The new EU roaming rules are created to sound good in voters' ears, but unfortunately, Neelie Kroes and her team have not thought through the economic consequences for the telecom industry and Europe with the roaming proposal. Strand Consult has analyzed the proposed roaming plan. This research note follows a note about the EU Commission's plan for an overall digital single market. Read the earlier research note. While it is a heroic idea to make mobile roaming cheaper, the proposed plan will put an end to investment in mobile infrastructure including deployment 4G/LTE deployment, the very thing that the Commission wants to support to create a connected and more competitive continent. It will also mean massive dismissals of employees in the European telecommunications industry. The plan, if implemented, will create perverse incentives for arbitrage and border trade in mobile telephony.
The EU Commission’s roaming proposal consists of four elements:
- "Rome like home" – The consumer pays the same abroad as when at home.
- When roaming, no charges to receive calls or text messages – just like at home.
- Price harmonization – Calling from one country to another should be the same price as calling within a country.
- Required operator participation and no restrictions - EU member states and companies must comply with the rules. No technical or contractual barriers to trade are allowed.
In practice this means that a mobile consumer can buy a SIM card in any EU country (with the rates and terms that are connected to it) and travel to any other country and use the SIM card with the conditions included with the purchase. For example, a German can buy a cheap SIM card in Lithuania, bring it back to Germany, and call, text or surf at the cheaper Lithuanian rate. Kroes and her staff confirmed this at their recent press conference presenting the roaming plan.
Each European country has a unique mobile industry cost structure based on geography, technology, and regulation, and has a different set of mobile operators. The cost to deliver a minute of voice, a text message, or a megabit of data can vary significantly from country to country. With the "Rome like home" plan, the underlying cost structure of taxes, mobile termination rates, fixed and operating costs are completely divorced from end user mobile prices. This means that consumers pay the retail price for a mobile package and then use the service in any country they want, regardless of whether the price covers the local or roaming costs. If the roam like home plan were applied to physical goods, a consumer could go to a supermarket in Copenhagen and demand the same price for a chicken sold in Budapest. To be sure, it sounds good for consumers, but roam like home will be a disaster for the mobile industry.
The challenge for the EU Commission is large
In their heroic struggle to make a win for consumers, Neelie Kroes and the Digital Single Market Committee at the EU have presented a proposal in which they have forgotten to consider the larger social and economic consequences. Consumers will naturally gravitate to the lowest prices. This means that operators with low costs, such as asset light mobile operators with only small network investments or MVNOs with no network at all, will win at the expense of national network operators that have to buy licenses, deploy infrastructure, and manage networks. To be sure, prices can equilibrate at a new low, but that level will squeeze further network operators that are already straining to invest in networks. If Kroes thinks that the situation for investment is bad now, just wait until prices drop even further.
The new proposed plan combined with EU rules on free movement of goods in the EU member states will make it even easier to market mobile services across borders. More than 50% of Europeans who have shopped online in the last year. Read this report.
Many Europeans are quite comfortable buying mobile services online. In Denmark more than 50% of all private SIM cards are purchased online. In fact two Danish companies, Telmore and CBB, originated the concept of buying mobile services online 12 years ago. Read Strand Consult's research note about this topic. This trend has spread to the rest of the world. Within just the last three years, Danish Onfone has lifted online sales of mobile telephony through the network to a new level of efficiency, and 10 executives from network operators lost their jobs. Read our research note about this topic.
To be clear, Strand Consult supports online sales and marketing of mobile telephony and the trend of MNVOs. But it is something else entirely to exploit the differences of national tax rates and value added taxes (VAT) and to create an artificially low priced market. Read Strand Consult’s report where the challenges of creating a single market are described. It is clear that Kroes and her people have overlooked the factors that have the greatest impact on the telecommunications industry, including the different tax regimes of individual member states.
The “roam like home” proposal combined with EU rules for free movement of goods means that the market for mobile telephony arbitrage will explode, forcing Europe's mobile operators to reduce their costs significantly and perhaps stop investing all together.
Watching the video of the press conference held in conjunction with the launch of digital single market initative, it is clear that Neelie Kroes and her people have not understood the consequences of their own rules. In fact they are proud that their regime will allow consumers to buy a SIM card in one country only to use it in another.
During the press conference journalist Jacob Klok from the leading Danish business daily Børsen asked a question about arbitrage and border trade. As Kroes did not understand the question, her press representative Ryan Heath made a follow up email to Klok where he wrote the following:
Sorry you got such a strange answer at the press conference. I think Neelie didn't understand what you meant at first. What we said was correct but incomplete.
One thing that would be harder for a German or Danish person (or whoever) to just got to Lithuania and take a "roam like home contract" is that the Lithuanian operator would probably impose a "reasonable use" clause in a contract. They don't really want people using 100% of a plan while roaming because it is still a bit more expensive for them compared to domestic use. So while you would be able to take a contract in another country (like you are able to now), there are also disadvantages to doing so (including as I mentioned, potential differences in customer service levels, maybe the staff of your new operator do not speak your language, costly to send the phone back for repairs if needed etc).
Strand Consult’s doubts that a mobile retailer in this example would willingly add a “reasonable use” clause to any contract, especially under the conditions in which low prices are incentivized and in which the prices are decoupled from underlying network costs required to produce the traffic. Perhaps the Commission believes that the retailer will make a “reasonable use” clause out of the goodness of its heart. This statement from the Commission's office reflects the misunderstanding that most mobile customers in Europe have a post-paid contract with their mobile operator that includes a phone. The fact is that the vast majority of mobile customers in Europe are pre-paid customers. They don’t have a contract for their phone, and they buy their SIM card separately, either in a retail store or over the Internet. The online model is the fastest growing payment method in the world today.
Furthermore the Commission seems to think that prepaid customers can’t roam today. The reality is that the vast majority of mobile operators in Europe offer their customers roaming through a technology standard called Camel. If there was any doubt from reading the proposal, the press conference and its follow up demonstrate that Kroes and her team are out of touch with the telecommunications market and the reality that 507 million Europeans experience with mobile telephony every day.
Strand Consult expects that the impact of the “roam like home” proposal on the mobile industry will be catastrophic in the short term, and there after, negative for consumers who will have unwittingly supported the collapse of the industry. Following is Strand Consult’s summary of the outcomes to expect from Kroes’ proposal, if implemented.
7 Outcomes of EU Commission’s plan
There is a high probability that mobile operators in Europe will lose up to 20–40% of their turnover, and that the industry will lose up to 75% of its revenue, based upon the EU's own figures
. There are some errors in the EU’s calculations, but that does not change Strand Consult’s outlook. This assessment is based on the price gap between 27 markets in Europe and if customers converted from their current plans to the lowest priced plans in Europe.
Operators across Europe will put their investments on hold, given the decline in revenues which will likely result in the next 5 years should the plan be implemented. Strand Consult finds it highly unlikley that a board of directors of any telecommunications company will approve the use of shareholders' funds for a market where profits are plummeting. Strand Consult expects that the environment for investment in Europe will be worse than after the 3G auction in 2000.
Institutional investors will sell off their European telecom shares, and international telecom operators that have the greatest exposure in Europe will be hardest hit. If European operators have large exposure to markets in Asia and South America, they will likely ponder how to service their debt, especially if Europe is important for their revenue.
Should the plan be implemented, expect immediate movement in the financial markets. Within a matter of weeks, financial institutions will reduce their exposure to telecom in Europe. Investors will not wait around to see what happens. To lessen their losses, they will get out fast. If one adheres to the efficient market hypothesis, expect that many investors will move even before the plan is implemented, as they calculate future expectations into their present decisions.
Should the plan be implemented, over the next 3-5 years expect a price war so fierce in Europe that companies will cut all costs significantly. Subsidies for smartphones will fall away (bad news for phone manufacturers), retail commission for "top up" of prepaid cards will be moved to the Internet, and dealer commission in the stores to "top up" will be eliminated. Meanwhile operators will lay off 30-50% of their employees. It is not the first time this has happened. Orange pulled out of Denmark and something similar happened in Belgium and Austria.
The sharp decline in prices will lead to a consolidation of the mobile industry in Europe. The operators with the best economy today may be able to buy cheaply some of the operators that come into massive problems as a result of the new plan. It will be interesting to see how national and EU competition authorities will look at consolidation. Until now, they have not wanted consolidation, even though it has been on Kroes’ wish list.
In the next wave, banks and pension funds will be hit hard. There will likely be a number of banks that will have large losses on those operators with large debts. Operators such as Telefonica and Telecom Italia are in danger of collapse. Though it is difficult to calculate exactly who gets hit and how hard, it is certain that the telecom sector in Europe will find it difficult to raise capital until Europe has found a new equilibrium with fewer operators.
The 5 Winners and 5 Losers of the EU Commission’s Plan. Judge for yourself who will suffer the most
There are some winners that will experience some short term gains, which may evaporate over time. Longer term, China and the U.S. emerge with the best conditions. Here are the 5 winners:
Winners are small operators in small countries that are asset light and can sell cheap flat rate products to the countries where the prices are relatively higher and where the operators still use minute billing. Local operators in countries such as Denmark, Estonia, Latvia, Lithuania and especially Luxemburg would emerge winners.
MVNOs such as Lyca Mobile, Lebara, Maxroam, and other such as Skype which have a business model based on selling cheap traffic across a number of countries. Actors such as WhatsApp and Facebook should consider establishing themselves as MVNOs in Europe. See Strand Consult’s assessment of the Facebook MVNO
Consumers will gain in the short term, as some of them will experience a significant price decrease. In practice, pre-paid customers will get the biggest savings, especially those consumers who are in countries with high pre-paid rates and those consumers in countries with high tax rates. Consumers will use the internet to purchase mobile telephony from the lowest cost producers.
Entrepreneurs who can create a website that delivers the mobile telephony business model over the internet and offer it in the 7 main languages in the EU will be winners. Just as Telmore, Onfone, CBB, Simyo, Blau and others see the possibilities of using an MVNO agreement to sell SIM cards and traffic through the network, these entrepreneurial companies will buy cheap traffic in one country, only to sell it to another.
The knowledge industry in China will be a big beneficiary. As the European infrastructure providers decline because investment in Europe dries up, Chinese suppliers, with their access to cheap financing, will swoop into Europe. They will see opportunities to establish themselves on the EU, and thus the knowledge industry in China be stimulated.
When it comes to the losers, the list is long. The economic impact is huge not only for the telecom industry but also for a number of EU member states which rely on tax revenue from the telecom industry for their national budgets. Here is the list of losers:
Countries with high taxes on telecommunications and high VAT will lose. Where customers can save the first 12% of the mobile bill by buying their traffic in a country with low VAT, these countries will be first to lose out. The model will work until 2016 when the new rules in the EU are are changed.
Mobile operators that took out loans to make network investments will regret their decisions. The operators with high debt that the EU Commission mentions in their report are probably those that will be hardest hit. To put it another way, homeowners with low or no debt in their home usually have only minor problems when property prices fall, but for homeowner with high debt, the situation is the opposite. Strand Consult believes that credit rating agencies will react quickly when they find out what is happening. Should some mobile operators’ credit rating be downgraded, which is likely for some, they will have a hard time to raise new capital to meet their obligations.
European mobile internet users will experience increased congestion in the next 2 years. Lower mobile prices will result in an increase in traffic, and operators, with no or low ability to invest, will fall behind in their network maintenance and upgrades.
Infrastructure equipment providers will find that demand for their products in Europe will decline significantly. This trend will also lead to further consolidation of the European infrastructure industry, similar to the massive layoffs in the industry in 2000 after the 3G auctions. There is a good chance that Chinese suppliers that have access to cheap Chinese financing will see an opportunity to take large market share in Europe, thus putting further pressure on European manufacturers.
European citizens will be the biggest losers when the telecom industry that builds and operates the foundation of modern society collapses. It will not be unlike the crisis triggered by the collapse of financial industry just 5 years ago. Europe's knowledge industry will be hit by an avalanche of cost cutting and consolidation, putting a brake on innovation. Asian hardware companies and American internet companies will be the big winners. Europe is already a cash cow for companies such as Google, Apple, and Facebook that combine the sale of their digital services with smart tax models that exploit the different tax regimes in Europe.
The list of losers could be even longer. In any case, it is clear that Neelie Kroes and her people have not thought their plan through. Their misguided attempts to help European consumers with high roaming prices will create a perverse arbitrage model to exploit mobile telephony prices across the EU.
Can the EU do limit the damage?
Since the EU Commission’s proposal was released, Strand Consult has spoken to many in the telecom industry and the financial sector. Everyone is looking for ways to prevent an economic avalanche hitting the European telecommunications industry. Here are some of the counter-proposals:
Put a cap on how much consumers can roam. The question is where the ceiling should be, what people should pay when they hit the ceiling, and whether operators in a particular country can put the relevant caps from operators from other countries, for example a "Roam like home in France" model. Strand Consult is pessimistic about such models, because there are many mobile customers in Europe with very low consumption.
Operators could create a roaming ceiling for their own customers. Strand Consult is also pessimistic on this option. Why would an operator place a limit on its own business?
Set minimum roaming prices. In theory setting minimum prices could allow operators in high costs countries to cover their costs when a low cost SIM card enters. Strand Consult finds this unrealistic because it goes against the idea of Kroes' plan. In practice, Strand Consult believes that roaming prices will be identical to the national termination rates. At the press conference, Kroes' team said that they would not compel operators to lose money on roaming. If so, then "Roam like home" is dead.
Operators that specialize in international traffic only will emerge. This evolution is contrary to the Commission's proposal that it should cost the same to call from Paris to London as it costs to call from Paris to Nice. There are a number of MVNOs such as Lebara and Lyca Mobile that specialize in international calling. However the Lebara and Lyca model requires that national network operators take on the job of building and running mobile infrastructure. There can be no MNVOs without network operators.
There can be restrictions on using SIM cards from other countries. French citizens could be prohibited from using a Lithuanian SIM card in France. However this model is contrary to EU treaty to ensure that goods move freely within the EU.
Strand Consult does not believe that the EU Commission would willingly present a proposal that would leave Europe worse off, but the report shows certain assumptions, generalizations and simplifications about how the market works were made. As a result they have misdiagnosed the problems and proposed the wrong solutions.
The roaming proposal is especially distressing as it creates a market for opaque products that exploit the cost differences between countries and undermine the investment modern mobile networks. The message of the proposal for operators is: go for low capex but ensure high profitability. Operators that invest will get into financial trouble and become a takeover target for operators that are holding back.
There's only way to avoid these bad outcomes: remove the "roam like home" plan all together.
To learn more about this topic, request a copy of Strand Consult’s research note “Generating Growth in Europe - How ICT Is the Solution”. Strand Consult's CEO John Strand can be reached at firstname.lastname@example.org and +45 2085 0444.