Jan 22, 2013

Building a "billion dollar" M2M business

Over the past 1-2 years, the concept of a “billion dollar” business has often arisen in my project related discussions concerning multi-national operators. Indeed, Matthew Key (Head of Telefónica Digital) recently set a target of Eur.0.5-08bn (almost US$1 billion) for its M2M revenues by 2015. A billion matters in the frame of reference for most large operators because anything smaller often does not warrant management attention. This is understandably the case when resources are being requested of Group-level decision makers who have to weigh competing market opportunities.

So, what does a billion dollar business look like? How might an MNO reach this level of revenues within a 3-5 year interval of time? And, what are some of the business model implications for operators pursuing a “billion dollar” goal? 

A Simple Connectivity Model

Let’s begin by looking at top-line, recurring revenues. In the case of a first-generation M2M business unit that is focused on adding connected devices to its network, this is most easily calculated from the number of connected devices and the average revenue per device. The traditional M2M market is associated with low-levels of revenue per connected device, typically in the US$1-5 range. For illustrative purposes, let us work with a mid-point revenue figure of US$3 per device per month and let us also assume that prices decline over time, as with other telecommunications services; for illustrative purposes, we use a rate of 5% per year. 

Let us also posit that our multi-country operator has already built-up a base of 7 million connections. This is not an unreasonable assumption; the analyst firm Berg Insight estimates that the world’s ten largest telecom operators by revenues accounted for 68.2 million M2M subscribers at the end of 2011. Citing specific operators, Berg Insight estimates an installed base of 7-9 million for each of T-Mobile, Telefónica, Vodafone and Verizon Wireless. For its part, Vodafone’s 2012 Annual Report indicates an installed base of 7.8 million connected devices. Furthermore, Vodafone's base has grown by about 45% in each of its last two years of operation.

With these initial assumptions, our representative operator can achieve $1 billion after 5 years of operation if its installed base of M2M connections grows at 55% per year as illustrated below. To get to a billion in 3 years requires a compound annual growth rate (CAGR) of over 150%!

A CAGR of 55% is roughly double the rate of growth that most analysts project for the connected devices industry as a whole. To put this into perspective, Ericsson’s much quoted 50 Billion vision works out to a CAGR of about 30%. The likelihood that more than one operator can consistently capture a disproportionate and dominant share of this market is low, barring a significant merger or acquisitions strategy.

As the market develops, the assumptions behind this simple model are likely to face further stresses. One such relates to the average revenue assumption for connected devices. Consider two of the leading application areas for near-term and high-volume M2M opportunities - smart metering and emergency assistance automotive applications. The basic services associated with both of these applications are expected to involve low-volume and infrequent transfers of data (data usage is an important determinant of device revenues due to the industry’s legacy pricing models) and a low perception of the value that can be monetized from these services. As a result, the per-device connectivity revenues from these market segments are likely to be at the lower end of our estimated range. This will dilute the average revenue per device prompting an annual price decline that could exceed our -5% per year assumption.

Other Ways to Drive Top-line Revenues

Other approaches to boost revenue take the form of one-time service opportunities. Examples include hardware sales and implementation management services.

Some specialist M2M providers in the US market began their businesses by selling connectivity hardware in combination with M2M data services. If an M2M modem or connected device can be sold for $100 this significantly boosts overall revenues bearing in mind that our representative operator generates about $36/year from connectivity services. Telular, a US based M2M service provider, has reported that it has been able to sell connectivity hardware and generate a modest but sufficient margin to offset its customer acquisition costs. This is nonetheless a challenging proposition and Telular has progressively sought to reduce its hardware business in favour of M2M services.
Another way to boost revenues is through professional services for companies that require design advice in implementing and operating a connected devices strategy. In 2011, I was involved in a survey of over 200 non-mobile companies planning to add connectivity to their products. The exhibit below characterizes current and future demand for M2M outsourcing services across several industry verticals.

The intent to outsource is pronounced for each and every vertical. The healthcare sector in particular stands out for its projected level of demand. This probably reflects the fact that healthcare device vendors anticipate a significant shift to remotely connected services while also recognizing the need for external expertise in implementing embedded connectivity solutions.

The provision of outsourcing services holds considerable value and can contribute to the top-line revenues of a service provider. As with hardware sales, the revenue contribution is likely to be material relative to M2M connectivity revenues and front-loaded to the inception of any given implementation.

Neither the hardware nor the outsourced services strategies totally resolves the question of a billion dollars in recurring revenues which plays a part in the valuation of an M2M business unit. Since the connected device installed base is likely to grow at a rate that is more in line with the overall connected devices industry, additional sources of revenue have to come from sustainable and on-going increases in per-device revenues. To a limited degree this is happening as higher data consumption applications such as remote video monitoring, for example, are deployed. At present, there are not enough mass market offerings such as this to shift the industry-average revenue per device.

A Billion in Recurring Revenues

A more broadly applicable approach is possible if M2M service providers augment their basic connectivity offering with service enablement and managed connectivity offerings. Data from the previously referenced M2M Service Enablement Service (SES) study from Beecham Research shows that on a per-device basis, declining connectivity revenues can be more than offset by rising SES revenues.  Pricing expectations from this study indicate that while connectivity pricing is expected to decline by about 2% per year, SES revenues could grow at about 9% per year. Considering the range of over 20 services categories that form the SES portfolio, the scope for value creation that underpins the 9% projection is not unreasonable.

Applying these assumptions to our hypothetical M2M service provider yields a billion dollars in revenues within 5 years from a base of connected devices that needs to grow at about 24% per year. While this is still demanding it is not as extraordinary as the initial case. This can be seen from the contrast in connected device installed-base projections below.

The figures above are generalizations to illustrate the challenges in building a billion dollar business. Without an extended run of exceptional good fortune, a connectivity-only strategy is fundamentally flawed. Additive value propositions, such as M2M service enablement services, that are applicable across the M2M applications base and which represent a recurring stream of revenues represent one long term strategy. A discussion of other approaches will be saved for a future post. Whichever strategy is chosen, mobile operators will need to acquire and also to market new capabilities through some mix of organic initiatives and alliances with specialists in the market.

The bottom line from this basic analysis is that MNOs need to address the twin challenges of converting connectivity opportunities into active, revenue contributing units. At the same time, they also need to market new services that are incremental to basic connectivity and which are capable of driving recurring revenue streams. You can read more about a framework to analyse and address these challenges here.

On a final note, while this post has focused on top-line revenues, preferably of a recurring nature, an equally important issue is that of profitability and sustainable value creation. These are topics I plan to cover in future posts.

1 comment:

  1. 29 Oct 2015 update

    It's interesting to note how attitudes are shifting in the mobile-operator space, especially the growing recognition that serious revenues will come from platform services (and eventually applications).

    Here's how Verizon sees the relatively tiny share of connectivity revenue in M2M/IoT applications.

    “We’ve figured out how to drive revenue, and it’s not a connections market, it’s really about how to grow revenue for your customers and serve your customer better,” Lanman says. He adds that Verizon has figured out that 80% of the revenue opportunity in the Internet of things comes from applications and 15% comes from the platform and only 5% is in the connectivity—so if Verizon were to only focus on connectivity it wouldn’t be playing in the market at all".