Kellogg Graduate School of Management
Global Initiatives in Management – Russia
Prepared by:
Amy Ballew
Ross Nelson
Tim Sznewajs
April 18th, 2001
Introduction & Overview
This paper focuses on the cellular telecommunications industry in Russia. This topic was selected due to its attractive growth characteristics, its cutting-edge technology, and its potential to improve the quality of life for Russian citizens. As evidence of the market potential, cellular telecommunications is one of the few sectors of the Russian economy (outside of the domain of natural resources) that has attracted substantial amounts of foreign direct investment in the years since the 1998 crash.
Research and interviews demonstrate that the Russian cellular industry is burgeoning, with the country’s major carriers operating profitably and rapidly expanding existing service territories. However, the cellular industry also faces serious threats to sustained growth and profitability, plagued by both the tumult resulting from a decade of radical change as well as industry-specific issues.
This paper therefore attempts to provide a high-level overview of the Russian cellular industry and the issues surrounding its further development. This involves the following:
a) An overview of the larger Russian telecommunications industry and its current state of development. This is relevant as it provides a perspective on the other telecommunications services which cellular interacts and competes with on a regular basis;
b) A commentary on Russian corporate ownership rules and the implications for the development of the Russian cellular market. This is a crucial element due to the common ownership of both traditional telecommunication firms and cellular providers in Russia;
c) Summary profiles of major Russian cellular operators;
d) Assessment of major opportunities for, and potential obstacles to growth within the industry.
Developing
telecommunications infrastructure is a top priority for Russia. As the world moves towards a more global
economy, effective telecommunications infrastructure and services will become
more and more critical to a nation struggling to stabilize its economy.
Russia’s
telecommunications industry is one of the more robust industries in Russia; it
has grown successfully since the 1998 financial crisis and attracted
significant foreign direct investment.
However, Russia still lags peer countries in overall levels of
telecommunications infrastructure.
Currently, there are over 54,000 towns in Russia that do not have wire
line communication access. Russia’s
telecommunications industry revenues account for only 2% of Russia’s GDP, as
compared with an average of 5% in industrialized countries[1];
and these lower revenues in such a major industry have far-reaching economic
ramifications. In order to compete with
other industrialized nations, Russia has recognized the need to improve its
telecommunications offerings.
To meet demand for
Russian telecommunications services, in December 2000 the Ministry of
Communications & IT Policy (“MinCom”) announced that is has developed and
approved a plan for Russia’s telecommunications development. MinCom’s regulatory responsibilities include
issuing licenses, certifying equipment, and policing the frequency spectrum
(MinCom no longer has either ownership of the public switched telephone network
(“PSTN”) or direct managerial responsibilities over the industry). The Ministry hopes the new plan will “create
an environment that would help the industry meet the growing market demand for
telecommunications services, improve the national telecommunications
infrastructure, and bring telecommunications services to every town in Russia.”[2]
The plan identifies what
has to be done to improve Russia’s telecommunications infrastructure and
outlines the government’s future regulatory role. The plan details several positive initiatives including [3]:
1) Adjust regulatory policy
to allow further growth
2) Restructure 80+ regional
operators into 7 large holding companies
3) Eliminate
cross-subsidies to fairly distribute local telephone costs
4) Reclassify many
operators as non-monopolists or natural monopolists to encourage competition
5) Make interconnection a
mandatory, non-discriminatory service
6) Introduce Universal
Service, guaranteeing some level of telecommunications access to all Russian
citizens
7) Obtain more cellular
frequencies from the Ministry of Defense
8) Introduce competition
into license tendering
9) Attract investment by
selling a portion of Svyazinvest shares
10) Modernize the PSTN
The plan also outlines
specific growth goals for the telecommunications industry, as listed in the
table below.
Table
1
Russia
Telecommunication Infrastructure Projections
|
(Numbers
in millions, unless otherwise noted) |
2000 |
2005 (estimate) |
2010 (estimate) |
|
Number of phone lines |
31.2 |
36.9 |
47.7 |
|
Number of mobile phones |
2.9 |
9.2 |
22.2 |
|
Number of Internet users |
2.5 |
6.0 |
26.1 |
|
Telephone density per 100 people |
21.3 |
25.3 |
32.7 |
|
Mobile phone density per 100 people |
2.0 |
6.3 |
15.2 |
|
Internet user density per 100 people |
1.7 |
4.1 |
17.9 |
Achieving these goals
will come with a hefty price tag, however.
The MinCom plan indicates that Russia must attract $33 billion over the
next 10 years in order to its goals. A
former Minister of Telecommunications stated that MinCom is seeking $20 billion
of the $33 billion from domestic sources, leaving the remaining $13 billion to
come as foreign investment.[4] It is unclear from the Ministry’s plan,
however, what portion of this $33 billion is to be devoted to cellular
development. It will be important for
Russia to strike a balance in the future between building landline
infrastructure and cellular infrastructure.
In a country as vast and geographically dispersed as Russia, landlines
will be impractical in many remote areas due to the high development and
maintenance costs.
The MinCom plan also
proposes restructuring to alleviate a noticeable imbalance in the Russian
telecom market. Residential
telecommunications services, particularly in the regions, are by far the least
profitable segment of the industry.
Most growth in recent years has been focused on commercial and cellular
access, because the residential services market is not as fiscally attractive.
Monthly residential user fees amount to only 77% of maintenance costs, and many
users pay less than the standard rate due to programs which provide government
subsidies. Minister Reiman implied in
the MinCom plan that the government prioritizes giving every Russian citizen
access to the PSTN, regardless of his or her income level and location through
the Svyazinvest restruturing. However,
there is no law in effect that guarantees a Russian citizen access to a phone.[5]
Through speaking with various participants in the Russian telecommunications industry it is clear that there is broad consensus for amendment to the current restrictions surrounding corporate ownership. The need for reform is due to the sheer complexity of such rules, and is further aggravated by the necessity to raise much more capital in a national environment full of economic hardships. As mentioned above, current MinCom plans call for investments in excess of $30 billion in the telecommunications industry alone, with more than one-third of this from international corporate investment[6].
Andrew Corporation has experienced some of the current ownership restrictions first-hand. The company is 49% owners in all of their joint ventures, despite providing a majority or all of the capital to many of these agreements. If more capital is needed and has to be funded by the non-Russian entity, this entity must then invest in the venture via debt vehicles. Robert Hudzik believes that having a strong partner who can deliver is more important than attempting to change laws to gain a majority stake[7].
Currently, the Ministry of Communications is considering further legislation regarding foreign ownership of Russian companies. “Interests of development of national telecommunications market demand to address both the issue of restrictions on direct access to foreign entities to the Russian telecommunications services market and restrictions of their direct and indirect majority ownership in Russian telecom companies.”[8] The agency is foreseeing issues related to the further foreign investment into Russian telecom companies and wants to limit the power a foreign power can garner within an industry so critical to national interests. In summary, though there are limitations on joint venture stakes, there are currently no straight-forward restrictions on foreign ownership of pure Russian companies.[9]
Furthermore, another important issue for foreign investors in Russia is that of the protection of ownership rights. MinCom has openly stated its interest in attracting investment from outside of Russia, and has acknowledged the importance of legally protecting investments made inside of Russia, especially by foreign companies, which own minority stakes in formed ventures.[10] Former Minister Pervyshin seconded these insights and stated that there are many bills in the Russian Duma that pertain to protecting investor rights, which he believes will pass without problems later this year.[11] Executives at Andrew Corporation reiterated that passage of these laws is critical to their business, and that they are not satisfied with current laws in this area. These insights are based on the experience of having been involved with eight joint ventures on average at any given time over the past ten years.[12]
Mobile TeleSystems OJSC (“MTS”)
Mobile TeleSystems OJSC is the largest GSM (Global System for Mobile Telecommunications) operator in Russia in terms of subscribers. As of March of this year, the company had over 1.2 million subscribers, which is a significant increase from the 307,000 subscribers at the end of 1999. At the end of 1999, the company had licenses to operate in 34 regions in Russia, representing a population of 67 million people or 45% of the country’s total population. At that time MTS was operating in 19 of those regions with a total population of 19 million, including 15 million in the Moscow license region, with plans to expand to the other regions per the terms of the licensing agreements. At the end of 1999, MTS was the largest operator in Russia in terms of net revenues, with VympelCom, the next largest competitor, generating one-third less revenues. An analyst report by Credit Suisse First Boston (CSFB) estimates total MTS subscriber base of approximately 2 million by the end of 2001 based on a 55% market share of the projected 3.6 million customer base.[13]
The company’s strategy is to strengthen its competitive position in the Moscow license area, while also expanding in other parts of European Russia. In addition, the company plans to expand its network gradually into selected parts of Asian Russia. Other key elements of the company’s strategy include: focusing on revenue growth and profitability in the Moscow license area, enhancing the quality of customer service, further promoting the MTS brand in the Moscow and regional licensing areas, selectively expanding coverage beyond the Moscow license area, acquiring other GSM operators and license-holders, and developing and introducing new mobile data services when sufficient demand materializes. Through construction of new networks and acquisitions, MTS intends to become the first truly national mobile cellular operator in Russia. The company believes it can develop a viable business beyond the Moscow license area by relying on economies of scale, project management and marketing capabilities, technical expertise and brand recognition of the MTS name.[14]
In June of 2000 the company furthered its strategic initiatives by completing an initial public offering (IPO) of its stock in the form of an American Depository Receipt (ADR) on the New York Stock Exchange. The company tendered approximately 15 million ADRs representing over 300 million shares of common stock, which raised over $300 million. Before completion of the IPO the company was cash flow negative, despite $100 million in 2000 net income, due largely to its extensive network buildout.[15] The proceeds of the IPO were used for further building out the infrastructure of the company, which now include 1123 base stations in Russia and 767 of these in the Moscow area. Deutsche Telecom is also a minority investor in MTS.
Currently the cellular market has about 13% penetration in the Moscow area, of which MTS owns 55% of this market. Looking at Russia in aggregate there is currently a penetration rate of 2.3%. Dividing MTS customers into “mass market” and “business/corporate”, 80% of the customers are mass market but these subscribers only generate 47% of the revenues.[16]
Looking to future penetration rates, Svetlana Soukhanova of MTS has many thoughts. She believes that further penetration will not be driven by increases in the Russian GDP. Instead, she feels that the cellular service demand driver is competition, which inevitably leads to lower prices. Currently countries like the Czech Republic or Hungary, which have similar per capita GDPs but more developed competition, are seeing penetration rates in the range of 25-30%. Soukhanova also feels that cellular phones are currently a complement to land lines, but this may change; in the future they may become a substitute product.[17]
Despite its solid cash position and positive net income business, MTS faces some challenges in the near future. The company knows it cannot sustain its 55% market share in the Moscow area. MTS also faces “frequency issues” as broadband frequencies will need to be subdivided more efficiently. Lastly, Soukhanova states a need for more interconnection regulation between land and cellular lines.[18]
In March of 2001, MTS announced the planned acquisition of Telecom XXI, which operates in the coveted St. Petersburg market. Telecom XXI holds one of the two licenses to operate in the St. Petersburg market using the GSM standard. Telecom XXI has done little in St. Petersburg to develop the market, installing only 15 base stations and one switching center, enough to satisfy requirements to maintain its license. MTS plans to move aggressively to carve out a place in the city’s cellular market and forecasts having twenty to thirty thousand subscribers by the end of 2001. The only obstacle pending is approval by the Antimonopoly Ministry. Analysts feel that the acquisition of a GSM license for St. Petersburg and the Northwest region will be a major positive development for MTS, as St. Petersburg is the second most lucrative market in Russia for telecom services after Moscow. A low penetration rate of 6-8% compared to 14% in Moscow area implies that the local market has a great deal of room to go. The estimated cost of the acquisition is $50 million.[19]
VympelCom is the second-largest cellular entity in the Moscow area, with approximately 853,000 subscribers in the Moscow area. Until early 2000, the firm was larger than MTS in terms of total number of subscribers, but it has experienced slower growth and been displaced as the market leader. Since the erosion of this market share advantage, VympelCom has been striving to catch rival MTS. The cause of VympelCom’s lost market share is mainly a result of its operating disadvantages. It has lower gross margins (higher cost of goods sold), inferior quality of assets (which generate a return on invested capital only commensurate with cost of capital), and most importantly, much less revenue per subscriber than MTS.[20]
In order to successfully compete with MTS in the future and subsequently attain similar stock price valuations, VympelCom must focus on three initiatives. First, VympelCom must attain critical mass and amass a subscriber base similar in size to MTS. Penetration in the Moscow market is about 14%, and it is expected to reach 23% with 3.6 million subscribers by the end of 2001. Currently VympelCom has about two-thirds of the subscriber base of MTS in the Moscow market, giving it about 40% of the total market. VympelCom’s present strategy focuses more on profitability and is currently striving to achieve the profitability goals at the expense of increasing subscriber base dramatically. Secondly, VympelCom must focus on improving earnings before interest, taxes, depreciation, and amortization (EBITDA). VympelCom plans to accomplish this improvement by lowering its cost of services by decreasing its interconnection and leased-line costs. The company must also lower subscriber acquisition costs (SAC). With the market in Moscow maturing, the differences in gross margins between MTS and VympelCom should converge. Thirdly, the company must find a way to narrow the gap with MTS in terms of average revenue per user (ARPU).[21]
In addition, VympelCom has aggressive expansion targets. The company plans to spend approximately $140 million in capital expenditures per year from 2001-2003. As much as $120 million of the funds will be used to expand the network and develop new services in the Moscow region. The remainder of the money will be invested in its other operating regions. VympelCom plans to develop its regional franchise through a newly established subsidiary VympelCom Regions (VCR). It is likely that the company will invite a partner, possibly an international operator, to participate in this venture. Furthermore, VympelCom’s stake in the venture will be assumed to be 51%. The company has about $176 million in cash on its balance sheet and earnings for 2000 were $41 million. Because the company is currently cash flow negative ($41 million less $140 million in investing in 2000), the company foresees a possible need for further financing in late 2002. It is assumed the funds would be raised through a follow-on equity offering.[22] Telenor, a Norwegian telecom company, has a minority stake in VympelCom.
The overall telecommunications market in Russia
was a $5 billion market in 2000, and is expected to grow to $9 billion by 2002.[23] However, even if Russia realizes this
substantial growth, it will not propel Russia to the level of other
industrialized nations. Therefore,
given this underdevelopment of this key asset, telecommunications companies
around the world are watching this substantial market as a potential source of
growth.
However, Russia is a vast country geographically
and building a landline infrastructure to suit the needs of the entire country
will come with a staggering price tag.
As Russia struggles to isolate where is should invest precious domestic
capital and allow foreign investment, it will face critical issues about
whether investment in the landline system or wireless system are more critical
to economical and social development.
This analysis identifies several opportunities currently available to
domestic and foreign investors in the Russian cellular industry, as well as the
obstacles facing the development of a robustly competitive cellular market.
Globally, wireless telecommunications markets are analyzed along a few standard metrics, with penetration rates seen as one of the most relevant points of comparison. Penetration rate is defined as the percentage of the population that uses a mobile phone. For example, Nordic countries currently lead the rest of the world with 60%-70% wireless penetration rates, with most European countries between 35%-50% penetration, and Russian cities such as Moscow and St. Petersburg at 13% and 8%, respectively[24]. In the past, penetration rate has also closely mirrored GDP per capita, with those countries with higher GDP per capita experiencing higher penetration rates. However, research performed by one Russian investment bank, United Financial Group (“UFG”), shows that International Monetary Fund and World Bank data indicates that the link between wireless penetration and GDP per capita may not hold true in the future[25]. Instead, other factors can and will play a more important role with respect to wireless market penetration, some of which portend well for the Russian wireless market.
UFG argues that instead of simply analyzing GDP per capita, one must also examine levels of income distribution, along with viable network investment. This is because while overall GDP per capita is low in Russia, there are substantial pockets of the population that have meaningful disposable income and are currently being targeted by Russia’s mobile carriers. For example, at the end of 2000 Moscow had a penetration rate of 13%, while GDP per capita was $1,691 (including factoring in the gray economy). This 13% rate is higher than Mexico, Brazil and South Africa, each of which have substantially higher GDP per capita rates (See table 2 below).
Penetration
vs. GDP per capita[26]
|
Country/City |
Cellular Penetration Rate |
GDP per capita ($) |
|
Finland |
67% |
23,780 |
|
Norway |
62% |
32,880 |
|
Moscow |
13% |
1,691 |
|
South Africa |
12% |
3,160 |
|
Brazil |
9% |
4,420 |
|
Mexico |
8% |
4,400 |
|
St. Petersburg |
8% |
1,475 |
From an investment perspective, these statistics bode well for the Russian mobile wireless telecommunications sector, suggesting that country-wide penetration rates may reach as high as 10%, a substantial market in a country with a population of 175 million inhabitants. However, most critical to reaching these penetration levels are the issues raised throughout this paper, particularly slanted regulatory policies and corporate cronyism. Overall Russian penetration rates remain low (2%), suggesting that if governmental and regulatory bodies can change course and begin to facilitate network investment and fairly license and allocate spectrum, the Russian wireless market may hold substantial promise above what current forecasts predict.
Most analyses of Russian economic conditions remark upon the clear contrasts between Moscow/St. Petersburg and the remainder of the vast countryside (the “regions”). In particular, low earning power and even lower disposable income, coupled with tremendous geographic dispersion and insufficient infrastructure, separate the regions from the cities. For that reason, most areas of the regions are considered to be economic lepers, untouchable due to the poverty and hardscrabble nature of everyday life. While these stereotypes are certainly rooted in some economic reality, market research and analysis demonstrates otherwise for the mobile telecommunications industry.
United Financial Group suggests instead of economic stagnation that different sectors will emerge in Russia with different levels of wireless penetration among them. This follows from the trend noted above that Russian cellular penetration will be driven by a force other than overall per-capita GDP, a metric commonly applied to cellular market analysis. Instead, mobile telecommunications usage will be driven by the deployment of high-quality cellular networks and viable operators to market such services. Provided that the Russian governmental and regulatory agencies can correct past mistakes (not necessarily a given), Moscow and St. Petersburg’s cellular uptake trends signal potentially positive trends for the regions of Russia. While market potential in the regions won’t approach that of Moscow and St. Petersburg, it should substantially exceed current levels and those predictions based on per-capita income. This additional penetration will occur because of the virtual non-existence of a middle class in the regions; spending power for certain classes will support increased cellular usage. Russia’s richest 10% receive 34% of the nation’s total income, providing a healthy market to consume cellular services.
Further, when it comes to Russia’s regions, cellular technology provides a compelling alternative for both consumers and users based on the geographic space and lack of solid landline deployment. This resembles other wireless buildouts which have taken place in emerging markets in Asia and Africa which bypass landline technology and rely almost solely upon cellular. Among various parties interviewed in Russia, there was a consensus that roughly six million customers await the installment of a landline phone, a large market of customers who could easily be serviced by cellular telephony. Further, over 54,000 settlements in Russia’s regions lack access to any sort of telecommunications offering. While all of these potential customers are not necessarily financially viable from a carrier’s perspective, their presence will drive cellular adoption in addition to the normal complementary purpose wireless services have performed in more developed areas of Russia.
As hard evidence of this, research points to the preliminary success which smaller cellular carriers like Kuban-GSM have had in regions such as Krasnodar[27]. Kuban-GSM has had to put new subscriptions on hold due to rapid adoption, and expects to increase its network capacity to handle 300,000 subscribers, far above any market projections. The impressive thing about this story is not the number of subscribers, but instead Krasnodar’s unspectacular economic profile. Among Russia’s top twenty regions, it is 7th in terms of income, 20th in terms of purchasing power, and 20th in overall industrial output. These statistics suggest that there are ample opportunities for wireless mobile telecommunications providers in Russia’s regions if firms and the government can correctly allocate financial resources and market services appropriately.
The alternative contractual payment system which MTS and other cellular carriers have developed with their subscribers creates a unique financial advantage for Russia’s cellular carriers. Due to the uncertainties in the Russian economy, as well as because of Russian perspectives on credit rooted in the Soviet era, 95% of all cellular service is pre-paid. Operationally, a customer buys a phone, pays to activate it, and then adds money to the plan as he or she needs it. This prepayment plan allows subscribers to deposit money at any moment and also allows for easy checks of account balances via the internet or by phone. For example, MTS has 74 cash offices, 130 MTS offices, and 2050 dealer offices under its realm where customers can make account payments. While certain corporate clients with solid credit histories are given the luxury of paying at the end of the month as is common in the United States, prepayment is the predominant form of collection.
This system provides many financial benefits to carriers. First, and most importantly, it eliminates account delinquencies. If the money in the account runs out before it is replenished, the phone is simply turned off . Secondly, the cellular provider has the consumer’s money in their hands in advance of the time it is used, thus allowing it to earn interest on accounts or fund working capital needs. Finally, this payment scheme eliminates the need to create traditional billing systems with mailed invoices, another cost savings. Therefore from many perspectives, the prepayment system is an attractive aspect of the Russian cellular market.
The next revolution to hit cellular communications
will likely be third-generation wireless services. 3G technology will transform cellular communications from voice
to data, enabling end-users to access e-mail and the Internet (including video)
from hand-held mobile devices. Since
Russia does not have the capital to invest in research and development to
create 3G technologies, it must rely on the West to do so. However, the West may have created
artificial barriers to development.
Before the technology bubble burst in 2000, several Western countries
auctioned off their 3G frequencies. The
excitement and attention on 3G drove the prices up to the astronomical numbers
displayed in Table 3.
Table
3
3G Frequency Auction
Prices
|
Country |
Frequency Auction Price (US$) |
Frequency Auction Price (local
currency) |
|
Germany |
$44 billion |
98 billion marks |
|
United Kingdom |
$31 billion |
£22.47 billion |
|
New Zealand |
$54 million |
NZ$133.58 million |
These incredibly high prices, which delighted the governments that reaped them, have jeopardized 3G technology development. Companies that have paid these prices are now having difficulty finding capital to invest in development, because many industry analysts now view 3G as a negative NPV proposition. Nicholas Negroponte, a prominent researcher in cellular technology and head of MIT’s MIT Media Laboratory, said, “"[The U.K. auction was] such a big mistake, I'm not sure how to recover from it any more. When the UK launched 3G spectrum the government was gloating. Look at this wonderful thing that we have done. It wasn't wonderful. It was in fact terrible." Negroponte calculates that the prices paid at the U.K. auction will saddle cellular service providers with a $1,000 per subscriber rate at roll-out. High rates such as these will inhibit adoption rates, which are critical to the survival of a new network technology.[28]
Preliminary indications are that Russia is considering auctioning off its frequency upon a rebound in the worldwide cellular market.[29] However, Russia should regard its 3G cellular options with skepticism. The future of 3G in the West is unclear, and because Russia relies on the West for development, Russia should also regard 3G with a wary eye. In fact, some U.S. politicians and wireless operators are pushing to delay the FCC's third-generation spectrum auction this fall, saying an early sell-off could result in a multi-year delay in the deployment of U.S. 3G wireless services.[30] Therefore given these domestic and international market conditions, 3G should not be seen as a near- or medium-term opportunity for Russia’s cellular markets.
Russia’s regulatory laws currently have several critical drawbacks centering around national security issues, frequency management and licensing, interconnection services and cellular standards. These drawbacks negatively impact all players in the cellular market, including consumers, domestic companies, and foreign investors, serving as obstacles limiting the growth of the Russian cellular market.
Government access to telecommunications
infrastructure is commonly accepted in the Western world as a requirement of
national security. However, a major
concern to foreign investors is that there is no specific law that protects
Russia’s national security interests with respect to foreign ownership of
Russian telecom infrastructure.
According to the U. S. Commercial Service, the absence of this
provision, which is common in industrialized countries, is concerning because
the rules of the game are unclear.
Foreign investors would be more comfortable with investment in Russian
infrastructure if there were specific and enforceable laws that outlined their
rights and the rights of the Russian government.
Currently, there are no specific restrictions on
foreign ownership. The recent plan
indicates a need to review the issue of whether to add restrictions on foreign
majority ownership and management in Russian telecom operators; however, the
plan is weak in its conviction.[31] The Minister has at times suggested that
prudent foreign ownership should not exceed 49%, however, MinCom has not placed
any specifics around this suggestion.
Some individuals in the industry believe that MinCom is enforcing this
edict through withholding licenses.
Golden Telecom, the only major company to violate this tenant,
experienced difficulties recently when it renewed licenses to operate.[32] These difficulties were beyond the scope of
normal process and issued a cryptic warning to companies seeking foreign
investment.
Therefore, in order to attract prudent foreign investment, MinCom should pass specific laws governing foreign ownership.
ii. Interconnection Services[33]
Interconnection continues to be a major challenge to facilitating true competition in the Russian mobile wireless telecommunications sector. There are three primary reasons why interconnection is a major barrier for entry into the Russian wireless sector, the first of which is universal to all telecommunications markets and the others of which are specific to the Russian market.
Interconnection, regardless of the market where it is attempted, is an extremely complicated and time-consuming technical process. It involves the literal connection of thousands of network parts of one carrier to another, from switches and lines to back-office systems, many of which were not originally designed to interface with one another. This poses a unique network engineering challenge, and the Russian market is not immune to the same difficulties that other markets have experienced, including the U.S. This interconnection process is further complicated by the existence of antiquated technology in Russian landline networks that poses even greater challenges. However, while the technical issues associated with interconnection are daunting, they are not insurmountable and will be overcome in time.
The second and more troublesome issue associated with interconnection is the lack of clear and enforceable regulatory guidelines to govern company interactions. Such rules are necessary to ensure that all competitors can gain access to critical network elements in order to provide service. In its blueprint for overhauling and developing the telecommunications market (released in December of 2000), the Russian Ministry of Communications outlined in summary form the type of rules necessary to ensure fair and unfettered network interconnection. These rules included the mandatory requirement of monopoly operators to interconnect with all carriers, non-discriminatory terms and pricing, and the creation of a federal law to administer and enforce such guidelines[34]. Minister Reiman stated that “Interconnection should be non-discriminatory and transparent” in the new MinCom plan.[35] While these summary guidelines and statements provide reassurance that the Ministry of Communications recognizes the importance of clear interconnection rules, the market will continued to remain closed to outside providers until these rules are fully enacted and enforced.
The final issue surrounding interconnection in Russia is intimately related to the second issue above, and that is the complicated web of corporate ownership which results in preferential treatment of certain mobile carriers by monopoly service providers, particularly in Moscow and St. Petersburg. While detailed information for interconnection rates and terms is not publicly available, information provided by the company indicates that Mobile TeleSystems (“MTS”) benefits from corporate affiliations which provide a competitive advantage vis-à-vis its competitors[36]. MTS’ ultimate corporate parent is Systema, a large Russian holding company which controls, among other things, MGTS, the exclusive last-mile landline provider in Moscow. This corporate relationship between MGTS and MTS results in the mobile carrier receiving lower interconnection rates and higher quality service than any of its mobile competitors, allowing it to offer the most competitive rates. These types of relationships, while beneficial to the parties involved, ultimately serve to hinder the development of competition in the Russian wireless telecommunications sector and pose substantial barriers to new entrants.
In order to ensure healthy and fair competition, MinCom should write and guide into law legislation that regulates pricing and criteria for interconnect services. This would include requirements to provide interconnection services in the newly restructured Svyazinvest companies’ charters, and give new entrants a fair chance, thereby developing healthy competition in the market.
Spectrum availability is a critical issue for cellular competition and growth in Russia. Only 4% of available radio frequencies are used by civil organizations, with 26% shared between military and civil organizations. The remaining 76% are used exclusively for national security. The two spectrum frequencies currently available for commercial use are 900-megahertz and 1800-megahertz. The 1800-megahertz is used exclusively by civil organizations, while the 900-megahertz frequency is the portion shared by civil and military organizations. [37]
The allocation of frequency is one of the most critical issues facing cellular providers. The frequencies civil organizations are allowed to use are filling up rapidly, creating an artificial scarce resource and limiting competition in the major markets. The military and national security organizations, however, are reluctant to relinquish their frequencies because their infrastructure is calibrated to them. Ultimately, to give up frequency spectrum means a cash outlay to reconfigure or purchase new equipment. It should be noted that the allocation of spectrum frequency is not an issue exclusive to Russia. The United States, members of the European Union and many other countries are dealing with this same issue, as military uses have traditionally consumed the vast portion of commercially viable spectrum. In this regard, all countries involved in this issue will be forced to make tough choices regarding national priorities and willingness to absorb the economic impacts of spectrum management decisions.
In addition to limited frequency, the method MinCom uses to allocate frequency also causes cellular providers to incur unnecessary maintenance costs that could be reinvested into infrastructure. For instance, Mobile TeleSystems (MTS), which has the largest cellular market share in Russia, expends significant resources navigating the frequency minefield. For each license they obtain in the 900-megahertz spectrum, the firm must negotiate with the local military as to what portion of the band they will use.[38] The effort must be repeated in every new area a company enters, and must be renegotiated on an annual basis. In addition, the annual request for licenses and frequency places a cellular provider at the mercy of the whims of the regulatory body. Several organizations believed that MinCom has, on occasion, used the allocation of licenses and frequencies as a deterrent to majority foreign ownership.[39] Whether this is a well-founded claim or not, the absence of a clear frequency allocation protocol is of concern to all cellular providers.
In order to encourage competition and reduce bureaucratic waste, MinCom should create a comprehensive plan to manage spectrum issues, including striking the appropriate balance between military and commercial frequency usage. Russia would also benefit from an orderly and transparent spectrum allocation process.
Cellular transmissions are coded according to certain standards and protocols. There are three major cellular standards used in Russia: NMT, AMPS/DAMPS, and GSM. These three standards currently account for 99% of the cellular market. The remaining one percent is CDMA. NMT was the first standard in Russia and still leads the group in terms of geographic coverage. The largest service provider using NMT is Moscow Cellular Company (MCC). AMPS/DAMPS is used by Vympelcom. NMT and AMPS/DAMPS are both losing share to GSM, which is currently the most popular cellular technology in Russia. Both VimpelCom and Mobile TeleSystems (MTS) use this standard; GSM is also the standard in Western Europe.
Table
4
Market
Share of Cellular Standards (Moscow)[40]
|
|
1998 |
1999 |
2000 (estimate) |
2001 (estimate) |
|
GSM |
33% |
47% |
57% |
53% |
|
AMPS/DAMPS |
43% |
26% |
18% |
15% |
|
NMT |
23% |
24% |
17% |
4% |
|
CDMA |
|
3% |
8% |
18% |
CDMA’s future in Russia is unclear. Ignoring the sunk cost of the existing infrastructure and network externalities, CDMA is a superior standard for two reasons. First, the security level to the consumer is much higher than on the more popular GSM standard. Second, CDMA is used for fixed wireless transmissions as well, and fixed wireless may be an excellent option for Russia’s more remote areas. Fixed wireless entails laying one cable to an area, then serving an area around that space using wireless technology. As Russia faces significant investment in the telecom infrastructure, fixed wireless may offer an option that eliminates the costs of laying last-mile cable in the ground.[41]
However, politics may obscure the benefits of CDMA technology. The authority MinCom has over license and frequency allocation will have major impacts on the adoption rate of CDMA by controlling the rate at which cellular providers can build infrastructure. One member of the U. S. Commercial Service indicated that there may be conflicts of interest within MinCom; if powerful individuals within MinCom own portions of cellular providers that use the GSM standard, then the CDMA standard may be artificially suppressed, not because there is not market demand but because the regulatory body is preventing its development.[42]
In order to encourage competition and reduce cronyism, MinCom should create a transparent process for CDMA license allocation. MinCom should also create regulations limiting the amount of a telecom company a senior official within MinCom can hold, to avoid conflict of interest issues.
In any country, relationships, along with innovative, high-quality products and time to market considerations have the ability to drive successful business dealings. Nowhere is this truer than in modern-day Russia. Specifically, in the field of telecommunications, government ministries play a tremendous role in determining the “rules of the game” for the market participants. Spectrum allocation, licensing procedures, equipment certification, interconnection conditions: all are necessary steps to offering mobile telecommunications services before a firm even attracts a customer or earns a profit. These extensive, and sometimes duplicative regulatory processes encourage market participants to cultivate relationships with key governmental bodies in order to gain favorable interpretations of rules designed to obfuscate and confuse competition.
Make no mistake, building relationships with key figures makes good business sense in any market, especially one as Byzantine as Russia’s. However, numerous multinational and Western-based firms which discussed doing business in Russia emphasized the importance of “playing by the rules” in Russia through strictly obeying all laws, regulations, codes and procedures. The reasons provided for this rationale are straightforward and logical, and are also made in full recognition that current business practices by most market participants are not in-line with such standards.
Andrew Corporation’s Hudzik states, “it is still an intensely political environment to do business in and one must play by the rules, even if the rules make it tough for us.”[43] He gives an example. Though the Russian government and operators have not explicitly stated they will only buy equipment from Russian manufacturers, it is well known that there is a preference for purchases through Russian-connected companies.[44] This example illustrates Andrew Corporation’s need for joint ventures in Russia, and the company knows it must obey the rules and uses its partners to its advantage. These partners are critical to the company’s survival and prosperity in Russia.
In addition, Andrew Corporation also seeks influential persons to help them run their ventures in Russia and stay within the guidelines. Erlen Pervyshin is the perfect example. As stated before, he was Minister of Communications for 17 years in the former Soviet Union and was involved in the industry for many years prior to that. As a testament to his capabilities, he was the youngest minister ever chosen at 41 years old, and during his tenure he had three million people working under him. However, Mr. Pervyshin is not focused on the past; his forward-looking perspective and enthusiasm for telecommunications in Russia are a powerful combination with his experience and knowledge. He knows the Russian telecom market very well and is a huge asset to Andrew Corporation.
Additionally, Western companies emphasized the illegality (by U.S. standards) of not strictly following all Russian laws and regulations. Under the U.S. Foreign and Corrupt Practices Act (USFCPA), all U.S. firms undertaking business in foreign countries must obey all laws of that country to their fullest, or face substantial penalties and prosecution. As an aside demonstrating the difficulty of USFCPA requirements in a country as corrupt as Russia, a representative of the U.S. Consulate’s office in Moscow cited the USFCPA as one of the primary obstacles to U.S. success in penetrating Russian markets.
Following Russian laws to the letter provides cover to businesses that may otherwise be scrutinized by Russian law enforcement officials, especially if these businesses are successful. One presenter from Andersen Consulting pointedly observed that while undertaking unlawful activities under certain regimes may be successful to a point, at some time different individuals with different allegiances may come into power, leaving firms which have been well-positioned in a state of weakness very quickly.
Finally, maintaining lawful practices is also critical for the reason that Western and other international firms must lead by example if they hope to prevail upon the Russian leaders to implement and enforce a rule of law for corporate activities. In a market such as Russia with its tremendous commercial potential, a law-abiding environment in which corruption is significantly curtailed ultimately benefits those providers of superior products, a far more attractive outcome than success for those with superior relationships and ability to circumvent the law.
Conclusion
It is clear that there will be no absolutes in a market as large as the telecommunications market in Russia. There have been and will continue to be phenomenal successes in the industry, as well as tremendous failures. These successes and failures occur based largely on the positive and negative aspects to the Russian cellular telecommunications market, each of which present its own set of issues and challenges.
On the positive side, Russia has tremendous potential for investment and growth due to the relatively low penetration rates, the large base of untapped users in the outlying regional areas, and the attractive business model which has been utilized as a result of the unique credit conditions in Russia.
However, even with this potential, conditions in Russia pose great challenges to entry by Western-based firms into the cellular market. This is due to both country-risk and industry-specific risk. The country related risk centers around the large macroeconomic issues which all investors in Russia face – issues such as international debt payment