Consumers Might Find Bundles A Good Deal, Eventually

Precisely what is happening in the linear video and over the top subscription businesses is unclear, even if most observers would agree the business clearly is in slow decline.

Paradoxically, consumers might eventually find that video bundles--even mostly linear--provide more value than a la carte streaming "channels" and services.

To be sure, strains in linear video are growing. In fact, by about 2020, smaller U.S. cable TV companies are going to experience zero profit margins on their linear video programming businesses, according to the American Cable Association.

Some would argue Verizon Communications likewise will have a hard time earning a profit on its own widespread investment in fiber to home networks, at least in part because revenue from new services has been less than anticipated.

Meanwhile, profit margins for linear video, in particular, have been rather low, Verizon now maintains, though in the past Verizon has claimed it earned good margins on video entertainment.

It would be going too far to argue video service providers are aggressively taking the bundle apart. It would be fair to say they are taking unprecedented steps to control costs, either by shrinking bundles or replacing expensive networks with cheaper apps.

Nor is the linear video business declining fast. 

The biggest U.S. linear video subscription providers lost about 125,000 subscribers in 2014, on a net basis. Within the category, AT&T and Verizon gained about a million customers, while cable TV operators lost about 1.2 million accounts, on a net basis.

On an installed base of 95 million accounts, that barely registers, a tenth of one percent over a year’s time.

Of course, it is worth noting, the number of accounts does not speak to average revenue per account, or account profit margin, higher retention and acquisition costs, or other measures of segment health.

Presumably, those metrics are under pressure.

With the upcoming launch of HBO Now and Sling TV, we might see some indication of whether the rate of change--in terms of abandonment of linear subscriptions for over the top subscriptions--is about to increase.

But we might eventually find that cord cutting has demand more limited than many suppose. The reason is that cord cutting might not save most consumers money, and that arguably is the key attraction.

Some consumers buy a linear video subscription, plus Amazon Prime and Netflix. In other words, monthly spending is at about the $100 a month level. By switching to Sling TV and HBO Now, and keeping the other services, a consumer might replace an $80 linear subscription with an alternative $20 Sling TV subscription plus $15 a month for HBO Now, a savings of possibly $45 a month.

But that assumes the buyer is content to lose lots of channels. And the thing about linear video consumers is that each of us tends to watch only about a dozen channels, and perhaps only about seven on a regular basis.

Each consumer will evaluate how many of those "most watched" seven are sacrificed, to get lower recurring prices. If not, the consumer has to calculate the cost of obtaining them on a streaming basis. At a hypothetical cost of $10 per channel, those seven represent $70 a month in costs.

For some consumers, Sling TV represents none of the most-viewed channels. For others, Sling TV will represent a few of the most-watched channels. In other words, it isn't clear that unbundled streaming costs less than bundled linear service.

True, the ability to watch your subscription content “on any Internet-connected device” is valuable. But that probably will stop being a “unique” value at some point, when most content is available from one or more online sources, on an on-demand or subscription basis.

At that the point, the issue is going to be “cost,” compared to value. And it remains exceedingly hard to envision how a full on-demand business case will lead most consumers to pay less. In fact, they almost certainly will face higher costs for an a la carte approach.

Are We Nearing an Inflection Point for Over the Top Video?

A study of North American linear subscription video customer churn suggests an uptick in churn rates since the earlier quarters of 2014. In the fourth quarter of 2014, quarterly churn was nearly nine percent, up about two percent compared to the same quarter of 2013.

That works out to about a three percent monthly churn rate, which perhaps is high by recent comparisons. The issue is whether that is a quarterly issue, or something representing a new trend.

Nor does the churn rate, by itself, tell us much. If most of the customers who churn then buy a similar service from another provider, that only speaks to the level of competition in the market, not to a change in end user demand for the product.

The worrisome trend, for service providers, is churn of a different type, where consumers simply stop buying the product from any current supplier. The study does not address that question, though it found about four percent of subscribers claimed they would end their subscriptions at some point in the next six months.

Another 2.6 percent claimed they would switch to an online app sometime in the next six months.

With the caveat that consumers quite frequently do not follow through, dissatisfaction ratings seem to be climbing. Comparing attitudes in 2014 compared to 2013, about four percent fewer respondents claimed they were satisfied with their linear service, while three percent more claimed they were dissatisfied. That is a net swing of about seven percentage points in a year.

The study found that 5.7 percent of subscribers switched service providers during the final three months of 2014.

That works out to a monthly churn rate of less than two percent, which is about in line with recent historical norms, and down dramatically from levels of several decades ago, when three percent churn rates would not have been unusual for any consumer communications or entertainment service.

The study suggests a potentially continuing incremental shift away from linear subscriptions and a growing use of over the top online services. But the change remains slow and incremental.

The coming launches of stand-alone streaming services from HBO, CBS and a comedy-focused service from NBCUniversal, plus the new Dish Network service, will provide more evidence about whether the rate of change finally is about to hit a knee of inflection.

Zero Profit Margins for Linear Video by 2020, Small Cable Ops Say

By about 2020, smaller U.S. cable TV companies are going to experience zero profit margins on their linear video programming businesses, according to the American Cable Association.

At least in part, rapidly-growing content costs are an issue, the ACA says.

To the extent that linear video constitutes a key part of the business case for fixed network operations, that collapse of the linear video model will imperil further investments in networks, the ACA also argues.

The broader point might be the growing importance of scale as a driver of the linear video business model, and a growing potential threat to the survival of the business model as over the top alternatives, costing less, become more available.

Should that happen, the business model even for the larger service providers will be challenged.

source: American Cable Association

Telco Cloud Computing Revenue Opportunity is Still on Training Wheels

CenturyLink, like many other telcos, sees cloud computing as a key opportunity in the enterprise and business services segment of the communications business. There are several reasons for that belief.

Data centers now are primary generators of capacity demand. For example, Cisco’s latest Global Cloud Index estimates that global data center traffic will grow nearly 300 percent between 2013 and 2018.

By 2018, 76 percent of all data center traffic will come from the cloud, while 75 percent of data center workloads will be processed in the cloud.

But that might not even be the most significant prediction. Quantitatively, the impact of cloud computing on data center traffic is clear, Cisco argues.

Most Internet traffic has originated or terminated in a data center since 2008.

Where in the past most traffic (voice) functionally originated and terminate at a central office, though that traffic was passively transmitted to an end user telephone, now most global traffic originates and terminates at a data center.

At the same time, it is possible to argue that “cloud” now is becoming the architecture for computing in the present era, directly embedding the need for wide area and local area communications into the basic fabric of computing itself.

Where one might have argued that the addressable market for WAN transport providers was perhaps $232 billion in 2012, the addressable market now is much bigger. In fact, Bill Barney, Global Cloud XChange CEO argues the addressable market is six times larger.

That includes involvement in the $600 billion "software" business, as most software now is delivered or used "in the cloud."

The market also touches the $965 billion enterprise "information technology" business and the $103 billion data center business as well.

That doesn't necessarily mean WAN transport and services will displace most of the revenue in the extended ecosystem, only that WAN providers now play more central roles in those other areas, and for that reason will be generating additional revenue within the ecosystem.

That noted, cloud services still represent only about five percent of enterprise information technology spending. That is virtually certain to grow, as public cloud remains the first option for a minority of enterprise IT managers at the moment.  

According to Gartner, 75 percent of organizations use public cloud services today, “though sparingly,” while 78 percent plan to increase their investment in cloud services in the next three years.

Some 91 percent of organizations across all industries plan to use external providers to help with cloud adoption, Gartner says. That accounts for the belief that cloud computing can be a new revenue source for capacity suppliers, directly or indirectly.

In some cases, capacity suppliers own data centers as a way of generating direct revenue from data center clients, not just profiting from the communications into and out of the data centers.

By 2018, “data center to end user traffic” will constitute 17 percent of total “data center” traffic. About nine percent of traffic will move from data center to data center.

About 75 percent of global data center traffic will stay within the building, moving from server to server. That illustrates the value of generating direct revenue from data centers. Even if most clients will move data between servers in the center, that in-building traffic still eventually moves out onto the wide area network.

For most suppliers,  the primary revenue opportunity therefore is capacity.

Sometimes, Gigabit Access Primarily Leads to Sales of 20-Mbps and 40-Mbps Access

Investing in gigabit Internet access networks might be among the most-effective marketing tactics for at least some Internet service providers. But it might not be a product that many customers actually buy, in some cases.

Much depends on the range of available offers, the degree of competition in a local market and the positioning of gigabit offers by competing ISPs in a market.

Where gigabit access sells for closer to $100 a month, and is but one of several offers, gigabit headline speeds might lead to higher sales of 20-Mbps and 40-Mbps services, even if relatively few customers actually buy the gigabit service.

In fact, one example of demand dynamics explains why that might be so. In my own neighborhood in Denver, I can buy a gigabit access service for $110 a month, guaranteed for a year.

If what I want to buy is a 100-Mbps service, that costs $70 a month, with the price guaranteed for a year.

The 40-Mbps service costs $30 a month, guaranteed for a year. All those prices are for stand-alone service, with no phone service.

In that sort of environment, many consumers are going to conclude that 40 Mbps is “good enough,” and provides a better price-value relationship.

Where the only speed offered is a gigabit, priced at $70 to $80, take rates might well be higher. The issue is what other choices are available.

While CenturyLink hasn’t seen much demand for the gigabit Internet access service it began selling in Omaha in 2013, the product has helped CenturyLink sell slower speed services, according to Stewart Ewing, CenturyLink CFO said.

“No one takes a gig service,” Ewing said. “But they take a 20-meg or 40-meg service, and that’s fine.”

The other problem is that upgrades to gigabit speeds, or even 105 Mbps, might not actually lead to better end user experience. My own subjective experience is that 100 Mbps does not actually improve my experience, compared to 15 Mbps.

That might not be true for a household where multiple users are using the connection at peak hours. But that is not my own typical use case.

You Can't Forecast Telco Revenues and Costs 20 Years from Now

Projecting telco revenues and network costs 20 years from today is not useless, but likely to be highly inaccurate. 

As early as the 1990s, a rational executive could have claimed that the majority of firm revenue in a decade or two would be generated by products that had not been invented yet. That has largely proven to be the case.

Also, anyone in the forecasting business can look back on projections made 20 years ago and confirm the wisdom of not being too certain about such forecasts.

In the early 1990s, before the passage of the Telecommunications Act of 1996, it likely would have seemed inconceivable that the biggest U.S. telecommunications companies would, with a couple of decades, be minority suppliers of the key fixed network telecommunications products.

But that has happened. In the strategic high speed access business, the largest U.S. telcos have just about 41 percent market share.

Perhaps significantly, the incumbent telcos seem to be slipping further behind. In 2014, cable TV companies added 89 percent of the net high speed access additions, building on the 82 percent net gains cable TV companies made in 2013.

In the voice business that once drove 70 percent of industry revenue, Verizon Communications recently sold $10.5 billion in fixed network assets, to support its capital investment in mobile spectrum, the one area where the tier one telcos still dominate.

From 2000 to year-end 2013, telcos will have lost nearly 62 percent of all traditional phone lines  and 70 percent of traditional residential voice lines, USTelecom says.

For the twelve-month period from mid-2011 through mid-2012, residential and business consumers dropped 10.1 million ILEC switched voice lines, a twelve-month decline of 10.7 percent, according to Federal Communications Commission data..

From 2000 to mid-2012, the number of ILEC switched lines fell from 186 million to 84 million, or a decline of 55 percent. Straight-line trends suggest ILECs will have lost approximately 62 percent of these lines by the end of this year, according to the USTelecom.

Telco switched line losses have been greatest in the residential market, where the annual rate of decline from mid-2011 to mid-2012 was 13.6 percent, USTelecom says.

In 2000, some 120 million consumer voice lines were in service. As of mid-2012, there were approximately 45 million consumer telco lines being purchased, a decline of 63 percent.

Newer services such as linear video entertainment represent a smallish percentage of telco revenues, as both AT&T and Verizon have about six percent market share each, of the traditional subscription TV business.

AT&T’s planned acquisition of DirecTV notwithstanding, entertainment video has been--and always has been--a tough business proposition for any telco, of any size.

One study conducted for an independent U.S. telco in the early 1990s found the video subscription business would reach positive net present value only after eight full years of operation, even with a “first installed cost” of just $800, at $365 annual revenue for a subscriber.

The analysis by our consulting team assumed at 20 percent net income and a 12-percent discount rate. In other words, the venture would make money, but only barely, with breakeven in year nine of the 10-year investment lifecycle.

Even that analysis assumed use of fixed wireless access, as the first installed cost of asymmetrical subscriber line in the early 1990s ranged as high as $8,000 per line, at a time when fiber to the home cost $4,500 per line and fiber to the curb cost about $2500 per line.

Much has changed since the early 1990s. Access costs have fallen. Video revenues have skyrocketed. Significantly, the early 1990s analysis included zero revenue contribution from what we now call “Internet access.”

The biggest conclusion might be the near futility of forecasting network costs and revenue streams as they will develop over a couple of decades.

Are Spectrum Prices Out of Whack?

Equity valuations of Sprint, T-Mobile US and Dish Network seem out of line with the theoretical value of their spectrum holdings. Something does not seem right. Either the market is mispricing those firms, or the market is overvaluing spectrum assets.

It seems like the spectrum valuation is the mistake.

U.S. mobile service provider Dish Network Dish Network is gambling in a big way with its spectrum strategy, assuming it can monetize its mobile spectrum assets in some way.

The fact that some analysts believe 80 percent of the company’s equity value now rests on the deployment of that spectrum for commercial purposes illustrates the magnitude of the gamble.

Dish has assembled a portfolio of about 55 MHz of spectrum to support Long Term Evolution networks, but faces a 2017 deadline to get 40 percent of that spectrum activated, allowing mobile customers to buy service.

If it misses that deadline, Dish Network must deploy enough of its spectrum to reach 70 percent of U.S. consumers by 2020.

If not, Dish loses the spectrum, and possibly 56 percent to 80 percent of its market value.

Dish Network assumes it can either sell its spectrum for $25 billion to $45 billion, create a wholesale mobile business using the spectrum, or perhaps buy one of the U.S. mobile operators.

Dish will get no help from AT&T or Verizon. Sprint and T-Mobile US are viewed as possible partners. But Sprint, T-Mobile US and Verizon are viewed as the likely actors, for any Dish move.

T-Mobile US has been viewed as an acquisition target for Dish Network. Sprint has been viewed as a partner, leasing network facilities to Dish Network so spectrum can be converted into retail capacity.

Verizon has been seen as a buyer of Dish Network Spectrum.

There is a potential obstacle, though. The value of Dish Network’s spectrum, in the wake of prices paid in the recent AWS-3 spectrum auction, are high enough to make any purchase transaction for Dish Network spectrum very costly.

In fact, that auction featured the highest prices ever paid for mobile spectrum. Based on those recent precedents, some expect the 2016 auction for 84 megahertz worth of 600 MHz spectrum

could cost between $15 billion and $30 billion.

That upcoming auction is a part of the very-complicated spectrum acquisition picture. AT&T spent $18 billion in the AWS-3 auction; Verizon about $10 billion. A 2016 auction would require each firm to raise more debt, something neither is keen to do, and which neither Sprint nor T-Mobile US can afford, either.

But other spectrum conceivably will be made available. Shared spectrum in the 3.5 GHz band, new Wi-Fi spectrum in the 5-GHz band and then additional spectrum in the millimeter bands all are expected to be made available for commercial use, at some point.

Also, some spectrum presently not considered available for sale, including low power TV spectrum, could be considered for auction as well. In light of the AWS-3 auction prices and the upcoming 600-MHz broadcast TV spectrum auction, some within the low power TV business think they should have the ability to sell their TV spectrum as well.

There are, in 210 TV markets, 2,650 low-power TV licenses, representing an aggregate 15,900 MHz of spectrum, according to Mike Gravino, LPTV Spectrum Rights Coalition director.

Based on the AWS-3 auction prices, that spectrum might be worth $50 billion dollars, Gravino said.

There are lots of moving parts.

So one way of looking at matters is that, were Dish Network to sell, at AWS-3 prices, that spectrum might cost  $56 billion to $80 billion. The 600-MHz auction might add another $15 billion to $30 billion.

Sprint has talked about selling some of its excess 2.5-GHz spectrum. At AWS-3 prices, that implies a possible value of $155 billion, far in excess of the current market value for all of Sprint, about $21.3 billion.

Also, consider that T-Mobile US just spent $10 billion on AWS-3 spectrum. T-Mobile US current market capitalization is about $26.5 billion.

A rational person might conclude that something is out of whack, and that the likely problem is spectrum valuations, which are too high.

Spectrum valuations might be so costly, in fact, that many conceivable options for buying or selling spectrum might be beyond reach.