Communications Newsalert

18 November 2009

Welcome to the second issue of our PwC NewsAlert. This issue informs you of the most recent developments in the domains of tax, performance improvement and regulatory and compliance issues. There is also news of our upcoming business events.

• Margin Enhancement
  Today’s new, converged world of products, services, technologies and networks is far more complex than anything communications operators have experienced to date. In addition, the economic environment is one in which the market outlook is cloudy, margins have shrunk or are continuing to shrink, and competition is fierce. Read more
  
• The EU VAT package: Are you ready?
  The VAT Package will come into effect on 1 January 2010 and brings significant changes to key areas of the VAT legislation. Virtually every business that engages in international trade stands to be affected, including those making or receiving 'management' charges or inter-company recharges involving EU entities. Read more
  
• Content-Based Billing: Recent developments in Belgium
  In the first issue of the PwC Communications NewsAlert, we focused on the VAT treatment of ‘content’ sold via premium rate numbers (aka “content billing”). As announced, there will be significant changes to the Belgian tax regime applicable to the sale of content via premium rate numbers or other means of telecommunications. The Belgian tax authorities are currently finalising two practice notes in this respect, one in respect of the new VAT rules and a second on gaming tax. The publication of these practice notes is expected any day now and the new rules are expected to enter into force as from 1 January 2010, possibly with a transitional period to allow system and legal changes. Read more
  
• Combined offers: Where do we stand in Belgium?
  In its decision of 23 April 2009, the European Court of Justice ruled that the general Belgian prohibition on combined offers to consumers is contrary to European law. The only combined offers that can be prohibited are those that qualify as unfair trade practices given the specific circumstances of the offer. Read more
  
• Belgian MVNO market
  Mobile Virtual Network Operators are mobile communication companies that provide services to their end-customers using the network of another mobile operator. Depending on the level of investment made by the MVNO in own (core) network equipment and service-offerings, a distinction can be drawn amongst MVNO SPE, MVNE and Full MVNO. Read more
  
• Now available! Communications Review, Volume 14, No. 3, Striving for Efficiency
  This issue focuses on how operators can rethink their business models and strategies to achieve the highest possible efficiency at the lowest risk. Articles focus notably on simplifying the operating model so companies can be more responsive and nimble; developing and refining existing analytical tools to deliver granular insight into profitability at multiple levels.
  If you would like to receive this quarterly publication, please send an e-mail to: sophie.van.durme@pwc.be.
  Download the publication
  
• Upcoming business event: Register to our Communications Forum on 11 December!
  After a few months’ break and a beautiful summer, we are pleased to invite you to our next Communications Forum at the PwC offices in Brussels on Friday, 11 December. This seminar will mainly deal with a number of aspects of “Revenue Assurance” (billing, VAT and tax aspects, revenue control, etc.). To register or for further information: www.pwc.com/be/en/events/communication-forum-09.jhtml!

 
Margin Enhancement

Today’s new, converged world of products, services, technologies and networks is far more complex than anything communications operators have experienced to date. In addition, the economic environment is one in which the market outlook is cloudy, margins have shrunk or are continuing to shrink, and competition is fierce.

Therefore, even operators that consider themselves advanced in the areas of revenue assurance will need to prepare for a whole new set of challenges such as voice over IP, data products, video products and associated licensing/royalties, advertising models, applications such as games, and billing these new services in bundles.

These new challenges cannot be addressed by focusing on tracking CDRs from switch to bill. In the new world, operators will have to track the game played, the video viewed, the specific on-demand service accessed, the type of delivery device (TV, mobile device, etc.), the charging mechanism, revenue-share partners and amounts, licences/royalties due, “billing on behalf of” relationships and advertising relationships.

The risks do not stop there. Although the shared nature of IP is an enabler for convergence, it is also one of the largest areas of vulnerability, with identity theft, information theft and service disruption at the top of the list. In addition, internal IT and Technology departments must be trained to ensure that internal systems and processes are also secure.

To seize this opportunity, operators need to reverse the corporate mindset of revenue leakage from a “cost of doing business” to an “opportunity for profit growth and margin improvement”. By taking this non-traditional view, operators can use revenue maximisation to achieve competitive advantage. However, operators must act fast if they are to be proactive in addressing these new risks and challenges and not later “play catch-up”, leak revenue and/or overpay costs.

 
The EU VAT package: Are you ready?

The VAT Package will come into effect on 1 January 2010 and brings significant changes to key areas of the VAT legislation. Virtually every business that engages in international trade stands to be affected, including those making or receiving 'management' charges or inter-company recharges involving EU entities.

Those businesses that do not respond to these changes appropriately or in time could face significant compliance headaches (or worse, financial penalties, reputational risks or customer dissatisfaction) when they realise that there is not sufficient time to make the necessary changes to their business, systems, processes and/or operating structure before 1 January 2010. They may also miss out on cost-reduction and cash-improvement opportunities that arise, or conversely risk significant new VAT costs if certain steps are not taken.

The changes can be ranged into four main areas:

• Change in VAT place-of-supply rules for cross-border business-to-business (B2B) supplies

  From 1/1/2010, the rules for determining the place of taxation of international services between businesses will change.
  The new general rule for B2B services will be the place where the business customer is established, whereas for B2C services, the general rule remains unchanged, i.e. where the supplier is established.
  The VAT Package will also introduce a generalised reverse charge mechanism for cross-border B2B services in which the place of taxation is shifted to the recipient.
  As a consequence, the range of services that will be deemed not to be subject to local VAT when supplied internationally will increase.

• Intra-EU reporting obligations for services

  The VAT package will introduce intra-EU reporting obligations for all supplies of services to which the reverse charge applies (except where the supply is exempt in the Member State of the recipient).

• New 8th Directive refund procedure

  The existing mechanism under which EU businesses can reclaim VAT incurred in Member States where they are not established for VAT purposes will be reformed. The new system will include: electronic filing, a detailed timetable for processing refund applications and the right to interest on overdue refunds.

• Special scheme for electronically-supplied services (ESS)

  From 1 January 2015, B2C supplies of telecoms, broadcasting and electronically supplied services will be subject to VAT in the country where the consumer is established. Suppliers will be able to use a 'one stop' scheme that enables them to fulfil their VAT obligations in their home Member State in respect of services provided in other Member States where they are not established.

What action do businesses need to take now?

1. Business change assessment

   Businesses need to undertake a full impact assessment of the changes to identify the transactions, processes and controls affected by the new rules, and assess whether their billing, accounting and ERP systems are able to cope with the changes.

2. Monitor implementation of the new rules across the EU

   Businesses also need to keep track of how the new VAT Package rules are being implemented across the EU Member States in which they operate, and how they will affect them.

3. Implement solutions to deal with new compliance obligations

   In order to mitigate commercial risk and minimise disruption to business, businesses will need to implement solutions to ensure they are able to meet the future compliance obligations. This will require them to review their existing supplier and customer contracts as well as their client-acceptance procedures.

4. Systems reconfiguration (including staff training)

   The VAT Package changes will have implications for a business's existing billing, accounting and/or ERP systems and processes. Both sales (AR) and/or purchases (AP) may be affected by these changes and work will need to be undertaken to amend tax code structures/tax configuration tables and invoicing details to make sure that systems are compliant with the new rules as well as being able to produce the new reports required.
   
   Staff may also need to be trained to ensure they are familiar with both the new rules and the new systems/processes.

 
Content-Based Billing: Recent developments in Belgium

In the first issue of the PwC Communications NewsAlert, we focused on the VAT treatment of ‘content’ sold via premium rate numbers (aka “content billing”). As announced, there will be significant changes to the Belgian tax regime applicable to the sale of content via premium rate numbers or other means of telecommunications. The Belgian tax authorities are currently finalising two practice notes in this respect, one in respect of the new VAT rules and a second on gaming tax. The publication of these practice notes is expected any day now and the new rules are expected to enter into force as from 1 January 2010, possibly with a transitional period to allow system and legal changes.

Under the current regime, invoice flows are consistent with financial flows. The premium price is deducted from the prepaid account or billed to post-paid customers, together with the price for basic telecom services, Belgian VAT being charged (mostly at 21%) irrespective of the legal capacity of the operators or the nature of the content sold.

The main objective for the VAT authorities in changing their existing position is to align with the VAT position on prepaid cards and combat fraud offences by content providers.

Under the new regime, the basic principle will be that the invoicing scheme for premium services must be in accordance with the operator’s legal capacity and the type of premium services for which charges are passed on.

When a customer uses his telecom bill or prepaid card to pay for third-party content, the VAT can therefore be handled in two different ways:

• Above the line: the telecom operator acts as the principal (branded content) or as an undisclosed agent (3P content) towards the end-user. The telecom operator collects the VAT due from the end-user and transfers the VAT collected to the VAT authorities. On the telecom bill, the content is placed above the VAT line.
• Below the line: the telecom operator acts as an intermediary for payment and service delivery (disclosed agent, i.e. acting in the name and for the account of the content provider or the connectivity provider). The content provider or connectivity provider is the principal, collects the VAT due from the end-user and transfers it to the VAT authorities. On the telecom bill, the content is placed below the VAT line.

The new tax regime also includes the application of gaming tax, a subject that will be dealt with in a separate practice note. As a principle, games of chance that are offered via telecommunications will be subject to gaming tax and exempt from VAT without any credit (section 44(3)(13°) Belgian VAT Code). Gaming tax (15% in the Flemish and Brussels Regions and 11% in the Walloon Region) is due by the organiser on the gross amount of the wager, but can be collected from each intermediary in the supply chain.

From a business perspective, the adjustments to the current invoicing scheme could limit operators’ tax-liability risks. The new VAT regime also holds out certain business opportunities, notably when selling premium services that are subject to reduced VAT rates.

These new rules will affect not only the applicable VAT treatment (VAT rate, etc.), but also commercial relations between the different players in the supply chain. All areas of the operator’s ‘internal’ organisation (billing, marketing, legal, IT, accounting and collection) will be impacted.

In the end, content-based billing is not so much about the billing as management of the processes to present the same to the billing system. And that is where the real value lies.

 
Combined offers: Where do we stand in Belgium?

In its decision of 23 April 2009, the European Court of Justice ruled that the general Belgian prohibition on combined offers to consumers is contrary to European law. The only combined offers that can be prohibited are those that qualify as unfair trade practices given the specific circumstances of the offer.

As a result of this court decision, the trade practice of combined offers is in principle no longer prohibited in Belgium.

The Court’s decision raises interesting questions as to how the Belgian prohibition will be applied by the courts pending a change in the legislation.

Moreover, the question arises whether other restrictive provisions in the Belgian law on trade practices, such as the provisions on announcements of price reductions and sales at a loss, can be maintained in the light of this ruling.

A legislative initiative to amend the Belgian Trade Practices and Consumer Protection Act is in preparation but the timing of its publication is uncertain. A bill has gone up to the Legislative Consultation Commission (Conseil d’Etat/Raad van State) for guidance. Although the text of the bill is not currently available, one of the important changes is thought to concern substantially more flexibility in the price-reduction regulations.

On a European level, no new legislative initiatives are expected in connection with combined offers.

 
Belgian MVNO market

Mobile Virtual Network Operators are mobile communication companies that provide services to their end-customers using the network of another mobile operator. Depending on the level of investment made by the MVNO in own (core) network equipment and service-offerings, a distinction can be drawn amongst MVNO SPE, MVNE and Full MVNO.

Looking back over the past five years, the three classic MNOs’ total service revenues peaked in 2006 and decreased by slightly over 4% over the period 2006-2008. The combined cash flows of Belgacom Mobile, Mobistar and KPN Group Belgium even crumbled by almost 6%. During this period, general inflation averaged 2.5%. Although volumes for voice and SMS – still today’s cash-flow generators – increased significantly, the 30% retail-price erosion in mobile communications from 2006 to 2009 supports the “price-inelastic demand curve for mobile communication services” thesis.

Compared to the classic Belgian mobile market, total revenue generated by more than 50 MVNOs represents only a 5% market share. Growth of this segment in general stalled at about the same time as for the three MNOs. The main difference between them is the sharp fall in the profit margins of the larger MVNO players. Compared to the relatively comfortable 25% profit margin of Mobistar and KPN Group Belgian and even the luxurious +35% of Belgacom Mobile, the larger MVNOs saw their profit margins deteriorate to single-digit figures, some even ending up considerably negative. This may turn out to be a dangerous situation for smaller companies that have not been able to build up a strong cash position.

Although some MVNOs exceeded their initial business-case assumptions in terms of customer uptake and revenue per subscriber, net profit margins have rarely been impressive due to the low bargaining power that results in less-favourable wholesale agreements with their Host Network Operators. This is reflected in the increase in the cost of service as income from services increases. Given that these MVNOs have not invested such large amounts in own equipment as the big three MNOs, it has enabled them to continue in business, at least as far as the majority of the players are concerned. This may change in the future. Whereas classic mobile operators had to grow as quickly as possible to obtain critical mass for payback on their major investments in an expensive core radio network, MVNOs are strongly attached to volume-based wholesale contracts under which almost every minute used by their end-customers has to be bought wholesale.

Already in the last two to three years, the effect of increased price competition has caused some casualties amongst the financially weakest MVNOs. These have then been acquired by the stronger players but, as a result of the heavy impact of the wholesale agreements, only limited benefits of scale could be realised and hence the takeovers have not resulted in a material improvement in profit margins for the acquiring companies.

At present, there are still some MVNOs on the market that have generated value for their investors. In the near future, however, certain market developments may cause the sword of Damocles that hangs above them to finally drop.

What might these be?

First, a second fully integrated telecom player may appear on the market. So far, MVNOs have enjoyed the possibility of offering all types of communication services by setting up wholesale agreements with different networks for mobile and fixed telecom, internet and television services. The only market player today that has all the necessary infrastructure in its own property portfolio is Belgacom. There will not probably be any entire new company to enter the quadruple play market, but it is likely that expansion in the offering of one of the existing large operators could pose greatly increased competition for quadruple and triple-play customers. Recently, Telenet announced a new wholesale agreement with Mobistar to offer mobile services to its large customer base by setting up a Full MVNO. Mobistar and KPN Group Belgium could possibly acquire another market player to expand their current portfolios. If this results in a short but fierce price war, most MVNOs could be severely hit.

Second, regulation on wholesale rates to increase competition in the mobile communications market may have short-term negative impacts on MVNOs before the long-term benefits come through. One of the important revenue sources for an MVNO is the kickback it receives from its HNO when its customers receive calls. As European legislation is pushing for equal mobile termination rates within a single country, a significant rate cut is to be expected in the near future for all mobile operators in Belgium, and in particular for KPN Group Belgium.

So what can MVNOs do to escape this sudden-death game?

In order to be better armed against increased competition, MVNOs should reduce their dependence on expensive wholesale agreements. They should therefore continue negotiating with their HNOs. Unfortunately, MVNOs lack sufficient bargaining power to achieve significant results from this strategy. The customer base of most MVNOs is relatively small and SIM swap costs for changing Host Network are expensive when they include the costs of increased churn after swapping. Although takeovers and mergers have had no material impact on the profitability of MVNOs in the past, they could help them gain bargaining power once the subscriber base reaches a few hundred thousand subscribers. At that point, their bargaining power will have increased and they will be able to cope with the effects of a SIM swap. Once a few MVNOs have grown to this size, they may even become attractive targets for the classic MNOs. If a classic MNO bought an MVNOs hosted on another MNO, this could generate great added value for the shareholders of the MVNO since the MVNO customer base is much more profitable when there is no longer a wholesale agreement transferring an important share of the profits to the HNO. The difference in gross service margins between MNOs (at approx. 45%) and MVNOs (at approx. 10%) is a very substantial 30-35%. This would make the customer base of the MVNO (hosted by another MNO) up to three times more valuable to the buying MNO than to the MVNO itself.

Alternatively, or in addition, MVNOs may look for technological alternatives to the GSM networks they currently rent. Recently, Cherry Telecom announced the launch of a mobile service using WiFi. As approximately 30% of communications are made from home and another 30% from the office, this could have a strong positive effect on the company’s influence when it comes to a prize squeeze on the Belgian retail market. Both of the measures mentioned above are only mid- to long-term strategies, which should probably have already been initiated in order to be effective. The least MVNOs should try is to negotiate a natural hedge for wholesale and retail prices with their Host Network Operators. 

Over the next three to five years, a dispersed MVNO market in Belgium will probably be reduced to a handful of MVNOs with only a limited market share as the market shares of traditional MNOs converge in terms of customer numbers. 

Now available! Communications Review, Volume 14, No. 3, Striving for Efficiency

This issue focuses on how operators can rethink their business models and strategies to achieve the highest possible efficiency at the lowest risk. Articles focus notably on simplifying the operating model so companies can be more responsive and nimble; developing and refining existing analytical tools to deliver granular insight into profitability at multiple levels.

If you would like to receive this quarterly publication, please send an e-mail to:  sophie.van.durme@pwc.be.

Download the publication

Upcoming business event: 
Register to our Communications Forum on 11 December!

After a few months’ break and a beautiful summer, we are pleased to invite you to our next Communications Forum at the PwC offices in Brussels on Tuesday, 11 DEcember. This seminar will mainly deal with a number of aspects of “Revenue Assurance” (billing, VAT and tax aspects, revenue control, etc.). To register or for further information: www.pwc.com/com/be/en/events/communication-forum-09.jhtml! 

Best regards,