Mallinson: Operators should cut opex, not capex

With introduction of the first mobile networks worldwide, mostly on a national monopoly or duopoly basis and with cheap spectrum in the 1980s and 1990s, profitability and payback on investments generally came very rapidly, regardless of country--large or small, rich or poor. The cellular service proposition and business model worked very well everywhere. Strong financial returns promoted significant reinvestment to extend network overage and increase capacity in the era of 1G and 2G.

Current industry conditions with intense competition, significant spectrum costs, price regulation and weak economic conditions dictate that operators must tighten their belts with cost saving measures. However, whereas it is indispensable to increase efficiencies, operators also need to increase capital expenditures to facilitate growth and satisfy escalating demand for mobile broadband with 3G and 4G networks.

Stellar financial performance was not sustainable
Financial performance was stunning for the first market entrants, such as Vodafone UK (originally a joint venture) with a service launch in 1985. In the year of its creation, Vodafone UK was operating at a loss of £10 million (around $16 million at current rates); five years later pretax profits exceeded £84 million. With stellar performance at such an early stage in the business lifecycle, shareholder expectations for long-standing mobile operators such as Vodafone, and including those owned by fixed network phone companies such as Orange and T-Mobile, were and have remained for solid profits and dividend payouts.

Very high financial performance levels were impossible to maintain. Over the decades, with new mobile licensees increasing competition and lowering prices, saturating markets for voice and text subscribers, regulated reductions on international roaming and call termination fees, and weak economic condition in the last few years, many operators in Europe and elsewhere have suffered from weakening profit margins. Inevitably, some shareholders have become very disappointed with dull financial performance of several operators in recent years.

Operators are trying to improve matters by significantly by cutting costs. Vodafone, for example, will soon complete a programme to reduce £2 billion in spending with savings included from network equipment, advertising and logistics. CEO Vittorio Colao is now looking for further cost-cutting.

In response to shareholder pressure and in keeping with Vodafone's position as a stock that significantly seeks to reward shareholders through income as well as capital appreciation, the company recently raised its interim dividend by 7 per cent to 3.05 pence and indicated it would also pay a special dividend of 4 pence out of the £2.8 billion payment it expects from its investment in Verizon Wireless. The latter's dividend payouts, controlled by 55 per cent shareholder Verizon, were suspended since 2005 due to Verizon Wireless' capital expenditure requirements in the United States.

You reap what you sow
As I indicated in a recent FierceWireless:Europe column, Verizon Wireless has been generating rather better returns than the Vodafone Group companies, including Vodafone UK. Verizon Wireless has been purposeful and focused with its investments; most significantly on spectrum acquisitions and network developments that have resulted in its global leadership with LTE.

To stay competitive and grow demand it is essential both to drive down costs and invest for the future. As I wrote in another of my recent FierceWireless:Europe columns, I am concerned there is insufficient commitment to investment, in the UK, for example. Here, network quality is deficient in comparison to many other nations where 3G as well as 2G coverage and capacity are more extensively deployed. There is every reason to pursue reduced equipment costs through joint purchasing arrangements. However, this is a time to be raising very depressed European capex to sales ratios that trail those in America and Japan by several percent.

Mobile communications is undergoing a major revolution with the transition from voice and text services to predominant usage of mobile broadband-based services. Consumer demand has the potential to continue escalating exponentially. This can be the means for profitable growth in mobile communications. It is expanding the market, for example, with web access, application downloads and streaming on powerful devices such as smartphones and tablets. It can offset the terminal decline in the voice and SMS services cash cows. Network improvements and efficiency-based transformations (eg, in Billing and Operations Support Systems) can only be achieved with significant capital investment.

Mobile broadband investment is good for services market growth: the additional "infrastructure" will also help stimulate the lacklustre economy in general.

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 is publishing an annual update to its Extended Mobile Broadband Forecast in May 2011. The new forecast will include network equipment, devices and carrier services to 2025. Further details are available at: Find WiseHarbor on Twitter @WiseWarbor.