Saturday, June 10, 2023

Between a Rock and a Hard Place

In the competitive era of connectivity services, asset owners have confronted a fundamental strategic issue where it comes to revenue growth: stick to their core businesses or diversify. 


The former almost ensures slow growth; the latter poses debt and cash flow issues. Even the most skillful practitioners have yet to find that diversification contributes much to overall revenue growth, while posing other risks. 


Though global service supplier revenue has grown, it has done so primarily because of the shift to mobile communications, especially in areas of the world where use of communications has been low. In developed areas, mobility services have mostly cannibalized fixed network services. 


Once the coverage issues have been solved, and most people are able to buy and use mobile services, revenue tends to grow less than the overall economic growth rate. In past decades service providers have sought to add growth by investing in different geographies, but debt burdens and established competitors now make this a riskier proposition. 


Also, profit margins in the global industry have been falling for decades, largely because competition has wrung monopoly-era profits out of the business and in part because new digital technology allows firms to maintain profit margins at lower gross levels of revenue. 


Viewed as financial assets, connectivity services have been--in either monopoly or competitive eras--low growth businesses similar to other “utility-type” and infrastructure industries. 


So the advice to obtain growth has been predictable: connectivity providers need to take on additional roles within the value chain, which allows them to add growth, profit margins and asset valuations typical of firms in those segments of the value chain, and escape complete reliance on the connectivity function.


That has proven problematic. Such diversification moves often have failed. But even when the moves succeed, telcos often find the additional revenue is valued in a lower “connectivity service provider” manner, rather than at levels commonly expected of firms that are pure plays in the other roles and value chain segments. 


Looking at NTT, and only since 2000, the firm has made many moves into additional functions, roles or industry segments. And while the contributions to revenue or asset value are easier to identify, the contributions those assets have made to boosting profit margins are much harder to pin down.What is almost impossible to illustrate are any changes to NTT valuation metrics beyond those one would expect from higher revenue or growth rates. 


New Line of Business

Date Added

Contribution to Recurring Revenue

Contribution to Profit Margin

Contribution to Asset Value

NTT DoCoMo

1999

$10 billion

+2%

+$100 billion

NTT Comware

2000

$5 billion

+1%

+$50 billion

NTT Data

2001

$3 billion

-

+$30 billion

NTT Security

2002

$2 billion

-

+$20 billion

NTT Media Intelligence

2003

$1 billion

-

+$10 billion

NTT e-Healthcare

2004

$500 million

-

+$500 million

NTT Smart World

2005

$250 million

-

+$250 million

NTT Innovation Institute

2006

$100 million

-

+$100 million

NTT Global Communications

2007

$50 million

+1%

+$50 million

NTT Security America

2008

$25 million

-

+$25 million

NTT Data Americas

2009

$10 million

-

+$10 million

NTT Europe

2010

$5 million

+1%

+$5 million

NTT Data Europe

2011

$2 million

-

+$2 million

NTT Security Asia

2012

$1 million

-

+$1 million

NTT Data Asia

2013

$500,000

-

+$500,000


Almost perversely, when tier-one firms have made diversification moves--assuming they are positive in terms of adding revenue--calls inevitably rise for divestment, typically because those asset acquisitions have created debt burdens seen as more problematic than the value of the increased revenue gained. 


In essence, the desire for higher growth, higher profit margins and asset appreciation are at odds with the demands for maintaining cash flow and producing dividends. Were it possible to organically create new lines of business at sufficient scale, funded solely from retained earnings, there might not be a problem. 


The issue is that connectivity is a scale business, so acquisitions frequently are the only way to add new capabilities at scale big enough to affect bottom lines. But that means taking on debt burdens. 


And that is a fundamental problem. Sticking to the connectivity core almost inevitably means slow growth. But diversification might create as many new problems as it solves.


Friday, June 9, 2023

Does the Telecom Industry Really Need "Fair Share" Support?

Executives in the mobile and internet access industries might be forgiven their belief that profit margins are too low, requiring additional support in the form of “fair share” funding of access networks by a handful of app and content providers. 


One might argue profit margin issues are primarily caused by the competitive and formally deregulated status of telecommunications, but that might not be the case. Almost alone (commercial airline industry is the other main exception) among “utility” type industries, mobile and fixed telecommunications have profit margins significantly higher than most other utility-type industries, with energy suppliers at the top of the list, in general. 


Industry

Profit Margin (%)

Regulatory Framework

Degree of Competition

Natural Gas

10-15

Natural Monopoly

Low

Electricity

8-12

Natural Monopoly

Low

Mobile Telecommunications

5-8

Competitive

High

Fixed Telecommunications

3-5

Competitive

Medium

Wastewater

2-4

Natural Monopoly

Low

Fresh Water

1-3

Natural Monopoly

Low

Airports

1-3

Natural Monopoly

Medium

Seaports

1-3

Natural Monopoly

Medium

Commercial airlines

0-2

Competitive

High

Roads

0-1

Natural Monopoly

Low


But telecom executives prefer to compare themselves to internet app suppliers, which often have growth profiles and profit margin characteristics quite different from that of any utility providers. 


But margins across the internet ecosystem vary quite a bit, from the 20 percent to 30 percent margins a search firm might command, to the low margins most chip suppliers and content firms command, in general. 


Industry

Profit Margin


Content

6-7%


Internet commerce

5-10%


Computing Hardware

4-5%


System integration

3-5%


Chip suppliers

20%


Search firms

20-30%


Social media

15-20%


Software

10-20%


Advertising

10-15%



As always, differences between firms in any single industry can have a higher dispersion than differences between industries. 



Industry

Typical Industry Profit Margin

Range of Margins Within Industry

Chip Suppliers

10-15%

5-20%

Software

10-15%

5-20%

Hardware

5-10%

2-15%

Data Centers

10-20%

5-30%

Content

0-1%

0-5%

System Integration

3-5%

1-10%

Advertising

10-15%

5-20%

Internet Commerce

5-10%

2-15%

Social Media

15-20%

10-30%

Search Firms

20-30%

15-40%


The point is that although profit margins in the mobile and fixed telecom industry are fairly low, they are higher than found in most other utility-type industries, generally speaking. Application providers always seem to have the highest profit margins among participants in the internet value chain. 


All complaints aside, mobile and fixed access provider businesses seemingly are more profitable than many other types of network or utility businesses, and more profitable than some other parts of the internet value chain, including content, which is unpredictable and varies show by show.


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