Even in Era of Competition, Bezeq Still King of Communications Sector

Telecom leaders realigning since market reforms began in recent weeks ahead of May 17 restructuring

Bloomberg

About 15 years ago, Bezeq, which dominated the telecommunications market at the time, waged another in its many battles against the Communications Ministry. As usual, the issue reached a Knesset committee, and Knesset members were forced to decide whether to hurt Bezeq and encourage competition or leave the situation alone.

The usual ritual repeated itself. A large group of representative of the Bezeq workers’ union showed up at the entrance to the Knesset committee room and saw to it that all the Knesset members understood how they should vote. The union representatives quietly reminded the MKs that their primaries were soon approaching and the workers would remember how they voted.

Needless to say, at the end of the session, Bezeq again came away with what it had wanted. The workers’ committee, which had wisely put its own people in the central committees of the major parties, didn’t conceal its pride. “They should learn to be afraid of us,” said one workers’ representative.

And that’s how Bezeq, in its prior incarnation, managed to navigate attempts to reform the communications sector. The regulatory climate around the world adapted to advances in technology, but in Israel, everything was happening slowly.

In 2005, Bezeq was privatized, even though the Communications Ministry hadn’t managed to eliminate the monopoly that the company had, but since it became a private company rather than a government-held one, the company has changed. Its militant workers’ committee understood that it wouldn’t be able over the long term to fight technological changes, so it changed its strategy. Instead of fighting Bezeq’s management, it joined forces with it, and managed in the process to reap a piece of the company’s profits for the workers.

The first set of management at Bezeq after privatization, with Jacob Gelbard at the helm, continued to exercise its monopoly power and aggressively pressured the regulators. The change began in 2006, when Avi Gabbay become the company’s CEO and Bezeq shifted direction, becoming as one senior communications executive put it, a “friendly monopoly.”

A friendly monopoly doesn’t exploit its power through stagnation and paralyzing the entire market. Instead, it attempted to advance as quickly as possible to maintain its standing in the marketplace, which was slowly becoming more competitive. Beginning in 2009, it invested in increasing the speed of the Internet service it was offering and in upgrading its infrastructure.

It also avoided any kind of reputation for bad customer service by investing in customer service and a professional team of technicians who knew how to take care of the company’s major asset, its line-based communications network, both Internet and telephone. It periodically handed customers higher Internet speeds at no charge and managed to gradually and cautiously quell antagonism for the company.

It should be added that the so-called competitive field in which Bezeq operated provided assistance in rebuilding the company. There were cellular service providers on one hand and HOT, which initially built its business around cable television service, on the other, who stepped in as the targets of the public’s hatred.

Even though Bezeq was friendlier than the Israel Electric Corporation or the banks, it was still a monopoly. HOT did in fact eat into Bezeq’s market share, but the profitability of line-based communications – telephone and Internet – remained phenomenal. Competition may have seemed to erode its market share, but it didn’t bring about a significant drop in consumer prices, instead mostly resulting in Bezeq and HOT splitting the profits.

Bezeq underwent a quiet but massive streamlining process and, quarter after quarter, reported increased profits from its line-based operations, until its earnings before interest, taxes, depreciation and amortization reached an all-time high of 63% of revenues. No Israeli communications market, and for that matter, no market abroad, shows such profit levels.

But everything changed within just the last couple of weeks.

The people at Bezeq knew that this day would come, but this time, the company doesn’t have an aggressive workers’ committee with connections to protect it. It now has to face the day on which its network is being opened to competition but, since Bezeq was privatized, it has also distributed 21. 5 billion shekels ($5.4 billion at current exchange rates) in dividends to its shareholders and more than a billion shekels in perks to its workers. With such profit levels, Bezeq doesn’t have many defenses at its disposal in the face of the regulators.

1. Will it be easy to switch providers?

The key to the new reform in the line-based market is mobility, meaning the ease with which customers can leave their current provider for a competitor. The ease of mobility among cellular service providers is the real reason for the sharp drop in prices and the stiff competition in that sector. In 2013, about 3.1 million Israelis switched cellular providers, twice the rate in 2009. So it’s no coincidence that the Communications Ministry is now focused on the process of switching Internet service from Bezeq to competitors, and as a result of ministry pressure, it looks like switching will be easier than changing mobile phone service providers, so stiff competition in the line-based sector is expected.

2. Will Internet connection prices drop?

One can assume that the current 100-shekel monthly cost for 100 megabits per second Internet service is not going to stay with us indefinitely. (Up to now, Internet infrastructure and the connection to an Internet service provider were separate). After May 17, when the process of leaving Bezeq will be automated, the real marketing efforts by competitors will start and prices are expected to drop further. Golan Telecom’s foray into this market sector is expected to inject further price pressure.

3. How will market share be divided?

That’s a critical question, as is the proportion of Bezeq’s infrastructure that it will sell to competitors on the wholesale level. It is expected that within three to five years, almost all consumers will have shifted from purchasing Internet infrastructure and the services of an Internet service provider (ISP) separately to buying it all in a single package.

Currently the ISP market is roughly evenly divided among three major providers – Bezeq International, 012 Smile and Netvision. When it comes to Internet infrastructure, Bezeq has about 65% of the market, while HOT has about 35%.

HOT can rather easily retain customers by offering them additional services (cable television or telephone). But about 200,000 HOT customers only purchase Internet infrastructure from the company, so other ISPs are expected to court them to have them switch to another company that uses infrastructure that the companies lease from Bezeq. As long as HOT isn’t actively involved in the wholesale Internet infrastructure market, leasing its lines to Internet service providers, it is liable to lose up to about 5% of market share to clients leasing Bezeq infrastructure.

Bezeq International is currently the largest ISP in the country, with a 35% market share. It is expected to offer identical packages as competitors 012 Smile and Netvision. Its advantage is that Bezeq International is a separate unit of Bezeq itself, and most Bezeq International customers use Bezeq for their Internet infrastructure, so obtaining a package providing the entire Internet package from Bezeq will be relatively seamless for these customers. Bezeq International is therefore expected to retain or even increase its Internet market share. It is considered likely that next year Bezeq will be able to merge its Bezeq International unit with the main company, making it even more seamless.

Within the next five years, HOT is expected to be left with a 30% share of Internet customers, while Bezeq would have 35% with the rest split among 012 Smile, Netvision and the other smaller providers.

4. What about landline telephone service?

That’s a major open question. Unlike the situation in most countries, the Israeli Communications Ministry included the landline market in its reform program, and as of May 17 will require Bezeq to lease its landline telephone facilities to competitors to resell its use to consumers. Currently its landline revenues are almost pure profit in that it costs the company almost nothing to maintain the system. It is thought that competitors could offer home phone service at about 15 shekels a month (for 1,000 minutes of talk time), while Bezeq is currently charging 63 shekels on average.

But the future is not yet sealed on this front. Bezeq has petitioned the High Court of Justice to reverse the Communications Ministry’s decision, and its arguments appear relatively strong. There is already competition in the landline market using Internet lines (VoIP), and the ministry’s move has no precedent anywhere in the world. Furthermore, there is a much easier way of lowering prices. Bezeq’s telephone line service is price-controlled by the government. All that needs to be done is allow the company to drop its prices.

5. Will the market coalesce around major groups?

From the beginning of this year, we have seen the communications market coalesce around four major groups. Cellcom Israel, the cellular service provider, entered the television service sector and merger moves between Yes, the satellite television service provider, and Bezeq have made progress as part of a wider process that includes sharing cellular networks and the leasing of Bezeq’s Internet infrastructure to competitors.

In 2016, Bezeq is expected to merge some of its subsidiaries and function as a real communications group. HOT has already done so for the past two years since entering the cellular service business. In the coming weeks, Cellcom will begin offering packages that include Internet and television. And Partner, which does business as Orange, is active in marketing Bezeq’s infrastructure and is cooperating with HOT when it comes to cellular network capabilities. It is also expected to enter the television service market.