Wall Street Journal

Mobile Markets on the Move

Successful mobile operators will be those who seek to redefine their economics and upside opportunities by reconfiguring their entire business model.

Di Michael Garstka

First published on ottobre 25, 2000
Tempo di lettura min.


The mobile market is on the move. Over a quarter-trillion dollars has been stripped from the value of the major mobile telcos since the third generation (3G) mobile license auction earlier this year in Great Britain. At the same time, telecoms debt has been aggressively downgraded, which means it will become increasingly difficult to finance the half-trillion dollars purportedly needed for 3G broadband wireless networks globally. Are the capital markets over-reacting, or is 3G an extinction- level event for mobile operators? For some, extinction is clearly on the horizon. Funded by ready access to public debt and equity markets, and accelerated by the adoption of a common GSM technology standard and deregulation, a large number of second generation (2G) digital wireless networks and mobile operators rapidly proliferated in Europe and Asia in the 1990s. These digital networks displaced first generation (1G) analog cellular networks, which remained dominant in the US for much longer. Local regulatory regimes introduced multiple carriers (at one point up to seven in Hong Kong), which drove down prices and accelerated subscriber growth to the point where there are now more mobile phones than fixed lines in many Asian and European countries. But after all this investment, many are still not making any money. In a capital-intensive, heavily fixed-cost business such as wireless, profitability is heavily driven by market share dominance. It is thus not surprising that of the more than fifty mobile operators in Asia only a limited few are making money. Few operators other than the market leaders and near followers will earn positive long-term returns on capital. Winning market share for a new entrant requires growing faster than the existing competitors. Optus Mobile's profitable growth in Australia has been powered by a mix of branding, innovative tariffing and superior channel management that has the company taking share from Telstra MobileNet quarter-on-quarter for eight consecutive quarters, shifting its relative market share from 50% to 70%. But gaining share is not the whole business. While Hutchison has displaced the former HKT mobile business in subscriber share in Hong Kong, it's been chasing some of the least valuable customers — keeping revenue and profits below those of its rival. But it is the operators in distant follower positions — such as One.Tel and AAPT in Australia and Sunday and People's in Hong Kong — that are more strategically challenged. Like Shinsegi and Hansol in Korea, their future is likely tied to consolidation dynamics as an increasing portion of their value is in their scarce spectrum assets. But just as consolidation threatens to return rationality to the 2G space, 3G has captured the imagination of mobile operators. Compared to 2G networks, 3G will provide broadband connections to mobile customers, will primarily transmit data, and transfer that data via packet vs. traditional circuit switching. But for all the excitement, the economics of network-based mobile operators in 3G are likely to be even tighter than in 2G. Building a 3G network will be around 50% more expensive than a 2G network and more fixed-cost in nature. This is driven by three factors: the larger number of base stations required because of the higher frequency of 3G; a higher unit cost of the new technology base stations; and the additional cost of spectrum. As a result, 3G operator breakevens will be higher than for 2G, potentially as high as 25-30% market share. There are a couple of relatively straightforward but dramatic implications to this. There is room for two — at a stretch, three — profitable 3G network operators in most national markets. As a result, leadership becomes even more important. In the race for 3G leadership, an existing scale 2G network operator with an established customer base, brand and distribution channels is significantly advantaged. That is why it isn't a surprise that the capital markets reacted with shock when participants bid billions of dollars for each of six 3G licenses in Germany. Japan in contrast issued only three 3G licenses, with no spectrum fees. Some markets will clearly be more challenging than others. Successful mobile operators will be those who seek to redefine their economics and upside opportunities by reconfiguring their entire business model. The key design principles are deconstruction and focus. The next few years are likely to see considerable vertical and horizontal deconstruction of the traditional mobile operator. The size of 3G investments, their technology risks and resulting higher minimum efficient scale of a mobile network will drive the separation of traditional mobile operators into asset-intensive network companies and more nimble customer relationship companies. In some markets this is already emerging with the entry of so called "virtual mobile network operators" or VMNOs. Leveraging its brand franchise in the UK and now into Asia, Virgin Mobile is one of the early pure play movers in this space. Separation of the asset-intensive assets from the customer-focused ones will drive increased managerial focus, enable differential balance sheet structures of the two parts, and provide shareholders with different risk/return options. It would follow trends in other industries of shifting capital intensive "factory" functions off the balance sheet — Coke with its bottlers, Marriott with its hotel real estate, airlines with their aircraft, and semiconductor companies with their fabs. More importantly, it provides the management of the customer facing business increased focus and more strategic and financial degrees of freedom for winning in this increasingly competitive space. For AOL, for example, the development of its instant messenger product was profoundly more strategic than further investment in the modems and routers of the physical network providing customers access to AOL. In this hyper-competitive market, carving out a specialized niche will become increasingly important. Some operators will win in the mass market space. With over 13 million primarily young subscribers exchanging e-mails, downloading music and ring tones, and playing interactive games on the move, NTT DoCoMo has dominated the mass market internet in Japan. Other operators will potentially focus on the higher usage and high revenue generating business and corporate customers. Interestingly, the recently merged KDDI — Japan's number two operator — is tapping into this segment. KDDI's customer base spends more per subscriber than NTT DoCoMo's, even with all the additional data revenues generated by i-mode. Business customers are switching to KDDI's mobile service largely due to line congestion. The economics of 3G suggest that while the capital markets response has been directionally correct, as with most blunt instruments it has been precisely wrong. The eventual losers in 2G and 3G remain overvalued today, but many of the ultimate market leaders are undervalued. It is up to mobile operator management teams to develop and execute on the increasingly differential strategies necessary to keep them on the right side of this divide. Shareholders will become more demanding of those management teams without the vision to steer clear of extinction level events. Mr. Garstka is a vice president with Bain & Company in Singapore and leader of Bain's Asian telecoms practice. Practice members Satish Shankar and Ravi Vijayaraghavan contributed to this article.

The mobile market is on the move. Over a quarter-trillion dollars has been stripped from the value of the major mobile telcos since the third generation (3G) mobile license auction earlier this year in Great Britain. At the same time, telecoms debt has been aggressively downgraded, which means it will become increasingly difficult to finance the half-trillion dollars purportedly needed for 3G broadband wireless networks globally. Are the capital markets over-reacting, or is 3G an extinction- level event for mobile operators? For some, extinction is clearly on the horizon.

Funded by ready access to public debt and equity markets, and accelerated by the adoption of a common GSM technology standard and deregulation, a large number of second generation (2G) digital wireless networks and mobile operators rapidly proliferated in Europe and Asia in the 1990s. These digital networks displaced first generation (1G) analog cellular networks, which remained dominant in the US for much longer. Local regulatory regimes introduced multiple carriers (at one point up to seven in Hong Kong), which drove down prices and accelerated subscriber growth to the point where there are now more mobile phones than fixed lines in many Asian and European countries.

But after all this investment, many are still not making any money. In a capital-intensive, heavily fixed-cost business such as wireless, profitability is heavily driven by market share dominance. It is thus not surprising that of the more than fifty mobile operators in Asia only a limited few are making money. Few operators other than the market leaders and near followers will earn positive long-term returns on capital.

Winning market share for a new entrant requires growing faster than the existing competitors. Optus Mobile's profitable growth in Australia has been powered by a mix of branding, innovative tariffing and superior channel management that has the company taking share from Telstra MobileNet quarter-on-quarter for eight consecutive quarters, shifting its relative market share from 50% to 70%. But gaining share is not the whole business. While Hutchison has displaced the former HKT mobile business in subscriber share in Hong Kong, it's been chasing some of the least valuable customers — keeping revenue and profits below those of its rival.

But it is the operators in distant follower positions — such as One.Tel and AAPT in Australia and Sunday and People's in Hong Kong — that are more strategically challenged. Like Shinsegi and Hansol in Korea, their future is likely tied to consolidation dynamics as an increasing portion of their value is in their scarce spectrum assets. But just as consolidation threatens to return rationality to the 2G space, 3G has captured the imagination of mobile operators. Compared to 2G networks, 3G will provide broadband connections to mobile customers, will primarily transmit data, and transfer that data via packet vs. traditional circuit switching.

But for all the excitement, the economics of network-based mobile operators in 3G are likely to be even tighter than in 2G. Building a 3G network will be around 50% more expensive than a 2G network and more fixed-cost in nature. This is driven by three factors: the larger number of base stations required because of the higher frequency of 3G; a higher unit cost of the new technology base stations; and the additional cost of spectrum. As a result, 3G operator breakevens will be higher than for 2G, potentially as high as 25-30% market share.
There are a couple of relatively straightforward but dramatic implications to this. There is room for two — at a stretch, three — profitable 3G network operators in most national markets. As a result, leadership becomes even more important. In the race for 3G leadership, an existing scale 2G network operator with an established customer base, brand and distribution channels is significantly advantaged. That is why it isn't a surprise that the capital markets reacted with shock when participants bid billions of dollars for each of six 3G licenses in Germany. Japan in contrast issued only three 3G licenses, with no spectrum fees. Some markets will clearly be more challenging than others.

Successful mobile operators will be those who seek to redefine their economics and upside opportunities by reconfiguring their entire business model. The key design principles are deconstruction and focus.

The next few years are likely to see considerable vertical and horizontal deconstruction of the traditional mobile operator. The size of 3G investments, their technology risks and resulting higher minimum efficient scale of a mobile network will drive the separation of traditional mobile operators into asset-intensive network companies and more nimble customer relationship companies. In some markets this is already emerging with the entry of so called "virtual mobile network operators" or VMNOs. Leveraging its brand franchise in the UK and now into Asia, Virgin Mobile is one of the early pure play movers in this space.

Separation of the asset-intensive assets from the customer-focused ones will drive increased managerial focus, enable differential balance sheet structures of the two parts, and provide shareholders with different risk/return options. It would follow trends in other industries of shifting capital intensive "factory" functions off the balance sheet — Coke with its bottlers, Marriott with its hotel real estate, airlines with their aircraft, and semiconductor companies with their fabs. More importantly, it provides the management of the customer facing business increased focus and more strategic and financial degrees of freedom for winning in this increasingly competitive space. For AOL, for example, the development of its instant messenger product was profoundly more strategic than further investment in the modems and routers of the physical network providing customers access to AOL.

In this hyper-competitive market, carving out a specialized niche will become increasingly important. Some operators will win in the mass market space. With over 13 million primarily young subscribers exchanging e-mails, downloading music and ring tones, and playing interactive games on the move, NTT DoCoMo has dominated the mass market internet in Japan. Other operators will potentially focus on the higher usage and high revenue generating business and corporate customers. Interestingly, the recently merged KDDI — Japan's number two operator — is tapping into this segment. KDDI's customer base spends more per subscriber than NTT DoCoMo's, even with all the additional data revenues generated by i-mode. Business customers are switching to KDDI's mobile service largely due to line congestion.

The economics of 3G suggest that while the capital markets response has been directionally correct, as with most blunt instruments it has been precisely wrong. The eventual losers in 2G and 3G remain overvalued today, but many of the ultimate market leaders are undervalued. It is up to mobile operator management teams to develop and execute on the increasingly differential strategies necessary to keep them on the right side of this divide. Shareholders will become more demanding of those management teams without the vision to steer clear of extinction level events.

Mr. Garstka is a vice president with Bain & Company in Singapore and leader of Bain's Asian telecoms practice. Practice members Satish Shankar and Ravi Vijayaraghavan contributed to this article.