AS wireless penetration rates begin to approach, and in some cases exceed, the 100 per cent mark, telecommunication companies around the world have slowly begun to shift their strategic focus from growth to efficiency. This has led to an increase in the number of mergers and acquisitions, with Dealogic reporting that telecommunications was among the leading sectors for M&A activity in 2010.

The majority have been horizontal mergers whereby the assets of two rival telecommunications firms are merged to form a single firm. Examples of such mergers include that of Sprint and Nextel in the US and Deutsche Telecom AG and France Telecom in Europe. These mergers have been motivated by the desire to increase market share in a bid to realise economies of scale to combat falling rates and saturated markets.

Locally, the telecommunications industry has entered its mature stage, after experiencing subscriber growth averaging 10 per cent over the last five years and a more than 12-fold increase since liberalisation in 2000. With the slowdown in subscriber growth and mobile penetration rate at 116 per cent, two players, Digicel and Claro, have entered into talks to merge operations citing efficiency gains as motivation for the proposed merger. The decision to merge has broadly been influenced by the need to improve top-line growth in a subdued economic climate.

The local economy has been in decline since 2008 with an average contraction of 1.7 per cent over the three-year period to 2010. With weaker growth prospects in the medium term, telecoms operators are in effect competing for a larger share of shrinking consumer expenditure.

As a result, in-market consolidation, which reduces competition and results in costsavings, presents the best opportunity to local operators. However, having experienced the benefits of competition and with the monopoly experience still fresh in the minds of local consumers, there are fears that there may be significant disadvantages if the merger secures regulatory approval.

Jamaica’s telecom industry transitioned from a monopoly to one in which increased competition has resulted in lower prices and higher mobile penetration. Using ‘mobile to mobile’ (eg LIME Jamaica to LIME Jamaica) rates as a guide, mobile calling rates have declined by as much as 55 per cent since liberalisation despite inflation of at least 5.6 per cent in each of the 10 years. Mobile penetration has come a long way from the 9.6 per cent in 2000, and the sector is a major contributor to economic growth. Given the benefits of increased competition, the fear is that the Digicel/Claro merger would reduce the intensity of competition which would result in higher prices and reduced benefits to consumers. These fears are exacerbated by the fact that Lime (formerly Cable & Wireless Jamaica) has not been as strong a competitor and has been making significant losses which could threaten its viability. Given also the company’s weak cash flow position, it would have little room to spend on the necessary infrastructure to keep up with the competition, giving the merged entity room to increase its dominance in the market, and the market would more or less revert to a near monopoly.

The competitive landscape has also increased the drive to offer the highest quality products and services to consumers which has aided the development of the industry. Given the difficulty in achieving price differentiation in the local market, all three Telecoms companies have sought to top their competitors by modernising their networks, introducing new services, adopting emerging technologies while employing a variety of marketing and promotional activities. Smartphones such as Blackberrys and iPhones ‘know their way’ around the Jamaican market making the local market one of the most advanced in the Caribbean. The telecoms companies have also introduced local consumers to third generation (3G) and fourth generation (4G) services. In essence, first world products and services have been brought to the fingertips of third world consumers. In the event of a merger, and reduced competition, there is less incentive for these companies to make significant technological investments as the bargaining power of buyers are reduced. This could undermine development of the industry.

The telecoms industry is not only a significant contributor to economic growth but also a vital revenue source for other sub-sectors. Media entities in particular have benefited handsomely from the intense competition in the market as the large advertising expenditure by these companies have compensated for the fall-off in advertising spend by other companies. Digicel and Claro make up a large share of the industry’s advertising budget. As such, a merger between these two entities would mean a drop in advertising spending from the industry. This is likely to adversely affect the revenues of media houses, who undoubtedly, would be one of the biggest losers in the event of a merger.

Despite the negatives which have been discussed on this issue, the impact of competition on the industry has not all been positive and there are indeed valid arguments in favour of the merger. One of them is that intense competition has stymied industry profitability. Subscriber growth has slowed to single digits, which is evidence that the local industry has exited the growth stage and has entered maturity. Further, the PIOJ estimated that despite the increase in mobile subscribers, real value added for the industry contracted due to increased competition which led to reduced revenue. This, as the increased promotional activities have resulted in more giveaways, thereby dampening subscriber expenditure. Operators have also seen a decline in average revenue per user (ARPU) according to data from the Office of Utilities Regulations. The argument, therefore, is that a merger would curb the excess supply in the market, thereby prolonging the industry’s life cycle.

Local operators have seemingly placed heavy focus on the competition in the mobile market and have only recently begun to pay attention to other services which may present growth opportunities. Broadband penetration rate in 2010 was 4.3 per cent which underscores the scope for expansion in this area. The main indicators suggest that increased focus on other segments may be more worthwhile, and could turn out to be a major contributor to growth in the industry.

The most common reaction to a merger is that consumers are likely to end up with higher prices and lower quality products and services. In the case of the pending AT&T/TMobile merger in the US, if successful, there would only be three big companies remaining in the market and one senator has called on the FCC and the Department of Justice to ‘take a close, hard look at the merger to make sure consumers don’t end up worse off’. There have been similar outcries concerning the Digicel/Claro merger in the local market as only two companies will remain. But how much competition is enough? Do we need three companies? Will two companies allow for sufficient competition and industry dynamics? The challenge is trying to find that optimal level of competition which maximises consumer surplus but does not do so to the industry’s detriment. Some local consumers may be of the view that a merger of two of the companies in the industry could achieve this optimal level. However, Digicel and Claro would certainly not be their pick for the optimal pair.

Simone Hudson is a research analyst at NCB Capital Markets

hudsonsg@jncb.com