Sunday, 13 January 2013

“Rule of Three” and the Indian Telecom Industry v2.0

It is time to circle back after 4 years, look “forward-back” into the earlier blog on the Rule of Three…”.
Essentially, look at the current state of the Telecom industry in India, check progress on the views expressed in the earlier blog on the playing out of the “Rule of Three” (Ro3), and share a view on where the industry could be headed in the future

In reality, for the telecom industry in India, it has been an eventful 4 years. Not surprisingly, a lot of water has flown down the Ganges, a mother of all controversies and/or scams (the 2G scam) has plagued the industry.The New Telecom Policy (NTP) has been defined; is being debated and diluted (like several policy items in India…a great initial policy document, which through the “consultative” process attempts to accommodate all needs/aspirations of all “consulted” and in the end becomes in-effective!). Initial talk of M&A is in the air (Aircel by Sistema amongst others), new spectrum auction has taken place, telecom tariffs are now the lowest in the world, and the list could go on.

Before getting carried away with the exciting world of Indian Telecom, it’s time to introduce my co-author, Mr. S. Krishnan, a valued customer, a Dharmic leader (in every sense of the word), a technology stalwart, and a very dear friend. Mr. Krishnan is the CTO of Videocon Mobile Services. It was Mr. Krishnan’s call a few months ago saying “…looks like the Government, and TRAI have decided to implement the views expressed in your Ro3 blog…” that acted as the impetus and motivation to write this follow-on blog. We would also like to thank Radhakrishna Pai, Pamesh Khera, Vinod Melarkode and Kunal Bajaj - not from Amdocs, for their comments and suggestions on the draft version of this blog post.

Rule of 3 (Ro3), and India Telecom – Previous Blog Recap

As a reminder, the Ro3 at a high level states the following…

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.

Many of you will think “So why not two or four?” The proponents of this rule explain that consumers value a manageable choice between three suppliers, but that further 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.

As it relates to the India telecom industry the view expressed in the last blog was:

“…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 “market space”.With penetration levels reaching ~65% of the population, with network coverage exceeding 95% of the population and with 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”.

While we are in Jan 2013, several aspects of the above are starting to play out.   But having watched the telecom industry in India over the last few years, and in analyzing ground realities like; the huge (and growing) population and teledensity, the diversities within the country (23 circles, which could actually be 23 countries!),the important role that regulation plays, and continuous innovation in the industry, we now believe that the India telecom industry will likely have 5 competing operators that will dominate the India telecom market and it will NOT converge to three in the near future (next 5-7 years).  

In our view, amongst the factors listed Government regulation, and diversities within the country especially the large population will be the primary drivers to sustain 5 service providers/operators at ~ 200 million subscribers per operator. So the India telecom story will be one of Ro5 (Rule of five). BTW, we also believe that it is in consumer interest to “support” 5 operators and keep prices low.  As a point of reference, currently (as of Sept, 2102), the largest Indian operator (Airtel) controls about 20% of the market and the top 3 operators have less than 50% of subscribers. In effect, we say that the top 3 operators will have ~60% of subscribers in contrast to ~80% for other emerging markets (and 100% for China).

 Two factors emerge when we state the above:
  1. The diversities that make us conclude on 5 (and not 3) apply to other industries as well and this could mean that we will likely see a highly competitive market for goods and services. On a different note, the airline industry in India is starting to converge to 5
  2.  The economic paths that the two large Asian economies of India and China take will continue to diverge.  China for example has 3 very large providers and we will likely not see a change to the numbers 
 "Forward - Back" Assesment

Since the original blog was a projection of where the market could go, we thought it would be good to look backwards (hence “forward-back”) and rate the projections made in the first blog.  Let’s use; Good, and Bad to rate the quality of the projections. We have picked out the key items from the blog.




Current state Assessment

Leading effects of the Ro3 should start shaping the market by 2013”


We clearly see that the market is unable to sustain 13 operators, and the number of operators per circle is starting to go down for a variety of reason; 2G-scam, spectrum re-auctioning, profitability, economic viability, unavailability of funds etc. We also see initial signs of industry “consolidation”, while talk of consolidation has increased, the M&A norms are still unclear and payment for spectrum by the acquirer is a roadblock and it acts as a deterrent
The Mega carriers of the future are:

1. Airtel - Good
2. Reliance – Bad
3. Vodafone – Good
While the prediction about Airtel, and Vodafone pan out and we believe they will be Mega carriers. Reliance communications appears to be in rough waters. There is another Reliance (Reliance Infotel) starting to rise
Influencers that will determine the playing out of Ro3:

1.  Government and regulation
2.  Foreign operators’ interest in expanding brand into India
3.  Spectrum availability and congestion
4.   Corporate Governance

Government continues to play a very important role in the evolution of the industry.  Some industry watchers are going to the extent of accusing it of “..Shattering the Telecom dream”. We would not go so far but do acknowledge that the regulatory framework can be a lot more balanced, transparent, and consistent.
Corporate governance is the other issue plaguing the industry and one hopes that with greater transparency, corporate practices will improve. It is clear that in a transparent India of the futire, ONLY clean and transparent corporates will thrive.

Ro5 Crystal Ball 

In the revised view from 3 to 5, the job of predicting the mega carriers of the future may appear to be easier but we believe that dynamic nature of the industry will ensure that the future will be as exciting (if not more so) than the past. One area where we think is a unique opportunity for Indian service providers is for them to define a role they will play in India’s growth and societal development. If they so choose, there are two opportunities; a) being an active player in roll-out of data services to rural and semi-urban India, this may not be profitable in the short-term but will pay rich dividends in the long-term and b) diversifying into becoming a provider of relevant content and services that are essential to help grow the economy (education, healthcare, skills development, etc.).

Ro5 Providers

Airtel continues to be the leading provider (~186 million subscribers), has taken steps to export their success mantra to Africa, and continues to innovate in products, services, and on the brand.  Airtel has continued to maintain its market leadership position despite fierce competition. Finally, the chances of acquisition by a foreign player are remote….on the contrary we believe that in the coming years, Airtel will look beyond the developing markets for their growth and would likely target developed markets for acquisition.  Airtel gets our first vote for mega carrier of the future.

Vodafone has moved from being a contender to one of the leaders and is a force to contend with (~152 million subscribers) and gets our second vote.  Vodafone has been a good example of a global company operating in the paradigm of “think global, act global AND think local, act local”. Regulatory uncertainty that plagues all operators has had the greatest impact on Vodafone (because of the tax implication tied to the Vodafone acquisition of Hutch Essar), but the company has not allowed that to interfere with it market plans and impressive progress.

Success of Reliance Communications cannot be taken for granted any more. They were one of the clear incumbents in the last iteration of this blog.  They have massive debt (~$7 billion as of June 2012), which is about 3 times their market capitalization. More concerning is the fact that they are losing subscribers at a fast pace (the subscriber loss is beyond the disconnection of inactive subscribers).  On the positive side Reliance has great assets, their tower business (Reliance Infratel), the undersea cable (Reliance Globalcom), over 200 Reliance World stores, and media assets in Reliance BIG Entertainment.  These assets are highly synergistic and have not been monetized to the fullest.

Finally, we have the other Reliance (RIL) in the form of Reliance Infotel rising, and if the buzz on the street is to be believed the integration of the two Reliance telecom entities is not a question of “if” but one of “when”.  We tend to believe that there is inherent business synergy between two companies, and beyond family relationships the merger would make business sense.  4G capability from RIL will act as a catalyst to unleashing the potential of Reliance Communications assets (listed above)

In summary, we believe that “One” Reliance will be one of the incumbents and will one of the 5.

Idea cellular has made impressive gains and has over 115 million subscribers (as of Sept 2012).  What is striking about Idea is the brand recall that they have been able to achieve with a highly innovative and popular advertising campaign.  Whether it has been “…No Idea?, Get Idea!!…”, or the more recent and catchy “..Hunny bunny..” they have clearly stolen the march on the competition.  While this is positive, marketing campaigns help but do not make or break a company and here we feel that Idea has to acquire to be in the big league.  Aditya Birla group is more of an organic growth company, so they may be slow on this front; we tend to believe that they will need to adopt this route to continue to thrive and if they do, they will be the 4th mega carrier.

Before we conclude on the 5th operators, let us list out the markets movements that are likely to take place:
  1. BSNL/MTNL: We continue to believe that the question of the government divesting stake in BSNL/MTNL or letting them be acquired is a matter of “when” not “if”. The timing of the decision boils down to electoral politics.  Who acquires BSNL/MTNL may not make a material difference on the Ro5 outcome.
  2. Aircel: They have also been suffering from a heavy debt burden and margin pressures.  In reaction the operator has been pruning circles relocating resources to more profitable circles, refining its strategy to focus more on data. Finally, the word on the street is that it could be acquired by Sistema. We tend to believe that Idea-Aircel-Sistema can be a good combination.
  3. TTSL (Tata DoCoMo): Currently they have about 8.64% market share with about 79 million subscribers.  Their strategy is heavily focused on data/3G, and growing broadband services leveraging their relationship with Tata Communications.  Also, there are rumors that Telenor is interested in picking up stake in TTSL. NTT-Tata-Telenor can give the operators a combined subscriber base of over 120 million and make them a contender in the Ro5.
With the above background and information, the following are our conclusions:
  1. Tata-Telenor combine will be the fifth Ro5 incumbent
  2. Aircel-Sistema will likely roll into Idea
  3.  MTNL/BSNL will eventually be sold off (either together or separately) to one (or more) of the 5 
Note: The sequence and final combination (between Aicel, Sistema, Tata, Telenor, and Idea) that gets formed may change but we expect 2 operators to result. The sequence will determine the company name that survives.

The only operator that we have not covered above is Videocon (the other, Etisalat has decided to exit the India market), here Mr. Krishnan does not offer an opinion for obvious reasons. Here the belief is that Videocon will eventually be acquired as well. In the interim their focus will be to increase attractiveness and on this front they can and should do a lot more to monetize on the brand and several adjacent assets.


In summary, we believe that having 5 mega operators/service providers for the India operating environment is optimal and strikes the right balance.
  1. Customer: On the customer front this will provide manageable choice, ensure competitive pricing, drive service providers to innovate and differentiate on services/offers/experience, ensure that no segment of the society goes un-serviced.
  2. Service providers: From the operators/service providers point of view this will reduce hyper-competition (which may in-turn result in price increases, the fact there are still 5 operators we believe will limit the amount on increases) and improve economic viability, drive innovation and service differentiation (this we believe is good for long-term health of the service providers).
So, if indeed this is optimal state then the question is what prevents us from getting to the optimal state quicker. Here the problem is one of policy clarity and consistency. We believe that:
  1. The NTP should be implemented without dilution, implementation is the operative word. We suffer not from shortage of ideas but from the timely and consistent implementation of ideas.
  2. While we agree with Ministry of telecom that the future revenue potential from telecom services is huge, we disagree that the reserve price for auctions needs to be high.  The government should think about annuity revenue rather than one time upfront payments and one time revenue (this requires leadership, which will mean that all revenue is not obtained when the current government holds office).
  3. We should stop looking backwards on what could have been;  lost revenue from 2G auctions, tax revenue from M&A, etc. The guilty (where applicable) should be prosecuted but beyond that, for a growing economy the growth is in the future so the energies are better spent in that direction.
There you have it - our view of the mega service providers of the future in India. There is no doubt in our minds that Telecom services will become one of the top 5 sectors of the Indian economy in the very near future. The role the industry can play in the growth of the country is truly phenomenal. What is your view? Who do you think are the mega-carriers of tomorrow? Will we have an operator coming from no-where into the big league? Will we have 3 operators per State (each state is as big as any European country)? Will we have we have Ro3 at the country level PLUS a couple of regional operators that are different?

We look forward to knowing your thoughts on this topic!

1 comment:

  1. Here are my bid for the next phase
    Basic Service Operators
    1. MTNL + BSNL
    2. Reliance
    3. TTSL
    Mobile Services
    1. Airtel
    2. Vodafone
    3. Idea
    1. Reliance
    2. Tata
    3. BSNL
    Internet Service Providers
    1. BSNL + MTNL
    2. Reliance
    3. Tata

    Also we need to take care of 4G and its services, India is still waiting for VOIP to be implemented as it is pending from India government.

    As you mentioned that rural area is having problem with the growth aspects as it reduce the margin levels. We need to see following when and which company makes most out of it. And yes technical revolution is the key for rural market growth.

    Above comes as part of strategy of increasing Customer base, now we need to talk about other services. Clearly Airtel and Vodafone goes beyond all the othe players, but still Vodafone is lagging behind in the third field that is DTH, lets see how it rolls out if they have plans for that.

    I believe Ro5 will not make sense if MTNL/BSNL divested. It will be consumed between top three.