Article

Unbundling the Telecoms Conglomerate

While some telecoms CEOs seek greater scale and scope through ever larger transactions, a new breed of more focused competitors is emerging.

Par Mike Garstka

First published on décembre 02, 1999
min


As U.S. and European telecoms companies grow through a series of ever more breathtaking megamergers, their Asian counterparts are under pressure to undertake breakthrough transactions of their own. They perceive a risk of being left on the sidelines as a new industrial landscape takes shape. Both NTT and SingTel have made recent hundred-million-dollar deals in the region, and market rumors suggest that even more significant transactions are in the works. But while some telecoms CEOs seek greater scale and scope through ever larger transactions, a new breed of more focused competitors is emerging. These third-generation telcos offer an alternative to the conventional wisdom of "bigger is better" during this period of turbulent change in telecoms. The computer industry provides a salutary lesson on the values of swift and differentiated strategy in such times of change. IBM, Data General, Digital and Wang were the corporate icons that dominated the early years of the computer age. But when technological change accelerated and PC growth took off, these vertically integrated companies were slow to adapt. As these incumbents clung to their outdated business model, focused start-up competitors fragmented the computer industry into a series of companies with pure play "horizontal" models. These former start-ups now dominate the global computer industry — Intel in microprocessors, Microsoft in operating systems and applications, Cisco in networking technology and Dell in PC assembly. These four are now among the world's 50 largest public companies. Of the former computer dinosaurs, only IBM is in the top 50. The lesson? In times of turbulence, leaders who miss the early warnings, or respond too slowly, lose out to fast-moving new entrants. Today 10 incumbent telcos are among the world's 100 largest public companies, with a combined market value of over $1 trillion. In Asia, incumbent telcos such as NTT, Cable & Wireless HKT, Telekom Malaysia, Philippine Long Distance Telephone, and Telstra are among the largest listed companies on their local stock exchanges. If these incumbents cling to previously successful business, they risk being displaced, like the dinosaurs of the early computer age. Like the computer industry giants a decade ago, the first generation telcos are also vertically integrated. Their strategy has been to serve all customers with all products at a common service level. This business model involves running an end-to-end network, participating in all value chain activities (sales, billing, customer service, network operations) and owning 100% of their assets. Other elements of this original business model are also holdovers from the past. The companies finance investments via operating cashflow, use limited (if any) leverage, and pay out high levels of dividends. Investment cycles are long with depreciation periods of 10-20 years on fixed assets. Decision rules are, as a result, conservative. The pace is driven by a dominant former utility/civil service culture. For years, this has been an extremely profitable business — a protected monopoly at home, an oligopoly cartel in the international arena. The entry of second generation telcos was enabled by the first round of telecoms deregulation and provided the first challenge to this established order. But second entrants like Binariang in Malaysia, Dacom in Korea, and TelecomAsia in Thailand have tended to copy the business model of their rival incumbent, inevitably on a smaller scale. Battle was engaged between companies with essentially the same business model. The environment in which telcos operate today is changing more dramatically. This is due in part to advances in technology — fiber optics, wireless, compression, processing power and the shift to IP/packet switching and transmission. There has also been deregulation; explosive growth in adjacent data, internet, and mobile markets; new financial engineering options (private equity, high yield debt and off balance sheet financing); and the financial market's high rewards to mid-size high-growth companies. The impact of these changes on the incumbent's market position will be more dramatic than the introduction of second entrants. Price declines of up to 90% should occur, and share loss is expected to accelerate. The third generation telco can now "deconstruct" the lumbering telco of the past — both the incumbent and the second entrant — and reconfigure the limited set of pieces he needs to attack a highly focused set of profit pool opportunities. The result will be competitors with completely new business models. Who are these third generation telcos? They are companies such as Level Three, Northpoint, Covad, WinStar and NexTel in the US; COLT in the UK; Diginet and MetroRed in Argentina; and PowerTel in Australia. Each in a different way has picked a specific targeted customer and product set and built a tightly defined business model around it. They have built only a limited part of a network (typically enabled by new lower cost technology and/or a regulatory change) and focused their business models on those critical activities they need to excel, outsourcing the rest. They are typically start-ups, initially financed by private equity firms that have highly incentivized management teams. They operate at a blistering pace of decision making and execution that is unfamiliar to traditional incumbents. They have used their strategic and operational focus to build share aggressively in the highest growth, most profitable segments of the telecoms market. These third generation telcos have not yet hit Asia in full force, but the door is opening. The region's mobile markets, where new entrants have already taken significant share from the incumbents, provide an indication of what type of impact they can have once unleashed on less agile competitors. It is time for some critical thinking by the region's incumbents. Incumbent senior management teams must ask themselves: Where should we focus — on which customer, product, and geographic niches — to maximize growth and profitability? Perhaps more importantly, what do we stop doing? What should my business model look like? If we could start from scratch, which parts of our business and network would we keep, and which not? Would the market value us more highly than it does today if we operated as a series of separate companies? These questions make clear that it is radical strategic and structural change, not incremental operational adjustments that incumbents need to be considering in this time of turbulence. Both speed and strategy matter. The tendency is to delay decisions, as today's profit margins remain high and the new entrants are mere minnows. But delay could be fatal in today's fast moving environment. Cable & Wireless HKT's market share collapse and its recent first reported losses highlight the velocity of the challenges ahead. In reflecting on the management angst and inertia in transforming Intel, former CEO Andy Grove noted that even he moved too slowly. "In times of change, managers almost always know which direction they should go in, but usually act too late and do too little. Correct for this tendency: Advance the pace of your actions and increase their magnitude. You'll find that you're more like likely to be close to right." His advice is equally applicable to the CEOs and management teams of incumbent telcos today. When the dust settles on the Asian telecoms wars of the early 21st century, will today's incumbents be the fast and flexible leaders of a redefined industry, or will they join the unresponsive former icons of the early computer age, victims of their own early success? Mr. Garstka is vice president with Bain & Company in Singapore. Copyright © 1999 Dow Jones & Company, Inc. All Rights Reserved.

As U.S. and European telecoms companies grow through a series of ever more breathtaking megamergers, their Asian counterparts are under pressure to undertake breakthrough transactions of their own. They perceive a risk of being left on the sidelines as a new industrial landscape takes shape. Both NTT and SingTel have made recent hundred-million-dollar deals in the region, and market rumors suggest that even more significant transactions are in the works.

But while some telecoms CEOs seek greater scale and scope through ever larger transactions, a new breed of more focused competitors is emerging. These third-generation telcos offer an alternative to the conventional wisdom of "bigger is better" during this period of turbulent change in telecoms.

The computer industry provides a salutary lesson on the values of swift and differentiated strategy in such times of change. IBM, Data General, Digital and Wang were the corporate icons that dominated the early years of the computer age. But when technological change accelerated and PC growth took off, these vertically integrated companies were slow to adapt. As these incumbents clung to their outdated business model, focused start-up competitors fragmented the computer industry into a series of companies with pure play "horizontal" models.

These former start-ups now dominate the global computer industry — Intel in microprocessors, Microsoft in operating systems and applications, Cisco in networking technology and Dell in PC assembly. These four are now among the world's 50 largest public companies. Of the former computer dinosaurs, only IBM is in the top 50.

The lesson? In times of turbulence, leaders who miss the early warnings, or respond too slowly, lose out to fast-moving new entrants.

Today 10 incumbent telcos are among the world's 100 largest public companies, with a combined market value of over $1 trillion. In Asia, incumbent telcos such as NTT, Cable & Wireless HKT, Telekom Malaysia, Philippine Long Distance Telephone, and Telstra are among the largest listed companies on their local stock exchanges. If these incumbents cling to previously successful business, they risk being displaced, like the dinosaurs of the early computer age.

Like the computer industry giants a decade ago, the first generation telcos are also vertically integrated. Their strategy has been to serve all customers with all products at a common service level. This business model involves running an end-to-end network, participating in all value chain activities (sales, billing, customer service, network operations) and owning 100% of their assets.

Other elements of this original business model are also holdovers from the past. The companies finance investments via operating cashflow, use limited (if any) leverage, and pay out high levels of dividends. Investment cycles are long with depreciation periods of 10-20 years on fixed assets. Decision rules are, as a result, conservative. The pace is driven by a dominant former utility/civil service culture. For years, this has been an extremely profitable business — a protected monopoly at home, an oligopoly cartel in the international arena.

The entry of second generation telcos was enabled by the first round of telecoms deregulation and provided the first challenge to this established order. But second entrants like Binariang in Malaysia, Dacom in Korea, and TelecomAsia in Thailand have tended to copy the business model of their rival incumbent, inevitably on a smaller scale. Battle was engaged between companies with essentially the same business model.

The environment in which telcos operate today is changing more dramatically. This is due in part to advances in technology — fiber optics, wireless, compression, processing power and the shift to IP/packet switching and transmission. There has also been deregulation; explosive growth in adjacent data, internet, and mobile markets; new financial engineering options (private equity, high yield debt and off balance sheet financing); and the financial market's high rewards to mid-size high-growth companies.

The impact of these changes on the incumbent's market position will be more dramatic than the introduction of second entrants. Price declines of up to 90% should occur, and share loss is expected to accelerate.

The third generation telco can now "deconstruct" the lumbering telco of the past — both the incumbent and the second entrant — and reconfigure the limited set of pieces he needs to attack a highly focused set of profit pool opportunities. The result will be competitors with completely new business models.

Who are these third generation telcos? They are companies such as Level Three, Northpoint, Covad, WinStar and NexTel in the US; COLT in the UK; Diginet and MetroRed in Argentina; and PowerTel in Australia. Each in a different way has picked a specific targeted customer and product set and built a tightly defined business model around it.

They have built only a limited part of a network (typically enabled by new lower cost technology and/or a regulatory change) and focused their business models on those critical activities they need to excel, outsourcing the rest. They are typically start-ups, initially financed by private equity firms that have highly incentivized management teams. They operate at a blistering pace of decision making and execution that is unfamiliar to traditional incumbents. They have used their strategic and operational focus to build share aggressively in the highest growth, most profitable segments of the telecoms market.

These third generation telcos have not yet hit Asia in full force, but the door is opening. The region's mobile markets, where new entrants have already taken significant share from the incumbents, provide an indication of what type of impact they can have once unleashed on less agile competitors. It is time for some critical thinking by the region's incumbents.

Incumbent senior management teams must ask themselves: Where should we focus — on which customer, product, and geographic niches — to maximize growth and profitability? Perhaps more importantly, what do we stop doing? What should my business model look like? If we could start from scratch, which parts of our business and network would we keep, and which not? Would the market value us more highly than it does today if we operated as a series of separate companies?

These questions make clear that it is radical strategic and structural change, not incremental operational adjustments that incumbents need to be considering in this time of turbulence. Both speed and strategy matter. The tendency is to delay decisions, as today's profit margins remain high and the new entrants are mere minnows. But delay could be fatal in today's fast moving environment. Cable & Wireless HKT's market share collapse and its recent first reported losses highlight the velocity of the challenges ahead.

In reflecting on the management angst and inertia in transforming Intel, former CEO Andy Grove noted that even he moved too slowly. "In times of change, managers almost always know which direction they should go in, but usually act too late and do too little. Correct for this tendency: Advance the pace of your actions and increase their magnitude. You'll find that you're more like likely to be close to right." His advice is equally applicable to the CEOs and management teams of incumbent telcos today. When the dust settles on the Asian telecoms wars of the early 21st century, will today's incumbents be the fast and flexible leaders of a redefined industry, or will they join the unresponsive former icons of the early computer age, victims of their own early success?

Mr. Garstka is vice president with Bain & Company in Singapore.