Wednesday, 11 February 2009

“Rule of Three” and Indian Telecom Industry

In reference to one of my earlier blogs, (“India IT industry…”) it would be interesting to see how Satyam saga impacts the Indian IT industry, even though the recent moves being made by stakeholders are very positive. Also, one of the comment was a request to discuss the impact of the economic slowdown on the Indian Telecom industry; so here goes…my views on how this sector could evolve over the next few years… 

Rule of 3 (Ro3)
Before we begin, let us review the”Rule of three”; the contention in this rule is, in a mature market where competitive forces are allowed to thrive free of government interference or other special circumstances, the market driven result will be the situation where three companies and only three will dominate any given market. Whether it's U.S. fast food restaurants (McDonald's, Burger King and Wendy's) or South Korean chipmakers (Goldstar, Hyundai and Samsung), or US car manufacturers (Ford, GM, and Chrysler), each industry, has its "big three" dominant players. 
The current challenge, in the US with the auto industry could be attributed to this rule playing out…where the Japanese makers, especially Toyota, and Honda have become “domestic” manufacturers and now, the space is clearly crowded…resulting in competitive pressures on the “auto big three”, where it is unlikely, that all of them will continue to exist in their current form (it is simplistic to blame employee pension costs for the problems that the US auto big three faces).  The CSP industry in the US has AT&T, Verizon, and Sprint.
Many of you will think “So why not two or four?”
The proponents of this rule explains that, consumers value a manageable choice between three suppliers, but that additional choice just creates `clutter', and confusion in the market. Finally, the dilution of market share with four major players can also lead to instabilities, driving the weakest into the ditch. Industry consolidation is the key force playing a major role in the application of the theory, and this trend gathers steam whenever growth slows.

Indian Telecom industry
The Indian Telecom industry is shining belying slowdown blues. It’s the fastest growing telecom market globally with subscriber base of 384 million (please do not quote these numbers….they may have changed already!!!) and expected to go up to 500 million by 2010 and 750 million by 2012. Financial projections also indicate that the revenue generated from this sector will grow from current $ 20 bn to $ 35 bn in 2010.
It’s been a long journey (albeit rapid) for an industry that started with just one government player, i.e. BSNL, catering to the communication needs of the entire country. Not very long ago, BSNL operated with antiquated switching equipment and cumbersome manual exchanges. Today, there are multiple players–domestic and international catering to the ever increasing demands of the Indian consumers.With startup spectrum provided to 6 new operators and 3G spectrum auction round the corner, Indian telecom industry is surely changing rapidly. 
The Indian telecom market is in rapid growth stage where incumbents and new entrants are vying for “market space” (adding new mobile phone users both in rural and urban India). Interestingly, profitability of successful Indian service providers continues to improve, despite of continious investment in network coverage expansion, and declining ARPUs (Average Revenue Per User, typically expressed in $ revenue/user/month). 
One of the ways service providers are able to achieve improved performance is by rapid product, service, and business model innovation, examples include;
a) Reliance’s leverage of the CDM IT and Network Infrastructure for GSM launch,
b)Bharti’s revenue/usage sharing models for IT and Network. 
As I mentioned earlier, Ro3 is relevant when growth has slowed and competition is for “market share”.  My view is that in 5 years (by 2014) the competition will be for the “market space”. With penetration levels reaching ~65% of the population, network coverage exceeding 95% of the population and the government allowing market forces to dominate, we should see the Ro3 playing out. The leading effects of Ro3 forces should start shaping the market by 2013.

The Players
1.    The Clear Incumbents: Airtel and Reliance—are the two largest players in the market today and there should be no doubt that these 2 providers are the clear Ro3 incumbents.
2.    The Contenders: Vodafone, Tata Teleservices (TTSL), Idea, Aircel.
3.    The Start-ups: Unitech Wireless, Shyam Telelink, Swan Telecom, Datacom, Loop Telecom, and Stel.
4.    Propped up Navratna Players: MTNL (Mahanagar Telephone Nigam Ltd—services the Delhi and Mumbai metros), and BSNL (Bharat Sanchar Nigam Ltd—services the rest of the country) are promoted by the government
Of the above, only Reliance, BSNL and Airtel are triple play operators providing voice (wireless and wireline), data (high speed), and/or DTH (Direct to Home) satellite services.
Vodafone, Idea and Tata Teleservices are limited to providing voice and data.  The others focuses on voice.
Ro3 Influencers
The way I see it, the following factors could play a role in influencing the outcome when the Ro3 plays out: 
1.    Government: Regulatory direction on Mobile Number Portability (MNP), the minimum holding period before M&A can occur, 3G/Broadband Wireless Access (BWA) spectrum allocation guidelines, and divesting ownership in BSNL/MTNL (if and when).
2.    Foreign operators: Interest in expanding their brand into India;Vodafone is a successful example, the DoCoMo stake in TTSL, and others like Telenor, Telecom Italia, Sistema and Eilisat have taken stake in the start-ups.
3.    Spectrum availability and congestion: Currently all GSM and CDMA operators have crossed the DoT criteria for spectrum congestion and hence some of the small operators (possibly the start-ups) could get acquired for the spectrum that larger operators need (essentially there could be “spectrum” plays)
4.    Corporate Governance: It is hard not to add this as a determining factor on who survives and thrives because of the corporate governance concerns, in a post-Satyam India.

Ro3 Crystal ball:
As I share my view on the possible end state, I want to assert that getting to the “Three” is a process, and in a free market this process will inevitably take time to play out…a lot of water will flow down the Ganges, and a lot of money will be made between now and then. 

Clear Incumbents:
Airtel is the leading provider, has demonstrated brilliant market strategy, is innovative in products and services, has a great brand, and is a well-run organization. It has continued to one-up the completion and has increased their market lead despite fierce competition. Finally, the chances of acquisition by a foreign player are remote…the other way around is more likely.  Airtel is here to stay.

Reliance with its deep pockets, ability to compete on price, strong dealer network, brand recognition, and successful launch of GSM services, and BIG entertainment vision will inevitably be a very strong force here and abroad and it’s fierce completion with Airtel will imply that there are no marriages there, and hence it will certainly be the another one to be around. 

Finally, Reliance and Airtel both being fiercely nationalistic, it is hard to see them sell out to foreign operators (Vodafone had expressed an interest in Airtel before it settled for Hutch Essar).

Reliance and Airtel thus gets my first 2 votes of the future Mega carriers.

I see the impact on the contenders as follows:
1. Idea and Aircel strengths are very complimentary.  Aircel has strong presence in the enterprise market and is a Wimax player.  Idea is primarily focused on the consumer segment.  I can see a merger here.  The other possible option is for a foreign operator to acquire stake in one or both of them, they are better candidates than the start-ups.  Either way, I see that eventually either the combined entity, or acquired entity(s) will consolidate with the Mega Carriers above or the one below.
2.    Vodafone has made impressive gains since the acquisition of Hutch Essar, and is well positioned with the global Vodafone brand and has deep pockets.  It is likely Vodafone will use 3G to survive and thrive.  This would be the 3rd Mega Carrier in my view and gets my final vote
3.    TTS will leverage the benefits that  comes from being a part of the Tata empire and it will take longest to give up or go away, it is hard to see how it could survive even with the strength coming from the group companies and sister company, 'Tata communications'.  The only way I see that TTSL could be a player is, if corporate governance issues impact on any one of the Mega carriers. The staying power and Tata group’s reputed corporate governance will allow TTSL to capitalize on that opportunity and join the big league

The start-up operator story has been interesting, in most cases it is a story of successful business houses, with reasonable liquidity (at the time when they initiated moves), who felt that they could partake in the rapid growth of the telecom market and probably make money (at some time in the process) by selling out.
I believe that all the companies involved have smart business people and they know that their ability to be a Top 3 player is between remote and non-existent. 
My initial thought was that one or more of these start-ups would come to the market with disruptive strategies like; pursuing the most profitable segment of the population (Top 9% of the current subscribers contribute to 29% of the revenues, and 45% of the margins across all providers) and by getting them to switch.  Further, being a subscriber myself (and I am sure many of you will agree with me), I know that with the poor quality of service…I am yearning for THE ONE who can promise better quality of service.  Instead, in listening to industry insiders and analysts, it appears that the start-ups are gearing up to capture customers in the low income category, and in the rural masses, this segment across all operators comprises of 71% of the subscriber base, 27% of the revenue, and 15% of the margins.  Servicing this population incurs a higher network operating cost (driven by unavailability of electricity, logistics issues etc.), and hence the task for these folks is really uphill.  All combined, it is hard to see how the start-ups will capture more of that mid-single digit market share over the next 3 years (the government mandated lock-in period).
What the foreign operators see? in the start-ups, to me is questionable. It could be the desire to participate in the growth story or maybe do a “Vodafone”—this in my view is not possible anymore and not certainly with the start-ups. 
The current market environment and the inevitable risk-averse future will raise questions about these moves…and I believe some will look for a way out, or simply back out. 
Summerizing it, I do not see a single one of these operators being around in their current shape and none of them will be a contender when the Ro3 plays out.  In the most likely scenario, I see them end up (following different paths) as spectrum plays for the Mega carriers.
Navratna (translates as nine gems, term used for successful public sector enterprises majority owned by the government) players:  One has to give credit to BSNL/MTNL for adoption of competitive business practices; aggressive pricing, good branding and advertising etc. and become relevant in the current cut-throat marketplace. 
BWA offering launched recently at compelling prices is another great move...however, it rides on preferential treatment that they get from the government providing them with the first mover advantage. BSNL/MTNL assets are significant...and I see them of great value to anyone who can acquire them. The question of the government divesting stake in BSNL/MTNL or letting them be acquired, in my view is a matter of “when” not “if”...the decision boils down to electoral politics.  The journey BSNL/MTNL take will not impact the Ro3 outcome, unless TTSL gets hold of them (as was the case of VSNL being acquired by the Tata group…currently called Tata Communications Limited). 
I do not believe the Mega carriers will allow this to happen, but I did want to rule out that possibility.
So the Mega carriers of the future in my view are:
1.    Airtel
2.    Reliance
3.    Vodafone
Back-up: Tata Teleservices. NOTE: Used only if corporate governance issues, or other unforeseen events (like selling of BSNL/MTNL to TTSL etc.) impede the growth and success of one of the Mega carriers above.  The one of the three that drops out in such a scenario is difficult to predict…this would depend on the nature of the events.

The Inevitable comparison
It is hard to write an article about the Telecom growth and possible evolution in India and not talk about what could play out in China.  So here goes….
There are some key differences in the business environment in the two countries...The basic ones are that in India, entrepreneurship and competition in the Telecom space is vibrant, service providers are making significant EBIT, and most India providers (one can argue) are successful in-spite of the government red tape etc. 
Market forces will play out and we will see the unfolding of the Ro3, along the way the process will give rise to interesting opportunities for big, small, domestic, and international players alike. 
In China, the government is the entrepreneur, and a good one at that. So, in China we see that the government has fast-tracked the process to generate the outcome.  I see that China is taking the Ro3 seriously and has virtually folded the major Telco’s into China Mobile, China Unicom and China Telecom…the new kings in China’s $100 billion-plus telecom kingdom with 625 million mobile phone users. 
What is interesting is that, the government has even done the Technology selection/allocation for the operators.
It is hard not to fall into the trap and question; which is the better approach? my view and suggestion is that rather than falling into that trap, let us understand the journey that these two economies are taking that are inherently different and are governed by culture and values of each system...One should read/listen to Tarun Khanna (HBS professor) who argues compellingly that both cultures are powerful and are very complementary.
In summary, a constant and updated understanding of the Ro3 and how it could shape the world’s growth markets allows products and service providers to strategically position themselves for long-term growth and success. 
Long-term growth is important to deliver enhanced value to a company’s shareholders.

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