AI on the Smartphone: What telcos should do

Introduction

Following huge advances in machine learning and the falling cost of cloud storage over the last several years, artificial intelligence (AI) technologies are now affordable and accessible to almost any company. The next stage of the AI race is bringing neural networks to mobile devices. This will radically change the way people use smartphones, as voice assistants morph into proactive virtual assistants and augmented reality is integrated into everyday activities, in turn changing the way smartphones use telecoms networks.

Besides implications for data traffic, easy access to machine learning through APIs and software development kits gives telcos an opportunity to improve their smartphone apps, communications services, entertainment and financial services, by customising offers to individual customer preferences.

The leading consumer-facing AI developers – Google, Apple, Facebook and Amazon – are in an arms race to attract developers and partners to their platforms, in order to further refine their algorithms with more data on user behaviours. There may be opportunities for telcos to share their data with one of these players to develop better AI models, but any partnership must be carefully weighed, as all four AI players are eyeing up communications as a valuable addition to their arsenal.

In this report we explore how Google, Apple, Facebook and Amazon are adapting their AI models for smartphones, how this will change usage patterns and consumer expectations, and what this means for telcos. It is the first in a series of reports exploring what AI means for telcos and how they can leverage it to improve their services, network operations and customer experience.

Contents:

Executive Summary
Smartphones are the key to more personalised services
Implications for telcos
Introduction
Defining artificial intelligence
Moving AI from the cloud to smartphones
Why move AI to the smartphone?
How to move AI to the smartphone?
How much machine learning can smartphones really handle?
Our smartphones ‘know’ a lot about us
Smartphone sensors and the data they mine
What services will all this data power?
The privacy question – balancing on-device and the cloud
SWOT Analysis: Google, Apple, Facebook and Amazon
Implications for telcos

Figures:

Figure 1: How smartphones can use and improve AI models
Figure 2: Explaining artificial intelligence terminology
Figure 3: How machine learning algorithms see images
Figure 4: How smartphones can use and improve AI models
Figure 5: Google Translate works in real-time through smartphone cameras
Figure 6: Google Lens in action
Figure 7: AR applications of Facebook’s image segmentation technology
Figure 8: Comparison of the leading voice assistants
Figure 9: Explanation of Federated Learning

Sense check: Can data growth save telco revenues?

Introduction

A recent STL Partners report – Which operator growth strategies will remain viable in 2017 and beyond? – looked at the growth strategies of 68 operator groups, and identified eight different growth strategies employed over this sample. The eighth strategy was to expect mobile data growth to start to reverse the decline in revenues once the decline in voice and messaging revenues is complete. In the previous report, we argued that data revenue growth would not rapidly counterbalance the losses of voice and messaging due to the forces outlined in Figure 2 below:

Figure 2: Trust in the increasing value of (and spend in) broadband data

Source: STL Partners

In that report, we showed a number of examples, including NTT Docomo in Japan, which has been experiencing voice and messaging declines for the longest period of telcos we are aware of, and the UK market, which is competitive with relatively good availability of market data (See Figure 3):

Figure 3: STL Partners can find no evidence of long term revenue growth driven by increased mobile broadband demand in mature markets (outside duopolies)

Source: Company accounts, STL Partners

Despite the clarity of our own convictions on this matter, we are aware that some telcos are growing their revenues, and also that a minority of our clients (perhaps one in ten based on a number of informal surveys we have run in workshops etc.) believe that data could start to regrow the market in certain conditions.

Given how attractive this idea is to the industry, and how difficult and lengthy the path of transformation and creating digital services is proving for telcos, we decided that it would be useful to revisit our assertions, to dig deeper to see what signs of growth we could find and what might be learned from them. This report contains our findings from this further analysis.

Background: The telco ‘hunger gap’

This decline is not a new story, and STL Partners has been warning about this phenomenon and the need for business model change since 2006.

Back in 2013, STL Partners estimated that digital business would need to represent 25+% of Telco revenue by 2020 to avoid long-term industry decline. However, to date we have not taken the view that data revenues will to grow enough to make up for the decline in traditional services, meaning that “hunger gap” will not be filled this way (see Figure 4).

Figure 4: The telco ‘hunger gap’ between the decline in traditional and data revenues

Source: STL Partners

However, making the transition to new business models is challenging for telcos, who have traditionally relied on an infrastructure-based business model. Digital businesses are very different, and the astronomical growth in demand for mobile data services over the past decade is placing severe strain on networks and resources.

We have argued that telcos now need to make a fundamental shift from their traditional infrastructure-based business model to a complex amalgam of infrastructure, platform, and product innovation businesses.

Alternatively, growing data would be an innately attractive prospect for the telecoms industry. It would not require all the hard work, risk, change and investment of transformation. Hard-pressed executives would love nothing better than the ‘do little’ strategy to work out. It’s an idea that can easily find traction and supporters.

But is it a realistic prospect to grow data revenues faster than voice and messaging are shrinking?

To sense-check our original assertion that data will not grow overall revenues, this report takes a new look at the available evidence. We picked six different telcos appearing to exhibit representative or outlier strategies to see whether there may currently be grounds to change our view that data revenue growth will not grow the overall telecoms market.

Content:

Executive Summary
Introduction
Background: the telco ‘hunger gap’
Methodology
Review of global trends in data growth
The explosion in mobile data growth
The link between data consumption and ARPU
The rise of 4G
Data tariff bundles increase in volume
Mobile data offloading
Multiplay bundling and the fixed network advantage
International data roaming
Zero rating and net neutrality
Case studies – different data strategies
Four data growth strategies
The traditional growth model
The disruptor/challenger model
The innovator model
The OTT proposition
Case studies comparison: Investment vs risk in summary
Case study: Innovator: DNA (Finland)
Case study: Disruptor/Innovator: T-Mobile US
Case study: Super-disruptor: Reliance Jio (India)
Case study: Disruptor: Free (France)
Case study: Traditional/Innovator: Vodafone UK
Case study: Traditional: Cosmote (Greece)
Conclusions
Case studies comparison: Investment vs risk in summary
Telcos need to seek fresh business models
Network investment will need to be even more intelligently targeted than with 3G/4G
New growth opportunities are emerging
A little thoughtful innovation goes a long way
Recommendations

Figures:

Figure 1: Trust in the increasing value of (and spend) in broadband data
Figure 2: Trust in the increasing value of (and spend) in broadband data
Figure 3: STL Partners can find no evidence of long-term revenue growth driven by increased mobile broadband demand in mature markets (outside duopolies)
Figure 4: The telco “hunger gap” between the decline in traditional and data revenues
Figure 5: Cisco global data growth 2016-2021
Figure 6: Total estimated UK mobile retail revenues
Figure 7: SMS and MMS sent in the UK, 2007-2015
Figure 8: Selected telco data growth strategies
Figure 9: Analysis of mobile operator growth strategies
Figure 10: DNA revenues and churn 2012-2016
Figure 11: DNA mobile data growth 2010-2016
Figure 12: DNA mobile data growth forecast
Figure 13: USA average monthly data use, 2010-2015
Figure 14: Deutsche Telekom non-voice % of ARPU, 2009-2016
Figure 15: T-Mobile US total revenues and non-voice ARPU, 2009-2016
Figure 16: Reliance Jio subscription growth
Figure 17: Free Mobile 4G subscriptions and 4G data, 2015-2016
Figure 18: Iliad Free revenue growth 2012-2016
Figure 19: France average mobile data use per SIM, 2009-2015
Figure 20: France mobile value added service revenues, 2009-2015
Figure 21: Vodafone UK data use and total mobile ARPU, 2011-2016
Figure 22: UK mobile retail ARPU, 2010-2016
Figure 23: UK estimated mobile retail revenues, 2010-2015
Figure 24: Vodafone UK total mobile revenue 2013-2016
Figure 25: Greece data use and total mobile revenues

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

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

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)

Five Principles for Disruptive Strategy

Introduction

Disruption has become a popular theme, and there are some excellent studies and theories, notably the work of Clayton Christensen on disruptive innovation.

This briefing is intended to add some of our observations, ideas and analysis from looking at disruptive forces in play in the telecoms market and the adjacent areas of commerce and content that have had and will have significant consequences for telecoms.

Our analysis centres on the concept of a business model: a relatively simple structure that can be used to describe and analyse a business and its strategy holistically. The structure we typically use is shown below in Figure 1, and comprises 5 key domains: The Marketplace; Service Offering; Value Network; Finance; and Technology.

Figure 1 – A business model is the commercial architecture of a business: how it makes money

Source: STL Partners

This structure is well suited to analysis of disruption, because disruptive competition is generally a case of conflict between companies with different business models, rather than competition between similarly configured businesses.

A disruptive competitor, such as Facebook for telecoms operators, may be in a completely different core business (advertising and marketing services) seeking to further that business model by disrupting an existing telecoms service (voice and messaging communications). Or it may be a broadly similar player, such as Free in France whose primary business is recognisably telecoms, using a radically different operational model to gain share from direct competitors.

We will look at some of these examples in more depth in this report, and also call on analysis of Google, Apple, Facebook and Amazon to illustrate principles

Digital value is often transient

KPN: a brief case study in disruption

KPN, a mobile operator in the Netherlands, started to report a gradual reduction in SMS / user statistics in early 2011, after a long period of near continuous growth.

Figure 2 – KPN’s SMS stats per user started to change at the end of 2010

Source: STL Partners, Mobile World Database

KPN linked this change to the rapid rise of the use of WhatsApp, a so-called over-the-top (OTT) messaging application it had noticed among ‘advanced users’ – a set of younger Android customers, as shown in Figure 3.

Figure 3 – WhatsApp took off in certain segments at the end of 2010

Source: KPN Corporate Briefing, May 2011

There was some debate at the time about the causality of the link, but the longer term picture of use and app penetration certainly supports the connection between the rise of WhatsApp take-up among KPN’s broader base (as opposed to ‘advanced users’ in Figure 3) and the rapid decline of SMS volumes as Figure 4 shows.

Figure 4 – KPN’s SMS volumes have continued to decline since 2010

Source: STL Partners estimates, Mobile World, Telecomspaper, Statista, Comscore, KPN.

How did that happen then?

KPN’s position was particularly suited to a disruptive attack by WhatsApp (and other messaging apps) in the Netherlands because:

It had relatively high unit prices per SMS.
KPN had not ‘bundled’ many SMSs into its packages compared to other operators, and usage was very much ‘pay as you go’ – so using WhatsApp offered immediate savings to users.
Its market of c.17 million people is technologically savvy with high early smartphone penetration, and densely populated for such a wealthy country, so well suited to the rapid viral growth of such apps.

KPN responded by increasing the number of SMSs in bundles and attempting to ‘sell up’ users to packages with bigger bundles. It has also embarked on more recent programmes of cost reduction and simplification. But as far as SMS was concerned, the ‘horse had bolted the stable’ and the decline continues as consumers gravitate away from a service perceived as losing relevance and value.

We will look in more depth at disruptive pricing and product design strategies in the section on ‘Free is not enough, nor is it the real issue’ later in this report. This case study also presents another challenge for strategists: why did the company not act sooner and more effectively?

Denial is not a good defence

One might be forgiven for thinking that the impact of WhatsApp on KPN was all a big surprise. And perhaps to some it was. But there were plenty of people that expected significant erosion of core revenues from such disruption. In a survey we conducted in 2011, the average forecast among 300 senior global telecoms execs was that OTT services would lead to a 38% decline in SMS over the next 3-5 years, and earlier surveys had shown similar pessimism.

Having said that, it is also true that there was some shock in the market at the time over KPN’s results, and subsequent findings in other markets in Latin America and elsewhere. It is only recently that it has become more of an accepted ‘norm’ in the industry that its core revenues are subject to attack and decline.

Perhaps the best narrative explanation is one of ‘corporate denial’, akin to the human process of grief. Before we reach acceptance of a loss, individuals (and consequently teams and organisations by this theory) go through various stages of emotional response before reaching ‘acceptance’ – a series of stages sometimes characterised as ‘denial, anger, negotiation and acceptance’. This takes time, and is generally considered healthy for people’s emotional health, if not necessarily organisations’ commercial wellbeing.

So what can be done about this? It’s hard to change nature, but it is possible to recognise circumstances and prepare forward plans differently. In the digital era, leaders, strategists, marketers, and product managers need to recognise that profit pools are increasingly transient, and if you are skilful or lucky enough to have one in your portfolio, it is critical to anticipate that someone is probably working on how to disrupt it, and to gather and act quickly on intelligence on realistic threats. There are also steps that can be taken to improve defensive positions against disruption, and we look at some of these in this report. It isn’t always possible because sometimes the start point is not ideal – but then again, part of the art is to avoid that position.

Executive Summary: five principles
Introduction
Digital value is often transient
KPN: a brief case study in disruption
How did that happen then?
Denial is not a good defence
Timing a disruptive move is critical
Disruption visibly destroys value
So when should strategists choose disruption?
Free is not enough, nor is it the real issue
How market winners meet needs better
How to compete with ‘free’?
Build the platform, feed the flywheel
Nurture the ecosystem
…don’t price it to death

Figure 1 – A business model is the commercial architecture of a business: how it makes money
Figure 2 – KPN’s SMS stats per user started to change at the end of 2010
Figure 3 – WhatsApp took off in certain segments at the end of 2010
Figure 4 – KPN’s SMS volumes have continued to decline since 2010
Figure 5 – Free’s disruptive play is destroying value in the French Market, Q1 2012-Q3 2014
Figure 6 – Verizon is winning in the US – but most players are still growing too, Q1 2011-Q1 2014
Figure 7 – How ‘OTT’ apps meet certain needs better than core telco services
Figure 8 – US and Spain: different approaches to disruptive defence
Figure 9 – The Amazon platform ‘flywheel’ of success

Telco 1.0: Death Slide Starts in Europe

Telefonica results confirm that global telecoms revenue decline is on the way

Very weak Q1 2014 results from Telefonica and other European players

Telefonica’s efforts to transition to a new Telco 2.0 business model are well-regarded at STL Partners. The company, together with SingTel, topped our recent Telco 2.0 Transformation Index which explored six major Communication Service Providers (AT&T, Verizon, Telefonica, SingTel, Vodafone and Ooredoo) in depth to determine their relative strengths and weaknesses and provide specific recommendations for them, their partners and the industry overall.

But Telefonica’s Q1 2014 results were even worse than recent ones from two other European players, Deutsche Telekom and Orange, which both posted revenue declines of 4%. Telefonica’s Group revenue came in at €12.2 billion which was down 12% on Q1 2013. Part of this was a result of the disposal of the Czech subsidiary and weaker currencies in Latin America, in which around 50% of revenue is generated. Nevertheless, the negative trend for Telefonica and other European players is clear.

As the first chart in Figure 1 shows, Telefonica’s revenues have followed a gentle parabola over the last eight years. They rose from 2006 to 2010, reaching a peak in Q4 of that year, before declining steadily to leave the company in Q1 2014 back where it started in Q1 2006.

The second chart, however, adds more insight. It shows the year-on-year percentage growth or decline in revenue for each quarter. It is clear that between 2006 and 2008 revenue growth was already slowing down and, following the 2008 economic crisis in which Spain (which generates around quarter of Telefonica’s revenue) was hit particularly hard, the company’s revenue declined in 2009. The economic recovery that followed enabled Telefonica to report growth again in 2010 and 2011 before the underlying structural challenges of the telecoms industry – the decline of voice and messaging – kicked in, resulting in revenue decline since 2012.

Figure 1: Telefonica’s growth and decline over the last 8 years

Telco 2.0 Telefonica Group Revenue

Source: Telefonica, STL Partners analysis

One thing is clear: the only way is down for most CSPs and for the industry overall

The biggest concern for Telefonica and something that STL Partners believes will be replicated in other CSPs over the next few years is the accelerating nature of the decline since the peak. It seems clear that Telco 1.0 revenues are not going to decline in a steady fashion but, once they reach a tipping point, to tumble away quickly as:

Substitute voice and messaging products and alternate forms of communication scale;
CSPs fight hard to maintain customers, revenue and share in voice, messaging and data products, via attractive bundles

The results of the European CSPs confirms STL Partners belief that the outlook for the global industry in the next few years is negative overall. It is clear that telecoms industry maturity is at different stages globally:

Europe: in decline
US: still growing but very close to the peak
Africa, Middle East, Latin America: slowing growth but still 2(?) years before peak
Asia: mixed, some markets growing, others in decline

Given these different mixes, STL Partners reaffirms its forecast of 2012 that overall the industry will contract by up to 10% between 2013 and 2017 as core Telco 1.0 service revenue decline accelerates once more and more countries get beyond the peak. This is illustrated for the mobile industry in Figure 2, below.

Figure 2: Near-term global telecoms decline is assured; longer-term growth is dependent on management actions now

Global mobile telcoms revenue

Source: STL Partners

Upturn in telecoms industry fortunes after 2016 dependent on current activities

If the downturn to 2016 is a virtual certainty, the shape of the recovery beyond this, which STL Partners (tentatively) forecasts, is not. The industry’s fortunes could be much better or worse than the forecast owing to the importance of transformation activities which all players (CSPs, Network Equipment Providers, IT players, etc.) need to make now.

The growth of what we have termed Human Data (personal data for consumers and business customers, including some aspects of Enterprise Mobility), Non-Human Data (connection of devices and applications – Internet of Things, Machine2Machine, Infrastructure as a Service, and some Enterprise Mobility) and Digital Services (end-user and B2B2X enabling applications and services) requires CSPs and their partners to develop new skills, assets, partnerships, customer relationships and operating and financial models – a new business model.

As IBM found in moving from being hardware manufacturer to a services player during the 1990’s, transforming the business model is hard. IBM was very close to bankruptcy in the early 90’s before disrupting itself and re-emerging as a dominant force again in recent years. CSPs and NEPs, in particular, are now seeking to do the same and must act decisively from 2013-2016 if they are to enjoy a rebirth rather than continued and sustained decline.

Facebook + WhatsApp + Voice: So What?

Introduction

In 2010, we predicted in our analysis Facebook: Moving into Telco Space? that Facebook would inevitably decide to move further into the communications space in order to sustain and grow its valuation. In 2011 we published a major strategy report “Dealing with the ‘Disruptors’: Google, Apple, Facebook, Microsoft/Skype and Amazon”, which charted the complex and inter-related battles and relationships between the main internet giants of the western world. It showed how they’re disrupting numerous fields, including communications, commerce, marketing – and not least each other.

In 2014 we’re launching an extension of this research into an ongoing stream of analysis on the key players to help strategists and senior decision makers navigate these complex waters. As a precursor, Facebook’s acquisition of WhatsApp shows further aspects of, and lessons from this ongoing disruption.

Market Context: two ‘killer apps’

Facebook: constantly chasing the audience

Facebook has already had to re-engineer its business model since the traumatic (and predicted) flop of the IPO. Users flocked away to mobile, and Facebook had to redesign its primary user experience in order to cope. At the same time, the advertisers who are Facebook’s real customers lost interest in the brand-building display pages that were its key advertising product.

Facebook chased the audience, developing new advertising products to fit into the context of a mobile user experience. It worked: post-IPO Facebook has succeeded in getting revenue from its mobile advertising, so much so that it made $523m in net profits on revenue of $2.6bn in Q4. But it’s worth remembering that this represents Facebook concentrating on one very specific niche business: mobile apps discovery.

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In the last quarter, 53 per cent [1] of Facebook’s revenue, over $1bn, came from mobile ads. Mobile app downloads are becoming a very important segment of this. As Mark Zuckerberg said in the Q4 earnings call:

We’re finding that people also really want to buy a lot of app install ads, and that’s grown incredibly quickly and is one of the best parts of the ad work that we did over the last year

Sheryl Sandberg reiterated it later:

We are very excited about the mobile app space in general. If you look at our mobile app installation ads, we’ve really done a great job working with developers to help users discover and download their apps.

This is because app developers can expect to pay as little as $2 in advertising costs [2] for each install.

This is a significant change in the model. In Figure 1, the chart below, note especially that the mobile ads line of business starts immediately after the IPO in June, 2012, when ads in the News Feed were introduced, and accelerates further in early 2013, when mobile app ads were introduced.

Figure 1: Facebook’s rapidly growing mobile revenues

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This implies that revenue equivalent to roughly a quarter of app sales [1] through Apple’s iTunes App Store is going to Facebook just for ads, and much of it is advertising for apps. How long will Apple, whose app store it is, or Google, fundamentally an advertising business, put up with that before they launch something that competes?

The problem is summed up quite simply here:

“This exposes the strategic fallacy behind Facebook, which was the idea that there was going to be a monopoly on the social graph, and that Facebook was going to own it,” said Keith Rabois, a partner at venture capital firm Khosla Ventures. “That’s not true, and I don’t believe Facebook will constantly be able to buy its way out of this structural challenge.”

This pattern has been visible for a while. Rather than big multi-functional platforms, suddenly it seemed that leaner, focused, task-specific apps were in demand, notably Instagram, Snapchat, ask.fm, and Vine. It should come as no surprise that Unix-based iOS and Linux-based Android both seem to encourage app developers to do “one thing well” in the classic tradition of the core Unix/Linux utilities, with the unifying platform being the OS itself. So Facebook chased its audience again, buying Instagram.

Meanwhile, users sought out a new generation of mobile instant-messaging apps, which saw astonishingly fast growth and shocked the carrier industry with the hit to their SMS revenues. And Facebook has chased the audience again, with the WhatsApp acquisition.

WhatsApp: disrupting by doing one thing really well

WhatsApp’s user-base acceleration has been outstanding, as shown in Figure 2.

Figure 2: WhatsApp User Growth

Source: Facebook

Its usage stats are equally impressive (Figure 3), as are the comparisons between WhatsApp’s and Facebook’s user engagement (Figure 4)

Figure 3: Average monthly minutes of use by market

Source Mobidia May 2013

Figure 4: Average user screen time Facebook vs. WhatsApp (per month)

Source: Mobidia Q4 2012

WhatsApp is nothing if not a lean, focused, task-specific app that does one thing well. Its USP could be summarised as “instant messaging done right”. Its business model is simplicity itself, asking users for a dollar a year, rather than seeking advertisers or volume-billing. The simplicity, as with most simplicity, is founded on engineering excellence – WhatsApp holds the record for the most concurrent TCP sockets, 2 million, on a FreeBSD Unix server. It’s because they spent the time and money developing their highly customised fork of the open-source ejabberd XMPP server that they kept costs down to the level where their business model made sense. (There is much more information on WhatsApp technology in this High Scalability post.)

Across Europe, WhatsApp and the proliferation of other IM apps has dragged SMS pricing down until it has become a bundled, unlimited service. Vodafone, for example, bundles unlimited messaging with 1GB of data at its €29 price point.

While its appeal is not all about price, WhatsApp and other Over The Top (OTT) messaging apps capitalise on high priced markets, with much higher adoption in the markets with higher priced that we analysed in our recent Future Value of Voice and Messaging report (see Figure 5 below).

Figure 5: SMS Price vs. penetration of Top OSP Messaging Apps

Source: Onavo, Ofcom, CMT, BNETZA, TIA, KCC, Telco accounts, STL Partners

But, as we point out in the report, price is only part of the story. Price drove the acquisition of customers, but quality retained them. WhatsApp offers a searchable, conversation-based chat history and a one-tap voice messaging function; it remains shocking to this day that it took Apple to show SMS messages as threaded conversations like e-mail.

Executive Summary
Analysis: one plus one equals…?
$19bn: a lot of money …or is it really?
Two Fundamentally Different Social Models
What does Facebook want to do with WhatsApp?
Conclusions: disruptors of the world, unite…
Facebook, the hub for social apps that scale?
Telcos: victory is empty but there are lessons in defeat
So what for the rest of the digital ecosystem?
STL Partners and the Telco 2.0™ Initiative

Figure 1: Facebook’s rapidly growing mobile revenues
Figure 2: WhatsApp User Growth
Figure 3: Average monthly minutes of use by market
Figure 4: Average user screen time Facebook vs. WhatsApp (per month)
Figure 5: SMS Price vs. penetration of Top OSP Messaging Apps
Figure 6: Facebook’s share price March 2013 – February 2014
Figure 7: AT&T, Vodafone and Telefonica share prices Vs. Facebook
Figure 8: Voice and Messaging revenue scenarios

Call

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Cisco, Microsoft, Google, AT&T, Telefonica, et al: the disruptive battle for value in communications

Technology: Products and Vendors’ Approaches

There are many vendors and products in the voice/telephony arena. Some started as pure voice products or solutions like Cisco Call Manager, while others such as Microsoft Office 365 started as an office productivity suite, to which voice and presence became a natural extension, and then later a central part of the core product functionality. We have included details on RCS, however RCS is not globally available, and is limited in its functionality compared to some of the other products listed here.

Unified Communications

Unified Communications (UC) is not a standard; there are many different interpretations, but there is a general consensus about what it means – the unification of voice, video, messaging, presence, conferencing, and collaboration into a simple integrated user experience.

UC is an important technology for enterprise customers, it brings mobility and agility to an organisation, improves communication and collaboration, adds a social element, and lowers costs by reducing the need for office space and multiple disparate communications systems each with their own management and control systems. UC can be delivered as a cloud service and has the acronym UCaaS. Leading providers are Microsoft, Google, and Cisco. Other players include IBM, 8X8, and a number of other smaller vendors, as well as telco equipment manufacturers such as Ericsson. We have covered some of the leading solutions in this report, and there are definite opportunities for telcos to collaborate with these vendors, adding integration with core services such as telephony and mobile data, as well as customer support and billing.

There are several elements for an enterprise to consider when developing a UC solution for it to be successful:

Fixed voice functions and needs (including PBX) and integration into a UC solution
Mobile voice – billing, call routing, integration with fixed and UC solutions
Desktop and mobile video calling
Collaboration tools (conferencing, video conferencing, desktop integration, desktop sharing etc.)
Desktop integration – how does the solution integrate with core productivity tools (Microsoft Office, Google Apps, OpenOffice etc?)
PC and mobile clients – can a mobile user participate in a video conference, share files
Instant messaging and social integration
How the user is able to interact with the system and how intuitive it is to use. This is sometimes called the user experience and is probably the most important aspect, as a good user experience promotes efficiency and end user satisfaction

From the user perspective, it would be desirable for the solution to include the basic elements shown in Figure 1.

Figure 1: Basic user needs from Unified Communications
Voice Messaging Tech Cover

Source: STL Partners

Historically, Enterprise communications has been an area where telcos have been a supplier to the enterprise – delivering voice end points (E.164 phone numbers and mobile devices), voice termination, and outgoing voice and data services.

Organisational voice communications (i.e. internal calling) has been an area of strength for companies like Cisco, Avaya, Nortel and others that have delivered on-premise solutions which offer sophisticated voice and video services. These have grown over the years to provide Instant Messaging (IM), desktop collaboration tools, and presence capabilities. PC clients often replace fixed phones, adding functionality, and can be used when out of the office. What these systems have lacked is deep integration with desktop office suites such as Microsoft Office, Google Apps, and Lotus Notes. Plug-ins or other tools can be used to integrate presence and voice, but the user experience is usually a compromise as different vendors are involved.

The big software vendors have also been active, with Microsoft and IBM adding video and telephony features, and Google building telephony and conferencing into its growing portfolio. Microsoft also acquired Skype and has delivered on its promise to integrate Skype with Lync. Meanwhile, Google has made a number of acquisitions in the video and voice arena like ON2, Global IP Solutions, and Grand Central. The technology from ON2 allows video to be compressed and sent over an Internet connection. Google is pushing the products from ON2 to be integrated into one of the next major disruptors – WebRTC.

Microsoft began including voice capability with its release of Office Communications Server (OCS) in 2007. An OCS user could send instant messages, make a voice call, or place a video call to another OCS user or group of users. Presence was directly integrated with Outlook and a separate product – Office Live Meeting – was used to collaborate. Although OCS included some Private Branch eXchange (PBX) features, few enterprises regarded it as having enough features or capability to replace existing systems from the likes of Cisco. With Office 365, Microsoft stepped up the game, adding a new user interface, enhanced telephony features, integrated collaboration, and multiple methods of deployment using Microsoft’s cloud, on premise, and service provider deployments.

Technology: Products and Vendors’ Approaches
Unified Communications
Microsoft Office 365 – building on enterprise software strengths
Skype – the popular international behemoth
Cisco – the incumbent enterprise giant
Google – everything browser-based
WebRTC – a major disruptive opportunity
Rich Communication Service (RCS) – too little too late?
Broadsoft – neat web integration
Twilio – integrate voice and SMS into applications
Tropo – telephony integration technology leader
Voxeo – a pathfinder in integration
Hypervoice –make voice a native web object
Calltrunk – makes calls searchable
Operator Voice and Messaging Services
Section Summary
Telco Case Studies
Vodafone – 360, One Net and RED
Telefonica – Digital, Tu Me, Tu Go, BlueVia, Free Wi-Fi
AT&T – VoIP, UC, Tropo, Watson
Section Summary
STL Partners and the Telco 2.0™ Initiative

Figure 1: Basic user needs from Unified Communications
Figure 2: Microsoft Lync 2013 client
Figure 3: Microsoft Lync telephony integration options
Figure 4: International Telephone and Skype Traffic 2005-2012
Figure 5: The Skype effect on international traffic
Figure 6: Voice call charging in USA
Figure 7: Google Voice call charging in USA
Figure 8: Google Voice call charging in Europe
Figure 9: Google outbound call rates
Figure 10: Calliflower beta support for WebRTC
Figure 11: Active individual user base for WebRTC, millions
Figure 12: Battery life compared for different services
Figure 13: Vodafone One Net Express call routing
Figure 14: Vodafone One Net Business Call routing
Figure 15: Enterprise is a significant part of Vodafone group revenue
Figure 16: Vodafone Red Bundles
Figure 17: Telefonica: Market Positioning Map, Q4 2012
Figure 18: US market in transition towards greater competition
Figure 19: Voice ARPU at AT&T, fixed and mobile
Figure 20: Industry Value is Concentrated at the Interfaces
Figure 21: Telco 2.0™ ‘two-sided’ telecoms business model

Self-Disruption: How Sprint Blew It

Introduction

At the beginning of 2013, we issued an Executive Briefing on the proposed take-over of Sprint-Nextel by Softbank, which we believed to be the starting gun for disruption in the US mobile market.

At the time, not only was 68% of revenue in the US market controlled by the top two operators, AT&T and Verizon, it was also an unusually lucrative market in general, being both rich and high-spending (see Figure 1, taken from the The Future Value of Voice & Messaging strategy report). Further, the great majority of net-adds were concentrated among the top two operators, with T-Mobile USA flat-lining and Sprint beginning to lose subscribers. We expected Sprint to initiate a price war, following a plan similar to Softbank’s in Japan, separating the cost of devices from that of service, making sure to offer the hero smartphone of the day, and offering good value on data bundles.

Figure 1: The US, a rich country that spends heavily on telecoms

The US a rich country that spends heavily on telecoms feb 2014

Source: STL Partners

In the event, the fight for control of Sprint turned out to be more drawn out and complex than anyone expected. Add to this the complexity of Sprint’s major network upgrade, Network Vision, as shown in Figure 2, and the fact that the plans changed in order to take advantage of Softbank’s procurement of devices for the 2.5GHz band, and it is perhaps less surprising that we have yet to see a major strategic initiative from Sprint.

Figure 2: The Softbank deal brought with it major changes to Network Vision

Source: Sprint Q3 earnings report

Instead, T-Mobile USA implemented a very similar strategy, having completed the grieving process for the AT&T deal and secured investment from DTAG for their LTE roll-out and spectrum enhancements. So far, their “uncarrier” strategy has delivered impressive subscriber growth at the expense of slashing prices. The tale of 2013 in terms of subscribers can be seen in the following chart, updated from the original Sprint/Softbank note. (Note that AT&T, VZW, and T-Mobile have released data for calendar Q3, but Sprint hasn’t yet – the big question, going by the chart, will be whether T-Mobile has overtaken Sprint for cumulative net-adds.)

Figure 3: The duopoly marches on, T-Mobile recovers, Sprint in trouble

The duopoly marches on, T-Mobile recovers, Sprint in trouble Feb 2014

Source: STL Partners

However, Sprint did have a major strategic initiative in the last two years – and one that went badly wrong. We refer, of course, to the shutdown of the Nextel half of Sprint-Nextel.

Closing Nextel: The Optimistic Case

There is much that is good inside Sprint, which explains both why so much effort went into its “turnaround” and why Masayoshi Son was interested. For example, its performance in terms of ARPU is strong, to say the least. The following chart, Figure 4, illustrates the point. Total ARPU in post-paid, which is most of the business, is both high at just under $65/mo and rising steadily. ARPU in pre-paid is essentially flat around $25/mo. The problem was Nextel and specifically, Nextel post-paid – while pre-paid hovered around $35/mo, post-paid trended steadily down from $45/mo to parity with pre-paid by the end.

Figure 4: Sprint-Nextel ARPU

Sprint-Nextel ARPU feb 2014

Source: STL Partners

The difference between the two halves of Sprint that were doing the work here is fairly obvious. Nextel’s unique iDEN network was basically an orphan, without a development path beyond the equivalent of 2005-era WCDMA speeds, and without smartphones. Sprint CDMA, and later LTE, could offer wireless broadband and could offer the iPhone. Clearly, something had to be done. You can see the importance of smartphone adoption from the following graphic, Figure 5, showing that smartphones drove ARPU on Sprint’s CDMA network.

Figure 5: Sprint CDMA has reached 80% smartphone adoption

Source: STL Partners

It is true that smartphones create opportunities to substitute OTT voice and messaging, but this is less of a problem in the US. As the following chart from the Future Value of Voice and Messaging strategy report shows, voice and messaging are both cheap in the US, and people spend heavily on mobile data.

Figure 6: US mobile key indicators

US mobile key indicators feb 2014

Source: STL Partners

So far, the pull effect of better devices on data usage has helped Sprint grow revenues, while it also drew subscribers away from Nextel. Sprint’s strategy in response to this was to transition Nextel subscribers over to the mainline platform, and then shut down the network, while recycling savings and spectrum from the closure of Nextel into their LTE deployment.

Closing Nextel: The Scoreboard
Recapture
The Double Dippers
The Competition: AT&T Targets the Double Dippers
Developers, Developers, Devices
Conclusions

Figure 1: The US, a rich country that spends heavily on telecoms
Figure 2: The Softbank deal brought with it major changes to Network Vision
Figure 3: The duopoly marches on, T-Mobile recovers, Sprint in trouble
Figure 4: Sprint-Nextel ARPU
Figure 5: Sprint mainline has reached 80% smartphone adoption
Figure 6: US mobile key indicators
Figure 7: Tale of the tape – something goes wrong in early 2012
Figure 8: Sprint’s “recapture” rate was falling during 3 out of the 4 biggest quarters for Nextel subscriber losses, when it needed to be at its best
Figure 9: Nextel post-paid was 72% business customers in 3Q 2011
Figure 10: The loss of high-value SMB customers dragged Sprint’s revenues into negative territory
Figure 11: The way mobile applications development used to be

Communications Services: What now makes a winning value proposition?

Introduction

This is an extract of two sections of the latest Telco 2.0 Strategy Report The Future Value of Voice and Messaging for members of the premium Telco 2.0 Executive Briefing Service.

The full report:

Shows how telcos can slow the decline of voice and messaging revenues and build new communications services to maximise revenues and relevance with both consumer and enterprise customers.
Includes detailed forecasts for 9 markets, in which the total decline is forecast between -25% and -46% on a $375bn base between 2012 and 2018, giving telcos an $80bn opportunity to fight for.
Shows impacts and implications for other technology players including vendors and partners, and general lessons for competing with disruptive players in all markets.
Looks at the impact of so-called OTT competition, market trends and drivers, bundling strategies, operators developing their own Telco-OTT apps, advanced Enterprise Communications services, and the opportunities to exploit new standards such as RCS, WebRTC and VoLTE.

The Transition in User Behaviour

A global change in user behaviour

In November, 2012 we published European Mobile: The Future’s not Bright, it’s Brutal. Very soon after its publication, we issued an update in the light of results from Vodafone and Telefonica that suggested its predictions were being borne out much faster than we had expected.

Essentially, the macro-economic challenges faced by operators in southern Europe are catalysing the processes of change we identify in the industry more broadly.

This should not be seen as a “Club Med problem”. Vodafone reported a 2.7% drop in service revenue in the Netherlands, driven by customers reducing their out-of-bundle spending. This sensitivity and awareness of how close users are getting to their monthly bundle allowances is probably a good predictor of willingness to adopt new voice and messaging applications, i.e. if a user is regularly using more minutes or texts than are included in their service bundle, they will start to look for free or lower cost alternatives. KPN Mobile has already experienced a “WhatsApp shock” to its messaging revenues. Even in Vodafone Germany, voice revenues were down 6.1% and messaging 3.7%. Although enterprise and wholesale business were strong, prepaid lost enough revenue to leave the company only barely ahead. This suggests that the sizable low-wage segment of the German labour market is under macro-economic stress, and a shock is coming.

The problem is global, for example, at the 2013 Mobile World Congress, the CEO of KT Corp described voice revenues as “collapsing” and stated that as a result, revenues from their fixed operation had halved in two years. His counterpart at Turk Telekom asserted that “voice is dead”.

The combination of technological and macro-economic challenge results in disruptive, rather than linear change. For example, Spanish subscribers who adopt WhatsApp to substitute expensive operator messaging (and indeed voice) with relatively cheap data because they are struggling financially have no particular reason to return when the recovery eventually arrives.

Price is not the only issue

Also, it is worth noting that price is not the whole problem. Back at MWC 2013, the CEO of Viber, an OTT voice and messaging provider, claimed that the app has the highest penetration in Monaco, where over 94% of the population use Viber every day. Not only is Monaco somewhere not short of money, but it is also a market where the incumbent operator bundles unlimited SMS, though we feel that these statistics might slightly stretch the definition of population as there are many French subscribers using Monaco SIM cards. However, once adoption takes off it will be driven by social factors (the dynamics of innovation diffusion) and by competition on features.

Differential psychological and social advantages of communications media

The interaction styles and use cases of new voice and messaging apps that have been adopted by users are frequently quite different to the ones that have been imagined by telecoms operators. Between them, telcos have done little more than add mobility to telephony during the last 100 years, However, because of the Internet and growth of the smartphone, users now have many more ways to communicate and interact other than just calling one another.

SMS (only telcos’ second mass ‘hit’ product after voice) and MMS are “fire-and-forget” – messages are independent of each other, and transported on a store-and-forward basis. Most IM applications are either conversation-based, with messages being organised in threads, or else stream-based, with users releasing messages on a broadcast or publish-subscribe basis. They often also have a notion of groups, communities, or topics. In getting used to these and internalising their shortcuts, netiquette, and style, customers are becoming socialised into these applications, which will render the return of telcos as the messaging platform leaders with Rich Communication System (RCS) less and less likely. Figure 1 illustrates graphically some important psychological and social benefits of four different forms of communication.

Figure 1: Psychological and social advantages of voice, SMS, IM, and Social Media

Source: STL Partners

The different benefits can clearly be seen. Taking voice as an example, we can see that a voice call could be a private conversation, a conference call, or even part of a webinar. Typically, voice calls are 1 to 1, single instance, and with little presence information conveyed (engaged tone or voicemail to others). By their very nature, voice calls are real time and have a high time commitment along with the need to pay attention to the entire conversation. Whilst not as strong as video or face to face communication, a voice call can communicate high emotion and of course is audio.

SMS has very different advantages. The majority of SMS sent are typically private, 1 to 1 conversations, and are not thread based. They are not real time, have no presence information, and require low time commitment, because of this they typically have minimal attention needs and while it is possible to use a wide array of emoticons or smileys, they are not the same as voice or pictures. Even though some applications are starting to blur the line with voice memos, today SMS messaging is a visual experience.

Instant messaging, whether enterprise or consumer, offers a richer experience than SMS. It can include presence, it is often thread based, and can include pictures, audio, videos, and real time picture or video sharing. Social takes the communications experience a step further than IM, and many of the applications such as Facebook Messenger, LINE, KakaoTalk, and WhatsApp are exploiting the capabilities of these communications mechanisms to disrupt existing or traditional channels.

Voice calls, whether telephony or ‘OTT’, continue to possess their original benefits. But now, people are learning to use other forms of communication that better fit the psychological and social advantages that they seek in different contexts. We consider these changes to be permanent and ongoing shifts in customer behaviour towards more effective applications, and there will doubtless be more – which is both a threat and an opportunity for telcos and others.

The applicable model of how these shifts transpire is probably a Bass diffusion process, where innovators enter a market early and are followed by imitators as the mass majority. Subsequently, the innovators then migrate to a new technology or service, and the cycle continues.

One of the best predictors of churn is knowing a churner, and it is to be expected that users of WhatsApp, Vine, etc. will take their friends with them. Economic pain will both accelerate the diffusion process and also spread it deeper into the population, as we have seen in South Korea with KakaoTalk.

High-margin segments are more at risk

Generally, all these effects are concentrated and emphasised in the segments that are traditionally unusually profitable, as this is where users stand to gain most from the price arbitrage. A finding from European Mobile: The Future’s not Bright, it’s Brutal and borne out by the research carried out for this report is that prices in Southern Europe were historically high, offering better margins to operators than elsewhere in Europe. Similarly, international and roaming calls are preferentially affected – although international minutes of use continue to grow near their historic average rates, all of this and more accrues to Skype, Google, and others. Roaming, despite regulatory efforts, remains expensive and a target for disruptors. It is telling that Truphone, a subject of our 2008 voice report, has transitioned from being a company that competed with generic mobile voice to being one that targets roaming.

Consumers: enjoying the fragmentation
Enterprises: in search of integration
What now makes a winning value proposition?
The fall of telephony
Talk may be cheap, but time is not
The increasing importance of “presence”
The competition from Online Service Providers
Operators’ responses
Free telco & other low-cost voice providers
Meeting Enterprise customer needs
Re-imagining customer service
Telco attempts to meet changing needs
Voice Developers – new opportunities
Into the Hunger Gap
Summary: the changing telephony business model
Conclusions
STL Partners and the Telco 2.0™ Initiative

Figure 1: Psychological and social advantages of voice, SMS, IM, and Social Media
Figure 2: Ideal Enterprise mobile call routing scenario
Figure 3: Mobile Clients used to bypass high mobile call charges
Figure 4: Call Screening Options
Figure 5: Mobile device user context and data source
Figure 6: Typical business user modalities
Figure 7: OSPs are pursuing platform strategies
Figure 8: Subscriber growth of KakaoTalk
Figure 9: Average monthly minutes of use by market
Figure 10: Key features of Voice and Messaging platforms
Figure 11: Average user screen time Facebook vs. WhatsApp (per month)
Figure 12: Disruptive price competition also comes from operators
Figure 13: The hunger gap in music

The Future Value of Voice and Messaging

Background – ‘Voice and Messaging 2.0’

This is the latest report in our analysis of developments and strategies in the field of voice and messaging services over the past seven years. In 2007/8 we predicted the current decline in telco provided services in Voice & Messaging 2.0 “What to learn from – and how to compete with – Internet Communications Services”, further articulated strategic options in Dealing with the ‘Disruptors’: Google, Apple, Facebook, Microsoft/Skype and Amazon in 2011, and more recently published initial forecasts in European Mobile: The Future’s not Bright, it’s Brutal. We have also looked in depth at enterprise communications opportunities, for example in Enterprise Voice 2.0: Ecosystem, Species and Strategies, and trends in consumer behaviour, for example in The Digital Generation: Introducing the Participation Imperative Framework. For more on these reports and all of our other research on this subject please see here.

The New Report

This report provides an independent and holistic view of voice and messaging market, looking in detail at trends, drivers and detailed forecasts, the latest developments, and the opportunities for all players involved. The analysis will save valuable time, effort and money by providing more realistic forecasts of future potential, and a fast-track to developing and / or benchmarking a leading-edge strategy and approach in digital communications. It contains

Our independent, external market-level forecasts of voice and messaging in 9 selected markets (US, Canada, France, Germany, Spain, UK, Italy, Singapore, Taiwan).
Best practice and leading-edge strategies in the design and delivery of new voice and messaging services (leading to higher customer satisfaction and lower churn).
The factors that will drive best and worst case performance.
The intentions, strategies, strengths and weaknesses of formerly adjacent players now taking an active role in the V&M market (e.g. Microsoft)
Case studies of Enterprise Voice applications including Twilio and Unified Communications solutions such as Microsoft Office 365
Case studies of Telco OTT Consumer Voice and Messaging services such as like Telefonica’s TuGo
Lessons from case studies of leading-edge new voice and messaging applications globally such as Whatsapp, KakaoTalk and other so-called ‘Over The Top’ (OTT) Players

It comprises a 18 page executive summary, 260 pages and 163 figures – full details below. Prices on application – please email contact@telco2.net or call +44 (0) 207 247 5003.

Benefits of the Report to Telcos, Technology Companies and Partners, and Investors

For a telco, this strategy report:

Describes and analyses the strategies that can make the difference between best and worst case performance, worth $80bn (or +/-20% revenues) in the 9 markets we analysed.
Externally benchmarks internal revenue forecasts for voice and messaging, leading to more realistic assumptions, targets, decisions, and better alignment of internal (e.g. board) and external (e.g. shareholder) expectations, and thereby potentially saving money and improving contributions.
Can help improve decisions on voice and messaging services investments, and provides valuable insight into the design of effective and attractive new services.
Enables more informed decisions on partner vs competitor status of non-traditional players in the V&M space with new business models, and thereby produce better / more sustainable future strategies.
Evaluates the attractiveness of developing and/or providing partner Unified Communication services in the Enterprise market, and ‘Telco OTT’ services for consumers.
Shows how to create a valuable and realistic new role for Voice and Messaging services in its portfolio, and thereby optimise its returns on assets and capabilities

For other players including technology and Internet companies, and telco technology vendors

The report provides independent market insight on how telcos and other players will be seeking to optimise $ multi-billion revenues from voice and messaging, including new revenue streams in some areas.
As a potential partner, the report will provide a fast-track to guide product and business development decisions to meet the needs of telcos (and others).
As a potential competitor, the report will save time and improve the quality of competitor insight by giving strategic insights into the objectives and strategies that telcos will be pursuing.

For investors, it will:

Improve investment decisions and strategies returning shareholder value by improving the quality of insight on forecasts and the outlook for telcos and other technology players active in voice and messaging.
Save vital time and effort by accelerating decision making and investment decisions.
Help them better understand and evaluate the needs, goals and key strategies of key telcos and their partners / competitors

The Future Value of Voice: Report Content Summary

Executive Summary. (18 pages outlining the opportunity and key strategic options)
Introduction. Disruption and transformation, voice vs. telephony, and scope.
The Transition in User Behaviour. Global psychological, social, pricing and segment drivers, and the changing needs of consumer and enterprise markets.
What now makes a winning Value Proposition? The fall of telephony, the value of time vs telephony, presence, Online Service Provider (OSP) competition, operators’ responses, free telco offerings, re-imaging customer service, voice developers, the changing telephony business model.
Market Trends and other Forecast Drivers. Model and forecast methodology and assumptions, general observations and drivers, ‘Peak Telephony/SMS’, fragmentation, macro-economic issues, competitive and regulatory pressures, handset subsidies.
Country-by-Country Analysis. Overview of national markets. Forecast and analysis of: UK, Germany, France, Italy, Spain, Taiwan, Singapore, Canada, US, other markets, summary and conclusions.
Technology: Products and Vendors’ Approaches. Unified Comminications. Microsoft Office 365, Skype, Cisco, Google, WebRTC, Rich Communications Service (RCS), Broadsoft, Twilio, Tropo, Voxeo, Hypervoice, Calltrunk, Operator voice and messaging services, summary and conclusions.
Telco Case Studies. Vodafone 360, One Net and RED, Telefonica Digital, Tu Me, Tu Go, Bluvia and AT&T.
Summary and Conclusions. Consumer, enterprise, technology and Telco OTT.

Europe’s brutal future: Vodafone and Telefonica hit hard

Introduction

Even in the UK and Germany, the markets with the brightest future, STL Partners forecasts a respective 19% and 20% decline in mobile core services (voice, messaging and data) revenues by 2020. The UK has less far to fall simply because the market has already contracted over the last 2-3 years whereas the German market has continued to grow.

We forecast a decline of 34% in France over the same period.

In Italy and, in particular, Spain we forecast a brutal decline of 47% and 61% respectively. Overall, STL Partners anticipates a reduction of 36% or €30 billion in core mobile service revenues by 2020. This equates to around €50 billion for Europe as a whole.

Like the medical profession, we don’t always like being correct when our diagnoses are pessimistic. So it is with some regret that we note that our forecasts are being borne out by the latest reports from southern Europe. Vodafone has been forced into a loss for H1 2012, after it wrote down the value of its Spanish and Italian OpCos by £5.9bn. Here’s why:

The writedown is of course non-cash, and those of us who remember Chris Gent’s Vodafone will be familiar with the sensation. But the reasons for it could not be more real. Service revenue has fallen sickeningly, down 7.9% across Europe, 1.4% across the group.

Vodafone has enjoyed a decent performance from the company’s assets in Africa, Asia, Turkey, and the Pacific, and a hefty dividend from Verizon Wireless. It is the performance in Europe which is dreadful and the situation in southern Europe especially bad.

For while service revenue in Gernany was up 1.8%, it was down a staggering 12.8% in both Spain and Italy. And margins were sacrificed for volume; EBITDA was down 16.6% in Italy, and 13.8% in “Other Southern Europe”, that is to say mostly Greece and Portugal. Even the UK saw service revenues fall -2.1%, while the Netherlands was down -1.9%. Vodafone’s investments across Europe seem to have landed in an arc of austerity running from the Norwegian Sea to the Aegean, the long way around.

Vodafone’s enterprise line of business has helped the Italian division defy gravity for a while. Until recently, OneNet was racking up the same 6% growth rates in Italy that it saw in Germany and contributing substantially to service revenue, even though the wider business was shrinking. In Q2, service revenue in Italy was down 4.1% but enterprise was up 5.8%.

But strategy inevitably beats tactics. Tellingly, the half-year statement from Vodafone management went a little coy about enterprise’s performance. Numbers are only given for Germany and Turkey, and for group-wide One Net seats. They are good, but you wonder about the numbers that aren’t given. We are told that One Net is “performing well” in Italy, but that’s not a number.

Meanwhile, Telefonica saw its European revenues fall 6.4% year-on-year. The problem is in Spain, where the plummet was 12.9%. Mobile was worse still, with revenues thumped downwards by 16.2%.

The damage, for both carriers, is concentrated in mobility, in southern Europe, and in voice and messaging. Telefonica blames termination rate cuts (as does Vodafone – both carriers are big enough that they tend to terminate more calls from other carriers than they pay out on), but this isn’t really going to wash. As Vodafone’s own statement makes clear, MTRs are coming down everywhere. And Telefonica’s wireline revenues were horrible, too, down 9.6%.

But the biggest hit to revenue for Vodafone was in messaging, and then in voice. Data revenue is growing. In the half to 30th September 2011, Vodafone.es subscribers generated £156 million in messaging revenues. In the corresponding half this year, it was £99 million. Part of this is accounted for by movement in the euro-sterling exchange rate, so Vodafone reports it as a 30% hit to messaging and a 20% hit to voice. Italy saw an 11.4% hit to messaging and a 16% hit to voice. The upshot to Vodafone is a 29.7% cut to the division’s operating profits. Brutal indeed.

Obviously, a lot of this is being driven by the European economic crisis. It is more than telling that Vodafone’s German and Turkish operations are powering ahead, while it’s not just the Mediterranean economies under the European Union’s “troika” management (EC, ECB and IMF) that are suffering. The UK, under its own voluntary austerity plan, was down 2.1% for Telefonica, and the Netherlands, having gone from being the keenest pupil in the class to another austerity case in the space of one unexpectedly bad budget, is off 1.9%. Even if you file Turkey under “emerging market”, the comparison between the Mediterranean disaster area, the OK-ish position in North-Western Europe, and the impressive (£2.4bn) dividend from Verizon Wireless in the States is compelling.

But disruption is a fact. We should not expect that things will snap back as soon as the macro-economy takes a turn for the better. One of the reasons for our grim prediction was that as well as weak economies, the Southern European markets exhibited surprisingly high prices for mobile service.

The impact of the crisis is likely to permanently reset customer behaviour, technology adoption, and price expectations. The Southern price premium is likely to be permanently eroded, whether by price war or by regulatory action. Customers are observably changing their behaviour in order to counter-optimise the carriers’ tariff plans.

Vodafone observes plummeting messaging revenues, poor voice revenues, and heavy customer retention spending, specifically on handset subsidies for smartphones. In fact, Vodafone admits that it has tried to phase out subsidy in Spain and been forced to turn back. This suggests that customers are becoming very much more aware of the high margin on SMS, are rationing it, and are deliberately pressing for any kind of smartphone in order to make use of alternatives to SMS. Once they are hooked on WhatsApp, they are unlikely to go back to carrier messaging if the economy looks up.

Another customer optimisation Vodafone encounters is that the customers love their integrated fixed/mobile plan. Unfortunately, this may mean they are shifting data traffic off the cellular network in the home-zone and onto WLAN. Further, as Vodafone is a DSL unbundler, the margin consequences of moving revenue this way may not be so great. In Italy, although the integrated tariffs sold well, a “fall in the non-ULL customer base” is blamed for a 5.6% drop in fixed service revenue. Are the customers fleeing the reseller lines because Vodafone can’t match TI or Fastweb’s pricing, or is it that the regulatory position means margins on unbundled lines are worse?

Vodafone’s response to all this is its RED tariff plan. This essentially represents a Telco 2.0 Happy Pipe strategy, providing unlimited voice and messaging in order to slow down the adoption of alternative communications, and setting data bundles at levels intended to be above the expected monthly usage, so the subscribers feel able to use them, but not far enough above it that the bandwidth-hog psychology takes hold.

With regard to devices, RED offers three options with tiered pricing: SIM only, basic smartphone, and iPhone. The idea is to make the subsidy costs more evident to the customer, to slow up the replacement cycle on flagship smartphones via SIM-only, and to channel the smartphone hunters into the cheaper devices. Overall, the point is to drive data and smartphone adoption down the diffusion curve, so as to help the transition from a metered voice-centric to a data-centric business model.

The CEO, Vittorio Colao, says as much:

The reason why the whole industry is on a difficult trend…is because we historically voice priced really high and data priced really low.

Vodafone’s competitors face a serious challenge. They are typically still very dependent on prepaid voice minutes, a market which is suffering. Even in Northern Europe, it’s off 10%. Telcos loved PAYG because everything in it is incremental. Now, the challenge is how to create a RED-like tariff for the PAYG market.

Those in North and South America, MENA and Asia-Pacific may be looking at Europe and breathing a sigh of relief. But don’t fool yourself. SMS revenues in the US are down for the first time driven by volume and price declines. One rather worrying outcome of last week’s Digital Arabia event was that operators in the region seem to be under the impression that the decline for them is still several years out and destined to be a relatively gentle softening of the market. There’s more here on our initial take on what they need to do to avoid complacency and start to build new business models more quickly.

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

Summary findings and implications

Dark skies ahead

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

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

Figure 1: Mobile core Service revenues

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

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

Get your umbrellas ready now

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

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

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

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

Research. We have recently published several reports that focus on what the industry should do and how it should do it including those within our Executive Briefing Service, the freely available How to accelerate new business models and two major new strategy reports, A Practical Guide to Implementing Telco 2.0, which outlines a step-by-step methodology for each of the 8 areas, and Cloud 2.0: Telco Strategies in the Cloud.
Events. Our executive brainstorm events in London, Dubai, Singapore and Silicon Valley remain the best forum for senior executives to debate key strategic issues and develop their thinking.
Consulting. We continue to undertake advisory work with operators, vendors and technology companies that seeking to transform their business models and pursue new opportunities.

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

Introduction

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

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

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

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

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

But how bright is the future really?

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

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

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

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

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

EU5 Mobile Services Revenues Chart, Telco 2.0, Oct 2012

Source: STL Partners

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

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

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

Views vary widely on the outlook for mobile telecoms in Europe

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

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

Privately held view seems to be pessimistic…

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

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

Euro Mobile: The Future's Brutal - delegate views, Telco 2.0, Oct 2012

Source: Delegate Vote, New Digital Economics Executive Brainstorm, November 2011

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

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

Figure 4: Orange remains optimistic about European telecoms revenues

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

Source: FT Orange

Contents:

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

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

Euro telcos: fiddling while the platform burns?

Summary: Most executives across the European telecoms industry accept that the current telco business model is in decline (the ‘burning platform’), but wholehearted action to create sustainable new models is not in place. We identify the key barriers and next steps to overcome them in this top-level analysis of findings from our recent EMEA Executive Brainstorm. (July 2012, Executive Briefing Service, Transformation Stream.)

UK Services Revenues: Actual and Forecast (index)

Below is an extract from this 16 page Telco 2.0 Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service and the Telco 2.0 Transformation stream here. Non-members can subscribe here and for this and other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

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Executive Summary

The Burning Platform

It was clear at the Telco 2.0/New Digital Economics Brainstorm in London a few weeks ago that most executives across the European telecoms industry accept that the current telco business model is in decline (the ‘burning platform’), but wholehearted action to create sustainable new models is not in place.

Figure 1 – The burning platform illustrated: e.g. forecast decline in UK revenues

Source: Presentation by Chris Barraclough, Chief Strategist and MD Telco 2.0

Two thirds of delegates thought this leading indicator forecast ‘about right’ or ‘too optimistic’.

Telcos need to act more decisively

The core message to the leaders of the European telecoms industry is that they must make a more concerted effort to change direction now or will have much less control over their future destinies.

Some telcos are taking steps, but even the most advanced are still in experimental mode, and the rest somewhere between strategic slide-ware and tacit acceptance of a future as a ‘pipe’.

As well as prudent re-pricing of data and diligence in cost and efficiency management, the primary opportunities for telcos are to re-conceive the core communications proposition, re-define the overall experience of being a telco customer and ultimately to create interoperable multi-sided business models that help 3rd parties and end-users (people, organisations and devices) connect in more efficient and effective ways. These actions will create a more valuable and defensible role for telcos in the emerging digital economy.

Overcoming industry inhibitions

To progress, the industry needs to overcome the following challenges:

Time is short. Delegates perceived that telcos had significantly less time to secure strategic control points in the digital economy than at previous brainstorms. Telcos need to act more decisively now in payments, advertising, creating new forms of ‘OTT’ communications, identity and cloud services.
Money is hard to find. The business cases for some of the new models are complex and the economics are different from traditional telco business models. We know because we have been working on many recently, and have also been recommending important new evaluation metrics. It’s not straightforward, nor is it easy to fill the gap left by the predicted decline in the current model, but it is possible to create new value.
Technology is a tool, not a strategy. The business case for LTE, for example, is hard to make without new service revenues in addition to access, which somewhat begs the question of who and what is leading this major industry investment.
The right people are hard to find. 95% of delegates thought there is a serious shortage of the internal skills needed to manage, innovate and deliver very different types of propositions. Understanding, addressing and filling this gap is a vital priority.
Customers will not solve the industry’s problems. Most customers – upstream and downstream – do not understand how telcos could help them in new ways. Our research shows a range in comprehension and belief in telcos’ abilities, so telcos need to work harder to create and sell new solutions.
It’s tricky to organise innovation and change at scale. The operators that are starting to take action face a complex organisational challenge: should innovation be built into the core business or established in a new unit? In the core it is closer to the heart but also more vulnerable to the organisation’s white blood cells (the ones that attack unrecognised intruders). In a separate unit it’s easier to grant more freedoms but it’s much more difficult to integrate and change the core.
Collaboration: the Prisoners’ Dilemma. Many of the new business models will only work effectively if telcos cooperate on a common approach. This is usually slow and difficult (witness the slow progress of RCS-e and the demise of WAC). There is also regulatory uncertainty around industry collaboration, and fear of the regulator is quite reasonably a powerful internal inhibitor in telcos. Additionally, some players perceive they could achieve competitive advantage by ‘going it alone’. A way through this dilemma needs to be navigated, and our recent analysis suggests some new ways to think about this.
It’s hard to change a winning formula (even when you are losing). Financial markets have been keen on telcos’ relative stability and cash flows in turbulent economic times. At the same time there are also those high up in telco organisations who have known nothing but success with the existing model and who will argue to defend the status quo. Yet the financial markets, well known as fickle and irrational beasts, will at some point start to be much more sensitive to the structural change in the telco industry and seek a new direction. Unreasonably perhaps, they will expect change to happen quickly, and if this is not apparent, they will demand new leaders but by then it may be too late.

Next steps for STL Partners and Telco 2.0

Telco 2.0 first described the core challenges facing the industry six years ago in ‘How to make money in an IP world‘, and proposed the ‘two-sided telecoms business model‘ as a key part of the solution four years ago. Over the last year we have published the ‘Roadmap to New Telco 2.0 Business Models‘ describing core innovations needed, and ‘Dealing with the Disruptors – Google, Apple, Facebook, Skype and Amazon‘ outlining strategies in the adjacent competitive landscape.

We’re now driving a range of implementation projects with individual players and collaborative consortiums and will be publishing a further detailed Telco 2.0 implementation guide later this year. Through our research we will also be benchmarking telcos’ strategies, to help the capital markets better understand how to make investment choices in the industry, and looking in-depth at creative strategies in voice and messaging, m-commerce, cloud services and M2M, as well as continuing our work with the World Economic Forum on one of the biggest prizes, how telcos can play a pivotal role in enabling the emergence of a new class of economic asset, ‘Personal Data‘.

We will also be running further invitation only Executive Brainstorms in Dubai (November 6-7, 2012), Singapore (4-5 December, 2012), Silicon Valley (19-20 March 2013), and London (23-24 April, 2013). Email contact@stlpartners.com or call +44 (0) 207 243 5003 to find out more.

Support for Key Findings

The Platform is burning

Figure 2 – Delegates broadly agreed with STL’s UK Revenue forecast

STL Partners UK Revenue Forecast (June 2012)

Chris Barraclough, MD and Chief Strategist, Telco 2.0 / STL Partners, presented an example analysis of voice and data revenues from the UK market, and predicted a 24% decline from the peak in 2009 to 2018.

Delegates broadly supported this analysis, with over half saying they thought this was ‘about right’. We will be conducting and publishing further analysis in the top 5 European markets over the next few months.

NB The original ‘burning platform’ reference comes from this article describing a choice between certain death and possible death, and is now used to describe a situation where people are forced to act by dint of the alternative being somewhat worse. Nokia recently made ‘burning platform’ a famous phrase in the handset part of the telecoms sector, but it’s now relevant to telcos themselves as they face significant declines in their core revenues.

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

Time is short
Money is hard to find
The right people are hard to find
Customers will not solve the industry’s problems
It’s tricky to organise innovation and change at scale
Collaboration: the Prisoners’ Dilemma
It’s hard to change a winning formula (even when you are losing)
Next steps

…and the following figures…

Figure 1 – The burning platform illustrated: e.g. forecast decline in UK revenues
Figure 2 – Delegates broadly agreed with STL’s UK Revenue forecast
Figure 3 – Time is running out for telcos
Figure 4 – The business case for Telco OTT Voice and Messaging is complex
Figure 5 – Telcos need to transform skills, systems, structures and incentives
Figure 6 – Upstream customers’ views on telco capabilities
Figure 7 – KPN is building innovation into the core rather than a separate business unit
Figure 8 – The Prisoners’ Dilemma
Figure 9 – It’s difficult to get the timing of new investments right

…Members of the Telco 2.0 Executive Briefing Subscription Service and the Telco 2.0 Transformation stream can download the full 16 page report in PDF format here. Non-Members, please subscribe here. For this or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

Strategy 2.0: Lessons from Vodafone’s success in European SMB Communications

Summary: Vodafone have been quietly stealing a march in the European SMB communications market with a well executed strategy centred on its OneNet cloud-based product. We look at how, including comparisons with BT, Telenor, and others. (May 2012, Executive Briefing Service)

Vodafone Voice Analysis May 2012

Below is an extract from this 24 page Telco 2.0 Report that can be downloaded in full in PDF format by members of the Telco 2.0 Executive Briefing service here. Non-members can subscribe here, buy a Single User license for this report online here for £795 (+VAT for UK buyers), or for multi-user licenses or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

We’ll also be discussing our findings at the London (12-13 June) New Digital Economics Brainstorm where we’ll be joined by Bob Brace, Vodafone’s Head of Cloud and Unified Comms, in the Cloud 2.0 stream.

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Introduction – Challenges and Opportunities in Voice and Unified Communications

Although voice minutes of use are still rising slowly worldwide, it is increasingly the case that the predictions of falling revenues from traditional services are becoming a reality, and sooner than expected. A combination of regulatory pressures, price competition between operators, and disruptive competition from new entrants is crushing margins.

Figure 1: Skype Punishes Carriers on International Voice

Source: TeleGeography

Most worryingly, the continued huge growth in volumes at Skype and the popularity of alternative messaging options like WhatsApp, BlackBerry Messenger, and Apple’s iMessenger show that the disruption is disproportionately affecting the most profitable segments of the traditional telecoms bundle – international and SMS respectively.

Increasingly, small and medium-sized businesses (SMBs), another key line of business, are turning to the growing numbers of independent VoIP providers. And, more broadly, voice, messaging, and video conferencing features are being disaggregated and diversified, showing up in all kinds of software, hardware, and Web service contexts – exactly as we predicted in 2007.

Again as we predicted, voice is more and more being delivered as part of a broader communications product. In the enterprise, this typically manifests itself as a “unified communications” (unicomms or UC) application, integrating telephony, voicemail, e-mail, and often also instant messaging, presence-and-availability, teleconferencing, and collaboration tools. This can be delivered on-premises, for example by an Asterisk system or an integrated hardware appliance like the ones Cisco sells, as a Web service (like Huddle or Salesforce Chatter), as a hosted/cloud-based network service, or as a telecomms operator service (like IP-Centrex).

In this context, some operators are not just surviving but succeeding. There is not only crisis here, but also opportunity. Cisco forecasts that there is a world market for $20bn of hosted unified-comms services, making up about 40% of the total “managed” UC market. Vodafone expects a 25% CAGR over the next four years in both UC and cloud services for SMBs and enterprises, with a total European market of $15bn in 2015. As for the broader communications market, BT estimates that the total UK SMB communications market is worth some £29bn from 4.8 million customers.

Figure 2: Cisco estimates $20bn of hosted unified communications, $50bn “managed”

Source: Cisco Systems, STL Partners

The drivers are clear – SMB customers are keen to get rid of the costs of owning and managing local PBXes on the one hand, to enjoy the (perceived) low, low prices of VoIP, and also to upgrade their communications services from the early 1990s GSM feature set plus the late 1990s BlackBerry e-mail service to something more in keeping with the age of Google +, the Apple iPhone, and Skype.

At the same time, operators are in search of new sources of revenue to replace the business and international voice and SMS cash cows. As always, they also need to find applications that sell-through their basic connectivity products. Hardware vendors are keen to extend their own businesses, which are challenged by the availability of open-source software and cloud-based services. And the software and Internet service players are trying, in their turn, to defend against the remorseless drift towards “free”.

In this note, we will discuss three European operators’ response to the challenge and the results, and we will also discuss how the vigorous Voice 2.0 disruptor ecosystem relates to the SMB core market. We will start with an example of success – Vodafone.

Figure 3: Why SMB & enterprise UC is a priority at Vodafone

Source: Vodafone interim report

Vodafone: clear definitions and responsibilities pay off

In the UK, this space is dominated by two players, Vodafone and the ex-incumbent BT. Their results contrast dramatically.

Vodafone is aggressively promoting a cloud-based UC package, OneNet, to its SMB customers in the six biggest European markets, and looking to roll it out across the wider Vodafone Group.

Meet Vodafone OneNet: Unified Comms in the Cloud for SMBs

OneNet is a cloud-based unicomms product, which offers single numbers for both fixed and mobile telephony, advanced call management, multi-ring and hunt groups, and voicemail integrated with push e-mail across mobile devices, fixed phones, and VoIP softphones, with a single bill and central account management via a Web interface and a smartphone app. Vodafone also offer Office 365 from Microsoft as an extra cost option and later this year (2012) will offer integration between One Net and Microsoft Lync enabling “click to call from Microsoft applications and the ability to answer an incoming call to a mobile number in Lync.

OneNet Express is a lightweight version of the product for small businesses, offering virtual landline numbers and some call management features, as well as the account management service, for mobile lines only. Both versions of the product are delivered as pure network services, running in Vodafone’s core network.

A Note on the Accounts

Although Vodafone is increasingly keen to boast about its performance in the SMB and enterprise markets, it doesn’t yet provide a line-of-business analysis in its accounts. However, we’ve constructed a roughly comparable data series, based on the growth figures Vodafone does provide, its own statement that 31% of its European revenue is from business customers, and its geographical segment breakdowns.

A caveat must be introduced in that Vodafone Global Enterprises (VGE), the large enterprise & government business roughly analogous to BT Global Services, is included in the Vodafone series while BTGS is broken out in the BT accounts. BT does not provide a breakdown of BTGS revenue detailed enough to create an identical BT series. However, as we will soon see, it is unlikely that Global Services have contributed enough growth to falsify the conclusion we are about to draw.

In the six OneNet markets (Germany, Italy, Spain, the UK, the Czech Republic, and Portugal) through 2011, revenue growth averaged 4.8%, and it is worth noting that there is substantial momentum. Q1 saw sequential growth of 2.4%, Q2 4.85%, and Q3 7.38%. In the market and economic context, this is a spectacular performance.

Figure 4: Vodafone Is Doing Far Better In The UK

Source: STL Partners, Vodafone, BT

In the last 7 quarters, Vodafone’s revenue from UK business customers grew in 6 of them. It beat BT in every one of the quarters we looked at. Not only is it growing quite quickly, while BT’s is shrinking dramatically, it is almost three times as big in absolute terms (although some of this will be down to the differences in segment allocation).

In Europe more broadly, the same picture is visible even more strongly, with the SMB segment growing at 5-8%% in major markets like Germany and Italy, and accounting for most of the growth in final ARPU. Although Vodafone’s south European interests are in the firing line of the economic crisis, this line of business has been remarkably robust. In the last three months of 2011, service revenue in Italy shrank almost 5 per cent – but revenue from SMBs and enterprises rose 1.9%. At the same time, service revenue in Germany grew 0.3%, but the OneNet target markets grew 5%. In Q2, service revenue in Italy was down 4.1%, but enterprise was up 5.8%, and OneNet itself was growing at 70% annually. In Germany, at the other end of the European economic spectrum, enterprise was up 6.6% year on year compared with total service revenue at 1.2%.

Figure 5: OneNet Markets Doing Rather Nicely, Thanks

Source: Vodafone interim results presentation, November 2011

To read the note in full, including the following additional analysis…

BT: Incumbent or Innovator?
BT Voice: Volumes Shrinking…
Two other European operator plays
Telenor: The Same Factors, the Same Success?
So, How Did Vodafone Do It?
Compare and Contrast: Vodafone 360
The Disruptors: Twilio, Tropo, and friends
The Future: beyond hunt groups
Conclusions & Recommendations
1: Service design
2: Organisational focus
3: Channels to market
4: Cloud and software power
The Telco 2.0™ Initiative

…and the following figures…

Figure 1: Skype Punishes Carriers on International Voice
Figure 2: Cisco estimates $20bn of hosted unified communications, $50bn “managed”
Figure 3: Why SMB & enterprise UC is a priority at Vodafone
Figure 4: Vodafone Is Doing Far Better In The UK
Figure 5: OneNet Markets Doing Rather Nicely, Thanks
Figure 6: Enterprise & SMB Outgrowing Vodafone Group Revenues in last two quarters
Figure 7: BT Group strategic priorities
Figure 8: BT Organisational Structure – an SMB might touch all of these
Figure 9: BT Global Services revenues year-on-year
Figure 10: BT losing call volume in the UK…
Figure 11: A simple proposition
Figure 12: Enterprise revenue in Turkey growing 33% sequentially
Figure 13: Cisco’s view of SMB, Developer, and Enterprise Requirements

…Members of the Telco 2.0 Executive Briefing Subscription Service can download the full 24 page report in PDF format here. Non-Members, please subscribe here, buy a Single User license for this report online here for £795 (+VAT for UK buyers), or for multi-user licenses or other enquiries, please email contact@telco2.net / call +44 (0) 207 247 5003.

Technologies and industry terms referenced: SMBs, strategy, voice, unified communications, channel marketing, partners, business model, Vodafone, BT, Telenor, Twilio, Tropo, VOIP.