mobile operators - beyond cost cutting

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Beyond cost cutting: How to

make money in the data world

A publicat ion of the Telecommunications,Media, and Technology Practice

No.21

Telecom, Media & High Tech Extranet

June 2012Copyright © McKinsey & Company, Inc.

RECALL



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By: Pascal Grieder /// Ferry Grijpink /// Michael Gryseels /// Sergio Sandoval

Beyond cost cutting: How tomake money in the data world



3RECALL No.21 – TMT industry perspectivesBeyond cost cutting: How to make money in the data world

Facing pressure from all sides, xed and mobile operators needto look beyond cost cutting to safeguard and improve their top-line performance.

nize an outing with either ten text messages orone Facebook status update. As a result, theircost of spreading the news falls from ten calls at60 US cents each to ten messages at 15 US centsapiece to about 0.01 US cents respectively.

Competitive pressure. Fixed and mobile pricingcontinues to decline, since operators are feelingthe impact of new entrants that keep pushing theprice oor downwards. At the same time, effortsfocused on xed/mobile substitution and integra-tion are leading to more competition as mobile

players use their 4G long-term evolution (LTE) net-works to attack low-end xed broadband. Fixedoperators with Wi-Fi clouds meanwhile pose athreat to mobile player efforts to raise data prices.Beyond this, both private and business xed-linecustomers are replacing legacy data products withlower-cost alternatives in both voice and data.

Popular but less lucrative new products. Whiledata use continues to explode, operators are see-ing only limited additional monetization opportuni-ties. Mobile video use, for example, is booming,but operators fail to benet since most trafc owsover the top (OTT). Even if they share in the asso-ciated mobile ads, income remains limited.

Operators are also mostly left out of the mobileapps party. The most popular stores are run by

Apple, Google, and Amazon – not by the opera-tors. Sometimes, operators are involved as billingproviders – as with ads, this is an attractive busi-ness in its own right – but this stream is very smallcompared with traditional telco revenues. Revenue

streams generated in data are associated withsubstantial infrastructure costs, making the grossmargin of data as much as ten times lower thanthat of traditional voice. As a consequence, opera-tors need to start moving away from ARPU and

Fixed and mobile players have one thing in com-mon: both face growing economic pressure froma variety of sources. Trends in consumer behavior,market activity, and governmental regulation couldcost them over 15 percent of their revenue by2015. There was a time when an operator’s pri-mary prot preservation strategy could be rootedin customer acquisition or cost reduction. Withsuch heavy penetration and bare-bones costs,operators might benet by looking beyond merelycontrolling costs. When exploring opportunities tobolster the top line, it is important that the underly-

ing revenue-eroding trends are fully understood.

Revenue-eroding trends in telecoms

Increasingly savvy customers, growing competi-tive pressure, faltering new product revenues,and resurgent price-focused regulators have thepotential to destroy signicant amounts of valuefor xed and mobile players alike.

Customer creativity. Telecoms customers arechanging their behaviors, replacing high-marginproducts such as voice with cheaper alternativeslike SMS or social network messaging. Somemarkets are experiencing a major shift away from

extended voice con-versations to shortercalls augmented byan increased reli-ance on messaging,which is perceivedas less intrusive.

Tech-savvy consum-ers have learned,for example, howto replace makingten calls to orga-

Consumers havelearned to tradeten calls at 60 UScents apiece for

one Facebookstatus update that probably costs0.01 US cents



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subscribers as the main commercial KPIs, sincethese do not reect protability differences.

Regulatory impact on prices. Regulators continueto drive prices down – especially in Europe, wheremobile revenues and prot pools are affected bylow mobile termination rates and by new interna-tional roaming regulations. Based on the “localbreakout” structural proposal for roaming putforward in Europe, for instance, customers wouldbe able to use any roaming provider they choosewhen outside their respective home countries,while keeping their local phone numbers. Addition-ally, it is expected that Europe will start capping re-tail data roaming charges over the next few years,reducing revenues from this service.

These t rends are driving an overall reduction inxed and mobile industry prot pools. What’s

more, several ofthem are actuallycausing the over-all market pie toshrink. WhatsApp,for example, israpidly commoditiz-ing the multibillioneuro SMS marketwhile generatingvery small returnsof its own. In the

most optimistic case, estimates put WhatsApp’sannual per-user revenues at EUR 2, comparedwith traditional SMS subscribers who often spendover EUR 10 a month. This dynamic results in aninteresting paradox: while users deeply value theirmobile devices and spend ever greater amountsof time every day focused on them, the industryproviding this breakthrough value remains unableto capitalize on or monetize it.

Three ways to optimize economics

Fixed and mobile leaders seeking options to turnthis situation around have a number of choices.

They could, for example, optimize their costs by

aggressively pursuing network sharing or integrat-ing their core xed/mobile elements. While an ex-cellent and often necessary approach, three otherideas go beyond a strict cost focus to protect andenhance an operator’s top-line performance.

Rebalance the product and service portfolio.Operators would benet from making their currentproduct and service portfolios more robust againstOTT attacks while securing their legacy revenuestreams. A key strategy involves moving awayfrom “metered” products to data bundles andcontrolled at-rate voice and SMS plans.

Since at-rate data plans are largely unfeasibleas long-term solutions, operators should exploresmarter ways to package offerings, such as bun-dling data with SMS and even voice. They can alsodesign clear data upselling paths, offering custom-

ers attractive ways to move up to larger bundlesto circumvent data usage throttling. For SMS andvoice plans, operators could create controlledcommoditization paths that include at-rate plans.

Finally, companies can explore new service mod-els, such as allowing multiple subscriber identi-cation modules on one subscription. Operatorsshould also work to increase the perceived valueof their data offers. In a number of proprietarysurveys, consumers have expressed a strongwillingness to pay for data, but monetizing thiswillingness will require marketers to tailor theirdata offers more effectively so that they target realcustomer needs. This tailoring should be done inways that subscribers understand. For example,while 20 to 30 percent of consumers have indicat-ed a willingness to pay EUR 5 to 10 for a higherquality of service (QoS), operators have s truggledto develop products to capture this demand,explicitly communicating the value customers willreceive. On the upside, the emergence of LTE willcreate a disruption that operators can use to reset

their pricing structures. LTE offers a far richer setof QoS options, allowing operators to align theirportfolios more fully with customer needs. Earlysigns suggest this approach could become a realpricing game changer.

Paradoxically,mobile operatorsdon’t make muchmoney from thetremendous valuethey’re providingto consumers



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RECALL No.21 – TMT industry perspectivesBeyond cost cutting: How to make money in the data world

These routes should be explored on a situation-by-situation basis. Also, given the fast pace ofcompetitive and technology change, they need tobe revisited regularly (see text box).

Chase new revenue streams. Operators need todetermine the role they want to play in value-addedservices (VAS). In the last ten years, most opera-tors outside of Korea and Japan have struggled to

monetize these types of applications and ad-vanced services. Since companies are now beingattacked on their own turf – namely voice andmessaging – many are, however, reconsideringtheir stances on the need to play in the VAS space.

The rst VAS strategy, access-only services, isattractive to attackers. This strategy enables us-ers to gain the maximum freedom to use theirconnections as they please. It means there areno restrictions on, for example, the type of use,speed, or technical setup. Investments are low forthis option, which typically appeals to advancedusers who generate high ARPU levels and makeup a very small share of an attacker’s consumer

base. Some of these attackers have also startedleveraging data access to increase the appeal ofsmartphones, which are offered with “data inside,”similar to a Kindle device. This can be a key differ-entiator for smartphone OEMs, whose devices are

Value is in the eye of the beholder

After seeing unacceptably low margins from services its customers clearly valued, one mobile operatordeveloped four pricing-related guidelines. The operator was able to close the gap between what customerspaid for its services and what these were worth – effectively compelling its customers to rethink value.

Recalibrate the value of data vis-à-vis voice. Recognizing that VoIP was diminishing the perceived value of traditional voice, the operator decided to stop discounting data. As data enables an increasing amount of services, its price should more closely match its value.

Increase the value of low-ARPU customers. The declining value ofhigh-ARPU customers may be inevitable, so why not raise the value of low-ARPU customers? To maintainaverage value, the operator introduced a connection fee. It also designed bundles speci cally for its low-

ARPU customers that created and encouraged a subsequent upsell path.

Raise the commitment level of customers. The operator foresaw thatits out-of-bundle services (e.g., VoIP, IP messaging, and Wi-Fi) were on a trajectory of declining revenue.Their answer was to move these services into committed bundles. It campaigned to move its high-value

customers who used a signi cant amount of out-of-bundle services to a higher commitment level andintroduced regressive pricing for services that remained unbundled.

Capture the value of applications. Believing that a substantial part of themobile industry might move to applications, the operator decided to stake its claim in this arena. Itexplored its options to establish its own app store as well as develop country-speci c data servicesand applications. Under these principles, the operator was able not only to charge what its customers were willing to pay butalso to extract greater value from its least lucrative customers.



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becoming increas-ingly commoditizedbeyond the agshipphones of the lead-ing manufacturers.

A second VAS activ-ity has operatorsdeveloping their ownapps and running

their own app stores. In the current multiplatformworld, consumers may be reluctant to invest heav-ily in apps that will be useless if they switch toanother phone. By introducing rental models forapps, operators can play an attractive value-addingrole for customers. Furthermore, the latest HTML5advancements make it possible to develop device-independent apps. Key industry players like Face-book are increasingly embracing this concept. The

social network has launched its own HTML5 envi-ronment, which is giving the entire realm a strongboost. While never meant to be a full replacementfor native apps, this can be an interesting route foroperators that want to combat the power of theapps ecosystems. In fact, Facebook just addedoperator billing in the US and selected Asian coun-tries for their HTML5 store, which is generatingmore momentum for the HTML5 ecosystem.

The third strategy focuses on monetizing the net-work access control point. One way is based onpeering agreements – the voluntary link betweendifferent Internet service providers (ISPs) thatfacilitates trafc exchange between the custom-ers of each network. Such agreements are beingchallenged due to trafc imbalances from content-heavy applications such as video – a hurdle thatwill likely arise in the mobile space as well. Similarrecent confrontations increase the probability thatmore ISPs will charge distribution networks pre-mium prices for access to their “last mile.” Also,regulators in some markets appear willing to give

operators room to monetize this privileged accessto their customers, while others do not.

Explore partnerships with OTT players. Typically,operators can generate value for OTT playersby providing them with a go-to-market channel,billing capabilities, and the ability to bundle datawith their service. Two service categories showespecially compelling reasons for operators topartner with OTT players.

Voice- and address-book-related apps makeup the rst category. A number of operators areinvesting in applications that add value to voiceservice, such as high-quality voice and Rich Com-munication Suite (RCS), which offers the ability topersonalize voicemails and route calls. This is anatural t for operators because these platformsmake use of the subscriber’s address book tolaunch new OTT services. Controlling the addressbook is the key to monetizing certain services.

Apple’s iMessage, for example, enables users to

send unlimited text messages via Wi-Fi or mobilenetworks to other iPad, iPhone, or iPod Touchdevices without this being transparent to users.

The second category is data-hungry services suchas music streaming and video. Operators canbundle the service with high QoS data to provide asuperior customer experience. They do, however,need to ensure that such bundling does not con-ict with the emerging “net neutrality” regulations.While the European Commission is still shapingthe rules, some regulators (e.g., in the Nether-lands) are already passing “net neutrality” regula-tions that limit operator exibility in these areas.

Fixed and mobile players face challenges that areunlike anything most have ever experienced. To domore than just survive in this environment, opera-tors need to look beyond cost-cutting opportuni-ties and seek out new revenue-boosting ideas.

The authors would like to thank Ruben Monballieufor his contribution to this article.

With telcos beingattacked on voiceand messaging,many are pursu-ing value-added

services



7RECALL No.21 – TMT industry perspectivesBeyond cost cutting: How to make money in the data world

Sergio Sandovalis an Associate Principal in McKinsey’sBrussels [email protected]

Ferry Grijpinkis a Principal in McKinsey’s

Amsterdam [email protected]

Michael Gryseelsis a Director in McKinsey’s Brussels [email protected]

Pascal Griederis a Principal in McKinsey’s Zurich [email protected]

mobile operators - beyond cost cutting

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