Telecom Meltdown: Don't Blame Us, Say Forecasters
By Stephen McClelland
In walking around Palexpo, you think we are still recovering from what may turn out to be the biggest investment binge in any industry in recorded history, spare a thought for those whose forecasting skills were used -- and abused -- to cause it. Three years ago saw a wild time of inflated promises and over-expectations, and a set of predictions that ended in a bust. But forecasters, business modellers and market researchers deny they were responsible. What went wrong?
It could be a question of simple priorities. "We are where we are because people did not want to invest time and resources in coming up with the right answers to the marketplace," says Tacis Gavoyannis, worldwide head of the telecom sector of Taylor Nelson Sofres, a market research firm..Stefan Zehle, managing director of Coleago, a specialist consulting firm, acknowledges a fundamental truth: "Forecasting did not generally change during the bubble period, but people started to ignore sound analysis and did not apply 'reasonableness checks' to their forecasts." The comment sums up a madness of a period only a short time ago, but long lasting in terms of experience. Zehle himself has been moved to compile a how-to guide to improve business modelling and planning technieques, as co-author of a new book on the subject, 'The Economist's Guide to Business Planning'.
But Tomi Ahonen, consultant and author of 'M-Profits: Making Money from 3G', points out that not all predictions were bad or even inaccurate, even in 3G,"now, with hindsight, some of the major predictions were remarkably accurate, especially those made before licenses were auctioned and before network contracts awarded." Ahonen had previously some insight into the vendor forecasting process, setting up and heading Nokia´s 3G Business Consultancy Department that is responsible for 3G business models for the company.
Ahonen continues: "In 2000, Nortel said we would have 1.2 billion mobile subscribers today. That exact number was seen earlier this year. In 2000 Nokia said that there would be commercial 3G launches starting in 2002. The reality was that two networks launched in 2001, six were commercial in 2002 and by now we have 15 commercial 3G networks, eleven on W-CDMA and four on CDMA2000 EV-DO, plus a further two on EDGE. Back in 1999, Siemens said that, by 2003, there would be less than 100,000 subscribers on 3G networks globally. We have several times that amount today." But, says Ahonen, nobody predicted in 1999 or 2000 that there would be millions of 3G users for this year: "That was hype that came in 2001 as the industry raced to out-promise each other."
However, Ahonen concedes that while forecasts from a few years ago for 3G launch and subscriber numbers have been reasonably accurate, the forecasts for some services have been dramatically off the mark. Whilst it is a common contention that many analysts may also have had over-inflated expectations, Ahonen disagrees: "I think the major industry analysts like Ovum, IDC, Yankee Group, Gartner and so on, have been very well on the mark with 3G. They have consistently said that, early on, 'there will not be handsets, the migration to 3G will take time, there will be teething troubles', and so, I don´t think the major industry analysts have been too ambitious."
Zehle agrees: "Let's also remember that, at one stage, under-forecasting was the problem. This was true for 2G mobile and dial-up internet. In 1994/5 when the average mobile penetration in Western Europe was 4%, I forecast a 45% penetration to be reached in 10 years when working on the licence bid for Bouygues Telecom. At first management scaled this back to 30% and then to 17.5%. The 17.5% forecast went into the bid (a beauty contest) and Bouygues won. Within 10 years the penetration rose to over 60%."
So, given the fact that some numbers did hit the mark, or perversely, underestimated market demand, where to point the finger in an industry that has seen a trillion dollars and a million jobs vanish in the face of badly wrong arithmetic? Forecasters say industry executives didn't follow the analyses.Coleago's Zehle recalls: "Coleago worked for a 3G licence bidder in the UK and the business plan showed that at most £1 billion should be paid, but as we all know in the auction they paid £5 billion. This was sanctioned at the highest level."
But bidders for 3G were not the only people engaged in this self-deception, says Zehle. "Another example is Formus Communications, a start-up business that bid for broadband fixed wireless licences in many European countries. I was responsible for forecasting and writing the marketing section for bid books. In one country, I was told 'to double the forecast because otherwise the business plan would not work'. I pointed out that' we may want to do this for the bid book to win the licence, but not for our own internal plan'. Management said that this was 'primarily a spectrum landgrab and I should not worry about whether it made business sense'. Having won several licences, the company started to roll-out and went bust."
The lack of focus on forecasting and modelling is baffling in itself, especially since it is usually very cheap to do. It is, says John Tennent, a specialist at training firm and consultancy Corporate Edge, a way to explore business potential, and its benefit is to help identify good projects as well as eliminate poor projects -- all before a single penny is spent. " Telecom companies, he says, in their eagerness for a license, forgot these basic principles."
Tennent points out that the 3G licence situation should have been relatively obvious even with limited analysis. He continues: "Simple extrapolation of the [UK] market starts at 55 million population, eliminate those very old and very young and you are down below 40 million, segment by income and there may be saturation at 35 million customers, growing annually as people take the adopted technology into old age." The next stage, says Tennent, would have been to ask, "How much will these customers spend?" Tennent says "Old telecoms models average around 4% of GDP, and this will rise with other services and the ability to use the handset as a payment device instead of cash and so on, but revenue boundaries can be identified which have to be split between the competing companies." He concludes, "with just a few numbers it was clear that the 3G bids were beyond reality!" Moreover, says Tennent, the situation rapidly turned into a vicious spiral, "As there were only five 3G licenses available in UK and too many bidders the price rose until bidders dropped out. The only way the bidding teams could justify these new bid prices to their companies was to change their revenue forecasts and move them into unreal territory." For Tennent, the telecom meltdown on the 3G side was fundamentally caused by the bid prices being too high and, consequently, by the cost of debt required to finance these bids. " This prevented the telecom companies borrowing for their infrastructure investment and thus led to cost cutting programmes," says Tennent, "the rest is history." Clearly the hype in the dotcom era too spilled over into infrastructure-based telecom with a behaviour to match. Zehle again: "As regards pure dotcom businesses, many did not have any forecast in the real meaning of the word. Drawing a take-up curve without any supporting research is not a forecast, but wishful thinking. The main responsibility lies with gullible investors and the top management of large companies, as well as smaller entrepreneurs who exploited the gullibility of investors. Investors include firms such as Durlacher and other investment banks who drew up ridiculous revenue projections for all kinds of services. A second factor was the inflated valuation placed by the markets on businesses. For example, the stock market assigned huge per subscriber valuations to ISPs. Doing a business plan for an ISP and making a valuation based on discounted cash flow analysis, we could not come anywhere near such a valuation. The easy assumption was that 'the markets are right', and 'keep adjusting the business plan until you come to this over inflated valuation'."
Predicting the Unpredictable
But what happens when you are bringing a service like 3G to the market for the first time and there is no established experience to model from? Ahonen acknowledges: "Of course nobody can predict a totally new service like Korea´s Waiting Tone (aka Colour Ring aka Ringback Tone) or the airline mobile check-in like with Finnair, JAL, Ryanair and Virgin Blue. Totally new services will of course emerge out of nowhere. If the service is genuinely new, it is impossible to predict."
But Zehle points out, "Even if a product is well researched, it may still not perform as anticipated. For larger companies that have a portfolio of services, this does not matter too much. Some services will fail, others will be successful," he says. "From an investor's perspective, the biggest risk is with a business that has one unproven product."
The Image Game
Meanwhile, once set in motion, the momentum can be too difficult to stop. Ahonen acknowledges that the combined effect of hype and reality mismatch has (for whatever underlying reason) generated a "faulty image" particularly in the 3G sector; "If we examine the forecasts from 1999 and 2000, the general trends and numbers for 3G have been very close to what happened. But he argues that there was "a problem was a phase of aggressive press visibility in 2001 when suddenly many operators tried to push the launch timetable ahead, and the industry caught a fever of 3G anticipation." There was then the inevitable delay phase: "NTT DoCoMo pushed back its launch date, J-Phone did the same, Manx did the same, Sonera did the same, Hutchison did the same, and the industry was suddenly faced with an image problem of 3G being delayed. The initial forecasts, Ahonen, maintains, before the launch hysteria were very well on the mark and have stood the test of time."
Some commentators would argue that structurally the industry has not well placed to think strategically before it acts, sometimes a result of external forces. "If you look at [mobile] operator evolution," says TNS' Gavoyannis, "early emphasis has been 'coverage, coverage, coverage', perhaps because of regulatory pressures to have a national licence and service [in the mobile sector]." Gavoyannis says in the pressure to get customers on board, market research practices and how it can be strategically important, have been forgotten.
Better Practice Needed
Bitter experience may well educate the industry into better and more responsible practice. On the numbers side, experts are agreed that technical modelling skills may help significantly in the future. Coleago's Zehle points out that business modelling practices could be improved a lot, with much more emphasis on sound forecasts and business risk. He says, "A business model should constructed with an emphasis to examine the risk of lower than expected revenue growth on funding." But where, he says, there are cases where take-up is slightly slower and the cost of roll-out or customer acquisition slightly higher, a large funding gap appears quickly. While the business would still become profitable a bit later, the funding gap kills the business. But Zehle also points out that the same can be true for a business that grows faster than anticipated, because the initial outlay on customer acquisition eats up more funds in the short term, again creating a funding gap. In many cases a bad business situation was made worse by restrictive loan covenants that required to achieve certain targets, akin to a 'self-destruct' clause for the business.
And there is common agreement that forecasting in telecom has to stay as an essential element of business planning. "Without forecasting a business has no direction," says Zehle. "A business needs to have a view of future cash flows or investment decisions, for example, based on discounted cash flow or internal rate of return, cannot be made, nor can funding be arranged." But as an extension of this, the more resources such as market research supplemented by secondary data, as well as past cases and a what Zehle calls "a whole battery of reasonableness checks", the more likely it is that the forecast is accurate. In contrast to this 'best practice', during the bubble, many businesses just used assumption sets, says Zehle, derived from optimistic projections by investment firms instead of applying their own research.
As mobile services expand, the teams working on these proposals need to have a better understanding of how to build models and explore potential. Telcos adversity to risk makes investment today a tougher challenge that during the boom [and so] these skills are now mandatory, says Corporate Edge's Tennent.
All project evaluations should be based on research that is fundamentally categorized into the' three C's', says Tennent. The 'three C' principle works on analysis of: Customers (understanding the target segments, their profiles, spend and life cycle; Competition (competitors won't sit and watch, if the revenues are strong and the profit potential high then competitors will enter the market, the more attractive the market the more competitors) and Cash flow (the profile of the cash flows over the life of project -- often cost is underestimated at the start and revenue overestimated at the end).
There are intriguing consequences of this, particularly in the 'Competition' part of the analysis because Tennent says that, in time, with more competitors, price will become the main differentiator, but inevitably fades as too many competitors compete for too few customers. Tennent points out the need to revert to good business practice: "In the internet boom the principles of discounted cash flow evaluations were dismissed as old fashioned and irrelevant." He continues: " The language was of 'revenue per customer' and 'customer acquisition cost'. The companies talked of EBITDA. All of these measures are indictors of performance, but are too simplistic for deciding projects." Now we are back where we started, he says, at the discounted cash flow analysis, which always should have been the most important tool. But the shake out paradoxically might have helped forecasting in the longer term. Says Zehle "I think the busting of the dotcom bubble was actually good for serious forecasters, because investors now realise the importance of sound research and analysis and will devote more resources to this." Getting Psychological
But whilst at times, market behaviour has been perverse enough to outperform on low predictions as well as underperform on high ones, other issues have appeared, because in some cases, the industry completely misred customer behaviour completely. "Where forecasts have been remarkably wrong have been the major data services that were predicted in 2000," says Ahonen. "According to those predictions by now we should be madly surfing the web on mobile handsets, and the fad of SMS text messaging should have subsided and replaced by emails for the mobile, instant and unified messaging, and MMS." But Ahonen contends that the opposite happened. "Mobile web surfing today is not like fixed internet web surfing was some years ago. All of the content on the mobile internet is costly, as is the surfing time. Usage did not match the expectation because the forecasting analogy was wrong." Ahonen believes that rather than comparing mobile web surfing to general fixed internet surfing, the forecasters and modelers should have compared it to premium content surfing on the fixed internet: "That has grown very gradually and that growth pattern is more like what we have now been witnessing for example on WAP."
If forecasting and business modelling represent one issue, in getting to misinterpreted customer behaviour issues, however, the industry may have a deeper problem in its attitude and relationship towards customers, particularly in the consumer market. Market research has traditionally been the 'Cinderella' of telecom, left behind when the industry wants to move strategically, says TNS' Gavoyannis. Consumer market research, whilst based on scientific methodology, is more about assessing customer attitude and mood, says Gavoyannis. An important issue, for example, would be attitudes to 3G. Here, TNS has already released results of a selection of interviews made with randomly selected people in an urban area. It was revealing: most interviewees had no specific idea of what 3G was, and only two thought they might benefit.
Gavoyannis cautions that such an approach is not accurate in terms of the true status of the marketplace but "it is accurate in representing mood of consumer." He continues: "People are conservative in any new technology, and they ask questions such as 'what does it do for me, what are the benefits, what would I lose if I did not have one of those.' Gavoyannis says "they are pretty good at assessing what these are but the industry has failed to articulate those benefits." And, there is still room for strategic confusion, he says. "[At the moment] there is not as much clarity between services and segments. Operators are far too busy in trying to build, as opposed to focussing on the initial market research process."
Gavoyannis believes that there will over time be a better articulation of 3G and research will come down to more specific segmentations, such as the youth market. This segment, says TNS' Gavoyannis, is "almost unique in its own merits". It can embrace, he says, technology faster than anyone else but also promotes a high degree of viral interaction where young people interact with friends and pass on ideas and consumption. Again, he notes, that the youth market is particularly interested in spending time and money with music and games, but overall although it is an important segment, it is not necessarily the first target for P/L driven operator. But, he warns, if the youth market is disinterested in a particular service or application, operators should tread carefully as their attitudes are likely to affect the mainstream.
He suggests that much of the industry could benefit with attitudes derived from a customer point of view that involves embracing the customer, not merely from as a customer buying telecom, but also considers lifestyle. Gavoyannis considers this a 'holistic' approach. But, says Gavoyannis, current operator interest tend to be on much more immediate concerns such as "What is my brand doing? What are my customer satisfaction levels? What is my market share point?" Gavoyannis calls this attitude 'brand maintenance' as opposed to the true strategic thinking he believes needs to impact operator strategy." To a certain extent, the various camps in the telecom industry need a daily picture" he says, "but the reality is that a [customer] panel approach is gives a marketplace feel."
McClelland writes for the ITU Telecom World 2003 On-Line News Service