Preface

Rationale and hypothesis for this report

It is over fourteen years since David Isenberg wrote his seminal paper The Rise of the Stupid Network in which he outlined the view that telephony networks would increasingly become dumb pipes as intelligent endpoints came to control how and where data was transported. Many of his predictions have come to fruition. Cheaper computing technology has resulted in powerful ‘smartphones’ in the hands of millions of people and new powerful internet players are using data centres to distribute applications and services ‘over the top’ to users over fixed and mobile networks.

The hypothesis behind this piece of research is that endpoints cannot completely control the network. STL Partners believes that the network itself needs to retain intelligence so it can interpret the information it is transporting between the endpoints. Mobile network operators, quite rightly, will not be able to control how the network is used but must retain the ability within the network to facilitate a better experience for the endpoints. The hypothesis being tested in this research is that ‘smart pipes’ are needed to:

1. Ensure that data is transported efficiently so that capital and operating costs are minimised and the internet and other networks remain cheap methods of distribution.
2. Improve user experience by matching the performance of the network to the nature of the application or service being used. ‘Best effort’ is fine for asynchronous communication, such as email or text, but unacceptable for voice. A video call or streamed movie requires guaranteed bandwidth, and real-time gaming demands ultra-low latency;
3. Charge appropriately for use of the network. It is becoming increasingly clear that the Telco 1.0 business model – that of charging the end-user per minute or per Megabyte – is under pressure as new business models for the distribution of content and transportation of data are being developed. Operators will need to be capable of charging different players – end-users, service providers, third-parties (such as advertisers) – on a real-time basis for provision of broadband and guaranteed quality of service (QoS);
4. Facilitate interactions within the digital economy. Operators can compete and partner with other players, such as the internet companies, in helping businesses and consumers transact over the internet. Networks are no longer confined to communications but are used to identify and market to prospects, complete transactions, make and receive payments and remittances, and care for customers. The knowledge that operators have about their customers coupled with their skills and assets in identity and authentication, payments, device management, customer care etc. mean that ‘the networks’ can be ‘enablers’ in digital transactions between third-parties – helping them to happen more efficiently and effectively.

Overall, smarter networks will benefit network users – upstream service providers and end users – as well as the mobile network operators and their vendors and partners. Operators will also be competing to be smarter than their peers as, by differentiating here, they gain cost, revenue and performance advantages that will ultimately transform in to higher shareholder returns.

Sponsorship and editorial independence

This report has kindly been sponsored by Tellabs and is freely available. Tellabs developed the initial concepts, and provided STL Partners with the primary input and scope for the report. Research, analysis and the writing of the report itself was carried out independently by STL Partners. The views and conclusions contained herein are those of STL Partners.

About Tellabs

Tellabs innovations advance the mobile Internet and help our customers succeed. That’s why 43 of the top 50 global communications service providers choose our mobile, optical, business and services solutions. We help them get ahead by adding revenue, reducing expenses and optimizing networks.

Tellabs (Nasdaq: TLAB) is part of the NASDAQ Global Select Market, Ocean Tomo 300® Patent Index, the S&P 500 and several corporate responsibility indexes including the Maplecroft Climate Innovation Index, FTSE4Good and eight FTSE KLD indexes. http://www.tellabs.com

Executive Summary

Mobile operators no longer growth stocks

Mobile network operators are now valued as utility companies in US and Europe (less so APAC). Investors are not expecting future growth to be higher than GDP and so are demanding money to be returned in the form of high dividends.

Two ‘smart pipes’ strategies available to operators

In his seminal book, Michael Porter identified three generic strategies for companies – ‘Cost leadership’, ‘Differentiation’ and ‘Focus’. Two of these are viable in the mobile telecommunications industry – Cost leadership, or Happy Pipe in STL Partners parlance, and Differentiation, or Full-service Telco 2.0. No network operators have found a Focus strategy to work as limiting the customer base to a segment of the market has not yielded sufficient returns on the high capital investment of building a network. Even MVNOs that have pursued this strategy, such as Helio which targeted Korean nationals in the US, have struggled.

Underpinning the two business strategies are related ‘smart pipe’ approaches – smart network and smart services:

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Porter Strategy	Telco 2.0 strategy	Nature of smartness	Characteristics
Cost leadership	Happy Pipe	Smart network	Cost efficiency – minimal network, IT and commercial costs.  Simple utility offering.
Differentiation	Full-service Telco 2.0	Smart services	Technical and commercial flexibility: improve customer experience by integrating network capabilities with own and third-party services and charging either end user or service provider (or both).

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Source: STL Partners

It is important to note that, currently at least, having a smart network is a precursor of smart services.  It would be impossible for an operator to implement a Full-service Telco 2.0 strategy without having significant network intelligence.  Full-service Telco 2.0 is, therefore, an addition to a Happy Pipe strategy.

Smart network strategy good, smart services strategy better

In a survey conducted for this report, it was clear that operators are pursuing ‘smart’ strategies, whether at the network level or extending beyond this into smart services, for three reasons:

• Revenue growth: protecting existing revenue sources and finding new ones.  This is seen as the single most important driver of building more intelligence.
• Cost savings: reducing capital and operating costs.
• Performance improvement: providing customers with an improved customer experience.

Assuming that most mobile operators currently have limited smartness in either network or services, our analysis suggests significant upside in financial performance from successfully implementing either a Happy Pipe or Full-service Telco 2.0 strategy.  Most mobile operators generate Cash Returns on Invested Capital of between 5 and 7%.  For the purposes of our analysis, we have a assumed a baseline of 5.8%.  The lower capital and operator costs of a Happy Pipe strategy could increase this to 7.4% and the successful implementation of a Full-service Telco 2.0 strategy would increase this to a handsome 13.3%:

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Telco 2.0 strategy	Nature of smartness	Cash Returns on Invested Capital
As-is – Telco 1.0	Low – relatively dumb	5.8%
Happy Pipe	Smart network	7.4%
Full-service Telco 2.0	Smart services	13.3%

Source: STL Partners

STL Partners has identified six opportunity areas for mobile operators to exploit with a Full-service Telco 2.0 strategy.  Summarised here, these are outlined in detail in the report:

Opportunity Type	Approach	Typical Services
Core Services	Improving revenues and customer loyalty by better design, analytics, and smart use of data in existing services.	Access, Voice and Messaging, Broadband, Standard Wholesale, Generic Enterprise ICT Services (inc. SaaS)
Vertical industry solutions (SI)	Delivery of ICT projects and support to vertical enterprise sectors.	Systems Integration (SI), Vertical CEBP solutions, Vertical ICT, Vertical M2M solutions, and Private Cloud.
Infrastructure services	Optimising cost and revenue structures by buying and selling core telco ICT asset capacity.	Bitstream ADSL, Unbundled Local Loop, MVNOs, Wholesale Wireless, Network Sharing, Cloud – IaaS.
Embedded communications	Enabling wider use of voice, messaging, and data by facilitating access to them and embedding them in new products.	Comes with data, Sender pays delivery, Horizontal M2M Platforms, Voice, Messaging and Data APIs for 3rd Parties.
Third-pary business enablers	Enabling new telco assets (e.g. Customer data) to be leveraged in support of 3rd party business processes.	Telco enabled Identity and Authorisation, Advertising and Marketing, Payments. APIs to non-core services and assets.
Own-brand OTT services	Building value through Telco-owned online properties and ‘Over-the-Top’ services.	Online Media, Enterprise Web Services, Own Brand VOIP services.

Source: STL Partners

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Regional approaches to smartness vary

As operators globally experience a slow-down in revenue growth, they are pursuing ways of maintaining margins by reducing costs.  Unsurprisingly therefore, most operators in North America, Europe and Asia-Pacific appear to be pursuing a Happy Pipe/smart network strategy.  Squeezing capital and operating costs and improving network performance is being sought through such approaches as:

• Physical network sharing – usually involving passive elements such as towers, air-conditioning equipment, generators, technical premises and pylons.
• Peering data traffic rather than charging (and being charged) for transit.
• Wi-Fi offload – moving data traffic from the mobile network on to cheaper fixed networks.
• Distributing content more efficiently through the use of multicast and CDNs.
• Efficient network configuration and provisioning.
• Traffic shaping/management via deep-packet inspection (DPI) and policy controls.
• Network protection – implementing security procedures for abuse/fraud/spam so that network performance is maximised.
• Device management to ameliorate device impact on network and improve customer experience

Vodafone Asia-Pacific is a good example of an operator pursuing these activities aggressively and as an end in itself rather than as a basis for a Telco 2.0 strategy.  Yota in Russia and Lightsquared in the US are similarly content with being Happy Pipers.

In general, Asia-Pacific has the most disparate set of markets and operators.  Markets vary radically in terms of maturity, structure and regulation and operators seem to polarise into extreme Happy Pipers (Vodafone APAC, China Mobile, Bharti) and Full-Service Telco 2.0 players (NTT Docomo, SK Telecom, SingTel, Globe).

In Telefonica, Europe is the home of the operator with the most complete Telco 2.0 vision globally.  Telefonica has built and acquired a number of ‘smart services’ which appear to be gaining traction including O₂ Priority Moments, Jajah, Tuenti and Terra.  Recent structural changes at the company, in which Telefonica Digital was created to focus on opportunities in the digital economy, further indicate the company’s focus on Telco 2.0 and smart services.  Europe too appears to be the most collaborative market.  Vodafone, Telefonica, Orange, Telecom Italia and T-Mobile are all working together on a number of Telco 2.0 projects and, in so doing, seek to generate enough scale to attract upstream developers and downstream end-users.

The sheer scale of the two leading mobile operators in the US, AT&T and Verizon, which have over 100 million subscribers each, means that they are taking a different approach to Telco 2.0.  They are collaborating on one or two opportunities, notably with ISIS, a near-field communications payments solution for mobile, which is a joint offer from AT&T, Verizon and T-Mobile.  However, in the main, there is a high degree of what one interviewee described as ‘Big Bell dogma’ – the view that their company is big enough and powerful enough to take on the OTT players and ‘control’ the experiences of end users in the digital economy.  The US market is more consolidated than Europe (giving the big players more power) but, even so, it seems unlikely that either AT&T or Verizon can keep customers using only their services – the lamented wall garden approach.

Implementing a Telco 2.0 strategy is important but challenging

STL Partners explored both how important and how difficult it is to implement the changes required to deliver a Happy Pipe strategy (outlined in the bullets above) and those needed for Full-service Telco 2.0 strategy, via industry interviews with operators and a quantitative survey.  The key findings of this analysis were:

• Overall, respondents felt that many activities were important as part of a smart strategy.  In our survey, all except two activity areas – Femto/pico underlay and Enhanced switches (vs. routers) – were rated by more than 50% of respondents as either ‘Quite important’ or ‘Very important’ (see chart below).
• Activities associated with a Full-service Telco 2.0 strategy were rated as particularly important:
• Making operator assets available via APIs, Differentiated pricing and charging and Personalised and differentiated services were ranked 1, 2 and 3 out of the thirteen activities.
• Few considered that any of the actions were dangerous and could destroy value, although Physical network sharing and Traffic shaping/DPI were most often cited here.

NOTE: Overall ranking was based on a weighted scoring policy of Very important +4, Quite important +3, Not that important +2, Unimportant +1, Dangerous -4.

Overall, most respondents to the survey and people we spoke with felt that operators had more chance in delivering a Happy Pipe strategy and that only a few Tier 1 operators would be successful with a Full-Service Telco 2.0 strategy.  For both strategies, they were surprisingly sceptical about operators’ ability to implement the necessary changes.  Five reasons were cited as major barriers to success and were particularly big when considering a Full-Service Telco 2.0 strategy:

1. Competition from internet players.  Google, Apple, Facebook et al preventing operators from expanding their role in the digital economy.
2. Difficulty in building a viable ecosystem. Bringing together the required players for such things as near-field communications (NFC) mobile payments and sharing value among them.
3. Lack of mobile operators skills.  The failure of operators to develop or exploit key skills required for facilitating transactions such as customer data management and privacy.
4. Culture.  Being too wedded to existing products, services and business models to alter the direction of the super-tanker.
5. Organisation structure. Putting in place the people and processes to manage the change.

Looking at the specific activities required to build smartness, it was clear that those required for a Full-service Telco 2.0/smart services strategy are considered the hardest to implement (see chart below):

• Personalised and differentiated services via use of customer data – content, advertising, etc.
• Making operator assets available to end users and other service providers – location, presence, ID, payments
• Differentiated pricing and charging based on customer segment, service, QoS

NOTE: Overall ranking was based on a weighted scoring policy of Very easy +5, Relatively straightforward +4, Manageable +3, Quite difficult +2, Very difficult -2.

Conclusions and recommendations

By comparing the relative importance of specific activities against how easy they are to implement, we were able to classify them into four categories:

Category	Importance for delivering smart strategy	Relative ease of implementation
Must get right	High	Easy
Strive for new role	High	Difficult
Housekeeping	Low	Easy
Forget	Low	Difficult

Unfortunately, as the chart above shows, no activities fall clearly into the ‘Forget’ categories but there are some clear priorities:

• A Full-service Telco 2.0 strategy is about striving for a new role in the digital economy and is probably most appropriate for Tier 1 MNOs, since it is going to require substantial scale and investment in new skills such as software and application development and customer data.  It will also require the development of new partnerships and ecosystems and complex commercial arrangements with players from other industries (e.g. banking). 
• There is a cluster of smart network activities that are individually relatively straightforward to implement and will yield a big bang for the buck if investments are made – the ‘Must get right’ group:
• More efficient network configuration and provisioning;
• Strengthen network security to cope with abuse and fraud;
• Improve device management (and cooperation with handset manufacturers and content players) to reduce the impact of smartphone burden on the network;

Although deemed more marginal in our survey, we would include as equally important:

• Traffic shaping and DPI which, in many cases, underpins various smart services opportunities such as differentiated pricing based on QoS and Multicast and CDNs which are proven in the fixed world and likely to be equally beneficial in a video-dominated mobile one.

There is second cluster of smart network activities which appear to be equally easy (or difficult) to implement but are deemed by respondents to be lower value and therefore fall into a lower ‘Housekeeping’ category:

• Wi-Fi offload – we were surprised by this given the emphasis placed on this by NTT Docomo, China Mobile, AT&T, O₂ and others;
• Peering (vs. transit) and Enhanced switches  – this is surely business-as-usual for all MNOs;
• Femto/Pico underlay – generally felt to be of limited importance by respondents although a few cited its importance in pushing network intelligence to the edge which would enable MNOs to more easily deliver differentiated QoS and more innovative retail and wholesale revenue models;
• Physical network sharing – again, a surprising result given the keenness of the capital markets on this strategy. 

 

 

Report Contents

 

• Executive Summary
• Mobile network operator challenges
• The future could still be bright
• Defining a ‘smart’ network
• Understanding operator strategies
• Video: Case study in delivering differentiation and cost leadership
• The benefits of Smart on CROIC
• Implementing a ‘smart’ strategy
• Conclusions and recommendations

Report Figures

 

• Figure 1: Pressure from all sides for operators
• Figure 2: Vodafone historical dividend yield – from growth to income
• Figure 3: Unimpressed capital markets and falling employment levels
• Figure 4: Porter and Telco 2.0 competitive strategies
• Figure 5: Defining Differentiation/Telco 2.0
• Figure 6 – The Six Opportunity Areas – Approach, Typical Services and Examples
• Figure 7: Defining Cost Leadership/Happy Pipe
• Figure 8: Defining ‘smartness’
• Figure 9: Telco 2.0 survey – Defining smartness
• Figure 10: NTT’s smart content delivery system – a prelude to mobile CDNs?
• Figure 11: Vodafone India’s ARPU levels are now below $4/month, illustrating the need for a ‘smart network’ approach
• Figure 12: China Mobile’s WLAN strategy for coverage, capacity and cost control
• Figure 13: GCash – Globe’s text-based payments service
• Figure 14: PowerOn – SingTel’s on-demand business services
• Figure 15: Telefonica’s Full-service Telco 2.0 strategy
• Figure 16: Vodafone – main messages are about being an efficient data pipe
• Figure 17: Collaboration with other operators key to smart services strategy
• Figure 18: Verizon Wireless and Skype offering
• Figure 19: Content delivery with and without a CDN
• Figure 20: CDN benefits to consumers are substantial
• Figure 21: Cash Returns on Invest Capital of different Telco 2.0 opportunity areas
• Figure 22: The benefits of smart to a MNO are tangible and significant
• Figure 23: Telco 2.0 Survey – benefits of smart to MNOs
• Figure 24: Telco 2.0 survey – MNO chances of success with smart strategies
• Figure 25: Telco 2.0 survey – lots of moving parts required for ‘smartness’
• Figure 26: Telco 2.0 survey – Differentiation via smart services is particularly challenging
• Figure 27: Telco 2.0 survey – Implementing changes is challenging
• Figure 28: Telco 2.0 survey – Prioritising smart implementation activities