Verizon Puts Muscle Behind A LA Carte and Streaming Strategy

Verizon wants to make omelets.  It has to break eggs.

Did Verizon Just Screw The Content Giants? http://m.seekingalpha.com/article/3106216?source=ansh $VZ, $DIS, $FOX, $FOXA

Level 3 And Verizon Agree To Share Cost Of Network Upgrades

That is the way large networks and Internet domains always have interconnected. And it makes sense.

When networks exchange roughly equal amounts of traffic there is no structural problem. When traffic is unequal,  the sending network imposes costs on the receiving network. "Sending network pays" is how it works.

And how it should work, in fairness.

Level 3 And Verizon Sign Interconnect Agreement: Agree To Share Cost Of Network Upgrades http://m.seekingalpha.com/article/3106406?source=ansh $LVLT, $VZ

ESPN Sues Verizon Over Skinny Bundles that Do Not Include ESPN

ESPN obviously sees the Verizon skinny bundle as a bigger threat than DirecTV’s skinny bundle. Verizon excludes ESPN from the base tier, relegating ESPN to an optional sports tier.

DirecTV does something similar, albeit on a smaller scale, by allowing consumers to purchase a basic tier without ESPN, though most of the packages do seem to include ESPN.

So Verizon’s approach likely is going to affect more consumers. Verizon has been sued, and DirecTV has not been sued.

55% of U.S. Internet Homes Buy OTT Video

Some 55 percent of U.S. households with Internet access now subscribe to an over the top streaming (OTT) video service, up from 44 percent in 2013, Parks Associates estimates.

Subscriptions are highest among households with a younger head-of-household, with 72 percent of households headed by those 18 to 24 and 71 percent of households headed by those 25 to 34 having an OTT service subscription.

That alone might not suggest a tipping point, or inflection point, is nearing. More significant are moves by content suppliers to create stand-alone streaming services not dependent on a prior purchase of a standard linear service.

AT&T Acquisition of DirecTV Seems Likely, for Good Reasons

As a rule of thumb, I tend to assume U.S. regulators will nix any acquisition by a market leader that produces an outcome where a single entity controls more than 30 percent national market share.

That math suggested Comcast would not be allowed to buy Time Warner Cable, since Comcast’s share of high speed Internet access would exceed 57 percent.

The only issue, after the Federal Communications Commission raised the definition of broadband to a minimum of 25 Mbps, was how much higher Comcast’s share would grow.

By way of contrast, an AT&T that has acquired DirecTV would still only have a maximum of 17 percent share of the U.S. Internet access market. The actual share, under the new 25-Mbps definition, is not clear, but would be less than 17 percent. And linear video share would not exceed 27 percent, in a line of business universally recognized to be declining, in any case.

That is why rumors of merger approval seem logical. Even if the acquisition consolidates one of the major linear video providers, the new entity has 27 percent market share, and faces almost-certain declines over the next five to 10 years.

What if Nobody Wants to be the "Carrier of Last Resort?"

AT&T has about 17 percent share of the U.S. Internet access market, assuming none of its lines now fail the new definition of 25 Mbps. Most consumers buying satellite Internet, and probably most customers buying fixed wireless services likewise now are purchasing Internet access, but not, strictly speaking, what the Federal Communications Commission calls “broadband” or “high speed access.”

Beyond the issue of FCC regulatory fiat redefining a few industries out of business (most satellite and fixed wireless access services), causing a statistical, overnight decline in “broadband” adoption in the United States, and rendering multi-year tracking of Internet access more difficult, there are other perhaps perplexing issues in the U.S. Internet access business.

In a competitive market, some of us would argue, the low cost provider wins. In the fixed network Internet access market, that is cable TV.

So it is noteworthy that Verizon has been shifting capital investment into mobile, and generally away from its fixed networks.

And even allowing for its use in a lobbying capacity, AT&T now says its own fixed network is more costly than that of the cable operators that now are the market leaders in high speed access, in the U.S. market. AT&T's fiber to the neighborhood network cannot keep pace with the bandwidth offered by cable and other competitors, AT&T has told the FCC.

So AT&T increasingly will have to shift to fiber to the home to keep pace, as Verizon already has done with FiOS.

The problem is that the new investment will occur in the context of declining profit margins in the fixed networks business overall. Voice revenue is declining, linear video is expected to decline, and cable has the more efficient, and faster, Internet access services.

Put bluntly, the ability of a telco--even a tier one telco--to compete against a well-capitalized cable TV company is doubtful, long term, in the fixed network business.

That might be a shocking conclusion. But evidence points in that direction. It is fashionable, perhaps even directionally correct, to say that the fundamental strategic importance of a fixed network is mobile backhaul.

But that statement also suggests the revenue potential of a fixed network is shrinking. Special access might have been a high-margin service that drove profits for networks that recovered their costs substantially from consumer services.

But such business-focused services (backhaul) were not huge gross revenue drivers.

It is too easy to argue that telcos will discover huge new revenue sources to revive the fixed networks business, so there is no strategic issue. It is possible such revenues will never be found, leaving cost reduction or exiting the business the options.

That does raise issues for regulators. What if no single service provider wishes to, or can afford to be, the “carrier of last resort?”

And if the intent is to create and sustain incentives for any service provider to take on that role, what has to change? We don’t have clear answers, yet.

Scarcity and Abundance Have Strategic Implications for Access Providers

We sometimes forget just how much the telco business model is built on scarcity. Only a few fixed networks are viable, long term, in any community.

How many facilities-based mobile service providers are viable, long term, in any country, remains a question, but the number is probably three to possibly four.

Also, with consumer bandwidths climbing into the gigabit range in some markets, speed is going to drop away as a relevant constraint on experience or business models, just as processor speed and memory have ceased to constrain apps and devices.

App and device suppliers long have understood the implications of abundance of bandwidth and processing power for their businesses. Abundance means lower retail prices are possible.

Bandwidth suppliers long have understood this as well, which explains the fear of "commodity dumb pipe" services.

But abundance always has been a key enabler in the Internet ecosystem, at least for app and device providers. It can be argued that firms ranging from Microsoft to Netflix have been built on the notion that neither bandwidth nor processing power or memory would be fundamental constraints on business models.

That model has not worked quite so well in the mobile service provider business, in part because spectrum available for communications use always has been scarce, and licensed access meant whatever resources were available would remain fairly scarce.

That is why unlicensed access, or releasing vastly more spectrum for communications uses, undermines service provider “scarcity” value.

In all, AT&T now holds spectrum licenses worth more than $91 billion, estimates Goldman Sachs analyst Brett Feldman. He also estimates the value of Verizon's spectrum at $79.4 billion.

The current equity value of all AT&T stock is $176.5 billion, implying that spectrum alone represents 51.6 percent of AT&T’s total equity value.

Verizon’s market value is $207.9 billion, implying that Verizon’s spectrum represents 38 percent of total valuation.

Feldman estimates that the U.S. mobile industry, plus Dish Network’s spectrum represents $368 billion in value.

All that could change dramatically in the future, though, as shared spectrum, unlicensed spectrum and dynamic spectrum alternatives are made possible. All those methods could reduce the amount of licensed spectrum mobile service providers have to buy or reduce the market value of current holdings.

To be sure, many proponents of unlicensed spectrum believe releasing much more spectrum in that way will reduce the scarcity value of licensed spectrum held by mobile service providers.

Dish Network owns rights to use spectrum worth perhaps $50 billion, if actually deployed, and virtually nothing if Dish Network does not put the spectrum into commercial use, or sell the rights to some other company able to launch commercial services.

T-Mobile US might own about $55 billion worth of spectrum, while Sprint owns more than $67 billion worth of spectrum, according to Goldman Sachs.

That value is based on scarcity. But what is scarcity is replaced by abundance?

Big Internet Winners Prospered Using Non-Traditional Revenue Models: Can Device and Access Providers Do the Same?

Radically-new business models are something of a rarity in the communications, computing or consumer appliance business, though rather common in the Internet applications space.

Google is the best example of a technology company--or a software company--creating a business model on advertising, not sales of computing equipment or “packaged software.”

To the extent Amazon is viewed as a technology company--not a retailer--it might be be the first to build a build a business model on e-commerce. But PayPal might be an even-better example.

Up to this point, consumer electronics suppliers, including smartphone suppliers, have generated significant application or content revenue streams, but still representing a minority of total revenues. What could happen in the future is the issue.

As device supplier Xiaomi might put it, the firm someday might make money the way that

Tencent and Alibaba do, namely by selling games or engaging in e-commerce, and not by “selling phones.”

That ambition would be quite rare, if realized. But such rare outcomes might ultimately be decisive for any number of eventual big winners in the Internet ecosystem.

Oddly enough, the traditional or legacy communications “app providers” (voice and linear video) are making less money from apps and more from “access.”

Where use of a network was only a prerequisite to selling the service, now “dumb pipe” access to Internet apps is a major, and growing, underpinning of both mobile and fixed network businesses.

Recall that consumer Internet access, easily representing a third of revenues for many firms, is a classic dumb pipe service, allowing consumers to reach app providers and facing profit margin pressures.

Voice and video are apps--managed services--still represent major revenue sources, but are dwindling, overall.

The broader point is that business model innovations are becoming essential. Over time, cable, telco and satellite providers will earn less money from legacy apps, and more from dumb pipe access operations Profit margins then will be key.

That might not be a challenge restricted to access providers. Few smartphone suppliers except for Apple and Samsung actually make any money selling phones. And even app suppliers or bundlers are likely to make as much money from transactions, e-commerce or advertising as they do from app sales.

Even if direct sales account for the bulk of sales revenue, such activities often do not generate much actual profit.

So the broader strategic issue is how successful most  suppliers in the Internet ecosystem ultimately will be in creating new revenue and business models based direct content and app sales, and indirect (sponsorship, transaction or e-commerce) revenue streams.

For some suppliers, revenue streams based on e-commerce or advertising, even when relatively small, could have outsized implications. Xiaomi, for example, sells smartphones almost at cost, hoping to create huge audiences for applications.

Apple traditionally has had the opposite model--offering content to drive sales of devices--but seems to be moving in the direction of greater reliance on app, transaction or content revenue streams (mobile payments, mobile apps, streaming video services).

In a direct sense, mobile service providers creating connected car services--and selling “just” 4G access to vehicles--are an example of efforts to drive higher sales of apps, not access.

Mobile remittance services (generally successful) and mobile payments services (relatively unsuccessful) provide other examples. Firms such as Verizon have, so far, made little progress in creating viable mobile streaming services, but the outcome is not determined, , and such efforts are bound to continue.

The ultimate problem, for most contestants in any Internet segment, is that the number of viable suppliers in any category might be quite limited. In advertising, Google and Facebook dominate. In mobile advertising, Facebook might be the bigger factor at the the moment. In the e-commerce-supported arena, Amazon is trailed by lots of retailers who have yet to make much of a dent, in terms of market share.

Internet service providers (telcos and cable TV firms) are entering new terrain. They historically have prospered by selling apps that require the use of networks. Now their legacy apps can be provided by third parties.

The one truly-new line of business is Internet access. But because of network neutrality, that is a dumb pipe business, by definition, in the consumer segment.

That might be a situation more contestants in the Internet ecosystem find themselves confronting, in the future.

All the effort that goes into creating and selling devices or access could wind up generating a relatively small portion of actual profit, even if essential to the profit mechanism.

That could happen in two ways. Device and access providers could fail to gain a significant role in the apps and transactions role, and ride a dumb pipe or commodity business to the bottom. In that case, access and devices simply is not a high generator of profits, even when generating lots of gross revenue.

In another scenario, the new apps and transaction businesses or will have successfully created app and transaction services of sufficient size to drive profit margins.

Across the ecosystem, actual direct sales (apps, devices, access) remain vital. But indirect revenue models increasingly will be important (commissions, fees, revenue sharing), as core products (devices, apps, access) face blistering competition.

To the extent the analogy fits, think Google, the first technology company to build a revenue model based on advertising, or Amazon, the first technology firm to build a revenue model on e-commerce, or PayPal, perhaps the first technology firm to create a revenue model based on transaction fees.

Unique Value of Mobility Remains, Even with Greater Wi-Fi Access

There has been a two-decades long line of thought that Wi-Fi eventually could become a full substitute for a mobile network. So far, Wi-Fi has proven to be more a complement than a competitor to mobile access. But fourth generation networks have raised new issues about mobile substitution that fifth generation (5G) networks might settle.

The argument always is that a “Wi-Fi First” or eventually “Wi-Fi Only” model can fulfill most user needs, relegating the mobile networks to “filling the gaps between hotspots.”

That might be true to a great extent. But the value of the mobile network always has been about filling the communication space between fixed locations.

Think about it: the great value of mobile was the ability to communicate “on the go,” between places. That still is the case for Wi-Fi access and mobile access, to a very large extent. It is precisely the ability to stay in touch, when on the go, that is the unique value of mobile services.

In fact, that will continue to be the case for connected cars and other vehicles, where a mobile connection supplies in-vehicle Wi-Fi. Mobility at high to moderate speeds, with session handoff, remains the unique value.

That is true for high speed handoffs when communicating from moving vehicles or even out and about, on foot. Even when very dense network of public hotspots adds “public places” to the venues where Wi-Fi can be used, the primary and unique value of mobility remains the abilty to communicate when all fixed services (wired or untethered) are unavailable.

Such connectivity still will be the unique value of a mobile service, even when Wi-Fi access in stationary locations is available. That was true even when mobile phones were about voice communications.

In that sense, the fundamental value proposition for mobility is not diminished by even dense networks of public Wi-Fi hotspots.

Even Traditional LIne of Business Regulation is Being Swept into the Network Neutrality Framework

Ecosystems are tricky things. Value is created only when all the segments are aligned from the first supplier to the last consumer. But value and revenue within the ecosystem is unstable because one segment’s costs are another segment’s revenue.

Tougher still are situations where existing ecosystems bump up against new ecosystems. That is a big problem wherever whole industries once were regulated in silos, but now overlap, entirely or substantially.

How to treat Internet voice and messaging provides one clear example, as equivalent products and services now are provided under distinctly-different sets of rules.

But questions about how contestants in any market “should” be regulated or taxed now have been pulled into the language and thought categories “network neutrality.

Whether that makes sense or not remains to be seen. Consider the logic or arguments now raised in India about regulating Internet voice and messaging. Now even regulating “like things in like ways” is garbed in net neutrality language.

We might be stretching the slogan too much. Sometimes there might be very sound reasons for treating “like” services in unequal ways. That often happens early on, when policymakers want to encourage new ways of doing things, or new competitors.

More simply, the notion of consumer choice also suggests the ability to create different products, with different characteristics, at different price points. Net neutrality arguably helps app providers, but inhibits innovation on the part of Internet service providers who are bound by “best effort only” quality of service.

The new wrinkle is that older arguments about like treatment of like services is being recast in the thought patterns of network neutrality as well.

In India, service providers warn they might have to raise prices up to six times if new regulations treating Internet voice and messaging the same as carrier-provided voice and messaging are not adopted.

In other words, mobile operators want “over the top” competitors held to the same rules and standards as carrier voice in areas related to taxation and other fees paid by carrier voice suppliers.

Those issues are more important in a net neutrality context.

Net neutrality ultimately will raise capital investment requirements for mobile Internet access suppliers and possibly make unlawful some business models. The reason is the only way to deal with congestion is to supply more bandwidth. And that means higher infrastructure investments.

Equal treatment of like services, on the other hand, will make it possible for mobile operators to compete more effectively with OTT alternatives because all play by the same rules.

By prohibiting traffic shaping, net neutrality forces ISPs to rely on "brute force" bandwidth upgrades.

To the extent that net neutrality forbids zero rating, the rules also limit demand growth, and hence supply pressures.

OTT app providers, on the other hand, would see their costs of doing business rise by quite some amount, and those costs likely would be recovered from customers.

It is easy enough to predict that if most of the cost advantage of OTT voice and messaging is erased, the value of OTT apps will be reduced and consumption of carrier voice and messaging could grow, while OTT share shrinks.

Will Triple Play Service Revenue Drop 50% Over the Next Decade?

People who aren’t in the telecom business rarely understand just how much change, and how many challenges, service providers and their suppliers have had to face over the last several decades.

Since the 1980s the global industry has survived a fundamental shift from monopoly to competition; state-owned enterprises to private entities; the end of all communication monopolies; the rise of the Internet as an increasingly full-fledged competitor or enabler of full competition; steadily-decreasing profit margins and yet a huge extension of teledensity to embrace nearly everyone on the planet.

And yet the next decade will bring additional challenges of a profound nature. To point to the obvious growing tension today’s foundation strategy for fixed network services--the triple play--is itself coming under attack, because there are substitutes.

Google says a fixed network must sell both high speed access and linear video to be viable. Telcos and cable TV companies rely on the triple play.

But it will not last.

For more than a decade, the triple play has been the key retail strategy in the fixed network access market.

But every constituent service fundamental for the triple play now faces growing substitute products.

In other words, the fixed network revenue business model is going to face additional and fundamental challenges to the bulk of its current revenue.

Voice already is challenged by over the top messaging, VoIP, and mostly mobile substitution. Linear video faces disruption from Netflix and many other streaming video services.

And though high speed access is the newest service in the bundle, and arguably has proven most resistant to substitution, fifth generation mobile networks promise bandwidth available to every user or device of 1 Gbps to 10 Gbps, with latency of one millisecond.

As a rule of thumb, access providers since about 1977 have had to replace about half their present revenue streams every 10 years. It doesn’t seem as though that is about to change.

Voice already has been cannibalized; video certainly will face major substitution within five years, and then 5G will hit sometime after 2020.

It’s going to be another challenging and exciting decade, as access providers create or discover revenues equal to about half all their present revenue.

The 30% Rule Usually Works

I may have an overly-simplistic way of looking at the odds of big mergers in the access business, but there is a simple rule of thumb: antitrust opposition arises in the access business whenever any single provider is poised to exceed serving more than 30 percent of U.S. households.

It’s a simple rule of thumb, but it tends to work. In that regard, the Comcast purchase of Time Warner Cable, had it succeeded, would have given Comcast access to 84 million U.S homes, representing about 70 percent of the entire population, in a market where AT&T, the biggest provider in terms of homes reached, might potentially reach 50 million homes.

If total U.S. homes are about 123 million, and occupied units are about 116 million, then Comcast would have had access to 72 percent of U.S. homes. AT&T, by way of contrast, has access to 43 percent of U.S. homes.

“Access” is different than “active account at that location,” though. Since there are two to four major suppliers of any single service in every market, the market share held by any single provider is a fraction of total addressable homes.

AT&T knows it will not be allowed to increase its fixed network footprint. Comcast positioned its acquisition bid as being primarily about video accounts, where market share would have been held at about 30 percent.

Others had said the relevant “market” was high speed access, not video. Had the deal been approved, Comcast would have had about 57 percent share of the high speed market, and an overwhelming share of accounts in the fastest speed categories, and the widest footprint of gigabit and 2 Gbps service availability.

Verizon Communications, for its part, recently reported it had 42 percent adoption of FiOS Internet access services where FiOS is available, and 30 percent FiOS entertainment video adoption where that service is available.

At AT&T first quarter results were less robust. In the quarter, AT&T had U-verse TV adoption of 22 percent and U-verse  high speed access adoption of 21 percent.

High Speed Access was the Relevant Market for Antitrust Officials Looking at Comcast Bid to Buy Time Warner Cable

I may have an overly-simplistic way of looking at the odds of big mergers in the access business, but there is a simple rule of thumb: antitrust opposition arises in the access business whenever any single provider is poised to exceed serving more than 30 percent of U.S. households.

It’s a simple rule of thumb, but it tends to work. In that regard, the Comcast purchase of Time Warner Cable, had it succeeded, would have given Comcast access to 84 million U.S homes, representing about 70 percent of the entire population, in a market where AT&T, the biggest provider in terms of homes reached, might potentially reach 50 million homes.

If total U.S. homes are about 123 million, and occupied units are about 116 million, then Comcast would have had access to 72 percent of U.S. homes. AT&T, by way of contrast, has access to 43 percent of U.S. homes.

“Access” is different than “active account at that location,” though. Since there are two to four major suppliers of any single service in every market, the market share held by any single provider is a fraction of total addressable homes.

AT&T knows it will not be allowed to increase its fixed network footprint. Comcast positioned its acquisition bid as being primarily about video accounts, where market share would have been held at about 30 percent.

Others had said the relevant “market” was high speed access, not video. Had the deal been approved, Comcast would have had about 57 percent share of the high speed market, and an overwhelming share of accounts in the fastest speed categories, and the widest footprint of gigabit and 2 Gbps service availability.

Microsoft Cloud Revenue is Really Growing Fast

It remains difficult to precisely estimate the amount of cloud service revenue Microsoft actually generates, as it once was difficult to determine the size of Amazon’s Amazon Web Services business.

Microsoft’s cloud revenue is spread across a couple of business units, and also is bundled with revenue from non-related products.   

IDC expects the overall cloud infrastructure market to top $32 billion in 2015, with public cloud claiming $21 billion of the market, roughly double its private cloud peer.

Until a day ago, it has been guesswork to determine how much of that public cloud market is owned by Amazon. As it turns out, analyst estimates were very close, estimating AWS revenue at roughly $5 billion in mid-2014.

Analyst Karl Keirstead at Deutsche Bank, had estimated current AWS annual revenue of about $6 billion. As it turns out, that is the current run rate.

Microsoft now is viewed as the number two provider, by revenue share, with a blistering sales growth rate. Some think Microsoft’s cloud revenue run rate (the most recent quarter, times four) is about $4 billion annually.  

New Rule: No Triple Play Provider can Grow by Acquisition Beyond 30% Share of Any Single Service

The emergence of the triple play bundle now has affected its first big merger victim, one might argue. In the past, the rules for market leaders were fairly simple. In the voice, linear video and now high speed access market (it seems), the old rule of thumb was that no service provider would be allowed to gain more than 30 percent share.

Every large telco knows that, and Comcast likewise has known it would bump up against the 30 percent rule when it proposed buying Time Warner Cable.

It seems the math is a bit more limiting now, since no single bundle provider can have more than 30 percent of voice, linear video, high speed access of any other future consumer service that might be created in the future.

So now service providers have to worry not only about failing, and modest success, they also have to worry about robust success, as too much customer share in any one segment makes the evaluation of expansion through acquisition in any other area problematic.

Comcast now has reached a point where it likely cannot expect to gain any more fixed network customer share--defined as percentage market share for any of the triple play services--through acquisition.

As AT&T discovered with its failed effort to buy T-Mobile US, once that 30-percent limit is reached--in any single segment--growth by acquisition is blocked.

AT&T’s effort to buy DirecTV only has a shot at success because AT&T will not exceed 30 percent share in fixed network voice, linear video or high speed access.