Opening up how rd is changing in the telecommunications sector today

● To supplement the survey results, the Economist Intelligence Unit also conducted in-depth interviews with senior executives from a range of technology and telecoms companies globally..

telecommunications sector today

An Economist Intelligence Unit report

sponsored by

Opening up: How R&D is changing in the

telecommunications sector today investigates how

technology and telecommunications firms are dealing

with the process of innovation The report was

commissioned by SAS

The Economist Intelligence Unit bears sole

responsibility for the content of this report The

Economist Intelligence Unit’s editorial team executed

the online survey, conducted the interviews and

wrote the report The findings and views expressed in

this report do not necessarily reflect the views of the

sponsor

The research drew on two main initiatives:

● The Economist Intelligence Unit conducted a

wide-ranging online survey of senior technology and

telecoms executives worldwide during February

2008 In total, 327 executives took part

● To supplement the survey results, the Economist

Intelligence Unit also conducted in-depth

interviews with senior executives from a range of

technology and telecoms companies globally

Duncan Campbell-Smith was the author of the report

and James Watson was the editor

We would like to thank all the executives who

participated in the survey and interviews for their time

and insights

April 2008

Preface

Few industries can rival the rate of innovation

seen within the telecommunications sector over the past decade In 1998, mobile phone companies such as Nokia boasted of high-end models with built-in FM radio and infrared connectivity By

2007, many phones offered digital cameras and music players, video conferencing, wireless networking and the capability to browse the Internet and respond

to e-mails Accordingly, phone networks have been upgraded to handle rising volumes of voice, video and data traffic, even as users increasingly route their calls over the Internet instead Less than five years ago,

a start-up company released the first version of its software that allowed users to make free phone calls between any two computers Today, Skype is used by some 276m people to make voice or video calls, share files and send money

It has been a busy decade to keep up with This

is especially true for the thousands of companies responsible for these breakthroughs—or for those aiming to enter the telecoms market As the rate of innovation has increased, so have the pressures and demands placed on those responsible for this R&D effort Inevitably, this has forced them to change the way they work This report from the Economist Intelligence Unit, sponsored by SAS, aims to explore these changes in greater detail and the overall impact

on the innovation process Some of the key findings within the report include:

● Telecoms firms are increasingly embracing Open

Innovation The traditional R&D model in telecoms,

as in other industries, was to keep research tightly under wraps as companies developed new products

or services But this approach is giving way to a more open one, dubbed Open Innovation (OI) by business

professor Henry Chesbrough1, which instead seeks

to engage suppliers, corporate partners, academia and customers in the R&D process This extends

to intellectual property (IP), where companies profit from others use of their own ideas, while also licensing ideas from elsewhere The majority (74%) of telecoms companies polled for this report agree that the way they innovate today is significantly different from how they approached innovation a decade ago

● Open Innovation involves closer links with a

growing number of external partners Shifting

to an OI model will typically mean fostering more

of a venture-capital environment internally, while cultivating stronger links with start-up firms, academic researchers and commercial partners Over the past two years, companies typically partnered with two to five other organisations, although about one

in four tied up with just one or none at all Looking ahead, the number of those who won’t partner will decline (from 10% to less than 6%), while the proportion of those partnering with more than five other organisations will increase (from 23% to 35%) However, survey respondents also expect this to prove more expensive and labour-intensive

● …but most of all with customers Perhaps most

important of all will be the expansion of the role played by customers in OI More respondents to this survey (63%) say they have involved customers in the innovation process than any other of ten suggested approaches, including partnering with other firms, acquiring new technologies or financing a start-up Previous liberalisations of the telecoms marketplace saw first equipment manufacturing and then network services transformed by new entrants The impact of

1 Open Innovation,

The new imperative for

creating and profiting

from technology, Henry

Chesbrough, Harvard

Business School Press,

2003.

Executive summary

customers on the innovation process may prove to be

equally transformational

● But opening up the R&D process often requires

organisational upheaval Large companies with a

long history in the industry will need to revise their

organisational structures and processes significantly

if they are to pursue OI successfully Years of

upheaval have prepared many of them for this next

big change But newer, smaller companies with

less of an organisational legacy may yet prove—like

newly modernising countries with less of a legacy

infrastructure—to be keen competitors at the

innovation game R&D managers will have their work

cut out for them

● Most telecoms firms have already had new rivals

enter their market through new innovations—

or expect this to happen soon Within the

communications sector as a whole, the boundaries

between telecoms and computer software have been

steadily eroding About two-thirds (64%) of firms polled say that a new rival has entered their market through a new innovation over the past five years, with most of the balance expecting this to happen

in the next five years Just 8% don’t believe this will happen In this environment, companies are looking

to OI as a key resource—helping them to identify future revenue streams, speed up their response to technological change and come up with ideas for new products and services

Over the coming decade, technological developments

in the telecoms market will continue their rapid evolution Companies seeking a source of innovation will look to tap into ideas from all over the world

Indeed, today’s emerging markets look likely to

be a major source of tomorrow’s ideas Take based Spice, for example The telecoms firm recently introduced a mobile phone costing just US$20, in response to local customer demand Expect more innovations from unexpected places

India-Ten years ago, with projected sales for mobile

phones and anything connected with the Internet already pointing vertiginously upwards, it was still possible for leading companies

in the telecommunications industry to see secret laboratories as their ticket to the future New products were generally being kept behind closed doors, as ever, until the marketing people were ready

top-to unleash them Senior research executives might attend industry conferences for a welcome change of scene and some dutiful networking But they needed

to be wary of disclosing any proprietary information

When Nicolas Demassieux left the academic world

to join Motorola in 1997, he was surprised to find that in some cases its employees were discouraged from attending conferences at all: the risk of leaking valuable titbits, in the view of his US-based seniors, far outweighed the chances of learning anything that Motorola did not already know

Today, as director of its broadband wireless research, Mr Demassieux is one of the key figures shaping Motorola’s whole approach to technology and innovation He looks back at the late 1990s as the end of the road for the big R&D laboratories that dominated the global telecoms industry through most of the second half of the 20th century Ten years

on, he and his industry peers around the world must now work within a completely different paradigm

It is universally known as Open Innovation (OI) and has been winning converts rapidly in recent years

Adapting to it is now prompting changes in the telecoms industry that are transforming the R&D process out of all recognition—and reaching beyond it into every aspect of the business

The essence of OI is an acceptance of the need to collaborate with other parties—suppliers, academic

researchers, industry partners and perhaps above all customers—on the development of new products and services How this collaboration will work differs from one project to the next and needs constant reappraisal But the objective in every case is to harness ideas and expertise across a wider horizon than even the largest company could contemplate

on its own Matt Bross, BT Group’s chief technology officer, talks about seeking innovation “beyond the boundaries of our payroll” And where this can be fused with internal innovation, the result will be waves of successive innovations that catch up with customers’ constantly changing needs almost as soon

as they appear (or, indeed, rather sooner if needs can

be anticipated) Mr Bross likes to call it “innovation at the speed of life, not the speed of technology”

To the extent that this means innovation is led

by incremental, pragmatic adjustments rather than blockbuster inventions, the phenomenon is nothing new But OI has lifted the concept to a new level,

by bringing some of the most advanced ideas in the world’s applied research laboratories into direct and two-way contact with mass-market consumerism

In a world of universal access to computers and the Internet, millions of mobile handset-users have ideas about innovation and ways of sharing them The OI phenomenon is not unique to the telecoms business, but few others exemplify its impact so dramatically

In a sense it marks a third, climactic stage in the long-drawn-out liberalisation of the old global marketplace run by state-owned telecoms monopolies

In the first, it was opened up to outside equipment manufacturers, who transformed the hardware In the second, its networks and international cables were opened up to outside service providers, who helped

to ensure that, when the time came, the blessings of

Introduction

the worldwide web were quickly made available via

broadband to millions of ordinary customers And now,

in the third stage, it is wide open to the new ideas and

vaulting demands of those same customers

The broad consequence for industry executives is

a quantum step-up in the pace of change, bringing

increased complexity (and some additional spending)

in its wake In our survey of more than 320 executives,

74% of the respondents agree that their approach to innovation is already significantly different from the way they handled it five to ten years ago When asked about their expectations of change in the next two years, there was roughly an 80/20 split among respondents regarding pace, cost and complexity: around 80%

think change will be increasing either moderately or significantly under all of these three headings

Increase significantly Increase moderately No change

Over the next two years, how do you expect the pace, cost and complexity of researching

and developing new products/services to change?

Traditional telephone companies were large

organisations dominated by linear processes and silo-bound structures Adapting them to

the world of OI is taking time: there are many internal

barriers that need dismantling before colleagues can pool their work together and lift the boundaries between themselves and the outside world “Everyone

in the company really has to believe that the OI model

is going to work,” says Mr Demassieux

Most of the world’s large telecoms groups, both equipment manufacturers and service providers, have set off in search of new and better R&D models, with real momentum since about 2004 More than 40%

of our survey respondents estimate that over 10% of their employees are engaged on innovative projects, and a sizable minority, 23%, think the numbers

stretch to over one-fifth of the workforce A new breed

of “innovation directors” has emerged at corporate level, charged with remoulding the old structures and processes Theirs is a challenging task, however, and it has really only just begun Whatever the new familiarity of OI as a popular buzz phrase, traditional attitudes will be hard to dislodge Our survey invited respondents to indicate the extent of their R&D collaboration with outside partners across a range of seven categories Nearly 30% chose an alternative: continuing to develop new products and services entirely in-house

Leaving behind this model in favour of OI is described by Mr Bross at BT as “turning telco into softco” It is not widely expected to save on R&D costs: one-half of respondents say that they have increased R&D spending over the past two years and even more (59%) expect it to rise over the next two years, with many anticipating an increase of more than 10% Some

of the conspicuous features of the process include:

● Setting up internal “incubation units” to pursue new ideas within a kind of venture-capital environment This will provide access to funding and technical support, even though senior management knows that barely a quarter or so of the ideas, at best, will ever be carried through into commercial launches

● Being alert to start-up businesses, not just in telecoms but anywhere that a promising idea has taken off with a possible future application

in telecoms Their funding needs will invariably present opportunities for an enterprising telco

to step in as an investor or perhaps assume full ownership

From telco to softco

Developing new products/services partly in-house, but relying

on partners for some parts of this process Developing new products/services entirely in-house Developing new products/services in partnership/

collaboration with other firms Developing new products/services in partnership/

collaboration with our customers Focusing on developing concepts/architectures, while relying on partners for the rest

Relying on mergers and acquisitions to bring in new products/services Licensing intellectual property from third parties

Outsourcing all/most of our R&D to third parties Other

Which of the following approaches has your company primarily taken to develop new products/services over the past two years?

Select up to two

(% respondents)

53 28

24

18

15 13 10 4 1

Source: Economist Intelligence Unit survey

● Entering mutually supportive relationships with

applied research teams at the top universities

around the world These typically used to be

sponsorship deals for blue-sky thinking that carried

a “long-term” tag, but they are now just as likely

to be jointly managed investigations targeted

at specific problems and (or so management will

be hoping) a short-cut to clever solutions in the

near to medium term Around one-half of our

survey’s respondents acknowledge active links with

academic research

● Forming strategic partnerships with other large

companies, not just from the telecoms industry but

from adjacent sectors such as television, computer

games and publishing Our survey indicates a

big drop in the proportion of firms showing no

interest in partnerships or acquisitions over the next two years, compared with the past two years

Also, rather than ignoring intellectual property (IP) being developed by others, companies are encouraged to draw on it Equally, internal patents can be licensed to other firms as a source of revenue (rather than, as is often the case, using

it as a defence mechanism against another firm developing the same IP)

Above all, perhaps, the process involves a readiness

to accept that individuals, coming together from disparate corporate and non-corporate backgrounds, may now hold the key to the most successful brainstorming sessions BT talks about

“agile working” groups—drawing on technical, development, marketing and sales skills all in one

Case study: Telefónica’s

Internet laboratory

Young people in particular—armed with

laptop computers, mobile phones, the

power of the web and plenty of time at

their disposal—have become a potent

ingredient of any successful R&D effort

One striking reminder of this has been an

extraordinary event held annually since

2000 in the Spanish city of Valencia and

known as the Campus Party Around the

clock for seven days, thousands of (mostly

young) participants exchange ideas on

the latest crazes in computer simulation,

communications software and all things

digital The Valencia event is sponsored

these days by Telefónica, the giant

Span-ish group with telecoms businesses across

Europe and Latin America Russ Shaw was

appointed as Telefónica’s first director of

innovation in 2007 Sizing up the assorted

techno-heads attracted to the Campus Party from companies, consultancies, uni- versities and bedroom start-ups, he thinks

it “encapsulates the essence of Open vation”

Inno-He originally worked for O2, a UK mobile operator that was acquired by Telefónica in March 2006 Since then, and still branded as O2, the business has been able to harness customer feedback for OI projects over the Internet, in ways that have often surprised Mr Shaw At the start

of 2007, for example, O2 squirreled away

on its website the prototype of a proposed new mass-market product called Blue Book It has been designed to straddle mobile phones and the internet, allowing users to copy information (including photographs) off their handsets and onto their websites at the touch of a key or two

Within weeks, despite being quite hard to locate, the service attracted thousands

of experimental users By December

2007, it had 40,000 subscribers Their

comments, says Mr Shaw, have assisted O2 in numerous ways—helping, for example, to iron out some of the initial security concerns among users, which the company might otherwise have seriously underestimated in the promotion of the product (finally launched in March 2008) Another example has involved a much more structured approach to customers: in November 2007 a ring-fenced development team put “O2 Wallet” into the London market for a trial period with 500 users

It is a mobile service that includes a travel card capability for the city (under the Oyster card aegis) and a Barclaycard component The trial will last six months, and customer feedback via the internet is already prompting significant refinements

Mr Shaw sees the process as the kind of internal incubation that suits OI perfectly:

“it is all about setting up an environment in which managers can get away from the day- to-day operating business while remaining extremely close to their customers”.

room—that can bring a new dimension of flexibility

to its development programmes, delivering a better end-product faster and more cheaply that in the past

As recently as 2005, agile working accounted for less than 15% of the development prospects inside

BT By January 2008, the corresponding figure was 70% The company also taps external expertise with

“hothouse” discussions—and in deference to some of the most knowledgeable customers in the market, the company has not been slow to invite the participation

of teenagers at schools in the vicinity of its main UK research laboratories

More broadly, every teenager with a view now has the power to share it with a million of his or her

peers (see box: Telefónica’s Internet laboratory)

The Internet has left the telecoms industry with no option but to treat customers as an integral part of the innovation process Almost two-thirds of the respondents to the survey confirm that they have involved customers in the innovation process over the past two years As this suggests, Internet feedback is playing a steadily greater role in new product launches everywhere, and there is going to be no shortage of these The number of new products headed for the marketplace looks set to rise inexorably Among the survey respondents, about one in three expect to launch between seven and 20 new products in the next two years, up from about one in five over the past two years This increase exactly matches a drop among those anticipating few or no launches

None Less than 3 3 to 6 7 to 20 More than 20 Don’t know

How many new products/services did your firm bring to market over the past two years—and how many does it plan to introduce in the next two years?

(% respondents) Past two years Next two years

Source: Economist Intelligence Unit survey

Of course, people across the industry know

that OI is about much more than

last-minute market trials for emerging products

To really prove its worth, OI must help telecoms

companies to meet three principal objectives: help

find new ideas; accelerate new product development;

and create stronger links with customers

● First, it needs to stimulate fresh thinking about

future sources of revenue for an industry that has seen

the profitability of its traditional services worn to a

thread by competition: in many markets, including the

US, basic voice and data services are now increasingly

free to the end-user Telecoms firms must find ways of

linking remarkable new digital technologies to their

mass-market customer bases, through partnerships

where appropriate, or risk losing their customers to

breakthrough ideas from their rivals, which include

some of the most innovative companies on the planet

The danger is evident already in the extent to which

the boundaries of the traditional telco sector are

being blurred In the survey, about two-thirds (64%)

of respondents say that, within the past five years,

they have seen firms entering their marketplace for

the first time on the back of a new innovation, and the

survey garnered plenty of examples, such as Apple’s

entry into the mobile handset market

● A second main objective of OI is to accelerate the

whole business of turning blue-sky thinking into

marketable products and services The rationale

for good old-fashioned joint ventures has always

included a sharing of costs and a pooling of ideas, but

an added dimension of OI is the way that non-linear

processes might be used to move the whole R&D effort

along much more quickly The fundamental research

underlying today’s leading-edge products often dates back decades For example, the coding technology

at the core of the mobile communications standard, CDMA, was originally a military technology designed during the second world war Contrast this with the range of life cycles assigned by survey respondents

to their average product: a bell-curve distribution runs from less than three months to over three years, with the median cycle lasting 12-18 months When asked about the future trend, one-half expect to see life cycles shorten further in the next two years and one-fifth of respondents think that they will shrink

by at least 30% Mr Demassieux at Motorola says it

is hard to see how the time needed to establish a basic communications standard like 3G could ever be compressed to much less than ten years “But we must learn as an industry how to use OI to help us reduce the gestation period on new product ideas from 10-15 years down to three years or less.”

Raising the bar

Less than 3 months

What is the average amount of time it takes for your firm’s products/services to reach the maturity phase of their lifecycle

in their particular market?

(% respondents)

2

9

16 16

21 14

9

6 7

Source: Economist Intelligence Unit survey

● The third main objective is that OI must help companies to identify what Russ Shaw, director of innovation at Spanish telecom group Telefónica calls “differentiated customer experiences” This is where a much expanded role for customers in the innovation process might bring real dividends for the marketing department As ever, they are looking for new products that offer far more than just a lower price or even a better route to “convergence”—the

merging, that is, of hitherto separate services The marketing folk want to find new products with which customers will develop some emotional affinity It has happened in other high-tech markets: witness the way in which businesspeople especially have come to identify so strongly with a branded product such as RIM’s ubiquitous Blackberry OI will really prove its mettle if it can help to lead to this kind of breakthrough

Strongly agree Agree Neither agree nor disagree Disagree Strongly disagree

To what extent do you agree or disagree with the following?

Adopting OI with these goals in mind, however,

is simply not compatible with the risk-averse

culture that characterised the old telecoms

industry when so much of it was berthed alongside

national post offices For many managers, perhaps

most, the learning process is only just beginning They

will need, for instance, to contend with the difficulties

of handling far more partners at the same time,

juggling different timelines and conflicting priorities

They will face HR problems in the workplace, where

younger engineers will inevitably adjust to an

outward-facing (and heavily Internet-influenced)

culture rather more easily than will most of the

greybeards And in place of the old assumption that

nothing would be sourced externally that could be

made in-house, they will have to confront some tricky

make/buy decisions over the R&D budget—not least in

persuading in-house engineers to part with money for

research by third parties

In fact, novel make/buy decisions will crop up

at every point of the value chain as the switch to OI

gathers pace The essence of a more open approach

is that successive collaborative projects will need

handling in different ways Every corporate function

from finance and marketing to the management of

intellectual rights and corporate communications

will therefore need continuous reassessment This

prompts many people in the industry to observe that

“innovation” is not just about the introduction of new technology As Mr Bross at BT puts it, “the innovation genie is out of the bottle” In the survey, respondents were asked how far innovation would actually amount over the next two years to a refinement of existing business processes Almost 50% see it being “strongly focused” in this direction, a notable shift from the 29% who think the same is true of the past two years

Accordingly, there is strong endorsement for the view that business-process innovation would be increasingly important over the next two years

But then, standard business practices have been under pressure from all sides and not just from a need

to rethink R&D methodologies With a rising portion of income derived from mobile advertising, for example, many firms have needed to revise their basic revenue model: 58% of respondents agree that they have done

so in the past two years or would be doing so in the next two In short, no industry is more exposed than telecoms to the need for that fundamental break with past organisational norms that is now being so much discussed in management circles As the strategy guru, Gary Hamel, puts it in the first 2008 edition of

The McKinsey Quarterly2, “The Internet is making it possible to amplify and aggregate human capabilities

in ways never before possible … [so] we’re going to have to turn a lot of our legacy management beliefs

on their head.” But does this mean that younger

2 The McKinsey Quarterly,

McKinsey & Company, 2008.

Today new technology, tomorrow a new organisation

Strongly focused on Somewhat focused on Little or not at all focused on Don’t know/

refining business processes refining business processes refining business processes Not applicable

To what extent is innovation at your firm focused on refining existing business processes (eg, enhanced billing process)

or developing new business processes?

(% respondents)

Past two years

Next two years

Source: Economist Intelligence Unit survey

companies with less of a legacy to worry about might enjoy a lasting advantage? Given the heavily structured nature of the traditional telco and the appearance of so many sprightly new competitors since the 1990s, it is a potent question for the industry.

Those inside the biggest global groups can make

a fair case that the fixed-line business model has been under threat for so long that their teams are now well and truly open to new ideas Some smaller mobile operators, by contrast, have yet to see their core voice and SMS traffic volumes peaking: their businesses, it is implied, are less flexible than some outsiders might suppose And along with their legacy management beliefs, most of the big groups have

of course inherited plenty of cash They can use it to speed the realignment of their organisations, not least by purchasing successful mobile operators No doubt acquisitions will go on being used to perk up the innovation score sheet, especially where they might bring direct benefits to the bottom line as well as bright ideas As Mr Shaw confirms, “If, in the process of looking for venture-capital targets, I come across a company that has a more efficient way of delivering an existing service, I’m certainly going to take a closer look.”

We already did so more than two years ago Yes, we did so in the past two years Yes, we plan to do so within the next two years

We are considering this, but have no plans to do so right now

We have not changed our model and don’t plan to do so right now

Has your company revised its revenue model over the past two years, or does it plan to do so within the next two years, to reflect the rapidly changing telecommunications landscape (eg, switching to an ad-based revenue model)?

(% respondents)

9

31 27 14

9

Source: Economist Intelligence Unit survey