More to OTT debate than meets the eye
Far from the typical if simplistic good-guys-vs-bad-guys stand-off that generally pervades discussion on the topic, the “over the top” debate is actually rather complex and calls for a reassessment of traditional, perfunctory stances by everyone. By Guy Zibi.
The African mobile operator predicament with “over the top” (OTT) services has come to a head, with the issue of how to deal with the likes of WhatsApp, Skype and Viber flaring up anew over the past few months in Morocco, Senegal and South Africa.
What’s playing out here is an African version of the type of disruption of traditional industry models brought about by Web-based service providers like Uber — Parisian taxi drivers rebelling against Uber; New York hotels looking to fend off Airbnb; Bookstores protesting against Amazon; and now, African operators going off on WhatsApp, Viber and Skype.
Far from the typical if simplistic “good guys vs bad guys” stand-off that generally pervades discussion on the topic, the issue is actually rather complex and calls for a reassessment of traditional, perfunctory stances across the board — by the operators (and their shareholders), by regulators, by OTT providers and by the proponents of OTT for whom there is often only a binary choice between unfettered net neutrality and the death of the Internet.
We have developed a broad assessment, across five main points, based on our Africa research, discussions and overall work with the various parties involved.
1. The OTT revenue cannibalisation threat to African operators is real — in the short term
It is fundamental to this discussion to recognise that the OTT threat to operator revenue does indeed exist. For our research, we analysed the revenue performance over the past three years of two dozen operators in Africa and, for comparison purposes, five in Southeast Asia.
Our research suggests a strong cannibalising effect on operator messaging revenue, and SMS in particular. More than half of the operators analysed have seen a decline in messaging revenue. In markets such as Ghana, Uganda and South Africa, revenue from messaging services has declined by 20% to 30% annually since 2012, ostensibly cannibalised by OTT usage.
Another operator revenue line that has suffered from the OTT effect is international termination — the fees paid to local players to terminate international calls on their networks. As international traffic has moved to online platforms, this source of foreign exchange (and in effect, profit margin) is gradually tightening up.
We also found that the predominantly prepaid-based nature of African markets made them especially vulnerable to such revenue cannibalisation. In main post-paid markets, there’s a revenue floor that takes the edge off the impact of cannibalisation by OTTs. There is revenue cannibalisation for operators, but it’s primarily a cannibalization of the upside – of the incremental revenue operators can potentially generate from offering new services and applications. In African countries, the prepaid model means that revenue is more vulnerable to changes in customer usage patterns; a customer can directly cut their spending through usage shifts and this is directly reflected in operator revenue. In prepaid-dominated models, the OTT risk is therefore both to the revenue floor and to the upside.
Our research also shows that OTT services make a strong contribution to data revenues. Although it is difficult to put this contribution in precise numbers, a large proportion of incremental usage (people using more data) and users (more people picking up smartphones to use data) can be directly attributed to OTT services. With African operator data revenues growing at 20% to 30%/year or more (the fastest-growing revenue line for most), there’s no doubt that OTT providers have helped.
The issue is therefore the net differential between revenue gains and revenue losses attributed to OTT services. To assess this, we use a simple measure we define as the net revenue contribution (NRC) of data — in essence the difference between the incremental gains in data revenue and the losses of voice and SMS revenue over a given period, in absolute terms. This broad measure is slightly inflated by nature, acknowledging the fact that not all voice and SMS revenue loss is necessarily due to data services growth.
For the most part, we found that many African operators have a negative NRC — what they are losing on the voice and SMS side is not (yet) compensated for by what they are gaining on the data side, a potential argument for revenue cannibalisation. Even if one does not believe in this cannibalising effect, there has been enough correlative evidence to spur operators into some form of action.
The debate is now heating up because governments are asking operators to pay up for 4G spectrum, and increasingly noticing the revenue shortfalls — lower or flat revenue means lower tax revenue, at a time when economic growth is slowing.
The decline in international voice also threatens an important source of foreign exchange, at a time when African currencies continue to depreciate.
Furthermore, smartphone penetration is accelerating, and 4G is coming (and operators have to invest further in spectrum and roll-outs), completing what many service providers are seeing as a negative OTT vortex.
2. The OTT threat to African operator models is not existential
And yet, despite the above, our research also suggests that real though it might be, the purported OTT threat is hardly existential for mobile operators. This for three reasons:
— The revenue volumes threatened by OTT services are relatively small. We’re talking 10% to 15% of revenue (and much less on a net basis once incremental revenue from data services is accounted for). While the volumes can be important, operators can survive even one assumes a messaging revenue line at zero (now a realistic assumption) and slightly tighter margins. To be sure, the international incoming foreign exchange shortfall hurts, but it was always a somewhat arcane, relatively artificial and highly vulnerable source of margins. We’re not convinced it’s worth the terrible PR.
— Others have made this work; negative data contributions are not a foregone conclusion. They are intricately tied to each operator’s pricing strategy and pace of innovation. In Kenya, Safaricom’s net revenue contribution has been steadily positive, even excluding the M-Pesa service, thanks to the operator’s constant innovation around voice and SMS pricing. In markets such as the Philippines, operators have turned the NRC to positive territory — so much that they are actively offering OTT voice services as part of their data packages, as Cell C is now seeking to do in South Africa. In effect, what OTTs are now exposing is the fact that at a broad level, African voice pricing has probably been a little high on a per unit basis, making it highly vulnerable to arbitrage — and OTT services are now a vehicle for that arbitrage.
— The negative NRC is temporary. Our research also suggests that while the data net revenue contribution starts in negative territory, it really is a U-shaped curve that turns positive over time as more people use data services, thanks to network effects, accelerated usage and an operating model that becomes more optimised for data services. Once data revenue hits a given level (generally higher than 30% of revenues), its broader contribution should actually be positive. In effect, the negative net contribution phase is a transitionary phase to a data-centric model. How long it stays negative is really more of a commentary on each operator’s operating model and innovative approach.
3. The OTT challenge cannot and should not be legislated away
Even acknowledging the challenge to operators represented by OTT services, such services are now so intricately integrated into usage patterns that they would be extremely difficult to regulate without a materially negative impact on customers that have come to rely on them.
Besides the broader spirit of innovation that they bring, the widespread use of Skype, Viber and WhatsApp have made them critical to small business collaboration and consumer interaction. This is even more critical in Africa where small business (including the informal sector) is a critical contributor to economic development — and highly price-sensitive. Blocking OTT services is an indiscriminately blunt and short-sighted instrument for a challenge that, in effect, cannot really be legislated away.
4. Operators have to burn their SMS and voice platforms
Assuming that the search for regulatory redress is not merely dilatory (which in some cases, it may well be), operator focus in dealing with OTT services should really be at the strategic, marketing and operational levels. In fairness to operator management, they often have limited leeway for this at a time they need free rein. One of the most significant challenges facing organisations at different junctures is the need to reinvent themselves to adapt to changing market conditions.
This is where African mobile operators are increasingly finding themselves. But they are victims of their own success at driving profitability so effectively over the years. Investors (and company boards) have become so comfortable with high margins that they look uncharitably at anything that appears to threaten them, notwithstanding how artificial they might have been in the first place. In turn, management is often more rewarded for playing defence than going on offence. Addressing the OTT challenge requires the smart, long view, at the time when operator decision makers, unfortunately, often appear obsessed with the short view. Many are yearning for market conditions that no longer exist.
In a memo that is now part of corporate lore, Nokia’s then-CEO Stephen Elop told the company’s employees that they were standing on a “burning platform” and needed to jump off of it, transform themselves and move forward. This is where many leading African operators find themselves today. They should forget the deleterious regulatory dillydallying on OTT services and jump off that burning platform — and their boards should let them do it, share price be damned.
5. The case for adapted net neutrality
The above would still leave open the broader issue of net neutrality, which the OTT challenge really goes to the heart of. And in this respect, we believe there are legitimate policy reasons for firming up a regulatory framework governing OTT services taking into account African conditions. On a net basis, some African countries will lose tax or forex revenue over time from the rapid adoption of OTT services as popular services are offered by companies with little to no presence in their markets — if their operators do not transform fast enough, or their own tech ecosystem is not vibrant enough to develop local solutions.
For this reason, we are highly wary of a blanket application of US net neutrality rules to African markets. We believe a deeper introspection of net benefits has to take place, and a framework put in place that, while not blocking OTTs outright (for reasons highlighted above), at least favours companies with local staff and operations more explicitly. The alternative is that governments will look for other ways to address real or apparent revenue shortfalls: regulatory fines, increased taxation, more aggressive tax collection, high spectrum costs, etc. And that, in our view, is even worse, penalising local business to the benefit of large global Internet companies.
- Guy Zibi is principal at Xalam Analytics, which focuses on analysis of African and Middle Eastern digital infrastructure markets