Apple’s pivot to services: What it means for telcos

Introduction

The latest report in STL’s Dealing with Disruption stream, this executive briefing considers Apple’s strategic dilemmas in its ongoing struggle for supremacy with the other major Internet ecosystems – Amazon, Facebook and Google. It explores how the likely shift from a mobile-first world to an artificial-intelligence first world will impact Apple, which owes much of its current status and financial success to the iPhone.

After outlining Apple’s strategic considerations, the report considers how much Apple earns from services today, before identifying Apple’s key services and how they may evolve. Finally, the report features a SWOT (strengths, weaknesses, opportunities and threats) analysis of Apple’s position in services, followed by a TOWS analysis that identifies possible next steps for Apple. It concludes by considering the potential implications for Apple’s main rivals, as well as two different kinds of telcos – those who are very active in the service layer and those focused on providing connectivity and enablers.

Several recent STL Partners’ research reports make detailed recommendations as to how telcos can compete effectively with the major Internet ecosystems in the consumer market for digital services. These include:

Telco-Driven Disruption: Will AT&T, Axiata, Reliance Jio and Turkcell succeed? To find new revenues, some telcos are competing head-on with the major internet players in the digital communications, content and commerce markets. Although telcos’ track record in digital services is poor, some are gaining traction. AT&T, Axiata, Reliance Jio and Turkcell are each pursuing very different digital services strategies, and we believe these potentially disruptive moves offer valuable lessons for other telcos and their partners.
Consumer communications: Can telcos mount a comeback? The rapid growth of Facebook, WhatsApp, WeChat and other Internet-based services has prompted some commentators to write off telcos in the consumer communications market. But many mobile operators retain surprisingly large voice and messaging businesses and still have several strategic options. Indeed, there is much telcos can learn from the leading Internet players’ evolving communications propositions and their attempts to integrate them into broad commerce and content platforms.
Autonomous cars: Where’s the money for telcos? The connected car market is being seen as one of the most promising segments of the Internet of Things. Everyone from telcos to internet giants Google, and specialist service providers Uber are eyeing opportunities in the sector. This report analyses 10 potential connected car use-cases to assess which ones could offer the biggest revenue opportunities for operators and outline the business case for investment.
AI: How telcos can profit from deep learning Artificial intelligence (AI) is improving rapidly thanks to the growing use of deep neural networks to teach computers how to interpret the real world (deep learning). These networks use vast amounts of detailed data to enable machines to learn. What are the potential benefits for telcos, and what do they need to do to make this happen?
Amazon: Telcos’ Chameleon-King Ally? New digital platforms are emerging – the growing popularity of smart speakers, which rely on cloud-based artificial intelligence, could help Amazon, the original online chameleon, to bolster its fast-evolving ecosystem at the expense of Google and Facebook. As the digital food chain evolves, opportunities will open up for telcos, but only if the smart home market remains heterogeneous and very competitive.

Apple’s evolving strategy

Apple is first and foremost a hardware company: It sells physical products. But unlike most other hardware makers, it also has world-class expertise in software and services. These human resources and its formidable intellectual property, together with its cash pile of more than US$250 billion and one of the world’s must coveted brands, gives Apple’s strategic options that virtually no other company has. Apple has the resources and the know-how to disrupt entire industries. Apple’s decision to double the size of it’s already-impressive services business by 2021 has ramifications for companies in a wide range of industries – from financial services to entertainment to communications.

Throughout its existence, Apple’s strategy has been to use distinctive software and services to help sell its high-margin hardware, rather than compete head-on with Google, Facebook, Microsoft and Amazon in the wider digital services and content markets. As Apple’s primary goal is to create a compelling end-to-end solution, its software and services are tightly integrated into its hardware. Although there are some exceptions, notably iTunes and Apple Music, most of Apple’s services and software can only be accessed via Apple’s devices. But there are four inter-related reasons why Apple may rethink that strategy and extend Apple’s services beyond its hardware ecosystem:

- - Services are now Apple’s primary growth engine, as iPhone revenue appears to have peaked and new products, such as the Apple Watch, have failed to take up the slack. Moreover, services, particularly content-based services, need economies of scale to be cost-effective and profitable.
  - Upstream players, such as merchants, brands and content providers, want to be able to reach as many people as possible, as cost-effectively as possible. They would like Apple’s stores and marketplaces to be accessible from non-Apple devices, as that would enable them to reach a larger customer base through a single channel. Figure 1 shows that Apple’s iPhone ecosystem (which use the iOS operating system) is approximately one quarter of the size of rival Android in terms of volumes.
  - Artificial intelligence is becoming increasingly central to the propositions of the major Internet ecosystems, including that of Apple. The development of artificial intelligence requires vast amounts of real-world data that can be used to hone the algorithms computers use to make decisions. To collect the data necessary to detect patterns and subtle, but significant, differences in real-world conditions, the Internet players need services that are used by as many people as possible.
  - As computing power and connectivity proliferates, the smartphone won’t be as central to people’s lives as it is today. For Apple, that means having the best smartphone won’t be enough: Computing will eventually be everywhere and will probably be accessed by voice commands or gestures. As the hardware fades into the background and Apple’s design skills become less important, the Cupertino company may decide to unleash its services and allow them to run on other platforms, as it did with iTunes.

Content:

Executive Summary
Introduction
Apple’s evolving strategy
Playing catch-up in artificial intelligence
What does Apple earn from services?
What are Apple’s key services?
Communications – Apple iMessage and FaceTime
Commerce – Apple Pay and Apple Wallet
Content – iTunes, Apple Music, Apple TV
Software – the App Store, Apple Maps
Artificial intelligence and the role of Siri
Tools for developers
Conclusions and implications for rivals
Implications for rivals

Figures:

Figure 1: Installed base of smartphones by operating system
Figure 2: Apple’s artificial intelligence, as manifest in Siri, isn’t that smart
Figure 3: Apple’s services business is comparable in size to Facebook
Figure 4: The services business is Apple’s main growth engine
Figure 5: The strength of Apple’s online commerce ecosystem
Figure 6: iMessage is becoming a direct competitor to Instagram and WhatsApp
Figure 7: Various apps allow consumers to make payments via Apple Pay
Figure 8: Apple Pay is available in a limited number of markets
Figure 9: Unlike most Apple services, Apple Music is “available everywhere”
Figure 10: Apple’s App Store generates far more revenue than Google Play
Figure 11: Apple Maps’ navigation trailed well behind Google Maps in June 2016
Figure 12: SWOT analysis of Apple in the services sector
Figure 13: TOWS analysis for Apple in the service market

Telco-Driven Disruption: Will AT&T, Axiata, Reliance Jio and Turkcell succeed?

Introduction

The latest report in STL’s Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing explores the role of telcos in disrupting the digital economy. Building on the insights gleaned from the stream’s research, STL has analysed disruptive moves by four very different telcos and their prospects of success.

In the digital economy, start-ups and major Internet platforms, such as Alibaba, Amazon, Apple, Facebook, Google, Spotify, Tencent QQ and Uber, are generally considered to be the main agents of disruption. Start-ups tend to apply digital technologies in innovative new ways, while the major Internet platforms use their economies of scale and scope to disrupt markets and established businesses. These moves sometimes involve the deployment of new business models that can fundamentally change the modus operandi of entire industries, such as music, publishing and video gaming.

However, these digital natives don’t have a monopoly on disruption. So-called old economy companies do sometimes successfully disrupt either their own sector or adjacent sectors. In some cases, incumbents are actually well placed to drive disruption. As STL Partners has detailed in earlier reports, telcos, in particular, have many of the assets required to disrupt other industries, such as financial services, electronic commerce, healthcare and utilities. As well as owning the underlying infrastructure of the digital economy, telcos have extensive distribution networks and frequent interactions with large numbers of consumers and businesses.

Although established telcos have generally been cautious about pursuing disruption, several have created entirely new value propositions, effectively disrupting either their core business or adjacent industry sectors. In some cases, disruptive moves by telcos have primarily been defensive in that their main objective is to hang on to customers in their core business. In other cases, telcos have gone on the offensive, moving into new markets in search of new revenues.

Increasingly, these two strategies are becoming intertwined. As regulators use spectrum licensing and local loop unbundling to fuel competition in connectivity, telcos have found themselves embroiled in damaging and expensive price wars. One way out of this commoditisation trap is to enhance and enrich the core proposition in ways that can’t easily be replicated by rivals. For example, BT in the UK has demonstrated that one of the most effective ways to defend the core business can be to bundle connectivity with exclusive content that consumers value. This report analyses four very different variants of this basic strategy and their chances of success.

Note, the examples in this report are intended to be representative and instructive, but they are not exhaustive. Other telcos have also pursued disruptive strategies with varying degrees of success. Many of these strategies have been described and analysed in previous STL Partners’ research reports. Digital transformation is a phenomenon that is not just affecting the telco sector. Many industries have been through a transformation process far more severe than we have seen in telecoms, while others began the process much earlier in time. We believe that there are valuable lessons telcos can learn from these sectors, so we have decided to find and examine the most interesting/useful case studies.

Contents:

Executive Summary
Introduction
Strategy One: Aggressive Acquisitions
AT&T – how will engineering and entertainment mix?
Strategy Two: Fast and Fluid, build a portfolio
Axiata places many digital bets
Strategy Three: Leapfrogging the legacy
Reliance Jio – super-disruptor
Strategy Four: Building an elaborate ecosystem
Turkcell goes toe-to-toe with the big Internet ecosystems

Figures:

Figure 1: Figure 1: The largest pay TV providers in the US in September 2016
Figure 2: Fullscreen Entertainment – free to AT&T Wireless customers
Figure 3: AT&T’s television customer base is shrinking
Figure 4: But AT&T’s Entertainment Group has seen ARPU rise
Figure 5: Celcom Planet’s 11Street marketplace caters for all kinds of products
Figure 6: XL has integrated its commerce and payment propositions
Figure 7: The Tribe video-on-demand proposition majors on Korean content
Figure 8: 4G was designed to deliver major capacity gains over 3G
Figure 9: Vodafone’s view of spectrum holdings in India
Figure 10: Reliance Jio is offering an array of entertainment and utility apps
Figure 11: Reliance’s network is outperforming that of rivals by a large margin
Figure 12: Vodafone India has slashed the cost of its mobile data services
Figure 13: Vodafone, Airtel and Idea account for 72% of the Indian market
Figure 14: The performance required for Reliance to achieve a ROCE of 18%
Figure 15: Digital services have become a major growth engine for Turkcell
Figure 16: Downloads of Turkcell’s apps are growing rapidly
Figure 17: Turkcell TV+ is gaining traction both on and off network
Figure 18: Turkcell’s ARPU is growing steadily
Figure 19:Turkcell is seeing rapid growth in mobile data traffic

Consumer communications: Can telcos mount a comeback?

Introduction

Although they make extensive use of WhatsApp, Facebook Messenger, Snapchat and other Internet-based communications services, consumers still expect mobile operators to enable them to make voice calls and text messages. Indeed, communication services are widely regarded as a fundamental part of a telco’s proposition, but telcos’ telephony and messaging services are losing ground to the Internet-based competitors and are generating less and less revenue.

Should telcos allow this business to gradually melt away of should they attempt to rebuild a competitive communications proposition for consumers? How much strategic value is there in providing voice calls and messaging services?

This report explores telcos’ strategic options in the consumer communications market, building on previous STL Partners’ research reports, notably:

Google/Telcos’ RCS: Dark Horse or Dead Horse?

WeChat: A Roadmap for Facebook and Telcos in Conversational Commerce

This report evaluates telcos’ current position in the consumer market for voice calls and messaging, before considering what they can learn from three leading Internet-based players: Tencent, Facebook and Snap. The report then lays out four strategic options for telcos and recommends which of these options particular types of telcos should pursue.

Content:

Introduction
Executive Summary
What do telcos have to lose?
Key takeaways
Learning from the competition
Tencent pushes into payments to monetise messaging
Facebook – nurturing network effects with fast footwork
Snapchat – highly-focused innovation
Telcos’ strategic options
Maximise data traffic
Embed communications into other services
Differentiate on reliability, security, privacy and reach
Compete head-on with Internet players
Recommendations

Figures:

Figure 1: Vodafone still makes large sums from incoming calls & messages
Figure 2: Usage of Vodafone’s voice services is rising in emerging markets
Figure 3: Vodafone Europe sees some growth in voice usage
Figure 4: Internet-based services are overtaking telco services in China
Figure 5: Usage of China Mobile’s voice services is sliding downwards
Figure 6: China Mobile’s SMS traffic shows signs of stabilising
Figure 7: Vodafone’s SMS volumes fall in Europe, but rise in AMAP
Figure 8: Voice & messaging account for 38% of China Mobile’s service revenues
Figure 9: Line is also seeing rapid growth in advertising revenue in Japan
Figure 10: More WeChat users are making purchases through the service
Figure 11: About 20% of WeChat official accounts act as online shops
Figure 12: Line’s new customer service platform harnesses AI
Figure 13: Snapchat’s user growth seems to be slowing down
Figure 14: Vodafone Spain is offering zero-rated access to rival services
Figure 15: Google is integrating communications services into Maps
Figure 16: Xbox Live users can interact with friends and other gamers
Figure 17: RCS is being touted as a business-friendly option
Figure 18: Turkcell’s broad and growing range of digital services

Autonomous cars: Where’s the money for telcos?

Introduction

Connected cars have been around for about two decades. GM first launched its OnStar in-vehicle communications service in 1996. Although the vast majority of the 1.4 billion cars on the world’s roads still lack embedded cellular connectivity, there is growing demand from drivers for wireless safety and security features, and streamed entertainment and information services. Today, many people simply use their smartphones inside their cars to help them navigate, find local amenities and listen to music.

The falling cost of cellular connectivity and equipment is now making it increasingly cost-effective to equip vehicles with their own cellular modules and antenna to support emergency calls, navigation, vehicle diagnostics and pay-as-you-drive insurance. OnStar, which offers emergency, security, navigation, connections and vehicle manager services across GM’s various vehicle brands, says it now has more than 11 million customers in North America, Europe, China and South America. Moreover, as semi-autonomous cars begin to emerge from the labs, there is growing demand from vehicle manufacturers and technology companies for data on how people drive and the roads they are using. The recent STL Partners report, AI: How telcos can profit from deep learning, describes how companies can use real-world data to teach computers to perform everyday tasks, such as driving a car down a highway.

This report will explore the connected and autonomous vehicle market from telcos’ perspective, focusing on the role they can play in this sector and the business models they should adopt to make the most of the opportunity.

As STL Partners described in the report, The IoT ecosystem and four leading operators’ strategies, telcos are looking to provide more than just connectivity as they strive to monetise the Internet of Things. They are increasingly bundling connectivity with value-added services, such as security, authentication, billing, systems integration and data analytics. However, in the connected vehicle market, specialist technology companies, systems integrators and Internet players are also looking to provide many of the services being targeted by telcos.

Moreover, it is not yet clear to what extent the vehicles of the future will rely on cellular connectivity, rather than short-range wireless systems. Therefore, this report spends some time discussing different connectivity technologies that will enable connected and autonomous vehicles, before estimating the incremental revenues telcos may be able to earn and making some high-level recommendations on how to maximise this opportunity.

Executive Summary
The role of cellular connectivity
High level recommendations
Contents
Introduction
The evolution of connected cars
How to connect cars to cellular networks
What are the opportunities for telcos?
How much cellular connectivity do vehicles need?
Takeaways
The size of the opportunity
How much can telcos charge for in-vehicle connectivity?
How will vehicles use cellular connectivity?
Telco connected car case studies
Vodafone – far-sighted strategy
AT&T – building an enabling ecosystem
Orange – exploring new possibilities with network slicing
SoftBank – developing self-driving buses
Conclusions and Recommendations
High level recommendations
STL Partners and Telco 2.0: Change the Game

Figure 1: Incremental annual revenue estimates by service
Figure 2: Autonomous vehicles will change how we use cars
Figure 3: Vehicles can harness connectivity in many different ways
Figure 4: V2X may require large numbers of simultaneous connections
Figure 5: Annual sales of connected vehicles are rising rapidly
Figure 6: Mobile connectivity in cars will grow quickly
Figure 7: Estimates of what telcos can charge for connected car services
Figure 8: Potential use cases for in-vehicle cellular connectivity
Figure 9: Connectivity complexity profile criteria
Figure 10: Infotainment connectivity complexity profile
Figure 11: In-vehicle infotainment services estimates
Figure 12: Real-time information connectivity complexity profile
Figure 13: Real-time information services estimates
Figure 14: The connectivity complexity profile for deep learning data
Figure 15: Collecting deep learning data services estimates
Figure 16: Insurance and rental services’ connectivity complexity profile
Figure 17: Pay-as-you-drive insurance and rental services estimates
Figure 18: Automated emergency calls’ connectivity complexity profile
Figure 19: Automated emergency calls estimates
Figure 20: Remote monitoring and control connectivity complexity profile
Figure 21: Remote monitoring and control of vehicle services estimates
Figure 22: Fleet management connectivity complexity profile
Figure 23: Fleet management services estimates
Figure 24: Vehicle diagnostics connectivity complexity profile
Figure 25: Vehicle diagnostics and maintenance services estimates
Figure 26: Inter-vehicle coordination connectivity complexity profile
Figure 27: Inter-vehicle coordination revenue estimates
Figure 28: Traffic management connectivity complexity profile
Figure 29: Traffic management revenue estimates
Figure 30: Vodafone Automotive is aiming to be global
Figure 31: Forecasts for incremental annual revenue increase by service

AI: How telcos can profit from deep learning

The enduring value of connected assets

In the digital economy, the old adage knowledge is power applies as much as ever. The ongoing advances in computing science mean that knowledge (in the form of insights gleaned from large volumes of detailed data) can increasingly be used to perform predictive analytics, enabling new services and cutting costs. At the same time, the widespread deployment of connected devices, appliances, machines and vehicles (the Internet of Things) now means enterprises can get their hands on granular real-time data, giving them a comprehensive and detailed picture of what is happening now and what is likely to happen next.

A handful of companies already have a very detailed picture of their markets thanks to far-sighted decisions to add connectivity to the products they sell. Komatsu, for example, uses its Komtrax system to track the activities of almost 430,000 bulldozers, dump-trucks and forklifts belonging to its customers. The Japan-based company has integrated monitoring technologies and connectivity into its construction and mining equipment since the late 1990s. Komatsu says the Komtrax system is standard equipment on “most Komatsu Tier-3 Construction machines” and on most small utility machines and backhoes.

Komatsu’s machines ship with GPS chips that can pinpoint their position, together with a unit that gathers engine data. They can then transmit the resulting data to a communication satellite, which relays that information to the Komtrax data centre.

The data captured by Komtrax (and other Internet of Things solutions) has value on multiple different levels:

It provides Komatsu with market intelligence
It enables Komatsu to offer value added services for customers
It gives detailed data on the global economy that can be used for computer modelling and to support the development of artificial intelligence

Market intelligence for Komatsu

For Komatsu, Komtrax provides valuable information about how its customers use its equipment, which can then be used to refine its R&D activities. Usage data can also help sales teams figure out which customers may need to upgrade or replace their equipment and when.

Komatsu’s sales and finance departments use the findings, for example, to offer trade-ins and sales of lighter machines where heavy ones are underused. Its leasing firm can also use the information to help find customers for its rental fleet.

Furthermore, Komatsu is linking market information directly with its production plants through Komtrax (see Figure 1). It says its factories “aggressively monitor and analyse the conditions of machine operation and abrasion of components” to enable Komatsu and its distributors to improve operations by better predicting the lifetime of parts and the best time for overhauls.

Figure 1: How Komatsu uses data captured by its customers’ equipment

Source: Komatsu slide adapted by STL Partners

Value added services for customers

The Komtrax system can also flag up useful information for Komatsu’s customers. Komatsu enables its customers to access the information captured by their machines’ onboard units, via an Internet connection to the Komtrax data centre.

Customers can use this data to monitor how their machines are being used by their employees. For example, it can show how long individual machines are sitting idle and how much fuel they are using. Komatsu Australia, for example, says Komtrax enables its customers to track a wide range of performance indicators, including:

Location
Operation map (times of day the engine was on/off)
Actual fuel consumptionAverage hourly fuel consumption
Residual fuel level
High water temperature during the day’s operation
Dashboard cautions
Maintenance reminders/notifications
“Night Time” lock
Calendar lock
Out of Area alerts
Movement generated position reports
Actual working hours (engine on time less idle time)
Operation hours in each work mode (economy, power, breaker, lifting)
Digging hours
Hoisting hours
Travel hours
Hydraulic relief hours
Eco-mode usage hours
Load frequency (hours spent in four different load levels determined by pump pressures or engine torque)

Content:

Introduction
Executive Summary
The enduring value of connected assets
Tapping telecoms networks
Enabling Deep Neural Networks
Real world data: the raw material
Learning from Tesla
The role of telcos
Conclusions and Recommendations

Figures:

Figure 1: How Komatsu uses data captured by its customers’ equipment
Figure 2: Interest in deep learning has risen rapidly in the past two years
Figure 3: Deep learning buzz has helped drive up Nvidia’s share price
Figure 4: The key players in the development of deep learning technology
Figure 5: Mainstream enterprises are exploring deep learning
Figure 6: The automotive sector is embracing Nvidia’s artificial intelligence
Figure 7: Google Photos learns when users correct mistakes
Figure 8: Tesla’s Autopilot system uses models to make decisions
Figure 9: Tesla is collecting very detailed data on how to drive the world’s roads

Amazon: Telcos’ Chameleon-King Ally?

Introduction

Amazon is using an array of innovative propositions to sidestep the Android-Apple duopoly in the smartphone market and Facebook’s rapidly expanding digital commerce ecosystem. Amazon’s vast selection, unparalleled logistics, innovative bundling, laser-like focus on the customer, rapidly improving entertainment proposition and leadership in voice-controlled in-home systems mean the Seattle-based e-commerce giant is fast becoming a omnipresent convenience store that always has what you want, when you want it.

Continually reinventing itself, Amazon’s restlessness could seriously disrupt the balance of power between the major global Internet ecosystems. Although the Amazon, Apple, Facebook and Google ecosystems all originate from the PC-era, they have each managed to successfully extend their digital platforms into the smartphone and tablet markets. But not without a dramatic change in the pecking order. In fact, the advent of touch-controlled smartphones enabled Apple to become a major force in the digital consumer market, while weakening the position of its long-standing foe Microsoft.

Now these ecosystems need to navigate the tricky transition to voice-controlled digital platforms, which depend heavily on advanced speech recognition, artificial intelligence and machine learning technologies. Amazon is leading the way, having created this new market with the rollout of its Echo speaker, underpinned by the cloud-based Alexa personal assistant system.

This report analyses Amazon’s financial firepower, the Amazon Prime bundle and strategy of bundling entertainment with retail, before considering Amazon’s areas of relative weakness – the smartphone and communications markets. In this section, the report also considers whether Amazon can sustain its lead in the nascent market for voice-controlled speakers for the home.

It concludes by exploring whether Amazon has sufficient economies of scope to build the expertise in artificial intelligence that will be required to ensure the Apple-Android duopoly that exists in the smartphone market won’t also dominate the emerging smart home sector. Finally, it considers the ramifications for telcos and makes several high level recommendations.

The global e-commerce market

Online commerce continues to grow rapidly. In 2016, global retail e-commerce sales (products and services ordered via the internet) will rise almost 24% to reach $1.915 trillion in 2016, according to research firm eMarketer. As that represents just 8.7% of total retail spending worldwide, there is plenty more growth to come. eMarketer expects retail ecommerce sales will increase to $4.058 trillion in 2020, making up 14.6% of total retail spending that year (see Figure 1).

Figure 1: Retail online commerce continues to grow rapidly

The major global Internet ecosystems – Amazon, Apple, Facebook and Google – all take a slice of this market. Within their ecosystems, they act as brokers bringing buyers and sellers together, earning a commission for facilitating interactions and transactions. Google and Facebook are the leading players in online advertising, while Apple is a leading distributor of digital content: Although Apple still generates most of its revenue from devices, its App Store and iTunes service are now major contributors to its top line. Still, in online commerce, Amazon rules the roost: Its online marketplace, which offers a vast selection of products and services from millions of merchants, continues to grow rapidly.

Introduction
Executive Summary
The global e-commerce market
Amazon’s financial firepower
Key takeaways
Amazon Prime: The Convenience Engine
Eroding Google Search
Key takeaways
Why Amazon wants to entertain us
A push into user-generated content
Key takeaways
Amazon’s Devices: Ups and Downs
Navigating Google’s mobile maze
Amazon’s Attempts to Develop Device Platforms
Key takeaways
Communications: Amazon’s Blind Spot?
Conclusions and Recommendations

Google/Telcos’ RCS: Dark Horse or Dead Horse?

Introduction

The strategic importance of digital communications services is rising fast, as these services now look set to become a major conduit for digital commerce. Messaging services are increasingly enabling interactions and transactions between consumers and businesses. Largely pioneered by WeChat in China, the growing integration of digital communications and commerce services looks like a multi-billion dollar boon for Facebook and a major headache for Amazon, eBay and Google, as outlined in the recent STL Partners report: WeChat: A Roadmap for Facebook and Telcos in Conversational Commerce.

This report analyses Google’s and telcos’ strategic position in the digital communications market, before exploring the recent agreement between leading telcos, the GSMA and Google to use the Android operating system to distribute RCS (Rich Communications Service), which is designed to be a successor to SMS and MMS. Like SMS, RCS is intended to work across networks, be network-based and be the default mobile messaging service, but it also goes far beyond SMS, by supporting rich features, such as video calling, location sharing, group chat and file sharing.

The report then undertakes a SWOT (strengths, weaknesses, opportunities and threats) analysis on the new Google supported RCS proposition, before considering what telcos need to do next to give the service any chance of seeing widespread adoption.

Google’s strategic headache

To Google’s alarm, mobile messaging looks set to become the next major digital commerce platform. In some ways, this is a logical progression of what has come before. Although neither Google nor Amazon, two of the leading digital commerce incumbents, seem well prepared for the rise of “conversational commerce”, communications and commerce have always been interwoven – physical marketplaces, for example, serve both functions. In the digital era, new communications services, such as SMS, email and mobile calls, were quickly adopted by companies looking to contact consumers. Even now, businesses continue to rely very heavily on email to communicate with consumers, and with each other, and through Gmail, Google has a strong position in this segment.

But many consumers, particularly younger people, now prefer to use mobile messaging and social networking services to communicate with friends and family and are using email, which was developed in the PC era, less and less. People are spending more and more time on messaging apps – some industry executives estimate that consumers spend 40% of their time on a mobile phone purely in a messaging app. Understandably, businesses are looking to follow consumers on to mobile messaging and social networking services. Crucially, some of these services are now enabling businesses to transact, as well as interact, with customers, cutting the likes of Amazon and Google out of the loop entirely.

Largely pioneered by Tencent’s WeChat/Weixin service in China, the growing integration of digital communications and commerce services could be a multi-billion dollar boon for Facebook, the leading provider of digital messaging services in much of the world. The proportion of WeChat users making purchases through the service leapt to 31% in 2016 up from 15% in 2015, according to Mary Meeker’s Global Internet Trends report 2016. Moreover, users of WeChat’s payment service now make more than 50 payments a month through the service (see Figure 1), highlighting the convenience of ordering everyday products and services through a messaging app. In March 2016, Tencent reported the combined monthly active users of the Weixin and WeChat messaging services reached 697 million at the end of 2015, representing annual growth of 39%. See WeChat: A Roadmap for Facebook and Telcos in Conversational Commerce for more on this key trend in the digital economy.

Figure 1: WeChat users find it convenient to combine payments and messaging

Source: Mary Meeker’s Global Internet Trends 2016

Executive summary
Contents
Introduction
Google’s strategic headache
Winner takes all?
Google’s attempts to crack communications
Telcos’ long goodbye
RCS – a very slow burn
VoLTE sees broader support
Google and telcos: a match made in heaven?
A new phase in the Google-telcos relationship?
Building a business case
Conclusions
Strengths
Weaknesses
Opportunities
Threats
Next steps
Lay the foundations
What will Google do next?

Figure 1: WeChat users find it convenient to combine payments and messaging
Figure 2: Using Weixin Pay to complete a transaction in a fast food outlet
Figure 3: Leading communications & media sharing apps by downloads
Figure 4: Deutsche Telekom’s RCS app’s features include location sharing
Figure 5: All-IP communications services are gaining some traction with operators
Figure 6: Google Places aims to connect businesses and consumers
Figure 7: SWOT analysis of operators’ IP communications proposition
Figure 8: TOWS analysis for telcos in all-IP communications

Can Telcos Entertain You? Vodafone and MTN’s Emerging Market Strategies (Part 2)

Telcos and the entertainment opportunity

In most emerging markets, which are the focus of this report, mobile networks are fast becoming the primary distribution channel for entertainment content. Although television is popular all over the world, in much of sub-Saharan Africa and developing Asia, terrestrial television coverage is patchy, while cable TV is rare. Satellite television is broadly available, but fewer than half of households can afford to buy a television, meaning many people only watch TV in bars, cafes or in the houses of friends.

In Kenya, for example, only 28% of households have a television, according to the World Bank development indicators, while in Tanzania that figure is just 15%. In some major developing markets, television has a stronger grip – in Nigeria, 40% of households have a TV and 47% of households in India. For sub-Saharan Africa, as a whole, television penetration is about 25% and in South Asia, 36%.

For many people in these regions, purchasing a versatile smartphone, which can be used for communications, information access, commerce and entertainment, is a higher priority than acquiring a television. The advent of sub US$40 smartphones means more and more people can now afford mobile devices with decent screens capable of displaying multimedia and processors that can run apps and full Internet browsers. In India, 220 million smartphones were in use at the end of 2015, according to one estimate , while Ericsson has forecast that the number of smartphones in use in Sub-Saharan Africa will leap to 690 million in 2021 from 170 million at the end of 2015 (see Figure 1).

Figure 1: Predicted smartphone growth in developing regions

Source: Ericsson Mobility Report, November 2015

In emerging markets, most Internet users don’t own a television (see Figure 2) and many rely entirely on a smartphone for digital entertainment. Moreover, a scarcity of fixed line infrastructure means much of the entertainment content is delivered over mobile networks. Mobile trade group the GSMA estimates that 3G networks, which are typically fast enough to transmit reasonable video images, reach about three quarters of the planet’s people. Mobile network supplier Ericsson has forecast that mobile broadband networks (3G and/or 4G) will cover more than 90% of the world’s population by 2021.

Figure 2: Device ownership among Internet users in selected markets

Source: Ericsson

The reliance on cellular infrastructure in developing countries has enabled mobile operators to take on a central role in the provision of online entertainment. The fact that many people rely almost solely on mobile networks for entertainment is presenting mobile operators with a major opportunity to boost their relevance and revenues. Given the capacity constraints on mobile networks and the implications for cellular tariffs, entertainment services need to be optimised to ensure that the costs of bandwidth don’t become prohibitive for consumers. Mobile operators’ understanding and real-time knowledge of their networks means they are in a good position to both manage the optimisation and package connectivity and content (regulation permitting) into one service bundle with a predictable and transparent tariff.

Although the network effects and economies of scale and scope enjoyed by YouTube and Facebook mean that both these players have strong positions in much of developing Asia, Latin America, the Middle East and Africa, some emerging market telcos have also built a solid foundation in the fast growing online entertainment sector. In Africa and India, for example, the leading telcos enable third party content providers to reach new customers through the telcos’ dedicated entertainment platforms, including web portals, individual apps and app stores selling music, TV and games. In return for supporting content offerings with their brands, networks, messaging, billing and payment systems, these telcos typically earn commission and capture valuable behavioural data.

Introduction
Executive Summary
Telcos and the entertainment opportunity
Roles in the online entertainment value chain
Further disruption ahead
Vodafone India faces up to new competition
The land-grab in India’s online entertainment market
Vodafone India combines content and connectivity
Takeaways – greater differentiation required
Music Gives MTN an Edge
Takeaways – music could be a springboard
Conclusions

Figure 1: Predicted smartphone growth in developing regions
Figure 2: Device ownership among Internet users in selected markets
Figure 3: How the key roles in online content are changing
Figure 4: How future-proof are telcos’ entertainment portfolios?
Figure 5: Vodafone India curates a wide range of infotainment content
Figure 6: Smartphone adoption in India will more than double in the next five years
Figure 7: Vodafone Mobile TV enables customers to subscribe to channels
Figure 8: The new Vodafone Play app combines TV, films and music
Figure 9: Vodafone India offers an app that makes it easy to track data usage
Figure 10: Vodafone’s Mobile TV app hasn’t attracted a strong following
Figure 11: Competitive and regulatory pressures are pushing down prices
Figure 12: In 3G, Vodafone India has kept pace with market leader Airtel
Figure 13: Vodafone India’s growth in data traffic compared with that of other telcos
Figure 14: Vodafone’s performance in India this decade
Figure 15: MTN’s Telco 2.0 strategy is focused on digital services
Figure 16: MTN’s growing array of digital services
Figure 17: MTN Play has been localised for each of MTN’s operations
Figure 18: The Ugandan version of MTN Play caters for local tastes
Figure 19: MTN bundles in some data traffic with each music plan
Figure 20: MTN’s digital services are particularly strong in Nigeria
Figure 21: MTN tops a list of most admired brands in Africa in 2015

Can Telcos Entertain You? (Part 1)

Telcos and the entertainment opportunity

As telecoms networks are the primary distribution channels for the digital economy, all telcos are in the entertainment business to a certain extent. With more than 3.2 billion people worldwide now connected to the Internet, according to the ITU, entertainment is increasingly delivered online and on-demand over telecoms and cable networks. The major Internet ecosystems – Amazon, Apple, Facebook and Google – are looking to dominate this market. But telcos could also play a pivotal role in an emerging new world order, either by providing enablers or by delivering their own differentiated entertainment offerings.

Many telcos have long flirted with offering their own entertainment services, typically as a retaliatory response to cable television providers’ push into communications. But these flings are now morphing into something more serious: connectivity and entertainment are becoming increasingly intertwined in telcos’ portfolios. Television, in particular, is shifting from the periphery, both in terms of telcos’ revenues and top management focus, onto centre stage. Some of the world’s largest telcos are beginning to invest in securing exclusive drama and sports content, even going as far as developing their own programming. This push is part of telcos’ broader search for ways to remain relevant in the consumer market, as usage of telcos’ voice and messaging services is curbed by over-the-top alternatives.

The central strategic dilemma for telcos is whether they should be selling services directly to the consumer or whether they should be providing enablers to other players (such as Amazon, Google, Netflix and Spotify) who might be prepared to pay for the use of dedicated content delivery networks, messaging, distribution, authentication, billing and payments. In many respects, this is not a new dilemma: Operators have tried to become content developers and distributors in the past, building portals, selling ringtones and games, and establishing app stores. What is new is the size of the table stakes: The expansion of broadband coverage and capacity has put the focus very much on increasingly high definition and immersive television and video. Creating this kind of content can be very expensive, prompting some of the largest telcos to invest billions of dollars, rather than tens of millions, in their entertainment proposition.

It isn’t just telcos undergoing a strategic rethink. The spread of broadband, the proliferation of connected digital devices and the shift to a multimedia Internet are shaking up the entertainment industry itself. Mobile and online entertainment accounts for US$195 billion (almost 11%) of the US$1.8 trillion global entertainment market today . And that proportion is growing. By some estimates, that figure is on course to rise to more than 13% of the global entertainment market, which could be worth US$2.2 trillion in 2019.

For incumbents in the media industry, this is a seismic shift. Cable television companies, for example, have had to rethink their longstanding business model, which involved selling big bundles of television channels encompassing the good, the bad and the ugly. Individual customers typically only watch a small fraction of the cable TV channels they are paying for, prompting a growing number of them to seek out more cost-effective and more targeted propositions from over-the-top players.

Cable companies have responded by offering more choice and expanding across the entertainment value chain. For example, Comcast, a leading US cableco, offers an increasingly broad range of TV packages, ranging from US$16 a month (for about 10 local channels) to US$80 a month (for about 140 channels bundled with high speed Internet access). Moreover, Comcast is making its TV services more flexible, enabling customers to download/record video content to watch on mobile devices and PCs at their convenience. Even so, Comcast has been shedding cable TV subscriptions for most of the past decade. But the cableco’s vertical-integration strategy has more than compensated. Growth in Comcast’s NBCUniversal television and film group, which owns a major Hollywood studio, together with rising demand for high-speed Internet access, has kept the top line growing.

Roles in the online entertainment value chain

Other cablecos and telcos are following a similar playbook to Comcast, increasingly involving themselves in all four of the key roles in the online content value chain, identified by STL Partners. These four key roles are:

Programme: Content creation: producing drama series, movies or live sports programmes.
Package: Packaging programmes into channels or music into playlists and then selling these packages on a subscription basis or providing them free, supported by advertising.
Platform: Distributing TV channels, films or music created and curated by another entity.
Pipe: Providing connectivity, either to the Internet or to a walled content garden.

Clearly, virtually all telcos and cablecos play the pipe role, providing connectivity for online content. Many also operate platforms, essentially reselling television on behalf of others. But now a growing number, including BT, Telefónica and Verizon, are creating packages and even developing their own programming. The pipe and package roles present opportunities to capture behavioural data that can then be used to further hone the entertainment proposition and make personalised recommendations and offers. At the same time, the package and programme roles are becoming increasingly important as the platforms with the best content, the best channels and the best recommendations are likely to attract the most traffic.

Figure 1 illustrates how the package and platform roles, in particular, are increasingly converging, as consumers seek out services that can help them find and discover entertainment that suits their particular tastes. Google’s YouTube platform, for example, increasingly promotes its many channels (packages) to better engage consumers, help them discover content and help viewers navigate their way through the vast amount of video on offer.

By venturing into packaging and programming, telcos are hoping to differentiate their platforms from those of the major global online players – Amazon, Apple, Facebook, Google and Netflix – which benefit from substantial economies of scale and scope. But pursuing such a strategy can involve compromises.
In many cases, regulators force telcos to also make their programming and packaging available on third party TV platforms, including those of direct competitors. In the UK, for example, BT has to wholesale its BT Sports channels to other TV platforms, including that of arch rival Sky. Figure 2 shows how BT’s platform, packaging and programming is intertwined with that of third parties, creating a complex, multi-faceted market in which BT content is available through BT TV/BT Broadband and through other platforms and pipes.

Figure 1: How the key roles in online content are changing

Source: STL Partners analysis

Figure 2: BT has to provide standalone packaging & programming, as well as a platform

Source: STL Partners analysis

Introduction
Executive Summary
Telcos and the entertainment opportunity
Roles in the online entertainment value chain
Further disruption ahead
BT – betting big on sport
Takeaways – sport gives BT a broad springboard
Telefónica – leveraging languages
Takeaways – Telefónica could lead Hispanic entertainment
Verizon – acquiring and accumulating expertise
Takeaways – Verizon needs bigger and better content
Conclusions
Annex: Recommendations for telcos & cablecos in entertainment

Figure 1: How the key roles in online content are changing
Figure 2: BT has to provide standalone packaging & programming, as well as a platform
Figure 3: How future-proof are telcos’ entertainment portfolios?
Figure 4: The extras and upgrades to the free BT TV and BT Sports offer
Figure 5: The differences between BT TV’s free and premium packages
Figure 6: BT’s app enables consumers to watch premium content on handsets
Figure 7: BT Sport has driven broadband net-adds, but the rights bill is also rising
Figure 8: In the UK, BT is still behind the Sky TV platform but on a par with YouTube
Figure 9: How BT Sport creates value for BT
Figure 10: Telefónica offers a selection of bolt-ons to cater for different tastes
Figure 11: Acquisitions boosted Telefónica’s pay TV business in 2015
Figure 12: Pay TV and fibre broadband are the growth engines in Spain
Figure 13: Telefónica TV’s position versus that of Netflix and YouTube in Spain
Figure 14: Verizon’s three-tier strategy envisages providing platforms and solutions
Figure 15: Verizon was attracted by AOL’s growing platforms business
Figure 16: Verizon’s go90 is designed to be a content and social hybrid
Figure 17: AOL ranks sixth in terms of online visitors in the US
Figure 18: Verizon’s new go90 app has had a fairly positive response from users
Figure 19: AOL video trails far behind Internet rivals YouTube and Netflix in terms of usage
Figure 20: How future-proof are telcos’ entertainment portfolios?

WeChat: A Roadmap for Facebook and Telcos in Conversational Commerce

Introduction

The latest report in STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing explores the rise of conversational commerce – the use of messaging services to enable both interactions and transactions. It considers how WeChat/Weixin has developed this concept in China, the functionality the Tencent subsidiary offers consumers and merchants, and the lessons for other players.

The report then goes on to consider how Facebook is implementing conversational commerce in its popular Messenger app, before outlining the implications for Amazon, Google and Apple. Finally, it considers how telcos may be able to capitalise on this trend and makes a series of high-level recommendations to guide the implementation of a conversational commerce strategy. This report builds on three recent STL reports, Building Digital Trust: A Model for Telcos to Succeed in Commerce, Mobile Authentication: Telcos’ Key to the Digital World? and Authentication Mechanisms: The Digital Arms Race.

Communications and commerce: two sides of the same coin

For Facebook, advertising isn’t the only fruit. When it hired the former head of PayPal, David Marcus, to run Facebook Messenger in 2014, it was a clear signal of where the social network is heading. Facebook plans to go head to head with eBay and Amazon in the digital commerce market, generating revenues by enabling transactions, as well as brokering advertising and marketing. The ultimate goal is to transform communications services into end-to-end commerce platforms that enable consumers and brands to “close the loop” from initial interaction through transaction to after-sales care.

Facebook is not alone. In fact, it is following in the footsteps of Tencent’s WeChat service. In the STL Partners’ Wheel of Digital Commerce (see Figure 1), the remit of WeChat, Facebook Messenger, Twitter, SnapChat and other digital communications services is expanding to encompass the guide, the transact and satisfy segments (marked in blue, turquoise and green), as well as the retain, plan and promote segments: the traditional sweet spot for social networking services, email and instant messaging.

Figure 1: Communications services move to facilitate the whole wheel of commerce

Source: STL Partners

Facebook, in particular, is following in the footsteps of WeChat, Tencent’s messaging service, which is evolving into a major digital commerce platform in its home market of China. Whereas email, SMS and many other digital commerce services have long carried commercial messages, together with advertising and, inevitably, spam, WeChat goes much further – it also enables transactions and customer care. The central tenet behind this concept, which is sometimes called conversational commerce, is that consumers will become increasingly comfortable using a single service to converse with friends and businesses, and buy goods and services. In some markets, third parties are adding a commerce overlay to existing communications platforms. In India, for example, several startups, such as Joe Hukum, Niki and Lookup, are touting ways to use WhatsApp, SMS and other digital communications services to transact with consumers.

For telcos, the growing integration of communications and commerce exacerbates a key strategic dilemma. Through voice calls and text messaging, telcos led the digital communications market for two decades, but now face ceding that market to over-the-top players using communications as a loss leader to support digital commerce. The question for telcos is whether to compete head-on with these players in both digital communication and commerce (a major undertaking requiring major investments in product development and marketing) or whether to fall back to just providing enablers for other players.

The final section of this report discusses this question further. But first, let’s consider the arguments as to why digital communications and digital commerce are natural bedfellows:

Markets have always combined commerce and conversations

Markets – essentially a concentration of vendors in one physical location – have been a feature of most societies and cultures throughout recorded history. They fulfil two key functions: One is to enable buyers and sellers to find each other easily. The second is to enable the exchange of information, news and gossip: the communications required to help human societies to function smoothly. For many shoppers, a visit to a physical market is as much about socialising, as shopping. In other words, communications and commerce have been intertwined for centuries. Messaging apps could extend this concept into the digital age.

Conversations help build trust

Communication is often a prelude for commerce. In both a personal and professional capacity, people often seek word-of-mouth recommendations or they canvas friends’ opinions on potential products and services. As consumers increasingly use communications apps for this purpose, these platforms are already playing a key role in purchasing decisions across both services and products. The obvious next step is to enable the actual transaction to also take place within the app.

Conversations can drive commerce

People use messaging apps to organise their social lives. They chat with friends about which bars to go to, which restaurants to dine at, which films to see, which concerts to attend and other entertainment possibilities. Once the decision is made, one of the group may want to book tickets, a table or a taxi. If such a booking can be made within the messaging app, all of the group will be able to see the details and act accordingly.

Convenient customer service

After a transaction is completed, customer service kicks in. The buyer may want to change an order, check on delivery dates or make a related purchase. The seller may want feedback. For younger generations growing up with the Internet, messaging apps represent a natural way to interact with customer service representatives.

Messaging has consumers’ attention

Although most smartphones host dozens of apps, few are used regularly. Messaging apps are among this chosen few. In fact, communications apps (social networks/messaging apps) soak up a huge amount of consumers’ time and attention. Data from comScore, for example, shows that social networks accounts for between one fifth and one quarter of all the time that consumers spend on digital services (see Figure 2).

Figure 2: Share of digital time of different categories of apps

Source:comScore

Merchants and brands need to go where their customers are and one of those places is messaging. Messaging apps are typically always running, frequently generating notifications. That means, for many consumers, a messaging app could be a convenient place from which to make purchases – it saves them the hassle of switching to another app or using a web browser. In an interview with Tech in Asia, Joe Hukum co-founder Ajeet Kushwaha noted: “Conversational commerce is going to offer Convenience 2.0 – better and bigger than Convenience 1.0 offered by e-commerce,” adding that Joe Hukum plans to make API (application program interface) integrations with a range of partners in order to enable quick transactions. “We’re at a point where the way we consume and transact is going to change drastically,” he contended.

The success of WeChat and the lessons it holds for other communications players suggests Kushwaha could well be right.

Executive Summary*
Communications and commerce: two sides of the same coin
WeChat – the conversational commerce trailblazer*
The merchant experience*
Muted monetisation*
Lessons to learn from WeChat/Weixin*
Facebook now following fast*
How much money can Messenger make from commerce?*
WhatsApp also targets commerce*
Takeaways: Facebook needs to work with the medium, not against it*
Implications for Amazon, Apple and Google*
Amazon – in danger of disruption*
Google – down, but not out*
Apple – already has the assets*
Conclusions and lessons for telcos*
How can telcos differentiate?*

(* = not shown here)

Figure 1: Communications services move to facilitate the whole wheel of commerce
Figure 2: Share of digital time of different categories of apps
Figure 3: The world’s most widely used mobile messaging services*
Figure 4: An example of a WeChat Subscription Account*
Figure 5: An example of a WeChat Service Account*
Figure 6: The key features of WeChat’s official accounts*
Figure 7: The main developer tools available to WeChat verified service accounts*
Figure 8: WeChat enables merchants to create a distinctive look and feel*
Figure 9: Some Chinese nurseries use WeChat to communicate with parents*
Figure 10: The WeChat Wallet offers easy access to a suite of services*
Figure 11: Tencent’s Red Envelope promotion was hugely successful*
Figure 12: WeChat’s depiction of a typical day for one of its users*
Figure 13: Tencent remains heavily reliant on online gaming revenues*
Figure 14: Facebook Messenger seeks to fill the gap in digital commerce*
Figure 15: Facebook follows in Tencent’s footsteps*
Figure 16: Hailing a taxi from within a conversation on Facebook Messenger*
Figure 17: Facebook Messenger will increasingly compete with Amazon Prime Now*
Figure 18: Telcos’ mobile money apps are becoming increasingly sophisticated*

(* = not shown here)

AT&T: Fast Pivot to the NFV Future

Objectives, methods and strategic rationale

AT&T publicly launched its plan to transform its network to a cloud-, SDN- and NFV-based architecture at the Mobile World Congress in February 2014. The program was designated as the ‘User-Defined Network Cloud’ (UDNC).

The initial branding, which has receded somewhat as the program has advanced, reflected the origins of AT&T’s strategic vision in cloud computing and the idea of a software-defined network (SDN) where users can flexibly modify and scale their services according to their changing needs, just as they can with cloud-based IT. This model also contributed to an early bias toward enterprise networking, with AT&T’s first major SDN-based service being ‘Network on Demand’: an Ethernet offering allowing enterprises to rapidly modify their inter-site bandwidth and make other service alterations via a self-service portal, first trialed in June 2014.

Data center-based infrastructure and SDN architectural principles have remained at the heart of AT&T’s vision, although the focus has shifted increasingly toward network functions virtualization (NFV). In December 2014, the operator announced it had set itself the target of virtualizing (NFV) and controlling (SDN) 75% of its network via software by 2020. What this actually means was spelled out only in mid-2015, by which time AT&T also indicated that it expected to have virtualized around 5% out of the targeted 75% by the end of 2015.

What the 75% target relates to specifically are the 200 most vital network functions that AT&T believes it will need to take forward in the long term; so this is not an exhaustive list of every network component. The list comprises network elements and service platforms supporting IP-based data and voice services, and content delivery, ranging from CPE to the optical long-haul network and everything in between. What the list does not include is functions supporting legacy services such as TDM voice, frame relay or ATM; so the UDNC involves a definitive break with AT&T’s history as one of the largest and oldest PSTN operators in the world.

Correspondingly, this involves huge changes in AT&T’s culture and organization. The operator uses the term ‘pivot’ to describe its transformation into a software-centric network company. The word is intended to evoke a sort of 180o inversion of AT&T’s whole mode of operation: a transition from a hardware-centric operator that deploys and operates equipment designed to support specific services – and so builds and scales networks literally from the ground up – to a ‘top-down’, software-centric, ‘web-scale’ service provider that builds and scales services via software, and uses flexible, resource-efficient commodity IT hardware to deliver those services when and where needed.

AT&T has described the culture change needed to effect this pivot as one of the toughest challenges it faces. It involves replacing a so-called ‘NetOps’ (network-operations) mentality and team structure with a ‘DevOps’ (collaborative, iterative operations-focused software development) approach, with multi-disciplinary teams working across established operational siloes, and focusing on developing and implementing software-based solutions that address particular customer needs. According to AT&T Business Solutions’ Chief Marketing Officer, Steve McGaw, the clear parameters that the operator has set around the SDN architecture and customer-centricity are now driving team motivation and creativity: “A product that is going to fit into the SDN architecture becomes a self-fulfilling prophecy . . . . Because we have declared that that is the way we are going to do things, then there is friction to funding that doesn’t fit within that framework. And so everyone wants to get [their] project funded, everyone wants to move the ball forward with the customer and meet the customer’s needs and expectations.”

Allowing for some degree of marketing gloss, this description nonetheless portrays a considerable change in established ways of working, with hundreds of network engineers being retrained as software developers and systems managers. The same can be said for AT&T’s collaboration with third parties in developing the SDN architecture and virtualizing so many crucial network functions. AT&T is partnering with 11 vendors – both established and challengers – on the UDNC project, co-opting them into its dedicated Domain 2.0 supplier program. These vendors are:

Ericsson (multiple network functions, and also integration and transformation services);
Tail-F Systems (service orchestration: added to the Domain 2.0 program from February 2014 and then acquired by Cisco in July 2014);
Metaswitch Networks (virtualized IP multimedia functions, e.g. routers and SBCs);
Affirmed Networks (virtualized Enhanced Packet Core (EPC));
Amdocs (BSS / OSS functionality);
Juniper (routers, SDN technology, etc.);
Alcatel-Lucent (range of network functions);
Fujitsu (IT services);
Brocade (virtualized routers);
Ciena (optical networking and service orchestration);
Cisco (routers and IP networking)

In addition, in another challenge to AT&T’s traditionally proprietary mode of operation, the operator is collaborating extensively with a range of open source and academic initiatives working on various pieces of the SDN / NFV jigsaw. These include:

ON.Lab (a non-profit organization founded by SDN innovators, and specialists from Stanford University and Berkeley) – working on the virtualization of Central Office functionality (the so-called Central Office Re-architected as a Datacenter, or CORD) and the Open Network Operating System (ONOS) carrier-grade SDN platform. ON.Lab announced in October 2015 that it would partner with the Linux Foundation on open development of ONOS.
OpenDaylight (collaborative open source project hosted by the Linux Foundation, and dedicated to developing SDN and NFV technologies – various projects, including a tool based on the YANG data modeling language for configuring devices in the SDN)
OPNFV (another Linux Foundation-hosted open source project, focused on developing an open standard NFV platform – works mostly on the ARNO NFV platform).

AT&T’s Architecture – a technical summary

If you want to understand how this all fits together, consider the CORD project’s architecture as shown in Figure 1. CORD is an AT&T research project which aims to transform its local exchanges, Central Offices in US parlance, into small data centres hosting a wide range of virtualized software applications. As well as virtualizing the core telco functions based there, they will eventually also provide edge hosting for new products and services. The structure of CORD is the template for how AT&T intends to virtualize its network and how it intends to work with the three open-source groups ON.Lab, OpenDaylight, and OPNFV. Figure 1 shows how services are created in the XOS orchestration platform out of OpenStack virtual machines, OpenDaylight network apps, and ONOS flow rules.

Figure 1: How the Central Office Re-architected as a Datacenter project works

Source: ON.Lab

What’s the benefit?

This means that AT&T can …

Executive Summary*
Objectives, methods and strategic rationale (shown in part here)
Progress and key milestones*
Analysis: proceeding on all fronts*
Next steps: getting it done*

(* = not shown here)

Figure 1: How the Central Office Re-architected as a Datacenter project works
Figure 2: NFV means re-organising your product bundles, which is one of the main reasons it’s worth doing*
Figure 3: AT&T’s publicly disclosed virtualized network functions (VNFs) as at October 2015*
Figure 4: What AT&T is concentrating on versus Telefonica*
Figure 5: Functions in line for virtualization by AT&T*
Figure 6: How AT&T is doing versus its primary competitor, Verizon in this space*

(* = not shown here)

Building Digital Trust: A Model for Telcos to Succeed in Commerce

Introduction

This executive briefing considers how telcos can reduce fragmentation in the digital commerce market and create value for merchants and consumers alike. It outlines how inconsistent and clunky experiences for consumers, together with incompatible and sub-scale platforms for merchants, continue to hamper the development of the digital commerce market both online and in bricks and mortar outlets.

The report then looks at attempts by individual telcos to carve out a role in this market, as well as exploring how the GSMA’s Digital Commerce and Mobile Connect programmes are trying to make mobile operators’ propositions more consistent with each other. Finally, it considers how the telecoms sector might develop a single consistent framework – a trusted digital infrastructure – that would enable consumers and merchants to exchange information and value in a consistent and interoperable way. This final section draws on research and development work by Deutsche Telekom’s Labs.

This executive briefing also builds on previous reports by STL Partners exploring the need for better authentication, identification, data management and payment mechanisms. These reports include:

Telcos’ role in digital commerce

Two years ago, STL Partners published a strategy report outlining two major opportunities in the digital commerce market for telcos:

Real-time commerce enablement: The use of mobile technologies and services to optimise all aspects of commerce. For example, mobile networks can be used to deliver precisely targeted and timely marketing and advertising to consumer’s smartphones, tablets, computers and televisions.
Personal cloud: Act as a trusted custodian for individuals’ data and an intermediary between individuals and organisations, providing authentication services, digital lockers and other services that reduce the risk and friction in every day interactions. As personal cloud services provide personalised recommendations based on individuals’ authorised data, they could potentially engage much more deeply with consumers than the generalised decision-support services, such as Google, TripAdvisor, moneysavingexpert.com and comparethemarket.com, in widespread use today.

As these two opportunities are inter-related and could be combined in a single platform, STL Partners recommended that telcos start with mobile commerce, where they have the strongest strategic position, and then use the resulting data, customer relationships and trusted brand to expand into personal cloud services, which will require high levels of investment.

However, since that report was published, in developed markets, telcos’ efforts to pursue the mobile commerce market have suffered several setbacks. Over the past two years, the Weve mobile commerce joint venture in the UK has unravelled, the SoftCard joint venture in the US has collapsed and Apple has rolled out a relatively advanced and holistic proposition, now known as Apple Wallet, which effectively cuts telcos out of the action. Moreover, Google and Samsung are seeking to emulate Apple’s widely-lauded Apple Pay solution for completing transactions online and in-person. STL Partners explained the significance of these events in an executive briefing entitled Apple Pay & Weve Fail: A Wake Up Call.

These developments have led many commentators to question whether telcos can really compete with the major Internet ecosystems in digital commerce.

In emerging markets, telcos increasingly enable commerce

While telcos in developed markets are often racked with doubt, their counterparts in emerging markets continue to make headway. In developing Asia, Africa and much of Latin America, most people lack credit cards, debit cards, bank accounts, driving licenses, passports and most of the other collateral that people in developed countries use to authenticate themselves, identify themselves and conduct transactions. As many of these people have mobile phones and SIM cards, telcos are increasingly acting as intermediaries between consumers and service providers in emerging markets.

Mobile money services, which enable consumers and businesses to transfer money via mobile networks, continue to proliferate and are increasingly achieving scale. For example, Orange Money, which is available in parts of Africa and Middle East, reported a 37% year-on-year rise in customers to 15.5 million at the end of the third quarter of 2015. It also reported that revenues were up 71% year-on-year.

In some cases, mobile money services are evolving into broader digital commerce platforms. In Kenya, Safaricom, for example, has reported that the number of merchants accepting payments via its Lipa na MPesa platform more than doubled to 49,413 in the year to March 2015. In the month of March 2015, Kshs 11.6 billion was handled by the Lipa na MPesa platform, which enables consumers to use the well-established M-Pesa mobile money transfer service to pay for goods and services.

In emerging markets, mobile operators are increasingly using their distribution networks (both digital and physical) and their extensive customer data to move into financial services. As they know how much consumers are spending on airtime and are able to infer other relevant information, such as whether a subscriber has a job, mobile operators can gauge how affluent an individual is and what size of loan they can afford. If the customer is a regular user of a mobile money transfer service, the operator may also be able to assess how much disposable income they have.

In Kenya, mobile operator Safaricom reported its M-Shwari joint venture with the Commercial Bank of Africa M-Shwari had 2.1 billion Kenyan shillings (almost US$ 20 million) out on loan to customers as of March 31, 2015, up 75% from 1.2 billion shillings a year earlier. In Sri Lanka, mobile operator Dialog claims it now sells more insurance policies than all the traditional insurance companies.

In developed markets, fragmentation persists

Although developed markets are very different beasts, telcos could still play a key enabling role, which addresses various pain points in the digital economy. Although most people in North America and Western Europe have bank accounts, credit ratings and at least one digital wallet (be that PayPal, Amazon Payments or Apple iTunes), digital interaction can still be fraught with friction and mistrust. Telcos could help by enabling simple and secure authentication services as outlined in Mobile Authentication: Telcos’ Key to the Digital World?. Moreover, there is still an opportunity for telcos to become trusted custodians of personal data as explained in the aforementioned strategy report: Digital Commerce 2.0: New $50bn Disruptive Opportunities for Telcos, Banks and Technology Players.

Even the real-time commerce enablement opportunity, explained in that Strategy Report, still exists, despite the launch of Apple Pay, and the subsequent arrival of Samsung Pay and Android Pay. Industry executives say usage of Apple Pay so far has been modest. One problem is that relatively few people have one of the latest iPhones (the iPhone 6 or iPhone 6 Plus) needed to use the service. Another barrier is the limited number of stores in the US (the initial launch market) that can accept payments via Apple Pay. The net result is that only 14% of US households with credit cards have signed up for Apple Pay, according to Phoenix Marketing International, and less than one fifth of people who can use the system do so habitually, according to a report in the Financial Times, which cited banking sources.

Usage will rise, however, as Apple persuades more consumers to buy its latest iPhones and more merchants add their loyalty cards to the new Apple Wallet (formerly Apple Passbook), while installing point of sale terminals that can support contactless transactions. In STL Partners’ view, Apple Wallet, which is designed to hold digital representations of payment cards, loyalty cards, tickets and boarding passes, does address a genuine consumer need by providing a convenient way to organise all this collateral (see Figure 1).

But Apple Wallet isn’t a panacea for merchants. As iPhones will only ever be used by a fraction of a merchant’s customer base, they may prefer to rely on their own loyalty apps, rather than Apple Wallet. John Fisher, Costa’s head of mobile and loyalty, told Macworld that while the company believed Apple Pay would make the in-store experience “even more seamless,” Costa already has its own mobile loyalty app, which customers can scan at the till. “There is probably a role for mobile payments to be integrated into that in the future and we’re looking at that,” Fisher said. “The product that Apple has will really help to provide a simple solution around in-app payments and payments in store. That’s potentially where the market is going to head, so we need to have all options on the table.”

Figure 1: The new Apple Wallet can hold a wide range of digital commerce collateral

Source: Apple.com

Merchants are also seeking ways to improve the online shopping experience for people using mobile phones. The proportion of potential shoppers who complete an online transaction on a mobile device remains much lower than on a PC. That suggests many consumers still find it cumbersome to make a purchase on a mobile phone and/or are worried about security and/or privacy.

PayPal, which remains one of the leading digital wallets, continues to experiment with various mobile offerings. For example, its new One Touch service enables a consumer to register a device so that they don’t need to enter their login details when paying with PayPal. The service seeks to emulate Amazon’s famous one click purchasing experience, but both companies run the risk that consumers’ devices fall into the wrong hands and are used to make fraudulent purchases.

At the same time, the leading social networks are making a major push to merge online communications and commerce. For example, Facebook now offers advertisers the opportunity to add a buy button to an ad, which enables the user to purchase the relevant item without leaving Facebook. Google is also experimenting with this kind of functionality, enabling developers to place buy buttons in Android apps and in adverts, Meanwhile Amazon continues to push into the mobile commerce market through its keenly-priced Kindle Fire tablet range and its physical Dash Buttons (see Figure 2), which enable people to quickly purchase specific items, such as detergent or pet food.

Figure 2: Amazon Dash button supports one-touch ordering of a specific product

Source: Amazon.com

The US is acting as a test-bed for many of these new propositions, creating a fiercely competitive and cut-throat environment, from which telcos are increasingly excluded. US mobile operators have abandoned their elaborate and expensive SoftCard mobile commerce joint venture after it failed to gain significant traction. They are now providing support for third party solutions, such as Android Pay and Samsung Pay.

As the major US Internet players wrestle over the mobile commerce space, developing their own distinctive propositions and largely eschewing interoperability, consumers have to use different apps in different ecosystems. You can’t use Apple Pay to buy goods from Amazon, while iTunes doesn’t accept PayPal.

Exacerbating this fragmentation, some major merchants are still determined to sidestep the big Internet ecosystems altogether. Despite the widespread support for Apple Pay from US banks, many major US merchants, including Wal-Mart, Sears and CVS Pharmacy, continue to promote their own CurrentC solution, which was developed by the merchant consortium MCX. JPMorgan Chase is planning to launch a wallet, Chase Pay, which can be used in conjunction with the MCX solution. If anything, the fragmentation is getting greater, rather than less.

In summary, many incompatible and partial digital identification/authentication/payment solutions have been developed and deployed. Many of these solutions only work on one platform and are unable to share information with other solutions, resulting in frustration and confusion for consumers and digital service providers alike. As a result, service providers lack economies of scale, damaging the business case for more marginal digital services.

Telcos could make a big difference

One of the fundamental premises of the STL Partners’ Strategy Report, published in 2013, still holds true: Individuals are still looking for a simple and secure way to store the array of collateral required to interact with an increasingly digital world. As organisations embrace electronic authentication, identification and payment solutions, people are increasingly going to need digital versions of professional ID cards, house keys, car keys, payment cards, loyalty cards, membership cards, tickets, coupons, entitlements and receipts.

Telcos can help address that need. But instead of exacerbating the existing fragmentation by developing proprietary wallets that aren’t interoperable, telcos need to consider how they can play an enabling role for the wider ecosystem.

Although there are opportunities for telcos to fill gaps in the financial services market in developing countries, the role of telcos in developed markets needs to be more akin to that of a trusted infrastructure provider (as they are with the Internet), that provides a consistent digital framework for the existing financial services industry.

Some telcos are edging in this direction, while others continue to develop relatively rigid digital commerce and authentication propositions. The next section outlines some of these initiatives and gives STL Partners’ key takeaways in each case.

Introduction
Executive Summary
Telcos’ role in digital commerce
Telcos’ track record in digital commerce
Vodafone Wallet
Deutsche Telekom’s MyWallet
KDDI’s Digital Commerce suite
GSMA Mobile Connect
The case for a consistent user-centric framework
Core vision – put consumers first
Core principles – cross-platform, open and interoperable
Are telcos up to the task?
How could a framework be standardised?
How would telcos make money?
Would the wider ecosystem embrace a telco-led framework?
Conclusions and next steps

A flexible framework supporting different transmission and security tech
Figure 1: The new Apple Wallet can hold a wide range of digital commerce collateral
Figure 2: Amazon Dash button supports one-touch ordering of a specific product
Figure 3: The self-reinforcing flywheel Vodafone is aiming for
Figure 4: In the UK, Vodafone Wallet requires consumers to top up a prepaid card
Figure 5: Vodafone Wallet has polarised opinion on Google Play.
Figure 6: Deutsche Telekom’s MyWallet app has drawn few reviews
Figure 8: The ARPA of KDDI’s digital commerce business is on the rise
Figure 9: au Smart Pass subs are rising helping to lift ARPA
Figure 10: KDDI’s revenues and profits from value added services grow steadily
Figure 11: Mobile Connect Roadmap – Authentication, Identity and Attributes
Figure 12: The GSMA’s is looking to integrate Mobile Connect with mobile payments
Figure 13: The transactional services supported by the eZ Cash wallet
Figure 14: Axiata’s API Gateway supports a range of commerce and other services
Figure 15: Axiata’s vision of a consistent global platform for telco enablers
Figure 16: Apple Wallet is a repository for a growing array of digital collateral
Figure 17: Telekom Labs Has developed a prototype cross-platform wallet in HMTL5
Figure 18: Each piece of collateral could be represented by a digital card
Figure 19: A flexible framework supporting different transmission and security tech
Figure 20: Telekom Labs sees telcos as more trusted than other intermediaries

Baidu, Xiaomi & DJI: China’s Fast Growing Digital Disruptors

Introduction

The latest report in STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing analyses China’s leading digital disruptors and their likely impact outside their home country. The report explores whether the global leaders in digital commerce – Amazon, Apple, Facebook and Google – might soon face a serious challenge from a company built in China.

In our previous report, Alibaba & Tencent: China’s Digital Disruptors, we analysed China’s two largest digital ecosystems – Alibaba, which shares many similarities with Amazon, and Tencent, which is somewhat similar to Facebook. It explored the intensifying arms race between these two groups in China, their international ambitions and the support they might need from telcos and other digital players.

This executive briefing covers Baidu, China’s answer to Google and the anchor for a third digital ecosystem, and the fast-growing smartphone maker, Xiaomi, which has the potential to build a fourth major ecosystem. It also takes a close look at DJI, the world-leading drone manufacturer, which is well worth watching for its mid-to-long term potential to create another major ecosystem around consumer robotics.

Context: sizing up China’s disruptors

As U.S. companies have demonstrated time and time again, a large and dynamic domestic market can be a springboard to global dominance. Can China’s leading digital disruptors, which also benefit from a large and dynamic domestic market, also become major players on the global stage?

Alibaba, Tencent and Baidu, which run China’s leading digital ecosystems, have all developed in a digital economy that has been partially protected by cultural and linguistic characteristics, together with government policies and regulations. As a result, Google, Facebook and Amazon haven’t been able to replicate their global dominance in China. Of the big four global disruptors, only Apple can be said to be have a major presence in China.

Thanks to their strong position in China, Alibaba, Tencent and Baidu are among the leading Internet companies globally, as measured by market capitalisation (see Figure 2). As China’s economy slows (although it will still grow about 7% this year, according to government figures), many of China’s digital players are putting more focus on international growth. Alibaba & Tencent: China’s Digital Disruptors of this report outlined how Alibaba is gaining traction in other major middle income countries, notably Russia, whereas Tencent is trying, with limited success, to expand outside of China

Figure 2: China is home to four of the world’s most valuable publicly-listed Internet companies

Source: Source: Morgan Stanley, Capital IQ, Bloomberg via KPCB

Of the five companies covered in the two parts of this report, search specialist Baidu is the least international – its revenues are almost all generated in China and its services aren’t much used outside its home country. Innovative and fast growing handset maker Xiaomi is still heavily dependent on China, but is seeing strong sales in other developing markets. The most international of the three is DJI, the world’s leading drone maker, which is making major inroads into the U.S. and Western Europe – the heartland of Apple, Google, Amazon and Facebook.

As discussed in Alibaba & Tencent: China’s Digital Disruptors, international telcos, media companies and banks all have a strategic interest in encouraging more digital competition globally. Today, the big four U.S.-based disruptors dominate the digital economy in North America, Western Europe, Latin America and much of the developing world, limiting the mindshare and market share available to other players.

Many telcos are particularly concerned about Apple’s and Facebook’s ever-strengthening position in digital communications – a core telecoms service. They also fret about Google’s and Amazon’s power in digital commerce and content. On the basis that my enemy’s enemy is my friend, telcos might want to support Xiaomi’s challenge to Apple, while backing Tencent’s efforts to make messaging app WeChat an international service and Alibaba’s growing rivalry with Amazon (both aspects are covered in the previous report).

Introduction
Executive Summary
Context: sizing up China’s disruptors
Baidu – China’s low cost Google
Why Baidu is important
Baidu’s business models
How big an impact will Baidu have outside China?
Threats to Baidu
Xiaomi – Apple without the margins?
Why Xiaomi is important
Business model
Xiaomi’s likely International impact
Threats to Xiaomi
DJI – more than a flight of fancy
Why DJI is important
DJI’s business model
Threats to DJI
Conclusions and implications for telcos
Baidu, Xiaomi and DJI could all build major ecosystems
Implications for telcos and other digital players

Figure 1: Baidu is significantly smaller than Tencent, Alibaba and Facebook
Figure 2: China is home to four of the world’s most valuable publically-listed Internet companies
Figure 3: Baidu is in the world’s top 15 media owners
Figure 4: Baidu is one of the world’s leading app developers
Figure 5: Baidu’s clean and uncluttered home page resembles that of Google
Figure 6: Baidu is beginning to monetise its millions of mobile users
Figure 7: IQiyi has broken into the top ten iOS apps worldwide
Figure 8: 2014 was a banner year for Baidu’s top line
Figure 9: Mobile now generates almost 50% of Baidu’s revenues
Figure 10: Baidu says its mobile browser is popular in Indonesia
Figure 11: Xiaomi is a rising star in the smartphone market
Figure 12: The slimline Mi Note has won plaudits for its design
Figure 13: The $15 Mi Band: A lot of technology for not a lot of money
Figure 14: One of Ninebot’s products – an electric unicycle
Figure 15: Xiaomi is turning its MIUI into a digital commerce platform
Figure 16: Xiaomi even has fan sites in markets where its handsets aren’t readily available
Figure 17: Drones’ primary job today is aerial photography
Figure 18: DJI majors on ease-of-use
Figure 18: DJI claims its Inspire One can transmit video pictures over 2km
Figure 20: DJI’s Go app delivers a real-time video feed to a smartphone or tablet
Figure 21: Baidu’s frugal innovation

Alibaba & Tencent: China’s Digital Disruptors (Part 1)

Introduction

The latest report in STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing is the first part of a two part report analysing China’s leading digital disruptors and their likely impact outside their home country. The report explores whether the global leaders in digital commerce – Amazon, Apple, Facebook and Google – might soon face a serious challenge from a company built in China.

Part 1 analyses China’s two largest digital ecosystems – Alibaba, which shares many similarities with Amazon, and Tencent, which is somewhat similar to Facebook. This executive briefing considers the intensifying arms race between these two groups in China, their international ambitions and the support they might need from telcos and other digital players.

Both Alibaba and Tencent are potential competitors for telcos in some markets and potential partners in others. For example, like Amazon, Alibaba has a fast growing cloud computing business. (STL recently analysed why Amazon Web Services is so much more successful than many telcos’ cloud offerings, see: Amazon Web Services: Colossal, but Invincible?).

Like Facebook, Tencent has become a leading provider of digital communications in direct competition with telcos’ voice and messaging services. STL explored how telcos could respond to the rise and rise of Facebook in our recent report: Facebook: Telcos’ New Best Friend?

Part 2 of our report on China’s digital disruptors will cover Baidu, China’s answer to Google and the anchor for a third digital ecosystem, and the fast-growing smartphone maker, Xiaomi, which has the potential to build a fourth major ecosystem. Part 2 will also take a close look at DJI, the drone manufacturer, which is well worth watching for its mid-to-long term potential to create another major ecosystem.

Sizing up China’s disruptors

When it comes to disruption, China is a special case. Offering an enormous domestic market largely insulated by regulation, this vast country is proving to be fertile ground for Internet companies that may ultimately be able to mount a credible challenge to the big four globally – Amazon, Apple, Facebook and Google.

These four U.S.-based disruptors have used the scale and talent available in their home market to become leading digital commerce players globally, limiting the mindshare and market share available to other players. Moreover, Apple and Facebook, in particular, are carving out a strong position in digital communications, challenging telcos’ traditional dominance of this sector.

Greater competition among the Internet ecosystems would be in the strategic interests of many telcos, media companies and banks, as they seek to shore up their revenues and relevance. To that end, they could selectively encourage digital commerce and content companies that have gained sufficient scale in China to go global and compete with the U.S. giants.

In an ideal world, there might be a dozen or so major Internet ecosystems competing for a share of the worldwide digital commerce market. That would put individual telcos and other specialist players in the digital ecosystem, such as banks and media companies, in a stronger negotiating position, potentially enabling them to capture more of the value being created in the fast growing digital economy. For example, if Tencent were to mount a serious challenge to Facebook, telcos could potentially earn a commission for promoting one service over the other. Telcos could preload Facebook’s WhatsApp messaging service or Tencent’s WeChat on the handsets they distribute or they might zero-rate access (not charge for data traffic) to either service in their markets.

Similarly, if Baidu could build effective international search and content services in competition with Google, the latter may have to pay higher commission to companies that supply it with traffic. If Google faced more competition in the digital advertising market, media companies’ sites may have to pay less commission to advertising brokers. In the smartphone market, if Xiaomi were to weaken Apple’s grip on the high-end, telcos’ might be able to negotiate better margins for distributing Apple’s handsets or enabling iPhone users to temporarily subscribe to their networks when travelling abroad.

Greater incentives to expand outside China

China’s economy is on course to grow about 7% this year, according to government figures, down from the double-digit growth at the turn of the decade. As a result, its leading disruptors are increasingly treading on each other’s toes in China and have a greater incentive to expand internationally. Although the obvious move for China’s domestic Internet companies it to initially target Greater China, nearby Asian markets and the Chinese diaspora, some have much broader ambitions. Alibaba, in particular, has significant traction in other major middle income countries, notably Russia. And the world’s leading drone maker DJI is making major inroads into the U.S. and Western Europe – the heartland of Apple, Google, Amazon and Facebook.

Today, there are three major Internet ecosystems in China, headed by Alibaba, Tencent and Baidu respectively. Globally, these three players are in the top ten public Internet companies in terms of market capitalisation (see Figure 1). Moreover, Tencent has forged an alliance with JD.com, the fourth largest publicly-listed Chinese Internet company.

The first part of this report covers Alibaba and Tencent, asking whether either company is strong enough to pose a serious threat to Amazon, Facebook or Google on the global stage.

Figure 1: China is home to four of the world’s most valuable publicly-listed Internet companies

Source: Morgan Stanley, Capital IQ, Bloomberg via KPCB

Alibaba – digital commerce behemoth

Whereas most consumers in Western Europe and North America have heard of Amazon.com, many might associate Alibaba with folklore, rather than digital commerce. Yet Alibaba Group Holding Ltd. claims to be the world’s largest online and mobile commerce company in terms of gross merchandise volume (the value in US dollars of the products and services sold through its marketplaces). Although it is incorporated in the Cayman Islands, the Alibaba Group’s principal executive offices are in Hangzhou in China.

Founded in 1999 by its charismatic, combative and somewhat unpredictable executive chairman Jack Ma, Alibaba undertook the world’s largest initial public offering in September 2014. It raised USD 25 billion, which it has used to fund an ongoing acquisition spree.

Why Alibaba is important

With a market capitalisation comparable to that of Amazon and Facebook, investors clearly believe Alibaba is set to be a major player in the global economy. That belief is fuelled by the fact that Alibaba:

Runs several world-leading digital marketplaces
Is growing fast at home and abroad
Is assembling a major digital entertainment portfolio
Has acquired dozens of promising Internet companies
Is affiliated with one of China’s leading online payment services

Introduction
Executive Summary
Sizing up China’s disruptors
Alibaba – digital commerce behemoth
Why Alibaba is important
Alibaba’s business models
Likely impact outside China
Threats facing Alibaba
Tencent – a playbook for Facebook?
Why Tencent is important
Tencent’s business models
Tencent’s likely impact outside China
Threats to Tencent
Conclusions and implications for telcos
Alibaba and Tencent are very strong companies…
… but they both need strategic partners
Implications for telcos
STL Partners and Telco 2.0: Change the Game

Figure 1: China is home to four of the world’s most valuable publicly-listed Internet companies
Figure 2: Alibaba’s six major digital marketplaces
Figure 3: Alibaba has seen heady growth this decade
Figure 4: One of Alibaba’s recent investments was in MomentCam
Figure 5: Alipay helps Chinese consumers buy from overseas merchants
Figure 6: AliExpress sells a wide range of Chinese goods to the world
Figure 7: Alibaba’s UC Browser is widely used on Android smartphones
Figure 8: Comparing Alibaba and Amazon R&D over time
Figure 9: Alibaba’s mobile sales are rising rapidly
Figure 10: Almost half of Alibaba’s revenues are now generated by mobile services
Figure 11: Alibaba’s overall monetisation rate is slipping
Figure 12: Tencent runs three of the top five OTT communications services
Figure 13: Tencent claims leadership in digital content in China
Figure 14: Tencent sometimes leads Facebook
Figure 15: Tencent’s investment and partnership strategy
Figure 16: Tencent’s five years of fast growth
Figure 17: Tencent remains heavily reliant on online gaming revenues
Figure 18: Some of the use cases targeted by Tencent’s online payment portfolio
Figure 19: Tencent’s Red Envelope promotion was hugely successful
Figure 20: Both Alibaba and Tencent have seen strong growth in net income

Telco-Driven Disruption: What NTT DOCOMO, KT and Globe got right

Preface

The latest report in STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing is the second in a two-part series exploring the role of telcos in disrupting the digital economy. Across the two parts, STL has analysed a variety of disruptive moves by telcos, some long-standing and well established, others relatively new.

Part 2 builds on the analysis in Part 1, which considered telcos’ attempts to reinvent digital commerce in South Korea and Japan, the startling success of mobile money services in east Africa, BT’s huge outlay on sports content, AT&T’s multi-faceted smart home platform, Deutsche Telekom’s investments in online marketplaces and Orange’s innovative Libon communications service.

Part 2 takes a close look at NTT DOCOMO, Japan’s leading mobile operator, which has built up a major revenue stream from new businesses. Many of these new businesses are focused on enabling what DOCOMO refers to as a Smart Life. Revenues from its Smart Life suite of businesses, which provide consumers with advice, information, security, cloud storage and other lifestyle services, rose 22% to 421 billion yen (US$3.5 billion) in the year ending March 2015.

Part 2 also considers how South Korea’s incumbent telco KT used its high-speed broadband infrastructure to disrupt, but ultimately strengthen, its media business, which delivers IPTV to approaching six million households. This report also examines how Globe Telecom has carved out a significant position in the Philippines’ financial services market by enabling people to send each other money using text messages over a decade of patient experimentation. It also explains why the leading U.K. and U.S. mobile operators have struggled to disrupt the digital commerce market with their Weve and Softcard joint ventures.

Finally, Part 2 considers U.S. telco Verizon’s major push into cloud services, after spending US$1.4 billion to acquire specialist Terremark in 2011.

In each case, this briefing describes the underlying strategy, the implementation and the results, before setting out STL’s key takeaways. The conclusions section outlines the lessons other would-be disruptors can learn from telcos’ attempts to move into new markets and develop new value propositions.

Note, this report is not exhaustive. The examples it covers are intended to be representative. Some of these companies and their strategies are covered in other STL Partners reports, including:

The Telco 2.0 Transformation Index Benchmarking Report (also covers Verizon)
Apple Pay & Weve Fail: A Wake Up Call (also covers Weve joint venture)
Digital Commerce 2.0: New $50bn Disruptive Opportunities for Telcos, Banks and Technology Players (also covers NTT DOCOMO)
How AT&T overtook Verizon in strategic business services (also covers Verizon)

Introduction: Telcos Can and do disrupt

In the digital economy, start-ups and major Internet platforms, such as Alibaba, Apple, Facebook, Google, Spotify and Tencent QQ, are generally considered to be the main agents of disruption. Start-ups tend to apply digital technologies in innovative new ways, while the major Internet platforms use their economies of scale and scope to disrupt markets and established businesses. These moves sometimes involve the deployment of new business models that can fundamentally change the modus operandi of entire industries, such as music, publishing and video gaming.

Figure 1: Representative examples of disruptive plays driven by telcos

Source: STL Partners

Offensive, major financial impact category

A classic disruptive play is to use existing assets and customer relationships to move into an adjacent market, open up a new revenue stream and build a major business. This is what Apple did with the iPhone and what Amazon did with cloud services. Several telcos have also followed this playbook. This section looks at two examples – NTT DOCOMO’s Smart Life services and Globe Telecom’s GCash – and what other companies in the digital economy can learn from these relatively successful moves. Unlike many disruptive moves by telcos, the two businesses covered in this section have had a significant impact in the targeted market. They have also moved the needle for their parent’s telcos and given their investors greater confidence in their ability to innovate.

NTT DOCOMO’s Smart Life proposition

Japan’s telecoms market was one of the first in the world to go ex-growth and its telcos have been searching for new sources of revenue for the best part of a decade. The market leader, NTT DOCOMO, has also been hit by an aggressive campaign by the third largest player, Softbank, to win market share. DOCOMO has seen its revenues from telecoms services decline every year since 2006, giving its efforts to expand into adjacent markets, such as entertainment, commerce and financial services, a real sense of urgency. In particular, DOCOMO has tried hard to get closer to consumers by developing a sophisticated and multi-faceted “smart life” proposition.

Strategy

Rather than focusing simply on providing connectivity and fading into the background, DOCOMO is trying to maintain a close relationship with Japanese consumers. Its strategy is centred on using the data collected by its network to anticipate customers’ needs and provide them with tailored and timely propositions. In November 2011, DOCOMO set out a medium-term strategy (for the years up to and including 2015) called Shaping a smart life, which it positioned it as an interim step to realising its longer-term, corporate vision for 2020: Pursuing smart innovation: HEART (see Figure 2). This report looks, in particular, at the ‘T’ in the Heart strategy – DOCOMO’s bid to win consumers’ trust and clearly differentiate itself from other providers of digital services.

One of the central tenets of DOCOMO’s strategy is that individuals want the support of a “personal life agent” – an automated personal assistant that can make useful suggestions and recommendations. DOCOMO envisaged that this assistant would use the information collected by smartphones and wearable devices to perform various tasks, including making recommendations and even automatic ticket reservations.

In other words, DOCOMO was one of the first companies in the world to anticipate the market for personal digital assistants, which is now a key arena in the ongoing battle between Google, Apple and Microsoft, which have launched Google Now, Siri and Cortana respectively.

DOCOMO originally positioned its smart life proposition as part of a broader range of cloud services that would enable it to generate new sources of value. Back in 2011, DOCOMO pledged to create:

A personal cloud – a platform underpinning a wide range of services for consumers.
A business cloud – a solutions platform for the provision of new business styles
A network cloud – a platform that adds value through sophisticated information and communication processing performed on the network.

Figure 2: The smart life strategy NTT DOCOMO set out in 2011

Source: NTT DOCOMO, Medium-Term Vision, November 2011

Implementation

DOCOMO has set about strengthening and expanding its existing digital commerce business to build closer relationships with both consumers and the third party businesses supplying the services and content consumers want. To that end, Japan’s largest telco set itself goals to expand the number of content providers supporting its dmenu portal (a long-standing portal offering original content) from 700 in March 2012 to 3,000 in March 2016, while boosting the number of monthly users of its dmarket, which provides a broader range of digital content, to 20 million by March 2016, up from 1.5 million in March 2012. To that end, DOCOMO has expanded dmarket into new areas, such as fashion, travel and even food deliveries, effectively transforming dmarket in an e-commerce portal, as well as a content portal (see Figure 3).

Figure 3: DOCOMO has significantly expanded the services offered by dmarket

Source: NTT DOCOMO investor presentation, April 2014

Beyond dmarket, DOCOMO has also deployed a raft of other value added services, encompassing navigation, local information, NFC-based wallet and information services, credit card and carrier-billing-based payments, translation apps, health and wellness services, insurance and even pet and child tracking. DOCOMO also provides an i-concier service, which is designed to help people with daily organisation, as well as delivering offers and information from brands the user is interested in. For example, i-concier can be configured to give you a reminder when you arrive in a specific location. Confusingly, DOCOMO has also rolled out a separate service, called Shabette-Concier, which enables customers to talk Siri-style to “their smartphone about things you want to know or do, and your smartphone will display the best answers to your queries on the screen.” In other words, DOCOMO is offering many similar services and functionality to the major Internet players, such as Apple and Google.

DOCOMO was also quick to realise the importance of enabling individuals to use a single ID across multiple devices, while positioning the smartphone as an authentication platform in everyday life in both the physical world and online world. This kind of persistent identification across multiple devices and networks will help DOCOMO collect the information it needs to make personalised recommendations. At the same time, various DOCOMO services encourage consumers to volunteer information about themselves. DOCOMO also provides secure storage of personal data, an important step towards a personal cloud service (see Figure 4) along the lines of that outlined by STL Partners in the report: Digital Commerce 2.0: New $50bn Disruptive Opportunities for Telcos, Banks and Technology Players. While this approach is broadly similar to that pursued by the major Internet companies, DOCOMO’s marketing places a lot of emphasis on safety, security and peace of mind, implying it is different from the more ‘cavalier’ Internet companies – Google and Facebook’s business models are predicated on encouraging consumers to share personal information, so they tend not to highlight the need for safe and secure storage for that information.

Figure 4: DOCOMO’s personal cloud aims to offer consumers secure data storage, persistent ID and personalised recommendations

Source: NTT DOCOMO, Medium-Term Vision, November 2011

Next section: DOCOMO Results Analysis…

Preface
Executive Summary
Introduction: Telcos can and do disrupt
Offensive, major financial impact
NTT DOCOMO’s Smart Life proposition
Globe Telecom’s GCash
Offensive, limited financial impact
Verizon Cloud
The Weve joint venture
The Softcard joint venture
Defensive, major financial impact
KT’s media business
Conclusions

Figure 1: Representative examples of disruptive plays driven by telcos
Figure 2: The smart life strategy NTT DOCOMO set out in 2011
Figure 3: DOCOMO has significantly expanded the services offered by dmarket
Figure 4: DOCOMO’s personal cloud aims to offer consumers secure data storage, persistent ID and personalised recommendations
Figure 5: The Smart Life businesses are growing, but not quite fast enough yet
Figure 6: DOCOMO hopes its Smart Life business will lift group profits this year
Figure 7: The Smart Life businesses now generate 15% of DOCOMO’s ARPU
Figure 8: In 2011 DOCOMO saw digital commerce and content as key opportunities
Figure 9: The value of transactions through the dmarket has grown rapidly
Figure 10: Subscriber growth at dmarket stalled in the first half of 2014
Figure 11: TV-on-demand is the most popular of the dmarket services
Figure 12: NTT DOCOMO is putting more emphasis on providing enablers
Figure 13: DOCOMO’s confusing portfolio of money services
Figure 14: The GCash App has improved its user interface
Figure 15: GCash appears to be narrowly ahead of rival services
Figure 16: Facebook leads the OTT communications market in the Philippines
Figure 17: Verizon’s Global Enterprise revenues continue to fall
Figure 18: Weve originally planned to used transactional data to improve marketing
Figure 19: The Isis Wallet could be used to store and browse offers
Figure 20: KT is successfully managing the transition to IPTV
Figure 21: KT’s media revenue has climbed to 6% of total revenues

Telco-Driven Disruption: Hits & Misses (Part 1)

Introduction

Part of STL’s new Dealing with Disruption in Communications, Content and Commerce stream, this executive briefing explores the role of telcos in disrupting the digital economy. It analyses a variety of disruptive moves by telcos, some long-standing and well established, others relatively new. It covers telcos’ attempts to reinvent digital commerce in South Korea and Japan, the startling success of mobile money services in east Africa, BT’s huge outlay on sports content, AT&T’s multi-faceted smart home platform, Deutsche Telekom’s investments in online marketplaces and Orange’s innovative Libon communications service.

Note, this report is not exhaustive. The examples it covers are intended to be representative. Part 2 of this report will analyse other telcos who have successfully disrupted adjacent markets or created new ones. In particular, it will take a close look at NTT DOCOMO, Japan’s leading mobile operator, which has built up a major revenue stream from new businesses. DOCOMO reported a 13% year-on-year increase in revenues from its new businesses in the six months to September 30th 2014 to 363 billion Japanese yen (more than US$3 billion). Its target for the full financial year is 770 billion yen (almost US$6.5 billion). Revenues from its Smart Life suite of businesses, which provide consumers with advice, information, security, cloud storage and other lifestyle services, rose 18% to 205 billion yen in the six months to September 30th 2014, while its dmarket content store now has 7.8 million subscribers. In the six months to September 30th, the total value of dmarket transactions rose 30% year-on-year to 34.6 billion yen.

In South Korea, leading telco KT is trying to use smartphone-based apps and services to disrupt the digital commerce market, as are the leading U.K. and U.S. mobile operators through their respective Weve and Softcard joint ventures. In the Philippines, Smart Communications and Globe Telecom have recast the financial services market by enabling people to send each other money using text messages.

Several major telcos are seeking to use their network infrastructure to change the game in the cloud services market. For example, U.S. telco Verizon has made a major push into cloud services, spending US$1.4 billion to acquire specialist Terremark in 2011. At the same time, Verizon and AT&T are having to respond to an aggressive play by T-Mobile USA to reshape the U.S. telecoms market with its Un-carrier strategy.

Some of these companies and their strategies are covered in other STL Partners reports, including:

The Telco 2.0 Transformation Index Benchmarking Report (covers Verizon)
Apple Pay & Weve Fail: A Wake Up Call (covers Weve joint venture)
Free-T-Mobile: Disruptive Revolution or a Bridge Too Far? (covers T-Mobile USA)
Digital Commerce 2.0: New $50bn Disruptive Opportunities for Telcos, Banks and Technology Players (covers NTT DOCOMO)

Telcos can and do disrupt

In the digital economy, innovative start-ups, such as Spotify, Twitter, Instagram and the four big Internet platforms (Amazon, Apple, Facebook and Google) are generally considered to be the main agents of disruption. Start-ups tend to apply digital technologies in innovative new ways, while the major Internet platforms use their economies of scale and scope to disrupt markets and established businesses. These moves sometimes involve the deployment of new business models that can fundamentally change the modus operandi of entire industries, such as music, publishing and video gaming.

Although established telcos have generally been cautious about pursuing disruption, several have succeeded in creating entirely new value propositions, effectively disrupting either their core business or adjacent industry sectors. In some cases, disruptive moves by telcos have primarily been defensive in that their main objective is to reduce churn in the core business. In other cases, telcos have gone on the offensive, moving into new markets in search of new revenues (see Figure 1).

Figure 1: Representative examples of disruptive plays driven by telcos

Source: STL Partners

The next section of this paper explores the disruptive moves in the top right hand corner of Figure 1 – those that have taken telcos into new markets and have had a significant financial impact on their businesses.

Offensive, major financial impact

A classic disruptive play is to use existing assets and customer relationships to move into an adjacent market, open up a new revenue stream and build a major business. This is what Apple did with the iPhone and what Amazon did with cloud services. Several telcos have also followed this playbook. This section looks at three examples – SK Telecom’s SK Planet, Safaricom’s M-Pesa and KDDI’s au Smart Pass – and what other companies in the digital economy can learn from these largely successful moves. Unlike many disruptive moves by telcos, the three businesses covered in this section have had sufficient impact to properly register on investors’ radar screens. They have moved the needle for their parent’s telcos and given their investors confidence in their ability to innovate.

SK Planet – an ambitious mobile commerce play

Owned by SK Telecom, SK Planet is a major broker in South Korea’s world-leading mobile commerce market. It has developed several two-sided online services that are similar in some respects to those offered by Google. SK Planet operates the T Map, a turn-by-turn navigation service, the T Store Android app store, the Smart Wallet payment, loyalty and couponing service, the OK Cashbag loyalty marketing programme and the 11th St online marketplace.

Strategy

Taking advantage of South Koreans’ appetite for new technologies, SK Telecom is using its home market as a test bed for mobile commerce solutions that could be deployed more widely. As well as seeking to generate revenues from enabling payments, advertising, loyalty, couponing and other forms of direct marketing in South Korea, it is aiming to become a leading mobile commerce player in other markets in Asia and North America.

SK Telecom’s approach has been to launch services early and then refine these services in response to feedback from the Korean market. It launched a mobile couponing service, for example, as early as 2008. To reduce the impact of corporate bureaucracy, in 2011, SK Telecom placed its digital commerce activities into a separate company, called SK Planet. The new entity has since focused on the development of a two-sided platform that aims to provide consumers with convenient shopping channels and merchants and brands with a wide range of marketing solutions both online and in the bricks and mortar arena. Although its services are over-the-top, in the sense that they don’t require consumers to use SK Telecom, SK Planet continues to work closely with SK Telecom – its sole owner.

Downstream, SK Planet is trying to differentiate itself by putting consumers’ interests first, giving them considerable control and transparency over the digital marketing they receive. Upstream, SK Planet is putting a lot of emphasis on helping traditional bricks and mortars stores go digital and reverse so-called showrooming, so that consumers research products online, but actually buy them from bricks and mortar retailers.

SK Planet CEO Jinwoo So talks about enabling “Next Commerce” by which he means the seamless integration of online and bricks and mortar commerce. “Just as Amazon became the global leader in e-commerce by revolutionizing the industry, SK Planet aims to become the global ‘Next Commerce’ leader in the offline market by driving mobile innovation that will eventually break down the walls which separate the online and offline worlds,” he says.

Estimating the offline commerce market in South Korea is worth 230 trillion won (more than 210 US billion dollars), SK Planet is aggressively adapting its existing digital commerce platforms, which are underpinned by SK Telecom’s network assets, for mobile commerce. It is also making extensive use of the big data generated by its existing platforms to hone its offerings.

At the 2014 Mobile World Congress, SK Planet CEO Jinwoo So outlined how SK Planet has worked closely with SK Telecom to develop algorithms that use customer data to predict churn and provide personalized recommendations and offers. “We combined the traditional data mining with text mining,” he said. “How people create the search criteria or the sites they visit, we came up with a very unique formula, which gives up much two times better performance than before. … In 11th street, we have achieved almost three times better performance by applying our recommendation engine, which we developed. Now we are trying to prove the ROI for marketing budgets for brands and merchants.”

Introduction
Executive Summary
Telcos can and do disrupt
Offensive, major financial impact (Strategy, Implementation, Results)
SK Planet – an ambitious mobile commerce play
M-Pesa – reinventing financial services
KDDI au Smart Pass – curating online commerce
Offensive, limited financial impact (Strategy, Implementation, Results)
Deutsche Telekom’s start-stop Scout 24 investments
AT&T Digital Life – slow burn for the smart home
Defensive, major financial impact (Strategy, Implementation, Results)
BT Sport and BT Wi-Fi – High perceived value
Defensive, minor financial impact (Strategy, Implementation, Results)
Orange Libon – disrupting the disruptors
Conclusions
STL Partners and Telco 2.0: Change the Game

Figure 1: Representative examples of disruptive plays driven by telcos
Figure 2: SK Planet’s Syrup Wallet stores loyalty cards, coupons and payment cards
Figure 3: Shopkick enables US retailers to interact with customers in store
Figure 4: SK Planet is an increasingly important part of SK Telecom’s business
Figure 5: The flywheel effect: how upstream partners can increase relevance
Figure 6: M-Pesa continues to grow in Kenya seven years after launch
Figure 7: Vodacom Tanzania has made it easy to register for M-Pesa
Figure 8: KDDI’s revenues and profits from value added services grow steadily
Figure 9: au Smart Pass is bolstering KDDI’s ARPU
Figure 10: Immobilienscout24 has seen a steady increase in traffic
Figure 11: AT&T Digital Life gives consumers remote control over their homes
Figure 12: Investors value BT Sport’s contribution
Figure 13: BT Sport has driven broadband net-adds, but at considerable expense
Figure 14: Orange’s multi-faceted positioning of Libon in the App Store

Google’s Big, Big Data Battle

The challenges to Google’s core business

Although Google is the world’s leading search engine by some distance, its pre-eminence is more fragile than its first appears. As Google likes to remind anti-trust authorities, its competitors are just a click away. And its primary competitors are some of the most powerful and well-financed companies in the world – Apple, Amazon, Facebook and Microsoft. As these companies, as well as specialist service providers, accumulate more and more data on consumers, Google’s position as the leading broker of online advertising is under threat in several, inter-related, ways:

Google’s margins are being squeezed, as competition intensifies. Increasingly experienced web users are using specialist search engines, such as Amazon (shopping), Expedia (travel) and moneysupermarket.com (financial services), or going direct to the sites they need, thereby circumventing Google’s search engine and the advertising brokered by Google. This trend is exacerbated by Google’s ongoing lockout from the vast amount of content being generated by Facebook’s social network. As the Internet matures, general-purpose web search may become yesterday’s business.
The rise of the app-based Internet: As consumers increasingly access the Internet via mobile devices, they are making greater use of apps and less use of browsers and, by extension, conventional search engines. Apps are popular on mobile devices because they are designed to take the consumer straight to the content they are looking for, rather than requiring them to navigate around the web using small and fiddly on-screen keyboards. Moreover, Apple, the leading provider of smartphones and tablets to the affluent, is seeking to relegate, and where feasible, remove, Google’s apps and services in its ecosystem.
Android forks: Android, an extraordinarily successful ‘Trojan Horse’ for Google’s apps and services, is the market leading operating system for mobile devices, but Google’s control of Android is patchy. Some device makers are integrating their own apps into a forked variant of this open-source platform. Amazon and Nokia are among those who have stripped Google’s search, maps, mail and store apps from their variants of the Android operating system, reducing the data that Google can gather on their customers. At the same time, Samsung, the world’s largest handset vendor, is straining at Google’s Android leash.
Quality dilution: As Google is the world’s dominant search engine, it is the prime target for so-called content farms that produce large volumes of low quality content in an effort to rank highly in Google’s search results and thereby attract traffic and advertising.
Regulatory scrutiny: Despite a February 2014 settlement with the European Commission concerning its search practices, Google remains in the regulatory spotlight. Competition authorities across the world continue to fret about Google’s market power and its ability to influence what people look at on the Internet.

1. Google’s margin squeeze

Price deflation

Google, the company that facilitated massive deflation across advertising, content, e-commerce, and mobile operating systems, is itself suffering from the deflationary environment of the Internet. Although revenue and net income are still growing, margins are shrinking (see Figure 2). Google is still growing because it is adding volume. However, there is strong evidence that its pricing power is being eroded.

Figure 2: Google margins are steadily falling as volumes continue to rise

Source: Google filings

To put this in the context of its Silicon Valley peers, Figure 3 shows the same data for Google, Facebook, and Apple using a trend line covering the 2009 to 2013 period for each company. Note, that we have used a log scale to compare three companies of very different size. Apple saw growth in both revenue and operating margins until 2013, when it hit a difficult patch, although a big product launch might fix that at any time. Facebook has grown revenues enormously, but went through a traumatic 2012 as the shift to mobile hit it. While all this drama went on, Google has grown steadily, while seeing its margins eroded.

Figure 3: Google’s operating margins are now below those of Apple and Facebook

Source: SEC filings

What are the factors behind Google’s declining operating margin? We believe the main drivers are:

The amount Google can charge per click is falling – buyers get more ads per buck.
The cost of acquiring ad inventory is increasing.

Cheaper ads

As Figure 4 shows, Google continues to drive ad volume (paid clicks), but ad rates (cost per click) are falling steadily. The average cost-per-click on Google websites and Google Network Members’ websites decreased approximately 8% from 2012 to 2013. We think this is primarily due to intensifying competition, particularly from Facebook. However, Google attributes the decline to “various factors, such as the introduction of new products as well as changes in property mix, platform mix and geographical mix, and the general strengthening of the U.S. dollar compared to certain foreign currencies.” The second quarter of 2014 saw paid clicks rise 2% quarter-on-quarter, while the cost per click was flat.

Figure 4: The cost per click is declining in lockstep with rising volume

Source: Google filings

Introduction
Executive Summary
The challenges to Google’s core business
1. Google’s margin squeeze
2. The rising importance of mobile apps
3. Android forks
4. Quality dilution
5. Regulatory scrutiny
Google’s strategy – get on the front foot
Google Now – turning search on its head
Reactive search becomes more proactive
Voice input
Anticipating wearables, connected cars and the Internet of Things
Searching inside apps
Evaluating Google Now
1. The marketplace
2. Develop compelling service offerings
3. The value network
4. Technology
5. Finance – the high-level business model

Figure 1: How Google is neutralising threats and pursuing opportunities
Figure 2: Google margins are steadily falling as volumes continue to rise
Figure 3: Google’s operating mar gins are now below those of Apple and Facebook
Figure 4: The cost per click is declining in lockstep with rising volume
Figure 5: Rising distribution costs are driving Google’s TAC upwards
Figure 6: Google’s revenues are increasingly coming from in-house sites and apps
Figure 7: R&D is the fastest-growing ad-acquisition cost in absolute terms
Figure 8: Daily active users of Facebook generating content out of Google’s reach
Figure 9: Google is still the most popular destination on the Internet
Figure 10: In the U.S., usage of desktop web sites is falling
Figure 11: Google’s declining share of mobile search advertising in the U.S.
Figure 12: Google’s lead on the mobile web is narrower than on the desktop web
Figure 13: Top smartphone apps in the U.S. by average unique monthly users
Figure 14: For Google, its removal from the default iOS Maps app is a major blow
Figure 15: On Android, Google owns four of the five most used apps in the U.S.
Figure 16: The resources Google needs to devote to web spam are rising over time
Figure 17: Google, now genuinely global.
Figure 18: A gap in the market: Timely proactive recommendations
Figure 19: Google’s search engine is becoming proactive
Figure 20: The ongoing evolution of Google Search into a proactive, recommendations service
Figure 21: The Telco 2.0 Business Model Framework
Figure 22: Amazon Local asks you to set preferences
Figure 23: Google Now’s cards and the information they use
Figure 24: Android dominates the global smartphone market
Figure 25: Samsung has about 30% of the global smartphone market
Figure 26: Google – not quite the complete Internet company
Figure 27: Google’s strategic response

Introduction

Apple’s evolving strategy

Introduction

Introduction

Introduction

The enduring value of connected assets

Market intelligence for Komatsu

Value added services for customers

Introduction

The global e-commerce market

Introduction

Google’s strategic headache

Telcos and the entertainment opportunity

Telcos and the entertainment opportunity

Roles in the online entertainment value chain

Introduction

Communications and commerce: two sides of the same coin

Markets have always combined commerce and conversations

Conversations help build trust

Conversations can drive commerce

Convenient customer service

Messaging has consumers’ attention

Objectives, methods and strategic rationale

AT&T’s Architecture – a technical summary

Figure 1: How the Central Office Re-architected as a Datacenter project works

What’s the benefit?

Introduction

Telcos’ role in digital commerce

In emerging markets, telcos increasingly enable commerce

In developed markets, fragmentation persists

Figure 1: The new Apple Wallet can hold a wide range of digital commerce collateral

Figure 2: Amazon Dash button supports one-touch ordering of a specific product

Telcos could make a big difference

Introduction

Context: sizing up China’s disruptors

Introduction

Sizing up China’s disruptors

Greater incentives to expand outside China

Alibaba – digital commerce behemoth

Why Alibaba is important

Preface

Introduction: Telcos Can and do disrupt

Offensive, major financial impact category

NTT DOCOMO’s Smart Life proposition

Strategy

Implementation

Next section: DOCOMO Results Analysis…

Introduction

Telcos can and do disrupt

Figure 1: Representative examples of disruptive plays driven by telcos

Offensive, major financial impact

SK Planet – an ambitious mobile commerce play

Strategy

The challenges to Google’s core business

1. Google’s margin squeeze

Price deflation

Figure 2: Google margins are steadily falling as volumes continue to rise

Figure 3: Google’s operating margins are now below those of Apple and Facebook

Cheaper ads

Figure 4: The cost per click is declining in lockstep with rising volume

Sample Reports