Connect the Dots

After relying for years on short-term tactical moves to thrive in the hyperdynamic telecommunications industry, telecoms could get downright existential in the years ahead. The industry as a whole is seeking answers to fundamental questions: What business am I really in? Where are the boundaries? Will I be in a completely different business in five years? If so, what will my portfolio look like?

It may be a matter of survival. Continued shifts in technology, services, competition and regulation require telecommunications companies to rethink how they interact and serve customers. No longer settling for quick-fix efficiencies, the telcos are pursuing more strategic imperatives, from reducing complexity to using new business models to extracting value from larger market boundaries.

In times such as these, a strategic vision provides a steady reminder of a firm’s ultimate objectives. In the 1980s, Jack Welch had that vision. As head of GE, he asked the top managers of GE’s wide-ranging portfolio to capture no less than a 10 percent share of new markets and seek even more markets for additional (and longer-term) opportunities. Welch required his managers to make dramatic changes in their markets (where to compete) and to devise a competitive strategy for becoming number one or two in each market (how to compete).

Today, the telecom industry is ripe for a Welch-like vision of its own. Within the next 10 years, consumers will enjoy easier access to a convergence of products and a wider variety of services, from cell-phone access to email, photo and video sharing to social networking, music and maps (see sidebar: Telco’s Future Is Calling).

Are telecoms keeping pace with the new dynamics? Some are. Many are not.

Those in the latter group still tend to view their businesses as a series of individual strategies, with items on each agenda tackled in isolation. Yet new demands require new thinking. It is time for telecoms to connect the dots— managing their businesses as a portfolio of assets and future options and making clear choices about where to compete, when to merge complementary businesses, and how to manage the portfolio for growth.

Value, Like Beauty, Is in the Eye of the Beholder
Where should your company be in the next five years? Should it be moving toward achieving a 10 percent share in select new markets, as Jack Welch envisioned for GE? Or boosting market capitalization by a definite amount? To ensure that all goals and objectives are attainable, telecom companies must know their value, and exactly where that value lies in the eyes of the market.

The capital markets typically value telecom stocks based on the firm’s ability to “deliver on the fundamentals”—attaining market-required free cash flows, demonstrating leadership within core business lines, and building momentum around a future growth story for revenues and profits. Thus, if a company generates tremendous amounts of cash but has no pipeline of future innovation, it will not be highly valued and could even become the unwitting takeover target of smaller companies. Companies that generate no cash but communicate a grand vision of future business prospects will likely be highly valued, at least initially. Failure to deliver on the promise, however, will cause the stock price to tumble.

Expectations for telecom companies in early growth markets are significantly higher than for companies in conventional markets. Consider how companies in relatively new markets have grown. Today, Google, Yahoo! and Amazon.com have a combined market capitalization of $226 billion, while the world’s three largest telcos (fixed-line and mobile telephone companies), with almost nine times their revenue, have a similar combined valuation. Although current revenues and profits may not warrant a high valuation, analysts think highly of a new firm’s ability to generate momentum around a future growth story. However, as we have seen, this growth premium tends to disappear as markets mature. The moral of the story: Set aggressive (yet attainable) value-creation objectives on the basis of your firm’s market valuation.

To illustrate this further, we turn to our recent work for a leading Asian telco we’ll call TelcoX. Operating in a fast-developing market, TelcoX faced a number of challenges. It had a mix of integrated and stand-alone businesses. It was in fixed line, mobile, broadband, enterprise, call centers and pay TV. The market perception was that the company focused on its mobile business to the exclusion of other growth opportunities. There was some evidence to support the perception. Businesses brought out competing offerings, resources weren’t allocated efficiently, and sales targets overlapped as they were set up for the same sales channels. TelcoX was also weighed down by a corporate structure with little coordination and minimum accountability, and a large and aging workforce whose limited skills made it difficult to sell new technologies and services.

To determine TelcoX’s value, we had to investigate first whether or not telcos in developing markets actually have a growth premium attributed to their stock. A classic analysis of the discounted cash flow valuation showed this theory to be largely true. Companies in emerging markets are expected to have much higher long-term free cash flows than they are currently delivering and therefore are valued at 1.4 to two times their free cash flow. China Mobile and Bharti Airtel are two examples. More established companies such as Telefónica O2 and Telstra have what is called a “negative cash-flow expectation” gap and are valued at less than (0.5 to 0.9 times) their free cash flow. The markets do not expect more mature firms to possess more free cash flow in the future, presumably due to the increasingly competitive nature of the markets in which they operate, which will hamper their ability to deliver on the fundamentals in the future.

In keeping with this tendency, TelcoX’s analysis was not encouraging because the growth premium for its stock was relatively small. Cash flows were tracked against analysts’ expectations to understand how to generate upside potential. Since TelcoX wanted to double its market capitalization in four years, the information was valuable in setting top-down, aggressive-yetrealistic operational targets.

Deliver on the Promise
Determining if, under existing circumstances, a company can deliver on its value creation goals requires a model in which the portfolio of businesses is assessed along two perspectives (see figure 1):

Financial analysis. The financials of the various businesses are ascertained in terms of their potential for creating value (economic value added) and earnings growth (earnings before interest, tax, depreciation and amortization).

Market attractiveness. The attractiveness of each business is gauged on its size, growth, profitability and industry structure, along with its competitive advantage (relative market position, growth, profitability and source of its competitive edge).

The individual businesses can then be mapped on a stretch, build or scrap matrix to determine their strategic missions. The analysis identifies ways to reorganize the portfolio to create shareholder value. It has worked successfully when applied across many industries, including electronics and heavy engineering.

Figure 2 shows the portfolio assessment results for TelcoX, revealing six businesses that could be built or stretched, three that could be stretched or scrapped depending on the circumstances, and one that needed to be scrapped altogether.

We extended the analysis to include a future perspective, an evolution from 2000 to 2015, to highlight how management’s current plans would shape the portfolio over time. This “time-capsule” view divided the businesses into three clear segments: those that required cash to be extracted quickly, those that needed investment, and a third set of legacy businesses that required immediate restructuring.

Even though TelcoX’s market capitalization had grown more than 20 percent per year over the past three years, our analysis found that it would still fail to achieve the ambitious value-creation targets that shareholders, analysts and management had for the company.

Craft a Profitable Growth Strategy
If a portfolio is unable to achieve its value-creation objectives, what then? If strengthening the core business does not deliver the required market capitalization, we use a growth-strategy framework to evaluate what value the company might derive from expansion into new (international) markets or into adjacent industries (see figure 3).

We also scrutinize links among the businesses to ensure they are capturing maximum value. Unlike traditional multibusiness companies, telcos have highly interrelated lines of business that often share infrastructures and capabilities. A new broadband unit, for example, might be able to work within the telco’s legacy fixed-line infrastructure, but only if it can upgrade certain aspects. And while the operations group is able to serve traditional telephone network customers, serving broadband customers is another matter as it requires a workforce with real-time problem-solving skills.

Again, we can illustrate this using our TelcoX example. To strengthen the company’s core business and meet analysts’ targets, the focus was on three approaches—(1) maximize cash generators within the business, (2) invest the cash in new growth engines, and (3) improve the legacy business. To generate cash flow and upside value over and above analyst expectations, TelcoX developed growth strategies for its broadband and enterprise voice and data businesses. The company turned its legacy business around by focusing on new technologies, including next generation networks, mobile access and other wireless access technologies.

Our models suggested that strengthening the core would increase market capitalization but still fall just short of the firm’s stated objective. Following an assessment of the company’s options for expanding internationally and into adjacent industries, we arrived at a short list of preferred network providers that would allow TelcoX entrance into the media, entertainment and IT-services businesses. From 50 possible countries, three countries were selected for international expansion, potential cross-border acquisitions, or alliances.

Further analysis revealed, however, that TelcoX had been too eager to look beyond its current business and was flirting prematurely with aggressive overseas expansion before first leveraging what was in its own backyard. In the end, the decision was to focus on the company’s core strengths in the home market, and look at expansion only opportunistically.

Don’t Have a Portfolio of Businesses?
The portfolio assessment model is a valuable tool for identifying which businesses have stand-alone portfolio value, and which links among businesses have the greatest potential for generating more value. What about telcos that are not strictly a portfolio of businesses? Some have interrelated businesses within their portfolio that either complement or compete with one another. The portfolio approach can still work.

For interrelated businesses, each business is evaluated for its individual potential and for its strategic relevance to the group. For example, DSL operations could be a stand-alone business and also have a wider strategic relevance to provide the platform for Internet protocol TV and other direct-to-home services. Pay TV operations might be strategically relevant for the group but have limited potential as a standalone business—indicating the business should be monitored to determine if further investment is needed.

For stand-alone businesses with low strategic relevance (for example, the yellow pages), the company could continue to invest in the business, especially if there are no capital constraints, but in difficult times, any unit that falls into this category is a likely candidate for divestiture.

Finally, divestiture is often the only answer for areas that are neither strategically relevant nor viably independent, such as inherited legacy operations.

Turn Ideas into Action
Turning creative ideas into action depends on a clear implementation plan supported by executive leadership. At this point, we typically devise a road map that outlines short- and mediumterm strategic initiatives, defines specific projects, allocates resources, identifies project timelines and describes performance metrics.

We used this approach with TelcoX, first drawing up a roadmap of strategic initiatives and then developing tactical moves that included the steps necessary to implement each move. Working closely with the board of directors, implementation teams brainstormed ideas and generated buy-in for the strategy. They prioritized steps and phased them in over a four-year period, usually on a month-by-month basis.

Results to date have been impressive. Just a few months after the board approved the strategy and TelcoX communicated it to analysts, we have had positive feedback from equity analysts and shareholders. The market consensus is reflected in one analyst’s assessment that the “strategic roadmap study is likely to lead to better performance.” Since then, TelcoX’s market capitalization has risen by 30 percent.

Making the Connections
The changes in the telecommunications industry are daunting and will require senior executives to act decisively. Systematic choices are necessary, regardless of the firm’s current structure. The leaders in this industry must be prepared to make clear choices about where to compete, when to complement different elements of their portfolios, and how to manage the portfolio to achieve optimal growth. Those companies that connect the dots will be fierce competitors in the new industry order.

Consulting Authors
Naveen Menon is a principal in the firm’s communications and high-tech practice, and is based in the Singapore office.

Bernhard Kickenweiz is a principal in the firm’s communications and high-tech practice, and is based in the New York office.

John Kurtz is a partner in the firm’s communications and high-tech practice and is managing director of A.T. Kearney Southeast Asia and India. He is based in the Jakarta office.

The authors wish to acknowledge the contributions of Graeme Deans and Takakki Umezawa in writing this article.