Despite the ongoing economic crisis, “Brazilian telecommunications … are very healthy,” says Ricardo Knoepfelmacher, CEO of Brasil Telecom. What does need urgent attention, he adds, is the country’s outdated regulatory environment, which is preventing companies like Brasil Telecom from achieving the scale they need to compete with multinational firms that are threatening to dominate the industry. In an interview with Knowledge at Wharton, Knoepfelmacher described this challenge and his company’s strategy to succeed in the country’s booming market.

An edited transcript of the conversation follows.

Knowledge at Wharton: Our guest today is Ricardo Knoepfelmacher, CEO of Brasil Telecom, headquartered in Brasilia. Ricardo, thank you for joining us today.

Ricardo Knoepfelmacher: My pleasure.

Knowledge at Wharton: Let’s begin with a question that is on everybody’s mind these days: How has the global economic and financial crisis affected Brazil’s telecommunications industry?

Knoepfelmacher: Well, thankfully it did not affect it that much. [Brazil’s telecommunications industry], especially Brasil Telecom, is in a very strong financial position, a very conservative one. We run a company, not a bank, so we are not in [trouble]. And some Brazilian companies are in terrible shape because they started doing some derivatives and playing in the market, taking advantage of the subprime schizophrenia that we have had for the last few months. But Brasil Telecom and Brazilian telecommunications as a whole, I think, are very healthy. This is a sector that was privatized 10 years ago, and about US$95 billion have been invested in the sector…. So we have a relatively new network and the companies are not that leveraged.

Knowledge at Wharton: I understand that Brazil accounts for almost 80% of Latin America’s total telecommunications market?

Knoepfelmacher: That is true.

Knowledge at Wharton: Could you describe how the market has evolved since liberalization in 1997?

Knoepfelmacher: Well, Brazil had a very nasty situation right before privatization. The pent-up demand was very high for fixed telephony. And just to give you a few numbers: Brasil [Telecom], at that point in time, was launching the mobile sector here in Brazil and we had, I would say, in 1997, 2.5 million pay-TV [subscribers], about 5 million mobile phone [subscribers] and 18 million fixed-line phones. Today, we have 40 million fixed-line phones, 133 million mobile phone [subscribers], broadband is almost at 10 million [users] already — it was zero — and pay-TV is about 6 million [subscribers]. So, in total we have about 190 million accesses from a total of about 24 million accesses 10 years ago. So, even a small Indian tribe in the North of the country [may have] no water and sewage, no electric power, but if there is a solar panel and if it is a tribe with more than 300 people, there is a Brasil Telecom telephone working there.

Today, there is no substitution for mobile services. This premium of mobility is well-known worldwide, but here in Brazil, because the prices are still a little bit high and taxes are incredibly high, the penetration was very good for the mobile business, but [it was] a lot of prepaid phones — phones that you pay [for] only if you make the call, not if you receive the call. So, for the low-income classes in Brazil, it was a very important way of accessing telecommunications and it is still growing.

Knowledge at Wharton: The mobile market seems like a remarkable success story. How would you say the growth of mobile telephony in Brazil compares with other big countries?

Knoepfelmacher: Compared to some countries in Africa and some countries that have a very poor fixed network — in Eastern Europe, for instance — the mobile market bloomed very aggressively [here] because there was no infrastructure. So, the way to put telephony in this country was to [develop] mobile telephony.

Brazil is a very big country and very spread out, but we did have a good infrastructure for fixed telephony that needed some upgrades, needed more ubiquity. But the first big wave of investments was in fixed telephony.

Compared to other markets, Brazil is still growing its mobile telephony [market] at around 20% a year, which is pretty good. We have basically five national players, so the level of competition is very high. The EBITDA margins in Brazil are very low for the mobile sector because of very high competition. And some of the … funds that are [collected] during this high competition are also based on a scheme that was invented a few years ago to finance these mobile networks. That is, the interconnection rate that a fixed-line company has to pay to the mobile operators to use their network is very, very high in Brazil.

Knowledge at Wharton: And what kind of ARPU (average revenue per user) rates are you seeing compared to the other emerging markets?

Knoepfelmacher: As you know, Brazil’s fixed telephony market has a subscription fee — I think almost all over the world, except for in two or three countries, there is a subscription fee. This is needed in the model for privatization and puts our ARPU at about US$45 for fixed telephony. Mobile is much lower because of the prepaid business — let me see if I have the numbers here, but I would say the ARPU would be something like US$10 to US$13 a month.

Knowledge at Wharton: That is pretty good.

Knoepfelmacher: But still, I think there is a huge percentage — about 91% of the market — that [generates] very low ARPU and you have an average that goes a little bit higher because of the heavy spenders and corporate users.

Knowledge at Wharton: Now, within the overall context that you described, what is your strategy to drive growth for Brasil Telecom?

Knoepfelmacher: We are mitigating the loss in the fixed-line business. So compared to our main competitors and the main fixed telephony companies here in Brazil, although we are the fourth entrant in the mobile business, I would say we were [able] to make sure we had new products, new services, and that we had a very good segmentation in some markets that wanted the service and would be willing to pay higher prices.

The two engines we used to offset the loss in fixed telephony obviously were broadband — ADSL — and our mobile business. As the fourth entrant [in the mobile market], we had a lot of problems because we came late into the scenario. I started here three years ago, but we changed dramatically the mix of the different businesses and the importance they have in our cash flow and in our EBITDA generation.

I would say that broadband penetration is very, very important. We have 21% penetration among our clients. This is twice as much as, for instance, [Brazil Telecom giant] Telemar, and we always thought it was a good way of keeping ARPU high … to experiment and cross-sell value-added service products that were suited for growing [markets] that were being introduced to the Internet and computers and in need of broadband.

Our 3G network is already in place and working [throughout] our region; I would say this will continue [to grow] … We are having very strong sales of cards that enable people to access our 3G networks.

…We have fierce and asymmetric competition by another big company, Telmex. Telmex had a very clever strategy in Brazil of buying a cable TV company that had all the licenses. Since there is a cable law in Brazil that prohibits us from doing broadcasting, we cannot launch IPTV or things that you see in all operators in the world. We feel, in regulatory terms, this is like trying to hold the wind with your hands. [Telmex has] a significant competitive advantage because they can offer a “triple play” to our customers that is a very good sales pitch, with a very good price. So, we had to invent many different products and services to offset or to counterbalance this advantage they have.

Knowledge at Wharton: That is just what I was about to ask you. Competing against an incumbent with that level of strength and being the fourth entrant, what was your positioning and what was your competitor strategy?

Knoepfelmacher: Well, as an incumbent we leveraged our ubiquity in fixed telephony and our ability to cross-sell and to have a complete solution for our client. And this is something that our competitor cannot do yet. So, when we talk about convergence — and we do have a network that is IP based and very new — the big advantage is really how to bundle these packages together in a way that the regulatory agency approves and benefits the consumer. And the consumer sees this — the perception of value-added is tangible to the consumer.

So, what we did is bundled early on a few packages and showed that in Brazil there are some mobile operators that have no fixed-line businesses and [there are] some fixed-line new entrants. For instance, our company GVT [does] not have mobile. So for us, it was very important to have bundled these services.

Also, we launched some products that [proved to be] very good …. But more important than that, we decided to make some bold moves that were different from what the other mainstream companies in Brazil were doing. In the service part, for instance, we decided to internalize the Call Center inside Brasil Telecom because we knew we had a good product and one of the [potential] problems was in service — how you service your client, how you communicate with your client. We decided to bring more than 10,000 people inside the company, so we would have better control of training and turnover and of [how] these people to talk to our clients and explain exactly what the advantages of our products were.

And lastly, we launched interesting products … and the perception of being a state-of-the-art company that is always in the frontier of new developments was very good. For instance, [one product] was a phone that was a fixed phone when you were using it inside your house. It was through an access point. That access point would see that your mobile phone was in a radius of 50 meters or 75 meters of your access point, and it would be savings of about 86% over a regular fixed telephony client who was making the call, because fixed-to-fixed calls are much cheaper in Brazil than to a mobile. And when [the user] was out of the radius of this access point, outside his house, then [the] mobile phone would use the network that was there.

This was a big success, especially in some of the main urban areas where we operate, and I think this was also very good, not only in terms of the revenue it brought to the company but also because of the perception of having something that was a truly different from competitors and that was saving money for the client.

Knowledge at Wharton: Thank you for describing your strategy. What do you think are the principal risks that could perhaps derail the strategy, and what you are doing to hedge your bets?

Knoepfelmacher: [One of the] main strategic issues we have in fixed telephony is to limit the erosion that we are getting from mobile telephony and also from some of the new entrants that are going to our markets without having the [same] universalization goals and all the burden that [accompanies that objective].

In the broadband market, we want to grow but we want to grow making money and we are doing that especially in the lower income market that is still not very penetrated. In the mobile business we will continue to cross-sell and bundle packages, but also we want to grow with making money and not just getting market share.

In the data market, we will continue to [offer] some very interesting new products like very sophisticated video conferencing and things like that to our corporate clients. In the Internet market we are migrating … to a paid model. And I think we are being successful on all of these fronts, but the big risk is we have to work with the regulators to approve [our entrance into the] pay-TV business using our infrastructure, because too much money was invested.

And I will give you the example of state of Parana: There are only 27 [locations] where you can have cable TV, but we have broadband in 669 different places in that state. So, we have more than 600 different places [there] in which the consumer cannot choose to have another type of pay-TV other than DTH, for instance, the satellite [service] that is so much more expensive. What we want to offer to the consumer is choice, and I think it is very important to work with the regulators and with the congress to make sure that Brazil will not lag behind just because some law passed 10 years ago.

The second thing we have to do is have big companies. Brazil is an important country in Latin America, but as you all know there are two very big international companies that are basically dividing Latin America — that is, Telefonica and Telmex. The controlling shareholders of Brasil Telecom had received an offer from Telemar to merge the two big Brazilian operations and to have a much healthier, larger-scale business. I think that would be important if Brazil wants to have a role in having a big telecom, otherwise these companies at one point will be bought by these big international companies.

I have a few numbers that I can give you on how the market is divided between Telmex and Telefonica.… There is a need to upgrade or to make regulation [address] what is going on in the world today because it was done 10 years ago.… Today, you have Skype and you have all this IP telephony going on and it is not regulated.

…So, these are the three main things I think we need — we in the Brazilian market need to focus right now. But I think the market in Brazil is very good in general because there is scale…. It is a country with more than 100 million people. How can you grow some of these markets if you do not go to other countries? But Brazil is still a country that is very big and it is still growing.

Knowledge at Wharton: I would like to ask some questions about your own personal leadership at Brasil Telecom? You became the CEO of Brasil Telecom in August 2005?

Knoepfelmacher: Yes.

Knowledge at Wharton: You had been at McKinsey before that. What brought you to Brasil Telecom?

Knoepfelmacher: Let me go back a little bit and give you a little bit of context. I think Brazil is a very interesting place. I worked for McKinsey in the beginning of the 1990s and Brazil was privatizing a lot of different sectors. So it was a very interesting opportunity to really understand restructuring of companies, and I started my own restructuring company or consulting company that later was sold to Monitor Group. But at that time I thought the blue books from McKinsey and other very good consulting companies were important to set the direction, but a lot of the value of the consulting work and strategy work was being lost because of poor implementation. And the consulting companies did not want to go into these things. So, I started a small consulting company with another McKinsites and what we really did was to dig into the trenches of war and help the client to extract value from those strategies. I will give you two very brief examples.

One is there is a very big magazine in Brazil called Vision. It is one of the largest in the world and there was a very interesting distribution of this magazine that was done by airmail or mail in general, but the problem is that as a weekly magazine, some of the news was getting to the customers cold, many days after [the fact]. So this magazine could not compete with the weekend newspapers. And we saw there was a chance to increase dramatically the subscriptions for this magazine if we were able to put the magazine in the house of the client on Sunday. So we started doing these types of projects and I became, for instance, almost the manager of logistics and manufacturing for eight months until we had like 600,000 people [receiving] the magazine on Sunday and there was a huge increase in the number of subscriptions.

So we started [working in specific] areas of big companies and then we expanded that for companies as a whole. I became the CEO of Caloi — they are big bike manufacturer in Brazil. I helped move many factories from one place because of fiscal benefits, because of low labor costs, because of better logistics and distribution centers.

So, we did a lot of these things almost for a decade. And six years ago when I was the CEO of a small telecom company, that [company] was sold to Telemar…. I saw the chance to redo this company … but in a way that we could help private equity firms from abroad that left some of the investments — portfolio companies in Brazil — orphans, because they came, invested and then they left and they would send a board member every two or three months.

We knew we could help them restructure, work out, maybe merge these companies into others. By doing that, Angra Partners, the company I founded, at that time started doing advisory work for some private equity firms and started doing private equity work eventually, and was finally selected to substitute for a fund manager that was ousted [because of a] breach of fiduciary duty. This manager was managing Brasil Telecom and other companies.

And at that point in time, because it was impossible to reach an agreement with them to hand the management of the company [over] in a smooth way, I was the partner inside Angra Partners responsible for launching what we called at that time the “Omaha Plan.” Inspired by Omaha beach in Normandy, we had to take the company in a smooth nice way. So we put this plan together with all the different fronts – [including] operations, human resources, finance — [and] exactly what we needed to do when we arrived there, like the paratroopers that landed in the North of France on D-day. But also the first 100 days — what would be exactly the agenda of the CEO? What were the critical strategic decisions? What were the cost-cutting decisions? And I think because I was the one doing it and they needed someone with knowledge of restructuring, [some] knowledge of the telecom industry and knowledge of the litigation process, they asked me to stay for a while.

This was supposed to be [for] six months, and I have been there for three years. And I was very lucky to find a very good, engaged and motivated group of people that came with me and some people that I kept in the company. So we tripled the market cap of the company during this period. The EBITDA grew from 2.7 billion to more than 4 billion real per year. And we have a very interesting group of proud employees that now are working in a totally different company that will probably merged with another big operator here in Brazil. So I was lucky. Basically, that is the answer.

Knowledge at Wharton: It is a fascinating story. And you have handled so many different challenges, I wonder if you could describe the biggest leadership challenge that you have faced in your career, how you overcame it, and what you learned from it?

Knoepfelmacher: Well, I have to admit that I have many restructuring stories to tell. Luck was also always a very [big] part of the story, but what I learned with this much bigger example, Brasil Telecom, [is that] success has to do a lot with communicating your goals well. The company’s employees were very shaky, very damaged in their self-esteem and not knowing where the company was going. And how can you motivate people for a goal if they did not know what the goal is, right? … And –this is something I learned at McKinsey — you need to have some early wins. You need to show that you came to change things and that things are changing in a fast way.

Knowledge at Wharton: And, last question, how do you define success?

Knoepfelmacher: Everyone has their own measure of success. For me, success is being happy, and I am very happy.

Knowledge at Wharton: Ricardo, thank you so much for joining us.

Knoepfelmacher: Thank you very much.