reverse innovation in telecoms: the increased integration of developed and developing markets

8/6/2019 Reverse innovation in telecoms: The increased integration of developed and developing markets

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February 2011

The Delta Perspective

Reverse innovation in telecoms:The increased integration ofdeveloped and developing markets

Authors Victor Font - Group Managing DirectorDaniel Torras -Associate PartnerTammy Whyman - Principal

OVERVIEW

As the leading Management Advisory and Investment Firm specialised

in Telecoms, Media, and Technology within the Middle East, Africa,

Central & Eastern Europe and Emerging Asia, Delta Partners believes

that the telecommunications industry in emerging markets provides

significant product and service innovation opportunities to be adopted

in more advanced markets and across other emerging markets.

This white paper explores the reasons why emerging markets are

becoming more active as producers of innovation in telecommunications,

which are the key innovations, and the implications for operators and

vendors from developed and developing markets.


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A short history of reverse

innovation

After the World Wars, as technology and geo-politics allowed for the opening up of

world trade, we entered into a period of globalisation whereas Western inventions

reached economies of scale by being distributed on a worldwide basis. Eventually,

these products were slightly adapted, or de-featured, to appeal to more segments in

emerging markets. This phase of global trade is often referred to as glocalisation.

As glocalised products were not originally designed with emerging markets in mind,

there were still significant pockets of consumers in those markets who were not servedby these products, either due to price or to unattractive product features.

Over the past fifteen to twenty years, as emerging markets consumers have gained

acquisition power, local firms who understood the needs and limitations of these

consumers, and who had access to low cost production, soon began producing hit

products for developing economies. These hit products for emerging markets have

made many Western firms stand up and take notice, especially as their home markets

are stagnating. The process introducing emerging markets innovations into Western

markets has been coined by Dartmouth Professors Vijay Govindarajan and Chris Trimble

as Reverse Innovation.1 These innovations, when exported to developed nations, have

often opened up entirely new product categories that would not have existed if it werenot for reverse innovation.

In its 2003 almanac, Encyclopdia Britannica listed what

it considered to be the greatest inventions of all time.

Of these, 90% are credited as either North American

or Western European inventions. Now innovations from

emerging markets are beginning to have an impact.

EXHIBIT 1: ENCYCLOPDIA BRITANNICAS GREATEST INVENTIONS SPLIT BY REGION

(20TH CENTURY INVENTIONS ONLY)

Source: Encyclopdia Britannica 2003 Almanac

1 How GE is disrupting itself, Harvard Business Review, Oct. 2009


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Why emerging markets matter

In the last 15 years, the global telecom market has

almost tripled in size. Most of the growth has taken

place in emerging markets.

In the period between 1995 and 2010, the contribution of mobile to the global telecom

revenue pie increased from 14% to 63%. Emerging markets have been the catalyst ofthe majority of this growth. While in 1995 mobile revenues from emerging markets

represented a mere 2% of global telecom revenues, this figure had ballooned to 28%

by 2010.

In subscriber terms, the increasing weight of emerging markets is even more palpable. In

1995, only 15% of the worlds mobile subscribers resided in developing markets. By the

end of 2010, 79% of the worlds subscribers were in emerging markets. Undoubtedly,

emerging countries have been and will continue to be the engine of growth in the global

telecom market and the role that market players from the developing world will play in

the years to come will shape the direction of the industry.

EXHIBIT 2: GLOBAL TELECOM MARKET EVOLUTION, 1995-2010

Source: Delta Partners, Pyramid Research, Ovum, ITU, W TO


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Following the collapse of the high-tech bubble in 2001, many of the traditional

international consolidators from developed markets have been under shareholder

pressure to dispose of underperforming and non-core assets and adjust their regional

focus. Some of the early consolidators, such as Hutchison Telecom, KPN or NTT DoCoMo,

have abandoned or significantly downscaled their global expansion ambitions. In their

place, emerging market players such as Russias Vimpelcom and MTS, South Africas

MTN, Indias Bharti, Mexicos Amrica Mvil, and the Middle Easts Etisalat, STC, Qtel

and Zain, among others, have become true powerhouses, and have built their footprint

through aggressive M&A and licence acquisitions.

The appearance of these emerging market telecom superpowers is no coincidence. First,

these operators were producing strong cash flows from their growing home markets,

such as South Africa and the Middle East. Second, the emerging players viewed entry

into other emerging markets as less operationally risky, given their understanding of

the cultures and business practices of the regions. These factors coincided at a time

when greenfield opportunities were abundant and were snapped up by the emerging

players.

Finally, market fundamentals have added further pressure to the need to build scale.

Much of the subscriber growth in the developing world is coming from bottom-of-

the-pyramid consumers and multiple SIM card-holders that generate ARPUs in the low

single dollar digits. In addition, intensifying competition has led to aggressive tariff cuts

and hefty marketing and network investments, all of which have led to a reduction in

EBITDA margins in most parts of the world. In this context, consolidation promoted by

or involving operators from developing countries has been driven by the need to build

the necessary scale to compete effectively.

Proliferation of emerging

market challengers

At the start of this century, the global mobile market

was dominated by a handful of very large operating

groups, most of them with European roots, acting as

global consolidators. Today, the competitive landscape

has changed dramatically.


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EXHIBIT 3: MOBILE OPERATOR GLOBAL POSITIONING MATRIX, 2000 AND 2010

Note: Axis positions are indicative and not absolute

Source: Delta Partners


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In most instances, emerging market telecom innovation has been in the form of new

business models aimed at addressing profitably the needs of consumers with low

disposable incomes, as well as product offerings designed to stimulate usage of basic

and value added telecommunication services.

Reverse innovation in

telecommunications

Emerging market players in the mobile communications

space have been quite successful in building successful

regional and even global businesses, often through

innovation. But have they been successful at reverse

innovation, or at bringing those innovations to thedeveloped world?

EXHIBIT 4: BUSINESS MODEL INNOVATION DRIVERS, DEVELOPED VS. DEVELOPING

MARKETS



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While developed markets operators have traditionally focused on investing in the most

advanced technologies, and have sought competitive advantage by physically owning

the entire front- and back-end infrastructure required to provide services (e.g. passiveand active network infrastructure, customer care, IT, sales channels, etc.), emerging

market operators have taken different strategies. Some operators, faced with much lower

ARPUs and a predominantly prepaid (and thus less loyal) customer base, have resorted

to outsourcing non-core activities to achieve scalability, and turn capital expenditures

into operational costs to better manage cash flows. Other emerging players have been

able to successfully skim the barely penetrated markets by charging high price per minute

thus maintaining high margins as the business has grown.

By adopting new business models, and despite the fairly generalised drop in EBITDA

margins in most regions of the world in the past few years, emerging market mobile

operators have been able to record EBITDA margins that are on average higher than themargins of their developed market counterparts.

EXHIBIT 5: MOBILE OPERATOR EBITDA MARGINS BY REGION, 2005-2009

* APAC region includes some developed markets, e.g. Japan, South Korea, Hong Kong, Singapore, Australia

and New Zealand

Source: WCIS, Merrill Lynch, Delta Partners

(% EBITDA margin)


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The inherently different economic realities of the telecom business in emerging countries

have forced operators to look for creative avenues to tap into low revenue generating

customers without compromising profitability. In this section, we highlight those

innovations that have transformed business models in their markets and beyond.

Delta Partners selection

of innovations intelecommunications

While not all of the emerging market telecom innovations

selected may have the potential for immediate application

in developed markets, operators in developed markets

should take note of our selection.

EXHIBIT 6: SELECT TELECOM INNOVATIONS



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1. Micropayment and remittance transfer by SMART

2. OPEX and CAPEX outsourcing by Bharti

The concept In 2000, SMART was one of the worlds first tointroduce a remittance (SMART Padala) and micro-

payment (SMART Money) service aimed at the low-

income market

Theserviceexpandedtheaddressablecustomerbase,

created higher ARPUs and reduced airtime recharge

commission costs

Sincethen,manyemergingplayershaveintroduced

similar services but many are still struggling to gain

critical mass

ReverseInnovation

potential

With a worldwide potential micropayments marketof ~1.2Bn users and $700-900Bn of transfers by

20142, there is a significant drive for market players

(technology providers, financial and telecom players) to

attain a relevant position within its value chain

Operatorsindevelopedmarketscancreatetheirown

micropayment platforms to serve unbanked and low-

end segments

Micropaymentplatformscanalsoreplacetheneed

for cash which traditional debit or credit card business

models do not allow

The concept Bharti pioneered the network outsourcing model in2004 by awarding IBM a 10-year, $750Mn contract, the

scope of which is now worth over $3Bn3

Whilesomeoperatorshadoutsourcedcertainelements

of their networks previously, Bharti took the model a

step further by divesting infrastructure assets, including

active and passive elements, which was a first in the

industry

Sincethen,Bhartihasgoneevenfurtherbyoutsourcingthe building, maintaining and operating of their

networks, which essentially has turned Bharti into a

company that buys minutes from a third party

Reverse

Innovation

potential

Network outsourcing and the divestments of

infrastructure assets can radically shift an operators

business model, but caution should be taken when

setting up agreements and transferring assets and

operations, which is where most attempts tend to fail

AsmoreoperatorsadopttheOPEXandCAPEX

outsourcing model, mobile broadband networks will be

rolled out more quickly due to increased economies ofscale, thus precipitating a technology revolution

2 Delta Partners3 The Economic Times, 14 Nov. 2010


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3. Freelance sales force by Tigo

4. Location based management by Econet

The concept In 2006, Tigo Tanzania began introducing a freelancesales force to fill the gap where distributors did not

reach and where an owned sales force was not cost-

effective. The main focus of freelancers was on street

smart agents who would sell mostly voice products.

By implementing the freelance model in Tanzania, Tigo

was initially able to:

- Significantly increase effective presence in target

locations

- Address a powerful consumer decision driver in

operator selection in immature markets, namely

the availability of prepaid recharges

- Create a dynamic channel, able to capitalise on

opportunities and mitigate market trends quickly

- Provide competition between direct and indirect

channels, leading to overall better channel

performance

Reverse

Innovation

potential

Although a freelance sales force concept is not new to

developed markets, it is often used for more specialised

segments such as high end residential or SMEs. Tigos

model was innovative in that it targeted underserved

geographic regions and led to more visibility on thestreet

The concept A value-based investment method to allocateinvestment resources selectively where the pockets of

value are located. The overlay of in-depth customer

behaviour with network, sales, branding and actual

customer service performance data allows operators

to prioritise network and commercial investments for

specific segments of the market

AttheheartofLBMisthegeo-mappingofcustomer

value against specific network and distribution channel

assets (e.g. BTS, stores, etc.)

Reverse

Innovation

potential

In developed markets, LBM is most relevant for

operators looking to prioritise 3.5G and 4G network

rollout and optimise their sales channels

Indevelopingmarkets,LBMisapowerfultoolfornew

entrants that must make trade-offs between CAPEX and

time to break even, as well as larger operators looking

to improve cash flows and profitability


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5. Dynamic discount solution by MTN / Ericsson

6. One Network by Zain

The concept Named MTN Zone, it is a service designed to optimisenetwork capacity utilisation by offering consumers a

dynamic discount based on the current network load

in their coverage cell. Calls during periods when the

network is not busy are eligible for discounts of up to

100 percent, which are communicated to customers

through cell broadcast

Recognisedin2008byAfricaComastheMost

Innovative New Service of the Year

Reverse

Innovation

potential

As the amount of data transferred on mobile networks

in the US and Europe explodes and endangers overall

network quality, dynamic discounts can be applied for

mobile broadband as a way to control peak data usage

Thisisespeciallyrelevantascertaintypesofdata(e.g.

music downloads) are not time critical and can be

scheduled when there is spare network capacity

The concept The worlds first borderless mobile network, allowingZain customers to make calls at local rates across 12

countries using their home SIM card

CommentingaboutOneNetworkinSeptember2006,

The Economist said Celtel [Zains former brand name]

has, in effect, created a unified market of the kind that

regulators can only dream about in Europe4

Reverse

Innovation

potential

Creating a one network offer can quickly build a

strong and differentiated positioning for an operator,

especially in mature markets where brand strength is

the core differentiating element

Europeanoperatorswithalargefootprintcan

encourage their customers to continue to use their

home SIM when travelling without having to worry

about roaming costs. Operators will maintain share of

wallet (out of country and upon return) and can build

loyalty amongst high value segments

4 Zain press release, no date specified


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1. The Asian telecom network vendors are set to

become innovation leaders

On the equipment front, it is important to differentiate between the network infrastructure

market, pertaining to the manufacturing of access and core network components, and

the handset market. Until 2008, the infrastructure market was the larger of the two,

as operators were focused on building greenfield networks covering huge swaths of

territories, and also overlaying 3G capabilities on their existing 2G networks.

In the network infrastructure space, former North American giants Lucent, Nortel

Networks and Motorola have been acquired by their European counterparts Alcatel,

Ericsson and Nokia Siemens Networks, respectively. The consolidation among North

America and Europe-based network equipment vendors of the past five years was an

attempt by the incumbent players to defend their dominance in a stagnating global

network infrastructure market, and to compete more effectively with the Chinese

newcomers.

This consolidation, however, has not impeded Huawei from making a significant dent

on the market share of the established vendors. The combined market share of ZTE and

Huawei in the infrastructure space grew five-fold in the period between 2006 and 2009,from 5% to 26%. Today, Huawei is the worlds third largest infrastructure vendor, and it

is breathing down Nokia Siemens Networks neck for the number two spot.

Huawei has also been at the forefront of innovation in the network equipment space.

Huawei was the first vendor to commercially deploy a software-defined-radio (SDR)

GSM/UMTS network in Europe for TeliaSonera in Finland in June 2009 (ZTE, however,

claims that Hong Kongs CSL SDR-based HSPA+ network, launched in March 2009 and

built by ZTE, was the first of its kind in the world).

The future of reverse innovation

in telecommunications

While the past has helped us identify certain emerging

market innovations which could have the potential to

open new business categories in developed markets,

what does the future hold?


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2. Reverse innovation in handsets: A long road ahead

As markets have matured, operators focus has shifted to customer acquisition and

retention, and usage stimulation. In this evolving competitive landscape, devices have

played a key role as it is one of the major considerations that consumers weigh when

making a mobile purchase decision. Furthermore, the rapid pace of technological

development in the handset space, with new form factors and enhanced capabilities

being introduced at breakneck speed, has helped the handset market outpace the

network infrastructure market two-fold in recent years, and surpass it in total sales

volume since 2008.

Traditional handset makers such as Nokia, SonyEricsson and Motorola have been losing

share to the Asian vendors for quite some time. But unlike the infrastructure space

where we have not seen any genuinely new entrants for a while, in the handset market,

smartphone specialist vendors such as Apple (iPhone) and RIM (Blackberry) have grown

from virtually zero to a very respectable size. And if we consider only mobile broadband

USB modems, the Chinese dominance is overwhelming. Huawei and ZTE alone account

for over three quarters of the market by some estimates.

EXHIBIT 7: NETWORK EQUIPMENT VENDOR EVOLUTION

Source: Bernstein Research, DellOro, Delta Partners

EXHIBIT 8: MOBILE DEVICE VENDOR MARKET SHARE

Source: ABI Research, Delta Partners


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The handset space, however, has an important peculiarity that favours developed

market vendors: there is a strong trend towards convergence of networks, services and

applications. The recent rise of tablets, epitomised by the overnight success of ApplesiPad, illustrates how the boundaries between mobile phones, PCs, TV sets and music

players are getting increasingly blurry.

Companies such as Google and Apple are leading innovators in this space and provide

products and services that are software-centric but also include hardware components,

in addition to content and social networking utilities.

The innovation lead of western vendors in the handset space, however, might be short-

lived or at least challenged once again by developing market vendors such as Huawei

and others. A simple observation at the amount of R&D conducted and the number of

patent applications filed by the leading Chinese and Japanese vendors demonstrates thatAsian players are bound to exert very considerable influence in the consumer electronics

industry in the years to come.

3. Indias (and to a lesser extent Chinas) IT outsourcing

firms are gaining momentumIn an increasingly commoditised telecom market, ICT services present an opportunity for

telecom operators to differentiate, sustain growth and generate new revenue streams.

For most of the 90s and the 2000s, North American and European specialised IT

firms, many of which were offshoots of telecommunication operators, dominated the

ICT space. More recently, Indian firms such as Tata, Infosys and Tech Mahindra, and to

some extent also Chinas Huawei, have been gaining momentum, aided by the large

and inexpensive pool of human resources available to them in their home markets and

their ability to provide world-class solutions to their clients, often via managed services

platforms and offshore software development capabilities, at a fraction of the cost of

previously available alternatives. However, as long as ICT firms in emerging markets are

primarily relying on cost advantage to grow, the industry will contribute few reverse

innovations to the market.

EXHIBIT 9: TOP GLOBAL PATENT APPLICANTS

Source: WIPO, Delta Partners


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4. Infotainment will need to be wrestled away from

the developed world

As the least mature subsector of the telecom value chain, it is no surprise that much of

the innovation observed in the infotainment space has occurred in developed markets.

On the Internet front, search engines were originally conceived as directory businesses

by American companies (Yahoo!, Altavista, etc.), but it was Google that introduced the

now familiar single search box user interface and pretty much wiped out the competition.

Google then went on to further organise the worlds information and make it universally

accessible and useful with innovations such as Google Maps, Google Earth, Google

Docs, Google Realtime Search, and more. Social networking was first popularised by

MySpace and later on revolutionised by Facebook and Twitter.

In essence, most of the innovation in the area of utilities and infotainment applications

has sprung from developed markets. But in many cases developing market players have

seized the opportunity and adapted (and in some cases also enhanced) these innovations

to meet the needs of their own customers.

The Chinese online search market provides a case in point. Despite Googles world

dominance in online search, China has proven a difficult market to crack for the American

company. Only in large markets with specific language and cultural barriers will emerging

content players succeed, but that success will likely be restrained to their home turf.

Wake up call for developedmarkets

This whitepaper has established that business-transforming innovations in the

telecommunications industry are originating more and more frequently in emerging

markets, and that many of these innovations have the potential to transform developed

markets. Additionally, we have seen that emerging markets players are extending their

reach and influence across the value chain and are building their footprint through

aggressive expansion strategies.

Telecommunication industry players in developed markets, even if their strategy is to

focus on their current markets, need to realise that emerging market players will likely be

on their doorstep, either as competitors or vendors in their supply chain. One example

of an operator who is channeling innovation from emerging markets to its European

headquarters is Orange, who has built eighteen innovation centres dubbed Orange Labs,

across three continents.

With such examples of reverse innovations making their way back into the developed

markets, western operators should find a way to embrace the opportunities of reverse

innovation before their competition does.


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Delta Partnersis the leading TMT advisory and investment irm in emerging markets. With more than 160 proessionals, the

irm operates across 50 markets in the Middle East, Arica, Central & Eastern Europe and Emerging Asia. Delta Partners provides

three synergistic services: management advisory, corporate inance and investments rom its oices in the UAE, Bahrain, South

Arica, Spain and Singapore.

Advisory: Delta Partners advisory proessionals partner with C-Level executives in telecom operators, vendors and other TMT

players to help them address their most challenging strategic issues in a ast-growing and liberalising market environment in

over 50 markets.

Investments: As a und manager, Delta Partners manages an $80Mn private equity und, targeting investment opportunities in

the TMT space in high growth markets. The ocus is the Middle East, Arica, Eastern Europe and Emerging Asia. Delta Partners

private equity und leverages the frms unique TMT industry expertise to create value or its investors throughout each stage o the

investment cycle, rom deal sourcing to supporting portolio companies in driving value extraction.

Corporate Finance: Delta Partners provides corporate fnance services and has been involved in several buy-side and sell-side

telecom transactions in the region. As true industry specialists, the frm oers a dierentiated value proposition to investors

and industry players in the region. Delta Partners actively leverages i ts close link to its private equity arm to access the investor

community as well as top-level fnancial talent.

Delta Partners delivers tangible results to its clients and investors through its exclusive sector ocus on telecom, media and

technology, and a unique approach to services, combining strategic advice and a hands-on pragmatic approach.

Copyright 2011 Delta Partners FZ-LLC. All rights reserved.

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reverse innovation in telecoms: the increased integration of developed and developing markets

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