Analyst Angle (Special Edition): The forces affecting telecom operators

Editor’s Note: Welcome to our weekly feature, Analyst Angle. We’ve collected a group of the industry’s leading analysts to give their outlook on the hot topics in the wireless industry. This article is an excerpt from RCR Wireless News’ July Special Edition, “Riding the Wave: The Forces Impacting Carrier Strategy.” The 80-page special edition is available here.
After decades of slow progress, the telecom world is undergoing rapid change. Since the Bell breakup in 1984, market forces have played increasing roles in shaping our nation’s telecommunications industry.
Today, the mobile sector is the most competitive part of the industry, with four major national players, a range of mobile virtual network operators, substitute calling options like Google Inc.’s Voice or Skype Ltd., and data only players led by Clearwire Corp.’s Clear. I’m no Pollyanna: the market does still bear obvious signs of oligopoly (SIM locks, roaming rates, etc.), but the general trend is toward increased competition and more choice for consumers.
In this increasingly competitive environment, it starts to make sense to apply some of the classic business tools. One of the more interesting frameworks is Harvard professor Michael Porter’s Five Forces (5F). The 5F are useful here precisely because they examine a company’s competitive position based on the clout they carry and on the clout they must endure from other stakeholders. Really, Porter’s 5F were meant to determine how attractive an industry sector was, meaning, could a player in that sector expect to earn higher profits than in other sectors.
Porter proposed that companies face five main forces that, combined, affect the ability to extract economic rent (supernormal profit) from the market:
1. The threat of entry of new competitors: When it is very easy for other companies to enter a sector, the sector is less “attractive.” New companies will enter the sector, raising supply, lowering profit until the profit rate is no longer attractive.
2. The intensity of competition: If the existing players in the industry are highly competitive, they will offer more/better services and/or charge less to win customers. On the other hand, if competition is not intense, higher profit margins can be maintained.
3. The threat of substitute products: Not only is a company affected by other competitors in the same sector, but also by substitute products. The classic example of market myopia is the railroad industry, which ignored competition in a substitute from the fledgling trucking industry.
4. The negotiating power of suppliers: If your suppliers are powerful, and have some kind of clout (scale, regulatory protection, brand, monopoly), they will likely extract a large share of profits in a supply chain (producer’s surplus).
5. The negotiating power of customers: If the customers are organized and powerful (for example, Wal-Mart Stores Inc. is your customer), then the customer will leverage this clout to get more for less, and reduce profitability.
So with that brief primer out of the way, let’s have a look at how Porter’s Five Forces currently affect a typical national carrier in the mobile telecom industry sector.
1. The threat of entry of new competitors.
The mobile carrier space in the United States started back in the analog days as radio telephones and then analog-based cellular systems. In those days, it wasn’t a particularly attractive market. High costs and few customers limited carphones and bagphones to tools for the rich or very senior executives. But as cellular developed, it was generally planned that there would be enough business to fuel a two-carrier market in most service areas. An “A” carrier would usually be the fixed telecom incumbent and a “B” carrier would be a new entrant who won the rights to compete in that federally defined service area.
Naturally, a two-carrier market didn’t exactly demonstrate burning hot competition. The two carriers generally offered similar services at similar prices. The main differentiators were coverage area and roaming abilities.
In the current environment, we have long upgraded to efficient digital networks, and have held multiple spectrum auctions that allowed new entrants to emerge. Mergers and acquisitions have allowed the once-regional cellular companies to grow into national players, and a few regional players are cherry picking the urban areas (ex: MetroPCS Communications Inc.), while cable operators are launching into the market this year along with progress from data-centric players like Clearwire.
Meanwhile, MVNOs are also growing in import in the United States market. And while the high-profile examples of these network-renting carriers (ex: ESPN, Helio) have flamed out, the “Turtle and the hare” story applies: lots of slow and steady MVNOs (ex: Tracfone Wireless Inc.) are making sagacious inroads across North America, and reaching segments the marquee carriers couldn’t find. Though not network operators, these MVNOs add to the competitive landscape.
Overall, we are seeing an increase in the number of wireless carriers at rates we have never seen before. This certainly will make the market more competitive. In fact, we can look at many case studies here and abroad to see the effect of well-capitalized new entrants. When Hutchison Whampoa launched 3UK, we saw that new carriers start with zero customers, and, thus, are very hungry to “steal” them from the incumbents. Unusually low prices are standard fare with new entrants.
Some credit has to be given to federal regulators for designing spectrum auctions to benefit smaller players and new entrants. They are trying to create a more competitive cellular market, with some amount of success. As a note to our Canadian readers, you too are seeing the fruit of just such a spectrum auction, which is spurring an unprecedented rush of new carriers into the high-priced Canadian cellular market.
But the cellular sector is not the “Wild West,” where anybody can set up shop as a cellular carrier. The reality is that it is very challenging for new entrants to establish themselves in any major market. The barriers to entry are numerous and foreboding. Here are some of the hurdles:
1. It takes tremendous capital to build a cellular network, backhaul, operations center.
2. It takes tremendous capital to subsidize handsets. Every new subscriber actually starts out by costing money.
3. It takes tremendous capital to fund marketing, including brand awareness as a mobile carrier, distribution deals, and retail locations. This barrier is often underestimated, notably by some failed MVNOs.
4. It requires spectrum licenses across multiple service areas in order to offer a viable cellular service. The auctions are infrequent, have limited bandwidth on offer. To bid, the candidates must meet various requirements, and of course … they had better bring an immense amount of capital.
5. It requires some amount of political influence to out-maneuver the incumbents on regulatory issues, which are often stacked in their favor.
6. Operating a cellular carrier requires specific human resources, with specialized skills. It requires a field force to install and maintain the physical assets. It requires a training division. It requires a support group. It requires web experts to build a reliable website. These human resources are in limited supply and expensive.
So, any new entrant in the cellular industry faces myriad risks, and needs to put tremendous capital on the line. The new entrants must do this, while sustaining competition from incumbent carriers that have long since amortized much of their capital expenditures, and thus have a lower cost basis. Should a new entrant succeed enough to become a threat to the incumbent, the incumbent will lower its price and squeeze the newcomer’s margin.
So, from a Porter
perspective, there are especially daunting barriers to entr
y in the cellular market. It is only because the market is so lucrative that investors are willing to run the gauntlet, and put so much money at stake.
2. The intensity of competition.
Thus far, the intensity of competition in the United States market has been languid (and the Canadian market has been a notch or two less). This point is often debated hotly in articles, blogs, inside the beltway, and by consumer groups and lobbyists. Most recently, telecom analyst Tomi Ahonen and CTIA President Steve Largent engaged in a vibrant online debate. The problem with debating the question “Is the U.S. domestic cellular industry competitive?” is that there are, in reality, many different answers. Are we competitive…
… on a pure per-minute cost basis? Yes.
… on coverage? Yes.
… on data speeds? Yes.
… on value-added services, such as family finder, roaming, ringtones, data roaming? No.
The problem is a lack of perfect information: consumers just can’t compare every aspect of cellular service when comparing carriers. They only have mindshare for the core factors: cost per minute, the handset, coverage and perhaps SMS/data fees. So it is on those factors that carriers compete and this is readily evident in their advertising. Beyond those factors, there is just about zero competition. That’s why customer support is universally bad, roaming rates shock the customer, phones are SIM-locked and there is no discount for customers who bring their own phone.
That said, there is competition for the core factors, and it is growing with new entrants and with market saturation. As the market matures, competition will spread from the core to ancillary value-added services. This is evidenced today by a shift to tiered pricing on data services, which offers more options instead of the un-competitive one-size-fits-all approach with carrier pricing in lock-step.
3. The threat of substitute products.
Wireless telecom carriers, in most cases, are the substitute product in the current era. They are substitutes for fixed-line services, and as such are benefitting from fixed-mobile substitution.
If we portray the carriers as purveyors of mobile voice services, then they are under threat from Skype, Google Voice, Facetime, tablets and all the other VoIP solutions. However, the correct way to portray the carriers is not as “voice” companies, but as mobile connectivity companies. Currently, every carrier is managing a transition of their revenues from declining voice to increasing data. The value of mobile connectivity, and the demand for it, is currently increasing, and the range of substitutes is currently limited. Unlicensed frequency options (ex: Wi-Fi, UWB) still lack the reliability and coverage, satellite options are higher cost and introduce latency. Even “radical” new technologies like WiMAX can’t beat the incumbent juggernaut … and if they ever could, then the incumbents would adopt them and moot the advantage.
So, for now, mobile carriers have very little threat from substitute products.
4. The negotiating power of suppliers.
Telecom suppliers have undergone a great deal of consolidation recently. The classic infrastructure vendors have been reduced to Alcatel-Lucent, Ericsson, and Nokia-Siemens Networks. So one might think that the new, larger vendors had greater influence. However, we do see the staggering growth of, Chinese vendors, ZTE Corp. and Huawei Technologies Co. Ltd., and to a lesser extent, Datang Telecom Technology.
While the United States network operators have historically preferred to use Western vendors, they have recently shown an increased willingness to work with the Chinese newcomers. And whether a United States network operator wants to buy equipment from Huawei or not, they will certainly use the Chinese vendors as negotiating tools against the legacy suppliers. Thus, there is such animated competition in the telecom infrastructure sector that it is a “buyer’s market.”
The carriers face almost no threat of negotiating power from their suppliers.
5. The negotiating power of customers
The customer is, ultimately, where all the money comes from in the whole industry. They are the ones paying the bill every month, and funding all of our jobs and all of the investor’s gains. So, one would think that they have a lot of clout against the telcos and would negotiate for a great service at a low price. However, that just isn’t the case. Consumers hold very little clout in this equation, and the reason boils down to one of organization. Unfortunately for consumers, they are a disparate, disjointed group – each one (individually) insignificant to the carrier. The carriers, on the other side of the table, are well-organized, savvy and few. It’s the classic mismatch.
And the mismatch is strategically managed by carriers. Terms of service are obtuse, hard to understand, written in legalese and hidden in long documents with small fonts that almost nobody reads. Prices are confusing and don’t lend themselves to easy comparison. Many fees, such as “Federal Recovery Fees” appear on the bill, but not in advertised prices. The obfuscation is so palpable that it offers a market opportunity for certain new entrants offering a “simple pricing plan” as their differentiator.
Yes, customers are important and they do choose among multiple carriers. But they do so with limited information, limited understanding and their information is influenced by big-budget carrier advertising. We know that a good phone or a good user interface is rewarded by the marketplace … but customers have very limited influence as to exactly what phones and features ever make it to market.
To summarize, customers in the United States have very limited negotiating power.
Conclusion
So, what’s the upshot? Is it good to be a carrier in the United States? Based on Porter’s 5F, it looks like a resounding “Yes!”
There are new entrants, but in reality there are high barriers to sector entry. Competition is intense for commoditized voice minutes, but there are numerous value-added services carriers offer that are not commoditized. There are no substitute products on the horizon that threaten cellular networks. The telco’s suppliers are reeling from intense price competition in their sector, benefitting carriers. And customers are too dispersed to mount much of a negotiating threat.
Based on a 5F analysis, one can see that in spite of growing competition the mobile carrier sector can sustain an attractive rate of profitability. No surprise, then, that there is a line-up of entrants willing to invest.