Near-Zero Pricing Forces Continue to Operate in Much of Telecom Business

One of the biggest long-term trends in the communications business is the tendency for connectivity services to constantly drop towards “zero” levels. That is arguably most true in the capacity parts of the business (bandwidth), the cost of discrete computing operations, the cost of storage or many applications.

One can see this clearly in voice pricing, text messaging and even internet access (easier to explain in terms of cost per bit, but even absolute pricing levels have declined).

The reason it often does not seem as though prices have declined is that the value keeps increasing, as retail prices drop or remain the same.

In large part, marginal cost pricing is at work. Products that are "services," and perishable, are particularly important settings for such pricing. Airline seats and hotel room stays provide clear examples.

Seats or rooms not sold are highly "perishable." They cannot ever be sold as a flight leaves or a day passes. So it can be a rational practice to monetize those assets at almost any positive price.

Whether marginal cost pricing is “good” for traditional telecom services suppliers is a good question, as the marginal cost of supplying one more megabyte of Internet access, voice or text messaging might well be very close to zero.

Such “near zero pricing” is pretty much what we see with major VoIP services such as Skype. Whether the traditional telecom business can survive such pricing is a big question.

That is hard to square with the capital intensity of building any big network, which mandates a cost quite a lot higher than “zero.”

In principle, marginal cost pricing assumes that a seller recoups the cost of selling the incremental units in the short term and recovers sunk cost eventually. The growing question is how to eventually recover all the capital invested in next generation networks.

source: Quartz

On the other hand, we also must contend with product life cycles. As we have seen, in developed markets people use voice services less, so there is surplus capacity, which means it makes sense to allow people unlimited use of those network resources.

That was why it once made sense for mobile service providers to offer reduced cost, or then eventually unlimited calling “off peak.”

Surplus capacity caused by declining demand also applies to text messaging, where people are using alternatives. If there is plenty of capacity, offering lower prices to “fill up the pipe” makes sense. And even if most consumers do not actually use those resources, they are presented by value propositions of higher value.

Video entertainment and internet access are the next products to watch. Video is more complicated, as it is an “up the stack” application, not a connectivity service. Retail pricing has to include the cost of content rights, which have not historically varied based on demand, but on supply issues.  

Linear video already has past its peak, while streaming alternatives are in the growth phase.

Internet access, meanwhile, is approaching saturation. That suggests more price pressure on linear video and internet access, as less demand means stranded supply, and therefore incentives to cut prices to boost sales volume.

source: FCC

Marketing practices also play a big part, as the economics of usage on a digital network can be quite different than on an analog network. And some competitors might have assets they can leverage in new ways.

In 1998, AT&T revolutionized the industry with its “Digital One Rate” plan, which eliminated roaming and long-distance charges, effectively eliminating the difference between “extra cost” long distance and flat-fee local calling.

Digital One Rate did not offer unlimited calling at first, but that came soon afterwards. In the near term, lots of people figured out they could use their mobiles to make all “long distance” calls, using their local lines for inbound and local calling only.

With unlimited calling, it became possible to consider abandoning landline service entirely.

At least in part, the growth of mobile subscriptions from 44 million in 1996 to 182 million by the end of 2004 is a result of the higher value of mobile services, based in part on “all distance” calling.

Mobile revenue increased by more than 750 percent, from 10.2 billion dollars in 1993 to more than 88 billion dollars in 2003.

source: FCC

During this same time period, long distance revenue fell by 67 percent to 4.3 billion dollars, down from 13.0 billion dollars.

The point is that connectivity prices and some application (voice, messaging) prices have had a tendency to drop closer to zero over time. Moore’s Law plays a part. Open source also allows lower costs, and therefore more-competitive prices.

Optical fiber and microwave play a part in boosting capacity and lowering unit prices.  Internet protocol also helps (lower network interface costs).

Competition has had a larger impact. Regulatory cost reductions have been key in some markets.

What Revenue Sources Drive the Next 50% Growth?

As a rule, I expect that any given communications service provider will have to replace about 50 percent of current revenue about every decade. Among the best examples (because we have the data) is the change in composition of U.S. telecom revenues between 1997 and 2007.

Back in 1997, nearly half of total revenue was earned from “toll” services (long distance, including international and domestic long distance voice. Profits also were disproportionately driven by long distance services.

A decade later, toll service had dropped to 18 percent of total revenue, while mobile services had risen to about half of total revenues, up from about 16 percent of total.

source: FCC

A similar trend can be noted for European Union mobile revenues between 2010 and 2018, a period of less than a decade, but still a time when voice revenue dropped from about 80 billion euros to about 45 billiion euros, while messaging dropped from about 19 billion euros to perhaps 10 billion euros and mobile internet access grew from about 18 billion euros to perhaps 42 billion euros.

The point is that revenue sources changed at least 50 percent over eight years. So the big question now, in developed markets, is what will replace mobile internet access, voice and messaging revenues over the next decade, when half of current revenues, it must be assumed, will disappear.

That is why--for better or worse--internet of things, video entertainment, application, platform and other ultra-low-latency services are so important. If there are other candidates for revenue replacement, it is hard to say what they might be.

How Much Would You Pay for Ad-Free Facebook?

With word that Facebook is indeed looking at the possibility of offering subscription access, the question obviously arises: what price would a revenue neutral, assuming Facebook only needs to replace current revenue?

Facebook average revenue per user overall (globally) was a bit more than $6 a quarter in the fourth quarter of 2017. But U.S. revenue was in the $26.76 per user, per quarter range. So it will matter where the paid subscribers come from.

There  is, for that reason, no simple answer. Replacing a U.S. free user might involve replacing $9 a month in lost ad revenue, but just $3 in Europe, 83 cents in Asia or 67 cents per month in Africa.

source: Data N Charts

Source: Facebook

The “simple” answer is to charge different amounts in each market. And that is where matters get very tricky. How much additional cost is required to create a new marketing and fulfillment mechanism for paid subscriptions in any market? Does that cost scale linearly with living costs in each market, or is there some universal cost of computing infrastructure and marketing that applies globally?

That cost will hinge on volume, but assume a reasonable assumption is made that the incremental cost of selling a subscription amounts to 25 percent higher costs. Then the retail price of a U.S. Facebook subscription would be perhaps $11.25 a month.

Compare that rate with consumer willingness to pay for other apps. Even the most-desired mobile apps seem to be priced at just $3, total, all in, with no recurring costs. Netflix might cost $11 a month in the U.S. market, if fulfillment and marketing costs were just $2 per sub, per month.

Facebook arguably could sell for a price point closer to Netflix than a mobile app (low one time cost). If marketing costs are higher than $2 per month, retail prices could reach far higher levels.

It will be a tricky exercise. Prices much above $10 to $11 a month might face significant user resistance. Ask yourself whether you would pay $30 a month for an ad-free version of Facebook, for example. Most of us likely would refuse to do so.

So is “more privacy”  worth $11 a month to perhaps $15 a month on Facebook?

Cost is Being Ripped Out of the Video Ecosystem, Less Opportunity for Cisco CPE

There are many reasons why Scientific-Atlanta and General Instrument do not exist anymore, why those firms initially were gobbled up by the likes of Cisco and Motorola, and why the set-top box business has changed.

The changes also explain why Cisco now has sold off those former Scientific-Atlanta assets.

Initially, the set-top box business was seen as a way equipment suppliers could get into the customer premises equipment supplier end of the video distribution business. But changes in the consumer video subscription business now mean there is less profit in the value chain.

That means taking cost out of the business. So open source has become a more-important trend, and with open source, less opportunity for set-top suppliers. Moves by the U.S. Federal Communications Commission to open up the set-top box to third party competition also play a role.

Comcast’s X1 initiative, which has Comcast supplying its own decoders , is part of that firm’s effort to create additional value third-party approaches do not offer. In other words, the biggest U.S. cable set-top customer now has become a competitor.

Changes are even more advanced in the mobile business, where the smartphone itself effectively becomes an access device, with no need for third-party gear. In large part, that is possible because internet protocol has become the next-generation network of choice, globally.

There are implications. In the mobile arena, the phone itself displaces the fixed network modem, the fixed network set-top, the fixed network Wi-Fi router. In the mobile business, as in the fixed business, CPE costs are being ripped out of the value chain.

Is the Triple Play Dead?

Some might argue the era of bundling (triple-play and other offers) is over, and irrelevant, as customers are dropping linear video subscriptions.

The countervailing argument is that service providers are simply going to create new bundles, since the bundle itself is a hugely beneficial retail packaging tactic.

You can decide which strategy is more likely: killing bundles or changing the bundle elements.

But so long as bundling just two services can cut churn by half, or bundling four instead of three services cuts churn another 50 percent, service providers are going to bundle.

It is worth remembering that firms generally are lead by executives capable of understanding the fundamental revenue and profit drivers of their businesses, and can adapt.

One can argue that it makes no fundamental difference whether bundles are built on linear or streaming video; include mobility or not; home security or not. In the future other services are likely to become important as well.

There are gross revenue and margin issues to be addressed, but irrespective of the specific constituent contributors to consumer service bundles, bundles absolutely work, and for well-understood reasons. And that remains true, even if some products face declining demand.

In fact, it is easy to point out that bundling is an effective tactic for propping up sales of such products with lower value. In some cases, the incremental cost of adding a voice service is so low--and comes with a big enough overall discount--that buying a triple play package makes more sense than buying a dual-play package.

In other words, it often is the case that buying a triple play costs less than a dual-play service.  

Bundles increase perceived value; allow service providers to offer price discounts without damaging retail price points for standalone services; reduce churn and boost marketing potential.

In the mobile business the most-recent example are offers of free streaming when customers buy top-end internet access plans. The rumored DirecTV Now  service that would be free for AT&T mobile customers provides a good example.

A European mobile operator able to bundle multiple services found much-lower churn rates on accounts buying two, three or four services.

source: Merkle Sokrati

We shall see, but it is rational to argue that not even declining linear video take rates will change the strategic value of the triple play.

Majority of Homes with Fixed Network Internet Access Also Buy Streaming Services and Linear TV

About half of all U.S. households that buy fixed network internet access also buy linear video service and at least one streaming service as well, say researchers at Parks Associates.

About 11 percent of homes buying broadband use antennas for over-the-air broadcast TV.

LInear video subscriptions fell from 87 percent  to 77 percent between 2012 and 2017, Parks Associates says.

If you want to know why firms such as Comcast now bundle Netflix access as one more channel option, the reason is that this reduces churn. According to Parks Associates, 33 percent of cord cutters would have stayed with their linear service provider if offered a Netflix-style service bundled with broadcast TV channels.

Some will question the long-term value, as smart TVs able to directly receive Netflix and other streaming services become the standard TV device in homes. It might be marginally easier to open Netflix when it is offered as just one more channel in the TV lineup.

Still, how much extra effort is it to pull up Netflix or any other supported streaming service directly from the smart TV?

B

source: Parks Associates

20% of U.S. Residents Do Not Buy Fixed Network Internet Access

About 20 percent of U.S. residents now use their smartphones and mobile data services exclusively for internet access. That is a seven point increase from the 13 percent who used mobile exclusively for internet access in 2015.

Some 65 percent of U.S. residents report they subscribe to traditional broadband service at home, down two percentage points from the 67 percent reporting they bought fixed network internet access in July 2015.

About five percent of poll respondents say they do not buy fixed network internet access or smartphone service.

Some 11 percent of U.S. residents indicate that they do not use the internet at all.

Such non-buyers are disproportionately likely to be older. Some 40 percent of U.S. residents 65 and older report they do not buy internet access or use smartphones.

Some 25 percent of rural residents say they buy neither. About 25 percent of those who have not attended college and 23 percent of respondents in  households earning less than $30,000 per year also are in this category.