This is the first installment of Winning through Turns, a new McKinsey series of interviews with leaders in technology, media, and telecommunications.
In his more than two decades as a telecommunications executive, José María Álvarez-Pallete López has seen the sector evolve along with the growth of the internet, from the earliest days of dial-up and basic web pages to the rise of broadband, smartphones, and social media. Now the chairman and CEO of Telefónica S.A. and board chairman of GSMA, Álvarez-Pallete is eagerly anticipating another emerging inflection point, the dawn of the Web3 era. A trained economist and avid marathon runner, ÁlvarezPallete recently spoke about the implications of this technology shift with Tarek Elmasry, a senior partner and cohead of McKinsey’s Technology, Media & Telecommunications Practice, and Rolando Balsinde, McKinsey senior partner emeritus and special advisor. Other topics they discussed in this wide-ranging interview include the purpose of delayering, how the pandemic has impacted the debate over the costs of investing in next-generation networks, and why the current trajectory of the industry makes Álvarez-Pallete invoke the movie, The Curious Case of Benjamin Button. Their edited conversation appears below.
Tarek Elmasry: The telecommunications industry has changed the world in so many ways and enabled a lot of innovation. It has allowed us to stay connected and to thrive during the global pandemic. Despite this, the industry has had a hard time creating meaningful economic value for the shareholders in the last few years. When we were in Barcelona at MWC 2022 just a few months ago, you talked about the need for optimism in the industry. What is the source of the optimism?
José María Álvarez-Pallete López: There is probably no other industry that has contributed more in the last 25 years to the welfare and productivity and expansion of economies as the telecom sector.
And you are right. We have not been able to capture a significant part of the new value chain. Remember, we were born, in the case of Telefónica, almost 100 years ago to produce voice. But nobody wants to pay for voice anymore. So, we are deploying new networks, and we need to find what is our new raison d’être, what is our new core product.
We have been lucky enough to find data. Data is something that everybody loves, and data volumes are growing between 30 percent and 50 percent year-on-year, but so far, we have not been able to monetize data.
Still, the transformation is here, and we should no longer be thinking about this telecom sector as the traditional telco sector that built the voice ecosystem. This is a different ecosystem, a different, much smarter network, more like a massive decentralized, blockchain-enabled computer. And therefore, it is a brand-new era.
The strategic purpose of delayering
Tarek Elmasry: José María, when we met at MWC 2022, you were gracious enough to invite us to speak to the board of GSMA. We made a presentation about how the industry should think hard about delayering. How do you see that playing into your optimistic view of the future for the sector?
José María Álvarez-Pallete López: Well, first the message here is that we are at the age of something truly new, which is the Web3 concept and soon the metaverse. The Web3 concept is a new version of the internet and we are moving towards a three-dimensional internet.
The models that were built for the two-dimensional internet are not necessarily going to work for a three-dimensional internet. Web3 is the combination of several technologies: fiber deployment, 5G stand-alone, edge computing, hyperedge computing, blockchain connected to the network or incorporated into the network, cybersecurity, softwarization of the network.
You need to decide the elements of the network with which you’re going to be able to build your future, which ones are strategic and the ones that are not essential. It’s about delayering, but it’s also about switching off legacy networks, the ones that are not going to be fully embedded in this new Web3 concept. So, delayering needs to have a purpose, meaning you can create value with delayering, but it needs to match your strategy.
As a concept, delayering is very provocative. You know, we tend to like the status quo because it’s more relaxing, it’s more comfortable. So, I think that in a way that presentation was very provocative because it put on the table that doing nothing is probably not an option. And I think the board had this discussion about something that in some manner has marked a turning point in the mentality of the sector, considering delayering as a way to execute your strategy.
Rolando Balsinde: Jose-Maria, Telefónica has always been an innovator in this industry, and in the last couple of years, you have launched and executed on several very ambitious projects to create new growth engines for the company—whether it’s Telefónica Tech or Telefónica Infra. Can you make a connection between what you’ve done and the delayering pieces and some of the conversations we also had at the GSMA in Barcelona?
José María Álvarez-Pallete López: Oh yes, absolutely. We are a very capital-intensive industry, and we keep accumulating layers of complexity into our companies, whether based on legacy systems or adding new layers such as video initiatives, cloud, or cybersecurity.
If we want to move into the next stage of our sector, it is critical to delayer complexity. Because if you want to integrate your company into a seamless platform that is going to be interconnected with the other layers, then the less complexity you try to embed into that platform, the better.
We were one of the first to delayer the tower business. We created a separate company around six years ago. Thanks to that, we have been able to progressively crystallize the value of the towers going forward, divesting the business at a very high multiple.
At the same time, we have been able to create a secondary market for towers, which is a resource that we are going to need in the future, therefore optimizing the way going forward.
And we have been able to reinvest part of those funds in deploying fiber and in deploying 5G, and being ready for 5G stand-alone, all while taking down debt by a half.
That’s why delayering is an important part of the strategy, because while you deploy your new strategy, you need to reallocate capital. So, maybe delayering is a way of reallocating capital.
A new platform (and age) for telecommunications
Rolando Balsinde: You were beginning to allude to the role of the GSMA as a vehicle for making what you call this platform for connecting. I know this is early days, but what is your vision for how this could play out on a two- or three-year horizon?
José María Álvarez-Pallete López: First I think it is good to remember where we are coming from. The formation of the GSMA is one of the very few points in time in which the industry really came together and was able to define a single voice standard that was applied globally. And thanks to that success, we have been able to create a platform with more than six billion people, probably the most impactful platform in terms of welfare creation in the last 25 years.
Today, however, we are living in a data world, where nobody wants to pay for voice, and so, we must evolve. But the platform is already here. Just imagine that we apply the roaming concept into this platform world, and that we can create a layer of technology above the complexity of our businesses in which all the different features of the network in every single operator, in every single country, have already been integrated once.
And therefore, with open APIs you can plot technology once, and it’s already working. Now imagine those APIs being put downward into the stacks of the hyperscalers. And whenever somebody’s developing code for some new business model, they can drop lines of code not just from the hyperscaler’s side but also from that global telecommunication standard stacks. I’m talking about things like identity, cybersecurity, billing, signaling, geolocation. That’s the kind of vision, and real foundation of the GSMA.
This is like the Benjamin Button movie. We might have been born old, but beware, because we are becoming younger and younger every day, and the others are becoming older.
Rolando Balsinde: José María, many telcos obviously compete locally in given markets for traditional communications and broadband services. To what extent do you believe regulators might have competition concerns with the creation of these new platforms?
José María Álvarez-Pallete López: Oh no, I don’t think it has anything to do with regulation. Competition is still going to be there. Even if you have these common APIs, my commercial effort needs to be the same or even tougher, because the key differentiator is going to be how good have you been in the transition, how well have you been able to integrate the complexity of your business into this platform?
The overall strength is not going to be the platform itself. I mean, everybody has roaming today. Everybody has the same GSMA standard. It’s not the standard that defines the competition. It’s how well you play with that standard into the market.
Tarek Elmasry: In the future vision of the network that you described, you could imagine a lot of value accruing to the consumer segment. You could also imagine value accruing to the enterprise segment, as well as to a wholesale-type segment. If I can appeal to the economist in you, is there one of those three that may be seriously underappreciated now, or where there may be more opportunity going forward than what people naturally think?
José María Álvarez-Pallete López: Oh, yes. There is going to be a brand-new conception of our business model. While we will still have B2C and B2B, I think wholesale is going to be very different. Consider that you’re going to have people blending code with your APIs. And if that’s the case, there is a new revenue source coming from developers that are going to be using your APIs to build their business model. Right now, any such kind of integration—for instance, with Netflix into our network, CDN—that is done on a case-by-case basis.
But in the future, if we do things right, this type of integration will be done when the future Netflixes of the world are being created. Since they will already be using APIs within the industry, they will somehow be paying us for a line of code rather than on a traditional revenue model. And once those APIs are embedded into the stacks of hyperscalers, the pool of developers that has access to them will massively multiply. This is going to be a huge transformation for the whole ecosystem, and one that will benefit all, including the customers and the citizens.
Another critical thing to discuss: Today roughly 56 percent of the capacity of the network—of the European networks in this case—is being used by only five over-the-top [OTT] players that pay nothing for the use of the network. The huge growth in traffic during the pandemic has highlighted that there is an asymmetric effort here, and I think the time has come for more players to pay their fair share of the cost of investing in the networks.
So, I believe that sooner or later the bulk of the cost of investing in the network will start to be shared with the OTTs. I hope this can be the result of negotiations, but if not, it is possible that some entity or body may make this happen.
Paying a fair share of network buildout
Tarek Elmasry: Allow me to channel my inner hyperscaler, who might say, “Fifty-six percent may be used by only five OTT players, but there are millions of customers who already pay for that, and so is it really fair to try to charge both?”
José María Álvarez-Pallete López: Well, if you’re a hyperscaler, you are already charging both developers and customers.
In fact, most platforms are bilateral, because it’s not fair to charge customers the bulk of the cost. For instance, if you are Airbnb, you are charging the owner of the apartment but also the users that rent the apartment. If you are Uber, you are charging the drivers but also the passengers. App stores are not just funded by customers who download an app; a developer needs to pay a certain share of the revenues to offer its product.
So, why should this platform be the exception, supported by just one part of the market, especially when it means charging the bulk of the effort to customers?
Tarek Elmasry: This may very well be a trillion-dollar question.
Rolando Balsinde: Telco operators in many geographies have been trying to make this argument to national and regional regulators for several years now, as this has become a bigger problem for guaranteeing returns and providing services to customers. Why do you think the climate has changed such that these arguments might resonate or win the day with different regulators around the world?
José María Álvarez-Pallete López: Well first, I’m a deep believer in persistency, and I think that being stubborn might be a good quality from time to time.
As you noted, we really started making this case a little more than a decade ago. But the last few years of the pandemic have dramatically changed the situation, and there are more elements that are becoming aligned to make the case that all parties should pay their fair share.
At the start of COVID-19, nearly 100 percent of the population was shuttered at home, relying on digital networks for both their personal and professional lives. We had never designed our network to deal with that level of demand, with entire populations working from home, being educated from home, communicating with friends and family from home, and consuming all their entertainment from home, at the same time.
And of course, a huge increase in video demand was a major part of what the network had to deal with suddenly. So much so that in some countries—though not in Spain—the regulators and the authorities were forced to ask some video providers to reduce the video quality from 4K because the networks were not able to cope with the traffic.
I think that these developments shifted the view of some regulators, primarily in Europe. It showed that telecom networks cannot continue to be subject to the consumption of a small group of players that will charge customers the same even if the quality of network service is degraded.
But there is another factor at work. Europe has a “digital agenda,” which specifies targets for fiber deployment and funding over the coming years. According to the initial estimates, there is a $300 billion deficit to meet the stated investment goals. I mean, how are you going to force the existing players to meet those targets if they don’t have a decent return?
Currently, European telecoms are devoting around 20 billion to 40 billion euros of network capacity capex each year to cope with these recent massive increases in traffic. If negotiations can lead to making this a shared effort between the telecom and OTT players that are causing the traffic increases, we believe that could spur 1.5 percent additional GDP growth for the European economy.
We are not asking for any special treatment. We are simply laying out the facts and asking to have the playing field leveled so we can do our job.
Hitting and overcoming the wall
Tarek Elmasry: José María, you’re a marathon runner. What have you learned and practiced in your running avocation that is relevant for leading an organization like Telefónica and the GSMA?
José María Álvarez-Pallete López: I would say endurance and resilience are the most important, both for marathon running and the telecoms business.
After 100 years of success, our sector is entering uncharted territory. Nothing guarantees our success going forward. You need to try a lot of things, to try to reinvent yourself, your business model.
You know, marathon training is painful, but when you start the actual marathon the first five to ten kilometers is so exciting. Then you realize you have 30 more kilometers to go. And between kilometers 30 and 35, you hit the wall. Something physical happens to your body, but it’s also mental; you need to believe that you are going to be able to overcome that feeling, because then you will be successful.
And success is when you cross the finish line. There is no other feeling like crossing the finish line of a marathon because you have been overcoming so many challenges along the way, the training, the race itself.
For me, the telecom sector is like an amazing marathon, an amazing ultra-marathon. It’s really rewarding, and I enjoy the race. I mean, I enjoy even the challenge of facing the wall.
Tarek Elmasry: Is the wall ahead or behind for the industry?
José María Álvarez-Pallete López: Oh, I think it’s behind. I think that we just overcame the wall, and the finish line is closer and closer.