Fixed and Mobile Networks are Becoming Unsustainable, in Many Markets

An argument can be made that a growing number of tier-one service providers cannot invest profitably in their networks, even if markets require ever-more capacity. In the recent past, that might have been thought a problem for fixed network operators. Now it appears to be becoming an issue for mobile operators as well.

An analysis by A.T. Kearny suggests that only the top four players in any Southeast Asian geography are able to earn positive financial returns. More importantly, only the top two players in a geography seem to consistently make returns in excess of their cost of capital. Some have argued that is a problem for firms such as AT&T and Verizon as well, arguably pertaining mostly to their fixed networks.

Researchers at PwC studied the financial performance of 78 fixed-line, mobile and cable operators with a collective annual capex of some $200 billion, nearly 66 percent of the industry’s total spend.

The research found that, over the past decade, the average long-term return on investment (ROI) has been just six percent. That is three percentage points less than the cost of the capital itself. In other words, operating revenue is not covering the cost of capital.

At the same time, revenue growth rates are dropping in most markets.

Consider Verizon, which earns very little from its fixed network operations, and almost all earnings from the mobile business, or AT&T, which earns a bit more from its fixed network, but still earns most of its money from mobility services.

In 2013, Verizon generated 21 percent of total earnings from its fixed network, and 79 percent from mobile services.

Mobile represented 68 percent of revenue in 2013, while fixed operations generated 32.5 percent of total revenue. In other words, mobile creates significantly more profit margin than the fixed network.

source: Deloitte University Press

AT&T shows the same pattern, if different magnitudes. In 2013, mobile represented 54 percent of revenue and 60 percent of profit; the fixed network 46 percent of revenue and 40 percent of profit.

source: Deloitte University Press

 

And capital intensity seems to be rising.

source: A.T. Kearney

That mismatch between profit and investment explains why fixed network internet access speeds have lagged, compared to cable operator speeds. A rational executive would invest where there is growth, higher profit and strategic advantage--the mobile network--and harvest the proceeds of the legacy fixed network.

While it is understandable that policy advocates and regulators call for more investment by tier-one telcos in their fixed networks, “how” to make that investment at a profit is the issue. Tier-one service providers with mobile assets long have assumed mobile would lead their businesses. The only issue has been what to do with the fixed assets, which have been declining n value.  

Calling for ubiquitous fiber to the home deployment arguably is a losing proposition, as it no longer is clear that investment would ever generate a return.  

Other telcos without mobile assets might be able to use new shared spectrum or unlicensed spectrum assets to upgrade using fixed wireless platforms. In some cases, wholesale access might provide an opportunity to upgrade, as well.

What seems rather abundantly clear is that U.S. telcos already have lost the competition with cable companies for leadership of the internet access business. Cable operators have for a few years gained all of the net new additions in the market, and, on average, offer top speeds two orders of magnitude (100 times) faster than what telcos offer.

Most popular advertised service tiers
Platform	Company	Speed Tiers (Download)
DSL	AT&T DSL	1.5	3	6
	AT&T IPBB		3	6	12	18	24	45
	CenturyLink	1.5	3	7*	10	12	20	40
	Frontier DSL	1	3	6
	Verizon DSL	0.5-1	1.3-3
	Windstream	3	6	12
Cable	Optimum	25	50	101
	Charter	60	100
	Comcast	25	50	75	105	150
	Cox	15	25	50	100
	Mediacom	15	50	100
	Time Warner Cable	15	20	30	50	100	300
Fiber	Frontier Fiber	25
	Verizon Fiber	25	50	75
Satellite	Hughes	5	10
	ViaSat	12

source: FCC

“Cable based ISPs are driving the growth in new high speed service tiers,” the Federal Communications Commission says. In fact “the maximum advertised download speeds among the most popular service tiers offered by ISPs using cable technologies have increased from 12-30 Mbps in March 2011 to 100-300 Mbps in September 2015.”

“In contrast, the maximum advertised download speeds that were tested among the most popular service tiers offered by ISPs using DSL technology have, with some exceptions, changed little since 2011,” the FCC report notes.

Without major changes of business model (higher revenues, new revenues, lower capex, lower opex), it is fruitless to argue that legacy copper networks be upgraded, on a ubiquitous basis. That will not earn back the cost of deployed capital. Though some have criticized the effort to use wireless or mobile facilities as a replacement, that is a rational solution, with a business model that works. Even Google Fiber seems now to agree with that view.

Gigabit Price Anchoring

There are good reasons to believe that, in the gigabit era, most consumers still will buy speeds at the middle of the range, and in the middle of the price range, whatever those ranges happen to be.

When they have a choice of internet access speeds and retail prices, most U.S. consumers appear to buy packages in the middle of the range, as they arguably do with many products. Encouraging such behaviors is the intended outcome of price “anchoring” strategies.

Anchoring refers to the tendency to heavily rely on the first piece of information offered when making decisions. Once an “anchor” is set, other judgments are made in comparison to the anchor.

In other words, the best way to sell a $2,000 watch is to put it right next to a $10,000 watch, as consumers typically see “value” in the comparison.

That is why many types of products are structured into three price tiers, marketing professionals often calling those packages “bronze, silver and gold.”

So the primary sales benefit of selling fixed network gigabit packages is to sell packages in the hundreds of megabits range. A secondary aim to achieve the perception of leadership in the market.

Over the nearly-five-year period between 2011 and 2015, maximum advertised internet access speeds of the most-popular service tiers offered by U.S.cable operators have increased from “12 Mbps to 30 Mbps” in March 2011  to “100 to 300 Mbps” in September 2015, a factor of 10 increase in less than five years. That is nearly a Moore’s Law rate of change.

Of course, most consumers do not yet buy tiers of service featuring those “maximum advertised” speeds. Taking a look at products consumers choose to buy, median speeds have grown from 10 Mbps in March 2011 to 41 Mbps in September 2015. Keep in mind, that figure reflects the actual purchasing decisions made by consumers, not the faster speeds consumers can choose to buy.

As Google Fiber apparently has discovered, offering consumers 1-Gbps service roughly a “10 times faster, twice the price” of typical offers does not necessarily convince consumers to buy. That is the somewhat-odd element of the coming gigabit era.

So far, when offered a choice, most consumers opt for “good enough” services at lower speeds and prices, rather than the “fastest” service offered, at the highest price. Some will argue that is because internet service providers have not chosen to offer the highest speeds for the “normal” price. But that is a bit like arguing auto retailers do not sell Teslas at a Toyota Camry price.

Gigabit is part of the larger process of price anchoring.