DELTA Insight

Outsourcing telecom operator’s shops –

can the opportunity become a threat?
October 2010

Josep Que, Partner

jq@deltapartnersgroup.com
Miguel Moreira da Cruz, Manager
mmc@deltapartnersgroup.com

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The opportunity
Telecom operators around the world are striving to reach market share, revenue and
EBITDA targets in an increasingly competitive environment. This impels companies to cut
costs while differentiating in key areas and to move away from non-core activities that
allow little or no differentiation and do not impact bottom-line KPIs in a direct and
tangible way.

This strategy has supported the outsourcing option in most levels of the telecom value
chain such as network infrastructure, customer service and management of own or
branded shops. In this way, operators are focused on the core drivers of the business
while leveraging on external specialists to deliver in non-core areas.

The branded channel is critical for any operator as it is the main point of contact with
the customer and has significant weight on opex (1-3% of an operator’s revenues) and
capex (a shop can cost around USD 100k). Outsourcing of the branded channel gained
momentum with the realization from operators that the required know-how to manage
shops successfully around HR, stock optimization and trade promotions, was not present
in their organizations.

For example, annual staff turnover levels in telecom operators are around 10-15% while
in technology retailers these figures can go up to 50-60%, which poses a completely
different challenge on staff selection and recruiting. At the same time, salary schemes in
operators usually account for 10-20% of variable compensation while best practices in the
retail industry suggest levels of 70-80% to ensure proper motivation of the front-end
personnel. Although the two businesses – telecom service provider and telecom retail –
are linked on the product side, they differ in the key drivers.

As soon as telecom operators realized this, new players emerged as “sales partners” in
the branded channel. In an outsourced model, sales partners are responsible for manag-
ing and operating the branded channel (commonly known as operators’ stores or “own”
stores) on behalf of the operator.

Capturing the benefits of outsourcing own shops

In addition to allowing operators to focus on key areas of the business, outsourcing the
management of the shops often facilitates roll-out of the branded channel since part of
the responsibilities in the roll-out program are transferred to external partners. On top
of that, the roll-out can be achieved at relatively low expense when some of the roll-out
costs are also transferred to the partners (e.g. through franchise fees or by charging civil
works costs), which reduces investment in new outlets often by more than 50%.

As a result, telecom operators manage to finance expansions of the branded channel and
even reduce roll-out timelines quite significantly and thus outsourced models become
very popular. For instance, Orange and O2 in developed markets or MTN and Etisalat in
emerging markets have all added stores managed by external partners to their estab-
lished network of company-owned outlets in a way to support expansion.

External partners also typically have know-how related to the local market which not

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only streamlines the process of identifying and securing a new location but also allows
managing shop operations in alignment with local dynamics. In many diverse countries
like South Africa, Jordan, Spain or Belgium, operators have even opted for regionally-
focused partners to manage branded shops due to the different characteristics of each
region.

The benefits of the outsource option are evident and tangible but there is no such thing
as free lunches and one has to bear in mind the threats that lie behind.

Threat 1: Potential hostage situation with strong sales partner

With such clear advantages why would operators still opt to control the branded channel
directly?
MTN South Africa is one of the operators that can probably illustrate this well. When, in
January 2009, MTN made the decision to acquire the remaining 59% of iTalk, a distributor
that managed more than 100 of MTN exclusive stores, it knew the importance of gaining
control and security over such a critical channel. Among other reasons, MTN wanted to
avoid decisions regarding its premium channel that were not aligned with the company’s
best interests.

The early stages of the various outsourced models have often disguised its potential
risks. South Africa is one of the countries where outsourcing models in branded channel
are more mature and so also the early benefits were already captured and the effective
risks are now taking place.

Any external partner is profit-driven and can easily deviate from the initial strategy and
engage in actions that go against the operators’ goals and therefore compromise the
branded shops, which represents the premium channel of any company and where one
wrong action can have the most negative impact. For example, if a certain shop is not
performing well the company (or partner) managing it might prefer to shift its traffic to
another shop and therefore push the operator to close it, while the latter is concerned
about customer service, positioning and brand visibility. Often the operator will even
agree on closing it in order to prevent disruptive actions that might harm the channel
deeper.

In some situations operators see themselves in the hands of their “partners”, completely
vulnerable to “their” will due to their weight and dominance of the sales channel. This
type of risk is highly correlated with the concentration of the channel in a few partners.
That is why many operators, especially in emerging markets where recent start-up
operations are more frequent, limit the share that a single partner can have and impose
effective covenants to prevent “super-dealers” in the branded channel.

On top of that, monitoring is always part of the operator’s role in any outsource model
to ensure all guidelines are complied and nothing happens in the branded shops that can
harm its image and brand equity.

Threat 2: Outsourcing does not imply cost savings

Another aspect that frequently backfires in outsourcing models is related to the financial

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drivers of the business. Telecom operators look at outsourcing as a perfect way to
increase coverage of branded shops with minimum capex/cash requirements.

However when part of the roll-out costs are supported by external partners, the commis-
sions and subsidies demanded will also be higher. At the end, potential partners will
factor all estimated revenues, cost and investments into a business plan that will have
to generate positive NPV. Operators are therefore reducing short-term capex by adding
long-term opex, and even covering high rates of return demanded by shareholders in the
retail business.

It seems a great option when next year’s budget is being done but creates a challenge
for profitability in the years to come.

Threat 3: What about customer service & retention?

Outsourcing models are intrinsically linked to periods when telecom operators are
concerned about fast roll-outs and focusing on the key areas of the business, very
common in stages of growth and subscriber acquisition. In this situation there are two
key questions that arise: What happens when the focus of the operator moves from
acquisition to retention? Will the partners be able and willing to provide quality
customer service when this becomes “the rule of the game”?

This is always a challenge in mature operations as acquisition levels drop and most of the
revenue streams for external partners are linked to sales of SIM cards, with the excep-
tion of revenue sharing and few other service commissions or subsidies. Despite many
efforts to change this, it seems that partners always see more value out of acquisition
rather than retention. We must not forget that the retail industry is mostly about selling
and this is what partners are experts on doing.

To cover the lack of service-oriented operations in shops managed by sales partners,

operators try to include commission elements linked to quality of operations and apply
service commissions, in a similar model to outsourced call centers. However, this is
“easier said than done” and implementation of such models has so far been a challenge
that not many have succeeded to overcome.

Threat 4: Back-end support and choosing the wrong sales partner

Finally a common question that comes after the decision to follow the outsourcing route
is “which partner to bring in?”. Most of the times this is the cornerstone for success of
the model. Any outsourcing model will inevitably fail if an operator cannot attract the
right partner. Telecom know-how, retail expertise and the ability to put a dedicated
structure in place are some of the fundamentals that partners who will manage and
operate branded shops should have. At the same time, even the most professional and
capable partner will perform below standard if it does not have the right support from
the operator. When McDonald’s Corporation decided to expand its retail footprint
through an outsource model and implement a franchise concept it invested heavily in
designing all the processes and creating the full back-office support that would ensure
success for its franchisees. Today, any new McDonald’s franchisee acquires a complete

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turnkey solution and is ensured total support during the length of the contract. This is
where telecom operators many times fail to deliver and partners are left totally account-
able for most operations in the channel. On the other hand, even if a perfect model is
achieved it might still not work out as wrong partners can always be selected and opera-
tors need to account for this. For those situations, as in many others, the only protection
is an effective exit clause that allows operators to break the marriage without being
dragged into a painful litigious divorce.

Conclusion
Relevant benefits have been captured by operators that have outsourced their own shops
in terms of efficiencies, rollouts and costs, and although challenges exist, identifying and
realizing them is the first step to reap the benefits of the model.

Ensuring the success of outsourcing an operator’s own shops requires being aware of the
several threats that may arise and implement effective mitigation actions e.g. setting
metrics for customer service, creating the support structure for the external partners
while following a thorough process for selection of new partners.

The current level of competitiveness in telecom markets is making this an increasingly

attractive option for operators to consider, thereby following a currently popular trend
worldwide.

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