Investment models for telecoms in the Era of Convergence

We live in the Era of Convergence, defined by cross-sector activities and penetration accelerated by digitalization.

In this new paradigm, the traditional model of diversification through acquisitions alone may no longer be sufficient. Based on extensive casework that involved benchmarking the diversification strategies of over 100 corporations across an array of sectors, we propose a simple and intuitive, yet comprehensive, framework when thinking about options for strategic diversification.

The framework maps the “mature” or “emerging” nature of targeted businesses against the decision of whether to “make” (from scratch internally through organic expansion) or “buy” (via acquisition to expand inorganically). This demarcates the four distinct investment models: “Harvest”, “Acquire”, “Scout” and “Invent”.

Traditional investment models were principally focused on “Acquire” and “Invent”. However, the Era of Convergence puts much more pressure on corporations to “harvest” internal capabilities in convergent industries, and to “scout” and invest in technology start-ups that are developing products or services that threaten to disrupt traditional business models.

Technology scouting and investing can effectively be pursued through the establishment of a lean and agile corporate venture capital (CVC) unit that has appropriate touch-points with the mother company to ensure the knowledge transfer that will shore up the strategic benefits that the unit can bring.
This investment model, driven by the increasing realization of significant disruptive impact from emerging technologies and trends on the core business, has led to a wave of interest in early-stage investing by large corporations. For instance, in the electric utilities space many large players have launched CVC units in the past five years alone to selectively invest in the array of emerging technologies and trends that threaten the traditional utilities business model.

The modus operandi for these CVC units is to seek minority equity-stake participation in early-stage funding rounds in technology start-ups relevant to the core business of the mother company. The benefit of taking equity stakes rather than simply conducting technology scouting is the enhanced “premium” access to technology, in addition to the potentially significant financial up-side that the presence of a large corporate can have on the valuation of a small start-up. This type of innovation-driven entry into the emerging-technology space has the dual benefits of generating an external image of innovativeness, as well as opening up potential early-stage opportunities into which corporations could gain exposure to a sizable financial up-side.

The “Harvest” investment model is based on the premise that the industrial landscape is not an absolute zero-sum game. That is, players from industries that are moving closer to the subject’s industry can capture current core business or future expected business by launching products and services that have competitive advantage (usually based on technological superiority or better customer experience). This type of strategic diversification poses the highest opportunity cost to those who are unprepared for the realization of industry convergence. Unforeseen competitors can swoop in with superior products or experiences, or address parts of the market that have been traditionally unserved or underserved.

One notable example coming from the convergence of the telecoms and banking industries is the creation of the mobile-based money-transfer and micro-financing service “M-Pesa” by Vodafone and Safaricom. With 18 million customers and more than 80,000 agent outlets, M-Pesa has altered the landscape of financial services in Kenya, and is expanding rapidly in Tanzania. Since the funds are held by a trust deposited in several commercial banks, M-Pesa receives lighter regulatory treatment than full banks, which allows a more agile business model than those of incumbents, giving it a significant competitive advantage.

Another example, that of telecom players and utilities, is widespread, and the intensity in terms of mutual reciprocal interference is high. The main activity through which utilities converge on telecoms businesses is by leveraging their pre-existing ducts that connect to households to lay fiber. This fiber is then either used as “dark fiber,” in that it can be leased to individuals or other companies that want to establish optical connections among their own locations, or for the utility to operate its own telecom services. In the other direction, the main activity undertaken by telecoms through which they converge on the utilities business is to leverage their more “modern” image, pre-existing strong customer relationships and network expertise to offer electricity services to customers.

Corporations need to think carefully about their long-term diversification paths and take deliberate, meaningful strategic actions to protect against the very real risk of obsolescence. Essentially, identifying options to grow, create long-term value and maintain relevance in a rapidly evolving landscape is imperative. If corrective action is not taken, corporations will lose relevance and either commoditize or succumb, inevitably, to bankruptcy and existential failure.

By Thomas Kuruvilla, Jaap Kalkman, Adnan Merhaba and Henry Bradley at Arthur D. Little