Friday, October 10, 2014

ISP Business is Likely to Become More Challenging

Unless something rather unusual happens, it is likely that U.S. Internet access providers--and by direct implication cable TV and telco service providers--will in the future face tougher business models.

There are a few reasons. For starters, competition in the mobile and fixed segments of the business has heated up, and likely will get more intense. In the fixed networks business, telcos and cable TV high speed access providers now face Google Fiber and possibly other new ISP initiatives.

In the mobile segment, Sprint now is actively challenging T-Mobile US for the role of price disruptor. So now two of four national providers are attacking retail prices and packaging in a mobile marketing war that shows no signs of lessening.

All of that is going to cause pressure on gross revenue as well as profit margins, right at a point where access providers must invest heavily in their core networks to accommodate must-faster access speeds (gigabit fixed network speeds and fourth generation mobile network investments).

At the same time, new potential rules related to network neutrality will shape access provider revenue models, most likely in a more-limiting way. Regulating Internet access services using a common carrier framework also is a live issue, and likely would be worse, for ISPs.

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In addition to reimposition of net neutrality rules for fixed operators, extension of “best effort only” access rules for consumer mobile services could be imposed for the first time.
The consumer impact could be substantial, though industry participants differ significantly on the direction of the impact. App providers think consumers would be better served under either net neutrality or common carrier rules.  ISPs take the opposite view.

The net effect of possible future rules will be that “brute force” bandwidth upgrades will remain the dominant way of providing quality of service, compared to potential alternative network management methods.

That means more capital investment, and possibly less revenue, than otherwise would be the case if ISPs were better able to shape services to match end user priorities.

The best example is voluntary end user specified priorities for latency and jitter sensitive services such as voice and video conferencing.

In the business segment, other applications where low latency is important might include in-field sales reps interrogating inventory databases in real time.

Just how much bandwidth upgrade investments might be affected by new rules is unclear. A compelling argument can be made that major ISPs must now upgrade, for core business reasons, unrelated to policy changes.

For fixed network ISPs, the upgrade to gigabit networks is underway, irrespective of any other considerations. Some might argue the same is true of 4G Long Term Evolution network speeds.

In that sense, new network neutrality policies might be viewed as an irritant, at the margin. Common carrier regulation could have quite more impact, though.

It isn’t surprising that cable TV companies, telcos or Internet service providers oppose common carrier regulation, while ecosystem partners sometimes favor such regulation.

Common carrier regulation implies, and often imposes price controls, as well as shaping permissible features, terms and conditions of service.

When value in the Internet ecosystem is highly uncoupled--app providers can reach any customer so long as those customers have Internet access--”access” is an input to an app provider’s business.

For an ISP, access is the business. That explains the prevalence of past debates about dumb pipes and smart pipes.

Current efforts by the Federal Communications Commission to shape regulation of Internet access inevitably will affect revenue models for app providers and access providers alike.

The reason is that  there almost always are shifts in competitive fortunes within the ecosystem when pricing-related or quality-related rules are changed.

The Telecommunications Act of 1996 opened up competition in the local exchange market for the first time. AT&T, MCI and scores of new competitive local exchange carriers believed they would, as a result.

Major changes in wholesale discounts--not to mention the acquisition of both AT&T and MCI by former Bell operating companies--eventually reshaped competitive fortunes. Facilities-based cable TV companies emerged as the single biggest beneficiary in the consumer market, even if many CLECs were able to sustain themselves in business customer markets.

Dynamics in the ISP--and therefore broader telecom business--likewise will be affected once the current regulatory reset has occurred.

That is not to say the outcome is ordained. But under the best of circumstances (from an ISP point of view), restrictions are going to increase.

Whether that is dangerous or not depends on one’s view of industry health. The issue is whether the U.S. access provider market is robust and profit rich, or becoming less robust and less able to afford investment in new facilities.

That is important, long term, since any government policies that limit some important ways of boosting revenue, at a time of product maturation, will consequently lead to lower investment. That is an issue European telecom regulators are dealing with.

On that score, there is some disagreement about growth prospects for future telecom global revenue. Some predict slow but rather steady growth. Others think a slowdown could happen. 

The one scenario virtually nobody believes is that, after the new regulations, whatever the outcome, ISPs will have an easier time growing revenue, creating new products and innovating.

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