DT-FT chase EUR1.3bn purchasing synergies
25 May 2011
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DT-FT chase EUR1.3bn purchasing synergies
Deutsche Telekom (DT) plans to establish a major procurement partnership with France Télécom (FT), commencing in the fourth quarter of 2011. The pair predict annualised savings of around EUR1.3bn, after three years (presumably meaning from the 2015 fiscal year), which they envisage being extracted through a combination of “technology harmonisation [standardisation], and economies of scale” and best practice sharing.
Starting with pilot projects, four areas are being targeted:
- Customer equipment.
- IT infrastructure.
- Network equipment.
- Service platforms.
While the move was generally welcomed by analysts, though not necessarily always for positive reasons (‘better than a merger’), there was scepticism around the likelihood of the joint venture (JV) being approved or delivering on promised savings.
At least one analyst, James Britton of Nomura, questioned whether the announcement should be treated as materially significant, since the partners opted to brief the media but not the financial community.
However, in the company’s subsequent, 6 May 2011, Q1 FY11 results call to analysts (see separate report), René Obermann, DT’s Chief Executive, confirmed that the venture is an element of the Group’s efficiency drive, which is designed to help combat its “revenue pressures”. He highlighted expectations that the venture will “further increase… efficiencies for capital expenditure”.
Targeting savings of EUR1.3bn; initially sharing the spoils
The projected savings are skewed towards FT, perhaps reflecting disparate current efficiency or ambition, with DT merely projecting medium term savings of “above EUR400m”, in contrast to FT’s “below EUR900m”. Addressable spend has variously been put at EUR12bn-EUR13bn, indicating that savings of 10% are being pursued. These figures exclude T Mobile USA, which is now treated by DT as a discontinued operation.
The focus appears to be on relatively quick wins, with the companies’ combined total procurement estimated at around three times the venture’s addressable spend, giving potential to expand the remit in future. The three year ramp appears related to time entailed for existing contracts to expire, but annualised savings of EUR650m are targeted by mid 2013, according to Olaf Swantee, Executive Vice President, Europe & Sourcing at FT, apparently citing projections from external analysis.
During the first three years, savings secured from network equipment procurement will be “balanced out”, possibly identifying this as the area considered to offer the greatest immediate gains. Worryingly for vendors, this should also motivate each partner to extend their best deals, since each will share in the other’s savings. While squeezing suppliers was implicit in the press release, the accompanying media presentation was blunter, stating that the “purpose is to help DT and FT achieve a more competitive cost position by aggregating demand to vendors, aligning conditions to the best price already obtained by DT or FT”.
” A ‘benefit sharing compensation’ will be paid by either company to the other, in order to partially balance both companies’ actual savings from alignment to best price in network equipment in the first three years of the JV operations. “ — Media presentation.
To maximise the JV’s effectiveness, the partners will need to share strategic and long range planning, and navigate restrictive existing supplier agreements. This will require a high degree of trust and intimacy, which could unsettle regulators, disconcert vendors, and fuel thinking that a full DT FT merger is simply a matter of time.
” Nothing motivates like money, and the goal of securing EUR1.3bn in annualised savings by 2014 will certainly give strong impetus to the joint venture. What is more, the procurement plans announced today only cover the one third of the two groups’ combined annual spend of around EUR40bn that is deemed ‘immediately accessible’, a sure sign that there is scope for additional synergies further down the line. ”
– Thomas Wehmeier, Analyst, Informa.
The implication from the unbalanced medium term savings is that DT currently has more effective procurement. This could simply reflect relative scale, with DT’s FY10 revenue (EUR62bn) 26% larger than FT’s (EUR46bn). However, disposal of T Mobile USA might act as an equaliser, and be incentivising DT to bulk up its procurement.
In a formal statement, Swantee focused on sourcing, and “more effective partnerships with suppliers”. His counterpart at DT, Edward R. Kozel, Chief Technology and Innovation Officer, dwelt on the growing investment demands from data and addressing the digital divide.
” With France Télécom Orange, we have an experienced and trusted partner who shares the same approach regarding economies of scale as well as customer benefits in technology harmonisation. ”
” There is just an obvious financial opportunity on the table… because of the fact that the two companies are in almost completely separate markets, but we have such large commonality of equipment for both network infrastructure and terminal equipment. ”
– Kozel.
Operational structure — bipartite procurement subsidiaries
The JV will be equally owned by DT and FT, with two exclusive local procurement subsidiaries, in Bonn and Paris, each staffed by specialist staff drawn from the local incumbent. Seemingly, these local hubs will operate at arm’s length from each other, with orders and payments handled directly by each partner.
Media reports indicated the venture will have 200 staff, and involve EUR35m in set up costs. The venture will be funded on a ‘cost plus’ basis, with each parent supplying two board directors.
The partners will channel their requirements to the JV, which will negotiate framework agreements on their behalf. This apparently federated arrangement bears some resemblance to a purchasing consortium, potentially reducing strategic benefits and deeper synergies.
Evolution of the venture was mapped out in three phases:
- Short term: ensure both partners are benefiting from best prices.
- Medium term: ‘harmonise specifications’ and ‘aggregate demand’ across DT and FT, to maximise economies-of-scale.
- Long term: ‘upgrade relationships’ with strategic suppliers, to exert ‘greater influence’ over standards and innovation, and share benefits of cost reduction.
” The two industry giants alluded very clearly to the prospect of their strategic suppliers being able to use this change in procurement strategy both as a way to develop more proactive and deeper relationships, but also as a way to sell more efficiently to the operators themselves. A key aim is to speed up the process of bringing innovation to market, whether that’s in the form of new technologies, devices, or services, and that can only be achieved by agreeing contracts built on mutually acceptable terms. ”
– Wehmeier.
Subject to approval
Creation of the joint venture is subject to a number of hurdles, including respective board level and antitrust approval, and “talks [underway] with unions and its social partners regarding the necessary set up processes”. When announced, the partners had signed a non binding term sheet.
According to the Financial Times, citing Kozel, the venture could still proceed, even if regulatory approval is not received for all markets.
The partnership has been presented as an output of “bilateral exploratory talks” between the telcos, which followed the February 2011 Smart Industry announcement that the pair seek to collaborate in various areas, including:
- Equipment standardisation.
- Cross border machine to machine (M2M) services. This includes a four market co operation covering Belgium, France, Germany, and Luxembourg.
- New growth business development areas, namely: home media servers; cross-border e health; connected cars; in car entertainment; and video content and enablers.
- Radio access network sharing in Europe.
- Wi Fi roaming.
Following in Telefónica and Vodafone footsteps
When presenting the rationale for the venture, the partners highlighted centralised and cooperative purchasing arrangements of rival European groups (or ‘global peers’):
- Vodafone Procurement Company (VPC), 2008. Not mentioned was VPC’s Luxembourg domicile (and inherent, controversial pursuit of tax efficiency), wider reach (encompasses roaming and outsourcing), and China Sourcing Centre.
- Telefónica Global Sourcing, 2009. Based in Munich, Germany. Additionally, Telefónica’s cooperative procurement with China Unicom.
Also emphasised was global vendor consolidation, notably for customer and network equipment, including handsets. Together, the partners are said currently to buy around 45 million smartphones a year.
” There’s still an overwhelming requirement for consolidation in Europe, and operators are struggling to achieve that. It’s positive that they’re [DT and FT] trying to achieve the same benefits of scale in a way that’s short of a merger. ”
– Will Draper, Analyst, Espirito Santo Investment Bank.” It’s not a bad idea, though savings wouldn’t be huge for either company, and it would be difficult to later attribute any savings to this venture. I’m also not so sure they will be able to push down costs in the huge market for smartphones. ”
– Heinz Steffen, Analyst, Fairesearch.
The perfect couple
Conspiracy theorists, envisioning an impending DT FT merger, would dwell on the justification for the partners choosing to work with each other:
- Little overlap — just five-out-of-50 geographic markets.
- Comparable purchasing mix, spend, and maturity of procurement processes.
- ‘Cultural fit and track record of successful partnering’ (Everything Everywhere and network sharing were flagged, with the tie up in Austria revealed subsequently — see separate report).
However, in a recent interview with the Wall Street Journal, FT Chief Executive Stéphane Richard, promoted further partnership with DT, such as infrastructure sharing in Austria, Romania, and Slovakia, but denied any pending merger plans.
” We do not view this as a precursor to a merger, as this deal gets both companies many of the benefits without the downside risks. ”
– Robin Bienenstock, Analyst, Sanford C Bernstein.
[Further reference: Deutsche Telekom and France Télécom Orange to explore potential areas of cooperation for customer benefit -- FT, 11 February 2011; Deutsche Telekom, France Télécom set up purchasing venture -- Bloomberg, 18 April 2011; Deutsche Telekom and France Télécom agree joint procurement venture -- telecoms.com, 18 April 2011; Deutsche Telekom and France Télécom Orange to form procurement joint venture -- FT, 18 April 2011; DT and FT will form a 50/50 procurement JV to achieve a more competitive cost position -- analyst presentation; DT and FT, 18 April 2011; Telecoms groups team up on procurement -- Financial Times, 19 April 2011; Analysts on the fence about France Télécom, Deutsche Telekom joint venture -- Satellite News, 20 April 2011; France Télécom hunts for ways to raise revenue -- Wall Street Journal, 27 April 2011.]
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