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The Industry Handbook: The Telecommunications Industry

By Investopedia Staff A A A Filed Under: Fundamental Analysis, Statistics Fundamental Analysis, Statistics Think of telecommunications as the world's biggest machine. Strung together by complex networks, telephones, mobile phones and internet-linked PCs, the global system touches nearly all of us. It allows us to speak, share thoughts and do business with nearly anyone, regardless of where in the world they might be. Telecom operating companies make all this happen. Not long ago, the telecommunications industry was comprised of a club of big national and regional operators. Over the past decade, the industry has been swept up in rapid deregulation and innovation. In many countries around the world, government monopolies are now privatized and they face a plethora of new competitors. Traditional markets have been turned upside down, as the growth in mobile services out paces the fixed line and the internet starts to replace voice as the staple business. (For more on this process, read State-Run Economies: From Public To Private.) Plain old telephone calls continue to be the industry's biggest revenue generator, but thanks to advances in network technology, this is changing. Telecom is less about voice and increasingly about text and images. High-speed internet access, which delivers computer-based data applications such as broadband information services and interactive entertainment, is rapidly making its way into homes and businesses around the world. The main broadband telecom technology - Digital Subscriber Line (DSL) - ushers in the new era. The fastest growth comes from services delivered over mobile networks. Of all the customer markets, residential and small business markets are arguably the toughest. With literally hundreds of players in the market, competitors rely heavily on price to slog it out for households' monthly checks; success rests largely on brand name strength and heavy investment in efficient billing systems. The corporate market, on the other hand, remains the industry's favorite. Big corporate customers - concerned mostly about the quality and reliability of their telephone calls and data delivery - are less price-sensitive than residential customers. Large multinationals, for instance, spend heavily on telecom infrastructure to support far-flung operations. They are also happy to pay for premium services like high-security private networks and videoconferencing. Telecom operators also make money by providing network connectivity to other telecom companies that need it, and by wholesaling circuits to heavy network users like internet service providers and large corporations. Interconnected and wholesale markets favor those players with far-reaching networks.

Key Ratios/Terms Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): An indicator of a company's financial performance calculated as revenue less expenses (excluding tax, interest, depreciation and amortization). Churn Rate: The rate at which customers leave for a competitor. Largely due to fierce competition, the telecom industry boasts - or, rather, suffers - the highest customer churn rate of any industry. Strong brand name marketing and service quality tends to mitigate churn. Average Revenue Per User (ARPU): Used most in the context of a telecom operator's subscriber base, ARPU sometimes offers a useful measure of growth performance. ARPU levels get tougher to sustain competition, and increased churn exerts a downward pressure. ARPU for data services have been slowly increasing. Broadband: High-speed internet access technology. Telecommunications Act: Enacted by the U.S. Congress on February 1, 1996, and signed into law by President Bill Clinton in 1996, the law's main purpose was to stimulate competition in the U.S. telecom sector. Analyst Insight It is hard to avoid the conclusion that size matters in telecom. It is an expensive business; contenders need to be large enough and produce sufficient cash flow to absorb the costs of expanding networks and services that become obsolete seemingly overnight. Transmission systems need to be replaced as frequently as every two years. Big companies that own extensive networks - especially local networks that stretch directly into customers' homes and businesses - are less reliant on interconnecting with other companies to get calls and data to their final destinations. By contrast, smaller players must pay for interconnection more often in order to finish the job. For little operators hoping to grow big some day, the financial challenges of keeping up with rapid technological change and depreciation can be monumental. Earnings can be a tricky issue when analyzing telecom companies. Many companies have little or no earnings to speak of. Analysts, as a result, are often forced to turn to measures besides price-earnings ratio (P/E) to gauge valuation. Price-to-sales ratio (price/sales) is the probably simplest of the valuation approaches: take the market capitalization of a company and divide it by sales over the past 12 months. No estimates are involved. The lower the ratio, the better. Price/sales is a reasonably effective alternative when evaluating telecom companies that have no earnings; it is also useful in evaluating mature companies. Another popular performance yardstick is EBITDA. EBITDA provides a way for investors to gauge the profit performance and operating results of telecom companies with large capital expenses. Companies that have spent heavily on infrastructure will generally report large losses in their earnings statements. EBITDA helps determine whether that new multimillion dollar fiberoptic network, for instance, is making money each month, or losing even more. By stripping away interest, taxes and capital expenses, it allows investors to analyze whether the baseline business is profitable on a regular basis.

Investors should be mindful of cash flow. EBITDA gives an indication of profitability, whereas cash flow measures how much money is actually flowing through the telecom operator at any given period of time. Is the company making enough to repay its loans and cover working capital? A telecom company can be recording rising profits year-by-year while its cash flow is ebbing away. Cash flow is the sum of new borrowings plus money from any share issues, plus trading profit, plus any depreciation. Keep an eye on the balance sheet and borrowing. Telecom operators frequently have to ring up substantial debt to finance capital expenditure. Net debt/EBITDA provides a useful comparative measure. Again, the lower the ratio, the more comfortably the operator can handle its debt obligations. Credit rating agencies like Moody's and Standard & Poor's (S&P) take this ratio very seriously when evaluating operators' borrowing risk.

Porter's 5 Forces Analysis 1. Threat of New Entrants. It comes as no surprise that in the capital-intensive telecom industry the biggest barrier to entry is access to finance. To cover high fixed costs, serious contenders typically require a lot of cash. When capital markets are generous, the threat of competitive entrants escalates. When financing opportunities are less readily available, the pace of entry slows. Meanwhile, ownership of a telecom license can represent a huge barrier to entry. In the U.S., for instance, fledgling telecom operators must still apply to the Federal Communications Commission (FCC) to receive regulatory approval and licensing. There is also a finite amount of "good" radio spectrum that lends itself to mobile voice and data applications. In addition, it is important to remember that solid operating skills and management experience is fairly scarce, making entry even more difficult. 2. Power of Suppliers. At first glance, it might look like telecom equipment suppliers have considerable bargaining power over telecom operators. Indeed, without high-tech broadband switching equipment, fiber-optic cables, mobile handsets and billing software, telecom operators would not be able to do the job of transmitting voice and data from place to place. But there are actually a number of large equipment makers around. There are enough vendors, arguably, to dilute bargaining power. The limited pool of talented managers and engineers, especially those well versed in the latest technologies, places companies in a weak position in terms of hiring and salaries. 3. Power of Buyers. With increased choice of telecom products and services, the bargaining power of buyers is rising. Let's face it; telephone and data services do not vary much, regardless of which companies are selling them. For the most part, basic services are treated as a commodity. This translates into customers seeking low prices from companies that offer reliable service. At the same time, buyer power can vary somewhat between market segments. While switching costs are relatively low for residential telecom customers, they can get higher for larger business customers, especially those that rely more on customized products and services. 4. Availability of Substitutes. Products and services from non-traditional telecom industries pose serious substitution threats. Cable TV and satellite operators now compete for buyers. The cable guys, with their own direct lines into homes, offer broadband internet services, and satellite links can substitute for high-speed business networking needs. Railways and energy utility companies are laying miles of high-capacity telecom network alongside their own track and pipeline assets. Just as worrying for telecom operators is the internet: it is becoming

a viable vehicle for cut-rate voice calls. Delivered by ISPs - not telecom operators - "internet telephony" could take a big bite out of telecom companies' core voice revenues. 5. Competitive Rivalry. Competition is "cut throat". The wave of industry deregulation together with the receptive capital markets of the late 1990s paved the way for a rush of new entrants. New technology is prompting a raft of substitute services. Nearly everybody already pays for phone services, so all competitors now must lure customers with lower prices and more exciting services. This tends to drive industry profitability down. In addition to low profits, the telecom industry suffers from high exit barriers, mainly due to its specialized equipment. Networks and billing systems cannot really be used for much else, and their swift obsolescence makes liquidation pretty difficult.

6.Aug Entry#6: Analysis of the Indian Telecommunication Industry-The Changing Forces

7. 25 August 2013 inShare 8. The Indian telecommunication sector has emerged as a strong growth engine for the Indian economy in the last decade. Given the disruptive innovations and turmoil in this industry in the last decade, the typical Porters Five Forces cannot be used to analyze this industry. This article aims to study the industry using a modified Five Forces model, focusing on every aspect from entry to the market to relationship dynamics amongst the various stakeholders to exit options from the industry. The article contains valuable insights gathered from primary interview of industry experts as well as data from various secondary literatures. 9. 10. The new driving forces of Tele-communication: 11. Barriers to entry: 12. 13. Brands: 14. There are 10 major established players in the industry namely Vodafone-Essar, Airtel, Aircel, Idea Cellular, Tata Teleservices, Reliance Communications, Videocon, Uninor, BSNL, MTNL with cumulative market share of 96.98%.There is no considerable difference between the various basic service offerings by service providers. Thus, high mobility exists among customers in migrating between service providers. Also, the government regulations like MPN (mobile number portability) have provided more flexibility to users. There are certain specific cases where users prefer a provider because of better network coverage, easy accessibility or better Value-Added Services, but such a trend is short-lived.

15. 16. Economies of Scale: 17. Existing players enjoy certain degrees of economies of scale that help them offer lower unit pricing to customers. A notable part of the investments are one-time and are referred to as sunk costs i.e operator can only exit this particular market at considerable costs. Investments in telecom networks can be divided for the following functional elements: 18. -Terminal equipment 19. -Access Network 20. -Switching 21. -Transmission/Long line 22. -Other (buildings etc.) 23. 24. The biggest barrier is the availability for credit financing which is highly dependent on many external factors. However, to minimize this high deployment costs, service providers have started considering infrastructure sharing, which has been discussed in Industry Transformation. 25. 26. Spectrum Availability: 27. Despite technological changes that reduce the demand for spectrum, availability of spectrum continues to be a constraint. In order to allocate spectrum amongst competing service providers, auctions are often used. It is here that the governments regulatory powers come into play. Moreover, there are alw ays issues of interoperability with changing bandwidth and thus seamless integration of various services becomes a major issue. Thus, spectrum availability poses a huge barrier to entry, increasing the industry attractiveness.

28. 29. 30. Service Licensing: 31. Licensing also acts as a major barrier to entry as sometimes it becomes very difficult for the new entrants to obtain license. Existing players pay huge revenues to obtain licensing and new entrants face retaliation from incumbents regarding licensing. This increases the industry attractiveness. 32. 33. Technology Retaliation: 34. Wireless technology is based on two competing platforms GSM and CDMA. Accordingly, players have united themselves in lobbying with GSM service providers represented by Cellular Operators Association of India (COAI) and CDMAs by Association of Unified Telecom Service Providers of India (AUSPI). With each technology possessing inherent advantages as well as disadvantages, it presents a difficult proposition for a new entrant to decide on its offering. 35. 36. Rivalry among competing firms: 37. The Hirschman-Herfindahl Index (HHI) for the Indian telecom industry stands at 1421.29 which indicate a highly contestable but oligopolic industry. Moreover, the concentration of top four firms at 66% also confirms this hypothesis. 38. 39. Price wars: 40. The switching costs being low, the Indian market is highly value-driven and price sensitive, and telecom companies are in continuous pressure to deliver new services while improving customer experience and loyalty. The service providers priority is to add maximum number of subscriber per month and retain the existing user base. The preferred strategy among all competitors is to offer lower prices coupled with more value added services. This has a damaging effect on the bottom line for the industry as whole, leading to commoditization of the market with decreasing individual market capitalization and makes the industry unattractive for the entrant. 41. 42. Fixed Cost: 43. The industry suffers from high fixed costs and fast technology obsolescence. The service providers also incur expenses in procuring licenses and laying down network infrastructure. To garner these expenses, it becomes essential to have adequate capacity utilization. It takes tremendous capital to build a cellular network, backhaul and operations center. Operating a cellular carrier requires specific human resources, with specialized skills. It requires a field force to install

and maintain the physical assets, a training division, a support group and web experts to build a reliable website. These human resources are in limited supply and are expensive. Thus, increasing subscribers base becomes very important. This also furthers the competitive stakes. 44. 45. Strategic stakes: 46. We see players in this market are the ones typically considering big business powerhouses in India (Bharti Airtel, Reliance), and they branch out into other industries as well. These increase strategic stakes for the players. The tele-density is very less in rural India and this presents an untapped potential for the service providers once the urban market has started maturing. Migration to the new market requires more upfront investments and thus hard cash availability with the providers becomes essential. Moreover, it is always profitable to have the first mover advantage as it provides the opportunity to garner certain premium in pricing for services. 47. 48. High degree of Imitation, lowering switching costs: 49. There is almost no differentiation among the service providers regarding basic services, and even any innovations in value added services are quickly copied. So, it is very easy for the users to change their service providers and the industry operates with minimal customer loyalty. This makes the industry rivalry most prominent.

50. 51. Bargaining power of buyers: 52. 53. Buyers threat of backward integration and industrys threat of forward integration are nil. However, contribution to quality and cost, along with buyers profitability, plays a good part in determining buyers bargaining powers. 54.

55. 56. Switching Costs : 57. The market can be divided into household and industrial consumers. Additionally, they can be differentiated as either pre-paid or post-paid users. In case of post-paid users, customers exercise certain degree of loyalty because of high switching costs. Also, the industrial users have customized offerings from service providers that bind them. For household customers, TRAIs recommendation on MPN (Mobile Number Portability) has made it all the more important for the companies to charge lower tariffs besides providing better services to retain subscribers. 58. 59. Maturing Urban market : 60. With urban tele-density well over 100% the additional growth in revenue by service providers can only be achieved by market cannibalization. This results in more pronounced buyers power. 61. 62. Bargaining power of suppliers: 63. The supplier for the telecom industry includes: 64. a) Network Infrastructure provider 65. b) Information technology support 66. c) Passive infrastructure providers 67. d) Telecom equipment manufacturers-including handset manufacturers

68. 69. 70. On analyzing the industry, it is evident that infrastructure suppliers wield intermediate degrees of bargaining power over the service providers because of necessity of infrastructural support like network towers, high-tech broadband switching equipment, fiber-optic cables, mobile handset and billing software. The number of suppliers is few, substitutes are rare, and contribution of these

supplies to cost and quality are huge. Thus, although suppliers do not have a scope of forward integration, the high switching cost for the telecom industry provides great bargaining power to suppliers. But, here too, shared tower infrastructure has brought forth a transformation. Silicon chip manufacturers (for processors, memory chips, etc), sub-contractors and employees also act as suppliers to this industry. Due to heavy competition among chip manufacturers, their bargaining power is essentially low. But there is medium switching cost for telecom vendors since changing their hardware would lead to additional cost in modifying their architecture. Also, the switching to different set of hardware support involves modification in design architecture at the service providers end and this entails some costs. The suppliers side also faces the pressing issue of dearth of talented and skilled manpower, and this curtails the capabilities to innovate and strengthen the bargaining power for suppliers. 71. 72. Threat of substitutes: 73. The potential major substitutes for the telecom industry are as follows: 74. -VOIP (Skype, Messenger etc.) 75. -Online Chat 76. -Email 77. -Satellite phones 78. 79. Additionally, products and services from non-traditional telecom industries such as Cable TV and satellite operators are laying their own direct lines into homes, offering broadband internet services. Railways and energy utility companies are utilizing their vast infrastructural installations to support high-capacity telecom network alongside rail-tracks, pipeline networks, and electricity transmission lines. Many ISPs (Internet Service Providers) are offering "internet telephony" at low prices. For service providers skillfully managing their transition from voice to data services, internet messengers such as Skype, Google Voice and Chat pose a threat.

80. 81. 82. Unlicensed frequency options (ex: Wi-Fi, UWB, Walkie Talkie) also compete alongside. But, the issue of security, reliability and flexibility associated with mobile telephony, along with switching costs associated with substitutes, still make mobiles a preferred choice. Satellite options incur higher operating costs and the technology is not promoted by government due to security considerations.

83. 84. 85. Key Financial Indicators: 86. 87. ARPU: Average Revenue per User, which is calculated by dividing the total revenue by the number of subscribers. Given the total volume of VAS that contributes to revenue, this is a better measure than AMPU, or average minutes per user.

88. 89. 90. Figure 8: Increasing Subscriber Base and Decreasing ARPU [Source: Telecommunication, Market opportunities by IBEF] 91. 92. Customer Base: Analysis of annual reports of the major telecom companies revealed that almost all take great pride in commanding a huge subscriber base, and revenues are directly dependent on them. 93. 94. Penetration Levels: In this saturating urban market, telecom companies look out for possible expansion in any region using the penetration levels. Very low penetration levels are existent in rural areas, basically due to lack of infrastructure. Telecom companies target medium level penetration zones where added infrastructure cost would be low, and return on assets high. Low penetration level in Africa was one major factor which motivated Bharti Airtel to set up operations there. 95. 96. Data Rate Units: With data becoming the major segment of revenue earner, companies strive to provide data rate in the range of Kilo Bytes and Mega Bytes

to enhance user browsing experiences. Thus, Mbps is becoming one of the most important success factors in years to come. 97. 98. Churn Rate: It is defined as the rate at which customers leave a provider for a competitor. Largely due to fierce competition, the telecom industry boasts - or, rather, suffers from the highest customer churn rate of any industry, with a monthly churn of 1.9-2.1%. Strong brand name marketing and service quality tends to mitigate churn to some extent. 99. 100. Quality of Service: QOS serves as an important statistic that service providers monitor using signal strength indicators to maintain their standards of service. 101. 102. [The article has been written by Souvik Kumar Saha & Abhishek Kundu. They are presently pursuing their PGDM from IIM Bangalore.]