Communication Markets Do Not Conform to Share Patterns We See in Other Industries

Communication markets do not seem to conform very well to market share patterns one tends to see in many other industries where market entry is less capital intensive.

Put simply, a predicted pattern would have the market leader having share and profit margins double that of number two, which in turn would have double the share and profit margin of supplier number three.

Mobile service provider markets do not conform to the pattern. That is because, many could easily argue, mass market communications tends to be an oligopoly, not a monopoly or highly contested market with few barriers to entry.

In an oligopolistic market, a reference market share structure might be something like:

Oligopoly Market Share of Sales
Number one	41%
Number two	31%
Number three	16%
source: economicsonline

U.S. mobile service provider market structure deviates from the “classic” pattern one might expect. One might note the same is true in other mobile service provider markets, such as the Russian Federation. The same divergence exists in the Indian mobile market.

One might argue that a coming wave of U.K. industry consolidation could lead to a more traditional industry structure. That also could happen in the French mobile market, which still in 2012 had an “uncharacteristic” structure.

The Canadian fixed line triple play market likewise differs from a theoretical market share distribution. U.S. fixed service market share might have the same pattern, though in a growing number of markets, there is instability, as a big cable TV firm and a legacy telco now face competition from Google Fiber, for example.

It is at last conceivable that market structure in the fixed line market could change significantly, assuming Google Fiber emerges, in virtually all of its chosen markets, as the market share leader for Internet access.

Also, market share structures could assume a more traditional distribution once all communication markets are consolidated, and there is not a clear distinction between fixed and mobile services.

Whatever the reason--and many will argue it is sheer capital intensity--communication markets do not conform to patterns we might routinely expect to see in many other industries.

Since 2012, the possible fourth wave of mobile revenue growth seems to have clarified, at least in terms of expectations. Most observers might now agree that the Internet of Things represents the biggest future revenue opportunity.

AT&T Launches GigaPower in Kansas City: Important Test of Market Dynamics Looms

We soon will find out what the dynamics of a three-provider fixed network high speed access market look like, as AT&T has launched it “GigaPower” 1-Gbps access service in parts of Kansas City, Mo., parts of Leawood, Lenexa, Olathe, Overland Park, Kan. and in surrounding communities located throughout the metro area.

AT&T also has plans to expand the service to Independence, Mo. and Shawnee, Kan.

Perhaps the only issue is what share the new market might take, as some surveys suggest Google Fiber gets as much as 50 percent take rates. If that happens, the former market share leaders--Time Warner Cable and AT&T, might easily have lost half of their respective customers for high speed access.

Whether even a triple-play provider can sustain itself on just 25 percent take rates is the issue now to be tested. Survival would not seem to be out of the question, but profit margins would be very squeezed.

Splitting the high speed access market, AT&T and Time Warner Cable might have gotten between 20 percent and perhaps 40 percent profit margins on high speed access service (allocated overhead across voice, video and high speed access is somewhat arbitrary).

It might not be unreasonable to suggest profit margins have been sliced to a range of 10 percent to 20 percent after the loss of customer share.

U-verse High Speed Internet 1Gbps costs $70 per month, and AT&T is waiving equipment, installation and activation fees, as well as offering a three year price guarantee.

U-verse High Speed Internet 1Gbps with subscription video starts at $120 a month.

A U-verse triple play starts at $150 per month.

Kansas City will be one battleground where we begin to see how the business model for a triple play services provider changes in a three-provider market.

Can New ISPs Sustain Themselves? Can Telcos?

Revenue, in addition to the cost of the network and other operating costs, is part of the complex  fiber to customer business case. Traditionally, one might have argued that fiber to the home made for tough payback models.

But we now are seeing lots of activity by gigabit Internet access providers that have decidedly different potential economics, driven mostly by the payback model.

For starters, traditional modeling has assumed a mandatory city-wide construction project, and in the U.S. market, at least, a likely ability to convert only about half of all potential sites to the status of “customers.”

Over time, service providers also have moved from a “single service” model to the “triple play,” a change that allows fixed network service providers to build a sustainable model even when only 40 percent to half of sites are “customers.”

The latest innovation is the “build by neighborhood” approach, essentially allowing service providers (ISPs, telcos, cable TV companies) to “cherry pick” their targets, instead of using the older “universal service” approach.

That approach earlier had been used by business-focused service providers (competitive local exchange carriers) to compete for business customers. The basic approach has been to target clusters of customers, using leased access to reach them, and then, over time, deploying backhaul facilities to lower cost.

The new evolution has firms building fiber-rich facilities to neighborhoods where the estimated demand is highest.

The question is long term sustainability, as the price-value relationship is redefined. We might assume investment costs per-location, and potentially, cost per customer, are lower than they were for Verizon Communications.

We might also assume costs are higher than for a new hybrid fiber coax network supporting DOCSIS 3.

That might put the cost per location somewhere between a high of $2,250 per site and $660 per location on the lower end, including activated drops, but not including any required customer premises equipment.

Since none of the new ISPs seem to be using HFC, we can assume their costs are closer to what any other telco would pay for fiber to home network elements. But current prices for telco style fiber to home networks might be far lower than in the past.

The key breakthrough would be if telco style FTTH costs were to approach cable TV HFC costs.

Assume a smaller operator could manage to connect a customer and activate service (including customer premises equipment) for about $300, where a telco connection might cost as much as $800.

Much depends on what services a service provider actually is offering. Internet access will have one cost profile, but video service will add costs.

If the network portion of cost is in the legacy $1450 per passing, then a new contestant might expect to invest $2900 per customer, at 50 percent take rates, plus a connection cost of $300, for a total of $3200.

Against that, assume $70 to $130 of revenue, in some cases. Over a three-year period, that is about $2520 to $4680 in revenue.

Some ISPs, such as Sonic.net, are retailing gigabit connections plus voice for $40 a month, though. That implies three-year revenue of just $1440 per subscriber.

All of that is before operating costs, franchise payments and marketing. Clearly, service providers are counting on longer customer life cycles, incrementally higher revenues and muted operating costs.

Perhaps prices now paid for network elements and cabling are lower than $1450 per passing, though, perhaps in the $900 range per passing. That helps, but does not make for an easy positive business case.

At 50 percent take rates, investment per subscriber at $900 per passing is $1800, plus $300 for connecting and activating a customer, or about $2100.

At 33 percent take rates, costs per customer are about $3000. As always, the business model is highly sensitive to adoption rates.

So a key expectation might be that take rates will be closer to 50 percent than 33 percent.

But the business case still is not easy.

On the other hand, market dynamics might be trending in a direction that makes the gamble less risky.

If one argues the telco business case keeps getting worse, while cable TV holds its own, in many markets, the competition might evolve towards a “cable TV versus independent ISP” model, with telcos becoming weaker competitors.

There is only so much a telco can do to reduce costs, given dividend payout obligations and union workforces, plus pension obligations.

Ultimately, there will be growing questions about sustainability, the possibility of bankruptcies or other restructurings, with the possibility that new sets of owners might be able to create a more sustainable business model. As crazy as that now seems, it cannot be excluded as an eventual outcome.

ISP "Cherry Picking" Will Have Financial Repercussions

“Cherry picking,” as helpful as it is for new entrants to communication markets, reduces the addressable market for the largest service providers that collectively serve most consumers.

That can have the unwanted effect of causing price increases for all remaining customers, as fixed costs are spread over a small number of paying customers.

That noted, nearly all gigabit network construction occurs on a cherry-picked basis, where ISPs build in areas where there is customer demand. Those neighborhoods tend to be higher-income areas, it goes without saying.

That clear tendency to focus on the lowest-cost, highest-return geographic areas makes clear financial sense--both for incumbents and attackers--but also tends to conflict with the notion of universal service.

That is an obligation typically only one provider has in any market: the incumbent telco. Eventually, that obligation might become onerous, not only for the provider of last resort, but also for customers, a declining number of which will have to pay for the fixed costs of the whole network.

Economically, that is the same problem faced by nations where the number of retirees exceeds the number of working people who pay the taxes to support all the retiree benefits. Similar problems increasingly will be faced by individual firms whose markets are not growing fast enough to generate the revenue required to support retiree benefits.

If the new trend where smaller ISPs launch gigabit networks continues, and more importantly, if most major U.S. markets start to feature three large ISPs (cable, telco, Google), the problem of stranded assets will become a big problem for telcos and cable.

The companion issue is whether the new entrants can create networks affordably enough, and maintain operating costs low enough, to compete in markets where addressable market share might be about 33 percent of homes and other locations.

Traditionally, that has proven quite difficult on a “one service” retail platform. The difference now is the additional revenue provided by triple play services, where an ISP might serve one house, but sell two to three services, boosting gross revenue past $130 a month, where it might otherwise be $40 to $50 on a single-service basis.

Still, there are clear business model issues. All three of the core triple play services are under pressure. Consumers are abandoning fixed network voice, even if that trend tends to be obscured by the very fact of triple play bundling, where consumers rationally might conclude they are better off buying all three services, even if demand is high only for two services.

With the U.S. Federal Communications Commission moving towards licensing rules that would allow over the top linear video providers access to the same programming, on the same terms, as now purchased by cable TV, satellite and telco providers, the likelihood of new OTT suppliers is growing.

And even high speed Internet access, arguably the mainstay and anchor service for any fixed network service provider, increasingly is challenged by new suppliers offering gigabit access for $40 to $80 a month, a price that often is paid for rival services operating between 15 Mbps and 105 Mbps.

The biggest strategic changes are new services provided by suppliers with lower capital or operating costs, or both. That often means a cable TV operator or independent ISP.

In the United Kingdom, for example, cable TV providers supply the overwhelming number of the fastest connections. And “Project Lightning,” the new Virgin Media investment program, will extend higher speed access to about four million additional premises over the next five years.

After the investments, Virgin Media will increase its footprint by about 33 percent, increasing its ability to sell the fastest Internet access services to perhaps 66 percent of the country.

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.