Why Have Cable Companies Wrung More Value From "Up the Stack" Investments than Telcos?

Why have cable TV companies have been so much more successful with their diversification or "move up the stack" strategies and investments, compared to telcos? One rarely hears of cable companies making strategic or technology investments that later prove to be ineffective, or which are divested.

It is a truism that value is moving up the stack, and telcos and cable have invested in software, hardware and services that are intended to help with that value-creation process. Still, cable tends to reap more rewards from its investments, compared to telcos.

One might argue that is because U.S. cable operators are more careful with their cash, being a smaller segment of the industry with a smaller supplier base, smaller revenues and resources than telcos.

https://seekingalpha.com/article/3981296-revenue-trends-telecom-sector

One might argue cable takes a practical approach, never investing in “moon shots.” But the structure of the two industries was quite different. Cable operators are able to focus on competing with telcos as the threat of competition from other cable operators is nil to non-existent.

Cable companies do not compete against each other in any single territory, as do mobile companies or satellite firms. That means there is less pricing pressure and less margin compression.

That also means it is easier for cable operators to collaborate on developing new technology or software, compared to telcos. Each cable operator realizes the odds of any new technology being deployed against it, by other cable operators, is virtually zero.

Every mobile operator knows other mobile operators will use any new capability against all the others, minimizing the comparative advantage.

Many telecom specialists do compete against telcos and cable in the fixed network business services segment (system integrators, interconnect firms, competitive local exchange carriers), and there is some--and growing--independent internet service provider competition as well.

Telcos mostly have been incumbents facing market share attacks in voice, messaging, internet access and business services. Cable has been an attacker. So telco investments are more risky: telcos have to invest in new lines of business they do not understand. Cable only has to take market share in businesses that are well understood.

Also, cable platforms, whatever the original limitations, have been “broadband” since their inception. Telco platforms have been “narrowband,” and the costs of upgrading both types of platforms were disparate: it cost cable far less to upgrade to reliable, gigabit internet access speeds, compared to telcos wanting to do the same.

Cable companies also have had lower operating costs than telcos, in large part the complex legacy of telcos having had cost structures shaped by monopoly conditions. The cable industry  began life “capital starved,” with important implications for business outlook and culture.

On the other hand, the separation of apps from access has meant the core telco apps, traditionally bundled with network access, can be delivered “over the top” by third parties. At the very least, that increases competition in the app realm. At worst, “access” becomes a dumb pipe function with less value.

Also, cable operators have had other advantages in terms of securing a role in the applications business. Consider that potential apps in the communications business are virtually infinite. Potential apps in the cable TV business are quite finite.

So it made sense for Comcast to buy NBCUniversal, and gain control of a differentiated revenue stream that also lies at the heart of its cost structure, in an adjacent part of its core and well-defined ecosystem.

Though AT&T is attempting something similar with its acquisition of Time Warner, many other telco acquisitions have not proven so successful. Telcos have bought computing companies, data centers, home security, mobile advertising, banking and other assets with mixed results. Many started their own app stores or OTT voice and messaging apps, with mixed results.

Compared to cable companies, telcos had to guess at what might work. What has worked is “horizontal acquisitions,” in both telco and cable segments of the business.

source: Deloitte

source: Deloitte

The point is that there are any number of reasons why vertical, up the stack efforts arguably have been more effective when attempted by cable companies, compared to telcos.

How to Add "Value," and "Where," Still are Debated

The advice to "add more value" to existing applications and services has been standard advice for access providers for a couple of decades now. In other words, to avoid becoming a "dumb pipe," service providers have to become "smart pipes." That advice often requires "moving up the stack." In other cases, the advice simply is to pack more value into the access service. Neither has proven to be easy, or uniformly successful.

Retail prices for voice, messaging and internet access have fallen for decades, essentially proving that the "add value" approach has either not worked, or not been tried.  

Value really has become the key strategic problem for mobile and fixed network operators, and not even the advice of the smartest consultants offers an easy path forward.

Mobile devices and users require “access” to core networks. But it is no longer a certainty that “mobile” networks are required, McKinsey consultants argue.

At the physical layer, Wi-Fi has become a key access platform. Even “mobile” access will be challenged as well, as new providers enter the access markets, using a mix of access platforms or even building separate facilities that do not rely on mobile networks at all.

Facing major competition on the applications front, mobile operators now face the new threat of full or partial substitution of non-mobile access for use of their own networks, further reducing the uniqueness and value of the “mobile” network.

Consumers on the go may soon no longer need mobile operators to stay connected with the wider world. Wi-Fi networks, frequently offered free, are becoming much more commonplace, and emerging low-power and satellite systems could provide other ways for users to bypass traditional mobile networks entirely, note Ferry Grijpink, Suraj Moraje and Klemens Hjartar, McKinsey senior partners;  Halldor Sigurdsson, partner.

Because of these emerging alternatives, mobile operators risk being downgraded to the channel of last choice, the one used only on those rare occasions when Wi-Fi, low-power networks, satellite coverage, or other options are not available, they argue.

So what must be done? Mobile operators must take steps to position themselves as the premium connectivity option, they argue. In general, that has been the “advice” given to service providers for decades, and it is frightfully hard to do.

In fact, many consultant-recommended practices already are being taken.

The path is not  revolutionary. The indicators of such “premium” status are familiar: offer higher “quality of service and functionality, especially given its superior end­-to-end cybersecurity compared with current Wi-Fi networks.”

The consultants also say mobile operators must “ensure superior customer experience.” Hardly a new thought.

That requires “superior connectivity and network quality.”

“Enhanced functionality”  also will be part of the effort. “One example would be to optimize video streams for individual users based on better compression technologies,” they argue.

Operators also should create  content delivery networks at the edge of the network, to improve experience, they argue. Unlimited data and unlimited video streaming that does not count against the limits of their data plans are other steps to take.

Since price is part of the value proposition, operators also must “reduce costs,”  offering a cost per megabyte to a tenth of current costs and use other tools such as network functions virtualization and software-defined networking, and taking other steps to simplify processes.

Analytics and network sharing can help as well, they argue.

There is one key area where McKinsey is more bearish than many leading service providers. The McKinsey consultants are not optimistic about mobile operator upside in internet of things, calling the opportunity “bleak.”

That likely is among the reasons they believe adding more value to the “access” function is the only way forward. Essentially, they argue, the hoped-for revenue upside from IoT will fail to materialize.

Mobile Prospects in Internet of Things Space "Bleak?"

Many observers would say that 5G is such a huge gamble for mobile operators because it will test the notion that major new revenue streams and use cases can be created beyond the "human user" applications that today define mobility services.

Most of those hopes rest on internet of things apps used by enterprises and larger organizations, not new use cases for humans using smartphones, tablets, PCs and other internet-connected devices. 

Not everybody believes that will happen, though. Some consultants at McKinsey are quite bearish on the opportunities, and instead argue that access providers must rely on the value of their access services for success. For service providers hoping to move up the stack, that is a difficult analysis, indeed. 

Value really has become the key strategic problem for mobile and fixed network operators, and not even the advice of the smartest consultants offers an easy path forward.

Mobile devices and users require “access” to core networks. But it is no longer a certainty that “mobile” networks are required, McKinsey consultants argue.

At the physical layer, Wi-Fi has become a key access platform. Even “mobile” access will be challenged as well, as new providers enter the access markets, using a mix of access platforms or even building separate facilities that do not rely on mobile networks at all.

Facing major competition on the applications front, mobile operators now face the new threat of full or partial substitution of non-mobile access for use of their own networks, further reducing the uniqueness and value of the “mobile” network.

Consumers on the go may soon no longer need mobile operators to stay connected with the wider world. Wi-Fi networks, frequently offered free, are becoming much more commonplace, and emerging low-power and satellite systems could provide other ways for users to bypass traditional mobile networks entirely, note Ferry Grijpink, Suraj Moraje and Klemens Hjartar, McKinsey senior partners;  Halldor Sigurdsson, partner.

Because of these emerging alternatives, mobile operators risk being downgraded to the channel of last choice, the one used only on those rare occasions when Wi-Fi, low-power networks, satellite coverage, or other options are not available, they argue.

So what must be done? Mobile operators must take steps to position themselves as the premium connectivity option, they argue. In general, that has been the “advice” given to service providers for decades, and it is frightfully hard to do.

In fact, many consultant-recommended practices already are being taken.

The path is not  revolutionary. The indicators of such “premium” status are familiar: offer higher “quality of service and functionality, especially given its superior end­-to-end cybersecurity compared with current Wi-Fi networks.”

The consultants also say mobile operators must “ensure superior customer experience.” Hardly a new thought.

That requires “superior connectivity and network quality.”

“Enhanced functionality”  also will be part of the effort. “One example would be to optimize video streams for individual users based on better compression technologies,” they argue.

Operators also should create  content delivery networks at the edge of the network, to improve experience, they argue. Unlimited data and unlimited video streaming that does not count against the limits of their data plans are other steps to take.

Since price is part of the value proposition, operators also must “reduce costs,”  offering a cost per megabyte to a tenth of current costs and use other tools such as network functions virtualization and software-defined networking, and taking other steps to simplify processes.

Analytics and network sharing can help as well, they argue.

There is one key area where McKinsey is more bearish than many leading service providers. The McKinsey consultants are not optimistic about mobile operator upside in internet of things, calling the opportunity “bleak.”

That likely is among the reasons they believe adding more value to the “access” function is the only way forward. Essentially, they argue, the hoped-for revenue upside from IoT will fail to materialize.

Price Anchoring Affects Gigabit Take Rates

"Price anchoring" is the reason most consumers able to buy gigabit internet access will not do so. Price anchoring is the tendency for consumers to evaluate all offers in relationship to others. As the saying goes, the best way to sell a $2,000 watch is to put it right next to a $10,000 watch.

Anchoring is why "manufacturer's suggested retail pricing" exists It allows a retailer to sell a product at a price the consumer already evaluates as being "at a discount." Price anchoring is why a "regular price" and a "sale price" are shown together. 

In the internet access business, price anchoring explains why gigabit access speeds are priced in triple digits, while low speeds are priced in low double digits, while the tiers most consumers buy are priced in between those extremes.

Service providers who sell a range of internet access products differentiated by speed and price might “typically” find that a minority of customers actually buy the “fastest” tier of service. That is largely because of price anchoring.

People often evaluate a "best quality offer, at highest price" one way against the "lowest quality offer, at lowest price, before concluding that the "best" value is the mid-priced quality, at the mid-tier price.

That was true in the past when the top speed was 100 Mbps as well. Most consumers did not buy the "highest quality" offer, whatever it was.

So prices really do matter, as does price anchoring. In that regard, forecasts for gigabit internet access take rates hinge not only on where it is available, but how ISPs use price anchoring to package those services.

Some might make "gigabit" the only offer. Other ISPs will use price anchoring to create "basic, better and best" tiers with the assumption that most will buy the "better" tiers of service.

That will powerfully affect take rates for gigabit services.

Deloitte Global predicts that the number of gigabit per second (Gbps) Internet connections will grow by an order of magnitude, to 10 million globally, by the end of 2016. About 70 percent of those connections will serve consumer locations.

Still, those 10 million subscribers will represent a small proportion–about four percent–of the 250 million customers on networks capable of gigabit connections as of end-2016. By 2020, gigabit accounts might number between five and 10 percent of all fixed network connections, Deloitte believes.

Though that will grow, over time, there is an important marketing principle at work here: headline speed remains mostly a marketing tactic.

Never, it seems, do “most” consumers buy the top speed, when there are choices offering less speed, meeting consumer needs, at less price. That has been the case for most cable TV and telco providers of Internet access, for example.

Gigabit access availability and marketing has primarily lead to increased sales of 20-Mbps and 40-Mbps accounts, U.S. telco CenturyLink has said.

But there is no reason to believe availability of gigabit connections changes the tradtional demand dynamics for consumer Internet access. Where there are a range of tiers and prices, most consumers opt for lower-priced packages that still offer reasonable bandwidth.

Rarely does demand for the absolute top speed tier ever seem to exceed about 10 percent of the buyer base.

In other words, most consumers will buy a tier of service that is deemed to be “good enough,” and also provides a better price-value relationship, compared to the absolute “best” offer. In other words, given a choice between best, better and standard packages, most consumers will choose the “better” package or “standard” package.

Deloitte further predicts that about 600 million fixed network Internet access subscribers may be on networks that offer a gigabit tariff by 2020, “representing the majority of connected homes in the world.”

Deloitte predicts that between 50 and 100 million broadband connections may be of the active gigabit variety, representing take rates between five and 10 percent.

There are good reasons to expect such take rates, now and in the future. Historically, only a fraction of consumers actually have bought the “fastest” tier of service marketed at any specific point in time.“At each point in time much faster speeds have been available, but were only chosen by a minority,” says Deloitte.

It is likely the historic patterns will remain in force: multi-user accounts, and accounts where video consumption is high, will be the scenarios where the fastest speeds offer the greatest value.

Shockingly, consumer Internet access speeds have increased, since the time of dial-up access, at nearly Moore’s Law rates. Price-value relationships likewise have gotten better.

Equally shocking, and perhaps more disruptive, will be the availability of gigabit speeds on mobile devices, a development truly shocking for a market used to typically speeds ranging from hundreds of kilobits per second to a few megabits per second up to perhaps 15 Mbps, on average.

By 2020, the first commercial mobile networks capable of gigabit per device mobile connections should be in operation.

LTE advanced currently offers up to about 500 Mbps in trials, and up to 250 Mbps in commercial offerings. Fifth generation networks are expected to boost typical top speeds to a gigabit or more.

It appears that coming millimeter wave platforms will shatter all past expectations of mobile bandwidth, which historically have been at least an order of magnitude lower than fixed network speeds.

How Many Consumers Actually buy Gigabit Internet Access?

AT&T says it now markets its fiber-to-home network AT&T Fiber to over 5.5 million locations across 57 metros. AT&T also says that “over two million subscribers choose internet service from AT&T,” in those areas. That implies take rates of about 36 percent.

That does not mean all those consumers buy gigabit service, though. Assume AT&T sells 50 Mbps, 100 Mbps and 1000 Mbps service in those areas. Past experience suggests most consumers actually will buy one of the lower-speed tiers, with buying likely clustered around the 100-Mbps offer.

AT&T executives have in the past said that, where it is available, about 30 percent of customers buy a gigabit per second service, even when other tiers of service are available.

If overall take rates are about 36 percent, then perhaps 11 percent of AT&T Fiber customers buy gigabit levels of service.

source: nscreenmedia

Take rates for some other providers such as Comcast might not be as high, in part because Comcast builds its gigabit internet access everywhere across its service territory, and not only in some neighborhoods, because Comcast gigabit service sells for about $160 a month and because most consumers are going to pick speeds in the hundreds of megabits per second ranges, not the fastest or slowest tiers of service.

Comcast internet access average revenue per account tends to range slightly above $40 per month, further suggesting that not too many subscribers buy gigabit tiers of service, or that most consumers do not pay the posted rates.

Longer term, the issue likely revolves around competition between cable TV fixed network connections and mobile/wireless. Already, mobile represents 43 percent of U.S. internet access accounts, while cable represents 39 percent, with telco fixed network access at about 17 percent.

source: NCTA

Gigabit Access" Price Really Does Matter

Though that will grow, over time, there is an important marketing principle at work here: headline speed remains mostly a marketing tactic.

Never, it seems, do “most” consumers buy the top speed, when there are choices offering less speed, meeting consumer needs, at less price. That has been the case for most cable TV and telco providers of Internet access, for example.

AT&T executives have said that, where it is available, about 30 percent of customers buy a gigabit per second service, even when other tiers of service are available. In part, that relatively high take rate reflects the fact that AT&T builds gigabit networks first in neighborhoods where propensity to buy is highest.

Take rates for some other providers such as Comcast might not be as high, in part because Comcast builds its gigabit internet access everywhere across its service territory, and not only in some neighborhoods.

Service providers who sell a range of internet access products differentiated by speed and price might “typically” find that a minority of customers actually buy the “fastest” tier of service.

That was true in the past when the  top speed was 100 Mbps as well. Still, much hinges as how an internet service provider markets its services. ISPs who sell only one speed--gigabit--at lower prices, will tend to see higher take rates. Prices really do matter.  

Deloitte Global predicts that the number of gigabit per second (Gbps) Internet connections will grow by an order of magnitude, to 10 million globally, by the end of 2016. About 70 percent of those connections will serve consumer locations.

Still, those 10 million subscribers will represent a small proportion–about four percent–of the 250 million customers on networks capable of gigabit connections as of end-2016. By 2020, gigabit accounts might number between five and 10 percent of all fixed network connections, Deloitte believes.

Gigabit access availability and marketing has primarily lead to increased sales of 20-Mbps and 40-Mbps accounts, U.S. telco CenturyLink has said.

But there is no reason to believe availability of gigabit connections changes the tradtional demand dynamics for consumer Internet access. Where there are a range of tiers and prices, most consumers opt for lower-priced packages that still offer reasonable bandwidth.

Rarely does demand for the absolute top speed tier ever seem to exceed about 10 percent of the buyer base.

In other words, most consumers will buy a tier of service that is deemed to be “good enough,” and also provides a better price-value relationship, compared to the absolute “best” offer. In other words, given a choice between best, better and standard packages, most consumers will choose the “better” package or “standard” package.

Deloitte further predicts that about 600 million fixed network Internet access subscribers may be on networks that offer a gigabit tariff by 2020, “representing the majority of connected homes in the world.”

Deloitte predicts that between 50 and 100 million broadband connections may be of the active gigabit variety, representing take rates between five and 10 percent.

There are good reasons to expect such take rates, now and in the future. Historically, only a fraction of consumers actually have bought the “fastest” tier of service marketed at any specific point in time.“At each point in time much faster speeds have been available, but were only chosen by a minority,” says Deloitte.

It is likely the historic patterns will remain in force: multi-user accounts, and accounts where video consumption is high, will be the scenarios where the fastest speeds offer the greatest value.

Shockingly, consumer Internet access speeds have increased, since the time of dial-up access, at nearly Moore’s Law rates. Price-value relationships likewise have gotten better.

Equally shocking, and perhaps more disruptive, will be the availability of gigabit speeds on mobile devices, a development truly shocking for a market used to typically speeds ranging from hundreds of kilobits per second to a few megabits per second up to perhaps 15 Mbps, on average.

By 2020, the first commercial mobile networks capable of gigabit per device mobile connections should be in operation.

LTE advanced currently offers up to about 500 Mbps in trials, and up to 250 Mbps in commercial offerings. Fifth generation networks are expected to boost typical top speeds to a gigabit or more.

It appears that coming millimeter wave platforms will shatter all past expectations of mobile bandwidth, which historically have been at least an order of magnitude lower than fixed network speeds.

Have U.S. Telcos "Permanently Lost" the Internet Access Battle?

U.S. telcos now have permanently lost the battle for internet access market share to U.S. cable operators, analysts at Jefferies now say. “In our view, it is far too late for the ILECs to ramp spend to compete.”

The key exceptions, though, are AT&T and Verizon, which will be able to offer 5G access, both mobile and fixed, at speeds that will rival what cable operators can offer.

Still, unless something breaks the current trend, telcos collectively could become something of an afterthought in the access business, with market share as low as 28 percent by 2020, according to New Street Research.

That forecast, though, likely assumes 5G will not be an important factor for AT&T and Verizon, an assumption some of us do not share.

AT&T and Verizon represent 66 percent of all U.S. telco fixed network internet access accounts, while most of the fixed network telco accounts losses in the second quarter of 2017 came from the three former rural telcos CenturyLink, Windstream and Frontier Communications.

Depending on how the accounts are categorized (as accounts in the mobile business or the fixed networks business), AT&T and Verizon might be able to reverse the slow erosion they have been encountering in fixed network internet access connections.

It remains unclear whether other large incumbents will be able to use unlicensed spectrum and their own fixed networks to support backhaul to small cells, allowing them to provide fixed wireless.

Likewise, it also is unclear whether some firms might be able to lease assets from AT&T or Verizon to provide fixed wireless based on 5G platforms.

source: New Street Research

Telco	Internet Access Accounts, 2Q 2017	Net Change 2Q 2017
AT&T	15,686,000	(9,000)
Verizon	6,988,000	(23,000)
CenturyLink	5,868,000	(77,000)
Frontier	4,063,000	(101,000)
Windstream	1,025,800	(21,800)
Cincinnati Bell	307,100	(300)
FairPoint^	304,193	(1,160)
Total Top Telco	34,242,093	(233,260)

source: Leichtman Research

If at least 90 percent of U.S. mobile subscriptions include mobile broadband access, that implies 400 million U.S mobile internet access accounts could be in service by the early 2020s, dwarfing the 94 million fixed network accounts.

The point is that it might well prove nearly impossible to predict how internet access market share might change, by access platform or provider, over the next decade.

source: Ericsson