Verizon Will Flip Mobile Economics Upside Down

Verizon is going to flip mobile network economics upside down as it builds commercial 5G-based fixed wireless capabilities.

Make no mistake, this is a fundamental reworking of assumptions about mobile network cost and retail pricing of mobile data consumption.

The big challenge for firms such as Verizon, which want to build new 5G-derived platforms to supply fixed wireless, is that doing so will fundamentally challenge traditional thinking about the cost of wireless networks.

Fundamentally, network cost will have to be radically lower if the 5G platform, operating in fixed mode, is going to be competitive with fixed network usage and retail prices. Basically, cost per gigabyte has to drop by an order of magnitude (10 times) or more, if any 5G-based network hopes to compete, head to head, with fixed network internet access.

Ironically, the fear that service providers would not be able to afford to build and operate such networks seems to be proving manageable.

In other words, there is reasonable hope that 5G networks offering orders of magnitude better performance also will be affordable enough to compete head to head with fixed networks as suppliers of internet access.

“A prerequisite for continued data usage growth is that the total revenue per gigabyte is low,” say analysts at Tefficient. In some markets, such as the United States, Canada and Switzerland, where tariffs actually have been high and usage has been low, a disruptive challenge is coming from (of all things) Verizon, one of the biggest incumbents in the market.

source: Tefficient

What Verizon must do, in using 5G fixed wireless to compete head to head with other fixed network internet service providers, is flip the economics on its head.

Where tariffs are low, usage is higher, as you would expect. And that is the case in the U.S. market, which has high mobile data tariffs, and low usage. To compete against fixed network service providers, Verizon will have to be operate as a supplier of low tariff, high usage services, the polar opposite of where it is now in its mobile business.

And that is among the most-astounding facets of the strategy of using 5G both as a fixed wireless and a mobile platform. Such a blending arguably would have been impossible before the era of commercialized millimeter wave spectrum, cheaper small cell radios, fiber-deep networks, better radios and modulation techniques, cheap signal processing, massive multiple-input, multiple-output radios and even new ways to integrate unlicensed and shared spectrum.

Taken together, all those technologies are the foundation of Verizon’s effort to flip the network cost model so much that it can literally move from being a  “high cost, low usage” provider to being a successful supplier of “low cost, high usage” internet access, in a single mobile generation.

That is the underappreciated aspect of 5G fixed wireless.

What Else Could AT&T Have Done, Instead of Buying Time Warner?

With the caveat that the DirecTV and Time Warner acquisitions by AT&T remain controversial in some quarters, the arguments for both remain simple enough:

• AT&T’s core businesses are shrinking
• AT&T has to generate new revenues at scale
• AT&T needs that revenue to generate high free cash flow, to pay its high and growing dividend
• AT&T has done so historically mostly by acquisition
• Beyond which, AT&T has to reposition itself as has Comcast, in additional areas of the internet ecosystem

AT&T needs to generate lots of free cash flow to support its dividend payouts, which historically range between 50 percent and 100 percent of free cash flow. That is hard to do on a declining base of revenues, even if AT&T did not have a strategy of constantly raising its dividend over time.

          AT&T Dividend Payout Ratios (Dividends as a Percent of Free Cash Flow)

source: Seeking Alpha

Among the primary objections to the DirecTV and Time Warner acquisitions was the amount of debt AT&T would have to take on. This is a valid concern. AT&T has to execute on its plan to significantly reduce debt levels over several years.

Supporters of the DirecTV and Time Warner acquisitions might point out that without big acquisitions, AT&T would have had trouble sustaining free cash flow and its dividend strategy, as organic growth was not high enough to accomplish those tasks.

And it is hard to imagine where else AT&T could have found logical acquisitions that the company could afford, and that fit its core business strategy. Whatever else one might say, media assets have a lower multiple of price to equity than most other assets in the internet app and platform space, in computing or business services.

And a rational observer would likely agree that any big acquisitions must have some reasonable hope of synergy. Consumer video entertainment and video content assets are big enough to “move the needle” for AT&T.

Though we might debate the wisdom of the DirecTV deal, it seems to be working, at least in its role as free cash flow producer. Many have argued that AT&T should instead have made bigger investments in its network. Some of us do not see how that would have generated incremental revenue and free cash flow fast enough to matter.

For AT&T and other developed market tier-one telcos, huge new revenue sources must be found to replace shrinking connectivity revenues.

source: Seeking Alpha

AT&T’s first quarter revenue revenue trends (legacy business, prior to Time Warner impact) show the basic problem: the core business is declining. That trend compares with a “whole-industry” revenue picture that  is generally flat to just slightly positive.

                           AT&T First Quarter Revenue Trends

source: Seeking Alpha   

You can see the same trend for AT&T free cash flow, in the first quarter of the last three years.

            AT&T Free Cash Flow, First Quarter, Last Three Years

source: Seeking Alpha

In the end, one must ask what else could AT&T done with its capital to produce an immediate boost to revenue and cash flow, at higher levels or at less cost. Even if AT&T might have preferred investing in internet app provider assets with higher growth, such assets are quite expensive, compared to media assets.

Sure, acquiring assets in the coming internet of things space would be sound, but cannot move the needle on current revenue and free cash flow.

Sure, AT&T might fail to execute well, or might be tripped up by some other exogenous event. But the fundamental thinking is sound enough.

Millimeter Wave Could be Revolutionary

It is easy to underestimate the impact of commercialized millimeter wave spectrum. Since supply and demand always matters in any market, the sheer amount of millimeter wave spectrum, as well as its cost, is going to enable new business strategies.

The impact will be intensified as well by other related developments (small cells, spectrum sharing, massive multiple-input multiple output radios, better modulation techniques) that will greatly expand spectrum availability and also lead to lower prices for spectrum.

Though it is generally underestimated, millimeter wave spectrum and the other associated technology trends will enable wireless networks--for the first time--to directly challenge fixed networks for internet access customers, with features that are at least as good as fixed networks (and sometimes better), and with retail pricing that also is comparable.

Conversely, that is going to be a key business model challenge for tier-one operators of fixed access networks, which might well see accelerated market share loss, and greater stranded asset problems for their fixed network operations.

That is worth keeping in mind as Verizon readies its 5G strategy. Verizon has the smallest fixed network footprint among tier-one internet access suppliers in the U.S. market.

Comcast passes (can actually sell service) about 54 million homes. Charter Communications passes some 50 million home locations.

AT&T’s fixed network passes perhaps 62 million U.S. homes. Verizon, on the other hand, passes perhaps 27 million locations.

What that means is that Verizon has a clear interest in using 5G fixed wireless to expand its addressable market by more than 35 million U.S. homes that it cannot reach today, giving Verizon a fixed network footprint that is comparable to its key rivals.

And that attack will be based on use of 5G millimeter spectrum and fixed wireless mode. That might make Verizon a rarity in the U.S. market: a tier-one service provider that actually can earn lots of incremental 5G revenue by taking fixed internet access network share away from other key competitors.

Many observers believe 5G will rely mostly on 5G value for internet access, in the early years.

For the most part, though, it is likely that all mobile operations will largely replace 4G accounts with 5G accounts, offering some incremental new revenue, but not too much.

But even if 5G does not immediately lead to huge new revenue streams and new internet of things and ultra-low latency use cases, it is likely to enable a key near-term Verizon growth strategy, namely growth by taking market share now held by competitors in fixed network internet access markets.

While that might not address other long-term issues, taking market share is a proven way for attackers to boost growth and revenues in the near term. That is precisely what cable TV operators did in voice, are starting to do in mobile services what some telcos now are doing in video (both access and content).

Long term, gaining additional market share in internet access does not address what Verizon and other service providers must do to replace shrinking revenues in their legacy connectivity and linear video subscription businesses.

Nor does that same strategy make as much sense for Verizon’s other fixed network competitors. Comcast is focused on international growth; AT&T on content and other “up the stack” opportunities, with some international growth; Charter Communications has to upgrade its access networks and figure out what to do about “up the stack” content or other growth strategies.

Sprint and T-Mobile US do not have the resources or will to do much more than try and gain share in the core mobile business, for the time being. CenturyLink already has made a huge transformation into an enterprise services company with a big legacy consumer telecom business.

The point is that there is no single, universal strategy for 5G. Each company will move ahead based on its perception of other elements of its growth strategy.

Amazon Alexa, Echo Enable Voice-Controlled Speakerphone

Amazon's Alexa app and Echo voice appliances can be used to make (no incremental cost) voice calls to other Alexa users and devices, showcasing one more way voice over Internet Protocol has become a substitute for legacy calling.  

Alexa also can call “most phone numbers in the United States, Canada and Mexico” as well, essentially turning the Echo device into a voice-controlled speakerphone.

As is common with VoIP services, there are some limitations. There is no support for “911” emergency calls, premium-rate numbers (“1-900” numbers or other toll numbers, abbreviated dial codes (“211,” “411,”), dial-by-letter numbers (e.g. “1-800-FLOWERS”) or international calls to countries other than the United States, Canada and Mexico.

Of course, there is more than substitution going on. As legacy carriers move to replace their own calling services with IP platforms, some amount of former legacy voice then might be counted as part of the “VoIP” category.

But the largest impact is substitution, a process that occurs elsewhere in the telecom market. Consider demand for international bandwidth. In the early decades of the internet, “IP transit” was a product that service providers and transport providers bought and sold to move internet traffic, in addition to wholesale capacity of other types.

These days, much of the “public market” has essentially vanished, as major app providers and enterprises build and operate their own networks, obviating the need to buy capacity services from a service provider.

On routes across the Atlantic Ocean, such private networks carry 70 percent of all IP traffic. On Pacific crossings, private networks carry nearly 60 percent of traffic. On routes within Asia, private networks carry 60 percent of traffic.

The point is that IP-based apps and services cannibalize demand for existing services. That is as true for undersea capacity as it is for voice and messaging services.

source: Telegeography

U.S. Rural Customer Coverage Might Change in Big Ways in Future

The extraordinarily high cost of reaching the couple percent of most-isolated U.S. households is one reason why alternatives ranging from 5G to fixed wireless to Google Loon, Facebook Aquila, Google Wing or new constellations of low earth orbit satellites really have to be looked at, as much as existing incumbents might prefer that not be done.

It would not be uncommon in rural areas for fiber to home networks to cost $17,400 per location, according to CostQuest Associates, which produced a recent report that makes the case for federal subsidies for broadband infrastructure.

“The capital investment per customer location, for conduit and poles, is approximately 5.6 times higher in rural areas as in suburban areas,” CQA estimates. “For fiber optic cable, the capital investment is approximately 4.2 times higher in rural areas as in suburban areas.”

The issue is whether any of the newer platforms, including 5G, fixed wireless, unmanned aerial vehicles or constellations of balloons or low earth orbit satellites are commercially viable.

A recurring issue, of course, is which entities should be eligible to apply for such subsidies. In the past, and at present, legacy fixed network providers have been prioritized for federal subsidies, although in the past mobile operators have, in some cases, been eligible to apply for subsidies designed to promote investment in high-cost areas.

But subsidies have used a mix of approaches, including cross subsidies. In the past, revenues earned from urban areas were used to support service in rural areas. Revenues and profits from business users were applied to consumer communications.

High-profit long distance subsidized  local service. In addition, the federal government has provided direct support for high-cost areas. The Rural Utilities Service also has provided ost grants and low interest loans, while states have run their own universal service funds.

All of that is breaking down since the traditional “high profit” sources are dwindling in the competitive era.

R

The other issue, though, is the impact of competition on the business model, no matter what network platform is chosen. Take rates, especially when customer density is lower than about 10 homes per linear mile, have a major impact on capital investment.

CostQuest Associates

The point is that very-remote locations might simply be unfeasible to connect using fiber-to-home platforms, even with subsidies, and have typically been candidates only for satellite internet (geosynchronous or low-earth or medium-earth orbit).

Moderately-remote areas might be candidates for any number of existing and new platforms.

Can Most Telcos Replace 1/2 of Revenue in 10 Years?

AT&T first quarter revenue trends over the past three years have been worrisome. And that is why moves such as the Time Warner acquisition, and potentially the AppNexus buy, are so important.  

In the first quarter, over the last three years, revenue has fallen. And though free cash flow held up in 2016 and 2017, it dipped in the first quarter of 2018.

AT&T is not different from most other service providers in developed markets, in the sense that every legacy revenue stream is shrinking. With markets saturated (fixed and mobile services and customer segments), it is somewhat obvious that revenue growth has to be sought elsewhere.

So though debt levels are a clear issue, most tier-one service providers who hope to prosper over the next decade or two virtually must spend significant resources in the effort to create brand new revenue drivers, with scale.

Time Warner helps AT&T, in the near term, much as NBCUniversal has helped Comcast. The AppNexus acquisition is a more risky, but with outsized returns, if the AT&T strategy works. What AT&T says it wants to do is create a big ad exchange platform that can rival Google and Facebook.

So the potential upside is clear enough. The challenges arguably are even greater, but the need to replace as much as 50 percent of current revenues over the next decade are reason enough for bold moves. That might sound like hyperbole.

It actually is history. U.S. service providers, for example, have had to replace that much revenue at least once or twice over the last couple of decades. The first big change was the replacement of long distance revenues with mobile revenues. The second big change (and more recent) was the replacement of mobile voice and texting with mobile internet.

But there is little reason to believe the underlying trend will change. Many tier-one service providers will have to replace as much as half their present revenue with new sources in 10 years. One might argue they will have to do so every 10 years.

source: Seeking Alpha

source: Seeking Alpha

Is Business Connectivity Spending Growing?

The 5G era might represent a significant change in telecom market dynamics. Where consumer demand for internet access arguably has driven revenue growth for the past couple of decades, growth might shift to enterprise and business users.

The reasons are several. Though nearly all connectivity markets are competitive, and face pressures to reduce prices, almost continually, cloud computing and internet of things arguably will increase demands for business connectivity, virtually across the board.

On the other hand, substitution effects never can be discounted. Nor can we discount the growing ability to substitute lower-cost computing platforms for higher-cost platforms, which means quality goes up even as costs remain flat or even decrease. That means spending levels do not always linearly relate to demand.

And it always is difficult to tell whether U.S. business spending on telecommunications is growing or shrinking, in part because different forecasters use different definitions of what “telecom spending” includes. Nevertheless, several analysts now predict steadily-growing U.S. business spending on telecommunications.

source: Forrester Research

With the caveat that “North America” often includes the United States and Canada, or, perhaps as appropriately, those nations plus Mexico, spending on communications services seems to be on an upward trajectory.

source: Statista

source: Gartner