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  • 1. R A  V C RSwimming Against the Tide How Technology, Media, and TelecommunicationsCompanies Can Prosper in the New Economic Reality
  • 2. The Boston Consulting Group (BCG) is a global manage-ment consulting firm and the world’s leading advisor onbusiness strategy. We partner with clients in all sectorsand regions to identify their highest-value opportunities,address their most critical challenges, and transform theirbusinesses. Our customized approach combines deepinsight into the dynamics of companies and markets withclose collaboration at all levels of the client organization.This ensures that our clients achieve sustainable compet-itive advantage, build more capable organizations, andsecure lasting results. Founded in 1963, BCG is a privatecompany with 71 offices in 41 countries. For more infor-mation, please visit
  • 3. Swimming Against the Tide How Technology, Media, and TelecommunicationsCompanies Can Prosper in the New Economic Reality A  V C R David Dean Dominic Field Ron Nicol Frank Plaschke Daniel Stelter December 2010
  • 4. The financial analyses in this report are based on public dataand forecasts that have not been verified by BCG and on assump-tions that are subject to uncertainty and change. The analysesare intended only for general comparisons across companiesand industries and should not be used to support any individualinvestment decision.© The Boston Consulting Group, Inc. 2010. All rights reserved.For information or permission to reprint, please contact BCG at:E-mail: bcg-info@bcg.comFax: +1 617 850 3901, attention BCG/PermissionsMail: BCG/Permissions The Boston Consulting Group, Inc. One Beacon Street Boston, MA 02108 USA
  • 5. ContentsExecutive Summary 4The 2010 Technology, Media, and Telecommunications Value Creators 6Technology: A Sharper Focus on Growth and Margins 8The Innovation Cycle 8The Surge in Developing Markets 10Bright Clouds on the Horizon 10A Renewed Focus on Margins 10Media: Digital Disruption Continues Its March 13Successive Waves of Disruption 13Embracing the Digital World: Naspers and Pearson 14Telecommunications: Searching for Growth 18The Developing Markets: Telecom’s Next Billion 18The Internet Goes Mobile 20Cost Management and Cash Distribution 21Deconstruction Ahead 21Value Creation in Low-Growth Environments 23The Growing Importance of Cash Payouts 23The Growth Paradox 24A Fresh Look at Value Creation Strategy 26Balanced Capital Deployment 27Scenario-Based Strategic Planning 27Ten Questions That Every CEO Should Be Addressing 29For Further Reading 30Note to the Reader 31S A  T 
  • 6. Executive SummaryT his report builds on the twelh annual report in ◊ The five-year TSR for media companies ranks near the the Value Creators series published by The Bos- bottom, at 2.5 percent. ton Consulting Group. It provides detailed em- pirical rankings of the stock market performance ◊ Companies can chart their own destinies, however. of the world’s top technology, media, and tele- The average five-year annual return for the top tencommunications companies and distills managerial lessons performers in each of the three sectors was betweenfrom their success. We also describe key trends in the global 22 percent and 26 percent.economy and world capital markets and how these trends arelikely to shape future priorities for value creation. Finally, we The likelihood of slow growth in developed econo-share our latest analytical tools and client experiences to help mies has vast implications for value creation.companies better manage value creation. This report address-es the challenges that technology, media, and telecom compa- ◊ Growth will be constrained in developed nations ow-nies face in delivering above-average shareholder returns in a ing to high consumer-debt burdens, limited credit, andglobal economy marked by below-average growth. the winding down of many government stimulus pro- grams.Despite the strong rebound in equity values, globalcapital markets are still laboring under the shadow ◊ Economies such as Brazil, China, and India are grow-of the worldwide financial crisis that began in 2008. ing rapidly but are not yet large enough to carry the global economy.◊ Global market indexes were up roughly 30 percent in 2009 but have largely moved sideways through the ◊ Lower revenue growth and pressure on margins will first three quarters of 2010. likely lead to a decline in valuation multiples and cap- ital gains.◊ The weighted-average annual total shareholder return (TSR) for the 2010 Value Creators database, which cov- ◊ Increasingly, dividends and stock repurchases will be ers the five years from 2005 through 2009, is 6.6 per- larger contributors to TSR. cent. That is considerably below the historical average of roughly 10 percent. ◊ The best performers will find ways to combine in- creased cash payouts with above-average profitableThe technology, media, and telecommunications sec- growth in a more competitive environment. Rogerstors finished in the middle to lower tiers of perfor- Communications of Canada, for example, has managedmance among all industries. to increase sales, improve margins, and manage debt.◊ The five-year TSRs for the technology and telecom sec- Sales growth drove 70 to 80 percent of the TSR of su- tors are in the middle of the pack relative to other in- perior performers in all three sectors—but other TSR dustries, at 6.2 percent and 5.3 percent, respectively. drivers varied by sector. T B C G
  • 7. ◊ Technology companies demonstrated low growth in The ability of technology, media, and telecom compa- margins (with Apple and Hewlett-Packard being no- nies to develop innovative products and business table exceptions) and low cash-flow contribution. models will play a critical role in creating shareholder value.◊ The media sector’s sales growth was driven almost ex- clusively by the focused Internet players; the sector ◊ Taiwan-based MediaTek has thrived by building good- also had moderate cash-flow contribution. enough chipsets for inexpensive mobile phones.◊ The telecom sector had high cash-flow contribution ◊ Apple has succeeded not just with well-designed gad- but shrinking margins. gets but also with an ecosystem of audio and video content and applications that lock in customers andCompanies from emerging economies were big win- enable premium pricing.ners across all three sectors. ◊ The business model of traditional, integrated telecom◊ Seven of the top ten telecom performers, five of the carriers is breaking down. Operators need to develop top ten media performers, and four of the top ten tech- new strengths in order to succeed. nology performers are based in emerging economies. The future success of these three industries will de-◊ Companies from developing markets are playing in- pend on adaptive strategies that can anticipate, ab- creasingly larger roles on the global stage. sorb, and exploit the fast-moving market.◊ While Indian IT players are well known for their inter- ◊ Scale, size, and market position matter less than they national ambitions, telecom players are also spreading once did. their wings. For instance, Bharti Airtel’s recent purchase of Kuwait-based Zain Telecom’s African business made ◊ Experimentation and the ability to recognize and cap- Bharti the world’s fih-largest mobile company. italize on opportunities matter more than ever.The digital revolution has affected all three sectors, About the Authorsfor better and worse. David Dean is a senior partner and managing director in the Munich office of The Boston Consulting Group and a◊ In the media sector, many of the big winners, such as former global leader of the Technology, Media & Tele- Google and Tencent Holdings, are new entrants that communications practice; you may contact him by e-mail embraced the power of the Internet to aggregate and at Dominic Field is a partner and distribute content. managing director in the firm’s Los Angeles office and the U.S. leader of the media sector; you may contact him by◊ A few established media players, such as Pearson, have e-mail at Ron Nicol is a senior thrived by shiing their business lines to digital mod- partner and managing director in BCG’s Dallas office and els—but most have struggled to adapt. the global leader of the Technology, Media & Telecom- munications practice; you may contact him by e-mail at◊ Media companies might find new growth through con- Frank Plaschke is a partner and sumers’ rapid adoption of tablets and e-readers. managing director in the firm’s Munich office and the Eu- ropean leader for value creation strategy; you may con-◊ Telecom companies are trying to reorient their strate- tact him by e-mail at Daniel gies and operations to accommodate the rapid growth Stelter is a senior partner and managing director in of mobile data. Some will successfully turn mobile BCG’s Berlin office and the global leader of the Corporate data into a new source of growth. Development practice; you may contact him by e-mail at◊ For both technology and telecom companies, cloud computing may offer a chance for superior growth.S A  T 
  • 8. The 2010 Technology, Media, and Telecommunications Value CreatorsT he 2010 Value Creators rankings cover All three sectors posted returns below the global average shareholder performance from 2005 five-year annual return of 6.6 percent. The technology and through 2009. We analyzed 126 companies telecom sectors returned 6.2 percent and 5.3 percent, re- across three sectors: 36 technology compa- spectively, while the media sector returned only 2.5 per- nies, 52 media companies, and 38 telecom- cent. (See Exhibit 1.) This relatively poor performance re-munications companies. We also analyzed the perfor- flects the steep global decline in stock prices in late 2008.mance of each sector relative to other sectors and ranked The market only partly rebounded in 2009. (Historically,the top ten companies within each of the three sectors. TSR across all industries has averaged about 10 percent.) Exhibit 1. Technology, Media, and Telecom Were Middling Performers Value Fundamental Valuation Cash flow creation = value + multiple + contribution 1 Sales Margin Multiple Dividend Share Net debt TSR (%) growth (%) change (%) change2 (%) yield (%) change (%) change (%) Mining and materials 18.0 10 –4 11 3 –3 1 Chemicals 12.0 6 –1 5 3 0 0 Machinery and construction 11.7 9 3 –1 2 –1 0 Consumer goods 9.5 6 1 1 3 0 –1 Utilities 8.6 9 –4 2 4 –2 0 Technology 6.2 8 –1 –3 1 1 0 Telecommunications 5.3 5 –1 –2 4 1 –1 Retail 4.2 8 0 –5 2 0 –1 Automotive and supply 3.9 1 –6 10 2 –3 0 Transportation and logistics 3.8 5 –1 –1 2 –2 0 Pharmaceuticals and medical technology 3.5 9 1 –6 2 –1 –1 Media 2.5 5 1 –5 3 0 0 Multibusiness 0.3 7 –2 –4 3 –1 –2 Travel and tourism –0.7 5 –2 –1 2 –4 –2 Pulp and paper –1.7 –1 –1 0 3 –2 –1 Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; Bloomberg; annual reports; BCG analysis. Note: Decomposition is shown in percentage points of five-year average annual TSR; any apparent discrepancies in TSR totals are due to rounding. 1 Five-year average annual TSR (2005–2009) for the weighted average of the respective industry sample. 2 Change in EBITDA multiple. T B C G
  • 9. The technology, media, and telecommunications sectors ($2 billion for media companies and $12 billion for tech-are among the most unpredictable and fast-moving of all nology and telecommunications companies).industries. (See Exhibit 2.) Still, individual companies canescape the tyranny of averages and outperform their in- The overall rankings track performance from 2005dustry. Over the past five years, for example, the top ten through 2009, but we also show returns for the first threetechnology firms posted an average annual return of 23.3 quarters of 2010. In addition, we break down TSR into itspercent; the top ten media performers, 26.2 percent; and six component parts to show their relative contributionthe top ten telecom performers, 22.9 percent. to stock returns and assess how a company is creating value. (See Exhibit 3.) The first two elements—revenueCompanies from developing economies dominate the growth and changes in profit margins—reflect a compa-technology, media, and telecom rankings. Of the 126 com- ny’s change in fundamental value. Combining these withpanies analyzed, 81 are based in emerging markets—64 the third element—the valuation multiple—establishespercent of the total. Seven of the top ten telecom per- the change in a company’s market capitalization. The lastformers, five of the top ten media performers, and four of three elements—cash dividends, share repurchases, andthe top ten technology performers are based in emerging debt repayments—track the distribution of free cash floweconomies. to investors and debt holders and determine its contribu- tion to a company’s TSR.To arrive at the sample of 126 companies, we requiredcompanies to be publicly listed for all five years, with at The next three sections of this report explore the perfor-least 25 percent of their shares public traded. We also set mance of the technology, media, and telecom sectors ina minimum market-capitalization floor for each sector more depth. Exhibit 2. The Technology, Media, and Exhibit 3. BCG’s Model Allows a Company Telecom Sectors Are Unpredictable and to Identify the Sources of Its TSR Fast-Moving High Communications Semiconductors equipment Soware Fundamental Value Computers and Internet Office peripherals and electronics Revenue growth catalog 3.8% Electrical retail Media equipment Margin change –0.5% Diversified Electronic equipment telecom- munications Profit growth 3.3%Unpredictability and instruments(Average error in Wireless telecom- munication services earnings per share forecasts Internet + Change in valuation multiple 3.2% soware over the past and ten years) services = Gain in market cap 6.5% Cash payouts Dividend yield 3.4% IT services Share change 2.3% Low Long Industry rate of change Short Net debt change –2.3% (Time needed to move up or down one quartile) + Free-cash-flow yield 3.4% = TSR 9.9% The cost of being wrong (Difference in gross margin between 10th- and 25th- percentile performers) High Medium Low Sources: Thomson Reuters Datastream; Thomson Reuters Sources: Thomson Financial Datastream; Thomson Financial Worldscope; Bloomberg; annual reports; BCG analysis. Worldscope; Bloomberg; annual reports; BCG analysis. Note: Based on ordinal rankings along each dimension; does not Note: This calculation is based on an actual company example; the include marine, transportation infrastructure, or water utilities contribution of each factor is shown in percentage points of average industries. annual TSR.S A  T 
  • 10. Technology A Sharper Focus on Growth and MarginsT he technology sector is diverse—covering by ever-more-versatile soware running on ever-more- everything from semiconductors, handsets, powerful chipsets. In Innovation 2010: A Return to Promi- and PCs to soware and IT services—and nence—and the Emergence of a New World Order, a BCG re- historically, companies in this sector have port based on a global survey of global executives, four generated shareholder value through of the top five most innovative companies are technologygrowth. Over the past five years, 17 percentage points firms: Apple, Google, Microso , and IBM. (See the sidebar(70 percent) of the 23.3 percent total return of the top “Innovation: A Return to Prominence.”)ten technology firms came from revenue growth. (SeeExhibit 4.) In the future, innovation-led growth may be harder to find. Consumers and businesses alike are more reluctantThis year’s top-ten group is truly global. Six Asian compa- to spend on the latest hardware and soware, in part be-nies made the list. Three of these are Indian IT-service cause they’ve been able to live and work just fine withcompanies, propelled by the use of outsourcing. existing technology. A few new products, such as Apple’s iPad, may hit a sweet spot, but the environment is gener-But while the top ten technology companies excelled, the ally inhospitable, especially for large companies thatrest of the pack fared much worse. Several factors ac- need massive markets, not niches, to fuel double-digitcounted for the middling 6.2 percent return of the tech- growth.nology sector overall, which ranked sixth of the 15 indus-tries analyzed. Companies below the top ten were much At the high end of the market, successful innovation willless successful at generating revenue growth. Their mar- likely depend not just on great products but also on newgins and price-to-earnings (P/E) multiples also declined, business models—what we call business model innovation.reflecting heightened price competition and investors’ Apple, the leading technology value creator, with a totaldim view of future growth prospects. five-year annual return of 45.6 percent, has innovated on both fronts. Its well-designed gadgets and elegant inter-In the future, as in the past, revenue growth will drive faces are legendary. But its iTunes and App Store ecosys-shareholder value in the technology sector. The corner- tems lock customers in to Apple products and allow thestones of that growth will likely be innovation, developing manufacturer to charge premium prices. Apple’s strongmarkets, and emerging technologies such as cloud com- five-year showing was built around both superior reve-puting. Improving margins will play a supporting role. nue growth and margin expansion. At the low end, innovation will likely be aimed at achiev-The Innovation Cycle ing cost and scale advantage. Taiwan-based MediaTek, the second-leading technology value creator, with a five-For decades, revenue growth in the technology sector has year annualized return of 32.0 percent, manufacturesdepended largely on successive waves of innovation, from “good enough” chipsets. Its rapid product cycles have his-the minicomputer to the PC to the mobile phone, spurred torically allowed MediaTek to stay ahead of the pack. T B C G
  • 11. Exhibit 4. The Top Ten Technology Performers, 2005–2009 1 TSR Decomposition Market Sales Margin Multiple Dividend Share Net debt 2010 TSR2 value3 growth change change4 yield change change TSR5 # Company Location Industry (%) ($billions) (%) (%) (%) (%) (%) (%) (%) Computer 1 Apple United States 45.6 189.6 37 35 –21 0 –3 –2 34.6 hardware Semicon- 2 MediaTek Taiwan 32.0 19.0 24 –1 8 5 –2 –1 –16.5 ductors Computer 3 Infosys Technologies India 21.2 32.6 32 0 –11 2 –2 1 17.4 services Computer 4 Hewlett-Packard United States 20.8 121.8 8 12 –2 1 4 –2 –17.9 hardware Hon Hai Precision Electrical 5 Industry Company Taiwan 20.2 40.9 28 –5 –1 2 –3 0 –11.8 equipment (Foxconn) Tata Consultancy Computer 6 India 18.9 32.1 28 –2 –10 2 0 1 25.9 Services services Telecom 7 Research In Motion Canada 16.6 38.8 60 3 –46 0 –1 –1 –29.5 equipment Congnizant Computer 8 United States 16.5 13.5 36 –1 –17 0 –2 1 42.2 Technology Solutions services Semicon- 9 Samsung Electronics South Korea 13.3 91.2 11 –5 2 1 1 3 –2.1 ductors Computer 10 Wipro India 12.9 21.8 30 –1 –16 1 –1 –1 10.6 services Top ten average6 23.3 17 4 2 1 –1 0 7.4 Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; Bloomberg; annual reports; BCG analysis. Note: Sample included 36 companies. 1 Contribution of each factor shown in percentage points of five-year average annual TSR; any apparent discrepancies in TSR totals are due to rounding. 2 Average annual TSR, 2005–2009. 3 As of December 31, 2009. 4 Change in EBITDA multiple. 5 As of September 30, 2010. 6 Weighted-average TSR for the ten companies listed. Innovation A Return to Prominence Innovation is back. In BCG’s April 2010 report, Innovation The two greatest barriers to innovation, according to sur- 2010: A Return to Prominence—and the Emergence of a New vey respondents, are a risk-averse corporate culture and World Order, 72 percent of all survey respondents (71 per- lengthy development times. Few respondents identified a cent of respondents in the technology and telecom sec- shortage of great ideas as a major hurdle. tors) said that innovation was a top-three priority at their company, compared with 64 percent in 2009. That is the Technology companies should be placing part of their in- highest reading in the survey’s seven-year history. novation bets in developing markets, which offer talent, growth, dynamism, and increasingly demanding con- Innovation pays off. The TSR of the most innovative com- sumers. panies, as identified by survey respondents, was 12.4 per- centage points higher than that of their industry peers for the three-year period ending in 2009. Over ten years, the margin was 2 percentage points.S A  T 
  • 12. Innovation, however, is tough to institutionalize over sev- respondents planned to increase their product-develop-eral economic or product life cycles. In 2010, for exam- ment investments in developing markets.ple, MediaTek began facing stiff competition from Qual-comm, Spreadtrum, and other chipset producers. Itsrevenue and TSR declined over the first three quarters Bright Clouds on the Horizonof 2010. One budding trend that could create or destroy value for technology companies is the rise of cloudThe Surge in Developing computing—on-demand access to aMarkets The cloud could shared pool of computing resources. Most reshape entire organizations are just starting to exploitThe importance of developing markets is the opportunities afforded by the cloud toreadily apparent in the ranking of top tech- industries, just as the reduce costs, make business processesnology value creators. Three of the top ten Web did in the 1990s. more efficient, and accelerate time tofirms are India-based IT service providers market.riding the wave of outsourcing: InfosysTechnologies, Tata Consultancy Services, and Cognizant The cloud could reshape entire industries, just as the WebTechnology Solutions. More important, they have built did in the 1990s. For instance, the cloud can knit togetherglobal operations, created world-class hiring and training multiparty ecosystems, as Apple and Google have beensystems, and demonstrated an ability to quickly enter doing to upend the media industry. It can also facilitatenew businesses. asset-light business models: in India, dozens of commu- nity banks rely on Tata Consultancy Services’ “bank in aTheir success shows that many developing markets are box” cloud offering to automate deposit and loan proc-moving beyond their status as primarily a source of cheap essing.labor. Increasingly, the BRICI nations (Brazil, Russia, In-dia, China, and Indonesia), the Middle East, and other re- The implications for various IT providers are profound.gions have become important markets in their own right. The revenue models of soware companies could moveIn 2009, the BRICI countries represented about 45 percent from licensing and service contracts to monthly pay-as-of the world’s population and about 15 percent of global you-go arrangements. Subscale IT-services companiesGDP, and had some 610 million Internet users. By 2015, may have trouble competing against Google, Amazon,these countries will have more than 1.2 billion Internet and Microso , which are investing billions of dollars inusers—well over three times the number of Internet users data Japan and the United States combined. (See The Inter-net’s New Billion: Digital Consumers in Brazil, Russia, India, Because of the uncertainty about how cloud computingChina, and Indonesia, BCG report, September 2010.) will play out, many technology companies are hedging their bets by moving into several layers of the cloudSome rapidly developing regions have become important stack—infrastructure, platforms, applications, and socenters of technical innovation. India and China, for in- on—oen through acquisitions. (See the sidebar “A Quickstance, produce huge numbers of engineering and com- Guide to the Cloud.”)puter science college graduates who earn less than theirWestern counterparts. This combination of rising localdemand and a steady supply of technical talent has led A Renewed Focus on Marginsmany larger technology companies to establish R&D cen-ters in developing markets. Improving margins is a potential source of value creation for technology companies. Margins declined an averageIn BCG’s Innovation 2010 report, for example, 54 percent of 1 percent annually over the five-year period for the 36of survey respondents at technology and telecommunica- technology companies in the Value Creators database, astions companies said that they would increase their in- the recession took its toll on profits. Most other industriesvestments in China. Across all industries, 62 percent of experienced similar declines. T B C G
  • 13. A Quick Guide to the Cloud The cloud provides opportunities for value creation at Process Transformation. The primary benefits here are high- three levels in large enterprises: the utility level, the proc- er efficiency, closer collaboration, and superior integra- ess transformation level, and the business model innova- tion and coordination across processes. Avon Products, tion level. (See the exhibit below.) for example, is starting to rely on the cloud to coordinate communications with its sales leaders. Utility. CIOs see tangible opportunities to save 10 to 50 percent in costs and to go to market more quickly with Business Model Innovation. At this emergent level, the cloud new applications and upgrades. Most organizations are can power new strategies built around ecosystems and currently focused on infrastructure and are moving stan- supported by massive computing power and scale. dard applications, such as e-mail and other productivity tools, to the cloud. Cloud Computing Offers Three Levels of Value Description Select opportunity areas Lowers costs and increases ◊ Utilization of equipment and facilities agility through elastic ◊ Self-serviceability Utility computing resources and ◊ Scale pay-per-use models ◊ Agility Improves integration and ◊ Process standardization and composition collaboration by leveraging ◊ Streamlined handoffs and integration Process common assets ◊ New insights from data intensity and data transformation sharing ◊ Enhanced virtual teaming around specific processes Creates new business ◊ New services through integration across customers, models and ecosystems partners, and suppliers Business through linking, sharing, ◊ New insights through data analytics by integrating model innovation and combining capabilities and aggregating data across channels and enterprises among enterprises ◊ New asset-light business models that can be rapidly scaled to meet market needs Source: BCG analysis.Even among top performers, margins came under pres- the company with lower multiples. In the middle of thesure. Among the top ten technology performers, margins decade, the company’s margins began to improve evenrose by an average of 4 percent per year, but most of that while multiples continued to contract. In 2009, cash pay-increase came from Apple (through premium pricing) outs also became an important part of total return.and Hewlett-Packard (through astute cost managementof acquisitions and ongoing operations). There are limits, however, to the punch that margin en- hancement can provide. It typically runs its course aerH-P’s journey shows how a company can create value in several years, and companies have to reposition them-several ways. In the early 1990s, the company achieved selves for new growth. Finding growth in the face of un-most of its returns through growth; in the late 1990s, certainty and disruption is the central challenge for tech-through multiple expansion. (See Exhibit 5.) In the first nology companies. The group of top TSR performersfew years of the 2000s, growth remained strong but mar- could look very different in five years.gins narrowed and cash payouts fell. Investors punishedS A  T 
  • 14. Exhibit 5. Hewlett-Packard Has Moved Through Different Phases to Deliver TSR Average annual TSR, December 1990 through September 2010 (%) 10,000 H-P 15 1,000 S&P 500 9 100 10 Strong growth Multiple Strong growth offset Margin Cash expansion by multiple improvement, flow compression and multiple strength heavy use of cash flow contraction 1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total Annualized TSR (%) 41 30 –13 16 10 15 TSR decomposition1 Revenue growth (%) 19 8 14 10 3 12 Margin change (%) 6 –7 –10 15 6 1 Multiple change (%) 15 26 –12 –11 –3 2 Cash payout change (%) 1 3 –5 2 4 0 Sources: Compustat; Bloomberg; BCG ValueScience Center; BCG analysis. Note: Indexed to 100 on December 31, 1990; the y-axis is in log scale. 1 Contribution of each factor shown in percentage points; any apparent discrepancies in TSR totals are due to rounding. T B C G
  • 15. Media Digital Disruption Continues Its MarchT he media sector’s average 2.5 percent TSR Music piracy has weakened the willingness of consumers over five years was among the worst of all to pay for digital content, and the inertia of content own- industries and would have been worse still ers contributed to the decline of businesses that were without the strong showing of a handful of once highly profitable. Record labels have allowed Apple companies. The sector ranges from news- to define the pricing, usage rules, and economics of thepapers to music labels, television networks, movie stu- digital-music business. Newspapers have allowed aggre-dios, Internet search engines and portals, and business gators such as Google and Yahoo! and bloggers such asand educational publishing. Huffington Post to break apart their content and weaken their business models. Internet companies are now dis-Most of these companies have fallen out of favor among rupting the television, movie, and book industries by sell-investors. If investors had stayed neutral on the sector ing online works at discounts to their offline counterparts,and awarded it the same multiple as five years ago, the and relative newcomers such as Facebook are pushingsector would have reported a more respectable 7.7 per- the boundaries even further by blending user-createdcent TSR. A slight increase in revenues and dividend yield and professional content.accounted for the sector’s modest improvement in TSR. Many media companies are still struggling to adjust toThe performance of the media sector is a tale of two seg- these new realities. The movie studio Metro-Goldwyn-ments: traditional companies and relatively new Internet Mayer, for example, recently filed for bankruptcy protec-players. Many of the big winners among the top ten per- tion, wounded by slowing growth of DVD sales and theformers are new entrants, such as Google and Tencent rise of online streaming of video content.Holdings, that developed Internet businesses aggregatingand distributing content. Tencent’s QQ instant-messaging The recession magnified these longer-term trends for me-platform in China, for example, offers games, virtual pets, dia companies, which rely heavily on advertising. Adringtones, and other forms of entertainment. The top ten spending has historically tracked GDP, but it has becomeperformers posted an overall average TSR of 26.2 per- decoupled from the broader economy since the end ofcent, the strongest of the three sectors. (See Exhibit 6.) the recession. Many companies are permanently shiing marketing dollars “below the line” and away from tradi- tional media outlets. They are maintaining their ownSuccessive Waves of Disruption Web sites and engaging in both offline and online promo- tional activities.Long-brewing digital developments and the global eco-nomic downturn created a perfect storm for the media Media companies willing to make a break from the pastsector. For the past decade, the Internet has been eroding and fundamentally shi their business models have athe power of media companies to generate adequate re- fighting chance to succeed, but they must act both deci-turns from content. Disruption moved in successive waves sively and experimentally. (See the sidebar “Tablets andthrough different corners of the media sector. E-Readers: Another Chance to Master Digital Content.”)S A  T 
  • 16. Exhibit 6. The Top Ten Media and Publishing Performers, 2005–2009 1 TSR Decomposition Market Sales Margin Multiple Dividend Share Net debt 2010 TSR2 value3 growth change change4 yield change change TSR5 # Company Location Industry (%) ($billions) (%) (%) (%) (%) (%) (%) (%) 1 Tencent Holdings Hong Kong Internet 106.3 39.5 70 4 37 1 –1 –6 0.9 South Broadcasting and 2 Naspers 33.3 15.1 16 4 19 1 –7 –1 14.5 Africa entertainment Net Serviços de Broadcasting and 3 Brazil 30.3 4.7 27 0 3 0 –11 12 –7.9 Comunicação entertainment United 4 Google Internet 26.3 197.0 44 5 –21 0 –4 2 –15.2 States Modern Times Broadcasting and 5 Sweden 17.8 3.3 16 4 –2 2 0 –2 43.0 Group entertainment Shaw Communi- Broadcasting and 6 Canada 17.7 9.0 11 –1 0 3 2 3 8.0 cations entertainment Luxem- Broadcasting and 7 SES 13.5 10.7 9 –1 0 4 4 –3 21.1 bourg entertainment Broadcasting and 8 Grupo Televisa Mexico 12.8 11.9 10 1 4 3 –5 –1 –7.7 entertainment Beijing Gehua Broadcasting and 9 China 12.5 2.2 16 –4 3 1 –3 –1 –4.5 CATV Network entertainment United 10 Pearson Publishing 11.8 11.4 9 4 –7 5 0 1 14.7 Kingdom Top ten average 6 26.2 22 4 –2 2 –2 2 –7.4 Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; Bloomberg; annual reports; BCG analysis. Note: Sample includes 52 companies, including Internet content providers. 1 Contribution of each factor shown in percentage points of five-year average annual TSR; any apparent discrepancies in TSR totals are due to rounding. 2 Average annual TSR, 2005–2009. 3 As of December 31, 2009. 4 Change in EBITDA multiple. 5 As of September 30, 2010. 6 Weighted-average TSR for the ten companies listed.Embracing the Digital World: Naspers Africa, Brazil, China, Central and Eastern Europe, India,and Pearson Russia, and Thailand—locations frequently overlooked by media giants.A few traditional media companies are making strongmoves to protect their core businesses while building suc- Naspers developed expertise in choosing the right play-cessful digital franchises. Let’s look briefly at Naspers, the ers in local markets and in helping them to become evensecond-leading media company at creating shareholder more successful. It recognized that strong niche operatorsvalue over the past five years, and Pearson, the tenth- in regional markets can build protective barriers. Amongleading media value creator. Both companies have its successful acquisitions are Allegro—an e-commerce,thoughtfully expanded into developing markets and built classified ad, and price comparison portal in Eastern Eu-digital businesses, while also—at least in the case of Pear- rope—and Sanook!, the leading local portal in Thailand.son—making tough choices about shedding lower-poten- In 2001, Naspers had the foresight to acquire a 46.5 per-tial businesses. cent stake in Tencent Holdings, the leading media value creator.Naspers: An Expanding Footprint. Naspers has evolvedfrom a traditional newspaper and magazine publisher Naspers has also taken a gradual approach to expansion.based in South Africa to a leading electronic-media com- For example, it has invested in e-commerce and transac-pany in many developing markets. Since 2001, Naspers tion platforms to monetize new offerings. It has also con-has acquired Internet and mobile-content companies in verted existing TV customers to digital services in order T B C G
  • 17. Tablets and E-Readers Another Chance to Master Digital Content Tablets and e-readers, spurred by the successful launch who read print publications will own tablets within three of Apple’s iPad and Amazon’s Kindle, are poised to be- years, assuming that prices decline to the $130–$200 come as popular as VCRs and portable audio players range, far less than the current low-end model of the were in the 1980s or digital audio players in the early iPad, which retails for $499. 2000s. A recent BCG survey of nearly 13,000 consumers in 14 countries revealed remarkable underlying demand: The survey offers guarded good news for content provid- 28 percent of all respondents plan to purchase an e-read- ers. (See the exhibit below.) In the United States, for ex- er or tablet in the next year; over three years, 49 percent ample, consumers appear willing to pay $2 to $4 for a plan to do so. While intent always overstates actual pen- single issue of an online, interactive magazine—compa- etration, BCG projects that 25 percent of U.S. consumers rable to the cost of a print version—and $5 to $10 for a Consumers Will Pay for Content on E-Readers and Tablets ($) Willingness to pay for a digital book 20 17 15 13 13 13 13 12 12 12 10 Kindle book bestsellers: $9.99 10 9 6 5 4 3 8 2 7 7 7 7 7 7 7 5 6 3 3 2 1 0 Norway Spain Finland France United Japan India States Italy Austria Germany Australia United Korea China Kingdom ($) Willingness to pay for a single copy of a digital magazine 8 7 6 5 5 5 5 4 4 4 Newsweek Kindle: $1.99 4 3 3 3 3 2 2 4 1 3 3 3 3 3 2 3 2 2 0 1 1 1 1 Finland Spain Norway United Korea Germany China States Italy Japan France Australia United Austria India Kingdom ($) Willingness to pay for a monthly subscription to a digital newspaper 20 19 15 WSJ: $14.99 15 14 13 13 12 12 11 10 10 8 USA Today: $11.99 7 5 4 12 2 2 7 8 11 7 5 7 5 5 5 4 1 1 1 0 Spain United Australia Austria United Korea China Kingdom States Italy France Germany Japan Norway Finland India Sources: BCG survey of 12,717 consumers; BCG analysis. Note: Respondents currently own a tablet or e-reader or are interested in purchasing one within three years. Van Westendorp’s Price Sensitivity Meter method was used to calculate the optimal price.S A  T 
  • 18. Tablets and E-Readers (continued) monthly online newspaper subscription. Although this player in the market is conceivable. Media companies amount is less than the cost of a print subscription, a would have multiple buyers for their content, which digital version is cheaper to produce—and, of course, the would encourage innovation in products, pricing, and price is much higher than the free versions that most con- business models. sumers now read. ◊ An open market would be competitive but not necessar- It is likely that one of three scenarios will unfold in this ily comfortable. Consumers would be able to buy con- market: tent from multiple retailers whose products are in stan- dard content formats. Media companies would have a ◊ A single closed ecosystem, such as iTunes in the United wide range of outlets for their digital content and a high States, could take root. Content creators would be forced degree of pricing freedom. This explosion of choice to sell to a single buyer that has an extremely strong might be a mixed blessing for consumers who have position. The experience for consumers would be a grown accustomed to one-click purchasing. mixed bag, as they would have a unique, easy experi- ence but less choice. While Apple has set the bar high, No matter how the market evolves, media companies will it is unlikely that the tablet market will benefit from the need to make deals with device makers to protect their tight integration of device, soware platform, and ag- assets—something that music labels and newspapers, in gregation that characterized the success of iTunes. Too particular, did not do effectively during the past decade. many other companies have a stake in seeing a more They must also build business models and standards that open system, which is also what consumers want. meet the unique characteristics of the digital environ- ment and are thoughtfully positioned relative to their an- ◊ Several ecosystems with a few large players could create alog, Web, and mobile businesses. These new business their own rules and offerings to attract different con- models will almost certainly challenge key beliefs about sumer segments, as demonstrated by Microso , Nin- how value is created in their traditional businesses and tendo, and Sony in the game console market. For digital require working together with a wide set of partners. In content, Apple and Google are already starting to define other words, companies will need to become digital na- ecosystems, and the emergence of a third or fourth large sell premium programming. When entering new mar- tomers. Its FT Group subsidiary generated 73 percent ofkets, whether by acquisition or organically, Naspers has revenues from digital sources in 2009, up from 28 percentmaintained a local approach in its content, management, in 2000. This expansion has more than offset the declineand partnerships. in advertising-driven revenues. Across all of Pearson’s businesses, revenues from digital sources reached 31 per-Pearson: Old-School Panache in New Worlds. Pearson, cent in 2009, up from 21 percent in 2005.the London-based owner of such venerable brands as theFinancial Times and Penguin Books, and half owner of the Educational products and services in North America re-Economist, has an old-school pedigree. But it has been main Pearson’s largest business. Sales and profits haveanything but fusty in its willingness to go digital and to grown 8 percent annually over the past five years. Pearsonpursue global expansion. Since 2001, the company has achieved this growth by branching out from its roots as aradically overhauled its portfolio by making $6.3 billion publisher of educational materials and a provider of as-in acquisitions, oen in digital businesses, and by dispos- sessment services to invest heavily in digital learning. Bying of $4.1 billion in legacy assets, such as Les Échos in combining online-education modules with existing printFrance. content, Pearson has outperformed the generally flat ed- ucational-publishing market. For example, Pearson’s mar-Pearson may be the most successful of the traditional ket-leading engineering-mechanics textbook, Statics andpublishers in migrating to digital services. It has built suc- Dynamics, 12th edition, by Russell C. Hibbeler, gained fourcessful business lines in market intelligence, valuations, percentage points of market share in 2009 on the strengthand market indices targeted to premium business cus- of a new digital-learning and assessment product. T B C G
  • 19. Pearson has leveraged its strength in North America to dividends. At Penguin Group, despite a restructuring andbecome the global leader in education publishing and re- annual revenue growth of just 2 percent over the past fivelated services. International education is the company’s years, profits have improved an average of 5 percent an-fastest-growing business segment, with sales increasing nually. Pearson has also increased its dividend nearly 617 percent annually over the past five years. It has grown percent annually since 2000.both organically and through acquisitions. For example,it absorbed Wall Street English, a chain of premium Eng- The experiences of Naspers and Pearson show that ven-lish-language training centers in China, in 2009. erable media companies can reinvent themselves by find- ing pockets of customers willing to pay for digital infor-Unusual among media companies, Pearson has posted mation that is useful and timely and through thoughtfulstrong revenue growth while maintaining margins and and determined expansion into high-growth segments.S A  T 
  • 20. Telecommunications Searching for GrowthT he telecom sector’s 5.3 percent TSR over ◊ Cost discipline and margin maintenance are increas- the past five years puts it firmly in the mid- ingly important in all markets, not just mature ones. dle of the pack among industries. Sales growth contributed 5 percentage points ◊ The traditional model of an integrated, monolithic, all- and dividends contributed 4 percentage segments-all-activities carrier is becoming obsolete, aspoints to the industry’s overall return, with falling mar- suggested by the presence on our top-ten list of Amer-gins and weakening multiples pulling down the final ican Tower, the owner and operator of wireless andresult. broadcast towers.Seven of the top ten telecom performers are from emerg- Let’s look at each of these developments in more markets, where strong growth helped power TSR. Ofthe top ten’s 22.9 percent TSR, sales growth contributed17 percentage points. (See Exhibit 7.) Within the full sam- The Developing Markets: Telecom’s Nextple, telecom companies operating mostly in developed Billioneconomies generated a meager 2 percent TSR, whilethose operating in developing companies generated an Telecom in many developing economies has experiencedimpressive 21 percent TSR. strong, steady growth, especially in mobile services, which have attracted hundreds of millions of new subscribersThe telecom world, however, is not so easy to divide into each year. This growth has helped produce total returnsdeveloping markets characterized by growth and oppor- exceeding 25 percent for América Móvil, China Mobile,tunity and developed markets where carriers are focused and Bharti Airtel, the top three telecom performers.on cutting costs. There are at least four layers of complex-ity in today’s telecom market. Consumers in developing markets have quickly embraced mobile phones for communication and entertainment.◊ Profits remain elusive for many carriers in developing There are currently about 1.8 billion mobile-phone sub- markets, where competition can drive prices down to scriptions in the BRICI countries, compared with fewer rock bottom, as it has in India and Indonesia. than 400 million in the United States and Japan. (See Ex- hibit 8.) Among these countries, Russia has the highest◊ Mobile data will change the nature of the game. Data mobile-penetration rate, followed by Brazil, Indonesia, traffic now exceeds voice traffic in many markets China, and India, which still have plenty of room to grow. and is expected to continue rising sharply, spurred by strong demand for smartphones and Internet ser- Affordability and availability are driving adoption in the vices. As companies such as Apple and Google solid- BRICI countries, especially in India. Rates for voice calls ify their hold in the telecom market, operators in are currently as low as $0.006 per minute in India, and all markets must reassess their strengths and weak- price promotions are abundant. Not surprisingly, the mar- nesses. gins of Indian operators are under pressure. T B C G
  • 21. Exhibit 7. The Top Ten Telecommunications Performers, 2005–2009 1 TSR Decomposition Market Sales Margin Multiple Dividend Share Net debt 2010 TSR2 value3 growth change change4 yield change change TSR5 # Company Location Industry (%) ($billions) (%) (%) (%) (%) (%) (%) (%) 1 América Móvil Mexico Mobile telecom 27.1 75.6 22 5 –5 1 3 1 11.2 2 China Mobile Hong Kong Mobile telecom 26.0 188.5 19 –3 3 4 0 3 13.2 3 Bharti Airtel India Mobile telecom 25.6 27.3 44 –1 –18 0 –1 1 11.6 South 4 MTN Group Mobile telecom 23.6 29.3 34 2 –10 2 –2 –1 10.0 Africa China United 5 Network Com- China Mobile telecom 20.4 22.6 17 –4 7 2 0 –2 –29.6 munications 6 Telekomunikasi Indonesia Fixed-line telecom 18.6 20.3 14 –2 1 4 0 1 0.6 United 7 American Tower Telecom equipment 18.6 17.4 19 1 3 0 –11 7 18.6 States Rogers Communi- 8 Canada Mobile telecom 17.6 18.7 16 4 –9 2 –1 7 21.0 cations Nether- 9 Koninklijke KPN Fixed-line telecom 17.1 28.0 3 –1 3 6 7 –1 2.2 lands Turkcell Iletisim 10 Turkey Mobile telecom 15.1 16.1 12 –1 –3 4 0 2 –3.7 Hizmet Top ten average 6 22.9 17 –1 1 2 1 2 9.0 Sources: Thomson Reuters Datastream; Thomson Reuters Worldscope; Bloomberg; annual reports; BCG analysis. Note: Sample includes 38 companies. 1 Contribution of each factor shown in percentage points of five-year average annual TSR; any apparent discrepancies in TSR totals are due to rounding. 2 Average annual TSR, 2005–2009. 3 As of December 31, 2009. 4 Change in EBITDA multiple. 5 As of September 30, 2010. 6 Weighted-average TSR for the ten companies listed.Several Western European carriers have begun to invest com players that are based in developing markets un-in developing markets, but their success has been mixed. derstand the challenges of operating in prepaid,Telefónica, with its strong position in Brazil and Argen- low-tariff markets. But these markets may be harder totina, has done well, but others carriers have struggled to enter in the future as prices decline and penetration in-adapt their businesses to a very different environment. creases. In 2009, India added 200 million mobile sub- scriptions—some of them undoubtedly second or thirdOn the flip side, several companies from developing phones—but mobile revenues grew by just 2 have started to expand abroad. Early in 2010, Being even the fourth or fih carrier in a market such asIndia’s Bharti Airtel acquired most of Kuwait-based Zain India’s will be challenging, let alone the eighth orTelecom’s African business for $10.7 billion. The deal ninth.has made Bharti the world’s fih-largest mobile opera-tor with operations across 18 countries. In late 2010, Price competition is a benefit for consumers in the shortRussia’s VimpelCom, which is partly owned by Nor- term but not necessarily in the long term if it preventsway’s Telenor, and Weather Investments, the majority telecom operators from investing in future technologies,owner of Egypt-based Orascom Telecom, announced a quality of service, or customer relationships. Given the$6.5 billion merger that would create one of the largest importance of telecom operators to the economic growthmobile-telecom operators. and social development of many countries, governments will be under pressure to play a larger role in establish-Scale is less important than skill and knowledge in en- ing regulations that ensure adequate returns and afford-tering developing markets. Bharti Airtel and other tele- ability.S A  T 
  • 22. Exhibit 8. BRICI Mobile-Phone Subscriptions Vastly Outnumber Those in the United States and Japan Number of mobile-phone subscriptions, 2006–2015E Number of SIM cards (millions) 1,400 7 1,200 1,151 11 1,000 13 953 800 769 50 600 534 1 5 507 5 9 3 6 372 400 20 9 34 235 214 274 233 279 5 200 150 175 152 197 166 101 69 100 115 140 0 China India Brazil Russia Indonesia United States Japan 2009 57 41 86 1411 66 88 92 penetration (%) 2015E 84 75 113 155 107 115 112 penetration (%) 2006 2009 2015E Compound annual growth (%) Sources: Economist Intelligence Unit; CIA World Factbook; BCG analysis. Note: Mobile-phone penetration is the number of SIM card subscriptions divided by the population. 1 Mobile-phone penetration in Russia is believed to be less than 100 percent; there is a tendency for users to own multiple SIM cards, a large number of which are inactive.The Internet Goes Mobile cations. Many operators, especially in the United States, have managed to offset the decline in voice revenueFaced with a dramatic reduction in average revenue per through mobile data. Creating long-term shareholder val-user (ARPU) from voice traffic and tariffs, operators need ue through mobile data, however, may be challenging un-to find new sources of growth in order to generate higher less operators can wean their customers away from un-shareholder returns. One way is to encourage customers limited-data sign up for mobile-data services. Even in the BRICImarkets, consumers are increasingly accessing the Inter- In South Korea and Japan, for example, carriers pioneerednet through their handsets, especially when fixed-broad- innovative services such as mobile banking and payments,band costs are high or availability is limited. winning global accolades for the innovation. They have been less successful, however, in creating shareholder val-Bharti Airtel, for instance, has publicly said that it aspires ue. Intense price competition, open platforms, and regula-to become a “lifestyle enablement company.” It recently tory policies have created a challenging environment.was granted the first license to offer mobile-payment ser-vices in India. Safaricom has moved beyond traditional In other developed markets, mobile broadband is attract-communication services in Kenya through its M-Pesa ing powerful players—notably Apple and Google—frommobile-banking service. Vodafone, a part-owner of Safa- other industries. Google is building an ecosystem aroundricom, has introduced similar services in Afghanistan and its Android mobile-phone platform, developing enhance-Tanzania. ments to its Google Voice offerings, and investing in data centers for its cloud services. As Google, Apple, and otherIn many markets, revenues from mobile-data services are prominent brands expand into telecom markets, carriersgrowing rapidly, spurred by the spread of mobile-broad- need to carve out distinct roles that will allow them toband services, smartphones, and the availability of appli- create and capture value. T B C G
  • 23. Cost Management and Cash Distribution ed States with its TracFone prepaid-mobile-phone sub- sidiary.In the face of all these challenges, operators in maturemarkets are understandably pulling levers other than América Móvil has benefited from population growth ingrowth to maximize shareholder return. They have sev- Latin America and a strong presence in Mexico, a countryeral options. They can reduce churn and take other steps with high tariffs. But chairman and major shareholderto manage the customer base in order to maintain reve- Carlos Slim has also earned a reputation for tight financialnues or at least slow the decline of voice ARPU. They can management. Margin change contributed 5 percentageaggressively reduce costs by sharing networks with com- points, the highest among the top telecom performers.petitors and deploying low-cost technologies. They canalso improve cash flow in order to increase cash distribu-tions to shareholders. These levers represent a continu- Deconstruction Aheadous-improvement approach that is consistent with manybusiness models. Since deregulation in the 1980s and the emergence of the commercial Internet in the 1990s, the telecommunica-Koninklijke KPN and Rogers Communications have each tions industry has faced a rolling set of disruptions. Thegenerated substantial value despite operating in devel- stock market has punished most large carriers while rich-oped markets. KPN, the leading provider of telecom ser- ly rewarding companies in competition with telcos. Sincevices in the Netherlands, also serves mobile subscribers its IPO in 2004, Google’s market capitalization has risenin Germany and Belgium and provides business network to almost $200 billion, while the value of most operatorsservices and data transport throughout Western Europe. in developed markets has fallen. The U.S. telecom indus-It ranked ninth among telecom firms in shareholder re- try has lost more than 100,000 jobs in the past five yearsturn by taking a disciplined approach to costs and cash and more than 400,000 in the last Most of KPN’s 17.1 percent TSR came fromshare buybacks (7 percentage points) and dividend distri- Cost cutting alone, however, will not be enough for carri-butions (6 percentage points). ers to compete when game-changing forces—such as cloud computing and “voice for free” services—are warp-Rogers Communications, a diversified communications ing the industry.and media company in Canada, has managed both togrow and to adroitly manage cash. Sales growth contrib- As demonstrated by the successes of Google, Apple, anduted 16 percentage points of Rogers’s 17.6 percent total others, tremendous opportunities abound in the broaderreturn for an eighth-place ranking among telecom players. technology and telecom space. In order to capture theseAs a cable provider, Rogers is not saddled with the univer- opportunities, carriers need to make hard choices aboutsal service and other regulations borne by traditional tele- strategy and business models. Most, however, are sufferingcom carriers. Still, the company’s early investments in from the “curse of the conglomerate”: when their wirelinemobile and a high-speed network have paid off. business went into decline, they were able to turn first to mobile voice and then to mobile data, but now they haveAt the same time, Rogers has increased its focus on man- run out of businesses that can generate adequate returns.aging costs and margins. Its change in profit margins con- With no more cash cows le to milk, carriers must buildtributed 4 percentage points to total return, and lowering new sources of competitive advantage. (See the sidebarits debt load contributed 7 percentage points. (A narrow- “Five Ways to Play the Telecom Breakup.”)ing of its multiple, however, subtracted 9 percentagepoints.) The pace of change in telecom technologies is accelerat- ing, but despite the wealth of opportunities in developingAmérica Móvil, the top-performing telecom company, markets and in mobile broadband, only a few telecomwith a total return of 27.1 percent, also has successfully operators have successfully generated long-term share-focused on growth and cost discipline. From its base in holder value. To win in the future, operators will need toMexico, it has built a portfolio of companies across Latin choose their business models, offerings, regional markets,America and the Caribbean—and it has entered the Unit- and customer segments carefully.S A  T 
  • 24. Five Ways to Play the Telecom Breakup Because of the turmoil in telecom, the business model customer-relationship-management (CRM) service. To of traditional carriers is breaking apart. In this decon- pursue this approach, operators would need a strong in- structed world, operators will need to be both selec- novation pipeline. tive and aggressive in building businesses out of the fragments of their former selves. Five strategic options Platform Provider. Platform providers could supply specific are likely to emerge, of which operators can probably functionalities to other companies. Amdocs Limited pro- pursue two or three simultaneously. (See the exhibit vides CRM, billing, and operations support for mobile below.) operators. To pursue this model, carriers would need to develop efficient state-of-the-art global operations. One-Stop Shop. Many consumers and small enterprises are looking for trusted sources to help them sort through Network Developer. Operators could choose to build net- new services and products. Operators could become their work infrastructure for other operators, as ReggeFiber is partner of choice through enhanced retail capabilities doing in the Netherlands. This model would require strong and a broader footprint. project-management skills and a knowledge of local mar- kets and municipalities. Best-Practice Network Operator. Carriers could sell their net- work-operations capabilities to other operators. Bharti To thrive in the next phase of telecom markets, carriers Airtel, for example, has partnered with equipment maker need to focus on those businesses that create value and Ericsson to manage parts of its mobile network in India. excise those that do not. And because today’s innovative Such arrangements could serve as models for larger-scale services are developed at warp speed and exist in “per- developments that take advantage of scale, standardiza- petual beta” while the kinks are worked out, they will tion, and offshore operations. have to introduce Silicon Valley–type development capa- bilities. Global End-User Service Provider. Operators could develop global services such as, a cloud-based Operators Can Choose a Combination of Strategic Options Develop Build Operate Integrate Sell Serve Main strategic options Content 1 and 1 One-stop shop for customers communities Devices and local 2 Best-practice network operator networks 3 2 End-user services and 3 Global end-user service provider applications Platforms 4 Platform provider 4 Networks 5 Network developer 5 Data centers Traditional telco model Source: BCG analysis. T B C G
  • 25. Value Creation in Low- Growth EnvironmentsD espite signs of recovery, developed econo- the declining growth rate of profits into a company’s mies remain under significant pressure— stock price, its valuation ratio will likely drop as well. most recently from the sovereign-debt crises in Europe. It is likely that the devel- These changes will cut significantly into a company’s oped world is entering an extended peri- ability to deliver capital gains. At first glance, this mightod of below-average growth, with profound implications seem to imply that overall TSR will be lower as well;for how companies create value. however, the inherently dynamic nature of TSR changes the equation.The debt overhang of U.S. consumers, the reduced avail-ability of credit, and the winding down of government In the medium term, cash payouts can help offset lowerstimulus programs will brake the global economy. The growth as a contributor to shareholder return. As inves-International Monetary Fund projects that global eco- tors reset their expectations about future growth and re-nomic growth will have slowed in the second half of duce valuation ratios, they are implicitly increasing the2010. In the two-speed world now in operation, the IMF value of what we call a company’s free-cash-flow yield—forecasts that developing economies will grow by 2.2 per- the return that investors and debt holders get from cashcent in 2011, while developing economies will surge distributions by companies. By way of a simple illustra-ahead by 6.4 percent. Overall global growth will settle at tion, if a company pays out 50 percent of its net income4.2 percent for the year. and its P/E ratio is 20, then its free-cash-flow yield con- tributes 2.5 percentage points of TSR; if the company’sWhat characterizes value creation in low-growth environ- P/E drops to 10, the same cash payout yields 5 percentagements? Two broad trends and a paradox. Their implica- points of TSR.tions for any individual company will depend, of course,on the particular situation. As this illustration demonstrates, lower valuation multi- ples increase future free-cash-flow yields. This dynamic tends to counteract the parallel drop in net incomeThe Growing Importance of Cash growth, resulting in an average TSR closer to the histori-Payouts cal level.Using BCG’s model for quantifying the relative contribu- The cash accumulated during the downturn, along withtion of the various sources of TSR, executives can analyze currently high levels of free cash flow generated from costhow their company created value and—on the basis of cutting, has given many companies the opportunity tointernal plans—how it might create value in the future. improve their free-cash-flow yield dramatically.For example, lower global economic growth will meannot only lower sales growth for many companies but also For some companies, a value creation strategy that em-lower profit growth, as profit margins come under pres- phasizes cash payouts and a strong free-cash-flow yieldsure from increased competition. When investors factor may be a sensible approach in a low-growth environ-S A  T 
  • 26. ment. This is especially true for companies in mature sarily easy to shi the mix of investors from those pursu-markets that have high returns on invested capital and ing growth to those pursuing value. There must be aare generating far more cash than they can invest in prof- deliberate strategy to understand the composition of theitable growth. investor base and to communicate accordingly.Some technology companies, which have tended to avoid Third, although a value creation strategy emphasizingpaying dividends in order to preserve the ability to fund free-cash-flow yield can occasionally generate superiorgrowth, are taking this approach. Microso recently an- TSR, it is extremely difficult to sustain that performance.nounced a 23 percent dividend increase, and Cisco re- Most companies will eventually need to find a way tocently announced that it will start paying a regular divi- grow. To understand why requires grasping a phenome-dend in 2011 in addition to increasing its program of non that we call the growth paradox.stock repurchases. Oracle began paying dividends in mid-2009, supported by $8 billion in annual free cash flow. The Growth ParadoxThere are three important caveats to this strategy. First, itis unclear how long the current high levels of free cash Revenue growth is the greatest contributor to value cre-flow will last. As governments around the world cope ation for top performers across all industries. It is respon-with growing deficits and anemic tax revenues, cash-rich sible for nearly three-quarters of average annual TSR forcorporations will become a tempting new revenue top-quartile performers over rolling ten-year periodssource. from 1990 through 2009. (See Exhibit 9.) Indeed, most of the top-ten companies in our rankings for the technology,Second, investor expectations should be carefully man- media, and telecom sectors have double-digit revenueaged, especially those of growth investors. It is not neces- growth rates. Exhibit 9. The Growth Paradox For top performers, growth is the single most . . .but not all companies with above-average important source of TSR over the long term. . . growth necessarily create value Sources of TSR for top-quartile performers Correlation of revenue growth and TSR (S&P 500, 1990–2009) (S&P 500, 1990–2009) Average annual TSR (%) Average annual TSR (%) 40 40 Growth with 34 value creation 12% 30 20 22 21 46% 11% 20 7% 17 6% 19% 15% 5% 20% 20% 15% 0 13% 10 50% 58% 74% Growth without 29% value creation 0 –20 1 year 3 years 5 years 10 years –20 0 20 40 Free cash flow Multiple Margin Revenue growth Average annual revenue growth (%) Source: BCG analysis. Note: Each bar shows the average annual TSR for a given time period; the shaded sections of each bar show the percentage of TSR from each source. T B C G
  • 27. But growth alone does not create above-average TSR. opportunities, it becomes harder to successfully generateThe right-hand chart in Exhibit 9 shows that many com- shareholder return through profitable growth.panies grow without creating value. Their growth comesat the expense of other contributors to value, such as How can companies thread this needle? By developing anmargins and multiples. explicit strategy for value creation marked by three char- acteristics:A slow-growth economy exacerbates this paradox. Overthe long term, companies’ ability to generate above- ◊ Creativity in identifying new ways and new areas inaverage sales growth separates winners from losers. which to invest in profitable growthCompanies cannot become so reconciled to the lack ofgrowth opportunities that they focus exclusively on cost ◊ Discipline to invest only in those growth initiativescutting and cash payouts. that will truly be value creating—and to return excess cash to investors once the necessary investments toAt the same time, companies that are flush with cash pursue those opportunities have been madehave to be careful to avoid the opposite problem: growthwithout value. Companies with large cash reserves as a ◊ A long-term focus on sustainable value creation overresult of cost cutting may be tempted to overcommit to three to five years, rather than trying to maximizegrowth. As more companies compete for fewer growth short-term gains in EPSS A  T 
  • 28. A Fresh Look at Value Creation StrategyI n a low-growth economy, there will be more com- way to create value. Acquisitions that consolidate an in- petition—especially from companies in the fast- dustry can be a good way to preserve a company’s com- growing emerging economies. As everyone com- petitive advantage and protect margins. Similarly, buying petes for relatively fewer growth opportunities, businesses with strong future growth prospects can be a margins will be under threat. way to expand growth opportunities and build new growth platforms for the future. But investments in M&A tend toCoping with these challenges will require discipline. Com- be riskier than equivalent investments in organic growth,panies will need to take a tough look at existing business so a company needs to assess its opportunities carefullyplans in order to weed out those growth investments that and be realistic about its capabilities, both for doing dealsdo not create value and to focus on those that do—and and for the subsequent postmerger integration.they will have to be far more systematic in finding newways and new places to grow. When it comes to M&A, the main shi companies need to make is to think less about whether a particular dealGiven the likelihood of increased competition, companies is EPS accretive in the short term and more about wheth-should start by making any investments necessary to er it is actually going to create shareholder value in thebuild a competitive moat around the core business. Com- long term. A deal may appear to be “cheap” and deliverpetitors will be coming aer that business, so it is critical one-time EPS gains without necessarily improving a com-to preserve and protect existing sources of competitive pany’s TSR. For example, when a company that is tradingadvantage. at a P/E ratio of 20 acquires a company with a P/E ratio of 10, whatever benefit is obtained from combining theAs a company develops its growth strategy, it must also earnings of the two companies can be undermined by de-be especially alert to the impact of growth on margins. clines in the acquirer’s valuation multiple.There may be situations in which it is necessary to acceptlower margins in order to remain competitive. But com- By the same token, deals that dilute EPS in the near termpanies should avoid simply chasing share based on a can improve TSR over the long term. Indeed, in a low-weak competitive position. growth economy, some of the most value-creating acqui- sitions—those of companies with a higher growth rateOnce vulnerabilities in the core business have been ad- than that of the acquirer—will initially dilute EPS be-dressed, a company can begin thinking about new oppor- cause the target will likely be trading at a higher multipletunities for growth. For example, is there some way to ex- than the acquirer. Over time, however, such an acquisi-ploit the two-speed economy by expanding in emerging tion will lead to higher revenue growth and a higher over-markets? And if so, what is the best approach—organic all multiple.growth, M&A, or partnerships? Last but not least, no company should be thinking aboutWhen a company has few opportunities for organic where to grow without at the same time thinking aboutgrowth, growing through acquisitions can be an effective where not to—whether because it lacks advantage, is not T B C G
  • 29. producing returns above the cost of capital, or faces an looking for quality and sustainability. Some companiesindustry environment that makes a cash payout strategy may want to retire debt in order to become a “safer,” lesspreferable. risky stock. Others may want to preserve current levels of leverage because interest rates are so low and because it may be difficult to take on new debt in the future.Balanced Capital Deployment But whatever a company’s situation, it would be prudent to assume that the company will need to fund futureMany companies will have more cash flow strategies out of its ongoing operating freethan they can effectively reinvest in profit- cash growth. The worst outcome would be Investors see a strongto waste that cash by pursuing value- dividend as a sign notdestroying growth or to fail to exploit the Scenario-Based Strategicvalue-creating potential of that cash by of stagnation but of Planningsimply leaving it on the balance sheet. financial discipline.Rather, executives should ask how best to A comprehensive approach to value cre-deploy cash in order to create shareholder ation cannot take place within the normalvalue. strategic-planning process. As strategic planning exists at most companies today, business units develop plans thatGetting to the right answer will require challenging some are then aggregated into an overall corporate strategy. Re-legacy assumptions. The first is the lingering belief that thinking value creation strategy requires a top-down over-dividends are to be avoided because they signal to inves- lay to that process, led actively by the CEO and involvingtors that a company has few growth prospects. Increas- the board. (See “Rethinking Scenarios: What a Differenceingly, investors see a strong dividend as a sign not of stag- a Day Makes,” BCG Perspectives, September 2010.)nation but of financial discipline—and preferable toshare repurchases. One approach that helps sharpen the tradeoffs a company faces is to create alternative future scenarios that empha-A related assumption worth challenging is the manage- size significantly different uses of capital. What is the dif-ment preference for share repurchases over dividends as ferential impact of each of these scenarios on TSR? Whatthe best means to return cash to shareholders. Many ex- are the associated risks given the company’s starting posi-ecutives prefer share buybacks because, unlike dividends, tion, organizational capabilities, and investor base?buybacks boost EPS. And their incentive compensationis oen tied directly to EPS growth and the appreciation The point of this exercise is not necessarily for any onein stock price, not to overall shareholder return. scenario to be the winner. It is likely that the final strat- egy will include elements drawn from each scenario, per-BCG’s research demonstrates that dividends have a far haps with different moves playing a more central role atmore positive impact on a company’s valuation multiple different moments in time. But developing multiple sce-than share repurchases do. Indeed, in many cases, buy- narios can surface unanticipated opportunities, sharpenbacks can actually reduce a company’s multiple in the choices and tradeoffs, and force a tough, realistic assess-near term. ment of what the company can actually achieve.At the same time, companies need to be deliberate about As a company develops and evaluates these different sce-making this shi . Share repurchases are generally episod- narios, it should consider their impact on its investor baseic rather than consistent. A policy of paying dividends and, therefore, on its valuation multiple. This will be es-needs to be long term. Companies cannot stop and start pecially important in an environment in which multiples,dividend payouts without damaging their credibility with on average, will be declining.investors. BCG’s research shows that it is possible to identify andA third assumption to rethink has to do with the desirabil- actively manage the factors that determine approximate-ity of leverage. In a low-growth economy, investors will be ly 80 percent of the differences in valuation multiplesS A  T 
  • 30. across an industry. The key questions are: What are the their investor base and when investor priorities them-specific drivers of differences in valuation multiples with- selves have been a company’s industry? What are the likely impacts ofthe company’s business strategy, financial policies, and Once a company has identified its dominant investors, itinvestor messaging on its valuation multiple? should bring their perspectives into the planning proc- ess. Only by talking directly to investors, asking probingCompanies that have traditionally been viewed as growth questions, and carefully listening to and interpretingstocks need to be especially careful about making large their responses can a company’s management gain aunexpected shis to a more value-oriented approach. clear view of the expectations and priorities of the com-Companies can make the transition but need to articulate pany’s investor base. The point is not to do preciselytheir logic and story, recruit new investors to replace what investors want in every situation but to understandthose likely to sell, and be consistent in their new ap- how investors are likely to respond to a company’s stra-proach. Companies cannot easily change back and forth tegic moves. In some cases, in-depth interaction withfrom growth to value. leading investors can go a long way toward helping a company clarify the most sustainable path for value cre-Another way to gauge investor reactions to a company’s ation in the future.plans is by conducting a detailed investor segmentationto determine who the company’s dominant investors are By focusing on value-creating growth, optimizing theand to identify their key priorities for the company. Hav- tradeoffs among various uses of capital, and taking a sce-ing this kind of detailed information is important in any nario-based approach to strategic planning, companiessituation—but it is especially important today, when will be in good shape to address the challenges of valuemany companies have experienced significant churn in creation in a low-growth economy. T B C G
  • 31. Ten Questions That Every CEO Should Be AddressingIn conclusion, we offer ten questions about value cre- 7. Are your financial policies—such as the debt-to-ation that every CEO should know how to answer—and capital ratio and dividend payout—likely to appealthat will help guide strategy, especially in a low-growth to your target investors in a low-growth environ-economy. ment? 1. Do you know where and how your businesses are 8. Are your management processes—for example, creating value? By business unit, by product catego- planning, budgeting, and capital allocation— ry, by customer segment? aligned with the goal of increasing shareholder val- ue over the long term? 2. Do you have a process in place for discovering new ways to deliver value-creating growth? Are you in- 9. Are you rethinking your executive-compensation vesting to create long-term sustainable TSR or system for an environment in which capital gains merely managing the business to maximize your will be a less important contributor to TSR? Does short-term EPS? your system require that senior executives have substantial “skin in the game” in the form of long- 3. Are you emphasizing shareholder value performance term direct equity exposure (not stock options)? over relatively long time horizons (three to five years), rather than quarterly or annual EPS? 10. Have you thoroughly explored different scenarios for creating value in the future? Do you know the dif- 4. Are you evaluating future acquisitions by their long- ferent benefits and risks of emphasizing organic term value-creation potential, not by whether the growth, M&A, or cash payouts? deals would happen to accrete or dilute EPS in the short term? 5. Do you know what drives differences in valuation multiples in your peer group? 6. Do you know the segmentation of investors who own your stock? Which types of investors dominate? Are they the right ones given your value-creation strat- egy? Are you engaged in an active dialogue with your core investors in order to understand their ob- jectives and priorities?S A  T 
  • 32. For Further ReadingThe Boston Consulting Group pub- Lean Advantage in Media: Lean Advantage in Telcos:lishes many reports and articles on Rethinking Operations and Reducing Complexity and Building New Business Models Transforming Culturecorporate development, value cre- A BCG White Paper, December 2010 BCG White Paper, July 2010ation, and the technology, media,and telecom sectors that may be of The CMO’s Imperative: Tackling Accelerating Out of the Greatinterest to senior executives. Exam- New Digital Realities Recession: Seize the Opportunities A report by The Boston Consulting in M&Aples include the following: Group, November 2010 A report by The Boston Consulting Group, June 2010 Why Companies Should Prepare for Inflation China’s Digital Generations 2.0: BCG White Paper, November 2010 Digital Media and Commerce Go Mainstream The Connected Kingdom: How the A report by The Boston Consulting Internet Is Transforming the U.K. Group, May 2010 Economy A report by The Boston Consulting Megatrends: Tailwinds for Growth Group, October 2010 in a Low-Growth Environment A Focus by The Boston Consulting Group, Cloud Computing in Large May 2010 Enterprises: Questions for the C-Suite Innovation 2010: A Return to A BCG White Paper, September 2010 Prominence—and the Emergence of a New World Order The Internet’s New Billion: Digital A report by The Boston Consulting Consumers in Brazil, Russia, India, Group, April 2010 China, and Indonesia A report by The Boston Consulting Capturing the Value of Cloud Group, September 2010 Computing: How Enterprises Can Chart Their Course to the Next Threading the Needle: Value Level Creation in a Low-Growth BCG White Paper, November 2009 Economy The BCG 2010 Value Creators Report, Searching for Sustainability: Value September 2010 Creation in an Era of Diminished Expectations The Future of Telecommuni- The BCG 2009 Value Creators Report, cations: As Wireless Earnings October 2009 Wane, Carriers Confront Hard Choices The Customer Value Challenge: BCG White Paper, August 2010 Managing the Commercial Investments of Telecoms in Tablets and E-Readers: The Last, Europe Best Chance for Digital Content? A Focus by The Boston Consulting Group, BCG article, August 2010 February 2009 Investors’ Priorities in the Postdownturn Economy BCG article, July 2010 T B C G
  • 33. Note to the ReaderAcknowledgments Anders Fahlander, a senior partner For Further ContactThis report is a product of BCG’s and managing director in BCG’s For further information about the re-Technology, Media & Telecommuni- San Francisco office), media sector port or to learn more about BCG’scations practice and the Corporate ( John Rose, a senior partner and capabilities in technology, media,Development practice. The authors managing director in the firm’s New and telecommunications or in corpo-would like to acknowledge the con- York office), and telecom sector rate development, you may contacttributions of the following global (Stépan Breedveld, until recently a the authors.experts in corporate development: senior partner and managing direc-Andrew Clark, a senior partner and tor in BCG’s Amsterdam office). We David Deanmanaging director in the firm’s would also like to acknowledge the Senior Partner and Managing DirectorAuckland office and leader of the support of the practice’s regional BCG MunichCorporate Development practice in leadership in the Americas (Sebas- +49 89 23 17 40Asia-Pacific; Danny Friedman, a tian DiGrande, a partner and manag- dean.david@bcg.comsenior partner and managing direc- ing director in the firm’s San Fran-tor in BCG’s Los Angeles office and cisco office), Europe (Wolfgang Bock, Dominic Fieldleader of the Corporate Develop- a senior partner and managing direc- Partner and Managing Directorment practice in the Americas; tor in BCG’s Munich office), and BCG Los AngelesJérôme Hervé, a senior partner and Asia-Pacific (Patrick Forth, a senior +1 213 621 2772managing director in the firm’s Paris partner and managing director in field.dominic@bcg.comoffice and leader of the Corporate the firm’s Sydney office, and JeffDevelopment practice in Europe; Bowden, a senior advisor to the Ron NicolLars-Uwe Luther, a partner and man- practice). Both Arvind Subramanian Senior Partner and Managing Directoraging director in BCG’s Berlin office and Rishab Gulshan, partners and BCG Dallasand the global head of marketing for managing directors in the firm’s +1 214 849 1500the Corporate Development practice; Mumbai and New Delhi offices, re- nicol.ron@bcg.comand Brett Schiedermayer, the man- spectively, also provided valuable in-aging director of the BCG Value- put, as did Maikel Wilms. We thank Frank PlaschkeScience Center in South San Francis- Ben Orthlieb and Shawn Collins for Partner and Managing Directorco, California, a research center that their contributions to the research, BCG Munichdevelops leading-edge valuation and Dirk Schilder, Martin Link, and +49 89 23 17 40tools and techniques for M&A and Kerstin Hobelsberger for their data plaschke.frank@bcg.comcorporate-strategy applications. analysis. Finally, we thank Gary Callahan, John Campbell, Angela Daniel StelterWe would also like to thank many DiBattista, Mark Voorhees, and Senior Partner and Managing Directorcolleagues in the Technology, Janice Willett for their help with the BCG BerlinMedia & Telecommunications prac- writing, editing, design, and produc- +49 30 28 87 10tice for their insight, especially the tion of this report. stelter.daniel@bcg.comleaders of the practice’s technologysector (Christoph Nettesheim, a se-nior partner and managing directorin the firm’s Beijing office, andS A  T 
  • 34. For a complete list of BCG publications and information about how to obtain copies, please visit our website receive future publications in electronic form about this topic or others, please visit our subscription website
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