Verizon Mobile-First Strategy Validated by Fixed Network Results

Though it is the supplier of the great bulk of fiber to the home connections in the U.S. market, Verizon nevertheless has had a “mobile-first” business strategy for most of the last decade.

And though it originally expected the business case for FiOS deployments to be bolstered both by new revenues and operating cost reductions--and though that has happened--Verizon now sees the fulcrum of growth from its mobile segment.

Skeptical about the future return from deploying capital in the fixed network compared to the mobile network, Verizon clearly has concluded the investment returns are much better from mobile investment.

Verizon has capped its FiOS deployments to about 19 million homes passed, enough network to reach about 70 percent of locations served by Verizon’s fixed network. Obviously, that means 30 percent of the network never will be upgraded for FiOS.

Verizon is betting that capital invested elsewhere, in mobile assets and services, and possibly at some point in acquisitions, will produce a higher financial return than building FiOS to reach another 20 percent or so of its installed base of fixed network customers.

Stranded assets, in fact, could represent as much as half of the new FiOS access network investment, in “greenfield” builds.

The reason is simply that FiOS is unlikely to attain long-term penetration rates in excess of much more than 40 percent, either for Internet access or video services, where it operates.

FiOS Internet penetration was 39.5 percent at the end of fourth-quarter 2013, meaning that Verizon was able to sell a high speed connection to about four homes out of 10 it passes.

That might imply FiOS overall penetration of about 50 percent (assuming 90 percent of FiOS customers buy a dual-play or triple-play service) while about 10 percent of households only buy a single service.

Over a 10-year period, tthe issue is whether that actually covers Verizon’s cost of capital, given current revenue opportunities, the level of market competition and stranded capital.

In fact, Lowell McAdam, CEO of Verizon, says video growth is lagging high speed Internet access, reducing that amount of incremental revenue Verizon can earn from FiOS.

"We used to sell a TV service and an equal number of broadband services and we're seeing the gap now increase significantly," McAdam said at the J.P. Morgan Global Technology, Media and Telecom Conference. "In the first quarter where we had 20, 30 and 40 percent more broadband sales than linear TV sales."

And growth rates are slowing. In the first quarter of 2014 Verizon added a net 98,000 FiOS Internet customers, down from the 126,000 new subscribers added in the fourth quarter of 2013 and the 188,000 users it added in the first quarter of 2013.

In the first quarter of 2014 Verizon added a net 57,000 FiOS video customers, down from 92,000 customers added in the fourth quarter of 2013  and 160,000 subscribers in the first quarter of 2013.

The point is that Verizon is taking a “mobile first” approach for a good reason: that is where the revenue growth lies.

Will Low ISP, Video Provider Satisfaction Drive Churn?

Internet access service is the lowest ranked industry--last out of 43 industries--in the most-recent American Customer Satisfaction Index. Just above it--at position 42--is consumer satisfaction with video subscription services.

What that means for contestants in both markets is not immediately clear. 

The old joke about outrunning a bear--you don't have to be faster than the bear, only faster than the other guy being chased--likely applies here.

To be sure, to the extent that customer satisfaction is directly associated with customer loyalty, the rankings show relatively high unhappiness with most of the providers, and with the industry products compared to 41 others.

But relatively high dissatisfaction levels do not always result in product abandonment, especially when there are no reasonable product substitutes, or consumers judge all providers to have similar problems.

Cable TV services, for example, always have had “satisfaction” issues, and none of that stopped cable operators from growing to about 70 percent penetration before new competitors halted growth and began taking market share.

ISP service is purchased by about 75 percent of U.S. households, while video subscriptions are bought by more than 85 percent of U.S. households.

But competition arguably is growing in the ISP business, as it has grown in the video business.

Still, it is the video product that seems most exposed to potential new product substitutes, namely streaming over the top video.

At the same time, the ISP market arguably is in the process of evolving in a way that should increase satisfaction, ultimately, as the value-price relationship is reset, giving consumer much more bandwidth at equivalent prices (1 Gbps for $70 or $80 a month).

Video service scores a 65 on the ACSI scale. Internet service, which is provided by many of the same companies that provide video service, scores a 63 on the ACSI scale.

By way of comparison, mobile service got an ACSI score of 72. Fixed voice service scored 73/

Industries ranked between 85 at top and 63 on the bottom.

According to the American Customer Satisfaction Index, industry satisfaction scores fell 4.4 percent to an ACSI score of 65 after peaking at 68 in 2013.

But ISPs fared even worse, ranked last among all 43 industries tracked. Higher subscription prices, unreliable service, and slow speeds continue to pull ISP customer satisfaction down, ACSI says.

Verizon FiOS earned the highest satisfaction score among ISPs, scoring 71. Time Warner Cable scored lowest at 54. Comcast scored 57, while AT&T earned a 65.

To the extent that satisfaction ratings are correlated with “customer acquisition, retention and churn,” extremely-low ISP satisfaction ratings would seem to open up an opportunity for ISPs able to outperform the rest of the industry.

The same might be true in the video subscription business. DirecTV and AT&T U-Verse scored 69, Comcast scored 60 and Time Warner Cable ranked lowest at 56.

And though AT&T is facing some skepticism about the wisdom of its bid to buy DirecTV,

customer satisfaction with fiber or satellite services is eight points higher than cable (68 compared with 60).

Note that DirecTV and AT&T scored highest in terms of satisfaction with video providers.

Will Fixed Network Voice Be Big Loser in Transition to New Triple Play and Quadruple Play Packages?

source: broadbandgenie

The triple play (fixed network voice, video entertainment and high speed access) and quadruple play (mobile service, fixed network voice, video entertainment and high speed access) bundles have been a mainstay of service provider strategy in recent years.

But both triple play and quad play are changing in ways that might be quite negative for fixed network voice, and highly favorable for fixed network high speed access.

Consider only the impact mobile has had in the voice business. For many users, mobile now is the way they consume voice services, making the fixed voice service superfluous. 

So fixed network voice might not be an anchor of tomorrow's triple play bundle. Instead, mobile services will replace fixed network voice, creating a new triple play offer based on mobile, broadband access and linear video.

In a related way, mobile Internet access might emerge as a new key anchor for bundles. And that's where the difference between a triple play and a quadruple play becomes a matter of semantics, to a large extent. 


A consumer of a triple play bundle (mobile, video entertainment and fixed Internet service) might be said to be buying four key products: mobile Internet, fixed Internet, voice and linear video entertainment. 

One might otherwise call that a functional quadruple play (voice, video, high speed access and mobile), even if the formal offer is mobile, video and broadband access. 

The corollary implication is that the enduring value of a high speed access connection is lots of bandwidth at an order of magnitude lower cost than use of a mobile connection.

source: Nielsen

That will occur if and when linear video significantly is displaced by over the top delivery. Video is an application with bandwidth requirements an order of magnitude or more greater than all other applications.

So if significant viewing time is shifted from linear video delivery to over the top Internet delivery, the amount of Internet bandwidth required by many consumers will shift dramatically.

That will put a premium on Internet access services able to deliver lots of bandwidth at the lowest possible cost.

And that means the fixed network becomes more important, as it can deliver much more bandwidth, at lower costs, than the mobile network, as end user demand grows by an order of magnitude or perhaps two orders of magnitude.

One might argue that the cost of providing a gigabyte of consumption is an order of magnitude cheaper, using a fixed network, compared to a mobile network.

To be sure, what use of one megabyte or one gigabyte of Internet access actually costs an end user is a statistical issue.

The monthly price for use of any mobile or fixed high speed access connection is fixed. And that is one way of highlighting the cost of using a gigabyte of Internet data.

But the actual “price per use of a megabyte” depends on actual consumption, not the retail price to have access to a fixed bucket of usage. Likewise, the cost to supply a gigabyte or megabyte of usage is determined by actual usage.

In other words, a mobile service might feature a price of about $6 per gigabyte to $10 per gigabyte of mobile usage, for a 5-Gbyte bucket of usage. But it a user actually routinely uses only about 2 Gbytes a month, the effective cost is about $15 per gigabyte.

source: Nielsen

A fixed network service might retail for a price of about $50 a month, with usage buckets of 300 Gbytes, or virtually unlimited access, in some cases. The nominal price might be 17 cents a gigabyte.

But if a user consumes about 30 Gbytes, the effective price might be $1.67 per gigabyte, or less than two tenths of a cent per megabyte.

The point is that fixed network voice might cease to be an anchor component of a triple play bundle, its function replaced by mobile service. 

At the same time, if and when over the top video entertainment becomes a major development, the value of fixed access will soar, almost linearly with the amount of streamed video being consumed by the typical consumer.

For the first time, we might see an evolution of the component parts of a consumer "triple play" service, as well as a blurring of the value of a triple play that makes a "quadruple play" different.

Mobile Internet Access Retail Price Might Need to Drop by an Order of Magnitude

Retail price points for consumer mobile, and especially mobile broadband services, face huge challenges in emerging markets.

Consider a “typical” third generation (3G) mobile service network with a cost ranging around one U.S. cent per megabyte.

Emerging market retail prices might range from about 1.5 cents to 2.5 cents per retail megabyte of consumption.

But competition could drive revenue to levels of about $0.002 to $0.004 per megabyte, in many emerging markets, for 3G service, according to analysts at McKinsey.

In other words, retail prices could drop by an order of magnitude in the relatively near term.

That implies potential mobile service provider cost of about $0.001 (a tenth of a cent), to support the anticipated retail prices.

An order of magnitude reduction in costs, in a service provider context, is very tough to achieve. While one might argue backhaul costs, or wide area transport costs, could reach such levels, it is vastly more difficult to reduce costs that much in the other operating portions of the business.

Nor is it easy to reduce capital investment to create the access network, by an order of magnitude. Long Term Evolution, many argue, will cut costs of the network by about 30 percent. Thta's helpful, but nowhere near an order of magnitude (10 times) cost reduction.

AT&T Announces DirecTV Acquisition

AT&T will acquire DirecTV in a stock-and-cash transaction for $95 per share, or about $48.5 billion.

The transaction enables the combined company to offer consumers bundles that include video, high-speed broadband and mobile services using all of its sales channels nationwide, better positioning AT&T in the competition with cable TV operators.

That is the most immediate change, as up to this point AT&T had been able to sell an owned and branded video product only in parts of its fixed network, limiting the scale of AT&T triple-play and quadruple-play offers.

By 2015, AT&T, for example, will be able to market to only about 33 million locations, some argue, using its fixed network. But AT&T now says it will reach 70 million broadband locations, after the deal.

The DirecTV buy means AT&T can sell its own branded service to nearly every home in the United States.

Verizon’s FiOS covers about 17.8 million homes, so the two telcos will pass about 51 million U.S. homes, by 2015, out of perhaps 145 million U.S. homes by 2015. That implies coverage of about 35 percent of U.S. homes. Other telcos will sell telco TV as well, but collectively could only theoretically reach about 14.5 million homes, or so, by 2015, best case.

Even under the best of circumstances, it is unlikely U.S. telcos would pass even 45 percent of U.S. homes by 2015, some might argue, without satellite coverage.

So the DirecTV acquisition instantly and fundamentally changes AT&T’s video footprint. Though the ultimate implications are yet unclear, AT&T also gets DirecTV’s operations in South America as well, offering a potential growth vehicle in international markets, at some point.

But AT&T also points to the deal’s ability to help AT&T deliver entertainment video to any screen, fixed or mobile, linear or on-demand.

But AT&T also says 15 million customers--mostly in rural areas-- will get faster high speed access as a result of the deal, mostly because the additional cash flow can be used to upgrade existing facilities, in addition to the upgrade plans AT&T already had announced as part of Project VIP.

To help it gain regulatory approval, AT&T will sell broadband-only service at current prices for three years after deal closing, at speeds of at least 6 Mbps. That measure will address concerns that the deal will lead to forced bundling of video with existing “broadband-only” offers.

AT&T also will maintain “stand-alone” purchasing of DirecTV nationally for at least three years after deal closing, with uniform national pricing. That likewise is designed to allay fears that an immediate shift to bundling will happen.

AT&T also will operate under 2010 Federal Communications Commission network neutrality rules, selling “best effort only” consumer Internet access, for three years after deal closing, irrespective of whether the FCC re-establishes such protections for other industry participants following the DC Circuit Court of Appeals vacating those rules.

DirecTV’s South American business is the biggest in the region and DirecTV has more than 18 million subscribers, still growing.

The deal includes a stock price “collar,” automatically adjusting AT&T’s bid if the price of AT&T’s stock falls or grows before the deal is concluded.

Vodafone Buys South Africa's Neotel

Vodacom, the Vodafone-owned company serving South Africa, is buying Neotel, the  second largest provider of fixed telecommunications services in South Africa.

Neotel will become a subsidiary of Vodacom South Africa, creating a national service provider with annual revenues of more than R5 billion (US$0.48 billion).

Vodacom will gain 15,000 kilometers of optical fiber network, including 8,000 km of metro backbone facilities in Johannesburg, Cape Town and Durban.

Neotel also has rights to 24 MHz of mobile spectrum (2 x 12 MHz) at 1800 MHz, plus 10 MHz of (2 x 5 MHz) of 800 MHz spectrum and 56 MHz (2 x 28 MHz) of 3.5 GHz spectrum.

Vodafone says the deal will allow it to accelerate fixed network fiber to home and fiber to business connections and support a faster Long Term Evolution fourth generation mobile network.

Vodacom also expects annual cost and capital investment savings of US$28.9 million (R300 million, before integration costs) in the full fifth year, representing a net present value of approximately $140 million (R1.5 billion) after integration costs.

In one sense, the deal represents a trend: the integration of mobile and fixed assets as a fundamental underpinning of service provider strategy--telco or cable TV--in many developed nation markets.

The trend is most noticeable in Western Europe, where Liberty Global recently has moved to buy  both cable TV and mobile assets, and Vodafone owns mobile and cable TV assets.

Spain’s Telefonica is offering 725 million euros ($1 billion) for a controlling stake in Spain's pay-per-view TV operator, Digital Plus—Telefonica already owns 22 percent of Digital Plus.

Integration of mobile and fixed network infrastructure, in particular cable TV broadband networks, are emerging as a key strategic direction for Western European service providers.

At one point, AT&T in the United States bought all the assets of Tele-Communications Inc., at that point the largest U.S. cable TV provider, as the hoped-for underpinning of AT&T’s local access strategy.

The reasons for the strategy are simple enough: legacy lines of business are mature and declining. Combining mobile and fixed assets adds new product lines to bundle and boost revenue growth.

Unlike mobile or fixed telecom services, video entertainment revenues still are growing. Also, video entertainment has emerged as the second most-important fixed network service, after high speed Internet access.

Some might argue that cable TV operating costs, and the ability to upgrade Internet access speeds, are lower than those of competing telco networks, as well, allowing mobile service providers to capture fixed network capabilities with lower operating and capital costs.

In many markets, cable TV operations additionally do not have mandatory wholesale obligations imposed on telco access networks.

AT&T DirecTV Buy is Not Perfect, Just Best Available Move

None of the largest U.S. telecommunications providers have “perfect choices” where it comes to growth strategy. Comcast, AT&T and Verizon are big enough that market share issues alone will continue to raise antitrust issues in the internal U.S. market.

CenturyLink has room to grow, but as a fixed network services provider, faces the issue of inability to enter the mobile business. At this point, it has neither the capital to buy its way in, nor the platform to grow a business organically.

Historically a rural fixed line provider, CenturyLink now is a hybrid, operating some larger metro networks as well as in “traditional” smaller markets.

CenturyLink could grow by eventually acquiring rural assets AT&T or Verizon might like to divest. That is a tack Frontier Communications has taken, for example.

But both Windstream and Frontier, traditionally providers of smaller market fixed network services, have gotten their recent revenue growth from business services, not consumer services.

Dish Network has particularly been concerned about the viability of any stand-alone satellite video business in an era of triple-play and soon quadruple-play services in the consumer markets.

Though a combination of Dish Network and DirecTV might have made lots of near term sense, that deal would not solve the problem the satellite providers face as there is a strategic shift in the consumer market to quad-play services.

And such an option obviously is foreclosed if AT&T buys DirecTV. One way or the other, Dish now seems committed to becoming a provider of triple-play or quadruple-play services.

Despite the business model difficulties, one might argue that is precisely the context that has shaped small and independent fixed network telco strategic choices as well.

As always, the price at which any significant new assets are obtained could make a difference, but in the absence of “distress” sales, though additional scale helps, there are issues about the amount of leverage would-be acquirers must face.

In AT&T’s case, some observers worry that an acquisition of DirecTV means debt burdens would grow, as well as decreasing the amount of cash flow available to fund network upgrades and further growth. AT&T will have to address those concerns operationally.

And all of the larger firms face antitrust and competition concerns.

Comcast diversified significantly by buying NBC Universal, but also has offered to sell off perhaps three million video accounts as a concession to win Time Warner Cable, that move an effort to say below 30 percent share of the U.S. video market, even as it would vault Comcast into a clear lead in high speed access share, with perhaps 40 percent share of that market.

Sprint faces similar issues as it considers an acquisition of T-Mobile US.  Antitrust authorities and regulators consider the mobile market already too concentrated. The issue there is whether Sprint can convince authorities that long-term competition, innovation and investment, as well as consumer welfare, are better served by three strong providers.

As in France, that now is precisely the conclusion national regulators have reached. Though four strong providers are preferable, French telecom regulators now believe levels of competition in mobile services have reached ruinous levels.

At least in part, French regulators believe consumer welfare, in the form of lower prices, as well as investment, are best served by three stronger providers, rather than four weaker providers.

So in addition to regulatory issues, leverage and even dividend policy are key concerns for any large deals. Taking on large amounts of debt to fund acquisitions is out of the question for most of the largest service providers. But for AT&T, issuing new equity also increases the dividends it must pay.

There also is an issue of “where” growth by acquisition is most strategic. Some observers think AT&T does not benefit as much from owning DirecTV, compared to other uses of capital.

Beyond the concern that the linear video business is mature, with growth decelerating, there is the larger strategic concern of the shift to online delivery that imperils the whole linear video business.

For the larger rural providers, the issue is the wisdom of becoming bigger suppliers in a market whose growth prospects are negative, and where recent success has been gotten in business services, not consumer services.

For fixed network providers, where participation in the mobile segment might be helpful, it now is mostly too late to enter the market, with needed scale. Basically, the mobile business has become a “national” business, with little if any room for small or regional providers, long term.

Even if AT&T wants to grow its mobile share, regulators have closed that route. Whether AT&T can afford, or wants to add significant new fixed network assets, likewise is questionable, even assuming regulators would approve, and that seems equally unlikely.

Inability to grow domestically is one reason why AT&T had been looking to buy international assets, recently. In fact, buying a specialized video provider is one of the few domestic options AT&T actually can exercise.

AT&T faces all those issues, ranging from regulatory barriers to revenue growth to capital constraints.

In proposing the acquisition of DirecTV, AT&T undoubtedly will tout the incremental boost to free cash flow, a fundamental change in profile in the video services segment, ability to better manage large dividend payments as well as fund fixed network high speed access investments.

AT&T might also suggest there are advantages in negotiating programming contracts that could be worth $400 million annually. AT&T possibly will hint at ways to use DirecTV to offload video traffic as well, allowing nearly all of its fixed network bandwidth to support high speed access.

But none of the choices are “perfect” at this point, for any of the larger service providers. If it cannot grow internationally at the moment, and if its key U.S. competitors are making moves to gain share or change the strategic context, a DirecTV might be the best immediate move.

Keep in mind the fundamental growth context for cable and telco service providers over the past decade. Telcos have gained video share, while cable has gained voice share, as well as dominance in high speed access.

But there are strategic changes as well. As Google Fiber has shown, the foundation for fixed services revenue now is high speed access, packaged in a disruptive way, complemented by video entertainment, with new cost parameters.

Though “video” has been the big business model challenge for telcos, high speed access now has become more crucial as well, first to catch up with cable, and now to fend off challengers providing gigabit levels of service at vastly destabilizing price points.

AT&T is likely to argue, in essence, that buying DirecTV helps it solve both problems. At least in principle, buying DirecTV helps AT&T fund its fixed network high speed access investments while gaining an important new position in video, the key strategic complement to high speed access.

It perhaps is not a “perfect” move. But it just might be the best available move.