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Rostelecom Between the Past and the Future

Article provided by:"Diplomat" magazine

1 April 2003
Rostelecom Between the Past and the Future

Just as it happened a decade ago in the West, the development of the telecoms industry in Russia nowadays is driven by two market trends - a growing demand for cellular communications and rapid expansion of the Internet. The number of mobile phone users reached 20 million, while Russia’s cellular penetration rate is now 14 percent (compared to 6 percent at the beginning of 2002). Though by this measure Russia as a whole is still lagging behind Central Europe, the level of cellular penetration in the Moscow region, at over 50 percent, is already on a par with the United States’ average. The number of Internet users (about 15 million) now accounts for over 10 percent of total population and the market’s annual growth rates are similarly high. On the other hand, Russia is spectacular for underdevelopment of fixed-line telecoms: their 20-percent penetration rate is well below developed world levels, while the availability of free lines in many regions does not match the existing demand for regular phones. There is also a need for modernization of trunk fixed-line networks in some parts of the country.


Shortly described, such contradictory situation in the Russian telecom market shows that its saturation with various telecommunications services will not come soon. One explanation for this combination of breakthroughs with fallbacks is that new telecom operators not belonging to Svyazinvest, the state-controlled holding company, which inherited the Soviet nation-wide telecom network, are benefiting from rapid development of more lucrative segments of the market. But they are still wary of investing money in such projects with long-term returns on capital as construction of long-distance and local fixed-line networks. In other words, a high level of competition in the industry, which is strategically important for any nation, cannot by itself ensure its well-balanced development. Hence, the necessity of a flexible government regulation of Russia’s telecom industry that can provide stimulus for adjusting commercial interests of private companies to national priorities.


The cost of extensive growth


Russia needs modern fixed-line telecoms networks interconnecting its vast territories not only for private and business users. The industry’s balanced development is fundamental for the government administration, for defense and other national security needs, for communicating with far-away and rural areas, as well as for retransmitting TV broadcasts. Even such modern means of wireless communication as cellular and satellite services still need reliable nation-wide fixed-line networks for domestic and international roaming of voice calls, text messages and video signals. Not mentioning the importance of the trunk lines for linking up Russian cities and countryside to the Internet. In view of the above, it is difficult to overestimate the special role played in the current and future development of Russia’s telecoms market by OAO Rostelecom, the national long-distance and international operator.


Since its establishment in 1993, the company has extended and improved the nation-wide trunk telecommunications network of digital and analogue lines. Its length has reached 200,000 kilometers and the level of its digitalization (in kilometer channels) is now over 76 percent. For the network’s development, technological innovation of fixed capital and introduction of new telecoms services substantial investments were attracted. Rostelecom shares are traded on the Russian Trading System and Moscow Interbank Currency Exchange, as well as on the London, Frankfurt and Berlin stock exchanges. Since 1998 they are also listed on the New York Stock Exchange as Level II American deposit receipts.


However, the bet on extensive growth, without a comprehensive development strategy, a reasonable tariff policy and a proper correlation of investment outlays and operating costs with profit margins, had drawn the company in 2000 into a financial crisis. Rising debts, low revenues from inter-city traffic, high administration costs and inadequate corporate governance resulted in profit losses and, consequently, in plummeting of the company’s shares on equity markets. In the beginning of 2001, a new team of young professional managers came to the executive board to save Rostelecom from bankruptcy.


Commercial priorities


Two years after the change in command, Rostelecom’s position in the telecoms market changed for the better. By the end of 2001, the new executive team managed to draw the company out of the crisis: its debts were restructured or partly repaid, operating profits were raised. Some of non-core businesses were sold, Rostelecom’s relations with its daughter companies were arranged in a more effective way and a reshuffle of the company’s management structure was initiated. Since October 2002, former 17 Rostelecom’s regional branches were reorganized into 7 subsidiary companies (in line with Russia’s seven federal districts) and 3 functional divisions---the inter-city and international telephone service, the main trunk network management center, and the training center. Rostelecom’s reorganization was carried out in conjunction with a similar reshuffle of Svyazinvest regional branches in order to improve management, cut operating costs and interconnect regional and federal telecommunications networks in a general scheme.


Rostelecom also managed to convince the Russian Ministry for Antimonopoly Policies of the necessity of raising settlement rates, paid by regional telecoms operators for inter-city traffic, in order to reduce the level of cross-subsidies in the industry. Under the Russian cross-subsidizing system, the revenues from long-distance calls cover part of the losses of local telephone operators, who have to charge their clients at currently affordable rates. At the same time, the company is optimizing its tariff policy in international traffic: in 2002 Rostelecom began negotiations with most of international operators, who are its partners in different parts of the world, on reciprocal reductions in tariffs. For instance, the agreement on a mutual reduction of tariffs, which had been concluded with China Telecom, enabled Rostelecom to cut substantially its rates for international calls not only in the Russia’s Far East, but in the Moscow region as well. Flexible tariff policies are pursued by the company on other international routes either. Since 2001, telephone calls to the U.S., Canada and to a number of West European countries from Moscow and St. Petersburg have also become cheaper.


From a commercial point of view, an increase in transit of international traffic is a particularly promising line of business, because the company already disposes of a fixed-line transit network connecting Europe and Asia, which is reliably backed-up with radio-relay trunk lines. The network is laid on the ground and, in contrast to the transit routes laid on the Atlantic and Pacific ocean beds and across the U.S. territory, it is cheaper to maintain and, consequently, lower rates for transit traffic can be offered. In view of that, a radical improvement in Rostelecom’s linkages with 25 international cable networks operating in 74 countries has become a major part of its development strategy for the coming years.


By the end of 2002, the company completed construction of the fiber-optic transmission line Russia-Kazakhstan, which increased transmission capacity for Russian transit traffic to the republics of Central Asia and their telecommunications access to Russia and Europe, as well as to Asia and the Pacific region. The reliability of this transit route westward will be further enhanced by the completion of the Baltic Cable System (BCS). It is now being built jointly with Telia, a Swedish company, that helps Rostelecom to modernize the Moscow-St. Petersburg-Kingissep fiber-optic line, which will be further laid on the seabed of the Gulf of Finland to reach Kotka in Finland. The construction of BCS will also enable Rostelecom to obtain new digital lines of access to Estonia, Latvia, Lithuania, Kaliningrad and Poland. The operating efficiency of the new lines will be much higher than that of the existing ones due to introduction of new technology called dense wavelength division multiplexing (DWDM) that increases the transmission capacity of fiber-optic cables 100-fold. The DWDM technology is also used by Rostelecom in trunk lines connecting Moscow with Novosibirsk and Novorossiysk, and the Far-Eastern Russian city of Khabarovsk with China.


Notwithstanding sharp competition, another commercially beneficial line of business for the company is to provide a larger range of services offered to other telecoms operators, corporate clients and private customers. These new services include: international roaming of mobile phone calls; leasing of dedicated channels in the integrated service digital network; linkages to international telecommunications and information networks (including corporate ones) with a provision of frame relay services; connection of the intelligent platform of a telecoms operator or corporate client to the FreePhone 800 service, to the TV-voting facility or to telephone directory and information services. Collect calls to foreign countries, as well as payments for phone calls or Internet connections with plastic cards of major international pay systems are now available to Russian private clients. They can also use a variety of Rostelecom’s pre-paid telephone service cards, including the Karta Mira (World Map) card, which allows its owner to call from Moscow to any part of the world and to Russia from abroad at Russian domestic tariff rates.


Betting on competitive leadership


The complex of measures aimed to increase profitability of the company and improve its corporate image among investors also included a strict control over cash flows by introduction of an enterprise resource planning system. This was enhanced by the adoption of an integrated billing scheme for settlements between operators for all telecoms services and the creation of a continuously up-dated data bank. The latter enabled Rostecom managers to monitor changes in the market and adapt their marketing polices accordingly, as well as to assess potential efficiency of investment projects. No less important among new approaches to doing business became the management’s efforts to make the company more transparent and its corporate strategy better understood by shareholders. Acknowledgement and protection of shareholders’ rights, disclosure of information on all substantial issues concerning the company, effective control over its management by the board of directors became basic principles of corporate governance, which will be secured in the Code of Corporate Conduct to be adopted by Rostelecom later this year.


Good intentions in business are put to the test of its financial results. In this the company executives did not disappoint the shareholders. In the year to September of 2002, Rostelecom’s consolidated revenues, calculated in compliance with International Financial Reporting Standards, increased, in U.S. dollar terms, by 3.5 percent and amounted to $623 million and its net revenues (less payments to telecoms operators) rose by 10.7 percent to reach $464 million. The company’s operating profits increased by 94 percent, while the consolidated net profits for the nine months reached $94.9 million. The company’s share prices on the Russian and foreign stock exchanges were also steadily appreciating.


Still the more important result of the company’s good performance in the last two years was the strengthening of its position in the Russian telecoms market. After consolidating its stance as a wholesale operator in inter-city and international telecoms services, Rostelecom is beginning to challenge competitors in value-added segments of the market. And this is changing its former reputation of a clumsy “natural monopoly” to an image of a market-oriented, diversified and competitive company.


The monopoly position of Rostelecom in the domestic long-distance telecoms market will stay unchanged during the six-year transition period after Russia joins the WTO. The Russian government insists on this, because the company must bear the social burden of cross-subsidies and due to the special role it plays in development of capital-intensive but less feasible telecommunication networks, envisaged by some federal government programs. But such protectionism has little in common with state subsidies, contradictory to WTO rules, to which some European governments recently applied to in their attempts to save ailing national telecoms operators from bankruptcy. As regards Rostelecom, it is the other way round. During the transition period, the company will be operating in a more severe market environment than its competitors, because it would have to bear the burden of social and state liabilities, which had been created by specific circumstances of Russia’s integration into the world economy. In view of the above, Rostelecom is interested in a free play of market forces in the Russian telecoms industry even more than its competitors.


According to Sergey Ivanovich Kuznetsov, general director of OAO Rostelecom, Russia’s accession to the WTO will be beneficial for the company in the same way as for other domestic businesses. It will stimulate an upturn in business activity in the country, increase the turnover of goods and services and the purchasing power of population. This would result in a growth of overall demand for various kinds of telecoms services. Russia’s entry of the WTO, said S. I. Kuznetsov, is in full compliance with Rostelecom’s goal to become a leader in a new and liberalized Russian telecoms market by creating an efficient and competitive business, which will be capable to foresee clients’ demands for new services and ensure a stable growth of profits in the interests of company’s shareholders and investors.


Felix Goryunov


1. Share capital of Rostelecom

Svyazinvest (50.67% of voting shares): 38%

Foreign shareholders: 45%

Rostelecom staff: 7%

Other Russian shareholders: 10%


2. General director of OAO Rostelecom S. I. Kuznetsov: “Above all, our mission is to enable everyone in Russia to participate in the worldwide information exchange by enhancing the broad coverage of our network with the latest technologies.”

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