Telco tussle

After years of stopping at your customer’s doorstep and simply passing on messages from the outside world, telecommunications providers are hungry to come in from the cold.

The phone call business is not what it used to be. Anyone can set themselves up as a telco. Competition is up, margins are down and the behemoths of the industry are keen to get their foot in your door to sell you far more than your phone calls.

Customer turnover or churn is a major problem for telcos as their customers go back to the market every 12 months looking to squeeze a few more dollars out of their communications costs. By selling bundles of products and services, telcos hope to return to the good old days of locking customers into long-term contracts.

The convergence of telecommunications and IT techologies into internet telephony threatens to pull the rug out from under old school telcos such as Telstra, which makes the bulk of its money from 10 billion local calls each year.

Convergence also provides the perfect opportunity for Telstra and other telcos to make a grab for a larger slice of their customers’ technology spend. Even so, breaking into the fast-paced IT services market is not easy for massive telco carriers that are not renowned for their agility or strong customer service.

After partnership agreements with IT giants produced mixed results, Australia’s telecommunications giants have decided to buy their way into the IT services market -- ingesting smaller companies while trying not to smother what made those companies successful in the fi rst place. The commoditisation of basic telecommunications services has forced local players such as Telstra and Optus to expand into other markets, resulting in a ‘complete revolution’, says telecommunications analyst Paul Budde.


An applications revolution

"The market is moving from voice services to applications. This is all IT-based so the telcos will have to become IT companies in order to stay relevant in this changing and converging environment," Budde says.

"It’s a complete revolution that’s changing a 100-year-old telephone service into a modern IT and video-based network.

"It will cost them a lot of pain as the problems are more managerial and cultural than technological, because the technology to do this is readily available."

To survive such a revolution, the telcos need to "move up the value chain", says Landry Fevre, telecommunications and consumer markets research director with research firm IDC Australia.

"For many years they’ve just been flogging products because you had to go to a telco to get a frame relay, for example. But now they need to have a more consultative approach," Fevre says.

"If you look at the ICT value stack, you start from the bottom with the network and then you add applications, network management, data management and on top of that application management. At the very top, you have the management consulting. The telcos are coming from the bottom so they need to get away from the commoditised areas in order to maintain their margins."

Last year, Telstra acquired arguably one of Australia’s largest IT services and outsourcing companies, KAZ Group. Telstra has a string of other purchases under its belt including one more in 2004: the acquisition of internet telephony specialists Damovo, a spin-off of Ericsson’s business solutions unit. Telstra was effectively buying back the traditional PABX maintenance and service business it sold to Damovo in 2001.

Optus lost out to Telstra in a bidding war for Damovo but is still on the acquisition trail. In July this year, Optus announced a $25.9 million takeover bid for Australian-owned systems integrator Alphawest.

Telstra’s $333 million acquisition of KAZ Group came after the telco tried to establish itself in the IT services market through several high profile partnerships involving technology giant IBM. In 1997, Telstra bought into Integrated Systems and Services Corporation, a joint IT services venture between IBM and Lend Lease renamed IBM Global Services Australia after Telstra’s entry. A managed services business venture, Advantra, was also formed between the trio in 1997.

Advantra was bought by Telstra in 2000 and rolled into Telstra’s business and government division as Telstra Enterprise Services. Two years later it was swallowed completely into the company’s main corporate structure.

In 2003 IBM bought out Telstra and Lend Lease’s shares in IBM GSA. At the time IBM GSA was the leading provider of IT services in the Australian market, with an estimated 15 percent share.

The sale meant Telstra was not big enough to compete with the global services companies, but was still too big to compete against the nimble smaller players, admits KAZ Group CEO Mike Foster. "We were in no man’s land, and that’s why we decided to look for taking on some more local capability and scale," Foster says.

"KAZ was looking for a larger parent and partner and Telstra was looking for growth in the services business."

Already the head of Telstra Services Solutions, Foster was appointed joint managing director of the combined IT services business along with KAZ Group founder Peter Kazacos. Kazacos had been KAZ Group deputy chairman, having stepped down as chief executive and managing director the year before.

Telstra’s partnership experiences convinced Foster that acquisition was ‘absolutely’ the right course of action for its next play in the IT services market.

"IBM GSA had some success but, at the end of the day, it was companies working together rather than a company bring some sort of converged solution to the market," Foster says.

"As a joint venture I think Advantra struggled to grow, it struggled to get a brand in the market and it really didn’t have a tight enough engagement model with any of its owners. When Advantra was bought by Telstra and became Telstra Enterprise Services, it then became too close to the telco."

"The lessons learned were about keeping the business close to the parent, but still running it separately -- because the processes and the metrics are different. These lessons were certainly well enforced to us when we looked at taking on KAZ."

Six months after its acquisition, KAZ Group was merged with Telstra’s Services Solutions group, with almost 1000 Telstra staff moved into KAZ Group to make up a quarter of its total workforce.

Six months later, in February this year, Foster was appointed KAZ Group CEO, and founder Peter Kazacos went from joint managing director to an executive director responsible for leading the KAZ Solutions and Innovation team. At the same time, Telstra’s Rob Roe replaced KAZ Group managing director Andrew Richardson and KAZ Group’s Asian operations began reporting to Telstra global business managing director Drew Kelton.

While its business structure has changed significantly, KAZ Group still exists -- unlike some other Telstra acquisitions. Even so, KAZ Group’s future as an independent entity is less than secure, says IDC Australia’s Fevre.

"They’ve kept KAZ separate so far but anything could happen now there’s a new Telstra CEO. They could merge it into Telstra or they could spin it off, it’s hard to know," Fevre says.

"I think KAZ is really trying hard, they’ve hired a very high flying top management. That’s good, but it’s not enough. Integrating an IT services company is never easy, because you’re talking about people rather than acquiring a product or a technology. You need to integrate the people and the culture. Customers that have been attracted to these types of smaller IT companies, compared to the big giants, don’t want to lose that feeling of working closely with a smaller company."

Lessons to learn

This is a lesson that both Telstra and Optus must remember as they move into the IT services market, warns Robert Schwarz, former managing director of 2004 Telstra acquisition Damovo.

After Damovo’s acquisition, Telstra Business Systems managing director Malcolm Flanagan took over Schwarz’s role and his office.

Schwarz stayed on for five months to assist with the transition, at which time Damovo was merged with Telstra’s Customer Premises Equipment business and relaunched as Telstra Business Systems.

In August, Schwarz was appointed chief executive of Canberra software developer
The Distillery.

One of the threats such telcos bring to the businesses they acquire is that their focus is
not the same as those of their acquisition, Schwarz warns.

"Those acquired companies got to where they were because of their focus on their clients and the ability to be flexible and a fairly tight focus on what their product offering was," he says.

"I think with the telcos that potentially gets diluted and the old internal politics start to come into play. They’re obviously going to want to try to push other services and other telco offerings through those channels, which I think starts to dilute the customer service."

Telcos need to let an acquisition ‘do what it does best’ and draw up a clear charter of where it fits into the larger organisation, Schwarz says.

"If Alphawest does go into Optus, for example, it’s got to be very clear about how they work and they need to have, I would think, a level of autonomy. If they don’t then what you’ll find is other parts of Optus’ business will start interfering with it and all that does is take away people’s time from a customer focus to an internal focus, and that’s where it all starts to suffer."

Telstra’s acquisition of Damovo to regain the PABX maintenance contracts it earlier sold to Damovo highlights another major issue confronting telcos: losing ‘face time’ with customers.

While rejecting the idea that the initial sale of the PABX contracts was a mistake, Telstra’s Foster admits their loss made it clear how important such regular customer contact is to a telco looking to claim a greater share of its customers’ wallets.

"I think there was an awareness as time went by that we still need to be in front of our customer on a regular basis," Foster says.

"The more you move away from that customer interface, whether it is PABXs or managing other end points of the network, you tend to get forgotten about and the customer doesn’t associate you with that particular service they want."

With the KAZ Group and Damovo within the Telstra fold, today KAZ Group wants to be seen as a "network services business", Foster says.

"We’re not interested in taking on mainframes and data centres, we don’t see it as our core to be doing huge application development. What I do see as our core is when someone says they’re moving their whole network to an IP capability. All of a sudden, the network and the application become more intertwined and that’s where I see KAZ playing."

Telstra works closely with several companies aside from KAZ Group in the IT services market, but Foster says there are no partnership agreements in place.

"The market is small and I think you’ve got to pick your partners and you can only go with one," he says.

Dimension Data continues to work closely with Telstra on a number of projects, such as IP telephony, but is aware of the brewing conflict, says Dimension Data Australia’s national solutions and services director David D’Aprano.

"We’re under no illusion that telcos want to get into this space and, realistically, they have to, their revenue is under pressure. The price for their core services is only going to go one way, which is down," D’Aprano says.

"I think it forces us to do it, move up the food chain from an integration perspective, and this is a challenge that integrators have had from day one. When they got into PC networking, it was specialised, it was hard, there were not a lot of people that did it. As the technology commoditised, more and more people did it and I think we’re simply seeing the same thing happen now with the carriers."

As Telstra further embraces the IT services market, Foster’s claim that you can only go with one partner would seem to leave companies like Dimension Data out in the cold.

"I think it would be a concern if Telstra decided they didn’t want to partner with anybody and they were going to do it all on their own," D’Aprano says. "But that’s totally contrary to what even their new CEO is saying about needing partners and wanting partners."

So as these big telco fish swim into a small pond, how do the other fish survive? By playing to their strengths in niche markets, says IDC Australia’s Fevre. "You need to analyse where Telstra is very good, if you need scale probably don’t go there. Stick to what you do well and don’t try to compete with them because you’ll spread yourself too thinly."

Further friction with existing business partners would seem inevitable as Telstra and Optus expand into the IT services market through acquisition.

While Optus’ acquisition of Alphawest is yet to be finalised, the telco has already written to its partners in the IT services industry to reassure them they have nothing to fear from the deal. The services Optus’ partners provide will "not be interrupted", says Optus Business acting director Danny Leddin.

"Any agreements they have in place with Optus will continue in accordance with the terms. We plan to keep Alphawest as a standalone business. It will be an Optus subsidiary reporting to the managing director of Optus Business," Leddin says. "Alphawest complements Optus’ growth aspirations and our plans to become an integrated information and communications technology provider."

Not all Optus’ IT services partners are comforted by Leddin’s reassurances. Network integrator NetStar regularly partners with Optus. Owned by an Asian investment company, NetStar manages devices in 42 countries but most of its work is in Australia.

Despite Leddin’s comments, NetStar views the Alphawest acquisition as a threat, says NetStar strategic relationships national manager John Hills. "It’s a mixed message and you tend not to believe them. Well, you tend to believe them like [you’re] working in a lion’s cage with a whip and a chair," Hills says.

"We’re at the stage where we’re assessing what we’re doing. We’ll still work with the areas of Optus that we work with well, and we’ll still give them the great service we try to offer, but we’re obviously looking at other telcos."

In the past, NetStar’s certifi cations, such as Cisco Gold partner and Nortel Networks nPower partner, have allowed it to offer value to partners like Optus but now telcos are acquiring such certifi cations themselves.

"Even so, they’ll never have enough people to offer the service capability that we can offer our customers. They’re just too big," Hills says.

"The pre-sales and post-sales for these guys is a really hard thing to do. I’m generalising, but their representatives traditionally can’t get their heads around all their own products, let alone converged solutions on a customer’s premises. So they need pre-sales comms consulting and engineering support to go and sell any of these solutions. That’s why Telstra has picked up KAZ and Optus is picking up Alphawest."

While Optus says it remains committed to partners such as NetStar, Optus’ Leddin says a growing number of customers want an all-in-one package.

"Corporate and government organisations are increasingly looking to have single suppliers for both their telco and IT needs, particularly with the migration to IP. Optus customers are already looking for us to provide ICT services," Leddin says.

Telstra’s Foster agrees. "Customers are saying they want someone not only to give them carriage services or data services or voice services, because where does one begin and the other end? They just want to make one phone call and have somebody come in and give them a service level across the whole lot."

Analyst Budde agrees businesses want single suppliers for both their telecommunications and IT needs, but asks whether they will trust this all in the hands of one telco.

"Very few customers will go to a telco for their IT services. So the telcos will have to change their business model, their image in the market and so on. This will be very diffi cult for them to do so, in the end, they will be the infrastructure provider."

NSC -- formerly North Shore Connections -- partners with vendors such as Lucent and Avaya to service the mid-size to large end of town, both corporate and government. Its customers prefer to have individual relationships with their telco and IT providers, says NSC managing director Craig Neil.

"I think it is because customers like to have that negotiation power. When they engage us they tend to lock us down for three to five years, but when they lock in a carrier they normally only lock them in for 12 months because every 12 months they go out to the market and get a discount."

"At the end of the day the client will choose whether they really see their technology partner as the integrator or the carrier," D’Aprano says. "I think the challenge for the telco is to convince the customer that they have the expertise to be a true technology partner."