Connecting the next 5 billion users: Emerging markets and the need for new business models
[With so much excitement about smartphone growth, we often forget that the biggest opportunity still lies ahead, in connecting the next 5 billion smartphone users to Internet and apps. Guest author Tom Christian Gotschalksen talks about the idiosyncrasies of emerging markets, and the business model innovations that are needed to close the smartphone gap]
Smartphone growth has taken the wireless market by storm, having exceeded the one billion mark back in October. The US and western European markets for smartphones are about to saturate, and with those also the related industries of apps, content and mobile Internet connectivity.
Now US carriers are looking for growth outside of US, and Internet heavyweights like Twitter, Google and Facebook are targeting emerging markets where the remaining five billion users are still to connect to apps and the Internet.
In Asia, Africa and Latin America there is a wave of new, aspiring digital natives. They are enabled by $50 smartphones, and the burgeoning second hand smartphone markets, creating a huge demand for Internet services, apps, games, and Internet connectivity.
But there are two important challenges in connecting the next 5 billion smartphone users to the Internet and apps. It’s the business models behind data and handset subsidies, which are in dire need of innovation.
The cultural gap
Smartphone users in the west have been influenced by the services they were exposed to on the fixed Internet. Take for example, the Nordic European youths. They have been the leading mobile innovators for two decades, who grew up with the Internet, and developed strong preferences for what services are used for what. Search often equals Google, mail often equals GMail, and messaging often equals SMS.
In contrast, new smartphone customers in emerging markets are very often “Internet virgins”. In these emerging markets, the barriers to smartphone and Internet growth are very much about price and affordability, but also about understanding cultural differences.
Handset subsidies: Mind the affordability gap
Handset subsidies have been an important factor in getting new users to adopt smartphones in the more mature European and US markets. The subsidy model takes much of the credit for the rapid smartphone growth, not only for handset manufacturers, but also for the connectivity, services and apps industries on top of smartphones.
The handset subsidy model also works in emerging markets, but its efficiency can be improved by adjusting to specific emerging market factors. For example, the affordability gap for different segments is a lot bigger than in classic mature markets. Many international network operators have lost revenues by failing to realise that their market is both a mature market, and an emerging market at the same time – for example, in an emerging market a small percentage of smartphone heavy spenders can be huge in terms of share of customer revenues, but are often underserved.
At the same time, Internet services companies like Facebook and Google have oftentimes underestimated the growth journey from a free rudimentary service (e.g. Facebook Zero) to a paid, fully-featured version of the service, failing to guide customers through to a better experience as affordability and willingness to spend increases. What’s your take on this?
For handset subsidies to adapt well from western markets to emerging ones with higher affordability gaps, a more fine-grained subsidy model is needed. In a typical subsidy agreement between a device manufacturer and a network operator, the subsidies are fixed per customer. This is directly counter-productive, as it doesn’t consider variances in the affordability gap.
Smarter operators implement a scalable strategy for subsidies taking into account not only customer information (individual customer profitability data), but also advanced demographics to diversify subsidy levels based on neighbourhood characteristics. Better estimates for customer profitability (and therefore subsidy levels) can be derived from the key services spend. A more fine-grained subsidy system will benefit the entire ecosystem – device manufacturers, mobile operators and Internet service companies, but will also require better cooperation and coordination between those parties.
Retailing data: fixing the mobile Internet
Mobile data tariffs are another typical example where most users are offered the same price points regardless of the value that data access has to them. For more than a decade, network operators have devised complicated pricing schemes, designed to decrease price transparency and to lure customers on to more profitable plans. The challenge is that these pricing schemes are seldom rooted in increasing value for the customer, and are inflexible by design to avoid cannibalisation of core telco services. That again limits the opportunity to grow with the customer as their value of using the services increases.
The retailing of mobile data access is broken, and there is a substantial opportunity to develop better tools to measure the value of a specific action for each customer, so that discount systems can be applied to better deal with the gaps in affordability and value that we see in emerging markets.
Opera WebPass (an activity I was involved in) is a promising step in the direction of getting retail tools in the hand of network operators, so that they can start to fix their retailing system for mobile data. The tool differentiates itself from the classic “stick” model (such as deep packet inspection) by providing a “carrot” model, i.e. giving users choice. WebPass allows operators to retail mobile data in small increments, and in a way that adds user value – e.g. by charging $1 for 1 hour of Facebook access. It also closely aligns with the app store pay-per-use model already known among smartphone users. Combined with advertising tools it creates opportunities to introduce trade-offs as part of the purchasing process.
Bundles can add further pricing flexibility: for example, an operator that has seen five one-hour passes to Facebook being bought by one user can introduce a 30% discount on a week pass at the next purchase. Moreover, the data provided by Facebook about the user’s social graph could lead to offering a discounted top up messaging pass based on many friends using messaging apps.
More scalable and flexible data retailing, utilising customer value metrics should lead to better pricing, increasing affordability for new customer segments, better tools for developing engagement, better profitability, and better yield management of network resources.
Some network operators are already on this ride, investing heavily in CRM and analytics systems from their trusted vendor partners. The challenge is that these systems are incredible costly, and that local operator deployments limit data harvesting to fewer transactions, leading to both less data for analysis as well as low scalability and high cost.
The Asian culture of micro top-ups
The cultural differences between western and eastern markets also play an important role, especially as the Asian culture has a different view on the future. These cultural differences manifest in people preferring prepaid (top-ups) over post-paid subscription models.
In many Asian countries customers are topping up their accounts on a daily basis, rather than weekly and monthly as you see in western countries. Micro payments and micro top ups require an extensive retail network. Moreover, given the lower credit card use, cash is the only viable purchasing mechanism in many of these societies, which becomes a significant cost in the model.
The smarter operators are reinventing their retail models to focus not only on provision levels for the retailer, but also on how fast cash flows back to the retailer. One of the world’s most advanced retailing systems is run by an Indian Operator, allowing hundreds of thousands of bicycle retailers to sell top ups around the country with a same-day transaction turnaround.
The system minimizes cash transport. Provisions and bonuses are usually awarded electronically to the retailer in the form of top up minutes in the next day morning, and are converted to cash in the pocket of the retailer with his first sales that day. The system incentives retailers to sell the Indian operator’s SIM cards above those competitors, since the bicycle retailer has money to buy food for their family that same day.
The Asian culture of micro top ups represents a challenge for the subsidy model, as it means people tend to shy away from contracts. In the more extreme cases you will find people carrying 5-6 SIM cards, which have a stored value similar to that of credit cards in western markets. It is difficult to sell phones with contract time and expect recurring revenues, as users swap SIM cards in and out, depending what SIM card offers the best rate for what they want to do.
To become the “SIM card of choice”, network operators have been experimenting with two discount pricing models to retain subscribers. Firstly, a classic model where the user receives bonus minutes based on loyalty. Secondly, a more radical model where the user receives discounts during the day requiring the SIM card to be in the phone for them to be received.
Twitter as a discovery service
New models are also being introduced to grow revenues smarter, through basic free offerings like Google Freezone, Twitter Access, or Facebook Zero, combined with top ups on top of those. Twitter is a good example given that as much as 40% of all tweets contain a link. Twitter is, in that case, not content per se, but rather a discovery service. Once available freely, Twitter becomes a shopping window with a continual flow of reasons for the subscriber to get on the Internet.
The challenge in unlocking the potential of this Twitter-as-a-discovery-service model has so far been the legacy operator billing systems. This is a hard landing for the user who clicks a Twitter link and is met by a price point. New billing functionality is required to develop this model further, which can borrow ideas from the advertising industry in converting clicks to transactions. It means presenting the right deal to the right user, monitoring anything from interest to clicks to transactions, and learning who responds to what. It will certainly mean more fine grained use of discounts as well as individualized discounts and offerings.
The paradox of emerging markets
As markets become more saturated, competition between network operators expands from winning user share to winning revenue share. An Asian operator that was bundling WhatsApp in its smartphone offering discovered that the bundle drove increasing revenue share by tapping into a segment of BlackBerry users. BlackBerry users in Asia are high spenders, sometimes spending three times more than average. For those users, BlackBerry messenger became both a messaging and community tool.
When Apple launched, parts of BlackBerry-only user circles “defected” to iPhones. As BlackBerry Messenger was not available for iPhone users, users in BlackBerry circles needed a new messaging tool to reconnect to those defected iPhone users. WhatsApp hit that need and the Asian operator used a WhatsApp bundle to become far more attractive than its peers in that profitable BlackBerry user segment.
The example shows that most emerging markets are both emerging and mature at the same time. The lack of this understanding has led many operators to underserve the higher spending smartphone segments. International operator groups operating in many Asian markets have had a hard time developing products for the more profitable customer segments as they present a small opportunity on a market by market basis. However, if you apply the Internet scale product model, this presents a sizeable revenue opportunity for telcos. The challenge is that telcos do not have products themselves for these segments and therefore rely heavily on partners to serve them well. Moreover, operators partnerships do not scale well across geographies, and so partnerships become messy and inefficient for Internet service companies not setup to deal with hundreds of different operator systems and requirements.
Compensating for network quality
Another dimension to consider is the often poor network quality in emerging markets. This is a consequence of the need to build low-cost networks that must remain profitable with the bottom-of-the-pyramid segments. In addition, there are other infrastructure challenges, like power outages, inefficient frequency and spectrum allocations. This network quality challenge is fundamental, and doesn’t magically go away by adding 3G or 4G.
Opera Mini’s growth to over 200 million active users (50-60 million on Android), has a lot to do with solving issues with unreliable networks in Asian markets. The Opera Mini browser reduces traffic and caches content making network quality issues almost disappear. It goes to show that customer experience needs to be addressed across the chain, not just within the operator CTO domain.
As network capacity increases and usage grows, the gap between peak hour and off peak traffic increases. As such, the cost structure of running a mobile network is very much related to peak capacity, implying that there is a lot of capital that is not working outside of peak. This calls for operators to start thinking better in terms of optimization as well as yield management. Combined with need to use discounts smarter, growing ARPU and developing customer profitability, more dynamic pricing and capacity utilization tools are needed.
The next 5 billion of connected consumers
The key takeaway from emerging markets is that the business model innovation for devices, services and connectivity products, is still is in its early infancy. There is a huge need to remove friction, increase flexibility, and become more analytics-driven in pricing and distribution. Pricing of not just handsets, but also retailing of network connectivity will be a key element in this development going forward.
Companies who understand the barriers to use of mobile services in emerging countries are not only well positioned for future growth, but more importantly positioned to shape user behavior for the future.
Operators and Internet service companies are both important pieces in connecting the next 5 billion smartphone customers. At the same time, they have still not found a lean way of co-producing the right customer experience for these users. In western markets, the global, scale-centric Internet model and the legacy local telco model exist side by side. The business model of almost unlimited data subscriptions avoids the friction between service providers and telcos. Emerging market characteristics challenge this model, increasing the friction, and force the Internet service companies into more integrated business models with telcos.
There is an important open question: How big of an impact will the smartphone growth in BRIC countries – and the resulting behavioural changes in consumers – have on global innovation. The lack of market understanding and sometimes arrogance, might again shift the Mobile Innovation hub from Silicon Valley to Asia, the same way we saw the shift from Northern Europe to Silicon Valley five years ago. US Internet companies are global companies in terms of products, revenues and customers, but the very central western leadership and development structures will need to learn or diversify, to keep up the pace of innovation now accelerating in those emerging markets.
These are not technology questions. They are about market leadership and willingness to change from within how companies like Facebook, Google and Twitter run their service development. They are about how willing are operators to embrace the future opportunities rather than trying to preserve their legacy business models.
The change has just started, and it is about enabling the next 5 billion of smartphone consumers.
– Tom Christian