GSM>3G Africa 06: masters of the universe face a tougher climb

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For the past ten years Africa’s mobile operators have walked on water. They have connected hundreds of millions of people incredibly quickly. They have extended coverage to places where there are no roads or power, making Africa’s telco incumbents look like flat-footed dinosaurs. They literally got Africa talking to itself. Almost everything they touched seemed to turn to gold. But as the growth curve tails off, these new African masters of the universe are facing some fairly serious challenges. At the end of the industry’s annual talk-fest GSM Africa > 3G Russell Southwood looks at the trouble ahead.

The mobile operators have become masters of the universe in a short period of time and they dominate the “mind-space” of the continent. Their branding and media spend in most African cities means that few people can ignore them and it is a visible sign of their seeming invincibility. They have gone from being insurgent challengers to becoming the new incumbents. But new challengers are going to enter the market and want to take a pop at them.

Although it’s difficult to generalise across a customer base in the millions, the African consumers on whom they rely are beginning to go from being deeply grateful for any service to becoming more demanding, particularly on price and quality of service: they are noticing the leads and lags in network investment.

Maybe when the histories are written in ten years time, it will be this year that will be seen as the high water mark of the mobile operators’ success. If you listen carefully, you can identify a number of pressures that are beginning to crowd in on them. Whilst it would be foolish to think they won’t be able to respond to them, they certainly have a much tougher climb ahead of them.

The challenges that they will have to get to grips with include:

Low levels of competition on price:

Although there are often three competitor companies in a country, there is usually only a very small percentage difference in price between the cheapest and the most expensive. In countries with two operators, the price difference is almost non-existent. For example in Botswana, you could not put a piece of paper between the rates offered by Mascom and Orange. All of this is obscured by a blizzard of tactical marketing offers. But to rework the famous phrase from the Godfather movie, this is a case of “make me an offer I can’t understand.”

There is now a dawning awareness amongst key African regulators that they have a role to play in protecting the African consumer and that price and quality of service are two issues they will have to tackle. Some are using investigations into interconnect pricing as a proxy for achieving this aim. The mobile operators are increasingly seen as the well-resourced new incumbents who resist greater levels of competition and technological innovation. This shift in positions was crystallised for me by watching a year ago a senior regulatory staff member from a mobile operator browbeating a regulatory CEO about his desire to open up his country to competition. In the event, the mobile operator was not successful in resisting change but the point is that the major mobile operators are now in a defensive rather offensive mode in terms of competition.

Price relative to income:

African mobile prices mean that consumers spend a far higher percentage of their income on mobile communications than their developed world equivalents yet they earn so much less. This used to be a factor to marvel at: it just goes to show how important communications is to Africans, people used to say (including myself) in a sage sort of voice.

But the truth is that high prices are actually blocking further market development. If you want your subscribers to spend money on other “value-added” services, then you have to free up that spending unless incomes grow much faster than at the current rate. If you want users to stop “beeping” and talk, rates have to come down.

A survey in an informal settlement in Nairobi called Kibera (that has 0.75m people living there) found that a single mobile was shared by five people. Again we all marvelled at how Africans found a way in the face of adversity. But actually what this is saying is that the mobile operators have failed to reach some significant portion of a potential customer base. If those who live in Kibera sell their tin shacks to each other, there’s money in there but the mobile operators are not reaching it.

The truth is that the mobile operators have not yet reached the bottom of the price elasticity curve. Rates need to come down to reach whole sections of Africa’s rural and urban populations. As we will see, the dilemma for the mobile operators is whether they will make the same from lower rates (as people talk more) or whether they can devise a way of lowering their rates for particular groups of people.

Even the normally sober-minded Informa Principal Analyst Devine Kofiloto was moved to observe that there have been few benefits to consumers:”It’s largely the shareholders who are smiling.” Celtel’s CEO Martin Pieters was sufficiently stung by this to point out that his company had not paid shareholders a dividend for ten years.

The other part of the pricing puzzle is the mobile fixed paradox. Once a mobile network is established and the CAPEX has largely been paid back, it’s much cheaper to connect a mobile subscriber than it is to connect a fixed line customer. Yet it is more expensive to use a mobile phone than it is a fixed phone. In the early days of mobile phones this could be justified by the fact that consumers were being charged a premium for mobility. However, when mobiles are the majority device for voice on the continent, it is significantly more difficult to sustain this argument. And fixed/ mobile convergence must surely mean that the two rates come together and disappear over time: rates based on technologies are certainly not technology-neutral.

Falling growth and lower ARPUs:

In his introduction to the conference, Informa’s James Barker told delegates that subscriber growth was slowing down: there had been two quarters with growth below 10%. Devine Kofiloto reinforced this gloomy message by showing projections that identified overall growth flattening in 2009. But in East Africa, growth flattens in 2008, which is only two years away.

However, the picture is not all gloom and doom. For example, Nigeria will surpass South Africa as the largest market on the continent in 2007. Nevertheless operators now have to face a slowing pace of subscriber growth and the newer subscribers will also be more costly to acquire.

ARPUs are falling as the hill gets steeper. A selection of pre-pay ARPUs from the second quarter of 2006 illustrate the point: Sonatel, Senegal ($15.42); Spacetel, Benin ($13.90); Vodafone Egypt ($10.41); UTL, Uganda ($9.07). Headline blended ARPUs often disguise this sharp-end reality.

The lowest overall ARPUs are found in East and Central Africa and it is East Africa where the uphill growth road is running out fastest. The highest decline in ARPUs has occurred in West Africa from where some of our examples above are taken.

Indian ARPUs have in some instances gone as low as $4-7 in some parts of the major networks and this is probably somewhat nearer the bottom of the pricing elasticity curve. But there are significant differences between India and Africa in terms of population densities: typically rural areas may have around 200 plus people per sq km against 100 or so people found in Africa’s uncovered areas.

The question is really what operating profit margins operators can sustain. The case of Zantel is illustrative. In 2005, operating only on Zanzibar, its ARPU was $10. It now has 320,000 subscribers but Zantel’s CEO Noel Herrity refused to reveal current ARPUs. Like the dog that failed to bark in the Sherlock Holmes story, we can reasonably deduce that the current ARPU is lower than $10 or there would be a lot of barking about it. And this is achieved in part through a roaming agreement (leasing the network, if you will) with Vodacom on the mainland. If the margins are there to lower prices (and thus ARPUs) while leasing a network, what might the network operator Vodacom achieve in price terms if it were so minded?

The more optimistic are looking to data to at least partly fill losses in income. However, whilst technology push is delivering ever more sophisticated services it is not clear how the majority of Africa’s hard-pressed mobile customers will afford these services. But for all the problems of literacy, SMS text messages remain the main driver of data revenue growth. And the story here is the same as for voice: where prices for SMS are low, as in Lesotho, usage goes up. African consumer communications spend may not be entirely a zero sum game (where one kind of spending will inevitably replace another) but there is little sign of a wave of rising incomes.

Competition from low-cost, mobile VoIP operators:

As African countries like Algeria, Kenya, South Africa, Tanzania and Kenya become more competitive, several of the continent’s hard-pressed ISPs are re-inventing themselves as VoIP service providers: sitting on the services and applications layer and offering voice services to their customers. A few have seen the light of day and more are in the wings. Initially they will offer fixed wireless services but even these services have a degree of in-built mobility: “locked to one cell” will become a largely negotiable space. Mobile operators would do well to remember the history of Reliance where it parlayed its fixed wireless presence across India into becoming one of continent low-cost mobile operators. And it is only a one to two year “skip, hop and a jump” to mobile VoIP.

Jamal Ramadan, Group Vice President, Special Products, MTN recently gave the following rather revealing comment on low-cost operators:“Community phones using VoIP over fixed wireless Internet connections will have some negative impact but it can be managed through data pricing and interconnect.” The last five words can only mean of two things. Either we will work closely in partnership with these kinds of operators or we will fix data pricing and interconnect to their disadvantage.

You do not need to be a cynic to imagine that the latter is more likely but the mobile operators may not be in a position to choose the interconnect. If in more competitive African countries, the telco incumbent’s network is used at a carefully established, cost plus price, why will it be any different for mobile operators? What’s sauce for the goose is sauce for the gander. So mobile operators will either have to go to the edges of the market themselves or help others to do so.

The operators rightly complain about the high level of Government taxes and how this prevents them from extending services and lowering prices. And Pieters of Celtel pointed out:”We expect (the roll-out) of power and roads to be in the interest of the Government but we see little happening there.” Of course, he’s right but this is a log-jam with blame-calling at high volume.

Why not turn the problem into the solution? An alliance of leading operators could negotiate time-limited “tax-breaks” for serious roll-outs of integrated packages of roads, power and telephony. Such a programme would easily attract international support. The mobile operators could use their considerable reputation to insist that there were independent power operators and privately commissioned road contractors. Does any one of them have the courage to turn this problem into an opportunity?

Falling international rates and roaming charges:

International calling and roaming revenues are a minor but significant revenue stream for mobile operators. The small percentage of their post-paid customers contribute a disproportionate amount of high-margin revenue. Unfortunately this is beginning to change: see the story below in Telecom News - International calling price falls are spreading across East and Central Africa.

The lower end of fixed and mobile operator international calling rates are now between 20-25 cents a minute down from previously much higher levels. Part of this reduction has been the liberation from monopoly international gateways but the rest is driven by VoIP service providers in competitive markets. However, there is a silver lining as lower rates mean that traffic goes up. But even with a considerable increase in traffic, you are probably back where you started in revenue terms. Good for bandwidth sales, less good for operator revenues.

In addition, roaming charges will come down as operators follow Celtel’s lead in lowering them for its neighbouring countries in East Africa. MTN’s CTO Karel Pienaar said they would follow suit although he couldn’t quite bring himself to say the word follow. He pointed out that in West Africa MTN now has a series of contiguous countries with only a gap in Togo. He observed that if they could connect these then rates could come down because there would be no expensive sending of calls to the USA and Europe to connect with African neighbours. Given how relatively small Togo is to cross, this is again a political problem that must find a commercial solution.

Increasing deal competition:

Fierce deal competition will put considerable pressure on those who raise their money in the market rather than from petro-dollar rich Arab investors. Those loaning money or investing are typically looking for 12-15% return on their investment, higher if there are risks attached. Riding on the wave of relatively high oil prices, Arab investors are willing to look at lower returns and longer time scales. Celtel’s Pieters pointed out that the Dubai Investment Authority typically looked at 50 years:”The shareholders I’ve worked with would be very happy with 3 years.”

These rather different assumptions about investment have driven up acquisition prices to stratospheric levels. In places as diverse as Egypt and Mauritania, Arab investors have paid “top-dollar” for licences: the price paid for the third mobile licence in Egypt was higher than the market cap of the number one operator. And as Celtel’s Pieters kept reminding his audience all this money “just for a piece of paper.” But financial markets behave in strange ways.

The current ramp of mobile shareholder value is built on the expectation of increasing capital value: what happens when this ceases to be true? What happens when the steeper climb produces lowered expectations reflected in lower subscriber growth and ARPUs? What goes up, must come down.

But the game’s not over yet as 57% of Africa’s operators remain outside the ownership of the big four: MTN – 15%, Vodacom – 14% , Celtel – 7%, and Orascom – 7%. Celtel’s Pieters foresaw a day when 4-5 players would control 60-70% of the business. But there are two potential challenges to this “onwards and upwards” narrative.

If Arab investors have deep pockets, Celtel will do well but what about Vodacom that has already said acquisition prices are largely too high for it? And surely Arab investors will think about buying MTN? MTN’s Pienaar said he was “not aware of anything like that happening at the moment” More intriguingly the issue of whether Cell-C would be bought by Celtel was raised. Celtel’s Pieters said: “Jeff Hedberg and I go back a long way. It would work easily at a management level.”

The other possibility is that someone will go round and gather up existing failing operators at relatively cheap prices and build themselves an entirely new brand. Unfortunately for the existing mobile operators any insurgent competitor will almost certainly challenge on price. But there are also a couple of CAPEX “down-steps” out there that may make this an even more difficult prospect. CDMA is cheaper than GSM particularly now as operators are putting in the full alphabet soup of data capability. What if someone had the nerve to bring together a group of CDMA networks?

But beyond that, there is the ground zero option: a fully IP mobile operation. If you’re a unified licence operator starting from scratch, you will build yourself a largely IP-enabled network. This might be extended out into the mobile network as the elements come into focus over the next three years. A greenfield IP mobile operator might have real cost advantages over the slower moving mobile incumbents. And arguably until recently not all major mobile operators have been characterised by high levels of technology innovation.

You take the high road, we’ll take the hot-spots:

Except for sales reps and similar professions, most people spend only up to 10% of their time on the road. The new wireless challengers in the voice space – Wi-Fi and Wi-MAX – will have difficulty taking the road but may acquire an interesting share of everything but the road. And where would this leave the mobile operators?

This was the implicit pitch being made by London-based South African Niall Murphy, CTO of the Cloud. Whilst apologising for bringing European experience, it was not too difficult to do the translation for Africa.

The Cloud operates Wi-Fi hot-spots in 8,500 locations across Europe, with the majority in the UK. It has worked hard to make this network of coverage as seamless as possible for data users and has recently added IP voice to its service offerings. Its partners are a revealingly eclectic mix of new wave challengers and incumbents: Telenor, O2, Vonage, Skype, Nintendo, Vodafone, Bengo, Sprint, iPass, CredeCard, BT Open Zone. It is tapping into the growing wave of municipal networks and recently won the contract to wire the City of London, the capital’s financial centre.

And this precisely because it allowed any device or service to connect and did not offer an “only our service” approach. And here lies the difficulty for the mobile operators. You can argue that MTN with its developing understanding of Wi-MAX might position itself in this market but how will mobile operators make sense of so many devices and services?

His European argument is that increasingly people are acquiring wireless enabled devices (particularly laptops) they want to be able to use anywhere. He is not selling it as a premium product but offering packages for between 10-15 euros for users. A small but significant proportion of traffic by kilobits is now coming from voice.

So let’s translate the proposition into African. There are two potentially different markets: the business or professional person who needs to be connected wherever they are and the person who might simply want a cheaper phone service. The latter might have to wait for Wi-Fi enabled phones but they will be here in volume before too long. The former is almost exactly a mirror-image of the European customer with a certain amount of price adjustment. Add in the roll-out of muni networks in African cities and the proposition slowly comes into focus. Speaking of which, the tender for doing this to Cape Town will be decided soon and there is already a study for a city-wide muni network north of the Limpopo.

It is at this point one might utter the Chinese curse to mobile operators:”May you live in interesting times.” The only problem with this is when I actually talked to a Chinese person about this well-known saying, he gave me a blank look and told me no such curse exists. So maybe that’s a lucky sign for Africa’s Masters of the Universe.