Telecommunications market

Worldwide, the market for information and communications technologies (ICT) grew by 2.1 percent in 2016 to EUR 3.1 trillion. This increase was due 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 to record an increase of 1.5 percent to EUR 1.8 trillion and the information technology (IT) market segment to record an increase of 2.9 percent for 2016. The global market for telecommunications services grew by 1.7 percent. In the European Union, revenues from telecommunications services stabilized in the 2016 financial year and for the first time recorded a slight plus of 0.3 percent following eight consecutive years of decline. The European Telecommunications Network Operators’ Association (ETNO) expects total revenues in the EU telecommunications market to have grown slightly by 0.2 percent year-on-year to EUR 245 billion in the reporting year. The growth in data revenues in the 2016 reporting year offset the declines in traditional voice and messaging services, which remain under pressure from extensive regulatory interventions including cuts in roaming charges and termination rates, and from the substitution effects caused by OTT (over-the-top) players.

The digitization of the economy and society 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 – for both download and upload, for fixed and mobile networks. New technologies, 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 European 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 the acquisition of spectrum. The British Competition and Markets Authority approved the acquisition of EE by BT unconditionally and without remedies in January 2016. By contrast, the European Commission only approved the combination of Liberty Global and BASE in Belgium subject to strict conditions. The Commission intervention resulted in consolidation plans being blocked in Denmark (between Telia and Telenor) and in the United Kingdom (between Three and O2); in Italy the Commission supported the establishment of a fourth mobile provider, thus creating favorable conditions for Iliad to enter the market. The Commission approved the combination of Vodafone and Liberty Global in the Netherlands subject to Vodafone selling its fixed-network business to a suitable competitor. Our Dutch subsidiary T-Mobile Netherlands participated successfully in a bidding process.

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 large 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).

EU-U. S. Privacy Shield. The European Commission put forward the EU-U. S. Privacy Shield in early February 2016. As in the case of the former Safe Harbor Agreement, the Privacy Shield is intended to enable personal data of EU citizens to be transmitted to and processed in the United States. The majority of EU member states approved the final draft of the Privacy Shield, which was then adopted by the European Commission on July 11, 2016. The Privacy Principles it contains represent an improved set of data protection requirements compared with the Safe Harbor Agreement. Following criticism of the first draft of the Privacy Shield, the European Commission endeavored in a revised draft to assuage in particular the concerns expressed recently by the Article 29 Working Party, which comprises representatives from national data protection authorities in Europe. It cannot be ruled out that the Privacy Shield will be referred to the European Court of Justice again, in particular with regard to the legality of the still possible mass recording of personal data by national U. S. authorities.

IT security legislation. Within the scope of the German IT Security Act (IT-Sicherheitsgesetz – IT-SiG), a draft ordinance (BSI-KritisV) was drawn up in the first quarter of 2016, which sets out, inter alia, specific criteria that operators of critical infrastructure (KRITIS) from the information technology and telecommunications, water, energy, and food sectors can use to determine whether they are subject to the provisions of the IT-SiG. The ordinance entered into force on May 3, 2016. As a result, the provisions of the German Telecommunications Act (Telekommunikationsgesetz) were tightened up for the telecommunications sector, requiring precautions to be taken in particular with regard to the failure safety of the networks and services. In our own interests, we took these precautions before the Act was amended, and hence we already satisfied the main obligations for safeguarding public security.

The European Parliament adopted the EU Network and Information Security Directive on July 6, 2016. The Directive – in addition to the provisions of IT-SiG – requires 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. It may become necessary for German lawmakers to amend the IT-SiG. It remains to be seen whether such an amendment would also remedy the previous deficiency of the IT-SiG regarding the non-consideration of hardware and software vendors.

Work on the new Payment Services Directive 2 at EU level is complete. The Directive will replace Payment Services Directive 1 from 2007 and must be implemented in the member states by the start of 2018. The Federal Ministry of Finance (BMF) published a first draft in Decem-ber 2016. Where no payment services license exists, billing models for voice and non-voice services for invoicing third-party services via the telephone bill are restricted to a maximum of EUR 300 per month and EUR 50 per transaction. Depending on its transposition into national law, this may lead to severe restrictions in business models for billing third-party and to costs for implementing compliance with the thresholds. In addition, it will impose additional reporting obligations on the Federal Financial Supervisory Authority (BaFin).

GERMANY

According to Bitkom, revenue from IT products and services, telecommunications, and consumer electronics increased by 1.7 percent to around EUR 161 billion in Germany in the reporting year. Information technology in particular recorded strong growth of 3.6 percent. Telecommunications revenues (telecommunications services, hardware, and infrastructure systems) decreased by 0.4 percent in 2016 to around EUR 67 billion. The positive development in infrastructure systems could not completely offset weakening business with terminal equipment – caused in part by the first ever decline in smartphone revenues in 2016 – 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 lower revenues from telecommunications services.

The German broadband market grew by more than 4 percent in 2016. There are now some 32 million broadband lines in Germany. Providers with their own infrastructure benefited the most from this market growth, along with resellers and regional providers that do not have their own network. 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 offerings comprising fixed-network and mobile communications not only offer customers numerous advantages, but also increase customer retention. The trend towards integrated offerings continued in 2016, with more and more providers incorporating them into their portfolios. We launched our first integrated offering, MagentaEins, 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 followed suit in 2015 with Red One; then O2 in 2016 with Blue One.

In the German mobile market, service revenues decreased slightly by around 0.5 percent year-on-year to approximately EUR 18.2 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; use of these services requires use of the mobile Internet and data flat rates. The growing popularity of connected products such as smartphones and tablets, as well as watches, shoes, bicycles, and much more, is pushing up demand for mobile broadband speeds and for large data volumes in the rate plan portfolios.

Digitization is continuing apace. The result: growing demand by the industry for ever 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 2016, 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 largely by the strong development of cloud services of over 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, Sprint, and T-Mobile US – 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. The market continues to be very dynamic. The Dutch company Altice completed its USD 17.7 billion acquisition of Cablevision Systems Corp. in June 2016. Charter Communications completed its USD 55.1 billion acquisition of Time Warner Cable in May 2016. AT&T has announced plans to acquire media giant Time Warner Inc. for USD 85.4 billion. Comcast, Charter, and Altice have all hinted at interest in launching their own mobile virtual networks, as well. The consolidation and convergence of the U. S. telecommunications market is expected to continue, as fixed and wireless become more integrated.

Growth has slowed as a result of the high market penetration. Voice revenues continued to decline slightly in 2016. However, the persistent data revenue surplus could more than compensate the decline. Mobile data usage remains at a high level, in line with the rapid development of LTE networks and the high use of smartphones, which now account for around 80 percent of all handsets. Data revenue is growing steadily year after year and is accompanied by tough price competition from the main market players. 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 fierce competition is accompanied by regulatory announcements of the FCC (Federal Communications Commission). In June 2016, the DC Circuit Court of Appeals upheld the FCC’s Open Internet Order. The provisions define a standard, which in the future is to apply to the conduct of the affected companies. For the first time, this also includes interconnection agreements between Internet service providers (ISPs) and third parties. The FCC reserves the right to carry out case-by-case reviews with regard to the conduct of the affected companies. The challengers have petitioned the court for a rehearing.

The Broadcast Incentive Auction for frequencies began in May 2016, and will continue into 2017. The underlying intention is for television providers to voluntarily hand back their licensed frequencies in exchange for a portion of the proceeds from the auction of the returned spectrum to mobile providers.

EUROPE

Revenues in the traditional communication markets of our Europe operating segment declined slightly overall in 2016. In fixed-network business, ongoing growth in broadband and TV business only partially offset the decline in fixed-network telephony. The mobile communications markets also reported a slight downward trend: Growth rates for mobile data usage were high, but not enough to fully offset the declines in traditional voice and messaging services. Special levies on telecommunications services, in Greece for example, along with the costs of acquiring new spectrum, in Poland for example, continued to put pressure on the telecommunications industry in some of our national companies.

Competitive and price pressure continued throughout 2016 – despite business combinations and partnerships. This is largely a result of the trend towards convergent product bundles such as KPN Compleet in the Netherlands and Kombinieren & Sparen (combine & save) in Austria. In addition, providers with aggressive pricing strategies entered the market, e.g., Digi in Hungary and SWAN in Slovakia. Services from OTT (over-the-top) players, like WhatsApp, are also increasingly replacing traditional voice and messaging services. We have already rolled out our MagentaOne convergence product (CosmoteOne in Greece) in all countries with an integrated telecommunications infrastructure. The growing significance of FMC is placing more consolidation pressure on non-integrated providers, as demonstrated by the combination of Vodafone and Ziggo in the Netherlands. We continue to develop our mobile-centric national companies in the direction of convergence and our aim is to establish integrated business models. Corresponding measures have been put in place and some are already being implemented, such as the acquisition of Vodafone’s broadband arm in the Netherlands.

The fixed-network operators in the markets of our Europe operating segments are increasingly switching from conventional telephony (PSTN) to Internet technology (all IP). By the end of 2016, we had almost completed the migration to IP in our fifth national company. The broadband build-out trend in fixed-network and mobile communications continued unabated. We invested heavily in driving forward the roll-out of the LTE and fiber-optic networks in many countries. In Hungary, the first production site for our pan-European all-IP network (Pan-Net) was ready for operation in August 2016 and is now starting central production of the first virtualized services. Our TV services were subject to intense competition in the reporting year; we successfully stood our ground thanks to exclusive broadcasting rights, such as for sporting events, and the modernization of our TV platforms in countries including Greece. 9

SYSTEMS SOLUTIONS

The business volume in the ICT industry in Western Europe, i. e., our core market, that the Systems Solutions operating segment and the T-Systems brand can address increased by 3.1 percent, from EUR 182  billion in the prior year to EUR 188 billion. However, this trend impacted the individual business areas 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 segment. Substitution effects between fixed-network and mobile operations continue to intensify. The migration to all-IP solutions, such as the combination of Internet access, Voice over IP, IP VPN, and unified communications solutions continued to increase.

In terms of IT services, demand has grown further for cloud services and cyber security services, as has the importance of digitization, intelligent networks, the Internet of Things (including Industry 4.0), and communication between machines (M2M). The advance of digitization 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 0.4 percent. By contrast, the market for consultation and integration services, infrastructure and Platforms-as-a-Service (PaaS) models grew by 31 percent.

The market for outsourcing computing and desktop services (CDS) shrank by 1.1 percent in the reporting year to EUR 57 billion. Two contrasting trends played a role in this context: Business from long-term, rather traditional outsourcing contracts declined by 5 percent, while the market for cloud computing grew by 14 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, OBS, and NTT in the telecommunications market, and IBM, HP, 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. But we are also entering increasingly into strategic partnerships with our competitors so as to offer our customers innovative solutions.