Beyond voice: the future of fixed-line telcos

Robert Maciejko is vice president and managing director of the Boston Consulting Group in Warsaw

The telecom incumbents in our region are among the bluest of blue chips. Telekomunikacja Polska (TPSA), Cesky Telecom (Czech Republic) and Matav (Hungary) are numbers one, two and one in market capitalization in their respective countries. However, as we join the EU, the conditions they have to work in will increasingly look like those in current EU countries, which are not necessarily favorable to incumbents.

Dominant market shares, steady if not unspectacular growth, generous margins and a long history of operations - these were the characteristics of European telecom incumbents in the 1980s and 1990s. Historically, incumbent fixed-line businesses spun off a lot of cash despite being closely managed by regulators.

In the coming years, though, increased competition, market saturation, regulatory action and cannibalization from new technologies will cause significant value decline. A study conducted in current EU countries reveals that the market value of fixed-line business will decline 40 percent-50 percent in the next five years unless significant countermeasures are taken.

Currently fixed-line operators make money on voice traffic, generated by individuals as well as small and medium enterprises (approximately 65 percent of profits) and leased lines used by large companies (approximately 25 percent of profits). Both these sources will shrink dramatically in the next five years and incumbents will increasingly derive profits from access services.

Value decline will be caused by a combination of factors. Voice traffic is threatened by carrier pre-select and increased competition from alternative networks such as mobile (and cable in some countries), resulting in continued price decreases and market share loss. The actions of regulators, aimed at further enabling competitor access to the established wholesale networks, will make the situation even worse for incumbents. In Poland and much of central Europe, we have the added element that mobile telephony is even more quickly overtaking the fixed-line business than it is in western Europe, first in terms of the number of subscribers and ultimately also in revenue.

Deployment of broadband Internet (mainly DSL) can result in the cannibalization of leased lines in the large companies segment and substitution of voice services with less expensive voice-over-DSL in the small and medium enterprise segment. Incumbents will find it difficult to make up for this value erosion by offering broadband Internet access based on DSL. In Poland, DSL penetration is currently bounded as well by both limited wealth and low personal computer penetration.

Senior executives of incumbent telcos will attempt to close the value gap by applying various means. Typically we can observe three streams of effort: revenue enhancement, lean telco programs and managed technology migration.

Incumbents' revenues in current EU countries are expected to decrease around 4 percent per annum in the next five years due to price erosion and market share loss. Customer retention and increasing revenues per customer will be a high priority for them. Changing pricing structures, for example by introducing flat-fee pricing for voice traffic and variable pricing for data traffic, charging for ancillary services (i.e. caller ID) and introducing new products (i.e. fixed-line SMS) will allow incumbents to capture their "fair share" of value provided to customers.

To maintain company value, incumbents require on average a 30-percent reduction in operating costs. Due to their large installed bases, capital expenditure reductions have limited impact on economic profit. A typical "lean telco" program emphasizes reducing operating costs and complexity, differentiating and matching service levels to customer value and increasing asset productivity. Based on our experience, typical initiatives can generate a 20-percent-50-percent reduction in relevant costs. Throughout central Europe all incumbents, including TPSA, have already started substantially reducing staff and simplifying their structures.

Managing parallel technologies will be key. New low-cost technologies such as IP VPN offer attractive economics for new entrants but cut into incumbents' profits. Incumbents are using pricing and marketing tools to delay migration until customers are about to switch to competitors. This requires in-depth understanding of customer switching behavior per segment and explicit market share.

Incumbents will need to transform their business models to grow value. Three issues are of key importance: what role to play in the value chain, how to make the cost structure variable and how to streamline the organization through more radical measures.

Overall, with a well-executed strategy that combines short-term value enhancements and long-term transformation, incumbents will be able not only to compensate for value loss but even to increase the value of their fixed-line business. Many will, however, fail in this challenge. In any case, our regional incumbents will indeed have full agendas in the coming years.