“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.

 

Projection	Quality	Current state Assessment
Leading effects of the Ro3 should start shaping the market by 2013”	Good	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	Bad	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	Good	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 4^th mega carrier.

Before we conclude on the 5^th 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.

Summary

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!

“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.

Contenders:

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 3^rd 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

Start-ups:

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.