The Indian Telecom Sector: Post a Decade of Reform
The telecom industry in India is undoubtedly the showpiece of reforms that have been initiated since 1991 in the country. From an almost monopoly till the early 1990s when mobile call rates were as high as Rs 16 per minute, the telecom space has evolved into a vibrant industry with at least half a dozen players and call rates as low as 1 paisa per second at the last count. However, in some ways the reforms have proved to be too successful. India currently has the lowest ARPUs across the world, low enough to raise questions on the sustainability of the current business model. Additionally, the recent auction for licenses that took place in 2007 has prompted a further spate of entry and a further round of price wars.
In this interview with Rajkumar Upadhyay, Deputy GM at BSNL and FPM student in management in corporate strategy and policy area at IIM Bangalore we try to figure out the reasons as to why the India telecom industry has evolved as one of the most competitive industries in the world, what is prompting recent entry and what the future developments in this area will be. A section has also been devoted to the lessons that can be drawn from this reform process and applied to other areas which badly need similar action.
The Indian Telecom Industry Today
What according to you is the reason that Indian telecom industry has evolved in a vastly different way from other mature markets both in terms of number of major players and also ARPUs?
RU: The difference in growth that you see is typical of the difference between a mature market in a developed country and a developing market like India. As to why the Indian market is growing faster than other developing countries, I think that has been both due to innovative private operators and the success of right government policy and fair regulation, apart from a large available population to be served. The key milestone in this respect was the NTP 99 (New Telecom Policy of 1999). That was the time when the government realized that a fixed license fee, which was based on exorbitant bids placed for licences, would not work and shifted to revenue share based license fee. At that time just to cover the license fee the operators would have had to generate Rs500 per customer per month. This was a significant drag on the growth in number of subscribers.
...innovative private operators and the success of right government policy and fair regulation, apart from a large available population to be served
On fast growth rate in the industry
The government also put in place the eco-system by creating good institutions like the TRAI and TDSAT which were necessary to attract private investments in the sector. As the duopoly structure stabilised, government issued third and fourth licenses promoting competition. The government then came up with Unified Access Service Licensing (UASL) in 2003, which made it possible for TATA and Reliance to provide mobile services through CDMA platform originally built for basic services, fuelling competition further. Having said that, the role played by the innovativeness of private operators in a highly competitive environment, cannot be underestimated. Given the large variations in income, they came up with plans like lifetime schemes, pay in installments etc
However have the falling ARPUs not made this industry unattractive and as some even fear unsustainable?
As to the falling ARPUs, that is a natural consequence of progressively adding customers from lower income segments, division of household telecommunication expenditures between separate cell connections by family members and fall in prices due to fierce competition. After the recent launch of services by new entrants, currently 10 to 11 operators in a circle are jostling with each other for the same pie.
RU:Yes falling ARPUs have definitely created a concern among many observers. For instance over last one year MOU (Minutes of Usage) per customer fell by around 10% but ARPUs has fallen by around 30%. Yet I do not think that the industry is unattractive as some observers are portraying it to be. Despite the 1p/second scheme, if you take into account the income through rentals or administrative charges as they call it for prepaid, the GSM operators are still earning close to 71 paise per outgoing MOU and their average ARPUs are around Rs 164 per customer per month. The large operators like Airtel are still clocking 40% EBDITA margin, even in latest (Dec-09) quarter.
The large operators like Airtel are still clocking 40% EBDITA margin, even in latest (Dec-09) quarter.
Now let us get into some hard numbers. The network cost per customer (Capex) is approximately $40. Assuming a 10 year life for network, the depreciation cost boils down to $4 per year. Now to this add cost of capital @ 12% p.a. and you have an additional expense of $5. Finally add operational expenses of approximately $17 per year. The total expense per year per customer is $26. Given ARPUs of Rs 164 per month this can be covered in approximately 6-7 months. Also with regard to the low ARPUS you need to realize that while in this industry the capital expenditure requirements are high and most of the costs are fixed costs. There is negligible marginal cost of adding a customer. Unlike in landline segment, access infrastructure (radio spectrum) for cellular is shared between customers. Customer requires and uses access infrastructure only when he/she plugs in to talk or transfer data, generating revenue either through outgoing call charges or incoming termination charges. Therefore, larger number of customer can be allocated/dimensioned for a single tower if the average traffic is lower, which is the case if you are adding low ARPU customers to the network.
There is some talk that the current business model that the industry is trying to follow is to keep rates for basic services low and to then use high value services like caller tuner to cross subsidize them. Do you think that is the case?
The problem you can argue is with the operators offering services on CDMA platform where the reported ARPUs are less than Rs 100 per month. However here also the problem in my opinion is of an inflated denominator due to a number of sleeping customers who were enrolled during various attractive invitation offers but neither have been active on the network nor are deleted from the system
RU: First of all, as we just discussed earlier this idea that a cross subsidization is needed is not right because telecom companies are not making a loss on the voice segment. Even otherwise the model that that people refer to is not viable simply if you look at the numbers. If we look at the revenue breakup of the telecom industry today then 87% of it is coming from voice. Of the remaining 13%, 4.7% is coming from SMSs where again because of the various schemes, on an average an Indian consumer is just sending 1 paid SMS per day. Balance 8.3% only comes from value added services (VAS) like GPRS, caller tunes, gaming and customer installations. So this cross-subsidization that you are talking about may not be the case as VAS is contributing only 5-6 % of the total revenue.
tejas@iimb: The Indian telecom industry has already witnessed a round of consolidation. Why are new players like Docomo, Uninor and MTS entering now in this already saturated market?
RU: Why not? If you see the total revenue of the industry it currently stands at Rs 1.3 Lakh crores. Which mean that even if we have 6-7 operators , each can be a 6-7 billion dollar revenue company , which is huge and this is when telecom penetration in India is only 46%. In rural areas it is only 18%. Many of these uncovered people currently do not have incomes to afford a phone but as the India growth story continues they will soon come into the fold. If you see there is a 5-6% growth in revenue quarter on quarter and a 25-30% growth customer take off. The demography due to large young population is promising and internet services are bound to increase. It is still an attractive market for new entrants. Current share of rural customers in the total subscriber base is only 30% as against 70% of urban customers. We may say the market is saturated when this ratio is reversed and rural accounts for 70% of the total customer base
tejas@iimb: Keeping aside the case of the arbitrageurs, why should the "serious" players believe that they can succeed better than the existing players who are already attuned to Indian market conditions?
Having said that, under-priced spectrum during allotting of licences in 2007 can also be one of the reasons why so many licenses were sought for. The true value of the license ultimately showed up in the higher market valuation of the companies that finally succeeded in getting the license. Once revised M & A policy guidelines are eased out consolidation will take place in the industry leaving sustainable number of around 6 to 7 players in the industry.
RU:While players in the market have so far competed on price, I don't think that that will be the case for long especially with the coming in of number portability. Instead, good quality service will emerge as the differentiator. As players in India have grown really fast the quality of the network has suffered in the race for increasing market share. So that is where these new players are looking to add value. Now one way to have quality is to have more spectrum but alternatively it is also about how efficiently you use the existing spectrum and optimize your network on regular basis. Since spectrum availability in future is going to be through auction, this will be an important factor. Some new operators feel that they have expertise in managing the spectrum more efficiently. Also they are seeing the churn rates in the market are around 6-7% which means, theoretically, that they can reverse the entire subscriber base of an incumbent in 12-14 months, something which will only get better with the introduction of number portability. Moreover, 3 G auctions are yet to happen and there will be no first mover advantage to existing players as all the successful bidders will get 3 G spectrum simultaneously.
tejas@iimb:One thing that is making entry easier for newer players is the fact that they have entered into agreements with players like Reliance and Bharti who have spun off their infrastructure arms. Why are existing players doing this? Isn't this detrimental to their strategic interests?
Further currently lots of restrictions have been placed for M&A in the sector , following the offload of under priced spectrum, which is preventing consolidation from happening in this industry. However, I think that some of these restrictions will get relaxed in the near future and we should see 6 to 7 operators emerging in each market. So the big international players may also look to benefit from that.
RU:The incumbents kept towers till the towers were strategic assets leading to competitive advantage. Today with independent tower companies entering the fray, this is no longer the case. If existing players do not share their infrastructure, these independent tower companies will provide the infrastructure to newer players for as little as Rs 30, 000 per month. Because newer players will be sharing infrastructure, they will be at a cost advantage. And this will be a huge disadvantage in a low ARPU market if you stick only to your infrastructure without any sharing. So I think the incumbents' move of sharing infrastructure makes a lot of business sense. In fact some of the tower companies like Indus towers are jointly owned by competing operators.
Future Developments Expected in the Industry
tejas@iimb: There are plans to launch 3G services in India later this year. Is the Indian consumer ready for 3G?
RU:3G technology will prove to be a game changer. The internet network on 2G was based on the GPRS/EDGE network but here the speed of data transfer was so slow that even e-mail application was slow to operate. No other good applications demanding higher data rates could be operated using this. Moreover, even operators had little incentive in making GPRS/EDGE network ubiquitous. This is because in 2G towers you have to reserve some channels for GPRS/EDGE separately and those channels then cannot be used for voice. Given the exploding voice markets and limited use of data services, operators were reluctant to reserve channels for data applications in all the areas. With 3G both these problems go away. You get much higher speeds where you could run various applications like video calls, mobile TV, gaming etc.
The 3 G network is like a highway which the operators will provide and I feel entrepreneurs will come forward to create the vehicles in the form of content to run over them
Currently only PSUs namely BSNL and MTNL have been provided 3G spectrum and 3G is already launched in around 400 cities. However, we do not see the impact of the technology because PSUs are lagging in marketing the benefits of the new technology to customers. Another major issue currently is high cost of 3G handsets which is preventing a 2G customer to migrate to 3G. Once 3G is allotted to multiple private operators after auction, enough competition along with entrepreneurial innovation will bring down the cost. This will result in higher number of subscriptions bringing down the cost of handset as well. The 3 G network is like a highway which the operators will provide and I feel entrepreneurs will come forward to create the vehicles in the form of content to run over them. The potential of this is enormous if you notice that there are only 14 million internet users in the country compared to 500 million mobile users. The spread of the net has been hampered both due the lack of availability of high speed broadband internet and also the restrictive cost of personal computers. This will change once people can access high speed internet along with applications on their mobile phones.
tejas@iimb:Given that 3G will be a game changer as you say how would it affect the dynamics between the incumbents and new entrants?
RU:Well it has both advantages and disadvantages for the incumbent players. The advantages include that they have a ready customer base which they can upgrade to the 3G network. The disadvantage is that they have already sunk costs on 2G network which they will be required to upgrade to 3G or 2G will have to work alongside 3G. This will add complexity and add to cost. New players in 3G can start with clean slate going straightaway for 3G network. With falling network prices this could provide cost advantage to fresh entrants in 3G.
Given the overcrowded nature of the market a number of players like Aircel and Tata Indicom have started focusing exclusively on data services. How lucrative is this market compared to voice?
RU:As I have already said that compared to voice all other segments including data are very small in India. TATA have been providing cellular services through their CDMA platform. Recently they have also added GSM platform to provide cellular services through TATA DOCOMO brand. Since GSM is the preferred choice for customers, I guess, a huge capacity remains idle on CDMA platform. To utilize the available capacity they offer 1X and EVDO data services through CDMA. As regards Aircel, to become pan India player, they have launched their services as new entrant in many circles. Due to the clutter created in the market they want to position themselves as a differentiator.
Currently, value added services including data account just 5-6 % of revenue which is quite a low figure compared to developed markets where it is above 20%. Once 3G comes in to the picture we can expect this segment to become bigger and play a very important role.
tejas@iimb: Why according to you have telecom reforms proven to be far more successful, than reforms in other areas?
RU:I think the lesson that has been learnt from the deregulation of telecom is that it is very necessary to create a whole ecosystem around the liberalized industry. Government should not hesitate in policy correction whenever needed in the evolving market. In the case of telecom, the newly liberalized industry was first stabilized by starting with a duopoly structure and then introducing more competition over time. A regulator, TRAI, was introduced to ensure fair play, competition and stability. The TDSAT was setup for managing disputes. Universal Service Obligation Fund (USOF) was created to fund the unviable operations in rural areas. Then in 1999, the government stepped in to help a collapsing industry by introducing the New Telecom Policy-99. The government displayed its readiness for a mid-course correction. The CPP (calling party pays) and the Unified Access Service Licence (UASL) which came in 2003 were two other important pieces of policy intervention which not only fuelled growth but also brought lot of litigations pending in the court to an end. In fact if you really see the industry took off after 2003 once prices crashed. Up to 2002 there were hardly a few million subscribers. The story of telecom in India also in a way tells us something about the appropriate role of the government vis-a-vis the private players. The role of the government as facilitator is very important. The government needs to be responsible not only for promoting competition but also ensuring overall health of the industry so that consumer welfare is maximized. With well functioning ecosystem as given, innovative private players will take care of the rest.
The telecom reforms in India have definitely been a crowning success driven as they were by rightly directed policies which were fully supported complemented by the innovative private players. One fear that in however often expressed is regarding the low ARPUs prevailing in the industry which make it unsustainable. However this interview challenges the claim presenting hard numbers to support its case. New international players are today entering the Indian market and while they may have not seen immediate success, their strategy seems to be one of providing better quality which will definitely find takers especially after the coming in of number portability. Finally 3G is a revolution that is waiting to happen on the Indian telecom scene and holds the potential of bringing the promise of internet and host of applications to millions in India.
Rajkumar Upadhyay is an officer of Indian Telecomunication Service (ITS) of government of India. He is working as deputy GM with BSNL on deputation. Currently he is pursuing the Fellowship Programme in Management (Doctorate) in Corporate Strategy and Policy at IIM Bangalore. An alumnus of IIT Roorkee and IIM Bangalore , Mr Upadhyay in his 22 year career has variously worked with the Defence Research and Development Organisation (DRDO), Department of Telecommunication (DoT) and finally at BSNL. In his current role he has handled various responsibilities for the Karnataka circle including IT, Business Development, Operations and Marketing. He has been a recipient of many honours including the J C Bose Award by Ministry of Defence in 1987; the National e-Governance award 2007 by Department of Information Technology and Department of Personnel and Administrative Reforms, Govt. of India; the CIO 100 award by International Data Group (IDG), 2007 and also Prof Deepak C. Jain award by IIMB Management Review (IMR) , 2009.