Free Mobile: A Prototype for Disruption?

Summary: Free.fr’s entry to the French mobile market has achieved extraordinarily rapid market share gains and resulted in comprehensive disruption. An analysis of its technology, tactics, and business model, and a high-level assessment of the applicability of its approach to other markets. (February 2013, Executive Briefing Service Dealing with Disruption Stream).

Mobile Market Share in France 2012 - Free 2013

  Read in Full (Members only)   To Subscribe click here

Below is an extract from this 25 page Telco 2.0 Briefing Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service and Dealing with Disruption Stream here. We’ll be publishing more on Digital Commerce in in 2013 and it will be a key theme at our Executive Brainstorms in Silicon Valley (March 2013), and Europe (London, June 2013). Non-members can subscribe here and for this and other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

Introduction: A Wave of Disruption

A major theme in our work on mobile operator strategy recently has been the potential for disruption on price. In the European Mobile: The Future’s not Bright, it’s Brutal report, we forecast a substantial decline in voice and messaging revenues across Europe, and identified a group of relatively high-priced markets in challenging Southern European economies that were especially at risk from a competitive shock. 

In the subsequent Europe’s Brutal Future: Vodafone & Telefonica hit hard we responded to the announcement of grim results at Telefonica and Vodafone’s southern European units. And in Sprint-Softbank: how it will disrupt the US market, we looked at the state of the US mobile market as Sprint is acquired by Softbank and investment starts to flow into T-Mobile USA.

Further, since we published the Sprint-Softbank note, 3UK has announced that it is planning to launch LTE later this year, as soon as the disbursed 1800MHz spectrum from the EverythingEverywhere merger becomes available. The service will be launched at a zero price premium to their 3G tariffs. This contrasts with EE’s initial pricing, which tried to define 4G as a premium product, and suggests that whatever pricing power their go-it-alone LTE deployment gave them will be very short-lived.

So it appears that structural pressures, like macroeconomic problems, the concentration of unemployment among the young (an early-adopter demographic), and the increasing availability and adoption of alternatives (Skype, BBM, Whatsapp, etc), are bearing down on prices in many markets. One outcome is that eventually operators will be forced to cut prices and therefore accept gradual reductions in their profit margins. Another outcome is more radical disruption through the entry of new players, which if successful can have a much higher impact on incumbent players. 

In this note, we will look at the disruption of the French MNO market brought about by the entry of Free Mobile, which is both a case study of best practice and also one that illustrates some of the key constraints on disruption. We identify a new class of operator, the low-cost disruptor, empowered by software to go after incumbents’ margins, and look at the criteria for their success.

Market Background

In France, everything was stable pre-2012

France, before Free’s entry to the market, was one of the less competitive and pricier mobile markets in Europe with three operators only, one of them being the part-nationalised incumbent France Telecom. Immediately before Free Mobile’s launch, Fitch Ratings estimated the price of a minute of mobile voice in France at €0.10, compared to €0.07 in the UK or Germany . In terms of monthly ARPU, we can see that the cheapest French operator (interestingly, the incumbent) has usually been around €15 a month dearer than the average German operator and about €10 a month dearer than the average British operator. 

Figure 1: France, a high-price market
Monthly ARPU in France & EU Markets Feb 2013

Source: STL

The regulator, ARCEP, was often characterised as being relatively weak, or else committed to a strategy of letting the operators have more margin in the hope of encouraging infrastructure development.

Politically, this isn’t quite accurate. Importantly, ARCEP wasn’t the only actor involved – the ministries and regional governments also had a substantial voice in policy, and the incumbent enjoyed special access to the top level of politics as a major state enterprise. (In fact, for part of the 2000s, the French minister of finance’s previous job was CEO of France Telecom.) 

Although the European Union’s Information Society, Competition, and Internal Market directorates also influenced the regulatory environment, telecoms is one of the fields where responsibility is shared between the EU and national authorities, and France is a big enough power within the EU to largely shape its own policy. This typically expresses a preference for the development of large national champion companies, and for infrastructure development over either competition or consumer protection.

On the other hand, ARCEP was one of the first regulators to permit independent ISPs to use the incumbent’s civil works infrastructure, and the public sector was very active in investing in middle-mile dark fibre. The upshot of this was that France has a fixed ISP market that offers customers remarkable value – FTTH is more available, speeds are better, and voice pricing is better for comparable rates to those prevailing in the UK, which has a roughly comparable market structure.

Free.fr’s fixed market entry

A major driver of this was a disruptive entrant, Free.fr. Free has been intensively studied, but we will briefly recap some key points. Free’s flagship service offering is €29.99/mo for everything, that including their fastest Internet service, unlimited VoIP to many destinations, and a variety of IT services. Over time, the purity of this price point has been diluted, but it still exists for new subscribers. Free.fr has no marketing department in a classical sense, and their tech support is largely provided by a network of partners recruited from the subscriber base.

On the other hand, they have historically invested without compromise in technology. Not only does Free develop its own software, it developed a succession of very successful set-top boxes, and it even developed its own ADSL2+ equipment. Further, they were an early adopter of FTTH, benefiting from the regulated access to civil works and the public investment in middle-mile fibre. Free was one of the first ISPs to provide IPv6 to end users. The TVPerso service was a pioneering user-generated content platform that provided multicast live streaming years ahead of anyone else. 

Figure 2: A disruptive product play – one product, everything, one price, €30
Logica February 2013

Source: Rudolf van den Berg, Logica 

In mobile, however, the picture was rather different. Only three operators, and one of those being the main supplier of backhaul connectivity, resulted in relatively little competition and high ARPUs and margins in the international context. Market share, particularly, has been remarkably, almost suspiciously, stable over time, as the following chart demonstrates.

Figure 3: Market share in France since 2005
Market Share in France 2005-2011 February 2013

Source: STL

Until, of course, Free became a mobile operator, launching on the 10th January 2012.

Free.fr enters mobile: a pure happy pipe strategy

Free Mobile’s product strategy could not have been simpler. It had two key points: price, and quantity. As with the fixed ISP product, the strategy was to offer big bundles at low prices, notably by unbundling the price of the mobile device from the service contract. The best deal was the bring-your-own-device option. (We also saw this with Softbank.) 

Specifically, there were two options at launch. New subscribers could pay €20/mo for unlimited national calls and international calls to 40 countries, unlimited messaging, and 3GB/mo of Internet service. Existing subscribers to fixed service benefited from a discount to €16/mo. There was also an ultra-low cost plan, which offers 60 minutes of voice and 60 text messages for €2/mo with no contractual commitment and no phone, and overage set at €0.05/minute. This was free as an add-on to an existing fixed subscription. In general, Free Mobile customers remain free to switch provider on a rolling basis, rather than being tied in for the duration of the contract.

As Diffraction Analysis’ Benoit Felten points out, the company traditionally targeted two groups, technology-focused early adopters, and price-driven discount chasers . As a result, as well as bringing your own phone, you could also have the latest iPhone, unlocked, if you were willing to pay an additional €19.99/mo.

Bigger bundles at lower prices suggest a material cost advantage over other players. This is the essence of a Telco 2.0 Happy Piper: engineer operations for efficient bulk IP traffic delivery and ensure prices remain below those offered by competitors and, at the same time, deliver acceptable margins.

Impact

Free rapidly gained subscribers from the other MNOs and from the MVNO sector, and probably also from new adopters on the ultra-low cost tariffs. By the end of March, it had gained 2.6 million subscribers, 4% of the market, and declared a target of between 15 and 25 per cent market share.  By mid-year, its market share had passed 5%, and by the end of Q3 2012 (the last published results), 6.4%, or 4.4 million subscribers with a run-rate of 270,000 net-adds per month.

Figure 4: Free Mobile Reaches 6.4% Share in 9 Months
Market Share in France, 1st 9 Months 2012 February 2013

 Source: WCIS, STL

This resulted in a price shock across the entire market and a rapid rise in indicators of competition generally. It also resulted in a surge of additional subscriber growth.

To read the note in full, including the following sections detailing support for the analysis…

  • How did Free.fr get there?
  • The fight for a license
  • The ‘MVNO plus’ network strategy
  • The role of Freebox set-top boxes
  • Getting Beyond the Unlimited Data Wars
  • Low-Cost Disruptors: International Examples
  • USA: Republic Wireless
  • Global voice-focused: Truphone
  • A failed attempt: UK01
  • Wholesale: Virgin Media
  • Key factors in the business model
  • Technical Arbitrage
  • Software Power
  • The Regulatory and Economic Environment
  • Could it happen here?
  • STL Partners and the Telco 2.0™ Initiative
  • Telco 2.0™ ‘two-sided’ telecoms business model

…and the following figures…

  • Figure 1: France, a high-price market
  • Figure 2: A disruptive product play – one product, everything, one price, €30
  • Figure 3: Market share in France since 2005
  • Figure 4: Free Mobile Reaches 6.4% Share in 9 Months
  • Figure 5: Contract-free subscribers in France, 2008-2012
  • Figure 6: Mobile number portability usage in France, 2007-2012
  • Figure 7: An overview of the disruption
  • Figure 8: ARPUs driven down industry-wide
  • Figure 9: 4th Mobile Operators’ Performance Over 1st 6 Years
  • Figure 10: The Urban Core – Orange Dominates the Base Station Count
  • Figure 11: The Disparity Is Much Less In The Suburbs
  • Figure 12: % of time connected to Free’s own network; 900MHz refarming causes a sharp spike
  • Figure 13: Use cases for software-defined networking in the Free context 

Members of the Telco 2.0 Executive Briefing Subscription Service and Dealing with Disruption Stream can download the full 25 page report in PDF format hereNon-Members, please subscribe here. For this or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

European Mobile: The Future’s not Bright, it’s Brutal

Summary findings and implications

Dark skies ahead

The mobile telecoms sector has performed quite strongly through the economic downturn but STL Partners’ forecast for UK, France, Germany, Spain and Italy suggests that the outlook is extremely bleak:

  • Even in the UK and Germany, the markets with the brightest future, STL Partners forecasts a respective 19% and 20% decline in mobile core services (voice, messaging and data) revenues by 2020. The UK has less far to fall simply because the market has already contracted over the last 2-3 years whereas the German market has continued to grow.
  • We forecast a decline of 34% in France over the same period.
  • In Italy and, in particular, Spain we forecast a brutal declines of 47% and 61% respectively.
  • Overall, STL Partners anticipates a reduction of 36% or €30 billion in core mobile service revenues by 2020. This equates to around €50 billion for Europe as a whole.

Figure 1: Mobile core Service revenues

European Mobile Core Services Revenue Forecast Chart, Oct 2012, Telco 2.0

Source: European regulators, Mobile operators, Barclays Capital, STL Partners assumptions and analysis

  • Even if our forecasts prove to be too pessimistic – and we have sought to be realistic rather than unduly negative and have built our models bottom up looking at pricing and volume trends wherever possible – the future looks much worse than other analysts and industry observers are currently forecasting. For example, a recent report by Arthur D Little and Exane BNP Paribas forecasts a 2.3% per annum decline in mobile to 2015 compared with our forecast of 4.3% per annum decline over the same period.
  • Data growth, service bundling, customer experience improvements and cost-cutting activities are valuable but fall way short of offsetting declines in voice and messaging. The game for mobile operators in Europe is changing forever: as things stand, in a few short years they will be forced to become very much more conservative businesses – more like gas and water companies. Interestingly, the capital markets already rate telecoms companies as utilities judging by their lofty dividend yields.
  • There will be casualties. Several operators will not exist in their current form by 2020. Despite the desire of regulators to have four or five network operators in their countries to encourage competition, the downward revenue pressure will favour scale economies and the pressure for many operators to merge or acquire/be acquired will be overwhelming.

Get your umbrellas ready now

We are starting to see a few European operators invest more actively in building new revenue streams – something that STL Partners has been pushing through its Telco 2.0 initiative for several years. Telefonica with Telefonica Digital, KPN, Orange, Telenor and a handful of other companies are becoming more active in ‘digital services’ and new business models. This activity urgently needs to be accelerated and prioritised if operators stand any chance of replacing the impeding revenue declines.

For future success, operators must embrace Telco 2.0 (and recognise the need for a new business model and new service offerings) whether that is as a lean ‘Telco 2.0 Happy Pipe’ or as a ‘Telco 2.0 Services Provider’. Both of these strategies require business model transformation that encompasses:

  • Major strategic choices and decisions about what the organisation should and should not do;
  • The identification, selection and development of new products and services;
  • More effective processes for bringing newly developed services to market;
  • A realignment of organisation structures to deliver the new services;
  • A redefinition of the way operators work with each other and with external partners to build value;
  • Clarification of how technology should support the Telco 2.0 business model and services;
  • A review of revenue and cost models to maximise value for consumers, partners and telcos themselves;
  • A new relationship with regulators as the industry seeks to redefine its role and value in the digital economy.

STL Partners remains committed to working with TMT players that want to make the changes identified above in three ways:

For more details of how STL Partners can help you, please contact us.

Introduction

The telecoms industry is performing quite well in a tough economic environment

At the moment, the global telecoms industry seems to be in relatively robust health – developing economies are driving subscriber growth, 4G is being rolled out, smartphones are being connected with data plans in huge numbers, service providers are selling bundled “integrated offers” to maintain revenues, and costs are being controlled with network-sharing and other strategies

But there is also a nagging concern held by industry managers and observers that all is not well ‘below the waterline’, especially in mature markets. There have been a few worrying signs from operators losing out on messaging revenues to OTT players like WhatsApp, or suffering outright reductions in revenues and subscriber numbers in markets like Spain. That said, these have been largely ascribed to poor pricing decisions or (hopefully) temporary local macroeconomic problems.

Certainly, the financial markets seem pretty convinced in the operators’ underlying ability to turn consumers’ desire for communication into ARPU. Not only that, but there is broad conviction that growing data revenues should be able to offset – plus or minus a little – slow declines in voice and messaging, especially when it is all wrapped up in a bundle.

The question is whether that assumption is really valid, or whether there are broader structural risks, or even any reality in the dystopian view that revenues could suddenly ‘fall off a cliff’? Looking at the fixed telecom industry, it is notable that voice revenues have undergone a fairly precipitous decline over the past decade, partly because of mobile substitution, partly because of competition and, in some cases such as lucrative international calls, because of competition from Skype and its peers. Meanwhile, adjacent markets such as cable have started to suffer from the popularity of alternative sources of digital TV and content. Some of the fixed operators have picked up the slack with IT services and cloud infrastructure, but others have suffered – often to the extent that they have sold out, typically to their mobile peers.

But how bright is the future really?

Will mobile operators fare any better over the next 5-10 years? In developed markets, they have to contend with market saturation, increasing competition on basic services, and tightening regulatory regimes. They also need to deal with the strategic issue of the internet-based app ecosystems such as Apple’s and Google’s, and OTT-type services from the likes of Facebook and Microsoft/Skype. There is also a possibility that the very nature of ‘core services’ like telephony might change, as voice communications starts to get embedded into apps and the web itself. Some observers even see our 100-year relationship with voice telephony diminishing in importance, as other forms of communication become more useful.

This report looks into the mobile marketplace – specifically, voice and messaging services in the main European countries. We have constructed a “what if?” scenario model, that takes some basic assumptions about voice usage and pricing, along with data revenues trends. Rather than just assuming that ARPU will remain broadly flat and then divide it up between voice and data, we’ve started looking from the bottom up. Can likely declines in voice revenues really be made up elsewhere, especially given the possible collapse of SMS and the commoditisation of mobile data? Just how big might the gap be that needs to be filled with ‘other services’ such as content resale, two-sided capability exposure, M2M, vertical industries or Telco-OTT propositions?

Taking together the five largest European mobile markets – Germany, France, UK, Italy and Spain – paints a picture that should cause some alarm. Despite the rise of smartphones and dongles, overall quarterly mobile revenues are down 10% on their peak from Q3 2009; falling from €24.7bn to €22.2bn in Q1 2012. Even accounting for seasonality, this is significant (a €10bn annualised shortfall) – and early results suggest the fall accelerated in Q2 2012, as economic and competitive factors bit deeper into sales, with recessions in several countries and new entrants such as Free in France.

Worse, if we just look at voice revenues, the market is now down 25% from its peak in Q2 2009, and that fall seems to be accelerating. While declining voice ARPU is not a huge surprise, the failure of other services to take up the slack is disappointing, especially as the source of new business – basic data connectivity – also is the most capex-hungry in terms of extra costs of new spectrum and 3G/4G build-out.

Figure 2: EU5 Mobile Services revenue already down 10% from 2009 peak

EU5 Mobile Services Revenues Chart, Telco 2.0, Oct 2012
Source: STL Partners

A set of cold-blooded forecasts for UK, France, Germany, Italy and Spain

To the best of our knowledge, nobody else has made forecasts that are both dispassionate and founded on hard data and bottom-up analysis.

Too many analyst (and we suspect internal) financial models seem to suggest that ‘It’ll be alright, somehow… telecoms operators need to harvest cash from voice and messaging, grow data and find some new revenues, but there’s plenty of options’. STL Partners is questioning the first and second premises in the statement above – about harvesting voice and messaging and growing broadband data – not because we’re pessimists, but because we think that many in the industry are not acknowledging the scale of the problems ahead and making the necessary (and often uncomfortable) decisions early enough.

Views vary widely on the outlook for mobile telecoms in Europe

It is fair to say that the fixed telecoms industry has undergone enough pain over the last decade to be under no illusions about its challenges. Operators realise that they face a continued hard slog against competition, regulation, content providers and indifferent consumers. They have increasingly focused on businesses, wholesale models and specific high-value niches like fibre-based triple-play. Deployment of FTTC/FTTH has been patchy, as they have realised that political support doesn’t equate to revenue uplift or return on capital.

Conversely, the mobile industry has pinned its hopes on LTE, data services and various collaboration and partnership business models. Some operators have essentially become Apple and Samsung resellers, offering credit-finance for expensive devices in the guise of handset subsidies. Plenty of other ideas, from mobile money to M2M to API exposure have been the subject of huge efforts. As yet, none has really moved the needle compared to the legacy telephony and SMS services that still make up a large (60%+) share of most operators’ top line revenues. The only bright spot has been plain-vanilla Internet access, initially with 3G dongle modems for PCs, and more recently for smartphone data plans. But the former has now gone largely ex-growth (thankfully, in some cases, given the traffic loads generated at low prices). And the latter faces growth challenges once most users have shifted to a smart device, as few users seem incentivised to upgrade to larger data plans so far.

Privately held view seems to be pessimistic…

In private discussions with operator executives, we encounter a fair level of pessimism, especially about voice and SMS revenues. At our conferences, we have asked senior executives (using our anonymised voting system) about possible price and value erosion, and are often surprised by how far and fast telcos seem to think these core services will dwindle.

Figure 3: Example Telco 2.0 delegate view of 3-year voice revenue decline

Euro Mobile: The Future's Brutal - delegate views, Telco 2.0, Oct 2012
Source: Delegate Vote, New Digital Economics Executive Brainstorm, November 2011

…yet publicly, there is much less acknowledgement of the scale of the issue.

We’ve seen investment banks’ forecasts that assume that ARPUs can be (mostly) maintained through the magic of bundling, while some operators themselves paint a picture that can, charitably, be seen as rose-tinted at best:

Figure 4: Orange remains optimistic about European telecoms revenues

Euro Mobile: The Future's Brutal, Orange Forecast, Telco 2.0, October 2012
Source: FT Orange

Contents:

  • The bundling paradox
  • General trends impacting core services revenues
  • Macro-economic issues
  • Competitive & regulatory price pressure
  • The declining demand for voice telephony
  • Data growth
  • The relative mix of pre-paid vs post-paid customers
  • Lower handset subsidies
  • Definitions, assumptions & methodology
  • UK
  • Germany
  • France
  • Italy
  • Spain
  • Europe-wide summary
  • Appendix – Benchmarking prices for core services

 

  • Figure 1 – Mobile core Service revenues
  • Figure 2 – EU5 Mobile Services revenue already down 10% from 2009 peak
  • Figure 3 – Example Telco 2.0 delegate view of 3-year voice revenue decline
  • Figure 4 – Orange remains optimistic about European telecoms revenues
  • Figure 5 – Vodafone view bundling as the way to stem revenue loss
  • Figure 6 – At least 4 of the 6 general trends that impact mobile core services revenues are negative
  • Figure 7 – Developed-market mobile pricing has dropped 10%+ per annum
  • Figure 8 – French, German and Spanish mobile voice has historically had higher prices than other European countries
  • Figure 9 – STL Partners recent analysis suggests that Spain’s voice prices are nearly double those of UK and France
  • Figure 10 – Spanish voice premium is not offset by materially cheaper data charges compared with other European markets
  • Figure 11 – Despite growth over 2005-2010 period, mobile voice volumes are now flattening in more mature markets
  • Figure 12 – The underlying decline in fixed voice minutes (excluding mobile substitution) appears to be around 2% per quarter in the UK
  • Figure 13 – Smartphone penetration of mobile user base, January 2012
  • Figure 14 – EU5 mobile data revenues have grown steadily, not exponentially – and show recent signs of flattening-off as SMS declines
  • Figure 15 – The UK has shown a steady decline mobile data revenue growth rate despite increases in dongles and smartphones
  • Figure 16 – UK Mobile voice volumes (billions of minutes)
  • Figure 17 – UK Baseline Mobile Revenues down 25% from 2011 levels by 2020
  • Figure 18 – Unlike the UK, Germany mobile voice traffic is still growing strongly…
  • Figure 19 – …and mobile data usage in Germany is exploding (from a low base)
  • Figure 20 – Price pressure has meant that German mobile revenues have been flat in the recent past
  • Figure 21 – Germany Baseline Mobile Revenues down 18% from 2009 levels by 2020
  • Figure 22 – French mobile telephony volumes are still rising
  • Figure 23 – SMS and mobile data traffic volumes growing strongly
  • Figure 24 – France Baseline Mobile Revenues down 35% from 2009 levels by 2020
  • Figure 25 – Italy Baseline Mobile Revenues down 46% from 2009 levels by 2020
  • Figure 26 – Spain has been hurt especially hard by WhatsApp
  • Figure 27 – Spanish mobile voice traffic has been flat, but now faces decline
  • Figure 28 – The Spanish mobile market will fall precipitously through to 2020
  • Figure 29 – Total EU5 mobile core services revenues will fall 38% from peak by 2020
  • Figure 30 – Spain and Italy, in particular, are likely to experience a major decline in core mobile services revenues
  • Figure 31 – Mobile Voice Telephony Revenue Forecast by Country 2012-2020
  • Figure 32 – Extract from STL Partners database of 30-day SIM-only bundles
  • Figure 33 – Extract of how unit prices were calculated by STL Partners