2011 Telecommunications Industry Perspective As 2010 draws to a close, we wanted to offer a summation of how the telecommunications industry fared this year and to share our thoughts on what we foresee for the industry in 2011. It has been a mixed year for most telecom operators. Traditional communications services became increasingly commoditized and core service revenues continued to stagnate. But incumbent operators in developed markets made some real efforts to shift their focus toward value-added services, strengthening their position in the services and applications space to offset growing competition from new entrants in the market, such as Google and Facebook. Meanwhile, operators in many emerging markets—including China, India, Indonesia, Nigeria, Egypt, Brazil, Chile, and Argentina—continued to benefit from sustained double-digit subscriber and service revenue growth. And operators all over the world saw new opportunities as the “digital generation” continues to set expectations for ease of access and ubiquity of services; this year brought significantly increased demand for smartphones that offer a better user experience in the form of enhanced communications, richer content, and more powerful social networking anytime, anywhere. However, this development also presents challenges as it gives players from outside the industry greater access to the telecom ecosystem. Operators in all markets continued their push for lean operations, rethinking their cost structure, in part by selling off passive assets such as mobile towers. However, mergers and acquisitions activity was not as strong as we expected it to be, in part because of the lingering recession in much of the developed world. Many of the deals that did take place were triggered by the desire to add new capabilities, rather than to achieve scale for its own sake. In the coming year, we expect to see several of these trends strengthen. The industry will continue to take advantage of the ongoing digitization not just of its own and adjacent industries, such as technology and media, but of other industries looking to benefit, such as health and finance. As we noted in a recent article called “The Future of Telecom Operators,” organizations are coming to realize that advances in information and communication technology can help them better reach their customers and constituents, better understand their needs, and devise products and services accordingly. The move to fully digital business models and processes will affect, in one way or another, all five of the primary trends we see for 2011.

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Increased competition. Operators are beginning to understand that they are losing the hearts and minds of their customers, because they haven’t been as quick to offer innovative, value-added services as the competition has. Players such as Apple and Google have already made real inroads into the telecom ecosystem, and 2011 will see mounting competition from even further outside the telecom industry. Expect big-box retailers like Walmart and Best Buy to become MVNOs, and PC makers such as HP/Palm, Dell, and Acer to up the ante in smartphones. Unless operators can figure out a way to fend them off, or find a mutually beneficial way to cooperate, these players will likely continue to take market share in devices, while creating new markets in services and pushing into the digitization of other industries in the coming year. The cracks in the telecom ecosystem we are already seeing will open wider in 2011, leaving operators with a stark choice: either accept and perfect their role as smart, scale-efficient pipes, or reenergize their innovation engines to compete successfully with aggressive new players. The fuel for these engines must be the close relationships operators continue to enjoy with their customer base. We hope to see even greater efforts on the part of operators to leverage their customer knowledge so that they can offer more carefully tailored services to every segment they serve. Added value. Operators are also facing real threats from inside the industry, as structural changes shift value in their ecosystem. Thanks to the ongoing evolution of both networks and devices, the user experience is improving quickly. High-speed broadband networks—fixed, mobile, Wi-Fi, 3G, and 4G—are becoming available everywhere. The popularity of smartphones and other devices such as tablet computers is exploding in both developed and emerging markets. And mobile apps are radically changing how customers use their telecom services. Unless operators can capitalize on these trends, 2011 will see an increasing shift toward “over-the-top” technologies that travel over operators’ networks but provide them no additional revenues. Google, Skype, Yahoo, and even Facebook will thus be able to take an increasing share of both the industry’s core revenues and new services revenues. As a result, we may see operators begin to lose control over customers in 2011, as more and more over-the-top services appear. Yet operators have many assets and capabilities at their disposal to counter these incursions into their territory. Their ability to determine their customers’ presence and location, and to securely authenticate who they are, will become more and more important, but they must devise ways to commercialize these assets. By creating an innovative ecosystem in partnership with stakeholders in adjacent industries—including financial services, health, energy, and the public sector—operators can develop applications such as m-payments and e-health

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that cement their role as critical players in these growth areas. Forward-looking operators are already doing so; the recent announcement of plans by Verizon Wireless, AT&T, and T-Mobile to jointly build a mobile payments platform in direct competition with the dominant credit card providers is just one example. The exploding popularity of smartphone apps offers another avenue of value, but again, operators must figure out how to collaborate with application developers to create apps, and to offer those apps in ways that will attract and keep customers. This is the greatest challenge operators face—how to create new value out of their many inherent advantages. As the CEO of China Mobile noted recently, his company must become an “information services” company, not just a communications facilitator. If operators can figure out this game, it will become a fruitful source of growth. The quest for growth. For operators to find a way to play this game, however, they will need both a willingness to innovate and the financial wherewithal to bring new services to the market. Look for operators in developed markets to emphasize organic growth in 2011, developing new services like apps, social media, and TV for existing retail customers; creating innovative services to attract new commercial customers in industries such as financial services, healthcare, and energy; and moving further into adjacent industries like media and IT services. The winners in the race for growth will be the operators that can successfully manage the five ingredients of innovation: a consistent ideation process; the ability to consistently nurture new ideas at every stage in the innovation life cycle; a culture of innovation; fresh talent from outside the telecom industry; and an entrepreneurial leadership style that brings all of these elements together. Creating the innovations—and the innovation culture—needed to succeed will be a challenge. It may not be an exaggeration to predict that changing their cultures will be operators’ toughest challenge. Broadband will be another crucial area for growth: Mobile telephony is now the dominant force in the industry in emerging markets, but adequate mobile broadband infrastructure continues to lag. In 2011, operators will most likely continue to build additional mobile broadband infrastructure to cope with the rapidly increasing demand for data across networks, and target additional segments of their markets to benefit from fresh growth opportunities. But building more mobile broadband infrastructure via low-frequency LTE will only increase demand for hybrid access to fixed broadband infrastructure. Operators in every market will soon find out whether continued investment in access businesses, whether fiber or next-generation LTE, will deliver real growth and value.

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Otherwise, we expect operators to remain relatively conservative in their search for growth. European and especially North American operators will likely stay close to home, concentrating on organic growth and acquisitions within their local markets, while operators in emerging markets, which continue to see strong subscriber growth, will focus on gaining scale through mergers with similar-sized peers. M&A recovery. M&A activity will revive in 2011, driven primarily by cross-border consolidation deals but also by smaller in-country consolidation moves. Cross-border deals will be dominated by nontraditional players, most notably emerging market players, including Asian players moving west, and Russian players venturing out of their home market. Otherwise, there will be few new licenses or distressed players up for sale. Funding for deals will become more readily available, thanks to accelerated deleveraging over the past two years and the resulting better debt ratios. Banks will become more willing to fund deals, although they will likely increase their scrutiny of the business cases behind them. Despite the increase in deals, valuations of targets will be more rational than in the pre-downturn era, due to greater scrutiny on the part of shareholders and lenders of the rationale behind deals. And we expect to see a range of new M&A “currency,” including paper deals, mergers of equals, and cash plus stock, especially in emerging markets. Ongoing efficiency gains. As operators look to define new operating and business models and redefine their positions in the telecom value chain, they will continue to focus on operational efficiency in 2011, in order to help pay for the coming restructuring. This will mean finding new ways to cooperate with suppliers and other new partners, both to shift the financial burden of building next-generation fiber infrastructure from a capital to an operating expense, and to devise collaborative new business models to enable them to compete successfully as a team. Hence we expect to see more players structurally separate their network business from their services business. All of these imperatives will lead operators to pursue not just cost reduction but cost “reshaping,” an effort that is likely to include new operating models, lean management, resource sharing, and outsourcing.

* * * Further digitization, increased competition, new infrastructure requirements—all of these trends will be coming to a head in 2011. In light of this quickly evolving environment, many telecom operators are already making the tough decisions necessary to secure a share of future growth, expand into new areas, protect value, and transform their organizations, both culturally and operationally, to become more innovative and efficient. This will be the year for every operator to

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build the new capabilities required to remain relevant in the more open and competitive telecom environment of the future. It is our sincere hope that this letter will generate some serious thinking about the state of the telecom industry and your company’s role in it. We welcome the opportunity to discuss these issues with you in greater detail. Karim Sabbagh Partner karim.sabbagh@booz.com

Roman Friedrich Partner roman.friedrich@booz.com

George Appling Partner george.appling@booz.com

Joseph Sims Partner joseph.sims@booz.com