Over-the-Top Communications : Threats & Opportunities for Mobile Operators

SECTOR REPORT

Over-the-Top Communications: Threats & Opportunities for Mobile

Operators October 2012

Chris White Lead Analyst

Matt Lewis Research Director

ARCchart 78 York Street London W1H 1DP United Kingdom Tel: +44 33 00 88 1355 Fax: +44 33 00 88 1350 [email protected]

ARCchart is an independent research and consulting firm focusing on all aspects of the wireless communications sector. Based in London, ARCchart’s depth and breadth of analysis provides a global perspective on wireless technology and industry developments. Combining original thinking with exceptional knowledge and experience, ARCchart assists clients in making sound commercial decisions about technologies, market strategies and competitive positions. ARCchart’s strategic advice covers all aspects of the wireless value-chain - ranging from semiconductors and WLANs to network operators, handsets and mobile applications.

This report draws upon research and analysis conducted by all the ARCchart information groups. Use of this report by any third party for whatever purpose should not, and does not, absolve such third party from using due diligence in verifying the report’s contents. Any use which a third party makes of this document, or any reliance on it, or decisions to be made based on it, are the responsibility of such third party. ARCchart, its affiliates and representatives accept no duty of care or liability of any kind whatsoever to any such third party, and no responsibility for damages, if any, suffered by any third party as a result of decisions made, or not made, or actions taken, or not taken, based on this document. ARCchart does not make investment recommendations, in this report or otherwise, and nothing in this report should be interpreted as an opinion by ARCchart either on market forecasts or on the prospects of specific companies.

Over-the-Top Communications: Threats & Opportunities for Mobile Operators

Executive Summary

Over-the-top (OTT) communications represents the largest threat to mobile operator revenues in the last 10 years. Prominent examples of OTT services, like Skype and WhatsApp, have had a direct impact on the mobile industry’s profitability and are placing pressure on operators at a time when they are compelled to build expensive new 4G networks.

Today, VoIP is capturing an increasing proportion of mobile voice minutes, but in terms of value it is still worth less than 0.5% of overall voice revenues. With regards to messaging, ARCchart expects that instant messages will exceed SMS volumes by 2014 and continue growing rapidly thereafter, accounting for 65% of all message traffic pushed over mobile networks by 2016.

This report examines the implications of widespread adoption of mobile over-the-top IP communications for mobile operators, handset vendors, and the OTT providers themselves, looking at how OTT players have gained a foothold at the expense of the mobile network operators and analysing how the various ecosystem stakeholders are dealing with the new industry dynamics. The report sizes the OTT market both in terms of revenue and users, and forecasts growth in relation to traditional circuit-switched voice and text messaging.

In many ways, the seeds of success for the OTT providers were sewn by the mobile operators themselves who offered flat rate data plans to encourage consumption of 3G data, and who opened their network APIs in an effort to fill the pipes. This research presents case studies showing how operator voice and SMS revenues – which still equate to 80% of total revenues – have been eroded through revenue leakage to third parties.

A major driver for OTT services has been the ever-increasing penetration of smartphones. Growth of iOS and Android devices and their respective ecosystems have acted as a fertile breeding ground for many of the nascent OTT services currently in play. Global smartphone penetration is expected to be 51% of total handset sales by the end of 2016, up from an estimated 31% in 2012.

The report examines how operators have responded to the OTT challenge, from early attempts to block OTT service from running through the network, to offering large bundles of SMS and voice minutes at attractive prices in order to compete with VoIP and IM. Some operators have looked to partner with the OTT providers as a way of differentiating themselves – a strategy that has proved successful with new entrants.

i Over-the-Top Communications: Threats & Opportunities for Mobile Operators

The strategies which mobile operators can leverage in order to fight back against the rise of OTT services are a central aspect of this research, and the GSM Association’s Rich Communications Suite (RCS) represents a key part of this defence. RCS-e exploits a number of the Achilles heels of the OTT community, including a general lack of interoperability. Skype – the largest of the OTT providers - has largely been protective of its user base and has prevented interoperability between other platforms. A lack of a strong business model is also weighing heavy on some OTT providers who have yet to monetise their offerings. RCS-e neatly combines interoperability through existing telecoms infrastructure and a billing relationship with the end-user.

Although RCS-e has been fraught with problems in its introduction, ARCchart anticipates a strong uptake of RCS-e, with around 35% of mobile VoIP users going through an RCS-e solution by 2016 and 19% of mobile IM users choosing RCS-e.

Nonetheless, several mobile OTT communications providers have critical mass and the evidence shows that even when SMS and voice are priced comparatively cheaper than IM and VoIP, many customers continue to use their OTT solutions because of the richer experience. To win back these customers operators will need to offer a compelling mix of quality products that are competitively priced and built with interoperability and ease-of-use in mind.

Selected companies within the over-the-top sector are profiled along with a discussion of how their business models are evolving. The report assesses how regulations could impact the market and how the prospects of a ‘Google tax’, or some form of tax on data usage, could turn business models on their head.

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Table of Contents

A. INTRODUCTION ...... 1

A.1 | History of Over-the-Top ...... 2 | Historical OTT Example ...... 2 Microsoft versus IBM ...... 2 | Contemporary OTT Examples ...... 2 Skype ...... 2 Apple’s Siri ...... 3 Facebook ...... 3 A.2 | The Threat to Traditional Communications ...... 3 | Operator Revenues at Risk ...... 4 A.3 | Operators Fighting Back ...... 5 | Attempts to Limit OTT Access ...... 5 | Operator Advantages over OTT ...... 6 A.4 | Report Overview ...... 6

B. MARKET OVERVIEW ...... 7

B.1 | The Evolving Mobile OTT Landscape ...... 7 | The Flow of Value Between Internet Companies and Cellcos ...... 7 | Risks to the OTT Business Model ...... 8 Transitioning from Free to Paid...... 8 User Consolidation of Services ...... 8 Support for RCS ...... 8 B.2 | Data Revenue Not Compensating for Lost Voice and SMS ...... 9 | Regional Examples ...... 9 UK ...... 9

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Netherlands ...... 9 South Korean ...... 10 | Operator Challenges to OTT Communications ...... 10 B.3 | Net Neutrality & Taxing OTT Providers ...... 11 | Google Tax ...... 11 Dangers of Taxing Usage ...... 12 | Interconnect Changes ...... 12 | South Korea Landmark Net Neutrality Agreement ...... 12 B.4 | Market Segmentation ...... 13 | Social Networking Communities ...... 13 | Mobile-First Instant Messaging Providers ...... 13 | Mobile VoIP Providers ...... 14 B.5 | Regulation ...... 14 | International Telecommunications Regulations ...... 14 Treaty Background ...... 14 Impact of the Treaty Renegotiation on OTT...... 14 Brining OTT Under the ITU ...... 15 | VoIP Regulation ...... 16

C. DRIVERS & BARRIERS TO OVER-THE-TOP COMMUNICATIONS ...... 17

C.1 | Market Drivers ...... 18 | International Calling...... 18 | Smartphone Adoption ...... 18 Smartphone Penetration ...... 19 Low-Cost Smartphones ...... 19 | Open APIs ...... 20 Ease of Handset Integratin ...... 20 OneAPI Initiative ...... 21 Carrier API Initiatives ...... 21 | Flat Rate or Low-Cost Data ...... 22 IP-Based Messaging vs. Bundled SMS ...... 22 | Social Networking ...... 22 Case study: Facebook Messenger ...... 23

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| New Business Models ...... 24 | Scale and the Viral Effect ...... 25 | App Stores ...... 25 | Data Speed & Quality ...... 26 Wi-Fi ...... 26 C.2 | Barriers to Growth of OTT ...... 27 | Narrowing Price Differential ...... 27 SMS Still Dominates ...... 27 | Quality of Experience ...... 27 | Lack of Strong Business Model ...... 28 | Lack of Interoperability ...... 28 Proprietary Nature of OTT Services...... 29 | Fragmentation ...... 29

D. VALUE CHAIN ANALYSIS ...... 30

D.1 | Operator Positioning ...... 30 | Operators in Developed Markets ...... 30 | Operators in Developing Markets...... 31 Nedjma Net ...... 31 Mobily Roamtalk ...... 31 | Operators Pressure Handset OEMs Over RCS-e ...... 32 RCS-e-Enabled Handsets ...... 32 GSMA Accreditation ...... 33 Lack of OEM Incentives ...... 33 Apple ...... 33 D.2 | OS Platform Positioning ...... 33 D.3 | OTT Provider Positioning ...... 34 | Pre-installation on Handsets ...... 34 Palringo & WhatsApp ...... 34 Facebook ...... 34 Skype ...... 34 D.4 | Instant Messaging Service Providers ...... 34 | WhatsApp ...... 35

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Platform support ...... 35 Features ...... 35 OTT Cannibalisation ...... 35 Production Positioning ...... 36 Revenue Model ...... 36 Outlook ...... 37 | BlackBerry Messenger ...... 37 Features ...... 37 Evolution towards Consumers ...... 38 OTT Cannibalisation ...... 38 Revenue Model ...... 38 Outlook ...... 38 D.5 | VoIP Service Providers ...... 39 | Nimbuzz ...... 39 Features ...... 39 Revenue Model ...... 40 Case Study: Nimbuzz on Telkomsel ...... 41 Outlook ...... 41 | Pinger ...... 41 OTT Cannibalisation ...... 42 Revenue Model ...... 42 | Viber ...... 43 Features ...... 44 Product Positioning ...... 44 Revenue Model ...... 45 Outlook ...... 45

E. OPERATOR STRENGTHS & WEAKNESS IN THE OVER-THE-TOP MARKETPLACE ...... 46

E.1 | Strategy Options ...... 46 | Operator Decision Matrix ...... 47 E.2 | Operator Anti-OTT Strategies ...... 48 | Blocking & Shaping ...... 48

vi Over-the-Top Communications: Threats & Opportunities for Mobile Operators

Restrictions at the National Level ...... 48 Traffic Shaping & Packet Inspection ...... 48 Vodafone UK ...... 49 T-Mobile Germany ...... 49 E.3 | Charging For OTT Communications ...... 50 T-Mobile’s VoIP Premium ...... 50 TeliaSonera ...... 51 | Indirect Charging ...... 51 Case Study: Telefonica Leverages OTT in Colombia ...... 51 | Price Competition ...... 52 Large Bundled Tariffs...... 52 Case Study: Nawras Response to WhatsApp ...... 52 SMS Fall-back ...... 53 Pricing Outlook ...... 53 E.4 | Partnering ...... 53 | 3UK & Skype ...... 54 | KDDI & Skype ...... 54 | Vodafone & Facebook ...... 55 | Orange & Google’s Gmail SMS Chat ...... 55 ForgetMeNot ...... 56 E.5 | Creating Operator-owned OTT Services ...... 56 | Case Study: Telefonica ...... 57 Telefonica Launches TU Me ...... 57 TU Me Features ...... 57 Jajah VoIP Services ...... 58 O2 Connect ...... 58

F. OVER-THE-TOP BUSINESS MODELS ...... 59

F.1 | Freemium ...... 59 Skype ...... 59 F.2 | Advertising ...... 59 Nimbuzz ...... 60 InnerActive ...... 60

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F.3 | Paid-For Download ...... 60 Viber & WhatsApp ...... 60 F.4 | VoIP Billing ...... 60 Yoigo ...... 60 Procera ...... 60 F.5 | Virtual Goods Market ...... 61

G. RICH COMMUNICATIONS SUITE ...... 62

G.1 | Rich Communications Suite ...... 62 | Enhanced RCS ...... 62 The Joyn Initiative ...... 63 | Operator Hopes for RCS-e ...... 63 | RCS-e-Enabled Handsets ...... 64 Handset Conformance Requirements ...... 64 | RCS-e Challenges ...... 64 Release Lead Times ...... 64 Installed Base of OTT Users ...... 64 Native Handset Support ...... 65 Handsets Availability ...... 65 Handset Performance ...... 65 Non-Compliant Services ...... 65 Clarity of Proposition ...... 65 Legacy Networks ...... 66 G.2 | Closing the Gap for Feature Phones ...... 66 | Case Study: China Mobile’s 139.com ...... 67

H. MARKET SIZE & FORECASTS ...... 69

VoIP ...... 69 Messaging ...... 69 RSC-e ...... 70 H.1 | Mobile Services Market ...... 70 | Voice & Data Revenues ...... 70 H.2 | OTT Communications Market ...... 72

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| Mobile VoIP...... 72 Global Mobile VoIP Revenues ...... 72 Regional Mobile VoIP Revenues ...... 73 Global Mobile VoIP Users ...... 74 Regional Mobile VoIP Users ...... 75 Mobile VoIP Volumes ...... 76 Destruction of Value...... 76 | Mobile Messaging ...... 78 Global Mobile IM Volumes ...... 78 Mobile IM Users ...... 80 Regional Mobile IM Users ...... 81 Mobile IM Revenues ...... 82 RCS-e Services ...... 83 Regional RCS-e Users ...... 86

I. CONCLUSIONS ...... 87

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List of Figures

Figure 1 - Vodafone’s mobile service revenue mix for Europe: 1Q 2011/12 ...... 4

Figure 2 - Correlation between smartphone penetration and lower SMS traffic for KPN...... 9

Figure 3 - Mobile data usage by application ...... 11

Figure 4 - Global smartphone penetration: 2012 - 2016 ...... 19

Figure 5 - Group chat on Facebook Messenger ...... 23

Figure 6 – Most frequently used app categories ...... 26

Figure 7 - Over-the-top value chain ...... 30

Figure 8 - Mobile users of OTT instant messaging services for US market ...... 34

Figure 9 - WhatsApp platform support ...... 35

Figure 10 - Viber’s features ...... 43

Figure 11 - Viber app downloads: 2012 ...... 44

Figure 12 - Summary of operator strengths and weaknesses in the OTT communications market 46

Figure 13 – Operator over-the-top strategy decision matrix ...... 47

Figure 14 - The 3 Skype phone ...... 54

Figure 15 - Vodafone’s 555 Facebook handset ...... 55

Figure 16 - Telefonica’s TU Me ...... 57

Figure 17 - User flow: RCS-e and OTT IP services compared ...... 67

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Figure 18 - Global mobile voice and data revenues: 2012 - 2016 ...... 70

Figure 19 - Global mobile voice and revenues as proportion of total revenues: 2012 - 2016 ...... 71

Figure 20 - Global mobile VoIP and circuit-switched revenues: 2012 – 2016 ...... 72

Figure 21 - Global mobile VoIP revenues, by region: 2012 – 2016 ...... 73

Figure 22 - Global mobile VoIP users as a proportion of all voice users: 2012 – 2016 ...... 74

Figure 23 - Global mobile VoIP and circuit-switched users: 2012 – 2016 ...... 74

Figure 24 - Mobile VoIP users, by region: 2012 – 2016 ...... 75

Figure 25 - Global mobile VoIP volume as proportion of all voice traffic: 2012 – 2016 ...... 76

Figure 26 – The Skype affect on carrier traffic: 2007-2011 ...... 77

Figure 27 - Global mobile IM volume as proportion of all messaging traffic: 2012 – 2016 ...... 78

Figure 28 - Global mobile IM and SMS volumes: 2012 – 2016 ...... 79

Figure 29 - Global mobile IM and SMS users: 2012 – 2016 ...... 80

Figure 30 - Global mobile IM user as a proportion of all messaging users: 2012 – 2016 ...... 80

Figure 31 - Mobile IM users, by region: 2012 – 2016 ...... 81

Figure 32 - Global mobile IM and SMS revenues: 2012 – 2016 ...... 82

Figure 33 - RCS-e users as a proportion of all IM users and VoIP users: 2012 – 2016 ...... 84

Figure 34 - Global RCS-e users: 2012 – 2016 ...... 85

Figure 35 – Global RCS-e users, by service type: 2012 – 2016 ...... 85

Figure 36 - RCS-e users, by region: 2012 – 2016 ...... 86

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ARCchart 78 York Street London W1H 1DP United Kingdom

Tel: +44 33 00 88 1355 Fax: +44 33 00 88 1350 [email protected]