wal marteconomics

7/31/2019 Wal MartEconomics

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CFN Services Optimizing the power of your networkDulles Technology Park 2325 Dulles Corner Blvd., Suite 500 Herndon, VA 20171 p:703.788.6633 1

Bringing Wal-Mart Scale Economics to NetworkOperators

Every competitor wants to be the Wal-Mart of its industry. Wal-Marts ability to scalerapidly from a single profitable unit way past the $300 billion mark in sales is the envy ofevery company on the plant. For more than 30 years, Wal-Mart has created equity valuefor its shareholders in ways that its competitors have not. Arguably the company has themost dominate strategic model of any major company in any industry, worldwide.

But, in telecom there is no model for scaling quickly and profitably like Wal-Mart. Thisdepresses levels of profit and growth, significantly diminishes opportunities, and drivesmarket revenues into the hands of non-telecom companies, like Apple.

Today, network economics do not begin to approach the cost effectivenessof Wal-Marts distribution network. Operators use a highly variable coststructure that increases linearly with network traffic growth. To grow youhave to flame off profits.

This is the single biggest challenge facing the industry. Failure toovercome this challenge means limits to growth and profitability, poor exitoptions, and serial financial crises for the foreseeable future.

Telecoms linear cost structure inhibits operators abilities to improve margins andcapitalize on the explosive growth of bandwidth-intensive applications and services. Inthe battle for profitable market share between cable MSOs, telcos, satellite companies,and wireless carriers, and media empires, the winner will have Wal-Mart-like distributioneconomics.

The number one priority of C Level management in everycarrier worldwide, therefore, is to replace its linear cost

structure with Wal-Mart-like scale economics.

Wal-Marts supremely efficient distribution network is the single most important enablerof its Everyday Low Prices mass marketing strategy. This White Paper will focus onbringing Wal-Marts peerless distribution strategy to communications carriers so they

too can achieve Wal-Marts scale economics, deliver everyday low prices to theircustomers, and grow and make money while doing so.


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Today we are at the dawn of a dramatically reshaped telecom landscape. When NorthRiver Ventures began creating growth models for the telecommunications industry over adecade ago, they observed that the lack of Wal-Mart scale economics would implode firstthe IXC business and then force consolidation on the wireless carriers and the IECs. This

process has unfolded exactly as NRV predicted and consolidation has acceleratedthroughout 2004-2005 as the strong devoured the weak and repositioned themselves fortheir next looming battles.

WorldCom devoured MCI, collapsed, renamed itself MCI, and was in 2005 acquired byVerizon in an $8.5 billion merger. SBC acquired AT&T for $16 billion and renameditself AT&T. Sprint merged with Nextel in a $35 billion deal. SprintNextel in turnacquired its affiliates for $6.5 billion. In 2004, Cingular, a joint venture betweenBellSouth and SBC, acquired AT&T Wireless for $47.5 billion. Almost every penny ofthat $113+ billion shareholder money was spent to achieve elusive scale economies.

Each of these deals was an attempt to position companies against competitors by offeringa broader array of seamless services in order to aggregate user demand, gain scaleeconomies, and improve profitability. In effect: become a mass marketer ofcommunications services. In short, the goal is to replicate Wal-Mart economics intelecom. The critical question is this possible given existing business models?

As North River Ventures pointed in 1995, Wal-Marts growth engine is so efficient thatWal-Mart doesnt need to make acquisitions. In fact, Wal-Mart acquired nothing until itexpanded overseas, and only then once its own management system was so effective thatit could easily absorb, and manage, these new operations.

In other words, replicating the Wal-Mart model means redesigning the business modelfirst, acquiring later. Getting this backward, as North River has so often pointed out,risks turning a company into a sinkhole for shareholder value. This is exactly whathappened to the IXCs half a decade ago and the risks of it happening with todays newgeneration of integrated carriers is very high.

This White Paper is about eliminating those risks, minimizing the potential foracquisition failure, and positioning carriers for profitable growth.

Wal-Marts Distribution Model

Wal-Marts economies of scale let the company offer the Everyday Low Prices that

gain it dominant market shares wherever it operates.

EDLP is about much more than price, too. Service and assortment are both importantelements in Wal-Marts policy of lowering customers total cost of shopping. Wal-Martbelieves its customers want a broad assortment of products under one roof, and expect tofind products they want in stock.


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EDLP has been so successful because it reduces the hassle factor for customers andassociated costs to itself of shoppingsuch as product stock-outs. EDLP is whatdifferentiates Wal-Mart from the rest of retail. Other retailers have attempted to mimictheir model on a limited scale, however Wal-Marts core distribution strategy keeps it themost dedicated and successful practitioner of EDLP.

Wal-Marts scale economies have allowed it to transform the shopping experience of itscustomers, something no one in telecom has ever managed to do.

According to Rob Walton, When Dad started the company we operated in rural areasand small towns that were not reliably served by distributors. To get reasonably pricedand dependable deliveries, we had to become our own distributor. This gave tiny Wal-Mart a competitive advantage because we were able to lower our costs by bringingdistribution in-house1.

By reaping the benefits one particular aspect of scale economiesthe aggregation

effectWal-Mart could offer EDLP to all of its customers, everywhere. Wal-Martaggregates and sells as many different items as possible, allowing it to grow revenue overits fixed cost base (more sales out of the same store). This is why Wal-Mart began to selllow margin groceries. As volume increases, Wal-Mart generates incrementalcontribution toward its fixed costs.

The efficiencies generated by Wal-Marts hub and spoke distributionsystem are enormous and play a large role in its success.

Discount Store News reported that Wal-Mart's distribution costs were only 1.3 percent ofits sales, compared to 3.5 and 5.0 percent for a major competing discount chain and amajor general merchandise chain, respectively.

In other words, for every $100 worth of merchandise sold, Wal-Mart spends only $1.30getting product from the factory to the store. It is not hard to see why retailers lessfocused on distribution have such a hard time competing price wise when theirmerchandise must go through multiple layers of wholesalers and distributors.2

Wal-Mart optimized its distribution network on delivered costthat is the total of allcosts to source/produce, inventory, sell, and transport product to each customer orcustomer groups.

Wal-Marts distribution strategy is mix of sophisticated supply chain managementsystems, applications, processes, and communications technologies. Wal-Mart investedbillions of dollars to develop these elements of its supply chain capabilities.

1 Rob Walton speech, Annual AAI meeting, 20032 Missouri Business.net, Competing with Mass Merchandisers, Kenneth E. Stone, Ph.D.


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However, at a fundamental level, it is Wal-Marts least glamorousdistribution assets comprising a network of distribution centers and a

large fleet of company owned trucks and trailers that ultimately make itslow cost competitive position virtually unassailable.

For example, owning its fleet of trucks enables flexible scheduling, cost-efficient deliveryto stores, accommodation for peak seasonal periods, night deliveries, and expediteddelivery. A company-owned transportation system also assists Wal-Mart in shippinggoods from warehouse to store in less than 48 hours. This allows Wal-Mart to replenishthe shelves 4 times faster than its competition.

Wal-Mart invested heavily in a complex, hard-to-imitate "cross-docking" warehousingsystem that enabled it to dominate K-Mart on product cost and availability, both criticalsuccess factors3. This unique cross-docking inventory system enabled Wal-Mart toachieve economies of scale, which reduces its costs of sales.

With cross docking, goods are delivered continuously to stores within 48 hours and oftenwithout having to be inventoried. The resulting lower prices eliminate the expense offrequent sales promotions and make sales more predictable. Cross docking givesindividual store managers more control where Wal-Mart needs it: with customers.

The heart of Wal-Mart's distribution system is its distribution center. A typicaldistribution center is about one million square feet in size and has the latest in state of theart inventory control and materials handling equipment.

A distribution center can accommodate about 150 retail stores located in a circularpattern around the center. Merchandise is delivered to distribution centers and thentrucked directly to retail stores daily.

As customers make purchases, the electronic scanner checkout system forwards salesamounts and inventory changes directly via Wal-Mart's own satellite system toheadquarters and to the appropriate distribution center for reorder. This daily updating ofinventory allows distribution centers to send the precise amount of merchandise to thestores to maintain the optimum level of stock. The result is minimum inventory and lowstock outages, a balance no one else achieves.

According to Discount Store News, about 78% of the merchandise Wal-Mart sellsdomestically moves through Wal-Marts distribution centers. In comparison itscompetitors move roughly 50% of sales through their own distribution centers.

Wal-Mart has 111 distribution centers in the United States, or roughly one distributioncenter for every 34 Wal-Mart stores. Among these, there are 30+ general merchandise

3 Stalk, G., Evans, P., & Shulman, L.E. (1992). Competing on capabilities: The new rules of Corporate

strategy. Harvard Business Review, 70(2), 57-69.


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distribution centers, 20+ grocery distribution centers, 8+ clothing distribution centers, and9+ are specialty distribution centers.

The specialty distribution centers ship items such as jewelry, tires, and optical supplies.The remaining merchandise is delivered directly from the factory or through vendors and

distributors. Globally, a total of 84 percent of Wal-Mart Discount Stores' andSupercenters' purchased merchandise was shipped from Wal-Mart's distribution centers.

Close examination of Wal-Marts supremely effective distribution strategy yields threekey insights regarding how its distribution strategy yields competitive advantage:

Distribution Operating Leverage Infrastructure Ownership/Control and Flexibility Distribution Ubiquity/Customer Proximity

Wal-Marts distribution fixed cost structure (trucks, store, and distribution centers) gives

it high operating leverage. This structure, along with an intense focus on reducingvariable costs, enables it to keep total delivered cost low and stabilize margins withincreasing volume.

Wal-Mart, relative to its less successful competitors, owns more of its distributionchannel. Ownership of key distribution assets gives it more control and flexibility thancompetitors. Whether its Digital TVs or diapers, Wal-Marts distribution system isflexible enough to respond in real time to the dynamics of the market. Finally, Wal-Martbuilt its retail stores around the distribution hubs to make sure merchandise was as closeto the customer point of sale as possible.

Diagram of Wal-Marts Distribution Delivery System4

4 From e-Business to Services: Why and Why Now?, By Ravi Kalakota, Marcia Robinson, CFN Analysis

Physica l InfrastructureTrucks, Stores, D istr ibut ion Centers, WarehousesPhys ica l InfrastructureTrucks, Stores, D istr ibut ion Centers, Warehouses


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U.S. Carriers and Wal-Wart Compared, 2000-2006

CFN asked North River Ventures to revisit its 1995 findingsthe company tracks Wal-Mart closelyto show our clients the state or risk today. Their findings, on the next twopages, are illuminating.

Nothing shows how much the lack of a Wal-Mart model for growth and earnings hurtscarriers that to compare how Wal-Mart and the big U.S. carriers stacked up in 2000 withhow the stand today. The following data uses North River Ventures telecom growthmodel that was designed around the Wal-Mart challenge by North River a decade ago

At the turn of the century, carriers were growing, though much of this growth, as in thecases of Verizon and AT&T, was built on acquisition, not organic growth.

But, by 2006, the situation had changed dramatically. The rate of telecom expenditure asa percent of GDP stalled, indicating a shift user behavior, and organic growth among themajors turned to decline.


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Wal-Marts growth rate, by contrast, actually increased during this period, demonstratingthat a company that was already huge at 95% the size of the top five common carrierscombined, could use a bricks and mortar strategy to accelerate, if distribution economicswere understood.

Today, the same five carriers that, combined, were almost Wal-Marts size

only a few years ago, are collectively 59% its size today, and this gap isgrowing.

Without a doubt, the top priority of common carriers, and all their suppliers, is to solvethis problem and get growth back on track. Without such a solution, there is noshareholder value engine in the U.S. common carrier business, with serious consequencesfor the entire sector. CFN will provide that solution.

Implications of Wal-Marts Scale Economies for Network Operators

Like Wal-Mart, to survive and prosper all wireline and wireless operators worldwidemust continuously improve the unit price performance curve for every bit transported anddelivered to and from the customer base ($/Mbps).

Whether the bit is voice, JPEG, MP3, or video, there are at least three competitors inevery market offering essentially the same services to the same customers. An examplemore like retail is hard to imagine.

As todays content-rich environment unfolds, broadband connectivity margins, whetherwired or wireless, are being squeezed as value is migrating from infrastructure towardscontent, applications, and services. This is similar to trends throughout the informationtechnology.


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In traditional wireless, ARPU has been falling steadily with price competition and aproliferation of minute bundles. With voice-over-IP making sharp inroads in telephony,the economics of voice and broadband combinations have significant downside, drivingblended EBITDA towards broadband connectivity margins (Exhibit 5)5.

Infonetics Research: Service Provider Plans for IP, MPLS, and ATM: North America, Europe, and

Asia Pacific 2006

Despite the margin pressure, total network traffic is increasing at double-digit rates. In2005, digital music sales reached a record of 352.7 million digital tracks, representing a150% increase over 2004. Similarly, digital album sales leapt 194% from 2004, with 16million-plus units sold. Just to stay in the game, therefore, carriers need to expand

network capacity to satisfy end user demand and deploy multiprotocal technologies whilereducing network access expenses.

In other words, in telecom services, the more you sell, the lower your margins.

5 Telecom War of the Worlds Part II, i2Partners


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To reverse this margin squeeze, improve the price-performance of their services, and gain

control over scale economies, carriers are trying to exploit the capabilities of multi-protocol technologies and bypass ILECs.

Carriers are using packet-based transport technologies and broadband wireless to upgradetheir networks with higher transmission speeds at ever-lower costs. Wireless operatorsare in various stages of deploying next-generation data networks such as EDGE, UMTSand 1XEV-DO, to attract large numbers of enterprise and consumer data subscribers.Fixed wireless and/or 2BaseTL (Ethernet over copper) lets carriers bypass theincumbents last mile networks. Bypassing provides IXCs, CLECs, and wireless carriersthe ability to save channel termination charges imposed by the LEC and to capture thebenefits of improved price-performance offered by broadband services delivered via

these technologies.

In 2003, IXCs, CLECs, and wireless carriers spent roughly $14 billion on access facilitieswith incumbent local exchange carriers such as Verizon, BellSouth and SBC. Accessfacilities (aka special access) encompasses the dedicated circuits carriers use to connecttheir networks to their customers via the ILECs.

Indeed, pre-merger, network access costs are AT&T and MCIs single largest expense at38% and 51% of revenues respectively. Mergers between AT&T/SBC and Verizon/MCIwill reduce but not eliminate these access expenses. For wireless carriers, backhaul costscan be up to 4060% of total network operating expenses. Some 95% of backhauled cell

sites use expensive, tariffed ILEC services, mostly T1 links.6

Roughly 80% of these costs are concentrated in the top 20%or 5,000of the 25,000local serving offices (LSO) nationwide. Due to the asset base and traditional operatingmodels of the competitive access providers (CAPs) such as MFS, Teleport, and BrooksFiber, which were acquired and integrated by the IXCs, the IXCs have largely continued

6 Telephony Magazine, FiberTower Targets Backhaul, pg 14., March 14, 2005


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the focus on total LEC bypass, deploying local access connections directly from the IXCpoint of presence (POP) to the end-user customer site, typically a commercial officebuilding. As a result large IXCs such as AT&T and MCI have amassed direct fiberconnections to some 6,000 buildings each, while only deploying fiber connections to

some 500 or so LSOs each.

While the Telecom Act of 1996 enabled, and the current regulatory environmentcontinues to support, collocation for the deployment of multiplexing and access tounbundled network elements, the IXCs continue to purchase these access services fromLECs rather that taking these costs in house on their own platforms.

This highly inefficient approach builds costs, rather than diminishing them, making

carriers less like Wal-Mart and more like its less successful competitors.

Pre-Merger Analysis AT&T and MCI Collocation Presence

CFN Services believes attacking these inefficiencies is one of the largest areas of postmerger cost savings and synergies available to both wireline and wireless carriers.

In the post consolidation environment, most carriers are undertaking a strategic review oftheir access cost structure and launching initiatives aimed at improving margins bysignificantly reducing these costs. We believe that customer-to-POP total costs (local

access plus backhaul transport cost) can be cut fast by leveraging third-party multi-modaltechnologies to optimize local access and transport infrastructure.

The legacy AT&T operation spends roughly $4.5 billion annually on local accesstransport services, historically 38% of top line revenue. This is huge. While the mergerwith SBC will mitigate a portion of these expenses, significant costs will remain in non-legacy SBC LEC territories such as Verizon and BellSouth.

The top 5,000 central offices drive over 80% of ILECspecial access traffic and revenues

95%+ of client locations are not candidates for fiber /building connectivity and thus require LEC T1-T3 tailcircuits

Leasing virtually unlimited capacity at the LSO levellocks in the access cost curve eliminating most of thevariable cost impact from increasing transport volumes

Expanding LSO collocation reduces IOF and MUX costswhile creating the opportunity for further expensereductions through channel termination (CT) substitution(DSL, Ethernet)

LEC collocation and managed CTs are a key enabler formulti-service packet platforms and delivering innovation

and improved service through NextGen IP based service

25,000 LEC COs

High Traffic

COs (5,000)*

AT&T900 MCI530 Sprint380

* **

80% of

businesscustomerbuildings

Collocations by IXC**

MCIs Converged Packet Access

services are limited to On-net

via MCI's fiber-lit buildings

and Off-net in select locations


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Additionally, the Verizon/MCI merger places new competitive pressures on local accessprices, the maintenance of which is critical to profitability from the full suite of AT&Tsenterprise services. Worse, this pressure will cut into the potential for expanding theseservices into the small and medium sized business (SMB) market.

In other words, because of structural inefficiencies in its distribution network, the mergerof AT&T and SBC could cause the company to lose margin rather than gain it.

AT&T will continue to compete with the legacy MCI for enterprise business in marketssuch as New York, Washington, and Boston, where each has traditionally had a similarlocal access footprint via on-net LSOs. MCI, by contrast, will have a significantcompetitive advantage in those markets with ubiquitous LSO coverage of Verizonsaccess networks.

CFN Services believes that by leveraging third-party multi-modal technologies tooptimize local access and transport infrastructure, these market asymmetries can be

solved, giving AT&T, in this example, an opportunity to grow profitably post merger.

Based on its analysis of wireless and wireline access costs and footprint, CFN Servicesbelievesstrategic access optimization initiative can yield savings in the range of 20-25%.

Getting to Wal-Mart Economics

The CFN Service platform brings Wal-Mart scale economies to telecom services. Weuse an off-balance sheet strategic platform to optimize off-net to on-net local accesstransport, giving our clients a clear path to profitable growth.

Our platform uses broad-based LSO expansion and collocation for implementation ofmultiplexing services and access to unbundled network elements for the deployment ofmulti-modal alternative access technologies such as H/VDSL and Ethernet over copper.

Additionally, our platform leverages fixed wireless technologies for cell site mobilebackhaul access and broadband Ethernet access expansion. This approach integratesseamlessly with existing carrier local access transport infrastructure, while supportingkey initiatives for expansion of converged packet and Ethernet services, and ensuringhigh-end enterprise services.

A platform-based approach to local access transport optimization will reposition wirelinecarriers strategically for long-term competitiveness in the enterprise market, while alsopositioning for expansion in the SMB markets.

For both wireless and wireline providers, our approach shifts and flattens the access costcurve from a linear growth curve to an incremental growth curve, where unit volumeand/or bandwidth growth drive continually decreasing unit costs across the platform, asin the core network.


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CFN is rewriting the telecom services business model in its entirety.

Leveraging expert resources and tools developed specifically for local access transportoptimization analysis and platform deployment such as FiberSource and FiberMAP,CFN Services performs a strategic analysis of carriers access costs.

Incorporating the extensive base of deployed fiber and facilities in over 120 marketsnationwide, our analysis identifies opportunities for the extension of existing local accessnetwork platforms and implementation of new metro fiber-based platforms in newmarkets. Our analysis incorporates customer metrics for ROI, and other critical businesscase measures.

CFN Services FiberMAP (Fiber Metro Access Program)

While our platform conservatively delivers 20-25% in annual access cost savings to

carriers, it does not require significant investments of capital or expansion of internaloperating costs.

The dilemma for carriers without CFNs Wal-Mart-style economics is that the more theyexpand, the less likely they are to achieve long-term competitive advantage throughnetwork differentiation.

To solve this, future infrastructure investments must be toward the edge, where more ofthe intelligence increasingly lies, and away from vulnerable commodity pipelines.

Verizon

Electronic CDRs

Paper Bills

Forecasts

Interconnect

agreements

CSX FN

Inventory

(fiber, facilities, and

relationships)

Conduct

Market

Optimization

(iterate)

BellSouthSBC

Cost,

Inventory,

Traffic

Circuit

Inventory

Data

Circuit

Inventory

Data

Traffic

and Network

Data

Traffic

and Network

Data

Gather Multi -

market

Access Cost

Data

Perform

Analysis and

Mapping

Tariffs

NECA

LERG

Tariffs

NECA

LERG

Map/Engineer

Optimized

Network(s)Design

Develop

Phased

Implementation

Plan

2

CSX FN optimizes, P OP locations, collocation

facilities and/or desired connection points viaproprietary analysis tools

Prioritized roll

out based on

savings

opportunitiesand strategic

priorities

Carrier

Demand

Data

Carrier

Demand

Data

CSX FN

FiberSource

Verizon

Electronic CDRs

Paper Bills

Forecasts

Interconnect

agreements

CSX FN

Inventory

(fiber, facilities, and

relationships)

Conduct

Market

Optimization

(iterate)

BellSouthSBC

Cost,

Inventory,

Traffic

Circuit

Inventory

Data

Circuit

Inventory

Data

Traffic

and Network

Data

Traffic

and Network

Data

Gather Multi -

market

Access Cost

Data

Perform

Analysis and

Mapping

Tariffs

NECA

LERG

Tariffs

NECA

LERG

Map/Engineer

Optimized

Network(s)Design

Develop

Phased

Implementation

Plan

22

CSX FN optimizes, P OP locations, collocation

facilities and/or desired connection points viaproprietary analysis tools

Prioritized roll

out based on

savings

opportunitiesand strategic

priorities

Carrier

Demand

Data

Carrier

Demand

Data

CSX FN

FiberSource


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Carriers must shun assets with long payback periods and/or table-stakes capabilities. Yet,carriers cannot improve margins if their cost structure is highly variable and they mustbuy LEC access circuits by the drink.


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Communications Access and Transport Networks v2.0

Since carriers cannot easily duplicate Wal-Marts in-house distribution dominance theymust use other means.

Wal-Marts distribution model allows it to compete on price and secondarily on productvariety. Wal-Marts capital investments reinforce this strategy as seen in its recent focuson RFID technology which is projected to eliminates as much as $7 billion in costs fromits annual logistics expense. By contrast, Target, which has been extremely successful inthe last five years, focuses first on product, with a strong emphasis on trendy items, andhas a secondary focus on price. Target has built its supply chain to be nimble andresponsive to its fashionable, fickle customer.

To support its strategy, Target embraces third-party logistics providers (3PL), thusavoiding capital investment risk in new technologies and facilities. Targets 3PLarrangements provide a cost structure that is more fixed than variable and give Target

control over capacity. Targets decision to selectively outsource gives the company anoff balance sheet way of increasing its distribution capacity.

CFN Services does the same thing for wireless and wireline providers. CFN givescarriers a quick and cost effective means to build out needed infrastructure withoutinvesting precious capital.

Our approach delivers flexibility on a market-by-market basis, enabling carriers toleverage existing preferred vendors and relationships, while taking full advantage ofplatform economics.

More importantly, our approach frees up staff and capital to focus on core activities suchas marketing and next generation service deployment. Our outsourced platform approachprovides carriers economies of scale, third-party expertise, at a shared services cost. Inshort, we provide carriers control over transport infrastructure without the burden ofowning the assets.

CFN has the capability to optimize transport network infrastructure and to deliver amanaged network including headcount resources, operations and maintenance,collocations and equipment. Since carriers needs are custom, CFN Services can offer allor portions of these services that fit best with their strategy.

Let us put on a webinar for your team. You will be simply amazed at the cost advantagesthat are simply lying around waiting for youor one of your competitorsto pick up.Call me today.

(Put in name and # ad e-mail)

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