A time of change: Thin markets see hope in a future of sophisticated data services

With close to 200m mobile phone customers, Indonesia’s telecommunications sector is active, competitive and vibrant. It is not, however, a profit machine. The constant race to capture price-sensitive customers, combined with the steady need to spend on network development, means that telecoms companies must be careful on costs, creative with promotions and have a well-articulated strategy in order to succeed. Wireless is where the vast majority of activity lies, and that market is maturing into one in which companies can compete in an increasing number of areas – it is no longer enough to claim the best network and get on with it.

RISING DISPOSABLE INCOME: Though recent price wars have softened portfolio investors’ enthusiasm for publicly traded telecoms shares, the long-term outlook remains positive. Perhaps 90% of customers are frugal and unlikely to use more costly services like data and roaming, but as the country’s economy grows, more people are finding themselves with discretionary income at their disposal.

For now, however, the major companies are seeking ways to control costs and stay profitable in the face of growing competition. Richard Kitts, president director Nokia Siemens Networks, told OBG, “The competitive environment in the Indonesian mobile market has become more stringent due to the number of operators and the sophistication of the users, who continuously demand new and more advanced services at a lower price.”

SIZE & SCOPE: While the Indonesian mobile phone market is huge, it is one that still has significant potential for growth. It is estimated that after accounting for people who use multiple SIM cards, about half of Indonesia’s 240m people use a mobile phone. Of that only about 5% are post-paid subscribers. These are typically higher-revenue customers who are much less likely to be lured away by a competitor. The rest are prepaid. The GSM market is dominated by Telkomsel, the mobile phone unit of Telkom, which is the monopoly legacy telecommunications services provider in Indonesia.

Two smaller rivals include Indosat, a 14.9% government-owned company with a long history in telecommunications, and privately owned XL Axiata. All three have significant foreign ownership stakes.

Other competitors include Axis Telekom Indonesia, a new ownership group that is attempting to turn an existing small player into one that competes with the big three, and international telecommunications firm HutchisonTelecom, which owns the global mobile phone network 3. Other small competitors are using code division multiple access (CDMA) technology; they account for about 15% of total wireless customers, against GSM’s 85%.

FIXED-LINE SERVICES: The incumbent provider for fixed-line service is Telkom. With 8m fixed-line subscribers, it accounts for 99% of the market, excluding fixed wireless lines.

A smaller competitor, Batam Bintan Telecom, provides fixed-line service for the islands of Batam and Bintan, located in north-western Indonesia near the Malay Peninsula. Indosat, which has some customers left over from its time as a state-run entity, has won a licence to expand its fixed-line offerings but has not used it yet. In the GSM segment, XL Axiata is purely a wireless telephony firm.

HISTORY: The current market landscape started to form in 1999, when deregulation laws were introduced. Before then Telkom and Indosat were the state’s two dominant actors, each with their own monopoly – Telkom over fixed-line service, Indosat over international calling. They also had joint ownership of other telecommunications companies in the country, including Telkomsel and the satellite company Satelindo. In 2001 their monopolies were revoked and competition was encouraged.

Telkom also lost its regulatory power, and in 2004 the Indonesian Telecom Regulatory Agency took control. For now, Indonesia’s telecommunications sector is governed by several separate laws, but a new comprehensive telecommunications law has been drafted and parliament could vote on it or an alternative version within the next few years. Telkom became the incumbent provider in the wireless sector when it bought Indosat’s 35% stake in Telkomsel. The government retains a majority share in Telkomsel through Telkom, with Singapore’s SingTel being the largest minority shareholder.

In 2002 Indosat came into the ring with its own wireless service, but Telkom’s first-to-market provider status has allowed it to keep its position as the biggest player. While both have some legacy fixed-line services, it is Telekom that maintains the copper phone wire network, the main trunk, switching systems and other key pieces of infrastructure. Because growth has come to wireless rather than fixed-line services, it is in wireless that the battle between these two state-owned firms and their private competitors has been the most heated.

A price war between the three main GSM providers intensified in 2007 and as yet it is unclear whether that war is either ongoing or finished but with lasting consequences. Statistics will confirm this – penetration rates and network usage are increasing faster than revenue and profit. Fitch Ratings has reported that the Indonesian telecommunications sector in 2011 has remained benign, forecasting that subscriber growth will yield revenue increases in the mid-to-high single digit range, and for a limited decline in subscriber average revenue per minute.

While the exact percentages are in constant flux, Telkomsel has approximately a 60% market share of GSM customers. Indosat is at about 21%, and XL Axiata at 19%. That reflects Telkomsel’s first-to-market advantage when Indonesia’s wireless business was in its infancy, but its reputation for having the largest network and the highest call quality has also helped. Although Telkomsel still has the most comprehensive coverage area, differentiating the GSM companies on the basis of their networks is increasingly difficult, and capital expenditure on networks is likely to be less a part of their focus in the future.

STRATEGIC EVOLUTION: In 2012, a trend that seems likely to emerge is the rise of companies that specialise in building, maintaining and owning mobile phone towers. Several of these companies are already in existence and are building their asset base by attempting to purchase existing towers from their current owners, the main telecoms firms. Herman Setya Budi, president director of Tower Bersama Group, told OBG, “I am very confident about the future of the tower leasing industry. Maintenance costs are low, profit margins remain high and the mobile industry continues to grow rapidly, which will result in more companies outsourcing their tower needs to third-party operators.”

Selling off towers to a specialist company and leasing back space from them has become a worldwide trend for mobile telephony providers. Wireless providers would rather not share space on their towers with competitors, but once networks are fully built, coverage and quality are often no longer a way to stand apart from the competition. This provides an incentive to share space and cut costs.

The Indonesian mobile telephony sector has reached this stage, and the government has been encouraging this practice by forcing owners to sell tower space to any potential buyers. The trend is also the natural evolution of a maturing market. For carriers, deciding where to build the next generation of towers could wrestle focus away from these increasingly important areas.

For this reason – as well as the appeal of such opportunities in terms of cutting costs – companies often look to sell their towers and lease space instead (see analysis). “There are a large number of companies looking to expand their operations in the industry. This factor is resulting in an intensification of the competitive environment,” Budi told OBG.

INCREASED COMPETITION: The GSM market is now a three-way race between companies that are starting to differentiate from one other. Telkom, which is in a transitional phase, is considering selling several chunks of its business, including its CDMA unit and its network towers. As a state-owned company, it has a reputation for being slower to identify trends and embrace change. Based on global trends, it is assumed that Telkomsel will not be able to sustain its dominant market share of 60%.

According to a study by the research department of DBS Bank, the gap between the leader and second-largest player in this market is anywhere from twice to four times the size found in most other countries. Based on this, the firm predicted in 2010 that Telkomsel would start losing market share. This has not happened yet, but a narrowing of Telkomsel’s lead would not surprise many in Jakarta.

NEW APPROACH: Indosat has been in flux since 2008, when Qatar Telecom (Qtel) bought the 40.8% stake owned by Temasek, the Singaporean government’s investment conglomerate. In March 2009 Qtel upped its stake to 65%, the maximum ownership level allowed for a foreign company. The new management then decided to address the market’s perception that Indosat’s call quality was inferior.

The company’s call tariffs were lower than those of Telkomsel, a problem mostly due to the glut of lowrevenue customers that were clogging traffic on the network. In 2009 the firm suffered a 10% drop in its subscriber base, with most of those customers migrating to Telkomsel, but the result was less network congestion. At that time the company also expanded its network, resulting in a greater capacity to support data-heavy services and smartphone users – a more profitable type of customer.

Indosat has now emerged as the leading choice for smartphone users. The upstart XL Axiata, however, is expected to be the biggest winner in the current round of competition, and posted better financial results than its competitors in 2010, according to research by Indopremier, a securities and investment firm based in Jakarta.

The third quarter of 2011 saw Indosat recording a 3.5% growth rate, with profits surging to 87% largely due to cost efficiencies. Telkomsel grew by 3.4% up to the third quarter of the year, but estimates growth of 4-5% until the end of the year. XL Axiata, on the other hand, grew nine-month profits at 5%.

SMARTPHONES: Current market focus is on those customers who can already afford smartphones. Over the medium and long term, however, the real growth in this market may come from lower-end consumers, the cost-sensitive network users from which companies have sometimes had difficulty making a profit. In a future of affordable smartphones, it is extremely likely that mobile phone networks will be the primary avenue of internet access for millions of Indonesians. Whereas about 80% of Indonesians have a mobile phone, less than 20% have access to a computer. The majority of Indonesians will not be able to afford smartphones any time soon, but that may change. This seems especially likely as Chinese firms are beginning to manufacture less powerful versions, with prices expected to start at under $50.

NETWORKS: Smartphones are typically built to upload and download on third generation (3G) networks. All of the GSM players maintain their own small but growing 3G networks, but demand is weak because 3G phones are too expensive for most Indonesians, as is the cost of regular data service usage. A cheaper method is to use the general packet radio service (GPRS), a technology that is sufficient for the most popular smartphone functions, such as accessing Facebook and other social networking sites, email and basic internet browsing.

Moving into data services is an obvious choice for XL Axiata and Indosat, which is already positioning itself as a telecom driven by data. Telkomsel’s parent Telkom, however, has a more complex set of factors to consider, given that embracing large-scale smartphone uptake would likely mean lower demand for its fixed-line broadband services.

CDMA: The 15% of Indonesian mobile phone users on the CDMA networks are typically customers of Flexi, Telkom’s CDMA network that had 15m subscribers in mid-2011, or Esia, Bakrie Telecom’s network, with around 11m subscribers, mostly in Java. Indosat’s StarOne network lags behind, alongside other networks, with about 500,000 subscribers.

OUTLOOK: With such stiff competition in this costconscious market, portfolio investors have been cautious. Direct investment into the sector, however, with a long-term view on profitability, comes with a different set of considerations. The average Indonesian today is a frugal customer, but a future in which the consumer can afford smartphones and data services is not far away, particularly given the determination of Chinese firms such as Huawei to introduce affordable smartphone technology to the market. The telecoms firms are enduring a difficult period of thinning margins and falling ARPUs, but it seems highly likely that a more profitable future lies ahead.