The prevailing wisdom about connectivity provider ownership of content assets always seems to be that bundling access to content with connectivity boosts revenue per account. The idea seems to be that vertical integration with content ownership benefits the connectivity provider primarily as it adds value to the connectivity product.
The logic is sound enough, as far as it goes. But it might also miss another point. In the internet ecosystem, only so much value can be driven in any single segment of the value chain. An alternative idea is to participate in the revenue upside in multiple segments of the value chain--vertically integrated or not--as a way of growing total revenue, free cash flow or profits.
In that view, while synergies are helpful, the larger issue is sustainability. To the extent that every connectivity product eventually becomes mature, and to the extent big new connectivity products are hard to discover or create, it is helpful if connectivity is not the only role within the ecosystem, or source of revenue.
Looking only at equity value, application providers vastly outproduce connectivity providers, looking at share price appreciation, for example. In the U.S. mobile market, only T-Mobile has been able to produce equity value growth at half the rate of firms such as Facebook, Amazon, Apple, Netflix and Google.
AT&T and Verizon have experienced flat growth since 2016. The difference is that T-Mobile is able to grow by taking share in the core connectivity business, the same formula used by cable operators.
source: Bloomberg
Eventually that exhausts itself. Eventually, as has been the case since the advent of deregulation starting in the mid-1980s, big new product categories must be created beyond mobility, the current revenue driver.
One sign of the looming exhaustion of mobility in advanced markets is steadily declining average revenue per user or account.
source: Bloomberg
The difficult, but obvious solution, is that connectivity providers have to participate more broadly in other segments of the value chain. This is different from “vertical integration.” Fundamentally, the additional roles need not directly contribute to core connectivity value or revenue.
What those roles must do is create additional and sustainable revenue, allowing firms to diversify their value, roles and revenue sources away from a strict reliance on connectivity revenues and services, even if such roles remain crucial.
Perhaps an analogy is the move by Apple from reliance on hardware sales with the addition of services, content and apps.
Amazon’s move into logistics is more an example of vertical integration, a way to reduce operating costs. Netflix original content is a similar “internal” move, designed to create distinctiveness for its streaming service, and is essentially an example of vertical integration.
Likewise, Facebook and Google own undersea capacity networks precisely because doing so reduces their operating costs. Amazon, Facebook and Google build their own servers and own their own hyperscale computing centers for similar internal reasons. Vertically integrating such functions reduces operating cost.
That is not necessarily the value of connectivity provider movement into additional roles within the ecosystem. When they have been successful, connectivity moves into data center operations, content ownership, mobile banking or payments, app stores or cloud computing have less reduced internal operating costs and more increased value, roles and revenue within the ecosystem.
if the core business keeps shrinking, new roles will have to be found.
Ericsson offers a fairly simple argument for why big service providers have to consider moving into other areas of the information ecosystem: growth will not be found in the consumer connectivity business.
Simply put, growth rates in the consumer communications business are forecast to grow only about 0.75 percent per year to 2030, while the broader information technology business grows at a compound annual growth rate of 12 percent per year.
source: Ericsson
In the connectivity business, suppliers lose half of legacy revenue every decade, and have seen this happen virtually every decade since competition replaced monopoly as the industry structure. Do “nothing” and the core business is guaranteed to shrink.
Just to keep revenues where they are, new sources of revenue, amounting to half current revenues, must be found every 10 years.
The point is that connectivity providers eventually will find new roles (larger or smaller) within the value ecosystem. Many firms will lack scale to do much other than supply local connectivity, and will be acquired or sold. Firms with scale will gain scale, but vertically within the stack, rather than simply horizontally.
If Bell Labs is correct, the key value proposition for the “communications” business will shift from “we connect you” to something else. It might seem quite ethereal. Someday it will be seen as eminently practical.
