Optimal Capital Structure, supporting evidence
I was pointed towards this post in Telco2.0 by Doc; it picks up the ‘because of’ rather than ‘with’ meme that Doc, JP and others have been successfully promulgating (through the blogosphere at least, maybe one day it will make it past the Fortune1000 boardroom gatekeepers…), here’s an excerpt:
There’s a huge body of economic literature on vertical integration of industries, and Coase did his seminal work on the structure of the firm based on analysis of internal and external transaction costs. This horizontal federation of adjacent businesses is not so well studied. The crashing co-ordination costs driven by hyper-abundant and cheap technology and communications is fairly new. It shouldn’t come as a surprise to find it confusing and hard to react to: they don’t teach it in business school yet.
So, what are the because of businesses that you should be considering as a network operator? We suggest three growth areas:
* Data assets. Google made billions out of the latent value of hyperlinks. Telcos are also sitting on a goldmine of digital social gestures in the form of call detail records, network address books, text messages and voicemail responses. With the user’s permission, you can mine the value to create new businesses.
* Platform APIs. The really hard-to-replicate parts of the business are all the call centres, logistics, servicing, tax remittance, and so on: a long list of non-network assets, each somewhat dull, all deeply profitable if milked by allowing third party access. Amazon do it, Google do it, and a Telco 2.0 will do it too.
* Advertising and attention. You’ve got that little screen in the user’s hand at great, subsidised expense. Shame there’s so little for sale. Buying stuff makes people feel good: empowered and in control. It’s almost as good a dopamine buzz as getting a text message. Fix the missing links to telco-assisted commerce and ads.
Basically if you understand ‘because of/with’, my arguments with respect to aligning the appropriate capital structure to the type of business/activity, can be boiled down (in an admittedly reductionist way) to:
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‘With’ businesses should be funded by debt (and if/when natural monopolies - which is often the case - regulated with fixed target returns)
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‘Because of’ businesses should be funded by the (more traditional) blend of equity and debt, with the amount of debt depending on the maturity/visibility of cash flow in the given business and/or company
So I guess I’m possibly slightly disagreeing with Telco2.0 in that I think that “horizontal federations” need to become or remain at most just that, ie federations. Trying to put them together in one organisation causes not only cultural and strategic issues but also results in necessarily sub-optimal funding. And worse, the capital structure will inevitably contribute to driving strategy, leading to a vicious circle where incompatible businesses are kept together with the justification articulated in terms of driving necessary returns on the capital employed. ie ‘As a telco network operator, I need to get into producing entertainment because ‘just’ selling network access won’t provide the return on equity that I need (to justify having equity capital…) And being in the entertainment industry, I need to be financed by equity given the uncertain and lumpy nature of cashflows (that the entertainment business generates…) [Repeat loop infinitely, create unwieldy suboptimized conglomerate. 
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September 26th, 2006 at 11:56 am
Always amazed me that the mobile network operators and the cable companies failed to exploit their billing infrastructures. After all that expense on acquiring HW & SW for billing, running credit checks and setting up direct debits, why not go after the 5% that credit card companies charge retailers for processing payments ?
September 26th, 2006 at 1:31 pm
I have to admit that I’d never heard of this distinction between “because of” and “with” prior to reading your post. It sounds like a very interesting concept and I can see where you’re going with your funding argument. I’m going to have to read more about this, but thanks for the start!
September 27th, 2006 at 9:32 am
Wouldn’t that suggest that Google should allow third parties to use Google search, but without having to use Google Ads — and let the Ad business evolve quickly and incorporate all kinds of innovative contextual stuff?
It’s a good question as to how best to structure “because of” side businesses. Wish I knew the answer!
November 4th, 2006 at 10:19 pm
Telcos are not going after the 5%, because they’re simply structured for larger margins. Eg. the gross margin of a mobile operator is around 30-40%. The cost structure is aligned to this. This is why m-commerce didn’t take up: transaction processing is a high-volume, low margin business. Telecoms, however is high in volume, but - compared to transactions - value added, even if it’s just a phone call.
Also, telcos may have the equipment, but you’ll be amazed seeing how hard it is to adapt a telco billing system to anything else. Telcos also don’t have the experience needed…