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Telecom Scam and Its Implications

Annapoorni C S, Kriti Jain, Utkarsh Vikram Singh, MDI

ConQuest Online June 2011 Edition

ConQuest, IIM Shillong Consulting Club

Telecom Scam and Its Implications

Annapoorni C S, Kriti Jain, Utkarsh Vikram Singh, MDI

Indian Mobile Sector Overview

Phenomenal subscriber growth

The telecom services sector has grown rapidly over the past 5 years on the back of a meteoric rise in the mobile services space. The mobile subscriber base soared from 99 Mn in FY05 to 584 Mn in FY10, making it the second-largest wireless market in the world, next only to China. Increased affordability (due to continuous decline in tariffs, handset prices and
(In Millions)

Total mobile subscribers base

600 500 400 300 200 100 0
584
392 261 36 57

reduction in initial subscription costs) and greater availability (with rapid expansion in coverage and wider distribution

99

166

14

2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008- 200902 03 04 05 06 07 08 09 10

network) of mobile services has fuelled this buoyant growth.

Mobile subscribers

Source: COAI, AUSPI and TRAI

The industry has witnessed phenomenal growth in the past eight years at a CAGR of 73.8% as is reflected in the graph above. As of December 2010, mobile subscribers in India had reached 752 million translating into an overall teledensity of 66.2%.
Industry wide ARPU witnesses significant fall

While there has been significant subscriber growth, Average Revenue Per User (ARPU) has plummeted due to intensifying competition between service providers in the sector. Fall in call tariffs, initial subscription costs as well as SMS and non-voice services rates, has led to a reduction in the average ARPU of the industry.

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The fall in ARPU has led to a reduction in the Revenue Per Minute (RPM) of service providers. With RPM for several players falling below the operating cost that the service provider is incurring per minute, survival in the industry has become tough.
Rural areas yet to witness the telecom boom

In urban areas, Teledensity (Number of mobile connections per person as a percentage) has crossed 100%. On the other hand in the rural areas, there is still tremendous potential for growth. As of September 2010, there were 236 million rural subscribers translating to just 28% Rural Teledensity.

Large untapped population coupled with relatively lower penetration has prompted the telecom companies to fine-tune their focus on rural areas. Service Providers had been reluctant to expand their services in the rural areas owing to the low quality of subscribers and the high power and fuel cost incurred in these areas.

Historical Spectrum Pricing Strategies

In August 1995, Mobile services were launched for the first time in India in the city of Kolkata. Under the National Telecom Policy, 1994, the policys key objectives included:
1) 2) Universal service with complete coverage of urban and rural areas Availability of a wide range of services at reasonable prices

Spectrum pricing strategies employed by DoT Key Selection parameter

Metros: Lowest Rental proposed to be charged from subscribers Non Metro circles: Highest license fee quoted by the bidders Shift from license fee to revenue sharing Additional spectrum issued on the basis of number of subscribers New licensees selected on arbitrary FCFS basis 3G & BWA spectrum alotted through auctions

In the first phase in 1994, 2G spectrum was allotted to four service providers per circle on the basis of the lowest rental proposed in metros (to increase affordability) and the highest fee quoted by service providers in Non
1999 2004 2008 2010

1994

Source: TRAI recommendations on spectrum allocation

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metro circles (to maximize revenues). This was later extended in 2001 to accommodate more players in order to increase competition leading to a reduction in prices. Moreover, the excess spectrum allocation from 2004 onwards had been done by DoT in proportion to the number of subscribers that a service provider had in the respective circle.
3G pricing strategy employed by DoT

In the case of the 3G spectrum allocation, government conducted an auction between interested parties for three-four slots of spectrum in the 2.1 Ghz range for service providers. As against a budgeted Rs. 35,000 crores from 3G and BWA auction made in the Finance Ministers speech for the 2010-11 Budget, the exchequer collected Rs. 107,000 crores from the two auctions. The opponents of the auction process argue that the economic and the social benefits which can be raised from the sale of spectrum should be the determining criteria for the pricing of spectrum with India being a highly competitive price sensitive market having high price elasticity. Hence, if mobile services were made affordable then an exponential growth in users could be expected.
International Pricing Strategies

Varied spectrum allocation strategies have been employed in various countries with reasonable success. The beauty contest plus fixed fee pricing strategy have been employed on most occasions. Some of the international pricing strategies employed in various countries are given below:
International pricing strategies for spectrum

Country
Australia Malaysia Singapore Korea UK

Pricing strategy
Auction Beauty content plus fixed fee Beauty content plus fixed fee Beauty contest plus fixed fee Auction

2G/ 3G
3G Both 2G & 3G Both 2G & 3G 3G 3G

Source:TRAI consultation paper issued 12th June 2006

Having considered historic as well as international pricing strategies, the following criteria can be used for determining spectrum price
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ConQuest, IIM Shillong Consulting Club 1) Demand supply situation reflective of scarcity 2) Economic and social benefits emanating from 3G services 3) Maximizing government revenue 4) Extent of competition in the market

The 2G Spectrum Scam

In September 2007, TRAI issued recommendations on capping the number of access providers. Salient features of these recommendations were:
1) 2) No cap to be placed on the number of access service providers in any service areas No additional spectrum to be allocated to licensees without fulfilling the rollout obligations and failure of the same would lead to termination of license.

Later that year, DoT accepted all the recommendations made by the regulator. However, despite the recommendation, DoT issued a press release accepting applications only till 1 st October, 2007. DoT further accepted applications only till 25th September, 2007.
Irregularities in FCFS strategy adopted by DoT

1. 2.

Arbitrary dates fixed as cut off for receiving applications in September 2007 Selectively leaking out information to benefit a few players who were ready with predated demand drafts prior to the date of issue of application asking for Demand drafts

3.

Out of 232 applications received from 21 applicant companies till the changed cut-off date, 121 applications from 16 applicant Companies were found eligible

4.

Opaque & uncertain delivery system due to UAS licenses barely being issued from 200405 to October 2007

5.

Change in the method for applying FCFS criteria from the date of receipt of application to date of compliance of LoIs
2G Scam : Timeline
24th Sep, 2007 19th Oct, 2007 2nd Nov, 2007 2nd Nov, 2007 2nd Nov, 2007 31st Dec, 2007 10th Jan, 2008 DoT conveys no application to be accepted after 1st Oct, 2007 Policy for dual technology announced, LoIs issued to Rcom & 2other companies DoT decides that only 232 applications till 25th Sep, 2007 will be considered PM writes to Telecom Minister to consider auction of spectrum in fair transparent manner Telecom minister writes back saying that sufficient 2G spectrum is available Secretary DoT and Member (Finance) DoT retired. Out of 232 applications received up to cut off date 121 LoIs were issued to applicants found eligible

The Prime Minister, Minister of Law and justice, Finance Secretary and the DoT Secretary were against the hasty allotment of spectrum at 2001 prices and believed that DoT had lost an opportunity to discover the real

economic value of a scarce national resource- spectrum.

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ConQuest, IIM Shillong Consulting Club Criteria for allocation not met by new entrants
2G spectrum scam: New licenses Company Irregularities in the new licenses
Suppressed non - registration of alteration in the main object clause of MOA by ROC Authorised share capital only Rs. 5.20 crore against requirement of 128 crore

Even ignoring the arbitrary FCFS methodology adopted by DoT in the issuance of articles, the real issue lies in the type of companies that were allotted spectrum to roll out 2G services. Most of the new entrants who won spectrum were novices in the telecom field having no background in the industry, existing only on paper. Additionally, most of the new entrants did not meet several criteria for the allocation of spectrum. In the table below, the irregularities with respect to

Shipping stop dot com now Loop Telecom

Request for Registration of increase in authorised share capital submitted 24 Oct. Suppressed non - registration of the resolution effecting alteration in the MOA

Datacom Solutions Pvt. Ltd. (Now Videocon Telecom Ltd.)

Authorised share capital only Rs. 1 lakh against requirement of Rs. 138 crore Submitted false certificate from Company Secretary Suppressed non - registration of alteration in the MOA/AOA Authorised share capital only Rs. 10 lakh against requirement of Rs. 18 crors; Submitted false certificate from Company Secretary

S Tel

Source: Various public releases on the website

the new licensees have been mentioned.

Impact on Industry
In an already competitive environment, number of service providers were raised from 6-7 to 11-12 in various circles, resulting in a hyper competitive scenario.
Preferential treatment for new entrants

While established players were waiting in line to gain spectrum, new players were offered spectrum within a few months of applying for the letter of intent. Idea Cellular had been in queue for more than 2 years for spectrum in the Punjab circle, while new entrant Unitech Wireless was issued spectrum in just 2 months, despite being much lower than Idea in the priority list for the Punjab circle.
Spectrum issued at throwaway prices

The spectrum issued to new entrants was offered in the range of Rs. 1,500 to Rs.1,600 crores which was the same price at which most of the incumbent players had received start-up spectrum post the implementation of the National Telecom Policy, 1999. In eight years, the industry had undergone major changes and from its infancy stage had

Equity sales by new entrants to foreign players

Seller Swan Telecom
S Tel Unitech

Buyer
Etisalat Mauritius BMIC, Mauritius Telenor, Norway

% Stake In Rs. Crores

50% 5% 67% 3,598 239 6,120

Source: Media releases on company websites

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zoomed forward. To realize the true value of spectrum, we can consider the equity sales made by the following companies, most of whom did not possess any assets on their books, but a piece of paper The 2G license.
Little impact on competition in the sector

While the allotment of 2G spectrum was expected to usher in a new wave of competition leading to a further reduction in tariffs, most of the new entrants failed to meet their roll out obligation norms.

Moreover, the new entrants have failed to garner a significant amount of market share since their roll out. Infact the top six players of the industry have remained unchanged in the past several years. As of December 2010, six new entrants (Etisalat, Uninor, Sistema Shyam, STel, Loop Telecom and Videocon) had managed just 4 per cent market share translating into just one per cent revenue market share.

Impact on Government
Non fulfilment of roll out obligation norms

As per the roll out norms, new licensees were required to roll out services in 90% of metro service area and 10% District Headquarters in other service areas within 12 months of being allotted spectrum. Although, start-up spectrum of 4.4 Mhz was made available to all players in 2008, none of them had rolled out services as per the earlier stated provisions till January 2010. Therefore, 1) DoT did not earn any spectrum fee from these operators in 2008-09 and 2009-10 2) DoT has also not recovered penalties amounting to Rs. 700 crores from these new entrants.

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ConQuest, IIM Shillong Consulting Club Huge loss of revenue

The notional loss suffered by the exchequer due to the 2G spectrum scam can be calculated in two ways, 1) On the basis of S-Tels offer to DoT of Rs. 13,751 crores for 6.2 Mhz of spectrum for 10 years, leading to Rs. 47,964 crores for 122 licenses 2) On the basis of the 3G spectrum auction price, which is Rs. 111,512 crores In addition, if losses due to dual technology
Estimates of loss due to 2G scam Based on Based on S 3G auction Tel's offer prices
Revenue expected Revenue through auctions Loss 47,964 9,014 38,950

specific losses and excess spectrum issued over and above 6.2 Mhz is considered, then the figures in the two cases amount to Rs. 67,634 crores and Rs.1,76,645 crores respectively.

111,512 9,014

Burgeoning fiscal deficit

102,498

In the year 2007-08, India ran a fiscal deficit of Rs. 1,509 billion representing 3.1% of the

countrys GDP. While in the union budget for 2009-10, this fiscal deficit had risen to 6.7 % of the countrys GDP. However, support was lent by the auctions conducted for 3G and BWA spectrum in 2010-11. Against a budgeted Rs. 35,000 crores

expectation by the government for 3G and BWA auction, the exchequer made Rs. 107,000 crores through the sale of spectrum. This helped in fiscal consolidation as fiscal deficit came down to 5.1 %.

Impact on Customers
When the Telecom Minister wrote to the Prime Minister on 2nd November 2007, explaining the rationale behind issuance of spectrum on 2001 prices, he mentioned the following points, 1) More number of operators per circle will bring down the tariff 2) In order to increase affordability, if a high cost was imposed on the spectrum, service providers would have no option but to pass on the costs The roll out of new licensees has led to competition further intensifying in the domestic mobile services space with the HHI falling from 1,590 to 1,394 as of December 2010 (Considering subscriber market share). However, it is imperative to note that the new

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licensees do not have a substantial amount of revenue market share in the industry with the incumbents still being the dominators.

Moreover, a high proportion of the subscriber additions that have been achieved in the past three years have been due to attractive schemes rolled out by the incumbents. 1) Airtel brought down lifetime prepaid scheme from Rs. 199 to Rs. 99 2) Simply Reliance plan offering competitive tariffs to subscribers 3) Tata DoCoMos launch characterized by per second billing
Subscriber additions in the past three years
(In Millions) 20
RComs GSM launch and Vodafone and Ideas new circle launches Sustained growth due to incumbents perfroming well & new entrants chiping in

18
16 14 12 10 8 Lifetime prepaid scheme reduced to Rs 199,

Tata DoCoMo's GSM launch characterised by per second billing

6
Jun-07 Feb-08 Jun-08 Feb-09 Jun-09 Feb-10 Aug-07 Aug-08
Aug-09

Dec-07

Dec-08

Dec-09

Source: TRAI, COAI and internal research

Lifetime subscription costs plummet

When we talk about reduction in tariffs, the initial lifetime subscription cost is an apt indicator of the tariff levels. Over the past few years, this initial subscription cost has been on a downward trajectory. But the noticeable point is that the lifetime subscription cost has always been lowered by the incumbent players such as Reliance Communications, Tata Teleservices and Bharti Airtel. In a nutshell, the impact on the consumers due to overcrowding of 11-12 players in each circle has been marginally positive, however, the new entrants have had little profits to show in this period.

Need for Regulations

Telecom Regulatory Authority of India (TRAI) was established in 1997 to regulate telecom services and for fixation/revision of tariffs, and also to fulfil the commitments made when
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Jun-10

Apr-09

Apr-10

Apr-08

Oct-08

Oct-09

Oct-07

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India joined the World Trade Organisation (WTO) in 1995. The formation of TRAI separated the regulatory function from policy making and operations which remained under DoT. With reference to the 2G Telecom Scam, several issues have come to light. 1. Disagreement in opinions of the regulator TRAI and the Department of Telecom (DoT) 2. Uniform decisions need to be taken by the DoT, Ministry of Finance & Prime Ministers office 3. Level of corruption and non-transparency in the Telecom Ministry 4. Nexus between media representatives, lobbyists, politicians, bureaucrats as well as industrialists. The regulator needs to be offered independent authority and a larger responsibility in framing policies for industry stakeholders. The regulator can go a long way in increasing transparency and accountability in the system and offering recommendations for the designing of policies to DoT. With reference to the current industry scenario, the regulator needs to design a uniform pricing strategy for future 2G as well as 3G spectrum allocations. Also, issues such as Spectrum trading, Mobile Virtual Network Operator, change in merger and acquisition norms need to be studied in detail and relevant policies need to be designed in order to ensure the smooth functioning of the sector for all major stakeholders.

Recommendations
The 2G scam has tarnished the reputation of Indian politicians and bureaucrats and in the aftermath a lot has changed. Despite the resignation of A. Raja from the post of the Telecom Minister, questions of corruption have also been raised against the Prime Minister and other members of the UPA government. On the other hand, the scam has resulted in a gargantuan financial loss to the exchequer amounting to more than Rs. 60,000 crores at least. Irrespective of the exact financial loss made due to the 2G scam, the Department of Telecom lost accountability and transparency. Moreover, there has been a substantial loss due to the new entrants not rolling out operations on time leading to lower revenue collections for the DoT. Going forward, DoT in accordance with the Telecom Regulatory Authority of India needs to arrive at a uniform spectrum pricing policy to avoid similar discrepancies in the future. Also, in order to make the sector sustainable for service providers and to promote expansion

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The Team

into the hitherto neglected rural hinterlands, DoT needs to relook at the Merger and Acquisition norms currently prevalent in the industry. With consolidation imminent in the sector, the next phase of growth is expected to stem from the expansion into the rural areas and revenue generated from 3G services. The Indian telecom sector has witnessed a honeymoon period till now and the good times can last going forward, if the Telecom Ministry, can tinker the M & A norms and make the industry environment more favourable for industry players.

Conquest Online is the online edition of ConQuest which is a student driven Consulting club of IIM Shillong. The ConQuest Team includes Anurag Prasad | anurag10@iimshillong.in Hemant Bhargava | hemant10@iimshillong.in Manbir Singh Tandon | manbir10@iimshillong.in Partha Mitra | partha10@iimshillong.in Priyansh Modi | priyansh10@iimshillong.in Ritika Parasrampuria | ritika.p10@iimshillong.in Siddharth Jaidev | siddharth10@iimshillong.in

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