Spectrum Prices Have to Fall in 5G Era

Spectrum prices are going to quite important in the 5G era, for fundamental reasons related to changing mobile business models. Higher network investment and limited revenue upside are among the key issues.

The next generation of 5G networks will cost more than 3G and 4G networks did, in part because they will use small cells. That will have dramatic cost implications for the simple reason that shrinking cell site radius by 50 percent quadruples the number of cells required.

That reduction of cell radius has been going on for some time, as higher-frequency signals have been put into use.

“One study found that the cost (capex) of coverage at 3500 MHz using presently available technologies (not 5G) was roughly 6.7 times as great as the cost of coverage at 700 MHz,” says Bruegel contributor Scott Marcus.  That cost differential comes primarily from the greater number of cell sites required at higher frequencies.

source: bruegel.org

At the same time, revenue upside is more questionable than has been the case in the past. One reason is that services humans will pay for (to use their smartphones and other personal devices) are more limited, as every major revenue source (voice, texting, internet access) is saturated, reaching saturation or going to reach saturation.

That means the higher capital investment is not clearly matched by proven incremental revenue upside that will pay for the new networks.

In many advanced countries, subscriber penetration is well above 100 percent and average revenue per account is not increasing.

Against this background, the ability of operators to monetize the growth in demand for mobile data, for example through fixed-mobile convergence or new value-added services linked to the Internet of Things, is uncertain.

Also, big changes in spectrum supply are coming, for a combination of reasons including a shift to small cell architectures, huge amounts of new spectrum in the millimeter regions, spectrum sharing and additional unlicensed spectrum, better radios and even the ability to create larger channels, which itself increases effective utilization of any available spectrum.

Normal economic realities suggest that vastly increased supply of a desired good should lead to lower prices. That suggests spectrum prices must decrease.

High spectrum costs always have been a barrier to market entry in the mobile industry. Indeed, some would argue that mobile business models are built on spectrum scarcity.

The corollary is that releasing more spectrum, at lower prices, spurs competition and innovation.

A study by NERA Economic Consulting, sponsored by the GSMA, argues that high spectrum prices have lead to lower-quality networks, reduced take-up of mobile data services, reduced incentives for investment, higher consumer prices and lost consumer welfare with a purchasing power of US$250 billion across a group of countries where spectrum was priced above the global median.

“Where governments adopt policies that extract excessive financial value from the mobile sector in the form of high fees for spectrum, a significant share of this burden is passed onto customers through higher prices for mobile and lower quality data services,” NERA says.

“In summary, the current outlook is for reduced spectrum scarcity but uncertain scope for operators to generate revenues from mobile networks,” NERA notes. “This implies that prices paid for spectrum should fall, especially as future releases are increasingly focused on higher frequency bands.”

“Countries that try to resist this trend, either by restricting spectrum availability or overpricing newly released spectrum, are likely to see large amounts of spectrum go unallocated,” NERA warns.

source: GSMA

Carriers Pursue Different 4G Business Models

There are several different revenue models driving fourth generation Long Term Evolution spectrum decisions.

For some carriers, the issue is simply a need for additional capacity.

Though carriers expect and hope that some incremental revenue can be generated, the strategic issue simply is that more spectrum is required, with or without the expectation of immediate net revenue growth from "new services."

The ability to support current customers and demand is reason enough to add more capacity.

In a few cases, 4G has additionally had at least a temporary perceived advantage. Sprint thought its embrace of WiMAX was that sort of decision, allowing it to move first and uniquely in the 4G services market.

In the United Kingdom, EE was able to launch 4G in former 3G spectrum, before the holding of 4G auctions or the building of the new networks.

For some attacking carriers, 4G is a weapon to continue a price assault, as Free Mobile is doing.

Longer term, some carriers also think 4G could enable unicast video services.

Still, contestants sometimes have paid too much to acquire assets. That was true of some Western European operators who, in retrospect, paid too much for 3G spectrum.

Service providers have become wary of such excesses, and auctions for fourth generation Long Term Evolution spectrum, while high in some cases, have not reached levels seen in a few 3G auctions.

But even “rational” decisions can be uncertain, in highly competitive markets.

In the case of a few 3G auctions, one might argue the problem was not the high cost of spectrum, but the low amount of new revenue, and the delay in “discovering” important new apps, which wound up being mobile email, and then mobile Internet access and then personal Wi-Fi hotspots.

In that regard, the danger with LTE auction prices is not so much the absolute cost of new spectrum, which is in some ways a necessary precondition for remaining in business in the future.

The danger is that that increased outlays for spectrum are not fully offset by new revenue streams, or at least higher revenue streams, even if important new apps do not appear immediately.

In markets where customers assume their is a price premium for getting access to LTE’s faster speeds and lower latency, the revenue model is clear. The bigger problem is markets where LTE investments are made, but there is no pricing premium.

That isn’t to say there is no value. Faster speeds and lower latency might well discourage customer churn. But if all major competitors in a market can offer LTE, then the value as a marketing platform is reduced.

Faster networks have value, to be sure. But it is hard to measure the competitive value if all service providers also offer faster speeds.

In the past, supporters of LTE have argued that the real immediate value is the greater bandwidth efficiency of 4G, compared to 3G, used to support data bandwidth. Nor is there doubt that ownership of more spectrum, in markets where demand for data access is growing, has value.

But is has to be disconcerting that LTE access carries no price premium at all, for at least some providers.

French mobile service provider Free Mobile has added an LTE 4G high-speed broadband service to its Free Mobile package without raising the price, in a market where its chief rivals charge a premium for using the 4G network.

Iliad says its monthly Free Mobile subscription remains unchanged at 19.99 euros a month including 4G, without a long-term contract. The no incremental charge policy has a clear logic, of course.

Illiad expects it can use its pricing advantage to further attack the bigger carriers, taking market share. So in the case of Free Mobile, the revenue model is “new subscribers,” not incremental revenue from offering customers a faster network.

Recently, mobile operators in India have faced the problem of revenues insufficient to allow recovery of investments, as well, unrelated to the particular problem of spectrum costs.

India's Bharti Airtel, for example, bought Zain's African operations in 2010 for $10.7 billion, considered a high price at the time, to gain access to the high growth potential in Africa. But competition has lead to low retail prices.

Bharti's average revenue per user grew eight percent from 2012 levels to 192 rupees in India and fell 10 percent in Africa.

For the moment, though, the big incremental decisions turn on spectrum investments.

Since no company invests capital without anticipating a return, every buyer of LTE spectrum has an explicit revenue model. In some cases, there also is an operating cost model (LTE offers lower cost per bit).

But what one hopes is not the case that investments in LTE, or investments in fiber to the home, are not ulimately a matter of “you get to keep your business.” In other words, as many fiber to home investments have largely been made to trade market share with a key competitor, it is not always the case that a traditional return on investment thesis drives the decision.

Instead, the investments are defensive in nature, more a strategic investment than a traditional “high return on investment” decision.

Spectrum Auctions Could Mean Big Trouble for India Mobile Firms

Posting a huge operating loss of 3,100 million Norwegian Krone (around Rs 2,530 crore) for its India mobile business, Telenor executives warned that they would exit the Indian market if it was unable to secure new spectrum at reasonable rates.

At the same time, the Indian arm of Telenor looks to expand 4G footprint and said it would offer the lowest tariff for these services as part of its affordable pricing strategy.

“We are not able to compete with the current spectrum portfolio we have in the growing data market,” Telenor global CEO Sigve Brekke said. But Brekke also emphasized that the additional spectrum would have to be available at “a price that we can justify.”

Some fear widespread damage to mobile company business models if most of the spectrum India plans to auction later in 2016 is sold at or above present minimum prices.

That spectrum auction involves a huge amount of spectrum, and might prove problematic, for traditional and new reasons.

On one hand, the auction will release up to 2,000 MHz of spectrum, across a wide range of frequencies useful for communications purposes.

The problem is that some observers believe the service providers cannot possibly afford to buy all that spectrum, at suggested prices.

Some speculate that sold spectrum--assuming virtually everything is purchased--will amount to about US$83 billion, increasing mobile service provider debt loads as much as 185 percent.

At such levels, the auctions would represent more than 25 percent of the country's national budget for the financial year 2016-17, and more than double the combined revenues generated (around $38 billion) by all telecom companies during the financial year 2014-15.

In fact, of the projected $85 billion in potential revenues, the sale of 700 MHz spectrum alone is estimated to represent around $64 billion. It would not be unheard of for some spectrum to remain unsold whenever an auction is held.

It is possible the proposed spectrum auction in India might result in quite a lot of the spectrum, even desirable spectrum, remaining unsold.

Spectrum deemed useful both for coverage (700 MHz, 800 MHz, 900 MHz) and capacity (1,800 MHz, 2,100 MHz, 2,300 MHz and 2,500 MHz) now are scheduled for sale.

To the extent that spectrum constraints contribute to call drop problems, the new capacity will help. But observers now warn that minimum prices are set at high levels, implying high prices for purchased spectrum.

In fact, some mobile service providers have called for postponing at least some parts of the auction, altogether.

Excessive prices been a problem in the mobile industry before. Overpayments for 3G spectrum nearly bankrupted a number of tier-one service providers in Europe, for example.

Business model stress might be a big problem in the wake of the auctions. For Telenor, it could mean selling its business.

India Spectrum Auction Nets about 11% of Government-Forecast Revenue

India’s big spectrum auction of 2,300 MHz worth of spectrum has ended, with spectrum sold at about 11 percent of what the government projected would be the case, or roughly US$9.8 billion (if I have converted the crore properly). The government had projected sales in the $83 billion range.

As mobile executives had warned, prices for 700 MHz spectrum were simply wildly overpriced. They behaved as they spoke: nobody made a bid for any of the 700-MHz assets. Mobile executives had suggested the government lower the prices and wait before auctioning the 700-MHz assets.

Of the total of 2,300 MHz of assets, the government sold 964.8 MHz of spectrum. Mobile operators purchased about 34 percent of spectrum in the 800-MHz band, about 75 percent in the 1800-MHz band, all of the spectrum available in the 2300 MHz band and about 60 percent of spectrum in the 2500 MHz band. About 20 percent of spectrum in the 2100 MHz band was bought.

Vodafone India and Bharti Airtel were the biggest buyers of 4G spectrum, followed by newcomer Reliance Jio Infocomm and Idea Cellular.

Vodafone spent over Rs 20,000 crore, Airtel Rs 14,244 crore, Jio Rs 13,672 crore and Idea Rs 12,798 crore.

The auction results, and the squabbling leading up the auction, illustrate several important facts about the Internet ecosystem. From a mobile operator’s perspective, though spectrum access is a necessary precondition for being in business, operators cannot pay “any amount” for that access.

And mobile operators demonstrated with their wallets that spectrum prices set by the government were too high. There is experience behind that thinking. In the past, mobile operators have overpaid for 3G spectrum, for example, in India and elsewhere.

Operators have learned, from experience, that the cost of spectrum has to be weighed in view of expected revenues that can be generated by those assets.

There also are a few larger points.

Since, in the end, consumers or advertisers are the ultimate sources of all ecosystem revenue, all costs--anywhere in the ecosystem--must be matched by revenues from those sources.

The Indian auction shows that government officials and mobile operators have vastly-different expectations about the revenues that can be generated by using mobile spectrum.

There are reasons mobile operators and others might rationally expect spectrum to prices to begin dropping. For starters, much more spectrum will be made available as 5G standards are set and regulators start to release brand new spectrum in the millimeter regions.

The role of unlicensed spectrum also is growing, reducing, to a real extent, the need to buy licensed spectrum.

In some markets, spectrum sharing also will add even more resources. Finally, small cell architectures are allowing service providers to make better use of any amount of finite spectrum.

India 700-MHz Spectrum Auction Faces Potential Buyer Strike

Minimum prices set for an auction of 700-MHz spectrum in India are so high (two to four times higher than prior auctions)  that many of the leading mobile companies will not bid. And, according to Fitch Ratings, the eventual spectrum winners might well regret having won. That “winner’s curse” has happened before, often with 3G spectrum auctions.

India's telecom regulator recommended a reserve price of INR115bn (US$1.7 billion) per MHz for nationwide 700MHz spectrum.

Fitch Ratings “believes that efficiency gains from deploying 4G services on 700MHz will be insufficient to offset the relatively high price.”

The reserve price is about twice the price set for 800-MHz spectrum, 3.4 times the reserve price for 900-MHz spectrum and four times the minimum prices set for 1.8 GHz spectrum.

Winning therefore “could exert further pressure on participating telcos' balance sheets and cash flow, and limit their ability to invest in capex over the medium term,” say Fitch Ratings analysts.

In fact, the top four telcos, including Bharti Airtel, Vodafone, Idea Cellular and Reliance Communications may hesitate to bid, as balance sheets already are “stretched,” while available cash is expected to become an issue once Reliance Jio enters the mobile market in the spring of 2016.

Instead, the leaders might choose to rely on spectrum they already have acquired. Bharti Airtel will use 900 MHz, 1.8 GHz and 2.3 GHz.

Reliance Jio, after having invested about US$15 billion on spectrum and networks, will use 800MHz and 850MHz spectrum.

In March 2015, the leading mobile operators had to spend of US$17.7 billion to retain use of spectrum they already were using.

“We believe that there are far fewer reasons for telcos to invest as much in the 700 MHz auction,” Fitch says. As always, there are other alternatives.

Companies can, to some degree, trade and share spectrum, for example.

They also can buy other firms, acquiring spectrum in the process.

During 2015, Reliance Communications merged with Sistema JSFC's MTS India. Reliance Communications also has further plans to merge its wireless unit with that of Maxis Berhard's Indian unit, Aircel Limited.

Fitch believes that smaller and weaker telcos will further seek to be acquired  or exit the industry.

Videocon India, one of the smaller firms which is struggling, has agreed to sell its 4G spectrum assets to the third-largest telco, Idea Cellular.

Fitch expects competition to intensify upon Jio's entry in the market

Blended monthly average revenue per user could fall by five percent to six percent to around INR160 (2015: INR170.

Earnings will suffer as prices drop and marketing spend increases.

Among Barriers to 4G in Africa, 3G Looms Large

It typically goes unsaid that a vibrant mobile Internet ecosystem allowing nearly anybody who wants to use the services to do so requires ecosystem alignment. In other words, every part of the value chain has to align to produce outcomes that allow virtually all citizens and residents to use mobile Internet.

And that emphasis on ecosystem alignment has to be foremost, if Africa is to experience widespread Long Term Evolution service, according to Ovum analyst Thecla Mbongue.

In early June 2015  there were 42 live LTE networks across Africa, spread across 21 countries, serving three million accounts, said Mbongue. That represents about one percent adoption.

The high cost of terminals and a fragmented, regional approach to spectrum allocation are the main factors impeding faster LTE growth, Mbongue notes.

So African stakeholders--ranging from governments, regulators, service providers, app providers and infrastructure and device suppliers--will be needed.

Device taxation and spectrum harmonization are two notable areas where work is required.

Import duties on handsets--which raise the cost for potential users, vary across the continent.

Exemption policies help, and are more frequent in East and Southern Africa, but most West and Central African countries are yet to follow suit, Mbongue said.

The government of Ghana recently announced a smartphone import tax reduction to 20 percent.

Until now, taxes could account for up to 35 percent of the cost of a smartphone.

Import duty for handsets are set at 20 percent in Senegal as well. In 2013, Nigeria moved to eliminate  import duties on devices by the end of 2014. Rates now are at about five percent.

Aligning regional spectrum allocations also would lead to handset economies of scale, and help reduce device prices.

The 1800MHz band is the most common because operators often re-farm spectrum initially allocated for GSM.

But slow adoption of 3G, which means service providers have not yet recovered their investments, also likely is a factor retarding investment by mobile operators.

In West Africa, where LTE is available in only four countries out of 15, there are seven networks, of which four are based in Nigeria.

Only one of those networks was activated by a traditional mobile network operator). The other six were started by ISPs. That suggests some of the sluggish LTE adoption on the part of mobile service providers is voluntary: they might be hoping to profit from their 3G investments before moving rapidly to 4G. .

That, in fact, is what Mbongue suggests. “3G is yet to be fully monetized,” she said.

So when will 4G become a higher priority? About 2019, Ovum’s surveys suggest. By 2019 LTE subscriptions should grow by two orders of magnitude to 318 million accounts.

“Operators must work with regulators to discuss and formulate a coordinated approach to tackling the barriers that prevent 4G uptake,” she argues. “Lower handset taxes, harmonized spectrum allocation, and a framework for network-sharing” can help.

How Will Telco Strategy Change Next?

Business strategies in the global telecom business have changed over the past four to five decades. Five decades ago, profits were driven by long distance calling and the base business was selling monopoly voice to everyone. 

Sometime in the 1980s the revenue and profit growth shifted from fixed network long distance to mobility. Fixed network operators facing stiff competition switched to a multi-product consumer services strategy. 

By the 2000s subscription growth drove mobile revenues. By the 2010s internet access began to be the revenue driver for fixed and mobile operators, not voice or subscriptions. 

It might be a matter of debate how much internal industry decisions and external forces have shaped strategy. 

As we enter the 5G era, it is possible to say that the fortunes of some mobile operators were determined early in the 3G era. Though it is reasonable to suggest that issues ranging from addressable internal market to regulatory policy have mattered, some argue that excessive spending on spectrum licenses for 3G created debt problems that hobbled mobile operator ability to foster growth.

But business strategy might also have played a role. When organic growth is quite slow, one obvious solution is to expand geographically, buying market share out of region, in other words. Many European firms, for example, went on a huge global expansion spree in the 3G and 4G eras. 

It also is impossible to ignore the impact of the internet and IP generally. Those trends essentially opened up the communications networks, ending the walled gardens that historically characterized telecom business models.

At the same time, the end of walled gardens, and the ease of competing “over the top” also mean that any telco-owned apps often must compete with third-party apps. And telcos never have been known for their prowess at creating big and popular new apps. 

Historically, there has been a simple solution for telcos wanting to enter new lines of business: acquisition. 

The new problem is that app provider market valuations and multiples make acquisitions of such firms expensive for telcos. In other words, telcos contemplating big app asset acquisitions encounter the price of expensive-currency assets to be bought with cheap currency. 

That has restricted the historically-important acquisition method telcos have used to enter new markets. In the past, most telcos have gotten entry into new and faster-growing markets by acquiring, rather than building, the new businesses. 

That is much harder when the would-be acquisitions are of high-multiple application suppliers, using low-multiple telco stock or borrowed money. Most telco free cash flow typically must be deployed to pay dividends and reduce past borrowings. 

Taken together, all those trends now suggest that decades-old geographic expansion plans conducted by some mobile operators now are unwinding, as the contribution to revenue growth has not often been matched by increases in profits. 

And that poses new strategy issues: where is revenue growth to be found if geographic expansion, once a logical path to growing revenue, is unavailable? The other logical answer--acquisitions of fast-growing firms in new markets--often is impossible because the market multiples of such firms are high, while telco valuations are low. 

In other words, acquisitions big enough to move the revenue needle cannot be made. Smaller acquisitions are possible, but often, because of small size, cannot move the revenue needle. And, in any market where scale matters, organic growth might never be fast enough to gain leadership. 

Most telcos, in most markets, have learned from their experiences with overpriced spectrum bids. Seldom, anymore, do spectrum prices seem unreasonable. On the other hand, the core telecom business is in slow growth mode in most markets, if still relatively higher in some emerging markets. 

Among the big new questions--if geographic expansion is not generally feasible--is how to reignite growth, especially in promising new markets. 

Compounding those questions is the growing need to look at revenue growth from outside the legacy domains based on connectivity services. Almost everyone assumes that will be quite difficult.

The traditional fear is that telcos really are not good at running businesses outside their core. And there are good reasons for that opinion. But with growth so slow in the core business, and competition not abating, while geographic expansion often is unpromising, telcos may ultimately have no choice. 

Of course, there are other paths. It might well be that most telcos will be unable to sustain themselves over the next few decades, as they are unable or unwilling to expand beyond connectivity. In that case, bankruptcy lies ahead, with potential restructuring of much of the business. 

Precisely how advanced connectivity still can be provided, if today’s business models fail, is not clear. It long has been the conventional wisdom that, in any competitive market, the low cost provider wins. Who those low-cost providers might be then is the issue. 

The other path, which only the biggest telcos might contemplate, aer risky, expensive acquisitions--exposing themselves to harsh criticism--to create new business models not so exclusively dependent on connectivity revenues. 

We already can see some illustrations of the stark choices. When big and small cable operators alike start to say their future is internet access, not video or voice, one must ask whether such a single product strategy will work, long term. The major reason why telcos and cable operators in the U.S. market have survived competition is a switch from single-product to multi-product strategies.

Essentially, they sell more things to a smaller number of customers. That might not work if the new model is one product sold to many customers, especially if the main competitors in those markets are competent. 

Cable operators clearly dominate market share in the U.S. fixed network internet access business. The issue is whether the business model works without other customer segments and products. If the answer is no, then the multi-product strategy will still have to be pursued.

The big shift might be from multi-product consumer bundles to multi-product operations based on consumer fixed network internet access, consumer mobility and business capacity services.

Asia Rural Mobile Coverage (2G) is 87%

There is a very good reason why most observers believe mobile service providers will provide most of the Internet access for people living in rural areas of the developing world: rural area mobile coverage is no less than 79 percent in Africa, 87 percent in Asia and 81 percent in Oceania.

That high level of coverage of course pertains mostly to 2G and 3G coverage, but the general principle remains valid: it is the mobile networks which have the greatest coverage at prices most consumers can afford. Satellites have wide coverage, but generally cannot match mobile operator retail prices.

In 2014, fixed-broadband subscriptions reached a total of 711 million accounts globally, corresponding to a penetration rate of almost 10 percent, according to the International Telecommunications Union.

In developing countries, fixed-broadband penetration growth rates have dropped from 18 percent in 2011 to six percent in 2014, and less than one percent in lesser-developed countries.

Asia and the Pacific stands out as a region with low fixed-broadband penetration (7.7 per cent) and a sharp decline in the growth of fixed broadband since 2010.

In large part, that is because mobile broadband is a substitute. Mobile broadband registered continuous double-digit growth rates in 2014 and an estimated global penetration of 32 percent.

Mobile broadband is growing fastest in developing countries, where growth rates

in 2014 were twice as high as in developed countries (26 percent growth in developing countries, compared to 11.5 percent growth in developed markets).

All regions continue to show double-digit growth rates, but Africa stands out with a growth rate of over 40 percent, twice as high as the global average growth rate.

By the end of 2014, mobile broadband penetration in Africa had reached 20 percent, up from less than two percent in 2010.

Basic 2G population coverage stands at over 90 percent worldwide. According to ITU estimates, global 3G population coverage stood at around 50 percent in 2012.

Backhaul access remains an issue.

In Asia and the Pacific, 40 percent of the population live out of reach of an operational optical fiber backhaul network (the facilities are more than 50 km distant), and just over 10

percent live within 0 km of an optical long haul fiber.

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