AUT Professor Wins International Award

PRESS RELEASE

AUT Professor Wins International Award

AUT's Dr Kate Kearins has won an international award for a case study on cellular communications company Vodafone and its standing in the New Zealand market place.

Dr Kearins, AUT Professor of Management, Faulty of Business, wrote the paper along with Dr Stephen Bowden from the University of Waikato.

The pair was awarded the Ruthe Greene Memorial Award for the Best Case from Outside North America by the North American Case Research Association (NACRA). Dr Kearins was presented the award at NACRA's 2003 Annual meeting in Tampa, Florida, USA in early November.

"Vodafone New Zealand was really supportive, with their execs giving us quite a bit of their time and speaking freely about various aspects of the company which was made for a great case study," says Dr Kearins. "Vodafone people's interactions with us showed how they lived up to the company's core values of integrity, being business savvy, hot, zesty and clever."

The case study looks at Vodafone's arrival in New Zealand in 1998 and ensuing success with the wireless generation, aided by its global presence and strong branding that it portrayed to its customers.

While mobile voice services are the core of current mobile services, data services are predicted to be the big growth area, with business likely to be the biggest data users.

The case study examines the big challenge for the company: how to best grow Vodafone NZ's "business' business while retaining current customers and continuing to attract the all-important next generation of mobile users.

Dr Kearins was quietly confident the case study would win the award, saying that her and Dr Bowden's study is indicative of the calibre of case writing underway in New Zealand.

"Some case writing is right up there amongst some of the best in the world. Key too is picking an industry that students would be interested in learning about. Lots of our students are Vodafone customers. They want to learn how these companies really work - and of course we can really only get inside the successful ones. Last year when we wrote the first draft of the case was a tough time for telcos around the globe, but Vodafone New Zealand was doing really well. Hence the case has international interest," she says.

Dr Kearins is planning to submit the Vodafone case to the prestigious Case Research Journal before Christmas.

ENDS

Vodafone New Zealand

Vodafone New Zealand was part of the global wireless communications industry that had undergone explosive growth. In August 2002, Vodafone NZ's Managing Director, Tim Miles admitted pride in the great people, strong brand and readily extendable technology platform that made up this young, vibrant company. Vodafone NZ continued to post healthy financial results - in a climate where many telcos were reporting large losses.

Remarkably, the Vodafone brand had only been in New Zealand since 1998 when Vodafone Group bought BellSouth NZ for $NZ 750m. BellSouth NZ had gone to market with its premium positioned mobile telecommunications service in 1993, but with its parents' focus elsewhere, the New Zealand business had lost momentum. With a catchphrase "Great things happen when you change your name' and an upbeat approach, Vodafone took the New Zealand market by storm. It grew the business from around 130 000 customers and 3-4% brand recognition in November 1998 to 1.128 million by 30 June 2002, and over 46% market share and 98% brand recognition - with a network that covered 97% of the population. Reflecting on Vodafone NZ's current position, the exuberant yet business-savvy Miles said:

We've been very successful in the consumer business, and to a degree in the business area. The business market is fundamentally different from the consumer market. Our values - cool tribe, hot, intrepid and zesty etc - could even be seen by some of the corporate mandarins as slightly risky. That's why we have people like me, because I come from that background I am reassuringly familiar to a lot of them. The real issue is that we are trying to change our business at a time when it's been relatively successful. This is the time to initiate the most change because we can afford it organisationally and build on the current winning platform.

Vodafone Group Plc: From the Top

Vodafone NZ was an offshoot of UK-based Vodafone Group, which trademarked itself "the world's largest mobile community" with one in every 100 people owning a Vodafone mobile phone in 2002. From making the UK's first mobile call on 1 January 1985, Vodafone Group had become Europe's largest company by market capitalisation and the world's largest telecommunications company of its kind in just fifteen years. Specialising in mobiles, it made substantial investments in its network and in strategic acquisitions around the globe. In August 2002, Vodafone Group boasted interests in mobile communications networks in 28 countries on five continents, providing for more seamless international roaming for customers. It was market leader or number two in 24 countries. Its operating companies (OpCos) now mainly operated under the Vodafone name, and global consistency was being sought. Along with many other telcos, however, Vodafone Group's financial performance declined in 2001-2. Suffering reputedly the biggest loss in European corporate history, Vodafone Group reported a pre-tax loss of $NZ 41.2b to the year ended 31 March 2002 including an $NZ 18.3b writedown in fixed line assets. Moreover, its share price had fallen sharply since its peak of GB399p two years previously, recently trading at GB97p. Both turnover and data revenue had grown substantially during the same period, however. With Vodafone Group having exceptional free cash flow along with proportionate registered customer base growth of 22% to 101.1m in the year to 31 March 2002, local Managing Director, Miles staunchly defended the underlying company's strength. He estimated that in almost four years in New Zealand, Vodafone Group had invested in excess of $NZ1.5b. Relationships with HQ were good. OpCos had the advantages of capital backing, a global brand, and massive Group buying power, coupled with a fair degree of local autonomy.

Vodafone NZ in the Greater Scheme of Things

Vodafone NZ along with OpCos in Japan, Australia and Fiji and Vodafone interests in China were part of Vodafone in the Asia Pacific area. The Pacific BHAG (Big Hairy Audacious Goal) was to be the leading communications company in the region via mobile and a leader in the Vodafone Group. Relatedly, Vodafone NZ sought to be the leading communications company in New Zealand via mobile and a leading business in the Vodafone Group. In New Zealand, Vodafone was number 1 in mobile revenue and number 2 in mobile customer numbers. It was structured so as to focus on the two key customer types: business customers and "consumer' customers. The 9 member executive team headed by Miles adopted the following strategic goals:

- Continuing to provide value to existing customers through new and improved products and services;

- Increasing market share from the business/corporate sector;

- Increasing revenue from data (80% + currently came from voice); and

- Ensuring operational effectiveness as the firm continued to grow (measured by operating expenditure as a percentage of revenue).

Company strengths included the advantages of global scale, strong New Zealand brand presence, and a vibrant values-based company culture that appeared difficult to imitate.

Vodafone People and Values

Jan Mottram, Human Resources Director, had seen the company grow from 50 to around 1200 staff with some 80% of all employees based in Auckland, engineering people in Wellington and Christchurch, and sales people around the country. With a positive employment brand, Vodafone NZ sought "gutsy, groovy grads looking for a funky full-on future" in engineering, IT, customer ops, marketing, sales and finance. Employee turnover was less than 20% with many people moving within the company.

Mottram and the HR team had driven the development of a strong values-based culture for the New Zealand organisation. Now common for the Pacific region, and extended to Group level, the values framework is encapsulated in Figure 1. The heart represented Vodafone Group's "Passion for the World Around Us', reflecting its concern for customers, for results, for its people and for the world around it. The values on the inner circle were the Pacific OpCos' foundational values that guided day-to-day decisions. Those on the outer rim were the inspirational values - they encompassed Vodafone's look and feel and reflected what the company aimed to be for its customers.

Figure 1 Foundational and Inspirational Values

The inspirational values linked to brand positioning. Vodafone NZ put considerable effort and expenditure into building its brand from the inside out, with the idea that management and employee commitment to brand values produced greater commitment to the organisation and to customers. Vodafone NZ's guide to employment reminded staff how important they were in the company's success:

We need our customers to actively prefer us. This all comes down to you. You are Vodafone. You are the difference. We need to support you so you can support our customers. The challenge for us is to inspire in all that we do and are. To be smart, energetic, reliable, innovative and intrepid!

Being innovative and intrepid was reflected in many Vodafone NZ activities. "Kick-offs', the first quarter strategy briefings from the Exec Team, had become legendary, with sessions also run for suppliers and business partners. The latest involved managers alongside professional actors as part of a stage set from The Matrix acting and talking through the company's vision and strategy. Equally, Vodafone parties and award ceremonies were known as lavish, and slightly outlandish in orientation. The Year 2000 Christmas party based on a Thailand theme, for example, incorporated topless dancers, a live elephant, monkeys, Buddhist monks and a Chinese dragon. The intended mood of fun was recast in media reports deeming the dancers culturally inappropriate following complaints from 4 of the 1400 partygoers. More offbeat and macabre, was the half million party in 2000 when the company celebrated achieving 500 000 subscribers. Partygoers were bussed out to the scene of a staged disaster. People were brought on in stretchers and winched down amid a scene of burning cars and buses while bands provided entertainment. This was a company where despite the fun, much hard work also went on - which ultimately was what was being celebrated.

Technology Facts

Vodafone NZ provided its Global System for Mobile (GSM) digital communication service on the 900 and 1800 MHz parts of the radio spectrum. The network consisted of more than 750 cell sites. Making a call involved routing through the nearest cell-site and relay to destination through a mobile switching centre linking cellsites with the landline telephone network and other mobile networks. Vodafone NZ had a relatively new General Packet Radio System (GPRS) overlay which had many possibilities in terms of customer applications. The company firmly believed in not advertising technology - rather it focussed on customer benefits. A key strategy, according to Director of Technology, Jeni Mundy, was to exploit technology for the benefit of customers.

Coming up next was 3G, or Universal Mobile Telephone System (UMTS) - another overlay in the radio network, which gave broader band-width and faster speeds, making lengthy video streaming achievable. Vodafone Mobile purchased the management rights for 5MHz of 3G mobile spectrum from TelstraClear, in addition to existing management rights for 10MHz it already owned and leased to Vodafone NZ. This positioned the company to take advantage of high bandwidth next generation mobile services such as high-speed data and video.

Vodafone NZ had four purpose-built technology centres. The main switching centres transferred calls around the country, with their geographic spread providing for business continuity or disaster recovery. They were also home to some of the company's best and brightest people, and were the source of new developments. Besides looking ahead to new technologies and new ideas through innovation, the company was compelled to deliver effective and efficient service across its network. More routine tasks carried out at various localities around the country involved the installation and operation of both an internal IT network and an external GSM/GPRS network. The technology team's across-the-board competency was believed to be quite non-traditional because, according to Mundy, it involved convergence of IT and engineering type skills, not found in many other industries. Vodafone NZ had managed to grow very fast, but also to retain a very simple, very scaleable architecture, without dropping the quality ball.

Technology challenges remained, however. Coverage was an industry-wide challenge. Vodafone claimed its coverage was as good as any other network in the country. Since November 1998, it had increased cellsites and enhanced cellsite capacity. Keeping everything running smoothly was another industry-wide challenge which required understanding what the business was trying to deliver to the customers, and adding the technology as seamlessly as possible. Making sure data applications which were industry-critical for customers ran to agreed service levels was an increasing focus. With network superiority and new products and services tending to be short-lived sources of differentiation, it was important to watch expenditure. Mundy explained:

We have 95% of the company's capital budget, and we could spend about $175 million this year. We probably have 40% of the company's operating budget, and that would be around about $80 million in operating costs, so we're really looking to drive those down, and we're really looking to be accurate in what we're going to do. It's very important for us. Our spending is driven by the needs of the business and the market. We're not interested in technology for its own sake.

Handsets, Plans, Pricing and Other Fancy Stuff

Technology was of interest to some customers, but most just wanted everything to work at the touch of a button. Customers needed the right mobile for their purpose. A huge range of increasingly sophisticated handsets were available - from standard to Wireless Access Protocol (or WAP)-enabled to more fully featured "power' devices. The latest handsets allowed customers to take PXTures (Vodafone's PXT service was launched in July 2002, quickly followed by head-to-head competitor Telecom NZ's) and email them instantly. Text messaging had caught on unbelievably well, selling at as little as NZ20c per message up to 160 characters to just about any GSM mobile anywhere in the world. Over 900 000 text messages were sent on the Vodafone NZ network each day. Using mobiles overseas, and using mobiles to connect to the Internet were other options increasing in popularity. Data was tipped as the growth area, particularly in terms of business applications.

Vodafone's website listed "what was hot', changing often as new and sometimes quirky services and promotions were offered. Much of these were targeted at "consumer' customers. Playing safe with the variety of screen tattoos and ring tones was said to be for sissies. "Wicked Welcomes' were Vodafone NZ's fun voicemail greetings customers could opt for. Services included TXT games, entertainment on line including jokes, insults, pick up lines and world of the day, TXT life - an ongoing mobile soap opera with weekday updates, quizzes, horoscopes, sports updates to customers' mobiles, snow reports and ticket purchase. CLOSE2U was a new service that could locate a range of services 'close to you' such as the nearest ATMs, petrol stations, parking buildings, taxi stands and even Coke machines in public places. WHAT'S ON allowed customers to check out restaurant guides, cinema times and TV listings. The new SIM card came preprogrammed with access via a smart menu to information and entertainment services.

Beyond the funk, the most basic customer decision still revolved around whether to be a Prepay customer or an On-account customer receiving all the standard services plus a range of more advanced options including autoroaming, faxMail and mobileData. Prepay was a pricing plan where customers paid in advance for calls using recharge cards or credit card top-ups. There were no monthly bills and no credit checkups needed in order to sign-up - typically Prepay suited the very young, but equally it suited anyone who wanted to keep costs under control through the advance payment system. Some businesses also used the Prepay service - and some of these were big spenders. The current price for a Prepay connection pack was just $NZ30, with usage charged according to one of two Prepay plans with different charge rates for peak and offpeak periods.

On-account plans had itemised bills noting the monthly access fee charged in advance, any additional products and services bought, and call usage charged in arrears. On-account contracts allowed users an allocation of free minutes in exchange for the monthly access fee, and beyond the free minutes, usage was charged according to the particular plan's airtime rate. There was again a choice of peak and off-peak pricing plans to suit different types of usage and to better distribute calls across the network. There were also personal plans for text for those sending text messages mainly and a group user plan targeted at organisations with multiple users. A data-only plan was also offered, providing a fast all-day connection where users paid only for data used.

On-account customers made up around 20% of Vodafone NZ's customer base, and Prepay around 80%. About half the On-account customers were businesses but there was potential to grow both the size of the business market and Vodafone NZ's share of it. There was overlap between business and "consumer' customers with business users also using their mobile phones outside work. Average revenue per user (known as arpu) for Vodafone NZ registered prepaid customers for the 12 month period to 31 March 2002 was reported as $287 for prepay customers, and contract customers was $1812. With lock-in and contracts becoming less common, the focus was increasingly on delivering great customer service. Attracting and keeping higher value customers was important.

Customer Service

Customer service was seen as the big differentiator, with Director, Arthur Neely stating:

We're a sales and marketing organisation, not a technology business. We can't differentiate on price or technology in the marketplace for long. The only sustainable differentiation is customer service.

Vodafone NZ operated two contact centres in Auckland with a staff of around 250-260 Customer Service Representatives (CSRs). Vodafone's contact centres were open 24/7 unlike Telecom NZ's residential mobile *123 which was open 7am-9pm 7 days (Telecom NZ had separate centres servicing corporate and business customers across both its landline and mobile businesses). Vodafone NZ's contact centres dealt with around 8000 - 10 000 calls a day and a small but increasing volume of e-mails. Service levels targets were for 80% of calls answered in 30 seconds; currently results wavered between 60-80%. Typically, On-account customers called the contact centres more frequently (around 55% of On-account customers called each month), whereas Prepay customers tended to have a more distant relationship. Prepay customers calling in every month dropped from around 24% to around 16% - which was taken as a positive sign. On-account customers typically cost more to service but also provided for higher margins. These customers included business customers with small to medium sized businesses being a high value segment for which there was fierce competition between telcos. Vodafone NZ's business/corporate marketshare was less than was Telecom NZ's and Vodafone NZ saw great opportunity for enhancing marketshare in these segments.

Contact centres around the world were moving towards differentiating service according to customer segment and value. Customers using more services and delivering more revenue tended to be handled by more experienced CSRs - while voice recognition systems could often offer automated self-service to lower value customer segments. Vodafone NZ was moving carefully in this direction, too. Its website provided customers with secure access to information on their Vodafone accounts and allowed for online provisioning of most services but not currently handset purchase or new account set-up.

Customer feedback was used to drive improvement and to differentiate service. Worldwide, it appeared that accessibility, first time resolution of problems, and dealing with a competent advisor were important to customers. Vodafone NZ took the customer knowledge function extremely seriously, analysing sophisticated perceptual data on both the company and its main competitor, with survey results providing a basis for decisions on service offerings. Senior managers assisted in the contact centres half a day every six months and often enthused about the work CSRs did in providing a differentiated customer experience. Call Centre Manager, Brian Beveridge said "Talk to any of those managers and you'll hear "Oh CSRs, they work so hard. They are so great at what they do. I was so impressed'". The challenge was "to love customers to death", according to Miles. "Give them a great experience and keep them through their lifetime as a customer." Vodafone NZ valued its relationships with customers - and external partners.

External Partners

Key suppliers from a technology perspective were Nokia for network infrastructure, Ericsson and Genesis for call centre technology and multi-messaging platform, Logica for prepaid platforms and text-messaging, and BCL for transmission backhaul and maintenance. The desktop environment was outsourced to HP including helpdesk, service and billing development. Vodafone's technology platform provided for buyer relationships with the world's leading GSM handset manufacturers. These included the Japanese/Swedish joint venture by Sony and Ericsson, Motorola (US), Nokia, Alcatel, Philips and Siemens from Europe. These companies typically tried to build very strong consumer brands. Other industry, but not specifically Vodafone NZ handset suppliers included Samsung, Hyundai, Kyocera and other small players. Handsets were increasingly featuring multi-media services and interconnection protocols such as Bluetooth which created a Personal Area Network with a standard 10m range, replacing the need for short cables such as those used between computers, printers, PDAs and phones. Key success factors for suppliers seemed to be substantial and directed R&D investment, design quality and pricing. With most supply relationships, there was considerable choice, although major decisions were often taken at Group level. Group purchasing advantages for technological inputs and new services were huge. OpCos were expected to roll out recommended products and services; however, it was up to them individually to decide what to do when to make their businesses a success.

Another key group of suppliers were contractors and consultants. Neely estimated that the company had spent close to $NZ 200m in the last few years with major contractors. Consulting engineers designed the company's civil works and construction companies carried out the actual work of putting those in place. Vodafone NZ appreciated its longstanding relationships with major partners including Connell Wagner Meritech (ex Worleys), and MainZeal who had been instrumental in building its network. As it headed into a future where services and applications played the key role, other key suppliers were emerging; among these were Optimation, Simple and Synergy. Partnerships for specific projects included that with Walker Wireless - a wireless broadband venture currently under trials to test customer reaction among target market groups. A partnership with security company Chubb was the Vodafone-enabled GPS Tracknet security system - a wireless vehicle tracking and control system able to pinpoint a vehicle within 5 metres.

Key suppliers and buyers as well as competitors were TelstraClear and Telecom NZ, who provided interconnectivity to all non-Vodafone network numbers in New Zealand. For these supply relationships there was no real choice. Interconnection charges, incurred when calls are transferred from one network to another, had been a source of contention. The major beneficiary Telecom NZ earned over $NZ100m in the past year from this source because it had the biggest network and the lion's share of fixed lines. Vodafone had a broad-ranging agreement with TelstraClear, regarding TelstraClear as the "supplier of choice'. It was less expensive for Vodafone to route calls to all non-Vodafone numbers through TelstraClear, than to go through Telecom NZ directly. Both Telecom NZ and Telstra Clear also provided their customers the ability to interconnect through the Vodafone network for a fee. The agreement with TelstraClear went further than interconnection. Before the merging of Telstra and Clear, Vodafone had an agreement with each company enabling them to on-sell Vodafone services and products. This enabled Telstra and Clear to provide a full suite of telecommunications products to customers, while Vodafone gained extra connection volumes which may have gone to Telecom NZ. Further integration had occurred, with one number destination, and services such as integrated mailboxes being introduced. People worried about having to change their phone numbers if they changed service providers, with businesses seeing it as a potentially huge switching cost. Vodafone had been in negotiation about number portability with other providers including market incumbent Telecom NZ for some time.

Also significant were relationships with exclusive dealers and other more general retailers. Vodafone NZ owned 25 retail stores, but had more than 1000 outlets nation-wide where products and services could be bought. Distribution typically occurred through the channels listed below.

Figure 2: Distribution

Vodafone NZ Retail Vodafone NZ Dealers Vodafone NZ Retailers

25 company-owned stores

(mainly targeted to the consumer market)

Business Direct reps

2 WOW spaces - wireless office working spaces targeted to business customers

Egs First Mobile (65 stores)

Digital Mobile

The Mobile Fone Shop

(some of these have their own outbound sales teams as well as selling from their stores)

Egs Bond & Bond

Noel Leeming

Hill & Stewart

Harvey Norman

Smith City / Powerstore

Dick Smith Electronics

Farmers' Stores

Appliance Connexion

Retrovision

Betta Electrical

The external network gave Vodafone NZ a huge footprint, with both dealers and retailers stocking a range of handsets and accessories, signing up customers, and offering services like upgrades, roaming, and often repair services. Whereas the stores catered mainly to the consumer market, they were also there for businesses. Vodafone's Business Direct representatives provided one-to-one service out in businesses, important for considering how best to configure the wealth of wireless applications for business advantage.

Finally, there were promotional partnerships with those boasting closely aligned markets like Coca Cola and McDonalds. With a well-evolved brand architecture, Vodafone NZ was careful about who it partnered with, and how relationships were leveraged. It took business seriously, though this was not always obvious, given its funky marketing edge.

Marketing and Sponsorship

Vodafone NZ's broad target market was anyone who would benefit from having a mobile - both consumers and businesses. The company was known for creative marketing campaigns like "tHE oLD rULES aRE gONE' aimed to create trust between Vodafone NZ and its customers when it removed term contracts on personal plans. Using the catchphrase "We're working hard to get less of your money", Vodafone NZ advertised Plan Check where every six months customers' rate plans were analysed and the optimum, least expensive plan offered. Innovative too was the V24 Challenge, New Zealand's first ever live TV advertisements ran for 10 weeks. They involved celebrities performing funny tasks while viewers guessed outcomes, attracting up to 30 000 entries via Vodafone text messaging a week. The focus here was on "consumer' customers - and particularly the youth market where Vodafone had popular appeal and done very well.

There had been a concentrated effort to win more of the higher value business customers through developing a variety of tailor-made services, and dedicated Business Direct representatives working with businesses to define their telecommunications needs. As part of an acquisition campaign targeted to small and medium sized businesses, sales reps were given a Licence to Thrill prospective customers. Based on the James Bond 007 theme, 230 sales reps were known as VSAs (Vodafone Special Agents) and VOs (Vodafone Operatives). In the second part of the campaign, a series of direct mail outs, television advertisements and press and internet advertisements invited business callers to meet with a Vodafone consultant and go into a monthly $NZ10 000 prize draw.

As well as Vodafone Group's sponsorship deals such as with Ferrari and Manchester United, local level sponsorship was also important in building the brand personality. Major sponsorships for Vodafone NZ included the Vodafone NZ Silver Ferns (the national netball team), the Vodafone NZ Warriors rugby league team, the Football Kingz, NPC rugby teams, Vodafone X-Air, an extreme sports event and the Vodafone National Dragon Boating Festival. Although many of these had a youthful feel, sport was taken quite seriously in New Zealand. Vodafone NZ's sponsorship spend has been estimated at $NZ6m, around a quarter of the estimated $NZ25m marketing budget. Sponsorship activities added profile to both the event and to the sponsor - with opportunities for integrating mobile technologies and for customer and employee involvement.

Under the company's Mobile Me Project, employees received new mobile phones, creating 1200 Vodafone brand champions. Vodafone NZ offices boasted an almost complete lack of fixed lines, reducing company communication costs and further demonstrating wirelessness at work and beyond.

Finance Matters

When the finance people talk about personal growth and values and not minding how much is spent on parties, you know you are in an unusual company. Along with finance and legal colleagues, General Manager of Financial Planning, Leonard O'Quigley featured as a rockstar in a video made to communicate their role to Vodafone people:

When you act out the message, the more the message actually gets across¡K with values you have less of the traditional finance control function and more investment in the handholding side of doing business and working as a true partner with better decisions being made.

A fairly static $180-90 million capital expenditure figure for the last couple of years was targeted towards services predicted to give the fastest and biggest returns. For most investment, particularly for network infrastructural additions, a one-two year return was expected. Gone were the days of ten year ROEs being the norm except for the really big upfront expenditure. Building the network to use the new spectrum rights purchased for around $NZ10m would likely cost the OpCo over $NZ200m more. Vodafone Group arranged loans for investment projects based on a very competitive interest rate.

A key operating expense was staff - a $NZ50-80 million ballpark figure was given. The biggest direct cost was interconnection - it was dearer to interconnect with mobile networks per call than it was with fixed lines. These charges also featured on the other side of the balance sheet as well. Another large expense was leased lines where line capacity was leased from Telecom NZ, TelstraClear and Contact Energy. Connection commissions to dealers and retailers or to Vodafone's own people were also a substantial expense, but also featured as part of overall company revenue. Vodafone NZ posted a net surplus for the year ended 31 March 2002 of $NZ48.885m up $NZ7.4m from the previous year on revenues of $NZ 702.779m. Current assets were over $NZ1b. Generally happy with these results, Miles and the executive team remained aware of the incredible potential yet to be realised in this exciting industry.

Cellular Telecommunications Industry Context

There had been spectacular take-off and growth in subscribership rates in cellular telecommunications. But, there had in recent times been a phenomenal decline in profits. A base of 11m global consumers of cellular telecommunications services in 1990 grew to over 500m by 2001, encompassing more than 8% of the world's population. In some developing countries, penetration in cellular services exceeded access to fixed-line services. Demand had soared. AT&T, in the early 1980s, forecast 900 000 global customers by the year 2000; reportedly it sold 900 000 handsets on January 1, 2 and 3 of that year! The global meltdown in telco stocks was commonly attributed to the huge outlays for spectrum and resultant high debt levels. Many telecommunications companies had lost considerable value and ROE had dropped to very low levels. With P/E ratios still seen as relatively high, further falls were predicted.

Cellular telecommunications companies sprung up alongside newly corporatised and former government monopolies in conventional fixed line provision. State-owned monopoly providers still flourished in many countries. These providers had built up knowledge and often transferred it to new businesses, and entered new markets. There was a feeling that fixed-line providers had over-invested in older technologies, and that younger, more nimble, future-minded cellular providers maybe had an advantage. Despite this optimism, predictions were for rationalisation across the industry.

Governments generally maintained a strong interest in the regulatory framework for telecommunications - and derived considerable income from licences. Depending on whose perspective one took within the industry (either entrenched incumbents or newer players), governments were seen as high-handed and overactive in regulating the sector - or as fair-minded, maybe even not going far enough towards creating a level playing field and lowering the barriers to entry. Questions raised on a global level included whether governments should grab the rewards of unexpected surges in demand and create more competition. Should there be further regulatory intervention? Would governments exert further influence in interconnection agreements? Would they concern themselves more in areas to do with health and electromagnetism? Would governments further regulate on collusive outcomes as to industry pricing - or discriminatory pricing as described below?

For telecommunications companies, there was a large upfront capital expenditure in buying rights to spectrum. Ten to fifteen years' payback was often predicted. High debt levels were not unusual with considerable debt attributable to the cost of 3G licenses in Europe in particular. Questions were being asked about the price/value ratio of 3G. Bets were on as to whether - and when governments would open up more spectrum - or would they renege on prior commitments? The rate of technological change within the industry was exciting and vexing. Change from 2G to 3G to 4.5G was predicted, with some analysts suggesting that the industry might go straight to 4.5G. Delays had also emerged in the availability of efficient low-cost internet enabled handsets - and customer demand for mobile data services was behind predictions. The challenge for cellular communications companies was in deriving sufficient profits from current investments while not standing still in the face of key new technologies.

There was some standardisation of technology across markets and competitors split largely between CDMA (the platform Telecom NZ used) and the European-inspired GSM (used by Vodafone) which covered 70-80% of the world. GSM was in some 80 countries. There was probably almost a billion GSM/GPRS customers, which meant a very large standards base and a lot of suppliers attempting to work in this arena.

There was, however, enormous uncertainty in future demand. Mobile telephony was generally expected to continue to substitute for fixed line networks in both voice and data services. One way in which demand was partially managed was by punctuated change in the commercialisation and roll-out of technological advancements. Technology had the potential to further develop and change business models in quite fundamental ways such as those implied by the much vaunted convergence of internet and cellular services. It also impacted the way people were communicating, in sometimes unpredictable ways as illustrated by the unforeseen uptake in certain segments like the youth market with text messaging. Would pictures and video via mobile go the same way?

Customer offerings in cellular communications had devolved into a mix of basic access fees, variable peak and off-peak per minute call rates and free minutes. A kind of market segmentation generally resulted from plans designed for different customer types - those with higher and lower willingness to pay. The high types were typically offered an attractive plan with a per minute-rate around or even below marginal cost. Those with lower willingness to pay were typically offered higher individual call costs to offset their higher servicing costs and lower overall usage. How to tempt mobile communications users to upgrade their handsets and service plans was a constant challenge. One headline shouted "Mobile operators seek to convert prepaid masses' - the 80% of some operators' subscribers who generated only one fifth of the revenues. Tempting these users to spend more could be difficult. Governments could and did intervene in pricing, and publics did on occasion protest against price hikes. How to get businesses to consider more wireless options was also a challenge, particularly when many felt budget-constrained and committed to previous investments in fixed-line infrastructure.

The New Zealand Market

As part of public sector reforms, the New Zealand telecommunication market was progressively deregulated, and from April 1989, it became possible to compete with the entrenched monopoly provider that was Telecom NZ. In 2000, the government conducted a comprehensive review of the regulatory regime and a year later passed the Telecommunications Act. It also updated service commitments applied to Telecom NZ, known as the Kiwi Share Obligations that had as its main purpose ensuring a universal service to residential users. Interconnection was now subject to determination by the newly appointed Telecommunications Commissioner in the case of disputes.

A light-handed regulatory regime persisted with the emphasis on commercial negotiation and industry self-management in the first instance. There were no regulatory barriers to entry but the dominant positions of Telecom NZ in the fixed line business, and of Vodafone NZ and Telecom NZ in cellular services meant new entry could be difficult. Customer expectations of the market being opened up were for lower prices - and for increasing volumes of data at higher speeds at decreasing prices. Fixed line providers like Telecom NZ expected reductions in revenues from traditional sources (such as toll calls which were increasingly the subject of discounts), and sought new revenue streams.

New Zealanders had taken to mobile phones. Figures showed 2 482 704 mobile users in New Zealand in June 2002, a market penetration of 63.6% of the population. Telecom NZ had a greater share of the business market. There were 281 339 non-farming enterprises in New Zealand as at February 2002 with a much greater concentration around Auckland than elsewhere. New Zealand was largely a nation of small firms; indeed these could be found across almost all industrial sectors. Approximately 93% of the total number of enterprises engaged less than 10 full-time equivalent employees. The much smaller number of large businesses did however account for 69% of full time equivalent employees. Some businesses such as those which were time-critical (where information was needed quickly) and those that had staff out of the office were seen as prime candidates for mobile solutions. Key was making the price of calling within businesses attractive enough to replace current systems. Up to a third of fixed line cost could be in building infrastructure making mobiles very useful in reducing set-up or relocation costs. Cellular providers looked to become more involved in providing data as well as voice services. Here price, speed and service were important. Applications abounded. Take as examples traffic wardens being able to send instant photographic evidence of parking infringements back to base when a vehicle is towed, workers sending photos of damaged pipes to engineers back at their desk for advice on resolution, salespeople handling orders while out with customers, and doctors able to remotely monitor large numbers of patients' treatment data. Mobile companies sought long term relationships with customers to assist them to recognise and solve voice and data needs. Business customers were meanwhile getting more savvy, wanting pricing breakdowns, and sometimes going to different providers for mobile and fixed line services, making cross-subsidisation more difficult for full service providers. Telecommunications companies focused on increasing average revenue per user - as new customers tended to be lower spenders than those who had come on earlier. Main players, Vodafone NZ and Telecom NZ split the market, as shown in Figure 3.

Figure 3: Vodafone NZ & Telecom NZ Customer Numbers & Market Share

Quarter Vodafone NZ customer numbers Vodafone NZ market share Telecom NZ customer numbers Telecom NZ market share

Dec 1998 145,600 20.5% 564,800 79.5%

June 1999 231,400 25.5% 677,000 74.5%

Dec 1999 397,000 31.6% 858,000 68.4%

June 2000 562,000 36.4% 980,000 63.6%

Dec 2000 753,000 39.6% 1.15 million 60.4%

March 2001 889,000 41.2% 1.269 million 58.8%

June 2001 989,990 43.3% 1.298 million 56.7%

Sept 2001 1.077 million 44.6% 1.337 million 55.4%

Dec 2001 1.043 million 43.1% 1.379 million 56.9%

March 2002 1.095 million 44.1% 1.388 million 55.9%

June 2002 1.128 million 46.3% 1.308 million 53.7%

Competitors and Possible Entrants

Telecom NZ

Vodafone NZ's archrival in the cellular telecommunications arena was Telecom NZ. Less obviously, Vodafone NZ competed to draw consumers away from the fixed line business in which Telecom NZ had the monopoly stake. Formed in 1987 out of the telecommunications division of the New Zealand Post Office, Telecom NZ became one of the first telcos to be fully privatised. It sold to wholly owned subsidiaries of Bell Atlantic Corporation and Ameritech Corporation for $NZ4 250m in 1990 on the condition that at least $NZ500m shares would be offered to the New Zealand public.

Overall, New Zealand stockmarket heavyweight, Telecom NZ's total return for the year to June 30, 2002 was minus 6.9 %, better than that of many other telcos. Telecom NZ reported a net loss of $NZ188m after a partial write-down of its investment in Australian telco AAPT of $NZ850m. It forecast total capital expenditure of approximately $NZ780m in the 2002-2003 financial year across major business areas including fixed line and mobile businesses in Australia and New Zealand, and internet and directories businesses. Telecom NZ's revenue from data had increased by 8.7% in the last year, following growth in the uptake of ADSL broadband products. Telecom NZ's Mobile JetStream was a faster but generally more expensive mobile data service than was Vodafone NZ's, depending on the plan chosen.

Telecom's New Zealand Mobile business provided voice and data on AMPS and CDMA networks. To the year June 30 2002, Telecom NZ's mobile operations posted revenues of $NZ761m increasing 5% from the previous year, mainly as a result of increased interconnection revenues. Increases in operations and support expenses for mobile of 8.3% resulted in a 0.4% decline in EBITDA. Telecom NZ also reported an 8.2% decreasing cost of sales for mobile operations attributed to lower customer acquisition costs as growth in subscriber numbers slowed and handset subsidies had been reduced. With potential to add new customers diminishing, both companies were looking at ways to increase the amount customers spent. Telecom NZ's reported average revenue per user at the end of March 2002 was $520 whereas Vodafone NZ's was $636. Vodafone NZ's average revenue per user was reported elsewhere as declining from $731 the previous year but showing signs of stabilising with increases in text messaging and data revenues. Despite its foray into Australia, Telecom NZ was generally seen as a staid but reliable player. It had a nationwide distribution network and a link up with major discount retailer, The Warehouse Group selling the Gold Prepaid Mobile brand. It boasted major sponsorships too which it could leverage across its fixed line and mobile businesses, but its image overall was much more conservative than was Vodafone NZ's. A big slice of the New Zealand stockmarket, Telecom NZ could have benefited from perceived vested interests from within the local business community.

TelstraClear

A third player, the second largest full-service communications company in New Zealand, was TelstraClear, created from the merger of TelstraSaturn Ltd and CLEAR Communications Ltd in December 2001. Wholly owned by Australia's Telstra Corporation, TelstraClear was reported to have served over 300 000 business and residential customers in every central business district and over 30 regional centres - more than 11% of the market through a full range of voice, data, Internet Protocol and cable TV services. It offered a very small but full mobile phone service - essentially reselling from Vodafone NZ - it was thus a competitor and a customer of Vodafone NZ's, targeting higher end customers. Indications were it wished to expand its mobile business. It had bought spectrum and could conceivably build its own network.

And Econet Wireless, Maybe

Econet Wireless NZ Ltd was a subsidiary of Zimbabwe-based Econet Wireless International. In September 2001, it announced a deal to utilise 2G and 3G mobile spectrum set aside by the NZ government for Maori (indigenous New Zealanders). It was planned that Maori spectrum holding company Hautaki Ltd would take up a 30 per cent shareholding in Econet NZ in exchange for access to its 3G spectrum right. Other overseas investors were to help fund the cost of Econet NZ building its own GSM network. Analysts predicted building a new mobile network could cost hundreds of millions of dollars and noted there would need to be extremely low cost technology to create advantage - particularly given Hautaki pledges to increase access to disadvantaged and marginalised communities unlikely to provide for high margins. Moreover it could be very difficult to get key customers to switch from incumbents. New entrants like Econet would be helped by government legislation introduced earlier in 2002 requiring mobile phone operators to share transmitter sites and require mandatory roaming. With a certain amount of its own infrastructure in place, Econet could utilise competitors' existing network infrastructure - at a fair price, but possibly posing capacity problems.

Or Virgin, Even?

Media talk among airline or telco people was that wherever British-based Virgin took its planes, other Virgin businesses were likely to follow. Virgin airlines and planes were seen as giant billboards for the rest of the company, with the Virgin brand once established being able to leveraged to other offerings including travel, music, cosmetics and mobile telephony. The establishment of the Virgin Blue airline in Australia in 2000 felt very close to home - and talk of Virgin seeking approval to operate an airline in New Zealand was frequent. If Virgin was to come and its mobile business followed then it would likely prove quite a threat on two levels. The company had deep and well-segregated pockets, and it occupied a slightly funky and offbeat brand space closer to that of Vodafone with whom its red livery could perhaps start to become confused.

An Exciting Industry Future - Or What?

Vodafone Group's future industry vision told the story of the old world where "data was restricted to voice calls and text messages. Network providers competed by price, service distribution and network. Nearly all these companies were self-contained national, not international operations." It contrasted that world with a new more much more complex world which brought wireless networks' convergence with the Internet and broadcasting - and painted the picture of people downloading movies and live news to their mobile screens. Vodafone Group predicted telecommunication network companies would not only be international in business structure but also in operations, serving customers across national and geographic boundaries, providing them the same convenience as if they were being served at home. Under this scenario, customer numbers were predicted to continue to double every two or three years. Users would have different expectations and needs. Voice calls were predicted to diminish in relative importance as other competing services gained attention. The new world, according to Vodafone Group, would "demand m-commerce (mobile commerce), information, entertainment, business services, device-to-device communication, location services and security services." Data services were seen as the big future with cellular companies playing central roles as network providers, partnering for content. Businesses, of course, were the biggest data users - and key to cellular telcos' futures.

Although technical capabilities ran rampant, bandwidth was increasing, and applications were proliferating, convincing customers they needed additional services and providing them without hitches at the right prices remained important. While the industry was moving towards more complex handsets, there was evidence to suggest users preferred single function devices. A full-colour multimedia era was possible but way beyond what many users were interested in right now. Business opportunities were many - but how to wow business to the possibilities with mobile was the big challenge. Across the board people were becoming more canny about how much they wished to spend. Some were also worrying about how much time they spent attached to mobiles and dealing with larger amounts of data now available on tiny screens. One European study had even shown the number of mobile subscribers had stopped going up.

For cellular services providers, technology was really not the big issue its enthusiasts made out, rather the concern was how and when they introduced it. Third generation technology was the big buzz in the industry. Vodafone Group confirmed in August 2002 that it intended to open the majority of its 3G networks for service and trials toward the end of the year and move into marketing 3G based services in 2003 when dual-mode handsets became more readily available. Capacity, potential demand for services and regulatory requirements all played a part in deciding where to build out 3G infrastructure.

Vodafone NZ's Managing Director, Tim Miles remained enthusiastic about opportunities to grow the business and continue its success through services like multimedia messaging, customised SIM cards and the wireless broadband initiative. There was a world of possibilities out there for an energetic company with a strong, if not somewhat funky brand. Vodafone NZ had largely won the youth market. Its consumer market presence was strong. Would Vodafone NZ be able to carve a bigger share of the business market - and convince these customers that wirelessness was what they needed now? How?

ENDS

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