Cable Targets Small Business

The coming year is when we see just how formidable U.S. cable companies will be in the small business communications market. To be sure, many veterans of the business communications market don't think cable will much of a factor in the enterprise market. Maybe not. That's not where cable companies are going to focus, which is the small business customer.

Comcast Corp. apparently plans to spend $3 billion to sign up 20 percent of small companies in its territories by 2012. Time Warner Cable Inc. is also pursuing businesses with fewer than 1,000 employees. And Cox Enterprises has been signing up lots of business customers for years.

Phone companies dominate the $25 billion annual market, which can generate profit margins about 10 percent higher than services offered to consumers or enterprises.

On the other hand, large telcos don't generate nearly as much money from phone lines and calling as they used to. In fact, small business lines provide only about five percent of at&t's revenue these days.

Cable providers, with less than five percent of the small business market, may seize one-third by 2012, saus Sanjeev Aggarwal, AMI-Partners VP.

So two things are going to happen. In some cases telcos will cut their own prices to match the discounts cablers are expected to offer. They'll keep share but sacrifice margins. Or, telcos can simply accept the loss of some share to maintain margins for a while longer.

Anticipating the onslaught, Verizon and at&t seem to be prepared to cut prices and bundle services to keep small-business customers who sign up on contracts.

Verizon offers 20 percent off Internet access for companies taking unlimited local and long-distance calling plans for one year. Customers buying voice services from at&t pay roughly 40 percent less with an annual Internet service contract.

About 54 percent of AT&T's small and mid-sized-business customers in areas where cable may compete have might already have signed new contracts, some observers suggest.

FCC Reimposes Market Share Cap

The U.S. Federal Communications Commission has voted to impose a limit on the size cable operators can reach on a nationwide basis, limiting any single company from controlling more than 30 percent of total subscribers. The FCC in the past has maintained such a rule, but the limit was invalidated by a court decision in 2001.

Consumer groups say a strict limit on cable television system ownership is needed to prevent them from dominating television programming and Internet services and from blocking video competitors.

As a practical matter, the FCC action could affect merger deals Comcast Corp. would like to pull off, as Comcast already has about 27 percent. The rule might also affect smaller operators like Charter Communications and Cablevision , as it might rule out their acquisition by Comcast.

Mobility and Video Will Drive Growth

If Bear Stearns analysts are correct, mobile penetration will zoom past 100 percent, as will digital TV penetration, quite soon. Which suggests those two types of devices are where ad revenue opportunities are brightest, not to mention other sorts of "for fee" services and applications.

Cable Squeezed on Both Ends

Most observers expect telco-delivered video to gradually take market share from cable operators, though modestly over the next couple of years. Most observers also think satellite-delivered services have crested, and will be lucky to hold onto their current market shares.

But one suspects there will be more change, longer term, than most observers now expect. For starters, video demand itself could shift to other IP formats, including at least some forms of Web video. So far, there isn't all that much evidence of shift. Consumers haven't embraced any of the devices and services that port video over to TV screens, though there continues to be evidence of a lessening of interest in linear television on the part of younger consumers.

Nearer term, satellite providers remain aggressive about high-definition TV services and pricing, and most consumers seem pleased with their satellite service.

And as compelling as many consumers find triple-play or quadruple-play services, not all buyers will find the pricing the most-compelling attraction. Some services, networks or suppliers are going to be picked as "best of breed" by some portion of the market, despite the fact that a bundle can be purchased from two providers in a market.

That will continue to put some incremental pressure on cable providers, who are using bundling, as telcos are, to lock in and protect the current customer base.

CLECs Must Race Tide

Even though consumers now account for only about 22 percent of total incumbent telco revenue, and even though dominant telcos are losing share in that market, competitors in the business segment essentially are racing an incoming tide.

That tide is lost incumbent market share. At some point, regulators will decide the market leaders have lost enough share, and give incumbents more freedom to price and package their services, which inevitably will lead to higher wholesale rates for competitors that now rely on incumbent facilities--and wholesale discounts based on their market power--to build their businesses.

So the essential strategic task is to take share now, while it can be more easily gotten, knowing that competitive conditions will sharpen once the incumbents are more free to package and price. And that tide is coming in.

U.S. telcos continue to lose residential phone subscribers to both cable VoIP and wireless subscriptions at a steady seven to eight percent a year, according to Citigroup analyst Michael Rollins. Wireless is a lesser issue, as incumbents own a majority of that business, and simply must cope with product substitution. Wireless penetration should rise from an estimated 83 percent this year to 87 percent by the end of 2008.

Indeed, by 2010, wireless-only households should rise to 27 percent, from 13 percent last year and an estimated 17 percent this year, Rollins argues.

Cable VoIP penetration should jump from 10 percent last year and an estimated 14 percent this year to 25 percent by 2010. If the Federal Communications Commission sticks with precedent, that is going to be enough lost share to trigger an end to wholesale access policies favorable to CLECs.

If Rollins is right, those deregulation rules will start to trigger in just a couple of years. Of course, one can argue that market share losses in residential are not the same thing as losses in the business markets. But that hasn't stopped the FCC from deregulating in the past.

Ironically, incumbent market share loss is the very thing that will unleash them as more formidable competitors.

Google Threat to Telcos: How Real?

Yesterday at the Stealth Communications Voice Peering Forum, there was spirited discussion about Google, and on Google's impact on the broader telecom industry. One line of thinking was that Google wasn't as big an issue as sometimes thought, because the one thing it really has succeeded at is advertising. The implication is that Google will not, or cannot, emerge as a force in the mobile or landline parts of the telecom industry.

The other point of view is that Google already has become a factor, even if it is only as a force reshaping all of advertising.

Likewise, some people are going to argue that Verizon Wireless and at&t Wireless announcements about the openness of their networks are essentially "no big deal." Customers already could swap Subscribe Information Modules" in at&t and T-Mobile phones because both carriers use GSM, and that's just a feature of a GSM network.

That misses the point. The entire U.S. wireless industry now has formally and publicly embraced the notion of open networks. There won't now be any retreat from that position, as end users increasingly will expect it, as every consumer expects such openness in Europe.

And though it sometimes seems as though all essential regulatory debates have ended in the U.S. market, the converse is true. In large part because of what now is happening in Europe, policymakers ultimately are going to have to reexamine the basic national framework for telecom regulation in the U.S. market.

The argument that a capital strike is inevitable in any "functional separation" regime, or a "structural separation" regime, does not seem to be borne out in the European markets. Carriers might not like the framework, as it is helpful to competitors. But dire consequences: a capital strike that cripples robust broadband access deployment, does not seem to be occurring in Europe, where such a strike might have happened.

That is not an endorsement of "anti-telco" restrictions. What is required is some encouraging, stable policy that provides clear incentives for rapid, aggressive optical access investment on the part of the leading U.S. telcos, and assures their investors that a predictable return is possible. "Structural" or "functional" separation essentially can "guarantee" a carrier that most wired broadband traffic (other than cable's) will flow over the carrier's owned pipes.

In essence, regulators can ensure that nearly 100 percent of broadband access traffic. other that that provided by cable operators, flows over the incumbent wired telecom network. Granted, the U.S. and European markets are diverging. Cable is a big factor in the U.S. market and is driving measurable and effective competition to a large extent.

The issue is whether some sort of separation can be crafted that actually creates a better investment climate for incumbent optical access facilities. That isn't the way separation traditionally has been viewed. But circumstances might be changing. A company whose "reason for living" is the "best possible optical access", serving virtually every potential retail competitor, with reasonable assurances of a return on investment, might be worth looking at.

The analysis will not be easy. Cable is a huge "fact on the ground". It might be too late to create a regime where all retail services flow over one huge physical access network. Also, cable operators historically have resisted giving up their networks. But there's a cost to upgrading those networks, and the financial markets never like it when cablers have to invest heavily in those networks.

But even large global carriers are discovering that spending more of their dear capital on transport facilities might not be the best way to proceed. It might seem improbable at the moment that such a fundamental new debate is possible. But give matters a couple of years. Demand for access bandwidth is going to explode. Carriers, with the exception of Verizon, will need to respond.

Financial markets will need reassurance. Maybe the current regime continues to work. But maybe it doesn't. Watch the European markets. If bandwidth demand continues to explode, and European end users start to routinely receive much more bandwidth than U.S. consumers do, there will be an inevitable demand for doing something in the U.S. market.

Telcos Practice "Strategic Indifference"

People who like the idea of rapid service and applications innovation typically are frustrated by the glacial speed at which network services operators move. In fact, the thought often arises that "pipes" companies, especially those dealing with actual "first mile" connections to actual users, are incapable of understanding threats to their business models.

Well, they do move slowly, compared with anything in the software world. There is no Moore's Law at work with construction, trenching, installing drop wires and network interfaces. Which explains the attractiveness of wireless alternatives.

That said, it also is true that incumbents do practice "strategic indifference." That is to say, they will seemingly ignore a threat such as VoIP, just as they seemingly ignored the advent of broadband access, in the form of Digital Subscriber Line and cable modem services.

You might not remember, but North American carriers were slow to understand mobility as well. As awareness grew, carriers simply bought the whole wireless industry.

The point is that the indifference is quite planned. If an innovation will harm current revenues, it makes business sense to plan to lose some market share and revenue rather than embrace the trend fully and lose even more money. Up to a point, incumbents will let attackers take share, on purpose.

If the innovation reaches a tipping point, where there are strategic drivers, incumbents simply pile on in a massive way. That's why the VoIP activity on the part of North American incumbents is so different from that of European carriers. In Europe, VoIP is past the tipping point, and incumbents must play. That point hasn't yet been reached in North America.

When the tipping point is reached, they'll move, and aggressively. But this is a matter of maximizing total revenue. If revenue is maximized by delaying VoIP, that's what carriers will do. If revenue is maximizing by making POTS more attractive, that's what they'll do.

Such carrier behavior is not "dumb." It is planned. In fact, other industries have been "dumb."

In fact, the music industry seems not to have understood the threat or the changes posed by digital media.

You can be quite sure the video industry has learned from that experience and is anything but complacent. No serious video executive takes user-generated content lightly. Everybody is taking steps to participate in a broader media landscape, though nobody yet knows how the business models will play out.

Of course, that also means nobody is going to sneak up on video incumbents. They know exactly where to look for opportunities and threats, and are doing so. IP video will not be a replay of VoIP, in terms of executive denial, simply because tipping points might be somewhat clearer, and because change in the video software space will not entail the massive capital spending carriers must yet contend with in migrating to a broadband, all-IP future.

Video contestants will move faster than you might think.

How Much More Can Vonage Take?

And what is the exposure for other independent providers of VoIP services? Not to mention software and hardware providers, though the dominant carriers are unlikely to sue their suppliers.

AT&T filed a lawsuit against VoIP provider Vonage Oct. 19 seeking damages for alleged patent infringement.

The lawsuit comes on the heels of a Vonage settlement with Sprint Nextel over patent infringement as well, and against an as-yet-unresolved patent infraction case filed by Verizon. Vonage also appears to have settled another legal dispute with Klausner Technologies, a small company with patents on voice mail technology, for an undisclosed sum.

In a filing with the U.S. District Court for the Western District of Wisconsin, at&t says Vonage willfully infringed an at&t patent related to telephone systems that allow people to make VoIP calls using standard telephone devices.

So far, Vonage's patent-related payments are north of $80 million, as Vonage announced on Oct. 8 that it settled its suit with Sprint Nextel for $80 million. As part of that agreement, Vonage agreed to license VoIP patents from Sprint, including more than 100 patents covering technology for connecting calls from a traditional phone network to an IP network. And then there is the Klausner settlement.

Vonage is also in the process of resolving a patent infringement dispute with Verizon. Unfortunately, of course, the Sprint Nextel settlement and the ultimate Verizon settlement will set a precedent likely requiring Vonage to settle with at&t as well. That will likely bump Vonage's patent payments well above $100 million in total.

And if Vonage is infringing patents held by all three giants, what are the odds other VoIP providers are immune? As for the giants, they'll simply cross-license. For everybody else, the warning is pretty clear: get too much success and you will be sued. So one wonders when the assault against cable companies will come. After all, if one wishes to slow down competitors, messing around with Vonage is okay if it creates the foundation for the bigger assault against cable. But Vonage isn't a telco incumbent's big problem in any case.

It is a sobering thought: all the other independent VoIP providers other than cable are much smaller than Vonage. What chance do they have if any conceivable profit goes to pay lawyers and settlement fees?

Deathstar!

Scott Moritz at TheStreet.com says at&t is gearing up to buy EchoStar fast. The logic is unassailable. at&t wants to get big in entertainment video. It will take a long time to get its entire network revamped to do so. Buying EchoStar puts at&t right into the big leagues with more than 13.6 million subscribers. Competitor DirecTV has about 16.2 million subscribers. So by acquiring EchoStar, at&t immediately vaults into a position where it serves more than 45 percent of the U.S. satellite-delivered multichannel TV market.

Disruption? Maybe Not.

Lots of companies and lots of people have been at the "telecom disruption" game for quite some time, beginning way back with the Carterfone decision and MCI's assault on the long distance calling market. We have had Internet service providers, competitive local exchange carriers, hosted service providers, application providers, instant messaging providers, portals, VoIP providers, cable companies, satellite providers and others attacking one part or another of the global telecom value chain.

Through it all, global communications service revenue has kept climbing. In fact, you'd be hard pressed to find any year when that didn't happen. Perhaps the issue is not disruption at all, but rather transformation. There will be new spaces created, and a rearrangement of older spaces. But nothing has stopped global revenue from climbing, year after year.

Of course, all the analysts could be wrong. Some cataclysm could yet await. But it sure doesn't appear to be something you would build your company on.