Fixed Networks Becoming Unsustainable

It is becoming clearer that the fixed network telecom business is losing its ability to sustain itself, as it becomes harder to generate core revenue.   

In other words, one might argue, the core business model is failing. That is why firms such as Frontier Communications now are in danger of bankruptcy, and why the Indian mobile business is rapidly consolidating.

A difficult business model is why Verizon and AT&T (and other telcos and internet service providers) are looking to fixed wireless as an alternative to fiber to the home.

Observers now speculate on whether Windstream and its facilities unit Uniti might also face bankruptcy.

The task for regulators therefore is what to do: encouraging investment at a time when that investment is growing difficult, while not placing new and unnecessary barriers on the industry, even while, by traditional antitrust metrics, industry concentration is high.

The problem is that if industry revenue and profitability continues to drop, more concentration is among the necessary steps to reshape the industry for survival.

That will require balancing the principle of maintaining competition with the need to manage industry decline (encouraging investment where that is possible).

To be sure, market share concentration is far from unusual in the U.S. market.

Also, concentration levels seen in the internet industry are far higher than what is seen in the access provider business. Internet search, for example, has an Heffindahl-Hirshman Index (HHI) score in the 7400 range.

The mobile industry, for example, has an HHI score in the neighborhood of 2500.

The HHI is a standard measure of industry concentration used by antitrust officials.

Revenues in nearly all markets are declining and profit margins are going negative. Mobile is faring better, but big risks still lie ahead as the 5G era arrives.

At the same time, revenue per bit is dropping as well, as transport and access providers earn less revenue despite higher capital investment. In some markets, facilities-based competition dramatically raises business risk, as well.  

To the extent that executives question the financial return from robust investment in access facilities, at least part of the challenge is that potential returns are paltry, especially in the fixed networks segment of the business.

That business model challenge can be seen in revenue trends. In 2018, global telecom revenue is expected to fall, especially in the fixed networks business, which will decline nearly 12 percent.  

The point is that in addition to the steps industry executives might take, regulators will have to adjust to creating policies appropriate for an industry about to consolidate, and is growth challenged at best. At worst, the global industry is going to massively consolidate over the next decade or so.  

That poses different challenges than would be the case for an industry that is rapidly growing. “Regulating for decline” perhaps is too strong, but “regulating to allow restructuring” is probably more apt.  

Global Telecom Revenue to Shrink 2% in 2018

Global  telecom revenue in the 60 biggest markets will fall by two percent  in US dollar terms, to US$1.2 trillion, in 2018, despite account growth, according to the Economist Intelligence Unit.

Average revenue per user (ARPU) will fall by 2.3 percent for mobile operators, and by 11.5 percent for fixed line providers.

At the same time, operator investment will grow three percent.

Regional variations will mask the global trend.

In Latin America, total revenue in U.S. dollar terms for both fixed and mobile telecom will fall, despite mobile subscription and penetration rate growth. In other words, subscription growth no longer automatically grows revenue.

The clear exceptions will be Asia and Africa where subscription growth will be robust enough to compensate for lower ARPU. Across the Middle East and Africa, the mobile penetration rate will increase from 111 per 100 in 2017 to 115 in 2018, while in Asia it will rise from 101 to 104, the Economist predicts.

Net Neutrality is About Freedom

One big problem with “network neutrality” discussions is that the concept often is stretched so far it makes no sense. Recall that the original idea was “freedom.” The notion of “permissionless innovation” is key to internet creativity. But that freedom was intended to apply to all parts of the value chain.

Freedom was for users: people were to be free to use all lawful applications. Freedom was for app providers, who would be free to innovate and create new value, functions and capabilities.

But freedom also was for access providers. That was why internet access services were not regulated as common carrier services. As with other parts of the ecosystem, the idea was to allow permissionless innovation for data services and apps of all types.

In recent years, advocates have acted as though the only part of the ecosystem allowed freedom were app providers, not consumers or access providers.

Along the way, the concept has been stretched beyond recognition. When the Federal Communications Commission developed its internet freedoms principles, it spoke directly only about application and end user freedom, the notion being that internet service providers were not to act as gatekeepers. Fair enough.

The problem is that many other practices--including those which impinge on or limit the freedom of other participants in the value chain--have come to be seen as network neutrality issues.

Are usage caps, overage fees or zero rating (giving consumers apps and services at no charge) “network neutrality issues at all? Or are all those examples of terms and conditions of service?

Are those pricing and packaging issues not also issues of “freedom?” It is an old problem. Consider freedom of speech itself. Whose rights are protected, those of the speaker, or those of the listener? And how do we resolve conflicts between the rights of speakers and listeners?

Even if the term “network neutrality” was not coined until about 2003, and no matter the partisan position, network neutrality basic principles have been fairly clear at one level.

The fundamental principle, in the United States, is that consumers are allowed to use any lawful application, and that use of lawful apps cannot be blocked by an access provider.

Also, one might well argue that such consumer freedom also extends to app providers and access providers, who similarly are free to pursue lawful ways of creating new services, features, apps and value, and are likewise free to create any lawful business models to support those efforts.

Still, looking narrowly at end user freedom, nothing about ending common carrier regulation of internet access undermines the fundamental principle of access to all lawful internet-accessed applications. But not all services or apps using internet protocol are actually “internet” apps.

All networks might use internet protocol. But not all IP networks are part of the “internet” whose applications consumers have a right to use. Private networks (business networks of all types, cable TV services, carrier voice and messaging networks) might use IP, but are not necessarily part of the “internet” used by consumers.

In principle, that is why managed networks and business internet access is not covered by consumer “network neutrality” rules.

So network neutrality is complicated because there are several other principles and freedoms involved, and as always is the case, rights and freedoms can conflict.

And one right a network operator has is to manage network resources under conditions when network load is very high, since no network actually is built to support any conceivable amount of potential use.

Instead, networks are built to support “typical” or “typical peak” demand. And that means any network can become congested, on occasion.

So even if all agree that U.S. consumers have the right to use any lawful app, there are other rights held by others. The way those rights might be exercised is the issue.

Do app providers or access providers have the right to maintain quality of service for their apps? Yes. That is why content delivery networks exist, and why “managed services” are regulated differently than “internet” apps.

Beyond all that, other arguably distinct issues have fallen under the “neutrality” concept, even if, logically, they are distinct issues. Whether it is lawful to offer “no extra cost” features and access to some apps (zero rating) provides a clear example.

Some oppose zero rating of features, services and apps that have value for consumers, and are offered at no incremental cost. In some cases that has been applied to “Free Basics,” a program supplying no charge access to Facebook and other apps, even when a user has not paid-for internet access connection.

In other cases, some have objected to ISPs subsidizing use of features or apps as well. A few have objected to mobile ISPs offering free HBO, free Netflix or free music apps to their customers. Some have opposed any policies that allow mobile users to consume streaming video or music without incurring any usage on their data plans.

The point is that, beyond a basic set of expectations related to use of all lawful applications by consumers (with exceptions for network management and business services), a number of other issues have been seen as within the scope of network neutrality, even if such prohibitions tend to compromise “internet freedom” of other app or access providers.

So strong forms of network neutrality always involve the issue of “whose freedom is taken away.”

Even actual “blocking of apps” (something network neutrality prohibits) has been a standard tool for managing voice network congestion. That speaks to the issue of end user application freedom, which is broader than existed for voice.

Though most people who now use voice networks have never encountered it, use of voice networks was managed, under conditions of very-high load, by denying callers access. The recording “I’m sorry, all circuits are busy now, please try your call again later” used to be the signal that the network was under high load, and some incremental users were literally blocked from using the network.

That is a clear example of network management, and did involve literally blocking of a lawful app (talking on the telephone).

And every network operator arguably has the duty, not only the right, to manage the network under conditions of congestion, in order to preserve quality of service.

And it matters whose freedom is limited. Historically, there have been a few (literally two or three instances) where an internet service provider tried to block a lawful app, and those instances were immediately prohibited by the FCC.

In one instance, a  small internet service provider tried to block use of Skype, a lawful application in the United States, was promptly notified by the Federal Communications Commission that this practice was impermissible, and was promptly ended.

Comcast is the only large ISP to have engaged in efforts to block or manage lawful apps in the U.S. market (Bitcoin).

Fundamentally, it is the consumer right to use lawful applications which is the heart of the “freedom” policy. But app and access providers are not, for that reason, denied their own freedom to create.

If an app provider wants to create a separate, for-fee feature or service, it may. If an access provider wants to create faster tiers of service, it may. If an app or access provider wishes to subsidize use of some for-fee features, they may. None of those impinge consumer freedom to use all lawful apps.

Revenue Per Bit Remains the Biggest ISP Problem

For transport and access service providers, video is a problem and a curse. Video has the absolute lowest revenue per bit, and therefore potential profit per bit, of any traffic type.

Video also dominates data volume on global networks, but has revenue per bit perhaps two orders of magnitude (100 times) less than voice, for example.

Those reductions in price per unit sold would be nearly catastrophic in any business, and tell you most of what you would need to know about the direction of network capital and operating costs to achieve sustainability.

At the same time, those catastrophically-lower revenue per bit measures also tell you why surviving tier-one service providers must (not “should”) find big, new revenue sources.

Text messaging has in the past had the highest revenue per bit, followed by voice services. More recently, as text messaging prices have collapsed, voice probably has the highest revenue per bit.

Video always has had low revenue per bit, in large part because, as a media type, it requires so much bandwidth, while revenue is capped by consumer willingness to pay. Assume the average TV viewer has the screen turned on for five hours a day.

That works out to 150 hours a month. Assume an hour of streaming (or broadcasting, in the analog world) consumes about one gigabyte per hour. That represents, for one person, consumption of perhaps 150 Gbytes. Assume overall household consumption of 200 Gbytes, and a monthly data cost of $50 per month.

That suggests a cost--to watch 150 hours of video--of about 33 cents per gigabyte. Assume a mobile or fixed line account represents about 350 minutes. Assume the monthly recurring cost of having voice features on a mobile phone is about $20.

Assume data consumption for 350 minutes (5.8 hours a month) is about 21 Mbytes per hour, or roughly 122 Mbytes per month. That implies a cost of roughly $164 per gigabyte.

In other words, video revenue for the access provider is perhaps 33 cents per gigabyte, while voice generates perhaps $164 per gigabyte. These days, unlimited domestic texting is often a feature, not a revenue driver, generating zero revenue per gigabyte.

Since video now is the application that now drives global network traffic, you can understand the need to reduce cost per bit in the network, and in all network-related operations, to sustain the networks, if revenue per bit is declining.  

As a corollary, and though it often is a criticized move, the way entertainment video now is created and distributed shows the imperative of moving beyond “distribution” as the video entertainment role.

Consider the way internet application providers now operate. Big app providers, using the internet, can simultaneously function as vertically-integrated suppliers, reaping economies across multiple parts of the value chain. Netflix, for example, is a content owner and creator.

Netflix also is a producer, the equivalent of a studio or channel. And Netflix also acts as its own distribution, the equivalent of a linear video service provider.

Those economics are necessary in a business where low-price bits drive network transmission and access economics.

source: Ericsson

S&P 500 "Telecom" Index Will Add Content Firms

In a move that illustrates the changes in the “communications” business, the telecommunications segment of the Standard and Poors 500 index will be recreated, including advertising, broadcasting, publishing, movie and entertainment as well as app firms supplying entertainment.

The change will happen in September 2018, with the firms to be added to the index announced in January 2018.

Several developments drive the change. First, the universe of U.S. telecom firms had essentially dwindled to just AT&T, Verizon and CenturyLink.

Also, the changes will add numerous higher-growth segments to the indices, which have been low-growth and therefore relatively less attractive to investors.

Some might also say the changes also reflect the importance of media, content and video businesses to the “telecom” industry. Those revenue sources are important, for a growing number of  tier-one service providers, to add new revenue drivers with higher margins, to fuel revenue growth and replace lost voice and messaging revenues.

source: Ali Saghaeian

What, and How Much, Should AT&T Do About its Access Network Investments?

At least some might point to stock performance of T-Mobile US, compare that to AT&T, and draw the conclusion that AT&T would be better off putting its capital into network upgrades, not content acquisitions.

The "problem" with such suggestions is that they are mistaken. AT&T does not have a gap to close with respect to its mobile network performance, versus T-Mobile US.

Perhaps an argument might be made that AT&T should further accelerate the moves it already is making to boost its 4G network, and create 5G networks. But AT&T is among the firms most active in doing so, and if there are such criticisms, one rarely hears them expressed.

To the extent there is a clear issue, it is the fixed network, and the issue there is market share with respect to cable TV firms and independent ISPs, not T-Mobile US.

Arguing that AT&T should focus on its "access" assets, rather than new revenue sources, mistakes a growth strategy based on taking market share with a strategy based on entering or creating new markets. Even if markets are not growing, attacking firms can grow simply by taking market share.

That is what cable TV companies have done in business service markets, voice services and internet access, for example. Growing by taking share was not possible for AT&T and Verizon, which already were the market share leaders in those markets.

That is germane when looking at T-Mobile US strategy, compared to that of AT&T or Verizon.

For starters, T-Mobile US--with no fixed network footprint--has only one avenue for growth: taking market share from other mobile service providers, something it has done.

And, in a zero-sum U.S. mobile market, T-Mobile US, with market share of about 15 percent, has room to grow at the expense of the other service providers, until some future time when it will be acquired or merged with another sizable firm.

In fact, should current predictions about the 5G era prove correct, T-Mobile US and Sprint might well require major fixed network assets to support small cell networks.

The point is that T-Mobile US has limitations and opportunities in its core business that are quite different from those of AT&T. Neither Verizon nor AT&T has seen much share change over the last decade.

So what makes sense--and is doable--for T-Mobile US is not necessarily sensible--or doable--for AT&T or Verizon.

Furthermore, it is by no means clear how much upside actually exists in the fixed network internet access area, for AT&T. It is a strategic product, to be sure. AT&T has to boost its capabilities, by moving to gigabit access, and is doing so, where it believes it has a market opportunity.

But AT&T, for the most part, has not been losing market share to cable over the past few years. Most of the share losses one can identify are coming from other telcos (rural and independent telcos). To be sure, AT&T has not taken much share, either.

The business issue is how much to invest in a business--beyond what is necessary to hold market share--that has largely reached maturity.

As voice and messaging already have entered the declining part of their product life cycles, so too internet access and mobility itself have reached near saturation in the U.S. market. That means finding brand new sources of revenue growth beyond the legacy core.

That is not to say AT&T or Verizon can afford to neglect upgrades of their consumer internet access capabilities. But it would also be incorrect to argue that such upgrades can drive overall revenues over a decade’s time.

One might argue that U.S. mobile internet access revenue will grow. It is harder to make the argument that fixed network revenue will do much, based on past experience.

source: PwC

Many observers were critical of AT&T for buying DirecTV, and are critical of AT&T’s effort to buy Time Warner. Some of the criticisms are similar to complaints made when AT&T was considering the purchase of DirecTV.

Capital should instead have been investing in the core fixed line network, instead, many argued when AT&T was considering the acquisition of DirecTV.

Now the issue is whether AT&T should make access investments in place of buying Time Warner.

But it is not clear how much upside exists for AT&T, in terms of fixed network internet access revenue. You might argue that the best case for AT&T, for a massive upgrade of its consumer access network, is about 10 percent upside in terms of consumer market share.

That is by no means insignificant, depending on the assumptions one makes about the cost of the upgrades. Still, given that as important as it is, fixed network internet access now is a mature business, there are limits to how much capital a telco “ought” to invest, compared to deploying capital elsewhere.

Realistically, a major telco has to expect it will, under the best of circumstances, and in a two-provider market, split share with a competent and motivated cable TV provider. If cable now has about 60 percent share, and AT&T about 40 percent share, that implies a sort of share ceiling of 50 percent. That is one driver of revenue. The other is revenue per account.

But typical account revenues have not risen as much as one might expect, given consumer shifts to higher-speed services that tend to cost more.

Basically, internet access prices in the developed world have tended to move roughly in line with growth in gross domestic product, and are flat to declining in terms of spending as a percentage of gross national income per person, according to the International Telecommunications Union.  

source: PwC

Though some believe there is much-more account revenue upside, experience so far suggests prices will be hard to boost, in the fixed network segment. Increasing competition from third parties is one reason. A shift to mobile access is another issue. Finally, consumers will only spend so much on communications services in general.

AT&T is a firm with many big decisions to make, and none of them are especially easy. Where to deploy capital for revenue growth is a prime example.

Selective Internet "Fast Lanes" Might be Close to Impossible to Create

"Internet fast lanes" have been the big reason many supported strong forms of network neutrality. But it now appears that creation of such "for fee" fast lanes will be next to impossible, in the sense of specific business deals between specific app firms and specific internet service providers.

In other words, the end of common carrier regulation of internet access service will not create fruitful opportunity, on the part of ISPs, to create such "fast lanes," even if they wish to do so. The reason is technology change, as so often is the case.

Consider the simple matter of traffic encryption. To selectively prioritize traffic, an ISP would need some way to identify the packets or partners whose traffic is supposed to be selectively handled. Encryption is a problem, in that regard, one might argue.

Nearly all traffic on ISP networks is encrypted. Under such conditions, it is not clear how selective QoS mechanisms could be applied. ISPs simply will have no way of knowing what traffic is moving, or who the owners are.

And that would seem to be a requirement for any packet handling protocols intended to provide expedited handling.

By about 2020, estimates Openwave Mobility, fully 80 percent of all internet traffic will be encrypted. In 2017, more than 70 percent of all traffic is encrypted.

The key point is that selective optimization of packets will be virtually impossible. ISPs probably can optimize all traffic over their networks, but probably cannot selectively optimize.

So despite the fears (fanciful and legitimate) expressed about the “end of network neutrality” in the repeal of common carrier (Title II) regulation of internet access, it seems highly unlikely that feared “quality of service” service tiers which could be created by internet service providers will be major issues.