Underestimating Demand is as Bad as Excessive Optimism

The launch of AT&T’s DirecTV Now streaming service reminds me of its launch of the Apple iPhone. As you will recall, the iPhone launch appeared to have caught AT&T somewhat by surprise, in terms of the added usage of its data network.

Roughly the same thing seems to have happened with the DirecTV Now launch. In both cases, customers complained about quality issues that appear related to capacity to support the new services.

You can guess what comes next. AT&T took steps to fix the capacity problems related to iPhone customer behavior patterns, and likely has spent the last few months figuring out how to better support scaling of its DirecTV Now service as well.

You might well expect a renewed growth spurt, as a result. It’s just a reminder of how networks are dimensioned: you have to make assumptions about consumer behavior. Overprovision and you waste capital. Underprovision and consumers will have a troubled experience. It is hard to get it right, for new services that prove quite popular.

AT&T DirecTV Acquisition Seems to be Working

AT&T’s acquisition of DirecTV was not universally acclaimed when it happened. Some observers said AT&T needed to spend the money on better internet access. Others pointed out that the linear video business already was in decline.

Supporters argued that the move made AT&T a nationwide quadruple play supplier for the very first time. Others pointed out that the free cash flow almost singlehandedly would fund AT&T’s dividend for some time. Some added that the additional scale would improve economics for the firm’s video business now, while creating a much-stronger platform for OTT video to come.

So the new way to reassess that particular choice is whether you think AT&T or Verizon is in a better position, today, strategically.

If you believe all access providers will have to replace half of current revenues within 10 years, the only question is how to do so. In principle, you can make horizontal or vertical acquisitions, invest in new lines of business or grow organically.

Organic growth helps. How much that can help depends on whether a firm can take market share in a market or mostly has to defend its share, whether the markets are mature or young.

An attacking firm with low share always can grow by taking market share from incumbents. New entrants with different cost structures, attacking from “outside” an industry, with different assets, often have a much-easier time than incumbents attacking each other, with the same asset bases.

But most observers would argue that organic growth, in markets that are saturated, does not provide the scale of new revenue, fast enough.

And some critics might say AT&T faces issues with its DirecTV performance, in the form of subscriber losses in linear video. But the DirecTV Now OTT service, despite some issues, seems to have kept the video base at flat levels, in a business that is shrinking.

Average revenue per user is an issue, but AT&T seems to be reaping bundling rewards.

“Half of our DTV Now subscribers are coming from traditional pay-TV, mainly from our competitors, and the other half had no pay-TV service at all,” said John J. Stephens, AT&T CFO.

AT&T has “reached nearly 0.5 million subscribers,” keeping This has the video account base “essentially flat” from year ago levels, he said.

source: AT&T

Importantly, the bundling of video and mobile services seems to be working. The number of wireless subscribers who also have a TV service from us has increased by more than 4 million, or up 31%, since the close of the DTV deal. Conversely, TV subscribers with wireless plans have increased by nearly 1 million, or 18%.

The number of mobile subscribers with DTV has increased by 72 percent, while the number of DTV subscribers with AT&T Wireless has increased by 1.7 million, or 52 percent.

The number of DTV subscribers in AT&T’s wireline footprint with IP broadband has grown by more than 2.7 million, to 67 percent of DIRECTV customers, said Stephens.

Go Horizontal or Vertical in Acquisition Strategy?

Access services are a mature market in developed countries, and eventually will become mature even in developing markets, even as new revenue sources are created to replace declining legacy services. That has business consequences.

Most large tier-one service providers (cable, telco, satellite) eventually grow more by acquisition than organic growth. That is not the pattern for smaller firms, but you get the point. In any “mature” market, where accounts are essentially saturated, any provider tends to get account growth mainly by taking an account away from another existing provider.

So supplier consolidation is a long-term process in the global telecom industry. The only question is how fast, and how intense, that process is at any moment in time.

But what sorts of acquisitions make sense? The easy answer has been to make “horizontal” acquisitions to gain scale in the existing business. In other words, acquire more access assets.

That is the thinking when analysts float trial balloons such as Comcast buying Verizon, or Verizon buying Comcast or Charter, or when smaller telcos do the same sort of thing.

At least in the near term, doing so is a faster, surer way to boost gross revenue, and boost profit margins, than investing in “long game” moves “up the stack.”

To be sure, in the near term, such horizontal acquisitions are likely to be the main trend in the global telecom industry (in terms of revenue accretion). Moving up the stack takes time, and might often contribute less incremental revenue than a simple horizontal acquisition.

But taking the “long game” route to moving up the stack is possible.

Consider Comcast, which is among the U.S. access providers with the best execution “moving up the stack.” In the first quarter of 2017, Comcast booked $20.5 billion in total revenue. The access part of the company booked $12,9 billion in revenue, while the NBCUniversal portion of the company generated $7.9 billion in revenue.

So the “up the stack” (content) part of the company represented about 39 percent of revenue, access about 61 percent of total revenue.

If any other major telco could claim it now earns 39 percent of revenue from “application layer” sources, it would be considered a major strategic success.

In the second quarter of 2017, AT&T earned virtually all its $39.8 billion in quarterly revenue from access services. That will change, assuming AT&T’s acquisition of Time Warner is approved.

In the first quarter of 2017, Time Warner booked $7.7 billion in revenue. In other words, after the acquisition, AT&T would earn just about as much as did Comcast in its most-recent quarter. That would boost content revenue at AT&T to about 16 percent of total.

It might not seem like much, but that would mean AT&T earns significant revenue, for the first time, from “up the stack” sources. AT&T of course will eventually want to do the same in enterprise and business areas related to internet of things, for example. But that will take time, both because the IoT market is nascent, and because the available acquisition targets therefore also are small.

Verizon has made a similar, if smaller move, by acquiring first AOL and then Yahoo, to create a new advertising business. In the first quarter of 2017, Verizon booked $29.8 billion in revenue. Revenue from its telematics unit was negligible as a percent of total, while, revenues from the  “Oath” unit were not disclosed. The point is that Verizon has not yet gotten to a point where “up the stack” revenues are significant.

But you see the point. Moving up the stack is hard, risky and often not able to move the revenue needle quickly. So the an emphasis on horizontal acquisitions is going to be hard to resist. But if you believe the access business is going to be fundamentally challenged, moves to gain scale in businesses “up the stack” is necessary.

The issue is, how to balance horizontal acquisition that boosts revenue and profit now, with investments in “up the stack” growth. Or, in an ideal scenario, can access providers move up the stack now, by acquiring assets that throw off enough significant current cash flow, to move the revenue needle immediately?

Comcast is the model for the U.S. market.

That illustrates an asymmetry for Comcast and Verizon, if you wantt to speculate on where value might lie, even if the odds of such an event are slim.

Comcast might value Verizon’s mobile assets, significantly growing the amount of its access revenues. But if you think a reliance on access revenues, going forward, is problematic, then Verizon gains more in any acquisition of Comcast, as it immediately gains “up the stack” assets, in addition to greater horizontal scale.

That is why some observers might argue that vertical acquisitions, where the synergy is clear, make more sense than horizontal acquisitions that increase scale in the access business.

Some will argue AT&T erred in buying Time Warner. Some of us would argue it is the right move, to move up the stack, when total revenue includes almost no “up the stack” contributions. If Verizon remains a buyer of assets, not a seller, “up the stack” makes more sense than a horizontal acquisition that simply adds more scale in access.

Some would focus on strategic angles, such as a faster path to “fiber deep” or “bandwidth deep” assets.

Others of us might argue that firms such as Verizon and AT&T, if they wish to remain leaders in the future (and not sell themselves), must create much more “up the stack” revenue. It is the only way to reposition their value in the ecosystem and escape a “dumb pipe,” low value, low margin existence.

"Move Up the Stack or Not?

Generally speaking, future telecom strategies come in two basic flavors. The first is the “be the low cost access provider” strategy. Among the key issues: can an entity gain enough scale to offset low average revenue per account? Can the entity cut costs fast enough, and continually, and still survive?

The other is the “move up the stack” strategy. Both are risky.

“Carriers have at various times tried to market their own devices, build portals for apps and entertainment, and provide outsourced IT services,” Strategy& notes. “The results, however, have been mostly disappointing.”

There’s a sort of simple way to plot strategic choices. Only a few of the larger entities will have the ability to really transform their business models and “escape” the “access provider” model.

For most service providers, some version of the “low cost provider” strategy will have to do, as there is not going to be enough capital or other resources to do anything else.

To be sure, there will be lots of fancy language about how former access providers can  transform their value, roles and revenue. All such thinking involves some form of “moving up the stack,” as hard as that might be. To be sure, there are things devices and networks supply, at the bottom of the stack.

source: Bell Labs

As always, though, the higher-value opportunities lie in the platform functions (if such a role can be created) and the actual outcomes or apps used by potential customers and users.

In the consumer space, consider the role played by video content and associated subscription services. Many point out that gains by “streaming” services that are a substitute (however imperfect) for linear subscriptions, so far, have failed to fully replace lost linear revenues.

There are analogies. IP voice services or apps have not displaced lost legacy voice and messaging services. So the point is not whether over the top (OTT) video subscriptions ever will directly recapture linear video revenue levels.

If the voice and messaging experience provides guidance, OTT video entertainment will not do so. So why bother? Because doing nothing leads to a worse outcome. Even if gross revenue and profit margins for OTT video dip from linear levels--even dip significantly--that incremental revenue and profit is important.

There appears to be nothing access providers can do to prevent erosion of voice, messaging and linear video revenue sources. And there is growing pressure on internet access revenues and profits as well.

But how sustainable is a future characterized by ever-smaller voice, messaging and video revenues, with perhaps flat internet access revenues? The point is that, even at the risk of lower margins and gross revenue, owning content assets is arguably more sustainable than not owning such assets.

The same observation can be made about legacy and emerging business and enterprise revenue sources. It is not likely that average revenue per unit for any class of connectivity services sold to businesses will grow, in the future.

So unless a service provider believes it can keep reducing cost to match declining revenues, a dumb pipe business model is risky. To be sure, moving up the stack also is quite risky. But unless you believe service providers can perpetually “cut their way to success,” value generation “up the stack” is going to be necessary, no matter how difficult.

Amazon "Chime" Illustrates "Value" Problem

“Everybody” knows that the telecom industry has a “perception of value” problem. A new conferencing service launched by Amazon illustrates the problem.

Before your head blows off, this is a conferencing service normally purchased by businesses, offered by Amazon Web Services.

Amazon Chime will be sold direct, and by partners Level 3 Communications and Vonage.

Level 3 will offer Amazon Chime as part of that firm’s “Unified Communications and Collaboration Services” portfolio.

Vonage now includes Amazon Chime in its business communications plans at no additional cost.

Three observations, here. AWS is the app creator and owner, not a “traditional” communications service provider or a unified communications specialist or enterprise voice provider. That is just one more example of over the top suppliers becoming substitutes for traditional telecom suppliers.

Level 3 is a distributor of Chime, not its creator and owner. That illustrates the growing role of access providers as conduits for third party apps, with obvious implications for business model, revenue and profit opportunities.

Finally, Vonage offers the service at no extra charge, showing another key trend: increasingly, service providers offer features and value, but not direct revenue-generating services.

In part, all those developments are part of one bigger reality: all apps now are conceptually created and delivered over the top, no matter who the owner. That is just the way the internet and IP networks work.

That also means more of the telecom business--by revenue, accounts, volume of data--is in the “dumb pipe” category. That is what internet access is, after all: a dumb pipe connection to all the resources of the internet.

Coupled with the decline of the traditional “apps” telecom provides (voice, messaging, content), there is a growing “value” problem, as the highest value lies with the OTT apps people and businesses want to use, not the suppliers of “access” to those apps.

Value, increasingly, is at the root of the telecom industry’s growing revenue problems.

"Layer Zero" Illustrates Broader "Value" Problem for Telcos

The industry audience listening to a talk by Marcus Weldon, Bell Labs president, about the drivers of future value in the next era of telecommunications drew immediate laughter when Weldon talked about where telecom sits in the end user’s estimation of value.

Go to 08:30 minutes into the video if you just want to hear the discussion of where telecom sits in the perception of value. Or watch starting at about four minutes in if you want to hear the Bell Labs vision of how "value" will be created in the next era. 

 
The point is that we work in an industry that once was considered layer one of a seven-layer model with “applications” at the top, but now is said by a growing number of observers to be at layer zero. 

Sure, the open systems interconnect model was created to illustrate the way modern programming should be done, but the idea has come to illustrate the "dumb pipe" problem as well.

To the extent that value is found "higher in the stack" at layer seven, then the logical corollary is that things happening at layer zero do not have as much value. 

Telecom's Layer Zero Problem

Telecom, if we are honest, is a business in trouble because its value to customers and users is no longer something we can take for granted. That is what the phrase “dumb pipe” is all about, if a bit of a misnomer.

Voice, text messaging, video content and other services sold by access providers often have a layer seven function as well as encompassing the lower functions, because those services literally are applications sold to the customer, not access to a cloud that sells or provides the services to a customer.

“Best effort” internet access turns out to be the first real “dumb pipe” product generally and widely sold to customers.

But, in an era where computing-based products provide the value that drives consumers to buy internet access, the access itself can be viewed as a low-value function.

“Layer zero” might only be a reasonable description of “internet access,” but the apt concern is that, over time, more of the former applications value supplied by telcos simply is removed to third parties in the cloud.

These days, even Bell Labs presentations show a “layer zero” that is “free Wi-Fi.” And Bell Labs is not alone. These days, cabling, mobile access, fiber to the home and so forth often is considered layer zero.

The point is that access networks arguably have lost lots of value in a world where Wi-Fi, accessed “for free,” is available as layer zero, with the price point being among the key business issues for telcos and other access providers.

The point is that the old telco business model is being destroyed, and a new model has to be created, as the old “buy our services to use voice, send messages and watch TV” increasingly is not relevant, in terms of end user value, as those things can be done using over-the-top apps.

When rational people with deep insight into the telecom business predict shocking levels of industry consolidation, that is simply a reflection of the rapid deconstruction of the global telecom business model.

source: programmerhelp404

source: Bell Labs