Just before the end of 2012, in association with Ericsson, we published the Telco Innovation Toolbox paper. It introduces ten economics and strategy frameworks that will help operators to accelerate their “digital” strategies, make the right innovation investments and avoid costly mistakes.
The ideas from the paper will be posted on VisionMobile blog in a series of blogs posts. Today we are publishing two opening chapters and the rest of the chapters will follow weekly. The list of chapters can be found here.
The full paper in PDF format can be downloaded here.
A new basis of competition
There are no silver-bullet solutions to telco disruption. Rather than focusing on quick fixes, this paper introduces a new way to think about telco innovation, with the aim of helping operators to make the right choices in their innovation investments.
Let’s start with the basic question: What is the nature of the telecom transformation? Is it just about new competitors that need to be fended off? Or are there more fundamental forces at play? We think the latter.
Telcos are being disrupted because the basis of competition in mobile has fundamentally changed. It has changed from “reliability and scale of networks” to “choice and flexibility of services” driven by the transition from “mobile telephony” to “mobile computing”. The change in the basis of competition is fundamental and irreversible.
Enabled by smartphone platforms and free from go-to-market bottlenecks imposed by telcos, hundreds of thousands of app developers are now able to compete for user attention and wallet share. Today, universal coverage, no dropped calls, voice quality and high-speed data connectivity are almost taken for granted in most mature markets. For more and more users, the availability of apps is becoming a primary consideration when selecting the handset. Signing up for a telco plan is increasingly viewed as a necessary cost for services that only need to be good enough to support the device. It’s like picking the car of our liking, knowing that once in a while we will have to pay at the gas station.
This brings us to the conundrum the telecom industry is facing today. Providing undifferentiated voice, text and data services to smartphone users leads to a competition on price and diminishing margins. At the same time, staying in business requires that telcos keep up with ever-growing demand for data and continued investments in building wireless capacity. Investments in networks are still necessary, but they alone are no longer sufficient for profitable growth. What’s next?
Harvard Business School professor Clayton Christensen recently said: “I think, as a general rule, most of us are in markets that are booming. They are not in decline. Even the newspaper business is in a growth industry. It’s not in decline. It’s just their way of thinking about the industry that is in decline.”
Telecom industry too can greatly benefit from looking at familiar challenges from a new perspective. Telecom is a booming industry with ever-growing demand for mobile data and rising numbers of subscribers. But the basis of competition in mobile has changed putting pressure on legacy telecom business models. Wireless networks alone can no longer guarantee profitable growth for telecom operators.
Competing head-on with asymmetric business models of OTT players won’t help either. Instead, seizing the full potential of this booming industry means leveraging mobile digital ecosystems to create meaningful differentiation and lock-in to telco services, as well as incremental revenues. This requires an understanding of ecosystem economics, development of new organisational capabilities and resetting the KPIs for “digital” initiatives.
The economic and strategy tools introduced here will guide telcos in their choices on what innovation initiatives they should pursue and how to execute on their choices in fundamentally new market conditions.
We describe ecosystem economics in the context of telco business in chapters 1 to 4, discuss the impact of traditional financial tools and the need for new innovation processes and KPI in chapters 5 and 6, and finally suggest how to leverage ecosystems to the benefit of the telco business in chapters 7 to 10.
Chapter 1: The superiority of ecosystem economics
What gives ecosystems their superior growth economics, and what can telcos do about it?
Telcos used to be the center of gravity in the mobile value chain, but no longer. In the new basis of competition, ecosystems like Apple iOS or Google Android have become the focal point for service creation and distribution, ironically with help from telcos in the form of device subsidies. In the space of five years, ecosystems have mushroomed to take control of what took telcos nearly 30 years to build.
What gives ecosystems their superior growth economics, and what can telcos do about it? Apple, Google, Facebook, Amazon and many other Internet players are in the center of value networks connecting the core business of the platform owner (e.g., hardware sales for Apple) with an array of complements, such as developers, media, brands and telcos. As such, they are carefully designed to drive the core business of the ecosystem owner. Complements are products that are consumed with and add value to the core product of the ecosystem owner. Ecosystem economics describe how the core product (e.g., iDevices or Google ads) becomes more and more valuable, as the numbers of developers and users around it grow.
Ecosystem economics are driven by network effects and lock-in. iPhone apps attract Apple users, who in turn attract more developers, who make more apps, which attract even more users, and so on. This network effect between developers and users drives the explosive growth of the iOS platform. Lock-in creates natural “walled gardens,” as users develop habits around apps, while developers are locked-in by high switching costs created by their investments into the platform.
Ecosystem economics are often misperceived as simple two-sided business models, where the telco needs to profit not only from users, but also from developers. This couldn’t be further from the truth. Developers, much like any complement, drive sales of the core product, and as such need to be viewed as partners, not as a source of direct profit.
For example, Apple runs a very successful consumer electronics business. About 80% of Apple’s profits in Q3 2012 derived from products running its iOS operating system. Flexibility and choice underpin the iOS value proposition — “There is an app for that,” in the words of Apple advertising. Today, the company lists more than 700,000 apps in the Apple App Store.
Given that the app economy has become a multi-billion dollar business, it is tempting to believe that apps are now a lucrative multi-billion dollar content business for Apple. In reality, the company runs the App Store at just above break-even, according to Apple CFO Peter Oppenheimer and CEO Tim Cook.
The App Store revenue share is an elegant solution to recover the high costs of running a thriving developer ecosystem. Given 30% revenue and the fact that Apple has paid developers $5.5B dollars, these costs amount to over $2.3B over the lifetime of the Apple App Store (as of July 2012).
App Store revenues are used by Apple to subsidise testing and hosting of hundreds thousands of free apps and billions of free app downloads — Over 80% of app downloads are free (including Facebook, Instagram, and many other apps). In other words, the App Store is not designed to generate profits from content sales, but rather is a key enabler for the app economy that produces critically important complements driving the profits of the wildly successful iPhone and iPad devices.
The Google Android ecosystem is built on very similar principles. It treats developers as partners who create vitally important complements. Google’s core business is online ads, and the Android ecosystem is optimised to drive eyeballs to Google properties and deepen its consumer intelligence. As opposed to Apple, Google prioritises user reach over user experience, and makes Android freely available to the broadest range of handsets.
In most developed mobile markets, operators are playing a supporting role within the iOS and Android ecosystems. Operators take on the financial burden of device subsidies, which reduces the cost of acquiring the smartphone users — all in exchange for upselling users into higher-ARPU data plans.
While telcos finance the expansion of smartphones, Apple and Google are taking over the customer “ownership” and creating strong user lock-in that surpasses that of operator brands. Ecosystems are much better at delivering choice and flexibility, the new basis of competition. This is due to their global scale and vast developer reach. Despite these adverse effects to the telco business, there is little telcos can do to roll back the clock. The ecosystem genie is out of the bottle.
As iOS and Android have reached critical mass, and established well-entrenched market positions, operators need to look for ways to build unique user value atop the platforms rather than competing with OTT players. Such “over-the-platform” innovation can indeed create new revenue streams, but even more importantly it offers opportunity to create unique differentiation relative to local competitors and avoid competition on price. Opportunities for such differentiation exist in the areas where platforms are inherently weak, or have little motivation to compete. These include local presence, user targeting and reach, content recommendations and vertical B2B solutions.
Over the longer term, telcos can look for ways to build parallel ecosystems, using pages from the ecosystem economics textbook. An example is M2M. It holds the potential to create a vibrant ecosystem of users and solution providers, thereby establishing strong network effects and lock-in. Telcos can become the central force in this emerging ecosystem if they learn to engineer the ecosystems to their advantage. By looking at M2M through the lens of ecosystem economics, operators will see opportunities that are much bigger than just selling modems and data connections.
Key questions telcos need to ask when evaluating innovation investments
- Does your initiative compete with the network effects of an established ecosystem or is it leveraging those effects?
- Does your project aim to add value where platforms are weak or have no motivation to compete?
- Does your project promise to create a parallel ecosystem where telcos will play the dominant role?
Chapter 2 “Ecosystem Engineering” and Chapter 3 “The modular telco” will follow next week. If you can’t wait until then, you can just download the full report in pdf format here
As usual, we are looking forward to your feedback! Please leave a comment below or send us an email to strategy /at/ visionmobile dot com.