Spotlight on South Korea:

Spotlight on South Korea:

The Delta Perspective

LTE developments, one year on
In our November 2012 article “Spotlight on South Korea”, we highlighted how South Korea emerged as a leader in the deployment of Long Term Evolution (LTE). The country’s innovation in new LTE technologies and services led us to predict that South Korea’s leadership would remain sustainable for the foreseeable future. Furthermore, we noted that valuable insights could be drawn from South Korea’s market developments, including the overseas impact as LTE user bases expand in other markets.

So, where is South Korea now?
Today, South Korea still remains the global leader in the LTE space. Less than two years after launching the nation’s first commercially-available LTE service, SKT followed-up with the world’s first commercially-available LTE-Advanced network in July 2013. Fellow national operators KT and LGU+ are expected to follow suit with their own LTE-A launches in the coming months. However, operators’ success in driving rapid adoption of LTE is already apparent with about half of all mobile users embracing the technology.
While other operators may seek to emulate South Korea’s success with LTE technology, the extent to which LTE services can be monetised must first be investigated. With that in mind, we propose two key questions that every Telco CEO needs to ask about LTE:

1. What impact did LTE have on top-line figures?

The answer is both clear and positive. Operators have managed to upsell LTE packages to users who, in SKT’s case, now spend on average 1.4x more than a non-LTE user1. This increased ARPU of approximately US$6 per month vis-a-vis other smartphone users is in turn accretive to the blended ARPU levels which, between Q1’12 and Q2’13, have grown at a 1-3% CQGR2 across all operators. Furthermore, with only half of all customers currently using LTE services, additional ARPU gains are to be expected as the base expands.
Coupled with success in avoiding the cannibalisation of voice and SMS revenues, the South Korean industry’s top-line has grown at a 2% CAGR since Q1’123. This is remarkable since other developed telco markets are mostly experiencing stagnant or even declining revenues.

2. What did operators invest to achieve such results? 

Significant resources were invested on two fronts: network CAPEX and device subsidies. Operators accelerated their network deployment and completed their LTE roll-outs within approximately two years. During that period, CAPEX intensity skyrocketed to an alarming 20-30% of revenues for two consecutive years, from 12-15% prior to the LTE roll-out4.
Carriers also heavily subsidised LTE handsets to guarantee a large LTE-enabled base of smartphones to foster service adoption. However, subsidies of $200-2505 per device eroded several percentage points of EBITDA. SKT’s EBITDA margin dropped from 34% in 2010 to 27% in 2012, mainly due to higher marketing expenses driven by higher subsidies.
These investments placed severe pressure on operators’ financials with cash flow dropping significantly in 2011 and 2012. However, 2013 is showing signs of stabilisation; CAPEX requirements have slowed and subsidies decreased as a consequence of the regulator’s intervention to enforce the cap of 270,000 won (~$240) per device6.
Overall, it is still too early to conclude whether South Korea has been successful in LTE monetisation. This will ultimately depend on the operators’ ability to sustain the ARPU uplift going forward in order to compensate for the incremental CapEx and OpEx incurred over the past two years.
Assuming a complete LTE subscriber base, we estimate that the blended ARPU would need to grow by a further $3-47 to compensate for these investments. This will present a challenge given that the majority of high-value customers have already adopted LTE, leaving only customers with a lower appetite for expensive plans to close the gap. The ARPU evolution in the second half of this year will give further clarity on what to expect.
In conclusion, what lessons can we learn from South Korea?
1. Get the pricing right: the LTE proposition needs to be clearly differentiated from the existing (3G) data offering. The objective is to upsell to customers who are willing to pay for a better experience (i.e. speed) and access to a broader value proposition (e.g. shared data plans, HD video, video on demand, etc.) This will increase ARPU, thereby justifying the CAPEX requirements and delivering shareholder value. Conversely, a mass market proposition with low cost of ownership will drive short-term adoption at the expense of longer-term profitability.
When SKT introduced LTE, it launched a new proposition distinct from its 3G offer. Its LTE pricing portfolio was designed to upsell the customer at any price, with the top-selling LTE plan priced just US$7 higher than the top-selling 3G plan8. However, SKT also launched LTE services with only capped plans to both control traffic evolution and initiate the shift away from the unlimited data proposition that characterised the 3G offer.
2. Differentiate through content: South Korea’s operators define their value propositions with unique content differentiators, with video being a key factor. With exclusive mobile broadcast rights on sports and TV services, SKT strongly pushes its mobile IPTV offer (which is expected to reach two million subscribers by year end9). Similarly, LGU+ is providing various value-added services such as HDTV, games, shopping, music, etc.10 Therefore, a fully-fledged content proposition can be instrumental in differentiating from competitors and extracting more customer value.
3. Limit the cannibalisation of traditional revenues: Despite the new business opportunities arising in the LTE-enabled, data-centric era, the lion’s share of telcos’ revenues still remains voice and SMS. In South Korea, the recent introduction of LTE unlimited voice plans in an effort to further upsell and retain customers seem to cannibalise existing voice revenues. Therefore, it is crucial to balance the transition towards a data-only play to avoid destroying value along the way.
4. Control device subsidies: South Korea sets a clear example on the strong correlation between the availability and price of LTE devices and LTE adoption. Subsidised phones lower the cost of entry for consumers and drive adoption of LTE services. The reverse however is true in more prudent markets such as Germany and Japan which have witnessed much slower LTE adoption.
A rational approach to subsidies, however, ought to be applied as the financial consequences can be dramatic. In 2011 and 2012, South Korean operators spent almost as much in device subsidies as in network CAPEX11. Therefore, for device pricing, it is critical to strike an appropriate balance between stimulating adoption and destroying value.
5. Leverage LTE as a competitive differentiator: The launch of LTE services disrupts the existing competitive dynamics and can dictate the winners and losers in the market. South Korea’s third player LGU+ launched its LTE commercial services six months before KT, leading to a 3% gain in revenue share in less than two years12. Furthermore, this early mover advantage allowed LGU+ to capture a larger share of higher-value customers.
Other competitive levers can also help to build a more attractive overall value proposition, including network coverage, device availability, pricing, sales and distribution. On one hand, challengers can play aggressively with their LTE proposition to pursue growth. On the other hand, incumbents need to be aware of the potential disruption to market dynamics without losing their rationality.
1 Source: SK Telecom earning results, 1Q 2013
2 Compounded Quarterly Growth Rate
3 Source: Operators’ annual reports
4 Source: Operators’ annual reports
5 Source: Delta Partners analysis based on South Korea Communication Commission (KCC)
7 High level estimate considering incremental LTE network CAPEX, LTE device subsidy OpEx to be compensated by incremental ARPU upside.
8 Source: SK Telecom investor presentation, 3Q 2011
9 Source: SK Telecom investor presentation, 2Q 2013
10 Source: LGU+ investor presentation, 2Q 2013
11 Source: Delta Partners analysis based on operator’s financial results
12 Source: Wireless Intelligence