Marginal Cost and ISP Data Caps

Some critics of internet service provider usage-based (buckets of usage) object to the practice as unfair, since the marginal cost of supplying the next unit of consumption is considered quite low. But the marginal cost of the next unit of capacity consumption is not the gating factor dictating ISP cost structure. 

Product/Service	Consumer Margin	Business Margin
Mobile Voice	30-40%	35-45%
Mobile Data	45-55%	50-60%
Fixed Broadband	40-50%	45-55%
TV/Video	25-35%	30-40%
VoIP	35-45%	40-50%
Cloud Services	30-40%	35-45%
IoT Connectivity	40-50%	45-55%
Managed Services	N/A	30-40%
Content Apps	60-70%	N/A
Enterprise 5G	N/A	50-60%

Of course, connectivity service is a highly capital intensive business as well, also featuring the necessity of high dividend payouts, capex, interest and amortization expenses, as well as the customary operating costs all businesses incur, so gross profit margin is only part of the story. 

Sunk costs, high capital investment and borrowing costs are the key drivers of cost, not incremental costs of supplying the next unit of consumption. 

Consider a sample business model for a firm whose revenue has been simplified from billions of dollars to just $100 million, but using the same ratios of cost in the model.

The point is that high gross profit margins also come with significant costs. The result is that high gross profit margins are matched by expenses high enough to reduce net profits to five percent to 15 percent, which might be broadly representative of many other types of businesses. 

Metric	Description	% of Revenue	Model Impact
Revenue	Total income from services and products	100%	$100 million
Gross Margin	Revenue minus cost of goods sold (COGS)	60-70%	$60-70 million
Operating Expenses	SG&A, marketing, administrative, salaries	20-25%	$20-25 million
EBITDA	Earnings before interest, taxes, depreciation, and amortization	35-50%	$35-50 million
Depreciation & Amortization	Wear and tear on assets, often high in telcos	10-15%	$10-15 million
Operating Income (EBIT)	EBITDA minus depreciation & amortization	20-35%	$20-35 million
Interest Expense	Payments on debt, which can be high	5-10%	$5-10 million
Pretax Income	EBIT minus interest expense	10-25%	$10-25 million
Tax Expense	Varies by jurisdiction	2-5%	$2-5 million
Net Income	Profit after all expenses and taxes	8-20%	$8-20 million
Dividends	Shareholder payments, often a priority for telcos	3-5%	$3-5 million
Net Margin after Dividends	Net margin after dividends	5-15%	$5-15 million

Connectivity services might generally range in the middle of industries for net profit margin, keeping in mind that participants at different stages of the value chain in each industry can have distinctly-different profit margin profiles. 

Industry	Typical Net Profit Margin
Pharmaceuticals	15-25%
Software & IT Services	15-30%
Banking & Financial Services	10-20%
Telecom Services	5-15%
Consumer Packaged Goods (CPG)	5-10%
Utilities	5-10%
Manufacturing	5-12%
Automobile Manufacturing	5-10%
Retail	2-6%
Airline Transportation	1-5%
Hospitality	2-6%
Construction	2-8%

Eventually, "Back to the Future" for Lumen Technologies

Eventually, Lumen Technologies will go back to the future, reversing its mashup of focused data transport and enterprise customer base with legacy telco local access businesses.

Right now, Lumen arguably is too small to compete with the likes of AT&T, Verizon and T-Mobile, but too large to effectively compete with local internet service providers.

And if Lumen separates its data transport from local access businesses, it will recreate its existence as a bigger version of Level 3 Communications, but shedding its legacy in the local access business. Still, it will be a smaller company than it is today.

The reason is simply that the capacity business is smaller than the mobility and consumer communications businesses Lumen will leave.

Looking at data transport revenue for major U.S. fixed network providers in 2023, excluding mobile revenues, Lumen’s position is arguably quite different from that of AT&T and Verizon. Because both of the latter firms have such huge mobile services businesses, the data transport portion of total revenue is relatively smaller than at Lumen. 

Though business revenues represent about 30 percent of Verizon’s revenue, and about the same percentage at AT&T, business revenues are 45 percent of Lumen Technologies revenue. Data transport is a portion of total business revenue.

Company	Total Revenue (USD Billion)	Business Segment (USD Billion)	Consumer Segment (USD Billion)
Lumen Technologies	$14.56	$6.6 (Enterprise)	$3.1
AT&T	$120.7	$36.3 (Business Wireline)	$15.1
Verizon	$134.0	$39.6 (Business Solutions)	$21.8

With the caveat that it can be difficult to separate out data transport revenues, such revenues are likely in single-digit billions of dollars for leading transport providers in the U.S. market. 

Company	Core Network Data Transport Revenue
Lumen Technologies	~$4.7 billion (2023)
AT&T	~$9 billion (2023)
Verizon	~$7 billion (2023)
Charter (Spectrum Enterprise)	~$1.5 billion (2023)
Comcast (Comcast Business)	~$2 billion (2023)
Cox Communications	~$1 billion (2023)

The point is simply that Lumen Technologies is different from the other noted providers in having a relatively small consumer business to rely upon for revenue generation. And that consumer business relies principally on the local access facilities, not the wide area data transport network. The other providers have substantial consumer revenue operations in both mobility and fixed network realms. 

Lumen does not have mobile revenue exposure and has a relatively small consumer revenue footprint, as business segment revenues are routinely about 78 percent of total revenues. 

That is the result of a sort of “mashup” of data transport assets with a traditional telco base that always was the least-dense of all former Bell company geographies. That also means it is less feasible for Lumen to upgrade its fixed network for fiber services. 

For that reason, it always has seemed reasonable to assume that, at some point, the former U.S. West (Qwest) assets would be separated from the core data transport assets. 

Looking at the acquisitions and asset dispositions Lumen has made over the past couple of decades, you can see the logic. 

U.S. West, the former telco, was acquired by Qwest Communications--a long-haul data transport and metro fiber company, in (2000. That was the first mashup.

Then, in 2011, Qwest was acquired by CenturyLink, a Louisiana-based telecom provider with a largely rural and consumer footprint. That would seem to be a move back in the direction of local access operations. In fact, CenturyLink sought a bigger role in business and enterprise services, but the acquisition of Qwest also gave the new CenturyLink a greater consumer services footprint. 

The 2011 CenturyLink acquisition of Savvis gave CenturyLink a bigger footprint in data center, cloud computing, and managed hosting services, rebalancing a bit back to enterprise and business revenue.

But it was the acquisition of Level 3 Communications in 2017 that completed the mashup, given Level 3’s huge presence in long-haul data transport, metro fiber operations and international assets. Level 3 has solely focused on enterprise and wholesale capacity operations, not consumer local access.

The first step towards reconfiguring the asset base came as Lumen divested its local telephone business in 20 states in 2021, shrinking the company’s revenue and highlighting its debt profile. 

The next shoe to drop, some would argue, is a separation of the remaining former U.S. West local access assets from the assembled portfolio of global capacity assets. If Lumen retains the capacity portfolio, while shedding the local access assets, it would be a smaller, focused capacity business, as was Level 3 Communications. 

Back to the future, in other words.