Disintermediation in the Subsea Business

“Disintermediation” is a term some attendees at the PTC Academy event in Bangkok, Sept. 20 and 21, 2018, heard for the first time. The term simply means that product and service providers go direct to end users and customers, rather than using distributors.

Since communications service providers are distributors, that has key implications. Think “over the top” and you get the point: apps go direct to customers and end users with no direct business relationship between the app/platform and the user.

To an astonishing degree, market demand for wide area communications has shifted away from telcos and to application and platform providers.

The amount of undersea traffic carried by the largest U.S. application and platform providers grew to 339 Tbps between 2013 and 2017. International capacity supplied by internet transport companies grew to 350 Tbps.

“15 years ago, 100 percent of my clients were telcos,”  said Sean Bergin, APTelecom president. “Now 80 percent of my customers are OTTs,”

source: TeleGeography

So platform and app companies Google, Facebook, Microsoft and Amazon do not yet move more bits than service providers do, but arguably will do so in the future. And that “function substitution” has happened in telecommunications before.

Though you are familiar with mobile substitution--the use of mobile networks to displace use of fixed networks--the substitution happening elsewhere is “over the top” substitution for carrier services and value.

In the undersea and wide area network business, that means enterprises of a particular type (tier-one application and platform suppliers) are creating and owning their own transmission networks, and no longer buying capacity from transport providers. And that also means disintermediation of the communications service provider.

source: Google

Put another way, wide area networks now are experiencing product substitution, as did fixed network service providers, where mobile services are preferred to fixed services. As "over the top" apps, platforms and services often displace carrier services and apps, so enterprises (app, platform, device providers) increasingly have found it makes sense to own their own global networks. 

And that means the demand for capacity services from "public" networks (telcos) is diminished. In other words, as bandwidth demand grows, the amount of growth available as "revenue for service providers" diminishes. 

source: Google

That trend can be seen clearly in the growth of transoceanic capacity that is supplied directly and internally by app and platform providers directly, on their own private networks. 

In other words, OTT now covers a much-wider range of business cases, all based on disintermediation, where producers go straight to their customers or users, without relying on distribution partners. 

source: TeleGeography

Intel Follows Pattern: Replace 1/2 of Current Revenue Sources Every Decade

One rule of thumb I use when looking at business model change is to assume that a tier-one service provider will have to replace half its current revenue with new sources every decade. And that might be a reasonable rule for suppliers of apps, platforms, devices and components as well.

Im 2012, for example, Intel earned nearly 70 percent of revenue from “PC and mobile” platforms. By 2018, PC/mobile had dropped to about half of total revenue. By 2023 or so, Intel should generate 60 percent or more of total revenue from sources other than PC/mobile.

source: Trefis

If you hear executives talking so much about innovation and new services, that is why: companies need to replace half their revenue every decade, and do so in every decade, from now on.

source: Intel

The good news is that, as tough as that sounds, firms have shown they can do so.

Verizon as Disruptor

As accustomed as we might be to seeing Google, Netflix, Amazon, Facebook, cable TV companies, wireless internet service providers, metro fiber specialists or T-Mobile US as market attackers and share takers, we are unaccustomed to seeing either AT&T or Verizon in such roles.

But Verizon is about to take that role, in fixed networks.

Verizon is launching Verizon 5G Home, its 5G fixed wireless service, on October 1, 2018 in parts of Houston, Indianapolis, Los Angeles and Sacramento, providing the first U.S. real-world test of customer demand for 5G fixed wireless.

And Verizon has specific business reasons for doing so. Simply, footprint, or homes passed, in its fixed networks business is a key driver for Verizon. Simply put, Verizon has far fewer homes passed than its major fixed network competitors.

source: GSMA Intelligence

Comcast has (can actually sell service to ) about 57 million homes passed. Charter Communications has some 50 million homes passed.

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

As dominant as Verizon is in the mobile services segment, it lacks scale in the fixed networks segment. And that means Verizon can gain revenue by taking market share in the fixed network business.

The companion issue is simply that, similar to Spring and T-Mobile US, Verizon’s revenue is heavily weighted to mobile services. As much as 69 percent of Verizon’s revenue is earned from mobility services. That is less than Sprint or T-Mobile US earn from mobile services, but is highly significant, as it means Verizon, the biggest revenue producer in U.S. mobile, has less room to grow.

source: Seeking Alpha

As cable companies have fueled growth by taking market share in voice services, business services and internet access, so Verizon expects to take share in fixed network internet access.

Would a U.S. Mobile Market with Merged T-Mobile/Sprint be Stable?

Assume a merger between Sprint and T-Mobile US is approved by U.S. regulators, and the tier-one mobile service provider business becomes a contest of three relatively equally-situated contestants, in terms of market share. Is the market stable, long term?

I would argue it remains unstable, even with new T-Mobile US at 31 percent share, AT&T at 30 percent share and Verizon at 36 percent (share of accounts). The rationale is partly strategic and partly historical.

The immediate rationale for the merger is that a bigger T-Mobile US will be better able to compete with Verizon and AT&T, and the rearranged market would arguably feature three firms with roughly similar mobility market shares. But that virtually certainly creates a new market that is as unstable as the four-provider market that is replaced.

source: GSMA Intelligence

The strategic rationale for an unstable market is that, if one assumes the “service provider of the future” owns both fixed and mobile assets, then new T-Mobile US is still half way through a repositioning exercise.

The larger T-Mobile US would remain “mobile only in an industry that is moving rapidly towards “integrated” operations involving ownership of both fixed and mobility assets. And that suggests yet one more big transaction where T-Mobile US and some other entity merge again, to create an integrated competitor. But the size of new T-Mobile US narrows the list of potential acquirers.

On the other hand, to the extent 5G makes a mobile platform a more-perfect substitute for fixed networks, and if the backhaul issues can be finessed, then it is even more likely that a non-traditional buyer of T-Mobile US assets could emerge, as there would be no need for such a non-traditional buyer to worry about ownership of the fixed network.

In general, such potential acquirers might be tier-one platform, device or app providers.

source: GSMA Intelligence

There also is an historical argument for further instability.  Established (oligopoly) markets tend to feature a structure with disparate and unequal market shares that encourage suppliers not to launch disruptive attacks.

A ratio of 2:1 in market share between any two competitors seems to be the equilibrium point at which it is neither practical nor advantageous for either competitor to increase or decrease share.

A market with three roughly equally-situated contestants means there always will be a temptation to launch disruptive attacks, especially if one of the three has such a strategy already.

Some studies suggest a stable market of three firms features a market share pattern of approximately 4:2:1, where each contestant has double the market share of the following contestant.

The hypothetical stable market structure is one where market shares are unequal enough, and the leader financially strong enough, to whether any disruptive attack by the number two or number three providers.

In a classic oligopolistic market, one might expect to see an “ideal” (normative) structure something like:

Oligopoly Market Share of Sales
Number one	41%
Number two	31%
Number three	16%

source: economicsonline

As a theoretical rule, one might argue, an oligopolistic market with three leading providers will tend to be stable when market shares follow a general pattern of 40 percent, 30 percent, 20 percent market shares held by three contestants.

Under most circumstances, firms that have a higher share of the markets they serve are considerably more profitable than their smaller-share rivals, according to the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.

And it is that disparity in profitability that allows the leader to weather pricing attacks, while making disruptive attacks often perilous.

To be sure, most financial observers believe new T-Mobile US will have reduced incentives to launch more disruptive attacks, allowing general price levels and profit margins to rise across the whole tier-one part of the industry.

Still, there is little historical precedent for stability in a three-competitor market that is roughly equally balanced in terms of market share. And mobility is but one element of competition.

Existential Crises Brewing in Internet Ecosystem?

Some have argued that 5G fixed wireless is an existential threat to cable TV and some telco fixed network service providers. That might turn out to be mistaken.

But more firms in the internet ecosystem might face similar existential problems in the future, for reasons either of business strategy or government intervention.

By definition, an existential problem is one that threatens the survival of the entity. And that is where strategic decisions matter, as a common rule of thumb is that a firm or entity facing an existential crisis might well have to consider fundamental changes and adaptations. “More of the same,” in other words, does not typically work.

But “more of the same” might be exactly the broad choice most service providers ultimately will make, simply because rival paths are unfeasible.

Some applaud Verizon’s apparent continued focus on the quality of its network and connectivity services, as opposed to other strategies that might reduce reliance on connectivity revenues.

Others think that is risky. Tier-one app, device or platform providers seem to be evaluating, testing entry into the connectivity business on a bigger retail level, or might well do so in the future. The simple reality is that bigger firms acquire smaller firms, and many tier-one platform, app or device firms have market values far in excess of even the largest tier-one telcos, mobile operators and cable operators.

Apple, for example, is the latest to be moving into a potential connectivity role. Google and Facebook already have developed technologies for communications, and Google Fiber of course already is a connectivity services provider.

So the big question is whether most communications service providers should “stick to their knitting” and be the best communications providers possible, or whether sustainability requires moves elsewhere in the ecosystem (“up the stack”).

Both strategies ultimately are likely to be chosen, by different providers with varying abilities to execute on a diversification strategy.

To be sure, in a developing area such as internet of things, connectivity revenue will grow, perhaps substantially. But upside is almost certain to be higher in the applications and platform areas.

source: GSMA Intelligence

Most service providers ultimately are going to choose to focus on connectivity services, even if that eventually means huge consolidation in the service provider space, as surviving firms seek to bulk up, gain scale, boost gross revenues and prop up profit margins.

A relative few will have the resources to diversify revenue sources beyond connectivity (Comcast, AT&T, NTT, SingTel, Orange, DT already are trying). Verizon’s strategy seems to be “focus on connectivity,” after a period where it tried without huge success to create a bigger role in content services.

And we might be premature in suggesting Verizon really believes it can sustain revenue and growth on the strength of connectivity services.

Of course, Verizon and other service providers are not alone in facing what might  be existential business problems. Even if it is easier to see that virtually every legacy telecom revenue stream has past its peak, it now looks as though many leading internet app platforms and app provider face their own huge problems, namely of the antitrust sort.

Mobile Data Prices Plummet in Africa and India

As a long term trend, communication costs have dropped, and likely will continue to drop, for a number of reasons:

• Moore’s Law
• Better technology (mobile, fixed, device, radios and network infrastructure)
• Competition
• Manufacturing efficiencies

The impact also can be quite substantial over short periods of time. Consider the retail price of mobile data in Asian and African countries over the past several years. Where mobile data in 2015 might have eaten up four percent of monthly income in Nigeria, gby 2017 mobile data had fallen to consume about 0.75 percent of monthly income.

source: GSMA Intelligence

Computing Eras Always Shape Communications Demand

Changes in computing nearly always have implications for communications and connectivity providers. In the mainframe era there was some need for lower-speed connections to connect remote locations to computing centers.

The client-server era created the need for local area networks, and arguably had some demand consequences for connecting computing centers with branch offices. But it was the shift to cloud computing which really drove the demand for connecting not just computing centers and branch offices, but consumer devices.

The coming era of edge computing should shift demand again, reducing demand for long haul connectivity but increasing demand for metro-area communicatiions.

source: GSMA Intelligence