What is ‘Repremiumization’?

Promoted as a viable strategy recently at STL Partners’ Senior Executive Strategy Seminar in London…

Last week STL Partners held an event for senior strategists, marketers, and digital unit leaders across Europe.  The event was attended by 24 executives from 13 operators and 5 executives from Cisco, Intel and CSG International.  All except a handful of people held senior positions within the European telecoms industry – they were not junior staff but instrumental in shaping the thinking at some of the leading European operators.

The event covered several strategic issues facing the European and, in many cases, wider global telecoms industry including:

1. What will the structure of the European market look like in 2020?  STL Partners presented four scenarios and asked attendees to vote on the most likely scenario as well as facilitating discussions.  The scenarios will be presented in a report published this month (June 2015), Reading the Crystal Ball: The European Telecoms market in 2020.
2. Where and how should operators build value in the digital ecosystem?  STL Partners presented the case for four strategic options for operators to compete (we will cover these in a forthcoming report in July 2015, Four strategic pathways to Telco 2.0:
   • Piper:  An infrastructure-led, network-oriented strategy focused on moving bits and bytes efficiently and effectively while leaving service development and delivery to other players.  Accept that Telco 2.0 equates to speedy and smart data pipes and focus on cost leadership now.
   • Content: Couple infrastructure capabilities with content distribution (especially video).  Explore options that range from sophisticated content delivery networks all the way to content creation either via commissioning (Netflix model) or exclusive rights.
   • Enterprise:  Accept that differentiation in the consumer segment is impossible but that operators have the skills and relationships to build an expanded role in the large and growing Enterprise ICT market.
   • Authentication: Building digital services has proved challenging for operators but authentication potentially presents a real opportunity to establish a new digital ‘control point’ for operators from which a viable services strategy –for B2B2C enablers and end-user services – can be established.
3. Winning approaches to building scaled telecoms digital initiatives.  Operators from Europe and beyond presented case studies on their digital activities – focusing on what had worked well and what less well – and attendees discussed the merits and demerits of different approaches.

It was in the second session on how to build value in future that the notion of ‘repremiumization’ was articulated (although nobody used this term). In essence, participants from at least two Tier 1 telcos felt that STL Partners’ description of the Piper strategy as one of competing hard in a commodity market – a market characterised by lack of differentiation in services – was wrong and that in future they would be able to ‘reframe the value of the network in the minds of consumers’ by differentiating against other players based on network quality. This differentiation would enable them to attract premium prices and grow ARPUs. The well-trodden path of ‘network APIs’ were cited as a key way of driving additional volumes (and revenue) through a premium-quality network.

Indeed, attendees were so insistent that this ‘repremiumization’ strategy was viable that when STL Partners asked attendees to vote on the four strategic options (2.1-2.4 above), they asked for it to be added as a fifth option which we have termed ‘Premium Piper’ in Figure 1 below. The chart reflecting the votes of attendees, below, is interesting for a number of reasons:

• Nearly two-thirds of attendees felt that a ‘Pipe’ strategy of some sort was the best for European operators.  In other words, competing in the services layer was regarded as extremely challenging by many.   This, one suspects, is due to the challenges European operators have had in launching digital services having pursued the strategy late (from 2009 onwards after the market for core voice, messaging and data services had already peaked) and, in most cases, in a half-hearted fashion.
• Exactly half of those that selected a ‘Pipe’ strategy felt that STL Partners’ Piper was the better approach and the focus should be building great pipes while striving for cost leadership.  The other half felt that a ‘Premium Piper’ strategy was more attractive and that differentiation could be achieve on a sustainable basis through network quality.
• Those that did support a Europe-wide digital services (non-Piper) strategy were quite evenly split between Content, Enterprise and Authentication (with one person selecting ‘Other’) suggesting that a single non-Piper strategy for the whole European telecoms market is not obvious. (NB We presented the Service Options as single choices rather than ‘do all’ in order to crystallise the debate at the event.)

Figure 1: Where should the European telecoms industry place its bets for future success?

Source: STL Partners Senior Executive Strategy Seminar, June 11th 2015, n=28

…and put forward by a leading strategy house

The notion of a superior network resulting in superior revenues and returns is one that has, for example, been put forward in a paper by Bain and Company’s European office – the argument is set out here and can be summarised thus:

1. Operators have chosen to compete on price and have thus ‘trained’ consumers to make price the main criteria for choosing an operator.
2. As prices have fallen, consumers have started to think of operators as mere providers of connectivity and networks as a commodity.
3. The focus on price has led to lower returns on investment in Europe and, consequently, less network investment.
4. Fortunately, there are markets (including the US) where customers pay a premium for great connectivity because they appreciate how important the network is to their digital lifestyle.
5. Therefore, operators must educate customers about how important their networks are and invest in them to realise a price premium as illustrated by this chart:

Figure 2: ARPU levels of 7 customer segments with and without better network services and digital ‘life experience’ offers

Source: http://www.bain.com/publications/articles/repremiumization-the-way-up-for-europes-telcos.aspx

6. NFV and SDN will be key drivers of premium networks by enabling operators to, for example, dynamically increase speed or bandwidth.
7. Unlike the past when tier 2 competitors have easily been able to copy market leaders network improvements and so have commoditised the network, market leaders can now use their scale and marketing skills to establish a ‘perceptual shift’ in consumers.
8. There must be cross-functional developments at operators to deliver on the new ‘premium product’ market promise.

Why is repremiumization 100% hogwash?

STL Partners is convinced that repremiumization is wrong.

Let’s explain why.

The repremiumization argument simply does not stand up to scrutiny

Here is our challenge to the 8 point argument outlined above for repremiumization.

1. Operators have not chosen to compete on price.  In fact, they have spent significant efforts trying to build and market differentiated brands and services.  Going all the way back to 2002, mobile operators were building digital lifestyle offerings under brands such as Vizzavi, Vodafone Live!, Orange Dot, Genie, and so forth.  Attempts to build differentiated services and brands that would enable them to attract more customers and/or achieve premium prices has been the main focus of marketing departments at every operator in Europe since they started out.
2. The attempts to differentiate have largely failed despite operators’ best efforts.  The fact that operators are seen as ‘merely providing connectivity’ is  illustrative of this failure and they have been forced, rather than chosen, to compete on price – falling prices are a product of a failed differentiation strategy that…
3. …has indeed resulted in gradually lower returns on investment as ‘excess profits’ have been competed away – something that happens in most markets and particularly in ones where there is healthy competition and differentiation is difficult to achieve – think commodities, utilities…
4. There are several reasons why customers pay premium for services in some markets.  These include:
   • Market structure: a consolidated market with a high Herfindahl Index (an economists’ measure of market competitiveness) will tend to have higher prices than fragmented markets with a low Herfindahl Index as one or two large operators are able to exert pricing power.
   • Higher growth markets tend to have higher prices because operators do not need to compete so hard to grow.  Winning customers is easier as new customers take the product for the first time.  Conversely, saturated markets tend to display greater price pressure as operators are forced to drop prices to retain or win customers.
   • Regulation.  In some markets the regulator creates a benign environment for operators by, for example, blocking VOIP which reduces the degree of substitution for traditional telephony.  Markets like this again tend to ‘enjoy’ premium pricing.The US market, cited by Bain, has enjoyed all three benefits compared with Europe. It has 4 mobile operators serving 300m subscribers (with two very large players in AT&T and Verizon and two much smaller ones in T-Mobile and Sprint) compared with 50+ in Europe serving a similar number of customers in total and with most individual European markets having more balanced and, therefore, competitive market shares. Mobile took off later in the US than Europe so the market has continued to grow over recent years while Europe has stalled. The FCC has, until recently, been relatively benign towards telcos despite the hoo-ha over the last 10 years’ around ‘network neutrality’. The European regulator has, by contrast, been pretty harsh on telecoms operators and, among several measures, mandated fixed and mobile price decreases and effectively abolished voice and data roaming charges.What is interesting now is that prices in the US are in freefall. The US price premium is rapidly on its way out. The reason for this is more aggressive behaviour from T-Mobile and Sprint combined with lack of underlying market growth (the market has peaked) and a less supportive regulator. Repremiumization has been tried by Verizon and by AT&T but it simply will not work if competitors charge significantly less for a satisfactory data service.
5. The Bain chart does indeed suggest that price premium is possible in telecoms but this is for services not for bandwidth, prioritisation, and other network capabilities.  ‘Better network offers’ suggest a negligible ARPU uplift so it would be a much better in point 6 to argue that…
6. …NFV and SDN will enable operators to cut operating expenses and capex and, potentially, speed up the delivery of new services.  Yes, dynamically adapting the network to support services may enable service differentiation for some segments but the value will be associated with the service itself not the network delivering it so the ability for operators to differentiate solely via the characteristics of the network will be minimal.
7. Challengers cannot beat market leaders in terms of perceptions of quality? Huh?  Are you serious?  Why?  What is different now?  Tier 1 operators have always enjoyed scale and marketing spend advantages.  If they have failed to differentiate their networks and brands in the past, then a ‘repremiumization’ marketing message won’t make the slightest difference.
8. We agree(!) that operators need cross-functional developments at operators to deliver new propositions and transform the core of their businesses.

Better networks are a source of advantage for operators by enabling cost leadership

3UK’s value-for-money strategy…

STL Partners does believe that operators with a network advantage do enjoy a competitive advantage.  3 in the UK illustrates this point nicely. It has gone from being a joke among consumers between 2003 and around 2010 owing to poor handsets and network quality, to being the network of choice for, as Bain’s survey puts it, the ‘Digitally Powered’. Indeed it heavily markets its network based on its quality:

‘Big-boned’ ‘Designed for the Internet’  ‘More capacity than any other’

 

The message is that the 3 network is bigger, faster and better than rivals.  So is this an example of differentiation and price premium based on network quality?

No.

3UK’s network, being younger than its peers, is more efficient – the company has a 3G and 4G network only and is not hamstrung by the expensive and complex patchwork of 2G networks that Vodafone, O2 and EE (T-Mobile and Orange) have to manage.  This cost advantage has been further increased by an outsourcing strategy that has been in force for at least a decade – 3 was the first UK operator to outsource its network as well as most product development and management functions.

An efficient network has enabled 3UK to focus on offering better value than its peers to consumers. Its strategy of connecting over 90% of its base stations with fibre backhaul rather than microwave and its dubious ‘advantage ‘of having lots of spectrum for each subscriber compared with other players (owing to its historical low market share) also means that it is not capacity-constrained. Because it is has a lower cost base and lots of excess capacity, it can offer more data and speed for the same price as peers and still make more money than them.

This is not differentiation based on network capabilities – APIs, dynamically delivered bandwidth, etc. but simply a cost advantage that means that 3UK can deliver data more efficiently than others enabling it to offer better value to consumers and so pull away from its peers in terms of volume and margin growth (see Figure 3). It is interesting to note that 3UK is, like the cost-leader Free in France and Play in Poland, a late entrant not a big Tier 1 incumbent at all – quite the reverse of the argument put forward in Bain’s paper.