Microeconomics Case Study

Telecom Sector & Reliance Communications

GROUP O

Sandeep AgrawalRagini Iyer (52)

Rishabh Khandhar (58)
Sandeep Agrawal (70)
Sria Majumdar (83)
Sushant Gupta (87)
Abhishek Singh (96)
Outline

1. Outline
2. Executive Summary
3. Telecom Sector Overview
4. Reliance Communications
5. Conclusion
6. References

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Executive Summary
Indian telecommunication Industry is one of the fastest growing telecom markets in the
world. The mobile sector has grown from around 10 million subscribers in 2002 to reach 150
million by early 2007 registering an average growth of over 90%. The two major reasons
that have fuelled this growth are low tariffs coupled with falling handset prices. The
regulatory changes and reforms by successive Indian governments have given a huge boost
to the sector.

From the point of view of economics, the market structure of the telecom sector is an ideal
case study for oligopoly markets with about 13 players. The major players include Airtel,
Vodafone, Reliance Communications, Idea, BSNL etc. The leaders in terms of market share
as of 2009 were Airtel, Reliance Communications and MTNL in that order. However with
new entrants such as Docomo and Uninor, the market has become very dynamic and
unpredictable with leaders changing every quarter. In this sector, the average revenue per
user (ARPU) becomes a very important factor for profit maximization. Also the rural and
urban penetration have to be considered as critical factors for analysis as companies are
targeting bottom-of-the-pyramid customers. Various critical factors such as ARPUs,
investments, costs etc have been considered to analyse the sector.

The second part of the study deals with Reliance Communications in particular. We have
tried to see how certain factors such as expenditure, profit, labour and capital are related.
Also, on the basis of our analysis we have projected the performance of Reliance
Communications as of 2011. In this sector, the effect of government policies is of vital
importance. We have tried to analyse the effect of information, and pricing strategies as
well as take on a brief discussion on 3G strategy.

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Telecom Sector Overview

During FY09, India's mobile subscriber base grew by 50% YoY, from 261 m to 391 m, while
the fixed subscriber base declined by about 4%, from 39.4 m to about 37.9 m. Key Points
FY09 saw the continuance of strong growth for the Indian telecom market, which witnessed
a 49% YoY increase in its subscriber base during the 12-month period. At the end of March
2009, the country’s total telecom subscriber base (fixed plus mobile) stood at about 429 m.
The tele-density level stood at about 36% by the end of the fiscal.

Growth remained robust in the GSM mobile space, with the same growing its subscriber
base by 96 m, thus contributing to about 70% of the total incremental subscriber addition
for the entire Indian telecom market. After a strong 76% YoY increase in subscriptions
during FY08, the GSM industry recorded another good performance during FY08, growing
subscriber base by 50% YoY to about 289 m.

Key Points

 Supply: Intense competition has resulted in prompt service to the subscribers.

 Demand: Given the low penetration levels in the country and continuously falling tariffs,
demand will continue to remain higher in the foreseeable future across all the segments
 Barriers to entry: High capital investments, well-established players who have a
nationwide network, license fee, continuously evolving technology and falling tariffs.
 Bargaining power of suppliers: Improved competitive scenario and commoditisation of
telecom services has led to reduced bargaining power for services providers.
 Bargaining power of customers: A wide variety of choices available to customers both in
fixed as well as mobile telephony has resulted in increased bargaining power for the
customers.
 Competition: Competition has intensified with the entry of new cellular players in select
circles. Reducing tariffs will hurt the new entrants as they will be unable to recover their
high capital investments.

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Sector Overview

Liberalization and reforms in Telecom sector

Liberalization in the Telecom sector started with revoking the Telecom manufacturing
equipment licence in the year 1991. Automatic foreign collaboration was permitted with 51
% equity by the collaborator. In 1992, Value added services were opened for private and
foreign players on franchise or license basis. These included cellular mobile phones, radio
paging, electronic mail, voice mail, audiotex services, videotex services, data services using
VSAT's, and video conferencing.

The Government announced a National Telecom Policy 1994 in September 1994. It opened
basic telecom services to private participation including foreign investments. 2. Foreign
equity participation up to 49 per cent was allowed in basic telecom services, radio paging
and cellular mobile. For value added services the foreign equity cap was fixed at 51 per cent.
Eight cellular licensees for four metros were finalized by 1995. TRAI was set up in 1997 as an

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autonomous body to separate the regulatory functions from policy formulations and
operational functions. An agreement between Department of Telecommunication (DoT) and
financial institutions to facilitate funding of cellular and basic telecom projects was reached.
External Commercial Borrowing (ECB) limits on telecom projects made flexible with an
increased share from 35 per cent to 50 per cent of total project cost. By the year 1999, FDI
up to 49 per cent of total equity, subject to license, permitted in companies providing Global
Mobile Personal Communication (GMPC) by satellite services.

Between 1999 and 2000, National Telecom Policy 1999 was announced which allowed
multiple fixed Services operators and opened long distance services to private operators.
TRAI reconstituted: clear distinction was made between the recommendatory and
regulatory functions of the Authority. DOT/MTNL was permitted to start cellular mobile
telephone service. Department of Telecom Services was set up to separate service providing
functions from policy and licensing functions. A package for migration from fixed license fee
to revenue sharing offered to existing cellular and basic service providers. TRAI Act was
amended in 2001. The amendment clarified and strengthened the recommendatory power
of TRAI, especially with respect to the need and timing of introduction of new services
provider, and in terms of licenses to a services provider. Department of Telecom Services
and Department of Telecom operations were corporatized by creating Bharat Sanchar
Nigam Limited. Communication Convergence Bill, 2001 was introduced in August 2001.
Competition was introduced in all services segments.

TRAI recommended opening up of market to full competition and introduction of new

services in the telecom sector. Usage of Voice over Internet Protocol permitted for
international telephony service. International long distance business opened for
unrestricted entry. Telephony on internet permitted in April 2002. TRAI finalized the System
of Accounting Separation (SAS) providing detailed accounting and financial system to be
maintained by telecom service providers. Unified Access Service Licenses regime for basic
and cellular services was introduced in October 2003. This regime enabled services
providers to offer fixed and mobile services under one license. Consequently 27 licenses out
of 31 licenses converted to Unified Access Service Licenses. Budget 2004-05 proposed to lift
the ceiling from the existing 49 per cent to 74 per cent as an incentive to the cellular

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 operators to fall in line with the new unified licensing norm. 'Last Mile' linkages permitted in
April 2004 within the local area for ISP's for establishing their own last mile to their
customers. Indoor use of low power equipments in 2.4 GHz band de-licensed from August
2004.

Budget 2005-2006 cleared a hike in FDI ceiling to 74 per cent from the earlier limit of 49 per
cent. 100 per cent FDI was permitted in the area of telecom equipment manufacturing and
provision of IT enabled services. Annual license fee for National Long Distance (NLD) as well
as International Long Distance (ILD) licenses reduced to 6 per cent of Adjusted Gross
Revenue (AGR) with effect from 1st January 2006. BSNL and MTNL launched the 'One-India
Plan' with effect from 1st March 2006 which enable the customers of BSNL and MTNL to call
from one end of India to other at the cost of Re 1 per minute, any time of the day to phone.

Important timelines

Foreign equity
participation up to TRAI WAS SET UP
Telecom 49 per cent
Manufacturing
Equipment DE
licensed in 1991.

DOT/MTNL was
TRAI Act was
TRAI recommended
permitted to start
amended
opening up of
cellular
market

to lift the ceiling 'One-India Plan' and

Telephony on
from the existing 49 five year plan
internet permitted
per cent to 74 per details
in April 2002.
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11th plan (2007-2012):

FDI in Telecom sector has increased in recent years with value of 81.62 billion with share of
10% in total inflow during January 2000 to June 2005. This is mainly in telecom services and
not in telecom manufacturing sector. Therefore, it is essential to enhance the prospect for
inflow of increased funds. The NTP 1999 sought to promote exports of telecom equipments
and services. But till date export of telecom equipment remains minimal. Most of the state-
of-the-art telecom equipments including mobile phones are imported from abroad. There is
thus immense potential for indigenous manufacturing in India. Certain measures like
financial packages, formation of a telecom export promotion council, creation of integrated
facilities for telecom equipment through SEZ and encouraging overseas vendors to set up
facilities in India, are required for making India a hub for telecom equipment manufacturing
and attract FDI. The telecom sector has shown robust growth during the past few years. It
has also undergone a substantial change in terms of mobile versus fixed phones and public
versus private participation. The following table and discussions from the report of
the working report on the telecom sector for the 11th plan (2007-2012) will show the
growth of telecom sector since 2003.

Major players

BSNL
On October 1, 2000 the Department of Telecom Operations, Government of India became a
corporation and was renamed Bharat Sanchar Nigam Limited (BSNL). BSNL is now India’s
leading company in Telecommunications sector and the largest public sector undertaking. It
has a network of over 45 million lines covering 5000 towns with over 35 million telephone
connections.

The state-controlled BSNL operates basic, cellular (GSM and CDMA) mobile, Internet and
long distance services throughout India (except Delhi and Mumbai). BSNL will be expanding
the network in line with the Tenth Five-Year Plan (1992-97). The aim is to provide a
telephone density of 9.9 per hundred by March 2007. BSNL, which became the third
operator of GSM mobile services in most circles, is now planning to overtake Bharti to

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become the largest GSM operator in the country. BSNL is also the largest operator in the
Internet market, with a share of 21 per cent of the entire subscriber base.

BHARTI
Established in 1985, Bharti has been a pioneering force in the telecom sector with many
firsts and innovations to its credit, ranging from being the first mobile service in Delhi, first
private basic telephone service provider in the country, first Indian company to provide
comprehensive telecom services outside India in Seychelles and first private sector service
provider to launch National Long Distance Services in India. Bharti Tele-Ventures Limited
was incorporated on July 7, 1995 for promoting investments in telecommunications
services. Its subsidiaries operate telecom services across India. Bharti’s operations are
broadly handled by two companies: the Mobility group, which handles the mobile services
in 16 circles out of a total 23 circles across the country; and the Infotel group, which handles
the NLD, ILD, fixed line, broadband, data, and satellite-based services. Together they have so
far deployed around 23,000 km of optical fiber cables across the country, coupled with
approximately 1,500 nodes, and presence in around 200 locations. The group has a total
customer base of 6.45 million, of which 5.86 million are mobile and 588,000 fixed line
customers, as of January 31, 2004. In mobile, Bharti’s footprint extends across 15 circles.

MTNL
MTNL was set up on 1st April 1986 by the Government of India to upgrade the quality of
telecom services, expand the telecom network, introduce new services and to raise revenue
for telecom development needs of India’s key metros – Delhi, the political capital, and
Mumbai, the business capital. In the past 17 years, the company has taken rapid strides to
emerge as India’s leading and one of Asia’s largest telecom operating companies. The
company has also been in the forefront of technology induction by converting 100% of its
telephone exchange network into the state-of-the-art digital mode. The Govt. of India
currently holds 56.25% stake in the company. In the year 2003-04, the company's focus
would be not only consolidating the gains but also to focus on new areas of enterprise such
as joint ventures for projects outside India, entering into national long distance operation,

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widening the cellular and CDMA-based WLL customer base, setting up internet and allied
services on an all India basis.

RELIANCE INFOCOMM

Reliance is a $16 billion integrated oil exploration to refinery to power and textiles
conglomerate. It is also an integrated telecom service provider with licenses for mobile,
fixed, domestic long distance and international services. Reliance Infocomm offers a
complete range of telecom services, covering mobile and fixed line telephony including
broadband, national and international long distance services, data services and a wide range
of value added services and applications. Reliance IndiaMobile, the first of Infocomm's
initiatives was launched on December 28, 2002. This marked the beginning of Reliance's
vision of ushering in a digital revolution in India by becoming a major catalyst in improving
quality of life and changing the face of India. Reliance Infocomm plans to extend its efforts
beyond the traditional value chain to develop and deploy telecom solutions for India's
farmers, businesses, hospitals, government and public sector organizations.

TATA TELESERVICES
Tata Teleservices is a part of the $12 billion Tata Group, which has 93 companies, over
200,000 employees and more than 2.3 million shareholders. Tata Teleservices provides basic
(fixed line services), using CDMA technology in six circles: Maharashtra (including Mumbai),
New Delhi, Andhra Pradesh, Tamil Nadu, Gujarat, and Karnataka. It has over 800,000
subscribers. It has now migrated to unified access licenses, by paying a Rs. 5.45 billion ($120
million) fee, which enables it to provide fully mobile services as well.
The company is also expanding its footprint, and has paid Rs. 4.17 billion ($90 million) to
DoT for 11 new licenses under the IUC (interconnect usage charges) regime. The new
licenses, coupled with the six circles in which it already operates, virtually gives the CDMA
mobile operator a national footprint that is almost on par with BSNL and Reliance
Infocomm. The company hopes to start off services in these 11 new circles by August 2004.
These circles include Bihar, Haryana, Himachal Pradesh, Kerala, Kolkata, Orissa, Punjab,
Rajasthan, Uttar Pradesh (East) & West and West Bengal.

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VSNL
On April 1, 1986, the Videsh Sanchar Nigam Limited (VSNL) - a wholly Government owned
corporation - was born as successor to OCS. The company operates a network of earth
stations, switches, submarine cable systems, and value added service nodes to provide a
range of basic and value added services and has a dedicated work force of about 2000
employees. VSNL's main gateway centers are located at Mumbai, New Delhi, Kolkata and
Chennai. The international telecommunication circuits are derived via Intelsat and Inmarsat
satellites and wide band submarine cable systems e.g. FLAG, SEA-ME-WE-2 and SEA-ME-WE-
3.

HUTCH/VODAFONE
Hutch’s presence in India dates back to late 1992, when they worked with local partners to
establish a company licensed to provide mobile telecommunications services in Mumbai.
Commercial operations began in November 1995. Between 2000 and March 2004, Hutch
acquired further operator equity interests or operating licences. With the completion of the
acquisition of BPL Mobile Cellular Limited in January 2006, it now provides mobile services
in 16 of the 23 defined licence areas across the country. Hutch India has benefited from
rapid and profitable growth in recent years. it had over 17.5 million customers by the end of
June 2006. In late 2007 it was bought by the English giant Vodafone and renamed Vodafone-
Essar.

IDEA
Indian regional operator IDEA Cellular Ltd. has a new ownership structure and grand designs
to become a national player, but in doing so is likely to become a thorn in the side of
Reliance Communications Ltd. IDEA operates in eight telecom “circles,” or regions, in
Western India, and has received additional GSM licenses to expand its network into three
circles in Eastern India -- the first phase of a major expansion plan that it intends to fund
through an IPO, according to parent company Aditya Birla Group.

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Competition in Telecom Sector

Monopoly of BSNL:

During these 50 years after India’s independence, the TRAI reports have observed that the
growth of tele-density has been a mere 1.92%.

Monopoly by BSNL has been one of the important reasons which attribute to low growth
rate. The telecom sector was a monopoly until reforms were introduced and liberalization of
the economy was effected in the early 90s. BSNL was the incumbent monopoly operator in
the telecom sector. Monopolies do not have sufficient incentive to perform. The incumbent
firms are generally complacent because there is no threat of new entry. Since the market
rates are set by the monopoly, and since the consumer demands are highly inelastic, due to
the absence of alternatives, the rates are usually unaffordable by the common public. All
these reasons attribute to poor performance and very poor delivery to the consumers.

Duopoly:

Bharti made its foothold in the NLD market, garnering revenues of Rs 430 crore from its NLD
services business. At the end of 2002–03, the company’s NLD services are operational
almost throughout the country except in the Northeast and Jammu & Kashmir. Ever since
Bharti forayed into NLD, most of its revenues have been coming from cellular operators

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scattered all across the country. It tied up with almost all major service providers in the
country for its NLD offering. However, eventually most of them have gone back to BSNL as
the latter is offering the services at cheaper rates. BSNL is currently charging Rs 1.10 per
minute for carrying STD calls, as compared to Bharti’s rate of Rs 1.49 per minute. Moreover,
BSNL has also been offering discounts of up to 10 percent to cellular firms. That apart, BSNL
had allowed the firms to fix their retail tariff, and thus maximize their margins. Bharti, on the
other hand, had fixed STD tariffs at Rs 2.99.

Nevertheless, Bharti managed to get traffic of 100 million minutes per month last year.

Oligopoly:

As NLD licenses were granted to Bharti Telesonic on 29 November 2001, Reliance on 28

January 2002 and VSNL on 8 February 2002. VSNL too was granted the NLD license in lieu of
giving up its international long-distance (ILD) monopoly in 2002 ahead of the scheduled date
of 2004. With BSNL was forced to go for a major cut, following the reduction in tariffs from
private players. BSNL announced its first rate cut last year when it brought down peak time
calling charges to a maximum of Rs 9 per minute. This was significantly lower than Rs 24
charged earlier. These rate cuts were announced when Bharti Telesonic announced
competitive rates for its IndiaOne long-distance service. The second round of rate cuts came
after Reliance Infocomm announced long-distance tariffs at Rs 1.20 per three minutes (40
paise per minute). Because of the steep drop in tariffs, BSNL’s revenues from NLD services
also showed southward movement to end up at Rs 5,500 crore in 2002-03, a decrease of
around Rs 2,000 crore from FY 2001-02.

Though BSNL has been corporatized for almost three years, it still does not have a system in
place for separating its revenues category-wise. This is a legacy from its monopoly days.
Being the incumbent operator, with a near monopoly on the basic and STD market, BSNL did
not separate its revenue streams. It instead chose to provisionally assess the revenues from
NLD services at 30 percent of its total revenues, and use the same for calculation of license
fees. DoT has now mandated that separate revenue streams ought to be provided for
license fee calculation.

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India's rural telecom sector is poised for explosive growth in the next five to 10 years,
grabbing a 40 per cent share of the new market, a study released on Wednesday said.
Market share as on September ‘09

The graph below shows the customer base split in the industry as of February 2010

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Reliance Communications

Rural Impact

“Of the estimated new 250 million Indian wireless users, in next 5-10 years approximately
100 million will be from rural areas," said the study by the Federation of Indian Chambers of
Commerce and Industry (Ficci) and Ernst and Young.
The paper said operators have demonstrated they can achieve profitability by reducing fixed
costs, controlling variable costs and carefully tailoring services to the requirements of their
customers, reports IANS. A similar model with minor customisation could be emulated in
the rural areas. The government will likely phase out the Access Deficit Charge (ADC) levy
imposed on private players in rural areas and roll out new incentives for mobile networks in
rural India, the report said. It observed that passive infrastructure sharing and “spectrum
hoarding cess” on defaulter operators who fail to meet their roll-out obligations are
illustrations of proactive government initiative.

Current Uncertainty due to Regulatory Environment

The recent reduction in profit in the telecom industry has been due to uncertain regulatory
actions. Allocation of GSM and CDMA licences has lead to extreme competition and over
capacity, which has resulted in drastic fall in the tariffs. Also the spectrum pricing by TRAI

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has created uncertainty over Capping of spectrum and shifting from more efficient 900MHz
spectrum to 1,800MHz spectrum, once the initial license period expires.

Performance of Reliance Communication on Nifty in last 2 years

The underperformance of reliance communication on Nifty has been on account of:

a) Declining tariffs, due to the hyper competitive scenario, as new players launch GSM
operations
b) Uncertainty on 2G spectrum’s pricing, regulatory aspects in telecom sector
c) Higher leverage due to 3G and BWA auction.

New players and business model – How viable are they?

With the Government allowing CDMA operators to launch GSM operations, the telecom
space in India has become hyper competitive with around 12-13 operators as compared to
4-5 in other countries. We believe that with low ARPUs and high capital expenditure they
will find it increasingly difficult to fund the losses. Though the investments by the new
players are likely to be lower than that of the older players, due to passive infrastructure
sharing, we believe at the existing tariffs, the ROI for the new players would be low.

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This is expected to result in the new operators not having the financial muscle to sustain
future tariff wars if any. In our view any further tariff reduction will only hasten the
consolidation in the industry.

With the tariffs declining and Reliance communication increasing its coverage, the under-
penetrated ‘B’ and ‘C’ category circles are growing faster than the metros and ‘A’ category
circles, where the penetration rate is high. However, the ARPUs and MOUs in these areas
are lower due to lower per capita income in these circles, thereby resulting in a decline in
ARPUs and ARPMs.

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1 Sep 2010: (Launch of 3G Lab)

Reliance Communications established a fully-integrated 3G Innovation Lab with end-to-end

wireless network infrastructure. RCOM’s 3G Innovation Lab will involve a community of
content developers, product innovators, technology platforms enablers, device
manufactures and OEMs. It will aid in demystifying 3G technology and make it simpler for
adoption amongst cross-section of customer groups.

Reliance Communications and Acer today announced the launch of a Netbook with
Embedded Wireless Broadband connectivity. Reliance has taken the lead in bringing
innovations in the mobile data space. Each of these innovations has successfully met specific
needs of our customers and this has resulted in significant growth in our mobile data
business.

Externalities for Reliance Telecommunications

Network Externalities is one of the most important externality in case of any

telecommunication company. This is a positive externality as the purchase of telecom
services by a number of people leads to bandwagon effect resulting in large number of
buyers. Network effects become significant after a certain subscription percentage has been
achieved, called critical mass. The existence of a number of such networks in the
telecommunication sector also discourages monopoly.

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Economics of Information

Economics of information is an indispensible aspect of any business, even more so for one
that exists in a highly competitive oligopolistic market. Information helps in the pricing
mechanism, Signaling, Screening and bundling. For Reliance, the most important
information would be about
 Competitor moves and pricing mechanisms
 Government regulatory policies
 Consumer trends
 Georgraphical, Socio- cultural information

The company has to keep a continuous track of information that is flowing from all these
quarters to take advantage of the information.

Conclusion

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References

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