Walking on Hot Rocks – Dick Simpson

SLIDE 1:Walking on Hot Rocks

Thank you X. It is a pleasure to be back in Japan and to be invited

to speak at Carriers World Japan. Let me offer the personal

apologies of our CEO, Dick Simpson, who had some last minute

business clash that prevented him from being here. I will do my

best to present his paper.

The topic “Walking on Hot Rocks” was selected as an analogy to

describe a situation that we as an industry are facing at the

moment.

(Ask audience)

Let me start by asking has anyone here ever walked on hot rocks

or been “fire walking”. Imagine what goes through your mind

before it was your turn to walk on those hot rocks?

That’s right. It is a nerve-wracking experience that puts you right

out of your comfort zone. However, once you witness ordinary

people like you and me walking on hot rocks, you say “If they can

do it, so can I!!! “

In a lot of ways this mirrors the predicament we find ourselves

facing in the telecommunications industry today. There are plenty

of industries, such as the IT, airline, manufacturing and automobile

industry, have already had their “hot rocks” experience. They have

been faced with enormous challenges, but have emerged to their

new environment and are looking for growth and profitability. As

an industry, we can do this too, but it will take a shift in the way we

currently think and do business.

SLIDE 2:An Overview of a Disrupted Industry

For over 100 years, the telecommunications industry has been at

the forefront of technological development. We have provided a

great service and we have been profitable in the process. We

have paved the way in many fields and now provide services that

are considered “essential”. We have massive resources at our

disposal and a cash capability that is the envy of all.

So what happened?

During the 1990’s, there was enormous pressure on companies to

grow. If you had large cash flows and a strong balance sheet, you

were criticised if you did not use these assets. I remember a period

where every analyst asked what you intended to do with your “lazy

balance sheet”!!!

Firms reacted. 3G spectrum came up for auction, Internet

companies were sold for multiples of Expected Revenue, but never

actual profit. European firms paid £109 billion for licences to

operate “third-generation” mobile networks. Let me put this in

context. £109 billion is slightly less than Hong Kong’s GDP last

year but greater than the GDP of either Singapore, Thailand,

Malaysia or Ireland’s last year. Companies bought up to have an

international footprint and/or offering in the digital space.

Everything that was for sale from Internet companies to local cable

companies was bought. The real synergies were often not there,

like the real profits.

Looking back, it now seems incredible that we paid so much for

these assets – it seems that everyone was caught up in the

“irrational exuberance” that consumed the industry. The telecom

sector peaked in the spring of 2000 and since then some US$1.4

trillion in investor wealth has evaporated.

As a result, paying down debt and disposal of non-core assets

became the focus. Some companies moved into Chapter 11 but

the industry, as a whole, still faces many challenges.

SLIDE 3: International Connectivity

To give you an idea of how distorted things became, let’s take a

look at the history of the Trans-Pacific Submarine Cable Capacity.

For the purposes of this presentation I have included all Lit

Transpacific Capacity excluding US-Australia Cables. In 1989, the

industry had only 0.56 Gbps of lit capacity. In 1991, this increased

by a factor of three due to the implementation of the North Pacific

Cable (NPC) from Japan to the US.

From 1991 to 1996 things were steady. At this stage, the industry

was a very good place to be. There was strong growth in demand

for bandwidth and very healthy prices. These are the days that

people still dream of!!!

From 1996 to 1997 lit capacity increased by a factor of four and

then doubled again each year for the next two years. In fact,

between 1996 and 2000, Trans-Pacific lit capacity increased by a

factor of 62. The industry was becoming overcrowded and

profitability was eroding rapidly.

SLIDE 4: The Perfect Storm

Since 2000, the situation has deteriorated alarmingly with lit

capacity increasing by a further factor of 6. With hindsight, no one

in their right mind should have funded these investments!!

People made bets on future demand that were spectacularly

optimistic.

The result has been something akin to the “Perfect Storm” in the

International Connectivity Business: Over-capacity; Hyper-

Competition; and Unrealistic Economic Valuations.

Going forward, this situation is exacerbated by the Chapter 11

process and debt traders. We are witnessing companies use

Chapter 11 to get rid of unwanted debts, unwanted contracts and

then re-emerge with a cost base lower than that of their

competitors. Chapter 11 process was not designed to provide a

haven for failed companies to challenge their competitors, but that

is what is happening.

With a normal liquidation process we would have witnessed more

industry rationalization by now because capacity would have been

taken out of the system. As a result, capacity remains in the

system at unsustainable prices. In addition, a secondary market

emerges of debt finances who buy the distressed asset purely with

the intention to trade it rather than operate it.

SLIDE 5: Bright Lights

I am not complaining, merely observing the fats of where we are.

But even with all the difficulties ahead, there are great

opportunities and grounds for optimism.

The bright lights in our industry are, without doubt, wireless and

broadband. The wireless industry is one area that continues to

demonstrate significant growth and innovation.

The number of mobile phones worldwide is expected to increase

from 1.3b today to 2b in 2007. In fact, Wireless subscribers now

exceed the number of fixed lines. Between 1993 and 2002,

wireless users in developing nations soared from 3 million to over

500 million. One in five people around the world now have a

wireless phone – up from one in 339 in 1991.

But, the opportunities to capitalize on the wireless industry in Asia

are even greater. As in many of the developing markets in Asia,

mobility is the customers first and only connection.

SLIDE 6: Wireless

o China – 1.2b people. 15% wireless penetration.o Vietnam – 85m people. 2% wireless penetration.o Indonesia – 200m people. 3-4% wireless penetration.o India – 1b people. 1% wireless penetration

China, which surpassed the USA last year to emerge as the

largest wireless market in the world, has been adding 5 million

wireless subscribers a month this year. In India, more than 1

million subscribers were added in July. In fact, China and India

will account for 60% of new wireless subscribers between now

and 2010.

SLIDE 7: Broadband (Use ITU broadband chart)

Another bright light is broadband. Currently, the world has

approximately 63 million subscribers. These 63 million customers

are in more than 80 countries, representing 1% of the world’s

population.

In a number of markets, broadband is predicted to be the fastest-

growing communications-based consumer devices. For example,

in the United States, broadband is likely to reach the 25%

penetration rate more quickly than either personal computers or

wireless telephones ever did.

Broadband is arriving at a time when the potential of the Internet is

yet to be fulfilled. With its faster “always-on” connections, it is

serving to accelerate the process of integration for internet

technologies into everyday life.

SLIDE 8: Broadband Penetration Rates

South Korea – 21%

Hong Kong – 15%

Japan – 10%

Broadband take-up has been successful in Asia. South Korea is

booming at 21%, in Hong Kong 15% and Canada 11.5%. Japan

(10%) is rapidly catching up.

South Korea, with a population of 47 million, already has 10.1

million broadband users; that’s one in every five people.

Dreams of a decade ago are now playing out. Look at Now TV in

Hong Kong. Now TV is a broadband portal which delivers true

video-on-demand to broadband subscribers. This includes

premium content such as new release movies or live sporting

events such as Premier League soccer - or more importantly at the

moment, the Rugby World Cup. Go the Wallabies!!!

A different example is Yahoo BB in Japan has been a key driver of

one of the world’s fastest growing broadband markets. One of the

leading features of Yahoo BB is voice over broadband which

contributes 25% of the company’s revenue.

Industry Trend

Now, while the wireless industry is driving voice growth, broadband

is accelerating the growth of data. It is estimated that over time

data revenue will exceed voice revenue for most carriers. This is

supported by the following facts:

From 1991 to 2002 voice growth increased 15% compound;

Price for voice related services declined 12% during the same

period; and

International broadband is growing at 80-90% per year.

For international traffic, the net revenue from voice and data is

about even today.

SLIDE 9: Change – Carriers are part of a Broader Eco-system

However, regardless of whether you are a domestic or

international carrier, in order to take advantage of the “Bright

Lights”, there is a fundamental need for change - as an industry we

need to take our turn and walk on the hot rocks.

So while I am an advocate for this great industry, we do need to do

some soul searching. It may help to pose a few questions.

Question 1 : Where is the value moving to?

Previously, much of the value that we provided was in basic

connectivity services or in transportation. We saw this get

challenged in the fixed internet wave. That time they were not

successful but the forces are all marshalling. If you think about it,

the dotcom era delivered significant value to Cisco, Dell and the

service providers in the food chain. They all took value - as did

Microsoft and software companies. I mean, who needed a virus

scanner, firewall protection and search engine before internet. So

the question is did we extract as much value as others. My

proposition is that we did not.

Our challenge is to work out where the value is moving to and be

there with a range of partners to develop it. Historically, we have

either resisted it or tried to do it ourselves. The food chain is just

too big for us to try to cover all of it. So we must adjust to life as a

significant part of the value chain, but not try to do it all. We will

certainly get commoditised if we try to play a “transportation” only

game.

The second question I pose is about our relationship with our

customers. We are rightly proud of our ability to provide services to

millions of customers directly. But the question is what do our

customers think of us? Do they say “Boy, that XXX carrier is a

great service company or marketing operation.”? Or do we provide

them with services they regard as essential, reliably, so they trust

us? My view is that going forward, we need to be great marketing

companies rather than technology companies. Let me give you a

small example. (Ask audience) Who here has customers? Who

thinks of their customers as an audience? You see one

relationship is about an established linkage - which is fine. The

other is about creating a value proposition in the consumer’s mind

so they will want to use your services. This is a very different value

proposition where the benefits must be compelling for the

customer. We find this hard to do.

SLIDE 10: Change - Focus on Customer

A different example is the auto industry. It has traditionally

focussed on engineering and low cost manufacturing. However,

after delving deeper and really understanding customer demand,

they found that owners are very concerned about safety and the

safety of family members. The result has been a real win for auto

makers who can partner with companies that develop safety

features, such as airbags and anti-skid lock brakes.

By getting closer to their customers and they have been able to

significantly improve margins, they have moved the price point

away from a basic car to a “safe car”. Who here would not part

with a few thousand dollars extra to get a much safer car for

yourself or your family???

Carriers must recognize that our greatest asset is our customer

relationship, and then we must leverage that relationship to fully

understand the needs of our customers.

SLIDE 11: Change – Re-think Cost Base

It is equally critical to think about your cost structure and which

assets are providing you with a significant ROI. Ask yourself

“What is my core business?”

We know that capital efficiencies, scale and geographic presence

are key advantages for a carrier. In the past, carriers have

invested heavily in expensive international networks. The question

is how effective is that? Many international networks are under-

utilised with high operational and maintenance costs which are

costing your company cash.

Some people respond that the investment in an international

network is “strategic”. What does this mean? Is this a euphemism

for losing money? I put it to you that switches, computer platforms

and software, base stations, etc, are a core point of your business

- but may carriers find they get a better return by outsourcing these

from others. What is the difference with the transmission network?

SLIDE 12: Plane slide

Again, looking at other industries, how many airlines actually own

the aircraft they operate or the reservation system they use?

These assets are key but they don’t need to own them - their core

business is managing transport schedules, yield management and

the passenger relationship. This is not just about financing but a

mindset change.

Adapting such thinking to the telecommunications industry would

allow carriers to focus on their key competitive advantages in their

core domestic markets, their international connectivity can be

managed by specialists. Negotiations and arrangements across

multiple carriers in multiple time zones, languages and

geographies is a specialist skill that few are really successful with.

Carriers who choose access to international connectivity, as

opposed to owning international connectivity, will have a more

cost-efficient business, and access to a broader range of services

for their customers.

Carriers can’t afford to stand alone and get their feet burnt. We

need to look at partnerships and outsourcing arrangements. There

are tremendous opportunities for companies going forward and I

am excited about the opportunities for REACH.

Let me finish by emphasizing that I believe the telecommunications

industry is still one of the most vibrant industries on the planet. We

play a critical role in facilitating communication between

governments, businesses and individuals. At this particular point

in time, however, we all face the challenge of “walking on hot

rocks” and each of us must chart a course for our own survival and

prosperity. However, we must embrace change, we must

challenge the way we currently do business and we must ask

ourselves whether we are focusing on our core competencies.

Finally, I’d like to leave you with a quote. In speaking with my fellow CEOs, more and more of them are drawing the same conclusion.

SLIDE 12: Quote

“Some companies have figured out that the network doesn’t

matter anymore. For the last 100 years, telcos have believed

that their business was owning and operating a complex

mesh of wires and switches. Now, ….they’re beginning to

realize that their true job is helping people communicate. And

their focus has to shift from managing infrastructure to

making sure customers are satisfied. Companies still split

along technology lines are missing the point.”

(BusinessWeek, October, 2003)

Thank you.