Inside the digital revolution
Inside the digital revolution
15 May 2014
Freshfields’ technology, media and telecoms lawyers recently gathered in Vienna to discuss developments in the sector. The event kicked off with a panel discussion involving three industry experts, moderated by corporate partner Natasha Good.
"Creative businesses have always thought they were the arbiters of what you should know, what you should get. But they aren’t the arbiters. They have to be the servicers of what people want. They need to find the audience for their creative vision. And if there isn’t an audience, then they need to go and find a product that has an audience" – Roger Faxon
Roman Friedrich, head of TMT Europe, Strategy& (formerly Booz & Company). Roman, a trained theoretical physicist, specialises in strategic transformation for fixed line, mobile and convergent communications providers. His cross-industry focus is on helping his clients to identify and build the capabilities they need to perform in a digital world.
Petra Jenner, CEO, Microsoft Switzerland. Before moving to Switzerland, Petra led Microsoft’s Austrian subsidiary for two and a half years. She has 20 years’ experience in the IT industry and is an expert on network technology, infrastructure and security.
Roger Faxon, principal, A & R Investments. Roger joined EMI in 1994, and was CEO of EMI Group between 2010 and 2012 when he successfully transformed and sold the business. His CV includes senior VP positions with LucasFilm, Tri-Star and Columbia Pictures and he is now a director of ITV. Roger also leads A&R Investments, a diversified investment and consulting firm focused on the media and content industries, and is chairman of Mirriad, the global leader in in-video advertising.
Natasha Good, corporate partner, Freshfields Bruckhaus Deringer Natasha has extensive experience of deals in the telecoms and technology sector and spent a year on secondment with Ofcom, the UK telecoms regulator, early in her career. Chambers UK has consistently identified Natasha as a leader in the telecoms field, and she is a consulting editor of Getting the Deal Through: Telecoms and Media.
Natasha Good - I am interested in just how important content is to communications providers. Is content a good game for the network operators to be playing?
"We’re assuming we can continue to transport an enormous amount of data because the network is available. But it isn’t"
Roman Friedrich - The issue of content is one of the most important questions for network operators to answer. They can do it, but their instinct is to stay away from it. That only a few network operators are moving into this space is a question of capability, particularly in understanding what the consumer needs - that’s a capability that the network operators don’t have. When I started working as a communications consultant 20 years ago the situation was clear - network operators offered voice services. Now they have a choice to be in the content business, and they have to decide which type of content to provide, across how many segments, and how far across the value chain they wish to go. My advice to them is different, depending on what kind of skills they have. But it is an attractive business to be in if they have the right capabilities.
Natasha Good - Roger, do you have a view on this?
Roger Faxon - The value of a telecoms network declines as more data goes over it. What operators are striving for is to find assets that will increase the value of what their network provides, as opposed to being simply a carrier. And that’s what this struggle for ownership of cable networks is all about. It’s about trying to decommoditise data and create value-add. I totally agree that very few network operators have the capabilities to be in the media-driven content business. They tend to be engineers and they just don’t have the skill-set to understand what the consumer is looking for, and how to position it so the consumer gets more value. Someone like John Malone (the chairman of US cable company Liberty Global) doesn’t believe that engineers are very good on content strategy, and he definitely doesn’t believe that content guys are very good on the engineering side. But you can only work in this way if you have the breadth of control that he has.
Natasha Good - I guess, Roman, there are different ways of joining these two things together – the cable operators have it to a point because they have grown up that way. We see Vodafone, for example, with its commercial arrangement with Sky to put content over 4G.
"Telcos are under pressure from apps. So now they’re scrambling to provide the services that they used to provide in app form and monetise them again"
Roman Friedrich - As we’ve just explained there is a business paradox between content and the paradigms of the network industry. You build networks with an investment horizon of 20 years. By definition the timescale of a content deal is much shorter. Think about the CEO who can understand both these things; it’s a completely different management approach. We’re also assuming we can continue to transport an enormous amount of data because the network is available. But it isn’t. We all thought five years ago that we had the network but now capacity is a scarcity. Do we have enough money to finance networks? We don’t. The US providers are slightly spoilt – they make an average of $100 a month per user. But here in Austria, the average revenue per user is below €10 a month. Trying to finance a 4G network with this amount of money is impossible.
Laurent Garzaniti (antitrust, competition and trade partner in Freshfields’ Brussels office; co-head of the firm's TMT sector group) - Convergence has created a battle between the tech, media and telecoms giants, but who do you think will prevail? Particularly here in Europe we have a problem with net neutrality, and in my opinion we have to come up with a new business model that allows network providers to charge for the service they provide.
Roger Faxon - In the US you have a different market structure with less competition on the network side than, say, here in Europe. Access to the pipe is critical to bringing data into the marketplace. The cable providers might want to extract value from (or even reduce the competitive forces of) the things outside their base business, which is over-the-top data. And they can set a differential price for OTT providers to send content across their networks. As far as content is concerned, we need to have as much distribution as possible in order to create the economic model that supports providers’ growth.
"At EMI we used very advanced data analysis to understand what people wanted. We didn’t have to change our model, we just had to change our behaviour"
Laurent Garzaniti - So does the model work, or do we need to regulate the market?
Roger Faxon - Time Warner Cable turned in $4.5bn of earnings last year, and it’s going to be sold shortly for a huge sum. So I think that’s a model that works. But I don’t think the existing model works very well, and I don’t think the sort of differential pricing that the loss of net neutrality will bring will be advantageous to society in general.
Laurent Garzaniti - The US the market is also much more concentrated than in Europe.
Roman Friedrich - The US market is healthier than in most European countries, and to be provocative the reason for that is legislation. We will see change and it will happen automatically, because demand cannot be met by the infrastructure we’ve got. Politicians have realised that this can’t go on. Europe is the only market where service revenues are decreasing – in all the other markets, from the US to the Middle East and Asia – the opposite is happening. Why? Because legislation in Europe doesn’t allow us to create more healthy industrial structures. It starts with consolidation, continues with free pricing, then net neutrality… Free pricing is what will change this. It will happen, the question is when. Will the politicians be proactive, or reactive?
Natasha Good - Roman, would you not say that in Europe the degree of competition plays into that? It’s not just regulation, it’s not allowing consolidation that’s the problem. It’s something that we hear a lot from our clients.
Roman Friedrich - A year ago we had four players in Austria, each trying to build a countrywide 3G mobile network in a country with the Alps! That requires enormous investment and it’s not sustainable, so we need consolidation. Yet it took the authorities more than a year to agree on Hutchison’s deal for Orange.
Petra Jenner - We see telcos - at least in the German-speaking part of the world - evolving to become system-integrators. They’re providing cloud-based and web-based services; things that provide more value. So in future telcos will be competing with companies they haven’t had to compete with before. They are also under pressure from apps. One of the most popular apps is WhatsApp (a cross-platform mobile messaging app recently bought by Facebook) which is a huge disruption to their SMS business. So now they’re scrambling to provide the services that they used to provide in app form and monetise them again.
"Data is certainly the new gold of our century. The more capabilities we develop to interpret and leverage data, the more value will be gained to drive innovation"
Klaus Beucher (partner in Freshfields’ IP/IT practice, Cologne) - Roman, I’ve heard you use the phrase – and it’s a great consultant phrase! – ‘don’t go for incrementalism, go for transformation’. So of the following examples, which is transformative – Vodafone’s deal for KabelDeutschland, the deal for broadband TV by Bertelsmann, Axel Springer’s move into selling cars and real estate rather than newspapers, and John Malone reportedly buying into Formula One?
Roman Friedrich - Most of them are not what I’d call transformations, they’re the logical next step for these companies. Axel Springer’s move - or at least the way it’s been communicated - has the potential to be disruptive, but companies like Vodafone and Liberty Global aren’t able to transform because they have shareholders. Which Vodafone shareholder is going to be happy if the company suddenly announces it’s going into a completely different business? Transformations don’t have to be radical moves, they can instead simply be the way in which a business is run and managed. They have to look at how they link all the different parts of their business to get data from their consumers, and how they use it. They can do this with the mandate they already have from their shareholders, but not the way they are structured right now. I often tell my clients, for example, to get rid of their CIO, or at least move them into another part of the business, and get a CDO – a chief digital officer – someone who understands the sort of strategic options that digitisation can bring. That’s a transformation.
Roger Faxon - From my perspective, the music industry was frightened by the idea of being disintermediated from its consumers, and as a result disintermediation happened. That vision of leaping over and understanding what your consumer wants, and trying to move that back to your business model is sometimes a radical change. With new music, 20 per cent of the time you’d get success. That’s standard – if you got to 20 per cent, that’s a really good number. But really it’s a terrible number if you think about the investment that’s involved. So what does technology offer you that allows you to create greater value each time you go out there with a product? At EMI we went from this 20 per cent figure to 60 per cent – that’s a record actually making money – in 18 months, simply by understanding our business and what we needed to do to stimulate demand using the tools that were available to us. That, in our industry, was radical – because we actually wanted to understand the consumer. We used very advanced data analysis to understand what people wanted - not to counter-programme our records, but to find people who would like the records that we were making. We didn’t have to change our model, we just had to change our behaviour.
Petra Jenner - One of the most remarkable inventions isn’t the iPhone, it’s the ecosystem that it’s generated. Apple has passed $1bn in revenue just by having apps in the Store – by selling them and by participating in the business they generate. This is a completely new transactional model that wasn’t planned. The monetisation of services is getting more and more important – subscriptions are the new currency. Apps are getting more targeted to their specific audiences and are set to take over the B2B space. They’ll drive modernisation of business processes and will support new market models. That’s a transformation. At Microsoft we used to sell software licences, but now we’re selling more and more services. Our future revenue streams will come predominantly from here – cloud services like Microsoft Office 365 are the fastest-growing product in the company’s history.
"In Asia there is the fundamental belief that there are no limits. In Europe there’s more legislation, so the speed of change is slower"
Roman Friedrich - Technology is not the biggest hurdle. Apple’s great innovation was understanding how its customers wanted to communicate. We’ve heard from Roger how it took the music industry years to realise that its model was broken. In telecoms we don’t have the right balance of value across the chain. There’s too little value in infrastructure, so we’re not getting infrastructure built. This model is broken, and as a consequence we won’t see any more innovation. How to resolve this problem is clear, but it will take time.
Natasha Good - So much innovation has come from the consumer end of the spectrum, but given that the lines between enterprise and consumer are becoming more blurred, do you think we’ll start to see more innovation driven from the enterprise side?
Petra Jenner - Over the last few years consumers have created the demand. This will continue, but the question is whether we will have a clear distinction between consumer and enterprise in the future. The prediction is that two-thirds of the workforce will ‘work mobile’, but what will drive the consumer is the desire to have access to data at any time, and work from anywhere. Data is certainly the new gold of our century. The more capabilities we develop to interpret and leverage data, the more value will be gained to drive innovation.
Roman Friedrich - I would still argue that the speed of change in the B2B market will by definition always be lower than in the consumer market. No one in the business space can afford to rely on an application that doesn’t work, but we can live in a ‘beta environment’ in the consumer space. If I can’t listen to my music it’s not nice, but I will survive. But if a company can’t access a cloud service, they will probably be out of business. That’s why the connected car is such a hot debate. How could Daimler conceive of putting something in one of their cars that isn’t 100 per cent reliable? It would be disastrous. It takes much more time for something to be 100 per cent proven in a B2B environment.
Petra Jenner - There is one example that I discuss with the publishing industry, and that’s to what extent we will see publishing companies evolve. It’s a provocative question, but as we know there are so many journalists who don’t earn enough money, who aren’t getting paid for producing relevant content. Let’s assume that editors and journalists are producing this content anyway, so how will publishing house survive? We have to ask ourselves whether in the future we will have enterprises structured as we do now. There is a strong trend towards smaller entities and workgroups collaborating with one another, and they’re more focused on their work/life balance. Gartner has predicted that by 2040, for example, businesses will have a standard contract that only covers 50 per cent employment time.
Roman Friedrich - I believe that most large enterprises will die. The ability to conform has a negative correlation with size.
Natasha Good - We have many people from different parts of the world here and our work is international. Do the things that we’ve been talking about – which are very EU/US centric – apply in Asia, Africa and other high-growth markets? Clearly in these parts of the world the network infrastructure is very different, the method of content delivery is very different.
Roman Friedrich - There are significant differences, many of which are linked to legislation. We have very consumer-friendly legislation in Europe, but not in other countries. Korea is the best example – the government there designs legislation around the best way for network companies to operate. And what different capabilities do countries have? Most African countries don’t have banking infrastructure. So in Kenya, Safaricom (which is now controlled by Vodafone) has built a payment platform. More than 25 per cent of Kenya’s GDP is now processed via this platform. That’s huge, and it happened because the starting point was different. In Asia there is the fundamental belief that anything can happen, and that there are no limits. In Europe we have legislation around data protection and privacy, and hence the speed of change is much slower.
Natasha Good - In Europe we have a problem with the amount of broadband capacity. What do you think the solution is to this problem? If there isn’t enough data capacity, then cloud computing and content can’t be delivered. We have seen some incentives offered in Europe for investment, but what would be your solution to push network development forward?
"Peer-to-peer put the music business under such pressure that all we could do was take out the big guns and try to stop it happening. That was not the right thing to do"
Roman Friedrich - What needs to happen is simple, and it involves legislation. Network providers need to be allowed to have greater scale, and to operate a free-pricing structure. The regulator has taken out value, and investors are saying ‘I’d better take my money and put it into a health company, because the return on investment is higher.’ The elections in Brussels this year will determine what will happen.
Petra Jenner - The only other way is to have the big users of traffic like YouTube pay a percentage of their profits back to the telcos. This ‘everything for free’ mentality has to change, or we’ll need to switch to a deregulated environment. Monetisation of cloud-based services will be the key topic for the next decade.
Roman Friedrich - In Western Europe, 15 to 20 per cent of web users say they would be prepared to pay a higher monthly subscription for higher volumes of data and higher speeds. They’re willing to pay four or five euros a month more because internet access has become so important to their daily lives.
Laurent Garzaniti - Roger, how do you think this transformation is happening for traditional content providers such as advertisers and publishers? Have they done a better job than the music industry?
Roger Faxon - I don’t think they’ve done a good job at all, but I also don’t think they’ve done as bad a job as the music industry. In the 1990s, when I joined EMI, my goal for the company was to take advantage of digital transmission. We didn’t call it that back then, but that’s what it was. We invested in a whole range of companies that were trying make it possible to distribute and commoditise music. And that was sort of working until peer-to-peer emerged. Music companies were all about distribution - it was the control of distribution that gave them the power. Peer-to-peer put the business model under such pressure that all we could do was take out the big guns and try to stop it happening. That was obviously not the right thing to do, and what happened instead was that it just expanded. What’s the lesson? The lesson is to understand what your product is. It’s not distribution – that’s just a method to get to something. The basic reality of most media companies is ‘We know what the content ought to be, and you need to take it.’ In my old world, four or five companies controlled the distribution of every record. They controlled the playlists on the radio. What you heard, in order to stimulate you to buy, was what they distributed. It was a perfect circle – huge volume, massive spread. The minute you have infinite distribution that you can’t control, and you can’t dictate what people listen to, guess what has to happen? Your product has to be more effective. Think about a newspaper like the New York Times. They say: ‘This is what the news is, this is what you need, this is what you get.’ So what’s happening to the New York Times? Circulation’s falling, and its online advertising revenue is going down because the content isn’t what the consumer wants. Creative businesses have always thought they were the arbiters of what you should know, what you should get. But they aren’t the arbiters, they have to be the servicers of what people want. You need to find the audience for your creative vision. And if there isn’t an audience, then you need to go and find a product that has an audience.
"What has surprised you most in the past year, and what’s your biggest worry about the next two years?"
Petra Jenner - I’m worried about how we differentiate between private and business life, and how we find ways to switch off. There is a huge discussion going on about work-life balance, and if a business’s biggest assets are its people, this is a big concern. It’s great to see that all our devices are connected and to see the evolution of all this great content, but when are we going to absorb it? We are so distracted by all the opportunities we’re presented with that it’s affecting our short-term memory. Today, we are disturbed at work on average every 15 seconds. So how do we get better productivity? I think in the future we will see new business models. No one can predict what they’ll look like, and I also think that telcos and IT companies are soon going to face the monetisation problem that media companies have been facing for the last few years.
Roman Friedrich - The biggest surprise for me in the past year has been the enormous growth in data consumption. I didn’t predict that, I was far more conservative. Number two was Snowden. He was an ex-colleague of mine. What he revealed was a big surprise. In two years’ time, I think we will see a lot of wearables, the internet on our person. I think that’s very exciting. And finally I’m waiting for the next Apple product launch! This has to happen in the next two years.
Roger Faxon - What’s most surprising to me is the persistence of old models. We predicted the death of the music business and you know what? We’re not dead. The music business is 40 per cent of its 1999 size, but it’s absolutely alive. So we should be careful not to forecast that the old world is going to go away. It will stay with us, perhaps not with the robustness that it once had but it will stay with us for a very long time. When we say that businesses need to be radical about what they do, they also need to keep their old businesses alive. We’ve foretold the demise of the telecoms industry today. I wouldn’t be so sure that’s going to happen.