reports from eb center 6 15804

Competition in Spain'sTelecommunications Sector

Reports fromebcenter

ESTUDIO TI inglés.qxd 15/6/05 16:18 Página 1

Competition in Spain's Telecommunications Sector

Authors: Prof. Josep Valor, Information Systems, IESE Business SchoolProf. Sandra Sieber, Information Systems, IESE Business School

Research assistants: Guillermo ArmeliniPascal Trauffler

Editor: Larisa Tatge

www.ebcenter.org

© 2005. e-business Center PricewaterhoseCoopers and IESE. All rights reserved.


Reports fromebcenter

Competition in Spain's Telecommunications Sector


Authors of the Study:

Prof. Josep Valor, Information Systems, IESE Business SchoolProf. Sandra Sieber, Information Systems, IESE Business School


Contents

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71.1. The Evolution of Telecommunications in Europe . . . . . . . . . . . . . . . .71.2. The Concept of Online Value Network . . . . . . . . . . . . . . . . . . . . . . . .9

2. Telecommunication Services Supply . . . . . . . . . . . . . . . . . . . . . . . . . .112.1. The Fixed Line Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11

2.1.1. History and Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .112.1.2. The Fixed Line Business Value Chain . . . . . . . . . . . . . . . . . . . .172.1.3. New Opportunities in the Fixed Line Business – ADSL

Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182.2. The Mobile Phone Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

2.2.1. Evolution and Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .192.2.2. The Value Chain for Mobile Phone Operators . . . . . . . . . . . . . .28

2.3. Fiber Optic Cable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .292.3.1. The Development of Cable . . . . . . . . . . . . . . . . . . . . . . . . . . . .292.3.2. The Online Value Network for Fiber Optic Cable . . . . . . . . . . .32

2.4. Emerging Broadband Technologies – Digital TV, Voice over IP, Satellite and Power Line Communication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

2.4.1. Digital TV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .332.4.2. Voice over IP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .362.4.3. Satellite . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .372.4.4. Power Line Communication . . . . . . . . . . . . . . . . . . . . . . . . . . .39

2.5. The Telecommunication Online Value Network – Overview . . . . . . .41

3. Competitive Situation in Spain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .423.1. Full Service Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .423.2. Multiservice Operators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .443.3. Specialized Operators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

3.3.1. Specialist in a Certain Market . . . . . . . . . . . . . . . . . . . . . . . . . .453.3.2. Niche Player . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

3.4. Selected Financials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .473.4.1. Wireline Operators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .483.4.2. Mobile Telephony . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53



4. Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .584.1. Spanish Household Spending in Telecommunication Services . . . .584.2. Estimate of New Product Consumption and Consumer Reaction

to Product Bundling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62

5. Industry Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .645.1. Content, Technology and User Expectation . . . . . . . . . . . . . . . . . . .64

5.1.1. Fit Between Content and Technology . . . . . . . . . . . . . . . . . . . .655.1.2. User’s Expectations and Content-Technology Mix . . . . . . . . . .66

5.2. Possible Future Scenario in Fixed Line Business . . . . . . . . . . . . . . .685.2.1. Substitution Between Fixed Line and Mobile . . . . . . . . . . . . . .685.2.2. Emergence of Voice over IP . . . . . . . . . . . . . . . . . . . . . . . . . . .705.2.3. Consequences of Substitution and VoIP . . . . . . . . . . . . . . . . .71

5.3. Broadband Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .725.3.1. What Can be Done to Stimulate Demand for Broadband? . . .745.3.2. Broadband Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77

5.4. Mobile Telephones . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .785.4.1. Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78

5.4.1.1. Virtual Network Mobile Phone Operators . . . . . . . . . .785.4.1.2. Trend Toward Post-Pay Contracts . . . . . . . . . . . . . . . .785.4.1.3. Clients’ Willingness to Pay for Mobile Phone Content 795.4.1.4. Content . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79

5.4.2. Current Competitive Dynamics . . . . . . . . . . . . . . . . . . . . . . . . .805.4.3. UMTS Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .815.4.4. Fourth Generation Mobile Telephony (4G) – What does the Future

Hold? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .835.4.5. Co-existence of Mobile and Landline Technology . . . . . . . . . .85

5.5. Major Operators’ Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .855.5.1. Telefónica’s New Strategic Orientation . . . . . . . . . . . . . . . . . . .855.5.2. Auna . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .885.5.3. ONO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .895.5.4. Vodafone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90

5.6. The Impact of Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .91

6. Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .946.1. OECD Survey Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .946.2. Sources for Figure 10 - ARPU (H1 2004) of Selected European

Mobile Phone Operators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .976.3. Selected Financials of Major Players in the Spanish Telecom

Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98



e-business Center PricewaterhouseCoopers & IESE 7


1. Introduction

1.1. The Evolution of Telecommunications in Europe

During the last 15 years, the European telecommunication industry has expe-rienced a deep and continuous transformation. The most significant triggersof transformation and corporate restructuring have been the liberalization andprivatization of formerly government-controlled activities and the arrival ofvarious generations of technological innovations such as mobile telephonyand data transmission, which led to a continuing globalization of businessactivities within the sector.

Traditionally the telecom sector had developed within the institutional frame-work of the nation-state. Conventional wisdom considered the supply of com-munication services as a natural monopoly, based on economies of scale(Fransman, 2001: 112). Hence, in most countries existed one incumbent servi-ce provider. In Germany, for instance, the public telecommunication operator(PTO) was Deutsche Telekom, British Telecom held the monopoly in the UK,NTT in Japan, and AT&T in the United States. These national carriers providedvoice, fax and later on some other enhanced services to the final customer. Ascan be seen in Figure 1, the value chain in these days was short and straight-forward: contents offered were scarce, there was only one network technologyand only one monopolistic player who produced content and assured deliveryof the latter to the end customer. In this value chain there was no room for addi-tional players or alternative value propositions. The absence of competitorsallowed the single operator to capture all the value along the chain.

Figure 1 - Telecommunication Value Chain Before the Liberalization of the Market

Source: The Authors.

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During the ‘90s a deep technological change in information and communica-tion technologies (ICT) took place. Increasingly, analog signals, be it voice,data or image, were transformed into digital signals and thereby converged intheir format (digital convergence). Hence telecommunication networks wererequired to carry more and more digital signals, Internet achieved critical massin 1997 and its penetration in households and companies has continued gro-wing. Additionally the deployment of broadband networks, both in local loopand backbone, enables the transmission of huge amounts of data usingInternet-based technologies. Finally wireless technologies, mainly cellularphones, have rapidly been adopted by the public, reaching penetration ratesof over 80% in Europe, Japan and the USA.

In the context described above, in 1987, the European Union (EU) started agradual process of liberalization, establishing the principles and conditions ofthe competition in the telecommunication sector in a document called “Thegreen book”. The aim was the transition from a situation in which a monopo-list competed for the market, maintaining high prices and limited volume,towards a market of free competition, within which the participants wouldcompete in the market, creating a dynamic of low prices and high volumes.After setting up the rules for a competitive market, the European commissioncreated an organization whose purpose is to control the liberalization processand to interact with the national regulators whose mission is to implement theregulatory framework in their respective countries.

The telecommunication business is one which tends to create natural monopo-lies subject to network externalities, which is why the EU deemed necessary thepresence of a regulator in order to create a competitive market. In effect, in mostEuropean countries, a single dominant telecom operator held a monopoly in thesector. Liberalizing the sector without a regulatory framework would probablyhave prevented the entry of new players into the market due to the huge advan-tage the incumbent has with its existing and fully depreciated telephone network.

The role of the regulator is not easy; it has to determine the “correct” pricesfor end customer and interconnection services, the level of investment requi-red for the new entrants (in order to prevent the latter from taking advantageof the incumbents, existing network without investing themselves in infras-tructure). Moreover the regulator needs to distinguish between innovative andanti-competitive action and act in consequence.

8 e-business Center PricewaterhouseCoopers & IESE





The process of liberalization in Europe has been a success from different pers-pectives. First, prices have considerably gone down especially for long distanceand regional calls. Another point in favor of this process has been the growingnumber of new operators with focuses on different markets (some of them aregeneralist operators while others are niche players). In the end, although gene-rally regulation is considered an impediment to free market competition, it provedto be a beneficial “necessary evil” for the development of the telecom sector.

In Spain the process of liberalization of the telecommunication sector began in1996 when the government created the Comisión del Mercado de Telecomuni-caciones (CMT), a public body whose main purposes are to grant operating licen-ces to telecommunication service providers, to control the reasonable develop-ment of the market, to guarantee compliance with network interconnection rulesand to watch prices of services and other features of the telecom sector.

In 1998 the congress of deputies approved the general telecommunication lawby which telecommunication services are not public services but general purpo-se services. With this new categorization the telecommunication services can beoffered in a competitive market.

1.2. The Concept of Online Value Network

The online value network1 is the set of industries creating the connection betwe-en the customer and the products or services in an interconnected, information-based economy (See Figure 2). It is the value network in which we represent thecontent provider on the left and the end customer on the right.

Figure 2 – The Online Value Network


1 Valor, Josep, “The Online Value System”, IESE Technnical Note SIN-37-E, March 2001.

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The change from a monopolistic market to a multi-player market with high tech-nological innovation had a double impact on the telecommunications valuechain.

First, there is more than one value chain: due to competing technologies andmerging contents, different value chains get into competition. The same content,e.g. voice, can be transmitted to the customer via the fixed line telephone valuechain or the mobile phone value chain. On the other hand, digitalization allowsdifferent contents to take the same value chain, while earlier, each content hadits own dedicated route. Formerly voice and TV were distributed through differentways, but thanks to digitalization, the same fiber optic cable operator can, atsome point of the value chain, channel different contents. Hence the former valuechain has become a value network.

But at the same time, the value network becomes longer. A good example for thisis the popularization of the Internet. While in the basic voice business at thebeginning of the 90s there was only the telephone operator between the contentand the end customer, in the Internet access business the network is made up ofa content provider, the web hosting provider, the network provider (e.g. a classictelephone operator), the Internet access provider, the suppliers of hard- and soft-ware, the end customer.

Today, the telephone operator is only one link in the value network and thus can-not capture the whole value created along the value network. At the same time,due to free market competition, at the level of each link, numerous firms compe-te for the favor of the customer.

The value chains have become longer and numerous, partly interchangeable andintertwined, which poses the question to each of the players in the telecom busi-ness where to position themselves strategically on this value network. We willnow proceed to study the businesses competing in this network.




2. Telecommunication Services Supply

For each of the existing carrier technologies currently in use in the telecomindustry, i.e. fixed telephony, mobile telephony and cable, we will briefly des-cribe the market situation, then analyze its position within the online value net-work. We will then try to identify the strategic implications for the players in thetelecom market.

2.1. The Fixed Line Business

2.1.1. History and MarketBefore 1996, the only company authorized to provide fixed line telephony inSpain was Telefónica de España (TdE). At that time 80% of its capital was inprivate hands. In June 1996 the government decided to increase competitionin the sector by creating a new player, Retevisión2, a public entity. After settingup this duopoly, the following step was to tender the assets of both compa-nies. In January 1997 the government sold its remaining 20.9% stake in TdEand in July of that same year it awarded 70% of Retevisión to a consortiummade up of Endesa, Union Fenosa and Telecom Italia. At the end of 1998, theremaining 30% was sold to these same three major shareholders and toBSCH which bought 5.5%3. In consequence, from December 1998 on, thefixed line telecom market became one of free competition with two private pla-yers subject to regulation.

Table 1 shows that from 1998 on, year in which the liberalization process wasinitiated, the evolution of fixed line telecommunications has been beneficial tothe user. Traffic minutes in long distance, international and mobile phone callshave risen substantially as a consequence of the price reduction. In all casesexcept calls to mobiles, the drop in price per minute is so huge that the incre-ased volume does not compensate it; revenue has dropped as a consequen-ce. Only the traffic in calls to mobiles has soared so tremendously that theoverall turnover increased in spite of the unit price reduction.

2 Retevisión operated wireline telephony and is shareholder (40%) of Retevisión móvil which operates under

the brand name Amena from January 1999 on.

3 In 2000 Retevisión becomes part of a holding company called AUNA under which Endesa, Union Fenosa,

TI and later BSCH regroup their telecom participations. In December 2001, TI sells its 27% in AUNA to

BSCH.




Table 1 – Changes in Prices and Traffic 1997-2003

DESCRIPTION Local Long distance International Mobile

Change in price per minute 2003-1997 -16% -75% -70% -45%

Change in turnover 2003-1997 -14% -64% -6% 112%

Change in traffic minute 2003-1997 2% 44% 212% 287%

Source: percentages calculated from CMT data.

The price reduction and the rise in traffic were accompanied by a progressiveloss of market share of the incumbent. This phenomenon was especially mar-ked in international calls, calls towards mobile phones and in inter-provincialcalls. (See Table 2).

Table 2 – Telefónica’s Market Share

Evolution of Telefónica’s market share (Revenue)

1998 1999 2000 2001 2002 2003

International calls 94.2 89.1 86.2 82.8 64.9 64.8

Calls towards mobiles 99.9 90.7 86.7 79.4 74.9 70.1

Inter-provincial calls 93.5 87.1 83.4 80.8 75.2 74.9

Provincial calls 99.6 96.0 90.6 84.3 79.1 76.9

Local 100.0 99.8 95.8 88.5 81.7 80.3

- Voice - - 98.9 90.5 82.5 77.2

- Internet - - 86.7 83.8 79.8 90.4

Total (Traffic) 95.2 92.9 89.7 84.3 77.2 74.8

Total (Revenue) 97.8 94.3 91.5 87.6 83.0 81.3

Source: CMT.

The loss of market share of the incumbent operator is observable in all dere-gulated markets. Based on international comparisons, we believe that thistrend can continue for a few years in Spain. Looking at the UK, a market whichwas one of the first in Europe to be deregulated, one notices a loss of marketshare of British Telecom. At the same time, despite this trend, the incumbentoperator maintains an overall market share of over 60% (See Figure 3). Similartrends can be observed in Germany4.

4 Source: RegTP annual report.




Figure 3 - UK Fixed Line Telecom Market in Volume – Market Shares of Main Players

Source: OFCOM.

A finer analysis reveals that the market share split depends very much on thetype of call. In local calls, BT maintains a very dominant share of 71.7% (involume) while the share erosion is strongest in international calls where BTretains only 30.3% (in volume).

100%

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1997/1998 1998/1999 1999/2000 2000/2001 2001/2002

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Table 3 - Market Shares in Local Calls, Volume and Revenue

Local calls (volume) BT Kingston Cable & Wireless NTL & Telewest Others

1997/98 83.0 1.0 6.5 7.3 2.2

2001/02 71.7 1.2 4.4 15.0 7.7

Local calls (revenue) BT Kingston Cable & Wireless NTL & Telewest Others

1997/98 85.3 0.4 5.9 7.0 1.4

2001/02 71.2 0.5 2.9 18.1 7.3

Source: OFCOM.

Although BT has lost most of its volume market share in international calls, theloss of market share in terms of revenue has been less. This indicates that BT’scompetitors have gained this market share at the cost of a fierce competition onprice. Also noteworthy is that none of BT’s three big competitors have gained asignificant share in the international calls; all other competitors together hold 55%of the volume but only 40.6% of the revenues. This can be explained by the highnumber of competitors in this segment and the variety of the offer (prepaid cards,call-by-call access, pre-selection, direct access, long-distance call shops).

Table 4 - Market Shares in International Calls, Volume and Revenue

International calls (revenue) BT Kingston Cable & WirelessNTL & Telewest Others

1997/98 49.30 0.20 17.70 3.40 29.40

2001/02 30.30 0.20 7.80 6.80 55.00

International calls (revenue) BT Kingston Cable & WirelessNTL & Telewest Others

1997/98 53.9 0.3 16.2 4.5 25.1

2001/02 45.7 0.3 5.4 8.0 40.6

Source: OFCOM.

In Germany, price erosion on international calls between 1998 and January2004 has been up to 96% for certain destinations. Deutsche Telekom’s res-ponse to the generalized price drop has been to offer flat rates, e.g. for natio-nal calls, thereby increasing the fixed part of the telephone bill. Consumersadopted these pricing schemes willingly. In Spain also, the industry has optedfor progressive increases in the monthly fixed fee to counteract the loss of reve-nue from falling minute prices (See Figure 4).




Figure 4 – Spanish Telecom Sector: Loss of Traffic Induced Revenue and Increase of

the Fixed Charges.

Source: CMT.

Nevertheless, this first stage of the liberalization process, which brought bene-fits to the consumer and loss of market share to the incumbent, has beenachieved at the cost of heavy investment efforts on behalf of the new entrants.It proved to be difficult for the latter to enter the market, investing hugeamounts of money, and some of them still do not see positive returns. As canbe seen in Table 5, Telefónica’s main competitors have invested tremendousamounts in fixed assets in the period between 1998 and 2003, but with theexception of a couple of operators, most of them still have not broken even.

7,000

6,000

5,000

4,000

3,000

2,000

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0

1999 2000 2001 2002 2003

BT

6,358.6

5,683.6

5,547.056,050.84

5,086.73

1,646.42,189.4 2,269.47 2,583.94

2,780.38

Monthly fixed charges Traffic




Table 5 – EBIDTDA of Selected Wireline Operators

EBIDTA

(millions of euros) 1998 1999 2000 2001 2002 2003 Total 1989-2003 M Share 2003

Jazztel -6.1 -135.7 -163.3 -90.6 -40.5 -6.9 -443.0 n/a

Auna Telecom n/a n/a n/a -100.0 -40.0 124.0 -16.0 8.9%

Uni2 n/a -98.3 -95.5 -81.5 8.0 n/a -267.2 4.1%

Ono -9.0 -30.2 -55.8 -57.4 15.8 102.1 -34.5 2.1%

BT Ignite -17.1 -29.5 -65.5 -54.3 -31.5 n/a -197.8 n/a

Euskaltel 0..0 -23.1 -37.3 0.9 5.7 n/a -53.9 n/a

Colt Telecom -2.4 -5.6 0 5.6 14.8 19 31.4 n/a

Comunitel n/a 0.1 -7.2 -3.1 13.0 5.7 8.6 1.3%

Telefónica 0,0 4,496.8 4,453.9 4,485.3 4,496.7 4,534.0 22,466.7 77.2%

Source: CMT.

For the telecom operators the first stage of the liberalization in the fixed linebusiness has been characterized by: 1) Heavy investments in the rollout ofown networks (first in backbones, then in the local loop); 2) Need to achievecritical mass in terms of number of customers and revenues to finance growthin an environment favorable to the incumbent; 3) Competition mainly on pricedue to lack of differentiation of the product (the indirect access is transparentto the customer).

For the end customer the liberalization of the fixed line telecom marketbrought along more than just price decay: 1) Improved service, e.g. it takesless time to get a line installed at home; 2) Choice of operator with the optionto go with a niche player providing custom-made solutions for corporate tele-com needs; 3) Faster access to latest technologies at reasonable prices.




2.1.2. The Fixed Line Business Value Chain

Figure 5 - The Fixed Line Value Chain


Traditionally telecom carriers transported only voice over their networks anddominated the whole value chain. The telecom operator provided the networkinfrastructure, the local loop and sometimes the hardware (the actual tele-phone set).

As the content changes from analog signal to digital signal, all kind of data canbe carried over the telephone network. This implies that to the left of the valuechain, there is an increased number of content providers depending on whatkind of data need to be carried over the network. On the other side, closer tothe customer, different hardware is needed (decoders, computers) and soft-ware plays an increasingly important role. The network in between the contentprovider and the customer only needs to be reliable and fast as the amount ofdata is ever growing, but it is completely transparent to the customer – it actsas transport only. The customer is unaware of the technology used. The net-

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work that carries the information becomes a commodity and is interchangea-ble with other technologies (cable, wireless).

The implication for the telecom carrier is that in its traditional business its valueadded is perceived as low and competition will mainly take place on price.

In order to keep creating value and to capture it, the telecom provider has toposition itself further on the side of the content provider or closer to the cus-tomer. In the first case, the telecom carrier enters the business of providingcontent (e.g. voicemail), portal services (terra.es) or application service provi-ding. Moving closer to the customer means providing hardware equipment(modems), software or services (e.g. 1004 by Telefónica).

2.1.3. New Opportunities in the Fixed Line Business – ADSL Technology

Figure 6 – The ADSL Value Chain


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POTS5 offered by telecom carriers are analog voice signal transmitted over apair of copper wires. This technology, when used to carry digital signals, islimited to 64 Kbps or less. It is called narrowband and is inadequate for theincreasing amount of data exchanged nowadays. Since 2000, Telefónicaoffers ADSL technology (Asymmetric Digital Subscriber Line) to its customers.ADSL allows more data to be sent over the same existing copper telephoneline, increasing its capacity to up to 9Mbps when receiving data and 640Kbpswhen sending data. ADSL thus increases the capacity of the existing telepho-ne network without having to replace it, only by putting a piece of hardwareand software at both ends of the wire.

The telecom carrier improves its value proposition to the customer by offeringbroadband services at an accessible price and reasonable cost. Moreover,ADSL technology allows the use of voice and Internet access at the sametime. But again, to date, the service has a few drawbacks: 1) It does not addvalue in terms of content and remains a commodity; 2) Its speed is limited to640 Kbps upstream versus 9Mbps downstream (hence the denominationAsymmetric DSL); 3) It is technologically inferior to its direct rival, fiber opticcable, which can carry data at speeds of 100 Mbps.

In order to overcome these shortcomings, some ADSL providers are currentlytrying to integrate content into their offer, the latest trend going towards TVover ADSL and video on demand.

2.2. The Mobile Phone Market

2.2.1. Evolution and Market

The picture in the mobile phone market in Spain and Europe is a different onefrom the situation in the land line business. Before the mobile phone becameaccessible to the masses (2nd generation mobiles with GSM technology), thelegal framework and standards (GSM) for the development of a competitivemobile phone market had been set. As a consequence it was unthinkable, atleast at the beginning, to see a monopolistic situation arising as was the casein the fixed phone telecommunications.



5 POTS: plain old telephone services.




The first Spanish mobile phone operator was Telefónica Móviles (originallynamed TS1). Telefónica Móviles operated mobile phones for cars since 1977.In September 1995 the company started offering GSM telephony under thebrand name MoviStar. Already in 1994 the government had decided to intro-duce a second mobile phone operator as an incentive to develop the service.A consortium of companies led by Airtel was awarded the licence and startedoperating in July 1995. At that time, the market was not yet liberalized.

After the national elections of March 1996, the Spanish government decidedto liberalize the telecom market. It granted a third mobile phone licence toRetevisión Móvil (subsidiary of Retevisión) which entered the market under thebrand name Amena in January 1999 in 10 major Spanish cities. At that time,Telefónica had already 5 million customers and Airtel had reached 2 million.

Liberalization and the introduction of three large companies led to competitionin this market, rather than competition for the market (monopoly). To date,these three operators have been sharing a constantly growing market in termsof number of clients. At the same time the price per minute has been slowlydeclining (see Table 6). Over the last four years the average revenue per user(ARPU) has been growing, despite the cheapening of the voice minute, due toa higher consumption of data, mainly SMS (See Figure 7). The SMS businessapparently is a very profitable one, with some consumer associations claimingthat the operators’ margin is as high as 80%6. In 2003, there were around 40companies in Spain providing content over SMS (logos, ring tones and games)for about 90 euro cents per unit, of which the mobile phone operator retains50%7.

6 Source: Federación de Consumidores en Acción (Facua-España) in an article of Redes & Telecom May 31,

2004.

7 Source: El Periódico, August 24, 2003.


Table 6 - The Mobile Phone Market

1998 1999 2000 2001 2002 2003

No. of customers 6,437.444 15,003.708 24,265.059 29,655.729 33,530.997 37,219.839

% Customers with

contracts/Total 66% 38.4% 35.1% 35.0% 37.7% 41.9%

Penetration rate in

the population 16.3% 38.1% 59.9% 72.1% 80.1% 87.2%

Billed Minutes (Mln) 5,216.0 10,427.0 17,026.0 22,942.0 29,258.0 36,266.0

Minutes per customer 810.3 695.0 701.7 773.6 872.6 974.4

Total Revenue (Mln EUR) (1) 2,504.4 3,420.0 4,894.2 6,315.8 7,474.2 9,953.7

Average price per minute (2) 0.48 0.31 0.26 0.24 0.21 0.20 euro

Revenue per customer (3) 389.0 227.9 201.7 213.0 222.9 240.6 euro

(1) Services to end customers only.

(2) Includes only voice minutes and fixed monthly subscription.

(3) Voice + all other services.

Figure 7 - Revenue Growth in Voice and SMS

Source: CMT. Nonexistent in 1999, in 2003 SMS already represents 13% of mobile phone revenues; it is the fas-

test growing segment.



8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

0

1999 2000 2001 2002 2003

Voice SMS

+28%

+18%

+19%

+117%+45% +27%

Milli

on E

ur.




The market dynamics that obviously benefited the consumer most were thepopularization of the mobile phone at a quick pace and at accessible pri-ces. The price drop has been especially rapid due to the necessity of mobi-le telephony providers to reach critical mass in order to amortize the initialinvestment in infrastructure. In the early stages of the race for critical mass,mobile operators undertook huge marketing efforts and heavily subsidizedthe handsets. Customers both in fixed and mobile telephony are price sen-sitive, but the mobile phone further characteristics of a consumer product:fashion awareness (especially at introduction of the product) and shortlifecycle.

The fast move of the price declining and the rapid technological improvementof the mobile phones also brought disadvantages for the consumer:

· premium prices to pay for latest technology and rapid obsolescence ofthe mobile device which especially hurt the first, fashion-consciousbuyers;

· difficulty in comparing tariffs as the operators competing on price try todifferentiate themselves through personal packages;

· risk of continuing to pay too high a price after tariffs for new phones areadjusted downwards;

· network externalities: go with the operator that most of your friends go,not the one with the best offer; cost of switching provider;

· incentive to postpone acquisition, waiting for prices to decline further.

In comparison with other major European countries, Spain has a relatively highpenetration rate, second only to Italy. This explains why in the last two yearsmobile operators try to increase customer loyalty rather than expand custo-mer base.




Figure 8 – Mobile Phone Penetration 2003

Source: European Commission, 9th implementation report.

In most European countries, the market share of the mobile subsidiary of theincumbent operator is close to 50%; Spain is no exception to this. The twobiggest operators in the country typically account for over 75% of the marketshare (See Figure 9). Only in the UK, the pie is split more evenly where the 4operators have an almost equal share of 25% each.

Italy

Spain

United Kingdom

Germany

France

60 70 80 90 100 110

96%

87%

85%

75%

66%




Figure 9 - Concentration: Market Shares

Source: ART - 9th report of the European Commission (data from August 2003)

The mobile market is highly concentrated with only 3 or 4 operators in mostcountries. Due to high penetration rates, it is unlikely that the cards will bereshuffled soon in terms of market shares, unless one of the players, or anew entrant, tries to gain market share by massively launching 3G tele-phony before all the others. In effect, we have seen Hutchison Whampoareaping share from the other players in Italy and the UK, but it did not enterthe Spanish market. Here the three operators launched their 3G offer duringthe year 2004.

The risk in such a highly concentrated market is to witness cartel formationbetween operators. In France in July 2004, allegations arose about SFR,Orange and Bouygues Telecom agreeing on prices. According to the July12 ‘Le Parisien’, a report submitted to the industry ministry by France’sDGCCRF anti-fraud authority has found proof of collusion in pricing8. InSpain, the FACUA (Federación de Consumidores en Acción) suspects theSpanish mobile phone operators of colluding on SMS prices in order tomaintain high margins9.

8 Source: Europe Information e-technologies, July 15, 2004.

9 Source: May 31, 2004 Redes & Telecom.

100%

75%

50%

25%

0%

Spain Italy France Germany United Kingdom

20.5%

26.0%

53.5%

17.0%

36.1%

15.7%

35.6%

48.7%

21.0%

48.7%

26.4%

24.9%

37.9%

41.1%46.9%

Incumbent’s mobile arm 2nd operator Other operators




As Figure 10 reveals, for the operators, the Spanish market is a relativelyattractive one in terms of average revenue per user (ARPU). Looking atVodafone, which operates in the UK, Spain, France and Italy, it shows thatSpain is the second most attractive market behind the UK.

Interestingly enough, in the 5 countries, the mobile arm of the incumbent -UK:mmO2 (ex BT), France: Orange (FranceTel), Germany: T-Mobile, Italy: TIM,Spain: Telefónica Móviles- is the one with the biggest market share, but doesnot have the customers with the highest ARPU. At the same time, late entrantsto the market, e.g. Bouygues Telecom in France, Amena in Spain or Virginmobile in the UK, typically tend to go for the lower revenue customers andhave a higher proportion of prepaid modality customers which explains theseoperators’ lower ARPU. There is one notable exception to this: HutchisonWhampoa extracts higher revenues from its Italian customers by being thefirst operator to offer third generation mobile telephony.

Figure 10 - ARPU (H1 2004) of Selected European Mobile Phone Operators10

Sources: see appendix.

500

400

300

200

Annual ARPU (EUR)

387409

436

276 288309

367343

362

516

364389

212

408 416

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10 The exchange rate used for EUR/GBP is 1.49; data were not available for all major operators. Sources:

see appendix.




How does the cost for the consumer for access to basic mobile telephony inSpain compare with other major European countries? Results from an OECDsurvey are shown below11; the figure represents the monthly cost of a sampleof 25 outgoing calls (42% of which are to fixed lines and 58% to mobile pho-nes) plus 30 SMS.

Figure 11 - Low Usage Basket: European Tariff Comparison 2003

Source: OECD.

Figure 11 shows that for low usage customers, Spain offers the cheapestaccess to mobile telephony.

Spain, Movistar, Plus Eleccion

Spain, Vodafone, Contrato Tarde

Italy, Omnitel, Italy New

Italy, TIM, Menu Family + Tutti Province

Germany, Vodafone, Sun

Germany, T-Mobile, TellySmile

France, SFR, Formule Perso 1H+10 Text

France, Orange, Forfait 1h

UK, Orange, Any Network 30 Your Message 30

UK, T-Mobile, Everyone 25

0 5 10 15 20 25 30

15.84

16.61

19.01

19.70

23.26

23.28

24.00

24.50

25.61

27.11

EUR per month

11 Source: European Commission – Telecommunication Regulatory Package – 9th Implementation Report.




Figure 12 below shows that these results remain true when OECD purchasingpower parities are applied.

Figure 12 - Low Usage Basket: European Tariff Comparison 2003 at Purchasing Power

Parity

Source: OECD Statistics.

The packages used in the OECD study are the ones designed for low usagecustomers. The study goes on and applies medium and high usage profiles tothese same packages. We consider that this reflects only what happens whena low usage customer uses his cell phone more intensively than he is suppo-sed to, insofar it does not reflect the real cost for a medium to high usage cus-tomer who would choose a different offer from his operator. We therefore con-sider that the OECD study is not conclusive for the cost of medium and highusage of mobile phones.

Spain, Movistar, Plus Eleccion

Spain, Vodafone, Contrato Tarde

Italy, Omnitel, Italy New

Italy, TIM, Menu Family + Tutti Province

Germany, Vodafone, Sun

Germany, T-Mobile, TellySmile

France, SFR, Formule Perso 1H+10 Text

France, Orange, Forfait 1h

UK, Orange, Any Network 30 Your Message 30

UK, T-Mobile, Everyone 25

0 5 10 15 20 25 30

20.17

21.15

22,13

22.94

23.72

23.74

26.34

26.89

26.72

28.28

Cost EUR per month




2.2.2. The Value Chain for Mobile Phone Operators

Figure 13 – The Mobile Telephony Value Chain

Mobile phone operators have a value proposition unequalled by their fixed linecompetitors which allows them to capture a bigger portion of the value crea-ted: mobility. Customers’ willingness to pay for mobile telephony is abouttwice as high as for fixed lines12. At the same time they are willing to put upwith the imperfections of a mobile network, e.g. communication disruptions oroccasionally poor sound quality.

The mobile business model has educated customers to pay per minute; it istherefore very likely that, once UMTS is in place and permits Internet access,the revenue model can be sustained, contrary to what happened to fixed lineInternet access. It remains to be seen if a change in the charging methodcould occur in the fixed line business at a later stage.

At the same time, while in the fixed line Internet Access Provider business thepresence of over 300 players in 1998 in Spain drove access prices downrapidly (and many IAPs out of business), this is unlikely to happen in the mobi-le business. There are only three big players in the market and recent historyhas shown that the price of the mobile phone minute tends to stabilize as thepenetration rate approaches saturation.

12 Source: red.es.

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2.3. Fiber Optic Cable

2.3.1. The Development of Cable

Cable network is a recent technology in most of European countries. Before1995, cable was an unknown technology in Spain. The fact that this countryopted for a public TV model instead of a pay TV model, which uses cable orsatellite technology, could be one of the main reasons which explains thedelay in the deployment of cable network in Spain.

With the purpose of fostering an alternative infrastructure to provide telepho-ne services, data transmission and television, the congress of deputies appro-ved the Cable Law in 1995, by which Spain was divided in 29 areas. In eacharea the government granted two licences, one to Telefónica and another oneto a new operator according to its financial background and market experien-ce. Telefónica at that time was interested in the cable business because ADSLtechnology was not known; later, Telefónica dropped its licence, deciding tofocus on the development of ADSL.

The initially elevated number of cable operators with relatively small operatingareas also contributed to the delay in the deployment of cable network. Table7 shows the detail of former operators in each area and the current one afterconsolidation. Cable, like other technologies, obeys the rules of networkindustries, i.e. need for huge investments and room for only a handful of pla-yers who need to gain critical mass in order to achieve economies of scale.The presence of too many players predictably triggered a wave of mergersand acquisitions between operators. AUNA Group and Cable Europa (ONO),a cable player with multiple shareholders, began to acquire local cable com-panies. In this process they had to adapt their own networks to the ones ofthe acquired companies, thereby postponing their investment schedule.




Table 7 – Former and Current Cable Operators

Area Former Operator Actual Operator

Albacete (City) Albacete Sistemas de Cable ONO

Almería (City) Supercable Almería AUNA

Andalucía I (Almería, Granada and Jaén) Supercable Andalucía AUNA

Andalucía II (Málaga and Córdoba) Supercable Andalucía AUNA

Andalucía III (Sevilla) Supercable Andalucía AUNA

Andalucía IV (Cádiz and Huelva) Cable and TV Andalucía ONO

Aragón Aragón Cable AUNA

Avilés Telecable Avilés Telecable13

Barcelona CTC AUNA

Basque Country Euskaltel Euskaltel14

Cádiz (City) Cádiz Cable and TV ONO

Canary Islands Cabletelca AUNA

Cantabria Santander Cable ONO

Castilla León Retecal ONO

Catalonia East CTC AUNA

Catalonia West CTC AUNA

Galicia Grupo Gallego R15 (Galicia)

Gijón Telecable Gijón Telecable

Huelva Huelva Cable TV ONO

Ibiza-Formentera ONO

La Coruña Grupo Cable R

La Rioja Reterioja AUNA

Madrid North CyC Comunicaciones AUNA

Madrid Southeast CyC Comunicaciones AUNA

Madrid Southwest CyC Comunicaciones AUNA

Murcia Cable Europa ONO

Navarre Retena AUNA

13 Telecable Shareholders: CajAstur (46%), HidroCantábrico (46%), La Nueva España (8%).

14 Euskaltel main shareholders: BBK (33.13%), Kutxa (19.98%), Iberdrola (11.14%), Endesa (10%), Caja Vital

(7.75%), EITB (5%), Telecom Italia (3%), Basque Government (3%), Grupo Auna (3%), MCC (2%), EVE (2%).

15 R shareholders (source: r.mundo-r.com): Unión Fenosa, Caixanova, Banco Pastor, Grupo Zeta, Faro de

Vigo (Grupo Moll), Grupo Tojeiro, Jealsa Rianxeira, Ceferino Nogueira, Hijos de Rivera, El Progreso, Editorial

Compostela (El Correo Gallego), La Región, Invertaresa, El Ideal Gallego, Dielectro Galicia, Ferro

Inversiones y Olsines (percentages not available).




Oviedo Telecable Oviedo Telecable

Palma Mallorca Corp. Mallorquí Cable ONO

Puerto Santa María Cable TV Puerto SM ONO

Sanlúcar de Barrameda TDC Sanlúcar ONO

Santiago Grupo Cable R

Seville Supercable Sevilla AUNA

Torrent MedNorte Sd Cable ONO

Valencia (City) Valencia de Cable ONO

Valencia North MedNorte Sd Cable ONO

Valencia South MedSur SdCable ONO

The strategy of cable operators consisted of the development of an alternati-ve network to compete against the incumbent, Telefónica. From 1999 to 2001,both AUNA and Cable Europa did not break even due to heavy investments inthe deployment of their own networks and low sales which could not take offuntil the deployment was finished. Although in 2002 and 2003 both compa-nies achieved positive operating profit, their net income remained negativeduring those years (See Table 8). In spite of their low current market share infixed line telephony (less than 6%), they have great potential as already morethan two million homes are cabled while only one third is currently connectedto the network.

Table 8 – Company Data for AUNA and ONO

Data 2003 AUNA ONO

EBDITA MM (1998-2003) (*) -16.0 -34.5

Residential Customers 670,000 581,345

Share of Customers 3.8% 3.3%

Homes cabled 2,097,000 2,003,233

Res Cust/Homes cabled 32% 29%

Cities in service 112 98

Investment (euroMM) (**) 4,573.0 1,542.5

(*) AUNA included information from 2001 and 2003.

(**) Antonio Hernández provided information about investment in AUNA. Investment in ONO is the sum of the

CAPEX of this company from 1997 to 2003.




Bundling is the strategy followed by the cable operators. Auna and Ono offercommercial discounts to the consumers when they buy a set of products.From 2000 to 2003 each of their customers subscribed 1.8 services on avera-ge (Table 9). According to ONO’s annual report, the most demanded service isfixed telephony, followed by television. However, in the last three yearsdemand for broadband services has substantially increased (see Table 10).

Table 9 – Average Number of Services Subscribed

2000 2001 2002 2003ONO 1.87 1.88 1.79 1.84AUNA 1.70 1.80 1.70 n/a

Table 10 - Product Demand as a % of the Total Customers

2000 2001 2002 2003Telephone 90% 92% 93% 94%Television 76% 70% 62% 58%Internet 8% 11% 24% 32%

2.3.2. The Online Value Network for Fiber Optic Cable

Cable providers have positioned themselves differently from traditional carriersright from the beginning. Knowing that they could not sell the cable networkitself for its intrinsic qualities, i.e. broadband technology, they formed strategicalliances with content providers (e.g. TV stations), offered access to content(Internet) or provided content themselves in the phone business (voice). Thesales pitch focused on content, not on content access.




2.4. Emerging Broadband Technologies – Digital TV, Voiceover IP, Satellite and Power Line Communication

Broadband technology is a carrier technology which opens up a new set ofpossibilities for transportation of data-intensive contents. We will look at twocontents which might contribute to shaping the future of the telecom industry:digital television and voice over IP.

2.4.1. Digital TV

Television had traditionally been a business unrelated to the telecommunica-tion sector. However, in the late ‘90s both businesses began to converge. Onthe one hand, cable operators, whose traditional business was television, star-ted taking advantage of their infrastructure to provide telecommunicationsservices such as telephone and broadband Internet access. On the otherhand, traditional telecoms operators began to invest in the television business–Telefónica had an important share in Via Digital (a digital television operator)–or developing new business models, such as video on demand using broad-band networks to broadcast the signal. Satellite television providers comple-te the picture.

In Spain, up to 1997, the only television model was the public and open TVwhich used the analogical spectrum to broadcast the signal. This market wascomposed of a public and national channel, RTVE, two national and private TVnetworks and several regional channels. In this model the main source of reve-nue was advertising.

Since 1995 the business model in the television market began to change, shif-ting from public open-free TV towards private, digital and pay TV. Digital TVoperators generally have a similar structure, comprising a basic package witha variable number of channels (between 22 and 50) and different additionaloptions which can be combined. These include cinema channels, cartoons,theme-specific channels and pay-per-view events. Premiere movies and sportevents, bullfighting and live music concerts are usually offered as pay-per-view. Cable network, satellite and TDT (Territorial Digital Television) are thetechnologies that the new operators use to provide pay TV services.


As described previously (see cable network analysis) the deployment of cablenetwork started in the mid ‘90s and one of the products offered by cable ope-rators was TV. Both Auna and Ono offer a set of 30 channels, premium con-tents, and pay-per-view sport events and other entertainment. TV has beenthe second most demanded service since 1997.

Satellite is probably the best device to broadcast a TV signal to a huge num-ber of customers. Its infrastructure has a fixed cost, allowing satellite opera-tors to obtain important margins once they reach critical mass. The combina-tion of satellite and digital technology enable to broadcast hundreds of chan-nels using the same signal. Therefore satellite-based digital TV platforms havebeen the most successful technology in the new TV business model. The mostimportant players in this market were Canal Satélite Digital (launched February1997; via Astra) and Distribuidora de Televisión Digital - Vía Digital (launchedSeptember 1997; via Hispasat). Both companies merged at the end of 2002.

Terrestrial digital television (TDT) is a new digital technology that will replacethe former analogical broadcasting system. With TDT it is not necessary toinstall a device to receive the signals (cable or satellite dish) because it goesthrough the former antenna. The digital technology allows optimizing the radioelectric spectrum; more channels can broadcast their signals in the same fre-quency, increasing competition between dominant and new operators.Additionally this technology improves the quality of the image and sound(similar to DVD) and it gives users access to interactive tools. Although thelegal framework for the development of TDT has been defined since 1997,public and private open channels will change from analogical to digital tech-nology only in 2012.

QuieroTV was the only attempt to introduce TDT as a pay service in Spain. Thecompany, whose main shareholders were AUNA Group, Media Park andCarlton Communications, was operational only for one year. An over-aggres-sive marketing plan (that included a promotion of three months free of char-ge), a deficient customer service that confused and upset its subscribers andtough competition from the satellite platform are among the main reasons whyQuieroTV went out of business at the beginning of 2002.

To complete the picture of the television business, in 2004, Telefónica rolled outImagenio, a pay-ADSL TV project with many of the content providers that were




put out of the digital satellite business. Imagenio offers Internet, a selection of22 TV channels, and near-video-on-demand. As of June 2004 Imagenio had2,533 customers i.e. less than 0.1% of pay-TV market share.

The television market, in term of revenues, has been growing in both open andpay TV. The latter represents an average of 29% of the total revenues (Table11). The main source of revenue is still advertising, and in open TV, grants fromthe government. In the advertising pie, pay TV has only a tiny slice. Accordingto CMT its share represents only 1.8% of the total, so the unique source ofinformation of pay-TV is monthly subscriber fees.

Table 11 – Revenues in TV

(Million Euro) 2000 2001 2002 2003

Pay TV 1,127.4 1,387.2 1,466.6 1,835.69

Open TV 2,899.6 3,281.3 3,528.4 3,558.26

TOTAL 4,027.0 4,668.5 4,995.0 5,393.95

% Pay TV 28.0% 29.7% 29.4% 34.0%

Table 12 – Revenue Sources in TV

(Million Euro) 2000 2001 2002 2003 % of rev 2003

Advertising 2,431.0 2,326.36 2,276.55 2,413.66 41%

Pay TV fee 1,071.6 1,191.93 1,322.69 1,385.25 24%

Pay per view fee 105.4 69.18 80.54 104.17 2%

Grants 853.0 1,264.19 1,468.72 1,455.62 25%

Others 16.0 267.53 284.55 512.54 9%

TOTAL 4,477.0 5,119.2 5,433.1 5,871.24 100%

% Fee over Total Revenues 26% 25% 26% 25%

Table 13 shows the evolution of pay TV subscribers from 1999 to 2003. The cus-tomer base of pay-TV services increased 65% over the period. The sum of CanalSatélite Digital, Via Digital and Canal Plus subscribers still represent more than70% of all pay-TV customers, meaning that despite the efforts of cable operatorsto introduce their TV services and to reap market share from satellite-based plat-form companies, the latter managed to maintain a high share in the pay-TV mar-ket. But especially in the last two years all cable operators have managed to stealcustomers from satellite TV in a slightly shrinking market.




Table 13 - Pay TV Subscriber Numbers by Operator

1999 2000 2001 2002 Chg 01/02 2003 Chg 02/03

Canal Satélite Digital 813,490 1,051,563 1,230,038 1,220,669 -0.8% 1,173,024 -3.9%

Via Digital 440,114 633,059 806,379 775,000 -3.9% 622,662 -19.7%

Canal Plus 760,424 885,449 787,370 720,199 -8.5% 705,050 -2.1%

Cableuropa (Ono) 31,023 128,242 232,099 286,536 23.5% 339,378 18.4%

Other cable operators 59,977 100,046 171,722 187,023 8.9% 231,925 24.0%

Aunacable 12,785 69,888 165,632 260,102 57.0% 296,132 13.9%

Quiero TV 0 113,233 133,113 0 0

Cable Local 0 0 18,376 77,717 322.9% 126,240 62.4%

Telefónica cable 0 0 0 0 3,011

TOTAL 2,117,813 2,981,480 3,544,729 3,527,246 -0.5% 3,497,422 -0.8%

Merged (CSD, VD, Cplus) 95.1% 86.2% 79.7% 77.0% 71.5%

2.4.2. Voice over IP

According to WebOpedia, Voice over Internet Protocol (VoIP) is a category ofhardware and software that enables people to use the Internet as the trans-mission medium for telephone calls by sending voice data in packets using IPrather than by traditional circuit transmissions of the PSTN (Public SwitchedTelephone Network). One advantage of VoIP is that the telephone calls overthe Internet do not incur a surcharge beyond what the user is paying forInternet access, much in the same way that the user doesn’t pay for sendingindividual e-mails over the Internet.

Why isn’t everyone using this technology? Although the concept of VoIP iseasily understood, its implementation is more complicated. In order to sendvoice, the information has to be separated into packets just like data. Packetsare chunks of information broken up into the most efficient size for routingfrom there, the packets need to be sent and put back together in an efficientmanner. This process is smooth in theory, but voice communications over theNet are not as seamless as they are over traditional phone lines. Voice over IPis now mature enough for mass adoption and companies and individualsworldwide are beginning to use it.

It is important to point out that since VoIP is the transmission of voice using highspeed Internet access, previous deployment of broadband connections is requi-




red. According to different sources of information, during 2003 more than 100million minutes (less than one percent of the total) were transmitted through theInternet. Forrester estimates that in 2005 more than half of Internet users will useVoIP to make their phone calls. According to Gartner group estimation, 19% ofUSA households will be VoIP users in 2008 when 45% of families have broad-band access. In Europe broadband penetration will occur at a similar rate accor-ding to the predictions of Yankee Group and Gartner. In most European coun-tries the telephone bill is composed of a fixed monthly fee and a variable partwhich reflects consumption. Keeping in mind that the average prices for domes-tic and international calls are still very high compared to the US, VoIP seem tobe one of the most important threats to the traditional fixed line business.

Skype provides VolP services to 160,000 new users each day. According tothe firm Evalueserve, Skype will serve between 140 to 245 million clients in2008, while VolP will cause the earnings of traditional providers to fall 10%and their profit rates to decrease between 22 and 26%.

In the fall of 2005, Skype is planning to launch a voice over Internet (VolP) soft-ware for latest generation mobile phones, which will employ operatingsystems such as Windows Mobile, Embedded Linux or Symbian. This will per-mit users with wireless Internet access to use their mobile phone with anotherSkype user completely free of charge.

In Spain, VolP is a nascent market centered mainly in big and medium-sizedcompanies, in which British Telecom is one of the most important players.While Skype continues attracting users, other small companies such asNetmeeting or the Spanish company Peoplecall are shouldering their way intothe communications business in Spain.

In Spain, VoIP is an incipient market focused mainly on corporations andmedium-sized companies, in which British Telecom is one of the most impor-tant players.

2.4.3. Satellite

Traditionally, the consumer knows satellite to be a TV signal carrier. In effectthe first TV satellites were one-way communication devices meant to send theTV signal from the broadcast station towards millions of homes.




Cable, the satellite’s direct competitor, has a bigger data-carrying capacity and isnot susceptible to weather conditions, but cable is very expensive to installbecause for every new user some cable must be laid and therefore it is financiallysound only in densely populated areas (it is estimated that laying a meter of cablecosts between 50 and 150 euros). Even ADSL, which uses the existing telepho-ne line, can be unprofitable in rural areas because the ADSL local exchange sta-tion cannot be more remote than roughly 5 km from the user’s home.

The satellite, which by itself costs between 290 million USD for a weather satelli-te and 680 million USD for a military device, requires an additional 50 to 400million USD for the launch, depending on its weight. But once placed in orbit, itdoes not require any additional investment to send its signal to an additional user.Only the user needs to get equipped with a satellite dish and a decoder. Thus thesatellite seems to be the ideal tool to bring broadband access to rural areas as itcan reach download speeds of 256 Kbps and more. But satellite, with as Internetbroadband access, has proved slow and marginal so far for several reasons.

First, only the more recently launched satellites have two-way communicationcapacities. The older ones do not allow the end user to upload data. For this rea-son, satellite Internet often relies for backhaul on using a normal fixed telephoneline, with the obvious speed limitations that this entails.

A second major obstacle, at the moment, is cost. In 2003, installation of a two-way satellite Internet connection cost around 1,500 euros and the monthly subs-cription stood at 75 euros, which makes it considerably more expensive than acomparable ADSL connection; a one-way connection with a fixed-line backhaulwas considerably cheaper. So far, only companies in rural areas, or people livingin regions where the local government subsidized Internet access, were interes-ted in the service.

Finally, because of the great distance between the customer’s antenna andthe satellite in orbit, there occurs a phenomenon known as latency. This delaybetween a signal sent and its response is due to the time required for the sig-nal to reach the satellite located in its geostationary position 22,000 milesabove Earth and the time required for the response to travel back. Add to thatthe time to compress and decompress the data and the delay becomes longenough to be noticeable and makes interactive applications like voice, chat orgaming uninteresting.




Like terrestrial data transmission, the satellite is also a contended service, mea-ning that numerous users will have to share the same bandwidth. But a singlefiber optic cable can carry many more signals than several satellites put together.The satellite link will hence get congested much faster, and in terms of cost perunit of capacity, the satellite remains much more expensive than any terrestrialnetwork.

Nevertheless, since September 2004, the Spanish ISP ya.com formed an allian-ce with SES Astra to offer broadband Internet access via satellite. It is a one-wayaccess which requires an additional telephone line for data uploading. The allian-ce hopes to acquire 10,000 customers in Spain in the first year in a market ofpeople without broadband access estimated at 5 million individuals, 300,000companies and 6,000 municipalities.

2.4.4. Power Line Communication

The idea of Power Line Communication (PLC), also called Broadband Power Line(BPL), is a simple one. It consists of using the existing power network that feedsevery home with electricity as a data transportation network. The huge advanta-ge of the power network is its ubiquity; penetration rate of electricity is even hig-her than that of landline telephony. No additional cables need to be laid, not evenin the end user’s home as the power sockets are used as access points. At localloop, distances delivery speed is very high and tests at 200 Mbps have been rea-lized in Japan; commercial offers can realistically be expected to supply 2 to 5Mbps, which is above the current ADSL offers (256 Kpbs – 1Mbps).

Several uses can be made of the power grid.

The first would be to use the whole power network, which is made up of the highvoltage, medium voltage and the low voltage grid. Theoretically, the three gridscould be used to carry signals but in practice, using the high voltage grid for longdistances deteriorates the signal and speed is limited to around 25 Mbps.Therefore, usually, a fiber optic backbone is used and the Internet is tapped at afiber-optic node somewhere within a mile or two of the end users. Data is con-verted through a processor and routed over medium- and low-voltage electricdistribution circuits for “last mile” delivery to consumers.

Another use of the power network would be strictly in-house. In this configura-




tion, Internet access would be provided by fiber optic cable to the end user, inclu-ding the last mile. But within the user’s premises the power lines of the housewould be used to build a home network. This avoids laying dedicated LAN wiresin the building.

The idea of PLC has been worked on since 1989, but several technical problemshad to be overcome before it was launched commercially in 2004 in the US. Inearly tests, the technology, which uses high frequency bands typically between2 and 30 megahertz, created interferences with WiFi networks and amateur radiofrequencies.

Although these technical problems have been overcome, other factors explainthe slow takeoff of PLC. Both utilities and their investors see the utilities businessas a mature, rather slow-moving one; utilities stocks tend to be considereddefensive during down cycles. This – and a few early failures in diversificationfrom the traditional business – explains the reluctance of utilities to invest massi-vely into PLC. Many utilities are also struggling to come up with a functional busi-ness model to market the service. At the same time, regulation in the field lagsbehind. Last but not least, nothing has been done to raise awareness for thetechnology; in all the hype around WiFi, PLC has been a bit forgotten.

Nevertheless, the technology is slowly taking off. In Spain, Endesa started itsPLC project in 2000 and conducted its first massive field tests in September 2001in Zaragoza. Endesa concluded these tests successfully and has offered the ser-vice commercially in selected areas of Zaragoza since October 2003 and in cer-tain neighborhoods of Barcelona since March 2004.

Whatever the commercial outcome in the next years, PLC can be considered acheaper alternative to the satellite to overcome the digital divide and a possibilityof broadband access for rural areas.






2.5. The Telecommunication Online Value Network – Overview

Figure 14 – The Telecommunication Online Value Network

The players in this increasingly complex environment have to position themsel-ves within this value network matrix by choosing the business(es) they want to bein and bet on a technology.

In terms of business, the challenges are to find one that is sustainable. First theremust be a continuous demand for the business, but more importantly thereneeds to be a willingness to pay on behalf of the customer, which is not alwaysthe case for Internet-related services. At the same time some of these busines-ses, e.g. the carrier business, are increasingly perceived as commodities with allthe related disadvantages: transparency for the end customer, substitutability,downward pressure on margins.

Competition is toughened not only by the existence of several carrier technolo-gies but also by the increased importance of software providers at both ends ofthe value chain, which can enhance or make obsolete a carrier technology. Theemergence of GPRS, also coined 2.5G technology, right after the billion dollarauctions of 3G licences is a telling example of this threat/opportunity. Hencethere is a huge risk of over-investing in the wrong infrastructure.

Inte

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Cen

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Loca

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Mob

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PM O B I L E

AD

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Inte

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Cen

ter

C A B L E

W i r e L i n e : P O T S & A D S L

CA

RR

IE

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HN

OL

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Mul

tiple

con

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: voi

ce, I

nter

net

cont

ent,

serv

ices

, TV,

VoI

P

Por

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Net

wor

kin

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(bac

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Pro

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Acc

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IAP

Dis

trib

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Cus

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User’s hardware, O.S. andsoftware


3. Competitive Situation in Spain

In the previous section we described the complexity of the telecom sectorusing the online value network framework. In this setting, which in the sec-tor is referred to as “ecosystem” (because of the coexistence and competi-tion between different technologies and networks in both the voice and databusiness), the operators define their strategic positioning through the com-bination of five criteria: telecom industry, activity scope, network access,technologies and product commercialization.

Telecom Industry refers to the different markets in which an operator can play:Fixed Telephony, Mobile, Cable, ADSL, Digital TV and VoIP. The positioning asspecific niche player or generalist defines the activity scope. Network accessmeans whether the operator reaches the consumer using its own network orthe one of the incumbent. Additionally in each value chain there can coexisttwo or more technologies (e.g. Broadband access technologies can be achie-ved through cable or ADSL). Finally product commercialization refers to theway of selling products, the distinction being between bundled and unbundledproducts.

3.1. Full Service Providers

In the Spanish market, Telefónica and Auna are the only telecommunicationfull service providers (FSP) with business units all along the value chains of thetelecom sector. Those companies are the most important players in terms ofrevenues, customers and infrastructure. They have focused their strategies inthe synergies between the mobile and fixed line markets but are also presentin the voice business and, at the same time, try to develop broadband accesstechnology in the Internet market.

Both FSPs offer their services to domestic and corporate customers.Additionally they both own their proprietary networks (in fixed as well as mobi-le telephony). To attract customers, they have taken different approaches tocommercializing their products: while Telefónica sells mobile services, ADSLand fixed line telephone as separate products, Auna’s strategy is productbundling. Auna uses the same wired network to channel TV content, voice andbroadband access and therefore offers these three products as a bundle to itscustomers. Another important difference between the two companies is that






they compete with distinct technologies. Telefónica uses a network made ofcopper twisted pair wires (the former, already fully depreciated public telecomnetwork) while Auna has deployed a new fiber optic cable network.

In the mobile market, Telefónica is the market leader followed by VodafoneGroup and Amena. While Movistar (Telefónica’s mobile brand) has been profi-table right from the beginning, Amena has reached positive results only since2001.

According to the CMT 2003 report, both companies together hold 70% of thetotal telecom and digital television market. While Telefónica has been profita-ble since the beginning in each of its business units, 2003 is the first year inwhich Auna Group broke even in its mobile and fixed line businesses. Asshown in Table 14, Telefónica group not only generates revenues representingfour times those of Auna, but also its operating profits are roughly 10 timesAuna’s.

Figure 15 – Percentage of Telecommunications Market Held by Each Group

Source: CMT, 2003.

9.8% AUNA Group

10.6% Vodafone (mobile Airtel)

60.1% Telefónica Group

19.5% Remainder




Table 14 – Comparison Between Telefónica Group and Auna Group

Telefónica 2001 2002 2003

Telefónica Móviles 5,841 6,770 7,496

Telefónica de España 10,222 10,272 10,217

Sales 16,063 17,042 17,713

Telef Móviles 2,817 3,490 3,941

Telef España 4,485 4,497 4,534

Operating Profits 7,303 7,987 8,475

Operating Profitability 45% 47% 48%

Auna

Amena 1,497 2,193 2,784

Auna Telecomunicaciones 849 925 1,076

Sales 2,346 3,118 3,860

Amena 497 957 768

Auna Telecomunicaciones -100 -40 124

Operating Profits 397 917 892

Operating Profitability 17% 29% 23%

3.2. Multiservice Operators

Generalists are companies who are active in more than one business (tele-vision, Internet or telephone) using wired networks. All cable operators,with the exception of Auna, are generalist players, because they takeadvantage of their cable network to provide multiple services to the enduser. There are some players in PSTN networks who followed a generalistapproach. Examples are Jaszztel and Uni2, a subsidiary of France Telecom.Both companies offer telephone and broadband (ADSL) services to the endusers and telecom services to large corporate customers and small andmedium companies.




Table 15 – Generalists: Sales and Ebitda

(Million Euro)

Companies 2000 2001 2002

Sales

Ono 51.5 143.6 253.4

Uni2 192.9 303.2 458.0

Telecable 11.0 24.9 36.8

R Cable 7.8 14.2 38.2

JazzTel 125.3 220.3 219.0

Euskaltel 101.3 155.3 215.7

Ebitda

Ono -55.8 -57.4 15.8

Uni2 -95.5 -81.5 8.0

Telecable 0.2 5.1 6.2

R Cable -17.6 -17.9 -9.9

JazzTel -163.3 -90.6 -40.5

Euskaltel -37.3 0.9 5.7

Profitability -75% -28% -1%

Table 15 shows that financial results of most of the generalists are similar tothe ones obtained by the specialists. From 2000 up to 2002 there is a strongcorrelation between sales growth and reduction of operating loss, which indi-cates the presence of a fixed cost component whose relative weight in thewhole cost structure decreases with rising sales.

3.3. Specialized Operators

Players with strategic focus on a defined market or market segment are calledspecialists.

3.3.1. Specialist in a Certain Market

In this category we include players focusing on only one market, like mobiletelephony or broadband access. The most important specialist in the Spanishmarket is Vodafone, a pure mobile operator. Vodafone is a European playerand the best performing mobile phone company in the world in terms of inco-




me and profitability. Vodafone’s main strength is its international cellular net-work that allows it to offer more aggressive prices and better conditions thanthe local competitors in the European countries where it has set foot.

3.3.2. Niche Player

Most of the indirect access fixed line operators follow a more narrowly focu-sed strategy. Some companies have positioned themselves in the internatio-nal call market which requires only low investments. Others prefer to concen-trate on the corporate segment, like Comunitel or BT Ignite, deploying theirown backbone network and reaching their customers using wireless techno-logy, thereby circumventing the incumbent’s grip on the last mile.

Table 16 shows sales and operating profits of the main niche players in thewired network business. From 2000 to 2002, although these companies couldnot get positive operating profit, they were able to increase their turnover andto reduce their operating losses.

Table 16 – Niche players: Sales and Ebitda

(Million Euro)

Companies 2000 2001 2002

Sales

Bt Ignite 103.4 176.6 205.0

Colt Telecom 42.8 76.7 114.3

Comunitel 37.7 71.9 110.3

Ebitda

Comunitel -14.7 -12.9 -2.9

BT Ignite -65.5 -54.3 -31.5

Colt Telecom 0.0 5.6 14.8

Source: companies’ financial reports

Finally Figure 16 represents the competitive positioning of the incumbent(Telefónica) and its competitors in both indirect (PSTN) and direct access. Todraw their position in the telecom market we selected two indicators, marketshare and operating profitability. Although Telefónica group has lost market share




during the last five years, it maintains a high percentage of this market and highprofitability (close to 20% over sales), while its competitors reach less than 10%share with negative results. The mobile market, on the other hand, is an oligopolyin which three players share the entire market with high levels of profitability.

Figure 16 – Market Share and Profitability

3.4.- Selected Financials

In order to get an idea of the financial performance of the different players inthe Spanish market, we have compiled a few financial data and ratios whosedetails can be found in the appendix.

We look at three operators in the wireline business, Telefónica de España (theSpanish fixed line subsidiary of Grupo Telefónica, non-listed), AUNATelecomunicaciones (non-listed division of Grupo AUNA) and ONO (non-listedcable operator); we also analyze three mobile phone operators: TelefónicaMóviles España, Vodafone España (non-listed subsidiary of Vodafone Groupplc) and Amena (mobile division of Grupo AUNA)16.

16 The companies we analyze are all non-listed. This limits the availability of certain data. Data are taken from

the last filings in the registro mercantil or from annual reports of the listed mother companies (which do not

always disclose full details for their subsidiaries).

35%30%25%20%15%50%10%5%0%

-5%-10%-15%-20%-25%-30%-35%-40%-45%-90%

0% 5% 10% 15%20%25% 30%35% 40%45% 55% 60%65% 70%75% 80% 85% 90%95%100%

Market share

Telefónica

MovistarVodafoneAmena

Indirect Acces PSTN operators (voice+data) Cable operators (voice+data) Mobiles

Op

erat

ive

Pro

fitab

ility

(EB

ITD

A/S

ales

)


First we shall compare the sales of each of the three companies over the lastfour years and their profitability in terms of return on sales.

Then we will turn to the level of debt expressed by debt over equity ratio andprofitability of the firms as measured by return on equity. In both cases we usebook value for the equity.

Finally we look at the level of investment in fixed assets over the last threeyears.

Except for the sales figures, we express all the other measures in ratios dueto the limited comparability of absolute figures for firms of very different sizes.

3.4.1. Wireline Operators

The land line telephony business is a very unequally distributed one inSpain. Telefónica de España (TdE) clearly dominates the market and thistranslates directly into profitability numbers. TdE’s sales are more than 10times those of its closes competitor, AUNA Telecomunicaciones. Due to ahigh number of companies active in this business, competition mainly takesplace on price and margins, as a consequence get squeezed. The marketas a whole is very mature and hardly growing, so competition is all abouthow to steal market share from TdE; for TdE the name of the game is cus-tomer retention.






Figure 17 – Sales and ROS in the Wireline Business: TdE, AUNA and ONO (2000 –

2003)

While TdE’s sales are slightly declining, its margins get ever thinner; its ROSdrops from 10.5% in 2001 to 1.7% in 2003.

In H1 2004 TdE revenues grew 2.2% YoY to 5,399.4 million euros. A big chunkof its revenues, 3,524.9 million euros, still proceed from traditional services(customer network access and voice) but are in decline of 139.4 million euros.Thanks to its customer retention effort, the decline rate has slowed as com-pared to 2003. The fastest growing revenue segment (+33% YoY) is Internetand broadband access, mainly ADSL, with revenues of 530.5 million euros. Onthe cost side, operating expenses are on a slight decline (-0.4% to 2,971.3

1999 2000 2001 2002 2003 2004

40%

20%

0%

-20%

-40%

-60%

-80%

ROSSales and return on sales

-20.4%1,076.0

27.1%358.6

-40.4%849.0

-52.3%925.0

-76.8%253.4

-151.1%143.6

TdE (wireline Spain only) AUNA Telecom ONO(1) Profitablility over Sales(2) Sales in Millons of euros

2.4% (1)

10,012.0 (2)

105% (1)

10,222.1 (2)7.9% (1)

10,272.1 (2) 1.7% (1)

10,217.0 (2)

-242.6%51.5




million euros): personnel costs were reduced by 9.8% while costs related toan increased commercial effort rose by 14.2%.

As a consequence, EBITDA rose by 6.2% to 2,487.5 million euros. Net resultwas nevertheless down by 42.9% to 325.4 million euros due to extraordinaryexpenses for the 2003-2007 Redundancy Program (611 million euros). ROShas improved to 6% though.

AUNA has growing sales, +9% in 2002 and +16.3% in 2003. 2003 is also thefirst year in which AUNA posts a positive EBITDA of 124 million euros, but dueto high depreciation costs, its net result remains negative, hence the negativeROS of -20.4%. In the first half of the year 2004 AUNA Telecomunicacionesreached revenues of 583 million euros (+18% on H1 2003) and an EBITDA of79 million euros (+201% on H1 2003). Net results are not communicated atthis time.

ONO, as compared to TdE or AUNA, has tiny but fast-rising sales (+76% in2002, +41% in 2003). Its initial heavy losses are due to big investments andlow sales, but with the former decreasing and the latter rising, its ROS has ste-adily improved to become positive in 2003 and reach an impressive 27.1%.ONO’s revenues keep growing fast with H1 2004 revenues of 214.1 millioneuros (+30% YoY) and EBITDA growth of +156% YoY. ONO builds its growthon expansion of its customer base and priority on broadband access sales atprices below Telefónica’s (€ 30/Month). At the same time ONO is trimming itsrefinancing cost by rescheduling its debt and converting part of it into equity.Net results are not available for H1 2004.




Figure 18 - Debt Ratios and Return on Equity in the Wireline Business

None of the three companies above are listed, which is why we use book valuefor shareholder equity when we calculate Return on Equity. It stands out againthat TdE is the more mature company insofar as it displays the least volatilityboth in its ROE and D/E ratio. AUNA Telecomunicaciones is struggling to getdebt and profitability under control. ONO has made tremendous efforts inreducing debt and increasing equity. It makes perfect sense get sound finan-cial as ONO is planning to go public in 2005.

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

High level of debt D/E Low level of debt

40%

20%

0%

-20%

-40%

-60%

-80%

Debt and profitability

2001

2003

2002

2000

20002002

2001

2002

2003

AUNA Telecom ONO TdE (wireline Spain only)

ROE




Figure 19 - Wireline Capital Expenditures

The wireline business is a capital intensive one; estimates vary from 50 to 150euros per meter of cable laid. Evidently the three firms above depart fromvery different positions: TdE only needs to maintain its network or upgrade itpartially while AUNA and ONO are still laying new cable. In 2001, both firmsspent more in capital expenditure than they sold; obviously they could not beprofitable.

But whatever the starting position, the trend goes towards decreasing capitalexpenditures. TdE officially states it wants to become a less capital intensivefirm and ONO has recently been growing through acquisition of smaller ope-rators with existing networks.

18.6%

250%

200%

150%

100%

50%

0%

2002 2003

Investment in fixed assets

122.1%

227.1%

16.8%

65.0%54.0%

13.8%

43.2%52.4%

TdE (wireline Spain only)AUNA TelecomONO

Cap

ital E

xpen

ses

(CA

PE

X)/

Sal

es

2001




All in all, the wireline business is not a very lucrative one. To begin with, capi-tal expenditure in the cable business is much higher than in other networks’technologies such as satellite or wireless telephony. Investment needs to befinanced by high levels of debt and have long payback periods.

The incumbent operator is very powerful, both operationally - thanks to itsexisting network - and financially. The technical superiority of fiber optic cablehas been reduced since the introduction of ADSL and therefore does not allowfor premium prices for data speed.

Finally, the revenue model yields decreasing margins as the trend towardscommoditization of data transportation goes on.

3.4.2. Mobile Telephony

The picture in mobile telephony is somewhat different. To begin with, there areonly three major operators in Spain. Here again, the subsidiary of GrupoTelefónica, Telefónica Móviles España, has a considerable market share, but ithas no cost advantage over its competitors. Its biggest competitor, VodafoneEspaña, is part of Vodafone Group Plc, the biggest mobile phone operator inEurope and therefore also has considerable financial firepower.


Figure 20 - Sales and ROS in the Mobile Business: Telefónica Móviles, Vodafone

España and Amena

Note: Telefónica Mobiles España (TME) is a 100% subsidiary of Telefónica Mobiles SA; in the unconsolidated finan-

cial statements TME posts a for extraordinary charges (writedown of 3G licences) which makes its net result nega-

tive in 2002. This, in turn, results in negative shareholder capital in the unconsolidated balance sheet of TME in

2002 and 2003 (therefore, no significant ROE or D/E could be calculated).

The three companies have considerable sales and all three are profitable. Thelatecomer Amena has been growing fastest over recent years and its profita-bility steadily improving.

In H1 2004, Amena posted revenues of 1,456 million euros (up 19% YoY) andan EBITDA of 460 million euros.



1999 2000 2001 2002 2003 2004

40%

20%

0%

-20%

-40%

-60%

-80%

ROSSales and return on sales

Telefónica Móviles España (uncons.) Amena Vodafone España

-54.0%835.7

-4.4%2,599.2 -8.0%

1,497.0

4.6%2,193.0

6.6%2,193.0

49.5%6,770.0

15.9%4,874.7

17.8%5,840.9 18.2%

3,000.6

24.8%7,495.5

17.7%3,320.0

Pro

fitab

ility

ove

r S

ales


Telefónica Móviles España increased its revenues by 12.5% to 3,904.0 millioneuros and its EBITDA by 9.7% to 2,058.7 million euros. The number of custo-mers is down to 18.639 million after elimination from the count of 1.3 millioninactive prepaid customers; the number of contract customers increasedduring the same period.

Vodafone Group PLC closes its fiscal year in March; no data for H1 2004 forVodafone España are available.

Figure 21 - Debt Ratios and Return on Equity in the Mobile Business



3.0 2.5 2.0 1.5 1.0 0.5 0.0

High level of debt D/E Low level of debt

70%

60%

50%

40%

30%

20%

10%

0%

ROE

Telefónica móvilesEspaña (uncons.)

Vodafone España

Debt and profitability


All mobile operators continue in their effort of gradually reducing their debtwhich most of them underwrote at the peak of the telecom hype in 2000 inorder to acquire UMTS licences.

While cutting costs and reducing debt, investment in fixed assets are spreadover longer periods of time. This is especially visible in the gradual way alloperators unfold their 3G antennas.

Figure 22 - CAPEX Expenditures in Mobile Telephony

AUNA Group, which is active in both the fixed line and mobile business, is agood example of the different levels of attractiveness of the two businesses.Within AUNA Group, AUNA (the cable company) still struggles to become pro-fitable, Amena (the mobile arm) displays positive results since 2002. The mobi-



7.5%

60%

50%

40%

30%

20%

10%

0%2002 2003

Investment in fixed assets

11.0%

49.9%

7.7%

29.1%

16.3%

7.0%9.0%

Telefónica MóvilesEspaña (uncons)

Vodafone EspañaAmena

2001


le business’s relative attractiveness is due to its different competitive landsca-pe, i.e. the lower market share of the incumbent, the lighter investment in fixedassets and a brighter future outlook than for the landline business. On theother hand, the mobile business also has the downsides of a very dynamicmarket: technologies are changing constantly and with every new technologythe market leader can theoretically be challenged. Investment in a given stan-dard can either bring first-mover advantages or financial ruin. Hence, with thechoice of a market or technology, a firm also chooses a given level of poten-tial return and risk.






4. Demand

4.1. Spanish Household Spending in Telecommunication Services

The communication budget of households has been consistently growing fas-ter than the increase of the total budget17. Telecom spending represented 1.9%of all expenses in 1996 in 2002 this figure had risen to 2.9% (See Figure 23).

The emergence of new communication media such as the mobile and Internetduring the ‘90s has led the household to assign a higher proportion of itsexpenses to communication.

Figure 23 - Household Spending Growth (YoY), Telecom Spending Growth (YoY),

Proportion of the Telecom Expenses within the Total Budget (Righthand Scale).

Growth in Real Terms.

30%

25%

20%

15%

10%

5%

0%

-5%

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

1995 1996 1997 1998 1999 2000 2001

1.2%

28.3%

0.7%

22.0%

-0.5%

6.5%

2.8%

7.1%8.9%8.2%

5.0%

13.3%

9.2%

0.0%

Total household spendingCommunciations% of total

17 INE – Continuous survey of familliy budgets.




A study undertaken by the Spanish Science and Technology Ministry18 on arepresentative sample for the 13.6 million Spanish households reveals thefollowing distribution for fixed phone line, mobile phones, pay TV and Internet(See Figure 24):

Figure 24 - Penetration Rates

Interestingly enough, although only 25.4% of the households have Internetaccess, the same study reveals that 43.4% have a computer. The Internetpenetration rate among Spanish computer owners is thus 58.5%.

Surveys based on telecom invoices show that for these four communicationmedia, the Spanish households spend most on their mobile phones (2003).Graph (See Figure 25) shows that the families that have all four media payslightly more for their mobiles than for their fixed line.

18 Study on the demand for telecommunications and information offered to the residential segment of Spain,

first were (July - September 2003) - Main Results, Ministry of Science and Technology, red.es.

90.2

75.4

19.225.4

InternetPay TVMobileFixed Phone

% of households (base13.6 million)

100

80

60

40

20

0




Figure 25 - Spending per Service

On the other hand, if we compare households that have only a fixed line (nomobile) with those that have only mobile telephony (no fixed), the surveyshows that the latter spend more than twice on their phones (€60.2/month)than the former (€24.2/month). The willingness to pay for mobility is thus sig-nificantly higher than for comparable fixed line services.

The second section of the red.es survey shows a relationship between thenumber of services subscribed and certain demographic variables such asincome, age, level of education and place of residence (rural vs. urban).

28.6 29.226.4

20.4

InternetPay TVMobileFixed Phone

Monthly Spending (euros)

40

30

20

10

0




Figure 26 - Number of Services Subscribed

Most Spanish households (41.3%) have a subscription to two services, typi-cally a fixed and a mobile phone. The study shows a positive correlation bet-ween the number of services subscribed and, household income; number ofpeople in the household; number of children in the household; size of the cityin which the household is located.

At the same time, the interest and importance expressed for new technolo-gies in daily life, at work, in education and in social relations are a positivefunction of level of education and socio-economic class.

On the other hand, interest is not as pronounced with older people and thevariable ‘residence‘ does not seem to be of statistical relevance.

Proportion of Households Subscribed to 1 or more Services

No service1.5%

1 service. Typicalprofile: Fixed 25.6%

2 services. Typicalprofile: Fixed+Mobile

41.3%

3 services. Typical profile:Fixed+Mobile+Internet

24.2%

4 services. Typical profile:Fixed+Mobile+Pay TV+Internet

7.4%




4.2. Estimate of New Product Consumption and ConsumerReaction to Product Bundling

The marginal willingness to pay for an additional service decreases sharplywith the number of services subscribed. On average the consumer pays €37,2/month for the first communication service, the difference in total spen-ding between the third and fourth service is only €4/month (See Figure 27).Thus bundling makes the consumer buy more services but pay less and lessfor any additional service. Bundling makes sense in order to gain market sharebut entails decreasing margins.

Figure 27 - Average Bill per Consumer According to Services Contracted (in Euros)

37.2

60.8

84.5 88.5

4 services3 services2 services1 service

Euros100

80

60

40

20

0


Figure 28 - Average Monthly Spending per Service (in Euros)



37.230.4

28.2

22.2

4 services3 services2 services1 service

Euros50

30

10

-10


5. Industry Outlook

In this section we analyze future possible scenarios in the telecom sector. Wethink that the main changes in this market will take place in the fixed line sec-tor due to the gradual replacement of switched circuit technology (the classictelephone line) by VoIP transmitted through the Internet accessed by broad-band connection. For this reason, and perhaps due to the development ofinteractive services such as video on demand, we will witness an increasingpenetration of broadband connection through both ADSL and cable techno-logy. Who will be the winner? Will those technologies coexist in the market orwill one of them prevail over the other?

UMTS is likely to be the mobile counterpart to fixed line broadband access(ADSL and cable). The combination of mobility and broadband access allowsoperators to offer a set of services that they could not sell before. The mobilehas a penetration of over 80% in Europe which makes it the device of choicefor the development of the information society.

We will start by looking at the different technologies available in the market-place and confront them with the contents that can be provided through them.This will help us find out if there is a dominant design for each of the givencontents.

We will then analyze the dynamics in the markets of these technologies and tryto look at the different possible strategic set-ups for the players in each market.

5.1. Content, Technology and User Expectation

As mentioned above, we believe that in the future, what will drive the businessis content, not so much how content arrives to the user. That is why we try tofind out which is, for the currently available contents, i.e. voice, live images,messaging, music, movies, games and e-commerce, the most appropriatetechnology to convey it to the customer.

With time, we will most probably see a dominant design in the media that willrender the content. In order to project which of the currently available techno-logies impose themselves as compelling (or dominant), we will first addresscontents with the media available and analyze the technological fit. Then we






will proceed to the analysis of what characteristics the general public asks forwhen accessing content. From there we will develop a most likely scenario ofdominant technology.

5.1.1. Fit Between Content and TechnologyIn the following matrix we analyze the fit between the currently available con-tents and their supporting media. For each of the combinations we rate thefollowing characteristics: mobility, quality, convenience, speed, price and avai-lability. The scale reaches from “LF” (low fit) to “OF” (optimum fit).

Explanatory Notes:

(1) Quality refers to the quality with which the content can be enjoyed, i.e. sound quality, resolution.

(2) Convenience measures the adequacy between medium and content or the comfort with which the content can

be enjoyed. For instance, we consider that watching feature movies on a small mobile phone display is not very

convenient.

(3) Speed refers to the velocity with which the data arrive at the medium.

(4) Price: OF (optimum fit) = cheap to the customer, LF (low fit) = expensive.

(5) Availability is conditioned by existence of the infrastructure.

MobilityQuality (1)Convenience (2)Speed (3)Price (4)Availability (5)MobilityQuality (1)Convenience (2)Speed (3)Price (4)Availability (5)MobilityQuality (1)Convenience (2)Speed (3)Price (4)Availability (5)MobilityQuality (1)Convenience (2)Speed (3)Price (4)Availability (5)

Coppercable +ADSL

Opticfibercable

Satellite

3GMobile

VoiceLive image

(videoconference)

Messages(e-mail, SMS)

Music(download,streaming)

Movies(download,streaming)

Games(download,multiplayer)

e-commerce

LF LF LF LF LF LF LFOF LF OF OF AF OF OFAF AF OF OF AF OF OFAF AF OF OF OF OF OFOF OF OF OF OF OF OFOF AF OF AF AF AF AFLF OF LF LF LF LF LFOF OF OF OF OF OF OFAF OF OF OF OF OF OFOF OF OF OF AF OF OFOF OF OF OF OF OF OFLF LF LF LF LF LF LFOF OF - - LF - -OF OF - - OF - -OF OF - - OF - -AF OF - - OF - -LF LF - - AF - -LF LF - - AF - -OF OF OF OF OF OF OFAF AF OF OF AF OF OFOF LF AF OF LF AF AFAF AF OF AF AF OF OFAF LF AF AF LF AF AFOF OF OF OF OF OF OF

LF (low fit) AF (average fit) OF (optimum fit)


For Copper cable, we consider availability of voice universal (optimum fit, OF)because the fixed phone has over 90% penetration. In the case of contentsrequiring a broadband access, we rank availability 2.

In the case of the satellite, we consider voice and videoconference over amobile device and movies on a home TV set, which explains the mark formobility. We do not consider Internet via satellite because of the limited bidi-rectionality of the signals.

5.1.2. User’s Expectations and Content-Technology Mix

Beyond the purely technological fit between content and medium, we will havea look at what customers are looking for when accessing a given content.

Figure 29 - Users’ Preferences for Content Access

The first conclusion that can be drawn from looking at the two matrices isthere is a division between mobile and stationary access. This divide is tech-nological but also exists in customers’ preferences. Mobility often comes atthe price of lower convenience e.g. smaller pictures or uncomfortably smallkeyboard.

In stationary technologies, both ADSL and cable are very close in the featuresthey offer, the only major difference is their respective theoretical data trans-mission capacity. Although most commercial offers today are far from rea-ching the technological limits, ADSL allows transmission at up to 8 Mbps while



VoiceLive image

(videoconference)

Messages(e-mail, SMS)

Music(download,streaming)

Movies(download,streaming)

Games(download,multiplayer)

e-commerce

MobilityQualityConvenienceSpeedPriceAvailability

• •

•• • •

•• • •

• •

•

• •• • •

• •• • •

•

• • •• ••

•• •

• • •

•

• •

• • •

• Desirable • • Higher preference • • • Most important




fiber optic cable can transport data at 100Mbps. The limits of ADSL mightbecome an obstacle in very data intensive transmissions (high quality strea-ming or video on demand in DVD quality).

The download time of a DVD (4.7 Gb) at maximum speed with ADSL (8 Mbps)is 1 hour and 20 minutes; with Cable (100 Mbps), it’s 6 minutes.

The satellite does not qualify as an acceptable stationary transmission modefor interactive content because it currently does not allow speedy data uploa-ding. It only proves to be a very good medium for digital TV whenever layingcables does not make economic sense.

Making abstraction of financial considerations, fiber optic cable stands out asthe superior technology for stationary content providing. It permits delivery ofany kind of content at extremely high speed.

Taking into consideration commercial factors, ADSL technology has the greatadvantage of using the existing telephone network and thus has greater reachin Europe than cable.

The mobile terminal with broadband capacity seems to be the ideal voice andmessage communication tool but can also serve as entertainment mediumwhile on the move (music and games). The only purpose it does not seem tofulfill is that of a mobile TV, first because of the small format of the screen butalso because it might prove to be very expensive to download an entire movieonto a mobile device as long as pay-by-minute or pay-per-Kbyte remain thepredominant billing modes. The question with 3G mobile telephony is notwhether it will be adopted but how fast it will become popular and what stra-tegies the operators will use to that aim.

Before we enter into considerations of how fixed line and mobile accessmight coexist or compete, we will have a look at the trends in the distincttechnologies.




5.2. Possible Future Scenario in Fixed Line Business

In the fixed line voice business, three major trends can be identified:

1) The above mentioned loss of market share of the incumbent operator;2) A substitution effect by which the user makes increased use of his

mobile phone;3) The emergence of a disruptive technology, Voice over Internet

Protocol (VoIP).

As we have already described the first point at length, we will subsequentlyfocus on the substitution effect and on VoIP.

5.2.1. Substitution between Fixed Line and Mobile

Substitution of fixed line voice communications by mobile communication is asteadily growing phenomenon. It is interesting to highlight that a high pene-tration rate of mobile phones is a necessary but not sufficient condition forhigh substitution rates (See Figure 30). Italy displays the highest penetrationrate (94%) and the highest substitution (51%), followed by Portugal (83%;39%). Germany has relatively low penetration (73%) and low substitution(6%). On the other hand, France has a high substitution rate (23%) given itsrelatively low penetration (65%). In Sweden we observe the opposite: highpenetration (89%) and low substitution (9%).




Figure 30 - Penetration Rate vs. Substitution

Sources: (1) International Telecommunication Union, (2) The McKinsey Quarterly, 2004 No. 3.

In Spain, mobile phone penetration and substitution go hand in hand. A goodindicator of the increasing substitution effect is the growing percentage ofconversation minutes spent on the mobile in the total number of minutesspent on the phone (See Figure 31). Although growing in absolute terms until2002, the traffic minutes between fixed and fixed loses importance as propor-tion of total telephone traffic. In 2003 we see the fixed-to-fixed traffic fall forthe first time, while mobile-to-mobile confirms its growth in traffic and share.In 2000, traffic implicating a mobile phone (either as initiator, as receiver orboth) stood at 28%; in 2003 it represented 40.7% of all conversations.

60

60

50

40

30

20

10

0

65 70 75 80 85 90 95 100

Penetration rate: number of mobiles per 100 inhabitants (2002)

FrancePortugalSweden

GermanySpainCzech RepublicTrendline

ItalyUKFinland


Figure 31 - Traffic Between Fixed and Mobile Telephony

Source: CMT.

5.2.2. Emergence of Voice over IP

VoIP has two major drivers: broadband access and cost. The first is a necessarycondition for VoIP to work properly, but as we can reasonably expect growingbroadband penetration, generalized VoIP use is only a question of time. Theother way round, the causality can potentially be turned around: if the generalpublic becomes aware of VoIP as a convenient means to save on their telepho-ne bills, the demand for VoIP might become the driver for broadband access.

Currently, awareness for VoIP is higher in the business community than at con-sumer level. Many firms have already identified the cost saving potential ofVoIP and have started replacing their circuit switched telephone installationsby VoIP devices.



Fixed to fixedFixed to mobileMobile to fixedMobile to mobile

100,000

80,000

60,000

40,000

20,000

0

2000 2001 2002 2003

12.8%

8.0%7.2%

72.0%

15.2%

8.9%

7.2%

68.7%

19.0%

8.9%

7.2%

64.8%

25.1%

7.9%

7.7%

59.3%

Traffic inmillion

minutes


5.2.3. Consequences of Substitution and VoIP

The concurrence of both effects, substitution and VoIP considerably accelera-tes the obsolescence of POTS and translates itself in an inexorable pricedecay for the traditional voice business. We envisage a transition from circuitswitched voice to VoIP in a three stage process:

· First, local calls will drop in volume (especially for the incumbent) aspeople increasingly use either cheaper alternative operators or theirmobiles for voice communication. The local access will be used in afirst stage to access the Internet via dial-up connection (narrowbandaccess). In stage two, narrowband access will gradually be replaced bybroadband access; the local loop will be used by ADSL technology.

· National calls also will be transferred from the incumbent to its chea-per competitors or to the mobile phone.

· International calls experience the fiercest competition, prices have alre-ady dropped dramatically and incumbents have seen their market sha-res shrink tremendously.

In stage 2, the consumers will replace dial-up Internet access by broadband,which is the necessary condition for stage 3, the large scale roll-out of VoIP.Gradually all landline telecommunication will pass through VoIP. At the sametime, if by then 3G mobiles are common and massive data transfer is possi-ble, mobiles also could be reached via VoIP, revolutionizing the billing modelin mobile telephony towards a flat-rate model or a pay-by-Mbyte model.

Figure 32 -Substitution Effect in Fixed Line Telephony



Phase 1 Phase 2 Phase 3

Local calls

National calls

International calls

Alternative carrier

Mobile

Internet Narrowband

Alternative carrier

Mobile

Internet Narrowband

Internet Broadband

VolP

VolP

VolP


How can fixed line carriers respond to the decline in revenue from POTS? Thefirst thing to be aware of is that landline voice transmission is a commodity, nomatter if it is circuit switched or packet switched. As aforementioned in ourvalue chain analysis, we believe that the answer lies in moving along the chainmore towards the customer.

A possible strategy for incumbent carriers we already observe in France, forinstance, is the “forward leap” strategy. It consists of acknowledging that theadvent of VoIP is inexorable and therefore one has to be the first to offer it inorder to gain a first-mover advantage. When aiming at residential customers,the incumbent can bank on its brand and established customer base to mar-ket VoIP before any other smaller competitor does. At the same time, it canmarket broadband access and VoIP as a package if regulation allows it. Therevenue model changes from a traffic oriented billing to a flat-rate model wheremarket share is the key success factor. Incumbents are in a unique position ofleveraging on their existing customers and should therefore move fast.

The other facet of the strategy is to offer VoIP solutions, rather than onlyaccess to a network, to its corporate customers. This implies a strategic repo-sitioning from telephone carrier to telephony solution provider. Here again, thesource of revenue will move away from consumption. The revenue drivers willbe telecommunication consulting, hard- and software providing and added-value services. Again, penetration is key, but even more so will be innovationin services and products (especially in software).

Another strategy, which Telefónica uses, is the customer retention strategy. Inorder for customers to continue paying at least the monthly subscription rate,Telefónica tries to sell as many ADSL connections as possible. The customermay stop using his fixed line phone but he still needs the line to get broad-band access. The strategy has one problem: broadband access is the firststep towards VoIP. Therefore, if Telefónica is not the VoIP provider, some com-petitor might capture Telefónica’s broadband customers.

5.3. Broadband Outlook

Internet broadband access is still perceived by many as too expensive; othersalso ignore its benefits. In Spain the average price for broadband access isaround 40 euros, while the average household spending on Internet access is






20.40 euros. Despite that fact, Spain leads the rest of the European countriesin terms of broadband percentage penetration of households with Internetaccess (see table below).

Generally speaking, broadband penetration is higher in smaller countries suchas the Netherlands (24%), Belgium and Denmark, where the telecom marketis more competitive than in bigger European countries. It is expected that bro-adband growth will be strongest in Sweden, Switzerland and Belgium over thenext several years19.

Table 17 - Broadband Households as % of Internet Households

By Country 2000 2001 2002

Spain 1% 21% 37%

Sweden 6% 18% 25%

Netherlands 7% 14% 24%

France 3% 9% 21%

Germany 3% 6% 18%

UK 1% 4% 13%

Italy 0% 5% 8%

Europe Total 3% 9% 19%

Table 18 - European Broadband Households (thousands)

By Country 2000 2001 2002

Spain 15 417 1,048

Sweden 129 429 656

Netherlands 190 504 925

France 128 546 1,520

Germany 284 834 2,848

UK 48 312 1,232

Italy 9 230 493

Europe Total 1,309 4,555 11,194

Copyright © 2002-2004 Web Site Optimization, LLC. Last modified: June 19, 2004.

19 Source: CNETnews.com.


5.3.1. What Can Be Done to Stimulate Demand for Broadband?

It might be interesting to look at South Korea, the country with the highest rateof broadband penetration in the world, to understand how this was achieved.We will first try to explain what the explanatory factors are, and then we willsee if it is possible to emulate them. In the end we want to briefly discuss ifhigh broadband access is beneficial.

In March 1995 the Korean government decided to orient the industrial deve-lopment of the country towards information technology. It established theKorean Information Infrastructure (KII) plan aimed at deploying high speed andhigh capacity networks.

The government took strong measures to foster Internet access: 1) It deregulated the industry, abolishing all barriers to entry to the market or

price regulation. This made several full service providers (FSPs) enter themarket simultaneously, setting flat-rate access prices at low levels toencourage dial-up customers to switch to broadband.

2) It helped FSPs get cheap financing (through prime rate public loans),3) Constructed broadband backbones,4) It gave broadband access to non-profit organizations such as educational

or research institutes, at the same time providing information education to10 million people to increase Internet literacy.

5) It supported R&D in order for FSPs to hedge risks in developing new tech-nologies.

6) It subsidized broadband access in rural areas and encouraged the connec-tion of all new buildings to broadband access.

As a consequence, in 2002, Korea had over 10 million broadband subscribersor 21 per 100 inhabitants, the highest ratio in the world. While much of the fastadaptation can be attributed to the government’s vigorous intervention, somefactors specific to Korea made this evolution easier.

First, Korea has a highly dense urban geography, making it easy for broad-band suppliers to achieve economies of scale.

But furthermore, Koreans display a marked preference for entertainment overthe Internet, network games and IP telephony.




The investment in IT brought several economic benefits. To begin with, Koreaovercame the 1997 Asian financial crisis with an astonishing velocity.

Second, while the Internet continues to make heavy losses in most parts ofthe world, in South Korea the web has started to make money. Internet-rela-ted transactions amounted to 170,000bn Won ($148bn, Euros 126bn, £89bn)in 2002, or nearly 30 per cent of gross domestic product, according to thenational statistics office20. One of the sectors that most benefited from theInternet is e-tailing, with cybermalls alone showing turnover of around $500million in September 200321.

Since the beginning of the program, at least $14bn of public and private sec-tor money was plowed into the project.

The Ministry of Information and Communication (MIC) announced in August2003 it will equip the country with the broadband convergence network (BcN)that provides the world’s fastest Internet connection speed of 50-100 megabitsper second (Mbps), up from the present transmission speed of 1.5-2 Mbps.

The MIC expected that the successful implementation of the government’s ITindustry fostering strategy based on the BcN will expand South Korea’s IT-related production to 400 trillion won in 2007 and provide 1.5 million jobs. Itadded that information and communication technology industry will make up20 percent of GDP by 2007 and increase the nation’s IT-related exports to$100 billion22.

On the negative side, since the inception of the project, two FSPs have expe-rienced financial difficulties. Thrunet, the first company to provide broadbandaccess, filed for court receivership in March and was up for sale in September2003. Only one month after Thrunet, Onse Telecommunications Co, one ofSouth Korea’s small broadband Internet and fixed-line telephone service pro-viders, filed for court receivership due to a severe cash crunch. Both firms gotinto financial turmoil due to excessive levels of debt.



20 Source: Financial Times, October 9, 2003.

21 Source: Retail Asia, November 2003.

22 Source: Korea Times August 26, 2003.




In 2004, Hanaro Telecom, the second biggest player in Korea, had to be resu-rrected from near-bankruptcy by a group of investors led by U.S. insurerAmerican International Group.

Is Korea’s example replicable? Following Korea’s example would entail amuch higher financial commitment and a much stronger interventionist orien-tation on the government’s behalf. For several reasons, we believe that theKorean example is not a way suitable for the Spanish market.

First, by choice, governments in Europe have decided to let free market dyna-mics rule the telecom industry within a given regulatory framework. Stronginterventions are currently off the agenda.

Second, Spain is less densely populated than Korea; therefore the main cha-llenge would be to avoid the digital divide between urban and rural areas.

It might also prove difficult to convince debt-loaded telecom companies andcable operators to invest further in infrastructure, especially in areas whereeconomies of scale are hard to achieve. In light of the fact mentioned abovethat two million Spanish households already have cable access but only 30%are actually connected, further investment does not seem to make muchsense. Instead of investing in infrastructure, the battle will have to be foughton the commercial side.

Rather than stimulating the offer, it might be more beneficial to foster demandthrough educational programs intended to increase Internet literacy.Regulation with regard to pricing and product packaging would have to berelaxed also (Telefónica is not allowed to sell DSL access under €40/monthand cannot bundle Internet access and telephony).

Broadband access can lead to regulatory measures that artificially drive pricesdown. In the UK, last May, British Telecom lowered the access price to the lastmile of its network by 70% of other ISPs, following indications from Ofcom,the British telecom regulatory body, that in the event of overcharging for thelocal loop, it might break up BT’s wholesale business.


5.3.2. Broadband Strategy

Broadband access providers can gain market share through action on price orthrough the nature of the service they offer.

In response to the perception of too high a price, access providers couldcome up with alternatives to the flat rate pricing model.

In Italy, for example, since the beginning of 2004 the incumbent Telecom Italiasells prepaid DSL access packages (€50 for 25 hours) and DSL access by thehour (€2 per hour), thereby leading innovation in European broadband pricing.Other Italian ISPs followed suit, slightly undercutting TI’s offer. Obviously, thisstrategy has the disadvantage of accelerating the downward price spiral.Nevertheless on September 9th, Telefónica applied for authorization from theCMT to commercialize a new ADSL offer for €9.90/month, giving 11 hours ofbroadband access to the subscriber; every additional hour costs €1.45.

Increased penetration can also be achieved through the promotion of thebenefits of broadband access. Triple play offers (broadband as gate to theInternet, digital TV and VoIP) should be the “killer application” that will stimu-late the demand for broadband. The ingredients for a successful implementa-tion of this strategy are: strategic alliance with content providers; the regula-tory freedom to offer bundled products; critical size and critical mass in termsnumber of customers.

The war for broadband customers will probably be a battle between cableand ADSL. At the moment, in Spain, the incumbent who owns the telepho-ne network is heavily regulated and has to give access to competitors atgiven prices. Once these regulatory barriers fall, alternative ADSL providersmight get squeezed out of business and only direct access operators willbe left in the market, which boils down to ADSL versus cable.

Cable operators’ competitive edge is the technological superiority of fiberoptic cable. As a consequence, it makes sense to promote cable with data-heavy content (e.g. fast movie downloads) that ADSL cannot deliver with thesame speed. At the same time, cable operators’ customer orientation shouldbe geared towards data intensive customers, i.e. companies that provide ser-vices over the Internet.




ADSL, on the other hand, is probably only a winning bet for the incumbentoperator who owns the fully depreciated twisted copper pair network. Forthe incumbent, the challenge is to convert an outdated circuit switchedvoice network into a packet switched network while avoiding heavy inves-tments, retaining a maximum of customers and reorienting its businessfrom a commodity supply to a value-added service provision.

5.4. Mobile Telephones

5.4.1. Trends

5.4.1.1. Virtual Network Mobile Phone OperatorsFollowing a trend seen in fixed telephony, we might see the emergence ofMobile Virtual Network Operators (MVNO), operators without a proprietarynetwork who buy talking time in bulk from mobile network operators in orderto sell it to retail customers as prepaid cards under an own brand name. TheGerman consumer goods group Tchibo Holding AG continued talks withGerman mobile phone operator O2, a unit of the British-based mmO2 plc, tooffer the prepaid cards for Christmas 2004. Industry experts forecast a boomin MVNO business, mainly due to growing competition and price pressure onthe mobile phone services market.

Swedish cell phone operator Tele2 is also considering setting foot on theGerman market as an MVNO and is in talks with German anti-trust authorities23.

5.4.1.2. Trend Toward Post-Pay ContractsIn the UK, Germany and Spain, customers show an increasing preference forpost-paid contracts. In terms of the evolution of the number of customers bycontract type, it can be seen that the pace of growth in the pre-paid segment(8.3%) was much slower in 2002 than in the post-paid segment, which incre-ased at a similar rate to the previous year (21.9%).

Of the total number of new customers in the mobile telephony market, 59%contracted post-paid services, whereas 41% chose the pre-paid modality(2002). This behavior reversed the trend observed since the launch of pre-paid



23 Source: Handelsblatt.


services, and was prompted by the loyalty-enhancing policies introduced byoperators. As a result of these loyalty-enhancing policies, particularly the eli-mination of monthly subscription charges, some pre-paid customers migratedto the post-paid modality.

5.4.1.3. Clients’ Willingness to Pay for Mobile Phone ContentA study24 carried out by Nokia in nine countries25 reveals that consumers areready to pay up to 28% more than they pay for their current content servicestoday (on average €7.4, younger consumer are willing to pay up to €10 permonth) for content. Film and entertainment listings are the contents userswant to access most on their mobiles. Roughly one third of the people ques-tioned would accept a flat rate with unlimited access, while only 9% approveof a pay-per-Kb model, which obviously appeals more to the content provi-ders. Also there are significant differences among age groups. Willingness topay declines with age, while older customers tend to need more educationand hand-holding.

This is a challenge for content providers to customers in mature marketswhere the population is aging and is more affluent than younger segments.

5.4.1.4. ContentContent has to be marketed, unlike voice which sells by itself. Moreover, ithas to be traffic generating. Stand-alone games generate one-time down-loads, but multi-player games generate additional traffic between users. Onthe other hand, it has to respond to mobile needs and respect the limits ofmobile technology. So far there is no single “killer application” and expertsexpect very few applications to reap a market share of over 20%. You haveto consider that the younger users are most open to new mobile serviceslike MMS, chat, picture and ring tone downloads and games. At the sametime they are the most price sensitive segment. In a market that reachessaturation (over 80% penetration) a long term strategy for content-provi-ding mobile operators is customer education at a young age and makingthe customer loyal to content as his willingness to pay for content increa-ses with age and income.



24 Source: CNET 2004, Nokia.

25 USA, UK, Germany, France, Denmark, Estonia, South Korea, Greece and the Philippines.


5.4.2. Current Competitive Dynamics

As of July 2004, Vodafone, T-Mobile and Orange had launched their first 3Gofferings in the UK. The offer consists of laptop cards that allow mobileInternet access to business customers. To get Internet on the phone, theconsumer had to wait until fall. This progressive, if not hesitant launch of3G might be attributed to the operators still not knowing how the networkswill react under operational conditions26. Widespread doubts still existabout 3G-to-2.5G handovers, and introducing the data card before thehandsets might be a prudent way of testing it. The only UK operator offe-ring UMTS handsets is Hutchison Whampoa which managed to attract400,000 users (as of July’04), far off the initially targeted 1 million for theend of 2003. Its success was considerably hampered by bulky handsetswith low battery life. Its content does not seem to be up and running either;3 (the brand name under which Hutchison markets its service) has backedaway from promoting its video telephony and download service and is nowconcentrating on offering cheap voice tariffs.

As of today, it looks like we are set for a price war right from the beginning ofthe 3G introduction. The first to offer the data card in the UK was Vodafone at£85 per month for a capped amount of data. Orange followed suit with a £75flat rate offer, which in turn made T-Mobile respond with a £70 per monthcounteroffer (with a lower transmission rate though). In Italy where TIM andVodafone began selling UMTS in May 2004, the price war already wages onhandsets; while Vodafone offers terminals at €649 and €599, Hutchison bru-tally undercuts these by offering entry level handsets at €90 and €108, barelymore expensive than second generation phones.

Given that 4G technology is being tested around the world, and could beginto be implemented in some countries in 2012, rolling out 3G services cannotcome fast enough. The hope of many mobile phone operators is to keep incre-asing ARPU in an environment with cheapening price per minute in voice bypushing customers to increase data exchange. This is no sure bet; in Japan,where third generation mobile telephony was introduced in 2001, the majorplayer, NTT DoCoMo, is experiencing falling ARPU in 2004.



26 Source: Stephen Pentland, partner with U.K.-based Spectrum Strategy Consultants.




5.4.3. UMTS Outlook

Nearly four years after the first 3G licences were allocated and after an emba-rrassing commercial failure of WAP, the European mobile phone operatorsseem to turn again to UMTS. So, is UMTS the next big thing in mobile tele-phony? In order to answer this question we will look at why 2.5G flopped inEurope while i-mode was a huge success in Japan to find out which errorsmobile phone operators should avoid this time.

The global trend in mobile telephony is dropping revenue share in voice andan increase in data communication. Both the huge success of SMS in Europeand the rapid adaptation of data services in Japan seem to confirm this. Aftera failed attempt to sell WAP to European customers, UMTS is the second runfor data services in an attempt to (temporarily) counteract the falling ARPUfrom voice.

A good example of how data services could be made appealing to the custo-mer is the highly successful introduction of i-mode in Japan. Setting asidesome aspects which are peculiar to the Japanese society -such as low fixedline Internet penetration and high access prices, low Japanese language con-tent (in 1999), preference for being on the move and cultural unacceptabilityof loud public conversations on the mobile– there are several factors specificto the offer of the service which explain its huge success (see Table 19).

Table 19 - i-mode Japan vs. WAP Europe

i-mode Japan’s success thanks to: WAP Europe failure due to:

Strong, compelling, user-oriented content No killer application.

at launch: Banking, e-mail, games, ring tones.

Introduced by dominant player NTT DoCoMo: Low active user base.

· 60% market share in voice; vicious circle: few customers give poor

· Strong brand name and critical mass. incentive to develop further content to attract

new customers.

· Intra NTT network discounts

virtuous circle: content attracts customer

which creates more content offer.

Standard controlled by NTT DoCoMo; content Theoretically unified standard; in practice

suppliers complied. some incompatibilities.


User friendly. Perceived as complicated and painfully slow.

Packet-switched: always on, voice and data Circuit-switched technology: dial-up,

at the same time. no simultaneous voice and data.

HTML: ease of adaptation for programmers. WML: powerful but complex, slower learning

curve for developers.

Marketed as useful mobile services. Marketed as the mobile Internet; creating too

high expectations.

Priced and targeted at young consumers. Highly priced and business oriented.

What can be learned from the i-mode/WAP experience to make UMTS asuccess? When NTT DoCoMo launched its i-mode service, it was the onlycompany to do so. With a market share around 60% in voice at that time, itdominated the industry and could set the IT and quality standards to be res-pected by external content providers. Europe, unlike Japan, is not a homoge-nous market with one dominant player but a set of national markets with adominant player in each of them. This makes it impossible to adopt an NTTDoCoMo strategy of controlling standards and content. For the platform stan-dards this means that the players have to agree upon one and, more impor-tant, they have to comply with it.

Due to the high investments in 3G and the necessity to recoup their outlay, itis in the interest of all operators to achieve very wide adoption of 3G in theshortest time possible. Therefore, there has to be a strong incentive for theuser to switch from 2G or 2.5G to UMTS.

There should be one or several compelling “killer applications” common to alloperators, the same way voice and mobility was the killer application of 2G.Trying to develop a proprietary closed, standard killer application, in the hopeto steal market share from rivals, will only slow down the adaptation of 3G bythe public. Possible applications would be video telephony and MMS. In 3G,MMS would be the logical successor of SMS which has gained wide accep-tance and has grown tremendously in recent years. For this to happen, its costhas to come down dramatically in terms of handsets with MMS capabilitiesand unit cost of the MMS itself.

These basic applications should be priced accessibly to assure early wides-pread adoption and high turnover. Competition, on the other hand, shouldtake place on other content: premium content, business-oriented content.




Another determining factor is the availability of affordable handsets within awide range of handsets. The most ready adopters of 3G are young peopleunder 25; at the same time these are the ones with the lowest purchasingpower. It is therefore crucial to lock in this customer base with attractive hand-set offers and make them spend on content. Due to this customer base struc-ture, UMTS services must be available to prepaid users also. Hence strongincentives must be created for users to switch their current phone for a 3Gdevice. As was the case at the beginning of the 2nd generation mobile tele-phony, operators should push their 3G offers with massive marketing cam-paigns and heavily subsidized handsets.

A differentiating factor for the operators could be high-end handsets. Themobile phone is not only a gadget but also a fashion accessory. Hencedeveloping carrier branded handsets in exclusivity with handset providerscould be an attractive way of segmenting the market and extract more valuefrom tech-enthusiasts and fashion-conscious customers with higher willing-ness to pay.

The rise and fall of 3G will depend on content. The consumer will only be readyto switch to 3G if he gets positive word-of-mouth from early adopters and willonly be ready to pay for content if it lives up to its expectations. At least in thebeginning, UMTS operators should be the gatekeepers of content, makingsure that content responds to customer needs, is easy to use and is welldesigned. On the other hand, the operator will be able to take a commissionfrom the content provider but also has the obligation to actively advertise thecontent without techno-gibberish. The big difference with voice is that the lat-ter sold by itself, while data content needs to be marketed.

From the operator’s point of view, ideal content is traffic generating, not a one-shot download. This means that content needs to be interactive or creates acommunity that exchanges information (e.g. multi-player games).

5.4.4. Fourth Generation Mobile Telephony (4G) – What does the Future Hold?

4G or fourth generation mobile telephony has a characteristic which makes ithighly speculative: as of today nobody knows what it will look like; all we knowis that it will some day follow 3G, but no standards have been defined yet anda considerable number of big and small telecom equipment providers are wor-




king on very different technologies. There seems to be a consensus on a fewpoints though.

To begin with, it will be faster than UMTS which theoretically can reach 2Mbps. Speed expectations for 4G reach from 100Mbps to 1Gbps. NTTDoCoMo announced in early June it has achieved a connection of 300Mbpswith its experimental fourth-generation network. It has managed to achieve amaximum connection rate of 300 megabits per second, and an average rateof 130Mbps, using cutting-edge wireless technologies.

But 4G will not only be faster, it will be the convergence of broadband mobiletelephony and radio access technology like WiFi or WiMax. It is expected toallow any mobile device to roam seamlessly over different wireless technolo-gies automatically, using the best connection available for the intended use. Inother words it would be “anytime, anywhere, anything” technology.

There also seems to be a consensus about the commercial availability in timeof 4G technology. Most experts believe 2010 to be the year for 4G.So what is the fuss with 4G if it does not even exist yet? Many see 4G as the“real” mobile broadband, opinion which stems from a certain disillusion about3G before it is actually unfolded completely. 3G has been promised to truemobile broadband. It turns out that instead of the theoretical 2 Mbps, the con-sumer will get 384 Kbps if things go well. At this speed, pictures are still grainyand time-lags on video conferences did not spark users’ enthusiasm. At thesame time, mobile operators have been slow in implementing and selling 3G.The disappointment is especially marked in Europe where operators are reco-vering from overpaying licences and from a telecom slump, to the point thatsome are even sceptical about 4G. The 4G buzz seems to be stronger in Asia,where China, South Korea and Japan have agreed to develop jointly commu-nications and other technologies for 4G which may lead to a unified commu-nications protocol. The three nations see in 4G the opportunity to leap aheadto define international standards and to gain technological leadership.

But we are not there yet. While this year in Europe, 3G is being rolled out,some are already working on improving its performance. A technology inten-ded to boost 3G networks to speeds between 8 and 10 Mbps, called HSDPA- or High Speed Downlink Packet Access - is currently being tested by NTTDoCoMo in Japan and is planned to be launched next year. It might become




the 3.5G choice of other operators. HSDPA is expected to allow downlink dataspeeds five times faster than the 3G networks being rolled out now. Most ven-dors are shipping W-CDMA equipment with HSDPA built in and other opera-tors are planning trials for the end of this year.

At the same time, radio access technologies are being developed by a num-ber of firms. All use Internet Protocol (IP), but while some are based on stan-dards like 802.20, more commonly known as WiMax (a development of Wi-Fisupported by Cisco, Motorola and Siemens), others use proprietary technolo-gies. Some see wireless access technologies combined with VoIP as a seriousalternative to 3G. At the moment though, it is a technology that does not offertrue mobility and a number of questions remain open: secure authentication,access authorization, charging mechanisms and billing systems need to beset up, and this, without centralization at the level of an operator as the net-work, is a patchwork of private WLANs.

5.4.5. Co-existence of Mobile and Landline TechnologyIn the medium term we will probably see a co-existence between landline net-work access and mobile access. The challenge for network operators will beto come up with a business model that offers a smooth interconnectivity bet-ween the two access methods. Ideally, the end user has only two devices: alaptop and a mobile phone, both interconnected and interchangeable accor-ding to the requirements of the moment (type of content, mobility). The win-ning operator will be the one who provides both stationary and mobile access,sending a unique bill to the customer at the end of the month charging for bothaccess and content.

5.5. Major Operators’ Strategies

5.5.1. Telefónica’s New Strategic Orientation

Telefónica is present in all segments of the telecommunication market. It aimsto provide communication solutions to respond to all the expectations of thecustomer by combining different technologies and services.

Generally speaking, the incumbent is currently trying to reinvent itself as amore customer-oriented company, moving away from being a product-orien-






ted firm. In order to achieve this, Telefónica plans to increase its sales force by25% after putting through a staff reduction plan concerning a few thousandemployees.

In the near future, selling broadband access will be the firm’s priority.

In the wireline business, ADSL is the obvious solution Telefónica is pushing.One of the top priorities is a huge effort to reduce customer loss in the fixedline business, the objective being to contain it to 3% per year. Besides acti-ve customer recuperation initiatives, ADSL is one of the defence strategiesagainst mobile substitution and cable. At the same time ADSL is the tech-nical platform that Telefónica will use to sell its content offer: Imagineo, anintegrated service with video and audio on demand, interactive digital TVand Internet access on broadband. This is a new concept of television, inwhich the customer designs his own programming. Imagineo is an exampleof Telefónica’s effort to generate revenue from added value services (SeeFigure 33).


Figure 33 - Telefonica’s Future Revenue Drivers

Source: Telefónica.

On the mobile side, the incumbent starts offering UMTS broadband accessfrom this year on.

It is noteworthy that Telefónica pushes voice and data convergence with itscorporate customers (e.g. IP-based telephony solutions) but does not do sowith its residential customers yet. Migrating the latter to VoIP would killTelefónica’s cash cow.

Internally, the group’s focus lies in cost contention and making investmentsprofitable. The declared goal is to spend no more than 9 to 12 percent of reve-nue in CapEx with a distribution of 53% for broadband and mobile and 47%for the maintenance of the traditional business (Figure 34).



Added valueAdded value

services

Connectivityservices

Newconnectivity

services

Solutions

Applicationsand content

New forms ofcommunicationinvolving NewConnectivity

Services

Greater needsof present

connectivityservices

Revenue

Today Future

New services for the digital customer

The new connectivity services that form the basis forprovision of future new Added Value Services are the key

to the future of Telecommunications Operators


Figure 34 - Telefonica’s Future CapEx Strategy

Source: Telefónica .

5.5.2. Auna

Auna positions itself in terms of image as the underdog, as the only true alter-native to the ex-monopolist. In the battle for broadband customers, Auna’seffort is centered on avoiding that people believe that broadband is equal toADSL in order to sell cable as the more effective broadband access.

Although Auna has its own fiber optic cable, it still has a high number of indi-rect access customers (946,000 preselected telephony lines). One of itsmedium-term goals is to convert these customers to direct access.

Convergence between wireline and wireless is another one of Auna’s priorities.The convergence materializes through advantageous rate plans which grantattractive prices for communications between Auna’s wireline handsets andAmena’s mobile phones. The group believes that convergence will provideAuna Group with a competitive edge, enabling it to expand its range of pro-ducts in the market, optimize costs and investments and, ultimately, to impro-ve its efficiency and productivity.

Auna also focuses on content. Having noticed the fast growth of games, it isdeveloping a network games platform, the main attraction of which is thestrengthening of the “community” factor as a key to success through sportsanimation.



2002

Maintenance oftraditionalbusiness

TransformationBroadband, fixedand Mobile

CapEx of revenue. Telefónica Group(data in percentages)

2006

34

66

13%

53

47

9-12%


In February 2003 the operator completed its range of services to individualswith the launch of the digital TV service, offering over 90 channels of everygenre, access to new movies and soccer matches with the PPV (pay-per-view)service. Shortly after, the first interactive television services were launchedwhich enabled users to send short messages from their TVs to mobile pho-nes, to chat, send emails, access games and share movie reviews.

Auna continues to focus on bundling of services for residential customersthrough its direct access network, as a means of distinguishing itself from itscompetitors.

On the UMTS side, Amena launched its offer in October 2004, with a fewmonths of delay with regard to Telefónica and Vodafone. It plans to invest 700million euros in 3G telephony and reach 95% of the population in 6 years.

Currently, Auna is in the process of being sold. There are two alternatives beingevaluated: either selling the group in an integrated way or selling the cable unit(Auna Telecommunications) and mobile phone unit (Amena) separately.

Auna has received various offers, including a $9 billion offer from Carlos Slim,owner of Telme and América Móvil.

At the same time, ONO (one of the major competitors in the cable sector) hasoffered $2.6 billion for Auna Cable. If the operation is carried out, the newcompany would compete wilth Telefonica ADSL.

Although the group’s managers are seeking an integrated sale, the decisionrests with the shareholders.

5.5.3. ONO

ONO, a pure cable operator, still has not broken even. Although EBIDTA hasbeen positive these last years, high depreciations and the service of a heavydebt keep it from reaching positive net profits.

ONO focuses on commercial effort to get as high utilization rates as possiblefrom its proprietary network. It does so by offering the triple play package:telephony, digital TV and broadband access.






At the same time the company keeps extending its network in commerciallyviable areas.

In terms of corporate customers, ONO focuses more on SMEs than its biggercompetitors.

ONO’s problem is its size. With around 700,000 customers and a limited pre-sence only in major cities, the firm will have problems to reach critical mass inorder to take advantage of both network externalities and economies of scale.That is why the company seems to have opted for external growth. In 2003,ONO acquired Retecal, a regional company. To date, ONO is in potential mer-ger talks with AUNA. Both companies plan to go public first, in the first half-year 2005 and potentially merge afterwards. Together they would have a jointdirect access customer base of around 1.4 million, becoming an increasinglyserious alternative carrier facing Telefónica.

More consolidation could be expected in the cable business as rumors circu-late about foreign cable operators, such as the American Liberty Media, beingpotentially interested in acquiring cable networks across Europe.

5.5.4. Vodafone

Vodafone pursues a double strategy which involves strategic alliances with otherbusinesses on the value chain.

First, on the consumer side, Vodafone focuses on data in mobile telephony.Vodafone did not wait for third generation mobile telephony to launch its dataservice. It has successfully launched its Vodafone Live! Platform and nowoffers the Live! service under 3G. In order to obtain entertaining content,Vodafone struck a global alliance with Warner Bros Online which will offergames, screensavers and other mobile applications.

But also on the corporate side, the mobile phone operator offers innovativesolutions in cooperation with wireline telecoms and hardware producers.

Vodafone seems to believe in fixed and mobile convergence, at least forprofessional applications. That is why Vodafone engaged in alliances withwireline network operators such as Colt, Jazztel and Sarenet to offer “wire-


less office”, virtual private network (VPN) and seamless fixed-mobile solutions.

Commercially speaking, Vodafone is moving closer to the customer byrecently striking a deal with HP which will sell its laptops in a package with theVodafone Mobile Connect 3G/GPRS card to corporate customers.

5.6. The Impact of Regulation

The Spanish regulatory framework for the telecom sector is set by the GeneralTelecommunication Law (GTL) of November 3, 200327. It is the transposition ofseveral European directives into Spanish national law28. The GTL of November3, 2003 modifies certain aspects of the previous GTL (11/1998 of April 24th).

To begin with, the new GTL institutes an “ex-post” control of the sector whilepreviously more “ex-ante”. The “ex-post” character of the control materializesin the freedom for any new operator willing to enter the market to do sowithout having to apply for an operating licence. The operator is solely requi-red to declare to the CMT its intention to set foot in Spain. Hence, the opera-tor does not have to provide much information at the moment of setting upbusiness but has an ongoing obligation of transparency and informationsupply with regard to the CMT. The Spanish telecom sector has therebybrought down considerably the administrative barrier to entry to the marketbut at the same time increased operating costs and disclosure obligations forall competitors; all multi-business companies have to present to the CMTseparate and externally audited accounts relative to their telecom activity.

But the most important novelty of the new GTL is the drop of the notion of domi-nant operator which generally referred to the incumbent. Instead, the concept ofreference markets and operators with significant market power has been inven-ted. To begin with, the CMT will look at the telecom sector and analyze it interms several reference markets (retail vs. wholesale, geographical scope etc.)whose definitions were to be made public in 2004 but will now probably take



27 Ley 32/2003, de 3 de noviembre, General de Telecomunicaciones.

28 Directives: 2002/21/CE, 2002/20/CE, 2002/22/CE, 2002/19/CE, 2002/58/CE, 2002/77/CE and decision

676/2002/CE.


place in 2005. The idea is to verify if the different reference markets are develo-ping in an environment of effective competition. Should this not be the case, theCMT will categorize, according to their market share, one or several players asoperators with significant market power (OSMP). The European Parliament andCouncil define as OSMP as “an undertaking which, either individually or jointlywith others, enjoys a position equivalent to dominance, that is to say a positionof economic strength affording it the power to behave to an appreciable extentindependently of competitors, customers and ultimately consumers”29.

This has several far-reaching consequences for the concerned operators: First, the incumbent is not always and not in every market the operator withsignificant power. This is especially true in the mobile phone market or in cer-tain geographical areas where Telefónica competes with cable operators in thewireline business.

Second, the significant power tag comes with a set of obligations that theCMT can choose to impose:

· transparency with regard to accounting practices, technical specifica-tions, characteristics of the network, supply and using conditions andprices;

· non discrimination in network access between independent companiesand subsidiaries;

· separation of accounts in a format and methodology provided by theCMT;

· access to specific network resources and uses;· price control.

Recently, the CEO of Auna, Luis Alberto Salazar-Simpson, expressed concernabout the risk of his Amena being pinpointed as OSMP which could entail thatthe CMT could regulate its interconnection prices. As of today, onlyTelefónica’s interconnection prices are regulated, giving an advantage toAmena and Vodafone.

The new GTL also redefines the financing of the Servicio Universal, i.e. the mea-sure that up to date obligated Telefónica to provide minimum telephony services



29 European directive 2002/21/EC of 7 March 2002 on a common regulatory framework for electronic com-

munications networks and services (Framework Directive).


to socially disadvantaged or geographically remote users at preferential tariffs. Sofar, Telefónica had to bear the financial burden of the Servicio Universal alone.Under the new GTL, the Ministerio de Ciencia y Tecnología can designate one orseveral telecom operators to provide the servicio universal, for different techno-logies and in different geographical regions. Financing of the Servicio Universalhas not yet been defined, but it will probably be provided by a fund, itself sustai-ned partly by all operators and partly by public funds.

The Spanish Government recently decided to maintain in 2005 the price capfor Telefónica30, a maximum price system which serves as reference to thewhole sector and is supposed to guarantee low prices for the consumer.Generally speaking, the implementation of the new GTL marks a new area forthe Spanish telecom sector. It represents the legislator’s acknowledgment thatthe sector has matured, that in certain markets free competition has alreadymaterialized and that it is time to level the playing field which so far containedartificial hurdles for the incumbent. As a consequence, although legally spea-king it will be easier to set up shop because no more licence is required, sma-ller new entrants to the market will hardly have a chance to compete againstthe established champions. New business will therefore either come fromniche players or from big foreign companies with the necessary depth of poc-ket to initiate operations.



30 Source: Gaceta de los negocios, August 11, 2004.




6. Appendix

6.1. OECD Survey Methodology

NEW OECD MOBILE BASKETS

Usage is split into three baskets: low usage, medium usage and high usage.Basket definitions:No. of outgoing of which to fixed

Basket number of calls percentage that go percentage that go SMS

to fixed phones to mobile phones

Low usage 25 42% 58% 30

Medium usage 75 36% 64% 35

High usage 150 40% 60% 42

· Each basket also has a unique definition of time of day distribution andcall duration, and includes the monthly rental, and any registrationcharges distributed over three years.

· The two most prominent operators in each country are covered, basedon available subscriber numbers. All relevant packages from each ope-rator are considered, but the final results presented here only show thecheapest package for each basket.

All baskets will include:· Registration or installation charges with 1/3 of the charges, i.e. distri-buted over three years.

· Monthly rental charges and any option charges that may apply to the pac-kage, or package combination.

The three new baskets are:· Low user basket: the usage level of this basket is low, with a call volu-me less than half of that in the medium user basket.

· Medium user basket: this basket will have 75 outgoing calls/month.· High user basket: the usage level is about twice the medium userbasket.

The usage profiles will also include a number of SMS messages per month.




Call and message volumes for each basket are:Outgoing calls/month SMS per month

Low user 25 30

Medium user 75 35

High user 150 42

The information received showed that there is little difference between theaverage pre-paid usage and the low user post-paid usage. The low user bas-ket can therefore be used for both pre- and postpaid tariffs, allowing a simplecomparison also between the two types.

Only national calls are included in the profiles, with four different destinations:· Local area fixed line calls: this is used to accommodate the tariffs thathave separate charges for the local area. When such charges are notavailable, this proportion of calls is included in the national.

· National fixed line calls: this covers all fixed line calls outside the localarea, except in cases as noted above.

· Same network mobile calls (On-net): this includes all calls made tomobiles in the same mobile network as the caller.

· Other network mobile calls (Off-net): this includes calls to all othermobile networks in the caller’s country. When the charges are differentdepending on destination network, the market shares based on subs-criber numbers are used for weighting the charges. Up to three othernetworks will be considered in each country.

Distributions per destination for each basket are:

% of total

Number of calls Fixed Local area Fixed National area On-net mobile Off-net mobile

Low user 28.0% 14.0% 40.0% 18.0%

Medium user 24.0% 12.0% 43.0% 21.0%

High user 26.0% 14.0% 42.0% 18.0%

As the information received produced little evidence on the split between localand national fixed line calls, the assumption has been used that the ratio wouldbe 2:1 for local:national, i.e. 67% local and 33% national. This assumption istaken from the averages in fixed baskets, and the scarce information received.




Instead of splitting time and day into distinct times and days, the followingapproach will be used:

Peak time calls at weekdays, most expensive time during daytime.Off-peak time calls at weekdays, cheapest time before midnight.Weekend time calls, at daytime Sundays.

Distributions over time and day for each basket are:

% of total number of calls ToD Peak ToD Off-peak ToD Weekend

Low user 38% 35% 27%

Medium user 47% 30% 23%

High user 63% 22% 15%

There will be three separate call durations:· Local and national fixed line calls· Same network mobile calls (On-net)· Other network mobile calls (Off-net)

Call durations for each basket are:

Minutes per call Dur Fixed National Dur Mobile On-net Dur Mobile Off-net

Low user 1.6 1.4 1.4

Medium user 2.1 1.9 1.9

High user 2.2 2.0 2.1

Any call allowance value included in the monthly rental will be deducted fromthe usage value once the basket is calculated. The deduction cannot be lar-ger than the actual usage value, i.e. negative usage is not allowed. No trans-fer of unused value to next month is taken into account.

Any inclusive minutes will be deducted from the basket usage before startingthe calculation of usage cost. The inclusive minutes are assumed to be usedup with the same calling pattern that is described in the basket, i.e. the samepeak/off-peak ratio and the same distribution across destinations. Where theinclusive minutes are clearly limited to specific destinations or times of daythis will be taken into account. No transfer of unused minutes is taken intoaccount.




Any inclusive SMS-messages will be deducted from the basket before startingthe calculation of the SMS message cost, up to the number of messages inthe basket.

For each of the operators covered, a set of packages shall be included so thatthe cheapest package offered by that operator can be calculated for each ofthe three baskets.

Multiple operators in each country shall be included, with at least the two ope-rators with the highest number of subscribers in each country. The operatorsincluded shall have a total market share of at least 50% based on subscribernumbers.

Basket results are calculated for a period of one year.

6.2. Sources for Figure 10 - ARPU (H1 2004) of SelectedEuropean Mobile Phone Operators

Operator Country Annual ARPU (EUR) Source Date

Orange (FR) France 387 Les Echos 28/07/2004

France Average France 409.2 ART / le figaro 27/07/2004

SFR (FR) France 436 Vivendi Universal H1

2004 results 29/07/2004

T-Mobile (DE) Germany 276 ddp.vwd Wirtschaftsdienst 12/08/2004

E-Plus (DE) Germany 288 German News Digest 09/08/2004

Vodafone Germany Germany 309 Europe Information

e-technologies 29/07/2004

O2 (DE) Germany 367 ddp.vwd Wirtschaftsdienst 21/07/2004

TIM (IT) Italy 343.2 PMF News 04/05/2004

Vodafone Italy Italy 362 Il Giornale 27/07/2004

Hutchison 3G (IT) Italy 516 Il Giornale 21/05/2004

Telefonica moviles (ES) Spain 363.6 Reuters 27/07/2004

Vodafone Spain Spain 389.1 Cinco Dias 27/07/2004

Virgin Mobile (UK) UK 211.58 FT 30/07/2004

Orange (UK) UK 408.26 francetelecom.com 27/07/2004

mmO2 (UK) UK 415.71 AFX International Focus 21/07/2004

Vodafone UK UK 460.41 Vodafone preliminary

results March 2004 25/05/2004




6.3. Selected Financials of Major Players in the SpanishTelecom Industry

TELEFÓNICA DE ESPAÑA (fixed line business Spain only)

Millions 1998 1999 2000 2001 2002 2003

Sales 0.0 10,118.8 10,012.0 10,222.1 10,272.1 10,217.0

EBITDA 0.0 4,496.8 4,453.9 4,485.3 4,496.7 4,534.0

Depreciation 0.0 2,669.0 2,886.3 2,804.5 2,701.8 2,568.0

Financial result 0.0 691.3 626.1 403.1 398.5 450.1

Net income 0.0 -207.0 236.7 1,077.6 807.9 178.1

Long term debt 0.0 9,555.7 8,904.3 8,155.9 9,051.5 n/a

Investment in fixed assets 0.0 n/a 1,808.0 1,903.8 1,729.9 1,406.0

Share Capital 2,889.8 3,126.5 3,366.1 3,351.0 n/a

ROS -2.0% 2.4% 10.5% 7.9% 1.7%

ROE (at book value) -7.2% 7.6% 32.0% 24.1% n/a

Interest cover ratio -0.3 0.4 2.7 2.0 0.4

Debt/equity ratio (D/E) 3.3 2.8 2.4 2.7 n/a

Investment as % of sales 18.1% 18.6% 16.8% 13.8%

AUNA TELECOMUNICACIONES

Millions 1998 1999 2000 2001 2002 2003

Sales 849.0 925.0 1,076.0

EBITDA -100.0 -40.0 124.0

Depreciation 263.0 355.0 369.0

Financial result 69.7 93.4 63.0

Net income -343.0 -484.0 -220.0

Long term debt 2,000.0 2,116.0 2,873.7

Investment in fixed assets 1,037.0 601.0 464.7

Share Capital 666.8 447.0

ROS -40.4% -52.3% -20.4%

ROE (at book value) -72.6% -49.2%

Interest cover ratio -4.9 -5.2 -3.5

Debt/equity ratio (D/E) 3.2 6.4

Investment as % of sales 122.1% 65.0% 43.2%




ONO

Millions 1998 1999 2000 2001 2002 2003

Sales 0.4 6.8 51.5 143.6 253.4 358.6

EBITDA -9.0 -23.3 -55.8 -57.4 15.8 102.1

Depreciation 1.9 11.6 33.9 80.8 98.8 103.2


Net income -10.9 -45.3 -124.9 -216.9 -194.6 97.0

Long term debt 10.0 458.5 643.6 1,250.2 959.2 1,080.1

Investment in fixed assets 50.5 203.2 476.3 326.1 136.8 188.0

Share Capital n/a 632.1 410.8 745.8 720.8

ROS -666.2% -242.6% -151.1% -76.8% 27.1%

ROE (at book value) -19.8% -52.8% -26.1% 13.5%

Interest cover ratio -0.8 -1.1 -1.5 -2.1 0.9

Debt/equity ratio (D/E) 1.0 3.0 1.3 1.5

Investment as % of sales12,625.0% 2,988.2% 925.4% 227.1% 54.0% 52.4%

Telefónica Móviles España (uncons.)

Millions 1998 1999 2000 2001 2002 2003

Sales 2,835.0 3,799.0 4,874.7 5,840.9 6,770.0 7,495.5

EBITDA 1,183.8 1,346.5 1,790.9 2,817.3 3,490.3 3,940.8

Depreciation 384.8 443.5 578.0 651.0 666.4 698.1


Net income 482.9 561.1 774.4 1,043.5 -3,350.3 1,856.6

Long term debt 728.0 628.2 1,342.9 1,149.8 4,305.0 4,006.3

Investment in fixed assets 209.3 369.0 530.1 436.0 519.0 521.0

Share Capital 1,016.6 1,343.2 1,273.7 2,295.3 -2,445.0 -588.4

ROS 0.2 14.8% 15.9% 17.9% -49.5% 24.8%

ROE (at book value) 0.5 41.8% 60.8% 45.5%

Interest cover ratio 8.2 11.0 13.5 2.3 -8.1 6.3

Debt/equity ratio (D/E) 0.7 0.5 1.1 0.5

Investment as % of sales 7.4% 9.7% 10.9% 7.5% 7.7% 7.0%




Vodafone España*

Millions 1998 1999 2000 2002 2003

Sales 1,222.7 2,041.1 2,599.2 3,000.6 3,320.0

EBITDA 262.9 458.0 659.6 1,095.5 1,212.0

Depreciation 188.3 196.6 254.3 302.9 319.0

Financial result 46.8 31.4 48.9 47.9 23.6

Net income 147.8 275.0 114.0 546.0 587.0

Long term debt 588.7 604.0 596.4 3.2 30.9

Investment in fixed assets 256.0 524.0 600.0 329.9 967.0

Share Capital 568.5 716.4 991.8 1,652.3 2,239.9

ROS 0.1 13.5% 4.4% 18.2% 17.7%

ROE (at book value) 0.3 38.4% 11.5% 33.0% 26.2%

Interest cover ratio 3.2 8.7 2.3 11.4 24.9

Debt/equity ratio (D/E) 1.0 0.8 0.6 0.0 0.0

Investment as % of sales 20.9% 25.7% 23.1% 11.0% 29.1%

* Change in fiscal year end from Dec. 31 to Mar. 31. Fiscal year 2001 (Jan-Mar) not conside-

red representative.

Amena

Millions 1998 1999 2000 2001 2002 2003

Sales n/a 177.3 835.7 1,497.0 2,193.0 2,784.0

EBITDA n/a -353.7 -342.9 497.3 957.3 768.0

Depreciation n/a 36.0 135.1 277.3 301.3 358.0

Financial result n/a 3.1 51.9 103.7 127.2 111.0

Net income n/a -230.9 -451.5 -120.0 101.0 183.0

Long term debt n/a 754.5 1,588.2 2,736.5 2,569.1 n/a

Investment in fixed assets n/a 605.0 1,256.1 747.0 358.0 250.3

Share Capital 202.6 152.0 139.2 54.2 154.9 n/a

ROS -130.2% -54.0% -8.0% 4.6% 6.6%

ROE (at book value) -152.0% -324.3% -221.5% 65.2% n/a

Interest cover ratio -75.7 -8.7 -1.2 0.8 1.6

Debt/equity ratio (D/E) 5.0 11.4 50.5 16.6 n/a

Investment as % of sales 341.2% 150.3% 49.9% 16.3% 9.0%


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