New Zealand reset the telco sector's regulatory foundations with the 2011 Telecommunications Amendment Bill. The move saw Telecom NZ become Spark and Chorus, and the birth of an open access fibre network. Things changed, but perhaps not as much as you might have expected

For years New Zealand’s telecommunications insiders have talked about industry consolidation. The talk grew louder after 2009 when the Government invested in an open access fibre network.

To date, there’s been little sign of a major wave of consolidation. If anything, the market has moved in the opposite direction. Today there are more broadband service providers than in 2009. And we’ve gone from two to three mobile networks.

Consolidation’s proponents argue that there are too many players in the market. This leads to too much competition. While this is good for consumers, it is bad for investors because it makes profits harder to secure. Supporters of consolidation argue that taking companies out of the market would mean fewer competitors. Then the remaining players will be more efficient and profitable.

Most consolidation happens when companies merge with or buy rivals. In some cases, they acquire businesses to fill gaps in their business offering. This is what happened when mobile carrier 2degrees acquired Snap, a landline business. In other cases, consolidation is about gaining customers. Or, as they say in the business, “building scale”.

In many technology industries scale has long been the touchstone to success. Microsoft swept the software world and earned billions thanks to scale. It cost Microsoft billions to develop software products like Windows and Office. Yet the marginal cost of making and selling each extra copy was close to zero.

After software sales hit the payback point, every extra sale is near pure profit. Google, Facebook, Amazon and Apple all earn fortunes by exploiting scale. How each company turns scale into rivers of gold may be different, but their wealth comes from size.

It’s less clear what scale delivers for telecommunications service providers. Spark and Vodafone complain that they see little extra profit despite rising customer numbers. People in the sector talk of profitless growth. In telecommunications there is a cost for servicing each extra customer.

Profitless growth hasn’t stopped service providers from shooting for growth. Consolidation could be the most effective way of doing this.

Last November, Spark managing director Simon Moutter told shareholders at the company’s AGM:

“We are now at the point where it is likely cheaper to acquire a customer base from another provider through an M&A (Merger & Acquisition) deal than it is to try to attract those customers through marketing efforts. For that reason, we expect to see, and participate in, significant consolidation of the retail broadband industry over the next couple of years.”

Moutter isn’t alone. Others in the local industry view consolidation as inevitable. After all, overseas telecommunications markets often have fewer companies than we have New Zealand. And there is an argument that says what happens there will happen here.

The expected major wave of consolidation hasn’t happened to date though. If it going to happen, then the consolidators are taking their time.  The Telecom-Chorus demerger was a clear step in the opposite direction to consolidation. So was the entry of the other fibre wholesale companies. Neither Northpower, Enable or UFF came from the telco sector.

Today more retail telcos chase broadband customers than a decade ago. We’re not talking minnows either. Relative newcomer Trustpower is now one of the top broadband brands. Stuff Fibre is still only two years old but is already making headway. Both are also part of much larger non-telecommunications businesses. And both have customers, brand recognition and reach. Depending on who you talk to, between 90 and 100 companies now offer retail telecommunications services. Often broadband is not their core business.

Not only are there now more players, but the industry power balance has changed.

In 2007, the top two telcos, Telecom and Vodafone, accounted for 84 percent of industry revenue. Telecom alone was 61 percent of the market. Ten years later, in 2017, the same two companies are still the giants, but now the pair only account for 61 percent of the market. Spark is still the biggest telecoms company, but it is now holds only a little over one-third of the total market.

Of course much of the difference is down to the Telecom-Chorus demerger.

New Zealand’s telecommunications market is competitive by international standards. Its open access model sees Chorus, Northpower, Enable and UFF act as wholesalers. This means the barriers to market entry are lower than in the past.

Wholesalers must offer the same products at the same price to all comers. This diminishes the main advantage scale might otherwise have given the largest companies. Under New Zealand’s rules, a wholesaler can’t give, say, Vodafone, a deep discount because it has more customers than rivals. The Commerce Commission regulates a fixed price per connection.

Fixed access pricing flattens the playing field, which, in turn, squeezes margins. Much of the profit that once came from the telecommunications sector is competed away as service providers race to offer customers the best deal.

Mergers and Acquisitions

New Zealand has seen consolidations plays. In 2012, Vodafone acquired TelstraClear for $840 million. At the time, Vodafone was the second largest telco behind Telecom NZ, now Spark. TelstraClear was New Zealand’s third largest telco. The combined business was still smaller than Telecom, but Vodafone went from being roughly half the size of Telecom to around three quarters the size. That ratio has changed little since. 

Vodafone has since acquired other smaller service providers, including the rural-focused Farmside. The Commerce Commission vetoed the attempted merger with Sky TV, but it wasn’t a consolidation play in the same sense as the earlier acquisitions. Yet it would have bulked up Vodafone and given it scale to compete with Spark. 

Vocus New Zealand was formed from a roll-up of smaller companies. It was a clear consolidation play. Around the time Vodafone acquired TelstraClear, Vocus Communications, then an unknown Australian telco, purchased Maxnet. Since then it has acquired CallPlus, Slingshot, Orcon, FX Networks and a handful of other brands. Today it is New Zealand’s third largest fixed-line business and the fourth largest retail telco. 

When 2degrees, the third largest retail telco, bought Snap in 2015, it was more about adding capability than consolidation. Until then, 2degrees was a mobile phone company. Snap was a second tier fixed-line telco focused on broadband. The deal allowed 2degrees to pitch itself as a full-service telco. It put it in direct competition with Spark and Vodafone. 

There’s another way the shape of New Zealand’s telecommunications market is changing. The big players are moving out of pure telecommunications services and becoming broader-based. Telecom started this in 2004 when it purchased Gen-i and Computerland, adding business computing services to its portfolio. 

Trustpower is an energy company that also sells broadband. Vocus owns a small energy company so it can now sell electricity to its customers. Spark owns Lightbox and has recently acquired the rights to a range of sports events. Vodafone’s aborted Sky TV deal was part of this trend towards telcos becoming broader-based companies. 

One barrier to consolidation is the Commerce Commission. Its role is to keep the market competitive. When Vocus put its New Zealand operation on the block last year Spark declined to bid for the business because regulatory scrutiny would have taken any acquisition well past Vocus’ self-imposed deadline. It is likely any major merger or acquisition would be held up or even halted by the regulator if it looked like it would reduce competition. 

But there is another part to the lessons learned from Vocus. Potential acquirers looking to expand and consolidate are not willing to pay the kind of premium sellers want. At least not yet. When this changes, we can expect to see another wave of consolidation.