A digital desert? The impact of regulation on Europe’s telecoms sector

By Mark Newman

Ben Verwaayen is not prone to making headline-grabbing comments. He is a seasoned industry campaigner but not really the type of industry leader to obsess about developing a strong public profile. But when, at a shareholders meeting earlier this month, the Alcatel Lucent CEO was asked about some of the factors behind the company’s slide back into the red, Vervaayen referred specifically to the status of telecoms regulation in Europe and the pursuit of policies which risked creating a “digital desert”.

Vervaayen accused regulators of focusing too much on cutting prices and, in doing so, removing the incentive for operators to invest in next-generation networks.

His argument is not a new one and was similar to the message delivered by mobile operator CEOs at this year’s Mobile World Congress. But the fact that Vervaayen has chosen a colorful image of a “digital desert” to describe the scene in Europe suggests that the message from the telecoms industry is not getting through to governments and regulators. It is also a message that appears to have little resonance with the media.

Europe’s rise and fall
It has been clear for some time now that Europe’s telecoms technology and manufacturing industry is in decline. The likes of NSN, Alcatel Lucent and Nokia are struggling to remain profitable and have shifted most of their manufacturing into Asia. Huawei and Samsung have become global powerhouses in telecoms infrastructure and devices respectively and their success has been at the expense of the European players. The US wireless infrastructure business has collapsed even more spectacularly than Europe’s but North America as a whole has become a stronger and more influential player on the global telecoms scene thanks to the rise of west-coast Internet, software and device businesses.

Now, however, it’s Europe’s operators themselves that risk stagnation and ultimately decline. Companies such as Vodafone, France Telecom, Deutsche Telekom and Telefonica have always been viewed as global heavyweights. But a combination of saturated markets and economic downturns means that these companies are seeing their businesses stagnate in their core European markets. To protect their margins, these companies will continue to focus on cutting costs rather than growing revenues. Indeed, most of these operators seem more intent on selling their assets where they are either the third or fourth operator or where they own minority stakes rather than acquiring new ones.

So, to what extent should the European Union be held in any way responsible for the demise of the telecoms sector and what can or should European institutions do to help it?

Part of the problem lies in the fact that Brussels did so much 20-25 years ago to help Europe become the heartbeat of the global mobile market. The creation of GSM and associated spectrum allocations, the expansion into GSM1800 and the introduction of three- and four-operator markets enabled Europe to set the pace in the global mobile market. As European technology and policies were adopted in other continents, European companies followed and grew fat on the opportunities that they presented.

The reversal in the fortunes of the European players dates from the auctioning of 3G spectrum at the start of this century. 3G license fees took tens of billions of euros out of the European telecoms market.

The rise and fall has been less pronounced in the fixed business. The regulatory focus has been introducing competition via LLU and, at the same time, trying (with limited success) to persuade the incumbents to invest in next-generation access networks.

Brussels has not explicitly said that it is now satisfied with the level of competition in fixed and mobile markets although its policies do indeed suggest that this is the case. For example, there has been no attempt in LTE spectrum auctions to reserve frequencies for new operators. Furthermore, EU officials have recognized that EU consumers cannot assume that the price of telephone services will continue to fall as rapidly as has been the case in recent years and that the price of some services could even go up.

Populist policies
Despite all this, Brussels continues to give the impression – both via its words and its deeds – that it is regulating an uncompetitive sector.

The unrelenting pressure on mobile termination rates has led to the erosion of a huge revenue stream for telecoms operators. More recently, the European Parliament approved new EU roaming prices caps and the opening of this market to structural competition. Meanwhile, the pressure that it is exerting on fixed operators to upgrade their access networks to fiber as part of the “Digital Agenda for Europe” will require a colossal investment program with no guarantee of payback (although it should be noted that the Commission has now power to enforce its targets for fiber).

When it comes to LTE, Europe’s days of leading the world in terms of spectrum harmonization and launch schedules are long gone. Launches in Europe have been extremely low key and there is no commonly-agreed position across member states in terms of spectrum allocation and licensing.

It is almost as if policy makers in Brussels are failing to think through the implications of these policies, or non-policies, on companies – telecoms operators – which are already operating in competitive markets. Or maybe they are well aware of the implications but do not consider it either to be in their interests or their remit to factor this into their policies.

The language used by EU policy makers suggests that they still consider telecoms operators to be bloated, inefficient businesses with little or no interest in their customers. Neelie Kroes likened the response of European operators to the most recent action on roaming to that of naughty children and criticized them for the “outrageous margins” on roaming services.

The problem for European telecoms operators here is that Brussels is merely tapping into a populist impression – reinforced by the media – that telecoms operators are inclined, wherever and whenever they can, to rip off their customers.

The benefits that competition has brought to consumers and businesses as a result of strong and transparent regulation should not be forgotten (see fig.). Europeans have cheaper telecoms services than in many parts of the world because, typically, there are four or more operators competing to provide different services. We take affordable, reliable mobile, telephone and broadband services for granted. And when it comes to specific policy areas – for example, roaming – Europe has (belatedly) done an excellent job in bringing down excessive prices. In doing so, it has provided one of the very few examples of where Brussels has developed popular policies in a market where national politics has failed.

Assessing regulatory trends and the health of the European telecoms sector from the 1980s to the 2010s

(Industrial) policy vacuum
So, if European politicians are more interested in populist policies and focus solely on the interests of consumers, who is going to look after the wellbeing of European operators, network vendors and device manufacturers?

For the time being, it doesn’t look as if any European institutions or senior policy makers are taking up the cause of Europe’s beleaguered telecoms sector. But at some time, sooner or later, there will be a groundswell of support for policies that support Europe’s telecoms companies as well as its citizens.

There could be any number of catalysts. It could be the takeover of a large European operator group from a telco in the emerging world (last month, Mexico’s America Movil made an approach for Dutch telco KPN). Or it could be the takeover of Nokia, Europe’s last handset manufacturer; or of NSN, one of the world’s top three wireless infrastructure vendors. Both have announced huge job cuts in recent months.

Alternatively, the realization that Europe is in decline could come from an assessment of the state of the region’s digital infrastructure. The rollout of fiber is painfully slow because of uncertainty over the extent to which incumbent operators will be forced to open access to other service providers. Europe was the first region in the world to roll out mobile broadband networks using HSPA but, in many countries, network coverage and capacity leave much to be desired. And when it comes to LTE, Europe is well behind the US, Japan and South Korea which, between them, account for more than 90% of LTE subscriptions.

The growing influence of US Internet companies is another theme which could provide a stark comparison with the state of Europe’s own technology giants. European telecoms operators have, until now, benefitted from the strong demand for fixed and mobile access to the Internet. But, as more people become connected, so the risk that they will use “free” services to communicate with each other, rather than buying operators’ voice and messaging services, will increase.

European telcos are trying to fight this battle on two fronts. Firstly, they are talking about working together on both technical and commercial issues to build a platform for innovation that is an alternative to third-party developers and to explore the potential for entering into revenue or cost-sharing relationships with so-called “over-the-top” players. Secondly, they are looking to change the way in which they charge for data (Internet) access to compensate for the loss of voice and messaging revenues.

However, their attempts to collaborate are being frustrated by the threat of intervention from the EU on competition grounds. The Commission has already asked for information about the activities of the so-called E5 group of operators – Deutsche Telekom, Telefonica, France Telecom, Vodafone and Telecom Italia.

The question of how operators charge for data access touches on the broader theme of net neutrality. The Dutch regulator has already stopped its mobile operators from charging their customers additional fees for services such as VoIP. The Commission itself has not announced its own net-neutrality policy yet although Neelie Kroes did say last month that she would be looking to establish a framework which both ensures that Internet users can always choose full Internet access and allows operators to offer different types of packages.

Digital scapegoat?
However guilty European institutions might be of falling short in supporting our telecoms industry, the harsh reality is that the demise of our telecoms sector is largely due to two other factors:

1.An evolution away from telecoms-centric standardization to Internet standards and standards-making bodies.
2.The shift to lower-cost manufacturing in Asia and the growing power and influence of Asian technology groups.
Back in the days of GSM, standardization initiatives and intellectual property rights gave European firms a massive advantage over Asian and, to a lesser extent, US technology firms. But, over the years, this advantage has been eroded as standardization initiatives have become more global – and the center of gravity for industry standards has shifted over the Atlantic to North America as the telecoms industry has started to embrace IP.

In the case of intellectual property rights, European firms still have strong portfolios of patents for mobile telephony but, in a smartphone age, patents in IT and computing can be equally important and leading players need to be strong in both areas.

The shift to low-cost manufacturing in Asia has been going on for a long time and has helped European companies to lower their costs. But the growing power and influence of ZTE and Huawei has been hugely damaging to them; with their lower staff costs and access to attractive lines of credit, it has been extremely difficult for the European firms to compete. In handsets, South Korea’s Samsung has overtaken Nokia’s position as the world’s largest manufacturer.

Creating a climate for investment
So, the decline in the power, influence and profitability of European telecoms firms cannot, by any means, be blamed on regulation. But it is true to say that the regulatory focus on the interests of the consumer rather than the health and wellbeing of the sector as a whole has come at the expense of European telecoms firms.

The one bargaining chip that European operators retain in their discussions with regulators relates to the political objectives around high-speed broadband. Brussels realizes that, in order to achieve its political goal of modernizing Europe’s telecoms infrastructure, it cannot afford to completely ignore the interests of the firms that will have to build these networks in the near future.

In recent months, European operators have been talking to Neelie Kroes and other senior EU officials about creating a climate which will allow them to persuade their shareholders that there is a justification for stepping up investment in next-generation networks.

Their discussions will have included a number of the issues raised in this article.

Informa Telecoms & Media expects that, when the Commission puts its proposals before the European Union and Parliament in late 2012 or 2013, it will give telcos some freedom to offer different types of Internet services from just the “plain vanilla” access. This will, potentially, allow them to migrate their revenues away from voice- to data-dependency.

However, this will not in itself help the telecoms industry build a path towards recovery. The telecoms industry needs to do more to demonstrate its importance to European citizens – be it in terms of providing jobs, building infrastructure that makes countries more competitive or providing affordable mobile and broadband services – in order to help change the public perception about the telecoms sector. This is going to be the most effective way of influencing national and European regulators, and the institutions that they are accountable to, and getting them to understand that the European telecoms industry is not something that can be taken for granted.