disruption calling – Global Homework Experts

Hello, operators?
This is your age of
disruption calling
Difficult times for operators call for
questioning old orthodoxies to win
Authored by:
Guido Frisiani
Jay Jubas
Philipp Nattermann
October 2017
2 Hello, operators? This is your age of disruption calling
For the better part of a decade, telecom
companies have suffered through declining
revenues, cash flow, and return on investment
just as tech companies like Google, Facebook,
Amazon and others have mushroomed by
building their businesses on the operators’ own
infrastructure. While these tech visionaries have
enjoyed well over a $1 trillion in combined marketcap growth by innovating and thinking differently
and adeptly, telecom companies have tried to
compete by implementing the same old survival
tactics: cutting costs, reducing the workforce, and
timidly entering into new business adjacencies.
The trouble is that playbook no longer applies.
It’s time the telecom companies embrace this new
reality and rethink the key orthodoxies that have
shaped their industry since the first phone call was
made about 140 years ago. If not, the alternative is
dire. Yes, the stakes are that high.
We’ve seen this before in other capital-intensive
industries. The airline industry, for example, despite
incredible growth in travel during the early part of
this century, destroyed economic value until 2015
when, for the first time, the industry-level average
return on invested capital (ROIC) was just in excess
of its cost of capital.
1 This return to economic
profitability was achieved through a combination of
falling fuel prices; significant industry consolidation,
especially in the US; and the growth of ancillary
revenues, such as checked-baggage fees. If global
operators were to follow the airline industry’s prior
trajectory, the implications could be dramatic.
Not just for the operators that would see declining
investment as capital and talent move into
sectors with superior returns but also for current
and future over-the-top (OTT) players, such as
Amazon, Apple, Facebook, Google, and Netflix,
who rely so heavily on the operators’ networks and
investments. Digital and analytics may just be the
plunging-fuel-price magic bullet to offset the trends
that threaten operators’ future; however, even then,
1 Economic performance of the airline industry,” International Air Transport Association, June 2015, iata.org
industry consolidation and new service revenues
are likely to be required for operators as well.
We see the need for a fundamental transformation
of the operator industry, rooted in and built upon
these companies’ new strengths and value. The
OTT industries and companies like Google and
Facebook have generated enormous value and
opportunities, not because they improved existing
industries, but because they created brand new
ones, using telecom infrastructure to do so. So
much of the value of these new companies comes
from the data they collect, analyze, and monetize.
Think about it this way: if Google and Facebook
know everything there is to know about their users,
the operators actually know such information first,
since everything must travel through the operators’
networks on their way to the final destination.
There is enormous opportunity for operators
to explore advanced methodologies, including
machine learning, digitization, analytics, and
artificial intelligence, to structure much of the
unstructured data they host to create a far better,
even completely new, experience for their own
customers. This is less a natural transition and
more a massive transformation. Operators must
view it the same way to effect the necessary,
meaningful, lasting, pioneering change. As such,
we believe that now is the time to question longheld beliefs by reexamining four core orthodoxies
that have driven operator behavior for the past 20
years:
1. What level of performance improvement
is possible?
Over the last decade, operators pursued costcutting and operating efficiencies to squeeze out
3 to 6 percent in costs annually, often across the
board and year after year. Be it through headcount reduction, capex optimization, or process
efficiencies, this approach has been like drudging
through mud: difficult and slow. Furthermore,
Hello, operators? This is your
age of disruption calling
Diffcult times for operators call for questioning old
orthodoxies to win

Hello, operators? This is your age of disruption calling 3
McKinsey & Company 0
Operators’ industry profit share is squeezed by tech giants and OTT players
SOURCE: McKinsey CPAT financial database
1 Includes TMT companies that may have shifted to adjacent markets (e.g., Payments companies)

order now
10% 10%
9% 9%
49% 37%
8% 7%
9% 8%
11% 12%
13%

100% =1
EP 2005-09 EP 2010-14
2%
156B
4%
257B
2%
Consumer Electronics (excluding
Apple)
Traditional Media
(excluding Google)
Operators
Software & Software-enabled
companies (excluding Microsoft)
Infrastructure

Tech giants Apple
Microsoft

1 2 3 4 5 6
Google
Distribution of economic profit by Tech, Media and Telecom sub-sector
+100%
-25%
2005-14, $B
by cutting costs year after year, operators have
become less attractive employers to top talent and
much (if not all) of the gold-rush mentality of the
2000s has evaporated.
The advent of machine learning and other
advanced-analytics techniques, combined with
the ability to now digitize large numbers of operator
processes, creates a new paradigm that allows
for an unprecedented change in operator cost
structure. Applying analytics to the vast customer
data available to operators delivers new insights
about needs and preferences and what may cause
customers to leave. By digitizing processes, for
the first time operators can act on this information
both cost effectively and at scale, tailoring
products, services, and interactions to individual
customers. These new technologies are just as
valuable in managing network infrastructure,
guiding investments in new capacity, and adjusting
wireless networks automatically.
While no single company has yet to exploit the
full set of levers, our analysis suggests that a cost
reduction of 30 to 40 percent and increasing cashflow margins from 25 to nearly 40 percent
is possible (see “
A future for mobile operators:
The keys to successful reinvention”
). Whether
incremental or dramatic, cost reduction alone
can by its very nature only provide a short-term
competitive advantage. It can, however, create the
headroom necessary to invest in more sustainable
sources of competitive advantage.
2. Who are my real competitors?
The overwhelming majority of the economic value
that has been enabled by the communications
industry over the last two decades has not been
captured by operators, but by tech disruptors like
Apple, Amazon, Facebook, Google, and Netflix.
The economic profit share of three tech giants
alone (Apple, Google, and Microsoft) across the
global tech, media, and telecom sectors doubled
from 13 percent in 2005–09 to 24 percent in
2010–14. These companies—including other OTT
players—are not only redefining the customer
experience but also now competing with operators
for ownership of the customer relationship.
What’s more, these tech players operate
globally and benefit from the corresponding
economies of scale—a marked contrast from the
communications industry that is fragmented by
national borders (exhibit).
“We see the need for a fundamental transformation of the
operator industry, rooted in and built upon these companies’
new strengths and value.”

4 Hello, operators? This is your age of disruption calling
Operators, therefore, will need to address the
fundamental strategic question of where and
how they want to compete going forward. Should
operators continue to see other telcos and cable
networks as their primary competitors—or are the
real competitors for value and customer ownership
the FANGs (that is, Facebook, Amazon, Netflix,
and Google) and other OTT players? Take the US
market as an example (any other market would
equally do): if AT&T were to win 1 or 2 percent
of the mobile market share from Verizon (or vice
versa), how would that compare versus Google or
Facebook introducing new targeted advertising
to AT&T’s or Verizon’s customers? The latter is
clearly a greater risk. Some operators are alert to
the threat and making strategic moves to better
compete against tech players – take AT&T’s
acquisition of DirecTV and pending acquisition of
Time Warner Cable, and Verizon’s purchases of
AOL and Yahoo.
But if tech giants are the greatest competitive
threat to telcos, then what does this imply for how
operators should view network sharing, jointdistribution networks, and bidding for spectrum?
Could a multi-carrier partnership advertising
platform compete? And what are the new
propositions and services that operators need to
develop—potentially jointly—to stand a fighting
chance against the OTT players?
3. What should be the primary differentiators?
As the competitive landscape is redefined, so
too are the sources of competitive advantage.
According to old industry thinking, spectrum
ownership, network assets, and distribution
channels were the chief sources of differentiation
and value. This thinking pushed operators toward
vertical integration and network-asset ownership,
with many players still nervous about even small
steps, such as network sharing, while failing to
generate the necessary returns. Yet the disparity
in profits between operators and tech giants
showed that the pipes are not the chief source of
value. In this new era in which the most industry
value is migrating to the OTT space, there are three
2 Ericsson Mobility Report, June 2017, ericsson.com.
important areas where operators can specialize
and differentiate:
ƒ Consumer insights: Operators can learn
from asset-light OTT players that are generating
strong top-line growth and returns based on
world-class understanding of customers.
Deep customer insights enable operators
to customize product offerings, tap new
marketing channels, and ultimately offer better,
more personalized service. Operators ought to
reflect on the question, Can customer insights,
understanding, and relationships become
meaningful sources of additional, or even
substitutional, value? This will undoubtedly
require new forms of investments and talent,
requiring other areas to yield investment funds,
but given the plethora of unexploited customer
data sitting with operators, it seems it is a
chance too good to miss.
ƒ Customer protection: Hand-in-hand
with customer insights is an opportunity
to offer customers much desired privacy
and protection. While research shows that
customers value more-relevant advertisements
that reflect their personal interests, it also
shows they want operators to protect their
personal data, not sell it to third parties. In
an era of growing concerns about security
and data privacy, can operators serve as a
trusted intermediary between consumers
and advertisers? Are there opportunities to
strengthen ties to customers, reduce churn,
and grow revenue through security services,
such as password, virus, and identify-theft
protection?
ƒ Video: Mobile video traffic is forecasted to
grow 50 percent annually through 2020 to
account for 75 percent of all mobile-data
traffic,
2 yet operators largely don’t offer
attractive content or video-related business
models, but leave this to players outside of
the operator space. Even more alarmingly,
OTT players operate on a global level, with

Hello, operators? This is your age of disruption calling 5
massive economies of scale, while operators
that compete in a handful of countries lack
scale for much content. The video ecosystem
is complex—and getting more complex as
new use cases of creation and consumption
and new disruptors emerge—but it is a space
that operators need to understand well. While
the winning strategy has not yet emerged and
some options are expensive and risky, standing
still will almost assuredly guarantee declining
returns.
4. Does the historically defensive public
domain and regulatory stance need to
change?
Operators have traditionally been highly reactive
and defensive in their public communications
and in discussions with regulators. Leaving
critics to tell their story for them, operators have
often been portrayed as oligopolists that fleece
consumers. This negative perspective of the
industry, reflected in high regulatory hurdles, has
made in-market consolidation nearly impossible,
which is particularly important in Europe to gain the
necessary scale.
Given the growing importance of their networks
and new sources of competition, do operators
need to engage in a more proactive and open
approach to regulatory and public-opinion
shaping, especially relative to tech giants and
network neutrality? A stronger narrative would help
position operators to make an affirmative case for
consolidation or, at a minimum, for deeper network
sharing.
Operators have a powerful story to tell: operators
play a critical role in deploying and managing the
infrastructure that is powering the digital economy,
protecting against cyberattacks, and enabling
new consumer experiences. Industry association
GSMA estimates that in 2016 the total mobile
industry made a contribution of approximately
$3.3 trillion in value-added terms, equivalent to
4.4 percent of global GDP, taking into account the
direct, indirect, and productivity impacts.
What’s more, the myriad of new technologies
under the rubric of 5G has the potential to unlock
tremendous new economic growth by enabling,
for example, smart cities, smart grids, autonomous
vehicles, advanced robotics, and other use cases
that utilize massive numbers of connected devices
and require extremely high speeds and low latency.
Operators must continue to invest in network,
spectrum, and ever-increasing populationcoverage targets to realize the potential of
these new technologies. Policy makers need to
understand that unless operators can achieve
greater returns on capital, this future might be
delayed. And it’s equally important for consumers
to understand what they are paying for on a
monthly basis—nearly constant access to data.
So what?
The appropriate way to change our perspective
on the four orthodoxies above will surely differ
by geography and possibly for each individual
operator. However, after more than 20 years of
persistent cost reduction, an intense focus on
operational-performance improvements, and
continued declining free cash flow and returns
on invested capital, we believe operators need
to question the traditional orthodoxies that have
shaped the industry for decades. With evergrowing demand for the services they enable,
operators have an opportunity to redefine who
they are—their markets, services, and competition.
Such reinvention is possible and beats neverending competition for shrinking industry profits.
Telecommunications is no longer only about
operational excellence. It is increasingly a matter of
vision and strategic choice.

Guido Frisiani is a senior partner in McKinsey’s Milan offce, Jay Jubas is a senior partner
in the Stamford offce, and
Philipp Nattermann is a senior partner in the London offce.
Copyright © 2017 McKinsey & Company. All rights reserved.
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