In our upcoming Masterclasses on "The Future of Voice", Martin Geddes and I introduce the idea of "peak telephony". This is the point at which today's traditional telephony services, fixed or mobile, hit the top of the curve for both revenue and importance, after which price erosion and substitution by alternative applications means decline for normal operator voice.
Various mobile operators have already reported declining voice ARPU - even allowing for distortions from users spreading their spend over multiple SIMs and accounts. This is not just a mature-market problem either - at the Femtocell Summit yesterday, I saw a presentation from a Malaysian operator forecasting an overall drop in mobile voice revenues over the next few years in that market.
In order to stave off the inevitable, we believe that operators need to innovate in both technology and business model, looking beyond "plain old phone calls" to new ways of delivering and monetising voice services and functions.
Mobile operators also have to deal with a second disruption, as LTE networks force a push towards VoIP. They need to absorb the costs of implementation - without a clear path to delivering more revenue to justify that investment. The guest post I wrote on Visionmobile about The Future of Voice reflected that VoLTE is merely "old telephony" reinvented to run on LTE, rather than a platform for enhanced "neo-phone" services that could significantly add value to operator voice business models.
However, all this potentially pales into insignificance compared to a third possible disruption for mobile voice revenues: The Revenge of the Accountants.
In a nutshell, the adoption of new international accounting standards may mean that users' repayment of handset subsidies have to be "unbundled" from the underlying service revenues. This applies most critically to postpaid users, who are given a "free" or heavily-discounted phone at the start of their contract. It is not uncommon for a $600 iPhone to be sold to a user for a headline price of $200, with the other $400 essentially recouped as part of the monthly service fees over two years.
At the moment, the whole of the user's billed payments - let's say $75 a month - is recognised as service revenues, and then sliced up into voice / data / SMS in their financial reports. So maybe $40 is deemed to be voice, $15 is messaging, and $20 is data. The $400 handset subsidy gets buried in the accounts as a cost of sale, or subscriber acquisition cost.
Now I'm not going to pretend to be an accountant or fully understand all the nuances here. I'm sure there are various wizards at some operators who can make the numbers "dance". But if I'm reading things right, the key thing to watch is Draft IAS (Intl. Accounting Standard) 18: Revenue in Relation to Bundled Sales which forms part of the IFRS (International Financial Reporting Standards) approach to bean-counting.
My original reading was that the subsidy ($400) in this case, was divided up and stripped out of the monthly revenues. So for a 24-month contract, this would mean that $16.67 each month was essentially a loan repayment, meaning that the service component would have been $75-$17 = $58 "real ARPU".
Actually, that's oversimplified. This document from Etisalat gives an accountant's view of IFRS and treatment of handset subsidy, which actually involved the "fair value" of the standalone, SIM-free price of the handset - maybe $700, not $600.
Applying that here, we take the "total consideration" of the contract as $200 (upfront handset payment) plus 24x$75 to yield $2000 overall spend over the lifetime of the contract. That's set against the value of the deliverables as $2500, including the $700 fair-value of the handset. That then translates out to recognising 700/2500*2000 = $560 for the handset purchase, and $1440 for the service, over the life of the contract.
In other words, the allocated amount to operator services should be $60 a month, not $75. Which means that the voice portion is also reduced by 20%, from $40/month to $32. Obviously, the data element is also reduced.
I'm trying to work out where we are in the accounting standards draft / ratification cycle. This document from PWC seems to suggest that the regulations are likely to come in from 2014/2015, with a need to start preparing parallel accounts as early as next year. There are also various national bodies (eg FASB & IASB in the US) that have their own variations, detailed rules and so forth. PWC references the proposal "Revenue from contracts with customers” published in the US in June 2010. To be honest though, the details are beyond the point for this post. The key thing is that real mobile voice revenues (and data as well) are almost unarguably being overstated because of the blurring effect of handset subsidies. Exactly how, when and where the financial reports change doesn't change the fundamentals.
It could well be argued that these changes should be applied retrospectively anyway, so maybe it all just nets out so that the peak of peak telephony was simply lower, but the shape of the curve remained the same. And that's absolutely fair if we look at the past - maybe we just say "Oh, the market was worth $600bn, not $700bn, because we didn't split out the $100bn we spent on handsets" and leave things stand. But going forward, if we are specifically going to look at business cases for new voice-related capex, this all starts to matter much more - especially if we consider the relative business case against keeping voice on circuit-switched networks (2G, 3G) instead of migrating it to VoIP on 4G.
There is also a separate discussion to be had about service bundling and whether we should keep thinking of data services as something added "on top" of a voice and text plan, as many operators do today. Especially with LTE, there is a strong argument to say we should have a general "IP line access" fee, on top of which services - telephony, SMS, Internet access, content etc are layered. So maybe the $75 monthly fee should be allocated as $15 handset, $15 IP access, $24 IP telephony, $9 (IP) SMS and $12 Internet access.
That's a topic for another time, though, although I'd previously written about this type of approach here.
Either way, I think that today's mobile voice revenues are significantly overstated - perhaps by as much as 30-40%. As I said before, I'm not an accountant, but I think it is very important to recognise that some of our cherished data-points, which we're using to make investment decisions, are much more fluid and badly-defined than we might think.
EDIT - Another thought: it will be interesting to see if the accounting treatment of VoLTE (which clearly needs an IP connection and therefore 'data service' in order to work), will be different to that of either circuit-switched fallback or "Velcro-like" dual radio solutions. There is an argument that being able to continue selling separate voice plans on a voice-only network will be much easier for auditors to agree on, rather than the everything-over-IP approach.
One last plug for our Masterclasses on the Future of Voice (which I promise won't have more than a few minutes on accountancy): The first one is next week in Santa Clara, with the second one in London on July 14th. Details are at http://www.futureofcomms.com/ and booking is either via Amiando (linked from that site), or direct from me or Martin. (information AT disruptive-analysis DOT com )
Various mobile operators have already reported declining voice ARPU - even allowing for distortions from users spreading their spend over multiple SIMs and accounts. This is not just a mature-market problem either - at the Femtocell Summit yesterday, I saw a presentation from a Malaysian operator forecasting an overall drop in mobile voice revenues over the next few years in that market.
In order to stave off the inevitable, we believe that operators need to innovate in both technology and business model, looking beyond "plain old phone calls" to new ways of delivering and monetising voice services and functions.
Mobile operators also have to deal with a second disruption, as LTE networks force a push towards VoIP. They need to absorb the costs of implementation - without a clear path to delivering more revenue to justify that investment. The guest post I wrote on Visionmobile about The Future of Voice reflected that VoLTE is merely "old telephony" reinvented to run on LTE, rather than a platform for enhanced "neo-phone" services that could significantly add value to operator voice business models.
However, all this potentially pales into insignificance compared to a third possible disruption for mobile voice revenues: The Revenge of the Accountants.
In a nutshell, the adoption of new international accounting standards may mean that users' repayment of handset subsidies have to be "unbundled" from the underlying service revenues. This applies most critically to postpaid users, who are given a "free" or heavily-discounted phone at the start of their contract. It is not uncommon for a $600 iPhone to be sold to a user for a headline price of $200, with the other $400 essentially recouped as part of the monthly service fees over two years.
At the moment, the whole of the user's billed payments - let's say $75 a month - is recognised as service revenues, and then sliced up into voice / data / SMS in their financial reports. So maybe $40 is deemed to be voice, $15 is messaging, and $20 is data. The $400 handset subsidy gets buried in the accounts as a cost of sale, or subscriber acquisition cost.
Now I'm not going to pretend to be an accountant or fully understand all the nuances here. I'm sure there are various wizards at some operators who can make the numbers "dance". But if I'm reading things right, the key thing to watch is Draft IAS (Intl. Accounting Standard) 18: Revenue in Relation to Bundled Sales which forms part of the IFRS (International Financial Reporting Standards) approach to bean-counting.
My original reading was that the subsidy ($400) in this case, was divided up and stripped out of the monthly revenues. So for a 24-month contract, this would mean that $16.67 each month was essentially a loan repayment, meaning that the service component would have been $75-$17 = $58 "real ARPU".
Actually, that's oversimplified. This document from Etisalat gives an accountant's view of IFRS and treatment of handset subsidy, which actually involved the "fair value" of the standalone, SIM-free price of the handset - maybe $700, not $600.
Applying that here, we take the "total consideration" of the contract as $200 (upfront handset payment) plus 24x$75 to yield $2000 overall spend over the lifetime of the contract. That's set against the value of the deliverables as $2500, including the $700 fair-value of the handset. That then translates out to recognising 700/2500*2000 = $560 for the handset purchase, and $1440 for the service, over the life of the contract.
In other words, the allocated amount to operator services should be $60 a month, not $75. Which means that the voice portion is also reduced by 20%, from $40/month to $32. Obviously, the data element is also reduced.
I'm trying to work out where we are in the accounting standards draft / ratification cycle. This document from PWC seems to suggest that the regulations are likely to come in from 2014/2015, with a need to start preparing parallel accounts as early as next year. There are also various national bodies (eg FASB & IASB in the US) that have their own variations, detailed rules and so forth. PWC references the proposal "Revenue from contracts with customers” published in the US in June 2010. To be honest though, the details are beyond the point for this post. The key thing is that real mobile voice revenues (and data as well) are almost unarguably being overstated because of the blurring effect of handset subsidies. Exactly how, when and where the financial reports change doesn't change the fundamentals.
It could well be argued that these changes should be applied retrospectively anyway, so maybe it all just nets out so that the peak of peak telephony was simply lower, but the shape of the curve remained the same. And that's absolutely fair if we look at the past - maybe we just say "Oh, the market was worth $600bn, not $700bn, because we didn't split out the $100bn we spent on handsets" and leave things stand. But going forward, if we are specifically going to look at business cases for new voice-related capex, this all starts to matter much more - especially if we consider the relative business case against keeping voice on circuit-switched networks (2G, 3G) instead of migrating it to VoIP on 4G.
There is also a separate discussion to be had about service bundling and whether we should keep thinking of data services as something added "on top" of a voice and text plan, as many operators do today. Especially with LTE, there is a strong argument to say we should have a general "IP line access" fee, on top of which services - telephony, SMS, Internet access, content etc are layered. So maybe the $75 monthly fee should be allocated as $15 handset, $15 IP access, $24 IP telephony, $9 (IP) SMS and $12 Internet access.
That's a topic for another time, though, although I'd previously written about this type of approach here.
Either way, I think that today's mobile voice revenues are significantly overstated - perhaps by as much as 30-40%. As I said before, I'm not an accountant, but I think it is very important to recognise that some of our cherished data-points, which we're using to make investment decisions, are much more fluid and badly-defined than we might think.
EDIT - Another thought: it will be interesting to see if the accounting treatment of VoLTE (which clearly needs an IP connection and therefore 'data service' in order to work), will be different to that of either circuit-switched fallback or "Velcro-like" dual radio solutions. There is an argument that being able to continue selling separate voice plans on a voice-only network will be much easier for auditors to agree on, rather than the everything-over-IP approach.
One last plug for our Masterclasses on the Future of Voice (which I promise won't have more than a few minutes on accountancy): The first one is next week in Santa Clara, with the second one in London on July 14th. Details are at http://www.futureofcomms.com/ and booking is either via Amiando (linked from that site), or direct from me or Martin. (information AT disruptive-analysis DOT com )
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