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Most African incumbent telcos may have a monopoly on international call termination but even before this monopoly may be removed, they are under pressure from all sides. Their key revenue stream and the underpinning assumption for their business model has been the lucrative international traffic paid in hard currency. But international call rates have tumbled and VOIP and ‘leaky PABXs’ are leeching away revenue. In this off-the-record briefing, Russell Southwood looks at why the bottom has fallen out of the incumbent telcos’ world and how they might shape a new negotiating hand.

Imagine it, if you will. The confident Manager of International Carrier Relations for an African incumbent telco twenty years ago looks out across his expansive desk and surveys his world. The imbalance in call revenues keeps his income high and he deals with only one or two bilaterals: companies with which he arranges outgoing and incoming international calls. Depending on where his desk is, these are the "usual suspects", telcos of the former colonial powers like France Telecom, Belgacom and British Telecom. The ITU’s accounting rate system holds sway and when agreed, rates are largely as stated for long periods of time. The Managing Director arranges new investment not on the basis of where traffic is growing but on an internal schedule to suit the organisation’s rather than users’ needs. Life is sweet and nothing much troubles you. As one insider put it:"They just let the thing go on autopilot and the revenues rolled in."

Roll that image forward to the present day and the changes are so enormous that it almost makes your teeth ache. For example, even a very small West African country will have as many as 10 bilaterals including BT, C&W, Belgacom, AT&T, Sprint, MCI/Worldcom and many other smaller companies. The major international telcos are "delaminating": instead of being single, vertically integrated operations, they are creating business units that compete for traffic. Recent turmoil in the international telecoms market has seen several spectacular defaults by cash-strapped larger players. In Asia, one incumbent telco suffered a US$40 million default.

The problem has not just been getting paid. Whilst Africa’s international rates have largely been maintained in a "competition-free zone", all about it the winds of competition have been forcing down rates. In a recent statement on the telecoms crisis in Ghana (see issues 145 and 148) the local ISP association GISPA noted that:"GT’s accounting rate at the beginning of the period cited was approximately US$1 and is now currently 9 cents; a 90% drop in the value of traffic to GT". And although rates across the continent have hardened somewhat over the last six months, the trend remains downwards.

But even with such a steep decline in the accounting rates there is still a complete disparity between the prices you can get independently for incoming and outgoing calls and those charged under the accounting rate system. In terms of outbound traffic to one destination from a Francophone country, the quoted rate is 23 cents a minute, whereas that minute actually costs only 1-1.5 cents. Out of this disparity most African countries now have a substantial "grey market" that is taking in international calls by going round the incumbent telco: internet calling (using the VOIP protocol) can be of a high quality and is often almost undetectable. It is also only one of a whole range of ways in which the incumbent telco can be got round.

Whereas in the old days, a state-owned telco would follow Government practice and set prices once a year, this is now only for the lazy or the stupid. Demand (and therefore prices) fluctuates so rapidly that the smart incumbent telcos and the new bilaterals are signing agreements with a much greater degree of flexibility on price so that if rates go down, both parties can share at least some part of the savings. As one international operator put it:"If they’re not offering you this flexibility, maybe you need to say to yourself, I don’t need to do it." Payment should be on a monthly rather than a quarterly basis.

African incumbent telcos are in danger of finding themselves trapped. In order to keep meeting their domestic roll-out targets, they need the cash flow from the incoming international calls. Without it, they havn’t got a business model. The difficulty is that the lowest market price is always lower as Sonatel discovered in Senegal when it reached an agreement with some of the grey market operators. The rationale was that it was better to get some revenue than none at all. No sooner had the deal been done than a new generation of grey market operators sprang up offering even cheaper calls. As one insider told us:"It’s like heroin. They’re hooked on the fiction of the rates delivered by the international accounting rate system. They don’t exist any more but to go over completely to free market pricing would blow them out of the water. They’d simply have shredded any credible business model they might have."

So why have rates come down so fast and why are they continuing to fall? The whole capital investment cycle has been foreshortened. Whereas international telcos used to put in switches and cable and write it off over 20-30 years, the upstart internet providers could provide IP calling on 5-10 year capital investment cycles. Add to this shift the massive bandwidth glut and you can begin to see why even the international telephone companies have their own troubles. As one of their competitors put it: "Most of their routes are under water."

The shift to IP calling has been slow: it still only represents about a sixth of all the world’s calls but it has consistently been cheaper than its switching equivalent. Telecom Italia has just replaced switching with Cisco routers and whether it’s ten (the optimist’s call) or twenty years, the future is IP calling.

So what kind of strategies will they be using to fight back with?

* African incumbent telcos are like national airlines. They have capacity for which they can get "top dollar" but they also need "bucket shops" to sell off spare capacity at a cheaper rate. This again is on the rationale that it’s better to have something for the infrastructure you have sitting around than all of nothing. So the smart African telcos (notably South Africa’s Telkom) have been using companies like ITXC as a "side-bet", a way of getting their feet wet in a more competitively priced world. It allows them to compete with and take back some of the traffic from the grey market and the minutes it gets in this way help rebalance its traffic. The majority of traffic still goes to the new bilaterals (70-80%) but the balance is income that it would normally find it much harder to pick up.

* African incumbent telcos need to be creating new products and services that will help them create new revenue streams. It’s hard to believe but a major African telco had not until a few months ago started making international roaming agreements for its mobile operation. You need to be offering pre-paid calling cards domestically and finding ways of targeting their international diaspora. They should be offering PC to phone services and finding ways of wholesaling their bandwidth to the grey market. They need to structure pricing in ways that will bring at least a substantial part of it into the area of legitimate business.

* African telcos need to work together to build up inter-country and international connectivity. African telcos built SAT-3 by coming together to pay for additional capacity. The east African link to this fibre cable and its completion northwards would help lower international calling costs. The encouragement of local and then regional IXPs could allow IP calls to be made from a growing number of points in Africa: the implications are complicated but not intractable. African telcos need to start thinking through their competitive position in this changed world. There are a number of natural gateway points: South Africa, Senegal and Kenya are obvious examples. The telcos will gather up international traffic from surrounding neighbours and use the scale of traffic collected to strike better deals with international carriers.

And if you’re in a mobile company, there’s no reason for you to start feeling smug. In pricing terms, most of you have already saturated the largest and easiest parts of your markets and will now need to reach the next layer down in pricing terms. As anyone who has used a mobile on international roaming in Africa (or elsewhere) knows, the costs of calling are fantastically high. It cannot be too long before these high prices come under attack.

Until recently, the weakest link in obtaining IP calling on mobiles has been the technology for connecting to the telco and a range of compression issues: all of these have meant that most have shied away from using VOIP but it’s only a matter of time.

So what’s the new business model for incumbent African telcos? To find out, you’ll have to wait for a future issue.