Academic journal article The McKinsey Quarterly

Value on the Line

Academic journal article The McKinsey Quarterly

Value on the Line

Article excerpt

Europe's telecom companies are hard-pressed to grow fast enough to satisfy their shareholders. Scale and focus should be their mantra.

Shareholders' relentless quest for growth is creating huge challenges for the European telecommunications industry. Share prices imply growth expectations of up to 20 percent a year for some large, integrated telecom companies-far exceeding forecast growth of 6 to 7 percent a year in the overall market for telecom services. Recent takeover battles among the likes of Deutsche Telekom, Olivetti, and Telecom Italia and between Mannesmann and Vodafone AirTouch are thus only the opening salvos in the campaign for more value. The eventual winners will be distinguished by their focus and scale, and the quest for both will reshape the industry over the next three to five years.

With few exceptions, the industry in Europe has far outperformed the overall stock market in total returns to shareholders. But the big question facing telecom companies is simply, "Can we keep up the pace?" Analysis of total returns reveals that in most cases shareholders' expectations have been responsible for a substantial portion of those total returns (Exhibit 1, on the next page). [1] And those growth expectations are still running high (Exhibit 2, on the next spread).

Telephone companies will have to satisfy these expectations just to maintain current market valuations. To create further value, the companies will have to produce earnings growth beyond today's levels, and that in turn will put companies under pressure to improve performance at a still faster rate--all in an environment that is increasingly competitive--squeezing margins and growth rates alike.

More competition ahead

Competition is intensifying for two main reasons. The first is deregulation. Auctions of wireless local-loop licenses in Germany, for example, could redefine competition. And the relaxation of local regulation of cable television networks or national roaming in mobile could have similar effects elsewhere.

The second reason is technology. New technology brings new market entrants, and new entrants bring more choice for customers as the range of products grows. Innovative cable, digital television, and fixed wireless-access products create additional means of reaching customers' homes, permitting upstarts to challenge established companies. Technology, moreover, is continually reducing the cost of delivering these services, giving customers greater choice in how they communicate and where. They can use a fixed or a mobile telephone, a personal computer, or a digital television, depending on their location--at home, in the office, or on the road--and decide whether to purchase service bundles from a single provider or to cherry-pick from several.

The contest to supply these customers will be waged on various fronts. Just as utilities, information technology companies, and computer companies are doing, brand owners such as Virgin and Dixons Group in the United Kingdom and Carrefour in France are leveraging their assets to enter the market and resell services in mobile telephony. The impact of the newcomers can be dramatic, especially when they focus on specific market segments. In several countries, long-distance tariffs dropped by between 30 and 70 percent within a year of deregulation and the entry of new competitors. Dixons achieved its leading position as an Internet service provider in only four months by offering free Internet access through its Freeserve service.

Clearly, integrated companies cannot carry on as before. Competitors are attacking their most lucrative market segments and exposing cross-subsidies among their businesses. The incumbents' historical strengths will be no guarantee of leadership in the new high-growth service areas.

Drawing the battle lines

This struggle for value is essential not simply to meet shareholders' expectations but also to survive. …

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