Why the Mega-Mergers?

It would be logical if connectivity industry participants have wondered why, in the Internet era, retail prices for virtually all communications services generally fall, while video entertainment retail prices can climb.

The same sorts of questions are logical where it comes to market value of firms in various segments, or the prices paid by third parties to various providers of internet apps and services (advertising prices, for example).

Cable TV prices have risen every year over the past 20 years, and in each year, the rise in cable prices has outpaced inflation, virtually every analysis concludes.

That is part of a bigger story, namely the generation of value within the Internet ecosystem. Analysts at A.T. Kearny, for example, estimate that the total value of the internet value chain has almost tripled (up nearly 300 percent) from $1.2 trillion in 2008 to almost $3.5 trillion in 2015, a compound annual growth rate of 16 percent.

Revenue sources are diverse. The proportion of revenues of online services generated by advertising, for example, has grown to 29 percent in 2015. The majority of revenues still come from direct customer payments, whether they are one-off purchases, subscriptions, or pay-as-you-go services, but that seems to be changing.

In almost all online services categories, the proportion of spend that is online versus its legacy or offline equivalent has increased, as well. That illustrates the generally-disruptive impact of internet apps and services, which nearly always cannibalize some existing industry or revenue stream.

In terms of economic performance, the largest players in any given segment are able to deliver higher returns and profit margins, benefiting from the inherent network and scale effects of the internet.

At the same time, the larger providers are moving into internet adjacencies beyond their original scope of operations. Google might have begun life as a “search provider,” but now operates across a number of internet roles. Likewise, AT&T might have been a fixed network services provider, but now is the largest U.S. linear video services provider, and, if its acquisition of Time Warner is approved, will become a major participant in the content production business.

For regulators, a more-complicated industry structure has to be accounted for. “It is no longer appropriate to develop corporate strategies, or to assess policy situations, with a narrow focus on a single segment of the value chain,” A.T. Kearney argues.

Within the connectivity segment, there is a strong shift towards the use of mobile networks, which now generate more revenue from internet-related services than fixed networks. That probably is among the less-important trends. Longer term, value is shifting away from connectivity and towards the other parts of the ecosystem.

In 2015, connectivity represented perhaps 17 percent of internet ecosystem value. By 2020, connectivity might represent only about 14 percent of internet ecosystem value. In 2015, apps represented about 47 percent of internet ecosystem value. By 2020, apps might represent 52 percent of value.

That explains, simply, why connectivity providers constantly look for ways to move up the value chain, or “up the stack.” Value is shifting to apps, and away from simple connectivity. At the same time, profit margins generally are higher in apps and content.

Where connectivity earnings margins are in the 10 percent to 15 percent range, margins in operating systems are greater than 25 percent. App margins can range from 15 percent to 25 percent.

source: AT Kearney

source: AT Kearney

At the same time, live sports has been a key contributor to higher content rights costs for distributors. The shift to mobile screens likewise is placing a new premium on “live” or “interactive” programming, compared to store-and-forward prerecorded content (movies, for example).

As linear distributors shift to lower-cost bundles, and most distributors move to over-the-top streaming access, there now are new questions about whether such content increases can continue, and if, so, where.

One reason Disney equity is under pressure is concern about dwindling prospects for its flagship sports franchise, ESPN.

What is not easy to contest is the value apps and content have in maintaining value, and hence retail pricing power, in Internet markets where substitutes increasingly are available.

At a large level, value within the internet ecosystem is shifting to apps, content and other app-layer services, diminishing in the connectivity segment, and growing in some other segments of the ecosystem (such as operating systems and app stores) and declining in a few segments such as personal computers and cloud computing.

source: Cordcutting.com

source: PwC

 

source: PwC

In a clear sense, linear video prices only illustrate a broader trend within the internet ecosystem.

That noted, linear video prices have escalated in what many now believe are unsustainable ways. Back in 1995, cable cost an average of just $22.35 a month. Now it’s up to an average of $69.03, a 208.9 percent rise.

Inflation alone can’t account for nearly so much change, as inflation has changed by just 55.8 percent over that same period.

On average, cable prices rose 5.8 percent each year, while inflation rose at an average of 2.2 percent per year.

That is why linear providers are moving to “skinny bundles,” and why consumers buy affordable services such as Netflix. Consumer perceptions of value are shifting. So far, though, it is generally true that “content” is being revalued, not necessarily devalued, though ESPN might be a salient exception.

None of that is going to obstruct the bigger trend. If value, equity value, revenue and profit are shifting to apps and other places within the internet ecosystem, and away from connectivity, connectivity providers must seek new roles in those growing parts of the ecosystem.

That is why Comcast bought NBCUniversal, and why AT&T wants to buy Time Warner. Even within the connectivity segment of the ecosystem, higher revenues and profit margin are why CenturyLink wants to buy Level 3 Communications.

CenturyLink's "Problem" is a Problem for Regulators as Well

CenturyLink’s proposed acquisition of Level 3 Communications illustrates as well as any recent development how much high-level strategy requires that tier-one service providers dramatically outgrow their legacy revenue streams and lines of business.

For an industry as highly regulated as local telecommunications is, that eventually will have--or should have--key regulatory consequences as well.

Consider that CenturyLink has fixed network operations across 33 U.S. states, a footprint that arguably is more extensive than the footprint of AT&T, which operates a fixed network across 18 states.

Founded in 1968 and headquartered in Monroe, Louisiana, CenturyLink has 11 million fixed network voice accounts, six million Internet access accounts and 285,000 linear TV accounts, in 37 states.

The problem is that its consumer business is bleeding away.

Some will argue, increasingly persuasively, that “CenturyLink's legacy landline phone business is beyond saving.” Keep in mind, voice accounts are nearly twice as numerous as Internet access lines. In principle, CenturyLink eventually could lose half its current access lines.

That would pose enormous, possibly fatal problems for the consumer portion of the fixed network business that already contributes most of the connections, but relatively little of the revenue.

Even as it invests in gigabit and faster speeds to serve consumers, CenturyLink is exposed to huge account losses that will strand most of the assets being deployed. In other words, of 100 percent of upgraded next-generation network facilities, perhaps 66 percent could eventually be stranded, meaning there is no revenue generated by the assets.

You might argue the problem is “copper access lines.” The real problem is “access lines,” namely the growing likelihood that too few customers will be served by the new networks.

The big regulatory problem then becomes universal service on a wide scale, not confined to rural areas. It might increasingly become impossible for CenturyLink to operate fixed access lines of any type for many consumers.

Nor can CenturyLink simply decide to stop serving consumers. Landline phone service remains a regulated utility--even if that whole industry is disappearing--and requires states to change laws before CenturyLink could discontinue voice services.

There is clear risk that CenturyLink will be forced to continue offering an obsolete service producing almost no revenue and stranding assets on a massive level.

LIke many smaller service providers, CenturyLink has made a pivot to becoming primarily a business services provider, though it is saddled with huge regulated service operations that are a huge drag on the business.

Prior to the acquisition of Level 3 Communications, CenturyLink earned 64 percent of its revenue from business customers, an astoundingly-high percentage for a firm that once was a rural service provider.

After the acquisition of Level 3 Communications (if approved), CenturyLink would generated 76 percent of its total revenue from business customers, certainly the highest percentage for any tier-one service provider in the U.S. market, and second only to AT&T in that regard.

AT&T, by way of comparison, generates about 17 percent of total revenue from business customers (enterprise, medium and small business), while Verizon earns about 13 percent of total revenue from business customers, according to CenturyLink.

The larger point is that many service providers--tier one and smaller service providers--have concluded that the way forward is as specialists serving the business customer. What is new, in this case, is the size of the required pivot by a tier-one service provider.

One might argue it makes little sense for CenturyLink to serve most consumer accounts at all, but it is a highly-regulated firm that has no choice to easily stop doing so. Like a crab molting its former, too-small shell, CenturyLink essentially is shedding its former identity and business model, under conditions where regulators might attempt to prevent that molting.

This is eventually going to have huge implications for regulators. What if the whole fixed networks business becomes unsustainable, across most of the country? CenturyLink might be the best example, but hardly the only example, of the problem. Old rules are not going to work.

Massive Disconnect Between App and Physical Layer Business Models

There is a massive disconnect between revenue and cost drivers in the mobile content ecosystem, and that disconnect now has to drive strategy for some of the providers in the ecosystem.

Consider only the key difference in metrics used in the advertising, content and commerce industries and the networks business where it comes to “usage.”

For advertisers, marketers, content providers and commerce businesses, what matters is user engagement (where they spend their time).

For advertisers, content providers or e-commerce providers, minutes of use (engagement) matters, since the markets move to where the users are, and where they spend their time.

For network facilities operators, capital investment comes first, where it comes to looking at usage, since usage primarily is a matter of capacity.

For “pipe providers,” it is the volume of bits consumed that matters. In other words, how much traffic, and where it flow, matter first. Only secondarily does “revenue” enter the discussion. Capacity must be deployed where there is need for it, and only secondarily because that correlates, more or less, with revenue.

For content providers, advertisers and e-commerce firms, usage means direct revenue opportunity; the chance to reach large audiences.

For transport and access providers, time of engagement matters only scarcely. What really matters is the volume of usage, since there is a weak relationship between “volume of usage” and “volume of revenue.”

So there is a big business model disconnect. For advertisers, content providers and commerce providers, usage creates direct business opportunity.

For transport and access providers, usage first creates need for capital investment, only secondarily revenue opportunity.

In other words, for app layer or “business layer” entities, “time invested” drives several business models, ranging from advertising to e-commerce. As the generalization suggests, “money follows attention.” So the attention itself creates revenue potential.

For physical layer facilities providers, “time” hardly matters, while “volume” is everything, primarily because volume dictates investment. But volume only indirectly creates business opportunity.

That provides one more bit of evidence that business models--and revenue--increasingly lie in the applications and services people want to consume over the internet, and not the pipes that connect people to their content.

It also suggests why “moving up the stack” or “moving up the value chain” is so important for tier-one service providers. For small providers of access, even that option is mostly unreachable. For providers without scale, only cost control and marketing prowess will matter.

Mobile Drives 75% of Internet Engagement Time

Mobile devices will account for 75 percent of global internet use next year, according to a new Zenith Media forecast. If Zenith’s methodology remains consistent, those figures are a measure of time spent with internet apps and content, not “data transferred.”

That is a key difference in metrics used in the advertising and networks business. For advertisers, minutes of use (engagement) matters. For network facilities operators, volume of bits consumed (traffic) matters.

The mobile proportion of internet use has increased rapidly, from 40 percent of total traffic in 2012 to 68 percent in 2016. Zenith Media expects mobile devices to generate fully 79 percent of total internal traffic by 2018, a perhaps astounding percentage.

Mobile internet already accounts for 85 percent of internet use in Spain, in 2016. In Hong Kong,  mobile represents 79 percent of internet use.

In China, mobile generates 76 percent of internet usage, while in in the United States mobile generates 74 percent of total internet use.

In Italy and India, mobiles are responsible for 73 percent of internet usage.

By 2018, Hong Kong to have the highest mobile internet use, accounting for 89 percent of total internet use.

China’s mobile devices will represent 87 percent of internet use, while in Spain mobiles will produce 86 percent of usage.

In the United States and Italy, mobiles will represent 83 percent of internet usage, with India at 82 percent.

The increase in mobile internet use is being driven by the rapid rise in the penetration of mobile devices. In 2012 just 23 percent of people in 60 studied markets had a smartphone, and four percent had a tablet.

Smartphone penetration has now reached 56 percent, and increase of 2.4 times over four years, and Zenith forecasts growth of smartphone use to 63 percent by 2018.

The highest levels of smartphone penetration are in Western Europe and Asia. Ireland has the highest smartphone penetration this year, at 92 percent, followed by Singapore (91 percent), Spain (88 percent), Norway (86 percent) and South Korea (84 percent).

We forecast Ireland to remain in first place in 2018, with 94 percent penetration, followed by Switzerland and Singapore at 92 percent each, and Norway and Taiwan at 91 percent each.

Artificial Intelligence in Telecom: How Big, How Soon?

Artificial intelligence now is a “thing” like “computing” was once a thing. But it might be quite reasonable to assume that, in the not distant future, AI will be embedded into products, processes and venue as routinely as computing now is part of the background fabric.

In the communications business, that should range from customer-facing service to the operation of core networks, enhancing pricing and packaging decisions, service configuration, resource allocation, network management, energy efficiency, use of assets to simple routing decisions.

Commercial AI revenues are expected, by some, to climb from less than $1 billion to perhaps $5 billion by 2020. Revenues might reach $31 billion to $38 billion, up to perhaps $41 billion, globally, different forecasts suggest, by 2024 to 2025.

Some forecasts are more aggressive than that, calling for a U.S. market of perhaps $67 billion for robotics applications by 2025.

Humana, for example, using AI to assist agents in its call centers, to help agents predict customer behavior while on calls. Right now, AI sometimes provides a digital coach. In other cases, AI might handle an inbound call until escalation to a human agent is required.  

In the future, AI, with big data sets to work with, might go even further. Some are working on ways of using machine learning to directly handle inbound calls without agent intervention. Indeed, one premise of AI is that it can be used to automate any process.

“Amelia can, after two months of learning from her human colleagues, handle over 60 percent of support tickets on her own,” argue researchers at  Kairos Future.

It would be fair to note that researchers have been working on AI processes for half a century, including research into deep learning, machine learning, natural language processing (NLP), and computer vision, machine reasoning as well as core computing.

source: Frost and Sullivan

Bank of America Merrill Lynch

It is anecdotally worth noting that among the firms pushing to create commercial AI platforms are firms with huge exposure to consumer apps and business models, including Amazon, Microsoft, Google, IBM, Salesforce and Baidu.

source: oreilly.com

Private Networks Deliver 39% of Global Traffic

The Internet has caused the biggest change in global telecom since the advent of mobility. To wit, former telcos now are participants in the broader Internet ecosystem, not the leaders of the “telecom” ecosystem.

One example of the trend: application providers already operate private wide area networks that

account for 39 percent of global traffic. In a few years, it is likely OTT app providers will carry a majority of global traffic, largely on their own networks.

In other words, the app providers no longer rely on “telcos” to carry their traffic, and increasingly operate their own networks, as functional substitutes for telco services.

Likewise, OTT providers now offer services and apps that effectively replace telco voice and messaging services. That is highly significant as voice and messaging have historically represented the vast bulk of telco revenues.

Facebook and Google also have been active reshaping access networks as well. Access historically has been the province of “telcos.” But Google is testing fleets of balloons, fixed wireless, unmanned aerial vehicles, Wi-Fi and fiber to the home networks.

Facebook is developing unmanned aerial vehicles, multiple-antenna array fixed wireless radios, and launched the Telecom Infra Project to create open-source telecom platforms spanning access, backhaul, core networks and network management. The Open Cellular effort likewise concerns ways villages and other entities can create and operate their own cellular networks.

Google has launched its own tablets and smartphones, increasingly, with its new Pixel devices, set to challenge the likes of Apple and Samsung at the high end of the market.

Facebook, meanwhile, has launched the Free Basics program to allow users to sample key Internet applications without having to buy mobile data plans.

One might well argue that innovation, to a large extent, has passed from the tier-one telcos to the few big app providers able to operate at “web scale.”

Few Actually Need a Gigabit: RCN

As it launches gigabit service in New York, RCN has provided one of the easiest, consumer-friendly ways an ISP can easily explain which speed tier should be purchased.

“Gigabit” mostly is a marketing platform, not a reflection of actual end user demand, in virtually all cases. Indeed, how much bandwidth any account requires is a function primarily of the number of users sharing an account, and secondarily of the types of applications used (especially streaming video).

Though RCN suggests accounts using streaming video choose a 50-Mbps plan, that assumption is based on four devices being used. In fact, for single-user accounts, even 10 Mbps will be enough to stream Netflix and other services.

The gigabit plan is said to be best for accounts supporting 10 devices or more. The 330 Mbps plan is best for eight devices; the 155 Mbps plan best for six devices. The 10-Mbps plan is said to be sufficient for one to two devices, perhaps typically a smartphone or two, perhaps sometimes a PC and a smartphone.

Faster speeds are a good thing. But few accounts actually “need” a gigabit service. The value of higher-speed services is mostly a function of the amount of bandwidth sharing on the account.

source: RCN