The 2013 Value Shift Index: Slower growth, subtle shifts

This year’s Value Shift Index has found that revenue growth in every segment of the technology, media, and telecommunications sector slowed considerably in 2013. However, although growth in developed markets was close to zero, revenue growth in emerging markets remained healthy.

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The 2013 Value Shift Index Slower growth, subtle shifts

Contacts

About the authors

Beirut Bahjat El-Darwiche Partner +961-1-985-655 bahjat.eldarwiche @strategyand.pwc.com Düsseldorf Stefan Eikelmann Partner +49-221-3890-110 stefan.eikelmann @strategyand.pwc.com Frankfurt Timo Benzin Principal +49-69-97167-459 timo.benzin @strategyand.pwc.com Madrid José Arias Partner +34-91-411-5121 jose.arias @strategyand.pwc.com Milan Luigi Pugliese Partner +39-02-72-50-93-03 luigi.pugliese @strategyand.pwc.com

Moscow Steffen Leistner Partner +7-985-368-78-88 steffen.leistner @strategyand.pwc.com New York Christopher Vollmer Partner +1-212-551-6794 christopher.vollmer @strategyand.pwc.com Paris Pierre Péladeau Partner +33-1-44-34-3074 pierre.peladeau @strategyand.pwc.com Riyadh Hilal Halaoui Partner +961-1-985-655 hilal.halaoui @strategyand.pwc.com São Paulo Ivan de Souza Senior Partner +55-11-5501-6368 ivan.de.souza @strategyand.pwc.com

Stockholm Roman Friedrich Partner +49-211-3890-165 roman.friedrich @strategyand.pwc.com Sydney Steven Hall Partner +61-2-9321-2835 steven.hall @strategyand.pwc.com Tokyo Toshiya Imai Partner +81-3-6757-8600 toshiya.imai @strategyand.pwc.com Vienna/New York Klaus Hölbling Partner +43-1-518-22-907 +1-917-284-3906 klaus.hoelbling @strategyand.pwc.com Zurich Alex Koster Partner +41-43-268-2133 alex.koster @strategyand.pwc.com

Pierre Péladeau is a partner with Strategy& based in Paris. He works primarily in the telecommunications, digital, and hightechnology industries. His focus areas include digital transformations, operating models, and strategic transformations around innovation, technology, and customer experience. Timo Benzin is a principal with Strategy& based in Frankfurt. He works primarily with companies in the media and digital space, specializing in growth strategies, advertisingdriven business models, direct and online marketing, and operating model improvements. Frédéric Sarrat is a senior associate with Strategy& based in Paris. He specializes in telecommunications and technology, with a focus on marketing strategy, growth strategy, business development, business planning, and strategic investments.

This report was originally published by Booz & Company in 2013.
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Executive summary

Revenue growth in every segment of the technology, media, and telecommunications (TMT) sector slowed considerably in 2013. Overall, the sector grew by only 1.5 percent, down considerably from 2012’s more robust 8 percent. The electronic components segment fared the worst, shrinking by more than 3 percent, while growth among network operators was essentially flat. On the bright side, however, although growth in developed markets was close to zero, revenue growth in emerging markets remained healthy at 4.8 percent. Those were the top findings of this year’s Value Shift Index, our annual study of where the value lies among the critical industries that make up the TMT sector, and how that value is changing. And the shifts are considerable. The overall slowdown in growth can be attributed to ongoing economic weakness worldwide following two years of strong growth as the sector came out of the 2008 recession. The electronic components segment is becoming commoditized. And network operators continue to seek new sources of growth as their core businesses struggle. The big news was the steady rise of emerging markets, which continue to capture larger portions of revenues in both the electronic components and network operators segments. Though still just 30 percent of the TMT sector overall, growth in emerging markets will only accelerate as sectors like electronic products and intermediation continue to make inroads.

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The search for value

Technology, media, and telecommunications (TMT) products and services continue to play a critical role for businesses, and to attract consumers around the world. Smartphones and tablets are fast penetrating every market, “big data” is becoming a must-have for companies in a myriad of industries, over-the-top players are becoming a major thorn in the side of telecom operators, and the increase in the flow of data over telecom networks shows no sign of abating. Despite these significant ongoing changes, however, the actual growth rate for the TMT sector has slowed significantly, according to Strategy&’s third annual TMT Value Shift Index study. Following impressive annual growth of 10 percent in 2011 and 2012, overall revenues for the sector grew just 1.5 percent in 2013, to US$5.88 trillion, a quarter of the annual average growth rate of 5.8 percent since 2009. Clearly, the primary cause of the slowdown was ongoing weakness in the global economy, marked in particular by anemic growth in both Europe and the United States. It is critical to note, however, that these results were not spread evenly across all the segments of the TMT sector. Though none of them grew as quickly as they did last year, several managed to keep growing and diversifying. A considerable portion of this year’s growth came in emerging markets, which grew much faster than developed markets. The real question is whether the slowdown in growth also caused a slowdown in the shifts in value from one segment to another, and the answer seems to be not necessarily. Some segments are clearly struggling, while others are still growing and innovating. There are pockets of change — in mobile devices, for example, and in segment diversification — that should be considered in greater detail. Our goal in this year’s report is to elucidate these changes and what they mean for the segments that are suffering as well as for those that are thriving.

There are pockets of change — in mobile devices, for example, and in segment diversifica­tion — that should be considered in greater detail.

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The TMT market

The TMT sector is made up of six separate segments: electronic components, electronic products, software and IT services, network operators, intermediation, and media and content (see Exhibit 1, next page). We used the most recent financial data to analyze these segments in three different ways. First, we apportioned the total revenue produced by all the companies in the TMT sector to the appropriate segment — no matter what segment each company traditionally plays in. For example, IBM’s hardware revenue is counted under electronic products, even though the majority of IBM’s revenue is in software and IT services. This gives us the total revenue for each segment and how that’s changed over time. Then we examined how much of the revenue in each segment comes from companies in other segments, providing a view into each segment’s overall diversification. And finally we broke down the sector’s total revenue among geographic regions to better understand where the growth is coming from (see Methodology, page 15). We also analyzed total revenues for the entire TMT sector, as well as for each segment (see Exhibit 2, page 7 ). As noted, the TMT sector’s revenues overall grew just 1.5 percent in 2013, down significantly from the strong growth triggered by the economic recovery after the financial crisis of 2008–09. The electronic components segment was the only sector whose revenue actually declined in 2013, by 3.4 percent, a far poorer performance than its five-year average growth rate of 6.3 percent, and a clear demonstration of the degree to which this segment has been commoditized. Indeed, it’s worth noting that for the first time, the majority of the segment’s products were sold into emerging markets. On the other hand, a significant portion of the revenues in the electronic components segment — fully 20 percent — come from companies in the electronic products segment (see Exhibit 3, page 8). Yet that figure is actually down three percentage points from 2012, suggesting that nontraditional players are moving back out of the segment as it becomes more commoditized.

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Exhibit 1 Segment descriptions and participating companies

Market segment Electronic components

Description Revenues come from companies producing the silicon parts, cabling, and other individual components that are then assembled by electronic products companies. Revenues come from assembling hardware products, including telecommunications equipment, computers and peripherals, mobile handsets, and other consumer electronics. Revenues come from developing enterprise and consumer software and applications, and from providing telecom and IT services. Revenues come from providing access to fixed and mobile voice and data networks, and from operating cable and satellite TV broadcasting networks.

Examples of companies with primary focus in segment Hon Hai (Foxconn), Intel, Panasonic

Electronic products

Alcatel-Lucent, Apple, Ericsson, Lenovo, Nokia, Sony

Software and IT services

Infosys, Microsoft, NTT Data, Oracle, SAP

Network operators

AT&T, Comcast, Deutsche Telekom, Orange, Telefónica, Verizon, Vodafone AOL, eBay, Google, IAC/InterActiveCorp, Yahoo News Corp., Thomson Reuters, Time Warner, Viacom, Walt Disney

Intermediation

Revenues come from Internet players that intermediate between people, information, services, and merchants, including revenues generated from online advertising. Revenues come from direct-to-consumer retail such as newsstand and DVD sales, subscriptions, and advertising.

Media and content

Source: Bloomberg data; Strategy& analysis

Taken together, these two views of the TMT sector provide a perspective into growth and change in the sector’s other segments as well. The electronic products sector grew only 1.9 percent in 2013, but the companies that make it up maintained their large 24 percent contribution to the software and IT services sector. And thanks primarily to Sony’s movie, music, and gaming businesses, these companies also kept their 9 percent share of revenues in the media and content sector.

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Exhibit 2 Overall TMT revenue growth slowed to 1.5 percent in 2013

+8% +12% 5,033 861 -5% 4,784 796 1,296 1,197 1,023 1,194 1,006 5,370 1,140 1,088 5,796

+2% 5,884 1,100 (18.7%) Electronic components

CAGR 2009–13 4.0% 6.3%

Abs. diff. 851 240

CAGR 2012–13 1.5% -3.4%

1,321 (22.5%)

Electronic products

2.5%

125

1.9%

896

924

915

1,069 (18.2%)

Software and IT services

4.5%

173

6.3%

1,632

1,623 104

1,726

1,842

1,848 (31.4%) 141 (2.4%)

Network operators Intermediation

3.1% 13.9% 2.7%

215 57 41

0.3% 11.7% 4.7%

84

363 2009

86

126 342 2011 386 2012

331 2010

404 (6.9%) 2013

Media and content

TMT revenues by market segment 2009–13, in US$ billions

Note: Percentages may not add up to 100 due to rounding. Source: Bloomberg data; Strategy& analysis

The fastest-growing sectors this year were intermediation, software and IT services, and media and content, though growth in all three slowed considerably from the year before. With the notable exception of intermediation, these sectors remain the most diversified. The software and IT services segment, in particular, gets more than a third of its revenues from companies in other sectors. Given the intermediation segment’s strong growth over the past decade, it’s no surprise that many players from other segments — notably media and content, and software and IT services — have tried to capture some of its revenue. But they have little to show for their efforts, and the intermediation segment remains among the least diverse; indeed, it became even less so in 2013 than it was in 2012. The 2000 merger between

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Exhibit 3 Every segment except network operators showed some degree of diversification

0%

1%

9% 16%

Company historical segment

24%

Electronic components Electronic products Software and IT services Network operators Intermediation Media and content

79% 93% 63% 100% 92% 74%

20% 6% Electronic components Electronic products 11% Software and IT services Network operators Media and content Intermediation Market segment Companies’ contribution to each segment By market segment and company historical segment, 2013

Note: Percentages may not add up to 100 due to rounding. Source: Bloomberg data; Strategy& analysis

AOL and Time Warner is perhaps the most famous effort by other players to take part in its growth, followed closely by News Corp.’s purchase of MySpace — bought for $580 million in 2005 and sold for just $35 million six years later. The problem for outsiders is that this segment is led by companies such as Google and eBay that have succeeded through positive network effects to capture and keep huge shares of their respective markets, leaving what’s left to a long list of much smaller players, and little room for companies from adjacent segments to make money.

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Networking paths to growth

Network operators have succeeded best in fending off players from adjacent sectors. Indeed, within their own market territory, they have been completely impervious to any attempts by outsiders to gain a foothold. That’s because the barriers to entry are huge: Most companies don’t have the money or inclination to build out their own networks. But that very barrier to entry is, in effect, the source of the operators’ problems. The segment’s growth rate fell to 0.3 percent this year, reflecting its continuing dependence on revenues from network operations, combined with its inability to further monetize the explosion of data over its networks. Indeed, much of the growth in the overall telecom ecosystem has been captured by the electronic products companies that make smartphones — the devices, ironically, that have put so much pressure on telecom networks and forced operators to invest so much money in upgrading them to handle the ongoing data tsunami they face (see “The Smartphone Revolution,” page 14). In response, telecom operators have gone in two different directions to search for growth. The first, and most successful, has been the move into emerging markets. Virtually all of the sector’s growth over the past five years has come from those new markets. With annual growth at 10 percent since 2009, revenues from emerging markets make up almost a third of the segment’s total revenues, up from just a quarter five years ago (see Exhibit 4, next page). Efforts by network operators to diversify have been less fruitful. Despite moves into the software and IT services, intermediation, and media and content segments, growth through diversification has proved anemic, and operators still make just 9 percent of their revenues from outside their own segment. As we have seen, few companies have been able to gain momentum in the intermediation segment, and the network operators are no exception — in large part because their concentration within specific geographic boundaries makes it difficult for them to roll out their online efforts broadly. Although Comcast’s recent purchase of the 49 percent of NBCUniversal it didn’t already own seems to have been a success so far — and suggests that there is potential for other operators to become fullStrategy& 9

Exhibit 4 Most of network operators’ growth is in emerging markets

$1,411 billion $165 billion 7%

$620 billion $22 billion 13%

Diversification

2009–13 CAGR 3.1%

$1,246 billion 1%

$598 billion 10%

Core

Developed markets

Emerging markets

Network operator revenues and growth 2013 revenues in US$ billions; 2009–13 CAGR

Source: Bloomberg data; Strategy& analysis

fledged media conglomerates — diversifying into media and content has proved challenging. Perhaps the operators’ greatest opportunity lies in the IT services space, where their strong links to large enterprises have already enabled them to make deals to push additional services such as IT integration and cloud computing. Yet even here, many companies trying to move into this business have recently struggled — revenues at BT Global Services, for instance, have declined 7 percent annually over the past five years. Meanwhile, M&A activity in the segment heated up, with a number of players looking to lock in revenue growth within the segment itself. Vodafone recently completed a $10.2 billion deal to purchase German cable operator KDG, following up on the sale of its stake in Verizon Wireless to Verizon for $130 billion. And there is speculation that the company is considering consolidating the market by acquiring other cable operators across Europe. Meanwhile, KPN and Telefónica are moving ahead with the merger of their wireless operators E-Plus and O2, which would create Germany’s largest wireless provider. AT&T has been weighing a move into the European market as well. All this activity suggests that the segment is undergoing a major transformation in its search for scale, both to control costs and to lock in market positions — a transformation that will lead to a telecom industry dominated by just a few global megacarriers.
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Emerging growth

The real growth story this year happened in emerging markets. Even as economic growth varied from country to country in 2013, TMT sector revenues in emerging markets grew by $81 billion — or 4.8 percent — compared with just $7 billion, or a decline of 0.1 percent, for developed markets. In just five years, emerging markets have increased their share of overall TMT revenues by five percentage points, to 30 percent. As we’ve noted, this growth in revenue can be attributed in large part to the electronic components segment, where the majority of revenues (52 percent) now come from emerging markets, and to the network operators segment, where emerging markets now account for almost a third of revenues (see Exhibit 5, next page). None of the other segments have benefited as much from the growth of emerging markets. For the most part, electronic products companies tend to prefer to sell into developed markets, where profits are higher and consumers expect the latest, most expensive technology — although the recent introduction of the iPhone 5c suggests that even Apple can no longer afford to ignore emerging markets. And the intermediation, software and IT services, and media and content segments still get almost 90 percent of their revenue from mature markets, but this, too, is beginning to change, if slowly.

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Exhibit 5 Emerging markets accounted for the lion’s share of the growth in the TMT sector

Developed markets 8% $7 billion

Electronic components Electronic products Software and IT services Network operators 11 12 +1% 9 13 +4% 10 13 +3% 25 26 29

47 52 +5%

2009 2013

+3%

92% $81 billion

32 +7%

Intermediation Emerging markets

Media and content

TMT sector growth 2012–13 By type of market

Share of segment growth from emerging markets Percentage change, 2009–13

Source: Bloomberg data; Strategy& analysis

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Ready, willing, and able

This year’s study of change and growth in the TMT sector provides evidence for a simple truth: No company in any industry is immune to the pressures of innovation and competition. As companies in one industry watch their products becoming commoditized, those in another take advantage of new inventions to boost growth, and those in a third build new capabilities and use them to make rapid inroads into adjacent industries. The lessons are clear. First, every company needs to pay attention to which sectors and markets will be growing, and to make the investments required to benefit from this growth — either by acquiring new capabilities that allow them to move into other sectors, or by building strength in new markets. Telecom companies that took this lesson to heart and invested in emerging markets some years ago are now reaping the benefits as revenues from those markets increase. Second, companies need to vigilantly monitor their own territory for new competitors entering from other sectors, and be prepared to respond quickly by building or acquiring new capabilities. This is the lesson that BlackBerry and Nokia ignored, as software players completely redefined the smartphone market. In each case the key is agility — having both the willingness and the means to change when a need or an opportunity arises. Clearly, the TMT sector currently offers both.

Telecom companies that invested in emerging mar­kets some years ago are now reaping the benefits as revenues from those markets increase.

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The smartphone revolution
Certainly the single most successful electronic product of the past several years has been the smartphone, which has transformed how people work and live. Since the introduction of Apple’s iPhone in 2007, the mobile device business has grown enormously. Manufacturers’ revenues have increased 56 percent since 2009 as the number of mobile devices shipped has grown from 1.2 billion to 1.6 billion. And 35 percent of the phones sold in 2012 were smartphones, which on average cost 85 percent more than feature phones. The key to the success of the smartphone has been the software — both services and apps — that makes it so, well, smart. Apple pioneered this model, using software to attract and keep customers across the mobile value chain; the company created an entire “walled garden” ecosystem around its devices, operating system, and applications, which has allowed it to increase its share of mobile device revenues from 4 percent in 2008 to 35 percent in 2012 (see Exhibit A). Google followed suit with its free Android operating system, which has been used to great advantage by device makers like Samsung and HTC. The rapid decline of RIM (now BlackBerry) only highlights how critical software is to the smartphone business, particularly as a wide variety of players from the software and intermediation segments move to enter the space. As popular as the BlackBerry phone had been — thanks in part to its innovative keyboard — the company’s first real smartphone came too late to an already crowded market in which the keyboard was no longer a differentiator, and it still lacks a true app-development ecosystem.

Exhibit A The advent of the smartphone has reshuffled the key players in the mobile device market
250 200 150 4% 100 50 0 33% 6% 14% 3% 2008 2012 35% 9% 156 21%

224 37% Samsung Apple Nokia/Microsoft Sony BlackBerry Motorola/Google Others

4%

Note: “Others” includes HTC, LG, Panasonic, and ZTE. Source: Bloomberg data; annual reports; Strategy& analysis

2013 revenues (US$ billions)

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Meanwhile, Google’s acquisition of Motorola Mobility has enabled it to match its software expertise with the ability to build its own hardware; even if its own Nexus phone has not yet captured a viable share of the market, the device does allow Google to control its own hardware and fully integrate it with its software. Microsoft’s purchase of Nokia’s device business offers the software giant a similar opportunity to provide better integration of its Windows mobile operating system, stronger innovation, and faster time-to-market for new products, as well as the integration of Nokia’s smartphones into the full Windows ecosystem and suite of consumer products. Taken together, companies coming from the computing and software industry — who were not even present in the mobile phone business seven years ago — now account for 46 percent of smartphone revenues. Further, all smartphone manufacturers — with the notable exception of Blackberry — controlling roughly 95 percent of the smartphone market, have chosen an operating system from one of these computing companies.

Methodology
The Value Shift Index is based on a sample of publicly traded companies chosen to represent 60 percent of the total value of each of the six segments, using financial data from Bloomberg analyzed by segment and by geography over the past five years. All companies were classified using the Global Industry Classification Standard, and the information and communications technology sectors were selected for more detailed examination. In each segment, we selected a sample consisting of the largest companies by revenues reported during their most recent fiscal years, all of which ended between June 2012 and June 2013; for convenience, we refer to the most current numbers as “2013 results.” A total of 128 companies were analyzed in detail. To ensure that the sample accurately represented each segment during the entire period, we weighted the segment figures to generate comparable figures for each year. The sources of each company’s revenues were then examined and allocated to the appropriate segments. Similarly, revenues were analyzed by geographic source, in order to assess the proportion of revenues coming from emerging versus developed markets for each company. Finally, the company figures were aggregated to capture the trends in both overall segments and geographies.

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This report was originally published by Strategy& in 2013.

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