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Overview - The communications industry

1.4 The communications industry

1.4.1 Introduction: the emergence of bundled products

Before examining revenues and sources of funding for the communications industry, it is instructive to look at some of the new business models and pricing structures being adopted by service providers.

During 2005, many major communications service providers re-evaluated their revenue, cost and investment models to reflect changes in the market. Consumers increasingly perceive communications services as commodity products, with purchase criteria driven largely by price. In such an environment, some operators can add value by branding, grouping and marketing their services in innovative ways.

A significant manifestation of this is the increase in service bundling, which is evolving to become a critical tool in offering better value to the consumer. Through bundling, operators hope to increase revenue and margins, reduce churn, and achieve efficiencies through increased cross-service use of infrastructure. (In this report, we define bundling in its broadest context: that of an operator offering multiple services under a single brand with a bundled retail price and a single bill covering the bundle. Bundling may also include a truly converged package where services are available across multiple networks and devices).

One illustration of this focus on bundling has been the recent offers of broadband services by some mobile network operators. A key enabler of this has been the improved ability to offer retail services directly to customers rather than taking wholesale products from BT. By accessing the local loop, operators typically incur higher fixed costs to install equipment at the exchange but lower wholesale charges, which can result in higher operating margins.

Consumers have demonstrated considerable interest in some of these products; Carphone Warehouse’s new bundle, which incorporates ‘free broadband’ and will be available to customers in July 2006, was demanded to such a great extent after its announcement in March that the company has warned there will be delays in connecting new customers.

Figure 1.16 below illustrates the evolution of bundled services since the cable operators first started offering TV and telephony in 1995.

Figure 1.16: The evolution of communications service bundling

Source: Ofcom

Note: Chart refers to time when bundles were first announced

1.4.2 New technologies may require new pricing structures

Voice over Internet Protocol (VoIP) could potentially prove disruptive to the business models of some mobile operators. If substantial voice traffic were to be delivered by VoIP, operators could experience revenue erosion. This threat might be mitigated through adoption of flat rate charging structures for broadband access; for example, as part of Carphone Warehouse’s ’free broadband’ offer, customers must also subscribe to a fixed line call subscription of £9.99 per month (in addition to a line rental of £10.99 per month).

Another area where pricing models are still evolving is on-demand, broadband delivery of television and radio programmes, where consumers’ propensity to pay has not yet been heavily tested. Much IPTV content (such as that in the BBC trial) is currently free, and those operators that have a pay offering have not marketed it particularly aggressively. Channel 4 and MTV have only offered a limited number of signature programmes as part of their pay offerings, although the AOL Film Download service suggests online content pricing could reduce rental or purchase prices for consumers as a result of lower distribution costs.

Most of these new operator strategies and revenue models are still in their infancy, and their impact has yet to be fully felt in reported results.

1.4.3 Overall broadcasting and telecoms revenues reach £50.6bn

Overall broadcasting and telecoms retail revenue increased by 5% to £50.0bn in 2005, equating to 4.1% of GDP (Figure 1.17). The bulk of this (£38.3bn) – and the biggest annual rise (£2.0bn) – came from the telecoms sector. Growth in 2005 television revenue was 4%, compared to 9% growth between 2003 and 2004. Combined net radio advertising and BBC radio spend declined marginally to £1.1bn.

Figure 1.17 UK communications retail sector revenue

Source: Ofcom / licensees / operators / BBC

In 2005, the mobile sector contributed £13.1bn of retail revenue – a 9% increase on 2004. The fixed-line market continued to decline, with a reduction of £800m, or 8%, year-on-year. Internet and broadband revenues grew from £2.9bn to £3.4bn. Other retail telecoms revenue (which includes elements from the wider telecoms value chain, such as mobile handset subsidies and a range of other value-added services) increased by 11% to £9.1bn (Figure 1.18).

Figure 1.18 Analysis of UK telecoms retail sector revenue

£ bn

Source: Ofcom / licensees / operators

1.4.4 Subscriptions drive TV revenue growth, with advertising slowing

TV industry revenue rose by £401m (4%) in 2005 to reach £10.5bn (Figure 1.19). Subscriptions (including pay television, PVR, high definition and multi-room services) totalled £3.9bn; net advertising revenue rose to £3.6bn; while public funding contributed £2.4bn.

The growth in total revenue was driven largely by an increase in subscriptions earned by BSkyB, NTL and Telewest. These rose by 8.5% in 2005 to reach £3.9bn and now exceed net advertising revenue by a 10% margin. This is a result of a slow down in net advertising revenue growth to just 1.9% in 2005 (following two years of average 5% per annum growth) which contrasts with five-year average growth of 14.5% for the pay-TV sector. This is turn has been driven by:

an increasing subscriber base;
a change in the mix of subscribers;
price increases; and
take-up of new services.

Public funding continued to play an important role in UK broadcasting. In 2005, Ofcom estimated that the funding allocated by the BBC to television stood at £2.4bn, up 5% on 2004. ‘Other’ revenue (which includes non-broadcast revenue such as pay-per-view, retail sales from shopping channels and premium rate telephony) has remained steady, at £0.7bn (Figure 1.19).

Figure 1.19 TV revenue 2001 to 2005

£bn

Source: Ofcom / licensees / BBC

In radio, total industry revenue declined by 1.7% in 2005 to £1.15bn – the first fall since 2001. This decrease was principally due to a fall in commercial revenue of £43m to £519m, with national commercial down £32m to £269m (despite an increase in listening share of 0.5 percentage points) and local commercial down £11m to £164m (Figure 1.20). The BBC ’s expenditure on radio in 2005 was estimated by Ofcom to account for 55% (£626m) of radio industry funding.

Figure 1.20 Radio industry revenues

£bn

Source: Ofcom

The combined net advertising revenue of commercial TV and radio grew by less than 1% in 2005 to £3.98bn, comprising a 1.9% increase in television to £3.6bn, offset by a 7% decline in radio to £0.43bn (Figure 1.21).

Figure 1.21: Growth of UK broadcasting net advertising revenue

£bn

Source: Ofcom / licensees

An analysis of the wider advertising market shows that total spend on display advertising grew by 2.1% in 2005 to £16.0bn (Figure 1.22). While newspapers, television, and direct mail accounted for 71.1% of this, internet advertising grew by 73% year-on-year to £1.1bn, increasing its share of total display spend from 4.2% to 7.1%. Internet advertising has now overtaken business magazines to become the fourth largest display advertising medium in the UK ; it is nearly three times larger than radio advertising and more than a third the size of television.

Figure 1.22: UK advertising spend by medium

£bn (2000 prices)

Source: The Advertising Association

Revenues at constant 2000 prices

1.4.5 The financial markets

Shares in the UK telecoms and media sectors have underperformed the FTSE100 since the start of 2005. The telecoms index (fixed and mobile) rose by 2% in the period to late June, while the media sector (including broadcasters, publishers and advertising agencies) was unchanged; by contrast, the FTSE 100 index gained 17% (Figure 1.23).

Figure 1.23: Telecoms and media sector share index

Source: uk.finance.yahoo.com

The Price to Earnings (P/E) ratio, a commonly-used valuation measure which relates share price to earnings per share, has reflected downward revisions to growth prospects for the telecoms sector, particularly in mobile. For Vodafone, by far the largest component of the UK telecoms index, the P/E ratio was a relatively low 11 in late June 2006 – compared to an average for FTSE100 companies of 12.6 and for the telecoms sector as a whole of 11.6 (Figure 1.24).

Figure 1.24: PE ratio and dividend yield in media and telecoms sectors

Measure	Jun	Dec	Jun
	2005	2005	2006
Telecoms sector
PE ratio	13.8	13.5	11.6
Dividend yield	3.1%	3.3%	5.1%
Media sector
PE ratio	20.7	19.1	23.8
Dividend yield	2.3%	2.3%	2.5%
FTSE100
PE ratio	14.7	14.0	12.6
Dividend yield	3.2%	3.1%	3.3%

Source: FT.com; data points for the last working day of the month

A similar pattern is reflected by changes in dividend yield (annual dividend payments per share expressed as a percentage of the share price). The average dividend yield on telecoms stocks was high in late June, at 5.1%, compared to the UK base rate of 4.5% and an average yield among FTSE100 stocks of 3.3%.

By contrast, the media sector is seen by investors to be a higher growth area, with an average P/E ratio of around 24, and a dividend yield of 2.5%, This sector contains a broad range of stocks, which may explain its resilience in spite of share price falls for broadcasters such as ITV and GCap, which were affected by lower advertising revenue growth than was expected by analysts.

Overview - The communications consumer