Tuesday, January 31, 2012

No Surprise: Internet Value is at App Layer

A new Boston Consulting Group perspective piece about the inescapable role of the Internet in economic life raises obvious questions about where value now lies, as “every business needs to “go digital.”

By 2016, there will be three billion Internet users globally, and the Internet economy will reach $4.2 trillion in the G-20 nations, BCG argues.

“No company or country can afford to ignore this phenomenon,” BCG says. But that doesn’t mean every part of the ecosystem benefits equally, one might argue.

On one hand, a trillion devices will need to be connected to the Internet, which obviously implies the need for access services. Many of those devices will be sensors, which is why mobile service providers see such potential for machine-to-machine services.

But the business now is “about ecosystems,” BCG says. “The Internet is increasingly being shaped by ecosystems orchestrated by companies such as Amazon, Apple, Facebook, and Google, Baidu, Tencent and Yandex, BCG argues. .

And that is the concern service providers have, generally expressed as the fear of being reduced to a “dumb pipe” provider in a business where most of the value gets created elsewhere in the ecosystem. But it is hard to argue with the fundamental underlying logic.

Across the G-20 nations, the Internet economy amounted to 4.1 percent of GDP, or $2.3 trillion, in 2010 and is contributing up to eight percent of gross domestic product. So when service providers ask “Where is the value in the Internet ecosystem?” they often don’t like the answers.

The BCG shows one element of the concern, namely that even in the “access” business, value has shifted from fixed line to mobile. 

BCG argues that all contestants need to understand and strengthen their “digital balance sheets” to succeed.

The Internet also conveys sizable economic benefits that do not get captured directly by calculations of GDP. In the G-20 nations in 2010, consumers researched online but purchased offline more than $1.3 trillion in goods, the equivalent of about 7.8 percent of consumer spending in those nations.

In addition, in many leading G-20 nations, the Internet generated a consumer surplus of about four percent of GDP. This consumer surplus is the value that consumers place on the Internet above what they pay for it in device, application, and access costs.

Further economic benefits include business-to-business e-commerce and collaboration within and across companies, for example.

The good news is that demand for access services now is ubiquitous. By 2016, the three billion Internet users will represent 45 percent of the world’s population. But, by 2016, mobile devices will account for about 80 percent of all broadband connections in the G-20 nations.

Of course, much of the growth is happening in emerging markets rather than developed markets. The Internet economy of China will approach the size of the U.S. Internet economy in 2016.

Social media have taken hold everywhere, especially in emerging markets. That, of course, drives value for application providers, though indirectly for access providers.

Indonesia has the second-largest number of Facebook users. More than 90 percent of Internet users in Argentina, Brazil, and Mexico participate in social media, a higher percentage than in any developed nation.

Across all nations, social media are responsible for most of the new time spent on the Internet, including 22 percent of total Internet minutes. At the same time, social communications are starting to displace email, another historic reason for use of Internet access services.

And change is not likely to stop. As recently as 2005, the broadband access business was almost exclusively a “fixed network business.” That won’t be the case in the future.

The bigger problem remains that much of the new created value happens at the application layer.

But even within the “access” business, revenue sources are changing. Time Warner Cable fourth quarter 2011 earnings show that broadband and other new services now are the revenue driver for cable and telecom providers.

Broadband revenue grew to $4.4  billion, a 8.6 percent increase over 2010. Commercial revenues grew 32.7 percent increase to reach $1.4 billion. 

By way of contrast, Time Warner Cable lost 53,000 basic video subscribers, despite adding 79,000 net new customers from acquired cable firms.

In other words, actual losses were more on the order of 129,000 customers. In the fourth quarter of 2010, Time Warner Cable lost 141,000 basic video subscribers. For the full year, the cable company lost 453,000 video subscribers.

But Time Warner Cable gained 117,000 broadband subscribers in the fourth quarter, up 31.4 percent from the previous quarter and up 40 per cent from the fourth quarter of  2010. For the year, TWC gained 437,000 broadband subscribers. The cable giant also gained 133,000 residential digital voice subscribers for the year.

Those results, along with declining voice customers at AT&T, Verizon and most other fixed line telecom companies, show that specific communications services are products like any other.

Most executives are familiar with the notion of a “product life cycle.” What might be a more provocative idea is the notion that collectively, the global communications industry might be entering a period where communications  itself hits something of a industry life cycle peak.

“The telco voice and messaging business is on the verge of going into meltdown,” muses industry consultant Martin Geddes. By that line of thinking, so much revenue and profit is about to be drained away that the replacement revenue streams (based largely on broadband access for the near term) cannot prevent some significant shrinkage of the overall business.

One doesn’t have to agree with all elements of the analysis to sense the danger. In some markets where the leading edge of the trend seems to be emerging (Europe), there is a palpable sense that voice and messaging revenues are about to become over the top apps, with an implied hit to the dominant provider revenue streams.

“I strongly believe the business model for voice and messaging is about to go into reverse,” says Geddes. “The value is going to drain out of minutes and messages charged to users.”

Many would agree with the fundamental challenges, without necessarily agreeing on the timing and magnitude of the revenue changes. In the near term, most also would agree that commercial services are the important new revenue driver for cable companies, while mobile broadband drives telco growth.

At some point, even those growth drivers will slow, which is why telco executives are working on new initiatives in cloud computing, machine-to-machine services and mobile commerce. The key issue is whether those, or other services not yet on the horizon, are big enough to offset the huge potential telco losses in voice and messaging and video losses for cable operators.

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