Telecommunications market

Worldwide, the market for information and communications technologies (ICT) grew by 4.0 percent in the reporting year to EUR 3.2 trillion. This increase was due in part to strong demand for telecommunications equipment and services, especially in India, China, and the United States. The high-tech association Bitkom (Federal Association for Information Technology, Telecommunications and New Media) and the EITO (European Information Technology Observatory) expect the telecommunications market segment (services and equipment) to record an increase of 4.0 percent worldwide to EUR 1.82 trillion and the information technology (IT) market segment to record an increase of 3.9 percent for 2017. In the European Union, revenue in the telecommunications market segment rose by 1.0 percent, primarily due to the capex-driven 5.0 percent increase in equipment. The European Telecommunications Network Operators’ Association (ETNO) expects service revenues in the EU telecommunications market to have grown slightly by 0.1 percent compared with 2016 to EUR 223 billion in the reporting year. Radical regulatory interventions, such as the reduction in the European roaming and national termination rates as well as substitution by OTT (over-the-top) players, continue to have a negative impact on traditional voice and messaging services, which declined as a result. In 2017, these declines were offset by growth in data revenues.

The digitalization of the economy and society continues to advance steadily. This changes on the one hand the existing market structures, and on the other, the market realities of many industries that have previously been exclusively analog. Use of data services is growing exponentially. Demand is also rising for more speed, both download and upload, in fixed and mobile networks. New technological developments, like the Internet of Things (IoT), Industry 4.0, big data, or cloud computing place high demands on network infrastructure: Ubiquitous connectivity and high performance standards and security are critical to success for many applications. In a market environment in which the network infrastructure needs to be substantially upgraded and a broad ecosystem of rival market players has developed, investment incentives must be created – for the good of consumers, the industry, and a digitally sovereign economy.

Consolidation pressure remains high in the telecommunications industry, partly due to declining revenues in many markets as a result of regulatory interventions, increasing competition, and technological change. In addition, high investments are needed for the network build-out, for innovation, and for the acquisition of spectrum. In Germany, the Bundeskartellamt approved the merger of United Internet and Drillisch without conditions; Drillisch profited from conditions imposed by the European Commission on the merger of E-Plus and O2. In March 2017, the European Commission approved our procurement joint venture with Orange, deeming it not to result in any restriction of competition. The European Commission conditionally approved Vivendi’s de-facto control over Telecom Italia: In order to avoid restrictions to competition, Vivendi must sell its 70 percent stake in Telecom Italia to the TV service provider Persiderain. In order to ensure the continued provision of high-quality telecommunications services to European consumers in the long term, the European competition authorities should take care that short-term price effects are not the only focus of their competition analyses.

European General Data Protection Regulation. The European General Data Protection Regulation will enter into force on May 25, 2018. The new data protection law closes a major gap in the regulation of service providers outside of the EU by imposing the same rules for all market players operating in the EU. The Regulation assures Europe of a high level of data protection and, at the same time, will pave the way for new digital business models. The General Data Protection Regulation applies directly in the member states and does not need to be transposed into national law. Contrary or redundant German law must be repealed by way of a specific act (Rechtsbereinigungsgesetz).

IT Security Act. In the course of implementing the EU Network and Information Security Directive, a number of provisions were added to the German IT Security Act (IT-Sicherheitsgesetz), requiring online marketplaces, search engine operators, and cloud service providers to comply with minimum requirements designed to safeguard the security of their infrastructures and to report incidents. On a positive note, the legislator included additional powers for telecommunications providers to enable the detection and clearing of network outages and security incidents – a significant step forward in view of the necessary inclusion of all parties involved in the value chain. It remains to be seen whether the new German government will make any further attempt to address the remaining deficits in the IT Security Act (lack of systematic involvement of hardware and software manufacturers). 16

EU subsidies for Croatia. On June 6, 2017, the EU Commission granted its approval for EU subsidies for Croatia. The Croatian government plans to use this money to fund a new state-owned network operator. The development increases the risk of a massive distortion of competition and of other countries following suit.

Payment Services Directive 2, which replaces Payment Services Directive 1 from 2007, must be implemented in the EU member states by the start of 2018. In Germany, this is being done by the German Payment Service Oversight Act (Zahlungsdiensteaufsichtsgesetz – ZAG), under which providers of telecommunications services must limit billing models for voice and non-voice services for invoicing third-party services via the telephone bill to a maximum of EUR 300 per month and EUR 50 per transaction – unless they have a payment services license. In addition, it will impose additional reporting obligations on the Federal Financial Supervisory Authority (BaFin). At the start of December, the Federal Financial Supervisory Authority published an information sheet on the practical implementation of the ZAG provisions.

GERMANY

According to EITO, revenue from IT products and services, telecommunications, and consumer electronics increased by 2.3 percent to around EUR 135.6 billion in Germany in the reporting year. Information technology recorded growth of 4.3 percent. Telecommunications revenues (telecommunications services, hardware, and infrastructure systems) decreased slightly by 0.3 percent to around EUR 57.7 billion. The positive development in data services could not completely offset weakening business with terminal equipment – caused in part by a further decline in smartphone revenues in 2017 – and steadily declining revenues from fixed-network and mobile services. Regulatory effects such as the reduction in EU roaming charges and interconnection rates were the main reason for slightly lower revenues from telecommunications services.

The German broadband market grew by 3.5 percent in 2017. As of the end of year, there were some 33 million broadband lines in Germany. Companies with their own infrastructure benefited the most from this market growth, along with resellers and regional providers. High-bandwidth lines are increasingly marketed in cable and VDSL/vectoring networks. The offerings in this area are supported by innovative hybrid connection technologies. The availability of high bandwidths in Germany and the large choice of HD content and video-on-demand services are stimulating customer growth in IPTV business. Integrated offers comprising fixed-network and mobile communications offer customers many advantages and help increase customer retention. The trend towards integrated offerings continued in the reporting year, with more and more providers expanding their portfolios. We launched our first integrated offering, MagentaEins, on the market in fall 2014. Since then, we have been gradually enhancing the service both in the area of traditional communication and add-on services such as smart home, cloud services, and security applications. Vodafone and O2 made up ground in terms of integrated offers. 9

In the German mobile market, service revenues decreased slightly by around 0.7 percent against 2016 to approximately EUR 18.1 billion, driven largely by the aforementioned regulatory effects and ongoing price pressure. The use of mobile data is growing exponentially, the percentage of voice and data rate plans is rising steadily. Traditional voice and text messaging services are increasingly being replaced by free IP messaging services like WhatsApp and social networks like Facebook. Connected products such as smartphones and tablets, as well as watches, shoes, bicycles, and much more, are growing ever more popular, pushing up demand for mobile broadband speeds and for large data volumes in the rate plan portfolios.

Digitalization is continuing apace, and as a result there is also growing demand by the industry for even more connectivity to allow machines and production sites to be networked and to tap efficiencies in value chains. Extensive IT and cloud solutions, as well as intelligent approaches to M2M communication (machine-to-machine) are needed in order to meet these demands. We believe that the M2M sector alone grew by around 30 percent in the reporting year, and this growth is unlikely to slow in the coming years. In the IT sector, we expect market growth to be around 5 percent, driven primarily by the substantial increase in cloud services of around 17 percent. 8

UNITED STATES

The mobile communications market in the United States continues to be divided between four major nationwide providers – AT&T, Verizon Wireless, T-Mobile US, and Sprint – and various regional network operators. In addition there are a number of mobile virtual network operators, which rely on the networks of one or more of the four national carriers to transport their mobile and data traffic. The two largest national network operators are AT&T and Verizon Wireless, followed by T-Mobile US and Sprint.

The market continues to be very dynamic. For example, the cable companies Comcast and Charter have activated their respective MVNO agreements with Verizon, and Comcast has already begun offering mobile services to its customers. Additionally, in May 2017, Comcast and Charter agreed to explore cooperation in the development of wireless products and services, and also agreed that each party must attain approval from the other before acquiring control of a full mobile network operator. Altice, whose 2016 acquisitions of Cablevision and Suddenlink created the nation’s fourth largest cable operator, announced its own MVNO partnership with Sprint. AT&T is still planning to acquire media giant Time Warner Inc. for USD 85.4 billion, pending a legal challenge by the U.S. antitrust authorities. The consolidation and convergence of the U.S. telecommunications market is expected to continue, as fixed and wireless become more integrated and wireless companies acquire content providers.

After three quarters of decline due to high market penetration, the U.S. wireless market has grown slightly since the third quarter of 2017, although down on a year-on-year basis. Although revenues were down overall, profit improved due to expenditure cuts, with operators also prepping for 5G strategies in 2018-19. Smartphone penetration continues to rise steadily, sitting now at 92 percent. Accordingly, mobile data consumption continues to rise and average usage surpassed 6 GB/month by the end of 2017.

Since 2013, T-Mobile US has brought about a significant operational turnaround and intensified competition in the U.S. mobile market. This is mainly due to improvements in their network, as well as successful implementation of the Un-carrier initiatives, which contributed very successfully to customer satisfaction.

The FCC has noted the fierce competition in the market and has embarked on a deregulatory agenda. It has eased wireless infrastructure deployment by removing administrative obstacles; it has adopted new sharing tools in the 3.5 GHz band to free up 150 MHz of spectrum for broadband services; and it is working to free up spectrum above 24 GHz to enable deployment of 5G services. The Broadcast Incentive Auction (600 MHz) ended in April 2017. T-Mobile US purchased an average of 31 MHz of 600 MHz low-band spectrum covering 100 percent of the United States. In addition, the FCC adopted new rules on December 14, 2017, that pare down net neutrality regulation to just a transparency requirement. Bright line rules (no blocking, no throttling) will be eliminated and paid priority will be permitted. The rules are expected to be challenged in court.

EUROPE

Following a period of steady recovery, the traditional telecommunications markets in our Europe operating segment saw a return to moderate revenue growth for the first time in 2017 on a full-year basis. Steady growth in broadband and TV business offset some of the ongoing decline in voice business. Mobile data usage grew rapidly, especially due to video services. Overall, mobile business recorded growth and more than offset the decline in fixed-network business. The continued levying of special taxes on telecommunications services in some countries had a negative impact, for example in Greece and Hungary. The acquisition of new spectrum and extension of existing mobile licenses had a relatively low impact in 2017 (e.g., in Greece). There was only limited consolidation activity in the countries of our Europe operating segment in the reporting year (e.g., T-Mobile Austria, UPC Austria, Digi/Invitel in Hungary, and UPC/Mulimedia Polska in Poland; both transactions are awaiting approval from the responsible authorities).

The trend towards convergent product bundles combining fixed-network and mobile communications (FMC) continues, for example with Kombinieren & Sparen (combine & save) in Austria, Love in Poland, and MagentaOne and CosmoteOne in our subsidiaries with integrated telecommunications infrastructure. These offers are enjoying strong growth and for some providers, already address the majority of consumers. New providers pursuing aggressive pricing policies (e.g., in Hungary and Slovakia), whose market shares are still small, are intensifying competitive pressure. Services from OTT (over-the-top) players, like WhatsApp and Facebook, are increasingly replacing traditional voice and messaging services. Video streaming services like Netflix and Amazon Prime have so far had limited significance in our Europe operating segment (with the exception of Austria).

In the business customer segment, the advance of digitalization has prompted massive growth in M2M/IoT applications; we participate in this with our Smart City projects, for instance in Hungary, Romania and Greece. 9 11

SYSTEMS SOLUTIONS

In the information and communications technology (ICT) industry in our core market of Western Europe, the volume addressed by our Systems Solutions operating segment and the T-Systems brand increased by 4.1 percent in the reporting year to EUR 192 billion. However, this trend impacted the business areas of the market in very different ways.

In the telecommunications (TC) segment, the market was dominated by continued price erosion in telecommunications services and by intense competition, while the economic recovery had relatively little impact. The focus in this segment continues to be on the substitution of elements of the portfolio and demand for stable, intelligent and secure network solutions with increasingly large bandwidths. Growth in ICT security (cyber security), Internet of Things (IoT), cloud computing, and unified communications is leading to a long-term stabilization of the markets served by our operating segment. Substitution effects between fixed-network and mobile operations continue to intensify. The migration to all-IP solutions, e.g., the combination of Internet access, Voice over IP, IP VPN, and Unified Communications, continues to increase.

In terms of IT services, demand has grown further for cloud services and cyber security services, as has the importance of digitalization, intelligent networks, the Internet of Things (including Industry 4.0), and communication between machines (M2M). The advance of digitalization and the shift towards cloud solutions also transformed demand in the systems integration business. Traditional project business – application development and the associated integration – declined by 0.9 percent. By contrast, the market for consultation and integration services for cloud solutions grew by 28 percent.

The market for outsourcing computing and desktop services (CDS) shrank by 0.6 percent in the reporting year to EUR 58 billion. Two contrasting trends played a role in this context: Business from long-term, rather traditional outsourcing contracts declined by 4 percent, while the market for cloud computing grew by 10 percent.

Competitive and price pressure persisted in all submarkets of our Systems Solutions operating segment. This was caused in part by competitors such as BT Global Services, Orange Business Services, and NTT Communication in the telecommunications market, and IBM, Atos, and Capgemini in the IT segment; in addition, the IT segment in particular came under price pressure from cloud providers such as Amazon Web Services, Google, and Salesforce. This effect is further intensified by providers of services rendered primarily offshore. We are positioning ourselves in this environment as a digital enabler, a cloud transformer, and an ICT operator, with a focus on quality, data security, and end-to-end responsibility for the transformation, integration, and operation of ICT services. Furthermore, we are increasingly entering into strategic partnerships with our competitors with the aim of offering our customers innovative solutions.

GROUP DEVELOPMENT

The environment of our Group Development operating segment is largely dominated by the markets served by our companies
T-Mobile Netherlands and Deutsche Funkturm (DFMG).

The mobile communications market in the Netherlands has been marked by high price and competitive pressure for quite some time, and this situation intensified again in 2017. One of the trends contributing toward this is the growing bundling of fixed-network and mobile products into convergent offers (FMC). The merger of Vodafone and Ziggo, for instance, has created a second strong nationwide FMC provider alongside market leader KPN. As in the past, the trend towards bundled offers brings pressure to bear on prices for mobile products. The strong discount segment, comprising mobile providers’ secondary brands and MVNOs, has further intensified competition. In December 2017, we signed an agreement with the Tele2 Group on the acquisition of telecommunications provider Tele2 Netherlands by T-Mobile Netherlands.

DFMG is the biggest provider of passive wireless infrastructure for mobile communications and broadcasting in Germany. The market also saw increased demand for cell sites in financial year 2017, due on the one hand to the fact that network operators plan to close gaps in coverage, and on the other to the fact that demand for mobile data services is growing, which calls for a further increase in the density of mobile networks.