A Helpline for European Telcos

7/23/2019 A Helpline for European Telcos

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The incumbents must adapt their organizations andacquire new skills to win the war of inches against theirattackers.

SHANKAR JAGANNATHAN, STANISLAV KURA, AND MICHAEL J. WILSHIREThe McKinsey Quarterly, 2003 Number 1

Europes incumbent telecom operators are heavily in debt following their ambitious expansion efforts in

the 1990s and an enormous bill for third-generation licenses.1So far, the response has been to slashspending. In 2001, these companies trimmed their operating costs by up to 6 percent, reduced thestaffs of their core fixed-line divisions by as much as 12 percentmore cuts are to comeand paredtheir capital spending to the bone (Exhibit 1).

But cost cutting alone wont revive their fortunes: in addition, they must do something about fallingrevenues, for at some of the incumbents revenues from the fixed-line voice business, which stillaccounts for 70 to 90 percent of the wireline total, have been shrinking by up to 12 percent a year. Sofar, revenues from data have also been lower than expected, because an oversupply of data networkshas forced down the price of such servicesa particular blow to incumbents, since a good deal of their


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will worsen and valuations will fall even further.

Perhaps because no "silver bullet" comes to mind, few incumbents have as yet done much to improvetheir revenues. Given the competition for voice traffic, these companies fixed-line voice telephonybusiness wont grow briskly regardless of what they do, but they can still squeeze more cash from theirfixed-line voice and data services. Although the telcos cant rescue themselves with any single initiative,undertaking several at once could do much to tide them over this difficult period: at Spains Telefnica,

for example, revenues fell by 0.6 percent from 1997 to 2000 but rose by 2.5 percent from 2000 to 2001,following the introduction of such a program.

A typical European telco could expect its revenues to improve by 2 to 5 percent within a year afterembarking on the course discussed in this article. Small beer? Not if you consider the alternative:stagnant or falling revenues. Moreover, these initiatives dont require much extra spending, so theresulting cash contributes directly to earnings, and even a modest program could raise a companysvalue by 15 to 20 percent.3

TURNING THE BUSINESS AROUND

The voice revenues of the incumbents are stagnating because of increased competition, and theirpredicament will certainly get worse if they dont act soon. Although overall telecom spending is up, theshare of fixed-line voice operators is shrinking as mobile and data service providers capture most of thegrowth. Such newcomerscable companies, wireline attackers, and mobile operatorshave not onlymade considerable gains in market share but also, with help from tariff reductions imposed byregulators, forced down prices.

Mobile competitors have proved particularly threatening, for mobile telephony has swelled the voicemarket but, at the same time, eaten into the fixed-line operators share of it. Some 15 percent of UKresidential users now regard their mobile telephone as their main one (compared with 13 percent a yearago); 6 percent of households in the United Kingdom have only mobile phones, as do 31 percent ofhouseholds in Finland, where two-thirds of all 14- to 25-year-olds use them exclusively.

A model we developed to forecast voice and data revenues predicts that even telcos where they


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increased moderately in 2001 will see revenues from fixed-line voice operations fall by as much as 4percent over the next three years (Exhibit 3). To reverse this decline, these companies must embark ona range of small-scale initiatives in three broad categories: preventing customers from defecting (andwinning back some of those who have already left), launching new services, and encouraging existingcustomers to spend more.

The order of priority will differ among national markets, depending above all on the extent to which eachof them has been deregulated. As a general rule, telcos operating in a newly liberalized market, such asCentral Europe, can expect the going to get much tougher, since they have yet to experience the fullimpact of competition: the simultaneous erosion of their prices and their market share. Moreover, thepenetration of wireless relative to fixed-line phones is already quite high there, so many customers maywell give up or never adopt fixed-line services. When a Czech operator raised its line-rental fee in early2002, for example, 2 percent of its subscribers, believing that it was no longer worthwhile paying forboth fixed and mobile service, canceled the former. In these markets, initiatives aimed at preventingcustomer defections to new competitors should thus have a higher priority than they would for telcos inlong-deregulated markets, where much of the customer churn has already taken place. Indeed,incumbents in more developed markets have a chance to win back customers because overcapacitythere has already killed off some attackers.

A telco hoping to revive its revenues should direct its efforts toward the three main customer segments:households, small and midsize businesses, and corporations. The residential segment provides thesteady cash flow needed to offset the fixed costs of the access network. Small and midsize businesscustomers are important profit generators, providing typical earnings before interest, taxes,


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depreciation, and amortization (EBITDA) of approximately30 percent, as compared with 25 to 28 percent forcorporate clients. Yet though the corporate segment maybe less profitable, it is essential for rolling out newservices, since it helps to provide the volumes needed fornetwork economies of scale.

SPOILED FOR CHOICE

The revenue-generating ideas outlined here give an idea of the dozens of approaches that telcos canchoose from to prevent their customers from defecting and win back some of those who have alreadyleft, to launch new services that will earn quick returns with little capital outlay, and to encourage theircurrent customers to spend more on existing services.

COMBATING DEFECTIONS

In the three years following liberalization, the average European incumbent lost 22 and 35 percent of itsshare of the national and international long-distance markets, respectively, as customers signed up withcompetitors. Prices too dropped rapidly (Exhibit 4). Most of the defectors believe that the incumbentscompetitors offer better value for money, so initiatives to win back these people should focus onimproving their perceptions of the value the incumbents offer.


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Such initiatives may target an entire market segmentall small and midsize businesses, sayor aparticular subsegment. Targeted campaigns work best if they pinpoint customers, especially high-valueones, in the group most likely to defect. One operator, for instance, wanted to concentrate on retainingonly those small and midsize businesses it risked losing. To that end, it analyzed its customer databaseto see if earlier defectors in this category had much in common. It turned out that they tended to makemore customer service calls, suggesting some dissatisfaction on their part, and paid by check orpayment order rather than direct debit, suggesting that they werent convinced the relationship wouldlast. The telco then trained its sales force to approach similar customers, offering them volumediscounts on their contracts. The sales reps received a special commission on these deals. During a

seven-month trial, the company estimates, the initiative cut the number of customers that would havebeen lost over this period by 27 percent.

Another incumbent, which was trying to win back business from corporate customers, first identifiedaccounts whose traffic had fallen by half or more. The company then targeted the biggest of thesecustomers whose business it thought it had a fair chance of winning back; the targets represented about10 percent of its total customer base. Next, the telco calculated the present value of the lost businessfrom each of the customers should it be regained and tailored an offer (from a range including attractivepackages of products to discounts on individual products) for each of them. The offer was designed tocost less than the present value of the incremental profit of the traffic won back from these customers.The result? Some 25 percent of the companies approached signed new, profitable contracts.


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Although targeted initiatives are usually more successfuland cost-effective than segmentwide ones, they arentalways possible: poor customer data might limit acompany to segmentwide campaigns, for example, aswould restrictions on the right to offer different prices todifferent customers. Nor are targeted initiatives likely tobe effective if an incumbents brand is in trouble.Residential customers wrongly perceive many European

incumbents to be much more expensive than their f ixed-line competitorsa result of the attackersenergetic marketing and of the incumbents lethargy. Indeed, few of these customers know the actualprice differences between the two. A few incumbents have fought back by launching price-perceptioncampaigns: BT, whose advertising once focused on connectivity and customer service, recently ran acampaign to show that some of its packages were cheaper than those of its competitors, and a similareffort by an Eastern European incumbent raised residential off-peak traffic by 8 percent and revenuesby almost 2 percenta worthwhile gain given the relatively small advertising outlay.

OFFERING NEW SERVICES

When share prices were booming and telcos could borrow easily, adding new services to generategrowth stood high on their agendas. Now that capital is tight, telcos have frozen their capital spending.We, however, think that many of them are acting too conservatively: they should consider offering newservices, especially in data, to customers such as corporations and certain small and midsizebusinesses, which are often among the earliest adopters of new, sophisticated, and integrated telecom

systems. The key is for the telcos to identify services that require a moderate investment on their part,have short payback periods, and can improve the bottom line without cannibalizing other productsofcourse, taking into account a companys special skills and the level of competition.

Take, for example, Internet Protocol virtual private networks (IP-VPNs), which provide networks ofsecure links over a shared IP infrastructure. Their benefits to customers resemble those of dedicated IPnetworks using leased lines, but they are much less expensive, since the infrastructure is shared withother customers. For a fairly small outlay on encryption equipment, servers, and software piggybackedonto a telcos existing network infrastructure, the telco can earn revenues by managing the IP-VPNinfrastructure of their customers, by transporting higher volumes of data, by using the new network as aplatform for other services (such as videoconferencing), and by providing services to remote locations.And as IP-VPNs become more popular, the technology may generate network effects: customers andsuppliers of large corporations will want to adopt their IP-VPNs in order to be integrated into the samesystems and share the same benefits.

Yet the economic attractiveness of an IP-VPN to the customer carries some risks for incumbent telcosbecause, initially, some of their leased-line services may be cannibalized. A more economical optionmay be to provide smaller offices with cheaper alternatives, such as Asymmetric Digital Subscriber Line(ADSL) connections, while making IP-VPNs available to customers only if the incremental benefitsoutweigh the risk of cannibalization. By contrast, it will always be hard to make an economic case forGigabit Ethernetan extremely fast form of metropolitan data connection that can also cannibalizeexisting data lines. Incumbents should install this technology only if revenues from a customers datalines will probably be lost to competitors.

ENCOURAGING CUSTOMERS TO SPEND MORE

Wireline incumbents often overlook several ways to increase revenues from existing customers. Thesetechniques include the promotion of existing services such as voice mail and call forwarding as well asattempts to stimulate traffic through promotional trials of new services, flat-rate offers, and the bundlingof new services with those that customers already purchase.

Such efforts can yield important gains. Flat-rate offersthe operator sells a defined number of minutesin a single package for a fixed, discounted priceencourage customers to use their telephones moreoften. Revenue gains of 10 percent from subscribers are not unusual, and the deal gives the operator amore constant cash flow. Wireless operators, which are exposed to greater competition, are way aheadof the wireline telcos in using such offers to ensure stable average revenues per user.

Bundling is another effective means of encouraging people to spend more; customers, it seems, arewilling to pay for service bundles if they offer at least one of two benefits: convenience (eliminating theneed to deal with different suppliers, say) or, more important, cost savings. A potentially lucrativeexample of this approach would be to offer small and midsize companies a bundle consisting of the


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core telco products they already use, such as voice or broadband access, together with new ITservices, such as the management and security of their local-area networks (LANs)a service theywould normally buy from IT specialists or provide in-house. The telco can manage these servicesremotely over its existing networks, so it can offer them as a natural extension of core services such asInternet access.

This kind of bundled offer not only increases an operators revenues in the short term but also providesa uniform platform for future sales of other advanced servicesfor instance, virtual private networks

between different locations. Such offers can attract small and midsize businesses by giving themcomplex IT services relatively cheaply and by simplifying their dealings with suppliers. Our analysis ofone such bundled offer revealed a potential 4 to 6 percent cost reduction for the customer, whose valueto the operator still rose by around 10 percent.

THE IMPACT

To show the potential gains of a suite of revenue-generating initiatives, we modeled the consequencesof seven of them for a hypothetical telco operating in a Western European market that was liberalized in1998. We chose the initiatives likely to have the most impact on revenues, taking into account themarkets particular conditions, such as regulatory constraints, and the operators capabilities.

Exhibit 5 shows each initiatives potential impact on a companys revenues. In the residential segment,the telco had an opportunity not only to undertake a price-perception campaign and to make targetedoffers that could reduce churn but also to turn a legal requirementoffering directory servicesinto arevenue-generating offer: for a small fee, customers would get additional information such as drivingdirections or restaurant locations. The initiatives in the small and midsize business segment included abundled offering, a targeted program to reduce churn, and a move into network security services. (Thismarket, though small, is a lucrative one because of growing concerns about security, an area in which atelco can use its core network capabilities and infrastructure.) Finally, in the corporate segment, thetelco, given its knowledge of standardized monthly billing processes, appeared well positioned to offerbilling services to other companies: since its own billing operation was very large, it could add additionalvolume at marginal cost. We estimate that rolling out these initiatives successfully could increase thetelcos revenues by 3 percent in a year.


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Some incumbents recognize the impact a program of this kind can have. One such company forecast a6 to 10 percent year-on-year drop in wireline traffic if it took no action at all to stanch the defection of itsbusiness customers to wireline competitors and of its residential customers to mobile networks.Moreover, the spending power of its customers was below the European average, so it was hard for

them to pay for higher-quality but more expensive services such as residential DSL lines or corporatewireless LANs, which might help compensate incumbents in wealthier markets for lost customers.

Under these unpromising circumstances, the operator designed and carried out 17 initiatives in lessthan a year. While not all of the results are available, the company is on course to raise its averageannualized revenue per user by more than 4 percent, and many of the initiatives showed results almostimmediately. Although they wont entirely offset the forecast fall in traffic, the company has learned agreat deal about the behavior of its customers along the way, and the will to improve its core voicebusiness continually is becoming a part of its culture. The company will find these new assetsinvaluable, for though none of the initiatives we suggest requires much capital outlay, many do requirean understanding of the behavior and needs of customerssomething that not all telcos have, giventhe protected environment in which they used to operate.

To win this war of inches, telcos with vestiges of the protected mind-set will have to adapt theirorganizations and acquire new capabilitiesfor example, better marketing skills and a better

understanding of how their customers use their services. But these companies will find their skillsconstantly improving once they set in motion the approach outlined here. They dont have to doeverything themselves: they could, for instance, outsource customer loyalty programs or use third-partycall centers that specialize in telemarketing. But since marketing skills and an understanding ofcustomers will be crucial to many future operations of such companies, they will need to invest in theseareas in any case. Of course, senior managers will have to pay close attention to choosing andcoordinating the many different initiatives that revenue-enhancement programs entail. But the resultsshould make the effort worthwhile.

Notes:


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Shankar Jagannathan is a consultant in McKinseys Charlotte office; Stanislav Kura is an associate principalin the Prague office; Michael Wilshire is a principal in the London office.

The authors wish to acknowledge the contributions of Monika Hencsey, as well as those of Santiago Comella,Nathan Marston, and Mark Steen.

1Third-generation (3G) wireless technology provides for packet-based transmission of text, digitized voice,video, and multimedia at rates of up to 2 megabits a second. In some countries, operators paid license feesas high as $7.6 billion.

2UBS Warburg and Salomon Smith Barney sum-of-part valuation for the fixed-line operations of CeskTelecom, Deutsche Telekom, France Tlcom, KPN, TDC, and Telecom Italia.

3This estimate was arrived at through a cash flow analysis of the incremental revenues that would begenerated by initiatives contributing an earnings margin of 70 to 100 percent to the bottom line.

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A Helpline for European Telcos