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Telecommunications

RECALL No7

High-Growth Markets

RECALL No 7 High-Growth Markets

Welcome ...
to the 7th edition of Marketing RECALL, McKinseys publication for senior executives in the telecoms industry. Our High-Growth CxO Roundtable in Paris during October of last year was a great success and generated fascinating insights. In this special edition, we have consolidated some of these learnings with the knowledge distilled from our daily interactions with CxOs with a special interest in high-growth markets. High-growth markets are enjoying dizzying performance compared to mature markets. From 2006 to 2007, subscriber growth in emerging markets rose approximately 17 percent, while revenues shot up 26 percent. Additionally, these markets saw an enviable EBITDA increase of 44 percent. An average of 3.8 million new subscribers are added per month and capex investments totaled more than USD 16 billion in 2007. Industry growth is unmatched in these regions where leaders will be shaping the industry, especially in the area of wireless applications. In fact, many of their innovative business models have caught the attention of operators in developed markets. We kick off this edition with a summary of our view on the telecoms trends in high-growth markets. Then its on to a look at how operators might position themselves to capture maximum value from the imminent explosion in broadband demand. Further keeping in mind the consumer realities of emerging markets, we examine the role of handset cost in market penetration as well as the unique opportunities that lie at the intersection of banking and mobile telecommunications. Next, well walk through a perspective on telecoms regulation and how emerging market characteristics require more than merely importing the regulatory frameworks of developed markets. We covered the topic of pricing in Marketing RECALL No1, and in this edition, we offer further guiding principles on designing price plans for emerging markets, which focus on the balance between simplicity and customization. We then discuss how improvements in collections can yield a 15 to 30 percent net loss reduction in high-growth markets by reducing exposure to high-risk and delinquent customers and increasing net recoveries from contractual write-offs. Our final article specifically addresses the current economic situation. This global reality is top-of-mind for nearly all telecoms leaders, but the implications of a downcycle for operators in emerging markets are unique. Many high-growth telcos have remained resilient due to their stronger cash positions and are starting to seize M&A opportunities and experiment with bold marketing moves. We conclude this edition with an interview with Zain Africas Chris Gabriel in which he shares his experience as chief executive of a telecoms giant and his perspective on the sociopolitical and economic dynamics of high-growth markets. The editors would like to thank Daniel Boniecki, Paulo Fernandes, Andr Levisse, Stefan Schmitgen, and John Tiefel for their leadership on McKinseys High Growth in Telecoms Initiative and their guidance on this special issue on high-growth markets. We thank you for reading, and, as always, we welcome your thoughts and comments.

Jrgen Meffert Leader of McKinseys EMEA Telecommunications Practice

Boris Maurer Leader of McKinseys Telecommunications Extranet

Pedro Mendona Leader of McKinseys Marketing in Telecommunications Practice

Gloria Macias-Lizaso Leader of European Telecoms Mobile Pricing, Marketing RECALL Editor

RECALL No 7 High-Growth Markets

Contents
01 02 03 04 05 06 07 08 09 High-Growth Trends: Seven Agenda Toppers for Telecoms Managers Broadbang! Building Bandwidth in High-Growth Mobile Markets Low End, High Yield: Bringing Mobile to the Masses Banking on Mobility: Transactions, Technology, and High-Growth Markets Mandating Growth: Regulating Emerging Markets Righting Whats Wrong: Fixing Emerging Market Mobile Pricing Paid in Full: Improving Telco Collections Performance The Silver Lining: Downcycle-Driven Opportunities for Emerging Markets Sub-Saharan Success: Zains Wonderful World Just Got Bigger 7 13 21 27 33 39 45 51 57 63

Appendix

RECALL No 7 High-Growth Markets High-Growth Trends: Seven Agenda Toppers for Telecoms Managers

01 High-Growth Trends: Seven Agenda


Toppers for Telecoms Managers

Mobile network operators in high-growth markets contend with a set of challenges and opportunities very different from those of their developed market counterparts. These unique dynamics mean that top management to do lists in Swaziland are quite different from those in Switzerland. The priorities of telco top managers in high-growth markets differ significantly from those of their counterparts in more developed countries. The absence of fixed-line infrastructure, the preeminence of prepaid subscribers, and the evolution of innovative business models all play unique roles in shaping these differences. Furthermore, emerging market players can earn outsized profits; based on ARPU (average revenue per user) levels as low as USD 5, some operators capture EBITDA margins in excess of 50 or 60 percent. McKinseys long-standing work with telcos in emerging markets reveals seven major themes that head the agendas of most top executives in these high-growth markets.

high-growth markets approach the downcycle with a relatively stronger debt position as compared to their counterparts in more developed markets (Exhibits 1 and 2). While wide variances exist at the company level, depending on its leverage, we expect operators to focus on several opportunities. Manage risks. Successful operators will likely revise plans to make sure that they can weather worst-case scenarios, assess the strength of key distributors (which in prepaid are at the crux of everyday sales and often have weaker credit positions than large operators), and tighten cash leakages such as price and collection. Improve the conditions of operations. One lever is the renegotiation of the spectrum, license fees, or the conditions of deployment (3G coverage, for example). In many countries, regulators or governments levied heavy duties on spectrum to take their share of the telecoms bonanza. For smaller players, this may be unsustainable; many are renegotiating this in exchange for sustained investment, competitive industry structure, contribution to GDP growth, and taxes. More classical optimization, like outsourcing and tower sharing, can also be considered as levers. Consider consolidation. In many countries, such as India with more than 12 operators and Indonesia with more than 10, the debate over consolidation is open. Players in these markets still have to invest major amounts of capital to gain coverage, and achieving a positive outcome for all is often questioned. This of course also stirs the interest of both emerging and developed market players

Managing for cash


Of course, in the current economic climate, managing for cash has naturally become the most urgent concern in all markets. However, there are several important nuances when it comes to emerging markets: first of all, there is still growth. For example, in Asia, while the IMF lowered its growth expectations by 2 to 3 percent during 2008, the base case still remains above 4 percent per year. More recently, decreases in fuel and food prices helped unlock consumer spend, at least in urban areas. Second, in general, telecoms players in

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High-growth players are entering the downcycle with significantly stronger portfolios

to expand internationally into Africa, Southeast Asia (Vietnam), and the Middle East, in the hope of benefiting from reduced valuation and fewer buyers. Consider adjacent industry acquisitions. In the same spirit of consolidation, healthier players in high-growth markets also see the opportunity to shape adjacent industries: buying players such as music labels or instant messaging sites or acquiring banking licenses to expand into mobile money.

Growing revenues through marketing


Given the fixed-asset nature of the industry, enhancing revenues is an evergreen priority for telcos. What is new is the transition of many high-growth markets to a more mature stage of development (typically when penetration passes 20 to 40 percent). At this point, more sophisticated sales and marketing techniques are necessary to increase the top line. Pricing, distribution, marketing spend effectiveness, and Customer Lifecycle Management are the major focuses of top management efforts. The distinction between visible and invisible pricing. Pricing initiatives are ways to quickly improve a telcos top-line results by 3 to 6 percent. Sophisticated

pricing activities include managing the visible and invisible elements of prices in a scientific manner. Two pricing elements on-net voice tariffs and top-up validity, i.e., the amount of time top-up minutes are valid for use are examples of the visible/invisible difference. Customers closely watch on-net voice tariffs, but top-up validity (while just as important from an economic perspective) elicits far less consumer reaction. Shortening the validity period for low top-up denominations enables telcos to increase revenues without losing subscribers. Telcos can also employ conjoint research (similar to the type conducted by the consumer goods industry) to analyze customer trade-offs and determine the optimal port folio of brands and promotions. Distribution management by micro-markets. A telcos market share may appear stable from a distance; in reality, however, a more granular measurement may reveal that its market share varies significantly from city to city (up to 30 percent). As a result, telcos should manage retail distribution channels from a lower altitude. To do so, managers should first segment retailers by micro-market, which reveals their potential to increase sales and allows the setting of targets and the continual assessment of performance. They could leverage

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than their counterparts in developed markets

electronic top-up (i.e., over-the-air recharge) as a fantastic tool to gather information. Territory development and demand stimulation efforts such as mystery shopping, sales competitions, or localized promotions will then need to be deployed in hundreds of micro-markets to enhance market share (please refer to Seeing the Forest and the Trees: Micro-Market Channel Management in Marketing RECALL No5 for more on this topic). Marketing spend effectiveness. Industry leaders that remain successful during downcycles tend to refocus not cut their marketing spend. In fact, industry leaders actually spend significantly more on advertising and SG&A (selling, general, and administrative) costs in comparison with their less successful competitors. The key is to focus spending in the right areas (e.g., customer segments, product areas, shopper purchase tracking, or media channels) and include tactics for managing advertising agency relationships in the marketing strategy. In our experience, the potential exists to reduce (or redeploy more efficiently) marketing spend by between 5 and 15 percent. Customer Lifecycle Management (CLM). Telcos should adopt a disciplined, heavily interactive approach

to personalized marketing. Maturing markets require sophisticated CLM strategies, especially in the hard-todefine prepaid segment. One size does not fit all, and if a telco offers the same promotion across the board, it will most likely see a mixed effect, increasing revenues for certain groups, while lowering them (along with customer satisfaction) for others. For example, subscribers who do not use SMS would likely view a free SMS reward as little more than irritating spam, but might prefer loyalty points for topping up. For heavy SMS users, on the other hand, a music download promotion could stimulate alternative revenue sources.

Regulation: Think like a marketer


In both high-growth and developed markets, regulation management is the first value lever, and the value at stake can often equal 10 to 20 percent of a telcos annual revenues. What is specific to high-growth markets is a focus on wireless, a major government focus on the digital divide and the development of rural areas, and a wide variation of spectrum and license fees. As a result, to strike the optimal balance between economics and sustained investment, emerging market telco leaders should aim to achieve the same levels of sophistication in this field as they do in marketing, with two main areas of focus:

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Understanding the economic impact of different regulatory decisions. Managers need to quantify the set of regulatory issues and understand the range of acceptable and unacceptable parameters. Potential levers include the interconnection regime, wholesale obligations, and significant market power designation. For example, with an MVNO (mobile virtual network operator) mandate, telcos need to consider how much value is at risk and how this value goes up or down as a result of the mandated transfer price between the network operator and the virtual network operator. Managing the stakeholders. Telcos should work to understand the industry stakeholders positions regarding key objectives such as rural development, employment, or taxes and identify the channels required to build successful coalitions and deliver benefits.

As a side note, we believe many of these techniques could now even be successfully adopted in developed markets.

Value from broadband demand


Many industry players estimate that within five years, up to a quarter of homes in emerging countries could have broadband access. So broadband may become almost as ubiquitous in these markets as it is in more developed ones. At the end of 2008 for example, there were one million broadband lines (mostly wireless) in the Philippines. The most interesting business cases explored so far focus on fixed wireless access (i.e., providing wireless broadband to an in-home PC terminal). The majority of offers use postpaid models (with ARPU in the USD 15 to 30 range), but several players also promote prepaid models, based on their wireless billing infrastructures. The availability of new low-cost terminals such as NetBooks (with the Asus Eee PC being the first and most well-known example) makes broadband much more accessible to the masses. PC penetration is no longer an issue because consumers may actually buy computers once they know that Internet access is an option. Telcos have signaled their readiness to make the major investments in the network backbone and international links required to ensure that service quality is maintained even when users constantly surf heavy-bandwidth sites such as YouTube. Network planning and investment therefore becomes a key differentiator in this area.

Gain a cost-per-minute advantage


Markets from India to Thailand have incredibly low average prices compared to those in developed markets: in the range of 1 to 3 US cents per minute. For telcos to maintain a healthy EBITDA (50 to 70 percent) at such prices, they must reduce their own costs to less than 1 cent per minute. In most cases, they can accomplish this drastic cost reduction by focusing on improved utilization. Companies need to leverage micro-marketing and CLM to increase the number of minutes per BTS (base transceiver station) without cannibalizing their existing revenues. This tactic calls into play core skills in network management, distribution, and pricing. The recent introduction of BTS-based dynamic pricing in Africa offers a good illustration of how well this practice can work. Pursuing total cost-per-BTS (opex + capex) reductions can prove effective at given levels of utilization. Techniques used by more advanced players to ensure they have the lowest cost position in a downcycle include equipment design-to-cost, minimum technical solution (quantifying the amount of gold plating and future proofing at each site), and the introduction of lean operation principles. Even in what are considered to be low-cost operations and low-cost countries, we have observed reductions in the range of 20 percent. These initiatives, with their intense focus on asset utilization, are at the core of the outstanding cost-perminute advantage enjoyed by high-growth players.

Monetizing digital content and services


Innovation has played a central role in many telecoms players dreams and failures. The differentiating feature of high-growth markets is that the habits and associated industry structure of the PC-based Internet are of much less importance and new, purely mobile ecosystems are possible. Beyond the hype and the disappointments, five themes command the attention of high-growth market players today: Mobile Internet. The availability of large-screen mobile devices across all countries is driving Internet browsing; introducing easy-to-use and affordable data plans on 3G and EDGE mobile broadband services further fuels

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this demand. The ARPU of non-voice, non-SMS data service is now reaching 10 percent of total average revenues per subscriber and should grow to 20 percent over the next few years. Social networking. As is the case everywhere, considerable interest is bubbling up around social networking in high-growth markets, with a special focus on mobile phone only. Given the large echo this kind of connectivity generates, the interest is especially high among the younger consumer generations. Software platforms and handset compatibility remain huge hurdles that must be overcome if this phenomenon is to become truly widespread. Mobile money. Given the limited reach of banking systems in these markets, mobile money is of special interest. From peer-to-peer remittance to payments to full-fledged banking, mobile money is well publicized (e.g., M-PESA in Kenya, Smart Money in the Philippines) and being developed in many markets, where the industry is addressing the major hurdles of regulation and customer education. Mobile music. Many players are exploring the possibility of becoming distributors of full-track music. Companies are closely monitoring examples such as China Mobile, and industry players are slowly working out key issues such as DRM (digital rights management), catalog rights, and handset compatibility.

Mobile advertising. Finally, many in the industry see advertising as the largest revenue pool beyond connectivity. However, models are unproven, and it currently remains mostly in the experimental phase. The key areas of activity include partnering with ad network companies, profiling the customer base, and setting up dedicated sales forces.

The undiminished importance of talent


Last but not least, the penthouse of the telco top managers agenda should be reserved for the search for the best talent to drive the above initiatives. The talent shortage is particularly acute in these emerging markets. In response, the most sophisticated players have implemented leadership engines to ensure the development of their next generation of leaders. *** The operators in high-growth markets with the most success will be the ones looking to capture immediate growth in voice and SMS, to hone the tools and techniques for maturing areas, and to invest in advanced data products. By giving priority to a defined set of initiatives, top managers in the telecoms industry in emerging markets can place their organizations in positions to significantly reduce their costs and realize large gains in earnings. The following articles explore most of these issues in greater depth.

Andr Levisse is a Principal in McKinseys Singapore office. andre_levisse@mckinsey.com

Nimal Manuel is a Principal in McKinseys Kuala Lumpur office. nimal_manuel@mckinsey.com

Noppamas Masakee is an Engagement Manager in McKinseys Bangkok office. noppamas_masakee@mckinsey.com

RECALL No 7 High-Growth Markets Broadbang! Building Bandwidth in High-Growth Mobile Markets

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02 Broadbang! Building Bandwidth in


High-Growth Mobile Markets

With mobile broadband about to explode in high-growth markets, operators must now position themselves to capture as much of the value as possible. But are industry players really ready to deliver all of what their customers are after? The challenges involved in spreading 3G throughout rapidly growing economies differ markedly from those experienced by mobile network operators (MNOs) in developed markets. Unlike their counterparts, MNOs doing business in high-growth markets are required to effectively manage a broad spectrum of customers. To be successful in doing this, they will need to overcome a number of unique hurdles that range from low income levels to low broadband awareness as they sort through the multitudes of technology options. But the effort is clearly worth it emerging market broadband will represent a USD 60 billion opportunity by 2011, when more than 200 million new customers enter the market.

Understanding customers
Operators can start to manage this customer range by fully understanding the nature of demand for wireless broadband in the market. First, it is important to clearly differentiate between PC-based and handset-based data traffic, as the nature of demand and adoption bottlenecks will differ between the two. In fact, a large portion of new emerging market wireless broadband growth is directly linked to PC-based demand, since alternative wired infrastructure is often underdeveloped and wireless technologies are unlocking latent PC broadband connectivity demand.

Also, operators can benefit from thinking in terms of segments, often based on a combination of customer profile and geographic environment that determines the cost to serve (Exhibit 1). The spectrum of broadband customers in emerging markets ranges from the high-end affluent to low-end aspirers, with a growing middle class (those on the lowest economic rungs typically can afford neither traditional mobile nor wireless broadband service). Within the high-end segment (typically 5 to 15 percent of an emerging markets population and concentrated in large urban areas), demand characteristics look similar to those of developed markets. For example, in the longer term, it is expected that these customers will adopt high-speed fixed broadband, developed by incumbents or fiber attackers in the leading cities. The fast-growing middle segment, typically constituting 40 to 60 percent of the population, is where the action is. Middle-segment households already enjoy significant levels of mobile penetration (80 to over 100 percent) as well as rapid PC uptake, followed by broadband growth. These customers provide an interesting pool for mobile broadband and typically represent the battleground between mobile and fixed. For the low-end segment, usually found in rural areas, wireless broadband may be the only economically viable access option. Finally, managers require a sure way to assess the current status of an emerging economys mobile broadband market. By examining affordability and analyzing barriers across the adoption funnel, marketers can define the addressable market (i.e., the share of population that can economically afford broadband at entry level cost) and then break it down to understand PC penetration, broadband adoption, and their own operators share.

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01

Different market realities exist in terms of customer demand and potential broadband adoption

The adoption funnel shows that the bottlenecks in and barriers to broadband adoption often vary by country and customer segment. For example, in Eastern Europe, the main adoption bottleneck is low PC penetration, while affordability is no longer a problem. In Brazil, affordability remains the main issue, while in Russia, the adoption of broadband by existing PC users is the issue. In some of the least developed emerging countries, such as Nigeria, affordability and low PC penetration both heavily constrain market performance. Once marketers identify the key bottlenecks, they are able to address them directly. They can overcome affordability issues, for example, by preparing low-cost entry plans, partially subsidizing equipment, or enabling new payment plans such as monthly installments. Marketers can also boost awareness through strengthened market support and communication campaigns; and increase broadband attractiveness by intensifying partnerships with content developers and financing the creation of local content.

for example, wireless broadband cannot compete head-on with the aggressive rollout of fiber infrastructure. Wireline attackers in Moscow have covered over 700,000 households with fiber in just two years, using innovative rollout approaches. As a result of this rapid coverage, wireless broadband competes only for on the move customers. In some markets, wireless broadband is becoming the dominant solution, leaving fixed-line behind. South Africa is seeing wireless data services beginning to take over the broadband arena, capturing nearly 60 percent of the market in early 2008. Mobile operator Vodacom began aggressively rolling out its 3G network and was followed by others. As a result, from 2004 to 2008, the local incumbent telco has seen its broadband share drop from 91 to 42 percent, as the market grew from a few thousand to about one million mobile subscribers. In other markets, wireless broadband competes head-on with fixed. Polands mobile players are pushing out independent providers and putting the incumbent under pressure. Mobile players have increased their broadband share from about 5 percent in 2005 to over 20 percent two years later via aggressive marketing campaigns. Market research there shows that the vast majority of wireless broadband subscriptions are for home and

Key trends in mobile broadband


The direction of wireless broadband development greatly depends upon the exact market contexts that exist in various cities and regions. In high-end urban areas,

RECALL No 7 High-Growth Markets Broadbang! Building Bandwidth in High-Growth Mobile Markets

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02

3G profitability depends on a number of drivers

office usage as a substitute for fixed broadband. Other wireless technologies are also competing for this market. While WiMAX gets the majority of media coverage, the most successful non-3G wireless deployment is the WiFi-based solution that has become the leading broadband access technology in the Czech Republic, ahead of DSL. In the least developed markets, several barriers limit mobile data usage, such as lower household income levels and nonexistent PC penetration. Other hurdles include limited data services promotions and a lack of GPRS (i.e., 2.5G) handsets. Nonetheless, some operators have managed to grow data revenue by concentrating on their 2.5G networks. These companies realize they must focus on reducing the key barriers and bottlenecks in order to monetize their existing 2.5G infrastructure before they begin to invest in nextgeneration networks. In some markets, such as Malaysia, regulators attempt to influence the direction of market development in holistic ways, seeing things differently than regulators in the developed world. For instance, there are huge variations in population size and mobile broadband coverage, and lower household income levels severely inhibit uptake. As a result, these regulators seek

to establish an approach to regulatory policies that is mindful of these factors in order to achieve maximum possible broadband rollout speed and coverage, while considering the entire spectrum of potential technologies.

Optimizing 3G network investments and stimulating demand


Countries without developed fixed-line infrastructure can make up for their copper shortfall via the quick rollout of 3G, thus positioning wireless as the primary access technology. However, to succeed, operators should maintain tight control of their economics. McKinsey experience shows that 3G profitability has a very concrete set of drivers. In a case example, one operator found that its 3G economics were extremely sensitive to two factors success in selling data cards at given price points and efficiency of the organizations capex which were highly influenced by the smart management of network capacity (Exhibit 2). This sensitivity raises three key questions regarding 3G wireless broadband deployment: What game to play. This choice can be viewed in terms of two factors whether a country has obsolete or

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03

Usage caps can reverse the decline in profitability

modern fixed-line broadband infrastructure and whether it has low or high broadband development (in terms of affordability, PC penetration, etc.). These factors allow managers to ultimately identify three main strategic positions. The first, high (or growing) market development but obsolete fixed broadband infrastructure, positions mobile broadband as a primary access technology. In this case, operators should push mobile 3G PC cards and modems as a primary broadband service, which is the case in South Africa. In markets with modern fixed infrastructure and high market development, two options emerge. In the first, mobile PC cards compete with fixed-line as the primary broadband service, as is the case in Poland. In the second, mobile broadband is a complementary connection to fixed-line service, as in the Czech Republic. When a market has obsolete fixed infrastructure and low market development, such as in Tanzania, operators can focus on a handset-based broadband strategy that targets the medium/low mass market along with a wireless PC card strategy for businesses and premium-segment consumers. Whatever the strategic option, first movers tend to capture competitive advantages, but they must achieve critical network coverage in order to see strong

subscriber take-up rates. In addition, an operators ultimate mobile broadband market share depends on the competitive context of both mobile and fixed offerings. For example, while mobile broadband continues to outpace fixed service in Poland, operators have been unable to maintain their price premiums compared to ADSL. In the Czech Republic, however, where mobile complements fixed broadband, players maintain a sizeable price premium. How to deploy the network. Experience suggests that by taking a granular approach to network rollouts, MNOs can combine 3G technology with their 2.5G initiatives to optimize both capex and future economics. When modeling a 3G rollout plan, the fixed-like component of demand is more relevant than it is with traditional mobile voice services. Thus, efficient network design requires a new approach and a new set of skills. One operator found that the best approach involves a rollout featuring a mix of full 3G, 3G/2.5G, and 2.5G-only coverage, resulting in a balance of costs and potential revenue over time. MNOs can also employ low-frequency spectrum to achieve rapid coverage at initially lower capex levels. By deploying 3G at 850 MHz, Australias Telstra gained a dominant position in the 3G market in just three years. The availability of this spectrum along with the expected digital dividend from the

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demise of analog TV will have a substantial impact on MNO economics. Managers should recognize that their success in driving dynamic increases in data use can have a negative impact on the networks quality of service (QoS), costs, and profitability. Fueled by unlimited data plans, data traffic continues to grow rapidly, forcing operators to upgrade their networks. Consequently, data capacity bottlenecks in network backhaul and access areas can cause QoS to deteriorate, requiring additional capex investments that put profits at risk or significantly compromise customer experience. One company facing this issue used a cost-efficient spectrum management approach to improve its network capacity, which ranged from deploying additional spectrum in 2.5 GHz and 800 MHz to spectrum refarming (i.e., clearing frequencies from low- to high-value applications). How to manage offers, pricing, and sales. Broadband pricing also requires a new approach from MNOs. As opposed to voice, data traffic can quickly require variable capex to meet demand, handsets dont factor into PC-based solutions, and the traditional advantage of on net disappears. This has broad implications for the offering. For example, the economic risks of flat-rate plans are very significant. Wireless broadband offers should avoid full flat-rate solutions and, instead, at the very least include usage caps beyond which pricing switches to a metered per kilobyte mode (Exhibit 3). Such a strategy enables operators to protect their network economics from subscribers with heavy bandwidth usage profiles. This solution raises another interesting question regarding how MNOs might deal with consumption above the initial cap. Limiting download speeds instead of pricing per kilobyte has proven to reduce the risk of alienating customers in the short term, avoiding unexpected large bills from the operator.

In constructing offers, operators should tailor their product and pricing designs to fit the needs of specific customer segments in order to balance attempts to stimulate demand against profitability targets. This process begins with a robust market segmentation that identifies significant customer clusters (mobility and coverage seekers, price-sensitive light users, etc.). Managers can also develop simulations of key offerings and focus on creating a portfolio of offers that generates the highest possible marginal EBITDA levels by working to understand the price elasticity of individual products by segment. One Eastern European market experienced explosive mobile broadband growth, but operators nonetheless maintained their price premium over DSL service through intelligent bundling (fixed-mobile or laptop data), minimizing head-on competition with DSL. These latter laptop/data bundles while proving exceptionally effective in luring subscribers, as is the case in many markets can pose risks if not managed well. One operator launched such a deal with great initial fanfare, only to be compelled to discontinue it weeks later due to unworkable economics. *** Mobile broadband has a bright future in emerging markets when operators focus on managing their unique customer segments and establish programs to address the challenges these markets present in terms of affordability, PC penetration, and awareness. Operators can also choose the right competitive game to play, work to deploy their networks effectively, and commercialize wireless broadband using smart pricing and bundling approaches. Experience-based approaches for overcoming these challenges already exist that can help operators in the pursuit of large-scale broadband penetration around the world.

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Daniel Boniecki is a Principal in McKinseys Warsaw office. daniel_boniecki@mckinsey.com

Nicolas Borges is a Director in McKinseys Madrid office. nicolas_borges@mckinsey.com

Lukasz Dobrowolski is an Associate Principal in McKinseys Warsaw office. lukasz_dobrowolski@mckinsey.com

Jindrich Fremuth is an Engagement Manager in McKinseys Prague office. jindrich_fremuth@mckinsey.com

RECALL No 7 High-Growth Markets Low End, High Yield: Bringing Mobile to the Masses

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03 Low End, High Yield:

Bringing Mobile to the Masses

Four out of five people in emerging markets live in areas covered by mobile networks, but less than half currently subscribe due to an inability to afford a handset that can cost up to 30 times their daily wage. Removing this barrier would open up a massive new segment for profitable growth. Serving the low-end segment can be a big deal in many parts of Asia, Africa, and South America. Operators that step out of their business comfort zones to seed their markets with low-cost handsets are already seeing returns that, to date, far outweigh any risks. According to the World Bank, more than half of the people in todays emerging markets close to three billion live on less than USD 2 per day. With a typical mobile ARPU (average revenue per user) of USD 3 to 8 per month, this segment represents a large slice of potential wireless demand in emerging markets. However, the majority of this potential remains unreachable, with mobile penetration typically ranging from only 7 to 40 percent, depending upon geography (Exhibit 1). This trend continues despite the fact that network coverage is no longer the main bottleneck to joining the mobile world in these markets.

messages, and distribution strategies to the low-end segment, leaving handset provisioning to manufacturers, local importers, distributors, and traders. Operators specifically those offering services under the GSM standard, where SIM cards and handsets are typically uncoupled often make the argument that handset marketing and distribution are not their core business and that the risk of obsolete stock or failure to recover handset subsidies outweighs the low value these prepaid customers offer, but this is not necessarily the case. One African operator found that it could profitably accelerate adoption by marketing low-cost handsets to its low-end customers. By reducing the street price of basic handsets, this company was able to substantially increase mobile penetration and acquire millions of additional customers. McKinsey research shows that in most African countries the retail prices of basic handsets start at USD 35 in large cities and quickly rise to as much as USD 60 in more rural areas, as local distributors and shops set their own prices and margins. Furthermore, the much-talkedabout USD 20 refurbished or secondhand phones find few purchasers, as low-income customers shun the risk of buying a faulty phone. To them, this cost is very high, and in an environment where service guarantees and skilled repair technicians are uncommon the device simply has to work. Experience suggests that three factors drive the retail prices of basic handsets, and it is within mobile operators power to influence each one of them. Reach of the distribution network. Handset manufacturers typically work with national or regional distribution

Handset prices are key to adoption


With handset prices starting at USD 35 to 60, its not surprising that the phones cost presents the main barrier to adoption for the low-income segment (Exhibit 2). In contrast, airtime affordability is a minor concern, and in terms of demand, only a few people say they dont need a mobile phone. Nonetheless, most operators focus on tailoring their price plans, marketing

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01

Mobile penetration ranges from 7 to 40% in many emerging markets

partners that focus on large cities (where distribution is easier) and depend upon local traders to move products in rural areas. Manufacturers exert little control in these rural areas and, as a result, traders and shops set their own prices and margins often selling handsets for twice the city price. McKinsey found that an operator can easily remove existing price premiums in these regions by marketing and distributing a homogeneous offer through its own distribution network/partners. The combination of promoting the offer (e.g., via radio or posters) and selling handsets in selected shops usually has the effect of driving the retail prices of all handsets in rural areas down to urban-market levels. Import taxes. The cost of importing handsets just from a tax perspective can reach 35 percent, dramatically hindering mobile adoption. Because operators already pay hefty amounts of tax on mobile revenue, they are excellently positioned to argue for the economic and (even) tax benefits of reducing import taxes on handsets. While subject to the specific context, we found regulatory authorities in emerging markets quite receptive to the idea of adjusting their legislation in this regard as part of a broader effort to close the digital divide.

Value proposition and subsidy level. Research indicates that a handset price level of USD 15 to 25 would unlock demand in most of the targeted segments. It was also discovered that everything not related to voice/SMS capability, robustness, battery life, or brand endorsement can be dropped. Adjusting to these feature requirements would minimize the need for handset subsidies, which might still be required in minor form in certain regions. McKinsey has also determined that even with a monthly ARPU of less than USD 10, the payback time of such a price drop would typically be under three months.

Driving low-end penetration


To get the maximum value from pushing ultra low-cost handsets (ULCHs) in emerging markets, operators can launch the following initiatives in an integrated approach: Source firsthand, USD 20 handsets if not currently available in-market. While branded handsets are preferred particularly by young, brand-conscious aspiring customers they can be too costly. As an alternative, several Asian manu facturers have chosen to offer minimally specified white-label handsets that provide acceptable quality levels. Indian mobile operators have been adept in sourcing entry level devices

RECALL No 7 High-Growth Markets Low End, High Yield: Bringing Mobile to the Masses

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02

Handset cost is the main barrier for the low-income segment

from, for example, Chinese manufacturers, but this is not yet widely practiced across Middle Eastern or African markets. While orders of these handsets need to reach an initial minimum amount, volume-related discounts beyond this threshold tend to be small, since manufacturers readily pass on the scale discounts they achieve by bundling demand across multiple operators. Develop a marketing and distribution approach for ULCHs. Depending upon the existing distribution landscape, operators may need to leverage their own channels in order to market and distribute these handsets. To ensure price compliance (and to avoid having subsidies end up in the pockets of traders, distributors, or shopkeepers), operators should focus primarily on trusted indirect channels as their preferred choices; these typically include operatorowned stores and top distributors. This trusted set can be complemented with occasion-specific sales measures (e.g., around sports events or other social gatherings) or operator sales vans that sell at local markets and events. Set subsidy levels and monitor payback times. Handsets represent very high costs for mobile operators compared to SIM or scratch cards. Obsolete phone stock, along with ineffective subsidies, can put a sizeable

hole in an operators EBITDA. As a prevention measure, companies should monitor four key profitability drivers: Cost per handset/SIM sold, including the handset subsidy, incremental marketing and distribution cost, and the cost of bundled airtime Activation rates or the percentage of handsets/SIMs sold that are activated at customer level and that consume more than the bundled airtime (to mitigate fraud within one channel) Incremental revenue for activated SIMs, which includes outgoing traffic and a share of the incoming traffic (i.e., the portion of traffic that would not have occurred if this low-end customer had not been activated) Contribution margin from incremental revenue. Managers can calculate payback time using the above profitability drivers. Operators should typically set subsidy levels to drive penetration, but keep the payback time within a three- to six-month range. Encourage usage and prevent seasonal churn. Once an operator sells the handset and SIM to a low-income

24

customer, persuading him or her to use it becomes the primary goal. First, bundling the package with free airtime is a must. Second, operators can drive micro-segment campaigns through SMS or via local sales outlets to stimulate recharging and continued usage. Third, operators can encourage usage by providing additional airtime on a more periodic basis via above-the-line offerings, e.g., a credit for incoming calls. Finally, this segment is prone to high seasonal churn levels because customers go through long periods with very little income (e.g., outside of the harvest season). Bridging these periods enables operators to capture customer mobile spend during the richer period. Again, providing low levels of credit to maintain activity can help here.

*** Operators can boost mobile penetration in emerging markets by ensuring the affordability and availability of basic handsets. This may require sourcing, subsidizing, and marketing both in urban and rural areas, which operators typically consider risky and distracting from the core business. Achieving the next wave of mobile penetration, however, is their core business, and the lack of handset affordability is a key barrier that must be overcome.

Martijn Allessie is an Associate Principal in McKinseys Amsterdam office. martijn_allessie@mckinsey.com

Fabian Blank is an Associate Principal in McKinseys Berlin office. fabian_blank@mckinsey.com

Pr Edin is a Principal in McKinseys Stockholm office. par_edin@mckinsey.com

Zakir Gaibi is a Principal in McKinseys Dubai office. zakir_gaibi@mckinsey.com

RECALL No 7 High-Growth Markets Banking on Mobility: Transactions, Technology, and High-Growth Markets

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04 Banking on Mobility: Transactions,

Technology, and High-Growth Markets

Mobile communication technology has transformed daily life, simplifying routine tasks for customers while creating value for operators. In high-growth markets, a significant part of this value may lie at the intersection of mobile telecommunications and banking. The benefit of mobile communication to society is huge according to a McKinsey study, mobile communication and its auxiliary industries contribute to 0.7 percent of Indias GDP and 3.8 percent of Chinas. Beyond this, the mobile industry is already starting to change a very basic aspect of our everyday life the way we handle money. Cash may be king, but in large emerging markets, it impedes financial efficiency: sending money home requires paying high fees, getting personal loans or making deposits demands 100 kilometers of sweaty travel, running a small shop in a remote area means hiding cash under the mattress, and paying salaries sometimes requires securing weekly cash transfers in unsafe or corrupt environments. Owing to a couple of major pioneers in the Philippines Smart Communications in 2001 and Globe in 2002 as well as MTN in South Africa in 2003, mobile communication towers and electromagnetic waves have brought banking services to handsets. At the same time, operators are able to net a handsome share of revenue and enjoy a more loyal subscriber base. With the potential to bring banking services even closer to customers and, indeed, to unbanked customers, the nascent mobile banking industry has demonstrated that money can be mobile. The mobile phone is capable of performing a full range of activities, including

transferring money; paying for utilities and bus fares; purchasing at vending machines and shops; providing banking services, such as deposits at service centers instead of just banks; and providing enterprise ser vices (Exhibit 1).

A customer perspective
On Sunday morning, a Filipino maid hands cash to a remittance clerk in a shopping mall near her home in Singapore. Her e-money wallet on her mobile telephone network (no transfer information is stored in the handset itself) is credited. Minutes later, she sends USD 5 to her younger brother at Ateneo de Manila University for his birthday and USD 100 to her parents in North Luzon an amount they receive from her on a monthly basis. They each receive a text message notifying them of the transaction and instantly gain access to the money, which they can then redeem at a local reseller store (30,000 existing to date) or at an ATM. They can also pay for goods or utility bills, transfer money to others, or load airtime onto their phones.

Mobiles unique role in high-growth markets


While some of these mobile banking applications have been widely discussed over the last decade, for developed markets mainly focused on micro-payments high-growth markets have distinct interests: Little need for payment alternatives. Cash as primary payment method is very practical in economies where labor is cheap and waiting time is not an issue. sales excellence in contact centers (Exhibit 1).

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01

Mobile banking simplifies international remittance

Natural market for money transfers. Countries with high domestic or international migration have a healthy appetite for money transfers. In 2005/06, India received close to USD 25 billion in remittances from a 17-million-strong overseas Indian community. In China, India, and Indonesia, domestic migration is an even more important driver of money transfer. Banking the unbanked. Governments and financial institutions are especially keen to enable financial efficiency in countries where credit card penetration is ten times less than mobile penetration. A major e-money player in the Philippines, Smart Communications Smart Money tool processes about 2 million transactions per day and, in 2006, reported a cash float of more than USD 10 million, which is facilitated through a network of 700,000 cooperating salespeople. From Smarts base of 35 million subscribers, Smart Money has grown from about 2.5 million customers at the end of 2005 to 7.1 million today. Globe, also in the Philippines, has about 0.5 million customers and a documented transaction volume of USD 100 million per month. In South Africa, MTN had about 0.5 million active customers in mid-2006. In India, 2.5 million of ICICI Banks 13 million customers have adopted its platform for mobile banking, while

80,000 customers were attracted to Airtels mobile movie ticketing feature. Several other smaller-scale applications exist, including Safaricoms M-PESA system in Kenya. With a large unbanked population and high or potentially high rates of mobile penetration, mobile banking offers sizable value creation in emerging markets. In many models, average revenue per user (ARPU) contributions are in the range of USD 1 to USD 10 per year. In decreasing order of importance, the main sources of value are: Transaction fees. For example, for a USD 100 remittance, both merchants would receive 1 percent of the total amount as a service fee and pay the telco a fixed 5 US cents for the backbone service. Both sender and receiver are notified by the telco, which charges 5 to 10 US cents for that service. Interest benefit. Offering banking services to a large unbanked population would yield a significant interest spread. Reduced churn. Experience shows that subscribers who use mobile money churn two to four times less than the average subscriber, given the perceived value of a device that receives money.

RECALL No 7 High-Growth Markets Banking on Mobility: Transactions, Technology, and High-Growth Markets

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Enterprise service fees. These could be on the order of a magnitude of 0.1 to 1.0 percent of salary cost for enterprise payroll or supply chain management. Commerce and advertising. Although estimates at this stage would be speculative, there is great potential in bringing commerce and advertising to mobile. Security. Governments often see additional benefits from the safety aspect of digitized cash and the social impact of bringing banking services to the unbanked.

provides a good example of a stable yet flexible regulatory environment. Its central bank works closely with the operators of Smart Money and G-Cash to establish appropriate regulations, allowing healthy growth of mobile money. Choosing a model. Mobile money sits at the intersection of banking and mobile telecommunications, requiring expertise in both fields. There are two models that can be used to exploit this opportunity: telco-led mobile money requires a telco to obtain a banking license or special mobile money license and fully own the customer transaction details and operations. Clearing would be undertaken by the telco. Telco-enabled mobile money uses the telco as a channel for a bank, which takes or keeps ownership of customer accounts and is responsible for the marketing and sale of mobile banking products. Of course, combinations of these two models, such as which financial services are offered in Model 1 and how many banks are enabled in Model 2, are possible. McKinsey believes there is no overwhelmingly superior solution and the outcome will be highly dependent upon the aspirations of the players. Selecting the best technology. In emerging markets, due to the reduced focus on vending machine payments, the SIM card offers the most appropriate security. Loaded with an application, it not only stores encrypted data, but can also encrypt communication to and from the network-based wallet. The other important technology is the communication interface. A simple and intuitive interface is essential to minimize user difficulties. SMS, with which data can be encrypted before transmission, offers the best blend of simplicity and security for markets with highly literate populations. In countries where literacy is less widespread, such as South Africa and Zambia, an intuitive, menu-based interface may be a better choice. Educating the market. A great deal of education is necessary to ensure that customers place their faith and money in the technology and adopt mobile banking. During the launch of iMobile a phone platform for mobile banking the Indian bank ICICI sent its customers SMS alerts and WAP links to detailed information on installation and use, together with an animated online demo. Experience has shown that the journey should start with receiving money through mobile phones. Thus, players attention should focus on applications such as salary payments via mobile phone or

Creating the ecosystem


Many electronic money experiments in developed markets have been stopped, such as Visa Cash in the United States and Mondex in the United Kingdom (both in 1998). There are, however, four main hurdles to creating such an ecosystem in emerging markets. Achieving regulatory balance. The concerns of regulators range from preventing money laundering to managing the money supply. Many concerns are genuine, for example, those around the proper due diligence of loan seekers. However, many impediments to mobile commerce exist because regulators have not yet created the right set of rules to make mobile commerce work. For example, there is no clear demarcation between what kinds of phone connections are permissible (prepaid or postpaid). There are insufficient financial limits on mobile banking transfers between bank accounts and a lack of knowyour-customer norms for mobile banking. Given that mobile banking is on the frontier of innovation in two critical industries, regulators are even more risk-averse. It thus becomes imperative that companies proactively shape their regulatory environments, helping regulators understand how mobile banking operates and its impact on public policy. Regulatory challenges range from macro-issues such as control over money supply to the operating detail of authorizing non-bank agents to take deposits to projecting liquidity ratios. The creation of mobile money, for example, reduces the amount of cash in the economy while formalizing transactions that would have otherwise been unrecorded in cash economies. Regulators must also look to modify regulations without compromising their original purpose. For example, a strict proof of identity is needed to transfer money through banks. However, if transaction amounts are very small say, only USD 5 then identity verification could be relaxed. The Philippines

30

domestic and foreign remittances. Spending or outflow then becomes natural. *** With all of its direct benefits and positive social values, mobile money may be growing faster in high-growth markets than electronic cash in developed markets. The opportunity to radically transform money and bring

new benefits to consumers may be at hand. Transformation will require the alignment of an ecosystem in each country among banks, regulators, telcos, and device manufacturers. While not a simple task, it may be less difficult than the task of shaping the new form of communication that telcos have undergone over the last 15 years. A pioneering spirit from operators and financial institutions is required, but the technology and the customers are already there!

Jia Jih Chai is an Associate in McKinseys Singapore office. jia_jih_chai@mckinsey.com

Andr Levisse is a Principal in McKinseys Singapore office. andre_levisse@mckinsey.com

Nimal Manuel is a Principal in McKinseys Kuala Lumpur office. nimal_manuel@mckinsey.com

Noppamas Masakee is an Engagement Manager in McKinseys Bangkok office. noppamas_masakee@mckinsey.com

John Rubio is an Engagement Manager in McKinseys London office. john_rubio@mckinsey.com

RECALL No 7 High-Growth Markets Mandating Growth: Regulating Emerging Markets

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05 Mandating Growth:

Regulating Emerging Markets

Emerging markets are the rising favorites of operators with a taste for double-digit growth. Sustaining growth at these levels, however, will require substantial future investments, which will only be possible if operators work in close cooperation with regulators to design policy frameworks that match the realities of high-growth markets. With mobile penetration rates rising by more than 30 percent annually from 2003 to 2007 and broadband increasing by more than 50 percent per year during the same period, high-growth markets at first glance appear to offer telecoms players the chance to revisit the glory days of developed market expansion. Despite strong growth, emerging market penetration levels lag far behind those in mature markets, and operators still need to make massive investments in order to close the gaps. For example, the public telecoms per capita investment for OECD members from 1997 to 2005 averaged USD 135, while the emerging markets as a group spent about USD 55. In order to reach OECD investment levels, these emerging markets will require additional annual investments of about USD 250 to 400 billion. In addition to low investment levels, high-growth markets are also characterized by a bias toward mobile, the sector with the most growth. Mobile revenues grew at around 10 percent annually from 2003 to 2007, while fixed-sector revenues declined by 8 percent per year during the same period of time. For instance, in terms of infrastructure, between 2001 and 2007, mobile investments in one Latin American country nearly doubled, but fixed-line spending dropped by half. The

fixed telecoms markets investment decline creates an extra challenge for operators attempting to develop next-generation fixed infrastructure. Finding the cash to make either mobile or fixed-line investments could be a challenge for many operators in high-growth markets due to the substantially lower average revenue per user (ARPU) levels they see compared to more advanced telecoms markets. For example, while monthly broadband ARPU in developed markets averaged USD 40 in 2007, emerging markets in the Asia/Pacific region generated only an average of USD 12 and operators in the Central and Eastern European (CEE) nations received about USD 18. Likewise, monthly mobile ARPU for operators in developed nations averaged USD 45, while Asia/Pacific high-growth markets generated just USD 8 per user. In the CEE, the average was USD 11. As a result, in most emerging markets, the industry will probably not generate the cash needed to increase investment levels. Taking Chile as an example, a McKinsey analysis shows that although the industry requires infrastructure investments of USD 3 to 4 billion, the best-case scenario is that it will generate just USD 1.1 billion in cash available for investments. Reaching connectivity targets would require approximately ten years of incumbent fixed cash flow in Chile. Operators facing this investment challenge need to work with emerging market policy makers in order to adopt an appropriate regulatory framework one that is specific to their circumstances and encourages the industry to continue its healthy development.

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01

High revenue concentration in one customer subset can lead to sharp, post-liberalization decline

Developed market regulations wont fit


Given this significant investment challenge, McKinsey asserts that operators should collaborate with policy makers to avoid importing regulations from more developed countries that will hamper not help high-growth markets. Thats because these countries differ fundamentally from developed economies in several ways. First, these markets typically feature a rapid pace of market liberalization. But fast forwarding the rules that regulators have applied in developed markets robs emerging market incumbents of the transition time needed to prepare for liberalization, unnecessarily exposing them to competition. For example, many high-growth markets reduced their fixed interconnection rates much faster than did their European counterparts (i.e., in 15 months instead of 4 to 5 years) and thus missed the opportunity to properly increase their fixed-line access fees. Second, the high revenue concentration seen in emerging markets that accompanies high-income concentrations can encourage cherry-picking behavior from new competitors in terms of both customers and geographies.

This increases incumbents exposure to the effects of changes in regulation in their most profitable markets. One incumbent realized that more than half of its long-distance revenue came from the top 10 percent of its subscriber lines (Exhibit 1). Once market liberalization occurred, the incumbent experienced a revenue decline of more than 45 percent, as alternative operators began to target these lucrative customers. Third, the emerging markets low retail prices reduce the room for obtaining an acceptable rate of return on investment. Unlike in European markets, where the fixed-to-fixed retail-to-wholesale call charge ratios range over six times higher, high-growth markets offer little room for European style wholesale regulation. Beyond simply not generating enough revenue to cover needed investments, the significantly lower prices in emerging markets mean few opportunities for wholesale pricing regulatory intervention. Finally, an emerging markets low fixed network quality levels increase the need for larger investments. Telephone faults in high-income countries typically average about 6 per 1,000 main lines per year, while low-income countries can see annual rates as high as 60 per 1,000 main lines.

RECALL No 7 High-Growth Markets Mandating Growth: Regulating Emerging Markets

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02

Each emerging market group requires its own regulatory alternative

Adopting regulations that work


In order to fashion mandates that address the realities on the ground, regulators need to first establish how many different types of markets exist. McKinseys research points to three distinct groupings within the larger set of emerging markets. Each of these will likely require its own unique regulatory approach (Exhibit 2). Group 1 consists of emerging markets characterized by a per capita GDP below USD 5,000 (all per capita GDP levels are in purchasing power parity PPP terms) and low fixed and mobile service penetration. Group 1 markets need to focus on providing incentives for investments in the sector focused on ensuring voice access by increasing mobile penetration via universal coverage obligations. Once voice access approaches the 50 percent level, policy makers should also focus on fixed networks in order to promote broadband penetration. Group 2 markets consist of transition economies with high mobile penetration levels and a GDP per capita that ranges from USD 5,000 to 20,000. These countries should focus on boosting broadband penetration and on planting the seeds of regulatory measures to increase competition levels in the mobile sector. Regulators

can promote broadband penetration by encouraging investments in fixed networks, particularly the provision of fiber broadband in selected areas. Group 3 countries are mobile leaders with high income levels (i.e., GDP per capita of USD 20,000 or more). They feature very high mobile and moderately high fixedline penetration. Countries in this group should focus on increasing broadband penetration while establishing fair competition between mobile and fixed players. They should also promote lower prices and quick adaptation of new and innovative services. Regulators can consider innovative solutions focused on three key levers to support emerging market infrastructure development. The first lever involves regulatory wholesale obligations how the market maintains open networks while also achieving revenue and profitability targets. The second focuses on regulatory pricing concessions options such as pricing relief or guaranteed return on investment schemes. And finally, government support can play a major role the availability of creative mixes of funding and nonfinancial mechanisms and how industry players can use them. Markets may require a combination of these levers to reach the desired levels of connectivity and ensure competition and consumer choice.

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Tailored Solutions: Regulatory Success in Malaysia and Israel


Malaysia provides a great example of an original regulatory solution; one customized specifically to meet the countrys needs. Engaging all three levers, Malaysia developed a three-tiered approach for deploying broadband. It first covered major economic areas, such as Kuala Lumpur, with high-speed broadband (HSBB) and broadband to the general population (BBGP). Next, it covered general public areas using BBGP, thus encouraging competition among wireless technologies such as 3G and WiMAX as well as fixed-line options. Third, in rural areas, it established public hot spots in places such as schools. These access areas featured BBGP as a first step in closing the countrys digital gap. With the policy in place, the country plans to take broadband penetration from 18 to 50 percent in just two years. Israel offers yet another example of the effectiveness of a custom-tailored regulatory policy. In 2001, Israeli household broadband penetration (at 2 percent) lagged behind that of other nations (e.g., 49 percent in South Korea). Therefore, the government established a committee to assess the best way to foster the broadband market without hurting consumers or the industry. Taking into account the countrys specific characteristics (e.g., small size with concentrated population, two parallel countrywide networks, and alternative fiber-based networks), the committee recommended that regulators halt plans to introduce local loop unbundling. As a result, broadband coverage jumped nearly 75 percent between 2001 and 2007, while prices declined by more than 15 percent during the same period.

*** High-growth markets differ from developed economies in fundamental ways, which is why it makes little sense to impose detailed regulations from one reality into another. Instead, countries that custom-tailor their regulatory policies in ways that support customer choice and protect the industry structure often achieve much greater success in encouraging infrastructure investments and development.

RECALL No 7 High-Growth Markets Mandating Growth: Regulating Emerging Markets

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Ilke Bigan is a Principal in McKinseys Istanbul office. ilke_bigan@mckinsey.com

Luis Enriquez is a Principal in McKinseys Brussels office. luis_enriquez@mckinsey.com

Mehmet Guvendi is a Principal in McKinseys Istanbul office. mehmet_guvendi@mckinsey.com

Sergio Sandoval is a Strategy Practice Expert in McKinseys Brussels office. sergio_sandoval@mckinsey.com

Ashish Sharma is an Engagement Manager in McKinseys Singapore office. ashish_sharma@mckinsey.com

Oleg Timchenko is an Associate Principal in McKinseys Moscow office. oleg_timchenko@mckinsey.com

RECALL No 7 High-Growth Markets Righting Whats Wrong: Fixing Emerging Market Mobile Pricing

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06 Righting Whats Wrong: Fixing

Emerging Market Mobile Pricing

Pricing excellence in emerging markets requires an approach that balances macroeconomic factors and competitive intensity with evolving customer preferences. Operators often leave money on the table by assuming that a one-size-fits-all solution exists. Achieving pricing excellence in emerging markets is a unique challenge, given the high subscriber growth, lower customer sophistication level, and evolving regulations. Mobile network operators (MNOs) in emerging markets are quickly learning that speed of execution is often more important than analytical sophistication when designing price plans to capture a share of the increasing subscriber base. Most operators continue developing oversimplified price structures to drive adoption, which is understandable, given the significant growth observed in several emerging markets as high as one million subscribers a month. However, what some operators tend to miss is the opportunity to shape customer preferences, which is available in emerging markets and allows operators to not only capture their fair share of growth, but to do so more profitably. Compared to those in developed markets, customers in emerging markets are just barely exposed to sophisticated price plans and bundles (in many countries, more than 90 percent of subscribers are on a single price plan). Operators can leverage this characteristic of emerging markets to shape preferences and develop first-order behavioral segmentation that protects their subscribers from competitive attacks and captures a higher share of wallet (even dominant operators have wallet shares of less than 60 percent among

their own customers). This is extremely important in emerging markets due to more rotational churn (e.g., temporary SIM usage due to hyper-promotions, expired validity due to affordability) than in most mature markets, predominantly driven by the prepaid nature of the market. Furthermore, large operators are often caught in a price war with new entrants trying to retain market share that can be partially avoided by focusing on stabilizing the interconnection price.

Emerging markets are different


Efficient emerging market pricing makes the most of the trade-off between average revenue per user (ARPU) and market penetration. Ideally, in order to maximize revenue, both will rise in tandem. For a given affluence, if service penetration grows rapidly but ARPU doesnt, issues could include declining pricing levels or network limitations. When the opposite occurs (high ARPU, low penetration), issues might include distribution limitations or saturation of the high-income segment. Likewise, when a market exhibits both low ARPU and low penetration, it requires the introduction of low costto-serve models. In assessing the differences across emerging markets, McKinsey developed a segmentation based upon ARPU, penetration, and GDP per capita levels. From this, six market-type clusters were identified (Exhibit 1), two of which will be examined here. Affluent savers have ARPU levels below USD 35, penetration rates above 50 percent, and GDP per capita levels that exceed USD 5,000. The aspiring adopters segment, on the other hand, features ARPU levels above USD 35, penetration

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01

Emerging markets fall into 6 actionable clusters

rates below 50 percent, and per capita GDP below USD 5,000. Each market segment will require a unique solution to capture the most revenue possible. For example, MNOs can selectively increase prices for affluent savers, since ARPU is largely dependent upon price and penetration remains unaffected by it (Exhibit 2). However, any pricing moves need to take the competitive context into consideration as well. While dominant operators should focus on retention as they increase prices, they can minimize customer dissatisfaction if the firstorder behavioral segmentation is in place. For operators with low market share, raising invisible prices is a much more pragmatic approach to improving revenue performance. On the other hand, MNOs in certain aspiring adopter markets can lower the minimum cost of ownership and prices, if needed, to drive penetration. McKinseys analysis shows, for instance, that lowering prices for high-priced aspiring adopters can increase penetration without hurting ARPU (Exhibit 3). Options to lower prices include employing flat-rate pricing, lowering prices for certain call types, and offering deep friends and family discounts. While all boost penetration, they also help shape customer preferences and, hence, develop

behavioral segments that can be further targeted in the future. Two cases of note show where MNOs successfully leveraged their market characteristics to improve revenue performance. One incumbent operator in an affluent saver market increased its ARPU by 10 percent by developing four new price plans that effectively raised prices by 12 percent. And, an operator hoping to boost its penetration in an aspiring adopter market increased its number of gross subscriber additions by more than 50 percent, while also increasing ARPU by 6 percent. Its success was driven by the introduction of three new segmented pricing plans, including a per second plan targeted at low-income groups, which was expensive for high-ARPU subscribers to switch into.

Operators can boost penetration and ARPU by pricing right


Experience in emerging markets shows that MNOs can increase both market penetration and ARPU performance by focusing on customer behaviors and perceptions regarding different pricing models. Unlike mature markets, in which new price plans are launched only after months of design and testing, emerging markets demand deployment in weeks. Quickly

RECALL No 7 High-Growth Markets Righting Whats Wrong: Fixing Emerging Market Mobile Pricing

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02

Affluent savers are candidates for selective price increase

understanding revenue trends of the existing base (plus competition where possible) and rapid market testing allow MNOs to not miss out on the 50 to 100 percent annual growth seen recently. Analyzing revenue performance can bring out insights regarding customer behavior. Low adoption, high churn, or traffic sharing across multiple SIMs are typical drivers of low-revenue performance. The following is a sample of other performance drivers that operators can address. Brands matter, and pricing is not necessarily the (only) fix. In markets with very low penetration (e.g., certain African markets), adoption and churn can be driven by customers perceptions of an MNOs market or technology leadership not necessarily its price leadership. Imagine a market with 10 percent penetration and customers with USD 5 ARPU wanting to be associated with the MNO providing 3G service. Driving appropriate communication is often the key. One operator rebranded an existing price plan for the youth segment and saw ARPU rise above 10 percent in that segment. Branding matters to all segments. Growth may be hiding value share loss. One operator proudly posted stunning quarter-over-quarter results

in subscriber growth and attributed its ARPU decline to higher penetration rates. What the operator failed to realize until very late was that its oldest and most valuable customers were gradually reducing their usage and eventually leaving the MNO. The leading performance indicators of customer cohort or vintage can often provide MNOs a better perspective than lagging indicators, such as churn. Wallet share is an enormous untapped opportunity. Even the most capable of MNOs seems to only achieve 50 to 60 percent of wallet share among its high-ARPU customers (dual-simming rates in excess of 40 percent are not uncommon in many markets). Understanding the needs of these customers (e.g., international call rates, quality of international calls, off-net rates) can be instrumental in designing plans to secure the most valuable segments in the market. Elasticity varies dramatically across segments. While most MNOs are tempted to lower prices to match those of competitors, they should know that elasticity is often significantly below 1 for most active customers. Dropping prices can be accretive, provided substantial new customers sign up as subscribers and inactive customers become active. In certain segments (rural, for instance), elasticity figures substantially greater

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03

Lowering prices for aspiring adopters can help increase penetration

than 1 have been observed. Misjudging segment-specific pricing needs can be catastrophic. To avoid this, some operators have deployed real-time pricing tools to take advantage of differences in elasticity across segments. Comprehending revenue performance drivers provides ample indication of the price preferences in the market that can be further recognized by testing for price awareness. This often highlights a wide gap between real and perceived prices, with most customers overestimating prices. MNOs can overcome such perceptions by heavily advertising headline discounts, e.g., very low on-net, off-peak rates. Also, the perception of high prices can lead to opportunities to raise prices, as one Middle Eastern operator learned. By changing the billing pulse, the company raised its prices for national calls by over 12 percent without sacrificing usage. In some emerging markets, customers can be highly sensitive to a few price levers. Developing a clear picture of these preferences can help prevent the launch of price plans with low success potential. Significant sensitivity to subscription fees in one market was seen to the extent that a price plan with a subscription fee but much cheaper call rates performed very poorly (a take rate ten times lower) compared to another price plan without a subscription fee, but with higher call rates.

MNOs can leverage their revenue performance and price preference understanding to develop new price plans that can help drive penetration, boost ARPU, or both (in some cases). However, MNOs should avoid ARPU-boosting efforts that attempt to capture elasticity benefits by dropping prices across all market segments. As noted, elasticity varies significantly across segments, and dropping prices across all segments creates a risk of nullifying elasticity benefits from super-elastic segments by losing ARPU in nonelastic segments. Most MNOs can develop new price plans within eight to ten weeks by rapidly building on customer insights with survey data. However, prior to launching any new price plans, operators should be sure to test them with customers and refine them accordingly to maximize their impact. Of course, this may not be possible in all markets due to the risk of being copied and preemptively launched. Additionally, several major price plan failures have occurred due to poor network experience (e.g., no capacity to handle customer surge) and poor marketing execution (e.g., limited awareness, poor distribution). McKinsey has developed a number of guiding principles that can help MNOs interested in designing effective price plans for emerging markets. First, abandon any

RECALL No 7 High-Growth Markets Righting Whats Wrong: Fixing Emerging Market Mobile Pricing

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one-size-fits-all thinking because the needs of highARPU customers are very different from those of low-ARPU (in some markets very low) customers. Keep things simple, introducing no more than four or five price plans to avoid customer confusion. Make price plan headline rates attractive, perhaps by designing plans that have the lowest possible headline rate but not necessarily the lowest monthly costs to the customer. Operators should also avoid triggering price wars unless absolutely necessary and ensure the lowest on-net rates with a balanced off-net rate. And finally, balance the clubbing offer, since exploiting deltas between on-/off-

net tariffs can worsen price penetration, as customers perceive these tariffs as more expensive. *** MNOs in emerging markets need to understand the unique likes, dislikes, and preferences of their subscribers in order to drive penetration and capture the highest ARPU rates possible. And, while emerging markets may seem like different planets from a pricing perspective, operators can achieve success by pursuing a proven methodology.

Salman Ahmad is a Principal in McKinseys Dubai office. salman_ahmad@mckinsey.com

Martijn Allessie is an Associate Principal in McKinseys Amsterdam office. martijn_allessie@mckinsey.com

Zakir Gaibi is a Principal in McKinseys Dubai office. zakir_gaibi@mckinsey.com

Sanjeev Kohli is an Engagement Manager in McKinseys Dubai office. sanjeev_kohli@mckinsey.com

RECALL No 7 High-Growth Markets Paid in Full: Improving Telco Collections Performance

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07 Paid in Full: Improving Telco


Collections Performance

Getting telecoms customers to pay up on past-due accounts can really pay off for emerging market players dealing with high default levels. Best-in-class collections practices can help telcos in emerging markets achieve significant reductions in losses. Telcos in emerging markets have a large and growing number of low-income customers. The profile of this segment is typically one of financial instability, relatively low education levels, tenuous employment, growing levels of high household debt, and customer debts accumulated across different institutions. Companies can help ensure that these customers pay their bills by establishing a more effective collections process, which can quickly deliver significant value. In working with telecoms players, McKinsey has developed practical approaches and tools that rapidly and significantly impact bottom-line collections performance by enabling emerging market telcos to capture a 15 to 30 percent net loss reduction. Typically, many companies that employ these approaches also retain half of the customers they normally would have lost using prior methods, having a significant positive impact on churn. Collections is becoming increasingly important for customer retention and, ultimately, bottom-line impact. The current economic situation makes it even more critical. During any crisis, default levels tend to increase, but at the same time, retaining these customers is key. This creates the need for companies to optimize and take full advantage of collections opportunities.

Telcos can pursue three specific initiatives to reduce their gross collections losses: reduce exposure to high-risk customers in the active portfolio by using risk models and adjusting the product offering accordingly as well as by developing pre-delinquency actions; reduce losses from delinquent customers by increasing contact rates with the right-party person and developing sophistication to increase conversion of contact into a payment; and increase net recoveries from contractual write-offs by introducing advanced management techniques for external agencies focused on transparency, peer pressure, and compensation based on relative performance.

Reduce exposure to high-risk customers


Telcos need to identify and actively manage high-risk customers (Exhibit 1). Typically, around 10 to 20 percent of customers can account for about 80 to 90 percent of total losses. Once these customers are identified, telcos can develop product offerings according to risk profile. For example, they can offer high-risk customers highly controlled lines (e.g., prepaid or limited expenditure postpaid), while lower-risk customers would receive more traditional products and the offer of additional products in an effort to increase average revenue per user (ARPU). It is also advantageous to pursue pre-delinquency measures. For example, telcos may find that their billing process inadvertently encourages first payment default (FPD), resulting from an accumulated initial

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It is important to identify high-risk customers and actively manage them

bill. In some situations, depending upon the date of initial subscription and billing cycle, users may receive an invoice for more than one cycle or more than one month of consumption. This can create a mismatch of capacity and ability to pay. Hence, these customers start their relationship with a provider based upon an inability to reconcile the first bill (Exhibit 2). Depending on the date of initial subscription and billing cycle, customers may not receive invoices for more than one cycle. This hinders consumer usage education and capacity to pay a first accumulated bill. Streamlining the billing cycle drastically reduces the number of FPDs, thus lowering delinquency rates. For example, McKinseys observations of several collections processes indicate that the average number of days for first bill can be reduced by up to 25 percent, resulting in the first bill generating a 1 to 2 percent reduction of total losses.

loss. In other words, a greater probability exists that a debtor will pay his or her debt if contacted. A number of actions can be pursued to help increase the contact rate. For instance, telcos can facilitate inbound contact and establish high service levels, develop an outbound contact strategy that includes standardizing the contact level, revise collections letters by introducing marketing and sales concepts, and introduce low-cost channels (e.g., automated phone warnings and SMS). McKinsey has piloted the strategy of sending automated voice and SMS warnings to the delinquent customer base with significant impact (3 to 6 percent reduction in losses). The use of these tools has been even more successful when applied at critical times (Exhibit 3). In addition to automated communications, telcos can also impose partial and total service suspensions to encourage payment in ways that minimize customer churn. The second approach to reducing losses from delinquent customers is to increase promises to pay and promises kept once the customer has been contacted. Developing distinct collections strategies based on collections-specific segmentation is key to maximizing recovery and minimizing operational costs. McKinsey suggests that telcos segment and develop specific models for

Reduce losses from delinquent customers


Managers can use two primary approaches in this step. The first one is to increase the rate of contact with the right-party person. Research by McKinsey shows that significant write-offs were never contacted, while the more contact a telco had with its client, the lower the

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02

The billing process may encourage the so-called first payment default

delinquent customers. These collections-oriented techniques enable telcos to gain an in-depth understanding that allows them to take the right actions regarding the target delinquent customer groups. To boost predictive power, telcos can combine clustering models (e.g., to determine the collections approach and strategy to each segment), self-cure models (e.g., to predict the probability of a customer to voluntarily pay without contact and, hence, optimize capacity), and risk models (e.g., to predict the probability of a customer to write off the contract once delinquent and, hence, focus contact). Doing so enables telcos to define the most effective contact strategies. The collections timing, approach, channels, and intensity can differ significantly based on the segment under review. At one end of the spectrum, lower-risk, high-value customers have a fundamental retention approach. The idea is to understand and accommodate a potential short-term financial issue, guaranteeing reinstatement capabilities. For this segment, contact can be less intense, an even friendlier approach might be used, and lower-cost channels could be prioritized. Client rupture is the last resource. At the other end of the spectrum, higher-risk, lower-value customers may require a much more intense, hands-on

approach, which may include significantly higher contact levels, more demanding letters, and the proactive use of reinstatement products. This approach can deliver large, quick results in the range of 30 to 40 percent. In this manner, one telco in particular captured a 30 percent reduction in net losses (USD 65 million) just within the first year of implementation.

Increase net recovery from contract write-offs


Typically, a high-delinquency portfolio is assigned to third-party collections agencies that receive compensation in proportion to the total volume they collect. While agencies have an incentive to ask for as large a share of the total portfolio as possible, they have both an already committed capacity with other companies and an available capacity in many situations, lower than that which is necessary. Agencies then select the most attractive accounts in their allotment, working via a skimming process. Therefore, unless telcos carefully manage portfolio allocation, a large proportion will remain untouched. One effective approach to collections requires companies to completely rethink their monitoring, portfolio allocation, and compensation schemes. By tracking batches, managers can expose significant differences in

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Applying certain collections methods at critical times can yield a 3 to 6 percent reduction in total losses

third-party agency performance. Applying this process can highlight the distinction between agencies that simply skim accounts and those that deliver the best results. High-performance monitoring and incentive systems include (a) introduction of batch tracking monitoring batches of accounts allocated to each agency over time and comparing the true performance of distinct agencies, (b) reassignment of accounts based on agency performance, and (c) creation of targets for collections agencies based on customer batches and improved monitoring. This approach has proven to increase by 10

to 20 percent the recovery performance of highdelinquency portfolios. *** Telcos in emerging markets will either become more systematically aggressive in going after collections or face the growing dead weight of late payments and write-offs. The key is to collect the delinquent payments without churning the higher-risk customers. The steps described here can help telcos boost collections and assess default risk among customers quickly and completely.

Paulo Fernandes is a Principal in McKinseys So Paulo office. paulo_fernandes@mckinsey.com

Sami Foguel is an Associate Principal in McKinseys So Paulo office. sami_foguel@mckinsey.com

RECALL No 7 High-Growth Markets The Silver Lining: Downcycle-Driven Opportunities for Emerging Markets

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08 The Silver Lining: Downcycle-Driven


Opportunities for Emerging Markets

Despite the global credit crunch and downward spiraling financial markets, telecoms operators in emerging markets have something to be bullish about. Globally, the downcycle puts pressure on the telecoms industry in two ways: First, attracting and retaining customers is likely to become harder, as overall acquisition rates slow and competition for each new customer increases. Second, most operators will find less available capital, and that which is available will come at a higher cost. However, unlike the automotive and retail sectors, where the credit crunch and recession are causing deep distress, the telecoms industry will likely experience milder effects. Historically, the correlation between revenue growth and overall GDP growth has not been as strong in telecoms as it is in many other industries. Moreover, telecoms businesses have lower ongoing fixed costs compared to companies in many other sectors. As a result, most players are not at risk of outright financial distress. However, the credit crunch will probably impact the industry significantly, changing the balance of power between larger and smaller players and between players in Asia and other markets. Within the telecoms world, emerging market operators enjoy more robust market positions than their counterparts in more developed markets for a number of reasons. In general and with some notable exceptions they operate in markets that have more attractive structures and, as a result, achieve higher sustained profitability. On average, operators in Asia earn free cash flow margins indicated here by (EBITDA - capex)/revenues of nearly 20 percent,

driven both by higher EBITDA margins and lower capex per revenue unit. In the Middle East/Africa region, free cash flow margins exceed 20 percent, as they do in Latin America and Eastern Europe. By way of comparison, margins in the US and Western Europe are about 11 and 12 percent, respectively. Furthermore, the leading operators in emerging markets have typically taken on significantly less debt than those in developed markets. Average net debt over EBITDA is just 0.4 in Asia, 0.7 in Eastern Europe, and 1.4 in the Middle East and Africa, while in North America it averages 1.9 and in Western Europe 2.4. Operators in emerging markets can leverage their unique positions to not only further shield themselves against the downcycle, but, in some cases, even emerge with the upper hand. However, far from monolithic, emerging markets differ greatly in terms of structure and profitability. For example, Chinas three operators generate a collective USD 14.5 billion in free cash flow per year. The group also includes small but extremely profitable markets that have yet to liberalize fully, such as Qatar. Operators in such markets enjoy significant home country advantages. At the other end, markets like Indonesia encourage massive infrastructure-based competition. Indonesia now has eleven operators, many of them subscale and loss-making.

Dealing with three downcycle trends


While many emerging market operators may find a safe harbor of sorts from the recession, they are not completely immune. A downcycle will affect their businesses in a variety of ways. The following three

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The bulk of M&A firepower will lie with Asian players

trends will present significant challenges and opportunities. First trend. Radically increased uncertainty, diminished planning visibility, and the risk of distress for critical partners are hallmarks of a downcycle and will increase the need for both flexibility and a greater emphasis on risk management. A recession limits telecoms operators planning visibility in the short and medium term in many ways. This presents significant challenges in an industry that requires high upfront capital commitments, making it more difficult to embark with confidence on big projects such as new network builds. For example, operators are likely to find it increasingly difficult to predict pricing and uptake rates in their markets due to the uncertainty that surrounds the possible depth of the recession. Furthermore, in less mature markets where market share is still up for grabs, there is a greater risk that operators might use the context to steal share from other players and, in doing so, spark destabilizing price wars. Critical industry partners are also likely to experience distress. Upstream vendors, for instance, will likely face significant pressure, as the industry cuts network

equipment budgets. Likewise, distribution channels, which in most markets face razor-thin profit margins, may go out of business. This presents risks for those, typically smaller operators whose sales rely more on third-party distributors. Operators should use this new context to find opportunities to reshape the telecoms value chain, as players and partners in adjacent industries and markets come under financial stress. Operators with healthy balance sheets could, for example, pursue acquisitions in complementary sectors such as retail. They could also seek partnerships, joint ventures, or the outright acquisition of distressed businesses (for example, in the Internet, content, or payment arenas) to accelerate the pace and quality of innovation and widen their scope of products and services. Second trend. Sound balance sheets and strong cash flow generation will shift financial power toward Asias emerging markets, with large operators in these markets on track to emerge as potential global consolidators. As the downcycle plays out, the leading emerging players will be able to accumulate far more M&A firepower than their counterparts in developed markets (Exhibit 1).

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02

Increased pricing pressure and rising capital costs likely to make smaller operators less viable

Our modeling indicates that the leading Asian telcos the ones that benefit from a combination of huge customer bases, high profitability, and lower debt levels will accumulate the bulk of this firepower. On the other hand, telecoms players in the Middle East/ Africa region, Latin America, and Eastern Europe will not accumulate enough cash to compete with these Asian players under any conceivable outcome. Similarly, over the shorter to medium term, the less profitable and more leveraged operators in Western Europe and North America will likely use their cash to service existing obligations. Thus, should they choose to use it, Asian operators are presented with a window of opportunity over their counterparts in Western Europe and North America in which they may be able to execute M&A, while facing less competition for the acquisition target. Third trend. As the capital deployed in the industry drops, a rapid reconfiguration of industry structures is probable, with smaller players in more fragmented markets becoming increasingly unviable. As a result, regulators will likely be more willing to shift their emphasis from encouraging infrastructure to pushing service-based competition.

The credit crunch has significantly reduced the overall amount of capital deployed in the telecoms industry, while making that which is available more expensive. Overall, we estimate that in the last quarter of 2008, new debt capital raised by operators in Asia fell by about 35 percent from a run rate of approximately USD 1.9 billion per month to around USD 1.2 billion per month. While the market still seems willing to lend to larger, more established players, smaller telcos and attackers will probably find accessing capital more and more challenging. Under these new conditions, some smaller operators, despite being able to capture subscribers and achieve cash flow breakeven, will remain below economic breakeven i.e., the point at which they return enough free cash flow to pay the carrying cost of their invested capital (equity plus debt) at the going market rate of return. This would render them unlikely ever to create value for their investors. For instance in Indonesia, one of the most crowded telecoms markets, we estimate that to achieve economic breakeven, the average small operators subscriber requirement will rise from about 6.4 million subscribers in 2007 to over 10 million in 2010, due to both rising capital costs and a price war that is driving down ARPU (average revenue per user). As a consequence of these trends, small attackers in all markets will almost certainly experience distress.

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These players have historically based their business plans on vendor-financed networks and cherry-picking strategies, assuming more limited price competition. Both of these factors have changed, raising the required critical mass needed for a company to attain minimum economic scale (Exhibit 2). Larger, multi-country operators should consider rethinking their ownership of smaller attackers. And the smaller companies themselves will likely need to seek a way out, either through in-market consolidation or a change in their business models away from fixed assets. There are signs of this already, as industry consolidation moves have begun. For example, after years of fighting for share, the two smaller operators in Australia Vodafone and Hutchison recently agreed to merge their businesses to create a 6 million subscriber entity with about a 25 percent market share. Similarly, Oi, the fourth largest mobile operator in Brazil, acquired the leading wireline operator, Brasil Telecom, creating a national champion. We see this trend accelerating in the more fragmented markets: Hong Kong, Indonesia, Sri Lanka, Thailand, and perhaps even India and Japan. On top of the potential in-market consolidation of operators in their traditional form, the reduction of available capital will likely encourage industry participants to rethink the way they have operated. Some of the players have gone one step further than just planning for it. Etisalat in Abu Dhabi, for example, has recently signed a 15-year agreement with Reliance Infratel for the sharing of passive infrastructure such as towers, repeaters, shelters, and generators. Critically, regulatory authorities, which act as the gatekeepers of industry structure, will probably face an increasingly difficult balancing act. The new conditions mean that they must take greater care to ensure that the goals of promoting competition and uptake are appropriately balanced against the growing need to ensure player viability and overall industry stability. As a result, the terms of regulatory debate in many markets will likely shift away from encouraging competitionbased infrastructure (i.e., lots of operators) to promoting shared infrastructure (e.g., network frequencies, towers, and backhaul) and more service-based competition. These changes could lead some telecoms players to refocus on different core business propositions, develop new capabilities, and compete with a greater emphasis

on differentiation through service innovation. In any case, taking a proactive stance on regulatory management will yield significant dividends.

The CEOs new priorities


Any recession creates winners and losers. The outcome of this one will probably favor the larger operators, who can use the context to both consolidate their market positions and potentially take advantage of their cash flows to make game-changing moves. Smaller players and attackers across all markets are likely to be challenged. For CEOs and management, there are a few no-regrets moves that every player should consider to improve flexibility and strengthen their core operations by getting back to basics. Operators need to focus on de-risking critical projects, building flexibility into their plans, and developing stronger risk management skills. First, managers should stress-test plans and capabilities against a broad range of potential market scenarios. Key risks going forward will likely be market-related, e.g., price shocks, as well as finance-related, including rising inflation and currency fluctuations, which may impact operators with vendor contracts in foreign currencies. Second, all operators need to take a hard look at their core and non-core operating expenses and explore solutions such as simplifying products or reducing the number of operational platforms. Now is also the time to redouble efforts focused on traditional good practices to strengthen the core, particularly in areas like revenue assurance, churn management, and capex optimization. Other no-regrets moves depend upon context and starting position. Specifically the leading larger operators have three sources of opportunity: they can work to reshape regulations, they can explore game-changing acquisitions in markets, and they have overseas expansion opportunities. For these players, there are no regrets in investing in regulatory management and attempting to improve market structures in their home markets. The context presents a unique opportunity to work actively with the regulators to shape a more stable and sustainable industry outcome. The stakeholders involved are open to such a dialogue now more than ever. Larger operators might also use the context to explore game-changing downstream acquisitions. The opportunities presented here could be particularly rich. In

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addition to consolidation of smaller players, as discussed earlier, attractive assets in adjacent spaces retail, content, Internet, and media to name a few could become available and will probably prove to be attractive targets. Finally, larger players might carefully consider the opportunities presented by geographical footprint expansion. Historically, many leading global players have enlarged their footprints during downcycles. With the firepower advantage these leading players now enjoy, this may be a unique window of opportunity. However, the record on value creation in situations like this is mixed, and such moves require a careful balance of risk and reward. Smaller players and attackers in more fragmented markets, however, are at risk. Managers here should consolidate their markets either directly or via infrastructure sharing to change the rules of their game. Multi-country operators who own such players

should take a fresh look at their entire portfolios, with a special focus on their smaller investments and an eye toward either reshaping their businesses, exiting, or consolidating. Due to the benefits of improved market conduct and reduced capital that results, such initiatives when available represent by far the most valuable inorganic move any player can make. *** While the current economic situation has deeply affected many industries and countries, strong telecoms operators in emerging markets might see more promise than panic as the downcycle plays out. Managers who realize that the rules of the game have changed fundamentally and make a commitment to working their way through the three key implications presented here will have the best chance of getting through this recession successfully.

Carl Harris is an Associate Principal in McKinseys Singapore office. carl_harris@mckinsey.com

Fredrik Lind is a Principal in McKinseys Singapore office. fredrik_lind@mckinsey.com

Alberto Menegazzi is an Engagement Manager in McKinseys Dubai office. alberto_menegazzi@mckinsey.com

John Tiefel is a Director in McKinseys Dubai office. john_tiefel@mckinsey.com

RECALL No 7 High-Growth Markets Sub-Saharan Success: Zains Wonderful World Just Got Bigger

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09 Sub-Saharan Success: Zains


An Interview with Zain Africa CEO Chris Gabriel

Wonderful World Just Got Bigger

In a bold new expansion beyond its Middle East borders, Zain acquired African mobile telecoms leader Celtel International B.V. The move in 2005 underscored Zains ambition of becoming an international telecommunications services provider. In 2008, all Celtel operations were rebranded under the Zain banner. The transformation coincided with the linking of the worlds first border-less mobile service. Zains One Network is the first mobile network to seamlessly span two continents. Chris Gabriel was named CEO of Zain Africa in December 2007. In this capacity, he oversees all 15 operations, serving 41 million active customers. McKinsey had the opportunity to meet with Mr. Gabriel and get his perspective on Zain Africas success, the role of telecommunications in emerging markets, and the future of mobile in the region. McKINSEY: What would you say has been the primary source of growth for Zain? CHRIS GABRIEL: Most of the growth, the organic growth, in Africa comes from further penetration providing relevant and affordable services to the people of Africa. There is still enormous growth potential despite the sentiment that the African market is saturated. The average penetration level across Africa is only 25 percent. There is also a growing demand for data services in metropolitan areas and the youth population is demanding content. McKINSEY: Do you have a sense of where this misperception comes from?

CHRIS GABRIEL: Many come to this conclusion because theyre assuming that growth stops at 100 percent. If you look at the more mature markets, however, growth has in fact exceeded 100 percent 120, 140 percent in some of the more mature global markets. Most of the penetration to date in Africa has been in the metropolitan areas. Operators shied away from rural markets, but theres a great opportunity there. If youre going to chase growth, however, you need to adapt your business models and ask yourself questions like How can we optimize distribution? or How can we streamline operations? The Zain Ultra Low-Cost Handset Initiative has proven enormously successful in driving rural penetration. McKINSEY: What exactly does this urban-rural penetration divide mean for you as an operator in emerging markets? CHRIS GABRIEL: Well, its about understanding the varying needs of the consumer while, at the same time, reducing operating costs. Customers in rural areas dont want elaborate products because their telecommunications needs arent that complex. On the cost side, we need to explore alternative energy sources so that we can put base stations in areas with limited or no coverage. Using wind and solar power or hybrid energy allows us to deliver these services in ways that are profitable for us and still affordable for rural customers. In urban areas, on the other hand, the demand for more sophisticated products is there. McKINSEY: As you push forward, are you concerned about the effect of new entrants on the market?

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CHRIS GABRIEL: At Zain, we welcome rational competition. Rational competition serves to grow the market. We have indeed observed a rise in the number of new entrants following the issuance of more licenses by regulators across most markets. We are maintaining our momentum growing our market share and aiming to be number one in all markets in which we operate. Most new entrants attempt to compete on price in order to rapidly grow market share such an approach is unsustainable. It only serves to shrink the market and reduce the funds available for future growth and investment. At Zain, we compete on customer experience, coverage, and quality of service leveraging the world-first Zain One Network advantage. McKINSEY: If these price-cutting tactics are unsustainable, what do you envision happening in the market? CHRIS GABRIEL: In my view, youll see consolidation across the African region. The mid-tier players will be eaten up, and, as a result, youll see the emergence of about three or four very significant players. At the smaller end, youll see more content providers and niche players emerging servicing the larger players. McKINSEY: Do you have a strategy for dealing with markets in East Africa where there are already multiple operators competing for customers? CHRIS GABRIEL: Zains ambition is to be one of the top ten global mobile operators by 2011, serving 110 million customers. Our focus isnt on our competitors; nor do we aim to compete on price. At Zain, we focus on providing relevant, affordable services to our customers, thereby growing our market share and generating a return for our stakeholders. We have a high-quality, unified One Network and extensive coverage. We also offer unique products and services to the various market segments. Furthermore, were conducting a commercial pilot in Kenya for Mobile Money Transfer and M-Commerce. In a nutshell, its about quality, coverage, and a relevant set of affordable products and services to the people in Africa we serve. McKINSEY: Is Zain unique in taking mobile banking to the market? CHRIS GABRIEL: There are already some offerings on the market, but we are leveraging our One Network service not only to provide banking, but also small

transactional services. Known as ZAP, our M-Commerce offering will revolutionize the market. McKINSEY: Looking beyond Africa, in particular to emerging markets as a whole, how do you explain places like India and Pakistan, where prices are extremely low compared to those in Africa? CHRIS GABRIEL: Well, theyre different markets. Africa still requires a significant level of investment, and we want to generate a sustainable cash flow to fund that investment. There are a lot of areas that havent been penetrated. The demand is there, so we need to tailor our product and service offerings in ways that allow us to capitalize on that demand. Its up to us to make sure that our business model is optimized to generate the returns that enable further investment pricing is only one part of that equation. McKINSEY: How do you deal with the political unrest that is often a marker of emerging countries? CHRIS GABRIEL: Well, with risk comes opportunity. We manage and mitigate the risks and leverage the opportunities. Security risks mean that a lot of operators will not do business in certain markets. Weve taken some bold decisions, which have been questioned by our competitors. Weve also had to work closely with the governments of the countries in which we operate, demonstrating to regulators how we bring value to their countries, through employment, taxation and, more importantly, through our extensive Corporate Social Responsibility Program, which is primarily focused on improving health and education for the people of Africa. McKINSEY: Is corporate social responsibility important for success in the emerging market, especially in your region? CHRIS GABRIEL: For me, it fits perfectly with our brand values. Were passionate about people the people are our future. I am thinking particularly of some very remote villages where schools lack proper facilities classrooms, desks, and text books for example. Zain has donated millions of dollars toward brand-new school buildings, desks, and text books in many of the geographies in which we operate. In addition to transforming peoples lives, which is the primary purpose of our Corporate Social Responsibility Program, such donations have a profound impact on the way people relate to the

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brand to Zain. The resulting loyalty is just phenomenal. My view of the world is that corporate social responsibility is a key component of business. Its part of our philosophy development is part of what Africa needs; and its part of creating a way for service penetration and growing the market. McKINSEY: Can you share any concrete examples of just how the connectivity Zain provides is transforming lives? CHRIS GABRIEL: I have heaps of stories that I can share with you how long have we got to talk? I went back to the remote village of Dertu, Kenya, three months after we had introduced service to see how things were going. The village elder ran up to me, threw his arms around me, and said, I now know how much a bull costs in Garissa! Now, Garissa is a village about a hundred kilometers away from Dertu. Historically, in the marketplace, if hed wanted to sell or buy a camel, he had to walk for two days to get to a market, only to find that there were no buyers or the price wasnt right. He would then need to walk to the next market and try again. Now, in just thirty seconds, using his mobile phone, he can contact all the markets and negotiate the optimal price he then only has to make one trip! McKINSEY: How else can connectivity be helpful? CHRIS GABRIEL: This same elder also told me about a lady in the village who was experiencing complications during childbirth. With one mobile phone call they were able to bring in help and save both the mother and the child. In the same village, a boy had been bitten by a snake, and they were able to call in and get the antivenom to save his life. When people go out looking for water in times of drought, they can call back to the village and say exactly where it is. The stories go on and on. The simple things that we all take for granted are things theyd never experienced before. Their lives have been transformed as a result of mobile telephony! McKINSEY: From a portfolio perspective, are there markets, like Sierra Leone, you would consider getting out of because theyre so small even by African standards? CHRIS GABRIEL: Zain is not about getting out of markets, were about getting into new markets and achieving the objectives we have set for 2011. We address the issue of small market size by regionalizing a lot of the

back-office functions and optimizing our cost to serve. We achieve economies of scale by leveraging our fifteen African operations and our seven Middle East operations so realizing broad-level synergies helps us profitably serve markets of all sizes. McKINSEY: Is innovation as important to success in Africa as it is in developed markets, like Australia and Europe? CHRIS GABRIEL: Innovation comes in many forms, not just technical or product innovation but in people, business models, processes, systems, and pricing. Technology is important, but the fundamental focus that will enable you to achieve success is a focus on the customer. A lot of players are caught up in talking 2.75G and 3.5G and WiMAX; all great technologies, but what is important to the customer is the ability to make calls and use relevant, affordable services not the technical details. McKINSEY: One of the areas I imagine you have been innovative in is in attracting talent. What is the secret of your success in getting people to move to Chad, for example? CHRIS GABRIEL: Well, what Ive found is that theres a lot of talent, a lot of potential, and a lot of passion within Africa. Historically, the African hierarchy has been very, very top-down, and Im not about that at all. When I visit an operation, I walk around with the people there; ask them what theyre doing; shake their hands; talk to them; encourage them the right way encourage them quietly. Were finding a lot of talent, a lot of passion, and Im about unleashing that talent and giving the younger people of Africa a lot more opportunity and a chance to prove themselves in roles that would normally be considered beyond them. McKINSEY: How specifically does Zain benefit? CHRIS GABRIEL: Were focusing our recruitment on young people, and a swathe of our recruitment will be from fresh university graduates. On that basis, we get young local people who are hungry and innovative and know what the markets demand, rather than bringing in dinosaurs of the industry who have been performing in other more mature or saturated markets and think that their way is the only way. Our emphasis is on leadership, on peoples ability to embrace the Zain brand and the Zain values. Furthermore, our human resource policies

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also focus on leadership rotating high-potential and high-performance team members across multiple geographies creating our own brand of international leader. McKINSEY: Considering expansion, are there particular markets youre pursuing? CHRIS GABRIEL: Zain Groups CEO, Dr. Saad Al Barrak, is on record as saying that Zains primary focus for expansion will remain the Middle East and Africa, at least until 2011, after which time we might consider Asia. In the Middle East and Africa, our primary focus is on acquiring existing operations. We do look at greenfield licenses; however, we like to limit the number of greenfield operations at any one time so as not to dilute our management focus. McKINSEY: Many believe that operators interested in entering Africa have to bribe their way to licenses. What has your experience been? CHRIS GABRIEL: Zains ethics, values, and standards preclude us from getting involved in any such activity, so if bribery seems to be the only path to obtaining the license, we will simply walk away. In fact, we have walked away from situations where that has been the expectation. McKINSEY: You said that in the long term you think therell be some consolidation. Does this present any market share issues for Zain over the next two or three years? CHRIS GABRIEL: I guess the prospect of consolidation for us means optimizing our business model so that we can continue on our growth path. I also expect that the quality we offer will serve us well through these changes. Its about having innovative products but also about stimulating demand by being both relevant

and affordable. Even very simple voice can create demand, all the way through to full video, data, and broadband services. But as Ive said before, we see challenges like this as opportunities, and we wont shy away from them. Were not fearful of the competition. Well work very closely with regulators to demonstrate the value Zain brings to their country in terms of GDP growth, employment, and productivity. Regarding our market share, the markets will grow and we intend to be number one in all the markets in which we operate. Well continue to grow our market share sensibly and grow our returns accordingly. McKINSEY: How do you think the current economic situation is going to affect Africa? CHRIS GABRIEL: I think were already seeing some impact. There are concerns about inflation and currency devaluation. Weve seen some governments cutting their budgets, and weve also seen some opportunistic behavior. The economy moves in cycles, and thus there will no doubt be a medium- and long-term upside. McKINSEY: What would be your advice to bright, young individuals interested in telecommunications in Africa? CHRIS GABRIEL: Look us up! Theres a wonderful world of mobile in the region, and at Zain, we are about making history. We have considerable historical milestones under our belt, and we will continue to make waves in the sector. The future is very exciting, and we encourage innovative young leaders to join our organization. We see no boundaries. With passion we can exceed even our own expectations. *** Mr. Gabriel was interviewed by Zakir Gaibi, a Principal in McKinseys Dubai office.

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McKinseys Telecommunications Extranet


McKinseys Telecommunications Extranet is the gateway to some of the best information and most influential people in the telecommunications industry. The Extranet offers selected McKinsey-generated information that is not available in the general Internet. Extranet users have access to selected McKinsey articles on subjects ranging from Industry & Regulation, Growth & Innovation, Sales & Marketing, Services & Operations, IT & Technology, Corporate Finance, Organization & HR, Corporate & Enterprise, and Equipment & Devices. Direct communication channels ensure that your questions and requests will be addressed swiftly. The site is updated weekly with new articles on current issues in the industry. Through McKinseys Telecoms Extranet you can: Obtain exclusive information free of charge and take advantage of an Internet portal specifically designed for the industry. Access cutting-edge business know-how, interact with other experts to gain new perspectives, and contact leading industry professionals. Stay well-informed with daily industry news from factiva that you can tailor to your needs and interests. General information about the site is available at: http://telecoms.mckinsey.com Contact: telecoms@mckinsey.com

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The Telecommunications Practice


McKinseys Telecommunications Practice serves clients around the world in virtually all areas of the telecommunications industry. Our staff consists of individuals who combine professional experience in telecommunications and related disciplines with broad training in business management. Industry areas served include network operators and service providers, equipment and device manufacturers, infrastructure and content providers, integrated wireline/wireless players, and other telecommunicationsrelated businesses. As in its work in every industry, the goal is to help McKinseys industry clients make positive, lasting, and substantial improvements in their performance. The practice has achieved deep functional expertise in nearly every aspect of the value chain, e.g., in capability building and transformation, product development, operations, network technology, and IT (both in strong collaboration with our Business Technology Office BTO), purchasing and supply chain, as well as in customer lifetime management, pricing, branding, distribution, and sales. Furthermore, we have developed perspectives on how new business models and disruptive technologies may influence these industries.

Telecommunications Practice 2009 Copyright McKinsey & Company, Inc.


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