Telecom (Americas)

Mobile industry at a crossroads

November 2012
Venkat Atluri
Jay Jubas
Dev Patel
Jeremy Schneider

Contents

Mobile industry at a crossroads 

Past drivers will recede

Forces of stability 

Drivers of disruption

The two scenarios

Mobile industry at a crossroads

The wireless-phone industry has performed well over the past five years. However, the tailwinds
that have propelled that performance may be reaching their natural limits, substantially raising
the level of uncertainty in the industry. We consider both the forces of stability and the drivers of
potential disruption that could reshape the wireless landscape.
Are we approaching an inflection point in the mobile industry
as the market enters the next and perhaps final stage of
consolidation? Could meaningful new pockets of opportunity
create new winners? Will industry leaders continue to benefit
disproportionately from the industrys growth? Will carriers
continue to slowly cede their share of industry profits to other
segments of the value chain?

concentrated at every segment of the value chain. For

example, in devices, the top two handset makers earned 85
percent of the profits in 2011. Similarly, the top two carriers in
the United States earned 92 percent of that segments profits
in 2011. With each passing year, the portion of profits
captured by the top two players in each segment continues to
rise (Exhibit 1).

We ask these questions against the backdrop of an industry that

has performed remarkably well, not only over the past decade
but even over the last five years, despite a difficult economic
environment. In fact, the $320 billion US wireless ecosystem
which includes component manufacturers, networkinfrastructure players, device companies, wireless carriers, and
application providershas maintained strong growth over the
last five years, sustaining 11 percent annual revenue growth,
which is more than five times faster than the growth rate of the
US GDP. Its also worth noting that this growth has come as
profit growth actually accelerated, increasing at 15 percent over
the period.

What has driven the industrys 11 percent revenue growth?

At the highest level, the development can be credited to
selling more connected devices at higher prices. That, in and
of itself, is unusual. Seeing prices increase during a wave of
rapid penetration growth breaks the traditional pattern of
technology-adoption curves. Drilling down a level, there have
been two sources of revenue growth for the broader wireless
ecosystem: 64 percent of the growth has been driven by an
increase in the number of devices and lines, and a further 45
percent by rising average selling prices (ASPs) for devices.
These factors have been slightly offset by a modest decline
in wireless-service average revenue per user (ARPUs). Sales
and advertising revenues for applications, while growing very
rapidly, have not reached a size large enough to meaningfully
affect the overall industry value pool.

However, this growth has not been evenly distributed. As the

overall industry has matured, profits have become highly

Exhibit 1 Revenue growth has been driven by a few key factors.

Impact on revenue growth, 200711
Increase in devices and
lines

Rising device ASP2

Service ARPU3 declines

Apps growth

Total impact to CAGR4

1 Household.
2 Average selling price.
3 Average revenue per user.
4 Compound annual growth rate.

HH1 mobile spending increasing

13x faster than HH income

<1

11

The continued strong performance of the US mobile value chain

over the past five years is particularly remarkable against the
backdrop of lackluster economic growth, but this also raises
important considerations about its sustainability. Indeed,
household spending on mobile as a category rose 13 times faster
than household incomes over the past five years, expanding the
portion of household spending on mobile devices, software,
and services at an unsustainable rate. As this wave of consumer
spending has driven growth over the past decade-plus, it raises
questions about how much new revenue the sector can expect to
book in the future.

Past drivers will recede

Data analysis of the past growth drivers noted above brings
some sobering news. If we model the expected revenue growth
for the period of 2012 to 2015, we see a marked deceleration
on growth, from the 11 percent of the past five years to the rate
of 5 percent going forward. This slowing growth is primarily
driven by a lower rate of line growth and falling device ASPs as
smartphone and tablet penetration begin to slow and increasing
price competition becomes viable. This 5 percent, of course,
is still a lot of money for an industry so large and diverse. The
broader ecosystem is due to pick up an incremental $45 billion
in annual revenue by 2015.
Is the industry headed for a fundamental slowdown? The good
news is that past drivers of growth represent only part of the
story. We see a set of new opportunities for the industry in areas
such as sensor-driven devices and innovations that result from
the next wave of applications, contributing a further $40 billion
to the mobile value chain over the next three years. At the same
time, we uncovered a number of factors that could put $25
billion in existing industry revenues up for grabs. This value
could move from one segment of the value chain to another,
or be redistributed across the players within a given segment.
Another $20 billion is at risk of being lost to consumer surplus,
meaning it will be eroded by pricing that benefits the consumer
rather the mobile industry. In other words, we see $130 billion
in annual revenueroughly 40 percent of the sectors total
revenue poolpotentially being redistributed over the next
three years (Exhibit 2).
Who is likely to capture that pool of money? Will the rich get
richer, or will the value be redistributed? We see a small set
of critical battlegrounds that will shape the answer to those
questions: forces of stability in the industry and drivers of

disruption. How these dynamics play out and where this $130
billion of annual revenue lands will be largely determined
by the choices, capabilities, and strategies of the industrys
leading players.

Forces of stability
Todays winners have several advantages that could enable
them to sustain their commanding share of industry profits.
These range from structural strengths to capabilities
to smart marketing choices. We see four advantages as
particularly important.
Spectrum advantage. Perhaps the most potent fundamental
contributor to the stability scenario is the high-quality, lowfrequency spectrum advantages that the two largest players
in the US market enjoy. Fully 80 percent of the low-frequency
spectrum in the United States is controlled by those two players.
The cost advantages of deploying networks on this spectrum
coupled with the enormous investment gap between the top two
players and others in the market make it difficult for challenger
operators to catch up.
Exhibit 2 By 2015, $130 billion of annual revenue will be at stake.

Existing revenue
up for grabs:
$25 billion

Secular growth
trends:
+$45 billion

2012 US wireless
value-chain
revenue pool:
$320 billion

Potential revenue
lost to consumer
surplus:
$20 billion

New opportunities:
+$40 billion

Telecom (Americas)
Mobile industry at a crossroads

New pricing structures. A second force that we expect to

contribute to the ongoing strength of todays leaders is the new
pricing architectures they have adopted. These pricing plans
include unlimited voice and messaging and pay-by-the-drink
data pricing that can be shared across devices. This pricing
strategy represents a response to four fundamental drivers of
revenue erosion that operators are facing globally. By making
voice and messaging unlimited, they respond to the rapid
growth of over-the-top (OTT) voice and social-messaging
services. For example, VOIP calls now account for a full 25
percent of international consumer calling minutes, and OTT
messaging software is rapidly eroding SMS revenue. Carriers
in Europe are now experiencing as much as 11 percent quarterly
declines in SMS revenue due to this technology. Aside from
addressing these concerns, the bundled pricing model has the
potential to boost the attach rate of tablets connected to the
mobile network, which currently sits at a lackluster 30 percent
in the United States. Lastly, the new pricing will offset the
destruction of data monetization, which saw revenue realized
per megabyte fall by 90 percent over the last four years, due to
the unlimited data plans of yesteryear.
We see this pricing architecture as a big step forward for
carriers and we expect that it will enable the major US telecom
companies to avoid the challenges facing European carriers.
In Europe, ARPUs have already fallen at a 22 percent rate since
2008 and are expected to fall at a 3 percent rate over the next
three years. We anticipate that the largest US carriers will see
an 8 percent increase in ARPU between now and 2015.
Privileged access to component innovation. The sources of
innovation in the mobile industry are shifting. The traditional
innovatorsthe wireless-infrastructure players, carriers,
and OEMsare reducing R&D spending, as fewer players can
afford to reinvest and the few winners in the market are taking
a larger portion of revenue to the bottom line. In total, this
will represents a 30 percent decline in R&D investment, on an
absolute basis, by 2015a dramatic and underappreciated shift
in the dynamics of the market. In the face of this decline, where
will the next wave of innovation come from? We see it emerging
from the component supply chain, where investment levels
continue to increase.
In the context of this fundamental shift in the industry, winners
are playing the game differently, tapping into the value chain
to build competitive advantage through locking up privileged
access to component innovation. One prominent model to do this

has been the vertical-integration model, where leaders invest to

establish privileged access to next-generation components (for
example, organic light-emitting diodes). Others have achieved
similar ends through a virtual-integration model, working very
deeply with the supply chain to bring new innovations to market.
While challengers are increasingly aware of the benefits derived
from these models, it takes scale and capital to play this game
effectively. As those advantages remain highly concentrated,
it is difficult for most traditional players to overtake this new
competitive dynamic in the near term.
Growing platform loyalty. A final source of stability in the
industry is the growing trend of platform and ecosystem loyalty
among consumers. They increasingly value affiliation with one
platform across devices. We see that the purchase intention
for tablets is 50 percent higher among customers who own a
smartphone that uses the same operating system. This growing
loyalty creates headwinds for players looking to challenge the
status quo.
These effects add up to a strong argument for the rich getting
richer. If this stability scenario plays out, we see the wireless
ecosystem earning $65 billion in organic, incremental revenue
over the next three years. Winning carriers and device OEMs
would continue to capture a disproportionate share of the
growth, with carriers actually recovering some of the profit
share that they lost over the past five years. Indeed, at every
stage of the value chain, the concentration of wealth would be
further intensified (Exhibit 3).

Drivers of disruption
There is, of course, a rather different situation that could play out:
one that would elevate the level of uncertainty and disruption in
the wireless ecosystem, shake up the pecking order, and engender
a new set of winners. In particular, we see four forces that deserve
attention as potential disruptions.
Alternate subsidy models emerge. The first driver of disruption
is the unsustainable increase in the overall level of device
subsidies. Over the last three years, device subsidies have
grown by roughly 50 percent and are expected to continue to
rise due to the appeal of high-value, leading-edge smartphones.
These devices create a trap of sorts for carriers, because once
a carrier begins subsidizing one popular handset, they must
subsidize other, competing models in order to keep their overall
device portfolio in balance. This expands the total subsidy

Exhibit 3 Forces of stability would further concentrate the wealth at every stage of the value chain.

Components

Devices

Carriers

Increase in
revenue, 201215

Apps and
mobile
Web

New revenue

+$65
billion

% of profit for top

2 carriers, 2015

pools, which have now become the largest expense a carrier

incurs, eating up 14 percent of total operating expenditures.

estimate that they could displace $15 billion of smartphone

revenue from todays established OEMs.

What could change this dynamic? We see the increasing potential

for players who plan to expand adjacent revenues from services,
retail, and mobile content, and to use those value pools to offset
lower gross margins on devices. Amazons Kindle e-reader is a
good example of this business model. This same approach could
be applied to smartphones, particularly given that Amazon could
generate roughly $150 in gross margin over the life cycle of a
smartphone. Other players with significant services, software,
and/or retail revenues can take a similar approach.

Shifting sources of innovation. A second potential source

of disruption involves the ease with which powerful
companies in adjacent markets can leverage originaldesign manufacturers (ODMs) and tap into the innovation
occurring in the component value chain to introduce
differentiated devices. As ODMs have become more proficient
in the smartphone supply chain, they can now spec out,
build, assemble, and test final products very effectively
and efficiently. This opens the door to players that have
traditionally focused on software services to quickly move
into hardware without having to build out a dedicated supply
chain and manufacturing capability. It could easily pave the
way for companies in adjacent markets to enter the mobile
arena, putting the current handset revenues of traditional
OEMs in play (Exhibit 4).

A second approach would involve a shift to a portfolio of lowercost but competitive handsets. Lower-cost handset makers
based in Asia have structurally lower operating costs, and lower
profit expectations, thereby creating the ability to deliver lowercost devices that are able to compete effectively with the leading
devices. Consequently, carriers could make smaller subsidy
payments and still meet the manufacturers profit expectations
as well as the consumers price expectations. It is interesting to
note that the market share of two low-cost Asian brands in the
US prepaid portion of the wireless market has nearly doubled
over the last year. Will the postpaid market be next to crack?
These two trends could pose risks for high-margin, highsubsidy business models. If these lower-cost handsets move
aggressively into the midrange smartphone segment, we

Unintended consquences of new data-pricing schemes. A third

disruptive element could be the consumer reaction to the new
pricing architectures we discussed above. If voice becomes an
unlimited product but data is capped, average users of mobile
data may find that costs double once the new pricing becomes
effective. As a result, while the new pricing could solve shortterm problems for carriers, it could also set the stage for future
troubles. It is unclear that consumers will be ready to double
their spend on data given the share of money that they are
already spending on mobile service. Some may decide they

Telecom (Americas)
Mobile industry at a crossroads

Exhibit 4 Consumers are dissatisfied with capped data plans.

2x data costs for average user
Average data use surging, driven by video
gigabyte/month
3.1

27% of heavy data users dissatisfied

3x more likely to churn

$60
10% of user base
$50

1.4
$10 billion of revenue at risk

0.4

2008

2012

2015

cannot afford to stream video on their mobile devices. Others,

who are already further down the demand curve, may opt to
leave their carrier in search of a better offer elsewhere. We
believe this segment of the user base is three times as likely to
churn as an average customer, and it represents 10 percent of
the revenue of an average carrier. Given the position of todays
market leaders, we believe that up to $10 billion in current
revenue could shift to competitors that offer unlimited or lowerpriced data.
New pools of value. The forces of disruption are not simply
about market share shifting among existing players; there
are also new pools of money being introduced into the mobile
ecosystem. One particular area is the product group known
as sensor-driven devices. We believe there will be 100 million
such devices that will be sold between now and 2015. These
will monitor health metrics (for example, insulin levels,
blood pressure), fitness levels (for example, calories burned,
pedometers), and outdoor-adventure metrics (for example,
altitudes). If you examine the ecosytem of device sales and
connectivity charges, sensor-based platforms (such as goggles,
mobile handsets, and so on), and the big-data/analytics side
of the sensor revolution, we see as much as $15 billion in value
within the United States that will be up for grabs. Yes, there are
many existing players experimenting in this segment of the
market, but no one player has made a focused play and therefore
garnered enough scale to capture a significant share of this

new revenue. As such, there is room for a new entrant to disrupt

the existing mobile ecosystem by becoming a leading player in
sensor-driven devices (Exhibit 5).
A second large pool of new revenue will appear in the mobileapplication market. We believe that the characteristics that
have driven value in app markets thus far will likely change in
a fundamental way. To help make this point, we classify mobile
apps into two categories: simply, pure-play apps (for instance,
simple games, basic activity apps) that derive revenue via in-app
advertising or add-on purchases, and then a second type of app,
which is leveraged as new interaction channels with customers.
For the first category, we see the economics of app monetization
becoming increasingly challenging, as development and
user-acquisition costs rise. This will drive many of the weaker
players out of the market. The challenge for apps that function
as interaction channels is different. There, the main issue will
be managing the usage shifts as customers migrate from online
channels to mobile, which is traditionally less well monetized.
This is doubly challenging for ad-supported content, because
there is not yet a clear, viable advertising format for mobile. As a
result, no advertiser knows what a mobile ad imprint is worth.
Within the interaction-channel space, we see the potential to
transform and, in some cases, disrupt large pools of value in
industries like retail, financial services, and health care. As such,
this trend could bring $15 billion to $25 billion of new value into

Exhibit 5 As much as $15 billion in value will be up for grabs with sensor-driven devices.
Devices & connectivity

68

Platforms

Big data and analytics

24

46

Market potential, $, billion, 2015

the mobile value chain. Already, there are innovative applications

of the technology in the retail, payments, and transportation
markets, and that, in our view, is only the first chapter.

The two scenarios

At some level, the dollar value of money coming into the value
chain is not terribly different, no matter which scenario carries
the day. However, the distribution of that value could look more
or less the same as it does today, or it could look very different
in three years time. With applications and mobile Web gaining
significant revenues, carriers growing at a slower rate, and
component players gaining strength along the way, we could see
a very different picture.

How this plays out depends on the players in todays mobile

ecosystem. If the existing players can develop the right
offerings for the right customer segments, and if they can
go to market with the right retail and pricing strategies in
place, the forces of stability could carry the fight. However,
the disruptions are potentially quite serious in nature, so one
cannot assume that keeping ones head down is a sufficient
defense. Any company with a role in the mobile ecosystem will
need to monitor its slice of the market very carefully and be
ready to adjust strategy if the right opportunity appears. Over
the next three years, the industry could be buffeted by large
changes, and with as much as $130 billion in value at stake, all
players will need to realize a good offense may be required in
order to prevail.

Venkat Atluri is a principal in McKinseys Chicago office, where Dev Patel is an associate principal. Jay Jubas is a director in
the Stamford office. Jeremy Schneider is a principal in the New York office.

Telecom (Americas)
November 2012
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