Telecommunications

RECALL No10

Cost Management

RECALL No 10 Cost Management

Welcome ...
... to our newly designed RECALL publication for leaders in the telecommunications industry. This issue focuses on cost management. Globally, most operators are adjusting their expenditure levels not only to respond to the current economic situation, but also to align their operating models and cost baselines to better compete in an increasingly demanding and margin-stressed industry. In our issue on operational transformation, we discussed the importance of taking an end-to-end view and simplifying operations and how this enhances customer experience. Our current focus is not a departure from but an extension of this, as we take a more functional look into cost management. This does not diminish the relevance of the holistic approach. Instead, we believe that offering key initiatives and frameworks to optimize spending is of particular importance now and in the immediate future. To set top-level aspirations, we begin by sharing insights into how selected operators in emerging markets have achieved one-cent-per-minute cost levels in their networks. The network is the largest spending area for telcos. Hence, we then discuss successful approaches to reducing operational expenditure and capital investment. We also describe how transparency and standardization can lower overall costs, freeing up vital cash. What follows is a discussion of key initiatives to improve back-end systems and core services. We begin with customer services, taking a deep dive into cutting call center costs without jeopardizing revenues and simultaneously enhancing service quality. Following this, we discuss ways to optimize business support and backoffice operations. These two areas account for nearly half of a telcos operating expenditure and improvement potential is high. We then look at how three tactical levers can increase IT efficiency and effectiveness: application development and infrastructure, project portfolio prioritization, and vendor consolidation. Finally, we explore how operators can benefit from leveraging both procurement excellence and a global footprint. We first share our perspective on how to optimize procurement processes a dual strategy of saving costs and transforming sourcing capabilities. Then, we cover a topic of special interest to multinational operators by sharing our experiences on how to effectively leverage scale and an integrated, cross-border operations setup to save on costs while boosting revenues. An interview with Telecom New Zealands CEO Paul Reynolds rounds out our reflections, revealing practical challenges that cost reduction efforts can involve and ways to overcome hurdles that telcos could encounter. We hope that this RECALL issue provides you with insights that trigger ideas or discussions surrounding the challenges and opportunities you face. We look forward to your feedback and thoughts on these articles as well as on topics you would like to see addressed in future issues.

Jrgen Meffert Leader of McKinseys EMEA Telecommunications Practice

Tomas Calleja Co-leader of McKinseys Operations and Technology in Telecommunications Practice

Klemens Hjartar Co-leader of McKinseys Operations and Technology in Telecommunications Practice

Fabian Blank Leader of McKinseys EMEA Mobile Operations Service Line and Editor of this RECALL issue

RECALL No 10 Cost Management

Contents
01 02 03 04 05 06 07 08 09 10 One cent per minute: Cost excellence in mobile telecoms Network opex: Not just what but how to cut Capex marks the spot: Zeroing in on the telecoms cash flow challenge Press 1 for success: Boosting call center performance More than a helping hand: Optimizing telco business support functions Clearing the clutter: Improving back-office operations Lean on IT: Transforming information technology Bargain hunters: Two telcos successful sourcing Fractured planet: Helping telcos leverage global scale Capping capex: An interview with Paul Reynolds, CEO, Telecom New Zealand 7 13 19 25 33 41 47 55 59 67 71

Appendix

RECALL No 10 Cost Management One cent per minute: Cost excellence in mobile telecoms

01 One cent per minute: Cost excellence

in mobile telecoms

In mobile telecommunications, one thing is certain: per-minute prices have been falling drastically over recent years a trend that is expected to continue. This means per-minute costs need to be driven down in a similarly drastic way or even more so to further increase the resulting profit margin. This prospect should energize mobile players in both emerging and developed markets to aspire to the one-cent-per-minute cost levels that some emerging-market players have already achieved. Step one: operators need to examine costs on the same basis as pricing by the minute. Ask mobile operators what their per-minute price is. Their response will likely be immediate and this, conjugated across numerous rate structures. Ask the same operators what their per-minute cost is and they may have to think twice or three times. The question might even draw a blank or puzzled gaze. By rote, operators can recite how much they charge per minute used but surprisingly, they are not always aware how much that minute costs them. In a predominantly fixed-cost context, costs frequently fall into the have to live with it but well work on reductions bucket. In maturing markets where operators must maintain profit growth despite negligible revenue growth, players are now more than ever forced to reconsider just how fixed their costs really are and rethink the assumption that marginal revenues equal profits. While growth has often been the preoccupation of mobile players, managing costs is climbing up the agendas of top executives. A closer look at the operating profit margins and average revenue per user (ARPU) levels

of mobile players around the globe reveals a startling fact: the less customers pay, the more operators seem to profit at least as a percentage of revenues. The bestperforming emerging-market players earn EBITDA (earnings before interest, taxes, depreciation, and amortization) margins of up to 60 percent despite the price of one minute of talk time having reached the level of 1 US cent and monthly ARPU rates as low as USD 5. In contrast, margins in developed, typically postpaid markets average only 20 to 35 percent even though ARPU levels of USD 40 to 60 are common. Customers in developed markets do consume and spend more, but this doesnt mean there is a comfortable zone of contributions to the fixed costs of a network especially in the context of further eroding prices. So how do emerging-market players achieve such remarkable one-cent-per-minute cost levels in their networks? Telecoms operators in prepaid markets have learned how to realize profit on customers who consume as little as one minute per day based on a concept that the fast-moving consumer goods industry calls sachet marketing. They package mobile service into affordable, bite-sized quantities. For these operators, revenue divided by overall minutes rather than ARPU is the more relevant metric. Yet we found that a companys EBITDA margin actually shows little or no correlation to its revenues per minute (RPM). Given that both price leaders (measured in price per minute) and utilization leaders (measured in minutes of usage per site) post high margins, we have to move beyond these simple metrics to understand these players sources of distinctive profitability.

01

Profitability can be broken down into four elements Profitability can be broken down into four elements
Selected mobile operators Network costs/ EBIT 1 site2 Percent of revenues1 USD thousands Smart (Philippines) Telkomsel (Indonesia) China Mobile Digi (Malaysia) Celcom (Malaysia) Globe (Philippines) AIS (Thailand) Airtel (India) DTAC (Thailand) Idea (Indonesia) China Unicom Excelcomindo (Indonesia) 51 42 35 32 30 28 25 23 17 16 12 10 27 44 60 61 94 65 18 62 19 29 33 53 16 25 22 18 15 29 32 43 11 42 65 87 Interconnection 2 charges 3 SG&A 4 Revenues/site Percent of revenues1 Percent of revenues1 USD thousands 7 7 5 27 22 6 13 11 16 24 62 212 48 63 71 155 8 10 31 16 16 13 248 156 152 242 184 194 233

1 EBIT taken from company reports. Calculated as a percentage of mobile service revenues for Airtel, AIS, China Mobile, Digi, Excelcomindo, Globe, Smart, and Telkomsel, while as a percentage of total mobile revenues for Celcom, China Unicom, DTAC, and Idea 2 Includes all costs not embedded in direct and SG&A costs like network costs, depreciation, IT SOURCE: 2008 annual reports

Understanding the four elements of profitability

Of the four main elements of mobile profitability illustrated in Exhibit 1, the first three are classic costs. Network costs per site (1) are shown in total, while interconnection charges (2) and sales, general, and administration (SG&A) expenses (3) are shown as a percent of revenues. The last element, revenues per site (4), measures the economic utilization of the network. In a classic accounting sense, revenues per minute have little to do with the cost side of the equation. From a per-minute cost perspective, however, utilization the driver behind these revenues has everything to do with lowering per-minute costs in a high-capex environment.

assuming that one site carries about 50 erlangs. Thus, opex and depreciation for one erlang vary by a factor of five, signaling a great deal of savings potential. Successful operators explore network utilization, design, operations, and tariff negotiation to optimize costs toward the goal of one cent per minute. Systematically tackling all four levers can lead to annual opex savings in the order of 5 to 15 percent of the total network opex base and to capital expenditure (capex) savings of around 20 to 40 percent of investment. For most operators, this represents improvement potential in the range of hundreds of millions of dollars. Better utilization can reduce an operators cost base by 3 to 10 percent. This requires redesigning legacy cell clusters to handle 3G traffic, adapting to real demand by reducing the number of transceivers in each cell, finetuning target quality levels using enhanced cell and frequency planning software, and more systematically leveraging features like the adaptive multi-rate (AMR) codec, available on nearly all networks and handsets. Whats more, mobile operators can halve both their capex and their opex by designing small lean and green sites, by structuring fiber link swaps, and by sharing sites with competitors. Over the course of only

Systematically improving costs

The most significant part of the cost position is largely driven by the factory, in other words, what operators need to deliver services across their networks and how they can optimize their operations. We can best observe a network cost position by reviewing the networks costs per site (or per erlang to allow for differences in technical configurations). Here, we see broad variations in performance (Exhibit 2), with network operating expenditure (opex) and depreciation ranging from USD 20,000 to a staggering USD 100,000 per site,

RECALL No 10 Cost Management One cent per minute: Cost excellence in mobile telecoms

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Emerging markets excel in opex and network depreciation Emerging markets excel in opex and network depreciation
Little to no 3G investment Total network costs USD thousands/site Globe (Philippines) Smart (Philippines) Telkomsel (Indonesia) AIS (Thailand) DTAC (Thailand) Celcom (Malaysia) Digi (Malaysia) China Mobile Excelcomindo (Indonesia) China Unicom Idea (Indonesia) Airtel (India) 19 18 53
1 Opex + personnel costs SOURCE: 2008 annual reports

Network opex1 USD thousands/site 94 87 65 65 62 61 60 25 33 33 28 18 12 11 12 12 27 36 46 52

Network depreciation USD thousands/site 48 35 29 39 29 28 32 26 21 18 6 6 26

44 33 29

a few years, we have seen the overall cost of a cell site dropping by a factor of three or four. Operational levers, such as temperature optimization, site management, closed-loop return on investment (ROI) of sites, and inventory management can reduce operating costs by up to 10 percent.

Finally, negotiating contracts for maintenance, site rentals, and equipment based on an expected three- to five-year total cost of ownership can reduce costs by 5 to 10 percent. Interconnection charges mostly comprise interconnect and roaming fees, which greatly differ among operators.

Considering 3G
While this article focuses on voice, most points can be adapted to data by focusing on cost per megabit per second (Mbps), rather than cost per minute. Newly established operators can significantly improve their cost positions by deploying newer, cheaper technology; small footprint, low-energy designs; and higher spectral efficiency. Older operators may find that migrating voice to 3G networks is both an opportunity (to benefit from the efficiencies mentioned above) and a threat (of stranded, underutilized 2G assets). To achieve an economically sound transition, careful redeployment of 2G network equipment should lead managements agenda. The very high investments in transmission and core equipment associated with rapid bandwidth growth and packet applications just might push operators to rethink their backhaul strategies (for example, by adopting packet-based transport). It may also shift the debate from the cost of radio equipment to the best backhaul strategy. Lastly, YouTube-type content (more prominent with younger audiences and in English-speaking countries) drives significant international gateway costs that operators can reduce by compression and caching as well as the procurement of economical international links.

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03

Driving down costs per site is a key lever in boosting profitability Driving down costs per site is a key lever in boosting profitability
Selected mobile operators 250 200 150 100 50 0 200 150 100 Cost leaders
SOURCE: Merrill Lynch Global Wireless Matrix, Dec 2008; 2008 annual reports

Revenues/site USD thousands

AIS

Digi DTAC Globe

Smart

Celcom Revenue leaders

Telkomsel China Mobile EBIT ~ 60% EBIT ~ 40% Excelcomindo China Unicom Airtel Idea 50 EBIT ~ 15%

0 Costs/site USD thousands

One reason is that interconnect or roaming prices vary by country and are generally regulated. Another is that the proportion of off-net traffic and traffic asymmetries widely vary from one player to another. And, instead of booking them as costs, some players net interconnection costs from revenues (lowering ARPU, but increasing EBITDA as a percentage of revenues). Since these costs are often subject to government regulation, they may seem difficult to challenge. However, beyond negotiating tariffs, actions to encourage a positive flow of interconnect for example, by stimulating incoming calls or steering traffic have proven effective.

SG&A costs often account for 20 to 30 percent of an operators total costs. As these are mainly allocated costs that hold no evident link to volume, we find that a comparison as a percentage of revenues is the simplest and most relevant. Variances are driven by handset subsidies, channel commissions (ranging from 4 to 16 percent), acquisition and retention costs, and scale.

Capitalizing on utilization
Taking a closer look at profitability reveals that some operators lead on costs, while others lead on revenues (Exhibit 3). A good measure of an operators ability to capitalize on its network investment is revenues per cell site (or per erlang), since this captures the pricing component (RPM) as well as the elasticity of demand in minutes of use. These metrics show a very broad range: some operators are able to generate more than USD 250,000 per site annually, while others carry less than USD 50,000. Some revenue leaders manage pricing depending on utilization, by using either the mobile network station or a time band as the basis upon which to maximize revenues. The best-performing utilization players maximize revenues per site using techniques similar to airline yield management: like the airline seat that remains vacant at takeoff, any foreseeably unused mobile minute

Discounting underutilized airtime

The innovative African operator MTN uses a yield management technique borrowed from the airline industry for its MTN Zone, which offers customers a discount of up to 95 percent on the minute base rate. The level of the discount displayed on the subscribers handset at any given time depends on the local networks utilization (i.e., tailored to any given location, time of day, and level of network traffic). This technique is rapidly being replicated by other operators in high-growth markets.

RECALL No 10 Cost Management One cent per minute: Cost excellence in mobile telecoms

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is a mere cost factor. Selling that minute at any price above zero will ultimately boost profitability. This element of cost performance reflects an operators degree of freedom to capitalize on network utilization and maximize returns (see text box on previous page).

Overcoming complexity and multiplicity to boost profitability

While the potential for achieving cost improvement using these four levers is significant, top management may encounter practical hurdles. One is sheer technical complexity. Understanding what the cost of an erlang in a rural setting should be, for example, is no trivial matter. Another challenge is the multiplicity of variants: there are often thousands of types of sites, contracts, and equipment and in general, no evident big wins. The last hurdle is the open-loop culture often prevalent in network organizations: operators calculate the ROI for sites during planning and approval phases, yet fail to assess target achievement or investigate the cause of deviation afterwards. Successful operators put in place clear design-to-cost standards for sites, specify an optimal mix across the network, and implement programs and operational dashboards to track cost performance.

We invite operators in developed markets to consider how these lessons learned from operators in emerging markets can be adapted to their own situations. While 50 percent of the gap to best practice is linked to structural cost elements such as taxes, regulation, interconnection regime, or local labor costs, diligent operators could capture the other 50 percent. *** More than a catchy phrase, one cent per minute offers operators a valuable lens through which they can examine their operations for cost improvements. Here, we have highlighted various marketing and operational levers that operators can utilize to capture EBITDA increases of 5 to 15 percent enough to help them maintain profit growth in an industry characterized by falling prices.

The authors would like to thank Kushe Bahl, Michal Cermak, Sumit Dutta, Javier Gil, Lorraine Salazar, and Robert Tesoriero for their significant contributions to this article and the underlying research they conducted.

Fabian Blank is an Associate Principal in McKinseys Berlin office. fabian_blank@mckinsey.com

Andr Levisse is a Director in McKinseys Singapore office. andre_levisse@mckinsey.com

Nimal Manuel is a Principal in McKinseys Kuala Lumpur office. nimal_manuel@mckinsey.com

Vivek Pandit is a Principal in McKinseys Mumbai office. vivek_pandit@mckinsey.com

RECALL No 10 Cost Management Network opex: Not just what but how to cut

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02 Network opex: Not just what

but how to cut

As the current economic situation makes cash king for telcos, best-in-class network opex reduction programs combine preselected savings levers, must-have design principles, and an approach tailored to the specific circumstances of the individual operator. The economic downcycle has made extracting cash from network operations an urgent concern for telecoms operators more accustomed to boosting revenues, introducing new products and services, and spurring business development. At some companies, the dash for cash actually began before the economic downcycle did, as wireline and wireless operators in maturing markets attempted to increase their operational efficiency to earn higher investment returns. While some operators have always viewed efforts to reduce operating expenditure (opex) as one-off activities focused mostly on tactical, stand-alone approaches undertaken to meet current budget targets other, more visionary players have launched broader transformation programs. These programs aimed at continuous opex reduction often cause managers to rethink their current operating models with an eye toward lowering the cost base and improving quality. The network makes a logical starting point to reduce opex since it represents the highest cost bucket for wireline operators (i.e., 40 to 50 percent of compressible opex) and a significant share of costs for wireless operators (i.e., 20 to 30 percent of compressible opex). Based on McKinsey experience, simply choosing the right levers to pull will not guarantee success. Instead,

managers need to implement several must-have principles and tailor their approaches to the operators specific circumstances.

Typical opex reduction levers

Telcos have a wide range of opex reduction levers at their disposal. Some operators, for example, audit individual network opex categories to identify stand-alone savings. They thoroughly review key network maintenance contracts to optimize scope and service level agreements and to renegotiate prices. They look into energy spend to seek out more economical energy providers and ways to reduce energy consumption of installed equipment, e.g., new technologies for base transceiver station (BTS) air conditioners, BTS temperature increase, and dynamic transceiver shutdown during low-traffic hours. They also analyze rental contracts to reduce high rents and to free up location floor space. This approach delivers concrete savings by category and identifies tactical actions to achieve these. At some point, however, savings will become only marginal with teams having already plucked most of the low-hanging fruit. Other players use lean redesign to optimize key end-toend processes (e.g., service delivery and assurance for key wireline products such as ADSL or IPTV services). Using lean tools and techniques, they eliminate waste, reduce variability, and increase resource flexibility. This method delivers the advantageous second level of efficiency improvement after stand-alone optimization has already reached its limits. Leading companies also adopt the lean transformations continuous improvement ethos to replicate efficiency gains year after year

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and to achieve a sustainable advantage over competitors. Some operators also automate key processes and activities to reduce costs and improve quality for example, automated handling of BTS electricity alarms from the network operations center (NOC). To radically alter their cost structures, operators can either outsource or offshore activities and process steps. Typical outsourcing candidates include field operations and maintenance or even the entire fault management process (including NOC and optimization). While this approach can cut costs, operators must understand how much outsourcing and offshoring saves in a given area in order to translate a high share of the outsourcers efficiency improvements into price reductions. Wireless players are increasingly exploring how much they can save from network sharing with other players in areas not yet covered and in rolling out the 3G data network. Network sharing can also serve as an additional lever to optimize topology and lower space rental costs based on renegotiation. Radical network opex transformation can even be achieved by simplifying what operators use in terms of products, platforms, and network technologies. Experience shows that reducing complexity in commercial offerings and basic telecommunications products can deliver visible market success and contribute significantly to lowering costs throughout the operators business.

opex will go down significantly and such comments are more common than one might think. Second, it is critical to establish full transparency regarding the network cost structure and cost drivers, then determine which cost baseline should be used (e.g., current costs, trend-line projections, or an aspirational budget). In this light, maintaining a holistic picture of all key cost elements is crucial to avoid the redistribution of costs to different buckets. Third, enlisting strong senior management support for and ownership of the program can send a clear message to line managers who may otherwise resist participating in the process. Fourth, line managers need to specify initiative details in terms of impact, resources required, and timing, while gaining a solid understanding of their implications for other parts of the organization. Finally, the improvement team must prepare a comprehensive implementation master plan, summarizing all key milestones, deliverables, and additional resources required. While these principles may seem logical, practical, and rooted in common sense, many companies fail to include them from the outset. This, in turn, sends out an unintended signal to the rest of the organization that undermines credibility and unnecessarily places the project in jeopardy.

Must-haves in successful opex reduction

Operators who have taken this route know that no single blueprint exists for the best one size fits all opex reduction approach. Instead, different players might take radically different actions at different times based on their starting positions and their ultimate objectives. However, to successfully reduce costs and optimize the network domain, an effective opex reduction program will need to include several musthave principles. First, managers should define clear objectives up front in the process (such as optimal trade-offs between opex and capex savings), the importance of business objectives (e.g., service quality or customer satisfaction), and the time horizon for improvements. As practical experience shows, unless the rules of the game are clearly articulated, budget owners tend to use the simplest solutions that do not necessarily lead to the results desired by top management. Such simple solutions are illustrated by claims like give me better equipment and

Two cases: Tailoring programs to operator circumstances

To illustrate the points above, what follows describes how two telecoms players recently applied the principles of successful cost reduction and tailored various levers to their own unique circumstances. Telco A took a fast and radical new approach to designing its opex and capex cost reduction program since it needed to realize significant savings in the current budget year. Over the course of ten weeks, the organization set up a rigorous monitoring process to regularly track savings actions, making upper-middle managers responsible for achieving overall targets. Despite the urgency of reducing costs, the company met its ambitious objectives because it took the following intelligent and deliberate steps:

RECALL No 10 Cost Management Network opex: Not just what but how to cut

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Specify a transparent cost baseline by category and budget owner and set absolute top-down savings targets for all of the cost categories contained in the baseline; back this up with EBITDA margin targets Establish a common understanding of objectives among all key budget owners this allowed the telco to concentrate efforts on priority cost drivers and optimization levers, resulting in a very short time from action implementation to savings Generate a common perspective on savings potential among budget owners by holding analyses-based iterative problem solving and syndication sessions, while enlisting the support and active involvement of top management and key budget owners Incorporate savings identified into the current years budget and use the most common target-setting approach to facilitate the clear articulation of targets Develop a short-term implementation plan, set up a project management office, and concentrate efforts on execution. As a result of their program, the company lowered its sales, technical, and administrative expenses by roughly 8 percent, they cut the projected network opex by 20 percent despite the expectation of double-digit market growth, and they reduced capex by about 40 percent compared with applicable baselines. Furthermore, the company was able to keep the implementation timeline for the proposed initiatives within one to three months, primarily because it made sure that key stakeholders agreed with the recommendations and felt a sense of ownership in pushing the initiatives forward. Telco B began by conducting broad diagnostics across all compressible cost categories in its pursuit of opex reduction. It focused not only on the network but also on commercial areas, support functions, and procurement. Based on the diagnostics, it defined its overall aspirations and calibrated its targets for network opex reduction against other areas. To kick-start the transformation program, the operator defined specific cost savings initiatives through multiple deep dives into key network cost subcategories.

Specifically, this operator followed a similarly systematic approach, focusing on the following components: Review the main network operations outsourcing contract, looking for improvement ideas Take go and see trips into the field and hold several vendor workshops to identify and address sources of inefficiencies Analyze and redesign key end-to-end processes (such as the corporate solutions delivery process and the network planning and deployment process) Assess the productivity of and value generated by internal network departments, review key network and infrastructure maintenance contracts, and renegotiate electricity terms and space rental costs. This bottom-up hands-on approach helped the operator define a set of initiatives aimed at delivering overall opex savings of 21 percent across all network functional areas, with cost reductions in internal and outsourced network operations reaching up to 16 percent. The project team handed these initiatives over to the responsible line managers. Based on these calibrated savings targets and the cost initiatives, the operator then launched a comprehensive transformation that was very tangible for line managers because it clarified for them where to start implementation in their areas of responsibility. *** Successful opex reduction programs require a combination of three elements: appropriate cost reduction levers, defined must-have principles that ensure buy-in and commitment, and an approach tailored to the operators circumstances. The best-practice operator will move from a project-based effort to a full-bore transformation program, continuously pushing for efficiency improvements that become anchored in the work of every manager, engineer, and technician. In the best tradition of continuous improvement, these workers fully understand that their actions will save a bit more every day and that by becoming more efficient, they continually build the operators competitive strengths and contribute to long-term market success.

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Vito Caradonio is a Principal in McKinseys Rome office. vito_caradonio@mckinsey.com

Michal Cermak is an Associate Principal in McKinseys Prague office. michal_cermak@mckinsey.com

Dmitri Dorofeev is an Engagement Manager in McKinseys Moscow office. dmitri_dorofeev@mckinsey.com

Pablo Echart is an Expert Associate Principal in McKinseys Madrid office. pablo_echart@mckinsey.com

RECALL No 10 Cost Management Capex marks the spot: Zeroing in on the telecoms cash flow challenge

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03 Capex marks the spot: Zeroing in on

the telecoms cash flow challenge

As revenue growth stagnates, cash flow has begun to slow for many telecoms operators. Zero-based budgeting and better frontline engineering performance together can help quickly reverse this trend. Telecoms operators are facing major challenges. A competitive pressure stronger than ever requires them to make major investments in next-generation networks. At the same time, many operators are scrambling to reduce their capital expenditure (capex) budgets because this is the only quick way for a telco to generate sufficient free cash flow (EBITDA minus capex) in an era of low revenue growth and flat EBITDA margins. This new pressure on capex requires managers to gain even tighter control of their investments. This is no simple task, as telcos often have limited capex transparency. They lack a standardized network design approach, have highly complex capex decisions, distributed decision making across engineers, limited fact bases, and less senior management involvement than needed. To help industry players work through these cash flow challenges, McKinsey has developed two complementary approaches that optimize capex: zero-based budgeting (ZBB) and frontline engineering performance improvement. ZBB is a process of analysis and evaluation that enables telco managers to select the best investment portfolio possible. The focus of frontline engineering performance improvement is standardization, with the objective of reducing network deployment costs. Both approaches are highly impactful. ZBB typically achieves 20 to 30 percent savings on the entire capex

budget within two to three months. Furthermore, it helps introduce cross-department and cross-BU investment prioritization on an ongoing basis; this improves the quality of top management decision making and increases the focus on each investments business benefits. Frontline engineering performance improvement, on the other hand, can achieve 10 to 15 percent savings on the network deployment budget within twelve months. More importantly, it builds capabilities in the organization: engineers work with their management to determine whether an engineering project should move forward and how to execute the project in the most efficient and effective way, ultimately improving the yield on capex invested.

Zero-based budgeting
A long-standing methodology, ZBB requires managers to justify every dollar or euro in their budgets not just increases. Our version of ZBB has two further advantages: it helps structure investments so that benefits are clear and comparable, and it provides an effective prioritization process. Managers analyze the entire capex budget and re-rank investments based on shared prioritization criteria. They keep higher-priority investments and cut the ones deemed least critical. ZBB increases effectiveness by aligning an operators capital spending with top management priorities, while providing a capex reduction of 20 to 30 percent. ZBB also enables top managers to make fact-based capex decisions and avoid conflicts among spend owners. Companies can follow a structured process for rolling out ZBB. This process begins with capex target

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01

Zero-based budgeting brings capex transparency and forces prioritization Zero-based budgeting brings capex transparency and forces prioritization
Iterate

Break capex into components Separate capex budget into decision units and each decision unit into decision packages Evaluate size of each decision package

Evaluate components Determine standard business benefit of each decision package Gather qualitative and quantitative info about business benefits, e.g., financials Define dependencies between decision packages

Prioritize and force-rank Prioritize decision packages within each decision unit and then rank within each business unit Consolidate business unit rankings into a single list across groups Select the lowest-ranking decision packages to be cut

Institutionalize new approach Revise key capex management processes to introduce zerobased budgeting prioritization Review capex management organization Address managers mindsets and behaviors to encourage adherence to spirit of zerobased budgeting Adapt IT systems to enable prioritization process, e.g., introduce decision unit/decision package split in enterprise resource planning system

SOURCE: McKinsey

setting and does not end until the organization has fully mastered and taken complete ownership of the approach (Exhibit 1). Break capex into its component parts. Managers split the capex budget into decision units. These represent discrete investments that are independent of each other, so the company can modify one unit without affecting the others. As an example, a company might divide a USD 2 billion budget into 30 to 40 independent decision units; units might include 3G network, Fiber To The Curb footprint expansion, core network reliability improvement, or development of new consumer products. Decision units are further split into decision packages, which reflect the incremental investment goals contained in a given decision unit (e.g., achieving the minimum regulator-mandated 3G coverage in a market or extending coverage to the next 10 or 20 percent of the population). Each decision package has a single clear business benefit. Examples of benefits include revenue increase, opex reduction, and meeting regulatory requirements. Evaluate the components. Teams then gather crucial financial information investment amounts, anticipated revenues and savings, and net present value along with nonfinancial information, such as a qualitative

description of the benefits and a structured analysis of the risks avoided by the investment. The exact type of information to be gathered depends on the type of business benefit. Prioritize, force-rank, and iterate. In this step of the budgeting process, the CFOs of each business unit come together and individually rank the proposed decision packages from first to last (or in quartiles). Changes mandated by regulation would usually have top priority, as would expenditures needed to keep the lights on. The CFOs then combine all of their rankings into a single force-ranked list that they discuss and adjust until they can make no further prioritizing decisions based on the information at hand. The group then gathers additional information and meets in a second workshop one week later. These workshops will ultimately produce a force-ranked list of decision packages, making budget-cutting decisions very straightforward the company simply continues to cut the lowest-ranked packages until it achieves its capex reduction goals. Question every design assumption. Teams disaggregate big capex units (towers) into their various subcomponents and question every design assumption based on minimum technical or regulatory requirements. A detailed study of design specifications is then used to unearth real insights. For example, teams question if

RECALL No 10 Cost Management Capex marks the spot: Zeroing in on the telecoms cash flow challenge

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02

A three-step approach is used to improve decision making A 3-step approach is used to improve frontline engineering in frontline engineering decision making
Step 3 Step 2 Step 1 Prove the case for action Understand how decisions are made today, the extent of the variance, and drivers of that variance Case study methodology Interviews to understand extent and drivers of the variance Build and implement the framework Develop the path to improve capital decision making Consistent engineering design process Decision making governance Frontline capability building Transparency in individual jobs and among engineers 9- to 12-month program Develop mechanisms for sustainment Ensure impact is sustainable by instituting the following actions Constant leadership involvement Consistent and regular communication Ongoing change management of framework Tool change management Continuous training to address any capability gaps

4-week diagnostic

SOURCE: McKinsey

air-conditioning can be replaced with simple exhaust fan air cooling in selected environments, whether it is possible to have a wall-mounted battery instead of an air-conditioned room, or if all towers really need to be painted when they are already galvanized.

posed by four engineers working on the same problem typically showed cost variance of five to ten times. We have even seen cases where the most expensive solution costs over 80 times more than the cheapest. Our experience suggests that operators have control over a minimum of five variance drivers: Problem solving approach. Differences occur because managers optimize for a variety of factors, such as cost, technical quality, or local leader goals. Financial rigor. Different teams often make cost and quality trade-offs differently (e.g., low-cost versus gold-plated). Guidelines. Teams might also vary in their adherence to company guidelines (e.g., how we do things versus how headquarters does). Tools. Individual engineers might use different tools, resulting in different outcomes. Leadership goal clarity. Companies can lack top-down clarity regarding strategic focus. 2. Build and implement the framework. During this stage, the organization builds its approach to improv-

Improving engineering performance

Our frontline engineering performance improvement approach strictly standardizes the decision making processes companies use to deploy given network elements, such as 3G base stations. This approach can yield field engineering capex reductions in the range of 15 to 20 percent. We employ three steps that focus on frontline engineering decision making (Exhibit 2). 1. Prove the case for action. Managers need to understand how the company makes decisions today, how much variance exists, and whats causing it. They can use case study methodologies and direct interviews to understand the extent of cost variances and their drivers. Differences can be significant: several telecoms operators used a case study methodology to examine proposed solutions from various engineers for the same projects. Nearly all were startled by the cost differences across solutions for the same problem. Solutions pro-

22

ing capital-related decision making, which rests on four key elements. First, companies develop a consistent engineering design process with rigorous, step-by-step engineering practices for the most common problems. A built-in financial case forces managers to make explicit capex/opex trade-offs. Second, telcos need to create specific decision making governance policies. For example, teams must submit every spending request for review and approval by a manager and director, and managers need to follow a standard method for prioritizing project spending. The third element concentrates on frontline capability building and involves the introduction of a new coaching role for peer design reviews as well as periodic, highly specific poor-good-better-best evaluations of every job and worker to spur continuous employee performance improvement. Engineers and managers also undergo professional development in the forms of training and structured feedback sessions to achieve the desired proficiency. Finally, companies need transparency in individual jobs and among engineers. A number of solutions present themselves, but one highly effective approach involves using a simple Web-based tool to capture solution designs and serve as a repository of spending

requests. Such a tool should provide a description of the problem, its quantification and a suggested diagnostic path, details of the proposed solutions, the effectiveness of the chosen solution, and its financial impact. 3. Develop ways to sustain the progress. Once a company has built a solid frontline engineering performance improvement foundation, it can pursue a number of ways to sustain and even ramp up progress. For example, constant leadership involvement sends a clear message to the organization that continued success in this area is important and will be rewarded. Managers can reinforce this story through consistent and regular communication and by offering continuous training and coaching to address any capability gaps within the organization. *** Telecoms players need to take what the industry once considered to be extraordinary measures to make sure they have enough cash on hand to survive today and build for tomorrow. The two approaches discussed here zero-based budgeting and frontline engineering performance improvement can quickly release the cash flow telcos need to quench their thirst for capital during the current credit dry spell.

Giuliano Caldo is a Senior Expert in McKinseys Rome office. giuliano_caldo@mckinsey.com

Kurt Cohen is an Associate Principal in McKinseys Stamford office. kurt_cohen@mckinsey.com

Sumit Dutta is an Associate Principal in McKinseys Mumbai office. sumit_dutta@mckinsey.com

Martin Jermiin is a Principal in McKinseys Copenhagen office. martin_jermiin@mckinsey.com

Pradeep Parameswaran is a Principal in McKinseys Mumbai office. pradeep_parameswaran@mckinsey.com

RECALL No 10 Cost Management Press 1 for success: Boosting call center performance

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04 Press 1 for success: Boosting

call center performance

An efficient and effective call center operation delivers both savings and great customer satisfaction. Heres how to get there. The current economic situation has forced many telcos to reexamine their entire operations in new and often excruciating ways, as they seek the cash and capital needed to survive the downcycle and eventually thrive when good times return. In such undertakings, a telcos call center organization is typically considered a target-rich environment, representing a significant share up to 10 percent of operating costs. Still, experience shows that when calling for big reductions in call center costs in times of economic uncertainty, managers must balance cost efficiency against the need to provide positive customer experience and generate revenues. By cutting service too close to the bone, telcos can disrupt service and degrade its quality, alienating customers, increasing churn-related costs, and ultimately causing revenue losses at a time when they can least afford them. In an economic downcycle, winning telcos work extra hard to collect every penny of available revenues by cross-selling and up-selling current subscribers, and the call center organization plays a key role in these activities. Clearly, attempting such actions on top of poor basic service is impossible. Exceptional players know they can achieve best-inclass cost, quality, and revenue levels simultaneously, without negative trade-offs. To help telecoms players cut costs without also inadvertently slashing revenues or chopping down customer numbers, McKinsey has developed and repeat-

edly applied an approach that typically delivers 15 to 25 percent cost savings, while simultaneously improving quality and revenue performance. This approach adopts McKinseys overall operations philosophy as applied to services, which holds that companies need to address the three dimensions of operations simultaneously: the operating system model, the management system, and the mindsets and behaviors of the companys workers (Exhibit 1).

Operating systems: Achieving four key goals

We concentrate on achieving four key operating system goals when pursuing improvements in call center efficiency and effectiveness performance: preventing the need for calls, automating calls, simplifying agent access, and preventing repeat calls (Exhibit 2). Prevent the need for calls. Our research shows that a small group of users often accounts for a large share of a call centers inbound calls. One credit card company found that only 14 percent of its members made over half of all inbound calls. If it could cut this number in half, then it would reduce its overall call volumes by more than 25 percent. We also know that the impact of unclear communications at any stage of the call center/customer interaction can be very high, as one telco learned to its regret. It determined that fully one quarter of all incoming customer calls resulted from unclear or inconsistent communications and that only 7 percent of its subscribers made almost half of all of its broadband-related technical calls.

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01

Three action areas comprise the transformation into a service 3 action areas comprise the transformation into a service delivery champion delivery champion

1 Operating systems Current situation Management systems 2

3 Mindsets and behaviors Sustainable improvements

1 Improving procedures, systems, and resources to achieve a step change in operational performance Costs Revenues Quality 2 Creating an organization to support the new operating system 3 Building ownership for the lean transformation at all levels of the organization

SOURCE: McKinsey

Telcos can reduce customer interaction needs by undertaking an end-to-end review of the communication process, beginning with marketing (coherent campaign message?), sales (correct terms and conditions?), provisioning (clear installation and use instructions?), and billing (clearly defined items and charges?). During the post-sales phase, the review should include off-site support (customer understands post-sales services?) and on-site intervention (customer kept in the know while waiting?). Overall, a telco should strive for communications consistency in the sense that all of its possible customer contact points always give the customer consistent, accurate answers to the same question. We find that an analysis of call types by customer can reveal relatively easy ways to reduce unwanted or unnecessary calls. For example, a credit card company was able to reassure customers calling to see if their payments had been received by inserting explanations in billing statements. And, by prudently granting automatic credit line increases to students, it saw a significant drop in credit line increase requests from this group of customers. Automate calls. Call automation can play a major role in reducing call center costs, either by moving some calls to the Web or by closing calls in an interactive voice response (IVR) system (see text box). But few things

enrage customers more than a poorly designed IVR system, thus an optimal IVR layout will take into account four key considerations: Call volume. How many calls per transaction? Customer service representative (CSR) interaction/ cross-sell. Do customers need to speak to a CSR due to the issues cross-selling opportunities or emotional factors (e.g., a lost credit card)? Call center queuing. Is there a separate queue in the call center to deal with this transaction? Transaction automation. Can the transaction be completed without agent contact? Companies can literally speed up IVR performance by boosting the rate at which the system delivers words to benchmark levels. One company found that its IVR system lagged behind its fastest competitors by nearly 30 percent in terms of words per speech-minute, thus lowering its overall system capacity and causing customers to hang on the line longer, which often leads to dissatisfaction. Value-based call routing allows firms to handle customers differently, depending on their potential value.

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02

McKinsey clients typically reduce their call center costs by more than 20% McKinsey clients typically reduce their call center costs by more than 20%
Efficiency improvement Increment over baseline growth (percent) 30 15 12 10 20 16 15 20 Number of initiatives pursued 7 3 4 4 6 3 4 4 Over 100 call center cost reduction engagements in last 3 years

Example European residential telco US retail bank European retail bank US credit card issuer US residential telco Canadian residential telco US small business telco US wireless customer care

SOURCE: McKinsey

Companies can harvest high-value, lower-volume calls from the IVR and route them directly to specialized agents, while making every effort to handle all low-value calls in the IVR system. Simplify agent access and handle other calls efficiently. Companies can follow three lines of attack to achieve these goals: standardize call handling, optimize network design and capacity management, and increase outsourcing and offshoring efforts. For example, by standardizing the handling process of technical calls, including the use of a standardized diagnostic process and tools, companies can significantly boost their overall response effectiveness and reduce the response variability that can cause confusion and errors. Likewise, the active management of call center agent capacity will enable supervisors to match call volumes with agent availability. A quick capacity utilization diagnostic (e.g., productive call time divided by paid time) can help managers determine where the organization stands in this regard. Companies that master seven disciplines accurate forecasting, capacity planning, staff scheduling, activity management, attendance and adherence, schedule adjustments, and real-time management do well when attempting to match supply and demand if they overlay these disciplines with a robust performance tracking system that has a transparent set

of key metrics and targets. Finally, companies should increase their outsourcing and offshoring of the lowestvalue call types to reduce costs. Prevent repeat calls. Repeat calls represent absolute wasted value for companies, raising costs, clogging queues, and angering customers. Regarding the final point, our research shows that repeat callers tend to switch services more often than other subscribers, boosting churn and reacquisition costs at a time when companies need to conserve every penny. To prevent repeat calls, telcos should track CSRs and telemarketers that have high repeat-call track records and offer them incentives aimed at changing their behaviors.

Management systems: Recruit, manage, and reward

A telcos management system defines how things get done within the organization: how the company at tracts and trains its people; how it tracks and manages their performance as they do their jobs; and how it rewards them for a job well done. All three elements play specific roles in initiatives to improve call center performance. Telcos have at their disposal sophisticated approaches for attracting and retaining the best call center workers. Best practices include having an end-to-end recruiting

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process, under which managers develop a job position profile, identify sources of potential hires, conduct a telephone screening assessment and subsequent faceto-face interview, and ultimately hire the best worker for the call center position. In assessing its ability to retain call center workers, one telco found specific departure trigger points over the tenure of a new worker. The first trigger was the initial training itself, while the next came as workers transitioned from training into their assigned jobs. Other spikes occurred when workers received their first job report cards and when they switched to new teams. Managers realized that they were either hiring the wrong candidates for specific positions or that a significant gap existed between the job candidates expectations and the realities of everyday work in that position. As a result of this assessment, the company restructured its hiring and communication approaches and initiated fewer transfers once a worker became part of a full-time team. This company also discovered that the best training approach for call center workers involved an initial deep-dive session lasting one week, followed by ongoing training for one to two hours at a frequency of every two weeks.

The second element of a competent business management system focuses on performance management, which describes key management responsibilities: how do you seed, grow, and cultivate an exceptionally competent organization? Our experience shows that a highimpact performance management program includes several essentials. For example, to monitor CSRs, managers should introduce a strong reporting discipline that provides standard daily performance assessments, best-practice sharing procedures, and consequence management processes. Coaching is another crucial performance enabler. A robust program will include specific coaching requirements (e.g., structured feedback sessions), a monitoring and reporting system managers use to review metrics with CSRs on a daily basis, briefing sessions to review what worked and what did not, and daily recognition sessions to celebrate individual and team successes. Companies should use multilayer scorecards and incentives to drive these changes throughout the organization, and they need to establish the right key performance indicators (KPIs). For a commercial call center, KPIs might include sales per call, answered calls, average handling time, and customer-perceived quality.

IT enablement: From idea to impact

Call centers can benefit from targeted technology upgrades designed to enhance performance without veering into gold-plated solution territory. With that in mind, McKinseys Operations Technology Laboratory (OpsTechLab) helps managers carry out interactive voice response (IVR) simulations and rapid pilot programs that can reveal and capture significant call center improvement opportunities. McKinseys OpsTechLab call center tools can typically reduce IVR task completion times significantly, while simultaneously increasing first-call resolution rates and boosting customer satisfaction. The call center end-to-end simulator helps teams specify the algorithmic and architectural changes that the system requires to capture potential improvements. The OpsTechLab has a number of engagement models to meet individual telco needs, from a basic technology tune-up to best-practice benchmarking. In one case, a public sector company decided to redesign its IVR system and wanted to pilot the new system in a real setting before rolling it out. Complicating the project, the company had to set up the system in a short period of time with only limited IT support. They decided to employ OpsTechLab call center tools, which enabled them to model IVR flows, examine flexible staffing options, experiment with both skill- and attribute-based call routing, and create call segmentation and triage plans. In order to iteratively test the IVR redesign, the team set up and tested multiple scenarios within a week, and the OpsTechLab made it possible for the company to explore different IVR design scenarios, get feedback from callers, and make running improvements to the system design. Small-scale pilot tests revealed that the new IVR design reduced task completion times by 30 percent a typical improvement rate.

RECALL No 10 Cost Management Press 1 for success: Boosting call center performance

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By choosing the right KPIs and then monitoring them continuously, one telco captured a 22 percent improvement in handling times and achieved a productivity improvement among 3,500 agents in six months that exceeded 30 percent. Finally, an effective incentive plan typically has five key components: Noncash programs. Use contests and noncash awards to generate enthusiasm and improve morale, while providing long-term career opportunities. Payout tiers. Determine the steepness of the incentive payout curve based on relative employee value creation. Metrics. Use stable, objective metrics to determine the specific payout. Consequence management. Make strict plans for moving employees who consistently perform poorly out of the organization. Reporting and payout. Provide frequent performance updates and pay incentives often. We know a number of rules of thumb for incentive systems that can help companies fashion such programs that suit their organizations particular needs. Regarding the selection of tracking metrics, for example, traditional approaches such as focusing on total revenues per CSR can serve to encourage call churning. These approaches can prevent reps from extracting the most value possible from each individual call. Therefore, companies should align their incentives with rep value creation in order to retain high performers. One company found that its star CSRs generated up to USD 10,000 more per month than average reps. Thus, they made sure that their payout curve amply rewarded these high performers.

agers need to foster leadership, establish a continuous improvement attitude among workers, and actively seek employee buy-in. We recommend four actions. Bolster key roles among supervisors and team leaders to increase their leadership and people management skills. Actions should include monitoring staff efficiency and effectiveness on a regular basis, communicating the results, and defining actions that can improve performance. Companies should also make proper training and technical materials readily available and work to instill common behaviors among workers. Stage feedback sessions on a periodic (e.g., daily) basis on specific KPIs to encourage behavior changes and the proper focus. KPIs might include call handling times or the percentage of repeated faults within a week. Use specific and targeted coaching approaches, including periodic training sessions, ad hoc demonstrations, and tools and scripts to gain buy-in and the trust of end users. Our experience shows that high-performing organizations typically ask their team leaders to engage in significantly more coaching than do their less successful competitors and that this effort translates into superior top-line results. Work to create a performance culture. Managers need to establish a systematic way to identify worker development opportunities, agree on improvement measures (with daily individual coaching sessions), and monitor progress via follow-up sessions and improvement action plans. One way to help kick-start this process involves changing the layout, look, and feel of the call center to signal the shift toward a culture of performance. *** The process of improving the call center frees up cash in the short term as it enhances medium- to long-term performance. This enables managers to reduce costs and boost the competitiveness of their call center organizations. These ideas and approaches can help managers build a highly efficient and effective call center organization. Based on our experience with more than one hundred call center cost reduction engagements over the past three years, we know that cost reductions of 15 to 25 percent are possible. More important, we have helped telcos achieve these reductions, while simultaneously boosting customer satisfaction and revenue levels.

Mindsets and behaviors: Nurturing a performance culture

Perhaps the most difficult transformation a company faces is the one that must take place in the minds of workers. Sometimes made cynical by prior, less-thaneffective performance improvement programs, workers often want concrete proof that an initiative can produce real results before they buy in to it. As a result, man-

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Raffaella Bianchi is an Associate Principal in McKinseys Milan office. raffaella_bianchi@mckinsey.com

Branislav Klesken is a Principal in McKinseys Prague office. branislav_klesken@mckinsey.com

Eric Monteiro is a Principal in McKinseys Toronto office. eric_monteiro@mckinsey.com

Gareth Morgan is an Associate Principal in McKinseys Dublin office. gareth_morgan@mckinsey.com

RECALL No 10 Cost Management More than a helping hand: Optimizing telco business support functions

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05 More than a helping hand: Optimizing

telco business support functions

While often overlooked, business support functions can make or break a telecoms players chances for success in todays challenging markets. Given the current economic situation, should telecoms incumbents spend precious time improv ing their business support functions (BSFs)? Should they advance the efficiency and effectiveness of their finance, human resources (HR), billing, collections, and other corporate functions using dedicated tools and expertise? Since BSFs account for roughly 15 percent of total fixed and mobile telco spending and since they carry an average improvement potential of 20 to 30 percent, which makes a reduction in total cost of 3 to 5 percent possible, we would respond with an emphatic yes! Beyond capturing value from improved efficiency, telco managers need high-performing BSFs to improve effectiveness. Greater effectiveness can mean a stronger talent bench, shorter budgeting cycles, faster general ledger closes, reduced working capital, faster IT development times, and many other benefits. Effectiveness improvements often deliver more value than efficiency gains. For example, most telco incumbents register in the low 30s and 40s in student employer rankings, which has a direct impact on talent choices and the skills of recruits. Furthermore, companies with top-performing BSFs develop employees more fully with rotations through support functions. Optimized business functions also deliver speed and transparency. For example, a typical full budgeting cycle can take more than nine months to complete, while BSF best practice delivers a 14-week process with even greater reliability.

Telcos also have an imperative to quickly adapt BSFs to their new roles and responsibilities, resulting from the turmoil that this sector faces. Many telcos lag be hind other service industry players in terms of staff performance, averaging nearly 50 percent more staff than their peers in the service industry overall this mismatch is especially apparent in the training and personnel administration functions. Stiff competition and deteriorating economic prospects herald increasing margin pressures a development accompanied by an explosion of business complexity, as new business models, the convergence of existing businesses, next-generation technology rollout, and industry globalization take hold. Consequently, incumbents gain competitive advantage by transforming their BSFs from helping hands to strategic enablers of sustainable success. Companies should prime these functions to support the requirement for quicker business decision making caused by shortened planning cycles and the need to quickly identify and recruit talent. Optimized BSFs can handle growing business complexity as well as more flexible processes and support the synergies of globalization through effective risk mitigation. Robust BSFs will also contribute to cost optimization efforts by providing highly efficient services. In short, telco incumbents really need what strong BSFs can deliver. Before managers can begin to improve their BSFs, they need to know where they stand versus the competition (Exhibit 1). For example, McKinsey segmented telecoms players in terms of their HR and finance staff members per 1,000 company employees. The team found

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01

BSF improvement starts with a comparison to best practices BSF improvement starts with a comparison to best practices
Finance 1 Total finance FTEs per USD 1 billion in revenues should be less than 90 2 Outsourced and offshored finance FTEs to low-cost locations account for 40% of resources 3 The budget planning cycle should not take more than 3 months 4 There is only one shared definition and value for key figures such as ARPU and internal network costs 5 Initializing the year-end report after closing should not take more than 2 weeks (ready for audit) Human resources 1 The number of HR FTEs should be less than 1.51 per 100 staff 2 60 - 75% of employee requests should be processed by employee self-service 3 Average time to hire internally should be less than 3 weeks 4 Training costs per employee should be less than EUR 600 per year 5 60% of HR employees should be organized in efficiency-oriented shared services centers2 (for transactional tasks) Billing and collections 1 Cost per invoice sent should be less than USD 1 in paper bills 2 The error rate in billing should be less than 1.5% 3 Share of e-bills should be above 50% 4 The coincident loss rate should be less than 1%

1 US around 1.0 2 Or outsourced, e.g., payroll SOURCE: McKinsey

dramatic differences in each case, with bottom-quartile players requiring three times more HR employees than top-quartile companies, and nearly twice as many finance people. Such wide gaps indicate significant opportunities for capturing new value by improving BSF performance. This article provides insights into improving the efficiency and effectiveness of four key BSFs: finance, HR, billing, and collections. Our suggested optimization approach begins with a diagnostic that includes proprietary benchmarks, an examination of key performance indicators (KPIs), and a cross-BSF performance review based on a standardized poor-good-better-best ranking system (Exhibit 2). The diagnostic enables managers to understand the main efficiency and effectiveness improvement levers in the telcos BSFs. From here, managers move to the optimization stage, drawing conclusions from the diagnostic phase and leverag ing performance improvement experience and knowledge resources. Finally, after having optimized BSFs in terms of efficiency and effectiveness, they establish systems and ways of doing things (i.e., continuous improvement, culture change) that will ensure the sustainability of improvements over time. In the following sections, we offer selected insights into best practices as they relate to the efficiency and

effectiveness of improvements in the finance, HR, billing, and collections BSFs. What follows represents only a high-level overview of the comprehensive workstreams that teams undertake when they optimize BSFs. With this in mind, these sections should serve as an example of the breadth but not the depth of McKinseys experience.

Finance efficiency
Telcos typically apply efficiency levers for accounting operations, planning, and reporting, but not for expert functions or in finance and administration management. Our experience suggests telcos can improve their finance functions efficiency by 20 to 30 percent with the following five approaches. Institute demand management, identifying non-valueadding demands on the finance organization and actively managing them to reduce costs. One telco reduced the number of reports generated by the controlling organization by more than 25 percent. Offshore or outsource labor-intensive transactional work, such as accounting. Moving this work outside the organization can deliver a greater than 25 percent cost reduction, depending on how well companies manage the performance of their vendors.

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02

An end-to-end approach ensures improvement sustainability An end-to-end approach ensures improvement sustainability

Diagnosis Overhead benchmarking initiative/external benchmarking KPI assessment Reviews across business support functions

Optimization

Sustainable change management

Understand the main efficiency and effectiveness levers in a telcos business support functions

Draw conclusions from case and approach database

Transformation tracking systems Culture change

SOURCE: McKinsey

Make organizational adjustments with a rigid division of tasks in areas such as accounting operations and financial planning and controlling. Companies can, for example, create a shared services center (SSC), control policies centrally, and eliminate redundancies. These actions can reduce costs in proportion to the levels of redundancy a companys service portfolio contains. Pursue structural changes in processes. Telcos can optimize core finance processes by identifying benchmarks, mapping current activities, and eliminating non-value-adding processes. Develop performance management capabilities. Telcos can better manage the performance of their finance employees by establishing and actively employing measurable KPIs. By using such a process, one operator saw a significant reduction in the number of complaints focused on the finance function.

differences are reflected in a given telcos ability to achieve world-class performance. In terms of the days required to complete the budgeting process, for example, McKinseys research shows that the best-performing companies accomplish this task in fewer than 80 days, while the worst performers require more than 200. Likewise, in terms of reporting (i.e., the number of days after year-end to publish annual results), the best performer finishes 3.6 times faster than the worst. Implement best-practice financial control based on an effective organizational design. Organization is a key lever to ensure that the finance role in a telco functions properly particularly within the controller dimension. The key organizational principle is that the controller needs to have full autonomy to act as the ultimate economic guardian of the company. The implication of this is that there is no single clear model: there are different organizational alternatives that can work under different circumstances if the incentives are right. Improve reporting effectiveness to accommodate an increasingly complex business model. Managers can improve performance report quality by employing consistent definitions, using KPIs, and streamlining and focusing management reports. One company could eliminate the need for more than 25 percent of its reports by getting rid of redundancies and obsoles-

Finance effectiveness
Managers striving to boost finance department effectiveness have captured value using five approaches. Introduce a rapid, flexible planning and forecasting cycle. Significant performance differences in the finance organizations exist across telcos, and these

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cence. In parallel, the company ensured they optimized new reports to meet the actual needs of internal clients. Develop excellent cost reduction and cash management skills. In increasingly competitive markets, all telco managers need to have these cost reduction and cash management skills to reach the increasingly rigorous cost reduction targets necessary to achieve the expected margins. Develop global footprint skills in risk mitigation, treasury, and taxation. Managers can significantly reduce credit and foreign exchange risks by using these levers. For example, improving treasury-related performance can boost before-tax net income by 20 percent.

Manage HR employee performance by setting up measurable KPIs and then using these for active monitoring. Newly established indicator programs ones that employees take seriously and managers track vigorously can increase performance by 50 percent and reduce complaint rates by more than 60 percent.

HR effectiveness
Companies have four main courses they can follow to improve HR effectiveness. Create transparency in the controllers office and in HR planning. Managers should professionalize both HR planning and the controllers office, increasing quantitative and qualitative transparency. This approach enables the function to focus on the core topics like recruiting and talent management. Improve recruiting and talent management skills. HR managers should implement best-practice recruiting and talent management approaches by, for example, defining a custom-tailored employer value proposition. A clearly defined employer value proposition can form a basis for telcos to improve their attractiveness as employers especially since telcos currently lag behind many other industries in precisely this dimension. They should also work to increase their access to a variety of talent sources. Develop relevant HR skills. Telcos need no less than excellent personnel cost management and integration skills in order to cope with organizational changes. These capabilities can make it possible for companies to improve how they respond to the adaptations and reorganizations that typically follow changes in business models, mergers and acquisitions, and other activities. Such capabilities can also enable the effective reduction of overstaffing. Position HR as a real partner to the companys business managers. By working to instill greater business acumen in HR managers, a company can quickly boost its management bench strength and generate greater levels of satisfaction on the business side of the organization. One company even created an actual HR business partner position. The role of the HR business partner was to act as an interface between HR and the management teams of the business units to make sure HRs responses were strongly oriented toward meeting the needs of the organizations business end.

HR efficiency
Telco managers have a number of options for optimizing HR efficiency, which collectively can deliver savings of 30 to 40 percent. Separate strategic from transactional tasks. Telco players should keep only the strategic tasks close by. They should centralize transactions in an SSC. An SSC can generate personnel services cost reductions that exceed 30 percent. Move labor-intensive transactional work offshore. By offshoring transactional work (e.g., pension administration, travel) and outsourcing skill-based non-strategic work (e.g., payroll, training), companies can achieve cost reductions of up to 40 percent. Benchmark HR activities both on an international level and on a business unit basis. Companies should promote unified HR demand management and engage in a rigorous division of tasks (e.g., centralize policies, eliminate redundancies). The impact of these actions will depend upon existing redundancies and differences in the service portfolio and can potentially deliver savings of 10 percent. Review the HR process portfolio for automation potential. By tapping into the automation portfolio e.g., introducing an employee self-service system and online recruiting and consolidating or integrating HR enterprise resource planning platforms and applications in some cases, companies often find that they can handle up to 60 percent of employee HR requests with automated systems.

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Billing efficiency
Our experience shows that telcos can reduce their billing costs by 30 to 40 percent, accomplishing this by focusing on four key levers. Optimize IT costs related to the billing platform, improving the system architecture by consolidating both hardware and software platforms. IT improvements typically emerge from three areas: software development and maintenance, software licenses, and hardware platform and data centers. In each case, the adoption of a single platform can help companies save up to 40 percent. Review process efficiency in areas such as bill generation and call centers. Simplified and centralized operations with fewer billing cycles can result in a reduction in FTEs of 15 to 30 percent. Within call centers, optimization work typically focuses on reducing the volume and length of calls, adapting the service to provide different levels based on the value of the customer and managing peak staffing requirements. Review the billing process for its automation potential. E-billing is 45 to 60 percent cheaper than mailing paper bills and can reduce a telcos monthly cash cost per subscriber by 5 percent. As a result, telcos need effective ways to migrate subscribers to online services. Outsource labor-intensive transactional work in areas such as IT, customer care, and billing. Outsourcing billing functions can lower a telcos operating expenditure by 15 to 30 percent.

records; a lack of integration between customer care/ sales and the billing system; and a lack of coordination between customer care/sales, provisioning, and billing processes. McKinsey telco experience shows that reducing leakage requires companies to focus on three areas: cross-functional processes (e.g., by simplifying bill calculation methods), rating and validation (e.g., by using a pre-billing process to monitor errors constantly), and rate table maintenance (e.g., by using a single rate table). Improve the organizations flexibility and scalability to handle increasingly complex business models. Telcos need to react fast to market changes, such as new pricing and the introduction of new applications. One company, for example, set up a flexible billing platform that significantly shortened the time it needed to launch a new discount plan (e.g., from 30 to 50 days to only 2 to 3 days).

Collections efficiency
Our work in this area reveals potential for a collections cost reduction in the 20 to 25 percent range for many telecoms players. Optimize the collections operating model by using the most efficient contact strategy, such as e-mail and text messaging versus mail and phone. By choosing the optimal contact method for different customer groups, a telco improved its call-to-contact ratio and reduced costs by up to 2 percent. Furthermore, its lower letter shipment volumes generated 4 percent savings. Improve call center processes by using techniques such as better call routing, auto dialers, and distributed work queues. By reducing its work queues and improving its call routing logic system, one operator was able to save 2 to 3 percent in this area. Improve the organizational structure by centralizing operations and increasing management spans of control. Depending on the degree of fragmentation, a more horizontal organization and centralized collections can yield cost savings that exceed 20 percent. Use smart sourcing strategies to determine the best ownership for specific activities (i.e., insourcing, outsourcing, offshoring) and actively manage vendors. For example, by charging back costs for external litigation and collections visits to customers, telcos can capture significant savings. By insourcing court representation, they will see furher savings on legal fees.

Billing effectiveness
Managers should concentrate on three key activities to boost billing effectiveness. Reduce the billing error rate, which will improve customer satisfaction levels and decrease call center customer handling requirements. By reworking this process, one telco reduced its customer complaint rate by 25 percent. Reduce revenue leakage by effectively coordinating sales, provisioning, and billing activities. Revenue leakage is a big problem for telcos because it represents a significant share of revenues (e.g., from 3 to 7 percent). Typically, three sources occur: error-filled call detail

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Collections effectiveness
How effectively a telcos collections department operates can have a direct impact on how quickly the company converts money owed into cash. Four specific actions can facilitate the conversion. Actively manage new customer credit risks through credit checks and product offerings. Telcos should introduce improved credit quality models and targeted product offerings that depend on risk profiles. For example, by reducing billing cycles for new customers (i.e., not waiting for subscribers to run up large initial bills), telcos can reduce losses by 1 to 2 percent. Reduce exposure to high-risk customer segments in the telcos active portfolio. Companies can achieve more active and segment-specific risk control by differentiating their approaches to collections. One mobile operator that used behavior triggers to drive its proactive risk control activity found that 10 to 20 percent of its subscribers were high-risk customers. In response, this player developed an escalating series of collections actions it would take based on the level of risk. Increase the cure rate of delinquent customers by increasing their right-party contacts and tailoring

repayment policies. Improved right-party performance can increase payment probability by up to 20 percent. Companies can also achieve up to 33 percent higher contact rates by optimizing call timing and the phone number contacted. They can also reduce net losses by 30 percent if they use a segmented contact approach and differentiated payment policies. Recover more money from write-offs by, for example, staging a performance improvement initiative for the contracted collections agency, which in our experience can result in up to 200 percent higher recovery rates. *** Given the pressures telecoms managers face and the wide performance variability seen in telco BSFs, players can benefit by boosting support function performance. Telcos with below-average efficiency can yield impressive cost savings while simultaneously improving the level of service their support functions offer to the core business. Furthermore, efficient players frequently have the opportunity to improve their effectiveness, which often delivers value beyond cost reduction. The ideas and approaches highlighted here provide savvy managers with the means to achieve excellent BSF performance quickly and confidently.

Alexander Arcache is an Expert Associate Principal in McKinseys Munich office. alexander_arcache@mckinsey.com

Kurt Cohen is an Associate Principal in McKinseys Stamford office. kurt_cohen@mckinsey.com

Andreas Palm is an Associate Principal in McKinseys Frankfurt office. andreas_palm@mckinsey.com

RECALL No 10 Cost Management Clearing the clutter: Improving back-office operations

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06 Clearing the clutter: Improving

back-office operations

Telco managers may think they run a buttoned-down back office, but what they dont know can hurt their bottom lines and customer relationships. A telcos back office can be a messy, complicated place, but it can also have a significant impact on a companys bottom line and customer satisfaction ratings, especially in business-to-business (B2B) operations. As much as 30 percent of a B2B players operating costs can be tied up in back-office activities, which play a major role in a telcos effectiveness, driving cycle times, error rates, and overall customer experience. Back offices tend to be messy because a number of different specialized groups perform lots of small, often discrete activities. As a result, companies sometimes have trouble understanding and managing back-office efficiency and effectiveness issues. In fact, key people sometimes hold significant misconceptions regarding the efficiency of their back-office operations. For example, while managers often note how busy their people are, studies show that true value-adding work (i.e., wrench time) often equals less than 30 percent of available capacity. Managers frequently say they monitor individual performance closely, but in reality productivity variability across individual workers often exceeds 400 percent, with no correlation to quality. Likewise, managers might also state that they have developed standard, replicable operating models, when in reality these models differ markedly in terms of processes and performance even within similar work centers. They might further insist that they understand back-office work flows and performance, but compa-

nies rarely track rework, fallout, and rejects accurately, which can constitute over half of all work. Yet another common argument asserts that companies cannot make real progress without significant IT investments in automation, when in fact telcos can typically capture 30 to 50 percent of improvement potential in less than twelve months and with very limited IT spending.

The next wave of improvement opportunities

Most telecoms players have attempted to reduce backoffice costs using approaches that focus on eliminating redundancies, consolidating work centers, automating manual tasks, and optimizing centers locally. These approaches have historically delivered small but consistent productivity gains and worked well while the industry was consolidating, making it easier to pick the low-hanging fruit. However, in our experience, several years of squeezing more work out of the same function is an approach that ultimately runs dry. Companies seeking to capture the next wave of backoffice improvement opportunities will have to use new, more transformational approaches. These include redesigning and standardizing processes, segmenting workloads in terms of complexity, employing crossfunctional work teams to open up organizational silos and functions, introducing lean work cells, and applying lean takt time analysis to smooth the pace of work. We find that best-in-class operators do a number of things right that less successful competitors miss. They sort back-office work in terms of complexity, establish a rhythm for service technicians, and build quality into

42

every step of a given process using root-cause problem solving (e.g., asking why? five times regarding any problem). High performers align incentives across organizational interfaces in order to make sure work handoffs proceed smoothly. They also build flexibility into processes to address workload variations. Beyond this, they also coach workers with an eye toward achieving specific outcomes and seek transparency regarding the performance of technicians and call handling.

The fundamentals of back-office performance improvement

McKinsey has developed an eight-pronged approach to back-office performance improvement that refocuses attention on the ways work gets done. The eight tools and techniques drive specific back-office outcomes (see text box below for complete description). By segmenting complexity, for example, one company moved from a standard collections process based on 30/60/90 days late payment performance to one that segmented accounts based on scores, response models, and other analytics. It then adopted different collections strategies based on this segmentation. As a result, the company was able to cut overdue receivables in half, to reduce bad debt by 40 percent, and to improve labor productivity by 25 percent.

Another company sought to create flexible manpower systems in its payroll department by balancing analyst desk workloads to eliminate artificial staffing peaks. Under its prior system, the payroll-related communications did not follow uniform paths, assigning processing for each location to specific desks. As a result, the workload on each desk could vary signif icantly based on the payroll cycle. Department leaders lacked a coherent set of rules and parameters to monitor operations. The company then shifted to communications that followed two well-defined paths and leveled workloads by eliminating desk-specific silos. Furthermore, lead analysts can now monitor and update the status of payroll operations by using a newly installed scheduling board and then intervene as required. In yet another case, a telecoms player opted to address rework comprehensively and take an end-to-end perspective of the customer experience, key metrics, and waste. It then eliminated non-value-added activities and interface work. By taking a sources of waste perspective, it was able to highlight issues a cost-only approach would likely miss. A final example describes a telco that sought to consolidate activities among its financial analysts. It found that these analysts spent just over 50 percent of their time on management reporting and they only invested about

Eight stepping stones on the path toward back-office improvement

1. Segment complexity. Create different methods and procedures for complex and simple tasks. 2. Create a rhythm. Manage variability in repetitive tasks to optimize the flow of work and define simple, highly visible key performance indicators (KPIs). 3. Reduce incoming work. Create incentives upstream for customers and centers to reduce the overall ticket volume. 4. Automate and standardize. Increase automation at each stage of the ticket flow to reduce manual handling/testing and to improve streamlining. 5. Create flexible manpower systems. Balance processing capacity with the incoming demand through auto routing and task level forecasting. 6. Address end-to-end rework. Take an end-toend view on customer experience, key metrics, and waste. Eliminate non-value-added activity and interface work. 7. Combine/colocate activities. Redesign, combine, or colocate specific activities to minimize rework. 8. Align interface KPIs. Align success metrics across the end-to-end process to ensure visibility of rework.

RECALL No 10 Cost Management Clearing the clutter: Improving back-office operations

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Back-office myths vs. realities

Common misconceptions that stand in the way of operational improvement

It is impossible to enhance productivity without degrading service level agreements. Service need not be sacrificed for productivity. Lean end-to-end typically yields benefits to productivity (20 to 25 percent), cycle time (30 to 60 percent), and quality (15 to 20 percent) all at the same time. Our people are really busy doing the work. We cannot afford for our best leaders to divert their attention from action to process. It is often true that the good ones are in short supply, but with the right coaching, these valuable resources can and should be change leaders. Attention can be given to process without causing the work to suffer. We dont have the necessary data, such as timestamped orders, to be able to apply lean methods to our back-office operations. More often than not, all the data required to begin improving back-office operations already exists somewhere in the operating systems. It just needs to be mined and analyzed.

Most of the problems are coming from other backoffice areas. We have no control over the processes or activities of those functions. Rework rates can be as high as 400 percent, often driven by mismatches between back-office activities and the responsible area. An independent look is required to reveal overlaps and redundancies. I have to optimize locally. That is how my people and I are measured. Local optimization can remain a priority, but it needs to be complemented with end-to-end metrics if comprehensive operational improvement is to be achieved and sustained. Unfortunately, theres no direct benefit in backoffice-wide optimization, as I am measured against my individual budget. Most times, the gains from end-to-end optimization are reflected in individual gains for each area. Everyone benefits directly from an optimization process that takes the entire back office into account.

5 percent on planning and analysis. The company realized it had to free up significantly more analyst time for planning and analysis by removing tasks from analysts schedules that added little in terms of value. These time wasters included preparing basic reports and entering data, tasks that managers could easily delegate to clerks or simply eliminate. By redistributing or cutting these low-value activities, the company captured a 15 percent overall reduction in its total financial analyst costs. The eight tried and tested tools are rooted in Toyotas lean production approach, which focuses on eliminating waste in all of its forms (waste being any activity that does not create value for the customer), reducing process variability, enforcing standardization, and pursuing continuous improvement.

We have adapted these and other lean principles to address service applications. However, this is not a onesize-fits-all approach because the steps used and their relative importance will vary based on the specific situation a company faces.

Improvement techniques in action

The process begins with one pilot initiative that managers replicate several times to fine-tune it and then scale it up and roll it out to the entire organization (Exhibit 1). This cascading increase of rollout projects provides teams with the chance to perfect the standardized process. It also fosters and anchors a continuous improvement mindset.

44

01

Tested process inspired by Toyota and adapted to services frames the effort Tested process inspired by Toyota and adapted to services
typically deployed in a standardized performance improvement process Pilot 4 Automate and standardize Key principles Align interface KPIs 8 Create flexible manpower systems Address 5 end-to-end rework 6 Scale 6- to 8-week pilot in 1 center or value stream Define/test model 2 - 3 replications Refine levers/weights in different scenarios 8 - 10 replications Capabilities built accordingly Packaged replication Full rollout capabilities built in Continuous improvement system and mindset in place Tracking of results and benefits

Proven approach for each center/value stream

1 Segment complexity

2 Create rhythm/ manage variability

3 Reduce incoming work

Perfect

Combine/ colocate activities 7

Roll out

SOURCE: McKinsey

Companies can face difficulties implementing these ideas. They will likely receive management pushback as they try to boost back-office performance (see text box on previous page). A dedicated initiative with top management support can overcome this; the size of the prize should motivate CEOs to take this step. Companies can typically see total savings of 15 to 25 percent, a 30 to 50 percent improvement in cycle times, and rework cut by half.

success stories will certainly build confidence, pull, and momentum. Manage pace and sequence in waves to maintain energy levels and to ensure a self-funding program. Successful companies typically structure actions in waves of increasing scope and complexity. Have line leaders drive the transformation, while developing a support structure that not only tracks back-office performance but builds employee capabilities as well. These best-practice insights have proven useful when tackling back-office clutter. They help smooth implementation and ensure a positive impact on a companys bottom line. *** With cash flows under water and continuing bad economic news, telcos need to find ways to extract as much cash as they possibly can from their operations in ways that do not hamper their market performance or customer satisfaction levels. Offering up to 25 percent in total savings, significant cycle time improvements, and half the former rework, the back office is a high-potential target, and the eight proven tools described here can help managers capture it.

Getting started
Experience suggests that companies apply several bestpractice insights to back-office improvement efforts: Set goals that force all involved to think and act differently, recognizing that traditional incremental approaches are not sustainable. Adopt new approaches and tools. Managers should start by assembling a rich set of ideas to test, and use cross-functional teams to evaluate and implement them via a rigorous set of analytical tools. Change how work gets done. Do not simply attempt to squeeze more of the same from each center. Make real changes to work processes and practices. Pilot early and often, planning for scalability right from the very beginning. Not only early but tangible

RECALL No 10 Cost Management Clearing the clutter: Improving back-office operations

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Harold Brink is an Associate Principal in McKinseys Boston office. harold_brink@mckinsey.com

Kurt Cohen is an Associate Principal in McKinseys Stamford office. kurt_cohen@mckinsey.com

Eric Monteiro is a Principal in McKinseys Toronto office. eric_monteiro@mckinsey.com

RECALL No 10 Cost Management Lean on IT: Transforming information technology

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07 Lean on IT: Transforming

information technology

IT costs represent a significant share of telco revenue. In a climate of economic uncertainty, identifying and eliminating IT waste prepares telcos to meet their competition head-on while boosting their bottom lines. McKinseys 2009 Telecoms IT Benchmark survey revealed that mobile operators spend an average of 4.7 percent of their revenue on IT; fixed-line operators, nearly 6.1 percent. Both figures represent large buckets of cost that CEOs and CFOs would like to cut, given the current market downcycle and its effects. As a result, telco CIOs face three key challenges. First, they need to reduce their IT spend to grow or at least maintain margin levels despite the likely revenue losses. Second, they must meet the new business priorities driven by hypercompetition and market uncertainty. Lastly, they need to build agile IT organizations that are able to quickly respond to changing business needs. In other words, telecoms CIOs are once again under extreme pressure. Three tactical levers can help telecoms CIOs deliver against these objectives, while helping them build a robust and agile IT organization for the future: Lean transformation to improve efficiency and effectiveness of application development and IT infrastructure IT project portfolio prioritization and demand management to ensure focus on key priorities and maximum value for the business IT vendor consolidation to capture economies of scale in purchasing.

Managers should consider these levers tactical because they can begin cashing in on initial benefits rather quickly within the first one to three months and with very limited or no investment. The rest of the savings will follow within six to twelve months.

Kick-starting a lean IT transformation

Taiichi Ohno, who literally wrote the book on lean manufacturing, says that the practice pursues optimum streamlining throughout the entire system through the thorough elimination of Muda (waste) and aims to build quality into the manufacturing process while recognizing the principle of cost reduction. These objectives are as applicable to IT as they are to manufacturing: improve productivity, quality, and time to market for application development and maintenance (ADM) as well as IT infrastructure services. Based on our experience, a lean IT transformation can improve productivity by 15 to 40 percent for ADM and by 40 to 60 percent for IT infrastructure (Exhibit 1). Achieving these objectives will directly translate into lower IT operating expenditure (opex) and capital expenditure (capex) for all new projects. At the same time, it begins to lay the foundation for a solid and agile IT organization. Lean focuses on five key dimensions: Voice of the customer involves the ways companies align IT and its services to the real needs of both internal and external customers.

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01

Adopting lean practices can boost performance significantly Adopting lean practices can lead to significant performance improvements
Indexed to 100
Application development and maintenance Productivity Project costs 100 15 - 40% IT infrastructure Number of FTEs 100 40 - 60% 58 39 Addressed support Mean time to resolve 100 Optimized support 40 - 60% 60 38 Baseline Post-lean 10 - 50%

85 60

Baseline Quality

Post-lean 20 - 45%

Defects (identified per iteration)

100

80 55

Baseline Efficiency Time to market (months) 100

Post-lean 90 50

Before
SOURCE: McKinsey

After EXAMPLES

Process efficiency looks at how well work flows have been implemented into an efficient value chain, while meeting the needs of end customers. Organization and skills concentrates on the match between the capabilities of the staff and what their jobs require of them. Mindsets and behaviors describes the ways people at work think, feel, and act, both individually and collectively. Performance management focuses on generating transparency in targets, achievements, and issues. Companies must tackle all five dimensions at once, not underestimating the organization and skills or mindsets and behaviors dimensions. These will likely be the most difficult to implement, but they remain critical to lasting improvement. Lean application development and maintenance In our experience, there are several sources of waste in ADM. These include overproduction and overprocessing, such as fulfilling requests not needed in the next three months or installing unnecessary functionality. Rework, caused by frequent changes in business

requirements or application bugs, and wasted motion, due to ineffective prioritization of requests, also negatively impact ADM performance. Companies waste their human potential (intellect) by pursuing only limited levels of cross-training and suboptimal worker utilization, while transportation waste occurs due to functionality duplication and unplanned task switching. Waiting time also dampens efficiency levels, such as when companies do not make key resources available on time or developers remain idle because they do not receive complete information when they need it. Finally, inventory waste results from maintenance backlogs or large numbers of partially completed requests. Revisiting processes and procedures from a lean perspective typically uncovers significant amounts of waste. At the same time, however, this vantage point also reveals many improvement levers. One operator went through this process to discover it was not effectively utilizing its external developers. By not carefully planning and managing external resources and continuously releasing and hiring externals, the company was spending hundreds of thousands of euros each year to get new contractors in and educate them on their system stack. By introducing continuous planning and better demand-supply management, the operator was able to limit this waste. In our experience, it is also not uncommon to see operators having to rework about

RECALL No 10 Cost Management Lean on IT: Transforming information technology

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02

Nine levers can be applied to reduce waste and achieve 9 levers can be applied to reduce waste and achieve operational improvement operational improvement
Implementation levers 1 Segment complexity 2 Redistribute activities 3 Pool resources 4 Create flexible manpower systems 5 Reduce incoming work 6 Reduce non-value-added work 7 Standardize operations Examples Separate complex tickets from simple tickets Transfer manual server reboot and password reset activities from system administrators to lower-tired monitoring operators Train individuals across multiple applications/technologies to support multiple projects Quickly swing resources across teams if workload increases in one area Improve requirements management process to prioritize features and maximize business value Review/reduce meeting frequency, duration, and attendance Standardize processes and procedures for common tasks (e.g., handling bridge calls) Infrastructure and ADM Applicability

8 Iterative stakeholder feedback 9 Continuous integration

Implement time-boxed iterations with function-tested code and regularly test with key stakeholders Integrate code frequently and maintain a latest and greatest running code base

ADM

SOURCE: McKinsey

30 percent of their application design due to business requirement changes. Lean IT infrastructure The same types of waste exist in IT infrastructure. To name a few, there is rework (such as correcting errors due to ambiguous specifications) or overprocessing (such as double or triple validation of data inserted). Also, few operators really manage their data storage appropriately, which can result in overcapacity, i.e., overproduction. The total cost of ownership of 1 terabyte can range from EUR 3,500 to 9,000 per year, but better managing storage capacity saves not only money but also work, hardware, energy, and floor space. Furthermore, server provisioning can be a long and complex process with many unjustified decision steps, taking weeks if not months to complete. In a streamlined, standardized, and fully automated data center, this can be reduced to one to two working days. Exhibit 2 presents nine specific levers to address such waste. Lean in data centers consists of reviewing and streamlining key processes, automating activities, eliminating hardware waste (e.g., for servers and storage), and packaging standard infrastructure products and services (i.e., infrastructure commoditization) to allow variability to be better absorbed.

Project portfolio and demand management

Managing business requirements and delivering solutions that meet business needs make up the key functions of a state-of-the-art IT organization. Effective demand management determines what the IT department will work on, when, and with what type of resources (i.e., external or internal). However, experience shows that, while most telcos have put good-practice demand-supply management in place at one time or another, the process becomes slack over time and fails to work as expected. Stage-gating A stage-gated process for IT investment approval helps key stakeholders keep the right focus and maintain accountability. This can also result in a more efficient and effective decision making process. Managers have to evaluate each IT project using the strength of its business case and its relative net present value (NPV) so that they can prioritize projects based on their actual impact (i.e., revenue increase and/or cost reduction). They should reject or delay projects with negative business cases until the next review if they do not meet special strategic, regulatory, or enabling needs. In essence, the IT organization should focus only on top-priority projects within its capacity. Effective project priori-

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03

The three vendor transformation models vary significantly along The 3 vendor key dimensions transformation models vary significantly along key dimensions
Maximum number of vendors Contract duration (years) SLA sophistication Only time-of-delivery SLAs Spend commitment No spend commitment just framework agreement Contractual commitment to a yearly spend Unit for pricing and basis of contracts Fixed costs per project

Current status

88

Step change

7 - 10

3 2 3+2

New SLAs on Quality Internal client satisfaction Year-on-year productivity increase Additional SLAs on Fulfillment of architectural road map Technological simplification End-user satisfaction Additional SLAs on Year-on-year real price reduction per function point Extra contribution to group consolidation

Function points in target with man-days for initial transition

Leap change

3-7

3 2 3+2

Contractual commitment to a yearly spend

Function points in target with man-days for initial transition

Revolution

2 5+2

Contractual commitment to a monthly spend with a 6-month forecast

Function point pricing from Day 1

SOURCE: McKinsey

tization should also consider technical factors, e.g., impact on application architecture and processes, and include a category of must-do IT projects for legal and compliance purposes. Furthermore, the IT department must stop enforcing and instead push the responsibility of business prioritization back onto the business. The business side not the IT department should manage its own demand, while the IT organizations role should be to help business managers better specify what they need, what technical alternatives exist, and how the overall demand/ supply can be managed optimally. Moreover, business sponsor accountability should be consistent from idea to delivery not only in the early stages of the decision making process. Power workshops We developed the power workshop concept to address, among others, the issue of where responsibility for demand management should lie. This is a series of concentrated, interactive meetings between the business units and the IT organization, with each workshop focused on clear inputs and outputs. Key roles are defined, and participants are empowered to make final decisions. Participating telcos should conduct power

workshops in a short time period and strive to establish an intensive business/IT dialog. By pushing for immediate answers and decisions, companies can dramatically reduce the time spent waiting for responses. To be successful, power workshops require the participation of decision makers and rely on well-organized preparations. Such preparations include creating or compiling the appropriate templates and documents to support the dialog. Power workshops have a number of advantages, one of the most prevalent being improved productivity because these workshops reduce the effort required to manage demand and make decisions, while reducing waste along the development process. Minimizing the need for rework caused by unclear or changeable requirements also leads to lower costs. Finally, the concept shortens the time needed for both planning and development, and ultimately delivers clear, high-quality requirements. Our experience shows that not only can an effective demand management process immediately capture significant amounts of value, but it also has the potential to further reduce total IT spending by up to 5 percent. Based on project portfolio and demand management optimization, telecoms operators can capture initial benefits within just a few weeks.

RECALL No 10 Cost Management Lean on IT: Transforming information technology

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Consolidating IT vendors
IT purchasing represents 60 to 70 percent of total IT spend for telcos, thus making vendor management one of their key priorities, especially in the current economic circumstances. Moreover, it is not unusual to find the following situation at telcos: a plethora of large and small vendors in both ADM and infrastructure, different contract models, limited service quality targets, no risk for the vendor of losing business continuity, limited application of contract penalties, lack of cost transparency mechanisms, and hundreds of RFPs to purchase IT products and services. IT vendor consolidation is a powerful tool for telcos seeking a substantial reduction in IT spend and a significant improvement in service quality. Top performers are able to reduce IT purchasing spend by up to 15 percent (i.e., 10 percent of total IT spend) by transforming their vendor management model. Vendor consolidation is the key enabling principle of this transformation, and four dimensions should be taken into account to maximize benefits: vendor relationship model, contract design, spend commitment, and decision making. The vendor relationship model is key to making the transition from a simple contractual relationship to the partnership required to achieve the spend reduction targets mentioned above without jeopardizing service quality. Important decisions within the vendor model are: average contract duration, share of vendor resources, consumption purchased without RFPs, and incentives for vendors to release efficiency gains from scale and continuous improvement practices. Contract design decisions have to focus on setting service level agreements (SLAs) on multiple dimensions including quality, a factor very often neglected. Furthermore, penalties and termination clauses should not only be included but strictly applied. Spend commitment is a key dimension of a more effective vendor model, i.e., contracts must include price commitment and not only price per man-day as in framework agreements. A structured metric, such as function points, should be used to measure project complexity as a basis for pricing. Finally, decision making should be a simplified approval approach that assigns sole responsibility for key projects and allows for contracts of longer duration for the vast majority of IT projects (e.g., ADM). There are three possible options when it comes to vendor model transformation: step change, leap change,

and revolution (Exhibit 3). The model chosen typically depends on the starting position of the telco, its corporate objectives, and management readiness to use a different vendor management approach. The most commonly adopted approach is the step change. The implementation of such vendor management transformation requires the following three steps: Understand the actual IT spending. This includes shedding light on the costs hidden on the business side of the organization, such as local application support or equipment purchases made outside the IT department. Verify refinement potential. Determine how the chosen vendor model can be adapted for each IT domain (e.g., customer relationship management, billing, enterprise resource platforms). Decide on the number of vendors per domain, the remuneration model to be used, how to verify quality (e.g., via SLAs or key performance indicators), and how to plan the transition of applications between vendors. Launch RFPs. Select vendors and specify contracts for effective vendor management. Operators should be careful that they do not become too dependent on one service provider because the benefits could then become major drawbacks as the operator becomes captive. Companies must pursue a vendor consolidation, while ensuring a multi-sourcing strategy. Some operators are implementing innovative and sophisticated approaches to vendor management that ensure competition among fewer preferred vendors across all domains, while guaranteeing substantial volume discounts due to the large scale of activities. For ADM, as an example, some operators assign development responsibility to one vendor, but split maintenance responsibility across all other vendors, giving them the ability to replace a dominant vendor in the case of low performance or rigid pricing. Common sense would suggest leveraging specialized vendors to reap the benefits of scale and expertise, but fragmentation is the most common pattern in the vendor base of many telcos. However, the current economic situation requires a focus on key business priorities and on tight cost reduction that will follow the trend toward vendor consolidation and overall vendor management transformation.

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Consolidating vendors often impacts the organization significantly. For example, this can greatly simplify purchasing, but a new organizational unit may be needed to oversee strategic vendor relations and to track and manage vendor performance. Telecoms operators need to ensure that they have the right internal capabilities to work with and manage multiple vendors. *** The ideas presented here can help telcos quickly generate the cash they need to ease the effects of the current economic downcycle, while operators consider more structural moves, such as hardware optimization, delivery productization, and outsourcing or offshoring. Such ideas will also support telcos in positioning themselves to face greater competition as markets turn around and establish an ongoing process to help them attain and sustain world-class IT performance.

Norbert Biedrzycki is an Associate Principal in McKinseys Warsaw office. norbert_biedrzycki@mckinsey.com

Vito Caradonio is a Principal in McKinseys Rome office. vito_caradonio@mckinsey.com

Stphane Rey is a Principal in McKinseys Zurich office. stephane_rey@mckinsey.com

RECALL No 10 Cost Management Bargain hunters: Two telcos successful sourcing

55

08 Bargain hunters: Two telcos

successful sourcing

Can a telco buy its way out of a cash flow jam? One European and one North American player both believe they can by launching strategic sourcing programs. To date, these have generated savings of 10 to 50 percent in direct spend categories and 10 to 20 percent in indirect ones contributing substantially to the companies 2010 free cash flow targets. The approach the telcos chose rests on three pillars: cost savings, structured changes, and capabilities development. Sourcing excellence goes well beyond savvy and relentless negotiation skills. Bringing prices down to the point where vendors cry uncle does cut costs but this is only one step. Two telcos on two continents share a common approach in framing vendor prices within the total cost of ownership (TCO) and establishing continuous improvement in sourcing. Placing strong emphasis on TCO to address costs led to a reduction in annual spending by EUR 100 to 150 million at the European telco and USD 200 to 250 million at the North American company. The TCO approach means scrutinizing cost drivers behind each spend category beyond the purchase price paid to vendors. In parallel, these companies also concentrated on strengthening their sourcing strategy. They chose the right products and services from the right suppliers at the right volumes, then began renegotiating contracts to gain general price concessions. To achieve their objectives, the companies sought to shift away from a transactional focus toward one built instead on sustainable and effective sourcing processes, employing basic procurement tools. They also aimed to improve sourcing performance by anchoring cross-functional, best-practice skills among their procurement specialists.

Conquering costs
Managers assessed the companies purchasing spend top down and compared this to McKinsey savings benchmarks. Annual savings potential ranged from EUR 130 to 200 million and from USD 150 to 200 million, respectively. The telcos savings in selected categories such as network construction services, ADSL, and USB modems ranged from 15 to 50 percent, due to better product and service specifications, bundling, global volumes, and a new price/performance focus. The approach these companies used did not merely comprise a series of steps or group of elements the effort was orchestrated. The companies drove sourcing cost reduction in category waves that built on each other. They developed and applied standardized purchasing processes to capture savings, conducted workshops in selected areas, and performed a diagnostic of the purchasing organization to decide where to focus. Next, they expanded their focus to include new purchasing categories and refined the processes and methods employed. The companies then widened project scope even further in yet another wave focused on new categories, while building capabilities along the way. In cases like these, McKinsey typically uses a number of proven tools and techniques to address the four tenets of cost reduction: Create transparency. To bring procurement spend into clear focus, managers employed classic spend analysis techniques that provided basic information for internal improvements and negotiations. They also conducted

56

price variance analysis to find inconsistencies in price trends at the category level and benchmarked competitors to determine design and cost differences. Generate ideas. Tools and techniques that prove useful during idea generation activities include linear performance pricing. This allows teams to identify optimum price/performance combinations, while TCO analysis examines cost drivers across all dimensions (e.g., value-added lifecycle cost). Such analyses establish a detailed cost structure that can help teams generate cost reduction ideas across the value chain. Similarly, a blank-sheet cost buildup (should-cost model) a deconstruction of a suppliers costs in producing and delivering materials or services enables telcos to completely rebuild each suppliers price per category, using their own knowledge and resources. Telcos can then estimate the suppliers profit margin, which can be particularly useful in preparing for negotiations. In one should-cost modeling example involving network construction services, one operator used industry benchmarks and cost data to reduce prices by up to 25 percent in some regions. Managers may choose to also hold idea generation and creativity workshops as well as supplier workshops focused on jointly identifying improvement opportunities. Prepare for negotiations. Teams have a number of proven methods and tools at their disposal when preparing for supplier negotiations. Supply market analysis allows teams to assess whether sufficient supply exists and to gain knowledge useful for negotiations. Category teams can create supplier profiles, collecting non-pricerelated data to gain insights into each vendors strategic focus, financial health, and ability to innovate. They can also perform a supply positioning and supplier account valuation analysis. This provides an article-level perspective on spending to determine specific sourcing strategies based on relative value and risk. In one cost reduction example involving microwave system sourcing, an operator used internal benchmarks and regional/global volume bundling to reduce prices by up to 35 percent. It employed a number of techniques to increase competitive pressure during negotiations. One of them involved raise the stakes meetings: competing suppliers were told by senior managers to submit their final offers and the supplier with the lowest bid was awarded the contract. Other techniques made use of pricing tactics to secure uniform prices from suppliers for all regional companies and incentivize suppliers

to reduce prices as volumes increase. Such tactics also included retrospective year-end discounts (rebates) based on volumes ordered. Track performance and capture savings. To help ensure savings are captured and that spend forecasts and budgets are properly updated, telcos should establish mechanisms to track baseline spend and savings at a very high level of granularity (unit volume and price by month, region, supplier, etc.). This knowledge enables telcos to, for example, isolate the impact of pricing and volume changes on any cost reduction achieved. Developing this capability sets the cornerstone to drive the next level of procurement savings opportunity.

Transforming capabilities
To identify performance gaps in their organizations, the two companies performed diagnostics that leveraged McKinseys comprehensive database of procurement performance drivers across industries. These diagnostics revealed mixed procurement capabilities. Compared with the telecoms industry average, for example, one of the telcos had significant shortfalls in a number of key areas. These areas included the organizations strategic alignment and posture, mindsets and aspirations, and knowledge and information management skills. The company also lagged behind in terms of talent management competencies, strategic value chain impact, and category value creation strategies. For the other telco, the diagnostic highlighted opportunities to improve alignment between the procurement organization and the different business units in terms of value creation, target setting, and processes. Creating integrated and cross-functional teams through the systematic use of broad TCO tools would make it possible to reach the next horizon in sourcing excellence. Our experience suggests that transformation activities work best when companies run them in parallel with the cost-cutting initiatives. Thus, overall programs should: Center on value creation that reflects superior category insights and forceful TCO reduction Build organizational capabilities to sustain progress Drive behavioral changes to raise aspirations and long-term commitment to change Establish the needed systems and structures

RECALL No 10 Cost Management Bargain hunters: Two telcos successful sourcing

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Focus on performance tracking and implementation to make sure identified savings actually hit the bottom line. To make all this happen, the procurement organization must boost its ability to execute all phases of the sourcing program from preparation to analysis and from planning to implementation. Implementation itself should include a continuous improvement component to drive value capture on an ongoing basis. At the same time, procurement managers must shift from a traditional transactional focus to emphasizing strategic sourcing. Many telcos involve the procurement department only after most technical and strategic decisions have been made, leaving the function to concentrate solely on vendor negotiations, final price agreements, and daily purchasing operations (e.g., order handling). Instead, procurement must become business-relevant, helping define the companys technology and business strategies, providing alternative options to the business owners, and shaping projects from a TCO perspective.

For many telcos, this not only requires radically rethinking the procurement functions role, but also emphasizing the importance of cross-functional teams in the early stage of any project. Ultimately, the most significant change for the two companies procurement organizations was not the step-up in capabilities and a systematic approach to procurement but insights into how they should shape sourcing strategies early on. *** The sourcing transformations of these two companies worked so well because they got the basics right, involved top management from the very start of the program, and clearly communicated the new roles and responsibilities that the procurement organization would have to assume. In the current economic situation, the faster telcos begin to focus on capturing procurement-related value, the better they will be positioned to survive the downcycle and compete aggressively when the business context improves.

Stefano Baroni is an Associate Principal in McKinseys Montreal office. stefano_baroni@mckinsey.com

Petter Andreas Berg is an Associate Principal in McKinseys Oslo office. petter_berg@mckinsey.com

Theodore Pepanides is a Principal in McKinseys Athens office. theodore_pepanides@mckinsey.com

Vats Srivatsan is a Principal in McKinseys Silicon Valley office. vats_srivatsan@mckinsey.com

RECALL No 10 Cost Management Fractured planet: Helping telcos leverage global scale

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09 Fractured planet: Helping telcos

leverage global scale

An increasing number of telcos have extended their global reach in recent years, but few of them capture all the bottom-line benefits this expansion can bring. As telcos are forced to seek new ways to combat eroding margins, a more integrated way of operating across borders could be one part of the solution. Today, several telcos generate over half of their revenues abroad. While this expansion strategy has been quite successful at capturing growth in emerging markets, many telcos have been unable to take full advantage of the groups size. Operations at many companies remain fractured across borders due to the highly independent nature of local operating companies (OpCos). This blocks the many benefits that complete integration could offer. McKinsey recently studied several large, international telcos. In doing so, we found that these companies would benefit from taking greater advantage of their global presence to capture significant upside potential by sharing best practices and making use of their new vast scale. With slowing growth and economic uncertainty, we believe that companies should focus more on consolidating the gains they made during the previous era of rapid growth and that implementing crossborder operations should be part of the solution. By no means is this an easy path. Telcos will have to change both their working approaches and their organizational mindsets. If telcos achieve this, however, the rewards can be considerable. Moving toward an integrated model can generate savings of approximately 20 percent of the total cost base and provide revenue stimulation opportunities of up to 7 percent.

Four ways to go global

As telcos internationalize, they typically set up their cross-border operations in one of four archetypes (Exhibit 1). These models span the spectrum from the independent portfolio to the most integrated and standardized one telco model. There is no single right example. The choice depends on the companys longterm strategy, its current status, and other contextual factors (e.g., ownership, cross-cultural differences). Also, the one telco archetype does not represent the end state that all telecoms players should aspire to. For example, the independent port folio might be best for a global telco that operates in very fragmented markets with little commonality and thus low integration levels or even for one that focuses solely on growth. The four archetypes apply both geographically and by function. For example, a telco could pursue a much more integrated approach in its mature European markets (where margin pressures and cost savings are great concerns), while letting its emerging market operations work more independently to focus on capturing growth. Likewise, the telco could take an integrated approach in one function (e.g., its global data centers), while maintaining an independent, local approach in another one (e.g., the customer care call centers). Functions such as business support and IT data centers can benefit greatly from cross-border consolidation; others, such as sales and marketing, tend to be inherently local and thus the benefits of cross-border operations remain limited. Our research shows that levels of cross-border integration vary a great deal among telcos and across indi-

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01

Global telcos select their integration archetype based on Global telcos select their strategic priorities their integration archetype based on their strategic priorities
Archetype Strategic priority Where applicable Independent portfolio Growth Selectively standard Growth with some cost efficiency Portfolio of operating companies at different maturities (e.g., Malaysia, Pakistan, and Norway) Regional blocks Cost efficiency while catering to regional needs Market clusters (e.g., Latin America and North America) at different phases of maturity and with different needs (e.g., languages, products) One telco Maximum cost efficiency throughout footprint Mature markets (e.g., Western Europe) with relatively homogeneous demand (e.g., data product offerings, ARPU levels) Possibly used to support acquisition-driven strategies (i.e., an acquisition engine)

New entry into fastmoving market with low penetration and active subscriber acquisition

Ownership

Several operating companies with minority ownership

Majority ownership

SOURCE: McKinsey

vidual organizations functional areas. No telco has yet achieved optimal integration across its functional areas, but some have made considerable gains in selected areas (Exhibit 2). Of all functions, procurement tends to be the first that most telcos integrate. Beyond this, however, no common path exists because of two main reasons: a) crossborder integration is typically implemented where tactical synergy opportunities exist (usually highly specific to each telco) and b) consolidation only succeeds in areas where sufficient management commitment and support can be gathered to back it. Moreover, telcos have been surprisingly slow to adopt some of the measures becoming commonplace in other industries such as shared services centers for routine business support function (BSF) activities or consolidating IT data centers even though nothing related to the business would prevent such moves. With most telcos still quite near the starting line, such activities equate to opportunities to gain a competitive advantage over the long term. In particular, telcos should implement no-regrets moves that allow them to quickly achieve cost savings without making significant changes in the way they do business. Consolidating procurement, BSFs, and data centers represent such potential opportunities.

Two benefits of consolidation

Global telcos can capture value from cross-border operations by replicating selected superior business models and best practices across the group and by leveraging economies of scale and scope. Our analysis shows that cross-border synergies can reduce the overall cost base by more than 20 percent about a third of this reduction results from scale and scope improvements (Exhibit 3). Replicating best practices of demand management, lean transformation, automation, and offshoring and then capturing the related savings does not require cross-border operations as such, since companies can implement superior business models in a single country. However, these actions may have global consequences because each OpCo can learn from best practices throughout the group, thus bringing the whole group to a higher performance level. Typically, this approach, as opposed to the corporate-driven one, has a positive impact on implementation because the OpCos become empowered to drive the improvement and learn from each other instead of feeling that corporate headquarters is interfering with the way they run their businesses. Savings from economies of scale and scope entail demand consolidation and procurement (e.g., volume

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02

Global telcos span the range of integration within own operations and Global telcos span the range of integration within own operations compared to each other and compared to each other
Degree of integration and standardization1 Operational domains Network Network planning Network procurement and rollout Network operations and maintenance Handset procurement Advertising Sales Customer support Product General support IT Product development Service delivery Support services Infrastructure ADM2
1 L = low; M = medium; H = high SOURCE: McKinsey 2 Application development and maintenance

L M H Operator 1

Customer

discounts), bringing subscale units up to scale (e.g., call centers), or developing skills group-wide to achieve distinctive expertise. An example of the last action would be a group-wide expert team that helps OpCos implement lean processes. These savings depend on the market and the OpCos operational situation. While cost reduction represents the most obvious effect of cross-border consolidation, the benefits extend beyond that. On the revenue side, single OpCos can achieve an uplift of as much as 7 percent through a selection of measures that fall into two main categories: the customer (e.g., churn management and revenue leakage) and the product (e.g., pricing).

sharing and cooperation are crucial as integration increases, but many telcos have had difficulty conquering this area. There should be effective communication and involvement as well as supporting tools to capture group-wide synergies (such as empowering OpCos senior managers as leaders of cross-border initiatives). A common complaint from OpCos regarding integration is that it hampers their flexibility, slows them down, and makes it more difficult for them to reach their operational and financial targets. The optimal level of integration then becomes a question of balancing the benefits of scale against the advantages of local business flexibility and responsiveness. The active involvement of OpCos in the leadership of cross-border programs would allow for the consideration of relevant local business priorities in shaping integration initiatives. Key business processes need to be aligned. If the cross-border consolidation is to have a significant effect, sooner or later the processes used by the OpCos will have to be standardized. Companies can harmonize some back-end activities (e.g., IT data centers) without much process consolidation. For front-end activities and those requir ing close interaction between the local and group levels (e.g., coordinated handset procurement), however, process standardization remains a prerequisite for consolidation.

Building blocks of cross-border integration

Companies need to put three key enablers in place organization, business processes, and technology to capture cross-border synergies successfully and to ensure smooth integration. The organization end product must reflect the archetype a company chooses. This requires changes within the organization as well as to its relationships with the OpCos. As the level of integration increases, the roles of the OpCo and the group must change accordingly. Organizational models that promote best-practice

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03

Maximizing the cross-border advantage can lead to a significant Maximizing the cross-border advantage can lead to a significant cost reduction cost reduction
Percent
100 14 5 5 Network 28 0 2 2 Customer 51 3 1 0 1 Achievable cost reduction 8 3 78 20 -22% Percent cost reduction for respective domain cost base -29

Product Support IT

5 9 7 Original spend A Replicating superior business model B Capturing economies of scale and scope

43 4 6 5 End state spend

-15 -22 -31 -36

SOURCE: McKinsey

Technology binds the consolidated organization together. Companies often find they have many layers of legacy systems. This makes it difficult to consolidate operations within a single country, let alone across borders. Although there is no easy answer to technology integration, one viable approach is to slowly standardize technology, since the older versions become obsolete and are replaced anyway. As cross-border integration moves to higher levels, the complexity involved in coordinating activities also increases and so does the difficulty of implementation. Complexity increases because the three key enablers organization, processes, and technology must all be in place and in sync to make integration happen. If companies do not align these enablers properly to the selected cross-border archetype, they will not fully capture the benefits from standardized and integrated ways of working. This fact illustrates one reason it might make more sense to pursue integration in selected areas the time, cost, and difficulty of implementation could outweigh the cost savings achieved. Indeed, many examples from other industries show that companies choosing to pursue high-level cross-border integration typically have other reasons besides cost savings for doing this. In banking, for example, Danske Banks standardization efforts have allowed it not only

to save costs but also to create an M&A machine able to quickly assimilate new acquisitions.

Meeting the organizational challenge

The opportunities offered by standardizing processes and technology are significant. The journey, however, can be formidable. Time and again, organizational issues cause cross-border consolidation attempts to fail, even if technically feasible. In fact, the typical question is: How do we make our people work together? Culture is a critical consideration on the path toward integration. There are numerous examples of failed or suboptimal cross-border projects where a clash of cultures between the OpCos and the company headquarters was the decisive factor. This situation usually arises when headquarters tries to push initiatives onto the OpCos, which either do not see a need for them or consider them to be good for the group, but too restrictive for themselves. Another situation is when attacker OpCos distrust the incumbent OpCo due to differences in situations and mindsets. Successful cross-border initiatives require the OpCos to commit to the process at least enough to try it out; therefore, launching limited-scale pilot projects that show the positive effects of the cross-border concept could

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04

Savings potential is a nonlinear function of integration archetype Savings potential is a nonlinear function of integration archetype
Percent
6.5 3.7 10.9 7.4 3.5 7.0 2.8 14.6 Superior business model A 21.6

3.9 0.3 0.3 0 3.2 0.7

Cross-border scale and scope

Independent Selectively portfolio standard

Regional blocks

One telco

Total

Increasing complexity of coordinating initiatives across OpCos

SOURCE: McKinsey

help. Telcos with successful cross-border activities usually faced initial skepticism, but after several years and some pilot successes, the new culture of coordinating activities between headquarters and OpCos has taken root in the organization, making change sustainable. Roles and responsibilities is another critical area, perhaps best exemplified by activities such as outsourcing, where managers need to control complex interactions between separate organizations. Learnings from outsourcing can be successfully applied to managing the complexity of cross-border organizations, for example, by mapping roles, responsibilities, and related performance indicators to the steps of the most important standardized processes. As the level of cross-border consolidation increases, the key challenge becomes managing the added complexity brought on by this new way of working. Experiences from todays best practices show that uniformity across countries, enabled by clear roles and responsibilities, is very important. While it may reduce individual flexibility, it keeps cross-border complexity under control.

rent position and then choosing the archetype that best matches its aspiration. Once the overall ambition level has been identified, the telco can then quantify the value of the opportunity as related to the various combinations of levers and functions. At this stage, it is important to carefully consider all of the costs and implementation challenges that cross-border initiatives can entail. After identifying the functional areas that best match the companys strategic goals and provide the largest cross-border value potential, the company should define a curriculum for the transformation programs needed to realize this potential. What combination of functions, levers, and geographies should be addressed and in what order? The ramp-up of savings potential associated with each archetype is not linear. For example, the marginal benefits continue to increase up to the regional blocks archetype and then begin to diminish when companies move toward one telco (Exhibit 4). This happens because many of the actions providing the most value are taken in the regional blocks archetype and the added value of one telco simply relies on the additional scale of the group overall. As telcos move toward greater integration, coordination complexity also increases.

Designing the program

A telco can begin its cross-border journey by first comparing the organizations strategic goals with its cur-

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Programs such as lean IT or procurement excellence are not new as such. The challenge is to implement them on a wide scale and to make sure all of the cross-border enablers are in place. Fortunately, there are numerous best-practice examples available to draw experiences from both in the telecoms industry and elsewhere. *** Achieving a fully integrated model is a long journey that requires the complete attention and commitment of the executive management team. With slow growth and economic uncertainty, the next few years are likely to be the ideal time frame to start leveraging global scale and reaping the benefits of increased cross-border integration. Our work provides a model and tools to quickly assess the potential of integration and defines solutions for successful cross-border operations.

Stefano Baroni is an Associate Principal in McKinseys Montreal office. stefano_baroni@mckinsey.com

Andr Christensen is a Principal in McKinseys Toronto office. andre_christensen@mckinsey.com

Jani Kelloniemi is an Associate Principal in McKinseys Helsinki office. jani_kelloniemi@mckinsey.com

Tor Jakob Ramsy is a Director in McKinseys Oslo office. tor_jakob_ramsoy@mckinsey.com

Teppo Voutilainen is an Engagement Manager in McKinseys Helsinki office. teppo_voutilainen@mckinsey.com

RECALL No 10 Cost Management Capping capex: An interview with Paul Reynolds, CEO, Telecom New Zealand

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10 Capping capex: An interview with Paul

Reynolds, CEO, Telecom New Zealand

Telecom New Zealand is a group of online and communications businesses operating in New Zealand, Australia, and beyond. The group offers a full range of Internet, data, voice, mobile, and fixed-line services, including converged technology and telecommunications solutions and next-generation wholesale network connectivity products. For the year ending June 30, 2009, the group saw an adjusted revenue of over NZD 5.5 billion. Paul Reynolds took up Telecom New Zealands chief executive role in October 2007. He has led one of the biggest change programs in the groups history, including the operational separation of its main businesses. He has had a long and distinguished career in telecommunications since completing his doctoral studies in geology at the University of London in 1985. Before coming to Telecom New Zealand, he was CEO of BT Wholesale, Europes largest and most successful wholesale telecommunications business, with annual revenues of GBP 11 billion and 30,000 employees. There, he played a central role in the companys transformation through a wide range of senior positions in its UK and international operations. McKinsey had the opportunity to sit down with Dr. Reynolds and discuss the organizations journey toward stricter capital management. McKINSEY: Telecom New Zealand, like most telcos, has been engaged in ongoing capex containment for quite some time. Why launch this recent effort on top of what was already underway? PAUL REYNOLDS: Capex requirements suddenly exploded. We were facing several major projects at the same time: operational separation, modernization of

our fixed network, building of a brand-new mobile network, and a new operations support system platform. This demand was placed on an organization that already faced prioritization challenges and had multiple product developments going on at once, so we were probably already doing a bit too much. The demands of regulatory modernization layered even more capex needs on top of that, and the sum was simply unaffordable. McKINSEY: How did you determine the appropriate capex limits? PAUL REYNOLDS: Well, one route would have been to look at the capex-to-sales ratio. We could have also focused on cash flow. But in my experience, every telco faces unique circumstances, which suggested that the answer was between the two. We had a real need to ensure we continued to generate free cash, while mitigating enormous incremental demands on the business, so I dont think there was any one single target to be set. In a sense, we came at it from the other direction and committed to some ruthless prioritization. We did some macro pre-planning to get a feel for what the overall affordability sum was, and then we went for it. McKINSEY: You mentioned a very diverse set of capex demands regulatory, technology, network, etc. How did you go about prioritizing these? PAUL REYNOLDS: I think you can boil it down to three broad drivers of capex. There is the stuff you have to do to meet legal requirements this goes without saying. The only question is what minimum expenditure is needed to meet these requirements. Then there are

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the things more tactical in nature that you feel just have to get done to compete, to modernize, or to stop things falling over in the short run. But the fundamental driver is return on invested capital. Its important to keep a very clear grip on that, and that means making sure this philosophy goes quite deep in the organization. Getting the organization to think in those terms is actually the biggest issue. Working with finance directors or consultants is pretty straightforward. They understand because thats what they do all the time. But for this approach to be successful, you ultimately need hundreds of people to be thinking this way about return on investment. You can design the process from the top, but the work happens in the guts of the organization. McKINSEY: And with hundreds of individuals come thousands of capex-related activities. How did you tackle that? PAUL REYNOLDS: We sought outside advice to get a handle on our various activities. Packaging them into groups by function, technology, or product gave us great insight because that allowed us to start seeing some of the duplication that was going on. There was a fair amount of redundancy and a lack of cooperation both between and within business units that was revealed by initial parcelling of activities. Some early decisions were made very easy just by gaining transparency. McKINSEY: Have you seen the changes in the organizations perspective on capex that you were hoping to realize? PAUL REYNOLDS: Ive seen a dramatic change at Telecom New Zealand the difference is like night and day. There is no one involved in decision making and Im talking hundreds of individuals who isnt aware that theyd better have a pretty solid justification for the capital they think they require. As a result, there is a significant degree of restraint because nobody wants to waste their time if they realize that their requests are not going to get the time of day if the justification isnt compelling. I think this added layer of accountability also means that people look for the answers before there is a problem. Now there is more of an incentive to figure out how the task can be accomplished using existing technologies and systems, cooperating with colleagues in other parts of the business that may be working in similar areas. I think the whole senior team just gets it now. In the old days, I guess everybody felt the need to push their projects through.

McKINSEY: It sounds like smooth sailing now, but did you have moments where prioritization was difficult? PAUL REYNOLDS: Initially, before we were able to make the shift in understanding and maturity, it was pretty horrendous. The culture was one of whoever shouted the loudest got what they wanted individually. Those behaviors needed to be unlearned and replaced with a sense of what was good for the group. McKINSEY: So is the attitude now completely selfless and group-oriented? PAUL REYNOLDS: No. Theres still room for individual business unit ambitions. In the more mature phase, where we now are, people just understand that getting the most important projects going at the beginning of the year means there will be a sum that becomes available during the year for other projects. We call it our holding pen. People are pretty comfortable in knowing that important projects in the holding pen will eventually move forward because, as some things get done more efficiently or drop off the list, the funding will become available. It takes some of the tension out of the system. McKINSEY: Have the changes in Telecom New Zealands approach to capex changed the decision making hierarchy at all? PAUL REYNOLDS: I think as you get better at this stuff, some of the capex decisions previously at the CEO level can be taken at a more junior level. Until about a year ago, we were funding massive change and our cash was going into new networks, products, and services. Decisions on expenditures in those areas didnt necessarily need to be taken at the CEO level. Weve come through that phase, though, and larger strategic decisions regarding where we take the business are now on the table. Questions like how much to put into mobile networks in New Zealand as opposed to fiber networks in Australia are the stage where we are now. These decisions that pertain to the shape, size, and markets in which we operate are always going to be CEO decisions. McKINSEY: Regarding this long-term perspective on strategy, investing in some markets is really capitalintensive. At what point does this become hard to justify against the decline in revenue? PAUL REYNOLDS: We all have to decide what business were in and how long we want to be in it. We are starting

RECALL No 10 Cost Management Capping capex: An interview with Paul Reynolds, CEO, Telecom New Zealand

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to see, for example, mobile networks acquire some of the characteristics of fixed broadband networks in the sense of a significant demand for increased bandwidth at relatively inelastic cost. There is also huge pressure for lower prices per megabyte at the user level. This is not the biggest issue for Telecom New Zealand yet, but I do see this development in other markets. Over the past 25 years, our industry has, if you like, crashed its own margins in many areas in a way that is not sustainable in the long run. I think a come to Jesus moment is on its way for our industry in mature markets where we learn not to throw good money after bad returns because we are running out of new growth markets with which to disguise the damage. McKINSEY: In many telcos, only 15 to 20 percent of capex requests are backed by an explicit business case. Would you say that, given your efforts, Telecom New Zealand is now doing better than this average?

PAUL REYNOLDS: I think we have trouble seeing where our benchmark performance is simply because we are still spending significantly on some regulatory commitments we made two years ago. In themselves, these would distort the proportion without a business case. That being said, I think theres another area in which we still need to improve in order to make sure that our expenditures are strategically essential. This area is developing a clear enterprise architecture. Of course, we have one, but nailing it down in a way that ensures that everything we are doing moves us toward our goals is a necessary discipline. Its a control that helps you make sure that your activities are actually strategic and efficient. We still have some progress to make there. *** Dr. Reynolds was interviewed by David Pralong, a Principal in McKinseys Auckland office.

RECALL No 10 Cost Management Appendix

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Modeling lean in telecoms

A model factory for lean processes offers hands-on opportunities to experience lean in its original context, thus injecting cutting-edge best practices from manufacturing into the realm of telecoms. In 2007, Technische Universitt Darmstadts Institute for Production Management, Technology, and Machine Tools and McKinsey set up the CiP (Center for industrial Productivity). Its holistic transformation approach is based on three elements: Operating system. Develop and implement optimized end-to-end processes that create value for the customer with the least waste, minimal variability, and high flexibility. Management infrastructure. Align the organization to support integrated processes, implement performance management (KPI hierarchy and performance dialog), and set up an end-to-end infrastructure. Mindsets and behaviors. Understand leadership role modeling and management capability building. The CiP has developed training and continuing education programs covering the methods of lean management that target employees at all levels from technician to board member. It offers expert support solutions to individual company problems and serves as a forum to exchange theoretical and practical insights. Of the CiPs host of workshop modules, Current State Value Stream Mapping, Performance Management Metrics and Targets, and a full 20 others have significant telecoms relevance. Following each module, a manufacturing-to-telecoms knowledge transfer helps apply lessons from batch production directly to the telecoms industry. For more information, please contact Rainer Ulrich: rainer_ulrich@mckinsey.com

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News, views, insights

McKinseys Telecommunications Extranet is the gateway to some of the best information and most influential people in the telecommunications industry. The Extranet offers selected McKinsey-generated information that is not available in the general Internet. Extranet users have access to selected McKinsey articles on subjects relating to Industry & Regu lation, Growth & Innovation, Sales & Marketing, Services & Operations, IT & Technology, Corporate Finance, Organization & HR, Corporate & Enterprise, and Equipment & Devices. Direct communication channels ensure that your questions and requests will be addressed swiftly. The site is updated weekly with new articles on current issues in the industry. McKinseys Telecoms Extranet lets you: Obtain exclusive information free of charge and use an Internet portal specifically designed for the industry Access cutting-edge know-how, interact with experts to gain new insights, and contact industry leaders Stay well-informed with daily industry news from factiva that you can tailor to your needs and interests. General information about the site is available at: http://telecoms.mckinsey.com Contact: telecoms@mckinsey.com

RECALL No 10 Cost Management Appendix

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Serving clients around the world

McKinseys Telecommunications Practice serves clients around the world in virtually all areas of the telecommunications industry. Our staff consists of individuals who combine professional experience in telecommunications and related disciplines with broad training in business management. Industry areas served include network operators and service providers, equipment and device manufacturers, infrastructure and content providers, integrated wireline/wireless players, and other telecommunications-related businesses. As in McKinseys work in every industry, our Practices goal is to help our industry clients make distinctive, substantial, and lasting improvements in their performance. The Practice has gained deep functional expertise in nearly every aspect of the value chain, e.g., in capability building and transformation, product development, operations, network technology and IT (both in strong collaboration with our Business Technology Office BTO), purchasing and supply chain, as well as in customer lifetime management, pricing, branding, distribution, and sales. Furthermore, we have developed perspectives on how new business models and disruptive technologies may influence these industries.

Telecommunications Practice December 2009 Copyright McKinsey & Company, Inc.

www.mckinsey.com