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Top 10 risks in telecommunications 2012 About this report As the challenges and opportunities facing telecoms operators around the world continue to evolve, the sector’s risk universe is changing rapidly. And as companies formulate and execute their strategies to sustain and grow value in today’s fastmoving environment, they have to ensure that their understanding and management of risk keeps pace. Today, navigating through the sheer speed and scale of change presents challenges for all operators. We have produced Top 10 Risks in Telecommunications 2012 to help them map out the right path. This is the latest in our ongoing series of studies designed to pinpoint the most critical risk issues, analyze the sector’s evolving responses and highlight elements of emerging best practice. As in previous reports, we do not claim that the list of risks we present here is comprehensive. Also, by its nature, it can only provide a generalized snapshot of the risks that we — and the sector as a whole — see at this time. Given this, we would encourage you to read this report with an open mind and inquisitive attitude. Are these really the risks you face in your own business? If not, how and why are your organization’s risks different? And how do those particular risks impact you? The answers inevitably vary from company to company. But in every case, we believe that leaders should take the following steps: • Undertake a thorough risk assessment at least annually, to define your key risks and weigh their impact on business drivers. The risks in this report can provide a useful starting point. • Extend this risk assessment beyond the usual financial and regulatory risks to consider the wider environment in which the organization operates and the full extent of its operations, now and into the future. • Conduct scenario planning for the major risks that you identify, and develop a range of operational responses, possibly as an integrated part of the planning cycle. • Evaluate your organization’s ability to manage its risks — ensuring that the risk management processes are linked to the actual risks that the business faces, especially those that are new and emerging. • Ensure that effective monitoring and controls processes are in place to provide both earlier warning and an improved ability to respond. • Keep an open mind about where new risks may come from. Despite — or, in some cases, because of — the continuing uncertainty and volatility in the global economy, there are major opportunities for operators. Each company’s ability to identify and seize these opportunities depends critically on its ability to understand and manage risk. Unless your growth strategy has a solid underpinning of risk management, it will never be truly sustainable. This publication aims to help you build and reinforce that sound platform. Contents Introduction The Ernst & Young risk radar 2012 Editorial committee Sector context Executive summary The top 10 business risks: 1. Failure to shift the business model from minutes to bytes 3. Lack of confidence in return on investment 4. Insufficient information to turn demand into value 6. Failure to capitalize on new types of connectivity 7. Poorly formulated M&A and partnership strategy 8. Failure to define new business metrics 10. Lack of organizational flexibility What’s below the radar? 10 12 13 15 16 18 20 22 2. Disengagement from the changing customer mindset 11 02 03 04 06 08 5. Lack of regulatory certainty on new market structures 14 9. Privacy, security and resilience 19 Contacts 25 Introduction Amid the recent global economic uncertainty, the telecommunications sector has performed relatively well, with operators once again emphasizing their strong defensive qualities and well-developed capex management capabilities. However, in a sector where new over-the-top entrants are competing fiercely for revenues from emerging service areas, the question is: Is now the time to shift from a defensive to offensive posture? For many telecoms executives, the answer today is a resounding “Yes.” As in previous years, we in Ernst & Young’s global telecommunications network seek to help operators maximize value and tap into new sources of growth through our ongoing series of reports identifying the key risks to their businesses. By addressing the top 10 risks highlighted in this study, we believe that telecoms providers will position themselves to take their businesses forward more effectively and make the most of the growth opportunities that emerge. This report was produced by collecting and synthesizing the insights of our practitioners and sector professionals, supplemented by research and analysis by the Ernst & Young Global Telecommunications Center. During the research process, we asked our sector professionals to evaluate the most important strategic challenges for telecoms businesses globally and to rate the severity of these risks for the sector. As in previous years, our 2012 study indicates that operators face a wide array of risks, and that the relative positioning and scale of these risks have continued to change. An understanding of how to respond to these shifts will help operators manage risk more effectively, optimize performance and increase operational efficiency. It will also empower them to capitalize on the profound changes under way in the telecoms ecosystem, ranging from rapid advances in technology to new customer behaviors and expectations. The most fundamental of these changes is encapsulated in the risk that tops our list: the migration of sector value from minutes of usage to bytes of traffic  a change that must be mirrored in operators’ business models. Many of the other risks in our top 10 spring directly or indirectly from that seismic shift. To help companies formulate and execute the right responses, we provide an analysis of each of the top 10 risks. We also report on risks currently “below the radar” that our panelists believe may move up the risk tables in future years. I would like to thank all our contributors for their time, insight and cooperation in the preparation of this report. This is a valuable dialogue that we hope to continue for many years to come. Jonathan Dharmapalan — Global Telecommunications Leader Jonathan Dharmapalan Global Telecommunications Leader 2 Top 10 risks in telecommunications 2012 The Ernst & Young risk radar 2012 Telecommunications Top 10 business risks for telecoms operators 1. Failure to shift the business model from minutes to bytes 2. Disengagement from the changing customer mindset The Ernst & Young risk radar presents a snapshot of the top 10 business risks in an industry sector, by dividing risks into four quadrants that correspond to Ernst & Young’s Risk Universe™ model. These quadrants are: • Compliance threats — originating in politics, law, regulation or corporate governance • Operational threats — impacting the processes, systems, people and overall value chain of a business • Strategic threats — related to customers, competitors and investors • Financial threats — stemming from volatility in the markets and in the real economy The radar below plots the top 10 risks for telecoms operators on the risk radar, and lists the risks that are currently just “below the radar.” 3. Lack of confidence in return on investment 4. Insufficient information to turn demand into value 5. Lack of regulatory certainty on new market structures 6. Failure to capitalize on new types of connectivity 7. Poorly formulated M&A and partnership strategy Top 10 business risks for telecommunications in 2012 l cia n a Lack of confidence in return on investment Failure to shift the business model from minutes to bytes Insufficient information to turn demand into value Poorly formulated M&A and strategic partnerships Lack of regulatory certainty on new market structures Fi n Co m pl Failure to define new business metrics Privacy, security and resilience e nc ia Disengagement from the changing customer mindset 8. Failure to define new business metrics 9. Privacy, security and resilience 10. Lack of organizational flexibility eg ic Lack of organizational flexibility er p O Below the radar Evolving service cannibalization scenarios Concentration of equipment vendors A more pressing green agenda Difficulties in managing debt and cash 3 Top 10 risks in telecommunications 2012 at io n s Failure to capitalize on new types of connectivity t ra St Editorial committee Jonathan Dharmapalan Global Telecommunications Sector Leader Jonathan Dharmapalan is Ernst & Young’s Global Telecommunications Leader, leading a team of over 2,000 telecoms professionals across the world in their work with the world’s leading operators. With 25 years of experience, Jonathan has served some of the largest companies in the telecommunications sector. He has significant experience in both mobile and terrestrial communications. Holger Forst Global Telecommunications Markets Leader With 20 years of experience, Holger Forst has been the Global Client Service Partner for Deutsche Telekom AG since 2007. In 2011 Holger was appointed the joint Ernst & Young Global Telecommunications Markets Leader. Prashant Singhal Global Telecommunications Markets Leader Prashant has extensive experience of over 15 years in Assurance and Advisory Business Services, servicing Indian and multinational telecom clients. In 2011 Prashant was appointed the joint Ernst & Young Global Telecommunications Markets Leader. Olivier Lemaire EMEIA Telecommunications Leader Olivier has 15 years of experience working in the telecommunication industry. As an Audit and Business Advisory Partner and chartered accountant, he has been rendering audit, transaction support and advisory services to many international telecom operators across Europe, Africa and Middle East. Olivier has been leading the Global Telecom Revenue Assurance team for 6 years and led several revenue assurance global studies. He is also experienced in group reporting under IFRS. Since September 2011 he is the leader of Ernst & Young’s telecommunications practice for the Europe, Middle East, India and Africa (EMEIA). Luis Monti Americas Telecommunications Leader Luis has 19 years experience in the telecoms industry, and has worked with several large telecom groups. Luis is the leader of Ernst & Young’s telecommunications practice for the Americas region. David McGregor Asia Pacific Telecommunications Leader David has been with Ernst & Young for over twenty six years and has worked in a number of countries including the UK, USA and Australia. He is the coordinating core assurance partner on Telstra and the telecommunications and media & entertainment leader for Asia Pacific. Rohit Puri Director, Global Telecommunications Center Rohit is a Director within Ernst & Young’s Global Telecommunications Center, and currently leads the development and implementation of the Center’s strategy. He brings over 12 years of professional services experience focusing on telecoms finance and business strategy. Bala Balakrishnan Telecommunications Partner — United States Adrian Baschnonga Senior Analyst, Global Telecommunications Center Adrian Baschnonga helps produce and deliver thought leadership for the Global Telecommunications Center. He advises clients on strategic issues in the telecommunications sector and is a regular speaker at industry events. Bala has over 20 years of consulting and industry experience within telecoms and other industries. Bala has assisted several cable and telecommunication companies with the definition and implementation of strategic initiatives, including channel strategy, sales effectiveness, marketing effectiveness and analytics, CRM strategy and implementation, product profitability, and operations effectiveness initiatives. 4 Top 10 risks in telecommunications 2012 Vincent de La Bachelerie Telecommunications Partner — France Dennis Deutmeyer Global Telecommunications IFRS Leader Mark Gregory Telecommunications Partner — United Kingdom Vincent de La Bachelerie has been involved in the telecommunications sector for 20 years. Vincent has extensive experience working as lead partner on large telecom groups. He has also participated in other projects for telecommunications operators including consulting and advisory work, merger and acquisition projects and valuations. Dennis has over 24 years experience providing auditing and advisory services to of our largest U.S. telecommunications clients. Dennis is the Global IFRS Leader for the Telecom Sector. Mark has over 25 years experience in more than 40 countries as an advisor to the telecommunications industry, working in strategy, regulation, cost and pricing analysis and market analyses. In his career he has undertaken engagements for several large telecom groups. Manesh Patel Telecommunications Partner — India Michael G. Stoltz Telecommunications Partner — United States Jeremy Thurbin Telecommunications Partner — France With over 19 years of experience working with Indian and multinational companies in the telecommunications sector, Manesh Patel currently leads the telecommunications risk advisory services group in India. With 35 years of experience serving global clients, Mike has extensive experience working as lead partner on large telecom groups. He has also participated in other projects for telecommunications operators, including risk reviews, regulatory, operational assurance and improvement and valuations. Jeremy is a partner in the Paris Assurance practice experienced in telecoms and media. His experience covers the audit of the €30b French fixed line, internet and mobile operations, the internal control 404 audit, and the international operations. He has extensive experience of internal audit, fraud, internal control and risk management issues within the telecommunications industry. Pieter Verhees Telecommunications Partner — Netherlands With over 15 years of experience, Pieter Verhees is currently working with leading fixed and mobile telecom operators, in and outside Europe, delivering and implementing complex projects, including price squeeze methods and models, costing models, cash-flow forecasting capabilities, performance management and regulation. 5 Top 10 risks in telecommunications 2012 Sector context “Safe haven” positioning threatened by questions over future growth Telecommunications has weathered the downturn and subsequent economic uncertainty and volatility relatively well compared to many other sectors. As a result, the sector is quite solidly positioned as a defensive “safe bet” in the eyes of investors (though the mobile segment is slightly more exposed). Looking ahead to future structural trends in the sector, players in Europe and other developed markets are likely to benefit from some easing of the regulations on mobile termination rates, while landline is set to see the pace of its structural decline slow down. More generally, the outlook is positive as smartphone growth opens doors to new opportunities in the sector. But this silver lining comes with a cloud: investors are taking an increasingly ambivalent view of the sector, asking questions about the levels of capital expenditure that will be needed to support future growth. They are also questioning whether operators will take their fair share of future expansion in service revenues, or whether the over-the-top players will once again seize the initiative in monetizing new offerings. Reaping the rewards of a defensive status Through its history, the telecommunications sector has often demonstrated its robustness in downturns and periods of market uncertainty. The recent past has been no exception. The sector is riding out the economic storms relatively well. For example, as Figure 1 shows, the fluctuations in telecoms revenue growth in Europe have been far smaller than the volatility in European GDP over last three years. This picture is being replicated in other regions across the world, with operators’ robust defensive positioning generally regarded as being reinforced by strong cash flow and rising dividend yields. In Asia, the high valuation multiples currently being applied to mobile players signal continued confidence in the outlook for the sector. And in North America, investors remain optimistic about the ongoing impacts of increasing smartphone penetration and investment in 4G networks. Figure 1. Europe — GDP and telecoms revenue development1 % change y/y 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 01 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 European telecoms revenue growth Euro area real GDP growth However, challenges remain. Experience shows that operators’ revenue performance tends to be linked to employment rates  which are trending downward and under threat of an accelerating decline. And of the sector’s segments, the stillgrowing mobile segment is the most economically sensitive, having seen its voice volumes fall significantly during 2009 in the wake of the recession. Improving performance — supported by structural trends Operators can look forward to improving performance, helped by positive structural trends. For example, rates of landline loss are slowing in the European fixed-line. And operators worldwide have proved themselves strong on cost control in recent years, with strategies such as network sharing helping to ease the pressure on infrastructure upgrades. Figure 2. Telecoms companies’ Operating Cash Flow margin 2 percentage by region, 2011F–2013F Operating cash flow margin (%) 25 20 15 10 5 0 Global Americas Asia ex Japan FY 2011 Japan Europe FY 2013 Africa FY 2012 1Eurostat; Deutsche Bank, “European Telcos: The best way to play,” 5 September 2011 (reports were sourced from author website unless otherwise noted). 2Macquarie, “Global Telecoms,” 15 September 2011. 6 Top 10 risks in telecommunications 2012 Driven by such cost control measures, operating cash flow metrics are forecast to improve for global operators. Investors are positive on North American telcos due to early investment in 4G and high smartphone penetration, while high valuation multiples in Asia reflect confidence in continued revenue growth. This improving picture, highlighted in Figure 2, both reflects and reinforces the current assessment by investors and analysts that the global telecommunications sector can weather any financial storms that may be ahead. At the same time, global smartphone shipments continue to escalate at impressive rates, with wireless data growth set to remain strong across all regions — although minutes of use (MoU) are flattening in mature markets such as the US. … but clouds are gathering Against this generally improving outlook, there are conflicting perspectives on how the sector will evolve. As Figure 4 shows, data is projected to rise from 20% of global mobile revenues in 2008 to 36% in 2015, threatening major disruption to revenue models. Investors are also concerned about the massive capex that will be needed to support this growth, and about whether over-the-top players might once again beat the operators in the race to secure new revenue streams, as they did with mobile apps. As a result, investors’ view of the telecoms sector remains fundamentally ambivalent, reflecting the difficulty reconciling its structural weaknesses — such as heavy regulation of highermargin activities — with specific opportunities for rapid growth, such as mobile data. There is also concern over the trade-off between the cost and value of new growth areas, given the uncertain capex commitments as mobile traffic growth and mobile data revenue growth diverge. Against this background, focusing on dividend yields tends to encourage a short-term view of the sector’s performance. Yet this is a sector where the models for long-term value creation need to be addressed — and soon. Figure 4. Global mobile voice and data revenues 4 A bright growth outlook … As these trends play out, the sector is already outpacing recent assumptions of its growth rate (see Figure 3). Mobile connections are forecast to surpass the overall human population in 2014, as the “long tail” of users in emerging markets get connected, and as trends escalate such as multiple SIMs and devices per person, embedded SIMs and machine-to-machine (M2M) connectivity. Figure 3. Global mobile device and subscriber penetration3 Global population and mobile connections (m) 8,000,000 6,000,000 4,000,000 2,000,000 0 2008 2009 2010 2011 2012 2013 2014 2015 Mobile connections Revenue (US$m) 1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 2009 2010 2011 2012 2013 2014 2015 Population Annual smartphone shipments (m) 600 500 400 300 200 100 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011E FY 2012E 0 Mobile voice revenue Mobile data revenue 3Ovum, UNFPA, 2008 Population Revision Database, Ernst & Young analysis; Deutsche Bank, “Global Telecommunications,” 25 July 2011. 4Ovum Mobile Voice and Data Forecast 2011-2016, January 2012; Cisco Visual Networking Index. 7 Top 10 risks in telecommunications 2012 Executive summary The top 10 business risks for telecoms operators The top 10 1 Failure to shift the business model from minutes to bytes Aggregating our interview responses worldwide, here is a summary of each of the top 10 business risks for telecoms operators. 1 Failure to shift the business model from minutes to bytes 2 Disengagement from the changing customer mindset 3 Lack of confidence in return on investment 4 Insufficient information to turn demand into value As value shifts from minutes of usage to volumes of data, operators need to move away from their legacy strategies focused on customer retention, which have had the effect of commoditizing the value of minutes and bandwidth in customers’ eyes. Instead of concentrating on fighting churn, operators need to target revenues from new services that tap into rising demand and master a wider array of charging models to monetize these services. 5 Lack of regulatory certainty on new market structures 6 Failure to capitalize on new types of connectivity 7 Poorly formulated M&A and partnership strategy 2 Disengagement from the changing customer mindset With global technology brands now top of mind for consumers, and technology cycles quickening, operators need to understand and respond to fast-changing customer expectations and behaviors if they are to fight off the competitive threat from over-thetop providers. This will require operators to communicate clearly the underlying value of the network and the sources of added value that differentiate their offerings in new service areas. Innovation in the service model could also be used to build brand loyalty in the same way technology players have done. 8 Failure to define new business metrics 9 Privacy, security and resilience 10 Lack of organizational flexibility 3 Lack of confidence in return on investment While operators have proved adept at managing capital investment and balancing it flexibly with free cash flow and dividends, it is increasingly clear that tight capex control can limit their ability to grow new services quickly. So they need to maintain their commitment to investing in growth opportunities, while tracking technology and consumer developments closely to ensure they target their financial investments at the right areas at the right time. 4 Insufficient information to turn demand into value To drive profitable customer propositions and improve their time-to-market for new services, operators need accurate, timely and comprehensive business intelligence and customer analytics, underpinned by aligned and integrated operational support and billing systems. These elements pave the way for efficient growth by enabling operators to produce better business intelligence for decision-making, helping them understand customer changes before their competitors, and allowing them to reuse network data in collaborative partnerships. Better information can also help operators reduce operational costs and ensure regulatory compliance. 8 Top 10 risks in telecommunications 2012 5 Lack of regulatory certainty on new market structures 8 Failure to define new business metrics Uncertainty over regulators’ approaches to new market structures is undermining operators’ willingness to invest. It is increasingly crucial for governments and regulators to adopt pro-investment policies to sustain the sector’s momentum and for operators to form workable stances on a range of issues, including the increasing relationship between fixed and mobile policies. At the same time, all these groups must work together to achieve greater clarity over regulatory approaches. 6 Failure to capitalize on new types of connectivity The metrics and key performance indicators (KPIs) that operators use to manage their operations internally and communicate their performance and prospects externally have not kept pace with the shift in business models from minutes to bytes. Many internal metrics are still service- and networkoriented, and do not provide enough granularity to improve the customer experience. Also, commonly used external metrics such as average revenue per user (ARPU) fail to give investors a full picture. Operators urgently need to define a new and different set of metrics that puts the customer first and leads to improved financial performance. New types of connectivity such as machine-to-machine (M2M) are redefining the concept of connectivity, requiring operators to adopt new strategies. Instead of continuing to think of connections in human terms, operators need to develop new understandings of connectivity and target new growth areas. This will mean identifying core competencies for use in composite value chains and delineating clearly between the need to build capability and the need to partner or outsource. 9 Privacy, security and resilience 7 Poorly formulated M&A and partnership strategy Customers place more trust in operators than in social networks, regarding operators as security guarantors across a range of services. Yet they still hold operators responsible for threats from third parties  even for mobile malware attacks and rogue apps. Operators should work closely with governments to clarify their responsibilities in areas such as anti-terrorism and content for children, and collaborate with suppliers and partners to tackle privacy and security issues in new service areas such as cloud security and mobile apps. Though M&A activity has accelerated recently, its nature and risks have changed. Footprint control increasingly takes precedence over footprint growth, and political, macroeconomic and regulatory risks are increasing. But acquisitions and partnerships are essential for success in emerging market segments such as mobile advertising and cloud computing. Operators need to clearly discriminate between when they should acquire and when they should partner. The ability to sustain partnerships will emerge as a strategic differentiator. Effective management and implementation of M&A and partnerships offers significant operational upside to telecom players. 10 Lack of organizational flexibility With their organizational structures subject to forces such as the shift to data services, the rise of partnering and the rising imperative for speed-to-market, operators have already made significant changes to their organizations. But more are needed. Operators now need to align their business units to maximize the economies of scale and scope in their geographic footprints while reconciling the competing forces of geographic sensitivity and global strength. 9 Top 10 risks in telecommunications 2012 The top 10 business risks 1 Failure to shift the business model from minutes to bytes Figure 5. Global mobile data revenue and traffic growth5 Revenue (US$m) 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 Traffic (PB per month) 6,000 5,000 4,000 3,000 2,000 1,000 2010 2011 2012 2013 2014 2015 0 “Losing ownership of the client” was ranked as the telecoms sector’s top business risk in 2008 and 2010. Our analysis shows that this risk has now been overtaken by the urgent need to develop and deliver new data-enabled services that will generate fresh revenues from users. And the customer-focused risk of “disengagement from the changing customer mindset” has slipped to number two, as the ongoing fragmentation of the sector value chain makes it increasingly clear that no single participant can ever truly “own” the customer. The risk of failing to shift from minutes to bytes reflects the new challenges now facing operators around the world, as a result of aggressive moves by competitors entering from other sectors and rapid change in telecoms’ established value chains. Pivotal to these changes is the migration of value from charging for minutes of usage to carrying rising volumes of data across networks. Mobile data revenue Mobile data traf fi c Adapting to a wider ecosystem … In response, operators need to adapt their business models to a wider ecosystem and make firm decisions about which revenue sources they are going to target within that broader environment. As Figure 6 shows, the current split of revenues is roughly 50% in the consumer segment, with the rest divided between business and wholesale. Depending on the chosen strategy, this split could evolve by 2020 into a “smart” operator with revenues dominated by customers or a “lean” model rebalanced toward wholesale service provision. In general, telecoms revenue mix forecasts point to an increasing shift toward wholesale. Operators face the challenge of identifying new types of wholesale customers in the context of a shifting value chain. Figure 6. Operator revenue mixes — 2020 scenarios6 Current Smart operator 2020 Lean operator 2020 0% 20% 50% 60% 30% 30% 25% 50% 80% 100% Wholesale 20% 15% Focusing on retention stifles value As operators respond to this seismic shift, they need to move away from legacy strategies that have focused on retaining customers’ loyalty rather than monetizing demand. The focus on preventing and minimizing customer churn has had the effect of commoditizing the value of minutes and bandwidth in customers’ eyes. The direct impacts of this commoditization are clear in offerings such as free upgrades for fixed broadband, flat-rate mobile data services and discounted multi-play packages. These underline the fact that user-loyalty considerations are now actually stifling value creation. Pursuing new service areas Instead of concentrating on fighting churn, we believe that operators should now raise their sights to target revenues from new services that tap into rising demand. As Figure 5 shows, data traffic is expected to grow exponentially in future years. As demand increases, new consumer service areas are being exploited by players with new business models, such as “freemium” music and data hosting/file transfer services, and advertising-supported apps. Even operator-provided products  such as SMS  that were previously insulated from new offerings are under growing pressure from new free services, such as mobile instant messaging. 20% 40% 60% Consumer Business … while seizing the enterprise opportunity In light of developments such as the rapidly intensifying competition for consumers’ spending, the revenue growth potential in the enterprise segment remains high in comparison to the consumer market. To exploit this potential, business models for enterprise customers have to embrace new approaches to provisioning — such as cloud computing — alongside collaborative approaches to service development and delivery. 5Ovum Mobile Voice and Data Forecast 2011-2016, January 2012; Cisco Visual Networking Index. 6Ovum, “Telecoms in 2020: Executive Summary,” December 2009. 10 Top 10 risks in telecommunications 2012 Operators are embracing this message, as demonstrated by a raft of announcements in late 2011 of cloud-based unified communications and collaborations services for businesses, often supported by new data center investments. Small and medium-sized businesses are expected to act as early adopters for these cloud-based services, an area where operators are continuing to make good headway. In parallel with these initiatives, operators should seek to master a wider array of charging models, ranging from flat-rate to per-event and ad-supported. And cross-sector growth strategies will require vertical market business models, tailored to the particular sectors — a need well served by the low costs and high scalability and configurability of cloud services. All of these changes, in turn, require changes to IT and charging systems. Quickening technology cycles reshape brand affinities This dominance by the technology players reflects the extent to which quickening technology cycles across both the consumer and enterprise segments are impacting consumers’ everyday working habits and lifestyles, and reshaping their brand affinities. As Figure 8 indicates, multiple devices per user is increasingly the norm. And the time taken for new technologies to reach 50% penetration is shortening rapidly  down from 15 years for mobile phones to 4—5 years for smartphones and tablets. Figure 8. Take-up of consumer electronics devices8 UK device penetration Q1 2011 (%) 100 98 80 60 40 20 0 TV set 93 85 60 55 54 33 2 Disengagement from the changing customer mindset Landline phone Mobile phone Games console HDTV receiver HD-ready TV Smartphone As we previously noted, there is now very little prospect of any individual participant in the value chain fully owning — rather than sharing — the customer. So, as well as slipping to second place behind the need to migrate from minutes to bytes, our number one risk in 2010 of losing customer ownership has evolved into the risk of becoming disengaged from the customer’s changing mindset. This risk is underlined by the extent to which technology brands are now top of mind with customers. As Figure 7 shows, today’s top four global brands are all technology players, with the top-ranked operator brand coming in at number six. Figure 7. Top 10 global brands 20117 Rank 2011 1 2 3 4 5 6 7 8 9 10 Rank 2010 2 20 5 4 1 7 6 10 11 8 Rank 2009 5 27 4 3 1 8 6 10 14 7 Brand Google Apple Microsoft IBM Walmart Vodafone GE Toyota AT&T HSBC Industry group Technology Technology Technology Technology Retail Telecoms Diversified Automotive Telecoms Financial services 27 4 4 Netbook 2 3DTV 2 Tablet Laptop One of the reasons for this acceleration is that operators’ fixed and mobile networks are now a platform for access to a wide number of sectors and services, such as television, retail and banking. As this explosion in online/mobile applications gathers pace, disruptive players are leveraging their rising brand values to extend their service propositions. At the same time, devices are playing a pivotal role in shaping the mobile customer experience. 7Brand Finance, “Global 100,” September 2011. 8Ofcom, “Communications market report: UK,” 4 August 2011. 11 Top 10 risks in telecommunications 2012 e-Reader Adapting to the new customer mindset As these changes in customers’ mindset — and behavior continue  and seemingly accelerate — operators have an absolute need to adapt their service offerings and customer experience to reflect these shifts in order to sustain and build customer engagement. These responses should be supported by clear communication with customers on the value of the network and on the effort and investment required to provide high-quality services. Network quality is often taken as a given, but it shouldn’t be. Service quality is not just about the device or application; it is also about the network infrastructure without which these elements would never work. If operators worldwide can get this message across to customers, then they will be able to improve perceptions of added value — including price, quality and convenience — and to work the proven levers of brand strength in telecommunications, including high trust and credibility. The scalability, flexibility and low costs of cloud computing not only help operators address the number one risk of failing to shift the business model from minutes to bytes — they can also help operators better engage with the customer mindset. As a host of players from the technology and telecoms sectors seek to deliver new services — either individually or via partnerships — the need to differentiate is paramount. With this imperative in mind, operators should clearly define and communicate their core added value in areas of new service provision — such as their security credentials in network-based enterprise services; their ability to deliver new types of bundle packages for consumers; and their role as a trusted provider of new and emerging services, such as m-payments. Ambivalent outcomes However, tight capex control has ambivalent outcomes — and increasingly risks sidelining operators from future growth. External forces such as regulation and customer demand mean operators remain cautious about investing in infrastructure. These same considerations — together with uncertainty over new market structures — are also contributing to persistent doubts over the revenue potential of new services. As Figure 9 shows, levels of capital intensity remain largely stable worldwide and are now relatively consistent in all regions. Growth-driven capex in emerging markets is falling back from its previous highs, and the release of new spectrum is lagging in some developed markets. Nevertheless, there is a risk that tight capex control can undermine service quality, competitiveness and the growth prospects of new services. Figure 9. Telecoms capital intensity by region 2008–Q2 20119 Fixed and mobile capex/sales (%) 30 25 20 15 10 5 0 2008 2009 2010 Europe Q1 2011 Asia Pacific Q2 2011 MEA North America 3 Lack of confidence in return on investment The importance of timing With the number of high-speed mobile connections globally continuing to grow rapidly (see Figure 10), getting the timing of new investments right is critical for achieving the targeted returns. To do this, operators need to understand clearly how infrastructure upgrades relate to customer demand, competitor actions and government industrial policies. This can be supported through better leveraging and optimization of legacy networks to complement network/service availability. In our 2010 report, the risk of ineffective infrastructure investment was ranked in fourth place. This year, the risks around investment have risen to third, while also evolving into a lack of confidence about the level of returns. In the past two years, operators have been quite successful in tackling the challenge of the data deluge on their networks, thanks to a combination of smart investment and growing use of alternatives such as WiFi and offloading to backhaul. These factors, together with operators’ readiness to flex capex to maintain free cash flows and dividends, have underlined their strong capex control and reinforced their defensive status. There is also a trend toward moving capex spend into opex through outsourcing, in order to smooth capex spend over time. 9Ovum, “Network infrastructure report,” 19 September 2011. 12 Top 10 risks in telecommunications 2012 Figure 10. Global high-speed mobile connections10 Connections split by technology (000) 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 2009 2010 2011 2012 2013 2014 2015 2016 Not having all these elements in place threatens operators’ efforts to increase time-to-market and build customer-centricity. It can also undermine the potential returns on their ongoing investments. This risk relates to the “inappropriate systems and processes” that ranked eighth on our list in 2010. However, the issue now is both more holistic and more pressing. Added urgency The requirement to ensure the right systems and processes are in place is being given added urgency by a widening gap between what operators know they need to do and what they are achieving. As Figure 11 shows, they agree that time-to-market is increasingly important. Yet operators’ time-to-market for new services has not improved in the last two years, and the percentage of operators that can bring products to market quickly has actually fallen since 2008. As technology and product life cycles shorten, this represents a growing risk — especially since disruptive market entrants are repurposing customer data dynamically for new services. In contrast, operators are struggling to repurpose their information assets, due largely to patchworks of legacy systems that hold fragmented customer and network information, and a lack of real-time analytics to build a single view of the customer across multiple devices and territories. Figure 11. Time-to-market — telco perceptions and performance11 % service providers that say time-to-market is very important to remaining competitive WCDMA HSPA TD-SCDMA (incl. TD-HSPA) LTE CDMA 1XEV-DO This is a complex task. It requires confronting challenges such as uncertainties in supply and demand amid factors such as spectrum releases, soaring usage of high-bandwidth applications and shifting market structures as network sharing and consolidation continue to gain ground. Also, many operators have multi-technology strategies and fail to fully understand the complementarities and optimization factors between them. Operators need to tackle all these challenges while continuing to invest in network infrastructure. All too often, their capex planning is driven by a focus on protecting cash flow or by pressure to build out greater bandwidth capacity even though the business case remains ambiguous, thus limiting the future revenue and margin potential of new services. These drivers for capex planning should change, for several reasons. For example, industrial policies in many markets will require substantial increases in super-fast broadband coverage over the years to 2020. Also, customers in all segments and markets are increasingly concerned about network quality. 2011 70 2008 50 55 59 60 65 70 75 4 Insufficient information to turn demand into value % service providers that can bring a product to market within 6 months As operators undertake the shift from minutes to bytes and seek to justify continued investment in new infrastructure and services, information becomes increasingly vital to their ability to create value. To drive profitable customer propositions, companies need accurate, timely and comprehensive business intelligence and customer analytics, underpinned by the right operational support and billing systems. 2011 65 2008 50 55 60 65 67 70 75 10Ovum, “Mobile Regional and Country Forecast: 2011–16,” July 2011. 11Amdocs, “Amdocs survey: time to market grows in importance,” 14 April 2011 (125 senior sector executives). 13 Top 10 risks in telecommunications 2012 Realizing the power and value of information Operators are collecting more information about the customer than ever before. Those who overcome the barriers we’ve highlighted and leverage their information assets as successfully as the over-the-top providers stand to reap significant benefits (see Figure 12). Repurposing customer data in new ways can enable operators to improve their market positioning, through advantages such as better business intelligence — for example, anticipating market and customer changes before competitors — and reusing network data for collaborative partners and sector verticals. Operators that upgrade their capabilities in understanding and applying customer data also open up opportunities to reduce operational costs, while simultaneously improving the speed of delivery of new data services and making it easier and cheaper to ensure regulatory compliance. Furthermore, the value of customer and network data extends beyond the organization itself and will continue to rise as the sector becomes increasingly partnership- and data-centric. Figure 12. Advantages of repurposing data inside the business 5 Lack of regulatory certainty on new market structures As new market structures emerge, the regulatory approach to these evolving sector ecosystems remains unclear. Consequently, policy challenges are undermining operators’ willingness to invest. This means that 2010’s third-placed risk of “rising regulatory pressure” has now narrowed into this year’s more specific risk factor — and that it is increasingly crucial for governments and regulators to adopt pro-investment policies to sustain the sector’s momentum. Shifting standpoints The challenges and uncertainties around the policy approaches to new market structures include shifting regulatory standpoints on wholesale broadband access pricing, and the trend toward imposing network separation as a pro-competition tool in super-fast broadband. Going forward, new spectrum releases will shape 4G market structures — and the rules vary from market to market in areas such as spectrum caps and trading. In new and emerging areas such as mobile money, regulatory jurisdictions and policies continue to lag behind the technology — a challenge compounded by the “broadband as a human right” lobby. On top of these uncertainties, there is continued regulatory pressure on legacy parts of the business, such as MTRs and roaming. In combination, these issues have pushed regulatory frameworks to the top of the list of challenges facing ISPs (see Figure 13). And in tough fiscal conditions, operators know that telecoms can be a rich source of government taxation as well as a focus for government investment. Figure 13. Survey: challenges facing ISPs12 Q. What is the key issue facing ISPs over the next five years? Regulatory frameworks Return on investment Launching new services Access to capital 0 15 20 40 60 % respondents 24 20 41 Dynamic charging capability Improved time-to-market Better distribution of network load Better targeted marketing initiatives Deeper relationships with third parties and partner ecosystems Improved monetization of new customer demands 12Ernst & Young/ITU Telecom World poll, November 2011 (85 online respondents). 14 Top 10 risks in telecommunications 2012 Seeking certainty These factors are creating an urgent need for greater regulatory certainty — and, alongside greater clarity and consistency from regulators, achieving this will require operators to engage with a wider set of stakeholders. Consolidation in markets worldwide will continue to impact pricing and investment, and the need to fund next generation access and spectrum releases (see Figure 14 for European examples) will require broad market consensus on the regulatory position. And overarching questions remain about the impact of the net neutrality agenda across the whole of the technology, media and telecoms ecosystem. To engage effectively on these areas of uncertainty, operators need to form workable sector stances on a range of issues. These include the increasing relationship between fixed and mobile policies — for example, in the regulatory approaches in adjacent markets (e.g., financial services) — traffic management of data services and the drive to increase broadband coverage in rural areas. Figure 14. European 800 MHz spectrum auctions13 Date Country MHz Total price (€m) Italy 60 Price/ Notes MHz/ pop Spectrum won by two of three existing network owners; simultaneous 1800MHz and 2600MHz auction 900/1800/2600MHz auctions also took place in mid-2011; further 900MHz spectrum to be released in Q4 2012E All three network owners won spectrum; 1800MHz auction took place in Oct 11 — two of three network owners won spectrum in first round Three of four network owners won spectrum; 1800/2600MHz spectrum awarded at same time to all network owners (total price €445m) 6 Failure to capitalize on new forms of connectivity This new risk, which has come straight into our top 10, springs from the fact that new types of connectivity — notably M2M links — require new types of strategies. As M2M takes off in various vertical markets (see Figure 15), the very concept of connectivity is rapidly being fundamentally redefined. From human- to machine-based While operators continue to think of connections in primarily human terms, sector growth increasingly relies on new understandings of connectivity. There is clear value in the “interconnectedness” of devices, through technologies and links including not just M2M but also NFC and multi-screen content. The business models for monetizing connectivity are also proliferating, spreading across the spectrum of B2B, B2C and B2B2C. The new connectivity-based services now emerging promise increased efficiency, higher customer centricity and valueenhancing repurposing of existing infrastructure. But operators’ moves into emerging market segments such as mobile money are often defensive and piecemeal  they also raise various challenges that include high upfront costs, lower ARPU per SIM card in the M2M environment, and exposure to new regulatory and reputational risks. Figure 15. Global M2M connections in 2020 by vertical M2M connections (billions) 0.07, 3% 0.03, 1% 0.28, 13% Utilities Security Automotive and transport Health care Government, retail and financial services 1.32, 62% 14 Sep 11 2,962 0.82 Jul 11 Spain 60 1,205 0.47 Mar 11 Sweden 60 228 0.42 Global M2M connections: 2.1 billion 0.45, 21% May 10 Germany 60 3,600 0.73 13Ernst & Young research. 14Analysys Mason, “Imagine an M2M world with 2.1 billion connected things,” January 2011. 15 Top 10 risks in telecommunications 2012 Unlocking incremental revenues As companies seek to tackle these challenges, new strategies can unlock incremental revenues. To realize these, operators need to work out how best to align themselves to new growth areas. This will generally mean deciding on their core competencies for use in increasingly composite value chains, and delineating clearly between the need to build capability and the need to partner or outsource, in light of their existing network and customer footprints. By way of example, Figure 16 shows various operators’ approaches to the M2M opportunity. Experience shows that majoring on specific industries can help to differentiate propositions and that the current stage of service maturity varies widely between different vertical markets. So, to avoid placing the wrong bets, operators should take great care in evaluating emerging use cases. Local and market-specific factors such as regulation, the vertical industry landscape and existing network coverage will play a pivotal role in emerging service areas. Issues around technological complexity must be assessed on a continual basis if multi-operator and cross-sector partnerships are to succeed in overcoming the current technological fragmentation. Figure 16. Selected operator approaches to M2M15 Operator M2M organization AT&T Emerging Devices Org as dedicated BU. B2B M2M is part of Advanced Mobility Solutions Group International M2M competence center in Bonn; US M2M outsourced to RACO Wireless 7 Poorly formulated M&A and partnership strategy Across the global telecoms sector, the rationale for consolidation remains strong  and partnership structures are gaining ground by offering new routes to growth. At the same time, the role and dynamics of M&A are changing, and operators are adapting their strategies to reflect these shifts. These developments have seen this risk rise two places from ninth in 2010. Joining forces in an uncertain world There was actually a pickup in M&A deal activity in 2010–11 compared to 2008–09 (see Figure 17). However, plenty of risks remain, including high levels of political risk in the Middle East/ North Africa, acute macroeconomic risks in Southern Europe and uncertainty over shifting regulatory attitudes toward competition. With operators eager to tap into the growth potential in emerging Asia, competition and ownership issues have emerged as hot topics in the region, notably Vietnam and Indonesia. Figure 17. Quarterly global telecoms M&A 2008–1016 US$m 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 # of deals 80 70 60 50 40 30 20 10 0 Service delivery platform Jasper-powered Control Center — provides analytics reports, automated provisioning M2M service portal since 2010 — can be integrated into customer environment via API Target segments Utilities, fleet management, security, health care, consumer electronics Home security, resource management, smart metering and grid, telematics, logistics, retail Environmental monitoring, remote maintenance and control, tracking, health care, metering, automotive telematics and fleet management Deutsche Telekom Vodafone Dedicated M2M organization launched in 2010 Automated SIM pre- and post-paid provisioning; policy management; API integration with customer systems Deal value # of deals 15Ernst & Young research. 16Ovum, 14 November 2011. 16 Top 10 risks in telecommunications 2012 The changing risk landscape creates increasing uncertainty over deal valuations and prompts greater board scrutiny and stakeholder caution (see Figure 18). Meanwhile, the changing nature of M&A deals reflects the fact that footprint control is now more important than footprint growth for some players. Also, shifts in the value chain are heralding new M&A trends, such as the creation of joint tower management entities. Under these circumstances, acquisitions and partnerships in emerging market segments remain important. In the cloud space, 2011 saw the launch of a raft of new services supported and enabled by a diverse range of acquisitions, partnerships and investments. Figure 18. Deal factors in telecoms17 Q. Which of the following factors have increased/decreased over the last six months? Price expectation gaps Regulatory pressures Board/audit committee scrutiny Competition for assets Stakeholder caution Decreased -7% -4% -4% -7% -7% Increased 39% 69% 46% 61% 45% 46% Partnering abilities come to the fore To capitalize on such opportunities, operators need to discriminate clearly between situations that call for acquisitions and those more suited to partnering. Going forward, the ability to create and sustain partnerships will emerge as a strategic differentiator, as their scope and usage widen due to a number of factors. These factors include a continued focus on realizing cost efficiencies through approaches such as network and procurement joint ventures, and a growing reliance on cross-sector collaboration for new product development. In combination, these trends make it important that operators build the ability to work with new types of partner — application developers, power utilities, technology companies and more — and continually reassess their relationships with partners outside the sector. However, issues over revenue shares within partnerships remain a stumbling block. Valuation uncertainty/complexity -3% 17Ernst & Young Capital Confidence Barometer survey, November 2011 (interviews with 31 senior telecoms executives). 17 Top 10 risks in telecommunications 2012 8 Failure to define new business metrics … and externally External stakeholders such as investment analysts are currently trying to gauge the value of telecoms companies by reviewing revenue, ARPU and basic subscriber growth numbers that fail to provide a full picture of a sector moving from a high-growth to a pure investment-yield story. Legacy penetration rates fail to give a clear view of the addressable market for new services, and reliable metrics for new growth segments such as mobile apps and advertising are lacking. One critical issue is that analysts are not generally focusing on  or gaining access to  the types of cost- and investment-related metrics that can point to how operators can become more effective at converting investment dollars into profitability. Financial metrics such as return on invested capital (ROIC) offer greater insight than EBITDA as a way to measure and communicate intrinsic value. In combination, operators’ internal requirement for information to turn demand into value, and their need to sustain confidence among investors and other external stakeholders, are driving a further sector imperative: an urgent demand for fresh ways to measure and communicate financial progress through a new and different set of KPIs. Metrics are inadequate internally … In terms of internal measurement, the problem is that operators’ current metrics fall short of providing the new and timely insights and business intelligence they need to maximize value in the evolving ecosystem. Many internal metrics are service- and network-oriented and do not provide enough granularity to improve the customer experience. In particular, customer-level usage metrics such as minutes-ofuse are failing to delineate the impact and effect of bundled and flat-rate packages, and tend to hit a plateau once users’ consumption behavior becomes established. But data service metrics such as megabytes per user are failing to fill the gap and are generally lacking at the customer level. For this reason, operators are developing and applying a growing array of operational metrics (see Figure 19). Figure 19. KPIs for consumer fixed-line services18 Key performance indicator Return on invested capital (ROIC) Return on capital employed (ROCE) Revenue generating unit per subscriber TV market share Metrics to put the customer first To address these shortcomings in their internal management information and external communications and reporting, operators should evolve metrics that put the customer first, and create more granular external KPIs that highlight network usage and related costs or new service take-up. This will enable the sector’s metrics to catch up with the way its products and services are progressing from mobile voice growth to mobile data maturity (see Figure 20). Figure 20. Evolution of KPIs in mobile data Mobile voice growth Voice maturity, mobile Mobile data maturity data growth Rationale Measures efficiency to utilize the capital invested to generate returns Indicates the efficiency and profitability of the telcos capital investments RGU per sub describes the average number of services taken subscribers, reflecting bundle take-up Share of the TV market helps communicate IPTV strategies • Network coverage • SAC/SRC • Subscribers • Penetration • Customer market share • Cost per bit • Churn • Data share of revenue • Mobile internet page hits transmitted utilization • 3G/4G network • Data usage per subscriber • MoU • ARPU • Pre- and post-paid split • Revenue market share • M2M connections • Mobile payment users • Smartphone take-up • App store revenue • 3G handset take-up • On-portal visitors and traffic 18KPN, “Third Quarter Results 2011,” 25 October 2011. 18 Top 10 risks in telecommunications 2012 The new KPIs for this environment will need to include metrics such as revenue generating units (RGUs) per customer and segment market shares and track the penetration of new services into the installed base. They will also have greater sensitivity to households and existing coverage areas, provide deeper insights into network utilization patterns such as urban versus non-urban traffic, and delve deeper into customers’ smartphone behaviors. Additional internal operational metrics will also help operators improve the customer experience, with more insights into quality of experience, and KPIs built on aggregated data drawn from a variety of systems and processes, such as service configuration, billing and customer care. Trusted to be secure but blamed for breaches Carriers should be well placed to help users address these threats, since they are regarded as more trustworthy than other service providers, such as social networks. Yet customers hold operators responsible for threats or attacks from third parties and suppliers  even including mobile malware and rogue apps. At the same time, privacy concerns hamper service innovation. For example, location-sensitive data can support advertising-based revenue models but may raise concerns around customers’ privacy. Figure 21. User perception of responsibility for mobile security19 9 Privacy, security and resilience Unexpected items on bill SMS text phishing Unsolicited messages/spam Malware/viruses Rogue apps that can steal data/spy 0% Carriers Content/app provider 55 54 46 36 74 8 7 11 10 50% 6 9 11 15 18 23 37 22 21 20 17 100% This risk area has risen by one place since 2010, reflecting the conflicting pressures that operators face. On the one hand, operators are widely regarded by customers and business partners as security guarantors across a range of services. On the other, they have to try to fulfill this role while coping with an array of threats that are expanding rapidly in number and severity. The challenges are compounded by rising concerns among customers. As mobile phones evolve into personal data hubs, end users are facing privacy and security dangers that are escalating and multiplying, as threats converge from a range of environments, including SMS, cloud, Web 2.0 and mobile apps. As a result, customers are now as concerned about data integrity as call quality (see Figure 21). Mobile handset manufacturers Me/the individual A recent survey by Futuresight for the GSMA highlighted privacy issues. The survey showed that a large majority of mobile users in developed markets feel uncomfortable with personal data being collected and repurposed by applications or shared with third parties for promotional purposes. It also found that four out of five end users believe safeguarding their personal information is very important, with customers voicing concern about areas such as targeted advertising, location-based services and third-party information-sharing. 19Adaptive Mobile, “Mobile Trust & Security Barometer — US,” September 2011 (survey consists of online interviews with 2,000 smartphone users). 19 Top 10 risks in telecommunications 2012 New definitions — new responsibilities To manage the resulting risks effectively, operators should bear in mind that concepts of digital rights are an emotive issue for customers and that national security considerations are rising in importance. The picture is further complicated by the fact that the nature and scale of security concerns vary for different customers and stakeholders, such as consumer, enterprise and government. At the same time, changing definitions of privacy and security are creating new responsibilities for the sector. In response, operators need to work closely with governments to define clearly their responsibilities regarding content and data, such as anti-terrorism measures and content for children. Operators should adopt a similarly collaborative approach with suppliers and partners, working with them to tackle privacy and security issues in new service areas (cloud security, mobile apps). Emerging service types such as mobile money and M2M connectivity will require new approaches to ensure solutions are secure. Data retention is a particularly sensitive issue, with a wide range of related effects (see Figure 22). Figure 22. Key issues in data retention regulation Conditions of access to and use of retained data 10 Lack of organizational flexibility This risk is new to our top 10 this year, driven by the need for operators to develop more agile organizations that can execute their new strategies. With their organizational structures now subject to various forces, including the shift to data services, the rise of partnering and the growing imperative for speed-tomarket, operators have already made significant changes to their organizations. But more are needed. The changes to date include a concerted sector-wide move away from product-based structures and toward segment-orientated organizations. New business units have also been created to investigate and exploit new growth areas (see Figure 23). However, the forces affecting organizational structures continue to change and strengthen. These forces include intensifying regulation of many incumbents’ domestic businesses, fastchanging levels of market maturity across different regions, and the need for in-market and cross-border efficiencies in fastchanging areas of demand, such as enterprise ICT, smart services and fixed/mobile bundles. Figure 23. Carrier organizations — sample new business units20 Date Operator New Unit Digital Services Notes Driving growth in internet-based ecosystems. Includes existing businesses such as Telenor Next and Comoyo Sep 11 Telenor Period of data retention Timing of implementation Regulatory issues Cost reimbursement of service provider compliance Group New unit established to drive Industrial operational efficiency, crossDevelopment market streamlining and other synergies Sep 11 Telefonica Telefonica Digital Headquartered in London, with 2,500 employees from Global Services unit, Jajah, Telefonica R + D among others New operating unit designed to leverage economies of scale and drive transformation into fully global company Merger of existing sales and retail customer service Delineating data types according to type of operator External attitudes to data retention, e.g., end users, privacy groups Global Resources Jul 11 Telstra Customer Sales and Service Applications Created to spearhead investment and Ventures in new and emerging broadband businesses 20Operators, Ernst & Young research. 20 Top 10 risks in telecommunications 2012 Further refinements needed for new market dynamics Given these forces, operators have to work out how they can best align their business units to maximize the economies of scale and scope in their geographic footprints. To do this, they must revisit their combinations of regional and globally integrated structures and devise new organizational constructs that reconcile global strength with important local market factors — such as a unified customer view and collective purchasing power. Four options for operators’ organizational structures are shown in Figure 24, and the outcome for most operators is likely to reflect a balance between all of these. In achieving the right structure, flexibility and pragmatism will be essential. Segmentation strategies should recognize that the boundaries between customer types will remain blurred, while regular large-scale restructuring is impractical and prohibitively expensive. Figure 24. Options for operators’ organizational structures Segment-based Consumer Enterprise Wholesale Fixed Product-based Mobile Other Function-based Finance HR Operations Geography-based Domestic Regional Int’l 21 Top 10 risks in telecommunications 2012 What’s below the radar? The top 10 1 Failure to shift the business model from minutes to bytes 2 Disengagement from the changing customer mindset In addition to identifying the top risks, we also asked our telecoms commentators to identify risks that sit directly “below the radar,” and which may rise up the agenda in years to come. The four risks they highlighted are split evenly between the categories of compliance, operations, financial and strategic. Below the radar — the next four risks service cannibalization 11 Evolving scenarios This represents a new below-the-radar risk for 2012. New types of cannibalization are appearing, such as the rapid rise of mobile instant messaging as an alternative to SMS. Operators need to anticipate and manage such trends by moving beyond legacy assumptions about users’ behavior. 3 Lack of confidence in return on investment 4 Insufficient information to turn demand into value 5 Lack of regulatory certainty on new market structures 6 Failure to capitalize on new types of connectivity 12 A more pressing green agenda The green agenda is now top of the sector’s below-the-radar risks. Operators should move beyond regulatory compliance and ensure that they begin to differentiate themselves in customers’ eyes through greater sustainability. 7 Poorly formulated M&A and partnership strategy 8 Failure to define new business metrics 9 Privacy, security and resilience 10 Lack of organizational flexibility 11 Evolving service cannibalization scenarios 12  A more pressing green agenda 13  Concentration of equipment vendors 14 Difficulties in managing debt and cash 13 Concentration of equipment vendors Consolidation is an ongoing feature of the telecoms equipment market  and M&A activity in the device and equipment market remains high in 2012. Operators need to ensure they are not overly reliant on any single equipment manufacturer. 14 Difficulties in managing debt and cash Operators entered the economic crisis in better shape than other sectors due to their balance sheet repair efforts in 2002–03. But a more constrained environment is now putting new financial demands on the sector. More defensive capex programs are helping to maximize operating cash flow, and current net debt/EBITDA levels remain strong, with the European average currently around 2.0x. 22 Top 10 risks in telecommunications 2012 Difficulties in managing debt and cash A more pressing green agenda Fi n ial c an Lack of regulatory certainty on new market structures Lack of confidence in return on investment Failure to shift the business model from minutes to bytes Co m pl Failure to define new business metrics Privacy, security and resilience e nc ia Disengagement from the changing customer mindset Failure to capitalize on new types of connectivity Insufficient information to turn demand into value Poorly formulated M&A and strategic partnerships eg ic Lack of organizational flexibility e Op Evolving service cannibalization scenarios Concentration of equipment vendors 23 Top 10 risks in telecommunications 2012 ra tio ns t ra St 24 Top 10 risks in telecommunications 2012 Global Telecommunications Center contacts Jonathan Dharmapalan Global Telecommunications Leader +1 415 894 8787 [email protected] Holger Forst Global Telecommunications Markets Leader +49 221 2779 20171 [email protected] Prashant Singhal Global Telecommunications Markets Leader +91 124 671 4746 [email protected] Olivier Lemaire Telecommunications Leader — EMEIA +352 42 124 8356 [email protected] Luis Monti Telecommunications Leader — Americas +55 11257 33550 [email protected] David McGregor Telecommunications Leader — Asia-Pacific +61 3 9288 8491 [email protected] 25 Top 10 risks in telecommunications 2012 Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. About Ernst & Young's Global Telecommunications Center Telecommunications operators are facing the challenges of growth, convergence, business transformation, technological change and regulatory pressures in increasingly difficult economic conditions. Operators choose Ernst & Young because they value our industry-based approach to addressing their assurance, tax, transaction and advisory needs. They know that they’ve much to gain from our clear understanding of the opportunities, complexities and commercial realities of the telecommunications industry — wherever in the world they’re operating. What gives us this understanding is our Global Telecommunications Center. Operating from Paris, Johannesburg, Riyadh, Delhi and San Antonio, the Center brings together people and ideas from across the world, to help our clients address the challenges of today — and tomorrow. Our clients benefit from our insights on key trends and emerging issues — whether relating to the economic downturn, next-generation services, infrastructure sharing, outsourcing, revenue assurance, operational efficiency, regulations, future growth markets or mergers and acquisitions. So they can react to trends in a way that improves the financial performance of their business. www.ey.com/telecommunications © 2012 EYGM Limited. All Rights Reserved. EYG no. EF0102 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.