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The Situation Room

Yesterday evening Safaricom announced a new top management structure that is supposed to help the company navigate the seemingly trickier telecoms market unfolding in the country. The Safaricom CEO is quoted as saying that this change is aimed at making sure that the company maintains its position as the leading mobile communications firm in the country.

There are many theories floating around on the reasons for this restructure but the main reason has to do with controlling costs.  These changes do not come as a surprise to me because in an earlier blog post I had speculated that this was bound to happen sooner or later due to the diminishing revenues that are as a result of the on going price wars. In today’s Business daily, the CEO has now shifted his focus on the middle management of the firm to cut costs further.

Why is there a sudden focus on costs rather than growth?

Its been shown that the structure of costs in a company determines how well its faring in any given situation. For companies that have a higher ratio of fixed costs to variable costs (more fixed costs than variable costs), these companies do very well when in the growth path but fair terribly in a downturn. However, for companies with a higher ratio of variable costs to fixed costs (higher variable costs and lower fixed costs), these companies fair better in a downturn. Safaricom runs on a higher fixed costs ratio and now needs to reduce these costs or convert them to variable costs to remain profitable in the short term. This is unlike Airtel Kenya that operates on a lower fixed cost to variable cost ratio. Because conversion rate for fixed cost is slower, the only thing Bob can do that will have an immediate impact is cutting down on staff costs by undertaking a restructuring exercise.
The long term way in which Safaricom will convert its fixed costs into variable costs is by outsourcing most of its functions such as network management, IT, customer service and non-core support services. In as much as it might cost nearly the same to outsource a service, outsourcing a service gets it converted from being a fixed cost into a variable cost in accounting books. This now enables the company that is going downhill to vary a big chunk of its costs in tandem with the reducing revenues. If these costs were fixed, it would be hard to vary them. The other way of overcoming these variations in revenues is to have wide margins that can absorb the changes in revenues. However, we all know that due to the price wars, telco margins are very thin and sometimes the only way to make them wider is to increase tariff fees (highly unlikely but possible in extreme situations where costs cannot be reduced further)

What’s next?

When the dust on the ongoing staff restructuring finally settles,  I see Safaricom working towards making its costs shift to the variable side of the equation by outsourcing its network management, customer service and IT (This has been the operating model for Airtel since its days as Kencell). The current on going shift from European equipment suppliers to Chinese suppliers will also intensify as this will further lower their capital expenditure on infrastructure. The recent network ‘upgrades’ announced by Safaricom were actually conversion of equipment from European suppliers to Chinese.
The outsourcing of customer service will also be another move by Safaricom to further lower its costs because this will enable it to not only get the opportunity to improve the perennially poor customer support but also cut costs associated with the labor intensive customer support function.

What this means to the sector

The telecoms and ICT sector is in for a rough ride as the realities of diminishing ARPU start to sink in, apart from Safaricom starting to look at controlling its costs, yesterday Access Kenya, the first listed ISP reported a loss for the last financial year. Many other telecom companies are also in financial difficulties due to the fact that they did not adapt fast enough to the changing operating environment in the telecoms and ICT sector.
Unlike the days of yore where a telco did everything from providing service to infrastructure building, new operating tenets dictate that the overall economic efficiency of the market is improved if there is specialization and tiered operation. It is therefore unwise for an Internet service provider to build networks because this is the work of a carrier and not a service provider.  For example, the several ISPs in the market should let a carrier such as Jamii or KDN build the networks and lease capacity from them. If this had happened, we would not be hearing of the many fiber cuts by saboteurs  happening in the country because any cable you cut could potentially be carrying your traffic too. The carrier would also be owning nearly all the wireless wimax frequencies and therefore enable them to plan and design a very robust last mile wireless network that is shared among all service providers. The current situation is that every other ISP has a small chunk of the frequency spectrum on which its built its wireless last mile. What this does is it introduces inefficiencies on the last mile network as frequency re-use is impossible and operating efficiencies are also lost by chopping up the spectrum due to the introduction of the many guard bands in between the slices of spectrum to prevent interference, if this spectrum was not chopped up and instead used as one big band, these portions of guard bands could be in active use serving customers and hence making it efficient.
So unless the telecom sector in the country stops its selfish acts of wanting to build ‘my’ wimax network, lay ‘my’ undersea cable, build ‘my’ international gateway, build ‘my’ masts and the many selfish actions they do, they will end up and remain in loss making territory for long.
The Kenyan telecoms market is very small and cannot survive without the operators coming to a round table and agreeing on some basic truths about what they can and not do. They should also learn from the US and EU operators who are well stratified into tiers and heavily share infrastructure to drive down costs and improve efficiencies. What is then left for them is to aggressively differentiate and market their services to the consumers.

I believe CCK should have done a better job at helping the operators collaborate from the start. Imagine how the Nairobi skyline would look if CCK had forced GSM or wimax operators to share masts from day one? Imagine how smooth our roads and pavements would be if only two carriers were allowed to lay fiber in the city? The two preceding points are not that critical, however, the critical point is that costs of service would also have been lower and the long term effect of that would have been a stable market without all these failures in the business models of the telcos and service providers. The Seacom East Africa head also seems to share the same sentiments about the role the regulator could have played in making the sector more efficient when he spoke to the AMCHAM Kenya luncheon yesterday here.

However, all is not lost, I believe the operators have now realized this and will work towards consolidation of services and infrastructure. I foresee carriers (KDN and Jamii) buying off most of the infrastructure and frequencies owned by ISPs and other non carriers and run them as one big highly redundant network from which these providers can offer service from in a Network as a service (NaaS) model. I also foresee several mergers and swallowing up of smaller or loss making operators as this will be the only way they will remain profitable and sustainable in the long run.

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Categories: Mobile Telephony
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