Practical analysis and valuation of heterogeneous telecom

services

Case-based analysis

Contents of the lecture

• Introduction:– Heterogeneous vs homogeneous mobile services– Business environment

• Service platform model• Valuation of service platforms

• Valuation theory• Conceptual description of the valuation model

• Implementation• Case: heterogeneous mobile services

• Conclusion

Introduction

– Heterogeneous vs homogeneous mobile services

• Technical aspects• Business aspect• User and service usage aspects

– Business environment• Value chains• Value networks

Your suggestion?Your suggestion?

1.1. What is a service?What is a service?2.2. What is an enabling service?What is an enabling service?3.3. Difference between heterogeneous Difference between heterogeneous

and homogeneous servicesand homogeneous services

Heterogeneous vs homogeneous services

• Value networks and constelations

• Service platform technology

• Users and usage scenarios

General business characteristics related to telecommunication projects

• Challenges with valuation of the heterogeneous service– Technological challenges

• Accelerated technological development generates insecurity• Canibalisation of existing services

– Market potential for services• Acceptance in the market• Pricing of heterogeneous services• Uncertainty about the price / demand relations• Uncertainty about the network effects and the critical mass

– Several business actors – various incentives• Investment decisions• Valuation

Marketing & contract management

Call Control – based services

Instant messaging

Streaming-based services

Download-based services

Group services

Information services

Service provisioning

Network infrastructure operation

Service platform operation

Service and Enabling Service operation

Service discovery, Service composition,

Service brokering, Service mediation,

QoS Management,

A4C Management

Infrastructure operation

Design new services and enabling services, Improving service platform, Expand communication network, Set standards, Define Open Interfaces

Technology development

Firm’s Infrastructure

Human Resource Management

Procurement

Figure . Excerpt of the value network configuration for the SPICE-FIRM. The activities are described in .

SPs (SP1, …, SPn)

ESPs (ESP1, …, ESPn)

CtxtPs (CtxtP1, …, CtxtPn)

CPs (CP1, …, CPn)

3PSPs (3PSP1, …, 3PSPn)

NPs (NP1, …, NPn)

Users

Legend: 3PSP – Third Party Service Provider SP – Service Provider ESP – Enabling Service Provider CtxtP – Context Provider CP – Content and Information Provider NP – Network Provider * - cardinality sign for all relations: many to many

Figure 5. Interconnected Industry Structure - Sketch of the business actors and their roles in the Industry mediating the SPICE value network. They collaborate in the mediation process. Mediation is equal to the service, which is the set of collaborating enabling services and service mechanisms, provided by various business actors.

Today’s competitors

Customers Suppliers

Substitutes

New actors

Bargaining dimension

Competition dimension

Figure 10. Branch analysis (Porter’s five forces)

Competition arena

Related industries / businesses

Demand conditions

Factors conditions

Authorities

Circumstances

Figure 9. Porter's diamond - national competition forces

Heterogeneous service model

How to model a heterogeneous service How to model a heterogeneous service (technical modelling)?(technical modelling)?

1.1. Methodology?Methodology?2.2. Tools?Tools?3.3. Pros and contras?Pros and contras?

Model of heterogeneous service

How to model a heterogeneous service How to model a heterogeneous service (business modelling)?(business modelling)?

1.1. PurposePurpose2.2. Methodology?Methodology?3.3. Tools?Tools?4.4. Pros and contras?Pros and contras?

How to model user behaviour?How to model user behaviour?

1.1. Why should we model user behaviour Why should we model user behaviour (Purpose)?(Purpose)?

2.2. Methodologies ?Methodologies ?3.3. Tools?Tools?

Model user behaviour

• Modelling various user groups– Youth– Business persons on the move– Seniors– Tourists etc.

• Modelling various service scenarios– Work process support– Tourism– Health services

Valuation of heterogeneous servicesValuation of heterogeneous services

1.1. How to valuate practically? How to valuate practically? 2.2. Discussion about various Discussion about various

methodologiesmethodologies

Needed input for the valuationNeeded input for the valuation

1.1. Which input?Which input?2.2. How to get it?How to get it?

Cash Flow

Capital cost

• Discounting rate

The capital asset pricing model (CAPM)

E(rj)= rf + E(rm) – rf j,

E(rj) = expected return on security,rf = risk-free rate,E(rm) = Expected return on market portfolio,j = systematic risk, measures the responsiveness of a

security to movements in the market portfolio.

Classical approach – Capital Asset Pricing Model (CAPM [11])

jr

xEXNPV

1

)(0

A risk neutral approach – moving a risk from a denominator to a numerator

Risk neutral approach – used in this work:

fr

premiexEXNPV

1

)(0

The risk neutral approach can be modeled by using two techniques: The replication portfolio calculations or The risk-neutral probability techniques [14].

Valuation methods

• NPV

• Decision trees

• Real option analysis

Table 1. Key criteria for decision-making tools [5].

Cash flow

based

Risk adjusted

Multi-period Captures flexibility

Real option value

NPV / DCF

Decision trees

Economic profit

Earnings growth

Both real options and decision trees capture the mechanics of flexibility. However, only options adjust for risk.

Figure 2. Six levers of financial and real options [1].

Invest/ grow

Defer/ learn

Disinvest/ shrink

Scale up

grow

Switch up

Scope up

Study/ start

Scale down

grow

Switch down

Scope down

Early entrants can scale up later through cost-effective sequential investments as market grows.

Speedy commitment to first generation of product or technology gives company preferential position to switch to next generation.

Investments in proprietary assets in one industry enable company to enter another industry cost-effectively.

Delay investment until more information or skill is acquired.

Shrink or shut down a project part way through if new information changes the expected payoffs.

Switch to more cost-effective and flexible assets as new information is obtained.

Limit the scope of (or abandon) operations when there is no further potential in a business opportunity.

Figure 3. Classifying real options (grow, defer or quit) [5]

How to model business scenarios?How to model business scenarios?

1.1. What is a business scenario?What is a business scenario?2.2. How to model the business How to model the business

scenario?scenario?

Table 5. Investment proposals for various business (growth) scenarios (based on calculations from appendix xx)

Investment proposals for various business (growth) scenarios

OPTIMISTIC SCENARIO - Service with extended functionality

R&D efforts (Total costs) 19 500 000,00 NOK

Annual increase in revenue (after the year 3) 15 %

REALISTIC SCENARIO - Service with full functionality

R&D efforts (Total costs) 13 00 000,00 NOK

Annual increase in revenue (after the year 3) 5 %

PESSIMISTIC SCENARIO - Service with basic functionality

R&D efforts (Total costs) 8 000 000,00 NOK

Annual increase in revenue (after the year 3) 1 %

1 2 3 4

Step

Compute Base Case Present Value (PV) without Flexibility,

Using DCF Valuation Model

Model the Uncertainty, Using Event Trees

Identify and Incorporate Managerial Flexibilities,

By Creating a Decision Tree

Calculate Real-Option Present Value (ROA)

ObjectivesCompute base case present value without flexibility

Identify major uncertainties in each stageUnderstand how those uncertainties affect the PV

Analyse the event tree to identify and incorporate managerial flexibility to respond to new information

Value the total project using a simple algebraic methodology

Comments

Still no flexibility; this value should equal the value from Step 1Exploiting estimate uncertainty

Incorporating flexibility transforms event trees, which transforms them into decision trees.The flexibility continuously alters the risk characteristics of the project, and hence the cost of capital

ROA includes the base case present value without flexibility plus the option (flexibility) valueUnder high uncertainty and managerial flexibility, option value will be substantial

OutputProject’s PV without flexibility

Detailed event tree capturing the possible present values of the project

A detailed decision tree combining possible events and management responsibilities

ROA of the project and optimal action plan for the available real options

Table 11. Four step process for Real Option analysis [14].

1 2 3 4

Step

Compute Base Case Present Value (PV) without Flexibility,

Using DCF Valuation Model

Model the Uncertainty, Using Event Trees

Identify and Incorporate Managerial Flexibilities,

By Creating a Decision Tree

Calculate Real-Option Present Value (ROA)

Tasks / Activities

Quantify three scenarios:

oOptimisticoRealisticoPessimistic

Calculate FCF Estimate WACC Calculate PV and set its development in time Find PV (Investment) Find NPV without flexibility

Understanding how PV develops in time for all three scenarios Still without flexibility: Value through stochastic process Identify uncertainties Monte Carlo simulation for correlated uncertainty factors for each scenario Exploiting estimate uncertainties Produce event tree for each scenarioCombine event trees in main event tree

Identify available real options Calculate option values for each node (start in the last time period) For each node compare the real option value with the actual investment Produce the decision tree

Valuate the company by use of risk neutral probabilities. New base case without flexibility (without optimisation). Identify optimal action plan for available real options. The values of real options finds by subtracting NPV (base case) from ROA.

Table 12. Tasks/Activities in four-step process for ROA analysis.

Sensitivity analysis of simulation variables

-0,6 -0,4 -0,2 0 0,2 0,4 0,6

1

Sen

siti

vity

Variable

Expenses - Sales/Marketing

Expenses - G&A

Expenses - R&D

Expenses - COGS

Sales - year -10

Sales - year -9

Sales - year -8

Sales - year -7

Sales - year -6

Sales - year -5

Sales - year -4

Sales - year -3

Sales - year -2

Frequency Chart

,000

,007

,015

,022

,029

0

7,25

14,5

21,75

29

0,20 0,20 0,21 0,22 0,23

1 000 Trials 994 Displayed

Forecast: J75-St.dev.chg.proj.val.y7

Table 15. Inputs and outputs from Monte Carlo simulations.

Risk-free rent0,0608

PV – realistic scenario - 4.964,77

Annual average standard deviation 0,12

Realistic scenario

Increase per time interval, u 1,12750

Decrease per time interval, d 0,886900

Risk neutral probability of increase 0,519981

Risk neutral probability of decrease 0,480019

Figure 4. Sensitivity analysis of simulation variables for Monte Carlo simulation of realistic business scenario.

Figure 5. Frequency chart for sales in the year 7 - based on 1000 simulations.

V0

u1u2V0

u1d2V0

d1u2V0

d1d2V0

C0

Cu1u2 = MAX [u1u2V0 - X, 0]

Cu1d2 = MAX [u1d2V0 - X, 0]

Cd1u2 = MAX [d1u2V0 - X, 0]

Cd1d2 = MAX [d1d2V0 - X, 0]

Value of the asset is affected by two sources of uncertainty: Source 1: with probabilities u1 and d1 Source 2: with probabilities u2 and d2

The value of flexibility, C0

Figure 5. Quadranomial approach - value of the asset affected by two sources of uncertainty

-5 0 5 10 15 20 25 30 35

NPV - base case

Sequential compound option

Sequential compound rainbow option

Simple option to abandon

Simple option to contract

Simple option to expand

Combination of simple options

Option value in mill NOK

Figure 6. Values of various options for R&D project.

Implementation

• Case: – PATS lab / SPICE project – prototype

services

Conclusion

– Heterogeneous vs homogeneous mobile services

– Business environment

• Model of heterogeneous services

• Practical valuation of service platforms• Practical valuation methods• Conceptual description of the valuation model• Case: Heterogeneous mobile services