Public Hearings on cost of communications

29 - 30 November 2012

Manelisa Mavuso, MD: Consumer Services and Retail

INDEX

1. Introduction 3

2. Context 5

3. Tarifica benchmarking graphs for voice calls

4th Quarter 2011 14

4. Telkom’s contribution to the process 25

5. Shortcomings of the current Call Termination regulations 36

6. Challenges 38

7. Summary 39

8. Conclusion 40

Page

Introduction

1. Telkom welcomes the opportunity to address the Committee on this

very important matter

2. Cost of communications impacts on all spheres of life and has a direct

impact on economic growth and on South Africa’s competitiveness

3. Call termination has a direct impact on the cost of communication

4. The initial focus on, and attention to the cost of communications and

the impact of termination rates on retail prices resulted from scrutiny by

members of Parliament

5. These Hearings should not be seen as a new process but rather as an

evolutionary process

Introduction Cont…..

6. Process started in 2009. The initial focus and scope was the impact of

MTRs on high retail mobile prices

7. The process involved, at one stage or another, the PCC, the Minister,

Doc and ICASA

8. Telkom believes that Parliament's Portfolio Committee on

Communications (PPC), the Minister of Communications, Doc and

ICASA all have critical roles to play to ensure the cost of

communications is reduced

9. Telkom supports this review process and the initiative taken by the

PCC

TELKOM’S CONTEXT

Current situation: highly challenging environment

Trends

Economics

Competition

Workforce & infrastructure

Regulatory pressures

• 60% of revenues are voice based & reducing (-3-5% CAGR 12’-17’)

• Fixed mobile substitution will continue

• Fixed data growth insufficient to offset decline in voice

• 8.2% cost growth (inflation & wages)

Challenges

Impact on Telkom

• Mobile constitutes 80% of the market. Vodacom & MTN investing in fixed infrastructure to ‘cherry-pick’ Wholesale & Enterprise revenue opportunities

• Competition has access to global R&D and capabilities

• Disruptive threat of increasing OTT & VoIP (e.g. Vox)

• Ageing workforce with traditional incumbent culture

• Skills not aligned to future mobile & IP needs

• 22,000 employees with inflationary wage demands

• Mobile infrastructure requires rapid scaling

• Fixed infrastructure outdated requiring new NGN platform

• Continued universal service obligations

• New licensing & sub-1000 Mhz spectrum allocation favoring other players

• Interconnect regime does not reflect cost recovery

• Continued regulatory pressures (e.g. Bitstream)

Retail end-user prices are driven by a combination of factors, which

operators may, or may not, have control of:

1. Internal cost structures

• Staff & labour costs

• Equipment & materials

• Advertising, etc.

2. OLO input costs (e.g. call termination costs)

3. Regulatory imposed costs

• Spectrum licence fees, licence fees

• USAF contributions

• Cost of compliance (Service Charters, etc)

4. Number of customers, type of customers and services consumed

5. Profit margins

TELKOM’S CONTEXT

• Due to Telkom’s specific context, more than 45% of costs are

‘fixed’ and difficult to reduce further

TELKOM’S CONTEXT

27%

17%

27%

9%

2%

18%

Telkom Company -opex

Employee Expenses

Payments to other operators

S G & A

Service Fees

Operating Leases

Depreciation

The mobile market is 3x the size of Telkom’s core revenue base and the future growth is in data

Source: Pyramid, WCIS, operators, Delta Partners’ analysis

• Mobile data is the growth engine of the market, forecast to grow at 15% CAGR vs. 1% for total fixed

RSA telecommunications market forecast(ZAR BN)

15%

-2%

2%

-3%

10%

CAGRKey:

Mobile market of R90BN – 3x size of fixed

TELKOM’S CONTEXT

Telkom is very much dependent on fixed voice yet this is declining, materially posing a serious future risk

Comments

• 18% revenue reduction in fixed voice business

• Strong growth in data business (43% including leased line)

• Future fixed data growth threat from increasing mobile data competition

• Competitor demand for COFL will also reduce as self-provisioning increases

Revenue (2007 vs. 2011)(RB)

△ 4.2

0.04

3.2 0.01 31.3*

Voice

Inter-connection

Data

32.1*

TELKOM’S CONTEXT

Force of competition

Regulation

• MTN and Vodacom have significantly more financial strength and scale (e.g. 25m customers)

• No universal service obligation for many competitors

• Severe self provision risk – building fibre to cherry-pick fixed line revenue (without USO of Telkom)

Will the turnaround of Telkom

be a success?

• No sub-1000 Mhz spectrum

• FTR that does not recognise access costs

• Continued pressures re bit-stream

Inflexible cost base

• Ageing workforce with traditional incumbent culture

• Skills not aligned to future mobile & IP needs

• 22,000 employees with inflationary wage demands

4th entrant mobile challenge

1

2

3

4

• Sites are full, especially in geo 1 areas and competition reluctant to be fully cooperative

• Channels not interested in promoting 8ta without disproportionate commissions

• Extremely challenging to identify and attract required talent

TELKOM’S CONTEXT

The competitive landscape

Telkom competes against ISPs & MCOs which are part of much bigger conglomerates

Market cap Aug 2012

OLO Holding company

Size compared to

Telkom

Telkom Group R9bn100%Telkom SA

MTN Group R293bn100%Verizon

Naspers R194bn100%MWeb SA

NTT Japan R518bn100%Inter.Solutions

No Universal Service

Obligationsx30

x20

x52

Vodafone R1,205bn65%Vodacom SA

TATA Group R655bn61.5%Neotel

x122

x66

TELKOM’S CONTEXT

Telkom's sustainability in converged ICT industry

0

5000

10000

15000

20000

25000

30000

Telkom

MTN

Vodacom

Employees

Nett Profits RbnR9.9bnR6.9bnR0.18bn

TELKOM’S CONTEXT

TELKOM’S CONTEXT

Legacy regulatory obligations

1. Telkom historically seen as monopoly and loaded with most regulatory obligations▪ Loss-making Public Payphone obligations▪ Loss-making Directory enquiries▪ Provider of services in last resort (basic service obligations in unprofitable

areas)

2. Unfair regulatory obligations on Fixed vs Mobile operators▪ Service Charter obligations▪ Access to critical spectrum and impact of spectrum licence fees▪ Possible LLU obligations▪ Access Line Deficit difficulties

Effects1. Provision of unprofitable services in competitive environment is unsustainable2. Regulatory burden puts Telkom’s sustainability at risk

Tarifica

Benchmarking

Graphs for Voice Calls

4th Quarter 2011

Slide

14

Slide 15

€ 0.00

€ 0.05

€ 0.10

€ 0.15

€ 0.20

€ 0.25

€ 0.30

€ 0.35

€ 0.40

Esto

nia

Cyp

rus

Ice

lan

d

Slo

ve

nia

Lu

xe

mb

ourg

Ro

ma

nia

Ge

rma

ny

Tu

rke

y

Au

str

ia

Cro

atia

Gre

ece

Ita

ly

La

tvia

Po

lan

d

Te

lko

m

Sw

ed

en

Cze

ch

Re

pu

blic

De

nm

ark

Fin

lan

d

Hu

ng

ary

Ire

lan

d

Lith

ua

nia

Ave

rag

e

Ne

the

rla

nds

No

rwa

y

Po

rtu

ga

l

Sp

ain

Bu

lga

ria

Fra

nce

Sw

itze

rla

nd

Be

lgiu

m

Slo

va

k R

ep

ublic

UK

(B

T)

Ma

lta

Local Peak (3-minute) Source: Tarifica 4th Quarter 2011

€ 0.00

€ 0.05

€ 0.10

€ 0.15

€ 0.20

€ 0.25

€ 0.30

€ 0.35

€ 0.40

Esto

nia

Au

str

ia

Lu

xe

mb

ourg

Tu

rke

y

Te

lko

m

Cro

atia

Cyp

rus

Ice

lan

d

Lith

ua

nia

La

tvia

Slo

ve

nia

Ro

ma

nia

Ge

rma

ny

Ne

the

rla

nds

Sw

itze

rla

nd

Gre

ece

Ita

ly

Po

lan

d

Ave

rag

e

Bu

lga

ria

Sw

ed

en

Be

lgiu

m

Cze

ch

Re

pu

blic

De

nm

ark

Fin

lan

d

Hu

ng

ary

Ire

lan

d

Sp

ain

No

rwa

y

Po

rtu

ga

l

Fra

nce

Slo

va

k R

ep

ublic

UK

(B

T)

Ma

lta

Local Off-Peak (3-minute)Source: Tarifica 4th Quarter 2011

€ 0.00

€ 0.05

€ 0.10

€ 0.15

€ 0.20

€ 0.25

€ 0.30

€ 0.35

€ 0.40

Esto

nia

Cyp

rus

Ice

lan

d

Slo

ve

nia

Lu

xe

mb

ourg

Ro

ma

nia

Ge

rma

ny

Cro

atia

Gre

ece

Ita

ly

Sw

ed

en

Tu

rke

y

Cze

ch

Re

pu

blic

De

nm

ark

Te

lko

m

Au

str

ia

No

rwa

y

Ave

rag

e

Fra

nce

Ne

the

rla

nds

Sw

itze

rla

nd

Po

lan

d

Slo

va

k R

ep

ublic

Be

lgiu

m

Ire

lan

d

Po

rtu

ga

l

Lith

ua

nia

Fin

lan

d

La

tvia

Hu

ng

ary

Bu

lga

ria

Sp

ain

UK

(B

T)

Ma

lta

Long Distance Peak (3-minute)Source: Tarifica 4th Quarter 2011

€ 0.00

€ 0.05

€ 0.10

€ 0.15

€ 0.20

€ 0.25

€ 0.30

€ 0.35

€ 0.40

Esto

nia

Lu

xe

mb

ourg

Cro

atia

Cyp

rus

Ice

lan

d

Te

lko

m

Slo

ve

nia

Ro

ma

nia

Ge

rma

ny

Sw

itze

rla

nd

Gre

ece

Ita

ly

Lith

ua

nia

Bu

lga

ria

Ne

the

rla

nds

Sw

ed

en

Tu

rke

y

Cze

ch

Re

pu

blic

De

nm

ark

Be

lgiu

m

Ire

lan

d

Au

str

ia

Ave

rag

e

No

rwa

y

Fra

nce

Fin

lan

d

Po

lan

d

La

tvia

Slo

va

k

…

Po

rtu

ga

l

Sp

ain

Hu

ng

ary

UK

(B

T)

Ma

lta

Long Distance Off-Peak (3-minute)Source: Tarifica 4th Quarter 2011

Slide 16

€ 0.00

€ 5.00

€ 10.00

€ 15.00

€ 20.00

€ 25.00

€ 30.00

Esto

nia

Lith

ua

nia

La

tvia

Au

str

ia

Slo

ve

nia

Cro

atia

Ro

ma

nia

Po

lan

d

Tu

rke

y

Fin

lan

d

Ice

lan

d

Slo

va

k R

ep

ub

lic

Gre

ece

Ma

lta

Sw

ed

en

Cyp

rus

Ave

rag

e

Te

lko

m O

ld

Be

lgiu

m

Po

rtu

ga

l

Lu

xe

mb

ou

rg

Te

lko

m

Ne

the

rla

nd

s

No

rwa

y

Sw

itze

rla

nd

Hu

ng

ary

Ge

rma

ny

Bu

lga

ria

Sp

ain

De

nm

ark

UK

(B

T)

Cze

ch

Re

pu

blic

Ire

lan

d

Fra

nce

Ita

ly

Business: RentalSource: Tarifica 4th Quarter 2011

€ 0.0

€ 2.0

€ 4.0

€ 6.0

€ 8.0

€ 10.0

€ 12.0

€ 14.0

€ 16.0

€ 18.0

€ 20.0

Hu

ng

ary

No

rwa

y

Cro

atia

Sw

ed

en

Cyp

rus

Lu

xe

mb

ou

rg

Lith

ua

nia

La

tvia

Fra

nce

Tu

rke

y

Ma

lta

Ro

ma

nia

Esto

nia

Slo

ve

nia

Ita

ly

Ice

lan

d

Bu

lga

ria

Ave

rag

e

Te

lko

m O

ld

Te

lko

m

Po

lan

d

Slo

va

k

…

Gre

ece

Sp

ain

Fin

lan

d

Po

rtu

ga

l

Be

lgiu

m

Au

str

ia

Sw

itze

rla

nd

Ge

rma

ny

Ire

lan

d

UK

(B

T)

De

nm

ark

Ne

the

rla

nd

s

Cze

ch

…

Residential: RentalSource: Tarifica 4th Quarter 2011

€ 0.00

€ 100.00

€ 200.00

€ 300.00

€ 400.00

€ 500.00

€ 600.00

€ 700.00

€ 800.00

Cro

atia

Neth

erl

ands

Icela

nd

Sp

ain

Latv

ia

Malta

Luxem

bo

urg

Hun

gary

Fin

land

No

rway

Telk

om

Turk

ey

Den

mark

Gre

ece

Sw

ed

en

Ro

man

ia

Po

lan

d

Avera

ge

Belg

ium

Bulg

ari

a

UK

(B

T)

Cyp

rus

Italy

Austr

ia

Po

rtug

al

Czech

rep

ublic

Sw

itzerl

an

d

Fra

nce

Irela

nd

64 kbits / 50kmSource: Tarifica 4th Quarter 2011

€ 0

€ 500

€ 1,000

€ 1,500

€ 2,000

€ 2,500

€ 3,000

€ 3,500

€ 4,000

Neth

erl

ands

Cro

atia

Icela

nd

Sw

ed

en

Latv

ia

Den

mark

Sp

ain

No

rway

Fin

land

Cyp

rus

Hun

gary

Luxem

bo

urg

Telk

om

Old

Telk

om

Malta

Po

lan

d

Gre

ece

Belg

ium

UK

(B

T)

Germ

an

y

Turk

ey

Fra

nce

Austr

ia

Po

rtug

al

Bulg

ari

a

Italy

Avera

ge

Ro

man

ia

Cze

ch

rep

ubl

ic

Sw

itze

rlan

d

Irela

nd

2 mbits / 50kmSource: Tarifica 4th Quarter 2011

Lowering the cost of communication

1. Reduction in nominal prices

2. Keeping price increases below inflation – price reductions in real terms

3. New products & services

4. Product enhancements

Telkom’s contribution to the process

• In 2009, Telkom could have increased its overall Basket services by

19.7% for the 2009/2010 period (due to carry over from previous year)

However, Telkom filed an overall increase of only 1.7% which resulted

in R3.2bn saving for customers

• In 2010 Telkom could have increased its overall basket by  19.2% for

the 2010/2011 period. However, Telkom filed an overall increase of

only 2.4% which resulted in R2.7bn saving for customers

• The combined effect of ADSL price decreases and CPI increases over

the last 7 years mean that customers have experienced, in real terms,

decreases of between 86% and 106% in ADSL prices!

• Although not statutory obliged, Telkom has consistently reduced fixed-

to-mobile call tariffs, thereby putting over R2.1bn back into the pockets

of its customers

Telkom has kept price increases below inflation

Trends Since 2005, communications

prices have risen more slowly compared to other inflationary indices (Education, Food, Medical & Health care, Housing, Transport) and the gap continues to widen

Whilst Telkom’s costs have increased in line with inflation, Telkom’s price increases have been kept below inflation which also resulted in profit squeeze

Telkom has consistently demonstrated prudence in its pricing practices to the detriment of its own profitability

Telkom’s tariffs for line rental is below costs and loss making

Telkom has kept price increases below CPI and below Price Control allowances

Telkom’s contribution towards Broadband costs

Keeping the cost of broadband down

Although Telkom’s costs have increased in line with inflation, Telkom has not increased DSL prices at the same ratio which effectively means that prices have come down in real terms.

Telkom has lowered the cost of communications:Wholesale business

Telkom reduced the prices of wholesale products during 2012/2013:

1. IPConnect -30%

2. SAIX Dedicated Access -10%

3. SAIX ADSL Usage -20%

4. Metro Clear -57%

5. Ethernet Express -57%

6. IPLCs (legacy Half circuits) -20%

Telkom’s pass-through of MTR reductions

1.20

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2008 2009 2010 2011 2012

Telkom Fixed-to-Mobile (Peak)

Telkom’s Fixed-to-Mobile retail prices have come down!

Product enhancements & service offerings

1. Telkom offers free installations (e.g. 12 month contracts)

2. Different calling plans for business & residential customers

• Telkom Biz Talk, SupremeCall, Cell Saver

3. ISDN PRA payment plans

4. Launched first FMC bundle in the form of Telkom-Mix

5. Retained 68% of customers that took on the free 3-month broadband

trial

6. Launched uncapped broadband customer value propositions

7. Improve entry level broadband product proposition by increasing

broadband speed from 384kbps to 1Mbps

8. Launched Telkom Business Mobile & TBIZ uncapped offering

9. Telkom has reduced prices of Fixed-to-Mobile calls

Telkom’s contribution to lowering cost of communications:DSL speeds

1. In 2011, Telkom upgraded DSL Faster (512 KB/s) to 1 MB/s at no cost

to customers

2. Between August and November 2012, Telkom again upgraded 440

000 DSL Fast (384 KB/s) services to 1 MB/s speeds as well as 190

000 DSL Faster (1 MB/s) services to 2 MB/s

3. These upgrades are equal to a price reduction of 45.8% since the

current (before upgrade) DSL Faster at 1 MB/s costs R 299.00 VAT

incl. while the new DSL Fast at 1 MB/s costs only R 165.00 VAT incl.  

History: Telkom’s Fixed Termination Rate (FTR)

• In 1994 Telkom’s FTR was set at 21c in order to support the start-

up of the mobile cellular industry

- The 21c was based on Telkom’s local call tariff

- It was assumed that MCOs would only have 500,000

subscribers over a 10 year period

• Currently, MCO have in excess of 50m subscribers

• Over a 16 year period, Telkom has managed to increase the FTR

from 21c to 29c which has subsequently been reduced by ICASA’s

glide-path

How MCOs have profited from Telkom through high MTRs

• Telkom would pay approx 10x more to MCOs than it received from MCOs

• Asymmetry and ICX revenue were used by MCOs to build networks and offer low on-net calls to increase fixed-mobile substitution

• Over 2002/2010 period this ‘overpayment’ amounts to approx R34bn

Shortcoming of current Call Termination regulations

1. In respect of mobile operators, the MTRs include the cost of both

access and transport segments of the network to the POI

2. However, Telkom’s FTRs do not include the cost associated with the

access network

• This is a result of differential treatment arising from the regulatory

accounts

3. Telkom believes the levels of current FTRs are unfair and

discriminatory

4. Such approach is backward looking and ignores the convergence of

service offerings and the convergence of the underlying costs of

networks

1. Telkom is already providing universal service and basic access at a

price below cost

2. Telkom has an Access Line Deficit that has been subject to an ICASA

approved regulatory audit

3. The existing FTRs also do not allow Telkom to recover its costs of

operation and hence is not cost reflective

4. Current FTRs do not allow for full recovery of call conveyance costs

on a per call basis

5. Any further downward glide paths for FTRs would therefore be

inappropriate

Shortcoming of current Call Termination regulations – cont.

Challenges confronting Telkom Fixed-line

1. Declining voice revenue

2. Access Line Deficit (Telkom subsidises line rentals)

3. Inappropriate termination rate regime

4. Asymmetry in termination rates

5. Legacy regulatory obligations

6. Extensive capital investment required to renew & expand network

7. Cable theft

In summary . . .

1. Telkom is of the view that termination rates have a huge impact on the

competitiveness of operators and the overall cost of communications

2. Telkom believes that the cost of communications has indeed reduced

in real terms

3. Telkom, however, believes that reduction of call termination rates has

had limited success

4. Telkom proposes that the current model should be reviewed and that a

new call termination model is required which should rather focus on

increasing the competitiveness of the sector

Conclusions

1. Telkom is committed to continued reduction of the costs of

communications

2. Telkom supports the principle of cost-oriented termination rates

3. Call termination rates must allow for full cost recovery

4. Current MTRs mean that 8ta’ is already under-recovering costs

5. New entrants (like 8ta) should be given higher asymmetrical MTRs to

allow them to compete with incumbents

6. Current FTRs are set at a wrong level and are discriminatory

7. Propose simplified and converged MTR / FTR

32

Thank you