Competitive spirit: Extensive reform is set to open up the market

After years of underinvestment and a market structure that has stifled service penetration, Mexico’s telecoms sector is undergoing reform. Legislation to reduce the influence of dominant players is being implemented, and the authorities hope to have an impact on prices and facilitate wider access. The benefits of the legislative revamp might take time to materialise, but the potential for increased access to services among the underserved population promises to boost economic growth. For telecoms firms in particular, the untapped market for additional services is becoming more attractive.

The new regulatory authority started to implement asymmetric regulations aimed at curbing existing monopolies in the telecoms and TV markets. The telecoms industry, which includes fixed and mobile communications as well as pay TV, saw its revenues expand from $26.6bn in 2009 to $34.7bn at the end of 2013, according to the Competitive Intelligence Unit (CIU), a consultancy specialising in the sector.

SHORTCOMINGS: Despite strong growth, development has been hampered by a lack of competition, insufficient investment in infrastructure and poor service. In 2012 the OECD’s “Review of Telecommunication Policy and Regulation in Mexico” report analysed many of the market’s failures, saying, “The poor development of telecommunications infrastructure in Mexico is due in large part to lack of effective competition, and the resulting high level of market concentration. In turn, this has implications for consumers, leading to lower levels of consumption as a result of high prices across the range of telecommunications services. This has resulted in a significant welfare loss for users.”

The impact of the market situation, with excessively high prices and inefficient telecoms services, cost the Mexican economy $129bn between 2005 and 2009, according to the OECD. The same report shows that despite Mexico being ranked last among OECD countries in terms of per capita investment in telecoms, the profit margins of its current players are nearly twice the OECD country average. The privatisation of the state-owned telecoms company in fact created a private monopoly, and despite its economic weight Mexico has one of the least developed telecoms sectors in the region. The reform is aimed at increasing competition, raising penetration levels of communications services and encouraging investment in the industry.

Agreement to restructure the industry was made possible through the Pact for Mexico, which united the country’s major political forces. On June 2013, the constitutional amendment was signed by President Enrique Peña Nieto, opening the door for a stronger government role in reversing the monopolistic status quo in the telecoms and media sectors. The constitutional amendment paved the way for the creation of a new telecoms regulator, the Federal Institute for Telecommunications (Instituto Federal de Telecomunicaciones, IFETEL), which has already announced changes, including regulations to curb América Móvil’s grip on the sector.

MARKET PLAYERS: The current market structure is the result of the privatisation of state telecoms monopoly Telmex in 1990. Its majority stake was bought by Group Carso, owned by businessman Carlos Slim. The resulting conglomerate, América Móvil, controls 80% of fixed-line communications through Telmex, and 70% of the mobile subscriptions through its subsidiary Telcel. It also controls 60% of the broadband internet market. América Móvil additionally offers fixed and mobile communications services across several Latin American countries.

Spanish company Telefónica operates in the mobile segment through its brand Movistar, which has a market share of 22%. Iusacell, which is partly owned by Mexican TV broadcaster Grupo Televisa, has a 7% share in the mobile segment. In early 2014 the company was reportedly in talks with Telefónica, although the merger has yet to be confirmed. The two had already entered into an agreement in 2012 to share infrastructure. The fourth mobile operator, Nextel, is owned by US-based NII Holdings, and has focused on post-paid business customers. It has a 4% market share, and has been expanding its 3G network. In early 2014 Nextel signed a deal with Telefónica to use the Spanish company’s 3G network to increase coverage in Mexico and Brazil.

A handful of mobile virtual network operators (MVNOs) also serve the market through Telefónica’s network. The two main ones, Maxcomm and Megacell, have 40,000-50,000 mobile lines each, according to CIU figures. The newest operator is Virgin Mobile, which entered the market in 2014 as part of its expansion in Latin America. Another entrant, Mexican supermarket chain Coppel, is set to launch its own service before the end of 2014.

The market is expected to attract more virtual operators, and in late 2013 Telefónica announced plans to open its infrastructure to up to five new MVNOs before the end of 2014. Other companies have fragmented stakes in the market. The second fixed-line provider, Axtel, has a 5% market share, providing local, long-distance and international calls, as well as broadband services. Alestra, partly owned by AT&T until 2010, also competes with fixed-line and broadband internet services.

With myriad small competitors fighting the giant market leader, the scene is set to be reformulated as fresh investment and new players prepare to take advantage of the legislative change. “If the reform is applied well, more investment will come in, because there is huge potential,” Miguel Calderón Lelo de Larrea, vice-president at Telefónica, told OBG. “USMexico communications, for example, is the biggest country-to-country market in the world.”

WATCHDOG: IFETEL was founded in September 2013. The new authority replaces the Federal Communications Commission (Comisión Federal de Telecomunicacione, COFETEL), which was created in 1996 but fell short of implementing anti-trust laws to rein in the existing monopolies. “The problem before was that these regulatory institutions were in effect held captive by the dominant powers,” Ernesto Piedras, director-general at the CIU, told OBG. Previous attempts to rein in the dominant players in the industry were stalled by court injunctions.

Through IFETEL, the administration’s goal is to create an authority with enough tools to protect the market against uncompetitive behaviour. Tasks specific to the Ministry of Transport and Communications (Secretaria de Transportes y Comunicaciones, STC), such as the attribution of licences and concessions, were handed over to IFETEL. The budget for regulation has also been enlarged. In late 2013 Mexico’s Congress approved IFETEL’s 2014 budget of MXN2bn ($155m), a significant increase on the MXN658m ($51m) allotted to COFETEL for 2013.

Unlike other regulatory bodies in Mexico, created as decentralised institutions under specific ministries, the telecoms regulator is constitutionally autonomous. This makes IFETEL a more robust watchdog. To fulfil its goal of reducing concentration in the market, IFETEL has been equipped with institutional levers that go beyond any of the instruments that were available to its predecessor. It will be capable of enforcing asymmetric legislation, determining attribution of concessions and their annulment, and even ordering the break-up of corporate assets to avoid excessive concentration. A draft bill containing the detailed laws through which IFETEL will be charged with regulating dominant players was sent to Congress in March 2014.

REGULATION: The document, awaiting approval, underlines a choice for asymmetric regulation to reduce the power of dominant players. First, Amé rica Móvil will be ordered to share its landline and mobile communications infrastructure with its competitors. Opening the local loop, which connects an operator to the final customer, will allow smaller players to access a larger number of potential clients who were previously out of reach. Interconnection fees between mobile operators will also be set.

Balance in the market will initially be pursued through price regulation. The fees América Móvil charges its competitors for using its infrastructure will be determined by IFETEL, and the regulator will be able to force dominant companies to seek approval for these charges each year. Also included in the draft is a measure that will prevent América Móvil from charging interconnection fees to its competitors, and yet still make it pay to connect its own customers to competitors’ mobile infrastructure. Besides strict policing of prices, the draft bill includes details on penalties. IFETEL will have the power to fine companies up to 10% of annual sales in Mexico for repeated monopolistic behaviour.

Asymmetric regulation, especially through interconnection fees, has been used in other markets, such as Colombia, as a way of correcting irregularities. By annually reviewing the fees that are charged by dominant players, IFETEL will be able to ease or strengthen restrictions, depending on how the market responds. Though included in its new powers, dividing company assets may be a last resort to enforce competition if initial measures do not work. In the 1980s the US government’s petition to the judiciary led to the break up of communications firm AT&T into separate business units. So far, this seems to be unlikely in Mexico. “Making dominant players divide existing businesses is an extreme position, and hard to implement because of financial and operational complexities,” Piedras said.

MOBILE MARKET: The reform is expected to increase competition in the mobile segment, which has been expanding at a fast rate, reaching a total of 103m mobile lines at the end of 2013.

Between 2000 and 2011, the number of mobile phone lines went from 14.7m to 94.5m, according to figures from IFETEL. Over that period growth rates surpassed 20% in some years.

The mobile communications market in Mexico has now reached an intermediate maturity phase, and annual growth rates are stabilising at 8-10%, according to CIU figures. Mobile penetration in Mexico is currently at 88%, significantly below some of the other major Latin American economies, such as Argentina, Chile and Brazil, which all have mobile penetration levels of above 120%. Most of the Mexican mobile market is made up of prepaid customers, who constitute 85% of the market.

Average revenue per user (ARPU) in Mexico is MXN170 ($13), according to the CIU, but is lower for prepaid customers at MXN130 ($10). Considering that prepaid customers are a sizeable majority of the market, ARPUs have been driven upwards by rising consumption levels at the higher-end of the mobile market. This growth in post-paid consumption has been enabled mostly by rising availability of mobile broadband. However, the penetration level of potential post-paid customers is already at 98%, said Gonzalo Rojon, director and senior partner at the CIU. “Basically, all the post-paid lines that might acquire mobile internet already have it, so the market is practically covered in terms of potential post-paid customers” he told OBG. Increased competition is expected to lower prices and eventually lead to an increase in average consumption, especially in the prepaid side of the market.

FIXED LINE: Expansion of mobile communications will also underline stagnation in the fixed-line market. Following a global trend in the sector, the fixed telephony market in Mexico has peaked in recent years, reaching a penetration rate of 17%. According to IFETEL, the number of fixed lines grew from 12.3m in 2000, to more than 20.5m by 2012. The figures have stabilised at between 19.5m to 20.5m fixed lines since 2005. This is clearly linked to the rise of mobile connections, but it also shows the lag that the telecoms sector in Mexico experienced.

“In Mexico we have under-penetration of fixed-line. Finland reached 60% penetration, the UK 70%,” Piedras told OBG. “These countries started to see their figures reduce to around 50% and stabilise. But in Mexico we didn’t even reach those numbers,” he said. The low penetration of landline communications, equivalent to 17 fixed lines per 100 inhabitants, is largely due to the high cost of communications. Low availability of fixed lines has also had an impact on internet access, as half of homes are not connected to a fixed line, and broadband is mainly accessed in the country through fixed lines.

SMARTPHONES: Increased disposable incomes, tied to the rise of low-cost, more advanced mobile equipment, has translated into strong growth for the smartphone segment. Today there are 35m smart-phones in the Mexican market, but, according to CIU estimates, that will rise to 55m by the end of 2014, and to 68m by 2015. The segment’s rapid growth is driven by increasing demand for mobile broadband access, multimedia, voice and video. “For several years, smartphone lines have been doubling year-on-year. Everybody wants one,” said Piedras.

Of the existing 35m smartphone lines, only 16m have a permanent connection to mobile broadband internet. Although the average smartphone user in Mexico is typically towards the top end of the socioeconomic scale, a large proportion of growth in the segment is now coming from availability of cheaper equipment, which is helping to bring more Mexicans online. “Even people with low monthly incomes want vanguard technology. They are disconnected; they do not own a data plan, but access the internet through free wireless networks,” said Piedras. This growth is increasingly important in Mexico, where 72m people are disconnected from the internet.

The bargaining power arising from having one large operator in the mobile market has affected the way new equipment is distributed. Several mobile brands were able to establish temporary exclusivity deals with Telcel in order to gain traction in the Mexican market. “When the iPhone was launched, we had to wait a year before we were able to sell it,” said Calderón. “This is because Telcel would demand Apple exclusivity as they were the largest player and would not agree to sell the iPhone if Movistar was also distributing it.” The reform is also expected to abolish exclusivity agreements between telecoms companies and equipment makers.

INFRASTRUCTURE: In hand with low-priced access to telecoms services, much of the current reform’s effectiveness will also depend on how the existing infrastructure is enhanced. The STC expects that MXN700bn ($54bn) of public and private funds will reach the sector from 2014-18. How this money will be spent is dependant on the implementation of the secondary laws arising from the telecoms reform.

Much private investment is also expected to come from the opening up of the sector. A change in the law will allow foreigners to own 100% of telecoms and satellite companies, as well as 49% of radio or TV broadcasting operations. This change will open the door for new entrants. But it might also draw fresh investment through existing players that have had trouble in establishing themselves so far and can now more easily attract capital. Furthermore, added competition will encourage operators to invest in telecoms infrastructure, where there are several gaps.

Demand for new networks, telecoms towers and antennas, the lack of which accounts for the current low penetration of telecoms services, will bring fresh investment from private operators. This will bode well for equipment suppliers wanting in on the market. “The geography of Mexico works against its own development. A kilometre of rail, road or telecoms cable is not same here as in Europe, because the terrain is difficult. In Mexico it is very expensive to deploy infrastructure,” Piedras told OBG.

RURAL CONNECTIONS: Much of the infrastructure improvement will focus on rural areas, and most of this effort on the government’s side will come from state-owned agency Telecomunicaciones de Mé xico, which manages the national telegraph network and Mexico’s satellite system, Mexsat. The agency will be responsible for managing and expanding the government’s fibre-optic network, which was previously in the hands of the Federal Electricity Commission. It is also entrusted with taking mobile communications, internet access and financial services to small and remote villages. To this end, a $20m pilot programme, running since 2012, is set to be extended to 30 communities with no current mobile access.

Rural communications will be further enhanced by two new 702HP geo-mobile satellites built for the Mexican government by Boeing, which will join an already operating Mexsat satellite, Bicentenario. The first, Centenario, will be launched in 2015, and the second, Morelos-3, is set to begin operating in 2016. “Mobile satellite communications are the right solution to connect isolated places, especially those with under 5000 people,” said Jorge Juraidini, general director at Telecomunicaciones de México.

The agency will also be charged with developing and managing a shared telecoms network, including more than 30,000 km of existing lines and the planned addition of another 35,000 km. The agency will determine how the network is to be managed, and will have powers and resources to promote broadband services and grow a telecoms backbone. The authorities will auction the management of the 700-MHz band, which will be freed up once digital terrestrial TV becomes the norm, most likely by creating a special public-private entity.

Another relevant change will bring convergence to the concession attribution regime. Before the telecoms reform, operators were compelled to obtain a separate concession for each type of service, either in telecoms or in pay TV service provision. From now on, a single concession will allow operators to serve all the different segments of the business.

OUTLOOK: Despite successive years of growth, Mexico’s telecoms sector is about to tap into unexplored market segments and expand its reach to a bigger percentage of the population.

Dynamics are sure to shift with the current reform drive. By implementing asymmetric regulation to curb the power of existing monopolies in both telecoms and broadcasting, the new watchdog expects to bring balance to the market, after years of dysfunctional growth. This will give breathing space to smaller operators in the mobile and fixed communications segments, as well as internet access providers, to invest in expansion and deploy infrastructure to reach a larger number of customers.

Coupled with a more attractive investment environment for private operators, the reform will also promote the expansion of infrastructure into previously unconnected regions as the government looks to widen access in rural areas. The shared network will allow more Mexicans to become connected, through a bigger variety of providers as well as more competitive pricing. Implementation of the anti-trust laws will be essential for the constitutional amendments to achieve their goals. It may take a few years for the process to bring tangible results, but a reformed telecoms sector will do a lot for GDP growth.