
  • The attraction of online distribution (streaming and downloading) to Amazon;
  • The success of the Kindle;
  • Why Amazon has failed to gain significant market share in music;
  • The rationale behind the move into movie streaming;
  • How Amazon will shake up the AppStore market;
  • Whether the success of the Kindle means a move into more own-brand devices;
  • Amazon’s potential impact on the digital value ecosystem and how content owners, networks and device manufacturers should interact with Amazon.

Amazon’s Current Performance

Amazon’s Operating Income in 2010 was $1.4bn with a typically low retail sector margin of 4.1%. This is a far lower margin than usually sought by the content industry, networks or the device industry and one of Amazon’s key strategic advantages – its investors do not expect huge margins. However, they do expect revenue growth and this it has delivered so far (see below) through the development of the most advanced retail platform on the Internet, fierce price competition, tight control over costs and increasing product diversification.

Figure 1: Amazon Operates with the Low Margins Typical of Retail

Source: Amazon, STL Partners

Amazon is now the world’s largest e-commerce site selling over US$34bn worth of goods and services in 2010. The Amazon main website attracts more unique visitors in a month than either eBay or Apple (see below).

Figure 2: Amazon is the busiest online store in the world

At the end of 2010, Amazon had over 130m ‘active’ customer accounts, a healthy increase of over 25 million in the year. In comparison Apple has over 200m accounts with credit cards stored – but does not break-out the percentage of these that are actually buying goods and services from it. It is therefore difficult to determine whether Amazon or Apple have the most paying customers passing through their stores. Whichever is the larger, Amazon’s retail prowess cannot be ignored, especially in entertainment media where its revenues continue to grow year-on-year.

Amazon’s Media Sales

Amazon’s roots are in selling books but over the years its portfolio has been extended successfully to other type of physical media so that its media category now comprises Books, Music, Movies, Video Games and Consoles, Software and Digital Downloads in most territories (USA, Canada, UK, Germany, France, Italy, Japan and China). The sales associated with its media business are still growing by over 10% per annum and, although declining as a percentage of total sales, still represented over 43% of total net sales in 2010. The reduction in percentage of total sales is therefore more a reflection of Amazon’s success in its diversified product range than any drop off in media.

Figure 3: Amazon’s media sales are still growing at over 10% per annum

Source: Amazon, STL Partners

It is noteworthy that Amazon doesn’t provide any further detail on the media category and therefore little is known outside of Amazon about how their customers’ habits are changing from physical media consumption to digital. However, Amazon has been very clear that it sees a future where media is consumed both physically and digitally. In short, it wants to grow the entire pie and Amazon is not abandoning the physical world in much the same way that Netflix is not abandoning the mailing of DVDs.

Amazon promotes itself to investors as growing the absolute level of Operating Income and therefore is less worried about margins than overall growth. This is important for content owners as it aligns with their priorities and means that Amazon is as concerned with cannibalisation of physical product revenues as they are. However, that does not mean Amazon is in anyway anti-online distribution.

Amazon is also highly focussed on growing Free Cash Flow per share which implies strict management of working capital and balance sheet expenditure and to understand the appeal of online business in this context, we first have to understand the costs and cost trends associated with physical products.

Counting the Cost of Physical Distribution

Amazon currently spends about US$1.4bn or 4% of revenues on the physical shipping of goods to its customers. Despite Amazon’s famed distribution efficiency, this percentage has increased over the last couple of years, eating ever further beyond the associated shipping revenues, as illustrated below.

Figure 4: Amazon’s Net Shipping Costs Continue to Rise Over and Above P&P Charges to Consumers

Source: Amazon, STL Partners

This is probably down to two factors:

  1. Amazon offers an annual “Prime” shipping service where for a fixed annual shipping commitment, customers receive “free” shipping for each purchase. It is estimated that 15% of Amazon customers are “Prime” subscribers. It is assumed that “Prime” customers are more loyal to Amazon and are their heavier spenders; and
  2. Amazon has moved into selling more bulky goods over the years, such as PCs, which are far more expensive to ship than books.

Furthermore, there are additional costs associated with physical distribution.

Figure 5: Physical fulfilment costs Remain Stable as a Percentage of Net Sales

Source: Amazon, STL Partners

Amazon spent around US$2.9bn or 8.5% of revenues in 2010 on fulfilment costs (or the picking and packing) of goods. Amazon doesn’t break-out how much it spends on payment processing (included within cost of goods sold) or maintaining the technology (elements include Technology and Content, Depreciation and Amortisation) for its various e-commerce sites. 

The Attraction of Online Distribution

With Amazon’s ability to manage the combined physical costs of shipping and fulfilment to 12.5% of revenues in 2010, we believe that Amazon should be able to deliver online distribution for less than the 30% benchmark ‘agency fee’ revenue share typical in the online distribution model. And, that is before the additional efficiencies that Digital distribution offers over Physical. Therefore the margins offered up by the digital environment are highly attractive to Amazon.

Furthermore digital goods, in the main, fit perfectly into Amazon’s Operating Income growth model as the carrying cost of inventory is minimal and cash for goods is received immediately from customers, while the payment to content owners is typically dispersed 30-days after purchase. The major exception to this rule is when content owners demand large upfront fees for either access to content libraries or for exclusive deals. This is a major feature of both the Movies/TV and Music industry and may account at least in part for the differing levels of take up Amazon has experienced between these and e-books.

So, where does Amazon sit in online distribution – streaming and downloading? Is it a major player that needs to be actively worked with or against or can it be left out of the strategic thinking of the others in the digital online ecosystem – content owners, network service providers and device manufacturers? A closer examination of the position of Amazon in each of the major digital content categories – publishing, music, video and apps, provides valuable insight.

The success of the Kindle: more eBooks than Paperbacks

Amazon launched the Kindle in 2007 as an e-ink book reader for an introductory price of US$399, which in its first iteration had connectivity exclusively provided through the Sprint CDMA network. However, Amazon developed more than a hardware device with the Kindle, it built the whole surrounding ecosystem for sale, delivery and management of mainly electronic books but also other publishing media such as newspapers.

Figure 6: The Amazon Kindle

Today, the hardware price of the Kindle has come down to US$139 (WiFi only) to US$189 (WiFi+3G) and Amazon has launched Kindle readers across all the major platforms from Apple (Mac, iPhone and iPad), Google Android, RIM Blackberry and Microsoft (Windows and Windows Phone7). If a customer buys a book from the Kindle store, it can be read on most of the major platforms for a single fee.

Amazon doesn’t break out sales data for either Kindle or eBooks, but the following extract from Amazon’s 4Q 2010 earnings release provides just an indication of progress being made.

Amazon.com is now selling more Kindle books than paperback books. Since the beginning of the year, for every 100 paperback books Amazon has sold, the Company has sold 115 Kindle books. Additionally, during this same time period the Company has sold three times as many Kindle books as hardcover books. This is across Amazon.com’s entire U.S. book business and includes sales of books where there is no Kindle edition. Free Kindle books are excluded and if included would make the numbers even higher.

The Company sold millions of third-generation Kindle devices with the new advanced paper-like Pearl e-ink display in the fourth quarter and the third-generation Kindle eclipsed ―Harry Potter and the Deathly Hallows – as the best selling product in Amazon’s history.

The U.S. Kindle Store now has more than 810,000 books including New Releases and 107 of 112 New York Times Bestsellers. Over 670,000 of these books are $9.99 or less, including 74 New York Times Bestsellers. Millions of free, out-of-copyright, pre-1923 books are also available to read on Kindle.

January 2011’s sales figures from the American Association of Publishers also point to the growing success of eBooks – US$70m – a 116% increase year-on-year – despite a small, 1.8% (US$805m), fall in the overall market. eBook market share figures are hard to verify. Apple recently claimed 20% of the market, Barnes and Noble (US-only) also claimed 20% of the market and Amazon claims between 70% and 80% of the market – obviously not all can be true.

Wild market claims are to be expected in this high growth stage of the market development and there is uncertainty whether a 20% market share is by downloads or value and whether downloads include free, out of copyright eBooks which generate no revenue. All estimates that the STL team have seen indicate that Amazon is the market leader with a market share in the 50%-75% range. This CNET interview with Ian Freed, an Amazon vice president in charge of the Kindle, provides more detail on where Amazon sees itself in the market.

Although detailed data isn’t available about whether Amazon is yet making a contribution to operating profit from the Kindle and eBooks generally, all the indications are that Amazon is happy with the results and the continued investment speaks for itself.

The STL team believes Amazon’s success can be put down to five key factors:

  • Amazon probably has the highest concentration of book reader users as its customers;
  • Reading books on the Kindle is a very pleasurable experience and much better than some non-dedicated devices, especially the PC and the phone;
  • Amazon has developed a very easy-to-use platform which removes the friction of purchase and delivery of eBooks to a wide choice of platforms;
  • Amazon has tried to deliver great prices to its customers with new eBooks typically priced cheaper than their hardback alternatives. The Kindle Store has always included a wide selection of free out of copyright books; and
  • Amazon has built a store with access to material from the largest publishers to the smallest self-publishers. Self publishers are driving innovation with low-pricing for smaller episodic books.

The STL team believes that this last point is extremely important. Currently, Amazon has over two million sellers on its stores most of which are small businesses selling physical goods with the help of Amazon tools and services. This volume is far in excess of most developer schemes and almost certainly far larger than the combined total of content sellers across all developer platforms. Amazon will have little problem building and managing an even larger community as the developer community has largely adopted ‘Amazon Web Services’ as their cloud platform of choice, and sellers are already familiar and happy with Amazon tools and services. 

Amazon and Music: Downloads not moving the needle

In the UK for example, Amazon share of the overall music retail market was a healthy 13.4% in 2009. Overall, the internet players have the largest share of the music market with 39%, compared to specialist retailers, such as HMV, with 33% and Supermarkets, such as Tesco and Sainsbury’s, with 23.6%. In a decade, the internet as an e-commerce channel has overtaken all of the UK’s high street. The download only Apple iTunes service with share of 10.6% clearly dominates the online distribution market.

Figure 7: Amazon’s Music Share is Healthy but not Dominant

Source: BPI Yearbook 2009

In the USA, Billboard estimated that in 2009 iTunes had 26.7% retail market share, which translated into 65.5% online market share. For a la carte download sales, the iTunes U.S. presence is overwhelming, with an estimated 93% market share.

In contrast, Amazon’s MP3 store had an overall 1.3% market share, which translates into about 5% share for a la carte downloads. Amazon commenced digital downloads in 2007 and has been a constant innovator.
The service launched with DRM-free tracks which were therefore portable between devices and with higher bitrate encoding, providing higher quality to the discerning ear. In the USA, the catalogue has continually grown and from an initial 2m tracks have grown to today having 1.4m albums and 15.2m tracks. But, as befits its corporate strategy of “everyday low pricing”, Amazon has put most effort into price innovation.

Figure 8: Amazon’s Smart Targeting & Competitive Pricing

Normally, Amazon has the lowest price for its chosen Album of the week. For instance, The Strokes new album is currently available for £4 compared to iTunes pricing of £8 in the UK. This is typical behaviour of a master retailer driving customers to their stores through headline offers and promotions to their customers. Apple has a very different approach relying on an agency model where the content owner has limited choice in setting retail prices.

In the USA, Amazon’s Daily Deal launched in June 2008 and it became the subject of a Department of Justice (DOJ) inquiry in May 2010 after iTunes began grumbling about Amazon promotions to the major labels. No comment has been released by the DOJ, but it seems clear that with Apple’s huge iTunes share that any attempt to discourage labels from participating in the Amazon promotions might be construed as price fixing. Amazon has continued to play its strongest card – differentiation though price competition.

Amazon has built an MP3 application for Android phones which allows the immediate purchase and playing of songs. It is noticeable that they haven’t built the same tools for Apple. In fact, the Amazon WindowShop application for the iPad actually displays download prices (and the playing of short clips), but doesn’t allow the direct purchase or download. Given, Apple’s domination of the music download market and the fact that Apple have allowed the Kindle store to operate on the iPad/iPhone, the STL team predict it will not be long before the DOJ launch another inquiry into Apple’s music practices.

In contrast to eBooks, Amazon does not seem to have built significant music share and the STL team puts this down to three main reasons:

  • The Amazon experience of buying music is not as good as Apple iTunes. This is made especially difficult to match as Apple control the device – the mass market seems to prefer convenience over price on low unit price items;
  • Amazon is not associated with the music market in the same way as Apple is; and
  • There are plenty of alternatives to paid music downloads. Spotify in Europe and Rhapsody in the USA, although of questionable profitability, have achieved success on other platforms with different business models, providing both paid-for and advertiser funded unlimited music streaming.

The move into Movie streaming

Amazon has taken a different approach to Movies than to either Books or Music.

In the UK and Germany, Amazon has recently acquired full ownership of a DVD and streaming service, called LoveFilm. This operates primarily under a subscription model providing access to a library of films. It is the UK and German equivalent of Netflix.

A subscription business operates under a vastly model than a retailer. It requires a much larger investment in both customer acquisition and retention and in content libraries. There is also reasonable investment required in gaining access and building clients for the plethora of devices coming onto the market to connect TVs to the internet. It also starts to compete with powerful payTV companies that have very deep pockets, large customer bases and similar ambitions.

In the USA, Netflix has managed to build a strong base of customers, a large market capitalization and is currently a darling of both the press and the investor community. The STL team has written extensively in the past about Netflix, its business model and prospects (see: The Impact of Netflix: Can Telcos Help Hollywood; Entertainment 2.0: New Sources of Revenu for Telcos?)

Amazon has decided to enter the fray in the USA with its Instant Video service. This service offers a limited selection of free streaming movies to subscribers of the Amazon Prime service. The Amazon Prime service is priced at US$79/per annum, compared to the Netflix streaming cost of US$8/month ($96/annum). Although, the annual fee may put some off, Amazon seems to have solved the problem of expensive customer acquisition. However, it is questionable whether Amazon under a licensing structure can afford similar levels of investment in content as Netflix.

A key factor in deciding this will be the support of studios for its model and their willingness to provide premium content and in this Amazon is gaining traction.

Figure 9: New Releases are Going to Amazon First

It is noticeable in the USA that Amazon are heavily promoting download-to-rent and download-to-own options which brings new releases to the library and are favoured by the Movie Industry.

Amazon is also an UltraViolet member which again we have written extensively about (see Telcos Risk Missing the UltraViolet Online Opportunity) and it is likely in the near future that Amazon will sell physical DVDs with the right to stream to multiple devices.

In Movies, STL Partners believes Amazon is uncertain which of the options will win in the future and is willing to invest in a wide range of options; effectively, it’s hedging its bets. But as in Music, Amazon has a long way to catch up with early platforms, whether that’s Apple, which leads the download-to-rent and own market, or Netflix which leads the subscription business. Again, this makes it an interesting target for partnerships, particularly for content owners looking to establish models that work better for them than Apple or Netflix.

Amazon shaking up the AppStore market

Amazon also has a significant business selling both physical electronic games and consoles. It was therefore hardly surprising that it launched Android AppStore heavily populated with games and featuring Angry Birds Rio as its launch game.

Figure 10: Amazon’s Appstore

The Amazon AppStore offers some very interesting features, including:

  • The ability to sample the game on a PC before committing to a purchase;
  • Amazon setting the retail price of the game with the developer only suggesting a retail price;
  • Free Daily Promotions of leading applications; and
  • Amazon performing a limited curation role, checking the applications are free of viruses

There are also teething problems with the service. For example, the Amazon AppStore is impossible to install on some “locked-down” Android handsets.

But Amazon has entered the market and the STL team believes it will be a serious player for years to come. It is also our belief that Amazon will want to develop AppStores for all major platforms, which will bring them into considerable conflict with certain platform owners, not just Apple.

To read the report in full, including the conclusions and recommendations…

  • Lessons for other players in the Digital Entertainment Value Chain
  • Content Owners
  • Network Services Providers
  • Device Manufacturers

Members of the Telco 2.0TM Executive Briefing Subscription Service and the Dealing with Disruption Stream can access and download a PDF of the full report here. Non-Members, please see here for how to subscribe. Alternatively, please email contact@telco2.net or call +44 (0) 207 247 5003 for further details. ‘Growing the Mobile Internet’ and ‘Lessons from Apple: Fostering vibrant content ecosystems’ are also featured at our AMERICAS and EMEA Executive Brainstorms and Best Practice Live! virtual events.

Full Article: A New Role For Telcos in the Digital Economy

NB. This 30+ page article can be downloaded in PDF format here or browsed on-screen below.

© Copyright 2008. STL Partners. All rights reserved.
STL Partners published this content for the sole use of STL Partners’ customers and Telco 2.0™ subscribers. It may not be duplicated, reproduced or retransmitted in whole or in part without the express permission of STL Partners, Elmwood Road, London SE24 9NU (UK). Phone: +44 (0) 20 3239 7530. E-mail: contact@telco2.net. All rights reserved. All opinions and estimates herein constitute our judgment as of this date and are subject to change without notice.

Executive summary

The bundling of voice, broadband data and media content is no longer enough to grow the telecoms industry. This ‘Executive Briefing’ outlines a new approach to growth and argues that a vital part of the business model is missing.

New value lies in addressing the friction that exists in everyday interactions between businesses and consumers, and between governments and citizens. Typical examples include: authenticating users; market research; targeting promotions; distributing goods and content; collecting payments; and providing customer care. Today, these processes are often slow, inefficient and ineffective. They waste money and affect customer satisfaction.

Collectively, telcos have assets that can address this situation: real-time user data; secure distribution networks; sophisticated payment processing capabilities; trusted brands; a near universal subscriber base; and core voice and messaging products.

To realise a new business model opportunity based on Telco 2.0, these assets must be reorganised. A two-sided telecoms market structure is required in which telcos facilitate improved interactions and transactions between people and organisations. Telcos must continue to attract retail consumers and satisfy their needs, but in addition, they should extend the capabilities of their traditional consumer products to explicitly support enterprise business processes.

To do this, telcos will need to create open and standardised platforms that third-party organisations can plug their enterprise IT and communications systems into, just as they plug into the telephone and internet networks today.

We estimate this opportunity could be worth $375bn of new revenue to telcos in 10 years’ time, equivalent to around 30% of total telecoms revenues at that time in mature markets alone. The value to the wider digital economy – industry and consumers – will be many times greater.

There is a sense of urgency. This revenue is not guaranteed and large-scale ‘over the top’ players are also interested in capturing value by re-engineering the value chains of other industries – witness what Google has done with the advertising industry. Operators cannot afford to sit and wait. They must act soon if this opportunity is not to pass them by and this means co-ordinated, cross-industry collaboration to develop the market opportunity. Failure to do this will lead to inevitable decline – see the charts overleaf.

Telco 1.0: The future isn’t bright

[Figure]

Voice and data business model pressures

[Figure]

Contents

Part 1

  • Telco 2.0: The next business model
  • Major growth potential for operators

Part 2

  • Introduction
  • Telco 1.0: Nearing end of life
  • Customer demand for Telco 2.0 solutions
  • Lessons from other industries
  • Telco 2.0 business models use unique operator assets

Part 3

  • Moving Forward
  • Conclusion

Part 4

  • Further Information

Part 1 – The Telco 2.0 opportunity

Telco 2.0: The next business model

A new role for telcos in the digital economy

In future, the job of a telecoms chief executive will be to balance three kinds of complementary businesses:

  • An enhanced retail1 platform, which deepens the intimacy of the customer relationship. This is an optimisation and evolution of the existing retail offering.
  • A rich wholesale platform2, which creates new value from network assets by addressing a much broader range of online delivery problems on behalf of a much broader range of commercial customers.
  • A new B2B2C value-added services (VAS) platform that addresses a wide range of business process inefficiencies and costs in the economy at large, again for a broad range of commercial customers.

The third line of business is new and creates what is known as a two-sided market. On one side, the retail platform acquires customers – the downstream end users in the graphic below. The data from these relationships is used to enable a whole new market of upstream organisations wishing to interact more efficiently and effectively with the public. Revenue is realised from both sides.

Telco 2.0 operator: Three businesses

[Figure]

Major growth potential for operators

STL has modelled the potential size of the opportunity to build new wholesale services3, as well as to develop business process value-added services4. The latter was done using a detailed model of 119 different verticals. The potential value of each telco value-added services platform was calculated for each vertical.

The model suggests that, in 2017, the size of the opportunity for new wholesale services will be around $250bn, and the opportunity for value-added services will be $125bn – if telcos choose to execute new strategies.  These numbers are sufficiently large to merit further evaluation.

Western Europe and North American telecoms market

[Figure]

W. Europe and N. America value-added services platform opportunity ($Bn)

[Figure]

Part 2 – Why Telco 2.0?

Introduction

In this section of the report, we focus on four reasons why the Telco 2.0 world described in Part 1 is attractive to operators:

  • Telco 1.0 is nearing end of life as a business model
  • Upstream service providers and downstream end-user customers have new needs that can be met by Telco 2.0 solutions
  • Other industries provide successful precedents for Telco 2.0 type business models
  • Telco 2.0 business models use operators’ unique assets.

Telco 1.0: Nearing end of life

A complex ecosystem that required central co-ordination

The telecoms industry was structurally stable from the early days of the telegraph and telephone systems, through to the 1980s. This was despite varying fortunes of individual players and rapid technology change. Indeed, many technology revolutions occurred, including: transition from analogue to digital switches; the development of fibre optic cable for long-distance communication; the introduction of satellite and microwave links; and the invention of cellular radio. All these changes left the same operators and suppliers with broadly the same business models as they had before each change. This contrasts with the IT industry, in which the move from mainframes to minicomputers and on to personal computers was accompanied by waves of mass corporate extinction.

The dominant Telco 1.0 business model has two pillars:

  • Vertical integration, where the network owner controls the services on the network and repays the capital investment by billing for them.
  • The revenue model is generally a one-sided market, where the telco buys equipment and content from suppliers upstream, integrates these and bills the end user for services downstream. The upstream side is cost and the downstream side is revenue.

Vertical integration is a model that has proved highly successful. In the late 19th century, the US could be regarded as an emerging economy. The same business model works in today’s emerging economies as they adopt wireless technology. Why is this?

  • Vertical integration brings together all the technological pieces into a working whole. For example, providing electrical power to the user’s handset and cellular base station remains a major concern in Africa.
  • It allows users to pay for service as they discover uses and value for communications systems. There is no need for a sophisticated banking industry or credit management system to enable payments.
  • It aligns value and pricing. Network effects can grow through price discrimination that makes service affordable to poorer users.
  • It provides clear incentives for investment in infrastructure. A business case can be constructed based on specific services and user demand.
  • It is easy to explain and sell to users. Broadband, megabits and gigabytes remain ethereal concepts to many users.

The one-sided nature of the business model has largely been a by-product of the technological limitations of the network and terminal technology. With the exception of freephone numbers and yellow pages directories, there was no viable mechanism for adding richer features to interactions between consumers and businesses.

Political and technology change strains business model

The first major challenge to the traditional telecoms business model came from the privatisation, divestiture and deregulation of fixed networks in the 1980s. Replacement of the PTT monopolies with competition fostered rapid growth. However, this was largely a case of creating many clones of similar vertically integrated telecoms service providers. Every message or transaction was still a potential billable event and advanced features were offered as value-added services, with competition stimulating more features and marketing ploys. Only large corporations bought raw data transmission to connect data processing centres and remote offices, and prices for all services remained high.

The arrival of affordable wireless telephony in the 1990s created a huge global boom. Again, this perpetuated the existing vertically integrated model, extending it from voice to include SMS, MMS and WAP. This effect was reinforced by handset subsidies that meant the network operator also dictated the capabilities of the devices. Thus, the operator could close out rival sources of services and content, forming  ‘walled gardens’. These media portals have generally failed to achieve anticipated revenues. There are a few exceptions, such as ringtones and i‑mode in Japan, but they are not a sustainable basis for funding large-scale network deployments. Today’s IPTV video portals follow the same walled garden model and have similar issues.

Simultaneously to the mobile technology boom, the internet matured from an academic research network connecting tightly clustered research communities, into a global media and commerce platform. A wave of technical innovation in fibre-optics and packet-based routers brought down costs. The Darwinian success of Ethernet and Internet Protocol in their struggle with proprietary rivals created a common open standard and vast network effect for equipment and interconnection. The internet marked the start of a fundamental shift in power, from telecoms network equipment vendors and telecoms standards committees, towards the IT and consumer electronics industries.

For the first time, consumers and small businesses could readily obtain new services and content without the active support – or veto – of their local telecoms provider. Users were hungry for these services and to reach them they needed to subscribe to an internet service provider (ISP). The ISP bridged users to the data network via their existing fixed voice lines, creating the first spark as two opposing business models touched for the first time. The result was a proliferation of dial-up ISPs. The new industry was an accidental by-product of the voice telephony system and was characterised by: free or cheap local calls; competition rules such as per-call carrier pre-select; common carrier non-discrimination rules; and some timely regulatory interventions. As a result of the interventions, internet access prices crashed, with the profit remaining in the ownership of the local loop on which ISPs depended.

At the same time, PCs rapidly became affordable to the average home and office user. Web browsers matured enough to support secure e-commerce, making the net a conduit for money, not just hypertext, and web sites became sufficiently usable for the masses. The outcome was explosive user adoption and demand for underlying telco services such as second home lines. In the Telco 1.0 business model, the internet was far more of an opportunity than a threat.

Downturn prompts defensive change

The twin mobile and internet booms created a capital investment bubble. As this passed through the system during the 2000s, there was a wave of consolidation. A group of powerful regional, and some global, operators emerged. Growth was maintained through two forces for greater user demand: the continued adoption of mobile telephony, particularly in emerging markets; and the switch from dial-up to both fixed and mobile broadband. Scaling the existing business was a greater concern than fixing any inherent problems within the business model.

The supply side also moved to maintain prices through the bundling of services. The ‘triple play’ comprises voice/messaging, video, both broadcast and on-demand, and internet access across both fixed and mobile networks. Thus, over the past five years, most telcos have been working on two core business initiatives: assembling their portfolios of products across the triple play; and solving associated back-office provisioning, billing and customer care problems.

All three components of the triple play bundle are part of a one-sided market. The network operator: buys equipment and content from suppliers; acquires spectrum, rights of way and licenses from government; integrates these with an IT back end; and markets the products to end users through a network of distribution channels. Money is paid to the upstream suppliers and received from a small range of downstream segments, such as the public sector, large enterprise, small business and consumers, divided into prepaid and contract.

A broken business model

Not all is well with today’s telco business model: the triple play is not making expected profits; tensions in the underlying, one-sided business model are increasingly visible; and the surrounding environment is raising the pressure for change. The hyper-growth phase is over in developed markets and the transition phase towards stability and decline of the old business model is coming to a close.

Voice and data business model pressures

[Figure]

Voice service revenue stops growing

Voice service comprises around 80% of global telecoms revenues. Technology improvement, competition and regulation have caused both fixed and mobile per-minute prices to crash. Long ago, fixed voice became a low-margin and high-volume commodity business.

Price elasticity of mobile voice has so far meant drops in per-minute call rates have been outweighed by increased usage. They have also been buoyed by an increased user tendency towards mobile telephony and rising disposable incomes. However, even mobile usage and revenues are peaking in mature markets. For example, in 2007, for outgoing voice minutes in the UK, Vodafone saw a 19% drop in per-minute prices, a 24% rise in usage, but only a 0.3% increase in revenue.

The backstops to high-margin mobile voice revenue are eroding: termination fees are being regulated downwards everywhere; roaming fees, of particular importance in Europe, have been capped; and international outbound calling is being attacked by an array of arbitrage players.

Most markets have three to five nationwide competitors and the physics of wireless naturally lends itself to competition everywhere. The future for mobile voice looks much like that for fixed – not  an easy business in which to make money.

Entry into the video market fails to meet expectations

Video has yet to become a money-spinner for telcos. There are a few exceptions and we discuss geographic variations later. Mobile TV appears to be limited in appeal, with few users willing to pay much to fill in a few moments of boredom as there are many other cheap ways of wasting time. IPTV has tended to be an expensive failure, both technically and in the market, while cable and satellite companies have skills that telcos simply lack, such as content acquisition, packaging, rights management, cross-media promotion and sales of sponsorship and adverts. Cable companies are rushing to take on the business model problems of telephony and broadband ISPs.

In the media value chain, the value is where telcos are weak – aggregation. As media becomes hyper-abundant, the user crisis moves to finding relevant products. Content creation, distribution and consumption no longer have the economies of scale that used to exist. Most people in developed markets can afford an HD video camera, to start a global video podcast site and view the results on a widescreen home theatre system. Even aggregation is becoming automated using algorithms and feedback from user behaviour. These aggregation functions – search, filtering and organising – are all dominated by IT companies. Telcos have been left producing IP-based emulations of media from the analogue era and are missing all the best ideas from the essential aggregation step.

Fundamentally, online media cannot be the growth engine of telecoms as it is becoming a hyper-competitive business with low barriers to entry. The value in telecoms has always come from connecting people, not from directing eyeballs to media.

Data services: cost inflation and pricing problems

Data services were supposed to be the industry’s salvation. This has not panned out as expected. As markets mature, revenues flatten as price competition is the only way to differentiate otherwise identical broadband products. Users get a taste for online video, which creates demand shocks and increases in peak-hour usage, thus driving additional capital spending. In many markets, the costs of backhaul are also significant.

Effectively, ISP customers are being sold mispriced options for nearly unlimited communication. Traffic shaping is only a stop-gap solution to managing costs and it is not possible to win a cat-and-mouse game with your own customers. STL expects the current mobile PC broadband boom to end in tears for many players as capacity is exhausted and cellular congestion increases in a few key concentration points, driving user dissatisfaction and churn.

Another problem with triple play is that completing the bundle can be expensive. Cable companies are compelled to enter the voice business, with slim margins on fixed networks and very high wholesale costs to buy in mobile voice as a mobile virtual network operator (MVNO). Telcos have to compete against entrenched players for rights to premium sport and entertainment. Mobile operators become unbundled local loop broadband providers, without having the scale to make the economics work.

Over the top attacks the bottom line

SMS continues to grow as a business, but price competition is creeping in, with unlimited bundles on offer and termination fees under regulatory pressure. SMS is threatened by IP-based bypass services that charge the user little more than the cost of terminating the message, but this threat to SMS should not be over emphasised. SMS is a convenient, simple and universally available service. For an arbitrageur, nearly all messages are off-net, whereas the telco that charges full retail prices for on-net SMS can use the charge to subsidise off-net SMS at, or below, cost.

The real problem is that users may abandon SMS for other forms of IP-based messaging. These include:

  • IM, which offers status and presence data
  • Twitter-like services, which excel at large group messaging
  • Voice-based messaging services, such as Phweet
  • Social networking sites, which have more raw data on ‘what’s going on?’ to induce new conversations.

A move away from SMS is being made in markets such as South Africa, where MXit, an ad-funded group text messaging service that uses GPRS, or 3G, rather than traditional and expensive SMS, has enjoyed tremendous growth. Introduced in 2005, MXit had 6.5 million users – around 25% of mobile subscribers – in South Africa by May 2008.

With voice, the situation is reversed, with arbitrage of the internet having more effect than complete substitution of the telco service. Voice over IP (VoIP) has largely failed to catch the public’s imagination, with good reason. As the price of circuit-switched voice has crashed, the incentive to jump through usability and provisioning hoops to avoid operators’ tolls has vanished, while few VoIP services have offered anything to differentiate themselves from basic telco voice services. Instead, people are using the internet as the signalling medium to set up calls and then enjoying the lowest possible originating and terminating charges, without the outrageous telco mark-ups for services such as international calling.

The growth of over the top internet services, with the telco as bitpipe, has prompted efforts to refresh core telco products. Technologies such as Internet Multimedia Subsystem (IMS) and Service Delivery Platforms (SDP) have been pushed by vendors as the basis for operators to launch dozens of new services quickly. However, the operators’ hands are tied by the very success of existing vertically integrated voice and messaging services. It is extremely hard to make any substantive changes. Most new features of interest, such as presence, cannot be deployed unilaterally, but to deploy across carriers it would be necessary to upgrade every handset and network, plus retrain support and sales staff. Interoperability of basic services, such as MMS, is still far from perfect or complete and interoperability of new services, such as push-to-talk and instant messaging (IM), is very limited. Telcos are not well positioned to fight the internet ecosystem in a battle over features targeted at end users.

A changed environment

During the long boom in telecoms and IT, risk capital poured into dotcoms. Few flourished, given the constraints of the day, but time is proving many of their ideas to be right. Application innovation is now largely outside telcos and network equipment providers. However, the telco business model is to build out each new network so that it either reaches people and places that others cannot reach, or offers speeds or capabilities that enable services others cannot replicate. To recoup the capital cost, telcos bill for the transactions conducted via the services deployed on the network.

The booms in mobile and internet fuelled growth hid the inner tension with the telco. The internet disintermediates the telco from the services value chain. Without the billable events that services generate, there is only data transmission to charge for. Megabytes and megabits are very weak proxies for end-user value. Without the ability to achieve value-based pricing, it is very difficulty to pay for the network.

Efforts to date create limited impact

Network operators are aware of these issues and are experimenting with new business models. Paid for premium content remains a perennial favourite. The problem with this business is that static media, as opposed to interactive, suffers from rampant piracy. The only solution appears to be blanket licensing that neither the content owners or government seem willing to offer or impose. Meanwhile, Apple continues to dominate music distribution and television companies are forging online distribution channels independently of the telcos.

Likewise, telcos have been testing the advertising business5, both as suppliers of inventory to host advertisements and as providers of services to optimise ad insertion into third-party content.  There are two small problems with this – and one big one. The amount of telco inventory is generally rather limited, as increasingly users go off portal, while for third party sites, there have been privacy and public relations issues with telco-powered ad insertion (witness the ‘Phorm storm’ in the UK).

The big problem is scale. By 2010, the entire online advertising industry – including Google – will amount to around $62bn. This sounds like an attractive market, until you discover that the entire telecoms business is estimated at around $2,490bn. Even if telcos got 25% of the online advertising market, advertising is too small a business to make any serious impact on the fundamental problems of the telco business model.

Other forms of diversification have met with varying degrees of success. Several telcos have built valuable services arms, offering systems integration, IT support, network management and hosting. Some have successfully entered banking and payments in both developed and emerging markets, while others are testing identity and authentication services. However, none of these complementary businesses can fix the problems of the core business. To date, what is also lacking is a coherent framework to help telcos provide the widest possible range of business processes across the widest range of industries. At present, these opportunities tend to be tackled as piecemeal business development activities.

Telco 1.0: The future isn’t bright

[Figure]

Change is needed, but must be carefully timed

The problems of the Telco 1.0 business model are not experienced equally by all. Fixed operators have fallen further and faster, forcing restructuring and diversification into complementary businesses such as systems integration and outsourced IT services. There are also regional differences: European operators are under the most strain; while North America remains a rather special case. In North America, receiving party pays voice and messaging, oligopolistic market structures and relatively weak regulatory intervention have left a few of the largest telcos and cablecos in a comfortable position. Meanwhile, the tier two and tier three operators are desperate for new business models. Elsewhere, Japan and Korea are trendsetters in technology, but their business models often fail to work in the rest of the world. Emerging markets are, rightly, continuing with vertical integration as modular, horizontal market structures are a sign of maturity, but there is also potential to leap-frog existing business models when not tied to an expansive legacy.

Industry support for Telco 2.0 strategies

[Figure]

Customer demand for Telco 2.0 solutions

The flipside of problems in the telecoms business model is that there are problems in the business models of all organisations. Where the telco has assets that can potentially reduce problems, every problem turns into an opportunity.  Starting close to home, telco assets can be used to solve business problems in the online media value chain6. This approach can then be generalised to help fix inefficiencies in common business processes across a wider range of economic activities.

Online services commonly suffer from the following problems:

  • Hard to pay for access and get provisioned: You visit friends, a client’s office, a coffee shop, an airport lounge. Every time, it is a new challenge to get online.
  • Advertising everywhere: Our eyeballs are continually polluted by irrelevant product pitches. The option of payment to avoid adverts us usually missing. Where you can or must pay, it is a tedious process.
  • Spam, viruses, phishing, 409 scammers: The attitude seems to be a big shrug because the cost of building strong identity schemes or creating proper governance, issues we take for granted in telephony and SMS, are too high.
  • A new site, another identity: Why do we have to enter usernames, passwords, address, date of birth and credit card details everywhere we go?
  • Lack of support: If a support line exists, expect the details to be well hidden.
  • Poor personalisation: This starts with multi-language and localisation support, but the problem is far broader in that services rarely adapt to you, your preferences, or your lifestyle.

The limitations of these services are often caused by the limited capabilities a telco can bring to bear.

Upstream customers want Telco 2.0 solutions

[Figure]

Further efficiency is possible in consumer interactions

Labour, energy and interest are wasted in real-world business processes. Parcels are brought to the door of your home, only for a ‘Sorry you were out’ note to be left – the telco knows you were away. Customers sign up for online services, which then spend considerable amounts to verify your identity – the telco has credit checked you, seen you in person, or been to your home. Customers call to complain that their games console or media box download is not working – the telco knows there is a network operation or configuration problem.

This scenario suggests a very different future for the telecoms industry than the one usually promoted. Instead of introducing hundreds of paid-for services and trying to market them to ever smaller segments, telcos should tackle a few universal business problems. The idea is to try and take a thin slice out of many industries, rather than piling all hopes into the online content and services business.

The trillion dollar rethink

Given these issues and opportunities, it is necessary to answer two questions: what is the purpose of a telecommunications service provider; and what does the future business model look like? To provide credible answers, there must be a clear journey to the future business model. This does not mean throwing out today’s business and starting from scratch. Instead, we need to answer the following questions:

  • How should underlying telecoms infrastructure be funded and what is the role of the telco in this?
  • How do we protect and evolve core voice and messaging products?
  • How do we turn online video distribution into a profit driver, rather than a cause of cost inflation to the ISP?
  • How do we create more value from current assets, both physical assets, such as networks and IT systems, and assets that are less tangible, such as brand, trust and customer data?
  • How do we find new classes of customers to service and, therefore, new revenue sources?

In answering these questions, there is a need for change in the industry to reflect a new world that is increasingly unlike that experienced before.

Lessons from other industries

Today’s pain points in the telecoms industry are not unique. There have been many previous manias, booms and busts in infrastructure-based networked industries, such as canals, railways and airlines. Telecoms is also not the first industry to restructure from vertical integration to a much more horizontal and modular structure. For example, in the late 1920s, Henry Ford commanded that a car factory be built in the Amazon basin. It would be near his rubber plantations and break an Anglo-Dutch monopoly on quality rubber.

Three lessons can be learnt by examining the history of vertical integration:

  • As industries mature and value chains get longer, the role of wholesale and business-to-business transactions increases.
  • Transport industries serve as a strong precedent for telecoms.
  • The money comes from using data by-products of business processes to form insights that allow you to solve business problems for your customers.

A shift in focus from retail to wholesale

As an example of the first lesson, consider the financial services industry, which has seen massive restructuring from the 1970s to today. Once, mortgages were bought from retail banks or mutual savings societies that would keep them on their books and collect payments until maturity. Now, people go to comparison websites that refer on to a broker who sells a branded loan that is immediately securitised and then derivatives traded to distribute risk, albeit with some clear failings unique to financial services. Each of these stages produces a market in intermediate, rather than finished, products.

Transport logistics as a precedent for telecoms

Logistics companies perform two services: distribution of products; and value-added services to smooth the supply chain. Future growth in telecoms will come from telcos acting as digital logistics companies, supplying customised logistics solutions to upstream customers. There is an added twist of two-sidedness, as each interaction can be personalised to each end user – something that does not happen in the physical world. For example, Fedex should know if you are home, but it does not.

Off-line logistics: Distribution and value-added services

[Figure]

Online Telco 2.0 logistics: Distribution and value-added services

[Figure]

Telco 2.0 logistics is a far grander and more profitable enterprise than a dumb pipe. It turns ‘over the top’ competitors into customers and they become a source of value, rather than a threat to revenue and sources of cost.

The value of logistics solutions in shipping

It is hard to sit through a telecoms conference without hearing dumb pipe mentioned at least once, but the reality of distributing goods and services is considerably more complex than this feared phrase admits. The container shipping industry provides us with a clear model.

Containerisation started in the mid-1950s, displacing the earlier break bulk system in which loose cargo was loaded individually. Shipping containers are to physical goods what IP packets are to information goods, a standardised form of distribution, capable of conveyance on many underlying modes of transport. The break bulk system bears a strong resemblance to the vertical integration of circuit telephony and SMS. The caveat is that telecoms and information goods do not always behave in the same way as the transport of physical goods. Data can be transmitted instantly, without the need to store and forward it, it can be copied at  no cost and the value of data is largely derived from the context of its use, rather than being intrinsic.

The winners in the transition to containerisation were not the shipping lines. Some ports that invested in new systems, such as Singapore, Rotterdam, Dubai and Newark, fared extremely well due to increasing returns to scale. Some that hesitated, such as London, or invested in the old model, such as New York, lost all their business. However, it was a logistics company, Maersk, that became the largest and most powerful player in the container industry. It was able to solve the problem of getting goods from factory to wholesale warehouse and beyond by assembling the necessary multi-modal transport services. It still owns ports and shipping lines, including the first transatlantic container company, Sealand, just as telcos will continue to own and operate networks.

Telco 2.0 business models use unique operator assets

Despite the moniker of being ‘service providers’, most telcos provide startlingly few and thin services, and create very little value out of the data they accumulate. This can be contrasted with other industries, such as aircraft jet engines. Many years ago, the engine salesman would be beaten down on price by the airline’s purchasing department, but would make up any loss with expensive spares over subsequent years. This created the perverse incentive to produce unreliable engines. Similarly, telecoms operators have misaligned incentives. For example, how many phone calls start with ‘Sorry, I’m on another call, can you phone back later?’, or see the caller bounced to voicemail because the recipient is busy? The airline industry has shifted to a new system that gives incentives to manufacturers to keep their engines running. Telemetry systems that radio performance data back to manufacturers each time an aircraft lands enable them to make adjustments, before things go wrong. Faults are detected and repaired before they happen and problems can be addressed quickly, before they result in a total breakdown, keeping the engine in service and improving safety.

An example closer to the digital world is Google, which reclaimed the latent value of hypertext links between web pages by treating each link as a form of endorsement. In turn, this was used to create Google’s search algorithm. User behaviour around which contextual adverts are clicked on then drives which adverts will be displayed. Google’s business is built on treating all data as potentially valuable business insight.

Operators have a huge volume of user and network data that could be used to ensure that:

  • Telco and partner retail products perform better for end users
  • Wholesale products are similarly improved
  • Third-party service providers benefit from the B2B enabling services of the value-added services platform to ensure that their sales, marketing and delivery processes are also improved.

Operators struggle to identify and abstract the data they hold and turn it into meaningful information, but that is not a sufficient reason not to address the problem. Google has shown that small volumes of customer data are extremely valuable and that customers willingly part with information about themselves if they receive value in return. For Google, users happily give away information about what they are searching in return for a list of web pages containing highly relevant information and products.

Telcos have a large volume of latent data assets

[Figure]

Google makes do with very few pieces of data…

[Figure]

…but has built a valuable platform business fast

[Figure]

Part 3 – Building a Telco 2.0 business

Moving Forward

Fundamentals: Separate infrastructure from operations

In the long term, passive infrastructure will become part of a completely different multi-utility business and not part of the telecoms industry at all. For example, when is the right time to dig up the road to lay fibre? It is when this coincides with replacing rusted lamp posts rather than when an optical switch is replaced.

It is likely that telcos will want to continue to own or operate active network infrastructure, particularly as the IT-centric parts crash in price and go open source. This is a stronger drive for a telco that is wholesale-centric than of a telco that depends for competitive advantage on the branded retail side. The latter could probably outsource network management and operations.

The primary reason to search for cost savings through shared infrastructure is that it is becoming more difficult to pay for the network through billable events on a telco’s own services. This will push access networks towards a new ownership model: network sharing; open access networks; municipal backbones; and vendor operated networks. This is a huge area, but not the subject of this report.

There is another, more subtle, reason why telcos should work hard to avoid creating competing, but ultimately duplicate, access networks. Competition in the distribution of digital goods and online services is moving down the value chain from the core of the network to the edge. Once it was the owner of the long distance network who ruled: AT&T dominated the independent local phone companies in the US because they needed interconnect and their independent existence was largely maintained by regulatory fiat. Then power shifted from the network core to access networks. Without effective unbundling rules, the US local exchange carriers and cable companies have collected monopoly rents. Mobile operators have spectrum auctions as a barrier to entry, as it is difficult to gather together nationwide or continent-wide coverage.

Now we are in a third wave, where the critical assets for distributing content and services are at the network edge: in the home; the office; and in the user’s mobile handset. Investing in access networks as a source of competitive advantage is often a waste of resources. It does deliver enough differentiation. The differentiating assets are in home and office networks and include edge devices, software, local storage and content.

Key actions to lay the foundations of a Telco 2.0 business

  • Divest infrastructure assets and activities that are not strategically aligned with the Telco 2.0 model.
  • Organise the business to tackle the three strategic opportunities around retail, wholesale and value-added services platforms. The value-added services platform is likely to be new and will need careful nurturing.
  • Create new financial and operational metrics to measure the progress of your move towards a Telco 2.0 organisation.

Become a better retailer and evolve triple play

The retail arm of a telco acquires users and creates a customer relationship. The core product is the triple play and is the ‘bread and butter’ of most operators. However, few, if any, of today’s telcos are really adept at selling the digital lifestyle, especially when you compare their retail stores to those of leaders such as Apple and Best Buy. Becoming a world-class retailer is a major challenge. Nevertheless, here are the steps needed to get there:

  • Bring on more partners and broaden the product mix beyond media content: Grocery stores offer a wide selection of products within each category, including own label and third-party brands, so that customers can find the products they want. Recently, they have extended this approach into banking services, insurance and even telecoms through a network of partners. Operators themselves have a very limited range of offers: ‘one size fits all’ voice and messaging; data; video; and a handful of portal services that are poorly marketed and difficult to find. They attempt to match customers to what they offer, rather than the other way round. This is a key reason for the lack of differentiation in the industry and the high levels of customer churn.

Telcos need to offer a range of devices and services that satisfy the underlying user need, such as ‘keep me in touch with my family’, a digital photo frame tied to a picture messaging service, or ‘lower energy bills’, a smart meter that offers a text-based advisory service on energy usage.

  • Invest in customer insight: Through the use of data mining, especially loyalty schemes, grocers have become very adept at promoting the right offers. An unread insert sent with a telecoms bill is not enough. In the UK, Tesco has developed tens of thousands of customer segments for its store shoppers, based on the information captured through the Tesco loyalty card. The online part of the business, Tesco.com, is even better at customer relationship management as every customer is treated separately and receives a unique portfolio of offers based on buying patterns.

This insight needs to be shared back along the supply chain. Good retailers share at least part of this information with their suppliers so that the whole value chain reacts faster to changing consumer demands and manages product development and inventory more effectively. This will be a key component in reducing product development lifecycles in telecoms and making the industry more flexible.

Customer insight and supply chain management are core parts of a basic retail skill: category management. Retailers break products and services down into groups, or categories, and manage these as a family, often with separate profit and loss responsibility. The advantages are obvious: increased management focus; an ability to think about growing the whole category rather than one brand or product; easier to manage suppliers of products and brands within the category.

Operators, on the other hand, often do not have anyone responsible for their most important product – voice telephony. It remains everyone’s and nobody’s responsibility. Although the CEO ultimately takes the rap, nobody else is solely responsible for arresting the voice category’s decline and turning it into a growth engine once again.

  • Make billing simpler and easier: We all know the Kiss principle – Keep it simple stupid – but, historically, operators have expected customers to segment themselves based on an ever-expanding range of tariffs to suit different calling patterns and budgets. The result is confusion for customers and sales and customer care staff, as well as huge systems and management costs.

For example, on the UK moneysupermarket.com website, which provides price comparisons for products, there were 550 different packages offered for a Nokia 6300 with 200 texts and 400 minutes per month. A bewildering number of different enticements are bundled in to deliver essentially the same offer. The enticements included handset subsidies, insurance, cashback, Nintendo Wii or other gaming consoles, laptops and fixed broadband. This does not differentiate operators from one another, it only devalues the core telephony offering and creates confusion among consumers.

  • Turn customer care into relationship sales: Every customer contact should be a sales opportunity. This is not just basic reading of a script, but a genuine conversation where a sales person listens and learns about the user’s needs. Operators hold huge amounts of information about their customers and could use this to ensure that call centre based conversations are more effective and efficient. As a start, because each Caller Line Identification (CLI) is linked to an account, it should be simple to automatically route calls to the right agent based on CLI rather than expect customers to wade through an interactive voice recognition system. This is one example of using customer information and technological know-how to improve the customer care process. Another would be to furnish agents with better information about customer behaviour so that they can offer suitable solutions to customers. Knowing a customer’s click-stream or call-stream history would enable care staff to provide compelling offers. For example, on noticing that a customer calls his or her bank several times a month, an agent could ask, “Would you be interested in text updates of your account balance?” Better still, this service could be offered free to the end user and paid for by the bank. The operator becomes a channel for bank products.

Clearly, this requires technological and business model development, but it also requires cultural change. Operator call centres need to focus on the quality of the customer interaction, not just on the number and duration of interactions, the key metrics of today’s call centres.

  • Change the brand promise: Most operators, particularly in the mobile space, have focused brand building around product innovation. But operators are not strong innovators, so brand investment is at odds with reality. Operators should focus their brands on trust – as the top retailers do and banks until the recent credit crisis. “We are an operator you can trust to bring you the right product and service, and customer care to meet your needs” is a much stronger message for a ‘telco supermarket’. Be open and honest with customers and become the trust mark for online services, just as a Visa or Verisign logo assures safety. Customers should feel comfortable that a product or service is fit for purpose when they buy it from their operator.

Underpinning these steps are capabilities such as analytics, local market intelligence, loyalty schemes and identity management.

For some operators that lack the skills or scale to build a customer intimacy business, it may make sense to reduce or exit the own-brand retail channel. This is particularly the case for operators that specialise in the Telco 2.0 wholesale platform, which provides services to the retail customers of other operators.

Recent years have seen a stampede towards triple and quadruple-play offerings of fixed and mobile voice, video and data. Most service providers recognise that the current pricing bundles are insufficient, but moving towards service integration is proving difficult. Even simple, early examples, such as BT Fusion in the UK, have not been very successful. Most operators seem to be trying to build complex integration between the media and telephony industries. This is misguided. Below we describe the retail issues and later we will examine the complementary wholesale changes that are necessary for success.

Voice and SMS services need to integrate with the online world7: The most important change is to focus investment on connecting people, using personal communications products, rather than on media content, information services or entertainment. The next wave of growth has yet to pick a definitive buzzword – it might be ‘mobile social networking’ – but the engine of telecoms has always been the desire of humans to be social and to converse. Yet voice and messaging products have stagnated and, if this continues, users will turn to non-telco products that better fit their needs.

For personal communications, value is migrating away from the metered minute towards:

  • Helping the right people rendezvous at the right time, perhaps using presence or IM to co-ordinate when a call starts
  • Being able to collaborate and share experiences, for example seeing the same picture or web page
  • Transacting money or information during a conversation using automated tools, not manual dictation
  • Using call detail records and other data from a call to inform other processes, such as reputation systems or scheduling algorithms.

Business models turned upside down: Value shifts to three new areas

[Figure]

Telcos are not in a good position to create and market innovative new voice and messaging services on their own. Voice, text and video messaging will be features of broader personal communications and productivity tools.

Where will these communications tools be found? The web, of course. The key to accessing new retail revenues and increasing customer satisfaction is partnership with online services. Operators must assemble a portfolio of partners and use existing voice and messaging products as a focal point around which services such as shared voicemail, address book, presence and preferences can be integrated. Simple services that work, are conveniently packaged and can be easily bought as part of an unmetered bundle. At the moment, we are a long way from this, but  we have seen the first inkling of operators starting to move on to the web with Vodafone’s recent application, Vodafone Connect to Friends, which enables Facebook users to send text messages from their Facebook page.

Video delivery is a wholesale capability, not a retail user product: The problems of video delivery8 require a new approach. STL does not believe IPTV or mobile TV can be significant growth drivers. These approaches replicate analogue TV and miss the rapid evolution of the critical aggregation function. They also resemble the closed online content portals of the 1990s that were swept away by the open internet. Trying to keep control as a gatekeeper does not work. Telcos cannot keep up with the speed of innovation and will not have enough revenues to match the rapidly evolving interactivity of internet TV. In the battle between internet TV and IPTV, the former will win.

The exception is an IPTV system that uses fibre for distribution, replicating the cable system of broadcast down one wavelength. Obviously, this requires substantial infrastructure investment and pits operators directly against cable and satellite players. It also requires operators to be skilled media players and to back the right content on their closed platform – skills that BSkyB and the cable companies have been perfecting for 10 years or more.

We prefer a different approach that allows operators to work with, not against, over the top aggregators and retailers. Operators should become open wholesale platforms that support a wide range of partner products. Telcos will make money from partners who use the wholesale distribution platform, in the same way as Akamai makes money from its content distribution solution.

Data needs more than the simple ISP product: There are three core forces pushing for change in the delivery of data services. These can be summarised as:

  • A huge corporate market that creates spill-over into the residential market. For instance, ISPs should be offering managed residential virtual private network (VPN) products so that home workers can work securely. Latency is low, service levels are high. The home office is a growth area, but there is a big disconnect between what users need for entertainment and family use, and getting work done. The latter is more important and offers higher margins.
  • Users who are seeking a connected lifestyle, but who are being sold a disjointed series of access products, such as fixed access, mobile access and Wi-Fi access. Provisioning needs to occur at different levels:
    • A data service that follows users regardless of their connection. So, when someone plugs a laptop into a hotel network it works with no splash pages or credit cards.
    • Finer-grained provisioning so users can buy individual connected applications, such as navigation on an internet tablet device.
  • The desire by users to use cheaper and more reliable fixed networks in place of mobile wherever they can. In the home and office environment there will be a strong incentive to offload mobile data onto the fixed network. There will not be such a thing as a purely fixed or mobile ISP, both must work in tandem. The winners will be those that develop the edge assets and business models to enable this.

Key actions to create a better retail business

  • Improve your retail offering by emulating leading retailers such as Amazon, Carrefour, Tesco and Ikea:
    • Develop a broad selection of partners and products to increase the value of your portfolio to end users.
    • Make your products very easy to search and evaluate, include user reviews and recommendations to help customers choose.
    • Reward your customers for loyalty and sharing data, information, views and recommendations with you. Adopt a permission-based marketing approach that rewards customers for contributing to the success of the telco’s retail, wholesale and value-added services platforms.
    • Invest in analytics and business intelligence so that you better understand how customers are behaving, why they are behaving in particular ways and what can be done to serve them better. Automate this process, do not rely on focus groups and market research. Let the customer and network data give you the answers.
  • Update your processes and product pipeline gating criteria to reflect new priorities. In particular, build in targets for new products to encourage user participation in the platform via feedback and reviews, and the acquisition of new customers. Also, develop a target for new products to reward end users for participation – perhaps discounts, offers, tangible improved service delivery or customer service – and promote these rewards to end users.

Develop richer, customised wholesale products

Many of the shortcomings of the voice, video and data components of triple play can only be improved by creating new kinds of wholesale product. Today, most telcos offer bulk wholesale products, such as high-capacity leased lines or voice termination, which are sold as quantities of millions of minutes. In future, a much wider range will be needed.

STL Partners sees three key changes to the wholesale business:

  • Moving access and transmission charges from retail voice, messaging and data products to wholesale products sold to the services that the user prefers. This is important as it reduces the charges made to an operator’s own retail base for the operator’s products and instead means wholesale customers pick up some of the tab.

Moving access and transmission charges to wholesale: Kindle

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  • Using wholesale as a means to access customers with whom an operator does not have a relationship. The benefit here is improved distribution as an operator can get access to the customers of third parties that build their retail presence on the wholesale platform. An example of this would be where an internet player offers the voice and messaging product of an operator to its customer base as a white-label service. The operator picks up the wholesale revenue for these consumers under its agreement with the internet player.
  • Providing tailored voice, video and data wholesale products that, unlike the bulk offerings, work within the context of the operator’s existing retail relationships. Operators manage the difficult hops across access networks for the end users and provide the right solutions to meet their needs, then charge the service provider for the magic.

Who pays for the network traffic?: The most important change is to enable sender party pays data via wholesale markets. This allows content and service providers to pay for voice minutes, video delivery and data charges, and include these in charges to the end user, or absorb the charges if ad-funded. The user has no need to consider usage caps, metered usage or fair use limits. Unlike today’s ISP product, which encourages free-riding distribution by content providers, this aligns the incentives of the user, telco and content provider.

Custom voice, video and data wholesale products: Operators need a content and service distribution platform that, unlike bulk wholesale, facilitates the delivery by third parties of a wide range of digital goods and services to their own retail customers. The operators may not be providing the service, that is done by the third party, but their relationships with the end user enable them to add value to the interaction. The media companies that want operators to distribute their services will pay to access those telco customer relationships and related assets, such as home hubs and set-top boxes. We have seen this in a very restricted form so far, either limited to web content, for example i-mode, or as one-off integration efforts. There is no platform commonality or interoperability across operators.

For voice service the telco needs to facilitate third-party applications to package up and sell minutes as part of a service offering. This is different from an MVNO, where the third party takes over the customer relationship. Instead, third parties can adopt voice as just one facet of their service. These wholesale offers allow price discrimination between different classes of users or partners. This can be done via contractual rather than technical means,  something that cannot be done so easily on the retail side.

Future voice wholesale example: Match.com

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Likewise with video, the ultimate goal is to encourage online services to work in co-operation with the telco, rather than going over the top. This needs to be done with carrots, not sticks, by providing a more flexible network that offers more options, reduced cost and improved user experience. This may be easier than it sounds, as many of the existing players in the value chain, such as broadcasters, are struggling with online video delivery and would eagerly embrace a more co-operative approach from telcos. After all, they are already paying Akamai, Limelight and others for improving content delivery and operators have the scope to do more.

We cover the video distribution opportunity for operators in detail in the STL report, Online Video Market Study: Options and Opportunities for Distributors in a time of massive disruption, but a brief summary of the key actions operators need to take includes:

  • Make content delivery cheap and efficient: Build Content Delivery Networks (CDNs) and cache content close to the edge. Participate in forums to make peer-to-peer (P2P) delivery more network-aware. Give third parties access to the capabilities of edge devices, particularly those sold through the telco, such as home hubs, set-top boxes and network attached storage. A content partner should be able to query how much free space is available on hard drives in the home and use it to pre-cache data. There also needs to be a menu of choices of content delivery, for example off-peak data, not just premium options like assured quality of service streaming.
  • Help content providers maintain a sustainable economic model: Make it easy for content providers to charge to the telco’s monthly bill, or offer an ad-funded model with the telco using its customer knowledge to target ads, or offer separate per-megabyte charges for delivery to the user for specific partners or applications. Then offer the billing and collections service on behalf of the third party.
  • Police the illegal stuff: Content owners and established aggregators and broadcasters are suffering not only because their business models are under pressure, but also because wide-scale fraud is being committed on the web. Illegal downloads of music and video being offered by several of the new aggregators and operators have turned a blind eye to this practice. Why? Because these downloads provide welcome pull-through for broadband access sales. But with broadband now reaching saturation, the continued growth of rich media streaming and downloads is putting pressure on the ISP business model. One way to control these costs is to work with content owners to clamp down on piracy. This can be done both with end users – letters telling them to desist or risk having their service terminated – and, more importantly, with the suppliers of illegal material. This will reduce costs for ISPs but, more interestingly, content owners and aggregators will pay operators to fulfil the role.
  • Market to the base: Telcos know who is using P2P to download music and video. More than that, they know who is downloading what music, which film and so on. Music and video fans will buy relevant offers from operators. In addition, retailers, aggregators and content owners will pay operators to deliver relevant marketing of their products and services to these people – a two-sided opportunity.

Necessary short-term activities are:

  • Getting core and access network ready for these options
  • Selling edge devices, for example network-attached storage, that create the capabilities that media partners need
  • Updating billing systems to cope with a mix of retail and wholesale data charges
  • Taking control over pipes and some responsibility for the content flowing through them. Expect to have to put in place age or parental controls and, rather than a porn site asking “are you over 18?”, the ISP account holder will need to authenticate himself or herself before content is delivered.

For data, too, the situation is similar. For example, fixed telcos need to think about how they can offer backhaul services to femtocells deployed by a number of retail mobile operators.

One additional wholesale capability unique to the broadband data product is to return control to users. Deep packet inspection and traffic shaping have got a bad reputation because they have been covertly used by ISPs to give users something less than what was apparently being sold. Operators have control over streams, even if, in practice, this power is exercised on the users’ behalf and provisioned by their online service providers. Make life easier for users by giving them, or their online service providers, the tools they needs to carve up bandwidth and allocate it to where it is needed. The operator can, if it wants to, charge the service provider for this. This is the inverse of the traditional telco approach to traffic management, which uses technologies such as IMS and would require every consumer electronics device to have an embedded IMS stack to talk an obscure telco protocol.

Key actions to achieve richer wholesale products

  • Considerably enhance your wholesale product portfolio as this is the new growth engine:
    • Work hard to increase the volume of SMS wholesale products, such as short codes and pSMS.
    • White label voice and messaging products for sale via non-telco channels, particularly the internet.
    • Support industry efforts to implement sender party pays data for rich media applications. This is an important move as it re-establishes the link between revenues and costs. As costs increase with rich media streaming, for example video, so revenues rise as operators are paid by content providers and retailers for delivery.
    • Develop new wholesale products to capture value as local access points continue to be developed. For example, as a fixed operator, develop a wholesale product for the backhaul of traffic from femtocells as they are deployed in offices and homes.

Support third-party business processes

Telcos are not dumb pipes as all have valuable assets beyond their transmission networks. They have a broad range of customer data assets and customer relationships that give them implicit permission to contact and interact with the customers. Both businesses and governments constantly interact with the public via telco voice and messaging products, portals and payment systems. Rather than trying to raise revenue directly from users by creating new services, telcos can use these assets to make B2C and C2B interactions more effective and more efficient, ergo better and cheaper.

There are seven generic business process areas that telcos can service using their platform service capabilities9. In each case, the telcos are optimising business processes:

  • Identity, authentication and security: Manage customers and their transactions securely
  • Advertising, marketing services and business intelligence: Profile and target specific customers, ad delivery
  • E-commerce sales: Complete the sales transaction
  • Order fulfilment offline: Manage delivery of physical goods
  • Order fulfilment online of e-content: Manage delivery of electronic goods
  • Billing and payments: Bill customers, manage credit and collect cash
  • Customer care: Post-transaction support.

Value-added services platform: Supporting the value chains of other industries

[Figure]

There are three key enablers for these value-added services:

  • Identity management: This acts not only as a capability that can be sold directly, but also as a foundation stone for all other value-added services.
  • Communications-enabled business processes (CEBP): This is where operators use their existing core products, voice and messaging, to take friction out of every day business processes. An example might be making automated calls to remind people to pay their non-telco bills, or to tell someone a parcel delivery is about to be delivered and give them the opportunity to reschedule it. Typically, the goal of CEBP is to reduce the lag in business processes, eliminating wasted labour and costs, and reducing working capital and inventory. It is lean thinking applied to the economy at large. In future, we see telcos being able to offer a wide variety of value-added CEBP services that offer significantly higher margins than, for example, today’s voice and SMS termination fees. For instance, a telco could offer the ability to deposit voicemail messages as Voice XML documents with embedded interactive voice recognition, rather than just delivering a stream of audio bytes. The customer can then hear ‘Press 1 to reschedule this delivery’, rather than ‘Call us on 123-456-789’, which the customer will not bother to do.
  • Agent-based software technologies: The data that the telco holds is highly sensitive and private, which makes it difficult to use in business processes serving third parties. The web services model assumes the data is transferred to where the business process is executing. There are two dangers in this:
    • To the privacy of consumers who do not want data about themselves passed around between companies. This position is also enshrined in law in most jurisdictions.
    • To the telcos’ new, two-sided business model. Operators will not be able to charge upstream service providers for this valuable data if they give it to them. There will always be a Google out there that will take the data and use it to compete directly against the operator.

Our agent model reverses the web services procedure. Business processes are executed inside the telco where the data is held. For example, a call centre might delegate outbound call distribution to the telco, which has the relevant presence, availability and location data. The telco initiates calls and, upon answering, connects the user to the call centre. At no point is the call centre given direct access to the user’s real-time contextual data. This mimics the success Paypal has enjoyed with payments. Paypal holds financial data about both the consumer and merchant, but does not reveal this data to either party. It manages the transaction by working with both financial institutions and both of the transacting parties keep their data safe.

The key idea here is to allow the third party to place flexible business rules behind the telco firewall. For example, automated call distribution might have rules that say ‘Do not call people in the Hawaiian time zone except during business hours in the region’. Rather than producing an API for every possible combination, the telco executes a piece of software supplied to it by the third party and the piece of software would has access to the time zone of the recipient, who could be someone with a Detroit area code roaming in Hawaii. The business rule comes to the customer data, which results in an action, but the data never leaves the telco

Key actions to support third-party business processes

  • Develop a handful of pilot projects to test the two-sided opportunity with upstream and downstream customers and:
    • Build credibility in the market and internally
    • Road test demand for one or more service capabilities
    • Capture platform functional requirements
    • Validate business models and pricing
    • Create basis for volume estimates.
  • Develop a 12 to 18-month plan to realise the B2B2C value-added services platform opportunity:
    • Develop a joined up strategy and business case for the new value-added services business. Recognise that no individual service capability, including advertising, marketing and business intelligence, or vertical industry is likely to be sufficiently large on its own. It is the combination of service capabilities across several industries that makes the opportunity interesting.
    • Engender board level support for the two-sided business model that underpins the value-added services platform. Without support from the top, any initiatives in this area will fail.
    • Create a separate, dedicated organisation to avoid the new business from being destroyed by the mother ship.
    • Build the key downstream capabilities: CRM, data mining and data protection/privacy to support the value-added services business.
    • Build the upstream capabilities: aggregation, distribution and integration partners.
    • Establish a process for operator collaboration. Recognise that this is an industry opportunity that requires several operators to engage to build value for all.

Create new two-sided markets

The growth opportunity is to make money from upstream customers that wish to interact with the telco retail customer base. The obvious corollary is that you need access to retail customers: either your own; those of third parties enabled by your own wholesale platform; or those delivered via interconnect-type agreements with other telcos. We noted earlier that this forms a two-sided market. There are some additional points to note:

  • To maximise participation, a two-sided market needs careful balancing of how much you charge each side. It may be necessary to lower charges on, some retail services, o even give them away. In return, user permission to participate is gathered and customers’ otherwise private data drives the high-margin upstream services, such as voice/messaging or CEBP. Operators will need to consider value across both sides of the platform and not simply focus on end user pricing and ARPU.
  • Telcos need to work through a network of intermediaries to develop this market. Transaction networks and aggregators will provide the upstream parties with a single interface that spans many telcos. The trick is to get the right balance between the intermediary creating value for the ecosystem, without being able to collect monopoly rents and subjugate the telcos. This problem has already been faced in telecoms with services such as voice and SMS roaming. It has also been seen in other industries, such as payment networks for credit cards and their relationship to issuing and merchant banks.10

Conclusion

STL Partners’ research suggests that building a Telco 2.0 business is viable if significant change is made to both the telco’s business model and its cultural approach. Telcos that grasp the opportunities of Telco 2.0 will take a new position in the market at large and will identify new growth and revenue streams. Those that do not move on to the new opportunities of Telco 2.0 may, in the long term, find it difficult to survive in a retail market characterised by pricing pressure and demanding innovation.

Telco 2.0 is a mix of one and two-sided markets, with a clear switch to put users in control of what they get and how they get it. The need to create relationships with users whereby they are actively involved in platform processes is critical. Operators must appreciate that their customer relationships are very important and that the survival of their future retail business will depend on their ability to foster customer intimacy. That does not mean operators must provide every service, as there is also great value in integrating voice and messaging into other companies’ products and services. Equally, there is great value in enabling other companies to provide their services better. Here, the operator acts as the enabler, for which it may get little credit (either monetary or brand loyalty) direct from the end user, but for which upstream companies will be willing to pay.

Operators have many touchpoints with end users – retail stores, fixed and mobile portals, bills, call centres – but little attempt has been made to involve them so that they contribute to the efficiency and effectiveness of the value-added services platform. STL will explore how this can be done in more detail in a forthcoming report, Digital Kids, How Today’s Kids will Change Tomorrow’s Telcos,  that will be published in January 2009.

Part 4 – Further information

Further Information

For further information about any of the following products and services, please contact our Commercial Director, Andrew Collinson on andrew.collinson@stlpartners.com or +44 (0)7802 587260.

Strategy Reports

Telco 2.0™ strategy reports address key Telecoms Industry strategic challenges.  Each report contains more than 150 pages of detailed analysis and insight, numerous case studies, reviews of winning and losing strategies, and short, medium and long-term action plans for Telcos, Vendors, Investors, and their business partners. Single, Group, and Corporate Licenses are available, as are collective subscriptions.  The current portfolio consists of:

  • Voice & Messaging 2.0
    “What to learn from – and how to compete with – Internet Communications Services”
  • Digital Kids
    “How today’s kids will change tomorrow’s Telcos” (Publication: January 2009)

Subscription Service

This Briefing is the first of, and introduction to, the Telco 2.0 Executive Briefings that articulate the detailed opportunities and strategies provided through our Subscription Service.

Telco 2.0™ Subscription Service Package includes:

  • A minimum of 15 x 30+ page briefings issued throughout the year to keep you fully briefed on the very latest in leading thinking and industry practice
  • Access to Telco 2.0™ analyst support so that you can validate assumptions / discuss key thoughts and options
  • A full list of Briefing reports is available online and includes:
    • Telco 2.0: A new role for Telcos in the Digital Economy
    • Introducing Two-sided Markets
    • Voice and Messaging: User Needs and How to Meet Them
    • Online Video Distribution: Three Scenarios for the Future
    • A Framework for Business Model Innovation

Individual Briefing reports are available for purchase separately.

Interactive Workshops

We create and run tailor-made client workshops around key Telco 2.0™ topics which we run either within our client’s organisations, or with a mixture of our clients and their customers. These sessions help to formulate strategy, agree plans, and create shared visions based on a thorough understanding of the future business environment and partners’ business goals and models.

These sessions use the Telco 2.0™ research, other bespoke materials, and client inputs in conjunction with our “Mindshare” technology. Outputs include full data from the sessions plus Telco 2.0™ commentary.

Consulting and Advisory Services

STL Partners provide advisory and consulting support to companies developing their strategy in key Telco 2.0™ areas. Our expertise is around business model innovation – new ways of making money in the Digital Economy. Please contact us for more information.

STL Partners consulting

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1 See Telco 2.0™ Briefing Report March 2009  for more detail.

2 See Telco 2.0™ Strategy Report Future Broadband Business Models, April 2008  for more detail.

3 “Future Broadband Business Models – Beyond bundling: winning the new “$250Bn delivery game”, STL Partners, April 2008.

4 “The 2-Sided Telecoms Market Opportunity – Sizing the new $125Bn Platform Services Opportunity”, STL Partners, April 2008.

5 “Telco’s Role in the Advertising Value Chain – How to make the Telco Advertising Channel work for Brands and profitable for Telcos”, STL Partners, 2007.

6 “Content Distribution 2.0 – Fixing the Broken Online Video Distribution Chain”, STL Partners, December 2008.

7 “Voice & Messaging 2.0: What to learn from – and how to compete with – Internet Communication Services”

8 “Content Distribution 2.0 – Fixing the broken Online Video Distribution Value Chain.”

9 “The 2-Sided Telecoms Market Opportunity – sizing the new $125Bn platform services opportunity”

10 See Telco 2.0™ Strategy Report The 2-Sided Telecoms Market Opportunity, April 2008 and Telco 2.0™ Briefing Report Introducing 2-Sided Business Models, December 2009 for more details.