"Move Up the Stack or Not?

Generally speaking, future telecom strategies come in two basic flavors. The first is the “be the low cost access provider” strategy. Among the key issues: can an entity gain enough scale to offset low average revenue per account? Can the entity cut costs fast enough, and continually, and still survive?

The other is the “move up the stack” strategy. Both are risky.

“Carriers have at various times tried to market their own devices, build portals for apps and entertainment, and provide outsourced IT services,” Strategy& notes. “The results, however, have been mostly disappointing.”

There’s a sort of simple way to plot strategic choices. Only a few of the larger entities will have the ability to really transform their business models and “escape” the “access provider” model.

For most service providers, some version of the “low cost provider” strategy will have to do, as there is not going to be enough capital or other resources to do anything else.

To be sure, there will be lots of fancy language about how former access providers can  transform their value, roles and revenue. All such thinking involves some form of “moving up the stack,” as hard as that might be. To be sure, there are things devices and networks supply, at the bottom of the stack.

source: Bell Labs

As always, though, the higher-value opportunities lie in the platform functions (if such a role can be created) and the actual outcomes or apps used by potential customers and users.

In the consumer space, consider the role played by video content and associated subscription services. Many point out that gains by “streaming” services that are a substitute (however imperfect) for linear subscriptions, so far, have failed to fully replace lost linear revenues.

There are analogies. IP voice services or apps have not displaced lost legacy voice and messaging services. So the point is not whether over the top (OTT) video subscriptions ever will directly recapture linear video revenue levels.

If the voice and messaging experience provides guidance, OTT video entertainment will not do so. So why bother? Because doing nothing leads to a worse outcome. Even if gross revenue and profit margins for OTT video dip from linear levels--even dip significantly--that incremental revenue and profit is important.

There appears to be nothing access providers can do to prevent erosion of voice, messaging and linear video revenue sources. And there is growing pressure on internet access revenues and profits as well.

But how sustainable is a future characterized by ever-smaller voice, messaging and video revenues, with perhaps flat internet access revenues? The point is that, even at the risk of lower margins and gross revenue, owning content assets is arguably more sustainable than not owning such assets.

The same observation can be made about legacy and emerging business and enterprise revenue sources. It is not likely that average revenue per unit for any class of connectivity services sold to businesses will grow, in the future.

So unless a service provider believes it can keep reducing cost to match declining revenues, a dumb pipe business model is risky. To be sure, moving up the stack also is quite risky. But unless you believe service providers can perpetually “cut their way to success,” value generation “up the stack” is going to be necessary, no matter how difficult.

Amazon "Chime" Illustrates "Value" Problem

“Everybody” knows that the telecom industry has a “perception of value” problem. A new conferencing service launched by Amazon illustrates the problem.

Before your head blows off, this is a conferencing service normally purchased by businesses, offered by Amazon Web Services.

Amazon Chime will be sold direct, and by partners Level 3 Communications and Vonage.

Level 3 will offer Amazon Chime as part of that firm’s “Unified Communications and Collaboration Services” portfolio.

Vonage now includes Amazon Chime in its business communications plans at no additional cost.

Three observations, here. AWS is the app creator and owner, not a “traditional” communications service provider or a unified communications specialist or enterprise voice provider. That is just one more example of over the top suppliers becoming substitutes for traditional telecom suppliers.

Level 3 is a distributor of Chime, not its creator and owner. That illustrates the growing role of access providers as conduits for third party apps, with obvious implications for business model, revenue and profit opportunities.

Finally, Vonage offers the service at no extra charge, showing another key trend: increasingly, service providers offer features and value, but not direct revenue-generating services.

In part, all those developments are part of one bigger reality: all apps now are conceptually created and delivered over the top, no matter who the owner. That is just the way the internet and IP networks work.

That also means more of the telecom business--by revenue, accounts, volume of data--is in the “dumb pipe” category. That is what internet access is, after all: a dumb pipe connection to all the resources of the internet.

Coupled with the decline of the traditional “apps” telecom provides (voice, messaging, content), there is a growing “value” problem, as the highest value lies with the OTT apps people and businesses want to use, not the suppliers of “access” to those apps.

Value, increasingly, is at the root of the telecom industry’s growing revenue problems.

"Layer Zero" Illustrates Broader "Value" Problem for Telcos

The industry audience listening to a talk by Marcus Weldon, Bell Labs president, about the drivers of future value in the next era of telecommunications drew immediate laughter when Weldon talked about where telecom sits in the end user’s estimation of value.

Go to 08:30 minutes into the video if you just want to hear the discussion of where telecom sits in the perception of value. Or watch starting at about four minutes in if you want to hear the Bell Labs vision of how "value" will be created in the next era. 

 
The point is that we work in an industry that once was considered layer one of a seven-layer model with “applications” at the top, but now is said by a growing number of observers to be at layer zero. 

Sure, the open systems interconnect model was created to illustrate the way modern programming should be done, but the idea has come to illustrate the "dumb pipe" problem as well.

To the extent that value is found "higher in the stack" at layer seven, then the logical corollary is that things happening at layer zero do not have as much value. 

Telecom's Layer Zero Problem

Telecom, if we are honest, is a business in trouble because its value to customers and users is no longer something we can take for granted. That is what the phrase “dumb pipe” is all about, if a bit of a misnomer.

Voice, text messaging, video content and other services sold by access providers often have a layer seven function as well as encompassing the lower functions, because those services literally are applications sold to the customer, not access to a cloud that sells or provides the services to a customer.

“Best effort” internet access turns out to be the first real “dumb pipe” product generally and widely sold to customers.

But, in an era where computing-based products provide the value that drives consumers to buy internet access, the access itself can be viewed as a low-value function.

“Layer zero” might only be a reasonable description of “internet access,” but the apt concern is that, over time, more of the former applications value supplied by telcos simply is removed to third parties in the cloud.

These days, even Bell Labs presentations show a “layer zero” that is “free Wi-Fi.” And Bell Labs is not alone. These days, cabling, mobile access, fiber to the home and so forth often is considered layer zero.

The point is that access networks arguably have lost lots of value in a world where Wi-Fi, accessed “for free,” is available as layer zero, with the price point being among the key business issues for telcos and other access providers.

The point is that the old telco business model is being destroyed, and a new model has to be created, as the old “buy our services to use voice, send messages and watch TV” increasingly is not relevant, in terms of end user value, as those things can be done using over-the-top apps.

When rational people with deep insight into the telecom business predict shocking levels of industry consolidation, that is simply a reflection of the rapid deconstruction of the global telecom business model.

source: programmerhelp404

source: Bell Labs

Internet Access--Good, Deployed Fast and Also Cheap--Pick any 2 (UNLESS)

There’s an old adage in marketing: “good, fast, cheap: pick two.” At least for most physical products--virtual or software products are different--that adage illustrates basic trade-offs.

Quality tends to cost more. Rapid availability of new products tends to cost more.

So products can be made available at less cost if they are “not as good” or “take longer to deliver.” In the area of physical or tangible products, speed, quality and cost tend not to align (intangible products often can break these rules).

You might say the worst of all worlds is to supply an intangible product (internet access) using a capital-intensive manufacturing process (building physical access networks).

One clear example: business models in competitive markets where facilities-based competition is possible.

As a rule of thumb, a third entrant in a fixed network access market has to hope for market share of about 20 percent to survive. On the other hand, the two existing suppliers then can hope to sustain share of perhaps 40 percent each, assuming each is equally skilled and the third provider is able to stay in business.

And that is why fixed network business models, where facilities-based competition exists, is so difficult. Monopolists enjoyed an easy time of it. Cost per customer (amortizing full network cost over the customer base) and cost per passing (the cost to build the whole network) were almost the same number.

In other words, if it cost $1000 per passing to build the network past 100 locations, then at 100-percent penetration (customer take rate) cost per customer was the same: $1,000. At take rates of 95 percent, cost per customer still was only about $1053.

At 20 percent take rates, the same network has a cost per customer of about $5000. At 40 percent take rates, cost per customer still is $2500. In other words, in a facilities-based scenario, cost per customer can range up to 1.5 times more than in the one-provider market, and up to five times more in a three-provider market.

And that assumes only a maximum of three competitors. In the 5G era, it is not clear how many total competitors will operate in any single market, in large part because mobile substitution will be possible for every key consumer product.

In a facilities-based, competitive market, there could well be three or more key competitors, with varying investment costs.

The point, to refer back to the basic marketing adage (fast, cheap, good: pick two), is that unless major innovations are discovered, fixed network internet access is not ever going to be good as well as cheap and rapidly deployed.

PIck two of three, that will be your choice, as a supplier. That is why there is intense work going on with 5G fixed wireless. In some developed markets, it could be the sort of innovation that breaks the limits. Perhaps customers can be supplied good access, cheap and with fast deployment.

That would truly be something new in the fixed networks access business.

Is There Enough Capital for All Telcos Must Do? Probably Not. UNLESS.

Aside from all the other strategic issues telecom executives will face in the coming decade, capital allocation will be a huge issue. Simply put, there might not be enough capital to do all the things service providers might prefer.

But there is a huge caveat. There might be ways to make massive acquisitions if the assets become cheap enough. Really cheap.

In other words, if global service providers collapse from about 800 to about 100 by 2025 or some similar date, that suggests most will either be acquired, or simply go out of business.

You might doubt there is enough capital to accomplish that scale of acquisition, so fast. You'd likely be correct.

But there is one scenario where massive consolidation is possible, and the survivors are not buried in unsustainable debt.

if asset values absolutely crash, and most sales are of the "distress" variety, that will mean most service providers have found their business models are not sustainable, their equity value will drop, and, at some level, become cheap enough that huge acquisitions cost far less than they do now.

The corollary is that there will be relatively few buyers, as the reason asset values have dropped so much is that the business model has broken.

The even-worse scenario? Most buyers simply stay away, as the assets are not worth buying. So there is a scenario where most of the 700 or so "vanished" service providers simply go out of business, without a buyer stepping in.

Under that latter condition, the global industry shrinks about 85 percent, but survivor debt levels do not become unsustainable, as most of the competitors simply vanish.

Unless that catastrophe happens, it is hard to see how enough capital will be available to do all the things service providers must accomplish.

With revenue growth difficult to stalled in developed markets, while “profitless growth” is more the issue in emerging markets, multiple competing uses of investment capital are going to collide.

Fundamentally, capital has to flow to horizontal acquisitions to grow revenues and attack costs by attaining greater scale.

source: Deloitte

But service providers also must make investments “up the stack” (content; IoT apps, services and platforms) to avoid becoming dumb pipe suppliers of internet access.

At the same time, service providers also must invest in 5G and other next-generation platforms (more optical fiber, network virtualization, spectrum licenses, small cells, advanced radios, applied artificial intelligence.

And such capex does not change that much, over time, either in aggregate or as a percentage of revenue, with higher spending tending to come in waves as next-generation network projects are launched.

source: IEEE

source: McKinsey

But such spending is only one part of “capex.” In most cases, forecasts of network spending include spectrum purchases, not necessarily investments in radios and cables.

Much of the “other capex” has to be paid for by borrowing (although share issuance or other one-time mechanisms such as assets sales sometimes are possible).

source: US Global Investors

Scale will be one “sink” for capital.  If you assume a massive consolidation wave is coming over the next decade, then huge amounts of capital will have to be deployed “buying assets” to gain scale. Such horizontal expansions will involve buying other firms, in other geographies.

But 5G and virtualized networks also are coming, and will command a share of capex as well. Though investment in networks is often how we think about service provider capex, acquisitions are going to compete strongly for a big share of capex. That means debt loads are going to climb, as no service provider can support network capex and big acquisitions without borrowing.

Acquisitions to achieve scale and next-generation network investments help service providers remain solvent in the current business (access services). Such horizontal investments to “bulk up and gain scale” do not fundamentally address the issue of changing business models.

Simply put, all legacy sources are declining, or set to decline. So scale postpones, but does not eliminate, the need to create a new sustainable business model. Sooner or later, even scale will not help grow the business.  

There are “really big” and “big” gambles to be made. The “really big” issues center on business model innovation, while the merely “big” gambles center on the payback from various investments (virtualized networks, 5G, fiber in the distribution and access network, spectrum, horizontal and vertical investments).

The “really big” issue is whether the access provider business model is sustainable.  All other issues are important mostly as they relate to that issue of survival.

How Costly is Internet Access, Across Countries, Really?

It never is easy to compare prices for internet access across countries, partly because of currency fluctuations, but mostly because prices have to be considered in context: what other goods cost locally, which plans are compared and which plans most people buy, for example, really matter.

Absolute prices are one thing. What something costs, in any local economy, can vary dramatically. The easy example is what US$10, or euros, will buy, in any local economy.

Most comparisons are made on “absolute” price measures, not adjusted for local prices. So one study of prices shows typical monthly prices between $45 a month to $65 a month for access at speeds between 25 Mbps and 50 Mbps.

source: newamerica.org

This chart from CB Insights shows typical internet access speeds and typical prices in a number of countries. With the caveat that it matters how one chooses a single speed or price to characterize access in any country, as well as stating prices in uniform terms across countries (purchasing power parity), South Korea remains the outlier, with faster speeds and lower prices than most.

source: CB Insights

And even when using the PPP method, prices (megabits per second per dollar) vary across countries.

But even adjusted for purchasing power parity, prices can be deceiving. According to the International Telecommunications Union, on a “percent of gross national income per person” basis, developed nation fixed network internet access costs about 1.7 percent of GNI per person, compared to levels an order of magnitude higher in developing markets.

So comparing prices is difficult. Beyond all that, there is the matter of “effectiveness.” To the extent that fast internet access matters for economic development and social well-being, most observers will argue that “more” is “better.”

But it is next to impossible to prove causation (better broadband creates more or faster economic growth). Yes, there are correlations. Richer nations have faster broadband, generally at lower cost, depending on the metric used to measure. But one might argue that correlation is not causation.

In other words, richer countries have faster broadband because they can afford faster broadband more easily. So wealth leads to faster internet access. Faster internet might help support economic growth (something we act as though it were true), but only when other foundations are present (stable legal framework, stable currency, critical mass of developers, investment capital available, literacy high, educational levels high, other sources of comparative advantage are present).