In March this year UK MVNO Sky launched its consumer mobile handset offering dubbed 'Swap'. This followed hot on the heels of Sky launching its MVNO in partnership with Telefónica UK (O2) in December 2016 as a SIM only proposition as part of its multi-play offering. These recent developments in the UK mobile market have prompted us to think about the current market conditions for mobile virtual network operators (MVNOs) in the UK, how those conditions are impacting on the ability of MVNOs to negotiate an optimum wholesale agreement with mobile network operators (MNOs), and what areas of those wholesale agreements are critical for MVNOs to address if they are to be able to compete effectively in the retail mobile market.
Market in context
Currently, there are four MNOs active in the UK mobile market: EE (part of the BT group), O2, Vodafone and Three. In addition to the four established MNOs, a significant number of MVNOs are active in the UK mobile market, including Tesco Mobile (a 50:50 JV between Telefónica and Tesco), Virgin Mobile, Lycamobile, Lebara Mobile, TalkTalk, Dixons Carphone and Sky Mobile. There is a high degree of competition in the UK mobile market between these MNOs and MVNOs, as well as mobile resellers and internet companies such as Skype, Apple, Facebook and WhatsApp who have been able to embed many traditional telecoms services into their offerings, at little or no cost to their customers. This high degree of competition, together with a general downwards pressure on retail prices for mobile services, has resulted in MNOs experiencing decreasing revenues from traditional voice and messaging services1. Regulation such as price controls on mobile termination rates and the caps on, and forthcoming abolition of, roaming surcharges is also impacting traditional revenues.
At the same time, MNOs are faced with having to make significant investments in infrastructure, spectrum and technologies to meet the ever-increasing demand for connectivity2. In-market consolidation is seen as one way to realise cost synergies which could give a merged entity increased investment capacity. However, current regulatory uncertainty (as evidenced by the decision of the European Commission in the Hutchison 3G UK / Telefónica UK merger), and political instability resulting from Brexit, are a risk to any proposed consolidation.
MNOs reviewing their MVNO strategies?
As a result of the significant EBIDTA margin pressure MNOs are under, MNOs are themselves now targeting discount or niche customer segments (often via sub-brands such as giffgaff in the case of O2) that have traditionally been the target market segments of MVNOs. MNOs may increasingly be taking the view that MVNOs are likely to damage their own underlying businesses by targeting MNOs' existing or target customers. MVNOs, in particular those with clear cost advantages in terms of existing distribution channels or other advantages such as a strong brand or content offering or being able to offer mobile services as a loss leader (either stand-alone or as part of a service bundle), pose the greatest threat to an MNO's business. Virgin Mobile and Sky Mobile are two obvious examples. Scale MVNOs may also exacerbate capacity issues (in particular in urban hot spots such as central London) for MNOs who have relatively low amounts of spectrum which may result in a poor quality of experience for MNOs' existing customers and the potential to lose market share and damage their businesses.
The incentive for MNOs to host MVNOs, or alternatively to provide competitive wholesale deals for MVNOs (particularly on 4G), is likely to be impacted by the factors outlined above. So much so that there is evidence of a number of new MVNO business models and services emerging as MNOs review their MVNO strategies, with examples including global virtual numbers, network roaming propositions, money remittance and mobile payment services and Wi-Fi calling apps.
The lure of wholesale revenue
So why do MNOs still choose to facilitate additional competition despite the pressures MNOs are under? The primary reason is that the MNO gains all of the wholesale revenue, does not incur any costs associated with customer acquisition and retention, and will (if it selects its MVNO partners carefully) only experience a marginal increase in competition. The case becomes increasingly compelling where the MNO has unutilised capacity on its network, it operates in a mature market or the cost of customer acquisition and retention is high. We therefore see traditional MVNO models continuing for quite some time yet.
With this in mind it is important for MVNOs in negotiating their wholesale agreements with MNOs to ensure that, in addition to negotiating favourable wholesale rates (in particular for 4G services), appropriate protections are included in those wholesale agreements to ensure they can compete effectively in the retail market. We describe some of those protections in Table 1 below. Naturally, how successful an MVNO will be in negotiating these protections will depend on the leverage it has which will be driven predominantly by the level (and credibility) of its forecast traffic volumes and therefore how much wholesale revenue the MNO will gain, and also the extent to which the MNO sees the MVNO as a real threat to its business.
| SUGGESTED PROTECTION | COMMENT |
|---|---|
| INVESTING IN THE NETWORK | It is important for an MVNO to have confidence that the MNO will continue to invest in its network so that the performance of the network (at least) keeps pace with the performance of the networks of the other MNOs in the market over the term of the wholesale agreement. This could be achieved for example by expanding the geographic and population coverage of the network, increasing, refarming and/or sharing spectrum holdings, upgrading and densifying its mobile sites, upgrading its mobile backhaul to fibre, introducing new software and hardware into the network and adopting new technology standards. This will be particularly important in the context of long-term arrangements with minimum revenue commitments and penalties for early termination.
We have seen MNOs agree to termination rights if the size of their spectrum holdings relative to their holdings at the start of the wholesale agreement reduces during the term of the wholesale agreement such that it has a material adverse effect on the services. MVNOs should push for such rights as this will incentivise the MNO to invest in spectrum, such as the 2.3 and 3.4 GHz spectrum bands which are expected to be awarded later this year. MNOs will naturally resist contractually committing to meet an investment standard, as they will say it is dependent on activities of the other MNOs and the MVNO should get comfort from the committed service levels and other contractual remedies it has for poor performance. |
| MEETING COVERAGE OBLIGATIONS | MVNOs may seek to contractually bake in an obligation on the MNO to meet certain population and geographic coverage obligations in the MNO's spectrum licences or which are otherwise imposed by a regulator. And we have seen such obligations tied to a right to liquidated damages if the coverage obligation is not met, as well as a termination rights in certain circumstances. MNOs will strongly resist such obligations, as they will argue that their coverage obligations are to the regulator and they are already exposed to the risk of substantial fines and reputation and brand damage if they fail to meet those obligations and, for that reason, it is therefore not reasonable for them to take on any more risk. |
| EXCLUSIVITY | Exclusivity is one of the key elements of any wholesale agreement for an MNO as it locks in the projected or committed wholesale revenue. What will be important for an MVNO is to provide for exclusivity to fall away in certain circumstances, for example, if a catastrophic service level failure occurred or the MNO breached the non-discrimination or most favoured nation pricing provisions.
MVNOs should also make it clear that exclusivity does not restrict their ability to structure, price, promote and distribute the mobile services in any way (including by bundling such services with other communication services), or build their own supplemental network using, for example, unlicensed or licensed spectrum. This is critical for MVNOs who either own or have access to a fixed network with a large installed base of small cells as it allows them to divert traffic away from the MNO's network and thereby mitigate the impact of high wholesale data rates. Furthermore, if the MNO will not commit to providing certain mobile services, for example, mobile services based on 5G standards, then MVNOs should insist on a carve out from exclusivity for those services. Finally, exclusivity should not prevent an MVNO from discussing a possible new wholesale arrangement or commencing a procurement process in advance of the end of the term of the wholesale agreement. |
| PRICE | MVNOs should insist on being protected against the MNO cutting its retail prices below or too close to the MVNO's effective wholesale rate. The most straightforward way to achieve this would be to agree a 'retail-minus' price per unit of traffic. |
| NON-DISCRIMINATION | MNOs should be required to provide MVNOs with at least the same quality and range of services and coverage as MNOs provide to their consumer and business customers (and potentially their affiliates and wholesale customers). This 'non-discrimination' obligation should also apply in circumstances where the MNO suspends the provision of the services for maintenance and emergencies or for fraudulent or other unauthorised use of the MNO's network by an MVNO customer. It is common practice to agree certain exceptions to the obligation, such as where there are differences in the specifications or standards of MVNO’s core network and MNO’s core network and such differences have a material impact on the services provided to the MVNO. |
| ACCESS TO TECHNOLOGIES | MVNOs should insist on MNOs giving access to all existing and new network technologies, spectrum, products and services at the same time as MNOs provide such technologies to their consumer and business customers (and potentially their affiliates and wholesale customers). Examples of such technologies may include VoLTE, LTE-Advanced and LTE-Advanced Plus.
MNOs should be receptive to such requirements but will usually be reluctant to agree to provide some categories of technologies to MVNOs 'at the same time' as they will claim there are technical and operational issues which prevent them from doing so. MVNOs need to stress test these claims to ensure the MNO isn't simply using this as way to steal a march on the MVNO and be first to market with such new technologies. |
| TECHNOLOGY ROADMAP | MNOs should be required to provide MVNOs with regular visibility of, and a right to input into, the MNO's technology roadmap. This is an important tool for MVNOs to be able to see what new products and services are planned for the MNO and its wholesale customers (including the timing of the prototypes and development trials, and commercial launch) and to therefore plan accordingly. |
| SERVICE LEVELS / KEY PERFORMANCE INDICATORS AND LIABILITY REGIME | The service levels negotiated between an MNO (if agreed at all) will, in most cases, be the same as the internal standards of performance against which the MNO is measured in providing the same services to its own customers. Service credits may be agreed depending on the commercial leverage the MVNO has. Probably more important than service credits though is that where the level of service is particularly poor (measured over an agreed period of time and subject to the implementation of remedial plans etc.), it triggers a right for the MNVO to break exclusivity and terminate the wholesale agreement. This is an important right to avoid a situation such as that experienced by customers on the Vodafone Australia network in 2010 where there were prolonged outages, blackspots and slow 3G connections. Whilst the principle is most likely to be accepted by MNOs, precisely what that trigger point is will be heavily negotiated. |
| MOST FAVOURED NATION PRICING | In order to ensure the MVNO receives the best wholesale rates in the market, it should consider requiring that, if during the term of the wholesale agreement, the MNO offers more favourable rates to a third party for services which are the same or similar to the services provided to the MVNO, then the MVNO is entitled to a retrospective adjustment of its rates to the same level as those of the third party. In some circumstances MNOs may be receptive to such requirements, but the issue of how to determine whether the services are "the same as or similar to" will be heavily negotiated. |
| FORECASTING | The parties will need to agree a traffic forecasting mechanism which enables the MNO to plan and build the capacity in its network that aligns with the MNO’s overall network demand forecasting timetable, and to meet the demand forecasted by the MVNO under the wholesale agreement. The MVNO should be permitted to change its forecasts, within certain agreed limits, up to a point in time in the forecasting cycle when the forecasts for a given period become binding. MNOs will seek to introduce measures in the wholesale agreement to promote accurate forecasting to protect the experience of all end users on the MNO network – such measures often include penalties for incorrect forecasting. This should be resisted by MVNOs, or at the very least, a requirement should be imposed such that any penalties imposed for incorrect forecasting only apply after consistent incorrect forecasting which has a demonstrated material adverse impact on the MNO and the quality of service experienced by its end users. |
| TERM | MVNOs should have the option to extend the term of the wholesale agreement at the end of the initial term. This will provide certainty around supply on the same terms, including price, for an extended period. MVNOs will, unless strictly necessary, want to avoid having to re-tender the services and switch MNOs given the cost and disruption associated with switching. MNOs will generally be receptive given the wholesale revenues they will receive as a result, however they will probably seek to impose certain conditions during any such extension period, such as that any minimum revenue commitment would be extended. |
| RESALE / DISTRIBUTION RIGHTS | The MVNO should seek maximum flexibility in how it can distribute the services provided to it under the wholesale agreement. Permitted distribution entities should include any MVNO affiliate, and any third party provided that the contractual relationship is between the MVNO or an MVNO affiliate and the end user of the services. The MNO will, for obvious reasons, reject any suggestion that the MVNO can provide the services to a third party on a wholesale basis. |
| OWNERSHIP OF CUSTOMERS / CUSTOMER DATA | The MVNO should take steps to ensure that it is clear that, as between the MVNO and the MNO, the MVNO 'owns' the relationship with the customers to which it provides services. In addition to more general provisions relating to data protection and confidentiality, specific provisions could be included which provide that, in respect of MVNO customers, the MVNO handles and administers all contractual relationships, including initiating and entering contracts, administering requests, credit checking, billing and collecting payment, supplying handsets, providing customer care and terminating relationships. And that the MNO will not perform any services directly for MVNO customers unless provided for in the wholesale agreement. |
| MARKETING | In order to protect an MVNO’s customer base, the MVNO should place restrictions on the MNO in relation to its marketing activities. Such restrictions could include, for example, that in marketing the MNO's services the MNO does not use the MVNO’s customer information or data, or directly target the MVNO’s customers with specifically created differential offers, incentives or advertisements. |
| EXIT / RUN-OFF | When the wholesale agreement is terminated or expires, the customers of the MVNO will need to be migrated from the MNO’s network to the network of a replacement MNO. Any material delay or issue in the migration process could result in a poor customer experience and have serious consequences for the MVNO's business. The MVNO should therefore require the MNO to agree to take steps to ensure that, during the migration, the migration is carried out with the minimum disruption possible to those customers. This can be achieved by having the MNO agree that it will continue to provide the services on the terms set out in the wholesale agreement during the exit period (such period to be set so that it allows for the phased migration of customers to the new MNO). And an exit plan should also be agreed (as part of agreeing the wholesale agreement) which sets out any other obligations on the MNO during the exit period. |
1 For example, in 2015 the total number of outgoing SMS and MMS messages continued to fall, down by 8 billion messages (7.6%) to 101 billion messages, although this was a smaller fall than in 2013 and 2014. (Source: Ofcom Communications Market Report 2016.)
2 The main drivers of such demand have been the launch and mass adoption of smartphones, the development and use of mobile data services and application, advancements in the capabilities and performance of mobile devices and the launch of 4G services. In the UK, in Q4 2015, 4G accounted for 46% of all mobile subscriptions. And the availability of 4G services in the UK is widespread, with at least one MNO having 97.8% outdoor premises coverage in May 2016. (Source: Ofcom Communications Market Report 2016.)
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