Ringing the changes

By Helen Twose

In a rare show of unity, the tech-heads who analyse the inner workings of the telco sector agree: the brave new world of competition is finally upon us.

Consumers should brace themselves for more market consolidation, more deals that bundle together mobile, land line and broadband, and more companies forming partnerships, they say.

That will mean faster and flasher services for computers and mobile phones.

But will they be cheaper? Well, that depends.

This month has seen a flurry of telco activity.

Two of Telecom's rivals - Orcon and ihug - have made their way into the Ponsonby telephone exchange, giving them direct access to Telecom's network for the first time as trials for local loop unbundling begin.

Within 24 hours of plugging in, Orcon and ihug's parent Vodafone unveiled deals that knocked up to $40 off residential phone bills.

Then Telecom revealed details of a portal for the exclusive use of its Xtra customers.

And TelstraClear is moving its mobile phone business from Vodafone to Telecom to become a serious third competitor in the mobile market.

Telecommunications and internet service providers will head down one of two paths, says IDC analyst Darian Bird: either broadening the range of services they offer to include mobile, broadband and fixed line services; or focusing on niche markets.

"The players that don't take one of those paths are the ones that are going to get eaten up," he says.

Those likely to gobble up market strugglers include well-known telco names such as Vodafone and CallPlus, but not Telecom.

Its current market dominance will see it ruled out of any New Zealand acquisitions by the Commerce Commission.

Bird says market consolidation will be driven by the need for companies to get significant scale to gain more revenue off slim margins and to justify major new investment.

"If you're reselling Telecom's broadband, you're making practically zero margin," says Bird.

"You can't change that margin, so the only way to improve your profitability is via scale."

Bird says selling broadband is not a cash cow and never will be. Improved profitability will be tied to new services offered over broadband, such as video conferencing and television delivered over the internet (IpTV).

David Kennedy, of Australian-based telecommunications analysts Ovum, agrees.

He says competition in the market is putting pressure on the average revenue per user.

Recent offers of "bundled" deals - taking all your phone business to one telecommunications company - are changing the nature of competition in the market, he says.

"What's driving this is the need to match Telecom New Zealand's power to bundle its fixed-line and mobile services.

"You really need to have a variety of offerings that you can bundle to be competitive in the market as bundling really takes hold."

Bird says bundling keeps a telco's customer away from rivals.

"If they can get you to buy your mobile off them and if they are providing a phone line and internet, you no longer get a bill from Telecom.

So Telecom can no longer stick those little brochures in."

Bundling is essentially a marketing tool aimed at increasing market share. Price cuts are not necessarily driven by technology change or better service-delivery platforms.

Telcos introducing product packages are banking on regulatory changes.

The current "land grab" for customers is expected to pay off when local loop unbundling allows them to offer services at improved margins.

The analysts are divided over whether consumers can expect huge price drops in the near future.

Bird says with slim margins on products and some companies even being prepared to take a financial hit to secure customers, prices are unlikely to fall sharply.

However, telecommunications analyst Paul Budde says faster speeds and improved services are relevant only if linked to affordable prices.

What consumers will end up paying for are the additional services built on top of basic phone and internet delivery.

According to Kennedy, telcos are going to need to build new services to compensate for revenue lost to price competition on traditional phone services.

While user-revenue may remain steady, telcos will need to work a lot harder to squeeze dollars out of their customers.

"Whether it actually goes down or not will depend on the extent to which they can generate new service revenue," he says.

Areas to watch are mobile data, broadband - possibly higher speed broadband services offered at a premium to some of the slower speeds - and content delivery.

"It's probably that third one - content delivery - that a lot of operators around the world are looking at in the medium term as a driver of new revenue."

Kennedy says the bigger players will develop a variety of strategies to survive in the changing marketplace.

Options range from becoming a full media company - a plan Telstra is pursuing in Australia - through to the opposite extreme of operating a network with no services.

Kennedy says a full media strategy brings big revenue rewards but also carries similar-sized risks.

In the middle of the spectrum are phone companies who are forming partnerships with service and content providers.

Last year Telecom announced a tie up with Yahoo!7, a 50-50 partnership between the Seven Network and Yahoo, ending a five-year relationship with Microsoft.

At the time, Telecom chief operating officer of consumer business, Kevin Kenrick, said it pursued the partnership with Yahoo!7 because it was "very difficult" for Telecom as a small player globally to develop content services in a market the size of New Zealand.

Telecom is positioning itself as an aggregator, says Kennedy, pulling together a mixture of content on a global, national and local level to offer - sometimes exclusively - to its internet and mobile consumers.

Bird says the New Zealand content market is in a transition stage where people are changing their perception about how they get entertainment.

He gives the example of Vodafone selling Sky TV packages over its mobile phones.

"It gets people buying 3G phones, it gets people using the network and it changes their ideas about where they want to watch Sky."

Kennedy says the real dilemma for telcos will be in the area of fibre investment to improve broadband speeds.

Network operators cannot justify investment in fibre without new service revenues, and the level of demand for new services is still unclear.

"It's hard to find a business case to put fibre into the access network at the moment," he says.

Telcos also face competition from the likes Google, Apple and Yahoo, who deliver content to set-top boxes and hand-held devices by "riding" the network in between.

"The threat telcos face is value actually being sucked out of the network and moving to these other areas of the business where they are not very well positioned," he says.

Budde says innovations in service delivery will not necessarily come from the existing phone companies.

"You've got the three largest players - none of them do I see as innovators, as movers and shakers.

"Services and applications are not things the big players are good at, and it doesn't matter if you talk about Telecom or Telstra or Vodafone.

"They are big companies, they have big structures, they have huge decision-making processes that do not allow them to act quickly and swiftly in a market that is changing daily."

Budde predicts the biggest action will come from the second tier of telco operators that have been around for a long time and are getting clear new opportunities for growth under local-loop unbundling.

He points to the example of an Italian company offering a $30 package which allows small businesses to monitor their premises via a security camera running over the internet.

A text message is sent to the business owner and the police if an intruder enters the property.

The owner could also check the security camera footage over their internet connection at home.

Budde says service innovation will occur in niche markets where smaller internet companies will sit down with customers, listen and build a solution if one is not available.

"If you look over the next five years, then I'm pretty sure that some of the players that are now small will be medium sized and they're really starting to punch above their weight. "But that might take three to five years."

All agree the market will remain challenging for existing players and new entrants.

Budde does not expect to see a lot of newcomers to the market.

But he says smaller players could be sitting down with big retail outlets, education providers and even local councils to bring services to the market. Again, he points to the example of the security product packaged into broadband which could be sold through a retail brand.

"Telecommunications products and service might be pushed further out into the market by using existing brands that might incorporate it," says Budde.

Kennedy says that future success will be determined by how well operators are able to reach specific market segments, rather than by the traditional approach of focusing on products.

Bird says the next few years will see the smaller players shrinking. Only those who were able to innovate will survive, with the bigger telcos gobbling up those that fail.

Out of the loop

May 2006: Government announces telecommunications industry reform, including opening Telecom's network to competitors.

December 2006: The Telecommunications Amendment Act introduces a new process allowing the Commerce Commission to set the rules on how Telecom provides competitors access to its network.

July 2007: Commission releases draft determination on local loop unbundling.

August 2007: Telecom voluntarily opens up five exchanges to allow rivals to test equipment in advance of local loop unbundling.

August 2007: Commission announces it would take control of prices for roaming - letting other carriers use Telecom and Vodafone's mobile networks.

What's to come?

August 2007: Government to release a draft review of the Telecommunications Service Obligation - the agreement made when Telecom was privatised 17 years ago to guarantee free local calling in all regions.

Commission releases draft determination on unbundled bitstream, allowing connection to Telecom's copper network without needing to pay it for line rental.

August/September 2007: Government to release plan to operationally split Telecom into three units - retail, wholesale and network divisions.

November 2007: Commission releases final determination for local loop unbundling.

December 2007: Commission releases final determination for unbundled bitstream.

April 2008: Five exchanges opened to rivals under Telecom's regulated proposal.

Looking ahead

* The telecommunications market will consolidate with any players struggling in the new environment being gobbled up by competitors, experts say.

* Partnerships will form between content providers and telcos.

* Partnerships will also be made between telcos, for example, an internet service provider and mobile operator, to allow for "bundling" of products.

* More services will be provided over broadband - both fixed line and mobile - to lift telco revenues.

* Survival will be determined by having a superior capability in a market segment, either as a niche player or across a number of markets.

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