When it comes to the crunchWhen it comes to the crunch
February 25, 2009
The world is in the grip of a serious credit crunch and no sector will escape unscathed. While it is unlikely that we will see scenes of devastation to compare with the telecoms collapse of 2001 – 2002, the mobile industry will be hit hard and forced to adapt.
‘Recession’ is an emotive word in this industry. When the telecoms and internet bubble burst in 2001, the impact on the mobile sector was devastating. Some estimates put total job losses as a result of the crash at more than half a million. Numerous companies folded and big ideas shrivelled by the score. It was a desperate time and the affect on the industry’s collective mood was profound and long lasting. For years afterwards, the word ‘cautious’ was a standard issue prefix to any mention of upturn or optimism.
So it’s not surprising that the global credit crunch that has us all in its maw should be a source of particular concern for the mobile industry. Of course, the current crisis is an entirely different beast. In 2001 an industry engorged with its own hype and pride was forced onto a strict diet for the sake of its own health. Other sectors performed well while the mobile industry suffered.
Today the problem is universal. Few sectors will escape unscathed, as property and auto industry professionals can attest. But while there may be some consolation in the knowledge that the mobile sector does not have to suffer this downturn in solitude, the affects will still be serious.
Three weeks into January 2009, Canadian kit vendor Nortel had filed for bankruptcy protection, Ericsson had announced 5,000 job cuts and Motorola had axed 4,000 workers as part of an existing cost cutting strategy that had already seen 10,000 jobs jettisoned. In November 2008 Vodafone announced a drive to cut £1bn in costs, followed by Telecom Italia, which pledged to slash ?2bn. Analyst firm Frost & Sullivan has predicted that 2009 will be “arguably the toughest economic year since 1992”. Times are hard.
But these developments – and others like them that will doubtless follow – cannot be attributed solely to the current macroeconomic climate. In this way, too, 2009 differs from 2001. The global crisis we’re caught in today has not caused the problems these companies are experiencing, rather it has hastened their onset. Mobile operators in mature markets have long been under pressure on voice costs; pressures that, in recent years in certain markets has been exacerbated by regulatory pressures.
Carrier pain has been passed along the line to the vendor community forever, and Nortel, one might reasonably argue, has never really recovered from the telecoms-specific recession at the start of the decade. Whether or not the current climate initiated or intensified telecom sector woes is largely irrelevant, though. What matters is that the situation is real and has to be dealt with.
An optimist might contend that, at a time when businesses from all sectors are tightening their belts, communications providers could benefit from a decrease in face to face meetings. Mobile should prove resilient. The reality, though, according to Bengt Nordstrom, CEO of industry consultancy NorthStream, is that this is wishful thinking.
“Historically GDP and telecom spend are very closely correlated,” he says. “And that’s quite natural because telecom services are consumed by ordinary people – corporate and private – around the world. So if the economy’s bad then people will spend less.”
It is with public spending where many of the problems related to the credit crunch will begin. Voice revenues are already squeezed and for many mature market carriers, data-specifically mobile broadband access-had been positioned as the saviour. But with consumer budgets under scrutiny, the attractiveness of these propositions is called into question.
“Carriers in Western Europe had a decent year with mobile broadband in 2008, showing progression, albeit from a very low base of users,” says Michael Kovacocy, European telecoms analyst and sector strategist at investment bank Daiwa Securities. “But now-in the current macroeconomic climate-if they want to push it to the mass market it will be a very difficult exercise. How many people who already have fixed DSL or fibre are going to want to take a mobile broadband modem as well? I don’t think we’re going to see the mass market taking on an additional outlay,” he says.
With end user spend being limited, carriers are going to have to work harder on their pricing to win and retain customers, constricting their revenues even further.
Similar problems are arising felt in the handset sector, although vendors here are under pressure from both their end users and their operator customers. The problem is particularly bad in emerging markets, says Carolina Milanesi, research director at Gartner.
“It was the great hope for 2009 that emerging market customers who had first taken a subscription one or two years ago would bring a new replacement cycle,” she says, “but this is not actually happening.” While new users are still signing up, able to find the $20 or so needed for an entry level emerging market handset, existing customers are unwilling to move up to a $50 – $60 spend, unless the handset they already have is broken or unusable.
Handset replacement cycles in mature markets are being hit by the operator strategy during 2006 and 2007 of extending contract lengths to 18 or 24 months in a bid to recoup customer acquisition costs; in particular handset subsidies. At the close of 2008 some European carriers were actively seeking to persuade customers to postpone their upgrades. In the UK, carriers have stopped using mid-term upgrades as loyalty incentives and in many markets the increasing popularity of SIM-only contract tariffs-where customers forego a new handset in exchange for reduced usage costs-are increasing the drag on handset sales.
Whether the lure of a new handset will prove sufficient to sell end users on long contracts as the year progresses remains in question, though. In the US, reports Carolina Milanesi, significant numbers of iPhone vouchers given as Christmas presents that could only be redeemed by the recipient with a 24-month contract on AT&T have not been used.
Carriers are unlikely to restrict their handset activities to talking their customers out of replacement. The vendors can expect renewed price pressures from the carriers looking to cut their subsidy costs and, says Milanesi, they also face the problem of carriers choosing to run down handset inventory rather than buying in new product.
At the time of writing, Motorola and Sony Ericsson had recently published their Q408 figures, with Motorola posting a 25 per cent sequential decline down to 19 million units, and Sony Ericsson’s shipments slipping to 24.2 million, down from 25.7 million.
Analysts at Deutsche Bank (DB) followed these announcements with predictions that pointed to Nokia’s fourth quarter shipments coming in at around 115 million units, Samsung’s at 49 million, Research In Motion’s (RIM) at seven million and Apple’s at five million. Deutsche Bank expected LG to be flat sequentially. The upshot, DB said, was that it was not only possible but likely that handset shipments for 2008 in the fourth quarter-traditionally when vendors enjoy their reap their biggest sales-could be down sequentially on Q308, which would be the first time a Q4 had failed to surpass the previous three months for years.
Gartner’s Carolina Milanesi offers a less apocalyptic view, though. “I wouldn’t expect Q408 to be down on Q308,” she says. “Q3 ended up being 308.5 million and I was working on a number around 330 million for Q4, which was in line with Nokia’s expectations. But now I think it’s going to be between 310 million and 315 million,” she says.
Carriers, handset vendors and infrastructure players-themselves already struggling in a highly competitive environment and now facing the additional worries of dwindling capex and, in some cases, exposure to ailing handset producing relatives-are all required to fight harder to stay in business.
The good news for operators, according to Emeka Obiodu, senior analyst at Ovum, is that dramatic actions are probably not necessary. “It’s only a fool who doesn’t react when his business is in trouble, but we expect operators to take a piecemeal approach,” he says. “They’ll slash some of their overhead, cut some opex, renegotiate handset subsidies, restructure the commission they pay retailers and reassess their presence on the high street. When all of these things accumulate they’ll have a cushion to fall back on. A large number of small adjustments seems to be the preferred approach,” he suggests.
Operator capex will also have to come under scrutiny. Michael Kovacocy suggests that North American carriers are more likely to rein in this kind of spend than European players because their capex to sales ratios are significantly higher. Vodafone-downgraded by Daiwa in January-has indicated that it could cut its capex in half and still maintain its infrastructure, Kovacocy says.
Overall, though, he’s upbeat about capex. “If the operators stay at the levels they currently have, with the same emphasis on different propositions that they currently have, then it appears that they should be ok.” One possibility is that carriers could contract their spend on a temporary basis-say three quarters-and hope they’re able to sit out the macroeconomic downturn. This could lead to a glut of spending late this year or early next, he adds.
But operators will have to make decisions about where their capex goes, especially if they are involved in substantial international investments. One the characteristics of the credit crunch, after all, is that it is becoming increasingly difficult to gain access to finance. So does it make more sense for carriers to focus on proven, core operations or to continue to fund new market exploits that, more often than not, are typified by large infrastructure requirements?
Opinions are divided. Bengt Nordstrom suggests that it is “quite natural” to expect carriers to downscale their emerging market investments, while Michael Kovacocy is more circumspect. “You can’t spend on everything, so if it came to having to choose between emerging and mature market investment, a decision would have to be made. But I would expect them to carry on pushing into the emerging markets because that’s where the growth is going to be in the future.”
Emeka Obiodu raises an interesting point when he observes that large carriers like Vodafone are able to shift kit from market to market, offsetting investment costs. When such a carrier is ready to roll out next generation kit in a mature market, the older infrastructure it rips out can be redeployed in an emerging territory.
Such benefits only exist for scale players, of course, and in the operator community it is a fair assumption that lower tier, unaffiliated carriers will face a sterner test than their larger competitors.
“The mobile market is increasingly a scale business,” says Obiodu. “If you are in just a single market, all of your fortunes are dependent on that one market, so you don’t have the opportunity to hedge your bets. That affects your ability to raise funds in the market to be able to embark on further network upgrades. You’re too small to raise more money, so you can’t diversify and it becomes a self fulfilling prophecy.”
If smaller carriers do indeed start to struggle, a further investment option becomes available to the scale players. More than a couple of mature markets are felt to have one too many mobile players and a credit crunch of the type that is biting in early 2009 could be just the catalyst needed for some necessary in-market consolidation.
Michael Kovacocy agrees with Obiodu: “The more you can bring to the market in terms of cost control and efficiency, the better off you are. That’s really the name of the game now. It’s all about cost control,” he says. “So everything points towards consolidation, which generally works in favour of the incumbents. They have the advantages so we would expect them to win at the expense of the second tier players due to market maturity and economic pressures. Maybe not right now but definitely towards the latter half of this year.”
A reduction in the number of players is something that we can expect to see mirrored in the supplier market as well. It seems fair to say that the wave of consolidation that created Nokia Siemens Networks and Alcatel Lucent has not gone far enough. The infrastructure market remains overpopulated, with the price pressure coming from China showing no signs of abating.
As we’ve already seen, the vendors with the most problems cannot attribute their current predicament to recent macroeconomic developments. But financial conditions will certainly hasten their decline. When Nortel filed for Chapter 11 bankruptcy protection, the firm’s management was keen to stress that the situation was salvageable and that the company could return to profitable, successful operation. But a process of asset stripping looks likely to ensue and it’s impossible to reliably predict what will emerge on the other side.
“We’re really down to an infrastructure market that can only sustain three players,” says NorthStream’s Bengt Nordstrom. “There are a number of second and third tier players that have been hanging round and surviving because they have a few strong geographical pockets, perhaps in their home markets where they’re protected by governments. These players are going to face very difficult times.”
If Nordstrom is right; if the mobile market today can really only sustain three infrastructure vendors, then some very big names could be about to fall by the wayside.
On the handset side similar outcomes-in that the weakest players will pay the penalties and the strongest will emerge in even better health-are looking likely. Carolina Milanesi predicts that Motorola will slide out of the top five handset vendor rankings during 2009, and that Sony Ericsson will struggle to hold onto the third position it reached in Q308 “more by luck than by credit.”
Motorola lags the leading pack in key areas such as software and user interface, Milanesi says. This, combined with a shift in geographical focus away from EMEA will cost the firm shipment numbers and an expected push from Canadian player Research in Motion could contribute to a relegation for a manufacturer that once led the world in handset sales. Sony Ericsson, meanwhile, could be penalised by its reliance on Western European markets, which Gartner expects to remain flat this year.
And any impact on the handset sector could ripple out. “Handset suppliers really have to look hard at the technology and functionality for which consumers are prepared to pay and which operators are prepared to subsidise,” says Milanesi. “They’ll have to cut out anything else that’s not necessary. Adding a DVB-H tuner to a phone won’t help you in today’s market, nor will being the first out with an LTE handset.”
The mobile industry will be hit hard by the global economic situation. Job losses are already into the tens of thousands and, while redundancies may not hit the unprecedented scale seen in the early years of the decade many people and companies will be adversely affected.
While they will be hard pressed to see any upside to the situation, there is a sense in which it could be good for the industry as a whole. Given all existing pressures, operators and suppliers alike need to be as lean as possible and the sector is probably carrying some surplus weight. What happens to the industry could, in fact, be necessary. “If you believe in the market economy you’d want to believe that this will be healthy for the industry,” says Bengt Nordsrtom, “Ultimately it’s something good.”
Not everybody will see it this way of course but adaptability is as crucial a talent for an industry as it is for the organisations that combine to create it. It seems another evolutionary stage is underway.
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