Pocket-Sized Telecoms
According to specialists, the share of the local telecommunications provider market in Russia is not more than one to two percent and is shrinking each year. Nevertheless, several building owners and developers continue to set up their own “pocket” operators, as they do not wish to miss out on the profits from this niche and they are confident in its success. Furthermore, primary and local providers accuse each other of the same faults – low quality of communications and high rates.
To begin with, the concept of a BLEC (building local exchange carrier) and “pocket” local providers should be defined. A BLEC is a simple middleman between the provider and the tenants of a building. The BLEC arranges for the delivery of telecommunication services to a specific building by leasing out the necessary equipment and fiber-optics network to a third-party operator. Accordingly, the local operator gains a definitive profit, but does not serve as the provider and does not bear any of the expenses associated with this. This practice is fairly widespread in the West. This article will discuss the Russian version of “local operators” - building owners who provide full-service in one or several of their buildings to make extra profits.
Market Niche
It is well known today that modern telecommunications increase the value of real estate facilities, and, in the past, owners and investors of commercial and elite residential real estate have set up telecommunications pocket operators. However, such types of non-core businesses very often do not generate anticipated results, says Mikhael Babaev, head of the corporate client relations department at Arctel.
The trend appeared nearly five years ago as a result of the rapid development of the commercial real estate market, as notes Anna Pleteneva, project director for commercial and residential real estate operations at Comstar-UTS. Vitaly Ezopov, general director at Mastertel, reckons that pocket operators occupy a rather insignificant percent of the Russian telecom market (1-2%). “Just two to three years ago, it was fashionable to set up pocket operators, as the owners and developers of business centers believed that it was possible to make extra profits.” However, once this theory was tested, it became clear that it was not possible to make a profit from only a few buildings, as the margin is small and fixed costs eat all the profits.
“Just last year there were enough operators formed by developers to consider the benefits of such an approach to outfitting a building with telecommunication services,” says Pleteneva. “However, the trend now has totally changed, as the pocket operators have dwindled.”
Nevertheless, pocket operators continue to appear, and the developers setting them up are certain of the prospects of their enterprise. “By all accounts, many developers are creating such operators today,” states Andrei Mezhevov, general director at MIAN-Info. “This could be an attempt to diversify business or earn additional profits.” There are at least 100 local operators in Moscow, estimates Tatiana Tolmacheva, managing partner at iKs-Consulting. This business is not capital-intensive, as it is enough to acquire a license, come to an agreement with the first-level provider, install the fiber optics, find a specialist and install the equipment. Furthermore, hotels and business centers in Moscow are located in relatively convenient areas, with the cables of a primary provider always nearby; if not, the primary provider is usually glad to hook one up.
Pavel Gorenkov, general director at Gars Telecom, believes that today in Moscow there are 20-25 well-known so-called telecommunications pocket operators, with around another 10 operating in Russia.
Moonlighting Owners
Owners set up their own telecom operators in order to avoid paying another party. “In terms of MIAN-Info,” notes Mezhevov, “we calculated everything and realized that it would be more profitable to set up our own operator rather than to have another party to it.” Moreover, Mikhael Stotsyura, general director at LegionСom, is certain that there is not a guarantee that outside operators will pay client compensation in line with actual tariffs, as an owner has “neither the technical nor legal means to control or monitor client accounts.”
Indeed, local operators do not differ from primary ones, as they have the same licenses for delivering local telecommunications services, transferring data and leasing communication channels. Furthermore, with a network of offices around the city, they offer tenants end-to-end service, which necessitates extending the main lines or leasing them from another provider. Accordingly, this can be an overwhelming obstacle, as the competitor makes knowingly unfeasible demands in regard to leasing a section of the main line.
According to Mezhevov, “Rendering services in a single building makes no sense whatsoever, as there is nothing to be earned. Any local operator formed by a developer today is expected to service all of the developer’s buildings.” In forming their own telecommunications operators, owners are counting on making a 100% profit from the services; however, as practice shows, small-time developers that set up their own providers often lose money. Owners often encounter a number of problems, such as designing and constructing the communications network, optimizing the use of the network resources, receiving approval from the federal authorities, developing and installing modern technology and recruiting additional specialists in telecommunications, explains Lada Zhgun, director of telecommunications services at AMT. However, “in permitting a third-party operator on its territory, a building owner realizes up to 20% profit from the said operator for communication services rendered to the tenants on said territory, without any expenditures on the part of the owner.”
Recently, modern local providers, as set up by large developers, have made their businesses profitable by increasing service areas as part of developers’ activities. According to Roman Cheptsov, director of development at Prime City Properties, a pocket operator theoretically could be profitable, but this would require this owner to have a significant area of at least 100,000-200,000 sqm. Accordingly, the owner would recover expenses on the set-up and operation of his own telecommunications.
Moreover, there are dozens of pocket operators in class C and lower buildings which offer expensive but poor services. “The practice of forming such operators is characteristic of unprofessional developers for whom commercial real estate is not a core business,” says Cheptsov. “As a rule, they do not intend to develop in the future, thus they squeeze the most out of the current project.” Tenants in such facilities must overpay for telecoms.
Additionally, the majority of large conglomerates set up their own telecoms companies. When the expenses for telecommunications exceed the $1 million mark per annum, business owners more often transfer the provision of telecoms services to a separate asset with its own legal entity, licenses, etc. “Today, many holdings, including real estate developers, have set up similar captive telecoms companies,” notes Gorenkov. “The logic for setting up such companies is understood, as it is possible to buy traffic in bulk and long-distance at prime cost, thus providing the parent company with effective savings.”
It is worth noting that such a policy is of interest to large holding companies, especially ones with various shareholders. Among the examples of such service companies are YUKOS’ Sibtech, TNK-BP’s RTS, Norilsk Nickel’s Norilsk-telecom, Guta’s Guta-telecom, etc.
Accordingly, local operators can be conditionally divided into three groups: those who were formed by large development companies with prospective growth, those that are pocket operators of one building, and those that are captive telecoms companies. In class C and lower buildings, there are many tenant complaints and negative assessments of competitors by primary providers.
The Burden of Response
Both local and primary providers speak negatively about the quality of service delivered by one another. The complaints against local operators include low data-transfer speed, erratic connections, high tariffs and the lack of alternatives. “I know of many cases where the local provider has a monopoly and its service is not suitable for the tenants,” notes Tolmacheva.
When there is a single pocket operator in a building, then the service charges for tenants are much higher due to the lack of competition, says Pleteneva. Such an approach often leads to losses by both parties, as, indeed, the tenants cannot receive a full-service package at an acceptable cost. Since an alternative operator cannot offer such a package, the developer risks losing important tenants as well as telecommunications partners.
It is worth noting that a situation has arisen on the market where each building has an exclusive provider. Indeed, even when an owner claims that there is a reserve operator, this usually does not correspond to reality. However, telecoms market consultants say that the situation today is changing, even though it has taken five to six years to do so. “Today in any large office building, there are two to three providers,” reckons Tolmacheva. “Each one offers its own solution and a tenant can choose based on the quality of service, technical features and rates.”
“The process of providing service to clients is a very hot issue which the users of pocket operator services must face,” says Ezopov. “These types of operators cannot respond in the appropriate manner to errors and malfunctions that clients may experience.” According to Babaev, “The reason for this is that pocket operators do not own the resources (telephone number capacity, cable trunk network, etc.), and they simply offer communication services by getting licenses and becoming agents.” Accordingly, there are no flexible tariff rates and no development concept for telecommunications equipment in such companies. Consequently, when a client moves from facility to facility, the pocket operator has difficulties transferring the communication services. In such cases, the work is often outsourced to technical specialists.
“However, primary providers can also be accused of low quality at high rates,” counters Mezhevov. “Indeed, the clear advantage of local providers is that we are obviously closer to the clients and all of their inquiries are responded to quickly and effectively.” Local providers are certain that primary providers, having been on the market for ten years now, are not flexible enough for the customer. “They are interested in making maximum profit at the expense of quality,” confirms Stotsyura. “We provide complete service support because we are in the same building. Just imagine if you are a client of a primary provider who has at least hundreds of other clients. As a result, the provider could not remedy your problems in an hour or two, but, rather, in 10-12 hours.”
On that note, according to statistics, the reaction time of a local operator is three hours in the event of a major problem, whereas a primary provider reacts within 12 hours. “Furthermore, small providers find it easier to meet a client halfway in terms of discounts,” clarifies Mezhevov. “The disadvantage of a local provider is that it does not have enough resources to provide telecommunications for large tenants with extensive networks throughout the country and the world. It is necessary to approach other providers in such cases. In our work, for example, we successfully collaborate with GoldenTelecom.”
From Last to First: The Meek Shall Inherit the Earth
It is difficult for market analysts to predict how the local operator market will develop, especially since the presence of a single provider in a building does not signify competition. At the same time, large Russian and international companies today are wary of a building with an exclusive owner-operator structure. Therefore, developers who set up pocket operators automatically lose impressive tenants. If we look at the West’s experience, we could forecast that pocket operators will gradually be replaced by other more efficient operating schemes.
Therefore, it is predicted that the existence of pocket operators will end either via merger with or acquisition by larger operators. Moreover, market players explain that stiff competition on the domestic telecommunications market has resulted in set standards of profit. Indeed, as oppose to a few years ago, new sector regulations prohibit business from developing in favor of pocket operators. One way of achieving a compromise in this matter could be by changing the status of a local “provider” to that of a local “operator” (BLEC).
In turn, local providers look to the future optimistically, as they figure they have taken up their niche on the service market on their territory. Entering the outside market is complicated by the fact that practically all buildings in Moscow are occupied by some operator. However, the problem remains with Russian legislation, which allows for communication services to become monopolies, thereby concentrating power in the hands of a small number of companies and squeezing out the other players from the market.
Nevertheless, local operators who formed as part of larger developer structures are striving to be profitable. Many remain positive that they can reach their goals if their developer constructs new buildings and thereby broadens their client base. Although this will take several years, primary providers recognize that this could work out for local providers.