An industry at risk: Commoditization in the wireless telecom industry

Executive summary

Competitive pressure is rising in the global wireless telephony industry. It’s coming from without, as companies in adjacent industries such as technology and media move into the space. And it’s coming from within, as telecom operators fight one another for subscribers in oversaturated markets. The result: stagnant growth, and a slow but seemingly inevitable commoditization of the industry’s primary services.

This process can be tracked by looking at two key metrics: changes in the spread between the wireless operators with the largest and smallest shares of each market’s subscribers, and changes in the spread between the one with the highest average revenue per user and the one with the lowest. As these gaps narrow, markets become more efficient and more commoditized — as long as there aren’t mitigating factors, such as anticompetitive regulation in certain geographies.

The extent of commoditization varies from market to market, of course. As a rule, however, two observations can be made. Markets in more developed economies tend to be more commoditized than those in developing economies. And the number of major wireless competitors in each market is leveling off, with larger markets settling at about three or four, and smaller markets at around two or three.

Can individual operators break out of the commoditization trap? That depends on their willingness to take steps to more clearly differentiate their offerings. First, they must examine their cost structures, shedding nonessential activities and investing the savings in new capabilities. Then they must scrutinize their core connectivity businesses to determine where the real value lies and invest in new capabilities and technologies on which to base truly value-added services that can provide sustainable competitive advantage.

Methodology

To measure and better understand the scope of commoditization in the wireless industry, we developed a commoditization score based on a combination of two independent variables at both the national and regional levels:

• Average revenue per user spread: The difference between the highest and lowest ARPUs of the market’s players. A declining difference indicates that operators are losing the ability to differentiate among their products and services, and thus are engaging in a pricing race to the bottom.
• Market share spread: The difference between the market shares of the largest and smallest players in the market. The smaller the spread, the more commoditized the market, as the pricing war leads to even greater interchangeability among providers, and thus less inclination on the part of consumers to change providers.

Depending on the scores on these two measures, we have placed each country and region we studied into one of four commoditization zones.

1. Zone 1: Comfortable. In this zone, there is a greater than 50 percent spread in market share and ARPU between highest and lowest market players, indicating that commoditization is far off. However, this can change quickly if new competitors enter the picture or a competitor launches a particularly aggressive pricing strategy.
2. Zone 2: Differentiated. There is a large spread in the ARPU between operators in this zone and no more than a 25 percent spread in market share. Although there is no dominant player in such markets, its operators have managed to maintain a range of pricing options.
3. Zone 3: On the edge. Countries in this zone have no more than a 50 percent difference in market share and ARPU between the highest and lowest players. Operators in these countries have managed to maintain some differentiation in pricing, but decreasing differences in market share are pulling the market toward commoditization.
4. Zone 4: Commoditized. Countries in this zone have less than a 25 percent difference in market share between the highest and lowest players in the market and less than a 25 percent difference in ARPU. Operators in these countries are fully in the grip of commoditization.

We have also assigned each country a Commoditization Index (CI) score — a single figure that provides an “at-a-glance” summary of where a country or region lies on the path from comfortable to commoditized. The CI score is an average of market share spread and ARPU spread, weighting both spread scores equally.

Although the CI score for a country or region is derived from the market share spread and ARPU spread, the score provides a complementary perspective on a market’s commoditization zone — and can drive insights obscured by a country’s zone position. For example, a market that is in Zone 1 (comfortable) may be identified by the CI score metric as more competitive overall or on the edge.

Ways to play

The great risk for wireless operators, especially those in mature markets, is that the trend toward commoditization may lead eventually to a point where they become little more than utilities — the “dumb airwaves” of the telecom industry. Once that occurs, their pricing options will narrow until they are just generating the revenue needed to cover their cost of capital and upgrade their networks.

To avert this fate, carriers must rethink their strategies along two critical paths — cut costs further, and break out of the commoditization spiral.

• Cut costs strategically. As noted, most operators have already reduced their costs considerably. But their previous efforts won’t be enough to maintain the cash flows that shareholders demand, or to fund their strategic investment agendas. So now they must go through a further, inevitable round of cost cutting, one that challenges the very foundations of the business. In short, they must fundamentally reconfigure their internal and external value chains, rebuild the capability systems that support them, and rethink how they deliver services.
• To this end, they must take a zero-based approach to resourcing and investment funding, looking at their entire range of capabilities and determining on a case-by-case basis whether each one serves to differentiate the company in the market, is required to maintain necessary operations, or doesn’t really contribute anything at all. This Fit for Growth* strategy should enable operators both to improve margins in the short term and to set themselves up for further growth by using some of the money saved to reinvest in new capabilities.
• Differentiate for growth. The key to breaking out of the commoditization trap lies in reversing the two trends that operators are facing — the narrowing of both the ARPU and the market share spreads. Further, these efforts must go hand in hand.
• First, operators must reevaluate the very nature of their core connectivity business. That includes understanding clearly its current strategic assets and control points, and how new technologies such as 5G and network function virtualization (NFV), along with software-defined networks (SDN), might enable them to build new differentiating capabilities.
• Rethinking the connectivity business must lead in turn to the development of an entirely new set of connectivity-based, differentiated, value-added offerings that can provide sustained competitive advantage and that won’t suffer in competition with over-the-top (OTT) players and digital device ecosystems. These might include services for the smart home, connected driving, and smart cities, as well as a means to gain some control over how content and advertising is distributed to consumers.

Together, these two moves should enable operators to move away from “metered data” and other pricing models based on commodity categories such as minutes of voice, gigabytes of data, and number of texts. Instead, they must develop value-based pricing schemes for their value-added service packages, through which customers pay for the value they attribute to the services they receive. This will depend largely on operators’ ability to segment customers into different personas — the video entertainment lover, the sports fan, the business traveler — and offer each group compelling services based on its specific needs and interests.

Such pricing mechanisms will let operators generate the most revenue from each customer segment, depending on its needs and willingness to pay for specific services — and if done right can increase ARPU and slow the process of commoditization, especially at the upper end of the customer range.

One final strategic move operators might consider is consolidation, which can help reverse commoditization pressure by increasing market share and expanding the spread between the market’s operators. Such a move can also lift some pricing pressure by removing a competitor from the market. Of course, the ability to take this approach depends largely on each specific market situation and the regulatory schemes governing it — the smallest number of players that will be tolerated is typically three, and several markets examined in this study have already reached that point.

What will the future bring?

No matter how diligently operators try to prepare themselves for the future, it is, of course, impossible to know what that future will hold, especially in an industry like telecommunications, in which change can happen quickly. Who knew, in 2006, how profound an effect the smartphone would have on the industry, shifting the competitive advantage — and the lion’s share of the growth — from the traditional operators to new ecosystem participants that captured value through device sales and OTT content, commerce, and advertising?

Strategic scenario analysis is an important — and often overlooked — discipline that can help operators avoid the pitfalls of linear planning and thinking, and it offers a valuable way to mitigate the risk of such surprises. Done right, it can enable operators to plan for a variety of possible futures, but it requires a disciplined act of the imagination.

First, determine the factors that could affect your company’s competitive environment along the same time line as the company’s strategic investment horizon. For an industry like telecommunications, this could be anywhere from three to seven years or so. In addition to the commoditization forces already at play, these factors might include the potential for the next revolutionary shift in consumer behavior, for disruptive new technologies, for changes in your market’s regulatory environment, for greater or lesser overall market growth, or for moves by competitors into new markets and business models. (And be sure to define competitors broadly, as competition from other operators may be the least of your longer-term worries.)

Look for signals and signposts that you can observe today, and combine them into the different plausible outcomes they may lead to. And do include that doomsday scenario, and quantify what your company’s economics might look like in a fully commoditized endgame. What you will see will likely be sobering but should provide an impetus for you to step out of the dangerous tendency to deploy incremental tactics focused on the next quarter or year, and fundamentally rethink the direction of your business.

Then, think through what it will take to shape and thrive in any of these futures. What are the handful of capabilities that will truly matter, which ones are you already good at, and which will you need to develop? What are the strategic assets that will determine who will control customer access and, ultimately, access to value? What would be a realistic goal for your margins, and the target cost structure you would need to get there? Challenge yourself to identify the “common denominators” — the factors that really matter because they represent true differentiation, cost leadership, or barriers to entry — and formulate the different strategic identities that would enable you to win under each set of circumstances.

Finally, engage your broader leadership team — strategists, operators, innovators, and marketers — to vet your scenario thinking and make your chosen strategic identity real and executable. Be sure to push for a strategic plan that balances value proposition with bottom-line requirements, technology with organizational capabilities, financial rigor with a plan to activate your talent base and culture. Wargaming can be a powerful tool to pull your company’s leaders out of day-to-day incrementalism and build a coalition for action.

A distinctive strategy

The sad irony is that the telecom industry has become a victim of its own success. Operators have saturated their markets, and new technologies, such as the smartphone, have exponentially increased demand for wireless data. As a result, the forces of commoditization have already been felt in many wireless markets around the globe. Even operators in markets that are currently positioned comfortably are at risk, as they scramble for market share and struggle to develop new, innovative services, while governments devise regulations to promote competition.

Only by choosing a strategy that plays to their strongest, most distinctive capabilities can operators hope to grow in this environment. The alternative — becoming a mere utility — is not an outcome that shareholders, business leaders, or their teams are likely to find attractive.

* Fit for Growth is a registered service mark of PwC Strategy& LLC in the United States.