Telecom giants diverge on best way to converge

Operators talk of massive cost savings in merging fixed and mobile assets
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Two of the European telecoms sector's biggest hitters have unveiled radical plans to tap growth from so-called "converged" services outside the mobile sector.

Telecom Italia is set to follow BT's lead by splitting its mobile operations from its fixed-line network to carve a strong position in the media sector. Meanwhile Vodafone, the darling of the mobile industry during the 1990s, has linked arms with BT to target fixed-line and broadband growth.

The plans will cause many observers to reassess what the overused industry term convergence - offering a variety of communications services as part of one package or over one network - actually means. Vodafone has made clear its intention to target broadband access as an area in which it can flex its muscles since the start of the year but Telecom Italia's U-turn has rocked the market.

There has been a buzz around the notion of convergence in the telecoms sector for some years. Fixed-line telecoms companies, mobile operators, media players, retailers and cable television operators have invested in expanding their operations to offer a host of communications services as part of one package. The cable television operator NTL has been the most active in this market after buying Virgin Mobile to offer broadband, television, fixed and mobile services as part of one package. By offering a variety of services as one package, with some products billed "free", companies hope to increase customer loyalty.

Until now, telecoms companies have approached the idea of convergence in different ways, based predominantly on an existing business model or set of assets. Hence BT - which has no mobile network - has focused on services that can be delivered over a fixed-line such as broadband and digital television. Conversely, Vodafone - which has offered similar services over its mobile network - will look to fixed-line broadband to shore up its mobile customer base. Meanwhile, integrated operators such as Telecom Italia and France Telecom have looked to tie fixed-line and mobile assets to drive cost savings and offer unique services.

Telecom Italia has been one of the most vocal advocates of fixed-mobile convergence since it brought its mobile division TIM back into the fold last year. The Italian incumbent operator spent more than €20bn (£14bn) last year to buy back the 44 per cent of the mobile operator that had been listed. Yet yesterday, it decided to separate its mobile and fixed-line network divisions and said it would seek ways to "extract value" from the assets. Hence, its decision last year to buy back its mobile unit not only looks like a very expensive strategic diversion, it also suggests that combining fixed-line and mobile assets might not be as compelling as the telecoms sector assumes.

When Telecom Italia repurchased TIM, it pushed the notion of a "one company" business model whereby its management, marketing and network would be merged into one. The company reported that in the first half, it had achieved more than €600m in operational savings as a result of the integration. Other incumbent operators, most notably France Telecom, which owns the Orange mobile network, also talk of massive cost savings in merging fixed and mobile assets that could be used to offer new services such as "home zone" phones that combine the functionality of mobile phones with fixed-line prices.

Yet it appears that Europe's fifth-largest telecoms operator is set to break stride with its larger peers in Germany, France and Spain in splitting off its mobile operations. Telecom Italia hopes that focusing on the media sector will drive a re-rating of its shares since media groups are valued at roughly twice as much as telecoms companies. A potential sale of its mobile operations would also reduce the company's €40bn debt pile.

Telecom Italia intends to focus its efforts on broadband services and selling media content through its broadband network. Marco Tronchetti Provera, chairman of Telecom Italia, has been negotiating with News Corp's Rupert Murdoch about a content deal. Telecom Italia will pipe content including Fox television and films, as well as live European football, to its broadband customers in Italy, Germany and France.

Yet the shifting of focus towards media services and away from mobile has raised eyebrows. Richard Ireland, at Ernst & Young, said: "This is a pretty bold move. It shows a lack of stability among the mid-sized and smaller players in the European telecoms space. It is a severe strategic U-turn against the grain of what we are seeing elsewhere."

Telecom Italia's decision will undoubtedly raise a smile at BT, which has for years battled against the perception that it could not survive without an integrated mobile division. Owing to its crippling debt, BT demerged its mobile arm in 2001 and for years struggled to convince investors it could grow revenue without a mobile arm. Yet with broadband booming and a television service launch around the corner, BT's transformation has caught the eye of its Italian peer.

Telecom Italia's decision to change tack and target the convergence between fixed-line and media services, as opposed to fixed and mobile telecoms, also reflects the view that life is only going to get tougher for mobile operators in mature markets such as Italy, Germany and the UK.

The need for mobile companies to diversify outside the increasingly competitive market for mobile-only customers is illustrated by Vodafone's entry into the UK fixed-line broadband market. Vodafone had been steadfast in its rejection of fixed-line competition but increased competition in the mobile space and booming demand for broadband in its core markets has led to a re-evaluation of that strategy. It has struck a wholesale deal with BT to use its network to offer branded broadband. The deal seals an inverse relationship as BT piggybacks on Vodafone's mobile network to offer branded mobile services in the UK corporate and consumer markets.

The wholesale arrangement lowers the risk for Vodafone as its investment in broadband will reflect demand for the service. Unlike its UK rivals Orange and O2, it does not own the network infrastructure so will not need to invest in building up its network. The service, launched in time for Christmas, means Vodafone can fight on an even keel against the likes of Orange, which is offering free broadband.

It still remains to be seen whether a focus on convergence will pay off. Although it has taken the lead on fixed-line and media convergence, BT has yet to prove such a focus will deliver the tangible financial benefits it hopes for, while NTL's decision to offer mobile, television, internet and fixed-line telecoms under one package has been met with scepticism.

With so many companies jostling for position for a slice of the future telecoms/media pie, it is yet to be determined which business model will succeed, if any.