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May 2011
ICT in emerging markets: a USD 200 Bln opportunity that cannot be ignored
Authors Jacobo Garcia-Palencia - Partner Juan Jose Rio - Associate Partner Dimitris Lioulias - Manager
OVERVIEW
ICT is a global market worth more than USD 3 trillion and it becomes increasingly relevant for telecoms players, both as an offensive and as a defensive play The ICT offering can be broken down into six different categories of services, from more network centric (and hence more synergetic to pure Telco players) to more IT centric (and hence more synergetic to pure IT players). These services range widely not only in terms of revenue generation potential but also in terms of EBITDA margins (3-45%) The motivation of telecoms operators to enter the ICT battlefield has been varied depending on the type of player. The result, however, has been strategies that turn ICT into an important part of operators business - In Emerging markets, the ICT opportunity is at different stages of development:In South East Asia, business process outsourcing is at the forefront of ICT services being provided. Operators are in some cases quite advanced as they started with their ICT efforts more than a decade ago - In the Middle East, slow deregulation of the telecoms markets hinders strong development of ICT. Operators are in the process of building their skills and they use partnerships to achieve so - In Africa, poor fixed infrastructure also affects ICT negatively. Operators try mostly to leverage their mobile assets to deliver ICT services The size of the opportunity in these Emerging markets is expected to reach USD 230 Bln by 2013. The window of opportunity for aspiring telecoms operators is narrow. Firstly, because competition is increasing on the access side. Secondly, because IT players are moving aggressively to lock in long-term contracts enterprise and SME customers willing to outsource a number of their networking and IT needs
Introduction
1. About Information and Communications Technology (ICT)
As the boundaries between telecommunications and IT continue to blur, there is an increasing interest in ICT, the services falling in the intersection of these two industries. Beyond the usual hype surrounding new service offerings, ICT is gathering pace and according to Gartner, it is estimated that ICT-related services will generate more than USD 3.3 trillion in 2010 and growing to USD 4 trillion in 2013. In this environment, players from both industries are moving to capture momentum. Pure network operators are expanding their portfolio beyond network products to include certain IT capabilities, while pure IT players are expanding from the opposite end of the range of ICT services.
ICT services
While a full ICT portfolio encompasses all services ranging from telecommunications to IT, a further categorisation is necessary to highlight not only the differences between assets and skills required to provide such services, but also the variances in margins for telecoms operators across those different categories.
Referring to Exhibit 1, the three service categories (and partially the fourth) from the left side of the exhibit are mainly enabled by operators network capabilities and could become immediate components of an ICT offering by a telecoms operator. In order to capture the new revenue potential, only modest investments would be required by operators, estimated between USD 5-15m1, e.g., in platforms and in peoples skills, as the majority of necessary assets (especially those that are needed to protect their traditional fixed connectivity revenues) are already in place.
Based on data from HP. These numbers will vary depending on the extent of service offering as well as the number of users that have to be provisioned. Investments highlighted exclude OPEX costs related to potential managed services agreement with a company like HP or other provider.
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EXHIBIT 2: INIDICATIVE INVESTMENT REQUIREMENTS FOR OFFERING OF MANAGED SERVICE, USD MILLION
Note: This is a high level estimations and needs to be taken very broadly due to the complexity of the requirements and the individuality of different projects Source: HP
Other factors that will drive growth in specific services relate to the size and economic situation of specific countries. For example, it is far more likely that services such as Business Process Outsourcing (BPO) will be a growth area for the Philippines ICT market (large population relatively low GDP per capita), than it will be for a country like the United Arab Emirates (UAE). In summary, while ICT services growth depends largely on market-specific conditions, managed services (network, convergence, IT) are positioned to benefit the most from growth in the market.
3. Cloud computing
Cloud computing is a decades-old concept that current technological developments allow to materialise and to fulfil the promise of significant disruption in the ICT space. While definitions and understanding of What is Cloud? vary widely, common ground suggests that Cloud is the provision of IT-enabled capabilities as a service via the Internet. Attributes that define cloud computing are that it has to be service-based, scalable and elastic, shared, metered by usage and all this has to happen via the use of Internet technology. The main benefits of Cloud-based services are that they provide enterprises with flexibility, scalability and speed, as well as the transformation of CAPEX into OPEX. Cloud-based services can be categorised as follows: Infrastructure as a service Platform as a service Software as a service Business process utility as a service
While cloud computing has been overhyped and expected to bring to enterprises benefits of transformational magnitude, the reality is that Cloud services are a viable means for delivering ICT in the future. As such, cloud-related revenues, while already sizeable today, are forecasted to reach USD 150 Bln by 2013. The Cloud, similar to any outsourced arrangement, contains certain risks compared to IT handled in-house. The main risks relate to security, availability and reliability, control, compliance. However, a phased approach together with selection of appropriate partners will usually help mitigate most of these risks. From the perspective of the telecoms operators, cloud computing presents opportunities. If addressed properly, it can open up the door to capturing value from the IT industry (albeit, not from the large players, e.g., IBM. In the case of players like IBM, it is more likely that it will enable the selling of joint standardised offers to SME driving more fixed internet and connectivity) and can be a defence against IT players foray into traditional telco areas.
As telecoms players design their Cloud strategy, they have to take into consideration of the following: Cloud services are a reality and their value, according to Gartner, is expected to almost triple in the next 3 years, by 2014 The key to provisioning of Cloud services is connectivity, i.e., the telecoms operators traditional strength. This means that uptake of Cloud services will always bring additional value to telecoms operators, as Cloud players require increasing amounts of bandwidth, it is especially the case in less competitive telecoms countries For telecoms operators it is difficult to become positioned at the forefront of Cloud services, as they lack the pedigree Telecoms operators, however, can pursue a phased introduction into the Cloud space by offering services in which they already have significant in-house capabilities, such as data centres, established business processes such as billing and customer care, and so on. They can then extend their offering that would include SaaS while building the relevant capabilities For the most part, the Cloud is a zero-sum game. As customers shift an increasingly large part of their IT budgets to the Cloud, the traditional IT expenditure, such as software purchasing, hardware purchasing, IT systems integration and other services, will lessen. Consequently, heightened competition is expected in the Cloud as traditional IT players resist the erosion of their revenues. This is likely to spill over to the telecoms arena, as Cloud services will enable those players to offer VoIP solutions
While this rationale applies to all telcos, the main focus is different for each of the following types of operators: Global players, e.g., BT: ICT is addressed as their core business Fixed incumbents, e.g., Telefonica: ICT is addressed as a vehicle to protect fixed market share Second, third fixed entrants, e.g., Orange in Spain: ICT is addressed as a means to gain share of fixed telco. Dumping data centres services in the process is not uncommon Mobile players, e.g., Vodafone: ICTs focus is to address the SME segment by leveraging on incumbent offers or promoting fixed line replacement by mobile
Furthermore, significant differences can be observed between operators in developed market and those in developing markets. Developed markets operators (e.g., Orange, Singtel, Telefonica) have embraced ICT more tightly and reap higher rewards, as ICT revenues contribute 10-15% of their total revenues. In contrast, emerging market players derive less than 1% of revenues from ICT.
While this classification is useful to understand the differences better between the players, market reality shows that there are many trade-offs that operators have to make. For example, focus on specific service categories does not necessarily mean that a telecoms operator can address the needs of all customers in these categories. Conversely, an operator that serves multinationals does not necessarily mean that it can offer the full range of P&S. Both local and global operators often offer part of their services to key clients through partnership models, both at home and abroad.
A prime example of addressing the above objectives via acquisitions is the case of BT. BT is the telecoms operator with perhaps the largest ICT capabilities, a large part of which were developed internally. However, BT has also spent approximately USD 3 Bln in the acquisition of more than 40 companies to develop presence in new geographies or solidify positioning in specific verticals. Joint ventures have been another common means for addressing the ICT market. This has been driven largely by the need of global ICT players to deliver services to their multinational clients, while they lack the local access assets in one of the clients countries of operation. On the flip side, incumbents in developing markets that lack ICT knowledge and capabilities see joint ventures with large ICT players as a way to leverage their telecoms assets and quickly build a certain level of ICT skills, e.g., AT&T and Qtel with their joint venture NavLink. Obviously, these different approaches imply fundamental trade-offs of immediate versus mid-term financial returns, time to market and operational control. While acquisitions have an immediate impact on capabilities and business size, they generally show more questionable financial returns and organisational difficulties.
Conversely, building capabilities internally takes significantly longer time, but at the same time the financial downside is limited, there is more organizational control and generally robust, long-term competitiveness is achieved.
I. Valuation considerations
First and foremost, the decision to move into ICT comes with a size versus margin-dilution tradeoff, which often impacts company valuation. Telcos with high ICT focus have lower valuations compared to other telcos as, while still having high CAPEX requirements, they attract additional revenues from ICT that have significantly lower margins. For the ICT foray to result in value accretion, the incremental revenues derived from IT services have to offer sufficient margin to make up at least for the difference in valuation between the traditional telco and the ICT telco business model.
For operators who choose to expand the service portfolio around network-centric skills, traditional telco margins are more likely to be maintained, while stretching the service portfolio to IT-centric skills and services will reduce average margin. Finally, the operators geographical footprint is very important in deploying an ICT offensive, as margins are generally linked to infrastructure ownership. Venturing into service provisioning for multinationals outside an operators own infrastructure footprint will generally dilute margins.
V. Implementation considerations
Telecoms operators have some of the network assets required to offer ICT services. However, successfully competing in this arena requires a different operating model and a different mindset than those common in telecoms players. In particular, the operating model surrounding the commercial, service delivery and customer care functions are fundamentally different. Offering ICT services requires a much deeper relationship with clients that go beyond the typical box-pushing approach of telcos sales. An ICT key account manager must understand the specific needs of the client and offer solutions to address them.
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These solutions often require customisation, and the product factory needs to have the capacity and sufficient independence from the telco factory to deliver it. Finally, offering customer care for the client often entails servicing customers at their own premises. All the above require a differentiated service mentality, culture and skills from those traditionally found in typical telcos. The transition from a telco to an ICT mentality has been accomplished with varying degrees of success by many telecoms players. However, one should not underestimate the need for a lengthy transformation program to make it happen.
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Conclusion
The ICT opportunity is sizeable, with potential for further growth and it represents operators with an avenue for additional revenues.
However, the opportunity and urgency to act is not the same for all markets. As depicted on Exhibit 7, the opportunity is expected to be higher in markets with greater fixed market and higher competition. Operators in South-East Asia, the Middle East and Africa are positioning themselves for ICT, as they see it both as a defensive response to threats to their traditional telecoms business from a multitude of competitors, and as an offensive strategy to capture value from adjacent revenue pools. Operators, however, do not yet fully capture the opportunity, especially in the Middle East and Africa, as they are in the process of developing their capabilities. Building these capabilities is a process that requires operators to transform away from the telco mindset, assets and operating model to those of an ICT player. This is the case even if operators prudently decide to follow a phased approach and mainly leverage their telecoms assets to offer a partial portfolio of ICT services. However, the investments required are relatively small and they may only increase if the ICT venture proves successful for the operators.
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In any case, operators have to consider their relative size, assets, capabilities, resources and market environment before they venture into ICT, as they have to devise their own clear strategy on how to approach the opportunities and risks entailed by the ICT market. These risks relate mainly to the reality that, due to lower margins of ICT services, ICT players are faced with lower valuations than those of pure telcos. Furthermore, the actual transformation onto an ICT player is a long-term process that requires strong top-management support and disciplined execution to make it happen.
Finally, operators have to consider that the window of opportunity for ICT is narrow, especially in the more lucrative oil-rich Middle Eastern markets and the key South African and Egyptian markets. On one hand, liberalisation and technological evolution could render operators uncompetitive if they have not developed the necessary ICT capabilities. On the other, the high-value clients are going to be locked away in longterm contracts with their telcos and IT competitors.
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