UK: Convergence is dead: long live convergence
The continuing evolution of the TMT industries

This article presents Deloitte’s views on the current state and likely future implications of convergence across the Technology, Media and Telecommunications (TMT) industries. It has been developed to help our clients frame their business thinking and strategy, by providing a longrange view of the way in which their markets might develop in the future. In doing so, the report addresses three key questions:

• What are the underlying trends driving continued convergence?

• How will convergence drive the evolution of the TMT sector?

• What are the critical success factors for TMT companies for the future?

In the late 1990s convergence in the Technology, Media and Telecommunications (TMT) sectors was the hot topic.

The world wide web and the growth of highspeed digital networks gave us instant access and transmission of information. We were presented with the vision of a brave new world of multimedia products and limitless content, all united by invisible connectivity.

The pace was frantic as TMT companies jostled for position in a rapidly evolving market. But the ensuing series of inter-sector marriages, takeovers and landgrabs cost – rather than made – the three sectors billions.

In 2004, the picture appears markedly different. The original promise of some high-profile marriages appears to have gone flat. Many of the overtly technology-led services have flopped. Markets are still struggling to recover from corrections in value.

But despite the failure of many grand visions of recent years, the promise of a converging world is still with us and the transformational effects of digital technology continue to advance relentlessly. Still, few companies are betting the bank: investment is measured and incremental, and progress is slow and steady. Put simply, we are in a more mature and cautious era where developments are rooted in evolving, but financially robust, business models.

The question is, how is convergence developing in this more cautious era? And how should TMT companies position themselves to succeed in this converged world?

In the late 1990s, the application of new technologies started to blur traditional content and channel boundaries. Media companies, service providers and advertisers saw opportunities to reach their customers in new and more valuable ways and offer a variety of new products and services. The seemingly imminent convergence of television, PC and mobile phone platforms held out the promise of highly profitable, multi-dimensional customer relationships.

This holy grail of converged service offerings drove a frenzy of inter-sector mergers and acquisitions within the TMT sector, as companies jockeyed for position. They gambled mighty sums on M&A: Vivendi and Seat Pagine Gialle spent €64billion between them. The pinnacle of the spending boom was the US$250billion AOL Time Warner merger in 2001, bringing together the US‘ largest internet service provider with a major media and cable conglomerate.

The market bristled with new media companies and dotcom launches, with heavy investment in new technologies and online services. Company valuations were increasingly based on fuzzy metrics. The markets were dominated by day trading and short-term positions rather than financial fundamentals and long-term prospects. New Economy pundits predicted the end of bricks and mortar.

The inevitable swing from boom to bust has left a 3-year ‘hangover’ in the TMT space. TMT companies were the biggest casualties as stock markets started to fall. Poor business propositions were found out. Ricochet, the US-based high-speed mobile data service provider which invested more than $1billion, but couldn’t attract sufficient subscribers due to high prices and low actual speeds of service, filed for bankruptcy. Video Network’s HomeChoice service in the UK, was forced to scale back its ambitions as the costs of building and running its services failed to fall as originally anticipated. Technology-driven WAP services flopped embarrassingly amid much hype. Plus, recent accounting writedowns suggest that some mobile operators, especially in the UK and Germany, substantially overpaid for their 3G licenses.

Whilst the dotcom collapse reflected the extent of the market’s over-valuation and widespread lack of financial discipline, a combination of culture clashes and huge operational challenges also frustrated some of the most ambitious mergers: Vivendi Universal has started to divest a number of media- and technology-related businesses; In January 2003 AOL Time Warner posted the largest ever annual loss in corporate history (US$100 billion) and has since dropped the ‘AOL’ from its corporate name.

Whilst convergence activity has in the past thrown up high profile failures, wildly inaccurate industry predictions and a frenzy of overspend, many convergence initiatives are quietly succeeding. The industry may have been over-ambitious about the timescales to achieve its aspirations, but the reality is that convergence is very much still alive. It is simply progressing at a different pace and in a different manner than predicted in the 90s: this is not to be a revolution after all, but an evolution.

Deloitte defines convergence as

There is evidence of convergence happening at three different levels: Product/service convergence: that is, the combination of formerly discrete products or services into an integrated proposition, driven by advances in technology, changes in consumer behaviour, shareholder pressure for improved operating margins and the quest for new ways to increase revenues, for example through new channels to market. Clear illustrations include the success of SMS voting in response to television shows (10.7m text votes sent during ‘Big Brother 3’ on Channel 4). In fact SMS-based entertainment is now a $1billion-plus worldwide market. The UK ring tone market was worth £60m in 2003, and is growing rapidly. Other growth areas include games on mobile phones, MMS (picture messaging) and video clips and video conferencing on 3. For the first time in the UK, live terrestrial TV footage delivered to your mobile handset was available during Channel 4’s ‘Shattered’, though it’s too early to understand its success. In the business-to-business market, Information and Communications Technology (ICT) is attracting attention from telecoms, technology and other players alike, especially around developing propositions that benefit clients by increasing efficiencies, improving service levels and driving down total costs of ownership.

Platform/device convergence: that is, both the reduction in the number of platforms as a critical mass is reached within a sector and the combination of platforms across previously discrete sectors. The key challenge for technology companies is to become the platform of choice. This issue is not new – it’s similar to the market tug-ofwars between VHS and Betamax, the IBM PC and Apple Macintosh platforms and now Microsoft Windows versus Linux operating systems.

The continued evolution of technology and development of universal standards will help bring platforms together on one device. For example, Sky’s success in the UK’s digital TV market has allowed it to set the relevant standards: their technology covers video, internet and interactive advertising. Playstation and X-Box consoles both now combine computer game and DVD capability in the one device. The latest 3G phones combine telephone, camera, email, calendar, radio, internet, audio and video capabilities.

Digital storage and processing are on the increase in more and more devices, with the range of functions they can perform growing ever wider and the speed of evolution advancing all the time. In digital communication, the success of Internet Protocol (IP) in connecting millions of computers around the world has now spread to printers, cameras, set top boxes, mobile phones, cars, VCRs, even fridges. Anything that can collect or use digital information is a target: any device employing digital technology can be IP enabled and the costs get lower every day.

Organisation convergence: the combination, whether through M&A, joint ventures or alliances of formerly independent TMT companies. In the late 1990s there was a high degree of integration across the three TMT sectors achieved primarily through mergers and acquisitions. Today, there is more intra-sector integration and consolidation - a trend that is consistent with platform convergence and the drive to focus on core competencies. The recent merger activity among record labels is a clear illustration of this, as is the consolidation in business application software – PeopleSoft have recently successfully acquired JD Edwards and have since been fighting a takeover bid from Oracle.

Integration activity across TMT sectors whether for business growth, efficiency, R&D or learning reasons is now being achieved primarily through alliances. These alliances enable businesses to collaborate on certain initiatives, extend beyond their core skills and share the risks and rewards. A good example is the BT/Yahoo! collaboration, where BT is providing the connectivity and customer access, whilst Yahoo! provides the content around broadband services

There has been an increase in focus on developing communities, as media companies coalesce around common areas of interest and target specific audiences rather than just the mainstream. Examples are The History Channel, CNN and MTV. The BBC has been in the vanguard, delivering content across a range of platforms - in particular through BBCi. And despite the promise of new entrants using new technologies, big platform owners like Sky, BT and ntl remain key gatekeepers to customers – although they are subject to ongoing regulatory scrutiny.

How are companies within the TMT sector positioning themselves to exploit current and future opportunities?

Technology and telecoms companies have gained from convergence, with peer-to-peer file swapping driving broadband connections and PC sales and music downloads selling iPods and other digital audio players. Telecoms companies are now trying new formulas to maximise the use of their bandwidth. For example, BT’s broadband alliance with Yahoo! is already up and running, and further promises include music distribution and TV over broadband. France Telecom and TPS have joined forces in France to provide a TV service over the phone line. In addition, 3 is leading the way in 3G multimedia services, albeit at a massive cost (current estimates put the total investment at €20billion). Far from standing still, technology firms are getting directly involved with media delivery. Microsoft is supporting a number of technology media investments, including MSNBC and MSTV. Sony now has a large media business, with Playstation becoming a focal point around which the company is developing new converged services.

In contrast, content-based companies, with the exception of premium content owners, have generally suffered as a result of convergence. Newspapers have seen sales fall whilst giving away their content on websites (which in some cases have required significant investment); music companies have seen sales fall whilst their content is exchanged, mainly illegally, across the net; movie studios are likely to be the next victims of piracy. Whilst they have been less damaged by the general TMT fallout, media companies have still been affected by the recent general market and advertising depression. More worrying is that many content companies face the erosion of their traditional distribution channels and are seeing traditional revenue streams fading – the music industry, for example, saw single sales drop by 30% in 2003. They do have the opportunity to take advantage of an increasing number of alternative channels to market and the associated revenue streams – polyphonic tones being a good example. Some online newspapers are also starting to charge for their content (ft.com, wsj.com and Guardian Unlimited) or allow resellers to charge on their behalf – like compactnews.com which sells Dow Jones content. However, due to the infancy of the many new channels and embedded customer expectations, the route to gaining a reasonable return is not always clear.

Knowing when to act to take advantage of new products and channels is crucial. Being first into an emerging market does not always create an advantage. Smaller organisations are often responsible for creating new products and stimulating customer demand, but they lack the ability to secure dominant positions once a market starts to establish. Larger enterprises will tend to enter the market once an idea is proven and use their scale and scope to win - either buying out the competition, collaborating with them, or competing head-to-head. Good examples of this are Sky with their Sky+ box out-manoeuvring TiVo in the UK and Nintendo and Sega, who are being nudged out of their home markets by Sony. In online music, following iTunes’s sales of 10 million songs within four months in 2003, multiple parties including Dell, Sony, Roxio and Virgin have all piled into the market.

Of course, this is not necessarily a bad thing: a small start-up company’s definition of success may well be to break a market and then exit through a buy-out. A good current example in telephony is the US-based, Vonage, whose voice over internet protocol (VoIP) service gives users a massive discount on long distance calls over the internet. Vonage seem content to remain small, but this is a business idea with enormous potential and with their core revenue under threat, telecoms and other companies will be invading soon. iTunes and a revamped HomeChoice may find themselves in the same situation as TiVo when their markets grow and more players enter.

TMT has been unpopular with investors recently. Capital – particularly for large scale M&A – has been limited; markets are sceptical and more focused on profits and cash generation. We are now witnessing a period of exploratory behaviour rather than furious landgrab; measured investment is the name of the game. Start-ups have to follow a normal business cycle and must prove their viability before ramping-up investment. For example, following the success of iMode in Japan, similar offerings like Vodafone Live!, Orange World, 02 Active and TZones have appeared. Following the success of SMS voting associated with television shows like Big Brother, other television programmes and media companies are following suit with the five UK terrestrial channels now generating over £1m revenue every week from phone and SMS interactivity. In broadband, the successful partnership between SBC and Yahoo! was followed by MSN-Verizon, MSN-Qwest, BellSouth Earth Link and BT/Yahoo!.

Throughout this process, staged investment cycles permit controlled expansion. HomeChoice in the UK has promised to broaden its service offering whilst continuing to press for wholesale broadband price changes to allow it to start making profits. When iTunes started it was only available on Apple Macintosh in the US. Once the concept was proved, it was made available on Windows and will eventually be available worldwide.

However, there are some exceptions to this more measured approach, notably:

• Hutchison’s 3 is still pressing ahead; most of the other companies who bought 3G licences (in some cases for vast sums) are holding back their investment and waiting to see how 3 fares, how the new technology works and how the market starts to shape.

• Microsoft is spreading its bets, investing and sometimes losing large sums in console and online gaming, TV, music and video.

• Sony is gambling the future of its PC and console business on the acceptance of convergent, multimedia devices.

Deloitte research in 2002 showed that 79% of infrastructure and 82% of content businesses said they were planning to increase their activity in broadband by strategic alliances. Only 30% said they were looking for merger opportunities; partnerships were the way forward. There are few examples of going solo and winning in a convergent play. Success more typically requires a combination of skills and capabilities from a number of companies so alliance arrangements are now more popular than straight M&A. For many organisations it is now not a question of whom you want to marry, but more like choosing a dance partner. Compare the difficulties of the mergers in the late 1990s with the more recent but successful SBC-Yahoo! and Sony-Ericsson collaborations. Under this kind of alliance arrangement, individual parties can focus on what they are good at and still maintain their flexibility to adapt to the market and their ability to adopt new technologies.

Time and again this path is proving successful. Think of Pixar partnering with Disney for distribution; Nokia’s collaboration with Electronic Arts who are developing games for their new n-Gage platform; and Sony, which is providing the console and broadband connector for online gaming and leaving the customer relationship and games hosting to the telecoms companies and game publishers.

This brings about a need for a different way of thinking; where organisations operate with a network of business critical relationships, usually characterised by collaboration, interdependence and some form of shared risk and reward. Furthermore, if everyone is starting to think seriously about alliances, how do companies differentiate themselves? Having a capability to partner is crucial. This means being clear about what you are trying to achieve, what you bring that is of value to others and then being able to deliver on it.

Collaborations have their own challenges, of course, in particular the creation and management of increasingly complex relationships and their resultant risks. As organisations become part of an extended enterprise their dependency on third parties increases and whilst the R in the ROI is generally higher than other choices, investment in portfolio management capability and alliance infrastructure is essential to achieve those returns. Consider businesses like IBM, Oracle, Siebel and SAP, each with hundreds or thousands of alliance ‘partners’. Even leading global alliance-centric firms like these, with already significant alliance infrastructure, recognise they must get more value from their alliance activity. As such many are increasing their efforts in building more scientific approaches towards alliances, aiming to be the ‘partner of choice’ in their respective fields, to improve overall performance.

With distribution channels increasingly becoming fragmented, players are concerned about retaining power and influence over elements of the service not directly within their remit. They are also concerned with being heard in the marketplace – is their brand strong enough to reach its intended audience, or does it get drowned out by other brand ‘noise’? One way to be heard is by becoming a gatekeeper and so maintaining a direct relationship with a large customer base which over time can be monetised. Becoming a gatekeeper, or a hub of activity, usually requires the business to have some relationship with its customers or end users – billing, for example. But this is not all: it also requires the ability to understand and assemble the right mix of skills to deliver what customers want in order to keep them happy. If you are unable to be a gatekeeper, or your business model is not designed that way, a world-class product and strong brand, with both a significant marketing and alliance capability are pre-requisites for success. Technology businesses such as Intel and Cisco, and many Media products such as newspapers and broadcasters rely heavily on third party relationships for distribution, but differentiate themselves in such a manner to drive demand over competitor offerings.

As services are delivered via multiple parties, it is important that clear business models are articulated and managed for all members throughout the value chain: even if you have significant influence over them, all those who participate need a fair slice of the cake and will want to understand their fit within your alliance portfolio.

New formats and new distribution channels tend to grow overall markets. Mobile telephony has enjoyed a compound annual growth rate of 60% without a significant impact on fixed line telephony’s revenues. Videos and DVDs now account for close to 70% of a movie title’s revenues. The European mobile gaming market is forecast to grow from just under $800m in 2002 to just below $7billion in 2006 without impacting PC or console gaming. The ICT solutions market has been a significant area of growth for telecoms and technology companies, with the UK market alone expected to grow to over $150 billion by 2007.

Technology typically provides the springboard and opportunity to do new things that create value for you, your partners and your clients, whether that be through growth or efficiency-based offerings. Broadband enables online gaming, video networks and music downloads. Mobile telephony leads to SMS, MMS and location-based services. Music and video compression enable DVD and video on demand. Reuters and HP recent collaboration to develop Linux-based solutions for users of Reuters Market Data Management systems (RMDS) is a good example of new opportunities being exploited to improve operational efficiency.

But the development of new markets and the pursuit of new opportunities cannot be pushed by technology alone; it must be business-led, with the market potential clearly understood and the technology proven and reliable. Otherwise, the risk is embarrassing service failures and the consequent alienation of customers: witness WAP’s washout, TiVo’s retreat from the UK market or Hutchison’s current struggle to offer handsets for its 3 service.

You cannot just ignore technology. If you do not recognise how technology is changing your market and take action to allow you to evolve and control it, you will suffer whilst the market responds around you anyway – look at how IBM nearly died before successfully transforming into a leading ICT solutions provider.

Incumbents can also recognise the potential but be resistant to change to protect existing revenue streams. BT, for example, until 2002, maintained a high price for broadband connections to protect significant ISDN revenues. In the music and film world, cannibalisation worries with electronic formats and the piracy concerns of sharing digital copies are now seriously threatening existing business models.

Regulation is also changing to reflect a converged world, with the 2003 Communications Act reforming the regulatory framework of the communications sector, transferring the majority of the responsibility to the Office of Communications (Ofcom). Competition no longer simply works within distinct industry markets differentiated along technology lines: it now reaches across markets at every level. The regulatory challenge for Ofcom will be to maintain and promote competition, both within and across traditional sectors, as the boundaries continue to blur.

All the evidence points to a more considered approach to convergence in the future, based on solid building blocks and business models. Instead of the major players creating media and telecom convergence through acquisitions, we will see more complex organisation convergence through alliances that offer tremendous opportunities to advance the next stages of both product and platform convergence. But in this environment, what are the criteria for success?

New business ventures are going back to basics and starting with sound business and financial models. The market opportunities must be fully understood in terms of demand and acceptable pricing. Managing the risk profile whilst allowing business models to evolve is crucial.

Technology is creating new revenue streams from products and services like VoIP, PPV, VOD and PVRs, but opportunities should be confined to proven technologies with a clear route to profitability, or based on more ‘calculated’ risk-based strategies. The technology driven ‘push’ has to be balanced against consumer ‘pull’ considerations relating to preferences and enthusiasm for new products and services.

The TMT fallout drove companies to hive off non-core operations and activities. There will be a continued drive to concentrate on what you do best, understand how you add value and leverage these capabilities into the market, by using alliances to create powerful propositions. However, the increasing complexity of these alliances will mean it is critical to be able to manage individual partners, the broader alliance portfolio and its associated risks. Having the appropriate infrastructure in place will be essential for future success.

The market for converged services will continue to change rapidly. It will be vital to maintain flexibility and speed to market, in particular keeping an eye on new opportunities enabled by technology, spotting trends in the market and being able to deliver on the promise in the marketplace. Successful larger companies in this space will be excellent fast followers and will clean up the first mover ‘minnows’. Smart movers will be able to take the good ideas from failing ventures and make them work (compare iTunes’ success with Liquid Audio’s failure). Success will be determined by being lean enough to react quickly and effectively and capitalise on new developments in the market, not only using your size to win, but using the extended enterprise and your third party relationships too.

Becoming a gatekeeper allows you to develop strong relationships over time with your customer. To realise and maintain this objective, companies need to continue to understand customer needs and develop meaningful relationships with them. They must display the necessary leadership, power and influence to pull in the key partners required to provide the products and services. It will always be necessary to ensure reasonable financial returns are visible to the key organisations involved in service delivery to keep them on side. Gatekeepers also need to be sharp about managing risk, returns and operations.

For those that cannot attain the gatekeeper position, or do not desire it, you should invest in your brand and focus on creating world beating products or services. Such players should pursue the increasing number of channels to market to allow them to maximise the value of their assets, aligning themselves within as many distribution networks that make financial and commercial sense.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.