Why U.S. Telecom Companies Need to Get Out of the Pipeline Business
June 14 2011 by Vijay Govindarajan and Jan Timothy Woodcock
We do not envy the lot of U.S. telecom CEOs. At a time of rapid change, potent forces are chipping away at their traditional business model (see graphic). Surrounded by device makers, content providers, social networks, and an array of disruptive technologies, the carriers face a daunting challenge. They must find a way to transition from owning and operating “dumb pipes” to creating new portfolios of smart network services.
Once owning that infrastructure was a good thing. The “pipes” were the heart of the business, a source of healthy revenue from all the voice traffic that flowed through them. They now risk becoming marginal. To give one stark example, the Apple iPhone runs on the AT&T network. It’s likely, however, that most iPhone users feel more like Apple’s customers than AT&T’s. For everything they like about the iPhone’s versatility, interface, and apps, customers credit Apple; for the dropped calls and dead zones, they blame AT&T. It’s a win for Apple. Not so much for AT&T.
While it is hard to overstate the difficulty any business faces in abandoning the way it has traditionally defined itself, U.S. carriers need to leave behind their traditional devotion to infrastructure ownership and instead embrace a new business model. Perhaps even more than one.
Today’s challenge is they must invest heavily in next-generation capabilities and infrastructure that will form the core of their future growth. These investments will put a heavy strain on the carriers’ balance sheets as AT&T alone reportedly spent nearly $20 billion in 2010 for upgrades to its wireless network. Instead, looking for ways to offload unnecessary risk and lower capital expenditures in non-core areas will increase their agility and maneuvering room.
A solution model is found in India and its booming telecom market.
Since 1994, the percentage of the Indian population with telecom services (known as “teledensity”) grew from less than one percent to nearly 53 percent. Over the past decade, subscribership grew from 39 million to nearly 690 million telephones (land lines plus mobiles), a 35 percent compound annual growth rate. That would be astonishing even without factoring in the market constraints of an underdeveloped and unreliable electric power supply; and a vast, poor, and dominantly rural nation.
Indian telecoms staggered under the cost burden of building out the network and keeping up with an overheated demand for service. Moreover, because competition for new customers was so cutthroat, the telecoms priced calling plans at rates that didn’t cover their costs.
Something had to give. Bharti Airtel, an entrepreneurial upstart whose competitive strengths lay in marketing and customer acquisition, was first to recognize the enormous burden of building infrastructure. In 2004, it developed a strategy to outsource network installation, maintenance and service to Ericsson, Nokia, and Siemens; and to have IBM take over its internal IT systems and services. These moves got Airtel out from under the massive upfront investments the rampant market growth was driving. The tradeoff enabled them to focus on what they were best at.
While some CEOs remain wary, outsourcing is a well-established hedge against yesterday’s corporate core becoming today’s commodity. As mature firms identify non-core activities and assets that can safely be managed by capable third parties they accomplish these valuable economies:
- Offload the burdens of non-core network ownership (maintenance, repair, and replacement of infrastructure);
- Pay only for the services they and their customers consume;
- Reserve more enterprise capital for investment in core activities;
- Liberate management bandwidth to focus on highest-value strategy;
- Structure contracts (like Airtel’s deal with IBM) that eschew fixed fees or “time-and-materials” models and instead include profit-share incentives making service providers, in effect, “partners” in the client’s success.
Certainly, the Indian market differs in important ways from markets in the United States and other developed nations. Nonetheless, it becomes obvious that the same sorts of benefits Airtel and its competitors achieved from network outsourcing would be available to U.S. telecoms—if only they could let go of the past.
One U.S. telecom has already made such a move. Sprint Nextel recently inked a seven-year deal to outsource operation of its networks to Ericsson, a contract said to be worth $5 billion. European wireless carriers are getting into deals in growing numbers. In the regions where such deals occur, there is a snowball effect that typically produces growing economies of scale for both clients and providers.
But the main—and most strategic—benefit U.S. carriers will realize is the flexibility to control their own destiny in an increasingly complex ecosystem. Times of uncertainty and complexity are often the enemies of courage. On the other hand, these are also times when courage is most generously rewarded.