Mallinson: Extolling the benefits of market consolidation

Keith Mallinson

European competition authorities and their political masters need to obsess less about maximising or preserving numbers of mobile network-based competitors, and, instead, help maximize--or at least not impede--infrastructure and services investments and other developments by letting market forces prevail. The United States shows us that allowing industry consolidation--with mergers and acquisitions among mobile network operators--increases economic efficiencies, improves financial returns and creates the incentive for further capital investments by large and small operators alike.

Transatlantic comparisons show that U.S. consumers have done well with respect to choice of offerings including availability of 4G LTE services, and low prices that stimulate demand. In contrast, European network investments have been lacklustre of late; and prices per minute, per text and per megabyte are relatively high.

Three or four national mobile operators is efficient and sufficient

Few advocate a return to "natural monopolies" in telecommunications, but there were good reasons why road, water, electricity and fixed line telecoms were mostly developed with one unified network connecting to each and every factory, home and office in any given region or nation. Deregulation in fixed line communications and licensing new spectrum to several mobile operators has introduced many new competitors in telecoms. However, consolidation is also a natural and positive consequence of competition that should be welcomed because it increases efficiency and attracts investment with improved financial returns. Consolidation also provides the potential "exit" needed to motivate potential investors in struggling second-tier players that might not ultimately make it alone. In the U.S. for many years, being acquired has been the end game for prepaid players MetroPCS and Leap Wireless while these operators have continued to expand their networks significantly and compete most aggressively with alternative, low-priced rate plans.

Having many operators and MVNOs has certainly led to plenty of retail competition with advertising, brand choice and cut-throat price competition including near giveaways with heavy handset subsidies. However, European spectrum licensing and competition policy has impeded network infrastructure development compared to the U.S. and some other developed markets including Japan and South Korea, where LTE deployments are much further along. Resisting mergers and spectrum consolidation can be harmful to market development. In contrast, the authorities including communications regulator Ofcom were right to allow the number of operators to reduce from five to four with merging of T-Mobile and Orange in the UK into EE.  Furthermore, it also makes sense to allow the acquisition Telefónica Deutschland's acquisition of KPN's E-Plus, with the reduction from four to three significant operators in Germany.

The writing is on the wall

There is plenty of evidence showing that the preference for managed competition with five or four national MNOs (or three in particularly small nations) and price regulation has not yielded the best results for European consumers, let alone MNO shareholders. Spectrum allocations and other measures have sought to equalise network-based competitors while reducing prices with controls on call termination and roaming charges. A December 2012 McKinsey study shows that Europe has much lower levels of public telecoms investment and LTE penetration than in the U.S. and some other nations.  Similarly, a May 2013 report produced by Navigant for the GSMA also shows that capital investment, network speeds and consumer consumption is much higher (in MoU, GB and ARPU per month, corresponding to lower prices per minute, per text or per GB) in the U.S. than in Europe.  However; some influential positions are entrenched and resistant to facing these facts.

To my amazement, when I challenged the assertion of speaker Kai-Uwe Kühn, outgoing Chief Economist at DG Comp, in a panel session Q&A at the recent GCR Live Telecoms, Media and Technology conference in London, that U.S. mobile service prices were higher than those in Europe, he rejected out-of-hand my firm belief that amount of money paid per quantum consumed is the most applicable measure of price. As explained in one of my previous articles here, the alternative of presenting (relatively high U.S.) ARPUs as the primary measure for mobile service "prices," as favoured by Kühn and some other commentators, is nonsensically akin to regarding the price of petrol as being as dependent upon how many miles one drives each month as to how much one pays per gallon or per litre for the fuel. Relatively high volume consumption and total spending--stimulated by relatively low per quantum pricing--as exists in the U.S., is the sure sign of a competitive market.

The U.S. mobile sector is flourishing with widespread availability, substantial consumer choice and operator competition. This is due to, not despite, high market share concentration. According to the FCC, whereas 80.4 per cent of the US population have the choice of five or more mobile operators, market leaders AT&T (33 per cent) and Verizon Wireless (29 per cent) collectively commanded 62 per cent of facilities-based connections (as of Q2 2012) and 67 per cent of total operator revenues (Q1-Q2, 2012). In fact, leader market shares are rather higher in many locations due to the regional or urban focus of several competitors. In comparison, whereas French market leaders Orange (43 per cent) and SFR (35 per cent) had a total of 78 per cent of connections in mid-2012, in the UK, market leaders EE (35 per cent), following the merging of T-Mobile with Orange, and O2 (29 per cent) accounted for 64 per cent. However, until this 2010 merger, former market leaders Vodafone (24 per cent) and O2 (27 per cent) collectively commanded only 50 per cent market share. Merging Telefónica's O2 (17 per cent) with E-Plus (21 per cent) in Germany in 2013 would provide a market share of 38 per cent, versus 33 per cent for Deutsche Telekom and 29 per cent for Vodafone.

Investment incentives

One illegitimate concern is that if the number of competitors is reduced, prices will increase and the additional profits will be passed onto shareholders rather than invested in the business. Whereas U.S. market leaders Verizon Wireless and AT&T are clearly earning handsome returns these days with EBITDA margins usually in the mid-40s percentage range, in comparison to less than 30 percent by many European operators, capital expenditures on networks and investments in spectrum are also world-leading by these U.S. operators.

Mobile is still a major market growth opportunity and thus provides the incentive to invest where sufficient additional returns can be made. Mobile voice and text messaging predominated until very recently. Within just a few years following the introduction of the iPhone in 2007, mobile broadband data has begun to dominate mobile business models. But it is still relatively early days in this land-grab and market development.  There is still scope for enormous growth including potential for a thousand-fold increase in network traffic over a decade or so if market forces are allowed to prevail and with sufficient additional radio spectrum. This demand will be driven by steeply declining prices. With the example of strong financial performance by market leaders Verizon Wireless and AT&T, Japan's SoftBank has been motivated to invest in Sprint, including Clearwire, while pricing aggressively to increase relatively small market shares currently around 16 per cent and 3 per cent, respectively.

The network sharing that is favoured by various European authorities and other interests, but has been shunned by the leading U.S. operators, should certainly be allowed. However, it is unwise to impose such an approach or make it the only way to achieve sufficient economies of scale.  One of the main reasons that Verizon Wireless, AT&T and other U.S. operators are each investing so heavily in LTE developments is that network is a major differentiator.  That's competition!

Keith Mallinson is a leading industry expert, analyst and consultant. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007. WiseHarbor publishes an Extended Mobile Broadband Forecast. This includes network equipment, devices and carrier services to 2025. Further details are available at: Find WiseHarbor on Twitter @WiseHarbor.