Financial Services

Corporate Governance and Transparency

for Chinese Companies P. 4

Strategy & Marketing

Machine-to-Machine Technology—
The Next Big Thing? P. 32

Procurement & Supply Chain

Cubisms
Are Turnkey Models the Future for
the Telecom Sector? P. 19

Analytics
Twitter Sentiment Analysis:
Tracking Consumer Attitudes
on Social Media P. 15

Vol. 3 Issue 1

Could Asia Pacific be

the Saving Grace for
the Airline Industry?
P. 10

thesmartcube.com
 Welcome to our first
installment of
Cubisms for 2013.
It’s always nice to start the new year afresh and this year, we
certainly embraced that philosophy. We’re excited to reveal our
new look to you—from our new corporate logo to the revamped
Cubisms you are now reading.

We’re most excited, though, to share with you some of the

latest insights around current market issues and industry
trends. This issue spans the globe and crosses industries
to look at how consumers, the economy, the political
environment, technology and suppliers are driving business
forward. In our cover story, we look at how one part of the
world is driving growth for an entire industry globally. In
Machine-to-Machine Technology—the Next Big Thing? and
Twitter Sentiment Analysis: Tracking Consumer Attitudes
on Social Media, we look at how technology is providing
myriad solutions and insights to a wide range of companies
across industries. In the financial services space, we look
at how globalization has led to an increase in the scale and
complexity of Chinese companies, creating a demand for
improved and more transparent corporate governance.
And last but not least, we look at the telecom industry and
how third-party service providers have shaped the future of
network deployment.

We hope you enjoy this issue and welcome any feedback

you may have. If you would like more insight into any of
the topics in this issue, or if you have specific ideas you
would like to see covered in future issues, please email us
at info@thesmartcube.com.

Omer Abdullah
Co-founder and Managing Director
The Smart Cube

2 Cubisms | February 2013


Cubisms
Vol. 3 Issue 1
10
Published by The Smart Cube
Managing Director:
Omer Abdullah
Managing Editor:
Amanda Beto
For more information on any of these
topics, to request article reprints or
learn more about The Smart Cube,
email insights@thesmartcube.com.
This publication may not be reproduced
or distributed (in whole or in part) to any
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the trademarks, trade names or service
marks of The Smart Cube without
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of The Smart Cube.
Visit Us
linkedin.com/company/the-smart-cube
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© 2013 The Smart Cube.
All rights reserved.
Table of Contents
4 32 19 15
Feature
10 | Could Asia Pacific be the Saving Grace for the Airline Industry?
Despite adverse economic conditions in the recent past, the airline industry globally has proven to
be resilient. After a short downturn, the industry recovered quickly and, in fact, grew moderately.
While the mainstay markets (Europe and North America) have not shown significant growth, and
are not expected to grow substantially in the near future, Asia Pacific has emerged as a savior of the
global air travel industry, driving growth and expansion.
Financial Services Procurement & Supply Chain
4 | Corporate Governance and 19 | Are Turnkey Models the Future
Transparency for Chinese Companies for the Telecom Sector?
Globalization has led to an increase in the scale In response to one of the industry’s most
and complexity of Chinese corporations. A natural challenging business environments, telecom
follow on has been the demand for improved providers have looked to Managed and
and more transparent corporate governance. Professional Services. How has this model evolved
23 | U.S. Major League Sports: and what drivers are propelling this evolution?
Industry Economics and 40 | The Importance of Coal to the
Investment Considerations Chinese Economy
45 | The Smart Cube Risk Appetite Index
Analytics
Strategy & Marketing 15 | Twitter Sentiment Analysis:
32 | Machine-to-Machine Tracking Consumer Attitudes on
Technology—The Next Big Thing? Social Media
M2M technology has evolved to provide Social networking sites can provide valuable
customized solutions to organizations across a insight into the minds of consumers. This
range of industries. While the market is set to article explores how one tool can be used to
grow globally, where does this growth lie and gauge consumer sentiment on a particular
what challenges should new entrants into the product across Twitter.
market expect?
38 | Manager’s Snapshot: Emerging
Trends in the Consumer Packaged
Goods Space
may 2013 | Cubisms 3
Financial Services
Corporate Governance
and Transparency for
Chinese Companies
Jyoti Prakash, Sajal Agarwal, Ashish Kumar, and Naman Vij
Financial Research
Corporate governance—
need of the hour?
Globalization of the world economy,
the opening of trade relations,
convergence of global capital markets
and the resultant move towards a
capitalistic, market-based economy
have led to an increase in the scale and
complexity of corporations, irrespective
4 Cubisms | MAY 2013
and confidence that is fundamental
to capital markets.” Companies with
stricter internal controls and higher
levels of corporate governance are
perceived to be more trustworthy and
usually enjoy higher valuations as well
as easier access to capital.
At the same time, this transition towards
complexity has also seen corporate
scandal and fraud rear its ugly head
with increasing intensity. While western
countries have seen large-scale scandals
such as Enron and WorldCom, more
recently, a growing number of such cases
(and with increasing regularity) are being
attributed to Chinese companies listed
on foreign exchanges.
of geography. A natural follow on has
been the demand for improved and
This alarming trend has brought to the
more transparent corporate governance
fore the issue of CG and transparency
(CG). According to the Organisation
standards in the country and has
for Economic Co-operation and
forced the Chinese government to take
Development (OECD), “Corporate
a hard look at its implementation and
governance is critically important to a
enforcement efforts in this area.
country’s economic growth and stability,
because it provides the credibility
“Corporate governance is critically important to a country’s of shareholders’ interests, thus setting
the stage for the formal development of
economic growth and stability, because it provides the credibility CG and transparency practices. This
and confidence that is fundamental to capital markets.” phase also saw the listing of B-shares in
1991, which attracted foreign investors,
Organisation for Economic Co-operation and Development (OECD)
further exposing Chinese corporates to
higher CG standards.

Background on CG in China
China embarked on the path towards
economic reform in the late 1970s, after
years of operating under the control
of the state which, until then, had
staked a claim on all production assets
in the country. The reforms focused
on shifting away from state-owned
enterprises (SOEs) to private enterprises,
and encouraged the liberalization of
the Chinese economy with respect to
foreign capital markets and trade.
As more Chinese firms transitioned
towards privatization, company
ownership became more diversified,
leading to a conflict between
management and shareholders’
interests. This led to the need to set
up standard CG practices to manage
conflicts. Increasing foreign trade also
Phase 2 (1993–2003)
meant more exposure to international
This phase was characterized by radical
corporate and governance standards.
changes in terms of liberalization,
including passing of the Company Law
The introduction of CG in China
in 1993 and China’s accession to the
and subsequent improvements can
World Trade Organization (WTO) in
be segregated into three distinct
2001. The Company Law provided the
phases (Fig. 1):
legal support to lay the groundwork for
China’s CG framework and established
Phase 1 (1978–1992)
companies as legal entities. Further,
During this phase, the focus was
accession to the WTO integrated
on the development of the Chinese
China into the world economy, in
capital market. In 1990, two major
turn, leading to the increased need
Chinese exchanges—the Shanghai
Stock Exchange and the Shenzhen for improved transparency.
Stock Exchange—were established.
Phase 3 (2004 and onward)
This was followed by the establishment
This phase was marked by
of the Chinese Securities Regulatory
improvements and amendments
Commission (CSRC) in 1992. This
in existing laws and policies and
opened up corporates to scrutiny
the introduction of new, enterprise-
by investors and also required the
friendly laws. The amendment in
government to ensure the protection

Figure 1 — A History of CG in China

Phase 1 Phase 2 Phase 3

(1978–1992) (1993–2003) (2004 and onward)
Separation of goverment Experimentation in Bridging the power gap between
and enterprise modern enterprise state and individual

1991 2001 2006

1978 Inflow of foreign 1993 Accession to WTO, Amendment in 2009
Beginning of investors, owing Company Law leading to need for Securities Law and Implementation of SOE
economic reforms to B-shares (amended in 2006) improved transparency Criminal Law Asset Protection Act

1990 1992 2000 2002 2007

Establishment of
Shanghai and Shenzen
stock exchanges
Establishment Implementation Development of Regulation on
of CSRC of Accounting Law code of CG for information disclosure
to standardize listed companies; of listed companies
accounting Implementation of
scheme for Qualified
Foreign Institutional
Investors (GFII) to trade
in A-shares (trading
started from 2003)

Sources: China Securities Regulatory Commission; OECD; “Chinese Corporate Governance — History and Institutional Framework”, RAND Center of Corporate Ethics and Governance, November 2012;
“Corporate Governance at the Chinese Stock Market — How it Evolved”, Junhua Tang and Dirk Linowski.

MAY 2013 | Cubisms 5

Financial Services

the Securities Law and Criminal
Law (2006) led to an increase in the
supervision of listed companies and
made issuance more transparent. The
law on protecting state-owned assets of
enterprises (2009) was promulgated to
safeguard the country’s basic economic
system, to consolidate and develop the
state-owned sector. In addition, the law
banned embezzlement of state-owned
funds and the sale of state-owned assets
at below fair value.
Steady regulatory progress,
but CG and transparency still
lagging developed and emerging
market peers
Despite the significant headway made by
the introduction of CG standards, China
continues to experience inefficiencies in
the implementation of these practices. As
a result, Chinese corporations continue
to suffer from weak enforcement of and
adherence to corporate laws.
The primary reason for this lack of
enforcement is persistently high state
ownership, which has had a trickledown
effect on all aspects of corporate
functioning and governance in the
country. Even after three decades of
reform, the state’s ownership of companies
in China remains pervasive, with close
to 80% of market capitalization being
accounted for by government-controlled
enterprises. As of mid-2010, the top 10
state-owned firms accounted for nearly
40% of the Shanghai Stock Exchange
market capitalization. Mutual funds and
financial institutions (which typically
encourage higher standards of CG) have
seen little growth since their debut in 1998.
A legacy issue related to state ownership
is non-tradable shares, which are shares
owned either by state enterprises or
other legal entities that cannot be
traded. Despite reforms over the years,
approximately 20% of issued shares of
listed companies continue to be non-
tradable. However, their percentage has
declined from 64% in 2004. Another
follow-through effect of ownership
concentration in the hands of the state
is the lack of independence among the
board of directors. Provisions allow
for the dominant shareholder (in most
cases, the government) to nominate all
directors, putting a question mark on
the “independence” of the directors.
According to an assessment of a
range of factors by Transparency
International (a non-governmental
organization monitoring corporate and
political corruption in international
development), of the largest 105 listed
companies globally, three of the six
Chinese companies on the list (including
one in Hong Kong) were among the worst
performers, i.e., least transparent, while
the other three Chinese companies fared
in the second-worst category (Fig. 2).

Figure 2 — Transparency in Corporate Figure 3 — CG Rankings of Asian Markets

Reporting Index: Largest 105 Public
Companies Globally Scores
Market
Cg Rules & Enforce- Political & Cg
Average score of companies in each country (countries with three or more Overall Igaap
Practices ment Regulatory Culture
companies in top 105)

Number of Companies Singapore 69 68 64 73 87 54

7 11 4 4 8 3 39 6 5 Hong Kong 66 62 68 71 75 53

7.0 Thailand 58 62 44 54 80 50
6.8
6.6 6.5
6.2 Japan 55 45 57 52 70 53
5.5
Malaysia 55 52 39 63 80 38
4.2 Taiwan 53 50 35 56 77 46

3.0 2.9 India 51 49 42 56 63 43

Korea 49 43 39 56 75 34

China 45 43 33 46 70 30

Philippines 41 35 25 44 73 29
y

om

ia

a
l
d

ce

s
zi
an

n
e
an

pa
al

ra

at
n

hi
gd

tr
m

ra

Ja
rl

St
B

C
us
ze
in
er

Indonesia 37 35 22 33 62 33
ed
it

A
G

Sw

it
d

n
e

U
it
n
U

Sources: OECD; Transparency International; Asian Corporate Governance Association

6 Cubisms | MAy 2013

Figure 4 — China Gdp and Fai Growth Figure 5 — Overseas IPOs by Companies
Domiciled in China
26.0% 23.9% 24.8% 25.9% 30.0%
23.8% 23.8% 20.7% 50 100
45 90
40 Accounting 80
11.3% 12.7% 14.2%
9.6% 9.2% 10.4% 9.3% 7.7% 35 Global Scandals 70
30 Crisis 60

2005 2006 2007 2008 2009 2010 2011 YTD 2012 25 50

20 40
GDP Growth (real. YOY) Fixed Asset Investment (nominal, YOY)
15 30
10 20
Notes:
1. 2012 GDP growth cumulative until 3Q 2012; 2012 FAI growth cumulative until October 2012 5 10
2. Includes IPOs in Hong Kong; 2012 data as of October 31, 2012 0 0
2005 2006 2007 2008 2009 2010 2011 2012
SourceS: National Bureau of Statistics, China; Thomson One; UNCTAD
Amount raised (USD million) No. of IPOs No. of IPOs in US

Another study by the Asian Corporate Many of these scandals have involved While the Chinese market
Governance Association revealed that companies that avoided the rigorous
Chinese companies lag their Asian peers disclosure requirements of IPOs by
scored well on accounting
as well. While the Chinese market scored opting for the reverse merger route, standards, it fared the worst
well on accounting standards, it fared in which a private Chinese company on CG enforcement.
the worst on enforcement of CG (Fig. 3). acquires an already listed shell
company. Insider trading has also been
Accounting scandals aggravating an ongoing issue, as has been seen in
the situation further recent cases in the news.
The lack of appropriate CG and
transparency practices among Chinese Stricter enforcement of CG and
companies has been highlighted by transparency required to reap full
the accounting scandals surrounding benefits of global capital markets
Chinese companies listed on the Continued economic growth will place
NASDAQ, NYSE and the Toronto Stock a continued emphasis on improved CG.
Exchange. Firms such as Muddy Waters, China, despite its growth slowdown, has
Alfred Little and Citron Research have fared significantly better than its global
revealed accounting discrepancies and peers, registering 7.7% GDP growth
erroneous information disclosure by in 2012, having witnessed an average
a number of Chinese companies. The growth rate of more than 10.0% during
number of cases filed against such the past 30 years. Although Fixed Asset
Chinese companies has increased Investments (FAI), which has been the
substantially, from 2 in 2009 to 15 in major driving force behind China’s GDP
2010 and 38 in 2011—with the most growth, has declined, it continues to be
typical issues usually being fraudulent close to 24.0% in 2012 (Fig. 4). Growth
or misleading accounting disclosures in industrial production, at 9.6% YoY
(e.g., overstatement of assets, revenue, in October 2012, beat the consensus.
profits and margins). Further, inflation eased to 1.7% and
retail sales increased slightly to 14.5%
However, some cases of other poor YoY, indicating that the economic
CG practices have also been observed. slowdown may be past the trough.

MAY 2013 | Cubisms 7

Financial Services
All of which is to say that, with
continued (and possibly further
pickup in) economic growth, Chinese
companies are expected to continue
to seek capital to expand existing
operations and fund growth. Chinese
companies have been active in the
foreign capital markets, with an
increasing number of them seeking
listings on foreign exchanges
to raise capital.
The primary factors making these
markets attractive business destinations
are easier access to capital/liquidity,
optimal valuation, high credit-worthiness
and the possibility of new partnerships.
The developed equity markets provide
a larger pool of capital, more liquidity
and the opportunity to raise funds
from institutional investors (who are
absent from China’s stock markets due
to stability and transparency concerns).
Further, as the issuers expect to obtain
the ‘right’ valuation for their securities,
due to the presence of a large numbers
of peers, these markets provide optimal
valuation opportunities. Moreover, an
international listing enhances the scope
for improved credit ratings and the
possibility of entering into partnerships,
Figure 6 — China Cross-Border M&A
Number of Successfully Completed Deals
946
791
769
399
360 384
2008 2009 2010
Chinese Acquirer/Non-Chinese Target
Note: 2012 data as of October 31, 2012
Sources: Bloomberg; UNCTAD
8 Cubisms | MAy 2013
either through acquisitions or creation
of joint venture with foreign firms, by
swapping American Depositary Receipts.
The US and Hong Kong have hitherto
been the primary markets to seek
capital. While the global crisis was a
major setback, with capital raised from
IPOs in foreign markets declining
75% YoY to $10.5 billion in 2008, the
recovery was quick. In 2010, the market
rebounded to $38.4 billion, with a
record of 90 IPOs. Further, in 2011,
foreign direct investment into China
was at consistently high levels, at $124
billion. However, concerns regarding
the Eurozone debt crisis and fears of a
hard landing for the Chinese economy
made investors cautious, a situation
which has been aggravated by the CG
issues described earlier. In 2012, only 32
IPOs have been launched by Chinese
companies, raising a total of slightly
over $2 billion. Vipshop, China’s leading
online discount retailer for brands,
was the sole US listing in 2012, raising
$71 million—39% lower than initially
planned (Fig. 5). China Auto Rental, which
had originally planned to raise $300
million, postponed its IPO after failing to
attract enough investor interest.
Figure 7 — China Cross-Border M&A
By Value (USD Billion)
718
455
377
264
11 12
2011 2012 7 6
4 5
Non-Chinese Acquirer/Chinese Target
2005 2006
As companies look to get back on track
in terms of IPOs and IPO strength,
improved CG will be a key factor in
driving listing performance (and beyond).
Beyond the individual company level,
the Chinese government’s “go global”
strategy (announced in 1999 in response
to the changing global environment and
with an aim to scale up local Chinese
companies and seek those resources
unavailable within the country) has
been going strong—with increasing
overseas acquisitions in both 2010 and
2011 (Figs. 6-7). Given the increasing
exposure of Chinese corporations to
foreign companies (through mergers
and acquisitions) and their corporate
standards, it is imperative for Chinese
corporates to continue to improve their
transparency standards.
Sound CG reflected
in improved performance
Does effective CG actually reflect
in performance, and does the market
recognize and reward better CG
and transparency?
To answer this question, The Smart
Cube evaluated CG and transparency
38
34
30
21
11 11
9
-2
2007 2008 2009 2010 2011
Net Sales Net Purchases
Figure 8 — Transparency/Disclosure
Percentage of Companies Following
Good Practices
Has adhered to prescribed time
limit to report results
Provides guidance/business outlook
Holds regular earnings calls
Has disclosure on CG/Code of Ethics
Has disclosure on Environmental
Sustainability
Has disclosure on Corporate 7%
Social Responsibility
0%
Best Performers
Sources: China Securities Regulatory Commission; OECD; “Chinese Corporate Governance – History and Institutional Framework”, RAND Center of Corporate Ethics and Governance, November 2012;
“Corporate Governance at the Chinese Stock Market –How it Evolved”, Junhua Tang and Dirk Linowski.
practices of the best- and worst-
performing overseas-listed Chinese
companies. It focused on overseas-
listed Chinese stocks, as the impact of
the accounting scandals is highest on
these stocks with overseas investors
becoming more aware of the issue
and hence greater scrutiny of CG and
transparency practices in these stocks.
The identification of the 15 best and 15
worst performers is based on excess/
lower returns generated compared with
their sector peers listed in China (this
is to separate the effects of sector and
macroeconomic factors), premium/
discount in P/E multiple (average of
last three years) to sector peers listed
in China, and the level of institutional
holdings in the stock (the higher level
of institutional holdings, the better;
therefore, institutional holdings level
as a parameter for the quality of the
company was used).
The analysis of CG and transparency
practices of these companies revealed
that, on the whole, better transparency
and disclosure practices are clearly more
prevalent among the 15 best performers
(Figs 8-9). This indicates that companies
with better transparency/disclosure
tend to perform better. However, there
is significant room for improvement
in Environmental Sustainability
Figure 9 — Other CG Areas
Percentage of Companies Following
Good Practices
100% 80%
Holds regulary AGM
73% 100%
100%
93% Majority of Board is 67%
independent directors 73%
100%
87% Shareholding is not concentrated among 60%
100% promoter/directors/management 20%
73%
Does not have differential 93%
40% voting rights 67%
47%
Specific committee 47%
for different roles 80%
Worst Performers Best Performers Worst Performers
and Corporate Social Responsibility This article was written by The Smart Cube (TSC)
on an independent basis. The insights included are
disclosures. That said, other CG areas
based on its own research and from sources believed
such as ensuring independence of board
to be reliable. However, TSC may have received
members and independent members on information on this topic that is confidential and
various committees also continue to be proprietary to a third-party. As such, this
a pain point for both worst performing information will not have been utilized and is thus
not reflected in this article.
and best performing companies.
The views mentioned in this article do not in any
way constitute investment advice and should not be
In conclusion
construed as an offer to sell, a solicitation to buy, or
In recent decades, China has continually
an endorsement or recommendation of any
reinvented itself as a globalized, market- company, security or commodity. TSC disclaims all
based economy. At the same time, CG responsibility for investment decisions based on the
content of this article or the dissemination or
practices are struggling to evolve and
distribution of this article to a third party. Any
break free of their bureaucratic past.
conclusions, calculations or determinations reached
While the Chinese government has
constitute TSC’s views as of the date of this
shown great initiative in introducing publication and are subject to change without notice.
radical reforms, the drive and effort
required to implement these reforms
must continue to develop.
To this end, continued privatization,
increased participation by institutional
shareholders (to create a broader
shareholder base), strengthening
of the legal framework (increasing
legal obligation of management and
controlling shareholders to protect
minority shareholder rights) and clearly
etching out the roles, responsibilities
and independence of the supervisory
board are some of the key areas that
need to be addressed on an immediate
basis for China to continue on its
growth trajectory.
MAY 2013 | Cubisms 9
Feature
Could Asia Pacific be
the Saving Grace for
the Airline Industry?
Vivek Goyal, Nitish Mittal, and Subash Chandar
strategic services
D
espite adverse economic
conditions in the recent past,
the airline industry globally
has proven to be resilient. After a short
downturn, the industry recovered
quickly and, in fact, grew moderately.
From 2011 to 2031, annual air traffic
is expected to increase at a compound
annual growth rate (CAGR) of 5%,
10 Cubisms | MAy 2013
EU struggling to contain its debt crisis
and the US registering stagnant growth
in air travel, consumers in these regions
are increasingly rethinking their air
travel needs. Freight volumes in these
regions have also grown sluggishly in the
recent past. All the while, Asia Pacific
has been registering healthy growth.
Airline industry in Asia
Pacific vis-à-vis the world
The commercial airline industry in
Asia Pacific is experiencing the best
phase in its history. Rapid growth has
been fueled by lenient regulations, the
emergence of low-cost carriers, favorable
demographics, and sustained economic
and reach about 13.8 billion revenue
activity. Between 2012 and 2031, the
passenger kilometers (RPK) (Fig. 1).
region is likely to record a CAGR of 7%
in air travel, increasing its market share
While the mainstay markets (Europe
from 27% in 2011 to 37% in 2031 (Fig. 2).
and North America) have not shown
In contrast, the North American and
significant growth, and are not
European markets are likely to grow at
expected to grow substantially in the
a relatively muted CAGR of 3% and 4%,
near future, Asia Pacific has emerged as
respectively, during the period.
a savior of the global air travel industry,
driving growth and expansion. With the
 Figure 1 — World Annual Traffic Evolution According to the International Air
Transport Association (IATA), in 2011,
(RPK Trillion, 1971–2031F) Asia Pacific, as compared with its peers,
recorded higher net and operating
profits. Of the 10 most profitable
Total Air Expected Air
Traffic Traffic carriers (by net profit), half were from
Asia Pacific. Also in 2011, the Asia-
Pacific airline market generated total
2011–2021
RPK (trillion)

revenues of approximately $200 billion,

5.1%
second only to North America. During
Air traffic
has doubled that year, 10 of the 20 largest airlines
every 15 (by revenue) were based out of Asia
years (compared with only five Asian carrier
2021–2031
Air traffic groups in 2001).
4.4%
will double in
the next 15 The IATA forecast also reported that
years Asia-Pacific airlines are likely to record
a net profit of $2.3 billion in 2012,
accounting for about 56% of the global
airline industry profits ($4.1 billion),
making Asia Pacific a driver of airline
industry growth (Fig. 3).
Source: Airbus Global Market Forecast 2012–2031 (September 2012)

Key drivers fueling growth

Figure 2 — World RPK Breakdown
2011 2031F
1
By Region Mounting downstream demand
Within the Asia-Pacific region, China
and India are leading the way. By 2014,
Others North America Others air passenger traffic on North America
Asia-Pacific
18% 28% 23% routes will increase to 360 million—45%
20%
of all global air passenger traffic—with
China and India being the largest
2011 contributors fueled by the emergence
100% = 5,198 of low cost airlines, increasing travel
billion RPK requirements, and rising disposable
income. Outbound trips made by
Asia Pacific Europe Asia Pacific Europe
Chinese tourists totaled 57 million in
27% 27% 37% 20%
2010, and this figure is likely to rise to
2031F 100 million by 2015. The Indian travel
industry has been recording double-
100% = 5,198 billion RPK digit
100% growth,
= 13,764 and RPK
billion it is expected to have
around 1.8 billion travelers by 2021.
h America Others North America

2
28% 23% 20% Increasing corporate travel
According to various statistical
bodies, corporate travel is also expected
to further drive growth of the Asia-
2031F
Pacific airline industry as a number
100% = 13,764
of professionals/entrepreneurs are
billion RPK
traveling within and to the region.
Europe Asia Pacific Europe
This is largely attributed to the
27% 37% 20%
increasing trade, business, and financial
opportunities happening within this
region among various countries. As
Source: Boeing Current Market Outlook 2012–2031 (September 2012)
100% = 13,764 billion RPK a result, Asian markets are likely to

MAY 2013 | Cubisms 11

Feature

Figure 3 — Airline Net Profits By Region (USD Billion)

12

10

6
USD Billion

-2 Europe Asia Pacific North America Latin America Middle East Africa

2010 2011 2012F 2013F

Source: IATA Financial Forecast (September 2012)

“We see tremendous growth experience continuous growth in
business travel, despite a weak European
potential in Asia Pacific. The economy. In China, business travel is
Asia-Pacific region is now the expected to grow 17% and 21% in 2012
world’s single largest aviation and 2013, respectively, and the country
is projected to pass the US as the world’s
market, as well as a growing largest business travel market by 2015.
economic powerhouse,
and tourism industry. OTAs are also
experiencing faster growth than airline
websites, leading all travel categories
in terms of unique monthly visitors
and attracting, in some cases, more
than twice as many visitors as airline
websites. Online gross bookings in this
region are likely to grow twice as fast as

making it crucial for airlines
to be a part of this market for
increased growth.”
Robert Bailey, President and CEO, Abacus
International (June 2012)
3
Budding middle class
the total travel market to comprise 25%
The rapidly growing middle class in of the total market by 2013.
Asia Pacific provides a large number of
opportunities for the airline industry,
Growth in Asia Pacific helps
domestically and internationally. By
airline industry soar
2030, Asia Pacific will be home to 66%
Many of the key drivers fueling growth
of the middle class population. Further,
among Asia-Pacific airlines have a direct
in Asia, there are 270 cities with a
impact on the airline industry globally.
population of one million that lack
Three primary areas are in new airplane
an airport. Additionally, by 2014, one
deliveries, demand for single-aisle
billion people are expected to travel by
aircraft and the outcrop of new airlines
air in Asia Pacific.
in the Asia-Pacific market.

4
Growth of online travel agencies

1
Asia Pacific to lead in new
Online travel agencies (OTAs) in
airplane deliveries
Asia Pacific continue to dominate travel
Between 2011 and 2031, the number
retail sales. There also is significant
of airplanes in the Asia-Pacific fleet
room for growth, as bustling economic
will nearly triple, from 4,710 to 13,670.
activity and the rise in adoption of
To meet the increasing demand,
e-commerce continue to aid the travel

12 Cubisms | MAy 2013

approximately 34% of new airplanes Figure 4 — Global Airplane Fleet
being produced globally will be
delivered to the region (valued at $1.7
By Region
trillion) (Fig. 4). This will make Asia
Pacific one of the primary contributors
to worldwide fleet growth, which is 2011 23.7% 33.4% 22.3% 6.4% 14.2% 19,890
expected to grow at an annual rate
of 4%, nearly doubling in 2030 as
compared with 2010.
2031F 34.4% 22.2% 20.9% 8.7% 13.8% 39,780

2
Rising single-aisle aircraft usage
The increasing preference for a
low cost carrier (LCC) model and the Asia Pacific North America Europe Latin America Others
increase in demand for short-haul
flying are likely to fuel a substantial Source: Boeing Current Market Outlook 2012–2031, September 2012
increase in demand for single-aisle
aircraft. Between 2003 and 2011,
single-aisle capacity doubled, and it
is expected to further double by 2021 Figure 5 — Share In Global Fleet
(Fig. 5). The narrow body, single-aisle By Aircraft Size
segment is likely to increase as well, as
these aircraft have lower maintenance, 19,890 39,780
better economics, and higher fuel
4.0% 2.5%
efficiency. This will be primarily due to
5.6%
the increased demand for LCCs from 14.0%
developing economies such as India 22.9%
and China. 18.6%

3
New airlines entering the market
To leverage these growth
opportunities, the number of new airlines
in Asia Pacific has increased sharply over 63.4% 69.0%
the past decade. New LCCs have cropped
up in almost every major nation (Fig. 6).
Regional airlines also are establishing
subsidiaries in neighboring countries 2011 2031F
and even diversified business groups are
entering the sector. Single Aisle Twin Aisle Regional Jets Large

Source: Boeing Current Market Outlook 2012–2031, September 2012

Asia-Pacific market set to
take-off amidst turbulence
The recent growth in the number of
new airlines in the Asia-Pacific region
is quite apparent. Looking ahead, “The economic conditions in China and India are helping to
passenger traffic is likely to continue drive business opportunities and thus generating business travel
to remain robust, with carriers looking
activity, because companies want to get their people where the
to maintain high load factors and
implement lean practices, while strictly business opportunities are.”
controlling unit operating costs to keep
Christa Degnan Manning, Director
air travel affordable. In addition, full
eXpert Insights Research, American Express Global Business Travel (November 2011)
service network carriers, with a focus
on premium services, are expected to
gain traction. LCCs will primarily focus
on streamlining short-haul operations,
while some (for instance, Indigo) will

MAY 2013 | Cubisms 13

Feature

also venture into international and long-
haul markets. Asia-Pacific carriers will
continue to invest in service innovation,
adding more fuel-efficient aircraft in
a bid to meet the projected growth in
travel demand.
However, the industry continues to face
challenges, such as a weak cargo market
and high fuel prices. Further, the global
economic slowdown has resulted in
significant downside pressure on air
freight volumes. This is primarily due
to weak consumer sentiment, especially
in developed economies such as Europe
and the US, and a corresponding
slowdown of exports from Asia.
On the regulatory side, the global airline
market has been affected by political
concerns in the US and Europe. In
addition, global air travel experienced
increased government regulations
regarding airport security, emissions
and taxes, resulting in dampened
growth. In Asia Pacific, the presence
of multiple governments and regulators
in a highly diverse region has led to
several inconsistencies.
From a workforce standpoint, the region
needs to train personnel such as pilots
and aircraft technicians to leverage the
benefits of rapid fleet modernization and
projected growth in air travel. According
to Boeing’s estimates, Asia Pacific is
likely to require the highest number of
new pilots and technicians over the next
20 years globally. A pilot shortage has
already started to take place in the Asia-
Pacific region, with airlines experiencing
delays and operational interruptions
due to pilot scheduling constraints. The
region is expected to need an additional
185,600 pilots and 243,500 technicians
by 2031, as airlines expand their fleet
and new carriers open shop.
Final destination
Amidst the rapidly changing market
dynamics and increasing regulations,
air carriers have started to adopt
different end user strategies. The
future may look bleak in the short term,
driven by immediate challenges such as
high fuel costs and risks posed by the
Eurozone crisis; however, air carriers
from Asia Pacific are likely to stand
out. The region is expected to exhibit
higher sales and margins than their
Western counterparts in the long term.
Carriers in the region also are looking to
innovate and differentiate by providing
travel features such as air-cushioned
seats and freshly-made food to attract
customers. The spirit of transformation
that is prevailing across this region, in
the form of strategic realignments and
versatile airline offerings, is likely to
propel these air carriers to look beyond
traditional business models and register
high sales growth in the long run.

Figure 6 — Asia Pacific Low Cost Carriers Overview

Country–
Airline Commencement of Development
Operations
In 2012, Jetstar Airways entered Japan by forming a partnership with Japan Airlines (JAL) and
Jetstar Japan Japan
Mitsubishi Corporation
Joint venture among AirAsia, Malaysia, and All Nippon Airways, Japan. The airline commenced
AirAsia Japan Japan
operations in August 2012

Scoot Singapore LCC subsidiary of Singapore Airlines. Began operations in June 2012

Air Mantra India Subsidiary of Religare Group, which started operations in 2012

Commenced operations in March 2012, as a joint venture between All Nippon Airways and the First
Peach Aviation Japan
Eastern Investment Group (a Hong Kong-based private equity and venture capital firm)

Tiger Airways, Australia Australia An Australian subsidiary of Tiger Airway, the airline commenced its services in November 2007

Tianjin Airlines China Commenced operations in 2007, with a focus on China, Mongolia, and South Korea

Began operations in November 2007. It is a long-haul, budget airline, with domestic and
AirAsia X Malaysia
international operations
Commenced operations in August 2006, and is India’s largest LCC. In January 2011, it qualified to start
IndiGo India
international operations, which coincided with an order for 180 A320s from Airbus worth $15 billion
A domestic airline established in 2006 It is a joint venture between Shenzhen Airlines of China and
Henan Airlines China
Mesa Air Group of the US
Began operations in November 2005, in India as a LCC. In 2011, the company ordered 72 new A320 Airbus
GoAir India
aircraft in a deal worth about $6.1 billion

Spring Airlines China A China-based LCC, which began operations in July 2005

Started operations in 2005, as an LCC. To augment its fleet of 20 Boeing 737NGs, it ordered 15 Q400s
SpiceJet India
(with 15 options) and 30 Boeing 737NG aircraft in November 2010, adding to another 8 B737s on order.

14 Cubisms | MAy 2013


Twitter Sentiment Analysis:
Tracking Consumer
Attitudes on
Social Media
Deepak Trehan and Rachit Khare
DATA ANALYTICS
S
ocial networking sites can provide
valuable insight into the minds
of consumers. The wealth of data
available can help marketers better
understand wide-ranging issues, such
as customer reception of a new product
launch, overall product attribution likes
and dislikes and brand perception.
Armed with this knowledge, marketers
can develop a more effective strategy
and make better decisions overall. That
said, given the unstructured nature
of the data, tracking and analyzing
information from social channels can
Analytics
be daunting, and many marketers today
are using statistical tools and analytical
techniques to derive meaningful insights.
This article explores the use of one
such tool to gauge consumer sentiment
on a particular product across Twitter.
An illustrative example is used to
demonstrate the tool’s effectiveness on a
particular topic—specifically looking at
the launch of the Apple® iPhone® 5 and
the nearly 60,000 tweets related to it.
Sentiment analysis:
a three-step approach
The overall model development can be
divided into three phases (Fig. 1):
1. Collect and prepare data
2. Derive sentiment and visualize data
3. Build a model
MAy 2013 | Cubisms 15
Analytics

Figure 1 — Sentiment Analysis Flowchart

Collection and
Preparation

Clean tweets –remove RT, http Normalize tweet words – remove

Data

Download tweets from Twitter

links, punctuation, etc. English keywords, stem words
Sentiment

Derive sentiment by matching

Derive

Visualize tweet data in Transform textual data into matrix

product-specific positive and
word clouds form (Term Document Matrix)
negative keywords
Build Model

Consolidate product- YES

Consolidation achieved? Build Decision Tree Model
specific keywords

NO

1
Collect and prepare data • Segregating commercial tweets • Cleaning text, such as removing http
R, an open source statistical software, links, punctuation, whitespace, etc.
• Cleaning tweets for word forms such
provides a Twitter interface that can
as nouns and adjectives • Removing stop words such as had,
be used to download tweets based on
which, that, product name, etc.
keyword and hashtag search criteria. • Filtering out commonly used
Nearly 60,000 tweets were downloaded English words • Stemming to get the root form of
two months after the launch of the every word
Some of these challenges were
Apple® iPhone® 5. This was done to ensure

2
addressed by applying the following Derive sentiment and
that consumers had enough time to use
set of operations: visualize tweets
and express their views about various
After the data was cleaned, a custom
features of the device. • Identifying words such as “win,”
list of positive and negative words
“contest,” etc., that could be attributed
Processing of these tweets for sentiment associated with the device was built to
to commercial tweets
analysis presented a number of classify the tweets. A matching logic
challenges, including: was developed to derive a sentiment

Figure 2 — Frequency Distribution of Tweets Across Sentiment Score

25,670

16%
30%
Frequency

11,102
53%
5,867
2,883
1,606 524
2 10 53 261
Negative Neutral Positive
-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7
Score

16 Cubisms | MAy 2013

Figure 3 — Overall
Sentiment Cloud
score for tweets, and accordingly
classify them into positive, neutral
and negative. The chart on the
previous page shows the output for this
classification (Fig. 2).
In addition to this, an overall
sentiment score was calculated. In this
case, the overall sentiment score was
+31% (+ indicating positive consumer
sentiment). At this stage of the
analysis, the analyst team used word
clouds to provide an effective way to
visualize textual data (Figs. 3-5).
The visual representation in the first
shows that the word “love” was the
most repeated word. However, this
alone does not present a clear picture
of factors driving positive and negative
sentiments. Therefore, the first word
cloud was split into two—one each for
positive and negative tweets (Figs. 4-5).
Even though the last two word clouds are
not directly comparable, they provide
insight into possible factors driving
positive and negative sentiments. For
example, the positive sentiment word
cloud seems to be crowded by the
appearance of related words, while the
words battery, screen, and voice-search
appear more often than any other
product attribute in the negative word
cloud. Hence, this data could provide
useful information for Apple’s product
development teams as well as marketers
engaging with consumers on various
social media channels.
Figure 4 — Positive Figure 5 — Negative
Sentiment Cloud Sentiment Cloud
3
Build a model bottom. For instance, node 12 represents
To derive more meaningful results, tweets containing only keywords related
secondary research and a count of words to the feature “body” of the smartphone,
was used to identify the most frequently and a majority (51%) of them carry
appearing words. Keywords related to negative sentiments on this feature.
product attributes were then classified Similar key nodes with high percentages
into product subcategories such as of negative sentiments can then be
battery, screen, apps, etc. (Fig. 6) researched further, to deep dive and
explore reasons for dissatisfaction.
Upon consolidating the data, a heuristic
model (decision tree) (Fig. 7) was built
Enhancements
to understand the relationship among
The approach illustrated in this article
various iPhone® 5 attributes driving
uses basic algorithms for sentiment
public sentiment. For our classification
detection in tweets. For better results,
model, tweets with neutral sentiment
advanced Natural Language Processing
scores were ignored, to avoid dilution of
(NLP) can be used to more accurately
model output. Various tree classification
identify the sentiment score for each tweet.
options such as CART, CHAID and
NLP can handle the many complexities of
Exhaustive CHAID are available to
unstructured text data through advanced
create relevant decision trees. We used
processes such as conference resolution,
the CART option in SPSS to arrive at
part-of-speech tagging, etc.
the optimum decision tree.
Additionally, other methods can
The classification tree presented here
alternatively be used to identify key
provides an easy way of visualizing the
product attributes, and model their
impact of different product attributes in
impact on overall public sentiment.
driving public sentiment, as captured
Alternatives include statistical techniques
by Twitter data. This decision tree
such as logistic/ordinal regression
highlights the attributes most important
modeling, and advanced techniques such
in segregating positive and negative tweets.
as supervised and unsupervised artificial
As seen here, attributes such as accessories,
neural networks (ANN). Feed-forward
voice search, camera, appearance, body,
networks like multi-layer perceptron,
and comparison with other phones seem
radial basis functions, and Kohonen ‘s self
most important in segregation of positive
organizing maps are commonly used for
and negative tweets.
this purpose.
To identify defining characteristics
Use of ANN provides many advantages,
of a particular node, the hierarchy of
including its ability to map and replicate
classification should be read from top to
MAy 2013 | Cubisms 17
Analytics

Figure 6 — Example of Keywords Consolidated into any mathematical relationship, and

its lack of dependency on any data
Product Attributes
assumptions. However, interpretation
of results from ANN may be difficult
Battery Screen Appearance Apps Storage
compared to conventional statistical
procedures, due to the relatively black
Charger Scratch White/Black Appstore Memory
box and often complex computing
involved in neural networks.
Battery Life Touchscreen Contrast Appnames CardSlot

Inches
Further applications
Adapters Body Download HDSlot
This article highlights one of the uses
Battery Dead Shine Design Install bits/GBs
of analyzing unstructured text data to
better understand consumer sentiment.
However, the field of text data analysis
offers a large number of opportunities to
gain insight into consumer minds across
multiple media, including:
Figure 7 — Decision Tree Output
• Social networking sites such as Facebook
Node 0 (n=11,917) • Blogs
Negative – 35%
Positive – 65% • Call center logs

N Accessories Y • Email

Node 1 (n=10,847) Node 2 (n=1070) • Service notes

Negative – 37% Negative – 19% • Warranty claims

Positive – 63% Positive – 81%
Y
• Open-ended survey responses
N Voice Search

Node 3 (n=10,019) Node 4 (n=828) Data from such media can be

Negative – 38% Negative – 25% analyzed and used in numerous
Positive – 62% Positive – 75% business scenarios, such as:

Y Camera N N Appearance Y • Monitoring of consumer perception

of specific products
Node 5 (n=1,161) Node 6 (n=8,858) Node 7 (n=569) Node 8 (n=259)

Negative – 28% Negative – 39% Negative – 33% Negative – 7% • Promotion impact analysis
Positive – 72% Positive – 61% Positive – 67% Positive – 93%
• Brand image analysis
N Comparison Y
• Red-flagging potential sources of
Node 9 (n=7,397) Node 10 (n=1,461) dissatisfaction
Negative – 40% Negative – 30% • Developing consumer targeting policies
Positive – 60% Positive – 70%

N Body Y The choice of relevant data source and

analysis methodology will depend on
Node 11 (n=6,256) Node 12 (n=1,141)
the business objective.
Negative – 39% Negative – 51%
Positive – 61% Positive – 49%

Cubisms is an independent publication and

has not been authorized, sponsored, or otherwise
approved by Apple Inc.

18 Cubisms | MAy 2013


Are Turnkey Models
the Future for the
Telecom Sector?
Pankaj Dokania and Subash Chandar
STRATEGIC SERVICES
I
n the first half of the last decade,
leading network equipment providers
(NEPs) such as Alcatel-Lucent,
Ericsson, and Nokia Siemens Networks
(NSN) faced one of the industry’s most
challenging business environments.
Confronted with declining profit margins
from voice services, increasing market
complexities, strengthening regulations,
and changing consumer preferences,
telecom companies realized the need to
streamline their operations and focus on
Procurement & Supply Chain
core competencies. Telecom operators
were forced to adopt new strategic
outsourcing business models on account
of changing market dynamics, which
included outsourcing various non-core
functions to third-party service providers.
One of the outcomes of this ‘rethink’
in business models was the origin of
Managed and Professional Services
(MAPS), a practice where telecom
operators transfer their network
maintenance and management-related
responsibilities to NEPs. From 2000
to 2009, a number of managed and
professional services deals were signed,
as network operators took aggressive
steps to streamline operations. Further,
the evolution of MAPS and increase in
trust among network service providers
and equipment manufacturers led to
the beginning of turnkey models in the
telecom sector, where NEPs handle
MAY 2013 | Cubisms 19
Procurement & Supply Chain
Figure 1 — Turnkey Logistics Management Model
Entirely Managed by the Equipment Manufacturer
Manufacturing
Facility
Before 2000, in the absence
of a turnkey model, network
operators typically hired
a telecom consultant for
network deployment,
including network planning,
design, and optimization and
engaged with a third-party
logistics provider (3PL), such
as DHL and Kuehne & Nagel,
for transportation and
warehousing of the network
equipment.
20 Cubisms | February 2013
Warehouse
(Logistic Company/Equipment Supplier)
Typically, equipment vendors employ 3PL players to manage
the logistics and warehousing initiatives
the complete deployment process from
logistics to installation of the equipment
in the base station for telecom
companies (Fig. 1).
Since then, the turnkey market has also
been driven by the growing demand for
new network deployment and expansion
from network operators that are either
resource constrained or lacking in
adequate in-house expertise. With the
continuing evolution, telecom operators
had a single point solution in NEPs
for their base station deployment and
management (Fig. 2).
Drivers propelling this evolution
Shifting business ecosystem
Telecom companies are increasingly
simplifying the supply chain and
moving closer to consumers. As a result,
these companies are relinquishing the
technological aspects of the business
and focusing on sales and marketing.
Further, increasing competition in
the telecom market requires network
Network Provider’s
Base Stations
operators to differentiate their product
offerings with new mobile services and
content. All these require an extensive
effort on the part of the operator,
while improving the time-to-market of
the new services. Therefore, telecom
companies are increasingly outsourcing
field activities—leveraging the
vendor’s expertise as the technological
environment is becoming more
complex—while keeping planning and
management functions in-house.
Reduction in operational costs
Globally, telecom companies have
come under increasing pressure to
streamline their operational costs due to
declining margins from voice services.
This has sparked growth of leaner
business models. Network operators can
leverage their manufacturing expertise
and R&D capabilities to drive down
costs. Therefore, a turnkey logistics
management model is a comprehensive
model that can address an operator’s
imperative to cost-effectively plan and
design new network deployment.
Figure 2 — Evolution of the Telecom Equipment Manufacturers’ Business Model
Pure Play Equipment
Manufacturer
The telecom industry
adopted a simple supply
chain, with the equipment
manufacturers involved
only in the equipment
manufacturing process
and sales
Before 2000
Increasing demand for
wireless services, especially
in emerging markets
The growth of turnkey deals is also
driven by the explosive growth in demand
for wireless services across emerging
markets. On account of the rapidly
increasing subscriber base for wireless
services, telecom companies are finding
it difficult to manage their infrastructure
and numerous base stations. As a result,
these companies collaborate with NEPs
as a strategic partner to help them
manage their network deployment and
logistics requirements.
Recent turnkey deals in the
telecom sector
A number of turnkey deals have been
signed between network operators and
equipment providers around the globe
since 2009 (Fig. 3).
The number of past deals and increased
frequency strongly suggest that turnkey
models will continue to gain broader
acceptance and further shape the future
of network deployment and logistics
management within this sector.
Turnkey Logistics
Management
Managed and
Professional Services In the recent past, telecom
network deployment and
logistics management has
With declining revenue been increasingly moving
from telecom equipment towards a turnkey model
sales, NEPs diversified as operators look to focus
into network operation on the marketing and
and maintenace services operational aspects of the
(MAPS) business, and outsource
their non-core activites
The model became very
popular and a large
number of MAPS deals
were signed
Early 2000s 2010 Onwards
Way forward
In 2013 and beyond, the telecom
sector is expected to be driven by
continuous innovation and more
complex competitive activity. To
remain competitive, industry players
will require a holistic perspective,
with a focus on differentiating service
offerings through product and service
launches and evaluating their business
models in the context of critical strategic
imperatives. Outsourcing models such
as turnkey logistics management can
help telecom companies address these
imperatives.
MAY 2013 | Cubisms 21
Procurement & Supply Chain

Figure 3 — Key Turnkey Contracts Between 2009 and 2012

Network Equipment
Deal Synopsis
Operator Provider

In May 2012, T-Mobile awarded a joint contract to Ericsson and NSN for LTE 4G network modernization and deployment
T-Mobile, US Ericsson
– Under the contract, Ericsson will provide turnkey services for a number of areas such as installation and commissioning

Based in Japan, SoftBank awarded a turnkey contract to NSN, in April 2012, to supply, deploy, and integrate its 4G,
SoftBank, Japan NSN Frequency Division Duplex—Long Term Evolution (FDD-LTE) network
– As part of the agreement, NSN will deploy Flexi Multiradio Base Stations

Telenor, a Norwegian telecom company selected ZTE, a Chinese telecom equipment and solutions provider,
in March 2012, to provide network equipment and construction services for its 2/3/4G networks in Pakistan
Telenor, Pakistan ZTE – The project scope includes about 18,000 network stations that covers 1,500 new GSM base stations,
7,000 new HSPA base stations, and 2,000 new LTE base stations
– The contract includes end-to-end network management

In March 2012, Optus—an Australian telecom operator, awarded a turnkey contract to Huawei to build a LTE
network in New South Wales and adjacent areas
Optus, Australia Huawei
– The contract’s scope includes a number of services, such as installation, project management, transmission
provisioning, and managed and professional services

Etisalat Misr, In February 2012, Etisalat Misr signed a turnkey agreement with ZTE, which would cover the supply, installation,
ZTE
Egypt and implementation of a number of equipment solutions, such as base station subsystem (BSS) solutions

M1, a telecom company based in Singapore, awarded a turnkey contract to Huawei, in May 2011,
for deploying a LTE 4G network
M1, Singapore Huawei
– The contract includes installation of macro base stations, distributed base stations and Evolved
Packet Core (EPC) architecture

In November 2010, Mobile Cellular, the largest mobile telephone operator in Mozambique, signed a multi-million dollar,
Mobile Cellular, Ceragon
turnkey-solution deal with Ceragon Networks for the planning and deployment of the Backbone Network link
Mozambique Networks
– The link will join the central part of Mozambique to the southern part, from the city of Beira to the capital city of Maputo

Togo Cellulaire awarded a turnkey contract to Alcatel-Lucent in January 2010, to extend its network capacity in GSM and
Togo Cellulaire, build a 3G wireless broadband network
Alcatel-Lucent
Togo – Alcatel-Lucent will provide a full end-to-end, turnkey solution, including converged radio access network (RAN) and transport
solutions as well as professional services, such as network planning, radio design and operation and maintenance optimization

In December 2010, Sprint, a telecom company based out of the US, awarded a five- year, turnkey contract to Alcatel-Lucent for
Sprint, US Alcatel-Lucent providing a number of services, such as network integration, converged RAN, and network monitoring
– The contract also includes base station solutions that support 3G and other technologies

Beijing Mobile, In January 2010, Beijing Mobile awarded a turnkey contract to NSN for deployment of TD-SCDMA base stations
NSN
China – Beijing Mobile plans to strengthen its 3G coverage through this contract

Based in Uzbekistan, UCell awarded a contract to Nokia Siemens Networks (NSN), in October 2009, to upgrade its network capacity
UCell,
NSN – NSN will install mobile soft switching and packet core network technology, transport equipment, base station controllers, home
Uzbekistan
location registers and media gateways, as a part of the contract

22 Cubisms | MAY 2013

 Financial Services

U.S. Major League Sports:

Industry Economics
and Investment
Considerations
Sourish Gupta and Nakul Kanchan
FINANCIAL RESEARCH

T
he four major sports leagues in
the United States—the National
Football League (NFL), Major
League Baseball (MLB), the National
Basketball Association (NBA) and
the National Hockey League (NHL)—
witnessed deals worth an estimated
$5.6 billion in 2012, an increase of 200%
YoY. The $2.2 billion1 sale of baseball
team, the Los Angeles Dodgers, to
Guggenheim Baseball Management in
May 2012, is the largest ever buyout of
a professional sports team. The deal
valued the team at an expensive 9.3x
EV2/Sales, despite the Dodgers being
in Chapter 11 bankruptcy at the time
with a meager $3.2 million in EBITDA3
in the preceding season. The valuation
multiple for the Dodgers deal was
much higher than that of any other
major league deal, but even the median
EV/Sales multiple of 3.8x for all major
league deals in 2012, was far from cheap.
All of this merits the question—are U.S.
major league teams good investments,
or are they only for affluent individual
investors following a personal dream Are U.S. major league teams
of owning a sports franchise? While
ownership of sports teams certainly
good investments, or are they
has novelty, glamour, and a passion for only for affluent individual
sport associated with it, our analysis investors following a personal
suggests that, following positive
developments between 2011 and 2013,
dream of owning a sports
major league teams can potentially franchise?
make for a strong investment case (at
an industry level). The major leagues’
recent media rights contracts promise
substantial improvement in top line,
while renewed collective bargaining
agreements (CBAs) with the players
have not only immunized the leagues
from labor disputes for several years
to come, but have also reduced payroll
costs. This can potentially transform
many teams into highly profitable
businesses. That said, the major leagues
remain an extremely heterogeneous
mix of profitable and deep-in-the-red
teams. Given the demanding valuation
multiples that deals have typically
commanded, not all teams will prove to
be truly attractive investments.

1) Includes $150 million paid for real estate in the vicinity of Dodger Stadium
2) EV: Enterprise Value
3) EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization

MAy 2013 | Cubisms 23

Financial Services

Figure 1 — Major League Deals Hit A High4 in 2012,

Notes Even if the Dodgers’ Sale is Excluded

• U.S. major league teams are privately

held entities and do not disclose financial 6 12
information publicly. As a result, all financial
datails in this article—revenue, EBITDA,
5 10
debt—for the U.S. major leagues is based
on estimates published by Forbes. Forbes
calculates revenue net of debt servicing 4 8
cost for stadium/arena related debt. This

No. of Deals
USD Billion
may result in a significant understatement 3 6
of revenue and EBITDA figures. Forbes’
estimates also have been disputed from 2 4
time to time by league officials.
1 2
• In this article, all references to financial
data of the NFL, MLB, NBA and NHL, 0 0
unless mentioned otherwise, refer to the 2007 2008 2009 2010 2011 2012
aggregated financials of the individual
teams within the league.

• All references to data pertaining to a NFL MLB NBA NHL Total no. of deals
specific year are to data for the season
ended in that year. For example, 2012 refers SourceS: WR Hambrecht + Co; Forbes, Thomson Financial, and various press
to the NBA season 2011-12.

Figure 2 — Deal Multiples5 Expanded Significantly in 2012

LA Dodgers
(MLB),
$2.2 billion1

10.0 Miami Dolphins Washington

Pittsburgh (NFL), Wizards (NBA),
Steelers (NFL), $1.1 billion $551 million Houston Astros
7.5
$800 million (MLB),
$680 million
EV/Sales

5.0

2.5

0.0
2008 2009 2010 2011 2012

Median Highest

SourceS: WR Hambrecht + Co; Forbes, Thomson Financial, and various press

1) Includes $150 million paid for real estate in the vicinity of Dodger Stadium
4) Deal values represent pro-rata allocation of Enterprise Value (EV) based on stake acquired
5) Deal multiples are calculated based on sales in immediately preceding game season; dollar values in comments on the chart
represent EV on a 100% basis

24 Cubisms | MAy 2013

The major sports leagues in the
U.S. are among the world’s top
professional sports leagues by
attendance and revenue
At approximately 75 million, MLB has
the highest spectator attendance among
the world’s professional sports leagues.
This is supported by each of the MLB’s
30 teams playing 162 games during the
regular season, compared with 16 games
per team in the NFL and 82 games
per team in the NBA and the NHL.
By revenue, the four U.S. major
leagues are among the top five leagues
globally, with the NFL’s large broadcast
television deals making it the highest
revenue earner.
Resilient revenue with a track
record of consistent growth
The combined revenue of the four
major leagues increased 4.3% YoY
to $22.7 billion in 2012. Except for a YoY
drop in revenue for the NBA in
the 2011-12 season, due to a five-month
league lockout by owners, each of the
major leagues delivered YoY revenue
growth every year between 2008 and
2012. In the recessionary year of 2009,
when U.S. nominal GDP declined 2.2%
YoY and nominal gross output of the
private services industry dropped
4.4%6, the major leagues outperformed,
with an increase of 5.2% YoY in
combined revenue.

Figure 3 — The U.S. Major Leagues are Among the Highest

Revenue Earners Globally By Revenue (USD Billion)

8.8
8.3

6.8
6.4

4.0
3.7 3.5 3.4
3.1
2.7
2.4 2.2

0.4

NFL MLB NBA EPL (UK) NHL Bundesliga La Liga Serie A (Italy) AFL
(Ger.) (Spain) (Australia)

Season Ended 2011 Season Ended 2012

SourceS: Forbes; Deloitte Football Finance Review 2012; DFL Bundesliga Report 2012; IBIS World
Revenue for European leagues converted at EUR/USD=1.39 (average during 2011; source: Bloomberg)
Latest publicly available data, other than US major leagues, pertains to seasons ended 2011

6) Source: US Bureau of Economic Analysis

MAy 2013 | Cubisms 25

Financial Services

Figure 4 — Consistent Revenue Figure 5 — Large Share of Long-term

Growth Across Leagues, Barring the Media and Sponsorship Contracts Offers
NBA’s 2011 Lockout YoY Revenue Growth Revenue Stability Revenue Mix, 2012

16% 23%
30%
8% 38%
Lockout reduced regular 11%
season to 66 games per team
(down from the usual 82) 16%
15% 42% 9%
25% 4%
12%
10%
5% 49%
42% 41%
34%
0%
-5%
NFL MLB NBA NHL
-10%
2008 2009 2010 2011 2012 Ticket sales (season, regular seating) National media
Parking, concessions Local media, sponsors,
merchandising, luxury box
NFL MLB NBA NHL

Source: Forbes Source: Forbes

The resilience and growth in the major leagues. In terms of spectator

major leagues’ revenue reflect the large
proportion of revenue derived from
multi-year media rights contracts and
growing revenue from digital media.
The NFL, for example, earned as
much as 42% of its 2012 revenue from
long-term contracts with broadcast
television companies for media rights
fees. Such contracts lend stability to
revenue and also contribute to growth
through “escalator” clauses that
increase rights fees over the duration of
the contract. MLB has historically had
lower levels of revenue from broadcast
television, but local media rights
contracts, agreed between individual
teams and regional sports networks
(RSNs), contribute significantly to total
revenue. Moreover, MLB has been able
to expand its revenue streams through
its Internet and interactive media arm,
MLB Advanced Media (MLBAM).
MLBAM has witnessed explosive
growth, with revenue growing from $75
million in 2002, to $620 million7 in 2012,
and has enjoyed major success with its
Apple® iPhone® application.
Gate revenue, comprising ticket sales,
concessions, and arena parking, is
the traditional revenue stream for the
7) Estimated (Source: Forbes)
attendance, the U.S. is a largely
saturated market, with attendance
seeing minimal growth over the long
term (for instance, the NFL’s regular
season attendance has grown at a
CAGR of 0.4% between 2000 and
2012). As a result, growth for these
revenue streams is dependent on price
improvement. Ticket sales during
the regular game season, the major
component of gate revenue, have
witnessed a recovery after a decline
between 2008 and 2010, when personal
income levels weakened and consumers
reined in discretionary spending.
For the NFL and the NHL, average
attendance at stadiums/arenas has
consistently been at or above 90% of
capacity from 2009 to 2012, enabling
teams to increase ticket prices steadily
from year to year. MLB has been the
exception among the major leagues,
with the high volume of total games
per season, at 2,430 (twice that of the
NBA and NHL and 9.5 times that of the
NFL), resulting in average attendance
of around 70% of stadium capacity
between 2009 and 2012. This has led
to MLB ticket prices stagnating despite
an increase in attendance during the
2011-12 season.

26 Cubisms | MAy 2013

Increasing media rights fees set
to significantly improve NFL
and MLB revenue and profits
starting 2014
For advertisers, the major leagues
offer virtually unmatched consumer
reach. According to Nielsen, combined
viewership for the title matches of the
leagues in 2012 was 143.9 million. The
NFL’s Super Bowl XLVI (2012, where the
New York Giants beat the New England
Patriots) garnered maximum viewership
of 111.3 million, with the Miami Heat
versus Oklahoma City Thunder NBA
finals garnering the second highest
viewership at 16.9 million. Backed by
such high numbers, television ad rates
have been in a long-term uptrend as
advertisers jostle for airtime during key
major league events.
The NFL and the NHL renewed their
national broadcast television rights
contracts in 2011, while MLB followed
suit in 2012. The contracts, ranging
between 8 and 10 years, were renewed
at substantially higher annual rates
compared with the previous contracts—
at a 62% increase for the NFL, 89%
for the MLB and 41% for the NHL. In
terms of addition to total 2012 revenue,
the renewed contracts translate into a
14% increase for the NFL and 5% for
MLB, but just 1% for the NHL. The
NBA’s broadcast television contracts
come up for renewal in 2016, and the
increase in rights fees is likely to be just
as large as the other leagues, given that
television ratings for the NBA’s regular
season were up sharply in 2011-12.
National media rights, however, are
just one part of the story of the major
leagues’ revenue growth. From 2011
through 2013, several teams have
separately signed large rights deals with
RSNs. Given that revenue from deals
with RSNs are categorized as “local
revenue” for teams, only a portion of
this revenue is shared with other teams
(as opposed to “national revenue”, which
is divided equally among teams). Teams
with the most lucrative RSN deals stand
to benefit the most. The largest RSN
deal to date has been the L.A. Dodgers’
contract with Time Warner Cable, a
25-year deal starting 2014 that various
press reports estimate to be in the range
of $280 to $320 million in annual fees (in
comparison, the Dodgers’ 2012 revenue
was $245 million). The New York
Yankees and the Los Angeles Angels
of Anaheim, among others, have also
negotiated significant deals with RSNs.
Along with media rights fees, the latest
deals included an equity stake in the
RSN, broadening the teams’ revenue
streams to include a share in cable
subscription fees as well.
Figure 6 — Latest Television Rights Contracts Have Been
Signed at Sharply Higher Fee Levels
Estimated Annual Media Rights Fees (USD Billion)
2014-22
8
6.0
6
2008-16 (renewal
negotiations expected
4
3.7 2014-21 to start in 2013/14)
2013-21
2 1.5
0.8 0.8 0.9
0.15 0.21
0
NFL MLB NBA NHL
Previous New
SourceS: Data on “Previous” contracts — “Theory of the perfect game: Competitive balance in Monopoly sports leagues”,
2009, John Vrooman, Vanderbilt University; Forbes; various press
The NFL, with a 14.9% EBITDA
margin in 2012, has consistently
delivered superior margins compared
with the other major leagues. The
remaining major leagues, despite
steady revenue growth, have so far
been low-margin businesses. The new
media rights contracts, which start in
2014 for MLB and the NFL, could be
a game changer for the profitability of
MLB and will help the NFL improve
margins further. The only incremental
MAy 2013 | Cubisms 27
Finance

Figure 7 — The NFL is the Most Profitable Among the

Major Leagues EBITDA Margin

Lower revenue
share for players
(new CBA)
15%

10%
Increasing
attendance,
5% ticket prices

0%
2007 2008 2009 2010 2011 2012

NFL MLB NBA NHL

Source: Forbes

cost associated with the additional
revenue from media rights will be the
share of revenue paid to players. This
implies (based on 47-50% players’ share
of revenue) a near doubling of 2012
EBITDA for the NFL and MLB, and a
relatively lower 12% addition to 2012
EBITDA for the NHL.
Owner-player negotiations have
ended on a positive note,
reducing operational risk and
payroll costs
Between 2011 and 2013, the major
leagues signed new collective bargaining
agreements (CBAs)8 with the respective
players’ associations. Barring MLB,
each CBA renewal witnessed intense
negotiations, resulting in lockouts9 in
the NFL, NBA and NHL and truncated
game seasons for the NBA and the
NHL. However, the negotiations
concluded positively for the leagues,
with the new CBAs drawn for periods of
10 years (except MLB, for which the new
CBA extends until 2016). This compares
with five-to-six-year durations for the
earlier CBAs and is a major positive
for the leagues as it reduces the risk of
revenue loss as well as possible damage
to the leagues’ brand value, which are
associated with work stoppages and
lockouts. The most positive impact,
however, was on the NBA and the NHL
teams’ profits. Along with the stability
provided by their longer duration, the
new CBAs reduced the guaranteed share
of revenue for players to 49-51% (from
57%) and 50% (from 57%) for the NBA
and NHL, respectively. This resulted in
significant EBITDA margin expansion
for the NBA in 2012, and will have a
similar effect on the NHL in 2013, the
first year of the new CBA.

8) Each league’s CBA lays down extensive rules including players’ share in league revenue, minimum and maximum player
salaries, team-wide salary caps, and the framework for revenue-sharing among teams. By setting player salary caps, the CBA
attempts to restrict financially strong teams from consistently outbidding financially weaker teams when hiring top players. The
revenue-sharing agreement divides revenue into national and local pools. National revenue comprises media rights (broadcast
television), sponsorship and merchandising deals entered into by the league, and is divided equally among teams. Local
revenue comprises local media rights (e.g. with RSNs), gate revenue, concessions etc. contracted by individual teams. Reve-
nue-sharing mandates that teams in large home markets share a certain proportion of locally generated revenue, such as gate
revenue and local media rights, with teams operating in smaller markets. Revenue-sharing for local revenue (as a percentage)
is the highest in MLB and at low levels in NBA and the NHL
9) Lockouts resulted from team owners shutting down facilities

28 Cubisms | MAy 2013

Wide disparities in financial Figure 8 — Revenue Disparity is Highest in the NHL and
performance of teams, not every the NBA Top 3 and Bottom 3 Teams by Revenue in Each
team is an attractive business League (USD Million, 2012)
Despite the leagues’ attempts at creating
a level playing field for team finances,
financial health varies widely among
teams. Even in the NFL, where pooled Dallas Cowboys 500
national revenue accounts for nearly New England Patriots 380
60% of the league’s revenue, the Dallas
Washington Redskins 373
Cowboys generated revenue of $500 NFL
million and enjoyed a 45% EBITDA St. Louis Rams 231
margin in 2012, against the league-wide Minnesota Vikings 227
average revenue of $275 million and
Oakland Raiders 226
average margin of 14.9%. The difference
in financial health of teams is the largest New York Yankees 471
in the NHL, which also had the highest Boston Red Sox 336
number of EBITDA-negative teams, at Philadelphia Phillies 279
13 out of the total 30. MLB
Oakland Athletics 173
Apart from the scale of business, as Kansas City Royals 169
determined by revenue, the critical
Tampa Bay Rays 167
driver of profits is player salaries.
According to the respective CBAs, New York Knicks 243
players are guaranteed approximately Los Angeles Lakers 197
half of league-wide revenue, making
Chicago Bulls 162
player payrolls the single largest cost NBA
component for the teams. The CBAs Charlotte Bobcats 93
also set a team-level salary cap as well Milwaukee Bucks 87
as minimum salary levels (identical
Brooklyn Nets 84
for all teams). While each team has
Toronto Maple Leafs 200
the flexibility of paying player salaries
within the range provided by the New York Rangers 199
minimum and cap levels, only a few Montreal Canadiens 169
teams are able to avoid hitting or NHL
Columbus Blue Jackets 85
breaching the cap as most try to outbid
other teams for the best players. Player Phoenix Coyotes 83
payroll costs have typically been one of New York Islanders 66
the primary reasons behind variations
in EBITDA margin among teams. The
Source: Forbes
Dallas Cowboys, Toronto Maple Leafs,
New York Knicks and Oakland Athletics
were the most profitable teams in their
respective leagues in terms of 2012
EBITDA margin, driven in large part by the debt-to-EBITDA ratio in 2012
being among the teams with the lowest among MLB teams varied between
player payroll expenses (as a percentage 298 for the Philadelphia Phillies and nil
of revenue). for debt-free teams such as the Atlanta
Braves and the Seattle Mariners.
The variance in EBITDA margins, and
consequently cash generation, has also With such significant variances in
led to large variances among teams financial performance, investments in
in terms of leverage. For instance, major league teams require investors to
excluding teams with negative EBITDA, be highly selective.

MAy 2013 | Cubisms 29

Finance
From an investor’s perspective,
key differentiators among
teams are size of the home
market and payroll
The revenue-sharing framework
followed by each league places all teams
on equal footing as far as revenue
from national media rights fees,
sponsorships, and merchandising are
concerned. The CBAs set the share of
revenue payable to players.
Consequently, the key factor separating
financially strong teams from weak ones
is the ability to generate local revenue.
Apart from MLB, where teams in
large markets share nearly half of local
revenue, the majority of local revenue is
retained by the team. In this scenario,
the size of the home market population
becomes the differentiating factor for
relative revenue generation potential
for a team. The size of the home market
population is the main driver for gate
revenue (through game attendance) and
in making media rights for the team
attractive to RSNs looking to reach out
to the maximum number of consumers.
Figure 9 – Most Teams in Top 10 Metropolitan Areas10
are Among the Top 10 Revenue Earners
Number of teams in top 10 U.S. metro areas that are among
top 10 revenue earners in their league
9 the NBA finals three times, reached
8 the final round of the playoffs three
7 7
MLB NBA NFL NHL
Source: US Census Bureau, Forbes
10) Metropolitan Statistical Areas as designated by the US Census Bureau; NHL figure includes three of the NHL’s top 10 teams
by revenue based in Canada, in Toronto, Montreal and Vancouver; according to the Television Bureau of Canada (based on
data from Nielsen), these are the top three television markets by population in Canada
30 Cubisms | MAy 2013
The impact of large home markets
on revenue is borne out by the fact
that the teams based in the 10 largest
metropolitan areas by population in the
United States constitute the majority
of the top 10 teams by revenue in each
league. For example, 9 of the top 10
teams by revenue in MLB are based
in these markets, while 7 of the top 10
teams by revenue in the NBA are based
in these markets. However, several of
the large markets house more than one
team in the same major league and this
can certainly lead to one of the teams
losing out in revenue.
On-field/court performance of the team
is clearly important as well, resulting in
higher spectator attendance and higher
television viewership, which leads to
higher gate revenue and better deals for
local media rights fees. However, team
performance is obviously unpredictable
and unlikely to be a good criterion
for investments. Moreover, the size of
the home market can, in many cases,
overshadow performance as far as
revenue generation is concerned.
For instance, during the 2000-01 to
2011-12 seasons, the NBA team, the
New York Knicks’, best performances
have been first round losses in the
Eastern Conference playoffs, with an
average wins-to-games-played ratio of
43%. In comparison, the San Antonio
Spurs, during the same period, won
times, and averaged a wins-to-total-
games ratio of 71%. However, the Spurs
generated revenue of $127 million
in 2012, compared with the Knicks’
$243 million.
Controlling spending on player salaries
is critical for profitability. The NFL and
the NHL have “hard” caps whereby
teams cannot exceed a set level for
aggregate player salaries. However,
MLB and the NBA have “soft” caps.
In this case, teams are penalized if
they exceed the team salary cap and
are required to pay a “luxury tax” as
penalty. As a result, if not consciously
controlled, profits of teams with high
player payrolls not only suffer due to the
salaries paid, but also take an additional
hit due to the luxury tax, significantly
reducing margins.
Deal activity may increase as
more teams become financially
attractive…
The majority of major league teams
are owned by individual investors.
However, private equity (PE) firms
as well as corporations have also had
consistent presence as team owners,
though to a limited degree until now.
Several top executives from well-known
private equity firms currently own
teams in their individual capacities
— this includes, among others, Mark
Walter of Guggenheim Partners (MLB’s
L.A. Dodgers) and Joe Lacob of KPCB
(NBA’s Golden State Warriors). PE firm
Platinum Equity currently owns the
NBA’s Detroit Pistons, while Towerbrook
Capital and the private equity arm of
Ontario Teachers’ Pension Plan formerly
owned the NHL’s St. Louis Blues and
Toronto Maple Leafs, respectively.
Corporate owners include Rogers
Communications (NHL’s Toronto
Maple Leafs), real estate investment
company Lerner Enterprises (MLB’s
Washington Nationals), Liberty Media
(MLB’s Atlanta Braves) and Nintendo
Corporation (MLB’s Seattle Mariners).
The current situation appears quite
conducive for investment by PE firms
— an imminent increase in revenue and
profits due to higher media rights fees,
high levels of debt on the balance sheet
of many teams across the four leagues,
negative EBITDA (which can lead to
difficulty in servicing high levels of debt
until the additional media rights fees
in 2014 start flowing in), and teams
with high payroll costs that can be
brought down (while still maintaining
them above the CBA’s prescribed
minimum) to expand margins. Strategic
investments by media companies could
11) All valuations based on share prices as of April 15, 2013; EV/Sales multiple is based on the latest reported financial year.
also be in order, given that ownership This article was written by The Smart Cube (TSC)
on an independent basis. The insights included
of a major league team could open up
are based on its own research and from sources
access to the team’s media rights. As
believed to be reliable. However, TSC may have
such, there is likely to be an increase in received information on this topic that is
the number of deals to buy into major confidential and proprietary to a third-party.
league franchises. The NFL, with its As such, this information will not have been
utilized and is thus not reflected in this article.
already high margins and upcoming
large media rights fees and the NBA, The views mentioned in this article do not in any
where the new CBA has already way constitute investment advice and should not
be construed as an offer to sell, a solicitation to buy,
expanded profits with new media
or an endorsement or recommendation of any
rights contracts expected to be signed company, security or commodity. TSC disclaims
during 2013-14, appear to be the most all responsibility for investment decisions based
suitable hunting grounds for PE and on the content of this article or the dissemination
strategic investors. or distribution of this article to a third party.
Any conclusions, calculations or determinations
reached constitute TSC’s views as of the date
…Though multiples are likely of this publication and are subject to change
to contract without notice.
The increase in EV/Sales valuation
multiples (based on historical sales) for
transactions executed in 2012, is likely
to reverse, as the multiples reflected
expectations of an increase in media
rights fees due to the upcoming contract
renewals. With these contracts having
materialized (except for the NBA)
through 8-to-10-year contracts, the
next wave of growth for major league
team’s revenue and profitability is
now several years away. Moreover, a
comparison with the trading multiples
of listed peers—major European soccer
clubs—shows that the average EV/Sales
multiple for U.S. major league deals has
been significantly higher. The EPL’s
Manchester United is the only listed
peer trading at a higher multiple (6.8x
EV/Sales11) than the U.S. major leagues’
2012 average deal multiple. However,
this is supported by Manchester United’s
reported EBITDA margin of 26.7%,
which is significantly better than the
U.S. major leagues’ average. Other peers
with meaningful market capitalization
(above $50 million) include the German
Bundesliga’s Borussia Dortmund,
Italian Serie A’s A.S. Roma and Scottish
major league’s Celtic. All three peers are
currently trading at EV/Sales multiples
in the range of 1.2-1.6x, much lower than
the median 3.8x for U.S. major league
deals in 2012.
MAy 2013 | Cubisms 31
Strategy & Marketing
Machine-to-Machine
Technology—The Next
Big Thing?
Rohitashwa Agarwal and Upasna Lal
strategic services
M
achine-to-Machine (M2M)
refers to the technology that
allows communication among
machines (wireless or wired systems). It
is based on a process in which a device
captures a particular event (inventory
levels, test results, etc.) and transfers the
information gathered through a network
(wireless, wired, or short-range network)
to another device. A special application
32 Cubisms | MAy 2013
(at the receiving device) is then used
to translate this information into a
meaningful event (placing an order for
inventory, dispatch of medicine, etc.) (Fig.1).
Since the first significant development
in M2M technology in 1995, M2M has
evolved to provide customized solutions
to organizations across a range of
industries, including retail, health care,
transportation, utilities, security, IT, and
telecom, allowing users to control remote
assets and systems, and access sensitive
information (Fig. 2). While the market
is set to grow globally, the emerging
Asia-Pacific countries are expected
to experience high growth, owing
to increased network coverage, data
throughput growth, expected regulatory
changes, and a rising number of health
care and infrastructural projects in the
near future.
M2M applications
As of 2011, M2M applications were
largely used by companies based out of
North America and Europe. However,
between 2012 and 2017, Asia-Pacific
countries, such as China and India, are
expected to become leading users of
M2M technology (Fig. 3).
Three types of connections are used in
the M2M market—wireless (2G, 3G, 4G,
and satellite), fixed, and short-range
(Wi-Fi, Bluetooth, ZigBee, MAN, etc.).
By 2015, short-range connections are
Figure 1 — M2m Process Flow

KEY INDUSTRIES

Coordination

Data Collection
BACK END FIELD SUPPORT
Retail Health Care SUPPORT TEAM
REMOTE EQUIPMENT

Industrial Security
M2M Server and Application

Wireless Data Transfer

IT & Telecom Transport

Monitoring and Diagnostics

On Site Support

Energy Smart Buildings

expected to dominate the market with
around 70% share, as most information
being transferred through M2M does
not require long-distance transmission.
This will be followed by wireless
connections (i.e., long-range cellular
and satellite connections)—accounting
for 20–25% of the market—and then
fixed connections, accounting for less
than 10% of the market.
Cellular M2M market are expected to drive significant demand
Ongoing developments in high-speed for cellular M2M applications across
data transfer, cloud computing, industries, making it a key focus area for
smartphone technology, and regulatory service providers.
initiatives have created a three-fold
Although the share of emerging Asia-
advantage for the cellular-based
Pacific countries in the total M2M
(wireless) M2M market— including
connections is expected to increase,
substantial reductions in installation
their share in cellular M2M connections
and operational costs, easy installation
(a part of the overall M2M connections)
and usability, and an increase in the
has registered only minor growth
number of applications. These benefits

Figure 2 — Evolution of m2m

First significant development in M2M technology took
place in 1995, when Siemens set up a dedicated
department to undertake development of products for
industrial M2M applications.
Technological breakthroughs between 2006 and 2008, led to a
substantial cost reduction in the development and application
of M2M-based products, and expanded applications of this
technology across industry verticals, including surveillance,
security, health care, and utilities.

From 1995 to 2005, several M2M products were Since 2009, M2M has become one of the fastest
launched for applications across point of sales (POS) growing markets with several players, including
terminals, vehicle telematics, remote monitoring, and AT&T, Vodafone, Telenor, Verizon, and Qualcomm
logistics routing and tracking purposes. making significant investments in this market.

General Motors and Hughes Electronics were among M2M applications have increased across smart
the first companies to adopt M2M technology. buildings, and energy distribution and monitoring, etc.

MAY 2013 | Cubisms 33

Strategy & Marketing

between 2009 and 2012. Technological Figure 3 — Global M2M Connections Breakdown
and infrastructural constraints in
By Geography
these regions are the primary factors
responsible for this slow growth of 30.0% 28.0% 27.0%
27.0%
19.0% 22.0%
cellular M2M connections (Figs. 4-5).
13.0% 11.0% 14.0%
9.0%
Highest M2M growth markets
Health Care
2010 2020F
Application of M2M across the health-
North America Europe Emerging Asia-Pacific Countries Developed Asia-Pacific Countries Other Regions
care sector—in the form of remote
health monitoring and telemedicine—is Note: This breakdown is for total M2M connections, including wireless, fixed and short-range (Wi-fi, Bluetooth, Zig, Bee, MAN, etc.)
Source: EIU, 2012
emerging as an effective means to
reduce health-care costs (both for
health-care providers and patients) and Figure 4 — Global Cellular M2M Connections
to improve the quality of health-care (USD Million) 364.5
services. The introduction of a variety
CAGR (2009-2011): 24.7%
of M2M-based applications across
298.2
radiology, cardiology, dermatology, and CAGR (2012E-2016F): 27.4%
other health-care areas from 2008 to 232.9
2011, created a sizable global market
180.3
for remote health monitoring and
138.4
telemedicine. 110.6
87.7
71.1
The key factors driving the growth of
M2M in the health-care sector include
the following:
2009 2010 2011 2012E 2013F 2014F 2015F 2016F
Cost-effective Health Monitoring Note: This breakdown is for total M2M connections, including wireless, fixed and short-range (Wi-fi, Bluetooth, Zig, Bee, MAN, etc.)
Source: ABI Research
Deployment of sensors (remote monitoring
devices) at patients’ homes enable
Figure 5 — Global Cellular M2m Connections Breakdown
doctors to monitor them from a remote
location. This is particularly useful for By Geography
patients with chronic illnesses, such as
42.0% 41.5%
blood pressure, cardiac diseases, and 30.4% 29.4%
diabetes. This results in a substantial 16.1% 17.6%
reduction in hospital visits and stay- 8.9% 9.2%
2.6% 2.3%
related expenditure for patients.

• Personal Safety and Drug 2011 2015F

Compliance: Application of M2M North America Europe Asia Pacific Latin America Middle East and Africa
technology helps to improve the Source: ABI Research

Examples of recent innovations in M2M health care:

Telefonica Tele-rehabilitation Service:
Telefonica, a Spanish communications
service provider, commenced sales of
its M2M-based product ‘Rehabitic’ to
hospitals and health-care providers in
2011. Rehabitic is co-embedded with
motion sensors that allows the doctor to
monitor a patient’s healing process from
a remote location, following the patient’s
discharge from the hospital.
Mobile Ultrasound Equipment:
In October 2011, the US Food and Drug
Administration approved a portable,
M2M-based ultrasound device called
Mobius, manufactured by Mobisante.
The device, priced at $8,000, can be
used to take fetal, abdominal, cardiac,
and pelvic imaging, and transmits the
data through a USB connection to a
smartphone for viewing. This enables
medical consultants to diagnose these
images without requiring patients to
visit clinics.

34 Cubisms | MAy 2013

 personal safety of patients, by
reducing their physical movements
and hospital visit requirements. In
addition, it helps to ensure regular
drug compliance, as per prescriptions.
• Effective Utilization of Health-care
Facilities: Many patients with
chronic illnesses can be monitored at
home, thereby eliminating the need
for hospital admissions for regular
medical tests. This leads to efficient
utilization of hospital beds and
resource capacity. This free capacity
can be provided to other patients who
require emergency treatment.
Proactive Monitoring and Treatment
Continuous monitoring through an
M2M network allows doctors to identify
signs of health deterioration earlier than
the scheduled physical examination,
which can be done only after certain
time intervals. M2M-based solutions
allow the doctor to diagnose diseases
proactively and on a real-time basis.
Product Life Cycle Management
Application of M2M technology provides
pharmaceutical companies with a more
efficient means to manage inventory,
control counterfeiting, and meet regulatory
requirements. The technology allows
companies to track and trace the location
and condition (including quantity,
temperature levels, etc.) of their products
in transit and storage.
Smart buildings/homes
Smart buildings/homes operating
on M2M-based networks allow users
to remotely monitor and control all
electronic devices; monitor electricity,
gas and water consumption; and
control security equipment using a
smartphone or PC, allowing for greater
control over energy costs. There is a
particularly increasing trend towards
the use of M2M-based tools to optimize
energy consumption (for heating, air
conditioning, lighting, etc.) within the
building and the home. By 2020, this
market is expected to account for 27%
of global M2M connections. Smart
buildings also help in the detection and
prevention of electricity theft or loss
(due to faulty systems). Although the
cost versus benefit is a key driver for this
market, the installation of a smart meter
(an advanced meter that enables two-
way communication between the meter
and the central system) in buildings
has shown to lead to cost savings with a
reduction in energy expenditure.
In 2009, the European Union
announced mandatory installation

Case Study: How Promega (a US-based biotech company) saved $1.7 million using M2M technology?

About Promega: Headquartered in Madison, Wisconsin,
Promega operates in the field of genomics, protein analysis
and expression, cellular analysis, drug discovery, and genetic
identity analysis. With more than 1,200 employees and 2,500
products, the company has an annual revenue of $300 million.
Challenge: Promega’s 15–18% of total inventory was being
written off each year as shrinkage—due to products not
being sold during their life cycle or being damaged in transit
or storage. This was costing the company approximately
$1.2 million per annum. Owing to the low level of control over
storage of products and low visibility on expiry dates for onsite
products, the company was losing an additional $500,000
each year as write-offs in product spoilage.
Solution: To tackle the problem of product spoilage, the company
decided to switch to advanced freezers for inventory storage.
These freezers are equipped with radio frequency identification
(RFID) technology that captures data such as volume of liquid
within a container and temperature of the product, and transmits
this information to the data center using M2M technology. It
also provides the user with information regarding location of the
product, its expiry date, details of the end user, etc., thus providing
the company with greater control over its supply chain.
Results: Deployment of RFID- and M2M-enabled freezers
helped Promega reduce its product shrinkage to near-zero
levels and hence, save about $1.7 million annually. Further, this
provided the company with more detail about end users and
their preferences, as well as the overall supply chain.

“The real advantage to Promega is the information it captures. Now, we really know who our
end customer is at the individual level. Now we have the intelligence about their preferences
and buying habits and usage patterns to proactively tailor our delivery practices to their
specific needs. And as part of improving our customer service, we find we have more
opportunities to introduce new products, more merchandising opportunities, and higher
ability to add incremental business through more efficient supply.”
Todd Clermont, Business Development Director, Promega (2012)

MAY 2013 | Cubisms 35

Strategy & Marketing
of smart meters in all homes by 2022.
The smart meter automatically collects
data about energy consumption and
quality of supply at the customer site
and communicates back to the utility
company for monitoring and billing
purposes. Between 2010 and 2017, the
number of smart meters installed in
Europe is expected to increase more
than four-fold.
Growth potential
Over the past few years, several reports
have been published, highlighting the
massive growth potential in the M2M
market. However, the market—in terms
of number of M2M connections as well as
total revenue generated—has not grown
as expected (Fig. 6).
Five barriers to growth
1
High investment costs
To effectively exploit the opportunities
in the M2M market, communication
service providers (CSPs) need to invest
heavily to keep up with growth in
demand. The key investment areas
include the following:
• Product development: Given the
customized nature of M2M products,
companies need to proactively identify
areas that need product innovation and
have strong in-house R&D capabilities
to support new product development.
• Platform-related costs: A high level of
Figure 6 — Global M2m Market Size
Revenue Opportunity (USD Billion)
CAGR: 18.1%
148
113
84 96
2011 2012F 2013F 2014F
Source: Machina Research
36 Cubisms | MAy 2013
technological innovation in the market
will require companies to regularly
update the platform used for integration
of internal and external devices—i.e.,
devices at customer locations and
back-end devices—and also ensure that
the platform is compatible with new
applications being launched.
In addition, companies will need to
invest in infrastructure and human
resources to expand their sales,
marketing, order management, and
after-sales capabilities.
• Service management: Service
providers need to develop strong
service management facilities to
deliver timely service, as required
by customers, and ensure smooth
functioning of devices, transmission
lines, and applications.
Declining ARPU (average revenue per
user) and slower-than-expected growth
of the M2M market have affected service
providers’ faith regarding return
on investments.
2
Standardization of M2M services
The M2M market involves multiple
platforms and devices as well as
operations through remote locations,
different types of networks and
applications, and most importantly,
transmission of sensitive information
through M2M systems. This makes
standardization of the complete M2M
376
341
299
257
217
180
2015F 2016F 2017F 2018F 2019F 2020F
solution, including product, platform,
device, and application development;
monitoring of transmission; and
processing of information critical in
gaining consumer confidence. Experts
believe that the absence of global
standards has acted as a key barrier to
M2M market growth.
• In July 2012, several global
standard organizations collaborated
on an agenda to standardize M2M
communication and launched an
initiative to develop oneM2M—a
single standard for the global M2M
market. Participating organizations
include the Association of Radio
Industries and Businesses (ARIB),
the Telecommunication Technology
Committee (TTC) of Japan, the
Alliance for Telecommunications
Industry Solutions (ATIS), the
Telecommunications Industry
Association (TIA) of the US, the
China Communications Standards
Association (CCSA), the European
Telecommunications Standards Institute
(ETSI) and the Telecommunications
Technology Association (TTA) of Korea.
• oneM2M is also expected to simplify
the development of M2M devices and
applications, create a mass market,
shorten the time-to-market for new
products, and help CSPs in reducing
operating and capital expenses.
Machina Research, a UK-based
advisory firm on the M2M market,
projected that the M2M market
offers a potential to expand to $376
billion by 2020.
However, actual growth in the M2M
market will be at a relatively slower
rate. The forecast market size for the
M2M market between 2012 and 2017
is 25–35% of the potential market
size, owing to several challenges that
will prevent operators from tapping
into this market.
Figure 7 — Other Industry Examples of Successful M2M Application Between 2006 and 2010
End User Service Provider(s)
ABB nPhase, Verizon, conEdison
American Trash Management KORE Telematics, Sprint, Verizon
CardioNet Sprint
Tata Teleservices (TTSL) Discom, TTSL
Vodafone Bglobal Metering, Vodafone
3
Strained growth in
emerging markets
While a few emerging countries (such
as Brazil, China, and India) are already
using M2M technology across industries
and are continuously expanding the
usage of these systems, the demand for
M2M products in the Middle East and
Africa declined over the past few years.
Slow financial growth and political
unrest in the recent past have been the
main reasons for strained growth of
M2M in African markets.
4
Fragmented target market
The M2M target market is highly
fragmented, covering several industries
and niche user segments. While certain
M2M solutions can cater to several users
across industries, others are customized
to meet the requirements of specific end
users only. For example, the user segment
of a fleet management application is very
limited, compared with that of a smart
metering application or a CCTV security
application. There is faster growth of
M2M applications in industries such as
transportation, logistics, and security,
where some relatively standardized
solutions can be deployed. However,
applications developed for specific
consumer segments offer limited revenue
opportunities, as the associated sales
volumes are low.
This fragmented target market leads
to a slowdown in the development of
new applications, as each application
involves longer go-to-market timelines.
Development of M2M solutions that are
applicable across industries will be critical
Application Key Benefits
Industrial and Energy
Reduction in service time by approximately 50%
Asset Monitoring
Transportation Reduction in operational costs by almost 25%
Reduction in health monitoring cost per
Remote Health Monitoring
patient by about 90%
Smart Grid and Metering Savings on bill collection costs of 15–20%
Reduction in electricity consumption
Smart Metering
by almost 10%
to the growth of this market. Convincing However, the outlook for the M2M
customers about the benefits of M2M market is not entirely rosy, as there
applications also is a big challenge. are multiple barriers that may prevent
the market from growing to its full
5
Customer persuasion potential. The investment costs
The M2M market faces a major involved are high and the target market
challenge of limited technology awareness is fragmented. These factors, coupled
among potential individual customers. with the fact that a large number of
According to industry experts, convincing customers are still not convinced about
end users about the benefits of adopting the effective cost savings of M2M
M2M technology is an issue due to high application in day-to-day operations,
installation costs. Standardization in pose concerns about the pace of growth.
technology used, and deployment of devices
that are more compatible with advancing M2M is a unique market and CSPs
technology can help operators in this regard. need to manage their steps within the
Security of information is another constraint space carefully. The future of M2M will
in the acceptance of M2M technology by be determined by service providers’
customers, as they are skeptical about ability to devise innovative strategies to
sharing personal information. improve their product development and
service capabilities, reduce the cost of
Although there are barriers to growth, technological upgrades, and market the
various companies have successfully product across untapped industries.
implemented M2M technology across
their supply chain in the recent past and
achieved cost benefits (Fig. 7).
The future of M2M technology
Industry analysts and market experts
agree that the market is set to register
exponential growth over the next decade.
The opportunities available in the market
are potentially limitless, as M2M offers
applications for almost every industry,
from automation in industries such as
automobiles, security and surveillance,
utilities, smart buildings/homes, to
improving health-care facilities and
monitoring logistics. The most critical
factor that makes M2M highly attractive
is that it can be customized to meet
general as well as niche requirements.
MAY 2013 | Cubisms 37
Strategy & Marketing
Manager’s Snapshot:
Emerging Trends in
the Consumer Packaged
Goods Space
Subash Chandar
strategic services
V
ery few industries today are
as global and multifaceted as
Consumer Packaged Goods
(CPG). Organizations within this industry
are extremely responsive to consumer
demands and sentiments and largely
operate in a business environment that is
highly dynamic and increasingly prone to
the following challenges:
• Need for continuous innovation and
product development
• Increasing government regulations
• Rapidly changing consumer demands
• Rising raw material and product
development costs
• Brand commoditization
• Emerging low-cost private
label manufacturers
Given these challenges, CPG players
are today operating in a more complex,
volatile, and changing environment.
In order to more effectively respond to
these challenges and attain sustainable
top-line growth, CPG companies
are deploying new strategies based
on innovation, reduction in time-to-
market, operational transformation as
well as the adoption of new technologies
and tools in marketing and sales. As a
result, five underlying trends have been
shaping the CPG industry beginning in
38 Cubisms | MAy 2013
2011 and will continue to influence this
industry in 2013.
Trend #1: Expanding into
emerging markets
Brimming with growth potential due
to rising populations and disposable
incomes, emerging markets—Argentina,
Brazil, China, India, Indonesia, Mexico,
Russia, Saudi Arabia, South Africa,
Thailand, Turkey, and Vietnam—
offer numerous opportunities for the
CPG industry. Consequently, CPG
companies are adopting inorganic
growth mechanisms to tap into these
markets at an increasing rate. These
acquisitions by CPG companies are
set to continue into 2013, and are
likely to provide newer (and in many
cases, locally attuned) platforms to
deliver sustainable growth in a rapidly
changing environment. Some recent
examples include:
• In August 2012, General Mills
acquired Yoki Alimentos, a Brazilian
food company, to accelerate its top-
line growth in Brazil. The company
also acquired Parampara Food
Products in May 2012, an Indian
food company that specializes in
producing ready-to-cook spice and
sauce mixes, to expand its meal
solution offerings within the country.
• In December 2011, Unilever acquired
approximately 82% of Concern
“KALINA”, a Russian beauty product
company. The acquisition is likely to
strengthen Unilever’s position and
offerings in Eastern Europe.
• In September 2011, PepsiCo acquired
Wimm-Bill-Dann, a Russian dairy
product and beverage manufacturer,
which made it a leader in the country’s
growing dairy product market. This
also increased PepsiCo’s presence in
Eastern Europe and Central Asia.
• In April 2011, H.J. Heinz Company
acquired an 80% stake in Coniexpress
S.A. Industrias Alimenticias, a Brazilian
manufacturer of the Quero brand of
tomato-based sauces, tomato paste,
ketchup, condiments, and vegetables.
This acquisition paved the way for
Heinz to enter the Brazilian market.
Trend #2: Streamlining portfolios
With improving macroeconomic
conditions, large CPG companies have
realized the need to restructure business
operations to more effectively (and
efficiently) drive long-term growth. As
a result, companies are increasingly
implementing spin-off strategies
to divest non-core businesses and
enhance their focus on those activities
they consider to be core to their
businesses. This is assisting companies
in reducing cost as well as time-to-
market and more effectively leveraging
competencies within newly created
entities. CPG companies will continue
to assess spinoff strategies in 2013,
and restructure portfolios to develop
systems that make them distinctive and
profitable. Some recent examples of this
trend include:
• In October 2012, Kraft Foods approved
a spinoff of its North American grocery
business into Mondelez International
Incorporated and Kraft Foods Group.
This was done so that the newly formed
entity (Mondelez International) could
focus on strengthening its snacks
business unit and the parent entity
(Kraft Foods Group) could focus
exclusively on core grocery products.
• In March 2012, Sara Lee split its
operations into two distinct public
companies—D.E Master Blenders 1753
(International beverage) and Hillshire
Brands Company (North American
Meat company). This was in line with
the company’s strategy to focus on
core business segments—meat and
beverages and coffee and tea.
• In October 2011, Fortune Brands, a
Deerfield, Illinois-based conglomerate,
split its businesses into two publicly
traded companies—one focusing on
liquor and the other on home and
security products—to leverage and
strengthen core competencies and
capitalize on the improving economy.
Trend #3: Focusing on
downstream data
In the CPG industry, out of stock means
out of business. In today’s volatile
market, increasing on-shelf availability
improves consumer satisfaction, while
driving top-line growth—essentially,
optimum on-shelf availability—ensures
that the right product is on retail store
shelves in the precise quantity at any
given point in time. As a result, CPG
companies are using downstream data
to improve on-shelf availability of their
products globally. Large CPG companies
are set to invest in technology to gather
downstream data points, which will
enable better and faster decision making.
Companies such as Nielsen and IRI, and
retailers such as Walmart and Target are
among leading players that provide point-
of-sale data points to CPG companies.
Specific CPGs investing in this area
include:
• In April 2012, Kellogg’s Company
chose Terra Technology’s Demand
Sensing solution to cater to the various
downstream segments and improve
stock availability while reducing costs.
• Since the beginning of 2012,
Procter & Gamble (P&G) has been
using downstream data to augment
on-shelf availability and eliminate
out-of-stock situations.
• Unilever is using downstream data to
ensure that its supply chain ends with
the consumer of its products and not
with its retail partners. In September
2011, the company rolled out a demand
sensing software from supply chain
solutions provider Terra Technology
across its businesses to access point of
sales data to study and monitor demand.
Trend #4: Innovating
product lines
Another noticeable trend across the CPG
space is the development of innovative
products that cater to alternative as well
as more customized consumer segments.
This means not only launching new
products, but also rebranding and
upgrading existing product lines.
Selected examples of companies that
have adopted this strategy include:
• In April 2012, Sara Lee launched its
new Ball Park Flame Grilled Patties as
a major extension of its brand. In doing
so, the company stepped outside the hot
dog category to tap into the $400-million
frozen burger category market.
• In February 2012, P&G launched new
Tide Pods, a liquid unit dose detergent
containing three ingredient chambers.
• In February 2012, Kimberly-Clark
launched MyKleenextissue 2.0 under
its Kleenex brand as part of its strategy
to provide highly customized products
to consumers—the tissue boxes can
be customized with personal photos,
messages, custom designs, and colors
from dozens of available options.
• In January 2012, Unilever extended
its portfolio of Axe deodorant products
into hair care. The company believed
that its highly successful marketing
campaign put Axe firmly on the global
map for male adults, and set to build
its popularity by targeting younger
women with its hair care products.
Trend #5: Creating innovative
marketing campaigns
CPG companies were one of the first
industries to embrace the digital
marketing realm, and over the years have
developed many innovative marketing
campaigns to help boost dampened
sales. Social sites, such as Facebook and
Twitter, are being used to build customer
loyalty, engage with customers on a more
personal level, and drive product demand
via special promotions, contests, and
more. Results to date have been very
positive, making this a key trend that will
continue in 2013. Some recent examples of
innovative marketing campaigns include:
• In August 2012, Reckitt Benckiser
tied up with Syncapse to help connect
social media marketing programs
on Facebook, Twitter, and Google+
across more than 20 brands, including
Clearasil, Durex, and Lysol.
• In May 2012, PepsiCo entered into
a partnership with Twitter to offer
free music and video downloads on
PepsiCo’s Twitter channel.
• In April 2012, Coca-Cola installed a
vending machine in Singapore that
does not take cash to dispense the cold
drink, but rather needs to be hugged to
get the drink. Industry professionals
stated that this was a part of its
strategy to go viral across Asia, leading
to an outbreak of “random hugging”
with the Coca-Cola brand in the mind
of consumers.
• During 2012, Unilever partnered with
Jana, a Boston-based mobile technology
company to create a social media
focus group on Facebook in Vietnam.
Through this campaign, the company
reached out to about 20,000 Vietnamese
citizens, doubling the original two-week
target of 10,000 people.
2013 and beyond
The CPG industry is in a time of
tremendous change and transformation
across the entire value chain—from
revenue through to operations. Given
the key trends discussed in this article,
it is anticipated that progressive CPG
companies will continue to restructure
business models and operations, as they
look to not only solidify their position
within developed markets, but also tap
into emerging markets through organic
and inorganic growth.
MAy 2013 | Cubisms 39
Procurement & Supply Chain

The evolution of China’s

coal industry
China’s coal industry has transformed
significantly over the last decade and
the country has moved from being an

The Importance of Coal exporter of coal to a net importer that

is influencing the global market for
the commodity. A detailed view of this

to the Chinese Economy evolution is provided in the following

graphic (Fig. 3).

Richa Singhal and Rakesh Ranjan By 2010, China became the largest
electricity consumer in the world,
strategic services
overtaking the US. Approximately 70%
of this demand was met using coal

C
oal has played a key role in
China’s economic development
in the past decade. As of
December 2012, China has been the
largest producer and consumer of coal
worldwide. According to the World Coal
Association, China’s coal production is
estimated to have tripled between 2000
and 2010, and in 2011, China accounted
for 45% of global coal production,
totaling 3,520 million tons. In that same
year, China accounted for less than
3% of the world’s oil and natural gas
reserves compared to approximately
13% of the world’s coal reserves, making
it an irreplaceable energy source in the
country. (Figs. 1-2).
Demand for coal in China has
predominantly been driven by the
electrical power sector. However, since
2008, a new trend towards coal-based
chemical production has been emerging
in the country, with the potential to
significantly impact both the Chinese
and the global economy. This includes a
shift in the usage of coal from fuel to raw
material. Some key questions analysts,
buyers, and producers are asking are:
• Will this trend hold?
• What are the drivers stimulating
this trend?
• What is the future of coal-based
chemical production in China?
reserves. And, as such, increasing coal
consumption over the years has been
driving China’s contribution towards
global GDP. Per the table on the
following page, China’s share in world
coal consumption has approximately
tripled over the last 30 years, and its
contribution to the share of GDP has
grown nine fold (Fig. 4).
Clearly, China’s economic growth will
be constrained if its coal production/
supply does not fulfill this energy need,
which also eventually will impact the
global economy.

Figure 1 — World’s Largest Coal Producers Figure 2 — China’s Share of World

By Volume Energy Reserves
(By Percentage, 2009)
4000
13.3%
3500

3000

2500

2000
3.2%
1500
1.2% 1.3%
1000

500
Oil Natural Gas Uranium Coal
0
1990 2000 2011
China US India Australia Russian Federation Source: EIA; OECD

Source: BP Statistical Review of World Energy, BP (June 2012)

40 Cubisms | MAy 2013

Figure 3 — The Evolution of China’s Coal Industry

2010: 2012: 2027:

Coal production 12th Five-year Coal production
2008: tripled Plan aims to projected to
Became compared to curb Chinese peak at
a net 2000; however consumption 5.1 billion tons
2007: importer still imported and production
Chines coal of coal 170 million to 3.9 billion
production
tons of coal tons by 2015
generated more
2001: energy than
Exported total Middle
90 million East oil
tons of production
coal

Coal as chemical feedstock is
the new way forward
Although China predominantly uses
coal for power generation, it is now
also being used to produce chemicals.
Certainly, the country is not new to
the idea of using coal as a chemical
feedstock. In the late 19th and early
20th centuries, coal tar was used in
the dye industry to produce aromatics
and specialty chemicals. Since 2000,
there has been a considerable amount
of investment to produce coal-based
petrochemicals as a substitute for
traditional crude oil-based processes.
China is using coal extensively for the
production of chemicals, because coal is
considerably less expensive and has the
potential to meet China’s desire to become
self-sufficient in resource inputs. As such,
China is expected to achieve sufficient
internal production from hydrocarbon
and coal-based feedstocks to become self-
reliant. Huge petrochemical facilities are
being built by Chinese and multinational
firms in the country. These planned
facilities will require more than 20 million
tons of additional coal every year. This
implies that China will continue using
coal for the production of chemicals in the
future. (Refer to Potential roadblocks to coal-
based chemical production on page 42.)

Figure 4 — Share of China in Global Coal Consumption and GDP

PPP

Percent of World Total

Year
Coal Consumption (%) GDP (%)

1980 17 2.2

1990 21 3.9

2000 25 7.2

2011 49.5 14.4

2016 50.8 (estimated) 18.1 (estimated)

Source: EIA; IMF; World Bank

MAy 2013 | Cubisms 41

Procurement & Supply Chain

As of 2012, the following four chemical exceeded its supply by a significant

products have been made from coal
in China:
• Coke-oven light oil (COLO) as a
source for aromatics: Coal is heated
in an oven to be converted into coke.
This results in the production of coke-
oven light oil, which mainly comprises
benzene, toluene, and xylene (BTX),
with benzene being the predominant
aromatic. It is estimated that China
produces 27% of its benzene from this
process, as compared with 4–5% being
produced globally.
• Acetylene to vinyl chloride monomer
(VCM) and butanediol (BDO): Lime
is reduced by carbon (in the form of
coke) in an electric furnace to produce
calcium carbide, which is further
hydrolyzed to produce acetylene. This
acetylene is then used to manufacture
chemicals such as VCM, BDO, and
vinyl acetate monomer (VAM). It is
estimated that China produced more
than 85% of the VCM from coal-derived
acetylene. It also is considered to be
the only country that uses coal-derived
acetylene to manufacture BDO.
• Olefins (CTO): The process of
converting coal to methanol to olefin
also produces ethylene and propylene.
China’s consumption of ethylene
margin in 2011. As per the 12th
Five-year Plan, additional plants are
scheduled to be established, which
will have a combined capacity of
providing 20% of ethylene and 17% of
propylene to meet local demand.
• Monoethylene glycol (MEG) and
ethanol: This process involves
preparing dimethyl-oxalate by
oxidizing carbon monoxide (derived
from the gasification of coal) with
methyl nitrite. Further, dimethyl
oxalate is hydrogenolyzed to produce
MEG. Finally, nitric oxide and oxygen
are reacted to make methyl nitrite
by releasing methanol. By 2014,
approximately five coal direct-to-MEG
plants are scheduled to commence
operations in China. This is expected
to increase the MEG production
capacity (from coal and not from
ethylene) to over 1 million tons/year.
The following figure shows the
estimated amount of coal to be used in
future for chemical production (Fig. 5).
Key drivers
China has abundant coal reserves and a
significant shortage of oil and gas. This,
quite simply, is the country’s primary
reason for choosing coal as a substitute

Figure 5 — Projected Coal Consumption in Coal

Conversion Plants in China (Million Tons)

418
363
298

204
175 172
143
120
70 85
58 47 58
16 31

Ammonia Methanol Acetic Acid Liquid Fuel Di-methyl Ether

2012 2020E 2030E

Note: The figures have been approximated using a measuring tool

Source: IMF

42 Cubisms | MAy 2013

for oil for economic development. In
recent years, favorable market conditions
have also stimulated the national
coal chemical industry. Continuous
fluctuations and increases in global oil
and gas prices are causing many national
and multinational firms to invest in
China’s coal gasification industry.
The Chinese government is, as
expected, playing a key role in the
development of this industry. Under the
latest Five-Year Plan, 37 deep processing
coal demonstration projects have been
approved by the China Development
and Reform Commission. The key focus
will be on seven areas, namely coal
liquefaction, coal-to-gas, coal-to-olefins,
coal-to-ammonia/urea, coal-to-glycol,
low-rank coal upgrading, and coal-
to-aromatics. The total investment in
these projects is estimated to be around
RMB700 billion (approximately USD
112 billion), which indicates significant
growth of the Chinese coal gasification
market in the future.
The key industries propelling this
growth are as follows:
Steel: China accounts for more than
half of global steel production and
plays a major role in boosting national
industrial growth. Although it has
coal reserves in abundance, coking
coal constitutes only 28%. Therefore,
China is expected to become the
primary coking coal importing country
in the world, as domestic coking coal
production is also slowing down.
This is substantiated by the fact that
Chinese imports of coking coal grew
approximately 60% in 2012 over 2011.
Non-metallics: At the global level,
cement is considered the principal
sector across all non-metallic industries.
Coal provides a major share of energy
consumed in manufacturing non-
metallic materials, such as cement,
soda ash, and other building supplies.
With a massive boom in the Chinese
construction sector, large quantities of
cement, soda ash, and other products
are being consumed, which will further
boost the demand for coal in China. “During the 12th Five-year
Automotive: The automotive industry Plan (2011–2015), China
is one of the largest consumers of
will establish 10 large coal
chemical products in China. The
industry recorded a CAGR of 26% from companies that will be capable
2006 to 2010. However, at present,
of producing 100 million tons
it is showing signs of a slowdown
due to withdrawal of government of coal per year, along with
support and stimulus measures. It
another 10 companies with
will need to focus on zero-emission
technologies and alternative power a capacity of producing 50
sources to increase vehicle sales. BYD
million tons per year. These 20
Auto Company Limited, a Chinese
automobile manufacturer, has started companies will be responsible
the process by entering the battery
for 60% of the country’s
business to provide cleaner and efficient
automobiles. It is expected that its output/production of coal.”
competitors will soon follow. This will
bring significant opportunities for
Wu Yin, Deputy Director, National Energy
Administration, China (May 2012)
chemical manufacturers (coal-based
chemical production) and will further
increase the demand for raw materials
such as coal over the long term.
Petrochemicals: Chinese oil and
chemical companies will keep
augmenting their ethylene production
capacities. As per government
estimates, production is expected to
increase at an average rate of 11% per
year from 2012 to reach 26 million tons
per annum by 2015. This will make
China the top producer of ethylene in
the global market, overtaking the US
and propelling the demand for coal in
the near future.
Cement: Industry analysts and market
experts across the supply chain state that
cement demand is likely to increase in the
near future, which will propel the growth of
coal, which is one of the key raw materials
used in the production of cement.
Others: Performance materials and
coatings used in the electronics and
consumer industries, and bio-products
will record high demand in the
future, and will affect the coal market
positively. The building/infrastructure
sector will also act as a catalyst in
China’s industrial development
(especially in western parts).
MAy 2013 | Cubisms 43
Procurement & Supply Chain

Potential roadblocks in coal-based chemical production

Using coal as a chemical feedstock poses certain limitations
for China’s coal-based chemical industry.
The biggest challenge is limited availability of water
resources. According to statistics, for each ton of coal
produced, seven tons of water is required in the direct
liquefaction process, whereas the indirect process requires
12 tons. It is estimated that water consumption by the
Chinese coal industry will reach 9.07 billion metric tons by
2015, which significantly exceeds its estimated supply. In
addition to water problems, local ecological issues and soil
degeneration will also be affecting the environment.
The technology used in coal-based chemical production is still
in its nascent stage and is not fully developed. Thus, pollution
and technological limitations make the future of China’s
investment in coal-based chemicals an open question for now.
According to Kai Pflug, CEO of Shanghai-based Management
Consulting, per capita coal reserves in China are below
average. It is expected to last for only 38 years if consumed
at the present rate.
Increased carbon emissions and environmental risk from
coal extraction are the other major areas of concern for the
coal-based chemical industry in China. These challenges are
threatening China’s target of cutting down greenhouse gas
(GHG) emissions.
To combat these challenges, China is taking various measures
that might help it in the long run. For instance, it is improving
the technology used in sewage treatment plants to recycle
waste water. The Baotou Iron and Steel Company plant
recycles 98% of its water, as directed by the country’s law that
prompts owners of industrial plants to conserve water. China
might also consider transporting water to its northern and
western parts, which are dry and receive less rainfall.
To reduce GHG emissions, China is moving toward scientific
development—a drive started by President Hu Jintao.
This drive aims to reduce waste and emissions, boosting
productivity, and shutting down plants where modern
technology cannot be implemented.

“Coal prices will remain low
in the long term, and the
structure of China’s power
supply is expected to change, as
the coal industry will enter an
adjustment period featuring
high costs and low profits.”
Shandong Provincial Coal Transporting and
Marketing Association, China (August 2012)
China’s transition into the
coal markets
After becoming the largest importer of
thermal coal in 2011, China is expected
to play a major role in setting its prices.
It is believed that this is the key reason
behind China’s slower approach to
reforming coal prices. This affected coal
miners from Australia and Indonesia
significantly, who supplied more than
half of China’s coal in 2012. According
to the local media, China’s cabinet is
considering the National Development
and Reform Commission’s (NDRC)
proposal to give more freedom to miners
for negotiating coal prices.
Looking to the future
Overall, the Chinese coal chemical
industry is now gearing towards
considerable growth. It is experiencing a
complete evolution with an environment
full of substantial opportunities, which
needs to be dealt with utmost care in
view of the existing challenges. One
should note that coal is an advantageous
feedstock only if international oil prices
stand above $80 per barrel. However,
with China significantly lacking in
crude oil and natural gas reserves, coal
has become a blessing in disguise for the
Chinese economy.

44 Cubisms | MAy 2013

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