volume 5: summer.08 It becomes necessary · Android, an open source mobile platform that marks a significant shift ... Operators who adopt this platform strategy are likely to see

Capgemini’s telecom

, media &

entertainment journal

volume 5: sum

mer.08

volume 5: summer.08

Capgemini’s telecom, media & entertainment journal

Making of Strategy

Internet TV

Private Equity

Online Advertising

Open Mobile Ecosystem

“”

It becomes necessary for ad agencies to re-examine their business model

—Olivier Fleurot, Executive Chairman of Publicis

Mobile 2.0: Strategies for Operatorsin an Open Mobile Ecosystem

Internet TV: Evaluating theDisruptive Potential in WesternEurope

Online Advertising Opportunities:A Telco Value Chain Analysis

Mobile Internet Services in Europeand USA: Initiatives to DriveAdoption and Usage

The Making of Strategy:Formulating Strategies in aStructured Manner

Private Equity: Strategies forWeathering the Storm

Telecoms in Africa: ReachingConsumers in “Constrained Markets”

Better Global Sourcing of Services:Frameworks for TME Players

Paying for Mobile Data, GoingOnline and All About Devices

CONTENTS

management insights

lite bytes

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industry insights

editorial

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Welcome to the Summer edition of Insights.

The Internet is emerging as the platform of choice for content delivery. Traditional media players are makingaggressive online forays, seeking a share of shifting consumer attention and advertising spend. Devices are playinga pivotal role in driving convergence, with the rapid development of consumer electronics and the emergence ofhandset vendors as service providers. These developments are disruptive to many industry players and success willdepend on the creation of innovative business models centered on collaboration rather than competition.

We start our Industry Insights section with an assessment of the potentially disruptive development of openmobile ecosystems that could significantly impact the control that mobile operators have over the consumerexperience. Our second article details developments in Internet TV, and investigates whether it could be utilizedby content players to reach consumers directly, disrupting existing broadcasting business models. Advertisers’spend is increasingly shifting online, and telcos are looking at this space as a potential area for diversification,which led us to evaluate the opportunities for telecom companies in the online advertising business. Finally,we investigate initiatives to drive the uptake of mobile Internet services in Western Europe and USA.

In an industry faced with dramatic change, players will need to develop radical strategies to effect sweepingchanges in their business models. In our Management Insights, we first propose a framework for strategydevelopment, leveraging our ongoing work in collaboration with business school INSEAD. A number ofmacroeconomic developments are posing key challenges to the private equity industry, and our next paperidentifies some strategies for private equity players to sustain growth in a time of uncertainty and slowdown.For Telcos in developed countries, emerging markets in Asia and Africa which are at the cusp of rapid growth inmobile services, continue to remain attractive expansion areas. Therefore, the next paper highlights the keychallenges ahead in these affordability-constrained markets and details strategies for profitably delivering mobileservices in Africa. We close the journal with an article on how industry players could decide on a model forglobal sourcing.

I hope you find this edition of Insights thought-provoking and appealing. If you would like to discuss any of theissues raised, please feel free to get in touch.

Didier BonnetManaging Director, ConsultingTelecom, Media & Entertainment

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initiatives from challenger operatorsseem to also have had an impact onmobile operator strategies. In Europe,operators are adopting open access incontrast to their erstwhile “walledgarden” strategies, and providingusers access to a set of externalapplications. Similarly, in the US,Verizon Wireless has announced thatit will open its network to externalapplications and devices1—asignificant shift from its policy sofar—to restrict applications anddevices that run on its network. Thesedevelopments appear to point towardsan open mobile ecosystem at eachstage of the value chain (see Figure 2).

In this paper, Capgemini analyzes thefactors that are leading to an openmobile ecosystem, and evaluates keystrategies for telcos to benefit from it.

Evolution to an Open MobileEcosystemThe mobile ecosystem is slowly, butdefinitely, changing in the way it hastraditionally operated. Initiatives thathave been taken by various playersseem to suggest that the ecosystem islikely to undergo a transformationthat it has not been seen in years (seeFigure 3). The pace of these changeshas been steadily increasing as moreplayers embrace the philosophy ofopening up networks and access.

Figure 2: Definition of an Open Mobile Ecosystem

Figure 3: Recent Initiatives Leading to an Open Mobile Ecosystem

An Open Mobile Ecosystem allows a consumer to access any application and content

on a device of their choice without binding them to any single network

Source: Capgemini TME Strategy Lab Analysis

Source: Capgemini TME Strategy Lab Analysis. Company Websites and News Releases

1 AOL News, “Verizon Will Open Network to All”, November 2007.

application itself are closely tied to thehardware specifications of the deviceand technical features of theoperators’ network, thereby restrictingreuse of applications and/or platformsacross device categories and operators(see Figure 1).

Recent industry announcements,however, promise to change themobile ecosystem by mitigating someof the controls at each stage of thevalue chain.

Companies such as Nokia and Googlehave launched multiple “over-the-top”services that directly interact with theend-user. Online players arestrengthening their capabilities totarget mobile users directly bylaunching application platforms. Forinstance, Google has introducedAndroid, an open source mobileplatform that marks a significant shiftfrom the proprietary platforms andoperating systems that dominate theindustry. Consumer demand and

nature, spawning an entire ecosystemof application developers and serviceproviders. On the contrary, in themobile space service innovation hashistorically been limited to initiativesled by the operator, and third partyapplication providers have little directaccess to end-users. Moreover, thedevelopment process and the

The mobile industry has remained aclosed ecosystem where operatorscontrol almost all aspects of theconsumer experience. This is in directcontrast to the fixed PC and Internetworld where access providers havehad little control over the applicationsthat are consumed by the end-user.Fixed Internet thrives in its open

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Abstract: The mobile ecosystem has historically been a closed system with little choice for end-users when it comes to applications and serviceson handsets. However, recent initiatives by various players in the mobile value chain seem to suggest that these closed ecosystems are soon goingto be a thing of the past. Online players such as Google are coming up with open platforms that seek to create a level playing field for all playersby ensuring that preferential and discriminatory treatment of applications and services is done away with. Moreover, the emergence of deviceplayers as “service providers” is making a wide range of applications available to end-users with little intervention by telcos. These developmentsare directly impacting operators’ ownership of the consumer and their service delivery experience. Capgemini has identified three broad strategicoptions for operators in the evolving open mobile landscape. It is our recommendation that operators position themselves as platforms fordelivering a wide range of third-party and self-developed applications, and adopt a “compete-in-some, collaborate-in-some” model with thirdparties. Operators should open up network APIs, build common content platforms in collaboration with online players, and also partner with devicevendors for mutual benefit. Operators who adopt this platform strategy are likely to see maximum revenue uplift, without ceding a significantamount of control over the customer.

Mobile 2.0:Strategies for Operators in an Open Mobile EcosystemJerome Buvat, Tushar Rao and Varun Saxena

Figure 1: Key Differences between Fixed and Mobile Ecosystems


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common platforms is likely to giveway to a scenario where there are fewdominant platforms. These platformswill ensure that the much neededstandardization becomes a pervasivereality.

Operator Response to Consumerand Competitive PressuresHistorically, third-party applicationand service providers were limited intheir reach of consumers due toinherent limitations of the networks.However, mobile network technologyhas evolved significantly in the pastfew years and is expected to continue

evolving to offer higher speeds andlower data carrying costs. Networkevolution to High-Speed DownlinkPacket Access (HSDPA), which offersup to 1 Mbps throughput, iseliminating some of the earliertechnical constraints faced byunmanaged services such as VoIP.Evolution of network technology toHigh-Speed Uplink Packet Access(HSUPA), which offers average uplinkspeeds of 600 kbps and beyond islikely to ensure that technicalhindrances to deployment ofunmanaged services are removed.These advances in networktechnology are likely to encourageconsumers in increasing their usage ofmobile Internet.

Increasing Consumer InterestTowards Near-PC Experienceon MobileConsumers increasingly want seamlessaccess to their favorite online servicesthat they have been accessing via thePC, on their mobile phones as well.For instance, the top three websitesaccessed on Vodafone mobile Internetin the UK are Facebook, Google andBBC.13 Similarly, NTT DoCoMo’s datatraffic trends clearly show thatoperator “walled gardens” no longerfind favor with consumers. Over 70%of NTT DoCoMo’s i-mode traffic isgenerated by consumers accessingnon-official sites.14 Going forward, itis likely that consumers will want totreat the mobile Internet as anextension of its fixed counterpart andbrowse their favorite sites,disregarding operator owned portals.Such developing consumer browsingpatterns are likely to impact operatorchoice of ecosystem.

availability of applications to end-users. The Android OS is expected tobe available for free10, andconsequently device manufacturersstand to gain an immediate advantageas software costs typically make upbetween 10-20% of the total handsetmanufacturing cost.

Moreover, by ensuring that Androidcan run on low-end processors11

(at speeds of 200 MHz), and yetdeliver rich applications, Google islooking to tap the growing mid-rangehandset segment (see Figure 6),thereby reaching a wider audience.

In addition to these initiatives, AOLhas announced an open mobiledevelopment platform, while otherinitiatives that were started earliersuch as the LiMo foundation aregaining more traction with recentannouncements. For instance, LiMoreceived a boost in its efforts withVerizon Wireless’ recentannouncement of its decision tosupport it.12 The current industryfragmentation surrounding such

10 The Android OS kernel is expected to be distributed under an open-source licensing model. 11 PC Mag, “Hands-On Android Demo”, February 2008. 12 Business Week, “Verizon Snubs Google's Platform”, May 2008.13 Vodafone, “Unlimited Internet Access on Vodafone’s New Monthly Price Plans”, May 2008. 14 Telecoms Magazine, “Walled gardens come tumbling down”, August 2007.

Source: Capgemini TME Strategy Lab Analysis. Company Website

Figure 5: Architecture of Yahoo! ‘Mobile Developer Platform’

BY ENSURING THAT ANDROIDCAN RUN ON LOW-ENDPROCESSORS, Google is lookingto tap the mid-range handsetsegment

“”

Source: Haywood Securities Inc, “Intrinsyc Software - The Right OS at the Right Price”, November 2007

Figure 6: Mobile Handset Shipment Market Share Based on Type of Handset,Global, 2006-2008

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In this section, we analyze trendstowards openness across the valuechain (see Figure 4).

Increasing Availability ofUnmanaged ApplicationsOnline players are looking atreplicating their successfulad-supported business model in themobile space, which has hitherto seensubscription-based models. Theseplayers are looking to tap into aportion of the global mobileadvertising market, which is estimatedto be $10bn2-$19bn3 by 2011.Currently, unmanaged services fromonline players include Google Maps,Yahoo! Go, and Gmail. VoIP playerssuch as Skype have also entered thismarket with Java-based clients thatcan be used for making calls at lowrates.4 New players such as Nimbuzzhave launched integrated instantmessaging services that combinemobile VoIP with IM and file-sharing.5

Over the years, such applications areexpected to become morecomprehensive in their offerings andinclude mature VoIP/SMS services,video calling and mobile shoppingplatforms.

Advent of Multiple Device/NetworkAgnostic PlatformsWhile mobile advertising offerssignificant growth potential, onlineplayers will need to surpassformidable barriers. They need towork around the issue of hardwarediversity in the mobile devices space,which makes customizing applications

a challenging task. For instance, today,there exist over twenty major handsetmanufacturers developing hundredsof models on over six differentplatforms that include Symbian,Windows, Apple, and many otherproprietary platforms. Similarly,adapting applications to differentclasses of browsers with differentcapabilities, and collaborating withmultiple stakeholders also leads tosignificant delays and cost in makinga service available to a wide mobileaudience. It is estimated that the costof porting an application to eachhandset platform often amounts to asmuch as 60-80% of the actualdevelopment cost.6

To overcome limitations that arise dueto platform and device diversity,online players are looking at settingup open platforms that are built

ground-up with the specific objectiveof enabling wider availability of onlineservices.

Online players’ standardized platformsseem to be the early steps towards anopen ecosystem. As an example,Yahoo! has launched its MobileDeveloper platform, consisting ofmiddleware, device client and aSoftware Development Kit (SDK). Theinitiative is aimed at enablingdevelopers and publishers to taketheir services quickly across multipledevice models without incrementalcosts of development. The SDK can beused to write code “once” andefficiently publish applications andcontent across hundreds of devices7

(see Figure 5).

While Yahoo!’s initiative aims atcreating an OS and device agnosticaggregation platform, Google hasannounced the launch of a full-fledged software stack including anoperating system, middlewareplatform, development toolkit and keyapplications. The Android initiativewas announced in November 20078

and consequently an update of itsSDK was released in February 2008.9

Google has also facilitated the creationof the Open Handset Alliance (OHA),drawing in a number of handsetmanufacturers, operators andapplication developers to create anecosystem that promotes wider

Online players arelaunching open applicationplatforms THAT STRENGTHENTHEIR CAPABILITIES IN TARGETINGMOBILE USERS DIRECTLY

“”

Source: Capgemini TME Strategy Lab analysis

Figure 4: Changes Happening Across the Value Chain

2 Stanford Group Company, “Google Inc”, November 2006. 3 ABI Research, “Mobile Marketing and Advertising to be Worth $3 Billion by 1Q 2008”, April 2007. 4 Skype, “Skype Tests Software for Mass-Market Mobile Phones”, April 2008. 5 Washington Post, “Nimbuzz - VOIP/IM aimed at mobile and social networks”, May 2008.6 AOL, “Open Source Technologies: Powering the Mobile Experience – the AOL Perspective”, March 2008. 7 Information Week, “Yahoo CEO Jerry Yang: The Mobile Web Needs Openness”, January 2008. 8 CNET News, “Google launches its cell phone ambitions”, November 2007. 9 TG Daily, “Google pumps out updated Android SDK”, February 2008.

external content. Operators opting forthis strategy will allow most externaldevices on the network with minimalsubsidies.

This is a strategy that enablesoperators to have revenue upside fromthe increased usage of data services,by ceding significant amount ofcontrol across the value chain toonline players and third partydevelopers. The strategy does notentail any costs to acquire or developcontent, or to create and manage theaggregation platform. However, thisstrategy also leaves holes in itsmonetization potential by neglectingareas such as content revenues. Openaccess can also pose a threat ofcannibalization of existing revenuestreams of operators, especially invoice and messaging by third-party“over-the-top” communicationservices.

Differentiated Network AccessWith the “Differentiated Access”strategy, operators go a step furtherfrom playing the role of anapplication-agnostic access provider,by creating distinct service pipespriced at different levels for the end-user. Operators can offer multi-tieraccess plans, which users couldchoose from depending on theapplications they wish to consume.For example, subscribers who wish touse mobile Internet only for browsingand other basic Web applications canchoose a low-priced basic data planwhich blocks VoIP and bandwidth-intensive applications such as videostreaming; while users who wish toaccess a wide range of advancedservices such as VoIP, over-the-topvideo and file sharing could buy apremium data subscription.

and entry of open platforms such asAndroid will ensure that even entry-level mobile devices have a rich set ofbase features.

These developments will have asignificant impact across the valuechain as it gradually opens up,operators will start experiencingtangible loss of control over thecustomer service delivery experience.

The Road Ahead for MobileOperators The emergence of an open mobileecosystem is posing new challengesfor operators in terms of their strategicpositioning in the value chain.Operators may need to forego theircontrol over the value chain, andadopt an “open” strategy allowing awide range of external applicationsand devices over their networks. Oneof the foremost issues facing mostoperators is whether they shouldallow external applications anddevices on their networks, andprovide them access to core networkfunctions; and if so, how to mitigatethe risks associated with adopting anopen strategy. Operators need tounderstand this new context that theyare operating in and redefine theirrole. Capgemini has identified threepossible positioning choices formobile operators (see Figure 9).

Possible Options for MobileOperatorsWith these positioning choices,operators have three associatedoptions (see Figure 10).

Open Network AccessThe “Open Access” option is the moststraight-forward of the three options,and is analogous to the role of anInternet service provider in the fixedspace where operators offerapplication-agnostic network accessthat supports all kinds of applicationsand end-user devices. The operatorextends its access network to all third-party “over-the-top” services and playsno role in provisioning or billing ofexternal applications. The operatoralso stays away from participating incontent and application developmentor creating aggregation platforms for

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Figure 9: Possible Strategic Positioning Choices for Mobile Operators

THE ADVENT OF OPENECOSYSTEMS will result in adefinite erosion of operatorcontrol over the customer

experience

“”

to open platforms, driven by acombination of consumer, competitiveand regulatory pressures.

Open Ecosystems Facilitated byDevice DevelopmentDevice development has advancedsignificantly in recent years to catchup with the proliferation of advancedmobile services. Device capabilities inthe three core areas of processingpower, storage capacity and batterylife have been increasing rapidly. Acase in point is the Apple iPhoneavailable with storage of 16GB, ahealthy battery life and a powerful400 MHz processor that runs anadvanced operating system (OS-X) onthe phone.17 Device manufacturersare recognizing the shift to open

Operators are Introducing OpenInternet PlansOperators are responding to thegrowing data needs of consumers bycoming up with flat-rate plans. Forinstance, in the UK Vodafone and 3have announced that they will beoffering flat-rate data plans providingunlimited usage to the consumerwithin fixed monthly data limits (seeFigure 7).

Operator flat-rate plans also comewith restrictions in place. Forinstance, Vodafone in UK does notallow VoIP, IM, P2P15 file sharing, andusing the phone as a modem in itsflat-rate plans.16 However, goingforward, it is likely that true flat-ratepricing with minimal restrictions onnetwork usage will be in place.Flat-rate pricing has also led to a steepfall in the absolute cost of data. Forinstance, in Italy, the cost per MB ofmobile data has fallen from €0.04 in2006 to €0.01 by 2007. Similarly, inGermany, price per MB has comedown from €0.33 to virtually zero,due to the enhanced data traffic limits.

Operators are Opening Networks toExternal Devices and ApplicationWhile most operators are coming upwith flat-rate data plans to encourageactive uptake of mobile data services,a few are realizing the customerdemand for greater access to theirfavorite applications and onlinecontent, and responding to the same.For instance, in the US, operatorssuch as Verizon Wireless and AT&Thave announced that they will beopening their networks to externaldevices and applications (see Figure8). While this may imply erosion incontrol of the consumer experience,operators are leaning towards openingtheir networks in search of a first-mover advantage. By opening theirnetworks, operators are addressingcompetitive and regulatory pressure aswell as customer concerns.

In the coming years, consumerdemand towards a seamless Internetexperience is only likely to growstronger. It is also likely that moreoperators will actively consider a shift

ecosystems and participating activelyin it. Nokia has released anapplication development tool for itsSeries 60 based phones that run onspecific chipsets from TexasInstruments. Similarly, Apple hasreleased a software development kitthat enables external developers towrite applications for the iPhone.Such toolkits help in simplifying theprocess of simulation, testing andporting applications for the developercommunity.

Going forward, advances in devices,enabled by open architectures andpublic software development kits, arelikely to ensure a significantlyintegrated user experience. Alongside,declining costs of electronic hardware

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Source: Capgemini TME Strategy Lab Analysis. Operator Websites

Figure 7: Evolution of Price per MB of Mobile Data Traffic, UK, 2005-2008

Source: Capgemini TME Strategy Lab Analysis. Company Websites

Figure 8: Key Features of Open Access Initiatives of Verizon and AT&T

15 Peer 2 Peer, a system of direct connectivity between two consumer devices. 16 Forrester, “Mobile Internet Pricing Strategies Mature”, July 2007.17 Tech Radar, “Apple iPhone-Our Review”, November 2007.


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Figure 12: Key Initiatives towards Developing a Telco Platform


Operators need to clearlyunderstand THE RISKS ANDREWARDS OF OPEN ECOSYSTEMSAND ADAPT ACCORDINGLY”


“

messaging, user authentication,location and presence. Operators canalso provide billing and hostingplatforms for third-party applicationsand content. In doing so, operatorsnot only mitigate the risks of their“on-deck only” strategy, but also openthemselves up to gaining richercustomer insights. Operators alsohave the option of working withhandset manufacturers in customizingtheir devices to ensure easier access tocontent and applications from theoperator as well as its partners.

This strategy not only offers scope forsignificant revenue uplift, but alsoretains operator control over asignificant part of the consumerservice delivery experience. Byworking in close association withcontent and application providers inidentifying and monetizing newerrevenue streams, operators stay at theforefront of innovation in the mobileecosystem. However, operators willneed to invest significant resources inbuilding capabilities around platformsand developer communities.

At the same time, the operator alsopartners with specific online playersin introducing services that come witha guaranteed level of Quality ofService (QoS), and are much moreintegrated with operator offerings.Operators then take a proactive role inmanaging such services by taking careof issues such as handset integration,billing and customer service, andsharing any consequent revenueuplifts with the online player.

This strategy offers significantly moreoptions for revenue uplift than what“Open Access” offers. By tying upwith online players in buildingadvanced services, operators ensurethat the extent of control over thecustomer experience that they cede ismatched by a corresponding rise inaccess and content revenues.Moreover, operators also reduce therisk of possible cannibalization thatsome services could have on theircore revenues.

Telco as a PlatformThe “Telco Platform” strategy presentsa significant shift in the way currentnetworks operate. Operators adopt a“compete-in-some, collaborate-in-some” model with regards toapplications and content. Operatorspartner with third-party applicationdevelopers and content players, whilstalso offering their own portals toconsumers. Third party applicationsare granted full access to networkfeatures, while being kept under theambit of a fair usage policy. Operatorsoffer APIs to help third partydevelopers build services around corenetwork features such as voice,

Figure 10: Comparison of Operator Benefits from the Various Strategic Options

Operators should positionthemselves as platformsTHAT ENABLE DELIVERY OFAPPLICATIONS AND CONTENTWITHOUT DISCRIMINATION

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the external developer community.Some operators such as Orange havealready launched initiatives such asthe Orange Partner Program to attractthird-party developers.

In conclusion, the mobile industry isbound to see a major disruption withthe unshackling of operator controlsover the development and delivery ofapplications. These changes threaten tobypass those that choose to ignore themand reward those that welcome them.Operators and other stakeholders alikewould do well to adapt themselves tothese changes in order to ensure thatthey stay relevant in the new mobileworld order. Operators are bestpositioned to play the role of enablers,by unlocking their network and dataassets to third-parties, and in theprocess, creating value in terms ofadditional revenues. Operators willneed to plan a clear roadmap intransforming themselves from deliveryplayers to platform providers.

Jerome Buvat is the Global Head ofthe TME Strategy Lab. He has morethan ten years’ of experience instrategy consulting in the telecom andmedia sectors. He is based in London.

Tushar Rao is a manager in the TMEStrategy Lab. His recent work focusedon analyzing disruptive technologies inthe broadcasting and mobile segments.Prior to joining the Lab, Tushar workedwith a leading converged operator inIndia, where he was responsible fordeveloping managed data services forenterprises. He is based in Mumbai.

Varun Saxena is a consultant in theTME Strategy Lab. His recent workfocused on advising a leadingconverged operator in Europe on itsonline advertising business. He isbased in Mumbai.

Benefits of Adopting the PlatformStrategyOf the three strategic positioningchoices that operators have beforethem, the platform strategy offersmaximum revenue uplift, withoutceding significant strategic controlover the value chain. While there areinvestments involved in embracingthis platform fully, these costs areimperative to position operatorsstrongly in the value chain as “serviceenablers” for the mobile platform, incontrast to reducing them to simpleutility providers.

Our estimates indicate that anoperator in the UK with a marketshare of 20% could look at a netrevenue uplift of 12% by 2011, bycarefully adopting the platformstrategy after considering any possibleerosion of core revenues by over-the-top services (see Figure 11). Asignificant portion of these revenuescould come from data traffic upliftdriven by a rich suite of third-partyapplications available on the operator’sopen platform. In addition to accessfees, operators can accrue a 5%revenue uplift from billing of third-party applications and by providingopen APIs for authentication andlocation information for end-users.

However, these revenue streams areonly indicators of the possible valueoperators could unlock, as they can alsoleverage the vast authentication andlocation information to tap the high-growth mobile advertising opportunity,both through direct advertising as wellas third-party partnerships.

Recommendations for TelcosWe believe that leading mobile telcosin Europe should open their networksto third-party applications andcontent, and allow a wide range ofexternal devices on their networks.

Towards this, operators should plan aclear roadmap for deployment oftechnologies such as IP MultimediaSubsystem (IMS), which abstracts theapplication layer from networks, andcreates open interfaces that allow coreinformation to be made available toapplications in a standardized manner.Operators will also need to take stepsto promote their platforms amongst

Operators should create platformsaround their unique assets, and addvalue to the user experience byenabling and delivering externalcontent and applications.

For most telcos, this will requireconsolidation of their core data assetsrelated to subscribers such asdemographics, authentication, creditinformation, usage patterns and socialnetworks. Such information is oftenspread across disparate systemsacquired over time, and is oftenavailable in non-standard orproprietary formats that cannot bedirectly used by applications.Operators will need to make openAPIs available to the externaldeveloper community for location,presence, authentication and otherdata repositories (see Figure 12).

Figure 11: Potential Revenues in 2011 for an Operator Adopting the PlatformStrategy (Assuming an Index of 100 basis points)

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Internet TVPlayers ARE INCREASINGLY OFFERING

MAINSTREAM CONTENT

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Figure 1: Select Launches of Internet TV Services, Worldwide, 2005-2007

Note: IPTV is the delivery of video content using closed network infrastructure while Internet TV is the delivery of video content over an open InternetSource: TME Strategy Lab Analysis; Company Websites. Note: (a) Due to the fundamentally different nature of the content involved, User-Generated Content (UGC) has not been addressed in this study

A number of content producers havealso begun collaborating to launchshared online platforms to expand thereach of their premium TV content.Hulu, for example, is an online portaljointly developed by NBC Universaland NewsCorp, offering consumersfree premium ad-supported contentfrom content producers such asNational Geographic, Sony Picturesand MGM.

Recent developments in set-topdevices are also enabling theconsumption of Internet video on TV

1 Note: An online TV stream is a continuous flow of multimedia content delivered in real-time to the end user. It is not permanently stored on the PC.2 Source: FierceIPTV, ”US Internet TV usage surges”, Feb 2008.

Comcast and Sky who own premiumvalued content have also startedoffering Internet TV services (seeFigure 1).

Not only are an increasing number ofInternet TV services being launched,the content now available online isalso of greater appeal to viewers. MostInternet TV specialists began by onlyoffering niche content; however, theyare increasingly offering mainstreamcontent on their online TV platforms.AOL Video, for example, struckcontent distribution deals with Disneyand ABC to stream full-lengthpremium shows the day after theirtelecast on broadcast TV. Contentproducers who initially offered onlyshort video clips have also begunoffering full-length premium content.In 2007, for example, CBS beganoffering full-length episodes frompremium shows such as DesperateHousewives and the Apprentice on itsInternet TV service.

In this paper, Capgemini’s TMEStrategy Lab assesses the likely impactof Internet TV on the Pay TV andIPTV market. We first discuss the keybarriers impeding consumer uptake ofInternet TV services, and assess whenthey are likely to be overcome. Next,we question the validity of thebusiness case for content producersoffering Internet TV services, andfinish by outlining a set of pragmaticrecommendations for contentproducers, established Pay TVoperators and telcos.

Players are Launching IncreasinglyComprehensive Internet TVServicesInternet TV has seen significantactivity from both online players aswell as content producers. In recentyears, a host of “Internet TVspecialists” such as Babelgum, Joostand Vuze have launched platformsoffering niche and mainstream TVcontent on the Internet. In addition,content producers such as Disney,

The Internet is fast-emerging as a newplatform for consuming TV content.In addition to the plethora of user-generated content already available,recent initiatives by content producersand online players have enabledconsumers to view full-length,professionally produced TV contentdelivered over the open Internet totheir PCs via their web browser orthrough dedicated applications suchas the BBC’s iPlayer. In addition,players such as Apple are enablingcustomers to view Internet-deliveredTV on their TV sets through set-topboxes and devices which stream anddownload TV content.

While uptake of Internet TV to datehas been predominately limited toearly adopters, content producerscommanding reach and offeringvalued premium content have thepotential to disrupt the established PayTV market by collaborating together tojointly offer Internet TV services directto consumers’ TV sets.

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Abstract: Internet TV offerings are becoming increasingly comprehensive. Initial uptake suggests consumer receptivity to theseservices is growing. While some players are striving to understand how best to tap into opportunities afforded by Internet TV, othersare grappling with how to mitigate the perceived threat to their own services. Capgemini’s TME Strategy Lab believes that contentproducers—through a collaborative offering—can offer a compelling Internet TV service directly on consumers’ TV sets. We believethat there is a business case for providing Internet TV services, if key service delivery issues surrounding access bandwidthlimitations, delivery architectures and limited availability of devices can be overcome in the medium-term. Indeed, we estimated thatan Internet TV offering launched jointly by content producers in the UK, for example, could garner a customer base of around one anda half million households, commanding annual revenues of over € 200 million and delivering a profit margin of up to 17% by itsfifth year of operation. Content producers, established Pay TV operators and IPTV players must work quickly to map out clearstrategies to accrue maximum benefits from Internet TV. We recommend that content producers work together to ultimately offer set-top-box based Internet TV services. Established Pay TV operators should use Internet TV to both capture a share of Free TV marketsand complement their own services, while telcos should work to develop wholesale propositions around managed video deliveryservices and leverage Internet TV to extend their IPTV reach.

Evaluating the Disruptive Potential of InternetTV in Western Europeby Jerome Buvat, Tushar Rao and Alex Kitson

sets rather than PC screens. The AppleTV device, for example, links the PCand TV, allowing users to watchdownloaded content on their TV sets,while the Babel TV set-top-box andselected Sony Bravia TVs enable directstreaming of content from the Internetto TV sets.

Initial Consumer Uptake of InternetTV Services has been EncouragingThe increasing array of Internet TVservices along with the growing rangeof premium content is driving bothsignificant uptake and usage of

Internet TV. In the UK, between 2006and 2007, the number of Internetusers watching TV online increased byover 50% to nearly 3 million users(see Figure 2). During the sameperiod, the number of online TVstreams1 watched grew even morestrongly by 75%, suggesting viewersare also becoming heavy users.Similarly, in the US, 43% of viewersreported to have watched TV online in2007, up from 25% in 20062.

Some players in particular have seenstrong uptake of their Internet TV

We expect bandwidth-relatedconstraints to be resolved as speedsavailable to the end-user evolve andadvanced compression standardsreduce bandwidth requirements.Operators in Europe are upgradingaccess networks to provide speedsupwards of 24 Mbps to a largepercentage of households. Operatorsin France and Belgium are rolling outfiber to the node (FTTN), while in theUK, BT has commenced deploymentof fiber to the home (FTTH) in selectgeographies.7 As a result of suchinitiatives, the average maximum DSLdownload speed in Western Europe isexpected to grow to 15 Mbps by2010, and 30 Mbps by 20128.

In mature broadband markets such asthe UK, for example, initial telcoresistance to Internet TV is likely to beresolved in the medium-term. Inaddition to growing access speeds, it islikely that government regulation willprevent telcos and ISPs from blockingvideo traffic. Further, contentproducers will be able to exertconsiderable pressure against throttlingof their Internet TV services, given thattelcos must depend on them forcontent for their IPTV offerings.

Content Delivery Network (CDN) isEmerging as the Architecture ofChoice for Delivering Video Content Internet TV providers will have tochoose an optimal distributionarchitecture for delivering video overthe open Internet. Hybrid P2P offersplayers with a low cost architecture forstreaming content; however, it canmaintain high quality of services onlyfor an extremely high user base andpopular content. Content DeliveryNetwork9, on the other hand, isemerging as the most suitable choice, asit provides the desired quality of servicefor both streaming video and on-demand services (see Figure 4). InternetTV players such as Jump TV andYouTube have built CDN architectures;however, despite its benefits, even CDNfalls short of offering linear TV servicesover the Internet.

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average actual broadband speeds fallsignificantly short of the 3 Mbpsrequirement for Internet TV deliveredon a TV set (see Figure 3). Moreover,contention ratios in some geographiessuch as the UK are as high as 50:1,resulting in a wide gap between actualavailable broadband access speeds andthe maximum possible speeds. Over60% of broadband users, for example,have experienced speeds less than halfthose advertised6.

Moreover, telcos and ISPs arebecoming increasingly concernedabout capacity requirements of high-bandwidth applications such asInternet TV. Companies such asComcast in the US are alreadyimplementing “traffic-shaping”measures to prioritize other trafficover peer-to-peer video, whilenumerous other companies areimposing fair usage limits oncustomers, thereby discouraging largevideo downloads. As a result, InternetTV companies may find it difficult toensure access bandwidth forbroadcast-quality TV services.

offering Internet TV directly toconsumers’ TV sets.

Only once players have addressedthese key questions will Internet TVbe capable of increasing itspenetration and impact video ondemand revenues of the establishedPay TV and IPTV market. In the restof this section, we assess when thesekey service delivery issues are likely tobe overcome, and as an illustration,quantify the potential uptake andrevenue evolution of an Internet TVoffering launched jointly by contentproducers in the UK over a five yearperiod.

Service Delivery Challenges areExpected to be Resolved in MediumTermSufficient Access Bandwidth is Expected to Become Available After taking contention ratios5 intoaccount, access speeds currentlyavailable in Western Europe are barelysufficient to deliver standard broadcast-quality TV content on a TV set, letalone HDTV. In Italy, for example,

services. Online players such as AOLVideo, for example, which launchedin mid-2006 and offers content fromNBC, Fox and ABC receives around19 million visitors per month.Similarly, Vuze which launched inearly 2007 and has contentpartnerships with the likes of NationalGeographic and the BBC has aninstalled base of over 10 million users3

for its software application. Certaincontent producers have also seennotable successes. Disney registered200 million streams in August 2007from its video service which was re-launched in early 2007 with enhancedcontent.

The Disruptive Potential ofInternet TVWhile there have been a number ofpromising recent developments in theInternet TV services space as well asencouraging initial uptake from early-adopters, Internet TV services willonly become mainstream oncecompanies are able to deliver highquality services to viewers’ TV sets asopposed to the predominately PC-based services available today. In asurvey in the US, respondentsoverwhelmingly favored TV sets forwatching Internet TV. Over 80% ofrespondents aged above 35 yearsprefer to watch Internet TV on a TVset, while 60% aged between 18-24years prefer a TV set for watchingInternet TV4.

However, Internet TV providers faceseveral challenges in the delivery ofTV services to the living room. Theseinclude access bandwidth constraints,challenges around the suitability ofdelivery architectures, as well as issuesaround the basic feature set ofInternet TV devices. In addition tothese service delivery challenges,content producers wishing to offerInternet TV services also need toexamine the business economics toensure there is a compelling case for

Source: Capgemini TME Strategy Lab Analysis. Continental Research “Internet & Convergence Report”, Autumn 2007; ScreenDigest, “Online TV: prospects for the UK market”, October 2007

Figure 2: Uptake and Adoption of Internet TV Services, UK, 2006-2007 Figure 3: Broadband Average Actual Bandwidth Speeds (Mbps), Western Europe,2007

Source: Capgemini TME Strategy Lab analysis; Zdnet, “Watchdog condemns broadband-speed claims”, August 2007;BBC, “World Broadband Speeds”, December 2007; BBC, “Government cracks broadband whip”, December 2007. Note (a): Standard definition resolution video delivered over Internet and viewed on a TV set

Figure 4: Comparison of Delivery Architectures for Various Content Types

Source: Capgemini TME Strategy Lab analysis. iDATE, “IP Video Distribution”, June 2007

3 Source: Business Wire, “Vuze Passes an Installed Base Milestone of 10 Million Viewers and Opens Its Internet Publishing Platform to Networks, Studios, and Content Creators “, October2007.

4 Source: eMarketer, “Online Video: Making content pay”, August 2007. 5 Note: Contention ratio describes the maximum number of users sharing the bandwidth of a broadband connection between the local exchange and broadband provider. With a 50:1

contention ratio, one dedicated access line could be shared by up to 50 users.6 Source: Zdnet, ”Watchdog condemns broadband-speed claims“, August 2007; BBC, “World Broadband Speeds”, December 2007; BBC, ”Government cracks broadband whip”,

December 2007.

7 The Guardian, “BT bets its future on broadband 20 times faster than now”, January 2008.8 Deutsche Bank,” The Digital Content Wave”, January 2007.9 Note: Content Delivery Network (CDN) is a video distribution technology which localises content caching with servers deployed at locations closer to the user. Users receive streams from

the closest caching server and route optimization techniques are used to ensure quality of service.

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rental model will lower entry barriersfor consumers who are not willing toinvest around € 150 to € 200 upfrontin procuring the STB. The smoothfunctioning of Internet TV will ofcourse depend on the mitigation of anumber of the key service deliverychallenges already discussed10.

Consumer Uptake is Likely to GrowStrongly Although Penetration willRemain LowContent producers launching such anoffering in the UK are likely toincrease Internet TV penetration froma low base of 1% of all TV householdsin Year 1 to 5% in Year 5,representing over 1.3 millionhouseholds (see Figure 5). As deliveryissues gradually become resolved andon-demand premium contentbecomes available at lower costs, weexpect uptake to increase rapidly, withannual subscriber growth rates of upto 55% between Year 1 and Year 5.

Existing free-TV households will formthe primary target segment forInternet TV services, as it will allowfree TV subscribers to upgrade to on-demand content offerings at aminimal incremental cost (see Figure6). Free TV households will be able towatch premium content at a fractionof Pay TV subscription fees, since adrevenues will subsidize the cost ofoffering. A small proportion of Pay TVhouseholds can take up the service aswell, but mainly for the purpose ofupgrading secondary TV sets ratherthan replacing their existing Pay TVsubscriptions which have widerpremium content offerings at aproportionately higher monthly fee.

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genre allowing easier search andcontent selection. Also, searchalgorithms based on analyzing videotags or “metadata” are beingdeveloped, which are more suited tosearching through large volumes ofcontent.

Content Producers have a BusinessCase to Offer Internet TV Profitably In order to evaluate the disruptivepotential of content producers jointlyoffering an Internet TV service to TVsets, Capgemini’s TME Strategy Labhas quantified the likely business case

for such an initiative in the UKmarket, forecasting consumer uptake,revenues and costs over a five yearperiod.

The most likely scenario would be thatthe content producer consortiumwould launch a service utilizing ahybrid set-top box in order to offercustomers a bundle of linear broadcast“free TV” channels through a DigitalTerrestrial TV tuner in addition toInternet TV and PVR capabilities.Offering free-to-air channels through

DTT will allow content providers todeliver linear TV as part of the overallInternet TV package, whilepartnership with external contentproducers will ensure availability of awide range of content on the platform.The Internet TV offering canencapsulate free streamed catch-upcontent in addition to pay-per-viewon-demand content such as moviesand premium TV show episodes,which are downloaded onto the harddrive of the set-top box. Since InternetTV STBs are relatively expensive, a

Content Delivery Network isemerging as the preferred deliverytechnology,“

”Internet TV Devices are Expected toBecome Mainstream in the MediumTerm Compared with other Pay TV devices,Internet TV set-top boxes are at anearly stage of development and offeronly basic features. For example, set-top boxes from Internet TV playerssuch as Vudu do not have featuressuch as surround sound or remoterecording which are standard on otherPay TV services such as Sky or VerizonFios. Moreover, most devices forInternet TV do not have a mechanismto consume broadcast TV and cannotbe used as an Internet or WiFiCustomer Premise Equipment (CPE).

Also, many Internet TV user interfacesoffer a poor navigation and searchuser experience as present ElectronicProgram Guides (EPGs) are notcapable of organizing large volumes ofcontent in a user-friendly format. Forexample, while EPGs on cable andsatellite platforms are designed forfewer than 150 channels, Joost andother Internet TV players typicallyoffer over 300 channels categorized bygenre. Large Video on Demand (VoD)content libraries also require advancednavigation and search methods. In theUS, Comcast’s VoD library comprisesover 5,000 programs, renderingtraditional navigation and search toolsineffectual.

However, advances are being made inset-top box (STB) and EPGfunctionality. With an increasingnumber of Internet-enabled devicesbecoming available, we expect feature-rich set-top boxes to becomemainstream by 2011. For example, in

2008 itself, LG is expected to jointlylaunch Internet-enabled TV sets withNetflix; Babel TV plans to launch ahybrid set-top box combining digitalterrestrial TV, PVR functionality, andInternet TV; and British Telecom willbegin streaming live content includingfootball matches to Microsoft Xboxconsole users over broadband.

Similarly, advances are now beingmade in content search technologiessuitable for Internet TV. For example,recently introduced “Auto Hot Key”EPGs automatically classify content by

AS INTERNET TV SET-TOP BOXES ARE RELATIVELYEXPENSIVE, a rental model will lowerthe entry barriers for consumerswho do not wish to pay upfront

“”

Figure 5: Forecasted Penetration and Subscriber Base of STB-Based Joint ContentProducer Internet TV Offering, UK


Figure 6: Positioning of Internet TV


10 For the purpose of our business case analysis we have assumed that media players offer the service over the open Internet and that access bandwidths are sufficient for delivering high-quality video content to TV sets. We have assumed the media players uses a CDN-based network architecture which delivers streaming and on-demand video download services, andthat the media players will make use of a managed CDN service to eliminate upfront investments in delivery infrastructure.

AS IT PROVIDES THE DESIRED QUALITY OFSERVICE FOR STREAMING VIDEO

AND ON-DEMAND SERVICES

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AS IT WILL ALLOW UPGRADE TOON-DEMAND CONTENT OFFERINGS AT AMINIMAL INCREMENTAL COST”“

Figure 7: Monthly ARPU Evolution (€/month) for STB-Based Joint Content ProducerInternet TV Offering, UK 2008 - 2012


Figure 8: Break-Even Analysis for STB-Based Joint Content Producer Internet TVOffering, UK, in € millions


Internet TV is Likely to Disrupt PayTV and IPTV On-Demand RevenuesIn the medium-term, we believeInternet TV will heavily impact PayTV and IPTV on-demand revenues. Inthe case of established Pay TVoperators, consumers are likely to beattracted by the relatively cheaper, ad-subsidized on-demand offeringsavailable through Internet TV services.IPTV players’ prospects are also likelyto be under threat, especially giventhat many telcos in Europe arepositioning VoD as the key sellingpoint of their IPTV services andrelying on it to make IPTV offeringsprofitable.

To a lesser degree, we also believe thatas video ad targeting capabilitiesmature, Internet TV is likely toaccelerate the ongoing migration ofad-spend from traditional TV toonline channels. However, whileon-demand and advertising revenueswill be impacted, we do not believethat the core Pay TV subscriptionrevenues will be impacted to anysignificant degree. Internet TV offers afundamentally different proposition toPay TV, and in the medium-term, isunlikely to displace consumers whoare willing to pay a premiumsubscription fee in order to avail awide range of linear and on-demandcontent.

In summary, at the current pace ofdevelopment, key Internet TV servicedelivery challenges will be largelyovercome in the next three years. Thereduction of these service deliveryissues will enable the growth ofInternet TV services, and although wedo not expect the service to rivalmainstream Pay TV platforms, we doexpect strong subscriber and revenuegrowth over the next five years. As aresult, in three to four years, InternetTV is likely to have a strong effect onexisting on-demand revenues, and alsocontent producer and broadcasteradvertising revenues to a lesser degree.

RecommendationsAmidst rapidly developing servicesand encouraging initial consumeruptake, many players are consideringhow best to tap into the opportunitiesafforded by Internet TV, while othersare grappling with how to mitigate theperceived threat to their services. Inthe rest of this section, we outlinesome key recommendations forcontent producers, established Pay TVoperators, and also telcos.

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Internet TV Players can Maintain aProfit Margin of about 17%We expect the Internet TV servicelaunched jointly by content producersto generate monthly average revenuesper household of around € 14 on TVin Year 1, comprising an STB rentalcharge of € 5, and € 5 consumerspend on VoD services in addition to€ 4 from advertising revenues.

As video advertising matures, contentcompanies can generate advertisingrevenues by inserting two 30 secondadvertisements, for example, one inthe beginning and another in themiddle of the video. An averagehousehold consuming about 20 TVepisodes or 30-minute videos permonth can generate up to € 4 permonth per household in advertisingrevenues at current CPM levels.Although usage will grow rapidly, thisfigure might grow only by € 1 asCPMs are expected to fall rapidly withincreases in ad-inventories.

Content companies can also look atgarnering a share of the currentaverage household spend of around€11 per month per household onvideos, whether DVD purchase, rentalor pay-per-view video. As the contentcompany adds an extensive catalogueof on-demand content to the InternetTV platform, it can expect to make upto € 6 per household through paidon-demand content (see Figure 7).

Finally, it will be important for contentcompanies to offer the STB on a rentalmodel to lower the entry cost of theservice for consumers who may findupfront cost of € 150 to € 200 for STBsprohibitive. We have modeled our caseconsidering the price point at the lowerend that a player could possibly chargefor the set-top-box, at around € 5 permonth for a 24 month contract. Giventhat a significant quantum of CAPEX isincurred on STB-subsidies, upfront saleof the STB to a section of users can onlyimprove the business case in favour ofthe content company.

We believe Internet TV is a viableproposition for content producers.Our analysis shows that the service

could break-even in the fourth year,delivering a profit margin of 15-18%,and generating revenues of over€200m by year 5 (see Figure 8).

While set-top box costs are likely toaccount for nearly three quarters of allcosts in the first year due to highcurrent prices of Internet-enabledSTBs, it is likely these costs willrecede by as much as half over thenext three to four years. As the servicewould leverage an outsourced videodelivery service from a CDN provider,CAPEX investments other than STBsare also likely to be minimal.

OPEX on the other hand is likely togrow substantially over time as useruptake grows. In order to encouragegreater usage and uptake, contentproducers will have to offer anincreasingly wide variety of content toconsumers. We expect companies willneed to add more and more contentfrom external sources, until almosthalf of all content consumed is non-proprietary by Year 5, driving upcontent acquisition costs from arounda quarter to nearly half of all OPEX.Despite these growing contentacquisition costs, steadily falling CDNprices, due to growingcompetition,are likely to help mitigatethe impact and achieve earlierprofitability.

Free TV households willform the primary targetsegment for Internet TV services

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Figure 10: Recommended Strategy for Pay TV Operators


“interest of viewers, telcos can displayads relevant to users’ interest area andrealize higher CPMs.

In conclusion, Internet TV offeringsare developing rapidly and seeingencouraging uptake. As servicedelivery issues gradually becomeresolved, we expect Internet TV on theTV set to become widely available inthe next two to three years. Contentproducers, Pay TV operators andtelcos should work to rapidly chalkout clear Internet TV strategies tocomplement their existing offeringsand generate additional revenuestreams. Content producers shouldcollaborate to launch compellingInternet TV services, affordingopportunities to reach the customerdirectly and tap into the onlineadvertising market. While Pay TVoperator on-demand revenues arelikely to be disrupted by Internet TV,their subscription revenues are likelyto remain unaffected in the short-term.Internet TV will also afford Pay TV

Figure 9: Potential Roles in a Content Producer Internet TV Consortium


2211 Guardian, “BBC iPlayer bursts through user target”, January 2008.12 Source: Ofcom, “International Communications Market 2007”, December 2007.

Cable and satellite playerscan leverage Internet TV to expand

their reach, ESPECIALLY IN GEOGRAPHIES WITHLOW PAY TV PENETRATION”for delivery of multimedia content to

consumers over the Internet. Telcosshould also consider propositionsaround broadband access. Qwest inthe US plans to sell higher capacitybroadband with speeds of up to 38Mbps at a premium to consumerswanting to access Internet-based TVand HDTV services.

Moreover, with IPTV likely to havelimited uptake in most geographies,telcos could view Internet TV as ameans to reach an extended consumerbase. Telcos should considerpartnering with free-view channels tooffer free content and positionInternet TV services as a basic/entrylevel service to target consumers whoare not ready to pay a premium forfully-fledged IPTV offerings. Byoffering IPTV as a premium service,whilst exploiting targeted advertisingand interactive capability of theinternet, telcos can build new revenuestreams and maximize overallrevenues. By analyzing the genre

not covered by their existing offerings(see Figure 10). Offering web-basedTV and subsequently integratingInternet TV capabilities into theirSTBs, will allow satellite operators tooffer premium on-demand services,catch-up TV and video downloads.

Cable and satellite players canleverage Internet TV to expand theirreach in geographies with low Pay TVpenetration. Countries with high FreeTV penetration, such as Italy, wherenearly three quarters of householdstake Free TV services, and Spain,France and Austria, where free-TVpenetration is over 60%12, offer largeaddressable markets for Internet TVofferings. By offering low-cost/high-value Internet TV propositions, PayTV operators can target expansivecustomer groups who have anappetite for premium content and yetdo not want a significant monthlyspend.

Telcos Should Develop Wholesaleand Retail Propositions AroundInternet TVTelcos should view Internet TV as anopportunity to develop propositionsaround managed video deliveryservices. AT&T, for example, isdeveloping a managed CDN offering

Initially, because of low customerawareness and familiarity for thisservice, players will have to themselvesprovision STBs dedicated for theInternet TV services. As customeracceptance for the service increases, inthe longer-term, players can envisage afully open Internet TV offering whereusers are free to choose their ownCPE, whether a STB, Internet-enabledTV set or gaming console.

Crucial to their success will be contentproducers’ abilities to also forgesuccessful alliances with other valuechain players to gain capabilities wherethey lack experience. In particular,content producers will need to partnerto gain advertising expertise inembedding ads in video content andselling ad spots. In order to broaden theappeal of Internet TV, contentproducers will also need to partner withSTB manufacturers and leverage theirexpertise to create feature-rich and lowcost devices.

Pay TV Operators Should UseInternet TV to Complement TheirServices and Extend ReachWe recommend cable and satelliteplayers to consider leveraging InternetTV to complement their existingservices and address market segments

Content Producers ShouldCollaborate to Offer CompellingInternet TV ServicesWe recommend content producersshould consider collaborating witheach other to provide joint Internet TVservices, offering customers a richvariety of popular content across genres.

Leading content producers shouldpioneer the creation of an Internet TVplatform, provide valued content anddrive STB development incollaboration with partners. Smallerplayers should leverage the platformcreated by leading media players andadd value by providing popularcontent. The consortium shouldpartner with a Free TV player toprovide the DTT or free satelliteplatform for delivering linear TVservices (see Figure 9).

Offering Internet TV services willenable content producers to fosternew revenue streams in the form ofadvertising, on-demand andsubscription revenues. No longersolely dependent upon broadcasters totelecast their shows, contentproducers will be able to use on-demand services to monetize theircatalog further by serving nichemarkets more comprehensively andextending the shelf-life of content; asan example, programs outside the topfifty account for over 50% of alldownloads on the BBC iPlayer.11

Direct reach to consumer homesthrough the Internet TV platform willallow content producers to assertgreater control over the value chain aswell as explore the viewing behaviorsof consumers, potentially channelingthis insight into the creation of newcontent.

We believe content producers shouldchart a clear roadmap to offer STB-based Internet TV services, beginningwith online video services in theimmediate-term where users canstream videos through their website, inorder to tap the online advertisingopportunity. In the short- to medium-term, players could then offer InternetTV to the living room through a STB.

operators the opportunity to widentheir reach by tapping marketspreviously left unaddressed. Theimpact of Internet TV is likely to bemost prominent on telcos as theirprecious on-demand revenue streamsbecome affected, especially as manyare positioning on-demand as themain selling point of their IPTVservices; however, we believe thattelcos can turn Internet TV to theiradvantage by not being defensive andtaking advantage of emergingopportunities.

Jerome Buvat is the Global Head of theTME Strategy Lab. He has more than tenyears’ of experience in strategy consultingin the telecom and media sectors. He isbased in London.

Tushar Rao is a manager in the TMEStrategy Lab. His recent work focused onanalyzing disruptive technologies in thebroadcasting and mobile segments. Priorto joining the Lab, Tushar worked with aleading converged operator in India,where he was responsible for developingmanaged data services for enterprises.He is based in Mumbai.

Alex Kitson is a senior consultant inCapgemini’s Telecom, Media &Entertainment practice. He has sixyears’ consulting experience in thetelecom and media industry, and hasauthored studies on topics includingmobile advertising, convergence andemerging consumer behaviors. He isbased in London.

decline in their core revenues bydiversifying into new areas. In the UK,online advertising currently representsa market as large as broadband and isgrowing rapidly (see Figure 2).Although telcos currently do notdominate the online ad market, thedynamic nature of the industry allowsnew players with the right offerings togain market share quickly. Newentrants, such as MySpace, have oftentoppled online leaders to become oneof the world’s most visited websites.

In this study, Capgemini’s TMEStrategy Lab outlines telcos’ currentstatus in online advertising and

evaluates key opportunities toimprove their market presence.Subsequently, this paper offersrecommendations for telcos tomaximize revenues from onlineadvertising services.

Telcos’ Current Status in OnlineAdvertisingA number of telcos now offer onlineadvertising services. In this section,we provide a brief overview of currenttelco activity in the online advertisingspace and also classify them into fourdifferent categories based on theirbreadth of services and revenues fromonline ads.

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Figure 2: Size, Profitability and Growth of Selected Industries, %, UK, 2007


In the UK, ONLINE ADVERTISINGCURRENTLY REPRESENTS A MARKET ASLARGE AS BROADBAND AND GROWINGRAPIDLY

”“

The online advertising market hasbeen growing rapidly across theworld. Between 2002 and 2007,worldwide online advertising revenuesgrew by a CAGR of 30% to €26billion, compared to only 6% foroverall advertising revenues1 (seeFigure 1).

Growth in online advertising hasattracted the interest of a variety ofplayers. News Corporation, forinstance, has recently acquired amajority share in Utarget, a Europeanadvertising network specializing inrich formats2, while Google made asimilar move to expand into displayadvertising by acquiringDoubleClick3.

Online advertising also represents asignificant opportunity for telcoslooking to mitigate the threat of

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Identifying Opportunities for Telcos in Online AdvertisingA Value Chain Analysisby Tushar Rao, Kaushal Vaidya and Manik Seth

Figure 1: Worldwide Advertising Spend by Media, € billions, 2002-2007

Source: Capgemini TME Strategy Lab analysis. Zenith Optimedia, “Global Advertising Figures”, December 2007. ZenithOptimedia, “Zenith Optimedia upgrades global ad forecasts again”, October 2004

1 Zenith Optimedia, “Global Advertising Figures”, December 2007. Zenith Optimedia, “Zenith Optimedia upgrades global ad forecasts again”, October 2004.2 Company websites and press releases.3 Company websites and press releases.

Abstract: Increasing Internet penetration and time spent online offer advertisers a growing audience for marketing messages. As a result, onlineadvertising spend has grown rapidly across the world. This has attracted the interest of a variety of players, including telcos. Although still fringeplayers in the online advertising space, we believe telcos can enhance their presence by exploring a number of opportunities. Capgeminirecommends that telcos decide their strategy based on their current breadth of services and online ad revenues. Telcos with limited presence inonline advertising, i.e. the “slow starters,” should consider leveraging their capabilities in procuring local content to offer portal services andutilize their existing directory assets to launch online directory services. Other areas of online advertising can be explored subsequently. Certaintelcos generate significant online ad revenues from a limited range of services such as online directory services and content portals. For such“specialist” players, it is important to diversify into other areas. For instance, they can offer social networking services to their existing residentialand business clients. They can also utilize the intelligence available to them about consumer behavior, demographics and location, to offertargeted ad network and ad agency services. Telcos with a wide range of online ad offerings but low corresponding revenues, i.e. the “strivers,”should focus on improving monetization of their existing operations. This can be achieved through better differentiation of their online ad offeringsby effectively leveraging their brands, existing subscriber bases and consumer intelligence. Finally, telcos who have emerged as online advertisingleaders should strive to remove dependencies on partners to command a higher share of advertiser spend.

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few key offerings to generate highonline ad revenues; for instance, 85%of AT&T’s online ad revenues comesolely from directory serviceofferings11. Strivers such as FranceTelecom and BT. offer a wide breadthof ad services but have not been ableto monetize them optimally.

Categories of Telcos in the OnlineAdvertising MarketBased on their breadth of services andonline advertising revenues, telcos canbe categorized into leaders, specialists,strivers or slow starters (see Figure 5).Leaders, such as SK Telecom, offer awide range of online advertisingservices and generate significantonline ad revenues, while specialistssuch as Verizon and AT&T focus on a

TELCOS HAD ONLYAROUND 4% MARKET SHARE inthe US online advertisingmarket in 2007

“”

Figure 5: Breadth of Services and Online Advertising Revenues for Select Telcos, 2007

Source: Capgemini TME Strategy Lab analysis. Company websitesNote: (a) BT revenues are estimated to be low due to its recent market entry. (b) SK Telecom revenues include those fromits ad agency Aircross (approximately €16.7 million) and social network Cyworld (estimated at around 10% of totalCyworld revenues of approximately €146 million)

11 AT&T, “Analyst Conference - Advertising and Search”, 2007.

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Telcos’ Presence along the OnlineAdvertising Value ChainTelcos’ presence in the onlineadvertising value chain ranges frommonetizing publishing assets to actingas marketing agencies and onlineadvertising networks (see Figure 3).

South Korea’s SK Telecom, forexample, recently ventured intoadvertising by increasing itsshareholding in online marketingcompany AirCross to 100%4. Orange,in addition to its local content portalsin France and the UK, launched itsown ad network in 2007, offeringpremium online ad inventory acrossthird-party sites as well as its own5.

BT recently launched BT WebClicks asan online search marketing agencytargeted at SMEs, while its partnershipwith ad network Phorm will help itenter the ad networking space.

Additionally, BT has launched portalssuch as BT Tradespace, a businessnetworking site, and BTPodshow, auser generated content portal, toenhance its publishing assets6.

Telco Revenues from Online AdsSome telcos have been successful ingenerating online advertisingrevenues. AT&T, for example, wasable to generate €438 million inonline advertising revenues in 2007through its local search engineYellowPages.com, and by offeringcontent on its portals7. Verizon’saffiliate company, Idearc grew itsonline classifieds and local searchrevenues by a CAGR of 20% between2005 and 2007 to reach €208million8. France Telecom alsogenerated €150 million in 2007,primarily through portal ads9.

Despite these initiatives, telcos’ shareof the online advertising marketremains small. In the US, for instance,telcos are estimated to have only 4%of the €15.6 billion market10 in 2007(see Figure 4).

Figure 3: Extent of Presence in the Online Advertising Value Chain, SelectedTelcos, March 2008a

Source: Capgemini TME Strategy Lab analysis. Company websitesNote: (a) 1. Search Marketing entails helping advertisers with keywords auctions. 2. Creative campaigns involve planningadvertising campaigns for advertisers. 3. “Own properties” refers to telcos who handle their own ad inventory on theirsites. 4. “Publisher affiliates” refers to telcos who handle their partners’ ad inventory as well. 5. Ad platform refers to telcoswho have their own ad network platforms or have a partnership for the same. 6. Content portal refers to telcos who havea content portal. 7. Local search & directory entail telcos having online local search and directory services. 8. Telcos whohave social networking websites.

4 Company websites and press releases.5 Company websites and press releases.6 Company websites and press releases.7 AT&T 2007 analyst conference “Advertising and Search”.8 Company 2007 annual report.

19 Societe Generale “Online advertising: a growth market but need for telecoms operator to prove its mettle”, January 2008.10 eMarketer “US advertising spending”, November 2007.

Source: Capgemini TME Strategy Lab analysis. Company websites. eMarketer, “US advertising spending”, November2007. Advertising Age, “Digital Marketing and Media Fact Pack”, April 2007. eMarketer, “Portal Marketing: The Big Four”,March 2007

Figure 4: US Online Advertising Market Shares, %, 2007

services through affiliate Idearc Inc.,and has 12.5 million unique visitorsper month26.

Targeted Ad Network ServicesOnline advertising networks store adsin databases and dynamically selectthe ads to be placed on variouswebsites depending on the relevanceof content published on the sitepages. This market has been growingsteadily over the past few years;between 2004 and 2007, global adnetwork revenues grew by a CAGR of21% to €5.8 billion27.

Google, Yahoo, MSN and AOLcurrently hold about 33% of the adnetwork market28. However, Telcoshave the necessary attributes to tapinto the online ad network market,particularly the significant sharecurrently held by smaller networks.Firstly, telcos can utilize intelligenceabout consumer behavior,demographics and location to offertargeted advertising. Additionally,telcos with high-traffic portals andstrong relationships with onlineadvertisers and publishers have directaccess to a pool of web inventory and

US, while the European market forthe same was €2.04 billion in 200723.

The market for online directory andlocal search is keenly contested, withofferings from global search playerssuch as Google, regional searchplayers such as Baidu and Suchen.de,and independent print directories. Inthe US, for example, Telcos such asAT&T and Verizon have just around14% of the market.

Still, telecom operators can enter themarket as many of them already haveexisting directory assets that can beleveraged upon. Additionally, they cangenerate revenues by convincingexisting corporate clients to advertiseon their online directories.

Many telcos have already startedattracting significant traffic to theirdirectory and local search sites.Currently, around a quarter ofbt.com’s traffic is generated throughBT Phonebook. ThroughYellowpages.com, AT&T generatedrevenues of €372.3 million in 200724,with 18.3 million unique visitorsaccessing its site per month25.Similarly, Verizon offers directory

Social Networking Sites forConsumers and/or BusinessesOnline social networking is a rapidlygrowing opportunity. Between 2006and 2007, worldwide online socialnetworking ad spend grew by astaggering 155% to € 876 million20.

Telcos wishing to enter the socialnetworking market will need tocompete with existing consumer andbusiness networks. While MySpaceand Facebook dominate thelandscape, there is still scope fortelcos to address the niche and portal-based market, which in 2007 wasestimated to represent a significant36% of US online social networkingrevenues21.

Many telcos have existingrelationships with businesses as wellas consumers. These can be leveragedto successfully offer targeted socialnetworking services. Althoughconsumer social networks might bemore difficult to monetize, asconsumers tend to be loyal to theirexisting social networks, telcos cantarget their SME clients as customersfor business networks that helpadvertise them within their owncommunity. Large telcos also benefitfrom their strong brands, which lendthem credibility as social networkinghosts and ad publishers.

Some telcos have successfullylaunched social networking sites andattracted significant number ofsubscribers. BT Tradespace, a businessnetworking site, has witnessed rapiduptake with around 10,000subscribers in three months from itslaunch in April 2007 and 39,000subscribers by end of 2007.

Online Classifieds and Local SearchThe local online advertising market isalso rapidly growing; for example, inthe US, it is estimated to have grownby 26% to reach €6 billion in 200722.Online directory and local searchservices generated €2.1 billion in the

29

20 eMarketer, “Social Network Marketing: Ad Spending and Usage”, December 2007.21 eMarketer, “Social Network Marketing: Ad Spending and Usage”, December 2007.22 Note: 2007 figures as estimated by Veronis Suhler Stevenson.23 The Kelsey Group “The Kelsey Report Annual Forecast”, February 2008.24 AT&T, “Analyst Conference - Advertising and Search”, 2007.25 Compete.com26 Compete.com27 CIBC, “Outlook for Online Ad Networks”, August 2007.28 Capgemini TME Strategy Lab analysis. CIBC, “Outlook for Online Ad Networks”, August 2007.

Opportunities for Telcos in theOnline Advertising MarketTelcos possess several key strengthsthat they can utilize to play a moresignificant role in the onlineadvertising market (see Figure 6). Forexample, telcos like AT&T and BThave unique assets such as extensivebehavioral, demographic and locationinformation about their consumers,which can be leveraged to serveeffectively targeted ads. Eachopportunity can be evaluated basedon market size, existing competition,

relevant strengths and success stories,where available.

Local Content-Based Portal ServicesThe market for display advertising onportals is large and growing. Between2006 and 2007, US spending onportal display ads grew by 16% to€4.2 billion, while in Western Europeit increased by 18% to €1.5 billion12.

Although this market is sizable, it isdominated by pure online players. Inthe US, pure online players dominate

53% of the display advertisingmarket, while media companiescontrol 18%, and other websitesincluding smaller search engines,gaming, gambling and niche sitesform the remaining 29%13.

Telcos can utilize their knowledge oflocal markets to procure relevant localcontent to tap into the displayadvertising market. Orange and T-Online for instance, were able toreach the top 10 websites in Franceand Germany, offering local contentportals to drive traffic14. Telcos withstrong brand names also have theadvantage of lending credibility to adson their portals, thereby enticingadvertisers.

Additionally, Telcos have largecustomer bases that representpotential portal traffic. AT&T’s portalgenerates significant traffic from its11.5 million broadband and 67.5million fixed-line subscribers15: theportal received 27.9 million uniquevisitors in the month of December200716. AT&T’s 2007 revenue fromadvertising on its portals, excludingits online directory, reached € 65.7million17. T-Online and Orange werealso able to create their own localcontent portals, attracting 13.218 and14.8 million19 unique visitors permonth respectively.

Many telcos have unique assets suchas extensive consumer behavior,demographic and location information,

WHICH CAN BE LEVERAGED TO SERVETARGETED ADS ”“

Figure 6: Telco Strengths and Potential Offerings in the Online Advertising Space


12 Forrester “European Online Display Advertising Spend Will Double By 2012”, August 2007. Advertising age “Digital marketing and Media Fact Pack”, April 200713 Capgemini TME Strategy Lab analysis. Advertising Age, “Digital marketing and Media Fact Pack”, April 2007.14 comScore, December 2007.15 Company website.16 comScore, December 2007.17 AT&T, “Analyst Conference - Advertising and Search”, 2007.18 ComScore, December 2007.19 ComScore, December 2007.

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Evaluation of Opportunities forTelcosConsidering the size of theopportunity and ease of entry basedon existing telco strengths, online adpublishing services such as portalsand directories are an attractiveprospect for telcos to enter the space.Offerings such as targeted adnetworks and ad agency services arethe next area for diversification, dueto relatively smaller size of the marketand higher entry barriers.

RecommendationsThe way forward for various telcos inthe online advertising space dependson their current breadth of servicesand online advertising revenues (seeFigure 7).

Slow starters The challenge for slow starter telcos isto identify appropriate opportunitiesfor entry into the online advertisingmarket. Generally, telcos with little orno online advertising presence should

start by consolidating their position inpublishing, as these opportunitiescouple low entry barriers with telcostrengths (see Figure 8).

Slow starters need to develop thenecessary capabilities required foroffering these services. For instance,for portals, telcos need to perform in-depth and ongoing consumer researchto identify the relevant content typesnecessary for driving traffic. Telcosmay also need to forge partnershipsfor content procurement and adinventory management. Developingthese capabilities can help telcossuccessfully monetize their services;for example, in 2007, France Telecomwas able to generate €150 million inonline ad revenues from its ownportal, mainly through extensivecontent partnerships and a wide rangeof innovative services.

Similarly, for offering onlinedirectories and local search, telcos

complex keyword bidding processeshas been increasing. This had led tothe rapid growth of the onlineadvertising agency market; between2005 and 2006, US Internet adagency revenues grew by 25% to€2.1bn31.

Currently, subsidiaries of large holdingcompanies such as Publicis, WPP andOmnicom dominate the interactiveagency market with 60% marketshare. However, the market remainsfragmented, as no single companycontrols more than 10% share32.Telcos can enter this market by usingconsumer intelligence to helpadvertisers define target segments formarketing campaigns. Due to theirlocal or national presence, telcos arebetter-placed than global players toattract local advertisers. Finally, telcoscan capitalize on their establishedrelationships with businesses to tapinto a sizable pool of potentialclientele.

Some telcos have already startedoperating marketing agencies. InSeptember 2007, BT launched its BTWebClicks service targeted at SMEs.The service helps SMEs in designingand placing sponsored links on localand major search engines33. SKTelecom increased its shareholding inad marketing company AirCross to100% in 2007. In 2006, AirCross hadrevenues of €16.9mn.

31

31 Piper Jaffray Investment Research, “The User Revolution”, February 2007.32 Piper Jaffray Investment Research, “The User Revolution”, February 2007.33 Company Websites.

Figure 8: Evaluation of Each Online Offering Based on Feasibility, Opportunity Sizeand Telcos’ Strengths


potential clientele for ad networkservices.

Some telcos have already forayed intothe ad network arena, but withlimited success. Orange, for example,started offering online ad networkservices in February 200729, sellinginventory on its own portals as well as

third-party sites, and givingadvertisers exclusive access to selectsites for targeted advertising30.

Ad Agency Services for OnlineAdvertisersWith advertisers trying to increasetheir Internet exposure, the need todesign ad campaigns and manage

Online ad publishingservices such as portals anddirectories ARE ATTRACTIVEPROSPECTS FOR TELCOS TOENTER THE SPACE

“29 Company Website.30 Company Websites.

Figure 7: Way Forward in Online Advertising for Different Telco Categories


”30

Leaders should also regularly monitormarket dynamics and make periodicinvestments to keep their offeringsrelevant and competitive. Forinstance, telcos offering interactive adagency services need to make regularinvestments in IT systems foranalyzing consumer data, as well asincur the cost of building andsustaining creative marketing teams todesign online ad campaigns.

In conclusion, online advertising is arapidly growing market andrepresents an attractive opportunityfor telcos seeking additional revenuestreams. Telcos have a number of corestrengths that position them well toenter the online advertising space.Those looking at a successful forayinto online advertising will need toperform a thorough assessment oftheir existing portfolio of onlineservices, and determine where theystand on the services versus onlineadvertising revenues matrix. Telcoswill also need to map their corestrengths against existing offerings andidentify areas for diversification basedon best fit with their specificportfolios. Additionally, Telcos willneed to develop capabilities such ascontent procurement, database and adinventory management, and ongoingconsumer research skills that theycurrently lack. Telcos could choose tobuild, acquire or partner to equipthemselves with the necessary

competencies. Collaboration can helptelcos jumpstart their online adofferings; however, they will alsorequire telcos to negotiatepartnerships carefully to protect theirinterests and command a sizeableshare of advertiser spend.

Tushar Rao is a manager in the TMEStrategy Lab. His recent work focusedon analyzing disruptive technologies inthe broadcasting and mobile segments.Prior to joining the Lab, Tusharworked with a leading convergedoperator in India, where he wasresponsible for developing manageddata services for enterprises. He isbased in Mumbai.

Kaushal Vaidya is a senior consultantin the TME Strategy Lab. His recentwork includes analyzing trends inonline advertising and assessinggrowth as well as profitability driversof players in emerging markets. Priorto joining the Lab, Kaushal hasworked as a management consultantwith the consulting arm of India’spremier business house. He is based inMumbai.

Manik Seth is a senior consultant inthe TME Strategy Lab. His researchinterests include new online and digitalmedia, and next generationcommunications technologies. Prior tojoining the Lab Manik was workingfor a leading software servicesprovider. He is based in Mumbai.

Moreover, these telcos can leveragecore strengths to enrich their services,which will help popularize theirofferings. For instance, differentiatingon the basis of consumer intelligencecan help telcos achieve better click-through rates for ad network services,thereby attracting publisher affiliatesas well as advertisers. After stabilizinga few core offerings, strivers cansubsequently explore furtherdiversification.

LeadersLeaders amongst telcos combine awide breadth of online advertisingservices with high revenues. The nextstep for these telcos is to aim tobecome dominant players in theonline advertising space. Leadersshould therefore strive to reducedependencies on online majors andincrease their share of revenue fromservices. This can be done byselectively developing or acquiringexpertise to deliver display and searchads, and manage publisher andadvertiser relationships. For example,a telco partnering with an onlineplayer for search ads can achievesizeable savings by acquiring orbuilding capabilities to servecontextual search ads themselves,which usually takes up 35% ofrevenues. Developing in-housecapabilities reduces externaldependence on critical areas of theoffering, which frees telcos fromhaving to share their data assets withonline players.

3332

networks such as Friendster, adnetworks/servers such as AdBrite andindependent online marketingagencies like AKQA with revenues of€5-40 million35 per year.

StriversStrivers offer a breadth of onlineadvertising services, but are unable tomonetize them optimally. Therefore,their primary focus should be toimprove the uptake and monetizationof these services before diversifyinginto new areas.

In order to increase monetization fromoffered services, strivers need to focuson improving revenue shares andincreasing popularity of services.Better revenue shares can benegotiated by leveraging their existingcustomer base and strong local brandname. For instance, AT&T recentlyrenegotiated its Yahoo! partnership toshift to a revenue sharing model froma fixed fees structure because of thetraffic it provides to Yahoo! throughits subscriber base36. Strivers can alsoreduce dependency on partners forserving ads to retain all of their onlinead revenue. For example, FranceTelecom handles its own publisherinventory, eliminating the online adnetwork’s share.

advertising. These telcos can leveragetheir strengths to offer online socialnetworks, interactive ad agencies ortargeted ad networks.

In order to explore these newofferings, specialist telcos will need todevelop additional online advertisingcapabilities. Online social networks,for example, require extensiveresearch to find out the rightdemography to target. Additionalcapabilities are required formanagement of content and adinventory. Online ad networksfunction as mediators betweenpublishers and advertisers, andrequire investments in developingdatabases and systems for storing,serving and monitoring ads. Similarly,the key capabilities required for telcosto offer interactive ad services includethe ability to use consumerintelligence to develop creative as wellas relevant ads and coordinate with adnetworks for placement of ads.

Acquiring small-sized companies inthese areas can help telcos in offeringrelevant services quickly and alsoobtaining the necessary capabilities forsubsequent scaling-up. Acquisitiontargets may include smaller social

need to develop capabilities in onlinedatabase development andmaintenance as well as searchtechnology. Verizon, for example, wasable to generate €208 million inonline advertising revenues in 2007through its affiliate Idearc’s localsearch portal SuperPages.com.

Acquisitions can also help telcos toenter the market quickly. Smallercontent portals and local searchengine players represent attractiveacquisition targets, as they can equiptelcos with essential capabilitieswithout excessive investment. Forinstance, local search engines such as192.com are likely to have modestvaluations as they typically generateless than €50 million in revenues peryear34. Telcos can subsequently scaleup operations and drive traffic bycoupling the acquired capabilitieswith their strengths, which includestrong brand names, existingrelationships, consumer intelligenceand publishing assets.

SpecialistsSpecialists, who generate high onlinead revenues from a few services, canlook to expand their portfolio bydiversifying into other areas of online

LEADERS AMONG TELCOSshould strive to reducedependencies on onlinemajors

“”

34 Capgemini TME Strategy Lab analysis based on Advertising age “Digital marketing and Media Fact Pack”, April 2007.35 Piper Jaffray Investment Research, “The User Revolution”, February 2007.36 Company websites.

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lack of compelling applications2 . Thekey initiatives that operators need topursue to enhance consumer value ofmobile Internet and drive itspenetration include offering a widevariety of content accessible from themobile device, enhancing userexperience by offering feature-richhandsets, and providing services atcost-effective flat rates to stimulateadoption as well as usage.

collaborate with various stakeholderssuch as device vendors and majoronline players to enhance theirofferings in order to boost adoption aswell as usage of mobile Internet.

Key Initiatives to Drive theUptake of Mobile Internet In 2007, around 40% of Europeanmobile consumers did not see value inusing mobile Internet services due tounattractive pricing and the perceived

AROUND 40% OF EUROPEANMOBILE CONSUMERS DID NOT SEEVALUE IN USING MOBILE INTERNETSERVICES

due to unattractive pricingand the perceived lack ofcompelling applications”

“

Figure 1: Mobile Internet Penetration (% of Mobile Subscribers) in Europe, USAand Japan, 2007

Source: Capgemini TME Strategy Lab analysis. Forrester, “European Mobile Forecast: 2008 To 2013”, March 2008.eMarketer, “Mobile Search - Clash of the Titans”, 2007. Ministry of Internal Affairs and Communications (MIC) - Japan,"Subscribers and Contracts to Information and Communications Services," March 19, 2008

2 Forrester, “Mobile Internet Pricing Strategies Mature”, July 2007.

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of mobile Internet servicesaggressively to drive data revenuesand protect margins.

In this report, Capgemini’s TMEStrategy Lab suggests operatorstrategies that would help instimulating the uptake of mobileInternet services in the respectivemarkets. The study also identifiesareas where operators need to

Internet services (see Figure 1).Further, adoption rates have beenalmost stagnant or have witnessedonly a marginal increase over therecent past in the two geographies.

With highly saturated markets andcompetitive pressures adverselyimpacting revenue and margin growthin the voice business, mobileoperators need to encourage the usage

Although operators in Europe andUSA have tried to stimulate theuptake of mobile Internet in theirrespective geographies, they havebeen unable to drive adoption in themass market so far. Mobile Internetpenetration rates1 in Europe and USAwere only around 14% and 12%respectively in 2007, compared with astaggering 90% penetration rate inJapan, the world leader in mobile

Abstract: Less than 15% of European and US mobile consumers use mobile Internet services regularly, significantly lower than leaders such asJapan which has a corresponding penetration rate of almost 90%. Moreover, growth in mobile Internet penetration in the two geographies hasbeen slow recently. We believe that operators in Europe and USA can enhance their mobile Internet offerings and stimulate adoption by pursuingcertain key initiatives. Allowing access to the open Internet and making popular Internet content available on mobile devices would encourageconsumers to complement their fixed Internet browsing with regular mobile access. Operators should also encourage the adoption of smart phonesand other feature-rich devices that allow user-friendly access to mobile Internet, as such consumers are more likely to use these servicesextensively compared to regular handset users. Additionally, tariff packages in Europe and USA need to evolve from pay per usage plans to flat-rates. Evidence from Japan also suggests that certainty of billing is one of the key drivers for enhanced uptake of mobile Internet. Lastly, activecollaboration with content producers, device manufacturers and online majors can help mobile operators in Europe and USA deliver enhancedconsumer value on each of the three key parameters and stimulate the adoption as well as usage of mobile Internet.

Mobile Internet Services in Europe and USA:Initiatives to Drive Adoption and Usageby Tushar Rao, Ignacio Blanco and Sushant Kumar

1 Refers to consumers using mobile Internet services regularly (at least once a month).

Mobile Internet penetration rates inEurope and USA were only around 14%and 12% respectively in 2007, COMPAREDWITH A STAGGERING 90% PENETRATION RATE INJAPAN

“

”

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made by operators to allow easyaccess to mobile search services fromplayers such as Google and Yahoo!.Similarly, Research-In-Motion (RIM)recently announced that almost 1million users of its Blackberry servicehad downloaded the Facebookapplication in only five months sincelaunch8.

Enhancing user experience throughfeature-rich handsetsA fast and hassle-free user experiencewhile surfing the Internet on mobilephones is one of the key drivers ofadoption and usage growth. Theminimum standard required for openmobile Internet access is 2.5G; elseusers can be turned off by the slow

7 Capgemini TME Strategy Lab analysis. eMarketer, “Mobile Search: Clash of the Titans”, July 2007.8 Market Wire, “Downloads of Facebook for Blackberry Smartphones Top 1,000,000”, 1st April 2008.

Operators should also aim to integrateconsumers’ fixed and mobile webexperiences, thereby encouragingthem to use popular Internetapplications over the mobile device.For instance, around 75% of mobileInternet users in Europe used searchservices in 20077. This can beattributed to the extensive tie-ups

PARTNERSHIPS WITH KEY INTERNETPLAYERS CAN BE A WIN-WIN SCENARIOfor both mobile operators as well asthe online majors”“

Figure 3: Operator Partnerships with Internet Players, 2007

Source: Capgemini TME Strategy Lab analysis. Company websites

36

Offering a wide variety of contentover mobile InternetOperators typically offer one of thefollowing four types of mobileInternet access—walled-gardens, i-mode like schemes, walled-gardenscoupled with access to popularInternet applications, and open,unbridled Internet. Mobile contentofferings have gradually evolved fromwalled-gardens towards partnershipswith Internet players andsubsequently full access to openInternet (see Figure 2).

Almost 50% of the data plans offeredby Japanese operators allow openInternet access. The rest of their plansare usually i-mode type schemes,which have extensive contentavailability3. In stark contrast, in2007, almost half of US operatorofferings allowed access only to theoperators’ walled-gardens, while only

around a quarter of offerings allowedaccess to the open Internet4. In fact,players such as Telefonica in Spaindid not allow access to the openInternet and Verizon in the USArestricted consumers from accessingcontent such as streaming audio andvideo services from non-portal sites in20075.

Capgemini believes that European andUS operators should endeavor toprovide extensive mobile content toconsumers by offering open Internetservices and/or by partnering withonline majors to ensure easyaccessibility of popular contentthrough mobile Internet.

In fact, many European operatorsincreasingly allow access to the openInternet and have also re-launchedtheir portals with additional content.The new content is primarily sourced

through partnerships with onlinemajors such as Google and Yahoo!(see Figure 3), and users are typicallyoffered easy access to popular webapplications through operator portals.This shift away from closed contentstrategies, such as walled-gardens andi-mode schemes, was driven by thelimited success of i-mode schemeslaunched by operators such as KPNand Telefonica.

Partnerships with key Internet playerscan be a win-win scenario for bothmobile operators as well as the onlinemajors. For instance, in June 2007,around 4.8 million consumersaccessed social networking sites suchas Myspace, Facebook and Bebo ontheir mobiles in Western Europe, withItaly and UK being the leadingcountries6.

3 Capgemini TME Strategy Lab analysis based on the study of mobile Internet offerings of NTTDoCoMo, au/KDDI and Softbank.4 Capgemini TME Strategy Lab analysis. 5 Capgemini TME Strategy Lab analysis. Company websites and press releases.6 M:Metrics, “Mobile Social Networking has 12.3 Million Friends in the USA and Western Europe”, August 2007.

Figure 2: Evolution of Operator Mobile Internet Offerings, 1999-2007

Source: Capgemini TME Strategy Lab analysis. Company websites

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high usage 3G consumers foraccessing its proprietary EZwebcontent platform. A variant of theplan, aimed at low usage consumers,was launched subsequently. Thesepackages stimulated adoption and by2005, 81% of KDDI’s 3G users hadsubscribed to flat-rate data plans15.

Accordingly, tariff plans for mobileInternet across the developed worldhave been evolving from “pay per use”

to flat-rate plans allowing almostunlimited usage, albeit capped by fair-use restrictions (see Figure 5).

Although operators in Europe havestarted following the example ofJapanese operators and started shiftingtowards flat-rate pricing for openInternet access, such plans comprisedonly around one-third of the overallpricing plans offered in 2007 andtargeted primarily high-usage

is critical to increasing widespreadadoption and usage.

Evidence from Japan and South Koreasuggests that the introduction offlat-rate data packages in place ofusage driven tariffs reduces billinguncertainty and encourages serviceadoption14. The trend of offering suchplans was started by Japanese operatorau/KDDI in 2003, when it launchedan unlimited flat-rate tariff targeted at

Empirical evidence from Japan andSouth Korea suggests THAT THE INTRODUCTIONOF FLAT-RATE DATA PACKAGES REDUCES BILLINGUNCERTAINTY AND ENCOURAGES SERVICEADOPTION”“

14 Capgemini Telecom and Media Insights, “Mobile and Broadband Services in Japan and South Korea: What can Western Operators Learn from their Eastern Peers”, December 2007.15 Analysys, “Japanese and South Korean Mobile Markets”, 2006. Company websites.16 Capgemini TME Strategy Lab analysis based on study of mobile Internet tariff plans of Vodafone, Orange, Telefonica/O2, T-Mobile, Boygues Telecom, E-plus Germany

and 3 Hutchinson UK.

Figure 5: Evolution of Mobile Internet Pricing Plans of Selected Operators

Source: Capgemini TME Strategy Lab analysis. Company websites and press releases

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speed of the Internet connection.Access technology such as 3G, whichoffers significantly higher speeds andrapid browsing, can provide a boostto mobile Internet by enhancingcustomer experience. Operatorsshould therefore strive to increasepenetration of 3G handsets, whichcurrently lags the penetration of 2.5Ghandsets by a significant amount (seeFigure 4).

Operators should also encourage theadoption of smart phones9 and otherfeature-rich devices that enhance themobile Internet user experience andtherefore drive its adoption. Therecent launches of devices such asApple’s iPhone have demonstratedthat smart phones indeed driveadoption of mobile Internet. Forinstance, almost 85% of iPhone usersand around 58% of smart phone usersaccessed news or information throughmobile browsers in January 2008,compared with the market average ofonly around 13%10.

Moreover, operators and devicemanufacturers should also pre-loadmore mid-range handsets withInternet browsers, which arenecessary to access various servicesover mobile Internet. The worldwidepenetration of handsets with pre-installed browsers was only around20% in 200711. Operators shouldtake a cue from players such as T-Mobile, which recently partnered with

Opera, an Internet player specializingin web access applications, to pre-install browsers in an extensive rangeof mid-range handsets. Thispartnership, initiated in 2006, nowenables T-mobile to provide openInternet access on almost 80% of thedevices it offers with its plans12.

Additionally, operators should partnerwith device manufacturers andInternet players to customize handsetsand incorporate features in the mobiledevice to make web content moreeasily accessible from the handset. Forinstance, NTT DoCoMo (Japan),Vodafone (Portugal) and TMN(Portugal) offer one-click-functionalitythat allows easy access to content,

without the need to know orremember the URL13. Clickable news“tickers” with scrolling news headlineson the mobile screen that can take theuser directly to the relevant news itemis another example of simplifyingcontent access for users. Japaneseoperators and Swisscom also allowcamera phones to capture “quick-response” codes printed onnewspapers or banners/posters atpublic places, and take users directlyto associated websites.

Simplifying tariffs and offeringflat-rate plans to encourage usageWe also believe that offering mobileInternet browsing at flat rates, insteadof charging consumers based on usage

Almost 85% of iPhone users accessednews through mobile browsers in 2008,COMPARED WITH THE MARKET AVERAGE OF ONLYAROUND 13%

“Source: Capgemini TME Strategy Lab analysis. Company websites. eMarketer, “3G Mobile Shipments Worldwide”,October 2007

Figure 4: Global Penetration of 2.5G and 3G Handsets, % of Mobile Subscribers

9 Smart phones include mobile handsets loaded with operating systems from vendors such as Windows, Symbian, RIM and Apple.10 eMarketer, “Mobile Content Consumption: iPhone, Smartphone and Total Market: January 2008”, March 2008.11 Capgemini TME Strategy Lab analysis. m:Metrics. The Mobile World. eMarketer. Online Publishers Association, “Going Mobile”, March 2007. Screen Digest.12 Opera Software, “T-Mobile and Opera Mini-powered Web'n'Walk hits one million”, February 2008.13 Uniform Resource Locator that specifies the address of the website on Internet.

”

Sushant Kumar is a consultant in theTME Strategy Lab. His recent workincludes development of entrystrategies into key African telecommarkets, and an assessment ofstrategies to grow voice revenues inEurope. Prior to joining the Lab,Sushant worked for a leading researchand consulting firm. He is based inMumbai.

Ignacio Blanco is a consultant inCapgemini’s Telecom Media &Entertainment practice. He has morethan 2 years’ of experience in strategyconsulting in the telecom and mediasector. His recent work includesassessing the mobile advertisingmarkets as well as evaluating newdevelopments in television services. Heis based in Madrid.

Tushar Rao is a manager in the TMEStrategy Lab. His recent work focusedon analyzing disruptive technologies inthe broadcasting and mobile segments.Prior to joining the Lab, Tusharworked with a leading convergedoperator in India, where he wasresponsible for developing manageddata services for enterprises. He isbased in Mumbai.

Figure 7: Comparison of Mobile Internet Offerings of Selected Operators


OPERATORS NEED TO ENSURE THATTHEY ADDRESS EACH OF THE THREE CRITICALSUCCESS FACTORS—content, handsets aswell as user experience and pricing—adequately

“”

4140

17 Thomson StreetEvents, “DT – Q4 2007 Deutsche Telekom Earnings Conference Call“, February 2008

subscribers16. Almost two-thirds ofoperator pricing plans across Europeoffered either flat-rate in walled-garden or i-mode schemes or usage-based pricing for open Internet access.Similarly, only around a quarter ofoperator pricing plans in the USallowed open Internet access at flatrates in 2007 (see Figure 6).

We believe that operator pricing mustevolve towards flat-rate access to theopen Internet in order to have asignificant impact on user uptake. Forinstance, T-Mobile was the firstEuropean operator to introduce openInternet flat-rate plans including bothdata and time-based pricingstructures. Its Web ‘n’ Walk offeringsenjoy high uptake rates with around3.2 million mobile Internetsubscribers across Europe in 200717.

Operators need to ensure that theyaddress each of the three criticalsuccess factors—content, handsets aswell as user experience and pricing—adequately and do not offer whatconsumers could consider to be sub-par value on any of the factors. Figure7 demonstrates that consumers areunlikely to subscribe to a service that

i-mode sites in Japan in 2006, therewere just 100 in the USA. Similarly,3 UK had initial traction issues,regarding non-availability of best-selling or mid-range handsets, whichresulted in a sub-optimal consumerresponse. 3 Italy, however, built onthe UK launch experience and wasable to deliver high consumer valueon all the three critical success factorsleading to high subscriber uptakes.

In conclusion, mobile operators needto drive the uptake of mobile Internetservices by actively collaborating withcontent producers, devicemanufacturers as well as onlinemajors to deliver high consumer valueon the three key parameters ofcontent, handsets as well as userexperience and pricing. Continuedoperator initiatives to make theofferings more compelling will becrucial in stimulating further adoptionand usage of mobile Internet services.However, as mobile Internet users andmobile content revenues grow overthe next few years, content and deviceplayers are likely to make increasinglydisruptive moves across the valuechain in order to capture a greatershare of the market. Operators willneed to continue offering the rightmix of content, user experience andpricing to subscribers in order toavoid becoming reduced toundifferentiated data pipes.

does not serve their needs on all threeparameters. For instance, i-modeofferings in Europe did not work aswell as in Japan due to non-availability of user-friendly handsets,operator restrictions regarding contentavailability over the open Internet andunfavorable revenue sharing schemesthat discouraged third-party contentdevelopment. For example, whilethere were around 12,000 official

Figure 6: Distribution of Mobile Internet Pricing Structures, Selected Regions, 2007

Source: Capgemini TME Strategy Lab analysis. Company web-sites and press releasesNote: Percentages represent the proportion of operator pricing plans in each category, not proportion of customers usingeach

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48

56

62

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wider environment, rather taking amore proactive and systematicapproach to major industry andmacro-economic changing stimulibeing adopted.

The fast-changing environment oftoday demands organizations spendenough time and resources on makingthe right strategic choices. In the past,strategic focus was around 95% onexecution and 5% on strategicchoices. However, we believe thattoday, the right balance is around50/50, with more effort being spenton the process of making strategicchoices.

Moreover, many companies stillconsider the making of strategy as a“closed room” exercise wherein veryfew selected people are involved.However, both the complexity oforganizations and their environmentmake it almost impossible for a fewpeople to take into account all theinternal as well as external dimensionsnecessary to craft a relevant strategy.Therefore, organizations need todevelop a process of “inclusion”,which opens up the process ofstrategy formulation to a wider groupwithin the firm and the firm’secosystem partners.

We believe that organizations need tofollow a structured process for themaking of strategy in order toproactively identify problems,continue to be in sync with thechanging environment and stay aheadof their competitors.

In this paper, we present an“inclusive” framework for strategyformulation that brings out theimplicit elements of the strategy

making process and engages managersacross the hierarchy. The frameworkhelps business executives respond tochanges in the macro-environment ina structured way and by making theprocess more explicit, allows forbetter control of the strategyformulation exercise.

The TFAS FrameworkThe framework developed byProfessor Szulanski at INSEAD,dubbed TFAS (Trigger, Framing,Alternatives and Selection)decomposes the strategy decisionmaking process into four componentsand helps organizations respond in asystematic manner to various eventsthat demand a change of strategy infast-changing environments (seeFigure 1). Furthermore, this approachis “inclusive” encouraging theparticipation of managers from across

the organization hierarchy – from linemanagers to senior management.

The front-end of the process is thecritical part. There is always a“trigger”, a signal that reveals thatsomething is not going right. The keyfirst step is to recognize that there is aproblem and that the part of theproblem that is visible – for instance,a reduction in net margin – can be astrategic inflection point. Thisindicates that the problem could bedue to a strategic dissonance wherethe current strategic insight,competitive position and performancemodel have started to get out of syncwith the evolution of customers,competitors or economic trendswithin a sector.

In practice, this is a very difficultexercise as we can easily see theconsequences - the lag effect - but

Source: Capgemini/INSEAD Research

In the past, strategicreflection was focused 95%on execution and 5% onstrategic choices; HOWEVER WEBELIEVE THAT TODAY, THE RIGHTBALANCE IS AROUND 50/50

“

”

formulation is also becomingincreasingly challenging as the fast-changing macro-economicenvironments demand acorrespondingly fast-paced response.

Although strategy formulation intoday’s environment is bothchallenging and important, manycompanies do not follow a structuredapproach towards the making ofstrategy. In most cases, strategyevolves as an afterthought as theorganization takes reactive steps tokeep abreast of competitor moves andchanges in the industry as well as the

Therefore, the key challenge for topmanagement is to determine thestrategic direction–deciding whatshould be implemented before settingthe course for accomplishing it. Infact, our research suggests a highdegree of correlation between theprocess of forming a strategy and itseventual success. The research alsoindicates that the strategy formulationprocess of a firm is a source ofdifferentiation by itself. Therefore,organizations would be well served ifthey pay heed to the process offorming strategies. In addition tobeing extremely important, strategy

Until recently, it has been commonwisdom that the main determinant ofa company’s success was its ability toexecute and implement its strategy.Usually, companies were clear abouttheir strategic direction, and the mainpriorities for implementation.However, in today’s world, where wecontinuously witness fast-pacechanges in market conditions,increasing blurring of industryboundaries and the proliferation ofnew technology products as well asapplications, it has become moredifficult for enterprises to define clearobjectives and direction.

Abstract: In today’s world, where market conditions and industry boundaries change rapidly, strategy formulation has become more challengingand important than ever before. Our research indicates that there is a high degree of correlation between the process of making strategy and itseventual success. However, many companies still place more emphasis on execution rather on the strategy formulation process, which is typicallymore reactive than structured. We believe that organizations can approach the making of strategy in a systematic manner by following the TFAS(Trigger, Framing, Alternatives and Selection) framework. The framework helps identify triggers or key changes in the macro-economic environmentthat necessitate strategic course correction, frames the key questions to be addressed from the point-of-view of the organization, identifiesstrategic alternatives and subsequently selects the optimal path to align the firm’s strategy with changes in the broader environment. Bydeveloping strategy in such a structured manner, organizations can identify a strategic path with greaterr probability of success.

The Making of Strategy:Formulating Strategies in a Structured Mannerby Dr. Didier Bonnet, Andre-Benoit de Jaegere and Professor Gabriel Szulanski

COMPANIES USED TO HAVE STRATEGYMEETINGS TWICE A YEAR. NOW WE HAVE THEMTWICE A WEEK. The fact is that themetabolism of enterprises is changingdramatically

Meg Whitman – CEO eBay”“

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Figure 1: The TFAS (Trigger, Framing, Alternatives and Selection) Framework forUnderstanding the Making of Strategy

Dr. Didier Bonnet is a Vice Presidentand Managing Director of Capgemini’sglobal Telecom, Media & Entertainmentconsulting practice. He was for manyyears a Vice President with GeminiConsulting and prior to this with severallarge and small strategy consulting firms.He is based in London.

Andre-Benoit de Jaegere is a VicePresident and Director of Innovation &Development for Capgemini Consultingin France. Andre-Benoit was leader ofthe strategy practice for GeminiConsulting in France and now focuses onthe strategic aspects of large businesstransformation programmes. He is also alecturer in marketing strategy at theESSEC Business School in France. He isbased in Paris.

Professor Gabriel Szulanski isProfessor of Strategy at INSEAD, whichis where he earned his Ph.D in Strategyin 1995. He joined the faculty ofINSEAD in 2002 after serving on thefaculty of the Wharton School at theUniversity of Pennsylvania. Gabriel’sresearch interests focus on strategicmanagement, with a specific emphasisthe management of knowledge assets andthe making of strategy.

In conclusion, in today’s era, wherestrategy making is frequentlyneglected or limited to yearly offsitediscussions that are often out ofrhythm with the fast-changingenvironment, organizations need toensure that they have a consistentstrategy making process withsufficient time and resourcesdedicated to it. The TFAS frameworkallows business executives to identifykey events in the macroeconomicenvironment as relevant triggers thatdemand a strategic course correction,and systematically explore alternativesthat can ensure retention ofcompetitive advantages for theorganization. This inclusive andstructured process to strategyformulation can help generatestrategies that have a greaterprobability of being successfullyimplemented.

THE TFAS FRAMEWORK HELPSMANAGERS identify events that demanda strategic course correction, findalternatives and select the optimal pathin a structured manner

“47 ”

Since 2006, Capgemini Consulting has been partnering with INSEAD on ajoint research and case building program focussed on deriving a betterunderstanding of the strategy-making process. As part of this partnership,Capgemini Consulting works with Professor Gabriel Szulanski’s innovativeMBA course called “The Making of Strategy”. A case-based researchprogram has been designed and has already generated in excess of 130cases built around the TFAS framework to advance the understanding ofstrategic decision making.

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The final challenge is the selectionprocess. The challenges of selection infast moving environments are those ofmanaging uncertainty. How do weavoid killing promising projects early?– “throwing out the baby with thebathwater”. How do we spot losersearly in the process? – “why are badprojects so hard to kill?” If the processhas been properly implemented tothis stage, the organization shouldface having to make tough choicesonly between good options. This is ofcourse the essence of strategy as mostorganizations will have far more goodoptions than they have resources tocarry them through.

The TFAS framework thus helpsmanagers to identify the importantevents in the macro-environment thatdemand a strategic course correction,and then takes a structured approachtowards identifying alternatives andsubsequently selecting the optimalpath. Figure 2 illustrates the makingof strategy using the TFAS framework.It also highlights the involvement ofmanagers across the hierarchy,reinforcing the inclusive nature of theframework.

find it difficult to identify the rootcause. We have observed that manyorganizations tend to dismiss earlysignals hoping that the situationwould get better. This can lead to theorganizations missing importantstrategic changes in their industry–for instance, the early move to a newbusiness model. In addition, incomplex and fast movingenvironments, corporations tend toadapt from the bottom-up, inventingthe journey as they progress, leadingto potentially sub-optimal results.

Once the existence of a problem hasbeen recognized, it needs to beframed and the question that needsaddressing should be clearlyformulated. The difficulty is in findingthe right “frame” or the key question,challenge or issue confronting theorganization. If one frames theproblem too narrowly, one will reducethe organization’s room formanoeuvre. On the contrary, if theproblem is framed too widely, theorganization will find it impossible tofind where to start.

Having framed the question the nextstep is to envisage the possibleanswers. It is very rare that only oneanswer will exist and yet manycorporations we have studied onlypush a single answer through theirstrategic process (e.g. we need toacquire this company or the answer isto boost our sales force in the US).Ideally for every question, executivesneed to form a series of options (say3-4), but at the same time avoid thetraditional problem that we encounterin many organizations of throwingseveral options on the table withoutproper research, knowing that theywill be rejected but they exist to“make the numbers”. Each optionneeds to be carefully documented andshould represent a realistic alternative.This part of the process is the mostcreative and therefore requires sometime and rigour. The final decision isa very delicate balancing act – first,because there is a risk that good ideasmight be disposed of and second,because it is easy to make the choiceby default due to a fear of failure orfor political reasons.

Figure 2: Strategy Formulation Process Mapped on the TFAS Framework

Source: Capgemini/INSEAD Research

£10bn5, the buy-out of Danishtelecom company TDC6 for €10bn,and the LBO of music label EMI for€3.2bn7.

The growth story continued into thefirst half of 2007, and it was led inlarge part by the US. The industry hadgrown over 60% in terms of fundsraised in 2006, reaching an all timehigh of $290bn8. This growth

continued into the first half of 2007,proof of which lies in the biggest PEdeal of 2007—TXU Corporation wasacquired by an investment group ledby leading PE firms Kohlberg KravisRobert & Company (KKR) and TexasPacific Group (TPG) for $44bn. Thepace of growth of the PE industry wassuch that in early 2007, a PE player,Blackstone Group, raised over $4bn ina record IPO that ranked amongstUSA’s top 10 IPOs of all time9.

H2 2007: Slowdown due to theCredit CrisisMortgage Crisis Effects of the USHowever, whilst there was stronggrowth in the PE industry up until thefirst half of 2007, the 2007 subprimemortgage financial crisis led to anunpredicted credit crunch. Withliquidity in global financial marketssignificantly reduced, PE players thatwere heavily dependant on syndicatedand high-yield debt, suddenly foundthemselves cash-strapped as banksstarted going back on their positions.Most major banks in the US andEurope have had to write-down multi-billion dollar losses due to theirexposure in the subprime vehicles.Many banks are today sitting on

were eager to invest in this fastdeveloping asset class which promisedsuperior returns.

A Favorable Environment for Fund-RaisingA low interest rate environment drovelarge institutional investors such aspension funds as well as high-net-worth individuals away from loweryield bond investments towards betterperforming PE investments (seeFigure 1). For instance, in the UK, 10-year returns on PE investments werearound 16% as of 2005, comparedwith 8–9% for UK bonds and publicequity.

The Number of LBO Transactions hasIncreased During the Growth Phaseof PE ActivityDuring the growth phase of the PEindustry, most investments hadfocused on buy-outs. LBOs accountedfor over 77% of all PE investments inEurope in 2007, as is evident fromFigure 2. Mega buy-outs accountedfor almost 18% of all deals in Europein 2007.

Deal sizes have been steadilyincreasing across Europe. Some of thelargest deals in Europe in recent yearsinclude the LBO of Boots by KKR for

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Figure 1: Global Fundraising by Private Equity Players, 2004-2007 ($bn)

Source: Preqin through RREEF Research, “The Outlook for Private Equity: First Quarter 2008”, April 2008

Figure 2: PE Investments by Stage of Financing, Europe, 2007 (%)4

Source: EVCA, 2007 Preliminary European Activity Figures, March 2008

4 Early Stage — Investing in a company in its early stages of development.Buy-out — Outright purchase of a company or of a controlling stake in a corporation’s shares. Buy-outs comprise small, mid-market, large and mega buy-outs based on size of dealReplacement Capital — The acquisition of existing shares in a company from another private equity investor or from other shareholders, or financing made available to a company as analternative to a bank loan.Expansion — Financing for the expansion plans of a company that might be at various stages of its growth.

5 Guardian, “High court sanctions £11bn takeover of Boots”, June 2007.6 Datamonitor Computerwire, “TDC Finally Agrees to Buy-out Deal”, December 2005.7 BBC News, “Music giant EMI agrees takeover”, May 2007.8 Preqin through RREEF Research, “The Outlook for Private Equity: First Quarter 2008”, April 2008.9 BusinessWeek, “IPOs: Top 10 U.S. Mega-Deals”, March 2008.

strategic options PE players have toweather these turbulent times.

A new context for the PEindustry2004 – H1 2007: An ExceptionalPeriodPE funds have had a strong period ofgrowth from 2004 up until the firsthalf of 2007. Leading firms wereaggressively deploying availablecapital and acquiring large companies.Limited partners3 around the world

through LBOs. However, sincesummer 2007, PE activity hassubstantially slowed down as thecredit markets have dried up and theglobal economic environment isdeteriorating. In Q4 2007, dealsworth only €45bn were completed,compared with over €86bn in Q420062.

In this paper, we discuss the effects ofthe current credit crunch on the PEindustry and analyze the various

Until recently, the Private Equity (PE)industry experienced strong growth,setting a new record each year infund-raising as well as the numberand size of deals. For instance, inEurope, 2006 saw over 1,290“Leveraged Buy-Out” (LBO) dealsvalued at more than €250bn1. Theavailability of large amounts of capitalcombined with exceptional liquidityin the debt markets enabled PE fundsto make large acquisitions, gainingmajority control in companies

THE PACE OF GROWTH OF THE PE INDUSTRYWAS SUCH THAT IN EARLY 2007, A PE PLAYER,BLACKSTONE GROUP

raised over $4bn in a record IPO thatranked amongst the top 10 of all IPOs inthe US”“

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Abstract: The Private Equity (PE) industry is currently going through a phase of slow growth. In the period up to the first half of 2007, the PEindustry had seen strong activity, both in number of deals and in total value. However, the credit crunch of 2007—a fallout of the subprimecrisis—has resulted in an increased cost of debt. The slowing global economy is also threatening to have a significant impact on the growth ofthe PE industry; however, PE continues to attract new investors and is likely to stay. Recent fund closures have provided ample evidence thatinvestors continue to view PE as a strong alternative asset class. Limited availability of debt financing has dented the ability of PE firms tocontinue seeking large leveraged buy-outs, as a result of which players are now looking for growth through newer types of transactions such asminority and no-debt investments. Firms will have to consider newer emerging markets across the world for identifying growth prospects. PEcompanies will need to concentrate on creating value through a combination of strategies such as consolidation of asset portfolio, costtransformation and strategic course correction in order to ensure that their growth story remains intact.

Private Equity Players: Strategies for Weathering the Stormby Stanislas Pilot, Thomas Bouton and Subrahmanyam KVJ

1 Mergermarket-Browne, “European Private Equity in Review”, February 2008.2 Mergermarket-Browne, “European Private Equity in Review”, February 2008.3 Limited Partners contribute capital and do not play any role in management of companies acquired by PE firms; they however have first rights in case of liquidation.

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Value opportunities that arise duringperiods of economic slowdown haveshown to have significantly betterreturns on investment. PE firms needto act decisively in identifying andtaking advantage of suchopportunities.

Grasp new deal opportunitiesThe new context in the PE industryalso brings new opportunities forfunds to venture out of theirtraditional model and look forinnovative ways to gain returns.

Shift focus towards Small/Mid-capand Minority TransactionsSmall and mid-market transactions—with lower enterprise value andrequiring minimal debt fundingcompared to large buy-out deals—arestill active. Due to the current softnessin the global capital markets, listedsmall- and mid-cap companies thathave been impacted by the bearishmarket offer opportunities for Publicto Private (P-to-P) transactions.

At the same time, PE funds need torealize that newer opportunities lie inacquiring non-control investments.Such transactions, whilst not givingcomplete control to the PE firm, canhelp the firm acquire a footing incertain sectors or specific geographies.Figure 6 shows the rise in minoritynon-control investments in 2007 fromthe first half to the second half.

and 1990s, the stock market crash of1987 and the depression in thetechnology sector in March 2000.Indeed, times of crises need not benecessarily detrimental to the growthof the PE industry. In fact, there isstrong evidence to the contrary thatduring times of economic andfinancial slowdown, a lot of PE firmshave generated very good returns.Figure 5 shows the returns from PEinvestments in the three most recentglobal meltdowns. The first of thecrises was the debt crisis of 1980-1982, which was largely triggered by“Petrodollar Recycling” and theincreasing inability of developingeconomies to repay their foreigndebt12. The recession of the 1990swas the next major period of turmoil,while the bursting of the dot-combubble and meltdown incommunication companies was largelyresponsible for the third major crisis.During all these periods, it isinteresting to note that the IRRs13 ofPE investments, across Europe, haveactually been quite strong.

Source: Carlyle Group Presentation from S&P Leveraged Buy-out Review, February 2008

Figure 4: Average large LBO Leverage Multiples (Debt / EBITDA), 1997-2007

Figure 5: Net IRRs to Investors Grouped By Vintage Years from Inception to 31-Dec-2007, 1980-2007, Europe (%)

Source: EVCA, “Performance Benchmarks 2007 European Private Equity”, March 2008

12 The University of Iowa Center for International Finance and Development, “The 1980s: The Debt Crisis & The Lost Decade”.13 IRR — Internal Rate of Return: It the annualized effective compounded return rate which can be earned on the invested capital.

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billions of debt commitments whichthey have not been able to syndicate.For instance, at the end of Q1 2008,it is estimated that American bankshad an exposure of over $197bn inleveraged loans still on their balancesheets10. As a result, these banksdrastically tightened their creditallowance conditions leading to thecurrent credit crunch, therebycontributing to a rising cost of debt.

Lower Deal Flow from H2 2007The credit crunch in the worldeconomies, led by the US, has affectedPE players, preventing many LBOfunds from making new investmentsor recapitalizing existing ones. Evensome mega deals initiated in 2007such as Harman International, SallieMae, and Home Depot Supply had tobe renegotiated before closing, orwere simply cancelled.

As a result, the PE industryexperienced a slowdown in the sizeand number of transactions from H22007 to Q1 2008. This slowdown hasbeen pronounced both across NorthAmerica and Europe. Figure 3 showsthe growth in PE buy-outs from 2003to H1 2007 and the subsequent fall indeal value as well as the number ofdeals during H2 2007.

Reduction of Leverage Multiple fromH2 2007PE firms typically value companies asa multiple of their cash flows. Since

PE companies finance a large part ofLBO deals with debt, the typicalvaluation ratio used is the leveragemultiple, which shows the ratio of netdebt to EBITDA11. These multiples forLBO transactions which rose from 4.0in 2002 up to a historic high of 6.2 in2007, have now declined as banksbecome more conservative (see Figure 4). Consequently, PE firmsnow have to structure deals in a wayso they have a higher equitycomponent. However, this is likely todepress the returns when they divestthe investment. This also has the riskthat PE firms will not be as attractivean option compared to other industrybuyers.

Recommendations for PEplayersFaced with this situation, PE playersneed to adapt their strategies tocontinue to deliver high returns toinvestors.

Keep the Long Term PerspectivePE firms typically manage funds overa 5 to 10 year horizon. As such, theyhave a long term perspective and canafford not to invest for 12 to 24months if short term marketconditions are not favorable.Moreover, the current crisis is not thefirst one and comes after a long list ofeconomic and financial uncertaintiessuch as the recessions of early 1980s

TIMES OF CRISESneed not necessarily bedetrimental to the growthof the PE industry“

”

Figure 3: PE LBO, 2003-2007, North America & Europe ($bn)

Source: Mergermarket-Browne, “North American Private Equity in Review”, Feb 2008; Mergermarket-Browne, “EuropeanPrivate Equity in Review”, Feb 2008

10 Oppenheimer & Co, through Wall Street Journal, “Leveraged Loans: The Hangover Wasn’t Worth the Buzz”, February 2008.11 Leverage Multiple: It is the ratio of net debt to Earnings Before Income, Tax, Depreciation, and Amortization (EBITDA).

appears to be good in Nordiccountries like Sweden in 2008. Banksprovide relevant debt financing, evenwith lower debt multiples, assistingdeal flows.

The investment environment alsolooks promising in Eastern Europe,where economic growth is forecastedto be in the 4% to 9% range. Theregion has not been affected by thesubprime mortgage crisis and thebanks have taken a proactive role inmaintaining a favorable debt market.Figure 7 shows funds raised inemerging markets between 2003 and2007 with the specific purpose ofinvesting in these geographies.

In a recent survey, Asia Pacific buy-outs and venture capital ranked firstand third respectively as the preferredareas for investment over the next oneyear. Proof of this is the fact that mid-market deals in developing countriesare on the rise with 31% of allinvestments in 2007 in the $10-25mncategory20.

A recent trend of large buy-out firmslike KKR and Blackstone is to activelyinvest in developing countries likeIndia and China. For instance, KKRacquired a minority stake in China'sTianrui Group Cement Co. for$115mn—its first investment inmainland China21.

Meanwhile in India, Blackstone hasinvested $150mn and $165mn in

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20 Coller Capital Private Equity Barometer through RREEF Research, “The Outlook for Private Equity: First Quarter 2008”, April 2008.21 AltAssets, “KKR leads $450mn financing for Chinese cement producer Tianrui Cement”, September 2007.

Figure 7: Fundraising Focussed on Emerging Markets, 2003-2007 ($bn)

Source: EMPEA, “Emerging Markets Private Equity Funds Raise US$59 billion in 2007”, February 2008

Some private equity firms havealready started to recognize theinherent growth of firms that are notavailable for acquisition. For instance,in the case of PE investments incompanies like Bharti Infratel (atelecom infrastructure company inIndia) and Moneygram International,the respective PE firms have decidedto go in for minor stakes. In the yearto April 9th, PE firms have made over245 minority investments worth over$12.1bn. This compares with 204such deals worth over $10.9bn in thesame period in 200714. By doing so,PE firms stand to be a partner in high-growth companies, as well as gainingunderstanding in the space for futureinvestment opportunities.

Investment with No Debt: VC &Expansion fundsThe current low market values alsooffer opportunities for Venture Capitaland Expansion Capital funds thatperform transactions on fast growingcompanies which do not involve adebt component. A recent case inpoint can be found when, in April2008, the venture capital firm 3iinvested €125mn in Unión Radio, aconglomerate of radio stations inSpain and Latin America, out of totalcommitments of €225mn15.

In Q1 2008, venture capitalistsinvested over $7.1bn in 922 deals16

with clean technology garnering someof the greatest interest from venturecapitalists. Range Fuels Inc., anethanol production firm, raised over

$130mn in Q1 2008, while SunivaInc., a maker of solar-cell technology,raised over $50mn17.

Even large LBO funds have recentlyundertaken investments with no debt.US-based leveraged buy-out firm TPGhas bought 50% stake of SIAInternational Ltd., the largestpharmaceutical distributor in Russia,for $800mn in cash18. Leading PEfirm Kohlberg Kravis Roberts & Co.(KKR) acquired Northgate Information

Solution at a price of 95 pence in cashfor each Northgate share. This valuedNorthgate at approximately £593mnin issued share capital to KKR19. Suchdebtless transactions are likely to yieldmaximum results when they arefocused on high growth companies.

Investment in Growing Economiesand Select Developed MarketsWhile macroeconomic conditions areexpected to weaken in many parts ofWestern Europe, the environment

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Figure 6: Minority investments by PE firms, 2007, ($bn)

PE FUNDS NEED TOREALIZE that freshopportunities lie in acquiringnon-control investments

”

Source: Dealogic, through Carlyle Group Presentation, “Ten Key Questions Facing the Private Equity World”, February 2008

“

14 Financial Week, “Leverage gone, PE vultures must settle for smaller bites. Beats sitting on all that cash”, April 2008.15 The Deal, “3i invests $356M in Union Radio”, April 2008.16 Financial Times, “VCs pull back from funding start-ups”, April 2008.17 Domain-B, “VC investments slow down in 2008”, April 2008.18 AltAssets, “TPG to invest $800m in Russian pharmaceutical company SIA International”, April 2008.19 Reuters, “KKR to buy Northgate Info for $1.2 billion”.

Interestingly enough, in March 2008,Bain Capital closed a €3.5bn fund,which was well over its €2.5bn targetand more than triple the size of Bain’slast €1bn fund. In the same month,Warburg Pincus announced theclosure of its $15bn fund, whichgarnered over $3bn in excess of itsinitial goal. The manner in which PEfirms have successfully closed newfunds since last summer are sure signsthat investors are strongly confidentthat the PE industry will keepbringing strong returns on theirinvestments in the future.

Stanislas Pilot is the leader ofCapgemini’s TME Private Equitypractice. Stanislas has more than 10years’ experience in strategic analysis,M&A and shareholder value creationin the telecom and media sectors. Priorto joining Capgemini, Stanislas was aprincipal with APAX Partners. He isbased in Paris.

Thomas Bouton is a managingconsultant in the Capgemini's TelecomMedia & Entertainment strategyconsulting practice. He has more than8 years' experience in the telcoindustry, and has recently been focusedon private equity within thetelcommunications sector. He is basedin Paris.

Subrahmanyam KVJ is a consultant inthe TME Strategy Lab. His recentwork focused on the convergingtelecom and media markets, and themobile industry. Prior to joining thelab, he worked with a leadingelectronics manufacturing services firmin a project management role. He isbased in Mumbai.

Consider the case of Netherlands-based mobile operator Telfort. In2003, Telfort was making losses andwas sold to Greenfield CapitalPartners, a PE firm, for €25mn28. ThePE firm changed Telfort’s strategy andstarted offering low-cost wholesaleservices in addition to its retail mobileservices, through two distinct businessunits. The increased focus onwholesale services made Telfort verysuccessful in attracting MVNOs to itsnetwork. Telfort’s total subscriber baseincreased and it became profitablewithin a couple of years. On the otherhand, incumbent KPN felt pressurefrom MVNOs who launched price-competition backed by Telfort’s lowwholesale prices. Faced with fallingARPUs and increased customer churn,KPN decided to buy Telfort for nearly€1bn in June 2005, therebygenerating significant returns for itsPE owners29.

In conclusion, the PE industry issubject to growth cycles, in wayssimilar to the global economy itself.The current slowdown is due to acredit crisis, not to an equity crisis.Thus, transactions with no or minimaldebt leverage are still occurring andthe LBO activity will restart as thecredit situation improves. During thisphase, the PE industry will need to re-focus on its core activity, which iscreating value for firms that arealready part of their portfolio byimproving their operationalefficiencies. Besides, emerging marketsand some selected high performingsmall/mid-caps will still offer goodopportunities to PE funds. Someplayers will also take advantage of thecurrent credit crunch and theeconomic slowdown by acquiringfirms with low enterprise value oreven purchase LBO loans that banksare selling at deep discounts to cleartheir balance sheets.

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28 Telecom Paper, “Greenfield Capital buys O2 Netherlands for EUR 25 mln”, April 2003.29 Red Herring, “KPN Snaps Up Telfort”, Jun 2005.

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market monitoring—especially incomplex sectors requiring strongindustry knowledge such as Telecom,Media, Energy or Life sciences. It isessential to understand the businessand competitive scenario thoroughly,and take a long term view ofinvestments. Therefore, this strategy isnot as common as the employment ofcost efficiency measures; however,several PE firms have used it verysuccessfully. In 2007, 12.9% of PEinvestment volume representing35.6% of the total number ofinvestments in Europe accounted forfinancing long term growth andexpansion of portfolio companies25.

For instance, leading PE firm ApaxPartners and OMERS Capital Partnersprovided equity funding of $125mnto its portfolio company CengageLearning to acquire Houghton MifflinCollege Assets for $750mn26.Previously, Apax Partners and OMERSCapital Partners had acquiredThomson learning for $7.75bn duringH1 2007 under favorable marketconditions27.

By consolidating companies, investors,therefore, can potentially theirreturns by selling the new, largerentity at higher multiples thanoriginally purchased, therebybenefiting from synergies.

Strategic Course CorrectionAt times, to turn around the fortunesof the acquired company, a PE playerwill need to correct the course of itsstrategic direction. This needsextensive industry expertise andforesight on the evolving dynamics ofconsumer behavior, industrycompetition and regulatory changes;but, if implemented correctly, thebenefits can be extremely high.

Limited availabilityof low-cost debt MAKES ITALL THE MORE IMPORTANT FORPE FIRMS TO FOCUS ON VALUECREATION

“”22 Business Standard, “Blackstone to invest $150mn in Nagarjuna Const”, August 2007.

23 LiveMint, “Blackstone buys 50% in Gokaldas”, August 2007.24 LiveMint, “Blackstone picks up 10% in Allcargo Global”, February 2008.25 EVCA Barometer, March 2008.26 Reuters, “Cengage to buy Houghton college unit for $750 mln”, December 2007.27 Forbes, “Thomson to sell Learning Assets to Apax and OMERS funds for 7.75 bln usd”, May 2007.

Nagarjuna Construction CompanyLimited22, a leading Indianconstruction company, and GokaldasExports Limited23, India’s largestgarment manufacturer and exporter.Blackstone has also agreed to invest$61.1mn in Mumbai-based AllcargoGlobal Logistics Limited24.

Focus on Value CreationMany PE firms have constructedmassive portfolios during favorablemarket conditions. Given the currenteconomic environment and the lack ofmega deals, PE players need tointensify their work on generatingappropriate returns from their existingportfolio. Since low cost debt is notavailable, it is all the more pertinentthat PE firms focus on value creationthrough a variety of means.

Build Cost EfficiencyAfter a buy-out, PE players need tofocus on extracting significant valuethrough operational improvementsaround cost savings, outsourcing andthe divestment of select assets.

Some PE firms have very successfullyachieved cost efficiencies in acquiredfirms. A case in point is the €10.3bnbuy-out of Denmark’s incumbentoperator TDC in February 2006 by aconsortium of PE players including

Apax Partners, Blackstone Group,KKR, Permira and Providence Equity.After the buy-out, in order to reducecosts, TDC announced annual 5-7%job cuts. It also outsourced the fullrange of IT infrastructure servicesusing a seven-year contract andtransferred around 150 employees toa third-party services provider.Furthermore, a decision was made tofocus only on the Nordic region, withTDC’s non-Nordic assets considerednon-strategic resulting in a sale at agood price.

While immediate gains can be madethrough cost efficiencies and thedivestiture of assets, investors alsoneed to look at medium and longterm prospects for value creation.

ConsolidationFor certain sectors, the best strategy ofadding value and thereby creatingpotential for enhanced return oninvestment is by focusing onconsolidation; this strategy is based onincreasing the scale of operationsthrough mergers and acquisitions.This entails more risk than extractionof simple cost efficiencies, as itinvolves further infusion of capitaland expert operational managementto create value. It also requires the PEplayers to undertake comprehensive

~440 MILLION AFRICANS livein markets demonstratingconstrained growth

Undeveloped MarketsThese markets include nations likeZimbabwe, Somalia and Rwanda—countries with a history of politicalinstability leading to low internationalinvestment and little development inthe domestic private sector. Thesedifficulties are reflected in the nationalGDP, with an average of only $986per capita4 and mobile penetrationrates which are less than 10%3. Theconstraints on mobile uptake areintrinsic in nature, with widerdevelopment needed before operatorscan develop the communicationsmarket.

Constrained MarketsThese nations generally have highpopulations, with widespread poverty.The GDP per capita of $1,6054 is muchlower than that of leading markets, as aresult of which foreign investments wereslower to reach these nations. Mobilepenetration is growing but remainsbetween 10 and 30%.3 Our experienceis that mobile growth in these marketsis constrained by significant usagebarriers, such as handset cost andservice availability.

In this paper, we focus on theopportunity presented by these

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2 ITU World Telecommunication ICT Indicators 2007, Capgemini analysis.3 ITU World Telecommunication ICT Indicators 2007, Capgemini analysis.4 World Bank GDP/Capita data 2008; www.worldbank.org.5 World bank 2006 Population estimates, Capgemini analysis.

“”

Figure 2: Mobile Phone Penetration, Africa, 2000-2007, %

Source: ITU World Telecommunication ICT Indicators 2007, World Bank 2006, Capgemini Analysis

Figure 3: Geographic Distribution of African Market Segments, 2007

Source: ITU World Telecommunication ICT Indicators 2007, Capgemini Analysis

Representing 23% of the world’sremaining non-mobile phone users,Africa should be considered alongsideChina and India as an engine of futuregrowth for mobile services.2

The opportunity presented by Africaat a continental level is considerable,but Africa is a highly heterogeneouscontinent in terms of socio-economicdevelopment, with correspondingdifferences in mobile market maturity.

At a high level, we can characterizeAfrican markets into three segments;leading, undeveloped and constrainedmarkets. These are outlined in Figures2 and 3.

Leading MarketsThe leading markets of Africa haveshown rapid development withaverage mobile penetration of 55%.1

These markets are concentrated inNorthern and Southern Africa, andgenerally constitute the wealthierAfrican nations; their average GDP of$7,500 per capita contrasts with acontinental average of $2,822.4

Investors entered these markets early,as Northern Africa attracted MiddleEastern and European operators,while the Southern African marketsbenefited from proximity tocomparatively developed areas ofSouth Africa—home to industryleaders MTN and Vodacom. Due totheir high state of development andmaturity, it is our understanding thatthe window of opportunity is endingfor operators to achieve further super-nominal subscriber growth in thesemarkets.

23% ofthe world’snon-mobileusers are inAfrica

positioned for growth, and discussstrategies for operators to removepresent growth barriers and unlockthe latent market potential.

African Market SegmentationWith mobile services universallypredominant over fixed line, Africansubscriber growth has been dramatic,reaching 265 million mobile phonesubscribers in 2007. Despite thisgrowth, 700 million Africans remainwithout a mobile phone in 2007,presenting many investmentopportunities (see Figure 1).1

which boasts over 900 million peopleexperiencing a subscriber CAGR of47% over the last five years, whichhas now driven penetration fromapproximately 2% to 27% since theturn of the century.1

Given the rapid development of thesemarkets, operators have a shorteningwindow of opportunity. In this article,we segment the African countries,identifying those markets which are

Saturation of mobile markets in theUS and Europe coupled withdeclining revenue growth in theseregions has brought emergingeconomies to the forefront of operatorattention. Among emerging markets,the African continent is generatingparticular interest, as shown by recentspeculation surrounding theacquisition of MTN by key Indianplayers, Bharti and Reliance.Operators are attracted by a continent

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Abstract: With approximately 700 million non-mobile users1 and low fixed line penetration, Africa is attracting widespread attention fromWestern, Middle Eastern and Asian operators looking for new subscriber growth. Whilst growth in some markets has been strong, Capgemini hasidentified a large segment of African markets, spread across twenty countries, where growth has been constrained by usage barriers thatoperators can address. The key barriers to mobile usage remain poor market regulation leading to high tariff prices, unaffordable handsets, lackof network coverage and product distribution constraints. The risk for established operators who fail to address these constraints rapidly isconsiderable, as operators with expertise in low ARPU markets, such as Bharti or Reliance, continue to be attracted to large unaddressedpopulations.

Telecoms in Africa:Reaching Consumers in Constrained MarketsJawad Shaikh, Ashish Sidhra and James Henderson

Figure 1: Population and Mobile Penetration Across Selected Markets, June 2007

Source: Capgemini TME Strategy Lab analysis. Telecom Regulatory Authority of India (TRAI). GSM World Web-site.Merrill Lynch, “Global Wireless Matrix Q2-2007”, October 2007

1 ITU World Telecommunication ICT Indicators 2007, Capgemini analysis.

“”

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Improving Handset AffordabilityWhilst we anticipate that call priceswill decline as markets mature andcompetition intensifies, handsetaffordability constraints will continueto be the single greatest limitation onusage growth.

The difficulty for operators is that inthese low ARPU environments,handset subsidization cannot bewidely justified due to the risk ofsubscriber churn and widelyunavailable credit structures.

Operators are increasingly supportedby the efforts of handset vendors whohave recognized the need for newultra low cost handsets, which willcontinue to be introduced into themarket at lower price points.However, in our view, operators

should still play an active role inaddressing this barrier. For example,African consumers have a highacceptance of second-hand handsets,which implies that operators whoinvest in importing refurbishedhandsets can often reach newconsumers rather than waiting for theprices of new handsets to reachfavorable lows.

Given the importance of low costhandsets, it is our view that there areopportunities for some operators tocollaborate in handset procurement.For example, if second-tier playerscollaborate to combine their spendand supply chain expertise, theywould benefit from economies of scaleand access to shared assets, allowingthem to threaten the hegemony ofleading players.

In constrained markets, lack ofregulation is limiting the ability ofplayers to replicate the Algerianexperience and pursue disruptiveprice strategies. Interconnectionagreements are often negotiateddirectly between participants inmarkets like DRC, Zambia andUganda 9, leading to very highinterconnect floors; in India, theinterconnect rate is mandated at$0.0075 10, whilst in the DemocraticRepublic of Congo it sits between$0.15 and $0.20 11, leading to pricesthat are 550% greater.

Established players with largecustomer bases lobby regulatorsheavily to maintain the status quo andprotect themselves from the damageof a price war. Whilst interconnectionagreements between operators mustbe ratified by the regulator, the lack ofa clear mandate to drive downinterconnect rates leaves thenegotiating power of incumbentoperators unchecked.

An example of an African marketwhere regulation has been successfulis Tanzania, where the interconnectrate is relatively low at approximately$0.078; tariff price declines havedriven an ARPU decline ofapproximately 70% from 2003 to2007, with subscriber penetrationgrowing from 5% to 20%. In thiscontext, the decline in ARPUdemonstrates the addition of manylow income consumers. 12

The failure of many African operatorsto reach poorer consumers isconfirmed by the relatively highARPUs seen in constrained marketssuch as Nigeria ($15), Zambia ($11)and DRC ($12) compared to Asiancountries like India ($9) or Russia($9.1) 13.

9 Capgemini experience, regulatory statements; www.caz.gov.zm/, www.ucc.co.ug/.10 Indian Telecommunications Regulator; http://www.trai.gov.in/.11 Operator Interconnection Agreements, DRC Regulator; Capgemini research.12 Capgemini analysis, various sources; Operator annual reports, regulatory documentation.13 Company Reports; Telecom Regulatory Authority of India (TRAI). Merrill Lynch, “Global Wireless Matrix Q2-2007”, October 2007.

Source: World Bank 2005 Household spend survey, Capgemini Analysis

Figure 6: $50 Handset cost as a percentage of average annual consumption perindividual in constrained markets, 2005, %

HANDSET COSTS are thesingle greatest barrier tomobile uptake“

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“constrained markets” as we believethat operators can remove some ofthese usage barriers and acceleratesubscriber growth. This is in contrastto “undeveloped markets,” wheresocio-political problems are too severeto be addressed profitably, and“leading markets” where established

players are already driving marketmaturation.

The constrained market size is huge,with 440 million potentialsubscribers, constitutingapproximately 50% of Africa’s totalpopulation.5

Unlocking Value in ConstrainedMarketsWhilst poverty is doubtless the mostsignificant barrier to marketdevelopment, it does not in itselfexplain the low mobile penetrationof constrained markets. Figure 4demonstrates that whilst countriessuch as Angola and Cape Verde havesimilar levels of wealth to Albania andMoldova, they have much lowerpenetration.

We believe there are four commonusage barriers that explain thediscrepancy of low servicepenetration: service affordability,device costs, service availability andtechnological literacy. By addressingthese usage constraints we believeoperators can unlock value and growthe size of the addressed markets.

Effective regulation can facilitateprice declinesAcross the constrained markets, pricescharged for basic voice and SMSservices remain at a premiumcompared to other regions; forexample, whilst 41% of thepopulation in Sub-Saharan Africa liveon less than 50 US cents per day,average calling rates vary between 15to 30 US cents per minute.7

Figure 5 demonstrates the pooraffordability of mobile calls in Africa.In our view, African markets are likeany other nascent mobile market inthat they exhibit high usage elasticity;i.e. a decline in price will result inincreases to both average minutes ofuse and subscriber numbers.

An example of stimulated growth isAlgeria, where the second entrant,Orascom, secured a market share of70% after only one year of operations.This strategy was based on aggressiveprice cutting, causing a staggeringeffect on mobile penetration—from2000 to 2002, market penetration wasbelow 2%; however, followingOrascom’s launch, penetrationreached 4.5% in the first year,climbing to 63% in 2007.8

6 Leading Markets (20 Countries): Algeria, Botswana, Congo, Cote d’Ivoire, Egypt, Equatorial Guinea, Gabon, Gambia, Ghana, Kenya, Libya, Mauritania, Mauritius, Morocco, Namibia,Senegal, Seychelles, South Africa, Swaziland, Tunisia. Constrained market (21 Countries): Angola, Benin, Burkina Faso, Cameroon, Cape Verde, Democratic Republic of Congo,Guinea-Bissau, Lesotho, Liberia, Madagascar, Mali, Mayotte, Mozambique, Nigeria, Sao Tome & Principe, Sierra Leone, Sudan, Tanzania, Togo, Uganda, Zambia. Undeveloped Markets(13 Countries): Burundi, Central African Republic, Chad, Comorros, Djibouti, Eritrea, Ethiopia, Guinea, Malawi, Niger, Rwanda, Somalia, Zimbabwe.

7 Department for International Development, UK, Report on Africa, April 2008; Capgemini Analysis (Figure 5).8 Orascom Annual reports, ITU 2007, Capgemini Analysis.

Source: IMF 2008; ITU 2007

Figure 4: Mobile Penetration and GDP/capita, % and USD$ (PPP)6

DESPITE WIDESPREADPOVERTY, African mobile costsare amongst the world’shighest

“”

Source: Company Reports; ITU 2007, Capgemini Analysis

Figure 5: Mobile Call Costs in Select Countries, February 2008, US cents and PPPUS cents

Given the low population densities inrural areas and the high cost ofbackhaul to connect them to the corenetwork, “Greenfield” consumers aredifficult to address profitably.Operators should first establish apresence in the profitable urban areas,before switching investment focus tothe latent opportunity of the ruralmarket.

The importance of rural coverage isemphasized by the high internalmigration to cities, which is typical ofAfrica, resulting in strong demand forcalls home to rural friends and family.Hence, an operator providingcoverage to a rural area is likely toattract both significant interconnectrevenue and net subscriber churn asurban users move “on-net” with theirrural contacts.

Technology ChoicesNew entrants must carefully considerthe network technology they employ.Differentiation through costly, highspeed networks can be risky;operators must not lose focus on thefact that these are predominatelyneed-based markets, and whilst aconsumer demand for high speedconnections may exist, the valueremains in offering standard mobilevoice and SMS services.

WiMax is especially hyped as adisruptive threat to mobile markets.However, with the availability ofcheap handsets key to mass marketpenetration, operators pursuingtechnology leadership strategies willlack the economies of scale offered byestablished GSM technologies, andthus will often be limited to the richersegments of society. In addition,African consumers would beparticularly sensitive to the technicalissues expected from immaturetechnologies like mobile WiMax, suchas poor battery life. For these reasons,constrained markets have a degree ofprotection from the threat of mobileWiMax.

In conclusion, despite the highnumber of operators already active inmany countries, the window ofopportunity for new entrants to buildan African presence remainsconsiderable as mobile penetration islow. In response, operators establishedin constrained markets must adapt theirstrategies to drive market maturity notonly as a path to increase profitability,but also to reduce the risk ofcompetitive disruption. If this is notaddressed, new entrants will continueto lead in the reduction of adoptionbarriers as they recognize the need tobe aggressive in disturbing the statusquo to gain market share.

We anticipate the next 2-3 years willbe key in determining whichcompanies become dominant inpan-African mobile communications,as growth in currently constrainedmarkets is accelerated.

Jawad Shaikh is a vice president inCapgemini's Telecom Media &Entertainment consulting practice.He has more than 10 years' experiencein the telecommunications market. Heis based in London.

Ashish Sidhra is a managingconsultant in Capgemini’s TelecomMedia & Entertainment consultingpractice with more than 7 years ofexperience in the industry. He has ledstrategy projects for a range of telecomand media clients and has recentlyfocused on the emerging markets ofAsia, Africa and the Middle East. He isbased out of London.

James Henderson is a consultant inthe TME Strategy Lab. His currentresearch focuses on analyzing theconverging telecom and mediaindustries, and emerging businessmodels centered on collaboration. Priorto joining the Lab; he worked on avariety of projects across the TMEsector with recent focus on emergingmarket strategies and the entrance ofWiMax to developed markets. James isbased in London.

New Entrants Entry OptionsWith around 50 single countryplayers in Africa accounting forapproximately 55 Million subscribers,acquisition opportunities for inorganicgrowth remain widespread.16

However, deal sizes to acquireoperations at a pan-African level havebecome high on a cost per subscriberbasis. In 2005, MTC beat rival biddersto acquire Celtel at a cost of US$680per subscriber, while in 2006 MTNwent on to pay over $1000 persubscriber to acquire Investcom.17

Premiums are being paid as operatorsbecome increasingly aware of thepotential of the “Greenfield” marketand face increasing competition foracquisition targets as players look toconsolidate. The success of playersexiting African markets at substantialprofit only serves to encourageinvestments from other operators.

Market entrance options can belimited by the viability of acquisitiontargets and availability of spectrumlicenses. Where both options areopen, Capgemini recommends thatcompanies be pragmatic inconsidering both the level ofcompetition already present in themarket and the impact that can beachieved within the company’sfinancial constraints. Profitability isstrongly correlated to scale and thereare numerous examples of Africanmarket entrants attempting networkroll outs despite being underfinancedand struggling to achieve profitabilitybeyond the anticipated investmentwindow.

Greenfield vs. Brownfield MarketAs constrained markets have such lowpenetration, operators are presentedwith a choice of strategic focus—i.e.either competing for existingsubscribers or targeting newconsumers. Existing subscribers areoften concentrated in major urbanconurbations, whilst “Greenfield”consumers are generally located inmore rural regions.

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16 WCIS (World Cellular Information Service), 2006.17 http://www.arabianbusiness.com/12348-lost-in-valuation?ln=en.

Expanding Network CoverageMany African countries have very lowpopulation densities outside of themajor urban conurbations. While thecosts of providing universal coverageare too high in many countries, webelieve that network sharing willbecome an increasing necessity toreach rural areas. For example, inIndia all major operators participate innetwork sharing on a one-for-onebasis which has led to 30-40% of sitesnow being shared.14 African regulatorshave an important role to play infacilitating these agreements aswithout faith in regulatory support,these agreements are commercially risky.

With the sharing of infrastructureproving to be a complex arrangement,national roaming agreements are a morecommon alternative. New entrants inparticular can benefit from theseagreements as they are able to reachcommercial launch much quicker. In2005, Zantel signed an agreement withVodacom to extend their coverage fromZanzibar into mainland Tanzania; thisallowed Zantel to confidently acquiresubscribers without having to worryabout poor service quality during theearly stages of network roll out.

Extending Distribution channelsLimited infrastructure and poor railand road connectivity makeestablishing robust productdistribution networks a hugechallenge. In countries like Liberia,the operators’ role in productdistribution does not extend beyondthe capital city—i.e. furtherdistribution is the responsibility offranchise owners and resellers.

Whilst major urban areas are oftensaturated with product outlets,operators can still differentiate in ruralareas where credit recharge availabilityis low. In order to improve productavailability, operators should fullyleverage the country’s informal marketstructures—i.e. ensuring productsreach street sellers and rural marketstalls. To drive this, operators canbecome more generous in thecommission fees paid for SIM card

and recharge voucher sales, whichcauses sale channel proliferation asdistributors are easily motivated topush a higher margin product.

RecommendationsA constrained market operator canaccelerate market growth byaddressing the barriers discussedpreviously. However, to establish ormaintain a market presence in thesedynamic markets, other strategicelements must be considered.

Established PlayersAnticipating DisruptionGlobal giants already have a heavypresence in Africa, with MTN,Vodacom, Orascom, MTC, Vodafoneand Orange accounting for more than60% of subscribers through 57operating companies.15 A second tierof pan-African multinationals has alsoformed including Etisalat, Millicomand Portuguese Telecom. Thestrategies of these players vary, butappetites for geographic expansion aregenerally strong.

The entrance of Warid and Bharti arewidely anticipated further increasingcompetition. These players are globalexperts at operating in low ARPUenvironments and driving mobilephone usage.

To protect market share and preventfurther market fragmentation,

operators must close the window ofopportunity for new entrants byrapidly acquiring subscribers—anobjective that can be achieved byaddressing the usage barrierspreviously discussed. The result is areduction in the non-addressedmarket, which is inviting disruptionbut players need to carefully modelthe risk of cannibalization to existingbusiness before adopting thesestrategies.

Lean OperationsAs operators adopt strategies aimedat subscriber growth, the decline inARPU can place operating marginsunder pressure. To maintainprofitability, lean operations andoperational excellence becomeessential.

Global companies such as Vodacom,MTN and Etisalat have a widepresence in the region and are henceable to centralize functions acrosscountries. Areas such as IT,procurement and networkmanagement can be centralized toachieve synergy savings as localfunctions are downsized. In productdistribution, flagship stores aregenerally cost effective for urbancenters, but operators should look toreduce OPEX and expand theirfootprint in rural areas by relying onsmall 3rd party distributors instead.

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14 GSM World, Infrastructure Sharing Report 2007. 15 WCIS (World Cellular Information Service), 2006.

Includes 2005-2007 Capex for MTN, Vodacom, Orascom and MTC.Source: Annual reports 2005, 2006, 2007, Company websites, Integrated Business Report 2005; Capgemini analysis

Figure 7: Capex Investments of the four leading Pan-African mobile operators,excluding South Africa, US dollars (millions), 2005-07

However, global sourcing of “services”is far more complex than that of“products,” as the delivered serviceshappen in real time, are harder todefine accurately, need constantmonitoring, and are affected byfrequent service quality variations.Consequently, the sourcing of servicespresents a number of specialchallenges, which result from the needto intercept requirements from abroader range of stakeholders, manageknowledge effectively, and define aswell as continuously manageperformance against service level

The wave of global sourcing thatstarted in the 1980s with theoutsourced and offshoredmanufacturing of physical productsnow also includes services sourcedfrom around the world. TME playershave also joined their counterpartsfrom other industries to leverage thebenefits of improved costs and higherefficiencies that typically accrue fromglobal sourcing of services.

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Abstract: Making decisions on global sourcing is challenging due to the large number of alternatives available. Keydecisions in global sourcing concern ownership (in-house or outsourced), location (onshore or offshore) and thelevel of hands-on management to ensure delivery performance. These choices can be made by analyzing fivecharacteristics: the nature of the service under consideration, customer demand issues, the sourcing organization’sexperience and capabilities in sourcing as well as collaborating with other organizations, competitors’ best practicesas well as threats, and the depth of the supply market of potential providers. The analysis of the above characteristicsas well as the selection of the appropriate sourcing mode can be carried out in a qualitative manner by respondingto the various questions in the Global Sourcing Framework. Corresponding to each response is a suggestedapproach regarding choice of ownership, location or management style. Once all the questions have been addressed,the suggested alternatives can be combined to identify the optimal sourcing options. Through use of a business casevariant of the Global Sourcing Framework, it can also be applied in a quantitative manner. Qualitative orquantitative application of the framework—accompanied by an in-depth investigation and analysis of the issuesinvolved—can help TME players identify the right sourcing modes for various services and thereby optimize theiroverall operating models.

by George Yip and Kaushal Vaidya

Three key decisions in globalsourcing concern OWNERSHIP, LOCATION ANDTHE LEVEL OF HANDS-ON MANAGEMENT REQUIRED

TO ENSURE SERVICE DELIVERY

“Figure 1: The Global Sourcing Cube

Source: Capgemini TME Strategy Lab analysis. George Yip, Yacine Chibane, and Melanie Knight, “Better Global Sourcingof Services”, 2007

Global Sourcing Options forTME PlayersThree key decisions in global sourcingconcern ownership (in-house oroutsourced), location (onshore oroffshore) and the level of hands-onmanagement required to ensure thatthe service delivers as per thebusiness’ needs. The first twoparameters are fairly well-known, butour research indicates that the thirdparameter also needs to be examinedcarefully, particularly for services. The“level of management” parameterassesses whether the service providerswould require ongoing day-to-day,hands-on supervision, or whetherthey can be held at arm’s length afterservice transition without excessivehands-on supervision, and drivenprimarily by Service Level Agreements(SLAs). The former case is referred toas tight management and the latter aslight management.

For each service sourced by TMEplayers, the three parameters can beplotted along a “global sourcing cube”(see Figure 1).

The Global Sourcing Cube has twochoices on each of the threedimensions, although there areintermediate points on each. Forownership, there is a spectrum from0% to 100%, including partialownership or joint venture. Forlocation, there are nearshore locations(e.g. Poland), and some offshorelocations (e.g. India) which are furtherthan others in terms of bothgeography and dissimilarity—such asin culture. It does not necessarilyimply that the nearer the location, thebetter the fit. By way of illustration,consider a UK-based business—aservice offshored to Australia will be

”Better Global Sourcing of Services:Frameworks for TME players

1 This study has been adapted from the paper “Better Global Sourcing of Services” written by George Yip, Yacine Chibane and Melanie Knight in 2007 for Capgemini Consulting.

criteria. Therefore, carefully evaluatingthe feasibility of a particular servicefor global sourcing becomes necessarybefore initiating the process of vendorand/or geography selection.

In this study1, the Capgemini TMEStrategy Lab describes an approachand supporting model that can helpTME players make sourcing decisionsmore effectively. The paper offers asystematic approach towardsidentifying the right mode in which aparticular service can be sourced. Thiswill help decision makers identify theright options for their uniquecircumstances.

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culturally closer than one outsourcedto Poland. Similarly, some Frenchcompanies offshore to Mauritius,thousands of kilometers away, butcloser in language than othergeographically closer locations. Formanagement, the tightness ofsupervision is determined by theextent to which the players seek toretain control over the servicesdelivered.

The use of two choices for the threeparameters helps to arrive at eightsimplified choices, represented byeight smaller cubes (see Figure 2).Each of the eight modes have beenassigned a label to help increaseunderstanding in an intuitive fashion(see Figure 2).

Each of the choices imply a trade-offin the levels of cost, innovation andrisk. Moving from the sourcing modeat the front-lower-left of the cube tomodes at the back-upper-right sidegenerally reflect movement to lesscontrolled modes but potentially tohigher levels of cost reduction. Theright place on the cube for aparticular service depends on thecharacteristics of the environment thatthe sourcing organization finds itselfin. The subsequent sections are aimedat aiding TME players in identifyingthe right box on the Global SourcingCube for the services underconsideration for global sourcing.

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2 The Herald, “iPhone boost for 02's Scottish workforce”, 29. February 2008. UK Business Park (ukbusinesspark.co.uk), “UK Activity Report - Computers and Electronics”, November 2007. 3 Company websites.

Figure 3: Effects of Service Characteristics On Choice of Sourcing Mode


Figure 4: Effects of Customer Demand Characteristics on Choice of Sourcing Mode


THE APPROPRIATE SOURCING MODE CAN BESELECTED BY EVALUATING nature of the service,customer demand, organizationcapabilities, competition

and supply market

“”

Comments If “highly agree”, then favors

Ser

vice

Cha

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1. Can the service be standardized andprocedures easily documented?

Outsourced, OffshoreLow cost to standardize and document theprocess before sending outside

2. Can the requirements for performing thisprocess be easily specified and effectivelymonitored?

Light ManagementEasy to monitor with minimal oversight

3. Will mistakes in this process have asignificant business impact from a legal,regulatory or financial point of view?

In-house, Onshore, Tight ManagementIf send out, then need to restructure andreengineer process, and train outside staffcarefully.

4. Does the process involve direct contact withthe organization’s clients (e.g., externalclients, suppliers)?

In-house, Onshore, Tight ManagementIf sent out, runs risk of poor processperformance causing loss of reputation andcustomer satisfaction, which in turn leads toloss of business

5. Can the service be delivered remotelywithout internal staff or customers’involvement?

Outsourced, OffshoreEasy to send out

6. Can decisions within the process be basedon standard specified criteria?

Light ManagementOnce the process is documented, littlemonitoring needed

7. Can responsibility for performance of thisprocess be clearly defined?

Light ManagementEasy to monitor performance


8. Are internal customers convinced thatoutsourcing will be beneficial?

OutsourcedSatisfies internal customers

9. Are internal customers more concernedabout the cost of the service rather thanservice excellence?

Outsourced, Offshore, Light ManagementGo for the modes with the maximum savings

10. Does the process in scope have significantbrand impact?

In-house, Onshore, Tight ManagementPlay safe, or if do send out, then need to trainoutside staff carefully and manage relationshiptightly

11. Does the process in scope differentiate theorganization in its competitive landscape

In-houseKeep in-house if the organization has distinctivecompetence, but outsource if the provider canprovide a superior process that also protects theorganization’s differentiation.

12. Is process success’ independent of localcultural influences?

OffshoreCan go to countries that are quite dissimilar inculture and language C

usto

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Dem

and

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Source: Capgemini TME Strategy Lab analysis. George Yip, Yacine Chibane, and Melanie Knight, “Better Global Sourcing of Services”, 2007

Figure 2: Eight Global Sourcing Modes

“Back of House”• Close but not at the forefront of attention; light

management of an in-house, onshore process

“Under My Nose”• Keeping the most control; tight management of

an in-house, onshore process

“Hand Over the Car Keys”• It stays in the family but the “car” is driven away;

light management of an in-house, offshoreprocess

“Trust but Verify”• Tight management of an in-house, offshore

process

“Someone Else’s Problem”• The process cannot be completely ignored but an

outsourced, onshore mode can minimize theamount of attention paid

“Cohabitation”• Tight management of an outsourced, onshore

process results in the two independentorganizations collaborating closely

“Move and Forget”• Keeping the least control; light management of

an outsourced, offshore process

“Gold Frequent Flyer”• Lots of travel for tight management of the

outsourced, offshore process

I = In-houseN = OnshoreL = Light Management

O = OutsourcedF = OffshoreT = Tight Management

Characteristics Affecting theChoice of Global SourcingModesThe selection of the appropriatesourcing mode for various services is asignificant challenge for TMEmanagers. Our research suggests thatthe decision can be made by evaluatingfive key characteristics, which includethe nature of service underconsideration, customer demand inrelation to that service, the sourcingorganization’s experience andcapabilities in sourcing, competitors’best practices as well as threats, andthe supply market of potentialproviders.

Managers can analyze each of the fivecharacteristics in detail as well as assessthe appropriate sourcing mode byresponding to a set of questions for eachcharacteristic (refer to Figures 3-7). Foreach service under consideration forglobal sourcing, managers’ response tothese questions can vary from “highlyagree” to “highly disagree”. Associatedwith each question is the suggestedsourcing approach in case the responseis “highly agree”. The responses to the30 questions, taken together, can helpmanagers in identifying the mostsuitable mode for sourcing of aparticular service.

The nature of the serviceThe nature of the service addresses theextent to which the service can bestandardized and easily sent outsidethe organization and home country.The related questions (see Figure 3)can help TME players distinguish

between easy to outsource and offshoreservices such as internal ITmaintenance, and difficult ones closerto core operations such as new productdevelopment and R&D activities.

Customer demandCustomer demand characteristics of aservice include issues such as theneeds of the internal customer toreduce the costs, and externalcustomer impact in terms of theservice enhancing brand image ordifferentiation of the firm in itscompetitive landscape. The relatedquestions (see Figure 4) also addressthe need to keep services onshore ornearshore to ensure language andcultural compatibility of the sourced

services. For instance, in November2007, O2 UK set up a customerservice department in the UK itself tooffer technical and operational adviceto customers for the new AppleiPhone2. Similarly, SunRocket, aformer pure play VoIP operator andnow a part of Packet8, had to bringback its outsourced and off-shoredcustomer service activities due to theincreased need for brandenhancement and differentiationthrough customer service3.

Organizational experience andcapabilitiesThe questions on organizationalcharacteristics (see Figure 5) cover theability of the sourcing organization toperform the process itself and also its

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4 Company websites.5 Capgemini TME Strategy Lab analysis. Company websites.

6 Capgemini TME Strategy Lab, “Network Outsourcing”, 2007. 7 Someone Else’s Problem” refers to a process that cannot be completely ignored but an outsourced, onshore mode can minimize the amount of attention paid. For more details and other

sourcing modes, please see Figure 2.

Figure 7: Effects of Supply Market Characteristics on Choice of Sourcing Mode

Figure 6: Effects of Competitor Characteristics on Choice of Sourcing Mode


20. Are competitors offshoring this service successfully? OffshoreCompetitors have shown that offshoring worksfor this service in this industry

21. Do competitors have long-term relationships withtheir service providers or vendors and is re-tendering, therefore, infrequent?

Light ManagementCan have similar long term relationship thatrequires only light management

22. Do competitors have distant relationships with theirservice providers?

Outsource, Light ManagementCosts are not expected to increase hugely ascompetitor behavior suggests that processeshave settled down

23. How unacceptable is it if competitors were to gainaccess to detailed knowledge about the process inscope (e.g., via a service provider or vendor)?

In-houseAny sourcing decision is constrained by thethreat of a loss of competitive advantage


24. Is the supply market of service providers(vendors) mature?

OutsourcedStart-up investment is minimal

25. Can this organization leverage vendors’economies of scale for this process?

OutsourcedCan enjoy cheaper provision

26. Does an external vendor or service providerhave the potential to become a competitorwithin the next five years?

In-house, Tight ManagementKeep in-house or avoid high threat providers. Ifoutsourced, then manage tightly to avoidleakage of proprietary know-how

27. Are the key skills required in this process allavailable in the vendor supply base?

Outsourced, Light ManagementProviders will not have to acquire skills atadditional cost, and need less management

28. Is the capacity of skills required all availablein the vendor supply base?

OutsourcedWide choice of effective suppliers

29. Is the labor attrition rate low offshore? OffshoreReduces potential costs of recruitment,induction and retention.

30. Is the supply market able to provide thisprocess at maintained service levels and atlower cost?

OffshoreSavings are highly likely



Sup

ply

Mar

ket

Cha

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Co

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Figure 5: Effects of Organization Characteristics on Choice of Sourcing Mode



13. In this specific process, are most“generalist” employees capable ofperforming other employees’ jobs?

OutsourcedLittle specialisation involved, so makes it easy tofind outsourced providers

14. Are the current in-house processes best inclass?

In-houseOr invest to bring outside provider up to best inclass.

15. Is there potential for industrial unrest if jobsare lost?

In-house, OnshoreHard to send jobs out of organization oroffshore.

16. Is the organization evolving and arerequirements changing quickly?

In-house, OnshoreIf sent out, will incur regular extra costs toreengineer processes

17. Are contracts with service providers orvendors reviewed frequently and activelymanaged?

Tight ManagementWill need regular management involvement

18. Does the organization have the capability todeliver the process or service in-house?

In-houseProvides a real choice, depending oneffectiveness and cost of outsourcedalternatives

19. Does the organization have experience ofcross-border activity?

OffshoreMakes offshoring less risky

Org

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n C

hara

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isti

cs

experience and ability in managingvendors. These questions directlyaddress the choice of ownership,location, and management mode.

SFR, a leading mobile operator inFrance and an affiliated operatingcompany of Vodafone Group, decidedto adopt the “Vodafone live!” contentportal as the backbone to its mobile,data and content services. In order tooptimize time-to-market and costs,SFR decided to outsource activitiesrelated to the integration of its contentservices with those of its partner4.

Competitor characteristicsCompetitor characteristics (see Figure 6)cover the extent to which competitorshave set precedents or pose threats inglobal sourcing. In many cases,companies need to utilize globalsourcing in order to match acompetitor’s level of costs or service.

For instance, three of the four largestplayers in Netherlands—Orange,Vodafone and Deutsche Telecom—outsourced their network operationsin 2006. The associated cost savingsgave them a competitive advantagecompared to the incumbent, KPN. Asa result, KPN was also encouraged tofollow its competitors in order to staycompetitive and protect its position asthe market leader.

A similar story unfolded in the Indianmobile market, one of the largest inthe world. In 2004, its leadingoperator Bharti Airtel decided tooutsource its network, IT andcustomer contact center operations toglobal majors such as Ericsson,Nokia-Siemens Networks, IBM andIBM-Daksh (this decision has beenanalyzed in detail using the sourcingframework in the subsequentsections). Once Bharti Airteloutsourced its operations and startedachieving significant cost benefits,other operators, such as VodafoneEssar (then Hutchison Essar) and IdeaCellular were encouraged to followBharti Airtel to match its cost-levels5.

Supply market characteristicsSupply market characteristics (seeFigure 7) address the availability,maturity and cost-saving potential ofvendors. A well-developed, maturecollection of vendors with necessaryskills typically encourages outsourcingcoupled with light management.

For instance, it is relatively easy todecide about outsourcing an IT orcustomer contact process because ofthe extensive supply market that hasdeveloped in India, and increasinglyin other countries such as China.Similarly, more than 90% of allnetwork outsourcing deals areawarded to equipment suppliers suchas Alcatel-Lucent, Ericsson and

Nokia-Siemens Networks, as thiscollection of vendors possess thenecessary skill-sets6.

The 30 questions discussed above(refer to Figures 3-7) are both generic(not specific to a particular service)and detailed enough (about particularaspects of the sourcing situation) toaddress a sourcing decision about anyservice. Typically, by responding to theset of 30 questions under the fivecharacteristics, managers can get agood idea of the appropriate sourcingmode to select. TME managers areencouraged to use these questions as achecklist to stimulate their ownthinking, support their own detailedanalyses and cross-validate theirdecisions. The following sectiondescribes in detail the qualitative andquantitative approaches towards useof the 30 question framework.

Qualitative and QuantitativeApproaches to Sourcing ModeSelection The 30-question global sourcingframework can be used to aiddecision-making regarding thesourcing of services. For a particularservice, qualitative or quantitativeapplication of the framework canindicate the feasible global sourcingmodes, which can be investigatedfurther by a thorough discussion andinvestigation of the issues involved.The qualitative and quantitativeapproaches are discussed in detail inthe subsequent paragraphs.

Identifying the appropriate mode byusing qualitative responses topertinent questionsThe following examples show how theGlobal Sourcing of ServicesFramework and its associatedquestions can lead to the appropriatesourcing decision. Although thedecisions described here were madewithout application of the framework,the associated discussionsdemonstrate how the framework canbe used to arrive at the actualdecisions made. The illustrativeexample used here is the sourcing ofnetwork infrastructure services. Wehave analyzed the relevant decisions(see Figure 8) made by KPN(Netherlands) and Bharti Airtel(India), two leading operators in theirrespective geographies, using theframework discussed earlier.

The examples of KPN and BhartiAirtel indicate that the decision tooutsource network services is drivenprimarily by favorable service,customer demand, competition andsupply market characteristics. In thiscase, the choice of outsourcing as anappropriate ownership mode is drivenby the maturity of supplier marketsand the importance of cost-saving.The choice of location is driven by theneed to provide services fromonshore. Further, servicecharacteristics influence lightmanagement mode as the processdelivery requirements can be easilyspecified and monitored. Thiscombination of outsourced, onshoreand light management mode isreferred to as “Someone Else’sProblem7” and is now usedincreasingly by telcos in sourcing ofnetwork services.

Dr. George Yip is Dean of theRotterdam School of Management,Erasmus University, and Professor ofGlobal Strategy and Management. Hehas also taught at Harvard, Stanford,Oxford and Cambridge. His extensivebusiness experience includes beingDirector of Research & Innovation atCapgemini Consulting. He is one of theworld's leading authorities on globalstrategy and marketing, managingglobal customers, and internationalization.His latest book is Managing GlobalCustomers (Oxford University Press,2007). He is based in Rotterdam.

Kaushal Vaidya is a senior consultantin the TME Strategy Lab. His recentwork includes analyzing trends inonline advertising and assessinggrowth as well as profitability driversof players in emerging markets. Priorto joining the Lab, Kaushal hasworked as a management consultantwith the consulting arm of India’spremier business house. He is based inMumbai.

Figure 9: Key Elements of the Global Sourcing Business Case Model

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The Global Sourcing Frameworkcan help optimize an organization’soperating model BY IDENTIFYING

THE APPROPRIATE SOURCING MODES

“”

Elements ofthe Business

ModelDescription Usage in the Business Case

Expected Value(EV)

• EV is the bottom-line value of the businesscase (as % of current total costs for theactivity)

Potential Value(PV)

• PV is the possible gross savings from usinga particular global sourcing mode (as % ofcurrent total costs for the activity)

Gross Savings (% of Costs of an Onshore, In-house Process)• Offshoring and Outsourcing: 35%• Offshoring and In-house: 30%• Onshoring and Outsourcing: 20%

Cost Impact(CI)

• CI is the maximum cost to create thecapability for a particular service orprocess (as % of current total costs for theactivity)

• One-Time Costs - Search and Contract: 4%,Restructuring: 5%, Process Changes: 10%,Transitioning Work: 3%

• Ongoing Costs – Lost Productivity/CulturalIssues: 10%, Governance – 10%

Probability(Pr)

• Pr represents the likelihood of incurring thecosts discussed above in Cost Impact (CI)

• It is determined by responses to the 30questions:

� For instance, if the supply market isquite mature, the probability ofincurring various costs is very low

• Pr ranges from 0% to 100%

CollaborationMode(CM)

• A CM of Tight Management reduces theCost Impact (CI) by making more effectivecoordination between the customer andthe provider

• Tight collaboration mode halves the CostImpact (CI) relative to a Light collaborationmode

Cost ofCollaboration

(CC)

• CC occurs when tight management is usedfor better coordination with vendors

• In-house, onshore, light managementincurs no extra costs, but other sourcingmodes increase CC

• CC increases by 10% for outsourced,offshore, tight management vis-à-vis in-house, onshore, light management


Figure 8: Application of the Global Sourcing Model to Identify the Optimal Mode forSourcing Network Infrastructure Services

Operators(Service)

GlobalSourcing

Mode

Rationale

Highly Relevant Questionsfrom the Framework

Response IndicatedApproach a

(NetworkOutsourcing)

Ownership:Outsourced

Location:Onshore

ManagementMode: Light

Service Characteristics:Q-2: “Can the requirements forperforming this process be easilyspecified and effectivelymonitored?”

Highly Agree Light Management

Organization Characteristics:Q-19: “Does the organization haveexperience of cross-borderactivity?”

Disagree Onshore

Competitor Characteristics:Q-20: “Do competitors havedistant relationships with theirservice providers?”b

AgreeOutsource, Light

Management

Supply Market Characteristics:Q-24: “Is the supply market ofservice providers mature?” Highly Agree Outsourced

Q-25: “Can this organizationleverage vendors’ economies ofscale for this process?”

Highly Agree Outsourced


Quantitative business casemodeling using the 30 questionframeworkThe set of 30 questions, discussed insection 4, can also be used to drive adecision support model that helps inidentifying the appropriate globalsourcing mode. The model focuses onthree critical factors—benefit fromglobal sourcing in terms of potentialcost savings, costs of sourcing as wellas implementation, and factors suchas collaboration that can mitigate thepotential cost. The key elements ofthe business case model are describedin Figure 9.

The above elements come together inthe following equation, whichcalculates the expected savings (as %of original costs) for a specificcombination of ownership, locationand management mode:

EV = PV – (Pr * CI / CM) - CC

For each of the eight possible globalsourcing modes, the model calculatesthe Expected Value (EV) based on theresponses to each of the 30 questionsin the framework discussedpreviously. The model then calculatesthe average EV for each globalsourcing mode and eventually ranksthe eight sourcing modes based on theaverage values. These ranks (from 1st

to 8th) are the model’s recommendationfor the priority in which to considerthe possible global sourcing modes.

In conclusion, the Global SourcingFramework is a decision support toolthat can help optimize anorganization’s operating model byidentifying the appropriate sourcingmodes for various services. Qualitativeor quantitative application of the 30-question global sourcing framework

can help TME players in makingappropriate decisions on ownership,location and management mode forsourcing of various services. Theinteractive nature of the model canalso help TME managers in assessingthe impact of changing assumptions,running alternative scenarios andcomparing the model’s output withinternal views on strategy. Thus,systematic application of the modelalong with in-depth investigation ofissues can help TME players optimizetheir sourcing model for existing aswell as new services.

69

Note: a. Indicated approach is the same as that suggested by the framework (see figures 3-7) if the response is “agree” or “highly agree”, andopposite to that suggested by the framework in case the response is “disagree” or “highly disagree”b. This question (Q-20) is more relevant for the KPN example, as Bharti lead the way in outsourcing in India.

Atlanta•Bangalore•Düsseldorf•Helsinki•Lisbon•London•Madrid•Milan•Mumbai•New York•Oslo•Paris•Rome•Shanghai•Stockholm•Sydney•UtrechtThis publication has been printed with vegetable-based inks on 100% recycled paper.

We value your comments and ideas. Please contact us at [email protected]

Insights is published by Capgemini’s Telecom, Media & Entertainment (TME) consulting practice. We are the leading global management consulting group dedicated to helping CEOs and senior executives

in the converging communications industries address their most critical strategic and operational challenges.

For further information visit: www.capgemini.com/tmeconsulting

Editorial Team: Benjamin Braunschvig Jerome Buvat Bobby NgaiDesign: Elisabeth Tahar

Helen Williams

© 2008 Capgemini. No part of this document may be modified, deleted or expanded by any process or means without prior written permission from Capgemini.

70

Paying for Mobile Data

A Vodafone user in the UK received a £27,000 bill for exceeding fair-usagelimits, after he inadvertently used his mobile phone as a modem to downloadfull television episodes. In another similar incident, a Bell Canada subscriberreceived an $85,000 bill after he used his mobile phone as a modem.

Source: PC Pro, “£27,000 phone bill for Vodafone customer”, Jan 2008; BBC, “Shock at $85k

mobile phone bill”, December 2007

An iPhone user from Pittsburgh (US) received a 300-page bill from AT&T,delivered in a box, detailing every text message and Internet use over a periodof one month. The user put up a video of the massive bill on YouTube, whichreceived over 3 million views in the first ten days.

Source: NY Times, “AT&T’s Overstuffed iPhone Bills Annoy Customers”, Aug 2007

Research conducted by the University of Leicester indicates that the cost ofsending a megabyte of SMS works out to £374.49, assuming the average size ofa text message to be 140 bytes. In comparison, NASA provided a figure of£8.85 per megabyte for the transmission of data from the Hubble SpaceTelescope to Earth. This means that SMS usage costs more than sendingmessages from space through the Hubble!

Source: University of Leicester

Going Online

YouTube is estimated to consume 1,000 gigabytes of traffic every second ornearly 300 billion gigabytes each month. In 2007, YouTube alone consumed asmuch capacity as the entire Internet took up in 2000.

YouTube spends approximately $1 million a day on bandwidth costs, andYouTube downloads are estimated to consume 3% of Google’s $11.5 billion inoperating costs for 2007.

Source: CNN Money, “YouTube looks for the money clip”, March 2008; Telegraph UK, “Web could

collapse as video demand soars”, April 2008

Somalia has the fastest growing Internet user base in the world, growing from200 in December 2000 to 90,000 in 2007, an increase of 44,000%. Iceland hasthe highest Internet reach with over 86% of residents using the Internet.

Source: Internet World Stats, 2007 and PC World

All About Devices

The most common tone played when an SMS (text message) is received onmany Nokia handsets is actually the Morse code for “SMS”.

Source: http://www.textually.org/ringtonia/archives/2006/08/013361.htm

A Singaporean student has set a world record for texting speed. She typed theofficial sentence for world record attempts, “The razor-toothed piranhas of thegenera Serrasalmus and Pygocentrus are the most ferocious freshwater fish inthe world. In reality they seldom attack a human” in 41.52 seconds.

Source: http://www.theregister.co.uk/2006/11/13/worlds_fastest_sms/

Some companies have introduced ringtones that are audible only to the youth.While they were introduced to help store owners drive away loitering youth,many youngsters have innovatively used the same in their classrooms, sincethese ringtones are inaudible to older people, namely their professors.

Source: http://www.nytimes.com/2006/06/12/technology/12ring.html

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