Jumping the S-Curve for Communications Service Providers - Part 2

Speed Of Change Is Vital For Survival As Disruption Escalates For Communications Service Providers

Communications Service Providers continue to face unprecedented challenges. I’ve talked about “jumping the S-Curve” in a previous article, highlighting the imperatives for adopting a platform-based model and transforming the core of the business

Gloom continues – what are the next moves?

Communications Service Providers (CSPs) continue to face unprecedented challenges and bad news continues. Uncertainties around macroeconomic scenarios and growth; potential 5G-related investment requirements are looming. Disruptive competitors are fighting hard to seduce the liquid and increasingly volatile consumer. In the infrastructure layers, continual regulatory pressures and a progressive commoditization of services abound and are diminishing ROIC.

Revenue growth in the industry has been single digit for the last ten years and hovers between 2% and 3%. Most worryingly, US mobile revenues turned negative in 2016 for the first time, while European mobile revenues have been negative for years. Overall, despite some signs of growth normalization, it seems premature to talk about sustained, material and value accretive growth recovery in CSPs. In fact, the stories seen by investors in 2016 are dividend/defensive and efficiency/ consolidation. Coupled with revenue challenges, the situation becomes more critical when looking at capex investment, which continues to rise driven by defensive reasons and competitive pressures.

With present day focus on dividends, concerns about vertical disintegration, a lack of scalability of operating models, and skills obsolescence—there’s a powerful incentive for the CSP industry to move at high speed to position for future growth. Moving out of their comfort zone will require radical strategic moves, instead of depending on returns generated from imperfect infrastructure competition.

The industry is heading in two directions – with the choice between a) a dumb pipe utilities model and b) a growth driven business model based on newly built advantages in the less regulated digital service layer.

We argue that while consolidation in the infrastructure domain certainly will provide value, few CSPs would accept ‘dumb pipe’ as their core strategy. However, a gap is emerging between operators that are making significant bets towards digital services powered by platform bets, and those who seem less prepared to challenge the status quo.

Recognizing disruption

With present day focus on dividends, concerns about vertical disintegration, a lack of scalability of operating models, and skills obsolescence, disruption is in full motion and evident in four key areas:

·       Tech/OTT-driven telecoms disruption: started on voice, evolved into data, then into the home market with Alexa and Google Home. As the soft SIM concept takes off, the “GAFA” companies (Google, Apple, Facebook, Amazon) are gearing up to move into the telecoms service market and build on their revenues from other sources such as devices and advertising that target the consumer.

·       Infrastructure disruption by Tech/OTT and specialized companies: increasingly this comes not only from specialized towers and fiber companies, but Tech/Internet companies such as Google and Facebook who are making direct investments into network deployment, last mile access and Wi-Fi/wireless internet infrastructure.

·       Consumer franchise disruption: digital convergence means that connectivity will be increasingly sold in bundles as opposed to standalone, with different forms of subsidizing taking place. This will mean more disruption of the Communications companies’ B2C business by content providers, pay TV, cable and tech/OTT and possibly also retail and consumer electronics companies.

·       Regulatory disruption of vertical integration: driven by the desire to boost universal access, regulators sometimes force the open sharing or full separation of the infrastructure.

A decreasing EBITDA-capex ratio in the industry is signalling that cost restructuring is no longer enough to sustain cash flow generation. For CSPs, moving out of their comfort zone will require radical strategic moves at speed, instead of depending on returns generated from imperfect infrastructure competition.

Inertia keeps much-needed investment cash leaking away into dividends and capex 

Negative growth rates, increasing Capex investments and plummeting ROIC. A decreasing EBITDA-Capex ratio is signalling that cost restructuring is no longer enough to sustain cash flow generation.

Against the background of intense disruption which I covered earlier, a number of different challenges are emerging which CSPs must address to be successful in this brave and courageous new world.

·       Changing rules of the game: driven by lower barriers-to-entry; collapsing market boundaries; traditional growth approaches that are no longer sufficient and write offs of historic positions of strength (and assets).

·       Shift and disruption of value: with a commoditized core not generating sufficient returns and creating a need for strong dividend policies to sustain stock prices, CSP businesses are challenged to find any ability to invest. A “me-too” approach to digital initiatives is not offsetting the decline.

·       The liquid consumer is on the rise: there’s an ongoing reduction of customer stickiness and a high retention cost, demonstrating brand fatigue; and the fact that incumbency is no longer seen as an advantage.

·       Outdated playbook: business models are still infrastructure-bound with perceived value in vertical integration and silos. Un-scalable operating and technology models and legacy workforces need radical change.

Time to Accelerate And Jump The S-Curves

The industry is heading in two directions – with the choice between a) a dumb pipe utilities model and b) a growth driven business model based on newly built advantages in the less regulated digital service layer. We would argue that, while consolidation in the infrastructure domain certainly will provide value, few CSPs would accept ‘dumb pipe’ as their core strategy. However, a gap is emerging between operators that are making significant bets towards digital services powered by platform bets, and those who seem less prepared to challenge the status quo.

I’ve talked about “jumping the S-Curve” in a previous article, highlighting the imperatives for adopting a platform-based model and transforming the core of the business. There’s now a powerful survival incentive for Communications Service Providers to move at high speed to position for future growth – and to find the cash to invest to do so.

Can CSPs rise to the challenge fast enough?