Telstra: What lies ahead

research Telstra's half-yearly results confirmed the disturbing trends of the last two years. The erosion of voice revenues, driven largely by fixed-to-mobile substitution, is barely being offset by growing mobile and broadband revenues.

This will place a cap on overall growth, unless Telstra can create new sources of revenue. Telstra is determined to do exactly that, by investing in new IP infrastructure and building managed offerings around the integration of infrastructure and services. This means turning Telstra into a new kind of business -- with major implications for the whole economy. However, it is not the technology that will be the real issue; it is the law, policy and practice needed to exploit the technology and bolster new markets that will separate winners from losers.

Telstra today
Announced in February, Telstra's half-yearly results contained few surprises on the financial side, but underlined the scale of the industry transformation underway in Australia. The key trends were the continuing drop in PSTN voice revenues, down 7.6 percent over 12 months, and the rise in mobile and broadband. It wasn't too long ago that PSTN line rental rebalancing was a major policy issue in Australia. However, Telstra's latest results confirmed the now-conventional wisdom that traditional voice is going the way of the dinosaur. No one is predicting a rapid collapse in fixed voice revenues -- yet -- but the erosion of voice revenues since 2004 has made the unthinkable thinkable: could IP put an end to the PSTN business?

The IP threat
All of this started a few decades ago because a few defence IT wonks wanted a better way to move data between computers. They came up with a packet data protocol that later became the Internet. Without realising it, they had lit a very long fuse. Only in this decade are we finally seeing the explosion, in the form of a major menace to the traditional telephony business model. It is a mistake to think of the new IP business as evolving from the old telephony business -- the two models are incompatible. This is not evolution, but revolution.

For a long time, telcos and not a few IT companies thought that the Internet could be co-opted in support of traditional business models. Microsoft famously tried to tame the tiger by setting up the original walled-garden Microsoft Network. But it's true what they say: tigers can't be tamed. There has been a shift in thinking since the 2001 crash and the erosion of PSTN business. Telstra's recently announced investment plans now assume the long-term replacement of PSTN voice revenues with a triple play of VoIP, data and digital video services.

Every revolution ends sooner or later, and a new kind of 'ordinary' emerges. If you put together all of the current market trends along with Telstra's recently announced strategy, you can begin to see the shape of things to come.

New technology, new rules
It's important to know that we've been here before. A few years ago, an economic historian called Carlotta Perez wrote a book called Technological Revolutions and Financial Capital.

The thesis of the book was simple. There have been several waves of enabling technology over the last two centuries: steam power, electric motors, the motor car and now ICT. Each of them has been associated with an infrastructure: first railways, then electricity grids, national motorways and the Internet. Each wave progressed just like the previous one: first, a period of innovation, then a decade or two of financial hype as everyone tried to capture the infrastructure, followed by a stock market crash when they realised no one had a business model. Then everyone dusted themselves off, and started to create a framework of law, policy and practice to exploit the infrastructure and provide some useful services that make a profit.

Sound familiar? If Perez is right then we are entering the final phase: a period of implementation and reform that will probably last another decade or two. The success of an enabling technology like ICT requires more than just infrastructure, important as that is. Rather, telcos and the rest of the economy will need new business models, skills and capabilities to exploit the infrastructure. Governments will also need new policies and legislation for privacy, security, copyright and payments, and for R&D, industry and skills development. Without these things, the benefits of the ICT infrastructure cannot be fully realised. Customers will be reluctant to use ICT for high-value transactions, and industry will be reluctant to invest. However, if it is done properly, we will have a new kind of economy and society. ICT technology (and maybe the industry itself) will ultimately become much more useful and much less volatile.

So let's look at all three in turn: telcos, economy and the government, and what this might mean for them.

Implications for Telstra
As an incumbent, Telstra has a lot to lose from the current industry transformation because it has the biggest investment in the old way of doing things. However, it also has the most to gain, because it already has economies of scale and scope that other telcos (including Optus) still lack. It can use those economies of scale and scope to deliver managed solutions, service and integration that no one else in the Australian market can match. This is broadly the strategy that Telstra outlined late last year. It's all about making the technology useful, hiding the complexity and reducing the need for customers to worry about it. This is the business model that Telstra believes is necessary to justify its investment in a next-generation network (NGN).

Hence Telstra's aggression on the issue of regulated access to the NGN. Telstra's strategy relies on it being allowed to exploit its own economies of scale and scope to provide a customer experience that no one else can replicate. And regulated access boils down to this: Telstra is forced to share those advantages with its competitors. It cannot submit meekly to that outcome, because it cuts right across its new business model. Regulated access would accelerate the shrinkage of telephony revenues, which would hit Telstra harder than anyone else. A regulated NGN is all downside and no upside for Telstra.

How this affects competitors depends on how well placed they are to offer an integrated customer experience. Optus is investing in service integration and economies of scale, with its recent acquisitions of AlphaWest and Virgin's mobile business, and can face the future with reasonable confidence. Some second-tier telcos may rely on their specialist expertise and infrastructure in specific markets, such as the corporate market. However, the future for small operators and resellers in mass markets looks difficult. To sum up: get big, get niche or get out.

New markets, more productivity, more innovation
If the telcos can successfully create the integrated service platforms they're talking about, this will drive a wave of business re-engineering across the economy as the customer moves to the centre of the business process. This will be especially true in industries where large numbers of businesses and individuals are working with the same customer -- industries like health, finance and government, which are plagued by fragmentation and a lack of information sharing.

Take an example: why do we all have so many different forms of identification? Because the companies and government agencies we deal with all have their own internal customer management systems, and maintain their own databases of relevant information. But why can't they share databases, with conditional access, so that service providers can get information on a need-to-know basis -- databases that are managed on the behalf of customers, by a trusted third party? Well, we can do this right now -- technologically at least.

However, we aren't just talking about technology outsourcing any more: we're talking about a service industry for identification and information, an industry that would need regulation, business models and investment. And unless we want this industry to be a monopoly, we'll also need to ensure mutual recognition and wholesale access as well. This requires a whole framework of law, policy and practice that does not yet exist.

Take another example: why don't we have an accessible, efficient micropayments service, one that could be used by the Web site of even the smallest online retailer? In Australia and most other places, it's because the current system of transaction settlements is too inefficient to make micropayments economic. But the Reserve Bank has already warned the Australian banking industry that the next generation of payment systems needs a new structural and pricing model, one that improves efficiency and makes innovation easier, and integrates better into the national IT platform. Again, this points to new technology, regulation, business models and investment for the banking sector.

This means the disruption that telcos are familiar with is going to expand to the rest of the economy. It sounds like a nightmare, and for some it is. However, think of the benefits.

Every business has customer relationship functions, payments functions and a host of others. Every one of them is a cost centre, but today the outsourcing of these functions is confined to the big firms. If the outsourcing model can be extended to medium and small businesses that make up the bulk of the economy, and sourced more efficiently from scaled-up ICT-based providers, the economy-wide benefits would be huge. And as western nations age, they'll need those productivity gains.

Right now, organising identity and payments is one of the hardest things for a smaller business that wants to offer content and other services online. If those issues could be easily and cheaply solved by plugging into a market for identify and payments, opportunities for service innovation would be greatly increased. When it was over, the productivity and innovation in the economy would be higher, and many things that were done by businesses in-house would have become separate industries.

And there's a lot of potential business for Telstra and other integrated telcos in enabling that future -- not to mention banks as well. Telcos will find themselves in a more complex market space, with new competitors and new alliances.

Implications for governments: rethink the agenda or face the consequences
The message for governments here is simple: a new policy agenda is emerging that is not about ICT as such, but about how ICT will be used. This means addressing a host of privacy, security, copyright, financial and, for R&D, industry and skills development issues, and doing so in a coherent way.

That doesn't mean that ICT issues can be forgotten -- they'll still be tough issues. Governments and regulators have some hard choices to make over access to NGNs and ULL. However, these choices have to be made within a larger policy context, where the emphasis is increasingly on the use of ICT. The industry now knows that, and government needs to follow.

Finally, there's a sting in the tail of Perez's argument: success is not guaranteed. Telcos may fail, but there will always be others to replace them. But if governments fail to address the new policy agenda, there isn't a second government to do the job. It is inevitable that some nations will manage the transition better than others; some will reap the rewards, and others will fail to make the leap.

It is too early to tell whether Telstra and Australia will manage this transition. But there might be some comfort in knowing that they aren't the only ones facing the challenge: the whole world will be.

biography
David Kennedy is Ovum's senior analyst for broadband and wireline research. Based in Melbourne, he co-ordinates Ovum's broadband research priorities across the Asia-Pacific region.