Deutsche Telekom Unveils Three-Year Growth Plan

The German incumbent presented a three-year growth plan and introduced a tightly structured management strategy at its supervisory board meeting last weekend (2-3 September). The new game plan, which will focus on a more aggressive pricing strategy and attractive triple- and quadruple-play product bundles, is expected to boost sales by 1 billion euro (US$1.3 billion) in three years. In addition to launching new products, strengthening the coordination of its operations in Germany, and increasing its market share in Europe, Deutsche Telekom plans to expand its mobile business in the United States by developing a strong retail presence, which is to become the largest division within Deutsche Telekom. The American move ties in with the company’s earlier announcement that it anticipates replacing high-margin revenue in Germany with more capital-intensive international revenue that generates a smaller margin as domestic growth slows (see World: 10 August 2006: Deutsche Telekom Lifts Q2 Revenue by 2.6% Y/Y, Helped by International Operations). The company aims to become Europe's leading telecoms group—not only by sales, as it is today, but also by profits by 2010. Its management is committed to profitability following disappointing second-quarter bottom-line results

As part of the reshuffle of management responsibilities, Deutsche Telekom has centralised key management functions. CEO Kai-Uwe Ricke will also take control of the group's overall marketing activities, including advertising budgets, media planning, and media coordination. In addition, T-Systems CEO Lothar Pauly will take responsibility for the worldwide operations of Networks, IT and Purchasing, while T-Mobile CEO Rene Obermann will be in control of domestic sales and distribution in Germany. The latter reflects Ricke's ambition to import the U.S. service model to Germany, to ensure faster and more customer-oriented services. Ricke's new accountabilities signal an aggressive marketing and advertising push for triple- and quadruple-play products. However, the CEO stressed that Deutsche Telekom does not aim to grab market share simply through price cutting, but also by focusing on providing the best packages.

The German government still holds a 32.5% stake in the incumbent, while U.S. private-equity fund Blackstone Group acquired 4% of Deutsche Telekom earlier this year. Deutsche Telekom has a market value of 50.3 billion euro, but its shares have declined by 19% this year, against the 5.3% fall in the Bloomberg Europe Telecommunication Services Index, which comprises 24 key European telecoms stocks.

Outlook and Implications

Price War: Like its European peers, Deutsche Telekom has struggled to stem customer flight to cheaper voice and internet services. It has seen revenues from fixed-line operations decline in three consecutive years, owing to intense price competition and slowing growth in the domestic mobile sector. Currently, the company's mobile units in the United States and United Kingdom are its key growth drivers. The telco has been losing market share in Germany and expects the cut-throat competition and fierce price pressures in its domestic market to continue. Despite the increased investment in its new ultra high-speed VDSL technology and heavier marketing expenditure, some 500,000 customers fled Deutsche Telekom and switched to other carriers in the second quarter alone, three times as many as in the first quarter. The telco generated about 54% of its first-half sales from Germany, compared to 59% a year earlier, reflecting sluggish growth at home. Hence, Deutsche Telekom hopes to reverse the earnings and revenue decline by slashing prices, cutting costs, and bundling broadband and multimedia products in efforts to retain customers.

New bundled products will enable the incumbent to exploit new sectors of the telecoms market, including on-demand entertainment and bundled broadband and multimedia services. The company has offered new triple-play service, branded T-Home Complete Basic, since the end of last month. T-Home Complete Basic bundles fixed-line telephony, broadband internet access and 60 TV channels, delivered on its DSL platform, and also offers on-demand programme and movie downloads, all at US$100 per month. The company is now moving into quadruple-play services, and plans to offer discounts to T-Mobile customers as an incentive to subscribe to bundled voice, broadband, IP TV, and mobile services for US$85 per month.

Deutsche Telekom plans to match its innovative products with price cuts, and last week reduced prices of its combined internet and phone-service packages by as much as 30% (see Germany: 1 September 2006: Deutsche Telekom Slashes Prices to Stop Customer Flight). However, Deutsche Telekom is running a risk of exacerbating a price war and thereby further denting its profit margins. Hence, it has to work hard to increase its customer base more quickly and tighten spending.

A Lucky Player? Deutsche Telekom has lagged behind its European peers in pushing broadband products such as IP TV. However, German market conditions have allowed the incumbent to delay the launch of combined voice telephony, broadband, and internet television products. Deutsche Telekom should consider itself lucky that competition in the German broadband cable or digital TV market is not as fierce as in Spain, France, or the United Kingdom. Unlike Spain, Germany has not seen the emergence of a nationwide cable operator—such as ONO in Spain, which acquired rival Auna Telecomunicaciones last year to create Spain's largest integrated fixed-line and broadband services operator after Telefónica de España. Likewise, France Telecom has been pushed by the booming cable and pay TV market to move into the IP TV market, and boasted 300,000 IP TV customers in June this year, representing 10% of its broadband user base. The United Kingdom, Europe's second largest telecoms market, has established itself as a global leader in digital TV, reaching over 70% of the population—nearly 19 million homes—in less than eight years. It is also where broadband internet services have recently been offered for “free” (see United Kingdom: 21 August 2006: NTL-Virgin Offers Free Broadband for Mobile Users). Major broadband cable TV company NTL, as well as leading digital TV player Sky, have moved into a British telecoms space once dominated by BT. The United Kingdom is also home to a successful IP TV operator, HomeChoice, recently snapped up by Italy's broadband player Tiscali. In addition, BT disposed of its mobile arm O2, and now finds itself needing to lease capacity from mobile operators so it can offer an integrated service portfolio (see United Kingdom: 24 August 2006: Broadband Surges to 72.6% of all British Internet Connections, Regulator Calls for New Rules on VoIP and 14 August 2006: Tiscali Dials into Triple-Play with US$189 mil. Swoop for HomeChoice). Hence, Deutsche Telekom has still some space to explore.

Cost–Cutting, Reorganisation: The major challenge ahead for Deutsche Telekom is to radically adjust its cost structures to the changing market conditions. Since the release of its first-half results last month, it has been seeking to save costs. The company lowered its forecast for full-year EBITDA (earnings before interest, tax, depreciation, and amortisation) by 1 billion euro, and expects its EBITDA to come in at 9.2-19.7 billion euro in 2006 and stay flat in 2007. It also slashed its earnings and sales forecast for 2006 and 2007, anticipating that increased competition from domestic and international rivals, as well as IP-based digital telephony (VoIP), will eat into its future profit. Deutsche Telekom will step up cost-cutting and announce its new cost-efficiency programme in November this year. According to its previous plans, some 32,000 jobs are to go, with 5,100 employees having departed by the end of June this year. Further cost savings are expected following the earlier reintegration of its internet and fixed-line divisions into a single unit. The current changes in management responsibilities represent a contingency measure and will not affect the structure of Deutsche Telekom's fixed-line (T-Com), wireless (T-Mobile) and technology services (T-Systems) units.