Capex Marks the Spot: Zeroing in on the Telecoms

Cash Flow Challenge

By Giuliano Caldo, Kurt Cohen, Sumit Dutta, Martin Jermiin, and Pradeep Parameswaran

As revenue growth stagnates, cash flow has Both approaches are highly impactful. ZBB
begun to slow for many telecoms operators. typically achieves 20 to 30 percent sav-
Zero-based budgeting and better frontline ings on the entire capex budget within two
engineering performance together can help to three months. Furthermore, it helps in-
quickly reverse this trend. troduce cross-department and cross-BU in-
vestment prioritization on an ongoing basis;
Telecoms operators are facing major chal- this improves the quality of top manage-
lenges. A competitive pressure stronger ment decision making and increases the
than ever requires them to make major in- focus on each investment’s business ben-
vestments in next-generation networks. At the same time, efits. Frontline engineering performance improvement, on
many operators are scrambling to reduce their capital ex- the other hand, can achieve 10 to 15 percent savings on
penditure (capex) budgets because reducing capex spend- network deployment budget within twelve months. More
ing is the only quick way for a telco to generate sufficient importantly, it builds capabilities in the organization: engi-
free cash flow (EBITDA - capex) in an era of low revenue neers work with their management to determine whether
growth and flat EBITDA margins. an engineering project should move forward and how to
execute the project in the most efficient and effective way,
This new pressure on capex requires managers to gain ultimately improving the yield on capex invested.
even tighter control of their investments. This is no simple
task, as telcos often have limited capex transparency due Zero-based budgeting
to the lack of a standardized network design approach,
highly complex capex decisions, distributed decision mak- A long-standing methodology, ZBB requires managers to
ing across engineers, limited fact bases, and less senior justify every dollar or euro in their budgets – not just in-
management involvement than needed. creases. Our version of ZBB has two further advantages: it
helps structure investments so that benefits are clear and
To help industry players work through these cash flow chal- comparable, and it provides an effective prioritization pro-
lenges, McKinsey has developed two complementary ap- cess. Managers analyze the entire capex budget and re-rank
proaches that optimize capex: zero-based budgeting (ZBB) investments based on shared prioritization criteria. They
and frontline engineering performance improvement. ZBB keep higher-priority investments and cut the ones deemed
is a process of analysis and evaluation that enables least critical. ZBB increases effectiveness by aligning an
telco managers to select the best investment portfolio operator’s capital spending with top man­agement priori-
possible. The focus of frontline engineering performance ties, while providing a capex reduction of 20 to 30 percent.
­improvement is standardization, with the objective of re- ZBB also enables top managers to make fact-based capex
ducing network deployment costs. decisions and avoid conflicts among “spend” owners.

The Capex Challenge I 9

Companies can follow a structured process for roll- Decision units are further split into “decision packages,”
ing out ZBB. This process begins with capex target set- which represent the incremental investment goals con-
ting and does not end until the organization has fully tained in a given decision unit (e.g., achieving the minimum
­mastered and taken complete ownership of the approach regulator-mandated 3G coverage in a market or extending
(Exhibit 1). coverage to the next 10 or 20 percent of the population).
Each decision package has a single clear
Break capex into its component parts. “business benefit.” Examples of benefits
Managers split the capex budget into “de- include revenue increase, opex reduction,
cision units” that represent discrete in- and meeting regulatory requirements.
vestments that are independent of each
other, so the company can modify one Evaluate the components. Teams then gath­
unit without affecting the others. As an er crucial financial information – investment
example, a company might divide a USD amounts, anticipated revenues and savings,
2 billion budget into 30 to 40 indepen- and net present value – along with nonfinan-
dent decision units; units might include cial information, such as a qualitative de-
3G network, Fiber To The Curb footprint expansion, core scription of the benefits and structured analysis of the risks
network reliability improvement, or development of new avoided by the investment. The exact type of informa­tion
consumer products. to be gathered depends on the type of business benefit.

01 Zero-based budgeting brings capex transparency and

forces prioritization
Iterate

Break capex into Evaluate Prioritize and Institutionalize

components components force-rank new approach

 Separate capex  Determine standard  Prioritize DPs within  Revise key capex
budget into decision “business benefit” each DU and then rank management processes
units (DUs) and each of each DP within each business to introduce ZBB
DU into decision  Gather qualitative unit (BU) prioritization
packages (DPs) and quantitative  Consolidate BU  Review capex
 Evaluate size of info about business rankings into a single management organization
each DP benefits, e.g., list across groups  Address managers’
financials  Select the lowest- mindsets and behaviors
 Define ranking DPs to be cut to encourage adherence
dependencies to spirit of ZBB
between DPs  Adapt IT systems to
enable prioritization
process, e.g., introduce
DU/DP split in ERP
system

Source: McKinsey
Prioritize, force-rank, and iterate. In this step of the budget- Question every design assumption. Teams disaggre-
ing process, the CFOs of each business unit come togeth- gate big capex units (towers) into their various capex
er and individually rank the proposed decision packages sub­components and question every design assump-
from first to last (or in quartiles). Changes mandated by tion based on minimum technical or regulatory require-
regulation would usually have top priority, as would expen- ments. A detailed study of design specifications is then
ditures needed to “keep the lights on.” The used to unearth real insights. For example,
CFOs then combine all of their rankings into teams question if air conditioning can be
a single force-ranked list that they discuss replaced with simple exhaust fan air cool-
and adjust until they can make no further ing in ­selected environments, whether it is
prioritizing decisions based on the informa- possible to have a wall-mounted battery in-
tion at hand. The group then gathers addi- stead of an air-conditioned room, or if all
tional information and meets in a second towers really need to be painted when they
workshop one week later. These workshops are ­already galvanized.
will ultimately produce a force-ranked list of
decision packages, making budget-cutting Improving engineering performance
decisions very straightforward – the company simply con-
tinues to cut the lowest-ranked packages until it achieves Our frontline engineering performance improvement ap-
its capex reduction goals. proach strictly standardizes the decision making pro-

A 3-step approach is used to improve frontline engineering

decision making 02
Step 3

Step 2 Develop mechanisms

for sustainment
Step 1 Build and implement the framework Ensure impact is sustainable by
instituting the following actions
Develop the path to improve capital
Prove the case for action decision making  Constant leadership involvement
Understand how decisions are made  Consistent engineering design  Consistent and regular
today, the extent of the variance, process communication
and drivers of that variance  Decision making governance  Ongoing change management of
 Case study methodology  Frontline capability building framework
 Interviews to understand extent  Transparency in individual jobs  Tool change management
and drivers of the variance and among engineers  Continuous training to address any
capability gaps

4-week diagnostic 9- to 12-month program

Source: McKinsey
cesses companies use to deploy given network ele- T ools. Individual engineers might use different tools, re-
ments, such as 3G base stations. This approach can sulting in different outcomes.
yield field engineering capex reductions in the 15 to
20 percent range. L eadership goal clarity. Companies can lack top-down
clarity regarding strategic focus.
We employ three steps that focus on front-
line engineering decision making (Exhibit 2). 2. Build and implement the framework. Dur-
ing this stage, the organization builds its ap-
1. Prove the case for action. Managers need proach to improving capital-related decision
to understand how the company makes de- making, which rests on four key elements.
cisions today, how much variance exists, First, companies develop a consistent engi-
and what’s causing it. They can use case neering design process with rigorous, step-
study methodologies and direct interviews by-step engineering practices for the most
to understand the extent of cost variances common problems. A built-in financial case
and their drivers. Differences can be sig- forces managers to make explicit capex/
nificant: several telecoms operators used a case study opex trade-offs. Second, telcos need to create specific
methodology to examine proposed solutions from various decision making governance policies. For example, teams
engineers for the same projects. Nearly all were startled must submit every spending request for review and ap-
by the differences in cost across solutions designed to proval by a manager and director, and managers need to
solve the same problem. Across proposed solutions by follow a standard method for prioritizing project spending.
four engineers working to solve the same problem, the
difference in cost is typically 5 to 10x, but we have seen The third element concentrates on frontline capability
cases where the most expensive solution costs over 80 building and involves the introduction of a new coaching
times more than the cheapest. role for peer design reviews as well as periodic, highly spe-
cific “poor-good-better-best” evaluations of every job and
Our experience suggests that operators have control over worker to spur continuous employee performance improve-
a minimum of five variance drivers: ment. Engineers and managers also undergo professional
development in the forms of training and structured feed-
 roblem solving approach. Differences occur because
P back sessions to achieve the desired proficiency.
managers optimize for a variety of factors, such as cost,
technical quality, or local leader goals. Finally, companies need to create transparency in individu-
al jobs and among engineers. A number of solutions pres-
F inancial rigor. Different teams often make cost and ent themselves here, but one highly effective approach
quality trade-offs differently (e.g., low-cost versus “gold- involves the use of a simple Web-based tool to capture
plated”). solution designs and serve as a repository of spending
requests. Such a tool should provide a description of the
 uidelines. Teams might also vary in their adherence to
G problem, its quantification and a suggested diagnostic
company guidelines (e.g., the local versus the “HQ” ways path, details of the proposed solutions, the effectiveness
of doing things). of the chosen solution, and its financial impact.
3. Develop ways to sustain the progress. Once a com- zero-based budgeting and frontline engineering perfor-
pany has built a solid frontline engineering performance mance improvement – can quickly release the cash flow
improvement foundation, it can pursue a number of ways telcos need to quench their thirst for capital during the
to sustain and even ramp up progress. For example, con- current credit dry spell.
stant leadership involvement sends a clear message to
the organization that continued success in
this area is important and will be rewarded.
Managers can reinforce this “story” through
consistent and regular communication and
by offering continuous training and coach-
ing to address any capability gaps within
the organization.

***

Telecoms players need to take what the industry once

considered to be extraordinary measures to make sure
they have enough cash on hand to survive today and
build for tomorrow. The two approaches discussed here –

Giuliano Caldo
is a Senior Expert in McKinsey’s Rome office.
[email protected]

Kurt Cohen Sumit Dutta

is an Associate Principal in McKinsey’s is an Associate Principal in McKinsey’s Mumbai office.
Stamford office. [email protected]
[email protected]

Martin Jermiin Pradeep Parameswaran

is a Principal in McKinsey’s Copenhagen office. is a Principal in McKinsey’s Mumbai office.
[email protected] [email protected]