When I was at school, business was about growth: growth leads to scale, scale leads to market share, and market share leads to margin. Big businesses made more money than small ones, both absolutely and per unit. They had better buying power, better systems, and could invest in the best tech. Small businesses picked up the scraps, by hand.
Well not anymore it seems, certainly in telecoms.
The GSMA has been saying for the best part of twenty years that the link between market share and margin has flattened and we certainly see this in the numbers. Today, it isn’t about being big, it is about being agile and being automated, something we strive to excel at.
If you look at our business compared to peers, you’ll see our per unit cost base (cost of calls etc.) is the same or potentially lower than any of our peers, largely thanks to the UK Regulatory regime which enables those who can be bothered to build out interconnects at price-capped levels – the FTR and MTR you’ll hear us talking about – blending costs to the level of ‘can be bothered’.
Below that is just OPEX. Conventional logic would suggest that bigger volume would drive OPEX efficiencies, but it doesn’t seem to.
First we have to normalise the accounting because bigger businesses, especially listed ones, go to great lengths to improve appearances for their shareholders. Big American ones could be said to just make shit up and wilfully defy accounting standards, as I’ve said is Enron-esque before. We’re not about to make stuff up, but we can apply the same legitimate policy as some of our more honest peers and, for example, capitalise development costs which we currently expense. That change alone transforms things.
On the same basis, our EBITDA margin is materially higher than a business 100x our size and we need to explore why. The incumbent still enjoys higher margins but there’s factors there I best avoid in the interests of my blood pressure and your engagement! What matters is how can we be more profitable, while apparently selling at lower prices, than a peer 100x our size?
One could consider product mix but if you look at it that is actually a counter-factor. Our business is primarily wholesale – the lower margin end of things – whereas peers are far more channel or retail focussed – the higher margin end of things. So they have structurally higher margins, at 100x the scale, but still make less money per unit.
One consideration is M&A. We’ve grown organically in the main. We’ve made targeted and pretty awesome acquisitions but we haven’t industrialised M&A, for M&A’s sake, like so much of our industry. We’d prefer to build than to buy, and that is unusual. If you buy, you can of course move quicker, but buying can lead to spending many times revenue for a capability you lack, a capability generally built by a much smaller agile company. If you then fail to integrate those acquisitions ruthlessly, you end up with layers of duplicate management, cost, and disincentivisation – all of Simwood’s staff are shareholders and they feel it in the dividends if things go too slow or cost too much. As a silo in a bigger business which didn’t care, would they care?
We’ve seen duplicate M&A too – big operators making strategic acquisitions and getting it so wrong they end up doing it again. Two acquisitions to enter a new market, two businesses not integrated, two new layers of management, two new platforms to operate.
Outside our sector there are known pariahs – big businesses who are a meal-ticket for any founder exiting, but renowned for being where great businesses go to die. M&A isn’t bad per se (although statistically 70-90% of deals fail), but a cottage industry of M&A existing purely because you can’t build anything yourself, is lazy. Sucking an efficient new startup into your inefficient infrastructure, simply sets fire to potential savings (let alone hampering the innovation and creativity which made it an acquisition target to begin with) . Leaving it incompletely integrated just layers cost on top too.
If they were clueful they’d recognise that if they can’t build a capability themselves, that capability has value, and the way that capability is executed is better scaled than killed. Imagine reversing an efficient new startup into a bigger business and learning from how it has solved problems. Sure, there’ll be problems of scale it hasn’t had to address yet, but why throw away those it has? Why not learn best practice and reverse those lessons into the bigger business. That, to my mind, is how you make 2+2=5, rather than the common current approach which results in 2+2=3 but, hey, 3 is bigger than 2 so aren’t we clever!
Another huge difference which is driving efficiency at the smaller end is technology. If you have got the scale where you view colleagues and friends as “human resources”, what is the incentive to innovate, to make their job more delightful, and to invest today? If you view colleagues as “mechanical turks” – hidden humans doing work you pretend is automated – it simply comes down to unit cost, and marginal gains through investing in their tools don’t appeal. I’ve always focussed on the cost of scale instead, investing in automation and technology not to make a load of people redundant (we’ve never done that) but to make them incrementally more efficient and ensure that as the business scales, we need to add people more slowly. Big businesses don’t think like this – they think in terms of culling departments for mass short-term savings, or offshoring broken processes so they can stay broken but be cheaper. The result: inefficiency and lack of agility, and long term destruction of value.
None of what I’m saying is new – the market knows this. That’s why listed counterparts have seen their share price fall 40% in a year and trade on single-digit multiples. The market is literally saying “we don’t believe in what you’re doing, stop fannying about and get efficient”. It is why American operators with made-up accounts, trade on multiples of 2 or 3x earnings despite being listed in the most optimistic market on earth at its all time high. PE knows this too if my diary is anything to go by.
So where does this go? Do large telecom businesses become the new Kodak or Blockbuster? Kodak dominated 90% of the film market and 85% of the camera market – it was big – but they were slow to embrace digital sensors, software and workflows. By the time they tried to pivot it was too late and their business was obsolete. Irony of all ironies: Kodak invented the first digital camera in the 1970s but management parked it because it was too disruptive! That feels eerily close to the acquisition of a disruptive smaller business and ditching their more efficient technology because it “wasn’t made here’.
Blockbuster was the same – clinging to high street stores, manual inventory and late fees while Netflix et al pushed into DVDs by post, and then delivered streaming.
Both industries were “working” right up until the point they weren’t. By the time Kodak and Blockbuster moved, cost bases and customer expectations were so different they could never catch up. Imagine if both had had a clue and used their scale productively.
Mark my words, the last business standing in telecoms will be heavily automated, ridiculously efficient, and have moved with the times in terms of new technology. Whether that will be a small business who becomes big, or a big business which gets a clue contrary to historic precedent remains to be seen, but what is clear is it won’t be a business which has become big for big’s sake and simply wants to be bigger. Those days are gone.
The video below is one of my all time favourites and couldn’t be more prescient:
