Can Most Telcos Replace 1/2 of Revenue in 10 Years?

AT&T first quarter revenue trends over the past three years have been worrisome. And that is why moves such as the Time Warner acquisition, and potentially the AppNexus buy, are so important.  

In the first quarter, over the last three years, revenue has fallen. And though free cash flow held up in 2016 and 2017, it dipped in the first quarter of 2018.

AT&T is not different from most other service providers in developed markets, in the sense that every legacy revenue stream is shrinking. With markets saturated (fixed and mobile services and customer segments), it is somewhat obvious that revenue growth has to be sought elsewhere.

So though debt levels are a clear issue, most tier-one service providers who hope to prosper over the next decade or two virtually must spend significant resources in the effort to create brand new revenue drivers, with scale.

Time Warner helps AT&T, in the near term, much as NBCUniversal has helped Comcast. The AppNexus acquisition is a more risky, but with outsized returns, if the AT&T strategy works. What AT&T says it wants to do is create a big ad exchange platform that can rival Google and Facebook.

So the potential upside is clear enough. The challenges arguably are even greater, but the need to replace as much as 50 percent of current revenues over the next decade are reason enough for bold moves. That might sound like hyperbole.

It actually is history. U.S. service providers, for example, have had to replace that much revenue at least once or twice over the last couple of decades. The first big change was the replacement of long distance revenues with mobile revenues. The second big change (and more recent) was the replacement of mobile voice and texting with mobile internet.

But there is little reason to believe the underlying trend will change. Many tier-one service providers will have to replace as much as half their present revenue with new sources in 10 years. One might argue they will have to do so every 10 years.

source: Seeking Alpha

source: Seeking Alpha

Is Business Connectivity Spending Growing?

The 5G era might represent a significant change in telecom market dynamics. Where consumer demand for internet access arguably has driven revenue growth for the past couple of decades, growth might shift to enterprise and business users.

The reasons are several. Though nearly all connectivity markets are competitive, and face pressures to reduce prices, almost continually, cloud computing and internet of things arguably will increase demands for business connectivity, virtually across the board.

On the other hand, substitution effects never can be discounted. Nor can we discount the growing ability to substitute lower-cost computing platforms for higher-cost platforms, which means quality goes up even as costs remain flat or even decrease. That means spending levels do not always linearly relate to demand.

And it always is difficult to tell whether U.S. business spending on telecommunications is growing or shrinking, in part because different forecasters use different definitions of what “telecom spending” includes. Nevertheless, several analysts now predict steadily-growing U.S. business spending on telecommunications.

source: Forrester Research

With the caveat that “North America” often includes the United States and Canada, or, perhaps as appropriately, those nations plus Mexico, spending on communications services seems to be on an upward trajectory.

source: Statista

source: Gartner

Online Ad Market: Many Challenges

Online advertising markets face significant long-term challenges, including growing demands for privacy that will have the practical effect of raising operating costs for ad platforms. That trend has been a threat since the rise of ad blockers, is raised by new data privacy rules and might evolve again if blockchain and other approaches to user ownership of data actually become ubiquitous.

But challengers also will not stop trying to unseat Google and Facebook, either.

AT&T hopes to create a viable ad exchange platform for advertisers who want an alternative to Google and Facebook. Verizon hopes to do the same, with less universal scope. In that regard, a number of other app providers also hope they can become the third option to Google and Facebook. And that list of would-be contenders includes Amazon and Twitter, for example. So it will not be easy for any contender to emerge as a significant third alternative.

source: Visual Capitalist

According to at least one new survey, consumers tend to see Google and Facebook as the most influential ad platforms. Facebook (54 percent) and Google (44 percent) were cited by consumers as the most influential platforms for advertising.

Instagram (23 percent), Spotify (28 percent), and Pandora (24 percent) followed Google and Facebook.

Some 43 percent of respondents felt negatively towards advertisements, compared to a similar survey from April of 2017 where only 34 percent reported a negative sentiment. So digital platforms perhaps are making some of the same mistakes linear video advertising channels have made, namely showing too many ads.

Will Autonomous Vehicles Increase Video Consumption?

The video entertainment business is not what it used to be. The receiving device once was a television. These days mobile phones, game consoles, personal computers or tablets also are used, and with increasing frequency.

But the range of use cases (and therefore “devices”) might eventually include a much-greater number of use cases. And at least some tier-one service providers believe automobiles, especially autonomous vehicles, will be added to the list of venues.

source: Marketing Charts

In the 5G era, where neither latency nor bandwidth will be barriers, use of self-driving vehicles will become possible.

And though many of the use cases are expected to begin with long-haul trucking, autonomous vehicles will create yet another new venue for “watching video.”

“If you’re not driving yourself to and from work to and from Los Angeles anymore, you can sit in the back seat and let the vehicle take you, what do you get?” asks John Stankey, AT&T Warner Media CEO. “You get another hour or two hours to consume great content that you build every day.:

So the autonomous automobile gets added to the venues and devices where video entertainment is consumed. Just as significantly, the hours per day envelope potentially gets bigger, one might argue.

Of course, it also is possible that people simply shift some amount of viewing from other venues to the “auto.” It also is possible that although the venue changes, the device does not. It is obviously possible that some amount of PC, tablet or smartphone video consumption simply gets shifted from a tethered use case (inside a home) to a mobile use case (in a moving vehicle).

Either way, mobile service providers might see upside. So too might content suppliers and advertising platforms also see gains from increased amounts of usage.

source: Tubular Insights  

source: Tubular Insights  

“Why am I bullish on building more content?” Stankey says. “Well, I think that the average number of hours that an individual consumes in a given day might actually increase somewhere in the range of an hour to an hour and a half over the course of the next four years because of that shift.”

And several sorts of shifts could happen: more mobile, more vehicular consumption, more mobile advertising avails, different content formats or display parameters (vertical, not just horizontal aspect ratios, to support smartphone consumption).

source: eMarketer

In the advertising area, we have been accustomed to the idea that billboards and other forms of outdoor, out of home or place-based and transient advertising, but generally not video as the media type used.

But as smartphones increasingly become media consumption devices, so does out of home or outdoor advertising change. The screen is in the purse or pocket, and is as mobile as the human using that device.

It might take some time, but owning Time Warner might allow AT&T to create a new venue for content consumption and advertising.

Implications of Building All Networks as Video Networks

All consumer networks are becoming video delivery networks, even if other revenue-generating media types are supported. Among other implications, that development means revenue per bit and “cost per bit” are losing relevance, as the revenue per bit varies so wildly between application types, and because video produces the absolute least revenue per bit of any application, by orders of magnitude.

Just how wide the variance is depends on the assumptions, but video revenue per gigabyte can be four orders of magnitude less than that of voice or text messaging, for example.

That is one good reason why many observers believe the telecom business no longer can be built solely on connectivity revenues and services, but must expand to embrace revenue sources elsewhere in the value chain.

If networks now are dimensioned to support delivery of video entertainment, without regard to revenue directly generated by such applications, then revenues generated by capacity requirements alone becomes a difficult business proposition.

Consumers cannot afford to buy video levels of bandwidth on a metered basis, unless the costs are very very low, since video consumes so much bandwidth per minute of use, compared to any other media type. That makes pricing of internet access quite challenging, as incremental capacity supplied produces little incremental access revenue, comparatively.

So the need to build networks and add capacity for apps that produce little direct revenue is a huge change from the way investments once were made in incremental capacity.

In the past, service providers added capacity as revenue-producing demand increased. These days, capacity has to continually be increased, even if no direct incremental revenue is reaped.

source: Cisco

No story is more consistent than the steady increase in bandwidth provided to consumers over fixed and mobile networks, satellites, undersea or Wi-Fi networks.  Wi-Fi network maximum bandwidth has been doubling about every two to five years, since 1997, for example.

The other story is decreasing prices per supplied gigabyte of usage, and declining prices, when prices are adjusted for inflation or purchasing power over time.

source: Ruckus Wireless

The Battle for Third Place in Digital Advertising

The battle for market share in the digital ad market seems to be a battle for third place, as no firm yet seems to have the ability to dislodge Google and Facebook from their present positions.

Ad buyers understandably worry about the “duopoly” of Google and Facebook in digital advertising. But many other would-be competitors worry about whether there is a shot at taking the clear “number three” spot in the market.

And that includes Verizon and AT&T, which must contend with Amazon, Twitter, Microsoft and others in the battle to secure a stable "number three" position. "Winning," in the sense of challenging Google or Facebook for the number one or number two spot, seems unlikely.

It would be a rare market indeed if the number-three supplier had anything close to market share parity with either the market leader or the number-two market share holder. And once the basic pattern gets set, it is nearly impossible to change.

Google, for example, has about 41 percent of the digital ad market. Facebook has about 17 percent, according to Visual Capitalist. And that is about what the classic rule of market share would predict.

The classic pattern is a market share structure that follows a 6:3:1 (or 5:3:1) pattern , where the leader has twice the share of number two, which has twice the share of number three. In many markets there also is a long tail of other providers who have small shares.

source: Visual Capitalist

source: eMarketer

Winner Take All is the Rule, Not the Exception, And Always Has Been

Some observers find troubling (and unusual) the present market structure of the internet apps industry, where a “winner take all” pattern tends to exist. Historians will argue that such patterns are absolutely normal, in any industry, and have been the case in the pre-internet era as well.

In other words, "winner take all" is not the result of a broken market, but instead the normal and expected outcome in any competitive market, in any era, and not just in the internet age.

For that reason, it is not so clear that "winner take all" trends in the app business are necessarily the result of a broken market. That is the shape markets tend to take. In fact, what is unusual are markets where the 6:3:1 pattern does not exist.

As a rule, any market or industry will tend to see a huge difference between the leader and number two and number three providers, in terms of market share, with a corresponding difference in profit margin.

So a classic market share structure would have something like a 60-30-10 pattern (or 55-27-18 if you want absolute fidelity to the rule). The key point is that pre-internet markets tended to be “winner take all.” That is not new, nor necessarily evidence of market failure.

So winner take all is the rule, not the exception, in most markets, and has been the case even before the internet ecosystem was created. The classic pattern is that the leader in any market  has twice the share of the second provider, which in turn has twice the share of number three.

You can see the pattern in app use. U.S. smartphone users spend nearly half their digital media time on their most-used app, with a long tail of lesser-used apps, comScore data shows. Tablet users spend 60 percent of their time on the most-used app.

source: comScore

ISPs Want Freedom Netflix Has

Netflix is introducing new premium plans in Europe featuring support for 4K and high dynamic range support that would not be available on standard plans. Adding features based on quality is not unusual for any product supplier, nor is the offering of different product models.

We note this only to point out that while observers seem to understand the business wisdom when suppliers offer different models and features, at different price points, to satisfy different segments of the market, that same business practice is supposed to be denied to internet access providers.

The point: Netflix is creating additional value, and differentiating plans, to support its business model. ISPs want to do the same thing.

source: BLS  

In principle, offering quality of service or other features of an access service, and therefore creating differentiation, is simply a normal business practice. So long as standard and economy products exist, premium versions are not necessarily harmful to consumer choice, the right to use any lawful application, or the ability of app providers to be reached by their customers and users.

Increasing product value might be a bigger business challenge in any industry where prices for the standard product version are falling, as has been the case for U.S. internet access prices, where prices have fallen for two decades, according to U.S. Bureau of Labor Statistics data.

According to the U.S. Bureau of Labor Statistics, prices for internet services and electronic information providers were 21.98 percent lower in 2018 versus 2000.

Between 2000 and 2018: Internet services experienced an average inflation rate of -1.37 percent per year. In other words, internet services costing $50 in the year 2000 would cost $39.01 in 2018 for an equivalent purchase.

Compared to the overall inflation rate of 2.09 percent during this same period, inflation for internet services was significantly lower.

As budget and standard consumer internet access offers keep getting better, in terms of bandwidth, usage buckets, latency and cost-per gigabyte of usage, as well as absolute prices in many cases (and certainly for inflation-adjusted pricing),  the search for ways to add value is understandable.

Australia National Broadband Network Falls Behind Plan for Revenue, Above Plan for Cost

It never is unexpected when a big construction project, especially a project being conducted on a continent-sized area, falls behind schedule. And Australia’s National Broadband Network appears to be falling behind its original targets, in terms of customer activations and planned-for revenue. But some might say the shortfalls are relatively minor.

Cumulative revenue, for example, is down about $18 million, but some might argue that is not so much for a national project of this scope, in its second year of actual construction.

More worrisome is the possibility that the NBN will never actually make a profit, as costs are higher than originally planned and average revenue per account is far lower than originally planned, balanced however by wholesale revenue.

source: McLaren Williams

source: McLaren Williams

Networks Creep Towards A La Carte

It is an open question whether most of today’s linear programming networks (delivered using one or more fixed or satellite networks) could exist if they had to go direct to consumer as stand-alone streaming packages, as does HBO, or as a few other networks might contemplate.

So far, channels historically not supported by advertising have had the easier time of the transition. HBO, Starz and Showtime, for example, can be purchased as streaming services.

A key issue is consumer expectations about cost of a single channel. Surveys show consumers expect a cost of about $2 per channel, per month, roughly five to eight times more than many channels now charge.

Few streaming channels are sold for such prices, though, suggesting the economics of stand-alone streaming---for most channels--does not allow the expected pricing of a couple dollars per month, as one might deduce from today’s 40-channel bundles selling for up to $40 a month.

CBS sells streaming access as well, suggesting the possibility that the most-watched ad-supported channels might be able to create stand-alone streaming services.

A sort of hybrid step is allowing big retailers such as Amazon to handle sales and distribution. Amazon Channels feature:

• HBO ($14.99 per month)

• Showtime ($8.99 per month)
• Cinemax ($9.99 per month)
• Starz ($8.99 per month)
• Mubi ($5.99 per month)
• Sundance Now ($6.99 per month)
• Sports Illustrated TV ($4.99 per month)
• Comic Con HQ ($4.99 per month)
• History Vault ($4.99 per month)
• Comedy Central Stand-Up ($3.99 per month)
• PBS Masterpiece ($5.99 per month)
• IndiePix Unlimited ($5.99 per month)
• DocComTV ($2.99 per month)
• Smithsonian Earth ($3.99 per month)
• Reelz ($3.99 per month)
• Daily Burn ($14.99 per month)
• PBS Kids ($4.99 per month)
• Shudder ($4.99 per month)
• Cheddar ($2.99 per month)

Some will point to the success of Netflix, Amazon Prime, Sling TV, DirecTV Now, Hulu and others.

Some of those services still use a bundling concept (a menu of TV shows, movies and specials), but not discrete channels. Others use a “skinny bundle” of channels to keep costs lower.

And while Disney and ESPN will undoubtedly be early to test the economics of single-channel streaming, most other networks are likely to resist, as it remains profoundly unclear whether such a strategy would be profitable.

Also, bundles remain popular with consumers, leading to the creation of “skinny” bundles that cost less because they contain fewer channels (and therefore less “cost of goods”).

Edge Computing Might Hit Inflection Point About 2021

Edge computing is entering an early “hybrid” state, and will enter its “native edge” period starting about 2022, GSMA Intelligence now estimates. Revenue will probably hit an inflection point around 2021, according to Grandview Research estimates.

source: GSMA Intelligence

U.S. edge computing market, 2016 - 2025 (US$ Million)

source: Grandview Research