Cutting the cord

The business of cutting the cord is usually followed by a lot of noisy crying. It's true of newborn babies and it's true in the phone business.

Telephone companies around the world - the big incumbents who for decades have provided customers with home lines - have for the past few years been feeling the pain of their subscribers flocking to cellphones.

Traditional calling revenue has been in free-fall as customers have done more of their talking on cellphones. An increasing amount are getting rid of their home phones entirely and going completely mobile.

It's a phenomenon being pushed by mobile-only operators called fixed-mobile substitution - a fancy term for cutting the cord. But the fixed-line providers aren't just crying about it, they're striking back. Most offer other services, such as mobiles and internet access, and are looking to exploit that resulting competitive advantage with a strategy called convergence - the bundling and packaging of those different offerings in a way that will keep customers on their fixed phones.

The mobile-only operators, in return, are being forced to compete by also offering those additional services.

It's a battle between two divergent strategies with the same ultimate goal: total ownership of the customer's communications dollars, a US$1.1 trillion global market last year, says analyst firm IDC.

In New Zealand, the struggle is between the country's two respective phone titans, Telecom and Vodafone.

Previous competition between the two has been described as a pillow fight, but the battle for the lion's share of the $5.3 billion telecommunications market is finally looking like it's heating up. The only question is, who will win?

The motivation behind Vodafone's strategy is clear. According to a report by industry analysts Ovum, mobile operators - of which Newbury, England-based Vodafone is the largest globally - will keenly drive substitution because mobile subscriber growth is slowing, average revenue per user (ARPU) is stagnating and premium data services have been slow to take off.

In January, Vodafone New Zealand reported it had added 68,000 mobile customers, down 8 per cent from 74,000 in the same quarter a year ago. ARPU for the quarter was also down 3 per cent to $51 a month, from $53. The company is pleased with the uptake of its third-generation (3G) service, launched in August, with 100,000 customers signed up at the end of March. But Ovum estimates overall 3G uptake - which includes a similar service from Telecom - has been low, accounting for only 3 per cent of mobile users.

In February, Vodafone's parent forecast that overall full-year mobile phone revenue growth globally will slow to 5 and 6.5 per cent next year, less than its estimate of between 6 and 9 per cent this year. Not surprisingly, Vodafone is being forced to think up new revenue streams.

Last October the parent company did just that with the introduction of the Zuhause voice and internet service in Germany. The service allowed customers to designate a 2km radius around their address as their "at home" zone - calls made from a cellphone within it were billed at a landline rate, with normal mobile pricing applying outside it. The service also included wireless broadband. Vodafone New Zealand has made similar moves recently. In January, the company filed a request with the Commerce Commission for a ruling on interconnection charges with Telecom.

The ruling, if granted, would pave the way for a service similar to Zuhause as Vodafone could offer cheap local calls to customers within a specified "home" zone.

Wireless broadband services are also becoming a major focus. Speeds and costs have so far paled in comparison to similar wired offerings, but steps are being taken to bring them into closer alignment, says Phil Patel, Vodafone New Zealand's director of business markets.

Vodafone recently lowered the cost of using its wireless broadband to $49 for a gigabyte of data from $149.

And although the top download speed offered on the 3G network is only 384 kilobits per second - compared with 3.5 megabits on Telecom's fixed lines - it is set to improve.

Vodafone is upgrading its 3G network and will offer speeds up to 3.6 megabits from September, Patel says.

The company has a roadmap to offer speeds up to 14.4 megabits, but he declined to give a timeline on further upgrades. Still, the move to 3.6 megabits should remove the speed barrier to wireless broadband uptake.

"The experience is going to be better than what the majority of users at home have today," he says. "Three-point-six megabits per second for the mainstream New Zealander is incredibly competitive."

Perhaps the hardest task for Vodafone is overcoming a psychological hurdle - convincing people to give up the home phone they have grown attached to.

But the increasing need for mobility, coupled with lower prices and a wider range of services, is providing that impetus, Patel says.

"People are getting over it."

The motivation for Telecom's convergence strategy is also obvious - declining traditional calling revenue, driven mostly by customers cutting the cord. For the year ended last June, Telecom's combined local service and calling revenue was $2.4 billion, down 4 per cent from $2.5 billion a year earlier. Last year's result is down 10 per cent from $2.66 billion in 2003.

On the flip side, mobile revenue has been steadily climbing - to $841 million, up 3 per cent from $813 million, or up 5 per cent from $796 million in 2003.

But this sort of tradeoff for fixed operators isn't worth it, Ovum says. If a customer cuts the cord and goes totally mobile, the revenue loss from the fixed line often outweighs the gain in mobile spend - even if they keep their business with the same company.

The answer for operators such as Telecom is to, therefore, think of ways to keep customers on those fixed lines.

The company has made several moves to that effect. Two weeks ago, Telecom announced an executive shuffle that will see the company restructured into customer-oriented segments, residential and business, rather than fixed and mobile units.

The new units will seek to create service packages that offer better value to customers.

Telecom launched its first such fixed-mobile pricing bundle last month with the "Freedom" plan, which allows home phone customers to call one mobile number, and vice versa, as much as they like for $10 a month.

On the technological side, there are several different flavours of convergence, the most radical of which is a dual-mode phone that seamlessly switches its connection from mobile network to fixed broadband network depending on where it is. British Telecom has been pioneering this approach.

Telecom last year joined the global Fixed Mobile Convergence Alliance, a 24-member consortium of phone companies that is investigating the different options.

Although BT is a member, the FMCA is leaning towards a slightly different method than the British operator adopted, says Matt Crockett, Telecom's wired division general manager.

Telecom and the FMCA are looking at introducing a handset that can function as a mobile outside, but then use a wireless connection to switch over to a regular phone network at the home or office.

The method doesn't require a broadband connection and requires less investment and tinkering with networks, Crockett says.

Telecom's big advantage over Vodafone's strategy, however, is its broadband offerings. Although Vodafone's planned service is "reasonably compelling" for basic broadband users, fixed services will always have an advantage, Crockett says.

"For each generation leap in mobile there's a generation leap even further than that that takes it an order of magnitude faster in fixed line," he says.

Telecom recently announced plans to install ADSL2+, or next-generation broadband technology that will offer download speeds up to 24 megabits per second. Among other things, the upgrade will allow the company to offer video and television services, Crockett says.

"That's what really locks in the reason to keep a fixed line."

Analysts have mixed views on which strategy will ultimately be the winner, but most see Vodafone at a disadvantage.

Chris Loh, senior telecommunications analyst for IDC New Zealand, says Vodafone's local plan is largely contingent on its getting an interconnection deal with Telecom - either commercially or through regulation - that will allow it to offer cheap local calls.

The longer such a deal takes to iron out, the bigger headstart Telecom will have in offering converged services.

Loh also sees Telecom's broadband offerings as a key advantage, and the faster uptake increases, the worse off Vodafone will be.

"[DSL is] always going to be cheaper. You get more bang for your buck for fixed line data service than a wireless service for the same speed.

"It's going to be harder and harder to argue to users to throw away their fixed lines."

Sydney-based telecommunications analyst Paul Budde says fixed-mobile substitution is a niche market and that most people will ultimately choose to go with a converged service.

Europe has led the way in substitution, but the level of fixed-line abandonment there is settling at about 15 to 20 per cent, he says.

"There are some exceptions on either side of that statistic, but I don't expect Australia or New Zealand to be much different."

He says Vodafone will have to undercut Telecom's prices significantly if it is to make any headway against the counter-strategy.

By the numbers

$5.3 billion
Estimated total value of NZ telecommunications market.

$2.4 billion
Telecom's annual local service and calling revenue.

$841 million
Telecom's annual mobile revenue.

$1.1 billion
Vodafone New Zealand's total annual revenue.

1.7 million
Fixed lines in New Zealand.

1.8 million
Telecom mobile customers.

30%
People who say they answer their mobiles at work, according to Vodafone.

2 million
Vodafone mobile customers.

30%
Voice calls at home made on mobiles, according to Telecom.

50%
Total voice calls made over mobile networks in Scandinavia and the US in 2004.

10,837%
Worldwide growth in mobile subscribers since 1991.

119%
Growth in fixed line subscribers over the same time.

2836%, 35%
Corresponding growth in mobile and fixed line revenues.

Sources: latest available company results, BuddeCom.