Telcos can raise profit by keeping it simple

Mobile broadband and some more expensive postpaid packages and add-ons often prove unprofitable. Akio Kon / Bloomberg

Profitability has slumped in the global telecoms industry over the past decade, as market saturation and increasing competition take their tolls.

To make matters worse, trying to satisfy customers’ seemingly insatiable appetite for data has driven up capital expenditure.

Many companies are now trapped between declining profitability and rising capital expenditure, a trend that calls into question the long-term viability of the business. To offset the necessary increase in capital expenditure, companies need to generate higher gross earnings.

Efforts have often focused on reducing the main categories of costs. This turns out not to be a sustainable method of solving the underlying problem. Slashing costs without close attention to a company’s strengths and long-term objectives can lead to diminishing returns and stifle growth. At the same time, aggressive pricing strategies replete with device subsidies, constant promotions and larger data allowances have negligible effect on revenue growth, but damage profitability.

Companies should adopt a different approach. They should examine then restructure their product portfolio. Only then should they rationalise infrastructure projects, and back-end and market-facing operations — the latter including distribution costs, customer care, marketing. This process ensures that spending and investment are aligned with growth strategy, rather than being treated as items detached from the overall business.

The aim of this portfolio revamp is to devote more attention to profitable products and those with the most growth potential, improve the less profitable ones, and eliminate the losers.

To understand where potential lies, companies need to analyse their offerings in great depth. Companies can use a tool kit that estimates direct and indirect costs for each product. It also allows companies to understand how much investment each product absorbs by calculating the long run incremental capital expenditure required for each asset, and then attributing an appropriate share of these asset items to each product. In this way, depreciation and amortisation can be accurately allocated.

For example, one Middle East telecoms operator was interested in developing an internet protocol television (IPTV) offering. Because of the considerable investment beyond the upfront fixed costs required to make the service available, a product analysis determined that the offering would lose money until it attracted a very large subscriber base.

The resulting product profitability report enables companies to determine how products contribute to company performance, and to predict how costs will evolve in the future.

What emerges can often surprise managers. Products assumed to be stars can turn out to be losing money. Mobile broadband and some more expensive postpaid packages and add-ons often prove unprofitable, while less glamorous products such as prepaid voice plans perform well.

The analysis can clear the fog and provide a course of action. One Middle East telecoms company, which was investing in fibre optics into the home, discovered that it was deploying infrastructure in regions that delivered a low rate of return. These investments resulted in just one quarter of relevant capacity being utilised, but absorbed about 60 per cent of total capital expenditure. More troubling is that this operator is not alone — the haphazard roll-out of fibre optic cable is crippling many telecoms operators in the other Middle East and western markets.

Before making a decision on overhauling the product portfolio, companies should perform a segmental and competitive analysis. These reveal all the revenue implications of a portfolio revamp, and reduce the risk that valuable customers will be lost in the fallout.

By estimating how various customer segments will react, companies can modify the details of products, prices and promotions. If the data usage of one customer segment is growing faster than the associated revenue, a tiered pricing model could be more effective for this segment. Likewise, if voice usage and the associated revenue from another segment are dropping, then flat-rate pricing and pre-bundled minutes could be the answer.

The competitive analysis then takes customers’ spending and usage into account, before highlighting any weaknesses in the portfolio or scope for targeted initiatives where there is a gap in the marketplace.

At the end of this process, companies can greatly simplify their offerings, a boon for management teams burdened by complexity. One leading European integrated operator was plagued by inefficiency because of convoluted service offerings. In one market, it was selling more than 200 mobile tariffs containing more than 63,000 specific offer elements, and was running more than 150 monthly promotions. The portfolio analysis led to the company eliminating more than half its products and three-quarters of its promotions, leading to an increase in gross earnings of more than $100 million within a year.

The current telecoms industry business model will prove unsustainable if gross earnings do not show such improvements. Only by evaluating then revamping their product portfolio, and then in turn making the necessary changes to operations and infrastructure, can telecoms companies ensure their long-term viability.

Chady Smayra is a partner with Strategy& (formerly Booz and Company); Lancelot Sursock and Antoun Halabi are principals with the same firm.

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