How Much Do New Platforms Boost Telco Revenue Potential?

One obvious fact about the competitive telecom business that makes it quite different from the old monopoly business (pre-1990s) is that better technology often has its greatest impact in the areas of operating cost or asset efficiency, even if the advantages are said to include ability to offer new services.

Although new technology more frequently reduce some forms of capital investment, new platforms sometimes drive big new revenue opportunities. Signaling system 7 improved telco operations, but also created the ability to offer text messaging as a retail service.

Optical fiber access networks add enough bandwidth that telcos could offer video entertainment services.

With a few exceptions, though, new platforms in the internet era have had very mixed implications for service revenues. The main problem is simply that the newer platforms (with the exception of enabling video entertainment), do not necessarily represent a chance to grow legacy revenues. Instead, new platforms mostly enable different (and arguably better) ways to deliver current services. The point is that, on a net basis, the better platforms do not necessarily represent “new” revenues, just better ways to supply “old” functions.

Consider voice over LTE (VoLTE). There are now 165 operators in 73 countries investing in VoLTE, including 102 operators that have commercially launched an high definition voice service using VoLTE in 54 countries, according to Juniper Research.

Some might interpret that development as representing a new revenue stream, in the form of high-definition voice services that are sold at a different price point. It remains to be seen if that actually happens. Some might argue HD voice only makes mobile voice usable where it frequently now is very sub-par in terms of audio quality.

In other words, mobile voice is “broken” and HD voice just fixes the problem, making mobile voice usable.

Likewise, some argue that over the top voice represents a revenue opportunity for mobile service or fixed service providers. The same might be said for voice over Wi-Fi. In most cases, though, such OTT voice mechanisms mostly provide indirect business value, operating cost savings or more-efficient use of existing assets.

For example, VoLTE means operators can avoid using 3G for voice services, freeing up capacity for other purposes, plus allowing simpler operations. Voice over Wi-Fi allows mobile operators to offload voice access operations in a more seamless way.

Still, for the most part, new platforms do not represent a net gain in service revenues. Part of the reason is simply that VoLTE replaces 3G voice, for example. To some extent, even investments in FTTH only allow telcos to keep pace with other competitors who are driving higher speeds, though FTTH does make high-quality entertainment video possible for a telco.

But since many alternatives exist for every legacy product, OTT voice and messaging allow new competitors to offer those services, with some ability to add features to a carrier service. That has a net negative impact on carrier revenue potential.

The larger point is that, in a competitive market, even better access platforms do not necessarily represent a huge net gain--if any--in carrier capabilities, where it comes to providing new services.

source: Ali Saghaeian

source: Juniper Research

source: Analysys Mason

FTTH Economics Might Now Largely Depend on Monopoly Conditions

The economics of fiber to the home now seem to hinge very much on whether a monopoly deployment is possible, typically when one national network is built that is used by all, or most, retail competitors. Think of Australia’s National Broadband Network; Openreach in the United Kingdom, New Zealand’s network or Singapore’s model, or nations of the European Union.

In markets where facilities-based fixed network competition exists, entirely or in part (United States and Canada being examples of the former; the Netherlands, United Kingdom and France examples of the latter), market dynamics are quite different.

In principle, a monopoly fixed network provider could hope to have market share up to 90 percent (some satellite, some independent ISPs, some cable operators could take some share). In a competitive, facilities-based market, any single competitor might hope to get 40 percent to 50 percent market share. The lower figure might happen where there are significant third party suppliers, the latter figure happening when there are just two participants competing.

CenturyLink, for example, now earns 76 percent of revenue solely from business customers. The implication is that no matter what CenturyLink does, its consumer fixed networks drive, at best, 24 percent of results. That is a practical illustration of the “80/20 rules,” or Pareto Principle, which means 80 percent of results come from 20 percent of activities. For CenturyLink, one might say that 20 percent of the assets (those serving business customers) drive 80 percent of results.

Over recent decades, telcos have had to replace half of revenues every decade. The big shifts so far have been fixed network long distance to mobile; then mobile messaging replacing voice; then mobile data replacing mobile messaging. For many fixed network providers, internet access replaced voice, and now entertainment video is replacing internet access.

The point is that highly-competitive markets and diminution of all legacy revenue streams now mean the potential financial return from any network investment is limited. In essence, telcos and other competing service providers have been running in place, losing some revenue sources and replacing them with others.

For many access providers, the business problem is that new networks cost more, but support new revenues at a lesser level, in part because the amount of stranded assets (assets that do not generate revenue) grows in a competitive market, and in part because all legacy revenue sources are maturing.

That has huge implications. It means the economics of FTTH now are not driven principally by asset cost, but by the nature of the markets where the assets are deployed. Monopoly, or near-monopoly scenarios, are most favorable. Highly-competitive, facilities-based markets are where the payback is most tenuous.

In other words, even Verizon finds that up to 60 percent of its FTTH assets are stranded, and not generating revenue. That is not unusual, in any U.S. market.

So the new questions are whether FTTH actually makes sense, as a ubiquitous network, in any market where there is robust, facilities-based competition.

Is FTTH Era Over, Next to Lead by Wireless?

AT&T and Verizon are pushing ahead with trials of pre-5G networks operating in fixed wireless mode. Though that might not make as much financial sense in many other markets, there is a very good reason why AT&T and Verizon feel fixed wireless is so important, as an early deployment strategy.

The reason is that they have lost the market share battle with cable companies for consumer internet access, and even full fiber-to-home network deployment would likely fail to change that. Even where Verizon runs ubiquitous FTTH networks (FiOS), it gets only about 40 percent market share.

If one assumes internet access is the core consumer service delivered over a fixed network, that is bad news, as it suggests even ubiquitous FTTH can change telco market share in consumer internet access.

That is a hugely important development. Even if FTTH can be deployed at lower costs, the business model might no longer work well enough to support full deployment. The hope always has been that FTTH costs would drop low enough that fiber was a complete substitute for copper access media.

Instead, markets now have changed enough that even cost equivalency with copper is not enough. The new issue is the business model for ubiquitous fixed networks, which increasingly drive less revenue and profit for U.S. telcos.

Hence the interest in platforms that are even more capital efficient, can be built faster and at lower cost, while better leveraging core assets. Recent trends suggest telcos might be forced to move in a new direction, as they now are losing the internet access business to cable, and even full FTTH might only halt losses to the point where telcos get about 40 percent share.

In other words, FTTH might no longer provide any hope of retaking leadership in the consumer internet access business.

Telcos Losing Internet Access Accounts at a Faster Rate to Cable

There is a reason much of the attention in the consumer internet access business now is focused on varieties of wireless access (balloons, low earth orbiting satellites, fixed wireless, bonding of licensed and unlicensed spectrum, 5G and millimeter wave).

Though the economics of fiber to the home have gotten better over the last few decades, the business model also has been under pressure from substitute products, the impact of competition on financial returns and the maturation of all legacy revenue models.

In the U.S. market, rival platforms already have had a huge effect, with cable companies using hybrid fiber coax platforms capturing all the net growth in the consumer segment of the internet access market.

The top cable companies netted 122 percent of the broadband additions in 2016, increasing gains from the 106 percent they gained  in 2015 and the 89 percent they got in 2014. To be sure, the leading telcos (AT&T, Verizon, CenturyLink) now have stepped up fiber-to-home deployments. But Verizon’s experience also suggests that that ubiquitous fiber deployment results in market share of about 40 percent to 45 percent.

The top telcos, in contrast,  lost 600,000 accounts in 2016, compared to a loss of about 185,000 subscribers in 2015. As the consumer internet access market is mostly a zero-sum gain, cable gains are at the expense of telcos.

In other words, under perhaps the best of circumstances (dense urban markets, lots of capital, marketing muscle), a big telco still loses leadership of the internet access market to cable competitors. To be sure, all-copper digital subscriber line services are where telcos mostly lose the battle to cable.

That scenario might remind you very much of Sprint, back in the days when it was bleeding former Nextel accounts, even as legacy Sprint accounts grew slightly, or lost just a bit of share. In other words, some segments of the customer base are more susceptible to predation.

Telcos face great difficulties in rural areas and less-dense suburban areas, where FTTH costs arguably would not produce a clear financially-positive result. Cable company networks always were built for low-cost access, always were broadband and now are easier to upgrade incrementally than telco networks.

All of that means there is a market opportunity, for all competitors to cable companies, in new platforms (mobile, Wi-Fi, LEO satellites, balloons, unmanned aerial vehicles, fixed wireless, 5G) now are getting serious attention to FTTH.

ISPs	Subscribers  4Q 2016	Net Adds
Cable Companies
Comcast	24,701,000	1,372,000
Charter	22,593,000	1,604,000
Altice*	3,907,000	122,000
Mediacom	1,156,000	71,000
WOW (WideOpenWest)**	718,900	20,600
Cable ONE	513,908	12,667
Other Major Private Company^	4,790,000	90,000
Total Top Cable	58,379,808	3,292,267
Phone Companies
AT&T	15,605,000	(173,000)
Verizon	7,038,000	(47,000)
CenturyLink	5,945,000	(103,000)
Frontier^^	4,271,000	(243,000)
Windstream	1,051,100	(44,000)
FairPoint	306,624	(4,506)
Cincinnati Bell	303,200	15,800
Total Top Telco	35,519,924	(598,706)
Total Top Broadband	92,899,732	2,693,561

source: Leichtman Research

5G Spectrum Will Feature Coverage, Capacity, Indoor Pattern

Up until the 4G era, mobile and Wi-Fi spectrum have been seen as having rather clear roles: lower frequency for coverage; mid-band for capacity and Wi-Fi for indoor distribution. In the 5G era, that tripartite pattern will be even more pronounced, with the key changes coming in the millimeter wave bands, which are seen as best suited for capacity and indoor coverage.

source: Ofcom

If ROIC is What Matters, So Does Market Share

Market share plays a large role in financial results. Looking at market share and return on invested capital (ROIC) for the three largest players in Thailand, China, and Indonesia since 2015, you can see that financial return and market share tend to be directly related.

My rule of thumb is that the leader has twice the share of number two, which in turn has twice the share of provider number three. In Thailand, China and Indonesia, the general pattern holds, In Thailand the pattern holds well. The leader has 53 percent share, number two has 31 percent and number three has 17 percent share.

The theoretical model I use would call for shares of 50/25/13, or any other ratio that maintains the same sort of relationships between market share among the top-three providers.

The Chinese market diverges: the leader has 69 percent share; number two 17 percent and number three 14 percent.

In Indonesia, the market leader has 65 percent share; number two has 18 percent and number three has 17 percent.

My approach also suggests that any market not having the 50/25/13 structure is unstable, with the big changes to be expected in share shifts from the number-one provider to number two. The third provider in all three of these markets actually is doing as well as a stable structure would suggest.

Those relationships also include varying rates of return on deployed capital, with one possible and important exception. Where the leading provider generally earns the highest ROIC, and in some cases can wring extraordinary profits out of market leadership, the relationship between market share and ROIC is less predictable for providers two and three, in any of these markets.

Still, the general pattern is important. Market share matters because it is related, more or less in a linear fashion, with profit and return on invested capital, although perhaps in a less certain way than market share structures tend to take, in stable markets.

Source: Reperio Capital

Source: Reperio Capital

ROIC issues for access services are one reason why the strategy of “moving up the stack” or “up the value chain” continues to be relevant and necessary for at least the larger telcos, cable companies and similar access providers. Mergers to gain scale will help, in many cases, but the fundamental problem--lack of organic growth for network services--will be a key constraint.

Market consolidation, in many cases, also will help, as market share and financial return tend to be correlated. So increasing share will tend to boost financial performance. In all three countries studies by Reperio Capital, market share and ROIC were related. In the clearest example, the number three provider in all three countries had single digit ROIC. Provider number one had high or even extraordinarily high ROIC.

ROIC Will be Key Concern in 5G Era

Some observers point out that the higher costs of 5G networks--driven by small cell architectures and the need for more backhaul and more radio sites--is going to mean 5G networks cost more than 4G networks. Logic suggests the merit of that view. Macrocell networks (4G and earlier generations) require fewer towers, sites, radios, frequency coordination and backhaul than microcell networks. 

And that means a current problem--return on invested capital--is going to become even more important in the 5G era. 

Return on invested capital, not earnings (EBITDA) or cash flow, now is the way major telcos have to measure business results, argue analysts at PwC. The fundamental reason is that “growth is gone and it’s not coming back,” say PwC analysts.  “Downward trends in return on invested capital (ROIC) are the result of a number of factors, from regulated price reductions to cannibalization of legacy revenues by OTTs, along with high capital intensity required to support demand for data,” say researchers at EY.

So if revenue growth is muted, what matters is how well access providers monetize invested capital. That is not going to be easy.

source: EY

Philippines telco Globe Telecom had a return on capital of about 7.7 percent in the third quarter of 2016. Airtel in India points out that, in 2016, some Indian telcos might have had a one-percent return on capital.

That 7.7 percent rate is about in line with global telecom firm financial returns from the 1990s until perhaps 2006. But there can be wide variation. In the U.S. market, in 2013, Verizon has ROIC of more than 13 percent, while CenturyLink has ROIC of minus 7.4 percent.

source: Bloomberg

source: Bloomberg

ROIC issues for access services are one reason why the strategy of “moving up the stack” or “up the value chain” continues to be relevant and necessary for at least the larger telcos, cable companies and similar access providers. Mergers to gain scale will help, in many cases, but the fundamental problem--lack of organic growth for network services--will be a key constraint.

Market consolidation, in many cases, also will help, as market share and financial return tend to be correlated.