ISP "Cherry Picking" Will Have Financial Repercussions

“Cherry picking,” as helpful as it is for new entrants to communication markets, reduces the addressable market for the largest service providers that collectively serve most consumers.

That can have the unwanted effect of causing price increases for all remaining customers, as fixed costs are spread over a small number of paying customers.

That noted, nearly all gigabit network construction occurs on a cherry-picked basis, where ISPs build in areas where there is customer demand. Those neighborhoods tend to be higher-income areas, it goes without saying.

That clear tendency to focus on the lowest-cost, highest-return geographic areas makes clear financial sense--both for incumbents and attackers--but also tends to conflict with the notion of universal service.

That is an obligation typically only one provider has in any market: the incumbent telco. Eventually, that obligation might become onerous, not only for the provider of last resort, but also for customers, a declining number of which will have to pay for the fixed costs of the whole network.

Economically, that is the same problem faced by nations where the number of retirees exceeds the number of working people who pay the taxes to support all the retiree benefits. Similar problems increasingly will be faced by individual firms whose markets are not growing fast enough to generate the revenue required to support retiree benefits.

If the new trend where smaller ISPs launch gigabit networks continues, and more importantly, if most major U.S. markets start to feature three large ISPs (cable, telco, Google), the problem of stranded assets will become a big problem for telcos and cable.

The companion issue is whether the new entrants can create networks affordably enough, and maintain operating costs low enough, to compete in markets where addressable market share might be about 33 percent of homes and other locations.

Traditionally, that has proven quite difficult on a “one service” retail platform. The difference now is the additional revenue provided by triple play services, where an ISP might serve one house, but sell two to three services, boosting gross revenue past $130 a month, where it might otherwise be $40 to $50 on a single-service basis.

Still, there are clear business model issues. All three of the core triple play services are under pressure. Consumers are abandoning fixed network voice, even if that trend tends to be obscured by the very fact of triple play bundling, where consumers rationally might conclude they are better off buying all three services, even if demand is high only for two services.

With the U.S. Federal Communications Commission moving towards licensing rules that would allow over the top linear video providers access to the same programming, on the same terms, as now purchased by cable TV, satellite and telco providers, the likelihood of new OTT suppliers is growing.

And even high speed Internet access, arguably the mainstay and anchor service for any fixed network service provider, increasingly is challenged by new suppliers offering gigabit access for $40 to $80 a month, a price that often is paid for rival services operating between 15 Mbps and 105 Mbps.

The biggest strategic changes are new services provided by suppliers with lower capital or operating costs, or both. That often means a cable TV operator or independent ISP.

In the United Kingdom, for example, cable TV providers supply the overwhelming number of the fastest connections. And “Project Lightning,” the new Virgin Media investment program, will extend higher speed access to about four million additional premises over the next five years.

After the investments, Virgin Media will increase its footprint by about 33 percent, increasing its ability to sell the fastest Internet access services to perhaps 66 percent of the country.
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