The era of “free handsets for everyone” seems to be coming to an end, but how did we come to this point? What are the drivers compelling more and more operators around the globe to curb handset subsidies? If you abstract from the wireless industry for a moment and imagine the following situations, the answers to the above questions might start becoming clearer:

• Imagine a Canal+, DSTV, Orbit, etc. sales rep, knocking on your door and telling you: “Dear customer, we see that your 46’’ 3D HDTV set is already 1 year old. Don’t you think it is time to change it? We will be happy to give you a brand new one for free, but please, stay with us and watch Canal+ for 18 months, ok?”
• Or we can fantasize about this other one: Imagine Exxon, BP, Repsol, etc. advertising on highways that they will give you a new car every year as long as you commit to filling the tank exclusively at their gas stations. I’ll admit this one is a bit far-fetched, but you get my point

Looking at it from this perspective it seems obvious that operators should have never gone that far down the road of handset subsidization. After all, is it fair for consumers to expect or even demand the latest cutting-edge equipment for (almost) free, especially when they enjoy and use them for things that operators often neither control or benefit from (e.g. taking pictures, listening to music, playing games)? Looking back at the early days of mobile will help us understand how the now much-criticized handset subsidy model unfolded.

How did this phenomenon start?

It all started in the 90’s, when mobile operators around the world, riding a healthy growth wave, started applying moderate subsidies on their basic phone portfolio. With the objective of decreasing the cost of entry and continue increasing mobile penetration rates (by enabling less affluent consumers to adopt mobile), operators offered discounts on many mid and low-end SKU’s to subscribers that acquired a line (even a prepaid one in the beginning). And on the basis of boosting mobile penetration, it is undeniable that handset subsidies were a successful strategy.

As the mobile industry evolved, basic phones paved the way for feature phones, and later on smartphones. The latter (especially the iPhone) changed the rules of the game drastically, but operators did not immediately realize the damage of continued handset subsidies. As smartphones became more and more popular, operators rushed to partner with leading OEM’s, trying to link their service with fancy phones and piggy back on the ascending brand image of the likes of Blackberry (we are still talking about a few years back), Apple, and the like.

Perhaps inadvertently, operators buried themselves in a bigger hole than they anticipated. Price wars were fought on two fronts: in addition to increasingly lower mobile tariffs (price per minute of voice and price per MB of data), operators were also competing to see who could offer the most advanced handset at the lowest price (or even for free). The phones themselves (and more recently even the OS’s) became one of the main hooks of the value proposition. With the push of ULPH (ultra low price handsets, not to be confused with ultra low cost handsets or ULCH), customers stopped paying attention to the operators’ prices and promotions to only focus on how cheap the upcoming iPhone 4S would be. Unlike TV sets and cars, however, mobile operators managed to change consumers’ purchase behaviour by fostering a culture of “free handsets for everyone”.  Putting it is simple: operators ended up becoming prisoners of OEMs.

This situation would not have been all bad if operators had been able to sustain or grow EBITDA margins and profits. But this has not been the case. Many mobile operators around the globe are seeing their profits and margins plunge, and some have openly stated that handset subsidies have been one of the main causes for this. For example, China Unicom’s profits decreased 60% in 2010, from 9.56 Bln Yuan to 3.85 Bln Yuan, and handset subsidies accounted for 3.17 Bln Yuan. The operator has admitted that the profit decrease was mainly caused by “rising costs for 3G handset subsidies and high depreciation and amortization fees”.

Coming back to reality

The handset subsidies conundrum has been on the spotlight since the appearance of smartphones. While many operators have alerted of the risks of excessive handset subsidization, few have taken actions to curb these risks. Most operators keep suffering its harmful effects in silence, promoting handsets that are harming their profitability.

Things may be changing, though. Some operators have started being more vocal about the need to change the model and rid themselves of the handset subsidy shackles.  Cole Broadman, T-Mobile USA’s CMO, said in a recent panel chat: “if I was the king for 1 day in the USA market, I would stop handset subsidies”,  to which the moderator told him that he was actually 1 out of the 4 kings of the market, and that he could do it. But generally, operators have been afraid to be the first to stop subsidies, lest the others not follow on their path and take their customers away.

But this apparent prisoner’s dilemma might not be such after all. While a first mover would probably see its market share eroding in the short term, player(s) maintaining handset subsidies would see their subsidy cost increasing (as customer acquisition rises), worsening overall margins even more. So a lose-lose situation could occur if only one player stopped handset subsidies in a given market (instead of a lose-win). The only way to win might be for all operators to stop subsidies.

My take on the future of subsidies

I foresee strong incumbents in advanced markets (with high subsidy levels) taking the lead and reducing subsidization costs in the short term (1-2 years). Smaller operators and challengers might be tempted to stay put and assess the impact on the market, but I believe they will also end up adjusting their handset subsidy models in the short to mid term.

The end of handset subsidies does not necessarily mean that operators will start charging the full price of handsets. Most likely, operators will look for alternative methods for subscribers to have access to smartphones and other devices with a reduced upfront payment, without compromising operators’ profitability, such as:

• Payments in installments, in partnership with local financial institutions, with low or no interest (e.g. Telefonica + Finconsum)
• Reverse subsidies: under this model, operators will not provide large upfront handset discounts, but instead offer in-kind services over a period of time to entice acquisitions or renewals. For example, offering a bulk of free minutes or SMS every month for a period of time with every new purchase
• Handset replacement schemes: allowing customers to return their old phones and get a discount on their new one (e.g. Telefonica is promoting this scheme in its new model, and it plans to refurbish and re-sell used handsets to lower income customers in its home market or ship them to Latin America or Africa)

In those cases where handset subsidies remain, these will probably be targeted as a retention strategy (i.e. for the purposes of customer renewal), rather than for new acquisitions. And more importantly, operators are likely to offset subsidy cuts with more attractive data prices in the mid term (a more natural basis of competition for operators after all).

Subsidies on low-rotating equipment (e.g. dongles) will be maintained, as penetration still needs to be pushed in most markets and consumers’ appetite to upgrade this type of equipment is limited.

Conquering the world

Handsets produced by Chinese firms are reaching the world in four main ‘flavours’:

1. Branded – ‘The originals’
A number of Chinese manufacturers have succeeded in becoming household brands all over the world. By now, everyone knows ZTE, Huawei and Alcatel (actually owned by Chinese TCL). There are also smaller Chinese manufacturers with the confidence and ambition to produce and export under their own brands, such as Amoi and Gionee.

2. White Box – ‘The chameleons’
White box handsets are willing to carry any colour, design and brand on them, depending on the buyer’s wish. The only condition is a commitment to the minimum purchase amount, often already starting at 1,000 handsets. Mobile operators in particular have made use of this opportunity – examples include Vodafone with Huawei, Orange with ZTE, 3 with Amoi or China Unicom’s WoPhone.

3. Localised – ‘The disguised’
A hidden and little noticed development is the emergence of a number of handset manufacturers, mainly in Southeast Asia, who instil a local flavour into their brands and products. The reality is, however, that these handsets are at best designed locally and often completely bought off-the-shelf from Chinese manufacturers. Some of these brands, such as Nexian in Indonesia, Q-mobile in Vietnam, TWZ in Thailand and Allview in Romania have been successful and gained up to 20% of total handset market share in their respective countries. In the case of Q-mobile, the product is piggy-backing on the international expansion of Viettel and is now sold abroad in markets as far as Haiti[1].

4. Fake – ‘The mountain stronghold’

Fake phones (or ‘shanzhai’ – literally mountain stronghold, alluding to the outlaw nature of the product) can be sold for as low as 5% of the retail price of an authentic device. For example, you can buy an iPhone 4S for between US$40 and $160 – depending on the features (dual-SIM, 3G-enabled, etc.) compared to the official price of US$948[2]. By saving on R&D and marketing costs, using cheaper parts and avoiding manufacturing licence fees or import duties, fake phones obviously gain an unlawful cost advantage.
According to iSupply[3], the total number of Chinese white box and fake phones produced in 2011 was 250m, which would represent around 13% of global devices shipments. Fake phones are particularly common in markets with low income and lax regulation. For example, in Kenya about 9% of total handsets are estimated to be fake.[4] Interestingly, it is no longer only the well-known Western brands which are being copied, but also ZTE or TCL.

Dominating the low-cost segment…

Chinese mobile handsets are increasingly dominating the feature phone and the low-end smartphone segment.

As mentioned, smartphones currently receive all the attention given their value share dominance and attractive features. But make no mistake: feature phones will stay relevant. According to research by Yuanta (based on Gartner information), by 2015 feature phones will still represent over 60% of the global handset volume share, worth about US$88b[5]. For developing markets, the volume share of feature phones will be higher still.

With innovations and investments concentrated on higher-end smartphones, feature phones are likely to become further commoditised, and their commercial success will depend on having the lowest production costs. This advantage lies with the Chinese manufacturers, thus the increase of their dominance in this sizeable segment can be safely assumed.

While Chinese manufacturers lagged behind the initial smartphone development and wave, they have since caught up. So far, the Chinese own-branded and white box smartphones mainly ply the lower-priced segment of the smartphone market. The Chinese expertise and capability in this segment is increasingly recognised. Therefore it is not surprising that for one of the most frequently raised questions in developing markets – When will there be a US$100 smartphone? – the world is looking to China.

…but more than just cheap

It would be unfairly one-dimensional to reduce Chinese handset manufacturing to low-cost or fake phones. The truth is they play an increasingly important role in R&D and in the mass-marketing of certain phone features, many of them particularly relevant for developing markets.

Latest ZTE and Huawei smartphones are competitive both in price and capabilities, as proven by their sales performance – ZTE and Huawei outsold RIM and HTC, registering high growth rates throughout 2011.[6]

Yulong is another example of Chinese manufacturing innovation – it is considered a global leader of dual-mode (GSM and CDMA) phones. Multiple-SIM phones were not invented in China, but their adoption has been fuelled by Chinese manufacturers as Western device producers were forced to shy away from such devices due to their close relationship with operators. Phones for the elderly are another example of Chinese manufacturers’ role in spreading of new handset features. While these devices remain a niche product with focussed distribution channels in Western countries, they are offered en masse by manufacturers in China.

Chinese manufacturers also show outstanding time-to-market: the Mi-Obama branded phone was launched in Kenya during the presidential campaign of Obama. The device came complete with the slogan ‘Yes we can’ on the back and was aptly advertised as ‘Get your own piece of history’.

The secret ingredient

A factor which helps the Chinese handset manufacturing industry prosper and innovate is the clustering of telecoms equipment and devices companies around Shenzhen. Access to the complete value chain within such a short distance is unique in the world, allowing close cooperation but also stimulating innovation and efficiency through tight competition.

Major component producers like BYD Electronics (2010 revenues US$2.6b) for keyboards and cases, and AAC (2010 revenues US$0.5b) for acoustic parts and antennas are just two examples.[7] The power of this cluster is certainly one of the reasons why no serious international mobile device manufacturing competition has yet arisen, despite growing labour costs in China.

Note also that most of the firms involved in this tightly knit value chain are not new kids on the block. On the contrary, they have been around since the ’80s or early ’90s, which makes them established veterans by mobile industry standards.

Implications for operators

This article has shown that for operators, especially those in developing markets, the trends and developments of Chinese handset manufacturing are increasingly important and need the proper attention.

The popularity of the multiple-SIM handset has opened a new dimension in the competition for the share of wallet. Customers do not need to carry multiple handsets anymore and thus the competition has less of a ‘winner-takes-it-all’ character. Now the question comes down to which button on the phone the customer will press. The introduction of smartphones below US$100, and possibly even cheaper in the future, will have significant consequences on the spread of these devices.

The most common way operators have extracted value from the opportunities Chinese handset manufacturers present is the cooperation on white box handsets. Besides the marketing effect these arrangements are often more profitable than the sale of branded handsets.

The options how these white box handsets can be used and positioned are manifold.  Beeline in Vietnam used ultra-low-cost handsets as a customer acquisition tool. It has been reasonably successful with the strategy, especially considering the highly penetrated and competitive nature of the Vietnamese market. PLDT Group in Philippines, on the other hand, orders fashionable high-end devices such as the Telpad (a device combining fixed connection and tablet) and Netphone (a smartphone equipped with a home-grown suite of applications) to address high-value customers. The Netphone has been the best and fastest selling smartphone in the company’s history.

In conclusion, there is doubtlessly strategic advantage and value to be gained for operators from the Chinese handset manufacturing market. However, in order to achieve this, operators need a greater focus on this marketplace to gain a better understanding of it. This should help them to approach the market adequately and to extract the maximum value from the opportunity offered.

Whilst C&W has a significant international presence, we believe Vodafone’s interest lies primarily in C&W’s assets and capabilities in the UK. The C&W acquisition will double the size of Vodafone’s enterprise division, will strengthen commercial relationships with key corporate and Government clients and will provide increased capabilities in the ICT space. Moreover, the acquisition will complement Vodafone’s own mobile network with more than 20,000 km of fibre-optic infra-structure within the UK. By extending its own fiber network, Vodafone UK will avoid paying transmission fees which according to Sanford C. Bernstein analysts could total more than £200 million a year.

Whilst offering enterprise integrated services, increasing ICT capabilities and lowering transmission costs might seem logical enough reasons for the acquisition, we believe there are more strategic reasons for this move.

The three real reasons why Vodafone bought C&W

Reason #1: To manage its mobile data growth

The world is witnessing an unprecedented explosion in mobile broadband usage on the back of new superfast technologies (HSPA+, LTE). According to Cisco, Global mobile data traffic is expected to increase 18-fold between 2011 and 2016.

The mobile data explosion is a double-edged sword for wireless operators (and Vodafone UK is no exception): their ‘pipes’ will continue to be used, but at the same time current wireless technologies (such as HSPA/LTE) may not be the most efficient medium to deliver the service. The naked truth is that fixed technologies deal much more efficiently with scale than mobile technologies.

Why? This is ultimately based on key differences between fixed and mobile data economics:

• Density: While 3G base stations can only deliver high speeds (3-5 Mbps) at very close distances, FTTH can today deliver 1Gbps or more with almost no degradation due to distance. Moreover, the coverage area of a 3G base station actually shrinks as the number of simultaneous users increases (a phenomenon called ‘breathing’). As the scale of mobile broadband usage goes up, the average individual cell site coverage will tend to shrink, which means more sites and more CAPEX will be required to cover the same areas.

• Spectrum: In mobile technologies data eats through spectrum capacity far faster than voice, making spectrum a key (and scarce) asset for wireless operators. Fixed technologies however have a major advantage as fibre-based transmission solutions are easy to scale and can provide almost any amount of bandwidth required.

This ‘asymmetry’ in data economics together with the spectrum and CAPEX constraints suggest the only way mobile operators will be able to serve the expected demand will be by relying (at least partially) on fixed technologies (FTTH/GPON, WiFi offload, microcells). Going underground may be a necessary move for mobile operators who want to live in the ‘cloud’.

In the UK all 4 MNOs are currently operating 3G in the 2.1 GHz band where, compared to lower spectrum ranges, it is significantly more expensive to provide mobile broadband coverage over a given geographic area. However, Everything Everywhere controls 2×60 MHz in the lower 1.8 GHz range and could convert this spectrum range into 3G, thus gaining a relevant cost advantage over Vodafone UK and O2 UK. And that is why traffic offloading becomes particularly critical for Vodafone UK and O2 UK. In comes C&W.

The C&W acquisition could give Vodafone UK (25% market share in the mobile market) the needed competitive lever to continue its data-intensive SuperNetwork strategy and challenge both Everything Everywhere’s and O2 UK’s market leadership (35% and 29% market shares respectively). How?

• On the one side, Vodafone UK will be able to leverage its business footprint to offload mobile traffic onto WiFi hotspots and microcells in office parks, business buildings and public areas at almost no additional cost. This is a substantial advantage when compared to O2 UK, who despite having similar spectrum will face significant challenges in replicating Vodafone UK’s data intensive strategy without access to a fibre network.

• On the other side, Everything Everywhere will have a bigger challenge to manage the data boom. Despite controlling wide 1.8 GHz spectrum, it is currently being used for 2G – this means that to meet the mobile data demand the operator will need to engage in a substantial re-farming exercise to use this spectrum for 3G and/or to secure the upcoming 2.6 GHz award (LTE).

Reason #2: To re-sell transmission capacity to other mobile data providers

The expected future data demand will require substantial amounts of transmission capacity. Besides providing Vodafone UK with significant savings on this front, the acquisition of C&W will allow for 2 other key benefits:

First, the C&W acquisition will give Vodafone UK a future-proof technical and economical solution for transmission, through a fibre network with one of the broadest reach in the UK, which will also allow for fast deployment of microcells and WiFi hotspots.

Secondly, Vodafone UK will be well positioned to capture the value in fast growing mobile data segment – even the share of growth captured by other operators: C&W’s network could be used to offer offload wholesale solutions to competitors, which would allow Vodafone UK to maximize its share of the transmission business.

Reason #3: To build up its ICT capabilities

Why is Vodafone interested in building up its ICT capabilities? In connection with the expected data traffic growth, ICT will be a key driver to secure the positioning in both the consumer and enterprise & Government segments. ICT will drive new services (e.g. cloud, smart city, smart campus/office/gated community) which will develop the connectivity business further and increase the number of high speed connections and share of traffic. ICT is not so much about increasing revenue but more about driving the adoption of super-fast connectivity and cloud services across enterprise and consumer segments.

Building these capabilities organically has proven very challenging for operators, forcing them to either partner with global players or acquire local companies with the required skills – skills that C&W partially brings to the table for Vodafone.

In summary – Building up capabilities for the hyper-connected cloud-enabled world

In a data-hungry, OS-driven, cloud-enabled world, only wireless operators with significant fibre-based fixed assets to manage wireless data growth, provide future-proof transmission, and drive connectivity business through ICT will have the opportunity to sustain long term competitiveness and challenge existing market structures.

Following this Vodafone move, we may see more M&A activity in highly competitive mobile markets where fixed assets seem to have become critical to sustain long term data strategies.

Global LTE strategies: Reasons behind the launch

LTE deployment strategies varied among operators and we have yet to see the effect of early launches. Verizon adopted the new technology in a move to lead the US mobile broadband market and is still expanding its LTE footprint and device portfolio. US operators such as AT&T and Verizon did not charge a premium for their LTE offering in a move to increase 4G subscriber base and to ease traffic on their 3G networks.

Teliasonera’s launch in the Nordic countries is mainly perceived as a move to preserve its brand image and mark itself as a technology leader. The infancy of the device ecosystem at the time of launch led to slow subscriber uptake, thus the operator did not realize the full benefits of the technology.

In Germany, LTE was a means to provide broadband connectivity to rural areas. As part of its license requirements, Vodafone has capitalized on low frequency benefits to deploy 4G networks in remote areas which lacked access to fast internet.
Almost 90% of LTE launches have opted for the FDD option. TD-LTE has yet to gain large scale adoption as the device ecosystem for TD-LTE (93 devices) is far less mature than FDD LTE (540 devices).

Exhibit 1: LTE spectrum bands and device availability

Source: Wireless Intelligence, GSA

Middle East launches: Brand positioning?

In light of global LTE developments, the Middle East has seen a race among Gulf operators to announce the launch of commercial services without clear strategies though. All three operators in Saudi Arabia claimed to be first to offer LTE in September last year while in the UAE,  incumbent Etisalat announced its launch in September 2011 but offers were not available until December 2011.

Exhibit 2: LTE launches in the GCC region

A lot of vibes accompanied the first launches in Saudi Arabia. STC and Zain’s phase one concentrated on the main big cities while Mobily’s initial coverage was targeted at six strategically smaller cities with a promise to expand coverage rapidly post launch ². STC expects to cover 65% of the population by end of 2012 and up to 95% of the population by end of 2014 ³. In the UAE, Etisalat had deployed 1,000 sites and covered 70% of the population towards the end of last year ⁴.

In essence, LTE is perceived as a means to preserve brand equity for the GCC operators that have launched the service. Pricing, device portfolio, spectrum choice and rollout plan in place make it hard to discern a clear strategy for the Gulf players.

GCC LTE Pricing:  Is there a clear proposition?

LTE pricing strategy for Middle Eastern operators is at best conventional with very limited pricing innovation.  Unlimited data is still used as a means to attract more subscribers while global operators have learnt the hard lessons of such offerings. Moreover, operators have not been realistic with the advertised speeds,  with some promising speeds up to 150 Mbps ⁵, a proposition that is evidently not seen anywhere in the world. Prices are not competitive either.  For example, a 10GB offering in Saudi Arabia is 2.4x to 4x more expensive than comparable data plans offered in some US, European and Asian markets. Saudi operators view LTE as a premium offering, thus premium charges apply over their HSPA+ prices while Etisalat’s offering at no extra charge is an intended move to encourage LTE adoption.

Exhibit 3: LTE offers by Middle Eastern operators

Source: Operators websites

In the broader global context, the scenario is different as offers are simpler and are targeted to subscribers’ needs. Operators are more transparent with advertised LTE speeds and provide fall-back to HSPA+ in areas where LTE is not available.

Differentiated LTE pricing strategies in the US, Europe and Asia are driven by the operator’s intent.  For example, Verizon’s LTE pricing without a premium is geared towards encouraging subscribers to migrate from its congested 3G network. It has recently doubled the data allowance while maintaining the price to further encourage migration. Most operators have moved away from unlimited mobile broadband offers with customized offer plans tailored to subscribers’ usage.

The GCC scene has seen an encouraging start on LTE deployments but innovative service offerings such as family data bundles are still not prevalent in the region as observed in more developed markets.

Exhibit 4: LTE offers by global operators

Source: Operators websites

LTE spectrum: Relevant to an operator’s success

Having said that, we do acknowledge the lack of a cohesive regulatory regime with coordinated spectrum planning in managing LTE deployments. The diversity in the choice of spectrum used for LTE launches in the Middle East makes roaming and network sharing very difficult. Operators have rushed to deploy LTE based on their current frequency allocations since no proper licensing process took place and since no coordinated timelines have been set by GCC regulators with regards to frequency planning and digital switchover.

Saudi Arabia: No clear regulatory plan for action

2 out of 3 LTE launches in Saudi Arabia were based on TD-LTE. Mobily deployed this technology in the 2.5 GHz band to which it has access through its subsidiary Bayanat Al Oula. The other TD-LTE network was launched by STC in the 2.3 GHz band. The third LTE network (FDD LTE) was launched by Zain using its 1,800 MHz 2G spectrum.  It is still a long way for the 2,600 MHz used by the Military to be freed or for the digital dividend to be planned with no date set for analogue switch off. CITC had planned to look at the possibility of freeing the TV broadcasting frequencies but no progress has been witnessed till date ⁷.

While further nation-wide LTE rollout was expected to be observed in Saudi, Khaled Al Kaf, Mobily CEO announced that the operator lacked the necessary spectrum to deploy LTE ⁸.

UAE: Regulatory will for action

UAE’s Etisalat has deployed LTE using 2,600 MHz and complemented it with 1,800 MHz for better coverage. The country has set December 2013 as a date for analogue switch-off. This is however subject to change depending on switchover plans adopted by other GCC countries, and readiness of the operators and the public to switch to digital TV. The 790-862 MHz band has been designated as a priority band for switch-off (by December 2012) in order for it to be used for mobile services, in line with the decisions taken at regional level ¹⁰.

Oman and Bahrain: Regulators in action

A glimpse of hope in the region has emerged in Oman and Bahrain. As the demand for data soared, Omani operators have engaged in active talks with the regulator to release the 800 MHz spectrum. The Omani Transport and Communications Ministry announced a few months after these discussions that it is planning to allocate OMR 50 million to release spectrum in the country ⁹.

Bahrain rises as the star of regulatory best practice in the region. The regulator is planning to award licenses in the 2.6 GHz band which is suitable for 4G technology. 40 MHz of paired spectrum will be freed by the end of 2012 while further 30 MHz of paired spectrum in the same band will be available by the end of 2014. The TRA is also offering 40 MHz (paired) in the 2.1 GHz, 15 MHz (paired) in the 1,800 MHz, 5.6 MHz (paired) in the 900 MHz, and 15 MHz (unpaired) in the 1,900 MHz. The license award process is expected to be finalized by the first quarter of 2013 ¹¹.

Developed markets: Active regulatory engagement

The global context when it comes to regulatory engagement in LTE is again different. Launches in European countries have followed a regulated process compared to the GCC counterparts. Licenses were awarded in auctions that saw operators gain frequencies in 800 MHz, 1,800 MHz and 2,600 MHz, all suitable for a good LTE deployment.

Harmonized frequencies enabled operators to engage in network sharing deals to speed up LTE deployment. This was the case in Denmark where Telenor and Telia signed a radio access network sharing deal for 2G, 3G and 4G.

Moreover, license obligations have pushed operators to commit to their rollout plans. For example, the German regulator has enforced rural coverage as a priority while the French regulator has imposed coverage targets for Mainland France and specific regions and had the operators commit to host MVNOs on their networks ⁶.

Active regulatory management and engagement with the operators has played a significant role in speeding up and regulating the process in developed markets. GCC regulators could step up and adopt a coordinated action plan to speed up LTE deployment within the region.

Exhibit 5: European and Middle Eastern LTE launches comparison

Regulatory bodies: The catalyst for change

The lack of regulatory uniformity on LTE has compelled GCC operators to go ahead with LTE deployment within the current frequency allocation until suitable spectrum is released. The key contention is spectrum management and harmonization rather than spectrum shortage. Regulatory bodies in the region are encouraged to act upon this and adopt a pro-market approach to foster innovation and encourage real competition.
In light of increased churn levels observed by many operators, active regulatory management will ensure that customer experience is sustained with the introduction of latest technologies and services.

GCC operators can emulate the innovative achievements of their global peers if regional regulators pro-actively push forward  to engage in their own race to promote technological, social and economic development. In essence, the GCC regulators hold the key to further LTE success.

References:

1 www.gsacom.org
2 http://www.dailywireless.org/2011/09/14/worlds-first-td-lte-service-launched-by-mobily/
3 http://www.ameinfo.com/289778.html
4 http://www.etisalat.ae/index.jsp?lang=en&type=content&currentid=10c8e15c0b56a010VgnVCM1000000a0a0a0a____&contentid=b25aad5e920a2310VgnVCM1000000c24a8c0RCRD&parentid=fa58800d1f52a010VgnVCM1000000a0a0a0a____
5 http://www.itp.net/mobile/586173-zain-ksa-joins-the-saudi-lte-network-launch
6 http://www.arcep.fr/uploads/tx_gsavis/11-1510.pdf
7 http://www.citc.gov.sa/English/MediaCenter/Annualreport/Documents/PR_REP_005E.pdf
8 http://thegulfonline.com/Articles.aspx?ArtID=4289
9 http://www.telecompaper.com/news/oman-allocates-omr-50-mln-for-spectrum-release
10 www.tra.gov.ae
11 http://www.tra.org.bh/en/pdf/SpectrumConferencePressRelease_en.pdf

Mobile data pricing has witnessed an interesting journey over the past few years. In the early days, mobile data was typically offered in an ‘all you can eat’ format in the USA and UK. Then along came the iPhone, with its attractive user interface and bandwidth-hungry applications. With growing demand for data from the iPhone and other smart devices, operators in the USA and UK noticed a strong decoupling between mobile data revenues and mobile data costs. To counter this pressure on profitability, AT&T’s data products¹ and later Verizon’s² were re-priced to capped data plans. So, profitability issue solved? Not quite.

The iPhone, and later Android devices, offered both 3G and Wi-Fi connectivity in a single device. These two radios gave subscribers a convenient way to “tether”, or to share the 3G data connection through the Wi-Fi radio with other Wi-Fi enabled devices (phones, tablets or laptops). The fact that there are tethering apps in the iTunes and Android app stores illustrate the demand for tethering. Android and iOS have actually included tethering as a standard feature in their OS in recent releases and the iPad 3 now offers the LTE enabled “Personal Hotspot” feature.

Exhibit 1: Illustrative example of tethering

2. Tethering as a revenue and profitability threat

Tethering is a potential threat to profitability and revenue of mobile operators, affecting them in 3 different ways:

a) Tethering in an uncapped world fuels the decoupling of revenues and network costs due to increased data traffic on the smartphone

Data traffic means networks costs. And more devices means more traffic. Hence a fixed price for unlimited access in an uncapped world offers the possibility to, through tethering, convert this plan into not only one device/user in this unlimited plan, but many sharing the same access. Hence, the risk of data consumption growing exponentially in the tethering device without any positive impact in revenues, lowers the profitability.

b) Tethering in a capped world might lead to data bundle optimization by customers

The risk of tethering in a capped environment lies in the reduced potential to “oversell” a customer or in the reduced need by this customer to buy a second connection. Tethering customers are more likely to fully consume the purchased data bundle when sharing among different devices versus using the bundle on the single device.
Cisco has demonstrated that currently smartphones on average consume 150Mb per month ²³. This consumption leaves some profitability buffer in the “commonly” offered data bundles of 250Mb, 500Mb and 1Gb. Therefore profitability will decrease when due to tethering this bundle is actually fully consumed.

c) Tethering could lead to customers not purchasing a dongle for laptop use or a second SIM for tablet use since the smartphone in both case can become the data connection

The risk of not being able to sell data mobility to tablet users has been recognized in many cases, and tethering potentially increases this risk. The share of 3G tablet sales versus the Wi-Fi tablets sales in the USA ²¹ has shown to be small and only a relatively small percentage of 3G/4G-ready tablets turn on the cellular radio and use it on an ongoing basis as shown by IDC. This effect has influenced Amazon’s decision to make its Kindle Fire Wi-Fi enabled only ²⁰.
This customer behaviour is linked to tablet users using their devices predominantly in a fixed residential environment where wireless connectivity (Wi-Fi) exists in most cases ³³.
A remarkable example of limiting data mobility upselling is the ‘Full Monty’ plan launched by T-Mobile UK. For GBP 41 a subscriber is offered unlimited data including tethering, unlimited SMS, a large voice bundle and additionally unlimited fixed voice. This plan with fixed and hotspot features, could functionally replace a double-play package.

A recent study by Allot revealed that only 15% of sampled operators charge for tethering, mainly in North America and EMEA ¹⁹. That same sample also showed that 14% of operators still offer truly unlimited mobile data plans. Consequently, still many operators are at risk of tethering hurting their top and bottom lines. Even more operators face profitability risk due to tethering with their capped data products.

3. Mobile operators’ current tethering strategies

So how have operators reacted to this tethering threat? In a mixed way it seems.

The most common approaches are:

a. Treat tethering as a revenue threat by blocking the functionality and upsell subscribers with a tethering add-on

Operators in the USA have adopted a clear strategy of treating tethering as a revenue threat. Over the last 12 months, AT&T and Verizon have both undertaken actions to block tethering and to sell it as an add-on. They consecutively blocked tethering, removed applications in Android stores that enabled “illegal” tethering³, launched tethering add-on packs allowing subscribers to tether (2GB for a price of 20USD ^3,4) and finally they cracked down illegal tethering ⁵ by automatically charging this add-on to subscribers with tethering activity. A similar approach has been adopted by Vodafone in Ireland with the offering of dedicated add-ons for tethering²⁹

Exhibit 2: AT&T’s BTL warning messages addressing tethering customers

Exhibit 3: Vodafone Ireland’s tethering add-ons

b. Upsell higher data plans to subscribers by integrating tethering into these plans

Various operators are including the tethering functionality within their “high-value” data plans. For instance, some Canadian carriers include a tethering feature only in their higher data plans of 1GB and up ²⁷. Similarly, Hong Kong’s SmarTone charges HKD 0.06 for every Kb used through tethering, although in its highest mobile data plan, tethering becomes free⁷.

c. Penalise subscribers with excessive data usage due to tethering to a fair usage policy

Vodacom in South Africa has decided not to block tethering but to throttle Blackberry users with high data traffic. Vodacom attributes abusive blackberry data traffic ¹⁸ to tethering. This approach is also adopted by CSL in Hong-Kong. Their HKD 439 data plan is truly unlimited inclusive tethering. Yet once a subscriber has reached the “fair usage policy” limit of 5GB within the month, he will get a low network access priority (no speed throttling or service termination is applied)³⁰.

d. Allow subscribers to tether and marketing tethering as an acquisition tool

O2 in the UK advertises free tethering in its data plans ⁹ after having removed the additional fees that were applicable in early 2011. Also 3 and T-Mobile in the UK offer tethering for free in selected unlimited plans and communicate this clearly ^{17, 22}.
Vodafone New-Zealand communicates openly to their customers on how to tether and even has a user guide³¹ yet the operator is not charging for the tethering functionality.

Exhibit 4: Vodafone New Zealand user guide to tethering

Exhibit 5: Classification of Operator’s positioning in tethering

4. Tools available for operators to detect tethering

Tethering detection has become a standard feature in policy management tools. Solution providers such as Cisco, Openet, Sandvine ²⁶ and Bridgewater all include tethering detection in their solution portfolio. Yet policy management tools are not always required as has been proven by AT&T last year. AT&T simply detects tethering traffic on the iPhone through the signature of the data traffic. The iOS routes tethering traffic through an alternate APN and this can be traced.

Based on detection, operators can launch initiatives to the subscriber such as a reduced quality of service, pushing BTL add-on upgrades or just a denial of service.

Most smartphone vendors have also given operators the functionality to push device settings to the subscriber over-the-air. For instance, in July last year, Verizon disabled the hotspot feature on the HTC Thunderbolt via an over-the-air software update ²⁴.

5. What about LTE and tethering?

The potential risk of revenue cannibalization will only become greater for operators with increasing data speeds and increasing data caps. Considering the higher speed of LTE and several operators offering large data caps with LTE, this technology could drive a significant revenue cannibalization risk due to tethering.

Take the example of Rogers in Canada. The promotional LTE shareable data add-on of 10GB is priced at CAD 50, whereas a 3G dongle consuming 2GB will cost a subscriber CAD 51. In this case, a customer would be better off leaving aside his dongle, and tether with his LTE smartphone ^10,11.

In Japan, NTT Docomo’s LTE prices for capped internet are slightly higher than the ones of unlimited packs for HSPA (a subscriber can pay ¥5,985 for 7GB of LTE data ¹³ or ¥5,460 for unlimited HSPA data ¹²). The Japanese operator has included tethering for free in the LTE pack, whereas the HSPA pack is subject to additional tethering fees ¹⁴.

Operators in the USA are applying the same tethering add-on price to LTE as to normal 3G bundles, while also no difference exists in the bundles size for 3G and LTE. Yet higher speeds means higher likeliness to consume the bundle fully.

With the rise of higher speeds internet, operators who still have not addressed tethering will need to increasingly consider tethering as a potential revenue threat if not “controlled”.

Exhibit 6 : LTE and tethering(27)

6. Shared data bundles could replace the need to tether

Although the US operators have been fighting tethering over the last year, tethering might soon become redundant. Both AT&T and Verizon have hinted that they will launch shared family data plans in 2012 ¹⁵. These plans will allow users to share 1 data bundle across similar devices hence making tethering redundant. Since tethering is battery draining, the customer experience in these plans should be better than tethering.  A single bill for shared data is an appealing feature as well.

Several other operators have already launched similar shared data bundles. Mobistar Belgium offers 1.5GB or 2GB plans to be shared between devices for EUR 15 or EUR 30 respectively. Orange UK launched a combined contract for use with both the iPhone and iPad ¹⁶. Other shared data plans have been launched by Orange in Austria, France, Spain and Slovakia while Vodafone, Optus and Vodacom launched some as well respectively in Ireland, Australia and South Africa³².

7. Should operators view tethering as a threat or an opportunity?

Tethering has already become a common component of the usage behaviour of younger mobile customers. A research by YouGov in the UK showed that 18-24 year old tablet owners are the most likely to tether their smartphone, with 1 in 5 (18%) already having done so.

With a strategic focus on data services by operators in both mature mobile markets and also increasingly in emerging mobile markets, operators will need to develop a stance on tethering. Delta Partners estimates that around 1-2% of total operator EBITDA could be at risk by 2014 when allowing free tethering.

Tethering can form a threat to data revenues but this threat can easily be transformed into a revenue opportunity. The tools are available to operators to make this transformation, which will become increasingly important in a high-speed data environment.

References

1 http://www.att.com/gen/press-room?pid=17991&cdvn=news&newsarticleid=30854&mapcode=
2 http://money.cnn.com/2011/07/05/technology/verizon_data_plan/index.htm
3 http://news.cnet.com/8301-30686_3-20059461-266.html
4 http://support.verizonwireless.com/clc/faqs/Calling%20Plans/data_package.html
5 http://www.engadget.com/2011/08/04/atandt-no-more-unlimited-data-for-illegal-tetherers/
6 http://www.vodafone.co.uk/personal/mobile-internet/on-your-pc-or-mac/using-your-phone-as-a-modem/index.htm
7 http://www.smartone.com/jsp/mobile/prices/hot_offer/english/priceoffer_08.jsp
8 http://info.singtel.com/node/9920
9 http://blog.o2.co.uk/home/2011/03/new-tariffs-simplicity-flexibility-and-inclusive-tethering.html
10 https://www.orderrogers.ca/rocket/stick#/data-plan/flex
11 http://www.rogerslte.com/new-lte-devices#samsunggalaxy
12 http://www.nttdocomo.co.jp/english/charge/packet/pake_hodai_f/notice/index.html
13 http://www.nttdocomo.co.jp/english/charge/packet/xi_pake_hodai_f/index.html
14 http://www.nttdocomo.co.jp/english/service/func_tool/tethering/notice/index.html
15 http://www.fiercewireless.com/story/verizons-mcadam-family-data-plans-coming-2012/2011-12-07
16 http://uk.news.yahoo.com/orange-launches-data-sharing-price-plan-iphone-4-101027967.html
17 http://support.three.co.uk/SRVS/CGI-BIN/WEBISAPI.DLL?Command=New,Kb=Mobile,Ts=Mobile,T=Article,varset_cat=internetapps,varset_subcat=3583,Case=obj(3599)
18 http://mybroadband.co.za/news/cellular/34240-vodacom-blackberry-abuse-what-you-can-expect.html
19 Allot MobileTrends Charging Report, Q3/2011
20 http://www.computerworld.com/s/article/9221642/Why_the_Kindle_Fire_and_Nook_Tablet_are_Wi_Fi_only
21 http://www.computerworld.com/s/article/9218284/3G_tablet_sales_very_slow_analyst_says
22 http://www.t-mobile.co.uk/
23 Cisco Visual Networking Index: Global Mobile Data Traffic Forecast Update, 2011–2016
24 http://www.zdnet.com/blog/mobile-news/verizon-tethering-police-reach-into-your-phone-and-disable-the-hotspot/3262
25 http://www.pcworld.com/article/228078/how_does_atandt_detect_jailbreak_tethering.html
26 http://www.sandvine.com/downloads/documents/Tethered%20Device%20Detection.pdf
27 http://www.rogers.com/web/Rogers.portal?_nfpb=true&_pageLabel=support_wireless&N=4294966681+42+11+4294966631
28 http://prepaidwithdata.wikia.com/wiki and operators websites
29 http://www.vodafone.ie/iphone/help/tethering/?ts=1287514722508
30 http://1010.hkcsl.com/jsp/service_plans/service_rate_plans/service_rate_plans.jsp
31 http://www.vodafone.co.nz/help/device-support/user-guide/?wm=man:4485,page:ins,ins:912266
32 http://www.telecomengine.com/article/4g-world-benefits-shared-data-plan
33 http://news.cnet.com/8301-13772_3-57377086-52/app-users-iphones-are-for-days-ipads-for-the-nighttime/#ixzz1n4VfB1yY

Take your smartphone and if you still haven’t installed Whatsapp (one of the most popular Instant Messaging (IM) applications) go to the app store and download it. Now check who is online. I bet more than 50% of your contacts (including your boss, your doctor and your accountant) are connected. You can try the same using Viber, IMO or BlackBerry Messenger. The result should be very similar. Surprised?  Don’t be. Instant Messaging is a pervasive form of communication and is here to stay.

The key question is how these apps are impacting the mobile industry. The BlackBerry outage of October 2011 yielded some interesting insight.

But first some history on IM apps…

The rise of Instant Messaging apps

RIM’s BlackBerry used to be a product designed almost exclusively for the corporate segment. Then, in a relatively short period, it became more popular than Harry Potter in nothing short of a magic trick among the mainstream urban population.

Two elements propelled BlackBerry into the young urban segment with tremendous success: (1) the introduction of lower cost devices, and more importantly (2) the launch of BlackBerry Messenger (BBM), a ‘killer app’ which allowed BlackBerry users to seamlessly communicate with one another through text.

Mimicking the success of BMM, but leveraging on the much bigger and growing base of Apple and Android smartphones, a myriad of open, device-agnostic Instant Messaging apps started to flood the market. Names such as Whatsapp and Viber immediately ranked at the top of  iTunes and Android app downloads. There is no doubt that these apps created a shockwave in the telecom industry and changed (probably forever) the way people communicate.

Although there is significant discussion around the damage done by IM apps to mobile operators, the actual impact is not easy to measure: even though these apps cause voice and SMS revenue erosion, they also increase the attractiveness of mobile broadband. Luckily and as in any good story, every now and then a rare phenomenon comes along to shed light where previously there was only darkness…

The day(s) the earth stood still

One such rare event was the 3-day BlackBerry outage of October 2011. From Monday 10^th to Wednesday 12^th of October BlackBerry data services went down simultaneously in several countries across the globe, causing panic at RIM headquarters.

Whilst the most notable effect was corporate executives not being able to access their email through their BlackBerry devices, there was a significant amount of complaints in the media coming from the non-corporate world. During those 3 days, millions of non-corporate clients (besides the white-collar execs) blamed BlackBerry for everything, from disconnecting them from the rest of the world to causing the earth to stand still. And the main issue was not even email – it was the beloved BBM. It was as if suddenly we had regressed to the dark ages of actually having to call people to have a real-time dialog… The Canadian Company, the first to find this new ‘goldmine’ and launch a new era in  telecommunications, was now forcing the world into a 3-day IM abstinence. Many even thought of crying out for Government intervention to solve the problem.

Luckily for us, from this chaos emerged a unique opportunity to better understand how customers use IM apps (such as BBM) and, consequently, how these services influence operators’ business models. The results have deep implications for mobile operators.

I know what you did last October

We took a very close look at customer behavior during those specific days to better understand the importance of Instant Messaging in how we communicate today. The outage gave us a golden opportunity to analyze traffic patterns before, during and after the event and gauge the impact on usage behavior across different services (in particular SMS and voice).

The results are eye-opening – BlackBerry users affected by the outage altered their communication pattern very materially during those 3 days by…

-          …increasing voice usage by 11%

-          …boosting their SMS usage by a staggering 85%!

Customers replaced their severed umbilical (read BBM) connection with alternatives, even if these were charged, substituting a text-based service for another (SMS)

“It’s not about the money!” (It never is)

The October event helps us draw some conclusions and evaluate the impact of Instant Messaging on mobile operators.

Text-based messaging has become a staple and often non-replaceable form of communication, irrespective of the delivery method.

The shift from voice to data-enabled Instant Messaging services has been traditionally justified by the fact that IM is for free. There is no doubt that this factor has been a major driver of adoption, but the “BlackBerry event” shows this is not the only reason for the take-up of IM. During these 3 days, the same customers who before were using messenger apps ‘for free’ showed us that they were willing to pay (and did so) to keep communicating via text. The communication patterns during the outage show that voice was not an option for them in many cases, opting to maintain a text-based messaging to avoid the intrusiveness of voice calling. Apparently the convenience of this communication form prevails over the money factor, at least in the short run.

The adoption of text-based Instant Messaging services is unstoppable and unavoidable – mobile operators should think twice before looking for ways to getting rid of them. The October blip showed that customers will find alternatives to meet their communication needs irrespective of the cost involved (to a rational extent). This serves as a reminder to all mobile operators in highly competitive mobile data markets as to how rapidly value can migrate to other players in the value chain if they fail or opt not to deliver the services that consumers want. Subscribers will incur the costs required to have access to these services, even if it includes switching providers

So, yes the earth stood still at Blackberry headquarters but not for Instant Messenger Users- they found their way to maintain their text based communication.

So what are the implications for mobile operators?

From a mobile operator’s perspective, the BlackBerry outage shows the relevance of Instant Messaging and OTT apps for their subscriber base and the associated cannibalization of traditional voice and SMS revenue. It further raises the importance of properly monetizing operators’ investments in newer technologies (e.g. LTE), capacity increases and additional spectrum acquisitions to keep up with the massive data requirements of the new mobile data environment (see our white paper “Navigating the challenges of Data Monetisation” for more on this)

The experiment also shows customers’ dependency on mobile text-based messaging services, which can be further extrapolated to other forms of mobile communication. Customers’ willingness to pay shows that they attach significant value to the service, much more so than the free ride they currently get with IM apps. And if in the short-term IM may impact mobile operators negatively, we believe that mobile operators – the true enablers of voice, data or whichever new forms of communication – will be the long-term winners of the hyper-connected world. After all, customers can easily replace BBM, Whatsapp or Facebook should they fail – replacing mobile operators is a completely different ballgame. The pipe (dumb or not) is still the unavoidable piece of the equation, something that mobile operators will leverage in the future and which will most likely be reflected in consistently growing data tariffs (check your last year utility bill!).

After all, if mobile operators took away our lifeline (i.e. mobile connectivity) even if just for a day, then most of us would say that the earth truly stood still.

Last week OSN, the biggest pay-TV operator in the MENA region, launched OSN Play, an online service through which OSN subscribers can stream movies and TV series from the OSN lineup at no additional charge.

Push Pause: why did OSN launch OSN Play?

In a world of digital convergence, we have seen multiple examples of players growing horizontally into adjacent spaces of the value chain and distribution channels. A notable example is UK’s Sky, which expanded from a satellite pay-TV platform onto a broadband platform delivering both internet access and premium video content. Spain’s Digital+ took a similar path when it made its content available online. In the cable world, Comcast and Time Warner in the US introduced TV Everywhere, in an attempt to give more value and flexibility to their cable-services client base and protect them from the aggressive propositions of OTT players such as Netflix and Hulu. OSN Play is the first such example by a relevant player in the Middle East.

But OSN’s markets – even its most valuable ones (UAE, KSA and Egypt) – are quite different from US or Western European markets: OTT offerings are few and far between and competition for pay-TV subscriptions is limited. So why did OSN choose to invest in the online platform?

We believe there are four main reasons OSN launched OSN Play:

1. Protect its subscriber base. We do not have visibility on the exact numbers, but it may well be that OSN is seeing slowing subscriber growth and/or loss of market share to other pay-TV players. Making this service available to its own DTH subscribers creates stickiness for the current base and is one more differentiating factor for new subscribers to choose DTH vs. IPTV.
2. Claim the VOD space. With OSN Play, OSN offers a broader VOD choice to its entire subscriber base (with access to a broadband connection) rather than just the current premium package DVR holders, estimated at 10%-20% of the base.
3. Preempt the OTT threat. Despite no major success stories as of yet, there is a lot of activity and experimenting happening in the region, some of it driven by the telecom heavyweights such as Etisalat and Telecom Egypt. The OTT space will soon become busy.
4. Stimulate revenues
   1. Monetize the long tail. OSN Play “monetizes” the content not being aired by OSN (i.e. the “long tail”). Even if not charged for, access to this content increases stickiness among its target audiences.
   2. Educate the base on VOD. OSN Play gives customers a no-risk approach to VOD, since all content is free with existing subscriptions. Once customers get used to VOD, there should be a spillover effect toward pay-per-view titles resulting in incremental revenue.
   3. Up-sell subscriptions. Premium OSN subscribers have access to more and better titles in OSN Play. As normal subscribers browse OSN Play, they will see yet another reason to upgrade their subscriptions.

Slow Motion: accelerating to cruising altitude

OSN Play has done a very good job on the customer experience front from the get-go. We expect to see further evolution and improvement in the following areas:

• Expanding the content offering. Currently there are a handful of titles on OSN Play. Increasing the online offering should be easy, as it involves amending the contracts with studios to allow the internet as a distribution channel (probably already done) and ingesting titles for the online platform.
• Increasing the number of screens. OSN subscribers can use OSN Play on two screens only – regardless of device. OSN should define quotas per device type considering that (1) the target audience will likely have four devices (smart TV, laptop, tablet and smart phone) and (2) average household sizes in MENA are close to six.
• Activating OSN Box Office as a default. Activating OSN Box Office – the paid-for access to premium titles – requires calling customer care and giving your credit card details. This process should be simplified or even pre-provisioned in order to monetize the footfall in the “digital shop.” After all, subscription is post-paid, so on-demand charges could be added to the monthly bill.

Fast Forward: expanding the reach

Probably the most important next step for OSN Play is expanding its reach, by addressing three key dimensions which are tightly interrelated.

1. Multiple platforms. Today OSN Play is offered only on the computer screen.  Making it available on iOS, Android and gaming consoles is key for achieving its business objectives. By introducing multiplatform compatibility, OSN play will come to the two new important screens:
   1. the mobile screen: tablets and smart phones in order to become truly “TV Everywhere”
   2. the connected screen: smart TVs and consoles in order to give customers a genuine VOD experience
2. Subscription model. OSN Play can expand its reach by:
   1. Making OSN Play available for IPTV subscribers as well. This move will eliminate the sidelining of IPTV partners and their customers. We believe that up to 1/3 of monthly subscriptions are sold through IPTV (as opposed to DTH) and OSN Play might alienate some of OSN’s key IPTV partners, which poses a material risk for OSN. The challenge here is a technological one – implementing the authentication mechanisms for IPTV customers will require more complex system integration between OSN and telcos.
   2. Making a trimmed-down version of OSN Play available to customers without an OSN subscription. This could be an incremental audience for OSN, made up of customers who cannot access or do not want a full subscription. Cannibalisation of existing subscriptions should be limited – “digital only” versions of print publications are an example of such practice.
3. Making the best of the access technology.
   1. For DTH subscribers with fixed broadband connections, OSN Play makes the case for a hybrid STB with both satellite and IP feed. It’s true that recently OSN ran an STB replacement campaign, but the cost of the subsidised hybrid CPE should be set off by the stronger customer lock-in from the rich VOD proposition enabled by Play. The first priority for OSN should be its markets where fixed broadband penetration is relatively higher compared to the rest of MENA. Such markets present a higher opportunity to push OSN Play with or without the hybrid STB and they are also most exposed to the threat from other OTT players or local fixed operators’ IPTV offerings.
   

   Figure 1: UAE, KSA, Qatar and Bahrain should be among priority one markets for OSN due to their relatively higher fixed broadband penetration.

   2. For subscribers who wish to access OSN Play on their mobile broadband connection, the situation is trickier since OSN’s MENA markets are very heterogeneous and therefore require a customised approach for each of them.

   We looked at the potential of mobile access to OSN Play across the major OSN countries by comparing the local retail cost of mobile broadband:

   

   Figure 2: Assessing the potential for mobile access to OSN Play. The vertical axis measures the price of 1 GB of mobile broadband data as % of monthly GDP/capita (proxy of income), on the horizontal is the estimated number of OSN subscribers. We excluded the non-3G countries (Algeria, Iraq, Yemen and Palestine) as well as the North African countries with small potential subscriber numbers for OSN

   For markets in the bottom half of the graph, OSN should promote and push the adoption of its OSN Play service, specifically in KSA and the UAE, as its key markets.
   For markets where the price per GB is relatively higher, OSN may want to consider partnerships with mobile operators to create a special “OSN Play” data plan. OSN should emphasise to mobile players that its content drives incremental data demand and revenues. In addition OSN may want to approach ambitious second or third players which have no mobile TV offerings and build their TV offerings, or alternatively act as complementary content provider for operators with their own mobile TV (the typical mobile TV offering is mostly news and information, whereas OSN can offer movies and series).

In conclusion

The MENA region has traditionally played a conservative game with regard to the digital video revolution happening in the West. OSN Play is the first serious proposition stirring the market, especially considering that OSN holds the richest lineup of premium video titles in MENA, which gives a lot of legitimacy to the proposition. We notice very close parallels with UK’s Sky model of TV Everywhere – and we believe it’s a good model to follow.

OSN has made a very important first step but the critical part of the journey is still ahead and will require careful navigation through a maze of partnerships, technology and regional market specifics.

References:

1. SNL Kagan
2. KIPCO Corporate Presentation (March 2011)
3. Arab Advisors
4. Wireless Intelligence
5. Global Insight
6. Business Insights
7. www.osn.com
8. OSN customer care
9. Mobile operators’ websites / customer care
10. Press clippings
11. Delta Partners analysis

At first sight Facebook and other OTT services such as Whatsapp, Mxit or Skype provide mobile operators with a very appealing hook to attract users to the internet. Even in markets where mobile internet has a relatively low penetration such as Indonesia, India, the Philippines or most of Africa, Facebook has amassed a significant base of users who access the service through other channels, such as internet cafes. Thus, it is obvious that this is an opportunity for mobile operators to offer social network sachet products as an entry level offering to attract customers to the internet with the hope that their behavior expands into other types of usage, such as browsing, email, streaming or instant messaging and they can upgrade their consumption later on.

The most feared threat is instant messaging, a clear substitute for lucrative SMS or voice services, mostly offered for free by the likes of Skype or Whatsapp and which has cost operators across the world 1.5% of total revenues as per Ovum’s estimates. What Ovum failed to estimate is the incremental revenues that mobile operators collected on mobile data connections required to then use the “free” OTT services.

If customers still need an internet connection to use free services, operators can monetize this opportunity, so, what are they scared of? Primarily of two risks:

1. Cannibalization of lucrative high unit price services like voice or SMS…
2. …at lower margins

Cannibalization of traditional telecom services

In 2011 KPN in Holland widely publicised the impact of Whatsapp on its base of “Hi” youth brand customers. In doing so, KPN set a benchmark for cannibalisation risk: as soon as 50% of the base of “Hi” users was on Whatsapp, the operator’s SMS revenue started to decline¹. This phenomenon has been termed the “square effect” and it is a measure of the compounded effect of social products within the same platform. The risk of cannibalisation of these messaging apps starts to be felt only when a relevant proportion of users sign up for it, so the risk is the square root of the penetration. In the past, some of these apps were Operating System (OS) specific, hence their effect was limited to customers in that OS group. However, services such as Whatsapp eliminated this barrier. Using a personal example, I started to feel Blackberry messaging having an impact on my SMS usage only when all of my colleagues got  Blackberrys. With Whatsapp I could also communicate with friends beyond my work environment.

Two of Facebook’s main products – the status update and the messaging system – are clear substitutes to part of the operator’s SMS revenues. Their impact is obvious on key dates such as Valentine’s Day, Christmas or New Year’s Eve when some operators have been able to measure up to 30% decrease in SMS traffic in 2012 compared with 2011². These are situations when 1-to-many channels like status updates suffice.

However, instant messaging and other OTT services also offer an opportunity to mobile operators as they are free on a paid mobile internet connection. Compounding concerns of cannibalisation, fear of free OTT services also stems from the fact that when it comes to broadband, operators have not been able to replicate the same margins they have historically attained on voice and SMS.

Lower margins for the same dollar of revenue

Although not exclusive to Facebook, Skype or Whatsapp, but to mobile internet in general, profitability still has a long way to go to achieve similar margins to that of lucrative services like traditional voice or SMS.

In many countries broadband is still offered through unlimited or time-based plans that do not link usage with revenues. Hence, the higher the bandwidth consumption the greater the costs to the operators without an improvement in the top line. Even in cases where mobile internet has been priced by volume, operators have yet to achieve the same margins as with voice or SMS. In order to reach a break-even point where operators would be indifferent to a dollar earned on mobile internet vs. one earned on voice, the bandwidth utilisation of a minute on VoIP should be considered. With a decent quality, a minute of VoIP could consume roughly 1 MB. Therefore, if the price of an MB is the same or higher than the price of a minutelong call, customers have no incentive to replace a better quality circuit-switched call for lower quality VoIP. However, in unlimited, time-based environments, or when operators offer very big data bundles, customers are effectively paying less per MB than for one minute of a call. This is even more obvious in the case of international calls, which tend to be priced high. Once the revenues have been levelled and the operator is paid the same for a minute of voice as for 1 MB of data, the margins need to be considered. For most operators, margins on data are much lower than those of voice or SMS. In order to make the same bottom line operators would have to charge 1 MB higher than 1 minute³.

In the case of SMS the point is even clearer: An instant message consumes 160 bytes, so with 1MB a customer can send 6,500 SMS, significantly decreasing the break-even point. Quality is less of a relevant decision-making factor, as customers are willing to accept a small delay.

Conclusion

Although the risk of replacement of products with high margins for lower ones is clear, operators stand a chance to offset some of this with new revenues from broadband. Whether the final picture is an accretive one will depend on the local competitive dynamics and the pricing models. If operators are able to price 1 MB of broadband higher than 1 minute of call, the top line may be maintained, yet margins will most likely suffer. In the case of SMS, substitution for IM is imminent. The only remaining question is how much and how fast. It will therefore be critical to ensure that new revenue streams beyond mobile internet offset the loss in SMS, especially in countries where they contribute a significant percentage to total revenues, such as Indonesia or Japan.

In some markets, such as the UAE, VoIP has been blocked on security grounds but in countries where net neutrality prevails, some operators have joined the enemy to promote Skype plans. Verizon in the US, 3 in the UK or Telefonica in Germany all offer free VoIP in their higher bundle plans.

Finally, to those operators that are considering delaying the launch of mobile internet services in the hope of reducing the substitution risk, Wireless Intelligence⁴ just published a report which shows that ARPU shrank less in countries that offered mobile internet than in those who did not, at half the rate. Mobile internet may be the only source of growth as pressure on prices of voice and SMS continues, but managing timing and profitability will be key to determine the top line in an all-broadband.

References:

1. KPN 2011 quarterly filings
2.  Delta Partners analysis
3. Delta Partners analysis
4. Analysis: The effect of mobile broadband on operator revenue

Although some analysts were slightly disappointed with the financials, in the internet era of “free” where many popular start-ups have failed to monetize their impressive user bases facebook made roughly USD 5 per customer in 2011.

The most interesting part of the filing is the detailed strategy supporting the high valuation. This is particularly important at a time when two of the most talked-about IPOs of the past years, Groupon and Zynga, showed poor revenue performance after going public, as if their decision to IPO came at the peak of their success².

In this blog we will discuss each of the key success factors of facebook’s future strategy, as outlaid by the company, in light of one of the clearest internet trends in 2012: the shift to mobile access.

Throughout the filing, facebook mentions the word mobile 122 times. It is raised as an opportunity for growth but also as one of the main threats as the site has not yet successfully monetized advertising on its mobile access.

1. Expand and build engaging mobile experiences

Facebook wants to “make the world more open and more connected” and for that to happen it needs to continue expanding its user base to the less penetrated countries, with especial emphasis on Asia. The company states that its focus will be placed on Japan, South Korea, India, China and Brazil. In all these countries local versions of social networking sites have already taken the lead off facebook. Sites such as Cyworld in South Korea, Mixi in Japan, Google’s Okrut in India – and until recently in Brazil³ and VKontakte in Russia have more combined users than facebook worldwide.

However, this is because these are big countries with huge populations and not necessarily because the penetration of social networking sites is high. For example, social site penetration over the internet population is 20-30% in India and Brazil but less than 15% in Russia, South Korea and Japan⁴.

Be it because of a shift in online media consumption habits (in developed markets) or because of affordability (in emerging markets), mobile access will be the driver for internet usage growth going forward and chances are feature phones will still prevail on several of facebook’s focus countries where, with the exception of Japan, smartphone penetration over mobile users is still below half of the population at only 40% in Brazil, 12% in India, 14% in Russia, 42% in Korea and 57% in Japan⁵.

Thus, to drive engagement in these countries in the short-term facebook needs to lure away users from existing sites, penetrate the non-user base and do so primarily through non-smartphone mobile access. How can it achieve these objectives?

1. Convincing mobile operators to offer affordable sachet packages to access the site. Sachet daily facebook access products are available in countries across the Middle East and Asia and they are successful at attracting users that cannot afford monthly data subscriptions
2. Ensure that even the simplest of devices, the feature phones, can enjoy facebook’s main products. In 2009 it launched the facebook.0 product in Africa offering a lighter version of the site that worked on feature phones. Users could update their status through a free SMS and they were typically charged only when accessing the fully fledged mobile site. Although its success is country-specific facebook needs to continue pushing for adequate solutions to the feature-phone challenge
3. Extract learnings from the Brazilian market: In order to compete with local social sites facebook needs to understand what made it overtake Orkut in Brazil at the end of 2011 and adapt this approach to other countries

2. Engagement

Aside from growing the number of active users facebook’s main concern is that of increasing the time spent on the site, already at the top of the rankings in the US, ahead of Google. Since advertising is the primary source of revenues for Facebook⁶ the longer the time spent on the site the higher the occasions for the user to interact with the advertiser. Engagement is therefore directly correlated with advertising revenues.

In 2011 users in the US spent 16% of their time online in social sites and that time was mostly spent on facebook which accounted for a little shy of 15% of all online traffic or 7h a month.

There are three ways to increase engagement:

1. Mobile access: Statistics suggest that mobile social network users may be twice as active as those accessing the service through a fixed connection⁷ and that social networking time spent on mobile devices is mostly incremental: PC and iPhone or iPad users spend three times as long on social networking sites as PC-only users⁸.
2. Frictionless sharing: adopted by popular website such as the Washington Post or Spotify it allows users to share their actions on the web effortlessly and without actively thinking about it. This provides endless amounts of information to facebook to build the user’s interest-graph
3. Continuously innovate to find the next big thing that will drive users to login more often and for longer. In this regard, facebook has just announced the publicly available new messenger client service for Windows which aims at taking the 7h a month spent on the site to a whole new level

Facebook does note that the level of engagement is also a source of risk to the company as it admits that with the growth in the user base the level of activity of the “older” users will also decline. Additionally, the choices for online entertainment are growing every day with other sites like Tumblr or Pinterest taking a significant share of “online time”.

3. Compelling experiences

Creating more compelling experiences out of the mountains of information users are bombarded with means making each individual’s experience more personalized. That requires organizing the space and the content on each user’s page accordingly and showing advertising campaigns that are most relevant to the socio-demographics, location and social context of each of us.

Facebook already does a good job at sorting through the piles of information generated by our friends, pages we follow, etc. through the distinction between social feeds and main status updates. Since most users have never told facebook who they want to classify in each of the two sections the algorithms behind the site are smart enough to select what matters most and least and to show only 16% of the activity made by each user’s friends, fan pages, etc.

Again, mobile access will have to be better incorporated into the mix and some features sharpened as users will be consuming entertainment, interacting with the site or viewing advertisement in completely different environments. This information pre-selection done in the web site is not yet fully aligned with the mobile app across platforms and some of them are not sorting through the activity feeds yet. If growth is to come more and more from mobile access and especially from markets where feature phones prevail facebook will have to make experiences in these OS equally compelling as those in sophisticated smartphones

4. Enable developers to build on the facebook platform

On top of social networking activities users on facebook can also interact with other users through a variety of apps and products whose aim is to increase engagement and ultimately, advertising revenues. One of the better known is Zynga.  Zynga provides facebook with a hook to drive engagement and it also generates additional revenues through in-app advertising and the sale of virtual goods.

Although still at an incipient level facebook’s revenues coming from virtual payments is one of the promises of growth. By facilitating in-app sales facebook will also be making the value proposition more attractive to developers as they will be taking a cut of the sales.

In order to monetize this opportunity in Brazil, India, Russia and China where cash is king facebook will have to find ways to facilitate payments without credit cards. The most pervasive payment channel is mobile billing. In all of these markets users will have a billing relationship with their respective mobile operators, even if only through prepaid airtime cards. Facebook should partner with these operators to be able to channel virtual payments through these relationships. As it recognizes this, facebook has just announced at the MWC in Barcelona that it has reached agreements with the US carriers as well as some other mobile giants such as Vodafone, Telefonica or Softbank to provide this service. Timing is unclear but beyond advanced markets this should be the key to unlock the potential of online purchases in developing markets where credit cards are not established payment methods.

Although the recent announcement by Zynga of its own mobile site will certainly take away some of the virtual goods sales to Zynga’s environment, the gaming platform signed an exclusivity agreement which still forces it to use facebook’s Payment service for some years giving the social site some time to find new partners to monetize the Payment platform.

5. Ad products

A staggering 4.8 trillion display ad impressions were delivered in 2011 in the US alone according to comScore and facebook was the top online ad display publisher delivering 1 in 4 ads or 1.3 trillion, 7 times more than Google. Looking ahead, online ad spent is bound to surpass print ad spent in the US in 2012⁹.

At 85% of total revenues advertising was the main source of revenues in 2011 for facebook and is expected to remain so. The more data the site can collect the more accurate the picture it can paint of a user and the higher the premium it can command against other platforms such as Google. At the same time, better targeting also ensures users don’t get bothered with irrelevant ads while they are having a good time with their friends.

However, as usage becomes mobile, facebook will be impacted by the dynamics of mobile advertising. Although mobile internet is already 10% of total media consumption time in the US its contribution to the advertising revenues is negligible as players are yet to find successful monetization models¹⁰.

Goldman Sachs estimates that desktop advertising monetizes at 10 times that of mobile advertising as click-through success is 8 times lower and the price per impression is low because of imbalances in supply and demand. Additionally, advertisers may optimize spent by consolidating multi-platform investments (mobile, desktop, tablet) and might shift some of their online ad spent into the cheaper mobile platforms that also provide the added benefit of location. Hence, better mobile targeting and ad products may cannibalize some of the desktop ad revenues if advertisers shift spent from more expensive to cheaper alternatives.

As it finalizes the monetization model for mobile advertising with the Logout Page ads, Sponsored Stories and other products facebook will have to ensure that growth in engagement thanks to an increase in complementary mobile usage does not translate into lower combined revenues.

Conclusion

Taking historical growth rates, industry analysts forecasts and expected handset shipments we estimate that facebook’s mobile users could soar to 625 Mln in 2012 or a 50% YoY increase¹¹.

In this environment, facebook will face distinct challenges depending on the type of market:

1. In established markets where penetration of social networks is already high connections are increasingly on the go and sharing will happen more and more on the small screen. Facebook will need to adapt its business to the attention levels and interaction models on mobile devices while ensuring that advertising revenues per user can be increased despite growing competition from other players such as Google and despite the challenging mobile advertising economics. This seems to be the main focus of facebook’s Marketing teams as shown in the recent Marketing Conference announcements
2. In emerging markets where social networks are yet to take off the company will have to find ways to continue growing the base of users while finding models to monetize the big subscriber base opportunity; online and mobile advertising spent is still incipient in most of these markets, payment channels for online goods are scarce and smartphone penetration is relatively low. Facebook will have to strengthen its partnerships with other players in the eco-system, be it device manufacturers to preserve an engaging user experience and push usage in the simplest of phones, mobile operators to foster take-up and the sale of virtual goods and developers to continue to create the next big thing. In the meantime, facebook will have to find a way to enter the last vestige of significant growth: China.

Whether 2012 will be the year of facebook or not is yet to be seen but what is clear is that 2012 will be the year of mobile for facebook and other Silicon Valley start-ups.

Contributor: Anna Arlorio, Senior Associate at Delta Partners

Resources:

1. Facebook IPO filing
2. Financial reports of Groupon and Zynga
   
3. comScore Media Metrix Jan’12
   
4. Facebook filing
   
5. Delta Partners analysis
   
6. Facebook IPO filing
   
7. Ofcom communication market report 2011
   
8. Goldman Sachs TMT Desktop: Secular themes persistent, despite volatile macro tides Feb’12 and comScore Digital Omnivores 2012 report
   
9. eMarketerhttp://mashable.com/2012/01/19/online-advertising-surpasses-print-2012/
   
10. eMarketer
11. Gartner, Delta Partners estimate. Assume 50% yoy growth in smartphone facebook users and 40% yoy growth for feature phone facebook users
    

France Telecom is taking content seriously. The group’s content strategy is designed to leverage their integrated network as a means to distribute and monetise video and audio amongst the subscriber base. Currently, the vast majority of content-related revenue comes from aggregation and distribution of 3^rd party material, all based on revenue sharing agreements with content rights holders. Besides a myriad of TV programming tie-ups in order to sell IPTV subscriptions, their recent tie-up with Deezer (the French answer to Spotify), gaming portals and VAS are all attempts to entice more subscribers and drive ARPU to their mobile business.

Exhibit 1: FT’s focus on distributing TV channels and developing interactive service

Source: Orange - Strategy in content and web services - vision + focus on TV – June 2010

This model is now the industry standard of sorts, as content for telecom operators is only a means to an end – selling subscriptions to the various network services. In other words, the operators add little value to the content itself, therefore, cannot reap the full spectrum of rewards from a hit song or an Oscar winning movie. By and large, this was France Telecom’s experience thus far.

‘The Artist’ is a black-and-white silent movie about the rise of ‘talkies’ – movies with a soundtrack and voice – set in the early 1930s Hollywood. The film is as far away from a Hollywood blockbuster as they come. There are no explosions, Brad Pitt or a cool soundtrack. It is a niche and unconventional (for our times) film and yet it took the movie world by storm, last Sunday’s Oscar awards being the culmination of a triumphant year – a 5 trophy haul including ‘Best Picture’ and ‘Best Directing’. Frenchman Jean Dujardin was extremely pleased to take the nod for ‘Best Actor’, beating George Clooney and the aforementioned Mr. Pitt. And yet nobody should be happier about it than France Telecom executives whose gamble to launch a small production outfit called Studio 37 (one of several that worked on ‘The Artist’) back in 2007 is truly paying off.

Direct revenues from the movie are not going to make or break France Telecom’s fiscal year-end results. Although the movie is expected to receive a major boost in sales following the Oscar wins and a re-launch in France, the ‘The Artist’ has, as late as December 2011, grossed just over USD 16 million according to IMDB. The estimated USD 15 million budget means ‘The Artist’ actually struggled to break even. To put things into perspective, last year’s top film, ‘Harry Potter and the Deathly Hallows – part 2’, grossed over USD 1.3 billion! Moreover, based on Bloomberg consensus at the time of writing, France Telecom group is estimated to earn USD 59 billion in revenue for fiscal year 2012, so even a significant portion of retained revenue from movie ticket sales is not going to be of major significance.

But in today’s market, the ability to cost effectively use content as a way to retain and ‘up-sell’ existing customers as well as attract new ones is essential.  Moreover, there are very few operators that need new ways of addressing competition in 2012 more than France Telecom. The lucrative French market has changed forever at the beginning of this year with an aggressive new mobile entrant, (Free Mobile) disrupting the status quo and forcing the incumbent players to cut pricing of voice and data products. Provided the necessary agreements and structure is in place, France Telecom could use proprietary content (and exclusivity rights) like ‘The Artist’ not only to generate direct revenues through sales on IPTV VoD and other platforms but to reduce the churn amongst its existing subscriber base. In addition, as France Telecom’s TV & video markets are, for all intents and purposes, limited to France and Poland, successful proprietary content can be effectively used to strengthen the value proposition when launching these service lines in other markets, just as they have done with Deezer and Everything Everywhere in the UK.

Exhibit 2: FT’s Integrated TV/Access Economic Model

Source: Orange - Strategy in content and web services - vision + focus on TV – June 2010

Proprietary Content – Internet giants jumping on the content wagon:

Success of operator-developed content has so far been limited despite the effort and investments made. This isn’t surprising as most operators take the passive approach and develop very little, if any proprietary content, mostly limited to Value Added Services (VAS). Certainly, there’s never been an operator with an Oscar-winning movie. Will the success of ‘The Artist’ strengthen (and possibly revive) the case for operators to channel further investment in proprietary content development? Very likely and if so, it would be almost prophetic – a movie about a massive shift in one industry helping to drive a shift in another. Will we see more Oscar-winning “Dujardins” instead of the usual “Pitts and Clooneys” when it comes to operator content? Almost certainly, it’s just a matter of time.