Service Providers Sometimes Get the Strategy Right, Sometimes Wrong

The advice to “stick to your knitting” or “concentrate on your core business” often is sage advice for market leaders, for the simple reason that if 80 percent of results are produced by 20 percent of the business, that properly requires one’s attention. 

The complication occurs when that core business is in permanent decline. Then the advice might change. Owners might be advised to “get out of that business” by selling the assets. When possible, owners might be told to harvest revenues from the declining business to fund replacements. 

When execution issues are not an impediment, the “harvest and reinvest elsewhere” advice can produce results. Many industries, including automobiles, energy production, retailing, music and video entertainment and most content businesses have had to face the challenge. 

The telecom business finds itself in that situation. Growth increasingly is slowing even in the fastest-growing regions of the business, while global growth rates in the one percent to two percent annual range. 

The great hope of the internet of things, edge computing and 5G itself is that growth can be reignited in the core communications business, without the need to diversify assets. 

Since retail service providers must replace about half their existing revenues every decade, diversification and growth within the connectivity sphere are considered far less risky than moves outside the core competency, if it can be done.

In my own experience, both execution risk and faulty strategy have bedeviled retail connectivity providers. When, in 1985, the monopoly AT&T Bell System was broken up, the “valuable pieces” were deemed by AT&T to be the long distance business and ownership of Western Union (later renamed Lucent Technologies). In other words, long distance service and the equipment manufacturing arm. 

The local access companies, the Regional Bell Operating Companies, were viewed as stodgy, slow-growth assets. That view was more broadly held, as well. When Rochester Telephone Company proposed deregulating its own monopoly in return for freedom to pursue the long distance business, the explicit reasoning was that long distance was the growth driver, local telephone service a slow-growth business with lower financial returns. 

The strategy proved flawed. 

Later, AT&T, struggling to find a facilities-based way back into the local access business, became the largest cable TV provider in the United States. The idea was to use the cable TV access lines for delivery of all services. But execution issues stymied that strategy, as AT&T could not support the debt loads the acquisitions imposed, nor could it get the hoped-for performance without major network upgrades. 

After that, AT&T gambled on growth from entertainment video, purchasing DirecTV to become the largest linear video supplier in the U.S. market. Now AT&T has pivoted again, moving the DirecTV assets off its books and betting on the streaming service HBO Max to drive consumer revenues. 

Many have argued the DirecTV strategy was wrong. Some say the same about the Time Warner content acquisition. Others would argue the strategy was the same as followed far more successfully by Comcast: diversify and then take share from competitors in the new lines of business. 

As Comcast sought to use the broadband network to deliver all services (including voice, enterprise connectivity and internet access), while diversifying revenue from connectivity (video subscriptions) to content ownership (networks, studios, theme parks), so AT&T attempted the same strategy. 

DirecTV would be a bridge to adding video entertainment revenues to the fixed network voice base, while owning Time Warner would create revenues not fundamentally based on connectivity operations. 

To be sure, the linear video business deteriorated faster than expected, to be replaced by streaming alternatives. And linear video underperforms most of the other lines of business in terms of cash flow generation. 

source: AT&T 

Many will be pleased at what they believe is a turn towards the mobility business, which generates most of AT&T’s free cash flow, with higher profits than the other lines of business. 

But the nagging question remains: if the mobile and connectivity businesses are in decline, how is growth to be maintained? Optimists will point to edge computing or IoT or enterprise services. 

The issue is whether incremental new revenues will come fast enough, or be big enough, to offset a loss of half of current revenue over the next decade. 

Product substitution will not abate. The ability to substitute applications for services--”free replacing fee”--is possible across a growing range of core products, including voice and messaging. 

Nor--for AT&T or the other market share leaders--is he most-logical growth path of buying competitors possible. Acquisitions are constrained domestically by governments that want some level of competition. 

Expansion internationally was a favored growth strategy over the past several decades, as government policy was either benign in terms of new foreign investment, or encouraged. Prevented from growing domestically, offshore growth made lots of sense. 

But as growth has slowed, many are retrenching again, partly to reduce debt burdens. 

In the past, usage has been tied to revenue: “use more, pay more” was the rule in the pre-internet and monopoly eras. Today, usage and revenue are uncoupled. As data consumption grows 50 percent a year, prices cannot be raised to match. 

As so often is the case in the internet era, higher usage often means higher costs occur faster than incremental revenue. 

The point is that growth options are difficult and risky, either concentrating on the core business or trying to move outside it. 

That noted, some competitors are able to take market share in the base business and grow that way, at least for a time. T-Mobile can grow by taking share, as cable operators took share in voice, business services and internet access. 

But flat industry revenue growth, plus attrition in the core business at a significant level, might tough decisions for the market leaders. If one cannot hope to take significant market share, and in the absence of significant new revenue growth in the core business driven by some combination of 5G, IoT and edge computing, focusing on the core fails as a growth strategy.

WFH Might Not be as Productive as You Think

Knowledge worker productivity is notoriously hard to measure, so we might as well admit we are only guessing about the impact of widespread work from home on productivity. WFH might not have affected productivity too much: boosting results for some but arguably having no impact or possibly even negative impact on others. 

On the other hand, there is growing evidence that longer term issues could be occurring. Respondents to a Plugable survey show that non-work-related activities during work hours were fairly common. About 33 percent reported they binge watched netflix during working hours in January 2021. 

source: Plugable 

But there also are other indicators that productivity might have suffered. About 34 percent of respondents say they lacked a "productive space for work." So 59 percent of WFH respondents "typically spend their time working somewhere other than a home office," Plugable says. 

Fully a third of respondents reported technical issues such as internet access interruptions. Nearly three quarters of respondents said their partner or spouse distracts them and 64 percent said working with their significant other causes them to feel less productive and have difficulty focusing, Plugable notes. 

During Pandemic, Video Conferencing Data Consumption was Up 5%; Video Up As Much as 40%, Gaming Up as Much as 80%

Not that it matters--a bit is a bit--but Comcast reports that during the Covid-19 lockdowns and social distancing, content consumption grew dramatically. Gaming downloads grew 20 percent to 80 percent in four months, while entertainment video demand grew 20 percent to 40 percent as well. 

source: Comcast 

One might think the demand was driven by people working or learning at home. It was not. You might think all of us using videoconferencing for work and learning drove consumption. It did not. All video conferencing usage represented less than five percent of data consumption. 

We were watching streaming services. 

source: Comcast 

It appears that with other recreational pursuits unavailable (movie theaters, concert venues, restaurants, bars, museums, sports arenas, parks, swimming pools, recreation centers), and with “stay at home” rules in place,  people were left to watch TV. 

Up Next: Mobile Substitution for Fixed Internet Access

Mobile substitution has been a huge driver of revenue, market share and profit margin change in the consumer connectivity industry. Long distance revenues, voice revenues have been the big obvious examples. 

The next areas to watch are video entertainment and internet access. 

Parks Associates, for example, reports more than 12 million U.S. households have cancelled their home broadband service and use only mobile broadband for internet access.

That equates to more than 15 million households using mobile broadband service exclusively. Some three million of those households that have never had a home internet subscription, and have been mobile-only from the start. 

Other estimates of mobile-only internet access support that observation. As much as 20 percent of U.S. households were mobile only for internet access in 2017, Deloitte estimated, with take rates correlating with household income. Mobile-only behavior occurred in 15 percent of richer homes and 20 percent in poorer households. 

The new wrinkle is 5G for fixed wireless, which some proponents suggest could add another 15 percent to 20 percent market share for mobile operators, with share taken directly from fixed network suppliers.  

Over the top application substitution has been the other big driver of revenue and profit margin change, diminishing service provider revenues and profits from text messaging, long distance calling and voice calling. 

In the connectivity business, the "mobile substitution" trend has occurred in phases, and affected a wider range of products over time.

Mobile voice supplanted fixed voice as the preferred consumer use case. "Mobile substitution" for voice has been a global trend since the advent of 2G networks. In fact, mobile is the only sort of ubiquitous network in most parts of the world. But that now might become an issue for internet access as well.

“I will say over time--a three to five year time horizon--unequivocally 5G will serve as a broadband, a fixed broadband replacement product,” former AT&T CEO Randall Stephenson said. “I am very convinced that that will be the case.”

“Back in the 90s everybody was saying wireless would never serve as a substitute for fixed line voice because there wasn't sufficient capacity,” Stephenson said. “Well it is a substitute for voice.”

Mobile messaging displaced voice. Mobile social media displaced fixed modes. Mobile turn-by-turn navigation displaced dedicated GPS devices and maps.

Mobile phones displaced watches, cameras, music players and flashlights. Mobile entertainment video is encroaching on fixed modes of viewing (TV sets, PC or tablet screens).

Mobile internet access, which began to find niches in the 3G era, found many more use cases in the 4G era (both for home broadband replacement and on-the-go access). In developing regions, mobile internet access is the preferred form of access.

In the 5G era, we will see a big test of fixed wireless and mobile wireless as a substitute for fixed network access in a wider range of settings. No later than 6G, we might routinely be using mobile access as a substitute for home broadband. The key enabling trends are higher routine speeds and some shifts of pricing plans and consumer behavior.

source: Parks Associates 

Cost and speed are cited by cord cutters as reasons for ditching fixed network internet access. Obviously that behavior could change if cabled network speeds are upgraded and cost becomes more appealing. 

At least initially, it can be hypothesized that mobile substitution will be most appealing for households with modest bandwidth requirements, as that is where the best match of fixed wireless speeds and pricing with customer demand. 

If the average U.S. household consumes 269 GB per month, according to OpenVault, and the average number of people per household is 2.5, than per-user consumption is about 108 GB per month.  

If a typical household spends $66 for fixed internet and between $40 and $60 a month for mobile data, we can roughly estimate the breakeven point where going all-mobile for internet access costs no more than what already is spent for mobile and fixed internet access, ignoring a bit of hassle factor for doing so.

Assume per-user mobile data costs $50 a month, while per-household fixed data costs $70 a month, and about $28 per user in each household. For a multi-user household of an average 2.5 users, that implies something like $78 per user for an all-mobile approach.

It’s a rough estimate, but that implies usage allowances currently set at about 110 GB, priced at about $80, would be competitive offers for many users, and allow substitution for fixed internet access.

The 95th Meridian and Network Cost

The 95th Meridian is important in the United States. West of the 95th Meridian, agriculture is not possible without irrigation. For most of the land area west of the meridian, water is a major issue. And with a few exceptions on the west coast, most of the U.S. west of the meridian is highly rural, contains much forest, uncultivated desert or range land, and relatively few people. 

source: U.S. Department of Agriculture 

In fact, most people live on just six percent of the U.S. land surface, according to the USDA. About 94 percent is unsettled or lightly populated, including mountains, rangeland, cropland and forests. 

All that has direct implications for the cost and speed of building networks. Dense urban networks cost the least, on a per-location basis, while rural networks cost the most. Also, incentives to build and operate networks are strongest on six percent of the land surface, and challenging on as much as 94 percent of the land surface. 

In just about any instance, in any market, 80 percent of the revenue might be generated by 20 percent of the accounts, locations or use cases. Ericsson studies show that just 30 percent of cell sites support 75 percent of all traffic on the network, for example. 

So it should come as no surprise that the cost of U.S. rural infrastructure can be an order of magnitude higher than for denser urban infrastructure. 

That is not to say all of the hard-to-serve areas are west of the 95th Meridian. Just most of them.

Telco Business Models in Competitive, Internet Era are Quite Different

The fundamental economics of any retail (networks serving all consumers and businesses) communications access network are distinctly different in the competitive era. In the monopoly era, a service provider could, in principle, assume take rates close to 95 percent. 

The simple corollary was that the “cost per location” and “cost per customer” were nearly identical. The business model math also is far easier. “Revenue per location” and “revenue per customer” were nearly identical. 

So a payback analysis is fairly straightforward. None of that is true in the competitive era. 

In the competitive era, former incumbents in some cases can assume retail market share between 20 percent to 60 percent. That can mean a “cost per customer” is 40 percent to five times more than the “cost per location” of the network. 

Assume just two competent suppliers, each good enough to possibly capture up to half the market for any service or product, over some reasonable amount of time, with revenue per customer roughly similar to the other competitor. 

It always is possible that “cost per customer” is twice as high as “cost per passing or cost per location.” For such reasons, possible take rates and market share will determine whether a specific network upgrade is viable.

A related assumption is that there will be a significant degree of stranded assets. Only a percentage of potential customers and locations will actually generate revenue. Even assuming a multi-product strategy, few service providers find they are sustainable below 30 percent market share.

Take note: that assumes as much as 70 percent of the access network will not generate revenue. In competitive markets, that is why the FTTH decision typically is so difficult. 

There have been similar changes in the applications area that shape the business model. Monopoly era business models generally were driven by sales of one product: voice on the telco network, video on the cable network, voice on the mobile network, generally because each net work was designed to deliver that one service or application.

The era of multi-purpose networks, plus competition, changes the math extensively. Though no single network can expect to capture 90 percent of demand, each network can, in principle, capture the demand for three or more anchor services. 

And that has been a foundational strategy in the competitive era, even as legacy services have begun their decline, overall. It is far easier to take market share in a mass market product than to create an entirely-new product that appeals to most of the market. “Same product, lower price” is a value proposition consumers easily grasp. 

It is far harder to scale sales of a product consumers are unsure they really need. 

Still, the economics of a multi-purpose network are far easier than that of a single-purpose network. As an advisor to a telco pondering a cable TV acquisition, I once asked a cable executive what would happen to the business if take rates dropped 10 percent. “We’d be out of business” was the immediate response. 

That might be true in a single-product business. It is not true of a multi-product business with three or more services to sell. Getting 33 percent share of three different mass market services--assuming equivalent retail prices and profit margins--is the same as 99 percent share of a single-product market. 

In principle--under those conditions--the cost per location and cost per customer are nearly identical. The revenue per location and revenue per customer also are nearly identical. 

That is a fundamental change in business model for suppliers of retail telecom services. 

Legacy Revenue Rate of Decline Really Does Matter

As with any other legacy service, the rate of decline and possible stabilization of demand are key issues for retail service providers. Long distance revenue provided an early example of fundamental decay of a key legacy service that required “harvesting.” 

The former AT&T, for example, faced one fundamental problem between 1983 and 2005: gross revenue and profit margins for long distance services steadily dropped. 

source: FCC 

That meant an immediate strategy of harvesting existing revenues, while searching for replacement revenue sources, largely considered to be local telecom service. That lead both AT&T and MCI--the dominant long distance providers--to be huge and dominant forces in the early days of the post-Telecom Act of 1996 era, when many service providers tried to build sustainable local telecom businesses initially based on wholesale mechanisms.

source: U.S. Department of Justice 

The search for a higher-margin facilities-based strategy drove AT&T to acquire cable TV assets, then considered a platform for broadband and voice services. For a time, AT&T was the largest cable TV provider in the United States. 

The unwinding of that strategy was caused by the high debt load AT&T took on to make the acquisitions as well as inability to make the cable platform perform as reliably as hoped.

AT&T discovered it would take too much time and capital to upgrade the cable assets sufficiently to provide reliable broadband internet access and voice services. The other issue was that the revenue growth model had shifted to mobile services. 

AT&T bought into the mobile business in 1992 when it acquired a minority stake in McCaw Cellular. By 1994 AT&T had acquired the whole company, only to spin it off in 2000. In 2004 the whole unit was sold to SBC and BellSouth. In principle, buying into the mobility and cable TV operator businesses made strategic sense, even if the execution was not optimal. 

The foundational issue is the rate of decline, which determines how much time and resources AT&T or any other firm would have to transition to a new business model. One might argue the long distance business simply eroded too quickly to allow a graceful transition. 

One might argue AT&T encountered the same issue in the aftermath of its purchase of DirecTV, which executives inside and outside of AT&T believed would see revenue declines more gradually than ultimately happened. 

Take rates for fixed network voice provided another early example of the process. Perhaps quite unexpectedly, demand for fixed network voice peaked about 2002, entering a period of sustained decline that added voice revenues to long distance and video revenues as causes for concern. 

Linear video is the current worry, as both long distance revenue and fixed network voice have long since declined so substantially they no longer are capable of driving supplier revenue to any significant extent. 

Homes paying for traditional linear video subscriptions will have fallen from over 90 percent in 2010 to 53 percent in 2026.

You know the next set of questions: what happens as mobile subscription growth slows? What happens when broadband growth rates slow? The early interim answers for mobile operators are to shift growth to mobile internet services. The early interim answers for broadband providers are to increase revenues by boosting speeds and other features. 

None of those interim steps will suffice long term. Some new revenue growth engine will have to be found, simply because customer willingness to pay ever-higher fees either for mobile services or broadband is sharply limited. 

Up to a point, retail service provider strategy over the past couple of decades has been premised on taking existing market share from other suppliers. Telcos have gotten into video services; cable operators have gotten into voice and mobile services. 

Business specialists have taken share from incumbent telcos. Global bandwidth suppliers have supplanted telcos as the drivers of capacity expansion. Mobile operators have grown at the expense of fixed network voice suppliers. Application providers have essentially destroyed much of the mobile text messaging revenue stream and demand for voice revenues and conferencing. 

The issue for AT&T with DirecTV is simply that the rate of revenue decline was faster than most observers expected. The gradual attrition of the asset always was expected. We saw that with long distance, fixed network voice and mobile messaging. 

Faster attrition means the search for alternative revenue sources does not produce results fast enough to compensate for legacy revenue decline.