Negative Scale Returns in Fixed Networks Business?

We might be in the early stages of another evolution of the U.S. fixed network business. The first stage had new providers, especially cable TV companies, emerge as key contestants in the fixed networks business, reducing incumbent telco market share by about half.

With Google Fiber and now a growing range of gigabit access networks by smaller firms, we might see the first of a wave of shifts to yet another wave of providers, namely independent and smaller providers.

Some might argue that if the trend continues, the smaller providers will simply be absorbed by larger providers, as has happened in the business in the past. That might not happen this time.

For starters, the advantages of scale might be diminishing, in certain respects, in the fixed networks business. In fact, some might argue the advantages of scale never have been so great in the fixed networks business, where as much as 80 percent of the capital investment has been in the local access network where costs are not shared, or not shared very much.

If that is the case, then scale might not be as big a value as has been believed. As we now are seeing many forms of decentralization and localized supply in the U.S. economy, perhaps we now are getting a glimpse of localism in fixed network supply, where many smaller and independent firms might emerge, in smaller city markets.

Though perhaps some consolidation could occur, the limits of scale might kick in fairly quickly, making large roll-ups uneconomical.

Dramatically lower prices will propel the localization moves. As retail prices dive, the advantages of larger provider scale become disadvantages, as there is less room in the business model for the overhead associated with tier one operations.

Some Internet service providers continue to push at dramatically-lower retail pricing levels for high speed Internet access, including gigabit prices. Sonic.net, for example, now is launching gigabit access plus voice for $40 a month, in Brentwood, Calif.

Sonic.net plans to bring its new service to about 8,000 homes within the next 15 months. Sonic.net also will provide a free 5 Mbps Internet access service (without phone service) for up to five years, after payment of an activation fee of $300 to $400.

To be sure, Sonic.net is a small ISP, and no matter what it does, it cannot affect many consumers in the U.S. market. On the other hand, the offer does suggest Sonic.net believes the economics work, for a bundle of gigabit Internet access and voice service, billed at $40 a month.

That does not mean a tier one service provider could do so, but a smaller firm, with lower overhead and operating costs, arguably can do so.

Paradoxically, as some claim there is too little competition in the U.S. Internet access business, competition is busting out all over. Existing municipal broadband providers have dropped prices for gigabit service from about $300 to about $70 to $80 a month.

Google Fiber has expanded to seven metro areas and another five metro areas are under evaluation. Brooklyn Fiber is firing up gigabit service for business customers in a part of the New York market, and some believe the firm eventually will start pitching service to consumers as well.

Even some incumbents, including CenturyLink, are offering gigabit service in Colorado markets, with plans to build in 16 metro areas. AT&T, for its part, has said it would build gigabit networks in neighborhoods in as many as 100 U.S. communities.    

As more “overbuilders” enter the Internet service provider business, providing more consumer choices, the exercise of that choice makes the business model harder for legacy providers (telcos, cable TV companies, satellite Internet providers, wireless broadband ISPs, municipal broadband providers).

It is easy enough to predict what likely will happen, longer term. Tier one service providers will start to invest capital elsewhere (international expansion, non-access assets, mobile or other technologies).

That will put tier one service providers that do so at a competitive disadvantage, but that also will allow more market share to be gained by smaller providers with lower operating and overhead costs.

One might note what has happened already in the tier one segment of the business. Verizon and AT&T now drive revenue volume and growth in the mobile segment, not the fixed network business.

Verizon has been divesting smaller landline markets to Frontier Communications, now perhaps the largest former-rural operator that has transitioned to a new business anchored by services provided to small business customers.

At the same time, Comcast and other cable TV companies, operating with lower costs, have begun taking serious market share from AT&T, Verizon and CenturyLink. It might not be unfair to characterize the change as cable becoming the dominant consumer services provider, while

AT&T and Verizon become mobile firms.

Price wars that destroy profit margins are virtually inevitable. In fact, some would argue, that is precisely what Google Fiber hoped would happen.  

Sonic.net , based in Santa Rosa, California, has been aggressively building its fiber to the home ISP business, using an approach similar to Google Fiber, selectively building in neighborhoods or communities where it believes it has a chance to disrupt market dynamics by offering more for less.

So far, Sonic.net has targeted smaller communities in northern California, including

Brentwood, Sebastopol, the Sunset neighborhood of San Francisco, Novato’s Hamilton Neighborhood, Healdsburg, Santa Rosa, Petaluma, San Francisco’s Bernal Heights neighborhood, Berkeley and San Francisco’s Castro neighborhood.

We might be seeing something new in the fixed network business: an age where scale economics apply in a lesser range of cases.

Does Spectrum Now Represent 80% of Dish Network Value?

The U.S. mobile business remains as unstable as ever in the wake of the recent AWS-3 spectrum auctions, which saw Dish Network acquire another $13 billion worth of spectrum assets.

In fact, some might attribute almost the entire value of Dish Network to its spectrum holdings. Conservatively, some might estimate the spectrum holdings at 56 percent of total value. Others might peg the spectrum as high as 80 percent of total value.

If the value of Dish spectrum now is about $72 billion, and the value of the video subscription business is $18 billion, then spectrum potentially represents 80 percent of total value.

Others might conservatively estimate the value of Dish Network spectrum at $36 billion, if it can be put to use in an active mobile network. Otherwise, Dish Network loses the right to use the spectrum, and its value dips close to zero, in the absence of any buyers.

Others might argue that the value of Dish Network spectrum potentially exceeds the present value of Sprint or T-Mobile US, even if Dish has no network and no customers.

But Dish Network faces perilous choices. If it cannot show 40 percent of its owned spectrum actually is active, supporting a retail network and service, by 2017, Dish loses the right to use the spectrum.

So what Dish Network does is among the biggest questions about the U.S. mobile market.

Dish Network at one point in 2013 was regarded as a legitimate bidder for Sprint, or at least significant Sprint spectrum, even if SoftBank eventually bought T-Mobile US.

Some have speculated that T-Mobile US might also have been SoftBank’s target, instead of Sprint, under some circumstances.

Illiad, the French telecom concern, actually did try and buy T-Mobile US in 2014.

Many believe Dish Network might make a bid for T-Mobile US, eventually. That is among the best options if Dish Network really believes its future survival depends on it becoming a mobile service provider.

Was a roll-up of assets--a combination of Sprint and T-Mobile US--always part of the strategic plan when SoftBank decided to buy Sprint, or was that an opportunistic development only after the strategy had been implemented?

That isn’t clear, from the outside looking in. What is clear is that the strategic terrain around Sprint and T-Mobile US continues to be volatile and unstable.

Maybe AT&T, Verizon, Sprint and T-Mobile US Don't Actually Make Money

When somebody says something “can’t  be done,” there normally are unstated conditions. Sometimes what is meant is that a thing cannot be done because physical conditions will not allow it (the “it violates the laws of physics” problem).

That’s the case for me beating Usain Bolt in the hundred yard dash.

Sometimes the unstated conditions refer to limitations of knowledge. In some cases, a specific set of people, in a specific discipline, might not know how a certain process can be made to work, but without claiming there is some actual physical impediment.

In many other cases there is only a business problem. A specific organization or entity might not be able to “accomplish something” with its present cost structure or capabilities, even if some other entity, with a different cost structure or skills, might be able to do so.

Verizon executives claimed, in 2011, that the new FiOS network would never be as profitable as its old copper network, a perhaps shocking statement.

To be sure, context matters. The old copper network largely supported operations that were conducted in a monopoly environment, with nearly-universal take rates and rate of return guarantees.

FiOS competes in a market where Verizon often has less than half its former market share, where mobile is the preferred voice network, its cable competitors are fierce rivals in high speed access and have the biggest share in video entertainment. And then FiOS competes also with DirecTV and Dish Network.

Stranded assets, beyond the cost of the FiOS network or the profit margins on new services such as video entertainment, are issues. Where it offers FiOS, Verizon might get only 30 to 40 percent video take rates, while cable gets a similar amount of share, and satellite gets the balance.

Verizon might get half of voice customer share, but overall demand for fixed network voice is declining, and is propped up by triple play bundles where a growing number of customers buy voice in large part because the overall cost of high speed access and video is more affordable.

So some might argue that firms such as Verizon might have lost money with their investments in fiber to the home platforms, for example.

The argument is that profits, over a 15-year period, will not recover capital investment.

Some might argue that is a problem for other telcos as well, which have a tough time earning a return on invested capital.

In fact, some might argue Verizon’s divestiture of lines to Frontier Communications illustrates the problem. The Verizon asset values arguably are less than Verizon spent to build FiOS.

The more shocking argument is that Verizon and AT&T might only be breaking even on mobile network investments, while Sprint and T-Mobile US might actually lose money on their mobile business.

Craig Moffett, Bernstein Research equity analyst, estimates that AT&T's financial return on its mobile network capital investment is about at  break-even, whileVerizon's return is only a bit  better. T-Mobile and Sprint are actually underwater, having invested more to create their networks than they are likely to earn.

Still, keep in mind the context. Even if Verizon or AT&T make much less money than you would suppose, while, Sprint and T-Mobile sometimes might not make money at all, that does not mean no other service providers are in the same situation.

Cable TV companies arguably have higher profit margins than Verizon and AT&T in the fixed network business. And it is not so clear that cable TV companies or others, when they enter the mobile business, might not fare better than AT&T or Verizon, as well.

The point is that as difficult as fiber to the home or mobile services might be for some providers, others might be able to do better. What “cannot be done” has to be taken in context. Arguing that “we cannot do so” does not mean others similarly cannot do so.

Mobile Device Replacement Cycles Slow

Mobile installment payment plans, replacing the device subsidy model long favored in the U.S. mobile market, have had some expected, and some unexpected impacts on smartphone adoption and replacement behavior.

Even if the new plans are largely constructed to be revenue neutral to the customer, there does appear to be a slowdown in replacement rates, according to Recon Analytics.

That was a concern when the new retail plans were created, and the concern appears to be justified, to an extent.

In 2014, roughly 143 million mobile phones were sold in the United States, and 90 percent of them were  smartphones. But that represents a drop of 25 million phones from 2013 when approximately 168 million phones were sold (only half of them were smartphones).

The decline in phone sales is caused by the rise of equipment financing plans, but also by slower new subscriber additions.

At the same time, consumers' phone purchase habits have changed significantly.

A growing number of American consumers appear to delay their phone upgrades to take advantage of the lower monthly service prices carriers offer to consumers who wait to upgrade phones at the end of their two-year contracts.

On the other hand consumers who are purchasing replacement phones are focusing on newer, higher priced devices, says Roger Entner, Recon Analytics principal.

While device sales declined by 15 percent year-over-year, device revenues increased by about five percent.

So, as expected, the shift to installment plans appears to be slowing the device replacement rate, a trend that arguably will slow innovation.

Entner expects device sales to fall by five perent to 136 million in 2015 and to fall again by four percent to 131 million in 2016.

In fact, says Entner,”handset replacement has abruptly slowed to the lowest rate since we began calculating the metric.”

Device replacement cycles are lengthening, reaching 26.5 months in 2014, an increase of 4.1 months compared to 2013.

In the past, U.S. consumers typically upgraded their phone at three points in time. Many upgraded at about one year,  when a new generation device was launched.

The next window was an upgrade every two years when the contract expired.

That now is changing.

The percentage of devices replaced at the traditional two year time point fell from 40 percent in 2013 to 16 percent in 2014, while replacement at three years grew from 15 percent in 2013 to 35 percent in 2014.

So nearly half of consumers upgrade every year, but more than a third keep their devices for three years.

Slower device upgrades might also have an effect on service provider efforts to provide more spectrum, as older devices often cannot get access to new spectrum that newer devices can support.

A six year old iPhone 3G will achieve download speeds of 2 Mbps on a 3G network, but a new iPhone 6 will be able to operate 25 times faster due to its new 4G LTE access.

To some extent, the delay in device upgrades also means it will take longer to migrate users off of congested legacy spectrum and onto new bands.

5G will be "4G on Steroids"

Despite the hype about future fifth generation network mobile networks, it is quite likely that 5G will simply be an evolution of concepts pioneered on fourth generation Long Term Evolution networks.

Among the more-important capabilities are access to multiple networks, built on today’s use of Wi-Fi and carrier networks; small cells; more complex antenna arrays; and a wider range of devices and applications.

As typically happens, new frequencies will be added, since carriers have to maintain existing networks while they add the next generation.

The degree to which millimeter wave spectrum (30 GHz to 300 GHz) will be a feature of 5G is not yet so clear, but is conceivable. The issue is not so much whether millimeter wave frequencies will be important for backhaul (they already are), but how effective they will be for distribution (direct access by mobile and other devices), using sophisticated new antenna arrays (multiple input, multiple output).

Fifth generation mobile networks, most supporters are quick to say, will not be about “faster speeds” or novel air interfaces.

Instead, at least for the moment, the emphasis is on making all access platforms available to mobile and untethered devices, seamlessly. And that will mean 5G is a development of 4G, not a sharp break from 4G.

In other words, all the fundamental concepts already exist, and all the fundamental underlying technologies already are being developed to support future 5G networks.

Those of you with long memories will see the pattern. All new next generation networks are preceded by a period where all marketing emphasizes “compatibility” with the new emerging standard. That is likely to be the 5G pattern as well.

On the other hand, 5G will bring new spectrum to bear, in particular in the millimeter wave area, where much work is being done to commercialize the use of frequencies that historically have been unworkable for communications applications.

Moore’s Law, though, allows cheap processing that enables networks to take advantage of formerly-forbidding millimeter wave frequencies (30 GHz up to perhaps 300 GHz).

In the United States, the 38.6 GHz to 40 GHz band already is used for licensed high-speed microwave data links and the 60 GHz band can be used for unlicensed short range (1.7 km) data links.

The 71 GHz to 76 GHz, 81 GHz to 86 GHz and 92 GHz to 95 GHz bands are also used for point-to-point high-bandwidth communication links.

The issue is whether sophisticated signal processing also will allow use of millimeter waves for local distribution (access) , in addition to trunking (point to point backhaul).

Observers will readily admit there are issues, ranging from propagation distances to atmospheric issues (rain fade) and even oxygen absorption. But at millimeter wave frequencies, extremely high bandwidths are possible, if distance is limited.

Still, 5G is highly likely to  be an extrapolation of trends we already see. Supporters will likely not appreciate the characterization of 5G as “4G on steroids,” but that is likely to be quite correct.

New Definition of "Broadband" Could Have Big Consequences

The Federal Communications Commission decision to redefine "broadband" might have consequences. Where the FCC had used a 4 Mbps definition, it now defines “broadband” as a minimum of 25 Mbps downstream.

With the new definition, about, 12 million U.S. households that previously qualified as having a broadband connection no longer have it.

All satellite broadband and most fixed wireless Internet service providers now sell “Internet access,” not “high speed” or “broadband” access. Many fixed network telcos likewise now do not sell “broadband.”

Paradoxically, 10 Mbps Ethernet no longer is “broadband,” either. The new definitions will mean a revising--downward--of U.S. “broadband” access connections.

Some think the new definition could derail the proposed Comcast bid to buy Time Warner Cable, as well.

Up to this point, Comcast has been careful to point out it would sell off three million video accounts, to keep total video accounts below the 30 percent market share level that the Federal Communications Commission historically has used as a limit for market share in linear video, mobility or fixed network communications.

The problem is is that some do not believe “video” is the key market where share is crucial.

With the new definition in place, Comcast’s share of broadband will  be 56.8 percent, up from 30.6 percent using the older definition.

That will be a problem.

Does U.S. Telecom Industry Skate on Thin Ice?

Do service providers actually make much profit? That might seem, at first glance, a silly question, looking only at quarterly or annual financial statements. To be sure, some contestants--typically the smaller providers in any industry segment--face clear challenges.

But some might argue the problems are greater than often perceived. And that means the opportunity or danger--depending on one's point of view--are quite high. The easiest example is the mobile handset business.

In some ways, handsets are fashion items. For that reason, device market share can change dramatically. That has applied to whole handset brands as well. In fact, some might argue leadership changes about every seven years, in the handset business.

Whether that applies to Apple is an open question at the moment, as so far Apple seems to be defying past rules of thumb. Apple's sales velocity and prices seem to defy rules of thumb that suggest prices "should drop," margins "should" weaken and growth rates "should" slow.

Whether Apple is the exception that proves the rule is one question. But other big questions "should" be asked. Among those big questions are the shape of future telecom service provider markets.

Product share is one issue. Share of revenue is another question. Who the leading contestants will be is yet another question. The three biggest U.S. communications service providers, by revenue, now are AT&T, Verizon and Comcast.

The point is that, for the first time ever, a "cable TV company" is in the top ranks of telecom service providers. One might suggest even that could change, in a decade or two.

On the service provider side of the business, one might argue, disruptive market share change occurs "rarely," even if the relative shares of existing providers does shift, largely because of acquisitions.

But huge market share shifts now happen rather routinely at the product level.

In fact, at least historically, one might argue that discontinuities--distinct or sharp breaks--in the telecom business are relatively rare. One might also argue that discontinuities now are more frequent in the telecommunications business.

In fact, it now is possible to argue that truly significant changes now can happen in the service provider business  over periods as short as one decade.

Consider the matter of fixed network voice services in the U.S. market. Compared to 2000, U.S. incumbent telcos in 2013 served about 42 percent of accounts sold in 2000. In other words, over about a decade, U.S. fixed network telcos lost half of their voice lines.

In some cases, providers arguably have lost as much as 70 percent of fixed network voice lines.

In the U.S. market, 27.6 million total lines were “lost” marketwide, a shrinkage of about 17 percent of total lines in the market. In other words, aggregate demand dropped by that amount.

There also was contestant market share change. Over the 2008 to 2013 period, cable TV voice accounts grew from about 20 million to 30 million, for example.

The point is that a triggering disruptive event–the Telecommunications Act of 1996, did not immediately produce huge changes in market structure or revenue shares.

In the years between 1996 and 1999, new competitors gained about four percent share.

From 1999 to 2003, a period of three additional years, competitor market share rose from four percent to 13 percent.

From 2003 to 2005, competitors gained four more share points.

After 2008, competitor share--aided perhaps b y a new way of counting--climbed to 27 percent, according to FCC data.

The point is that significant changes now can happen over a decade, and big changes over periods of perhaps two decades.

But market share might not tell the whole story. Some might argue that firms such as Verizon might have lost money with their investments in fiber to the home platforms, for example.

Some argue that is why Verizon is willing to shed even FiOS lines to concentrate on mobility.

The more shocking argument is that Verizon and others might lose money even on their mobile business.

That raises a disturbing question: what happens when even dominating scale is not enough to ensure robust earnings by the largest service providers?

What changes in business model might be needed? And by the time fifth generation mobile networks actually arrive, will even the biggest mobile service providers have a defensible “moat” against new competition?

And, and if tht is a real possibility, why do regulators spend so much time burdening contestants that, one might argue, are going to face sustainability challenges even greater than they face at present?

Sprint, T-Mobile US Improving; Verizon and AT&T Way in Front for Network Performance

Choose your storyline: "Sprint and T-Mobile US improving fast," or "Verizon and AT&T way in front." Both would be accurate ways of summarizing the latest Rootmetrics study of network performance.

Sprint and T-Mobile US gained significant ground on AT&T and Verizon in Rootmetrics studies of metro market performance in the areas of network reliability and network speed, across mobile data, voice and text messaging products in the second half of 2014.

While Sprint and T-Mobile US still trail Verizon and AT&T, both Sprint and T-Mobile either gained awards or held steady in every category in the second half of 2014.

Sprint and T-Mobile increased their award tally by 140 compared to what the two networks earned at the metro level in the first half of 2014, according to Rootmetrics.

One might note that the results are shaped by the lead AT&T and Verizon have, and therefore the room for improvement possible for Sprint and T-Mobile US.

That said, all the networks improved in the second half, compared to the  first half.

Verizon either won or tied for first in our “overall” scores in 113 of the 125 markets tested. AT&T had 51 such scores. Verizon won or tied for first in 117 of the 125 markets. AT&T had 78 first-place wins or ties.

But T-Mobile US “in particular continues to show very fast speeds in many of the metro areas we test and, as we note below, even recorded the fastest median upload speed we saw from any network in the second half of 2014,” says Rootmetrics.

Also, T-Mobile’s 27 “overall” RootScore Awards in the second half of 2014 also represents “the most we have ever recorded for the network,” Rootmetrics says.

Sprint has also “made tremendous strides in our measurements,” says Rootmetrics. “With much better reliability than what we saw in the first half of 2014, Sprint won significantly more RootScore Awards in our call, text, and reliability measures this time around.”

“Sprint even pulled ahead of T-Mobile in both our call and  reliability categories at the metro level,” Rootmetrics said.

On the other hand, “while Sprint was the biggest net gainer in RootScore Awards (improving by 108 awards compared to the first half of 2014), its tally of 135 trailed those of the other three networks.”

Mobile Data Consumption to Grow 59% in 2015

Mobile data traffic will grow 59 percent in 2015 and 53 percent in 2016, Gartner predicts, driven primarily by consumption of video.

“Mobile video is generating 50 percent of all mobile data,” says Jessica Ekholm, Gartner research director. “We expect video streaming to account for over 60 percent of mobile data traffic in 2018.”

Video-calling services will contribute to overall demand, as well. In terms of traffic, five minutes of 3G FaceTime video calling uses up to 15 megabytes of data, a small amount. But the number of users arguably is large and growing.

Though mobile video is the primary usage driver, mobile music streaming can easily generate hundreds of megabytes of data as well.

Usage is increasing for several reasons. Faster mobile networks lead to higher data consumption.

More affordable smartphones also mean more people are using smartphones, which also increases data consumption.

Despite the activation of new 4G networks, 3G networks will continue to fuel worldwide data growth during the next five years, Gartner predicts. “We expect 3G connections to grow by 45.7 percent globally in 2015,” Gartner says.

“We predict that, in 2018, half of North American mobile connections will use 4G networks, but in the Middle East and Africa 4G users will amount to only 3.5 percent of the region's total,” says Ekholm.

By 2018, 4G users will generate 46 percent of all mobile data traffic, with each 4G smartphone consuming 5.5GB of data per month, three times more than a 3G smartphone, Gartner says.