TThe truth is staring telco CFOs in the face: your industry and, almost certainly, your company is going to get smaller and less profitable.
FACT: Revenue in Europe is down 20% since 2012. STL Partners called this in a piece in 2012, The future’s not bright it’s brutal, and everyone said we had got it wrong. We hadn’t, and the rest of the world is now heading ex-growth too. Globally, the telecoms party is over.
FACT: Global telecoms capital expenditure is rising – from $217 billion (17% of revenue) to $360 billion (20% of revenue).
FACT: Global telecoms capital efficiency is falling – in other words each dollar invested is generated less revenue. In 2007, $1 of assets generated $0.78 of revenue but this had fallen to $0.65 by 2017.
FACT: Profitability is heading south too – industry EBITDA margins have dropped from 37% in 2007 to 35% in 2017.
FACT: The result of lower capital efficiency and lower margins means that more capital investment is being debt-funded. Net debt as a multiple of EBITDA has increased from 1.4x in 2007 to 2.3x ten years later.
FACT: 4G failed to generate incremental sustainable ARPU or revenue growth.
FACT: Investors have lost faith in the telecoms industry which is why corporate dividend yields rose from around 3% in 2007 to 7% in 2017. Investors want their money back, so they can invest in growth sectors and companies.
I could go on, but you get the point.
The party is over – but telcos keep playing the same song
Despite overwhelming evidence that the world is getting tougher and financials are (or will) head south, CFOs continue to adopt the same approach to investment planning, budgeting, and operational and financial governance that they have always done:
- Capital expenditure is seen as the best way of creating future value – network leadership (via 5G) is considered the best way of differentiating and creating a price premium.
- Subscriber numbers, ARPU and EBITDA margins are the core metrics for measuring current and future success.
- Investment in new growth is largely confined to M&A into adjacent markets. Development of core innovation processes and skills remains minuscule compared to capital investment and is quickly cut back if ‘success’ is not realised quickly. With a mantra of ‘3-year payback please’, few telco boards have the patience to invest over a long period of time and build a genuinely new business. NTT Docomo invested for 10 or more years to grow its content creation and financial services businesses which now generate annual revenue of more than $6bn.
This dedication to the old financial and commercial models wouldn’t matter if CFOs (and telco boards generally) faced up to the inevitable consequence: that the industry will shrink, that margins will tighten further, that being a low-cost player in a commodity market will be critical. But in most cases, what we hear is that the company is expecting future growth. How? How will investing more and more in better and better networks realise more value? Connectivity will remain a commodity and telcos will compete by giving more (higher speed, more security, lower latency etc.) for less (lower ARPU).
Time to change up
Building moats (networks) was great for telcos when they could keep others out. Voice and messaging were hugely lucrative when they were integrated into the network and third-parties couldn’t offer competing services. But the internet changed that. Network-independent services mean that moats have been breached. So, pouring money into networks is, well, sub-optimal. Sure, you can’t be way behind your competitors but seeking to differentiate through your network – to expect higher prices or more customers from having a better network – makes little sense.
Instead telcos, and particularly telco CFOs, need to think and behave differently.
Capital investment in networks needs to be managed down.
And, correspondingly, resources need to be increased in service innovation because only platforms and services will drive growth and value creation at operators. CFOs need to preside over a fundamental change in the financial model if telecoms operators are to undergo a business model change and reignite growth.
What does this mean in practice? I think the telecoms financial structure needs to shift in the in the following ways (see the chart for a graphical representation of this):
- Capital expenditure is currently around 16% of revenue and I would expect that to be reduced over the next ten years to around 10%.
- Most of operating expenditure is currently directed towards infrastructure operations–including interconnect, network management and maintenance etc., but virtualisation and automation would see this cost reduce materially going forward.
- Sales and customer care accounts for around 20% of revenue in 2018 but a continuing shift to online sales channels and AI-driven customer care should drive this cost down.
- Only 5% (or less) of revenue is currently spent on the activities associated with service innovation including R&D, service delivery, product/service marketing, customer experience management, analytics etc., and this should grow substantially over the next ten years: Operators that are now seeking revenue growth should devote around 20% of revenue to this by 2028.
If, and only if, operators develop successful platforms and services then EBIT margins should expand over the next ten years.
While marketing and product development departments may be the drivers of innovation within operators, they cannot innovate without resources. And CFOs hold the purse strings. They must change the financial model so that new operational and commercial models can flourish. Without this change, the ‘we are going to grow’ mantra simply doesn’t ring true.We cover this in much more depth in a recently published report, Why CFOs must start to drive telecoms business model change. Some of this is in front of the paywall. The full report is available to our lucky subscribers.
Written by Chris Barraclough, a co-founder of STL Partners that provides strategic research, consulting and events for telecommunications operators and their partners.
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