Over the last couple of years I have been focused on identifying sustainable business models for communication service providers. As part of this analysis I have investigated the return on invested capital (ROIC) as a ratio of weighted average cost of capital (WACC) for a variety of service providers globally. The Exhibit below summarizes the results for several Tier 1 service providers. For the sake of comparison I included companies that are not telecom providers, including Walmart, Procter and Gamble, RIM and Nokia and Visa.
The WACC essentially represents the minimum rate of return that a company must achieve before it creates value for equity and debt holders. In cases where the ratio of ROIC to WACC is less than one, we are essentially seeing capital value erosion. A variety of household names including Verizon, Vodafone, Comcast and Deutshe Telecom fall below the line, ATT is on the line, and players like Orascom and American Movil, Telstra, Telefonica and Orange/FT are in positive territory. Players who are doing well all have significant emerging market assets from which they drive disproportionate capital value creation?
With service providers coming under continuous pressure to offer more for less, capital value creation is a challenge, and generally depends on effective transformation strategies. Although service providers have made efforts to transform, most have failed. In several recent studies I have investigated why we have seen such lackluster performance in these transformation efforts.
To support this analysis, I formulated a scorecard which analyzed the service provider business in terms of six categories, namely their access networks, core networks, organizational structure, IT infrastructure, financial state, and partnership ecosystem. Based on this analysis, I came to the following conclusions:
- Service providers tend to have straddled strategies with conflicting objectives. On the one hand they want to embrace the next 2.0 that comes along. On the other hand they are incapable of self-disintermediation needed for the 2.0 initiatives to thrive.
- Employees must be incentivized to transform the business. Even with the best intentions and network technology investments, status quo will prevail unless remuneration is tied to transformation initiatives
- Transformation strategies are overly focused on the access network evolution. These are long lead investment items, and while they impact transformation initiatives, they do not drive transformation.
Transformation starts with organizational re-engineering that incentivize self disintermediation, followed by strategic IT investments to reduce transaction friction for broader ecosystems. Until service providers take this approach, we believe that many will continue to see capital value erosion.