WAN Business in Midst of Huge Product Substitution Trend

Product substitution is among the major underlying trends affecting the global telecommunications business.

Substitution of mobile voice for fixed; mobile internet for fixed; streaming video for linear; over the top apps for managed services; text communications instead of voice and private networking for use of public networks all are examples of the substitution trend.

Consider the wide area networks (WAN) business. In the 21st century, WAN traffic has moved steadily in the direction of carriage on private networks owned and operated by major application providers, and away from the public networks offering internet backbone carriage.

By 2016, more than 70 percent of all internet traffic across the Atlantic was carried over private networks, not on public WAN networks. Obviously, that also means no revenue was earned directly by public service providers for carrying that traffic.

On intra-Asian routes, private networks in 2016 carried 60 percent of all traffic. On trans-Pacific routes, private networks carried about 58 percent of traffic.

In other words, far less traffic now moves over public networks than once was the case, a development with important revenue and business model implications. To a growing extent, private networks are displacing WAN services.  

source: TeleGeography

source: TeleGeography

Premises Phone System Sales Fall 8%

A decline in on-premises private branch exchange (PBX) licenses led the global market to decrease eight percent in 2017 from 2016, to $5.7 billion, according to IHS Markit analyst Diane Myers. Total PBX lines were down nine percent year over year in 2017, with cloud alternatives and buyer caution being key issues.

“Just as we see one area begin to improve, it’s offset by slowdowns in specific geographies or market segments,” Myers said. “Many businesses are holding off on upgrades and new purchases, and the move to cloud services is having an impact.

Although enterprise spending is healthy, businesses are giving low priority to telephony upgrades and expansion on the premises side; PBX average per-line revenue was $167 in 2017, a 1 percent uptick from 2016

Enterprises continue to migrate to IP—to pure IP PBXs in particular—but the segment remains smaller than hybrid systems; hybrid IP PBXs represented 64 percent of all lines shipped in 2017

Demand for unified communications (UC) has been erratic over the past four years, but the segment was in positive territory in 2017, with revenue up five percent from the prior year, IHS Markit says. UC adoption also is growing as more functionality is incorporated into PBX packages.

The IHS Markit quarterly enterprise UC and voice equipment report tracks PBX phone systems (TDM, hybrid and pure IP), UC applications and IP phones.

Have Internet Access Prices Really Grown 25% Since 2010?

“Average fees for standalone broadband have increased nearly 25 percent since 2010,” says a study by Parks Associates on subscription TV and internet access. Other studies have noted higher prices for internet access over the past several years.

That is not the same thing as saying “people are paying more for broadband access.” Sticker or suggested prices are one thing; what customers actually pay can be quite another matter.

That is a major reality of the U.S. internet access market, where most consumer mobile or fixed services accounts are purchased as a bundle, offering discounts over separate purchases of each service. That is why actual internet access prices have dropped over the past couple of decades, despite faster speeds and posted rate hikes.

And make no mistake: bundling as a marketing strategy is designed to increase value and cut prices. In other words, effective prices are cut when consumers buy bundles (dual play, triple play, in some cases quadruple play).  

Also, bundling reduces churn. Some note that average spending by consumers on telco or cable services has risen. That is easy to explain. When consumers buy three or four services, or three or four products, even when getting a discount, average account value grows.

That also is an important point. Higher account spending is not necessarily caused by higher component prices, but because consumers are buying more units.

Mobility shows another trend. The other issue is that account spending can climb because more consumers have moved to “bundled” or “multi-user” or “family” plans, which reduces the total number of accounts, while raising average account spending.

In the U.K. market, 68 percent of fixed network consumers report buy bundles, for example. In the U.S. mobile market, most consumers are on multi-user plans, while in the fixed services market, a similar trend prevails.

In fact, when a consumer buys a bundle, it actually is impossible to determine the precise cost of any single component, except to note that the imputed price of each component comes with a discount.

So it might be much more accurate to say that posted retail prices for internet access have grown. The actual prices consumers pay has almost certainly declined.

U.S. Fixed Network Internet Access Market Reaching Saturation?

Is the U.S. consumer fixed internet access market near saturation? It is quite possible.

By at least one estimate, there are 95 million U.S. buyers of fixed network internet access.

In the fourth quarter of 2017 there were an estimated 136.9 million U.S. housing units. Vacancy rates are an issue, though. Some 16.7 million of those units were vacant.

In the fourth quarter of 2017, some seven percent of rental units were unoccupied, as were some 1.6 percent of owned residences. So assume the number of residences where fixed network consumer telecom services could be sold is about 120.2 million.

So that implies 79 percent of all U.S. households buy a fixed network internet access subscription. Assume another 1.6 million buy a satellite internet access service (about one percent of occupied U.S. residences. That implies 80 percent of occupied homes buy internet access.

But we also must add another six million subscribers served by all the smaller telcos, cable TV companies and independent internet service providers (assuming those smaller fixed network suppliers supply five percent of homes). That adds another five percent, bringing consumer household buying of internet access up to about 85 percent.

Also, some 10 percent of homes use mobile internet access exclusively, according to the Pew Research Center. So add another 12 million occupied U.S. homes to the total of buyers of internet access.

That brings buyers of internet access up to about 95 percent of U.S. occupied homes. The point is that we fast are approaching the point where at-home internet access is saturated. There simply are not that many more U.S. homes to convert, possibly six million or so (unless the percentage of occupied homes grows and millions of new households are formed, driving demand for new housing stock).

In fact, some might argue that as we move into the 5G era, there will be even more mobile substitution. That means it is possible we are very near to the peak of fixed network residential internet access penetration. With the exception of older demographics, home internet access adoption home internet access adoptionhas been flat since about 2010.

Leichtman Research Group reports the 14 largest U.S. cable and telephone providers of internet access  in the United States, representing about 95 percent of the customers--acquired about 2.1 million net additional high-speed Internet subscribers in 2017 (that figure also includes business users).

Broadband Providers	Subscribers at End of 4Q 2017	Net Adds in 2017
Cable Companies
Comcast	25,869,000	1,168,000
Charter	23,903,000	1,310,000
Altice	4,046,200	83,700
Mediacom	1,209,000	47,000
WOW (WideOpenWest)*	730,000	11,100
Cable ONE**	524,935	11,027
Other Major Private Company^	4,880,000	90,000
Total Top Cable	61,162,135	2,720,827
Phone Companies
AT&T	15,719,000	114,000
Verizon	6,959,000	(79,000)
CenturyLink	5,662,000	(283,000)
Frontier	3,938,000	(333,000)
Windstream	1,006,600	(44,500)
Cincinnati Bell	308,700	5,500
FairPoint^^	301,000	(5,624)
Total Top Telco	33,894,300	(625,624)
Total Top Broadband	95,056,435	2,095,203

The point is that market share shifts are likely to be the key battleground in the consumer fixed network access market, as it appears we are very near saturation, where nearly every customer that wants to buy the product already is a buyer.

AT&T Time Warner Acquisition Could Trigger Merger Wave, or Quash It

Consolidation tends to come in waves, as big deals by a major competitor trigger competitive responses by other contestants. So approval--or rejection--of the AT&T acquisition of Time Warner will matter.

Core Network Virtualization and the "Dumb Pipe" Reality

Virtualization and “dumb pipe” are related concepts and practices in core networks, just as applications and services now are logically separated from the transport and access networks. And both those trends illustrate where value is being created within the internet  ecosystem.

Today, owners of networks are virtualizing. Eventually, it is likely to be possible to federate across networks, for that very reason. So essentially, the commoditizing of physical infrastructure will increase.

“Virtualization implies that the control of services and networks can be accomplished outside the physical networks,” and separately from the bit transport layer, argues  Rick Talbot, Current Analysis principal analyst.

That applies initially to any single network, but eventually is likely to extend across multiple federated networks as well, where control lies outside any single transport network.

Network functions virtualization, for example, replaces embedded software in physical network elements across a range of appliances (firewall, packet core, broadband network gateways, customer premises equipment, network address translation, session border controller, provider edge routers), for example.  

“It is only a matter of time before most, if not all, of the specialized network elements and appliances are replaced with--or supplemented by--virtualized instances of themselves,” says Talbot.

There are analogies to this process of core network virtualization. Consider the generation of economic value within the internet ecosystem.

source: AT Kearney

At the moment, perhaps 15 percent of value (measured as firm revenue) is claimed by internet access providers. In the future, that is likely to fall, if mostly because the rest of the ecosystem will have far-higher rates of growth.

To be sure, service providers want and need networks that are more flexible, cost less and also are more capable. Virtualization is one way to achieve those goals. But virtualization also tends to lay bare the growing “dumb pipe” role of networks. Even when networks are “smart,” that smartness is abstracted from the physical network.

At the same time, the separation of logical and physical functions of networks is happening both within the core transport network, within data centers, in access networks and consumer devices.

The obvious analogy is the separation of application supply and network access that is fundamental to all internet protocol networks: any lawful application can be reached and used by end users over an IP network so long as they have authorization to use the apps, irrespective of the IP network used for access.

Where access to communication services once was highly vertically integrated, it now is highly disaggregated. Today, most services and applications used by most consumers are owned by third parties, not the access service providers.

To be sure, access providers (cable, telco, satellite, fixed wireless) have revenue models based on a mix of owned applications (voice, messaging, video entertainment) and “dumb pipe” (internet access, both fixed and mobile) services.

But it is hard to avoid the notion that, over time, value is shifting away from the supply of physical connections to networks (access) and towards “over the top” applications and devices. That does not preclude access providers creating or owning OTT applications themselves.

That, in fact, is what Sling and DirecTV Now are all about; or why Verizon owns automobile application assets.

In a study by AT Kearney of the U.K. internet ecosystem, analysts estimated that internet access accounts for 35 percent of the U.K. Internet value chain revenues (16 percent of the total Internet ecosystem). Excluding the value of e-commerce, the internet ecosystem in 2010 already had apps and services claiming 65 percent of value.

source: AT Kearney

The point is that virtualization is another example of the way networks are changing: as services and features have been abstracted from the network, now even the control and management of networks is being abstracted from the physical facilities.

Data Centers Drive 100G in 2017

Data center adoption of 100 Gbps platforms is driving global Ethernet switch sales, says IHS Markit

Worldwide Ethernet switch revenue grew twopercent sequentially in the fourth quarter of 2017 to $6.7 billion.

For the full-year 2017, revenue rose 8 percent, reaching nearly $25 billion—the strongest growth in seven years, says Matthias Machowinski, IHS Markit senior research director.

“The transition to 25/100GE architectures in the data center is in full swing, driving strong gains in 25GE and 100GE, while in turn bringing down the 40GE segment, which had its first annual decline,” Machowinski said.

100GE Port shipments of 100GigE grew 400 percent year-over-year, and reaching over four million ports in 2017, he said.

Growth in the North American Ethernet switch market was above five percent. Asia Pacific remains the top growth region, primarily due to China.

Cisco’s revenue declined two percent year-over-year, while Huawei grew its revenue 24 percent HPE (Aruba) grew 13 percent.

IHS Markit