How Will India's Telecom Industry Manage the Fallout from Falling Rates?

: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4433)

How Will India's Telecom Industry Manage the Fallout from Falling Rates?
Published : December 03, 2009 in India Knowledge@Wharton

In June this year, Indian telecom service provider Tata DoCoMo announced that it
would bill at the rate of one paisa (around 0.02 cents) per second. "In a market that
is cluttered with many operators and confusing options, we will offer simplicity to
consumers by being the country's most transparent, innovative and liberating
telecom brand," said Deepak Gulati, Tata Teleservices president, GSM (global
system for mobile communications) Business. A few months later -- in September
-- it unveiled the Diet SMS plan, one paisa per character with no charge for spaces
between words. On November 22, it extended the one paisa per second plan to
roaming services also.
"When a subscriber is roaming, most telecom operators in India charge a minimum
of 50 paise to 60 paise per minute, even when the call duration is less than a This is a single/personal use copy
of India Knowledge@Wharton.
minute," Gulati said in a press statement. "Under the Tata DoCoMo roaming offer, For multiple copies, custom
reprints, e-prints, posters or
subscribers will be charged only for what he or she uses -- at one paisa per second. plaques, please contact PARS
International:
For instance, a 15-second call made or received while roaming will elicit a charge [email protected] P. (212)
221-9595 x407.
of 15 paise only -- not up to Re. 1 on a per minute basis, as is the industry norm."
Tata's competitors have had to follow suit, and the result has been a price war with no apparent end in
sight. On October 30, market leader Bharti Airtel took the plunge with the one paisa tariff. In November,
it also cut roaming rates to 60 paise per minute for calls within its network and 80 paise per minute for
calls to other networks. On November 24, Bharti took its lowered rates overseas: U.S. customers using
calling cards to make calls to India would also be billed at one paisa per second.
'We Did Not Have a Choice'
The company was not happy about these forced countermeasures and their inevitable impact on profits.
"The tariff war has not been launched by us," Bharti chairman and managing director Sunil Mittal told
journalists at the World Economic Forum meeting in Delhi in early November. "We responded as we did
not have a choice. We have always said we will never lead the price war, but responding to the needs of
the market is something that every sector and industry has to do." Although Bharti is the market leader, it
has never directly pursued market share; its focus has been share of industry revenues.
An Economic Times Intelligence Group (ETIG) survey shows that it is holding its own. "While the
telecom sector's revenues and profits have plunged in the quarter ended September 2009, large private
operators such as Bharti Airtel, Reliance Communications (RCom), Vodafone Essar, Idea Cellular and
Aircel have all managed to increase their revenue market share during this period," according to the
survey report. Bharti's revenue market share has increased to 29.3% as of September 2009, compared to
27.6% in June the same year, while Vodafone Essar now accounts for 15.7% of the total earnings of the
sector as against 14.6% in June 2009.
On the losing side are the public sector telcom firms -- Bharat Sanchar Nigam Ltd. (BSNL) and
Mahanagar Telephone Nigam Ltd. (MTNL). On December 1, however, MTNL fired its own salvo by
reducing its rates to half a paisa per second for in-network calls and one paisa per second for calls made
outside its network. "Our pay-per plan is the most affordable in the industry," said MTNL chairman and
managing director R.S.P. Sinha in a press statement when the new rates were announced.
Plunging Revenues
The price war's impact on revenues is already apparent. "The brutal tariff war that has forced all operators
to slash call rates has also resulted in the sector's sales figures dipping over the past six months despite the

  All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 1 of 4 
How Will India's Telecom Industry Manage the Fallout from Falling Rates?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4433)

to slash call rates has also resulted in the sector's sales figures dipping over the past six months despite the
addition of 80 million customers in the period," according to ETIG. "The industry clocked about Rs.
38,755 crore in September 2009, which was lower than the sector's revenues in the quarter ended
December 2008, when it recorded Rs. 39,408 crore despite having 125 million fewer customers then."
The report notes that 13 operators are fighting for share in a market that many believe can optimally
support four or five -- and four more players are planning to enter the market by next year. According to
Arvind Mahajan, executive director, advisory services at KPMG: "At this point in time, it is all about
grabbing subscribers."
"Industry revenue growth for the quarter ending September 2009 was 1.7% quarter-on-quarter (Q-on-Q)
and 8.7% year-on-year (Y-on-Y), substantially lower than subscriber growth at 10.4% Q-on-Q and 49.6%
Y-on-Y," says a report by equity research firm Enam Securities. "The aggressive entry by new GSM
players has compelled the incumbents to reluctantly join the tariff war to protect their market share."
At Vodafone Essar, for instance, service revenues dipped 7% from the June quarter to the September
quarter. The EBITDA (earnings before interest, taxes, depreciation and amortization) margin is also down
from 28.4% in the first half of 2008-09 to 24% in the corresponding period of 2009-10. "The decline in
the EBITDA margin was primarily as a result of the expansion into rural areas and market price reduction
offset by scale efficiencies," says Samaresh Parida, director, strategy at Vodafone Essar. He adds that this
is entirely in line with industry performance; as noted by ETIG, Vodafone has actually done better than
most of its competitors on the share-of-revenue metric.
Vodafone has also joined the one paisa bandwagon. "One paisa per second tariff is one of the several
tariff options available to our customers," says Parida. "We continue to also offer many per minute tariff
options. Our customers can make the choice."
Giving a choice is not necessarily pro-consumer. According to Mahesh Prasad, president of RCom, Indian
telecom companies combined have 2,700 different billing plans across the country. On October 5, RCom
launched a 50 paise per minute plan called Simply Reliance. Under the plan, all calls -- whether local or
long distance, to landline or mobile -- will cost only 50 paise a minute. Currently, RCom itself has 265
plans. "Henceforth there will be just one plan," said Prasad, though older customers will be given a
six-month period to migrate.
The SMS Front
On November 28, RCom opened another front in the price war -- SMS (short message service). The
company unveiled two plans charging one paisa per SMS message. Under the first, customers pay Re. 1 a
day and are entitled to send an unlimited number of free SMS messages. Alternatively, you can buy a Rs.
11 monthly voucher and each SMS message will cost just one paisa.
Tata DoCoMo has been heavily promoting its one paisa per character Diet SMS plan. Now, it is inevitable
that they and other competitors will have to match RCom's rates. This will not mean a huge drop in
revenues: According to estimates, SMS brings in about 5% of total telecom revenues for Indian
companies. But companies' bottom lines will still be affected. The Telecom Regulatory Authority of India
(TRAI) has found that each SMS costs the service providers less than one paisa, while they have been
charging customers 60 paise to Re. 1 (depending on the plan).
Why has the competition heated up so intensely? New entrants like Tata DoCoMo that are capturing
market share are one reason. For the Tatas, the paisa per second plan appears to have worked. According
to TRAI data, the number of telephone subscribers in India increased to 525.65 million at the end of
October, up from 509.03 million in September. Tata DoCoMo grew 23.16%, the highest for all operators.
In absolute numbers, the Tatas added about four million subscribers against three million each for
Vodafone and Bharti and two million for RCom. This is no flash in the pan; in July and August, the Tatas
showed the fastest growth as well.
The Tatas, though just six months into their launch with DoCoMo (see "NTT DoCoMo's Tata Deal: Why
Global Telecom Firms Want to Dial India"), already have an established presence in the market through
Tata Indicom. New entrants are planning to kick off operations in the next few months, including
Norway's Telenor, Bahrain's Batelco and Abu Dhabi's Itisalat. "We will not be the most aggressive price
runner in the market," according to Telenor CEO Jon Fredrik Baksaas, who spoke to the press in India

  All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 2 of 4 
How Will India's Telecom Industry Manage the Fallout from Falling Rates?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4433)

runner in the market," according to Telenor CEO Jon Fredrik Baksaas, who spoke to the press in India
recently. "We will be competitive, but not the most aggressive."
There are a couple of other reasons for this frantic activity. On November 20, TRAI announced that
mobile number portability (MNP) would be introduced beginning on December 31. This allows users to
move from one service provider to another or even from one technology to another. More importantly,
TRAI said the maximum porting charges would be Rs. 19. This makes operator-hopping quite cheap.
"MNP will add more pain to the situation," says Mahajan of KPMG. According to a report by Anand
Rathi Financial Services, the move will lead "to churn rates higher than the current 4.5% to 8.0% per
month -- at least in the short run."
The level of satisfaction with service providers is low in the Indian telecom space. According to a July
Nielsen Mobile Consumer Insights study gauging consumer attitudes and behavior towards mobile
operators in India, 18% of Indian mobile phone subscribers plan to change their mobile operator when
MNP is introduced. The study found that attrition rates would be the highest for RCom and Tata Indicom.
3G on the Horizon
The second big event on the horizon is the launch of 3G (third generation) services next year. The
auction for 3G licenses has been delayed. But the proceeds are needed to trim the fiscal deficit. In his
budget, Finance Minister Pranab Mukherjee had estimated that Rs. 20,000 crore would come in through
the sale of these licenses, so there is enough incentive for the auction to happen during this financial year
(ending March 2010). The base price for these licenses has now been fixed at Rs. 4,040 apiece. Analysts
estimate that Rs. 30,000 crore to Rs. 40,000 crore could come in through the sale. The department of
telecommunications proposes to hold the auction on January 14, 2010. "An apparent lack of interest in the
auction for high-speed 3G and broadband wireless access spectrum won't stop the government from
getting bidders to cough up the cash that it needs to control a burgeoning deficit," according to business
dailyMint. "That's because many potential bidders running 2G services, already scrambling for scarce
spectrum to carry mobile phone calls, desperately want the additional frequencies that will come with a
3G license."
Some say this is the very reason why foreign companies don't seem too interested in bidding for the 3G
licenses. "Foreign interest in the form of participation in the pre-bid conference has been low probably on
account of two factors," says K. Raman, practice head, telecom, media & technology at the Tata Strategic
Management Group (TSMG). "First, there are regulatory uncertainties with respect to eligibility of 2G
spectrum along with a winning 3G bid. Secondly, a pure 3G play may not be attractive for operators and
would not make as much business sense as an overlay on 2G." Adds Alok Shende, principal analyst at
Ascentius Consulting: "A standalone 3G service is unlikely to succeed. The business will start with
virtually no consumers, unlike the current players who will have the advantage of captive 2G customers."
According to Shende, "Indian telecom markets are likely to undergo a tectonic shift with the introduction
of new licensees, MNP and the launch of 3G services all scheduled in the next one year. New players will
nibble at the market share of the incumbents and -- with regulatory constraints on M&A activity --
consolidation, a process that could have cleared the market, will be artificially restrained. The rural
markets will continue on their growth trail. Today, only 28% of the subscriber base is contributed by the
rural segment."
Growth at Home and Abroad
The rural market is the other problem area. This is where the growth is -- but it is also where very little
money can be made. "Rural markets are still under-penetrated" -- at about 15% -- "so there is still a
strong upside merely on customer addition," says Parida of Vodafone Essar.
The hitch is that some of the plans don't make money. The average revenue per user (ARPU) is now
down to around Rs. 200 a month for the industry. In rural areas, however, it is estimated to be in double
digits. "It certainly makes it harder to ensure viability, as the bulk of users are lower-income and less
tech-savvy," says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School
of Business (ISB). "The most [celebrated] aspect of the Indian telecom revolution, as well as its prime
driver, was the mind-boggling reduction of rates in a short span of time. Competition among private
players was most certainly the key for this. But the model seems to have been that high-margin products

  All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 3 of 4 
How Will India's Telecom Industry Manage the Fallout from Falling Rates?: India Knowledge@Wharton
(http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4433)

players was most certainly the key for this. But the model seems to have been that high-margin products
would subsidize access. It now seems that most Indian users are unlikely to use the more sophisticated
and high-margin features for a long time to come. Nor is the typical handset amenable to most such
features. So ARPUs are likely to stay low for a long time, and the subscriber may not move beyond the
most basic functions. The per-second billing will just worsen the ongoing price war."
If looking inwards -- to rural India -- doesn't work in terms of immediate returns, there may be a solution
in looking outwards. Indian companies are trying to balance their bets by foraying abroad. If the low-cost
model works there, it could bring some relief to the bottom line. The second merger attempt between
Bharti and MTN of South Africa may have failed (See Now That the MTN Merger Deal Has Collapsed,
What's Next for Bharti Airtel?), but the Essar Group (which owns a 9.9% stake in Loop Telecom, apart
from its Vodafone Essar interests) has just bought up Dhabi Telecom's African assets. And the public
sector MTNL and BSNL are eyeing Zain Telecom of Dubai. "Indian telecom companies are looking at
markets outside India to be able to grow revenues at the historical pace they are used to," says Raman of
TSMG. "The markets that they have attempted to enter are ones where tariffs are relatively high and
future growth through subscriber addition is possible. In other words, replicating an Indian model of
telecom growth is possible in such countries. If execution is handled well, there is no reason to believe
that such an approach will not work."
"Telecom is essentially a business of scale," says Chakrabarti of ISB. "So the bigger the scale, the lower
the costs -- proportionately -- are going to be. Hence, venturing abroad would be natural in some sense. It
may work, provided the regulatory issues and infrastructural and cross-border operational integration
challenges can be handled."
Chakrabarti sees problems, but he is not pessimistic. "The industry should be growing steadily in the years
to come. There is likely to be a shake-up with some consolidation and exits, and rates may stabilize or
even rise a bit. What we are seeing is not so uncommon for new industries -- recall the dot-com bubble
and bust in the first phase of Internet growth -- when players overshoot on the basis of overoptimistic
projections. This may be the time for a reality check and reassessment for the players as well as
regulators. But in the long run, the prospects for the industry are quite good."
"The future of the industry needs to be seen across various timelines," says Raman of TSMG. "The next
six months will see new operators completing their footprint and at least three serious operators launching
services in the country. All of this points to an intense phase of competition and price cuts. Factor in the
3G auction, and one would see below par profitability for [telecom companies] over the next six to eight
quarters. The industry could also expect to see consolidation as much as and as fast as regulation allows it
to happen."
According to Parida, the number of players in the Indian market has led to fragmentation, and that needs
to be addressed. "We feel market forces must be allowed to have a freer play in India and that will
certainly lead to a consolidation phase ahead. Telecom, particularly mobile telephony, has become an
integral part of India's social and economic fabric. As an industry, it is here to stay."
The industry will stay, but not the large number of companies in the fray, according to Raman. "Operators
with access to resources through internal accruals or credit lines will stand to gain from [any coming]
consolidation."

This is a single/personal use copy of India Knowledge@Wharton. For multiple copies, custom reprints, e-prints, posters or plaques, please
contact PARS International: [email protected] P. (212) 221-9595 x407.

  All materials copyright of the Wharton School of the University of Pennsylvania.                    Page 4 of 4