Do Service Providers Earn Back Their Cost of Capital?

To the extent that all U.S. broadband networks rely on private capital to invest in new broadband facilities, the question of financial return for such investments is fundamental. After all, telcos, cable companies, satellite and wireless providers go to private markets for the funding to build their broadband networks, and those investors have lots of choices.

If the financial return, and the risk, of broadband facilities investment do not roughly match or exceed what is available from alternative investments, those investments will not be made, and it won't matter much how much people scream about what they can't get.

In that regard, it is fair to note that many investors no longer consider telecom an especially desirable investment. It is rare these days to find a venture capitalist willing to consider backing a new telecom equipment supplier, for example. To the extent that interest remains, it is centered on mobile and mobile applications.

And there are reasons for that investor caution. Any perusal of industry statistics or quarterly or annual financial reports, at least in developed markets, will show stress around the traditional revenue sources most communications or video suppliers rely on. 

Growth rates are down, subscriber trends are negative in many cases, profit margins are lower than has been the case historically, and there is more competition and a shift of value elsewhere in the Internet, broadband and wireless ecosystems. 

In fact, Bernstein analyst Craig Moffett argues that, over the last decade, the returns on invested capital in communications networks in U.S. markets have been anemic, at best. He argues that economic value creation has been, in aggregate, barely positive.

Wireline networks have the weakest returns on invested capital with a 1.5 percent gain over the last decade. Wireless networks had a meager return of 0.3 percent. Cable garnered a 2.5 percent return. Satellite networks had the best return on invested capital at 5.5 percent. Others, including AT&T, Comcast, Dish,Sprint and Verizon, have negative returns, Moffett argues.

You might argue that though low, those are positive numbers. True enough. But there are borrowing costs, and in many cases the cost of "good will" associated with acquisitions. Add those in and returns can go negative pretty quickly.

It probably goes without saying that potential end user shifts in the direction of over the top video entertainment do represent a threat to subscription video revenues now earned by telcos, cable and satellite companies.

A new study by Edelman suggests U.S. consumers are are disenchanted with their entertainment choices. Only about 17 percent of respondents think entertainment sources today provide “very good” or “excellent value.” That should send up a warning flag about the latent potential demand for different video and other entertainment options. 

Declining entertainment value obviously creates a gap that competing providers might be able to exploit. Unlike many other businesses, though, the video entertainment business is unusually controlled by content creators and distributors, rather than distributors. DirecTV, for example, recently had unusual success with its “Sunday Ticket” service delivering National Football League games, says Michael White, DirecTV Chairman, Chief Executive Officer and President.

Those sorts of issues mean there is potential for alternative distribution methods, so long as content providers are willing to cooperate. For fixed-line access providers, there are other issues, beyond a threat to existing video service revenues, though. Some would argue that fixed networks already have trouble earning a return on invested capital that justifies deploying that capital.

Whether or not a provider of goods and services can remain in business is not a consumer's problem, of course. But the apparent difficulty of making money in the fixed-line service provider business is a key concern for service providers, naturally. 

Beyond that, to the extent fixed access networks are seen as a key underpinning of economic growth, and a "national resource," there are key public policy issues. Specifically, if robust and high-speed broadband access is a "public good," inability to earn a return on invested capital is a broader problem. 

Where is the Value of a Fixed Line?

One often hears it said that “broadband is the anchor service” for fixed-line service providers in the future. One also frequently hears that new value-added services would be a healthy antidote to service providers becoming “dumb pipe” access providers. One sometimes also assumes the growing use of "connected devices" benefits mobile service providers (it does), but not fixed-line providers.

All of those statements are true, but analysts and observers might be missing the growing potential of the “dumb pipe” access business, especially as the home and business environments increasingly feature the use of many different “untethered” devices, and as more users get used to switching even their mobile devices to untethered fixed line connections (Wi-Fi). Razorsight Blog


the value of a fixed-line broadband connection will grow as each additional connected device is added.

In August 2011, for example, the share of non-computer traffic for the U.S. market increased to 6.8 percent. The largest percentage from this share came from mobile devices, which drove 4.4 percent of total digital traffic in the U.S. market. The second largest driver of non-computer traffic was the tablet category, contributing nearly two percent of total traffic.



As the share of U.S. non-computer traffic rose over the past four months, the percentage of that traffic driven by tablets has risen from little more than 20 percent to nearly 30 percent. In May 2011, 22.5 percent of non-computer traffic came from tablets. By August 2011 that figure had grown to 28.1 percent, eating into the share of traffic garnered by mobile devices and other web-enabled devices.

That is but one example of how use of connected devices is changing the value and use of fixed-line broadband connections.



In fact, the GSMA expects the number of total “connected” devices to increase from nine billion in 2011 to more than 24 billion in 2020. “Mobile connected devices” (presumably those with a subscriber information module) will grow 100 per cent from more than six billion in 2011 to 12 billion in 2020.

40% Drop in SMS revenue by 2015

Industry executives surveyed by Telco 2.0 believe it is possible that over the top messaging services will displace about 40 percent of text messagin revenue by 2015, at least in Europe and the Middle East.

In part, that might be a function of generally higher costs in such markets. Costs for consumers in North America tend to be lower than in Europe, for example.

The main cause is competitive pressure from Facebook, Skype, Google and BBM. Mobile voice isn’t that far behind, with a 20 percent decline foreseen by surveyed executives. 40% drop in SMS revenue by 2015

What Would Double-Dip Recession Do To Telecom?

It isn’t yet clear whether Europe, or other regions, will enter a double dip recession in 2012 or not. Analysts at Gartner already are predicting that the next recession in enterprise information technology spending has virtually begun, and that spending will slow through 2015.

The impact of the Great Recession beginning in 2008 is easy enough to describe. According to TeleGeography Research, revenue growth  slipped from about seven percent annually to one percent in 2009, returning to about three percent globally in 2011.

The Economic Cycle Research Institute says the U.S. economy is either just beginning to dip, or is about to do so, says Lakshman Achuthan, the managing director of ECRI. "The critical news is there's no turning back,” he says. “We are going to have a new recession." U.S. Double Dip?

If that turns out to be correct, service providers probably will encounter revenue pressure much as was seen in the last recession. The issue will not be so much that “lines” or “accounts” are abandoned, as that users will consume less. So “line loss” will not be the issue so much as “average revenue per user.”

Some believe that, even in the absence of a new recession, there will be no quick post-recession recovery for Western European telecom revenue, according to new forecasts published by Analysys Mason. End-user spend was down by 4.4 percent in 2009, and will decline at a compound annual growth rate (CAGR) of –1.8 percent until 2012, the firm predicted.  No quick return to growth

What was expected in the last recession was a greater degree of product substitution. "The more flexible cost structure of mobile networks means that mobile operators are winning more of the lower usage end of the fixed services customer base," the International Telecommunications Union says. "This has happened in voice, and 2008 has demonstrated that mobile broadband can substitute for light-usage DSL." Recession impact on telecom

Also, more consumers are likely to opt for prepaid and flat-rate packages for telecom services to try and control their spending.

Point Topic does not believe any recession would affect “line growth.” The total number of broadband lines in these countries will grow from 393 million by the end of 2008 to 635 million by 2013.

Adding in estimates for the remaining smaller countries suggests that the world will add a further 48 million broadband lines to reach 683 million in total over the period. Point Topic forecast

This represents a 10.8 percent per year compound growth rate, well down from 27.7 percent per year in the 2004 to 2008 period, but still substantial, Point Topic argues.

One major reason for the slowdown in growth is that most of the richer countries are approaching saturation with broadband; new customers are becoming harder to find and sign up. At the same time poorer countries such as China and India have gone through the initial phase of rapid growth and are now growing steadily rather than exponentially.

Whatever else one might say, the number of accounts or lines in service seemed relatively unfazed by the recent “Great Recession.”  Fixed voice subscriptions will continue a downward trend, as users increasingly switch to mobile and VoIP substitutions. The recession impact is likely to be on average revenue per user, not abandonment of service, as such. Line growth

For its part, Gartner believes enterprise IT spending in Europe, the Middle East and Africa (EMEA), which will be €604 billion in 2011, a 1.4 percent decline from 2010, will face headwinds through 2015.

Euro-based enterprise IT spending in the region will grow by 2.3 percent in 2012. Western Europe will continue to slow EMEA growth through 2015, according to Peter Sondergaard, senior vice president and global head of Research at Gartner. IT to Hit Double Dip

“The second recession is about to hit and CIOs must decide which way to turn,” said Mr. Sondergaard. “The continued global economic uncertainty and the eurozone crisis will impact your IT budget in 2012, and your business will face difficult budgetary questions,” says Sondergaard.

Sharply lower economic growth in the mature economies of Western Europe is the reason for the tight IT budgets.  Austerity measures brought in to deal with the sovereign debt crisis will curtail government spending on IT in particular and hinder economic growth, which will result in lower demand for IT products and services from businesses.

Western Europe, which accounts for 80 percent of EMEA enterprise IT spending, will see enterprise IT spending in euros decline by 1.8 percent in 2011 and grow by only 1.5 percent in 2012, Gartner predicts.

Government (including education) IT spending will account for the largest share of Western Europe enterprise IT spending in 2011, at 20 percent of the total. Gartner predicts that this sector will decline by 4.8 percent in 2011 and 1.7 percent in 2012, and that it will not recover to the level seen in 2010 until 2015.

"Technology" Alone Will Not Disrupt Video

There is a recurrent theme among technologists that technology itself can "disrupt" the video entertainment business. Sometimes it is peer-to-peer delivery, at other times mobility, user-generated video, or really-fast broadband or local storage or sometimes even search that is believed to set the stage for a disruption of the video entertainment business. 

Those viewpoints miss the mark, for a simple reason. The value people seek in professionally-created video and movies is hard to replicate on an amateur basis. And the mere existence of an additional distribution channel (P2P, mobile, Internet) can be helpful, but only when the content owners agree to license the content people want to watch. 

Skype co-founder and Atomico investor Niklas Zennstrom now says "peer to peer is not disruptive today." One might argue it was not necessarily disruptive in the past, either. What was "disruptive" was the "stealing and sharing" of valuable content, not the method of sharing. Take away lawful access and technology by itself cannot disrupt anything.

In fact, that is not likely to be the case even when content owners decide to cooperate with new technology platforms to a greater extent. Content owners will not "disrupt" themselves in the sense of destroying the value of the businesses they now run. 

They are more likely to experiment with packaging and retail pricing in ways that augment, rather than disrupt, the existing order of things. For attackers to succeed, they will still need access to the content people want to watch.

What would disrupt the business, though, is a shift in end user demand. Lack of demand for the product (video cord cutting, for example) would open the way for disruption, since declining revenues would trigger more-aggressive moves by the content industry itself. But new technology, by itself, will not disrupt the video entertainment business, unless by "disruption" one only means the adoption of new channels that displace older channels. 

Typically, that is not what one means when using the term "disruption," which implies creation of entirely new "value" and a shift of revenues, often because some new technology is available. That often is the case. 

This illustration from Wikipedia shows how a technology can "disrupt" older ways of doing things, for example. 

Innovation	Disrupted market	Notes
8 inch floppy disk drive	14 inch floppy disk drive	The floppy disk drive market has had unusually large changes in market share over the past fifty years. According to Clayton M. Christensen's research, the cause of this instability was a repeating pattern of disruptive innovations.[11] For example, in 1981, the old 8 inch drives (used in mini computers) were "vastly superior" to the new 5.25 inch drives (used in desktop computers).[8] However, 8 inch drives were not affordable for the new desktop machines. The simple 5.25 inch drive, assembled from technologically inferior "off-the-shelf" components,[8] was an "innovation" only in the sense that it was new. However, as this market grew and the drives improved, the companies that manufactured them eventually triumphed while many of the existing manufacturers of eight inch drives fell behind.[11]
5.25 inch floppy disk drive	8 inch floppy disk drive
3.5 inch floppy disk drive	5.25 inch floppy disk drive
CDs and USB flash drives	3.5 inch floppy disk drive
DownloadableDigital Media	CDs, DVDs	In the 1990s, the music industry phased out the single. This left consumers with no means to purchase individual songs. This market was filled by peer-to-peer file sharing technologies, which were initially free, and then by online retailers such as the iTunes music store and Amazon.com. This low end disruption eventually undermined the sales of physical, high-cost CDs.[12]
Hydraulicexcavators	Cable-operated excavators	Hydraulic excavators were clearly innovative at the time of introduction but they gain widespread use only decades after. However, cable-operated excavators are still used in some cases, mainly for large excavations.[13]
Mini steel mills	Vertically integrated steel mills	By using mostly locally available scrap and power sources these mills can be cost effective even though not large.[14]
Minicomputers	Mainframes	Minicomputers were originally presented as an inexpensive alternative to mainframes and mainframe manufacturers did not consider them a serious threat in their market. Eventually, the market for minicomputers became much larger than the market for mainframes. Similarly, the market for main frames and mini-computers was seriously disrupted by personal computers. Although they were not at all competitive at the time of their introduction in the 1970s, by the mid 1980s they had improved exponentially and could compete directly with the more expensive machines.[citation needed]
Personal computers	Minicomputers,Workstations.Word processors,Lisp machines
Desktop publishing	Traditionalpublishing	Early desktop-publishing systems could not match high-end professional systems in either features or quality. Nevertheless, they lowered the cost of entry to the publishing business, and economies of scale eventually enabled them to match, and then surpass, the functionality of the older dedicated publishing systems.[citation needed]
Computer printers	Offset printing	Offset printing has a high overhead cost, but very low unit cost compared to computer printers, and superior quality. But as printers, especially laser printers, have improved in speed and quality, they have become increasingly useful for creating documents in limited issues.[citation needed]
Digital photography	Chemical photography	Early digital cameras suffered from low picture quality and resolution and long shutter lag. Quality and resolution are no longer major issues and shutter lag is much less than it used to be. The convenience of small memory cards and portable hard drives that hold hundreds or thousands of pictures, as well as the lack of the need to develop these pictures, also helped. Digital cameras have a high power consumption (but several lightweight battery packs can provide enough power for thousands of pictures). Cameras for classic photography are stand-alone devices. In the same manner, high-resolution digital video recording has replacedfilm stock, except for high-budget motion pictures.[citation needed]
High speedCMOS video sensors	Photographic film	When first introduced, high speed CMOS sensors were less sensitive, had lower resolution, and cameras based on them had less duration (record time). The advantage of rapid setup time, editing in the camera, and nearly-instantaneous review quickly eliminated 16 mm high speed film systems. CMOS-based cameras also require less power (single phase 110 V AC and a few amps for CMOS, vs. 240 V single- or three-phase at 20-50 A for film cameras). Continuing advances have overtaken 35 mm film and are challenging 70 mm film applications.[citation needed]
Steamships	Sailing ships	The first steamships were deployed on inland waters where sailing ships were less effective, instead of on the higher profit margin seagoing routes. Hence steamships originally only competed in traditional shipping lines' "worst" markets.[citation needed]
Telephones	Telegraphy	When Western Union infamously declined to purchase Alexander Graham Bell's telephone patents for $100,000, their highest-profit market was long-distance telegraphy. Telephones were only useful for very local calls. Short-distance telegraphy barely existed as a market segment, which explains Western Union's decision.[citation needed]
Automobiles	Rail transport	At the beginning of the 20th century, rail (including streetcars) was the fastest and most cost-efficient means of land transportation for goods and passengers in industrialized countries. The first cars, buses and trucks were used for local transportation in suburban areas, where they often replaced streetcars and industrial tracks. As highways expanded, medium- and later long-distance transports were relocated to road traffic, and some railways closed down. As rail traffic has a lower ton-kilometer cost, but a higher investment and operating cost than road traffic, rail is still preferred for large-scale bulk cargo (such as minerals). Since rail has always been faster than contemporary road vehicles[citation needed], it is viable for passengers in populated regions like Western Europe, south and east Asia and the Northeast Corridor. When urban density increases, rail systems often become more attractive and make a comeback.[citation needed]
Private jet	Supersonic transport	The Concorde aircraft has so far been the only supersonic airliner in extensive commercial traffic. However, it catered to a small customer segment, which could later afford small private sub-sonic jets. The loss of speed was compensated by flexibility and a more direct routing (i.e. no need to go through a hub). Supersonic flight is also banned above inhabited land, due to sonic booms. The Concorde service was withdrawn in 2003.[citation needed]
Plastic	Metal, wood, glass etc.	Bakelite and other early plastics had very limited use - their main advantages were electric insulation and low cost. New forms had advantages such as transparency, elasticity and combustibility. In the early 21st century, plastics can be used for nearly all household items previously made of metal, wood and glass.[citation needed]
Light-emitting diodes	Light bulbs	A LED is significantly smaller and less power-consuming than a light bulb. The first optical LEDs were weak, and only useful as indicator lights. Later models could be used for indoor lighting, and future ones will probably be strong enough to serve as street lights. Classical light bulbs for lower light indoor use remain, possible mainly[dubious – discuss] because of sentimental and aesthetic value, although some lamps using other technologies have designs resembling light bulbs. Incandescent light bulbs are being phased out in many countries.[citation needed]
Digital synthesizer	Electronic organ andpiano	Synthesizers were initially low-cost, low-weight alternatives to electronic organs and acoustic pianos. Today's synthesizers feature many automated functions and have replaced them for home and hobby users.[citation needed]
Mobile Telephony	Mobile Discount Operators	Mobile Discount / No Frills Operators (MDOs aka. MVNOs) first focused on a low-distribution-cost-through-internet sales model. In later times, innovations like low-priced mobile-internet tariffs were brought to market. This tripped the development of a new discount category in the market which was later entered by the large discount retail chains with own branded offerings leveraging their distribution power in the lower tier of the market.[citation needed]
LCD	CRT	The first liquid crystal displays (LCD) were monochromatic and had low resolution. They were used in watches and other handheld devices, but during the early 2000s these (and other planar technologies) largely replaced the dominant cathode ray tube (CRT) technology for computer displays and television sets, although CRT technologies have improved with advances like true-flat panels and digital controls only recently.[citation needed]
Digital calculator	Mechanical calculator	Facit AB used to dominate the European market for calculators, but did not adapt digital technology, and failed to compete with digital competitors.[15]
GPS navigation device	navigationalMap	The old navigational system using maps, needed knowledge of the use and posession of a sextant, a clock and an astronomical almanac known as "Ephemeris". A clear sky was paramount for the calculating of an exact position. GPS can show the exact position, either on a projected map or in degrees N/S/E/W (low end models), in any weather.
Ultrasound	Radiography(X-ray imaging)	Ultrasound technology is disruptive relative to X-ray imaging. Ultrasound was a new-market disruption. None of the X-ray companies participated in ultrasound until they acquired major ultrasound equipment companies. [16]
Wikipedia	Encyclopedias	The paper version of encyclopedias have been outcompeted by Wikipedia. Although one can argue about the validity of all the information on Wikipedia, the sales numbers of encyclopedias confim that Wikipedia has taken over the encyclopedias market.[citation needed]

But those examples also suggest why a disruption of the video entertainment business is going to be different. In none of those cited examples was there a controlling "gatekeeper" whose own behavior could cause a newer technology to "fail." People were free to adopt the substitute product in place of the older product.


In the case of video entertainment, there is no viable "substitute product." What people want, and will continue to want, is the older product of professionally-created video. The only thing technology might change are the distribution channels. The content owners themselves are gatekeepers who can prevent any substantive change in access, pricing or packaging. And that limits the amount of disruption any underlying technology change can cause, in and of itself.