Far-reaching effects of the world financial crisis

Consulting firms estimate that total losses directly related to the current financial turmoil are in the range of 15-20 trillion USD, or the equivalent to a drop of 1/3 in the GDP of the world' s major economies (such as the G-20). The worst part is that it will take at least a year for the domino effect to play itself out.

Real estate prices can continue to fall in the U.S., China and other parts of the world. Economic indicators look grim for the U.S. and Europe, and the Japanese economy also has trepidation. As investment slows down, so does disposable income, while living costs rise with inflation, home values decrease and credit tightens up.

For the past twenty years, the development of science and technology and wealth creation has been following the Dow Jones Industrial Average. Most fast-growing companies (especially IT and telecom companies) are fed by capital infusion and need a healthy global economy. With the current downturn of the macro economy, these fast-growing companies might get stopped in their tracks.

On a global scale, investment and economic development are proportional to the GDP as a whole. It is predicted that in the next two to three years, the GDP of many countries will see negative growth or a slowdown. The impact on information spending varies with the commercial environment, affecting about 5% of the real economies, which is quite significant.

History shows that the shortest lifecycle of a crisis is at least two years. What' s more, this crisis is so big that the foundation of the global economy shook and the tremors have no where near subsided and will reach places far and wide.

As a traditional sector, the telecom industry is intertwined with other industries and being in a transformational period, it is difficult to escape the crisis. Once the telecom industry gets into a recessionary cycle there will be stronger impetus for market share and more needed capital. It can be predicted that 2009-2010 will mark a very difficult and crucial period for the entire industry.

Industry chain feels the pain

The telecom industry follows the typical growth model of investment and consumption. The U.S. dollar-based economy has a direct effect on more than 60% of investment and financing in this sector. Europe and other developed markets have been hit hard by the U.S. subprime lending crisis and are stuck paying the bill for defaulted mortgages and loans. These losses will gradually be seen in the diminished expansion and growth cycle of some markets in the next few years.

Some operators are involved in subprime lending, exotic banking instruments, high investments and big risk taking. They raise the prices of their own stocks, apply for bank loans, and then push their stock prices even higher to raise more money by leverage. Market demand is artificially exaggerated and amplified which can cover potential problems. Cut-throat competition, new licenses, small size, high PE, and financing difficulty can easily pop the growth bubble, especially during the current crisis.

In many countries, traditional telecom infrastructure has been excessively developed, and the saturation of remaining markets has reached critical mass. Bubbles have also emerged in the traditional operations market. Inflation rates are notably higher in emerging markets than in developed countries, and inflation may get out of control in some emerging markets. In some regions, due to slowdown of GDP growth, telecom operators will have weakened investment ability and willingness to do so. Only the strong will survive if there is a negative growth rate of -5%.

Telecom investments largely consist of financial capital or sovereign wealth funds, with an emphasis placed on long-term returns. If the markets are stagnant and the economic downturn is chronic, investors cannot see expected returns and they will slow down or stop investing, particularly during transformation in the early stages of telecom development when balance sheets are still in the red.

The financial storm will expose the contradiction in the transformation of the traditional telecom industry, and the contradiction between the saturation of per capita access demand and per capita bandwidth demand. It will correct the course of bad investing as in the past, bringing more attention to per capita bandwidth, and cause some market bubbles to burst. Correct choices will be more crucial with no room for excessive and inefficient investments.

The growth of market demand will slow and customers will reduce procurement, leading to a dramatic decrease in operating income for the IT and telecom industries. Financial institutions, large enterprises, and governments are always large consumers of telecom and IT, spending heavily to replace equipment and upgrade networks each year. The financial crisis will make the financial chain tauter and lead to more complex embedded restrictions.

Since 2008 Q3, more than 90% of enterprises around the world have experienced negative year-on-year growth. 43% of enterprises have started to cut IT spending, and 49% of financial institutions have started to reduce IT budgets. Almost all enterprises have started to cut expenditures in 2008 Q4. In 2009, all enterprises will invariably cut their expenses. Due to various reasons, downsizing has begun in the information industry and around 10% of the total workforce have lost their jobs, and this is in an industry where the number of employees has already been declining.

As governments tighten up monetary policy and financing costs increase, over-expanded and fragile links of the industry chain will run the risk of their financing drying up. This is especially true for newly established companies that rely on venture capital and many of them happen to be the "anchors" of future supply chains. They will bear the brunt of the trauma. As credit and loans become difficult to obtain and liquidity drops, the traditional telecom industry will see slow development.

Multinational operators must also face the risks of exchange rates and inflation, because their revenue is generated in local currencies. Due to the impact of the US dollar economy, most countries have experienced inflation (depreciation of currencies). As a result, most multinational operators' revenue started to decrease in 2008, and revenue from operating companies will continue to drop. At the same time, multinational operators' operational baseline is rising with associated growing costs. Job-cutting and other cost reduction measures become an inevitable choice.

At present, light-asset companies are in a better position than the heavy-asset ones, because the latter have more links that require cash, and they have to mortgage their high-quality assets to get sufficient amounts of cash for survival. Large quantities of outdated networks, inventories, accounts receivable, redundant staff, old product lines, non-profitable businesses, and non-liquid fixed investments will become big burdens for enterprises with aged assets.

Riding out the storm

In developed countries and regions, as informatization provides notable support for (in developed applications and a high penetration rate), broadband and application growth. Despite the impact on the real economy, the digital economy (characterized by low cost and innovation) will be significantly stimulated and developed, creating new growth spaces and opportunities for innovative enterprises. In this scenario, the digital economy becomes a buffer between the virtual economy and the real economy, and provides a new impetus for the GDP.

In emerging markets, there is still considerable impetus for the development of mobile services. But the evolution from the per capita access model to the per capita bandwidth model will take place ahead of schedule because per capita access is essentially saturated all over the world. The financial crisis will expose over-construction in some developing countries where construction was based on outperforming the stiff competition. This will trigger more rational development of the telecom industry, and promote the cohesive development of services and applications, making it essential to adjust the traditional capital expenditure (CAPEX) model.

The cost of debt and inflation will dramatically increase an operator' s cost. Financing will become a precondition to contract signing for operators both in developed and developing countries. Operators will also adopt light-asset operation models, putting greater pressure on equipment vendors to adopt new models like managed service and capacity service.

Consumers will not give up mobile voice or fixed broadband for now. Internet-related applications and solutions like mobile broadband and mobile Internet devices (MID)/PC-like terminals, will become the new stars. In the terminal market, the high-end and the low-end segments will become the focus; iPhone, GPhone, and simplified black-and-white terminals will become primary choices for most people.

At least in the next three years, the traditional CAPEX will experience a CAGR of -3% - -4%, which forebodes a turning point for industry transformation. When revenue from voice services and traditional CAPEX cannot cover operators' total cost of ownership (TCO), new services and new investment will become new opportunities and breakthrough points.

Since the financial storm began, Mergers & Acquisitions (M&A) have decreased with a corresponding drop in the price of assets.
VC/PE firms have reduced the capital stock. IPOs are dormant. Stock markets are slack. Trading of cash and cash equivalents is brisk. At this point, although M&A takes place between operators, the outcome is not teaming up to overcome difficulties as wished. Because cash shortage plus cash shortage still equals cash shortage, and the result of weak plus weak is death.

M&A has gone from offensive to defensive, from size expansion and business diversification to the acquisition of more "winter clothes" to make it through the cold, bleak times. M&A deals concluded after the crisis began are generally cash transactions and prices are very low. Almost like a pawn shop where the seller can' t redeem the merchandise. The seller gets cash for selling high-quality assets cheap, while the buyer obtains a mortgage or cash equivalent that they can let appreciate and cash, namely a mortgage of a long-term loan. This is the basis behind the universal depreciation of the entire industry including the reduction of market capitalization.

In the past few years, telecom equipment vendors have posted a decrease in gross profits, which, to a great extent, resulted from the migration costs required by the development of G/U networks. In a sense, it signifies the relative economic saturation of markets. Mobile penetration rates are quite high in many countries. Competitors can only increase overall market capacity by trading in the market or encouraging new investments.

In the next few years, the financial positions of operators and equipment vendors will not allow this phenomenon to go on, and there are no more technical or business reasons to convince operators to adopt a migration policy to improve competitive conditions. CAPEX, including supporting infrastructure investment will notably decrease.

Only companies with robust business models that provide present and future value for customers can survive. At this time, customers need valuable services more than ever and most valuable services and applications are now Internet applications. Revenue from Internet-related services will show stronger growth and anti-recessionary features during this financial crisis. These services include digital media, digital media entertainment, digital property rights trading, digital advertising, search, e-commerce, wireless Internet, MID, intelligent Internet devices (IID) and mobile broadband communities.

The industry is experiencing fast, fiery, and profound changes that go beyond our expectations. We are living in the age of Web 2.0, where users are contributing content and networking socially. Telecom operators should take note and follow the trend to weather the storm.

During the crisis, operators will need to focus on revenue generating units (RGU). Only Internet-related services can yield high revenues at a low cost. Operators will cooperate with more partners in the value chain to share costs, and team up with successful dot-coms to gain revenue and create more data applications to meet new enterprise customer requirements.

Opportunity in adversity

The financial crisis will expedite the transformation of the telecom industry, resulting in the quick transition from the per capita access model to the per capita bandwidth model. As a result, the concept of information consumption and the digital economy will be fully validated in the market. Through years of cultivation, market demand has exceeded growth. Informatization has become essential to the bottom line and to people' s lives.

There is still solid market demand. In particular, a large number of capital-driven startups hold immense power for content creation on the Internet where there is no governing body. They are creating fresh demand all the time and there is no substantial decrease in their demand for broadband Internet. During previous crises, some history-making companies emerged. Google rose during the end of the IT bubble period, and Apple survived and prospered by evolving its product line and promoting Internet services. To ambitious people, a crisis actually spells a rare opportunity or as Napoleon once said, "I create opportunity".

Governments worldwide have unveiled economic incentives. Implementing governmental investments and consumer stimulation policies requires the assurance of information networks and IT systems. Consumer spending and retailing are moving away from brick and over to click. Among traditional industries excluding pure resource industries, only digital industries receive little or no impact and still achieve growth.

New information consumption models, mobile broadband, and Internet applications will become the highlights of growth. New-business handsets (terminals) also show a greater value for users. For example, Internet voting and online campaign advertisements accounted for nearly half of the total spending during the 2008 U.S. Presidential Election. Telecom has certainly entered an age when sales are driven by services and terminal applications.

Although the financial crisis is extending from developed markets to emerging markets, operators can be well positioned to protect themselves by promptly changing business models and gaining more revenue from information consumption. In China, a 4 trillion RMB (approx. USD583 billion) government plan can help offset the impact of reduced telecom and IT spending. China' s industries are still in the preliminary stage of informatization and there is still significant space for development and imagination.

History reminds us that a number of new-type enterprises and new business models will emerge after each crisis. The mobile broadband Internet industry will shine during this period of innovation. Creating new businesses and grasping new opportunities are very likely to be the recipe for success.

During the crisis, to address increased operating costs and outdated networks, operators need to streamline their organizations and cut back on investment and spending. Meanwhile, they need to cooperate with dot-coms and seek new opportunities to expand business scope, shifting from telecom services to information services.

If operators can effectively avert risks and roll out new valuable solutions at the right time to create long-term service value exclusively, they can turn difficult times into an opportunity.