Orange and Wanadoo in the UK: a match made in France? June 2006 [2006-e27]
• Orange’s new ‘free broadband’ offer brings savings of up to 60% for Orange UK customers who pay for broadband, and may appeal to a great many of them
• The product, however, has a massive cost to Orange’s economics, and we cannot see how lowering churn or offering extra services can possibly compensate for this – the strategy appears to be driven by French rather than English economics
• In any case, we estimate that less than 20% of UK mobile users are the actual bill payers for DSL broadband (hence addressed by this offer), so the converged mobile/broadband market is an expensive distraction for any operator that indulges in it
• This move puts further pressure on the remaining UK pure play ISPs to follow Carphone Warehouse’s lead into a combined voice and broadband offer based on full local loop unbundling
Following from the structural merger of Orange (mobile) and Wanadoo (broadband/ISP) in the UK, the company recently gave details of the merger of their customer-facing operations and offers. Wanadoo products will now be sold in the c.300 Orange shops and a merged website will sell both product sets, which will be supported by a merged customer service organisation. The company will also launch combined products, three of which are being launched this month, the most eye- catching of which is a 'free' broadband offer to Orange mobile subscribers.
Firstly, we should discuss the very relevant background to the two companies. Orange reports around 15 million subscribers, and has approximately 23% of the UK mobile market by revenue, making it the 3rd largest operator by this measure, but not very far behind O2 (it was #2 in 2004). Wanadoo has around 1 million broadband and 1 million dial-up subscribers, and has about 9% of the UK broadband market. Orange is about 10 times the size of Wanadoo in revenue terms, and although Wanadoo UK does not report profits, we are confident that Orange has much better margins. Both companies are slightly struggling in their respective markets, with Orange having lost contract subscribers for the first time ever in the March quarter, and Wanadoo having been recently surpassed by Tiscali in broadband subscriber numbers to become 5th in the market. Both Orange and Wanadoo are owned by France Telecom, the incumbent fixed and mobile operator in France, which is pursuing an integrated operator strategy in that market offering combined products and services.
Telecoms James Barford +44(0) 20 7499 1581 [email protected] Ian Watt +44 (0)7968 969438 [email protected] Will Harris +44(0) 20 7499 1582 [email protected] Adam Rumley +44 (0)7931 732407 [email protected] Orange and Wanadoo in the UK June 2006
In terms of market context, the UK mobile market is worth around £16 billion a year in service revenues, compared to the broadband market at around £2 billion, and the entire consumer fixed line market (including broadband) at about £8 billion. There have been numerous attempts by alternative fixed line operators to sell mobile services, all of which have disappointed, with even BT’s mobile business stagnating, and its Fusion product attracting only around 30,000 customers. The only mobile operator that we are aware of that has attempted to sell Internet services is, err, Orange, which was presumably not a great success, as it quietly closed its Orange.net service down.
It is an obvious conclusion that much of the UK integrated operator strategy is driven from France by a desire to align subsidiaries’ strategies with that of the parent. However, the very different sizes of the UK businesses implies different consequences of this strategy; while it is relatively easy for Orange to help boost Wanadoo's business (through marketing, distribution and network help for example), this does little for the combined company's growth profile. Wanadoo helping Orange would on the other hand make for a substantial boost, but is much harder to achieve.
Now for the details of the 'free' broadband offer. New or existing Orange customers qualify who sign up for an 18 month contract with a fixed element of more than £30 a month on the colourfully named Racoon, Canary and Panther tariffs (but sadly not on Dolphin). The broadband service is the same as Wanadoo's existing "Broadband Plus" offer, which is currently priced at £17.99 a month and which offers speeds of up to 8MB, a free Wi-Fi modem (Livebox), and free VoIP evening and weekend calls to landlines. The offer is available through Orange stores, online and by phone (but not through third party stores such as Carphone Warehouse as yet), and has no obvious catches that we can see.
Will it prove popular? The potential savings are quite dramatic - to state the obvious, a contract mobile user spending £30 a month can save £17.99 a month, or 60% of their mobile bill. While not all mobile users will match this particular criterion, we expect that millions would be able to save over 30%, still a very significant amount. Indeed, we expect that the vast majority of individuals who currently pay for DSL broadband can save something. Compared to mobile users, this group is actually not huge; the number of DSL (i.e. non-cable broadband) household subscriptions is about 8 million, or 17% of the 48 million UK mobile users (the reported mobile subscriber figure is obviously even higher, but not entirely relevant). The rest of mobile users are either cable broadband users, have access to DSL but are not the bill payer, or do not have access to the Internet at home. Even looking to the future and assuming that eventually 65% of households buy broadband, the figure peaks at just 26%. The offer is, however, not the cheapest combination available to these people; by our estimates, a T-Mobile Flext tariff combined with the TalkTalk 'free broadband' offer is actually marginally cheaper on the most directly comparable basis (although Orange will be cheaper for many calling patterns).
Our main concern for Orange is that the customers with whom it will prove most popular are already Orange customers. In the broadband market, the cheapest offer (provided it is well marketed) does very well (e.g. Tiscali's recent success), but in the mobile market quality is more important - for example the traditionally cheapest GSM operator, T-Mobile, is still the smallest of the four. Given also that the offer will only be available in Orange distribution channels, and it seems likely that Orange customers will convert in large numbers, but relatively few truly incremental customers will be attracted.
2 Orange and Wanadoo in the UK June 2006
This is bad news because the impact of the offer on Orange's economics is very significant. DSL broadband providers operate at very slim or even negative margins, and we estimate the full cost to Orange of providing the broadband service at around £17 a month assuming it uses a mix of IPStream and shared LLU with 500 exchanges unbundled (its plan for end 2006), and amortising equipment costs over the 18 month contract. The total cost of the broadband service over the life of an 18 month contract is thus £306, extremely expensive when considered as an additional SAC. To put this in context, taking our estimates of the revenues and costs over an 18 month contract for a £45 ARPU customer, the impact is to reduce the value from about £410 to about £100.
Orange is hoping to reduce its net cost by rolling out full local loop unbundling , which would enable it to bill the customer for line rental and all voice calls, which could reduce its net cost to as little as £8 a month1 in unbundled areas if they charge the full BT line rental price of £11 a month. However, we doubt many will take up this offer even if the line rental is modestly discounted; it means a complete break with BT, and the unreliability and variable quality of VoIP telephony. The current simple ‘free broadband’ offer is much more appealing, and therefore these cost savings will be elusive.
The main mitigating factor on Orange's financials is that only a small proportion of its base is likely to take up the ‘free broadband’ offer as only a small proportion currently are the bill payers for DSL broadband. However, we estimate the negative impact of even this small group taking up the offer to be around 10 percentage points of Orange UK’s margin. Even though some will not be eligible as they are spending below £30 a month, and not 100% of those eligible will take up the offer, this is still a very frightening figure.
Why is Orange pursuing such a strategy? We suspect that the impetus is from France, and that the UK subsidiary has put together an offer that will at least not harm its market position, even if it is expensive. However, the company does make two justifications: (i) Churn will be reduced. We are very suspicious of this - pushing customers onto an 18 month contract may not make them very happy at the end of it. Furthermore, mobile churn is in a way overstated – much of the churn is actually from customers re-signing with the same network to get a better deal; real churn generally comes from a poor customer experience, and we believe that offering a relatively complex customer support intensive service such as broadband will actually increase the chances of this. (ii) Revenue will be gained from new services. Orange is admittedly now in a position to offer more integrated services, such as a common voicemail, a BT Fusion type product, and the often mentioned online photo blog (?), but we think that the appeal of these products will be quite limited, and have little to no chance of making up for the £17 a month giveaway. The company even has ambitions in offering TV services, despite having no content that we are aware of.
The remaining UK mobile operators are faced with a clear choice: either compete with Orange in broadband, or focus on the 80%+ of customers who are not addressed by this service. Although all logic would point to the latter approach, we fear that some may take the former, with rumours abounding that O2 is interested in making a broadband operator acquisition, and Vodafone is developing a DSL resale strategy.
1 Note that Carphone Warehouse’s economics are not directly comparable to this because (a) CPW charges a connection fee of £29.99, (b) CPW’s ‘free’ broadband offer includes an implied £9.99 charge for unlimited calls to landlines, but Orange’s offer already includes unlimited off-peak calls thus it cannot add such a charge, and (c) Orange includes a Livebox with its offer, which is much more expensive than a basic modem. 3 Orange and Wanadoo in the UK June 2006
For operators that choose to ignore broadband, the prospects are actually quite favourable, as marketing focus is drawn away from the bulk of customers.
The prospect of free broadband for mobile users is obviously not a welcome one for the UK broadband industry. While NTL/Telewest is partly protected by customers having to return to BT to take advantage of the offer, and Carphone Warehouse (CPW) already has a competitive offer in the marketplace, the pure play ISPs such as AOL and Tiscali now have additional pressure to follow CPW’s lead into a fully unbundled voice and broadband offer, with those too small to unbundle left floundering. BT is the least able to react, and furthermore may see its consumer voice market share loss accelerating as the ISPs include voice in their offers. Orange’s launch also puts additional pressure on BSkyB, which has yet to launch its broadband service. If it delays too long, BSkyB will find that a significant proportion of its 8 million pay-TV customers have already signed up to the Orange or CPW offers.
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