Is telecom industry attractive?? - an analysis using Porter's framework

Background:
Telecom equipment industry is undergoing lot of changes. Many large companies have merged (NSN, ALU) and many others are selling off their key assets (Nortel selling its 3G portfolio and now contemplating about selling its MEN technology). What’s the reason behind these moves? Is it because the industry as a whole has become unattractive or because of bad decisions on part of the companies?
Lets use Porter’s five forces framework to analyze this industry & try to find how profitable this telecom equipment industry is. See Exhibit 1 for an overview of Porter’s framework.
Industry:
Telecom equipment manufacturing companies comprising of: wireless, data-networking, optical, access, NGN/IMS & s/w apps.
Main companies:
NSN, Nortel, Ericsson, ALU, Motorola, Cisco and Huawei. See Exhibit 2 for a brief overview of their financials.
Exhibit 3 clearly shows that performance of telecom vendors is much below S&P 500 signifying that this is a non-profitable industry.

1) Value creation
a. Buyer power: Buyer consists mainly of mobile service providers such as AT&T, Vodafone, Bell-Canada, etc; large companies such as IBM, Walmart, Shell for Enterprise Applications and governments such as the Chinese & Indian governments for optical and wire-line solutions. As we can see, these are very large entities compared to equipment companies.
These companies buy in large volumes and equipment costs form a significant part of their expenditure (except the governments). Hence they involve in negotiating good bargains.
Mobile service provider companies also have power to direct which technology is to be introduced to the market. For example, vendors perceived VOIP to be a substitute for mobile communication and did a huge investment in developing this technology. But service providers see VOIP as a major threat to their revenue generation model since VOIP is drastically cheaper compared to the existing mobile service thereby substantially impacting their revenues. Hence adoption rate for VOIP products is low among service providers due to which vendors are struggling to recover their initial fixed costs. The same is true with slow adoption of high-speed evolutions such as 3G & 4G among end-users. Vendors have spent huge amounts in developing these technologies but are not able to recover their initial sunk costs.
As mentioned above, vendors have high fixed costs (for initial R&D) and minimal incremental costs. Hence they would like to keep their sales volume high in-order to recover as much fixed cost as possible.
There is very little differentiation among the products and switching costs are low due the existence of standardizing committees such as ITU, 3GPP, WiMAX forum, etc.
Due to all these reasons we can conclude that buyer power is high in this industry.

b. Supplier power: The main suppliers to this industry are silicon chip manufacturers (for processors, memory chips, etc), sub-contractors and employees.
Due to heavy competition among chip manufacturers, their bargaining power is low. But there is medium switching cost for telecom vendors since changing their hardware would lead to additional cost in modifying their architecture.
Employees don’t have much supplier power since the required talent is widely available and companies can easily lay-off redundant work-force.
Sub-contractors also don’t have much power due to heavy competition among themselves and their relative smaller size compared to vendors. Telecom vendors make sure to outsource their work to a wide range of companies so as to not become completely reliant on a single sub-contractor.
Overall, power of suppliers is medium to low.

c. Threat of substitutes: There are not many substitutes for the products developed by these companies. Mobile services are considered a strong substitute to wire-line services. Today, mobile n/w equipment forms a major part of telecom vendors’ portfolio. Vendors have even taken a further step to understand possible future threats such as VOIP and have incorporated it into their portfolio.
Hence, threat of substitutes is low for this industry.

2. Value capture
a. Threat of entry: It’s not uncommon for some employees to join hands, take a funding from an angel investor or put in their own savings and start a company, competing against the parent company. But the products developed by these companies are piece-meal and cater to a very small set of customer requirements. Hence they may not have very strong preference among service providers; unless they offer a superior product at lesser cost. These startups neither have financial strength nor the kind of connections to bid a formidable threat against the larger incumbents.
Hence threat of entry is low.

b. Threat of rivals: Rivals are roughly equal in size and power and they cater to roughly the same customer base. They produce nearly identical products. Hence their best way to attract customers is by cutting prices. This is where Chinese firms such as Huawei are making inroads due to their low manufacturing costs and Western competitors are trying to minimize their overhead by cost cutting redundant expenses.
Another way to differentiate is by displaying to the customers the company’s technological prowess so as to assure its customers that their product is the best in the industry. This encourages companies to bet and invest more on future technologies even though they may not generate revenues in near future which in turn leads to low profit margins.
Therefore we can conclude that threat rivalry is high.


Conclusion
From the above analysis we found that buyer power and threat of rivalry is high. Both these factors are formidable. This could be reason of non-profitability and consolidation in the industry. Companies try to reduce threat of rivalry by merging or buying out rival companies.
Our overall analysis show that telecom vendor industry is not an attractive industry.

Exhibit 1: Porter's 5 forces framework


Exhibit 2: Main competitor's financials

*There was a goodwill impairment of $1,1142 mm due to EN & MEN business units
**Taken from Nokia’s consolidated statements
***Quarterly finance information not available


Exhibit 3: performance of S&P 500 and all telecom companies