Why Telcos Cannot Innovate

All other things being equal, people and firms who have a choice are better served choosing to work in growing industries rather than declining ones. They arguably are best served choosing new and potentially fast-growing industries. 

Likewise, connectivity providers would prefer to operate as "fast moving" innovators in new developing markets. The problem is that many such markets do not initially represent revenue scale, and for that reason are difficult for big firms to justify chasing.

Small firms have other problems, as they cannot generally compete successfully in any parts of the business that require scale (capital, people, large and extensive networks, lots of customer support). Any large connectivity market that requires scale are the best places for large tier-one providers to succeed.

That is more than a little troubling for firms and people in connectivity industries, and explains the common observation that "telcos cannot innovate."

Until recently, mobile phone services have been an industry “star,” driving strong revenue growth. But mobile revenue growth rates are stalling, and overall global industry growth rates have dipped to somewhere between one percent and two percent annually (not adjusted for inflation). 

source: GSMA 

Other fixed network services have been “cash cows” at best, “dogs” at worst. For most of the 1990s, international long distance calling was a cash cow, whose revenues were to be harvested. In the second decade of the 21st century, voice services generally are products with shrinking demand, slim revenues and marginal--if any--profits.  

New high growth markets are believed to exist in the internet of things and edge computing, but remain untested, and are “question marks.”

source: John Wiley, BCC

Over the past two decades, many potential lines of business have been proposed as growth engines, including VoIP, data center operations, app stores, entertainment video services, advertising, content ownership and cloud computing (to a smaller extent)/ 

Few of those initiatives have proven viable, with the exceptions, in some cases, of entertainment video and content ownership. There is much truth to the notion that “telcos cannot innovate,” but the broader observation might be the difficulty of carving out sustainable new roles in an ecosystem. 

In a by-now familiar pattern, CSG notes that 79 percent of telecom executives are concerned about becoming commodity providers of “dumb pipe” services in an ecosystem where value and profit migrate elsewhere in the value chain. 

Those beliefs also are clear in an Accenture white paper produced about digital transformation in the telecom industry by the World Economic Forum. To some extent, the industry’s problems are perhaps even deeper. Until recently, mobile subscription growth, and a shift of revenue drivers from voice to texting--then texting to mobile broadband--have been revenue “stars,” offering high rates of growth. 

But the mobile market clearly is maturing, with negative to slow rates of growth in developed markets, and slowing growth rates in developing markets. Note that the present growth driver in developed markets--mobile broadband--has been slowing since 2008. 

source: Researchgate 

Subscriptions still have room to grow in developing markets, but at some point even those markets will saturate. So growth (revenue and accounts) is a key industry challenge. 

Connectivity services firms with small market share have to compete differently from firms with large market share. For starters, small firms do not typically have access to huge amounts of capital, or the ability to hire huge numbers of people. 

That means they always must find niches of one sort or another, specializing and segmenting their customer opportunities. Where tier-one service providers must “think big” when chasing new revenue sources, smaller firms have to “think small.” 

Where a $1 billion opportunity is almost the bottom limit of what a tier-one service provider can try to address, a $1 billion opportunity is too large for many small firms to try and seize. Basically, the small firm strategy is to “go where the big guys will not follow” and will not try and compete. 

Historically, that has been clear in segments such as enterprise phone switches, local area networking, Wi-Fi and specialty mobile segments, for example, where connectivity providers have been content to leave those segments to others. 

The early broadband access market using digital subscriber line as the platform initially was left to independent retailers, for example. Prior to that, the dial-up internet access market similarly was left to third party providers. 

LIkewise, small firms typically lack the resources to diversify into new parts of a value chain, innovate technologically or compete by offering superior credit policies or other financial inducements. They typically cannot be leaders in high-growth, low-share new markets with high investment costs and low sales volumes.

source: Robert Grant  

Where small firms often can try and add value is by providing more intensive or customized support, especially for any market segments or products that are relatively low volume and routinely customized. 

Rule of Three in Kenya Mobile

Stable industries tend to have a market share pattern, as noted by Bruce Henderson, founder of the Boston Consulting Group. "A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest,” Henderson argued.

Sometimes known as “the rule of three,”  he argued that stable and competitive industries will have no more than three significant competitors, with market share ratios around 4:2:1.

The mobile services market in Kenya illustrates that pattern, where Safaricom, the market leader, has more than twice the share of the number-two provider Airtel, which in turn has twice the share of the number-three provider Telekom Kenya. That same pattern tends to hold for profit margins as well.  

source: Communications Authority of Kenya 

One sees this pattern in some telecom markets. Looking at market share and return on invested capital for the three largest telecom providers in Thailand, China, and Indonesia since 2015, you can see that financial return and market share tend to be directly related.

The real-world structure does not precisely match the rule of three predictions, of course, with Thailand having the almost-perfect correspondence between predicted results and actual results, according to a 2016 analysis by Reperio Capital. 

In many other markets, two observations are apt: where the 4:2:1 pattern does not exist, markets either are not competitive, or not stable, or both. And though we might be tempted to think such patterns exist mostly for capital-intensive industries, the pattern seems to hold in most industries.  

Source: Reperio Capital

My rule of thumb incorporating the “rule of three” is that the leader has twice the share of number two, which in turn has twice the share of provider number three. In Thailand, the general pattern holds.China and Indonesia do not fit the stable pattern so well. 

In Thailand the pattern holds well. The leader has 53 percent share, number two has 31 percent and number three has 17 percent share.

If those markets are actually competitive, some further change in market share would be expected, with the market leader losing share, gained by a clear and stronger number two.

AT&T Halts DSL Sales. It Has To

AT&T says it has stopped selling new digital subscriber line accounts, a move that predictably led to complaints by the Communications Workers of America. In areas where AT&T operates fixed networks, but does not have fiber to home available, that essentially means AT&T is abandoning the effort to compete with cable operators in the fixed network broadband market. 

Like it or not, AT&T was delivering speeds of about 6 Mbps where it was selling DSL on copper access lines. AT&T reported 653,000 total DSL connections at the end of its second quarter, compared to 14.48 million on its fiber optic and hybrid fiber services.

DSL on copper access lines did not qualify as “broadband,” using the Federal Communications Commission definition of 25 Mbps in the downstream. 

More broadly, AT&T earns most of its revenue from mobility, business customer services and content services. In the second quarter of 2020, total revenue was about $33.6 billion. 

Mobility generated more than $17 billion in the quarter; business fixed network services produced $6.4 billion in revenue; while content operations (Warner Media) represented $6.8 billion; and Latin America about $1.2 billion.

In fact, broadband access revenues are such a relatively-small portion of total revenues that all broadband access revenues are almost buried in the “entertainment” segment whose revenues are anchored by video entertainment services, which produced about $10 billion in revenue in the second quarter of 2020. 

Video subscriptions represented more than $7 billion of that total, and most of that was delivered by DirecTV, the satellite service. 

In the second quarter of 2020, AT&T generated about $2 billion in consumer broadband access revenues. All consumer fixed network voice services might have produced less than $1 billion worth of revenue. 

There is some smallish contribution provided by linear video on the fixed network, but all together, fixed network triple play services likely generate no more than $4 billion a quarter. 

Another way of putting matters is that AT&T now generates less than 12 percent of total revenue serving consumers on its fixed network. 

Simply put, consumer fixed network services--despite the cost of the network, do not produce much revenue or profit. All services in the entertainment group create only about $2.3 billion in cash flow (EBITDA). 

So it is possible that consumer fixed network operations now produce zero actual contribution to consumer fixed network cash flow. 

Like it or not, where AT&T has fixed networks, it generates rather slim amounts of revenue, and possibly no profit. Even if AT&T steps up investment in FTTH, cable operators have about 70 percent of the installed base, and all of the net new additions nationwide. AT&T would be playing catchup in broadband, at best. 

It no longer appears that voice or linear video will grow in the future, either. That leaves mobility and fixed wireless as the primary way AT&T can invest in faster broadband, in many areas, as AT&T is unlikely to earn a return on FTTH deployment. 

Competition and technology essentially have destroyed AT&T’s consumer fixed network business, while obvious revenue growth lies elsewhere. Cable broadband, satellite broadband and other alternatives will have to suffice for many customers across some of AT&T’s footprint.

Impact of Competition in Telecom on Prices

One example of the impact of competition in a capital-intensive industry can be seen by comparing retail price trends in the European, Japanese and South Korean electricity, natural gas and water industries--still regulated as natural monopolies--and the telecommunications business, which is deregulated and competitive. 

Between 2008 and 2019, for example, communications prices dropped, while prices for the other utility services increased. 

source: ETNO

The other trend we can note in those same markets is relatively inelastic demand for communications. In other words, people will only spend so much for communications. As a percentage of gross domestic product, for example, communications spending by households fell between 2006 and 2019, for example. 

source: ETNO

Basically, households tend to spend between 1.5 percent to 2.25 percent of GDP on communications. Other studies of household spending in developed markets show the same pattern. 

Over time, household spending on connectivity services has fallen. Nor has business spending moved much, either.  

Consumer spending does not change too much from year to year. Nor does the percentage of income spent on various categories change too much. 

source: IDC

In Myanmar, a new mobile market, spending per household might be as high as eight percent of total spending. In Australia, communications spending (devices and services) might be just 1.5 percent of household spending.  

In South Africa, households spend 3.4 percent of income is spent on communications (devices, software and connectivity). In Vietnam, communications spending is about 1.5 percent of total consumer spending.

In the United States, all communications spending (fixed and mobile, devices, software and connectivity, for all household residents) is perhaps 2.7 percent of total household spending. U.S. household spending on communications might be as low as one percent of household spending, for example. 

Deutsche Telekom to Wholesale FTTH for First Time

For the first time, Deutsche Telekom has signed a long-term wholesale agreement for the use of its fiber optic network, including fiber to the home (FTTH).

In a move expected to be extended to all other competitors as well, Deutsche Telekom and Telefónica Deutschland/o2 have a new 10-year contract that grants Telefónica access to DT’s broadband network, including all fiber-to-home facilities, including gigabit facilities supported by FTTH. 

Telefónica had wholesale access to DT’s digital subscriber line network since 2013.

Some might argue that DT and Telefonica are playing catch-up with European cable operators. 

source: Cable Europe 

Deutsche Telekom’s VDSL network currently reaches some 33 million households in Germany. About 1.8 million households (about five percent) are equipped with fiber optic lines. Deutsche Telekom plans to significantly accelerate its FTTH buildout in the coming years.

Telefónica Germany had in 2019 3.9 million DSL customers, or roughly five percent penetration of homes. 

source: FTTH Council Europe 

Deutsche Telekom ended 2019 with 13.7 million retail broadband subscribers, or roughly 42 percent penetration of homes. 

Is Remote Work Really "As Productive as in the Office?"

Microsoft CEO Satya Nadella might be among business leaders who are not so convinced work from home is as productive as in-office work. "Thirty minutes into your first video meeting in the morning, because of the concentration one needs to have in video, you are fatigued."

Granted, knowledge worker or information worker productivity is tough--perhaps nearly impossible-- to measure. But at least some believe mandatory work from home rules have hurt information worker productivity.

Aternity, for example, has aggregated usage details from millions of employee devices from over 500 Global 2000 companies, tracking use of business applications from home. Aternity analysis suggests that the United States has become less productive due to remote work because of the pandemic. 

At the end of March, 77 percent of work had been moved to be performed remotely in North America, the largest amount of any continent. U.S. enterprise worker productivity actually dropped 7.2 percent, Aternity reports, though Canadian productivity increased about 23 percent. 

“Overall productivity (as measured by hours of work computing time) in Europe declined by 8.2 percent,” according to Aternity. 

Those same trends continued through July 2020, Aternity says. “The main takeaway from Aternity’s latest data is that a ‘productivity tax’ is affecting enterprises deploying long-term remote work strategies,” Aternity says. “In countries where the remote work share remains at peak levels, including the United States and parts of Europe, employee productivity continues to fall.”

source: Aternity 

“In comparison, overall productivity is rising in European countries where the share of in-office work is increasing, showing that returns to the office are benefiting companies from an overall productivity standpoint,” Aternity says. 

The early data from the work-from-home change is not encouraging for productivity, say professors  Jonathan Dingel and Brent Neiman of the University of Chicago Booth School of Business. They suggest that the tools we have are not so much the problem as human ability to adjust to remote work environments and use the tools fully.

Also, if it is the case that only a third of jobs can be done remotely, forcing everyone to do so will not be universally productive. 

Nadella also notes that fully remote work is harder on new employees, as it is harder to form new work relationships and learn the new company culture when working fully remotely. As others have noted, all the issues about learning from mentors and acquiring new skills is a huge issue as well in a work-from-home environment. 

To be sure, many employees like working from home part of the time, and report that they believe their productivity is higher. Still, significant percentages already report that they believe they are less productive working from home. 

The conventional wisdom is that work patterns will be more flexible after the pandemic. What also seems clear is that the value of being in the office will re-emerge, as it seems clear that mode offers advantages for firms in terms of random and unplanned interactions, new employee onboarding and career development. 

What are Cash Flow Implications of an AT&T Sale of DirecTV?

One question some of us have about any sale by AT&T of its DirecTV asset is the impact on free cash flow, which might have been as much as 13 percent of total cash flow, or possibly more, by some accounts 

In late 2019 DirecTV was said to be spinning off about $4 billion in annual cash flow, which seems low to me, but appears to be about right. In the first full year of ownership, DirecTV likely produced $12 billion of free cash flow.

Some speculate that AT&T could retain a minority interest in the business, and some of the cash flow. The point is that the cash flow implications of selling DirecTV are far less than would have been the case five years ago, when it appears the cash flow was three times higher.

Aside from the need for high cash flow to help pay down debt, the company also requires high cash flow to pay its dividends. Though not a popular position, the DirecTV acquisition made sense to me as the only viable way to add so much cash flow so fast. 

Some had suggested the alternative of investing the capital in fiber to home facilities, but I never understood how cash flow could be boosted fast enough that way. Some might argue a massive diversion of capital to FTTH would not have recovered cost of capital, much less begun generating significant new cash flows within a year. 

When DirecTV was acquired by AT&T, it would have been easy to find detractors arguing that AT&T should have spent that money investing in fiber to home infrastructure. The new story is hat AT&T should not have done so, as the asset is wasting away. 

So what should AT&T have done with $67 billion, assuming a 4.6 percent cost of capital? Cost of capital is the annualized return a borrower or equity issuer (paying a dividend) incurs simply to cover the cost of borrowing.

In AT&T’s case, the breakeven rate is 4.6 percent, which is the cost of borrowing itself. To earn an actual return, AT&T has to generate new revenue above 4.6 percent.

Assume that for logistical reasons, AT&T really can only build about three million locations each year, gets a 25-percent initial take rate, spends $700 to pass a location and then $500 to activate a customer location. Assume account revenue is $80 a month.

AT&T would spend about $2.1 billion to build three million new FTTH locations. At a 25-percent initial take rate, AT&T spends about $525 million to provide service to new accounts. So annual cost is about $2.65 billion, to earn about $720 million in new revenue (not all of which is incremental, as some of the new FTTH customers are upgrading from DSL).

The simple point is that building three million new FTTH locations per year, and selling $80 in services to a quarter of those locations, immediately,  does not recover the cost of capital.

So as controversial as the DirecTV buy might be, it at least had the advantage of throwing off cash flow. It is unclear whether the alternative of a big new FTTH build would have done even that well. At the time AT&T made the acquisition, DirecTV likely was throwing off something like