SDN Likely Means Lower Capital Spending, AT&T Says

If one agrees the fixed network business models are growing more difficult, with a growing mismatch between revenue and cost, the only logical imperative is to align expected revenues with expected cost.

Furthermore, if one believes revenue gains will be tougher than in the past, then it likewise makes sense to look at all other ways to lower capital investment and operating costs.

And that appears to be among the things AT&T is signaling, with its moves to create a core network operating on software defined network (virtualized) principles.

One might expect that trend to deepen as we move towards fifth generation mobile networks that also will heavily rely on virtualized cores, virtual access and services that are supplied using cloud mechanisms.

Commenting about AT&T’s moves towards a software-optimized network that, at the same time, relies more on generic and lower-cost network elements, John Stephens, AT&T CFO said “we see a real opportunity to actually strive to bring investments, if you will, lower or more efficient from historical levels.”

“I think there is a real opportunity with some of the activities are going on in software defined networks, on a longer term basis, to actually bring that in capital intensity to a more modest level,” Stephens said.

Some of us would argue that virtually every fixed network operator will face similar challenges, and for several reasons. Some national governments will simply take the position that Internet access is a public service so important that retail prices must be controlled.

In China, for example, the Ministry of Industry and Information Technology has ordered retail high speed access price cuts.

It is expected that prices for broadband speeds between 50 and 100 Mbps will be reduced about 30 percent, and the price cut for 20 Mbps will be about 20 percent.

Beyond that, marginal cost pricing and competition pose growing risks to commercial Internet service providers and communications providers. Marginal cost pricing is the practice of selling incremental new units of a product near actual production cost.

In a business with scale, and especially any business selling digital products, the marginal cost is very close to zero.

That especially is the case since a time-tested tactic for new entrants into any market is to sell “same product, lower cost.”

That further tends to reduce overall gross revenues in any market. Some disruptors take the model further, literally pricing at levels guaranteed to reduce the size of the overall market, while simultaneously allowing the new entrant to take a dominant position in the new, if smaller market.

Let us be clear: what that all means is that there is a growing risk to the sustainability of traditional telco, satellite, fixed wireless and perhaps cable TV business models.

Hence the urgency of creating business models able to survive and thrive at lower cost levels. That means more self service, automated provisioning and lower overall capital and operating costs, generally.

That especially is crucial when key competitors operate at lower costs. And one might argue that Google Fiber, cable TV companies and independent ISPs across the United States already have a cost advantage.

One example: “the large incumbent telephone companies do not earn attractive returns in their wireline businesses,” said Craig Moffett Partner and Senior Analyst, MoffettNathanson. “For example, a decade after first undertaking their FiOS fiber-to-the-home buildout to eighteen million homes, Verizon has not yet come close to earning a return in excess of their cost of capital.”

In other words, Verizon FiOS has actually lost money.

AT&T also has earned poor returns on its fixed network.  AT&T return on invested capital has been declining for a decade and is, like Verizon’s, well below the cost of capital, Moffett said.

In 2014  aggregate fixed network telecommunications businesses earned a paltry 1.2 percent return, against a cost of capital of roughly five percent, Moffett argues.

“For the non-financial types in the room, that’s the equivalent of borrowing money at five-percent interest in order to earn interest of one percent,” said Moffett.

“That’s a good way to go bankrupt,” Moffett said.
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