For Most Telcos, Net Revenue Gain Comes not from 5G but Elsewhere

For the foreseeable future, net changes in telco revenue can happen only at the margin. Over the next decade, mobile operators, for example, will replace half their 4G accounts by 5G accounts. So the issue is whether average revenue per account stays the same; increases or decreases. 

Assuming at least a stable ARPA, the balance of revenue changes will come in fixed network services. And there the issue is whether new revenue sources offset expected losses in consumer and business service revenue. 

Keep in mind that revenue-neutral product replacement is necessary, but will not help telcos grow total  revenues. Product replacements only swap legacy revenue for new sources, as in the example of 4G accounts being replaced by 5G accounts. 

All things equal (operating costs; marketing costs; capital investment; revenue per account), swapping 5G for 4G results in zero net revenue gain. All revenue growth beyond zero must come in other areas. 

On a global level, revenues appear flat. But revenue contributors change substantially every decade. In fact, telcos routinely lose half of present revenues every decade. That seems unthinkable, but has happened. 

“Over the last 16 years we have grown from approximately 25 million customers using wireless almost exclusively for voice services to more than 110 million customers using wireless for mostly data services,” said Lowell McAdam, former Verizon Communications CEO.

It is an illustrative comment for several reasons. It illustrates Verizon’s transformation from a fixed network services company to a mobile company. But the comment also illustrates an important business model trend, notably that of firms in telecom needing to replace about half their current revenues every 10 years or so.

In the U.S. telecom business, for example, we already have seen that roughly half of all present revenue sources disappear, and must be replaced, about every decade.

According to the Federal Communications Commission data on end-user revenues earned by telephone companies, that certainly is the case.

In 1997 about 16 percent of revenues came from mobility services. In 2007, more than 49 percent of end user revenue came from mobility services, according to Federal Communications Commission data.

Likewise, in 1997 more than 47 percent of revenue came from long distance services. In 2007 just 18 percent of end user revenues came from long distance.

Though revenue attrition has been clearest for fixed network voice, the same process has been seen for mobile voice, text messaging, long distance revenues, mobile roaming and business customer revenues overall, in many markets. 

We can disagree about how much new revenue some communications service providers will have to create over a decade’s time, to replace lost legacy revenues.

If global telecom revenue is about $1.6 trillion to $2 trillion, and assuming about half the revenue is earned in mature markets, then the revenue subject to disruption ranges from $800 billion to $1 trillion.

Half of that represents $400 billion to $500 billion. That, hypothetically, is the potential amount of global revenue that might be lost, and would have to be replaced. The good news is that most of the replacement will come as 5G displaces 4G subscriptions. 

What is equally certain is that a huge amount of revenue from new services will be necessary, even if consumer purchases of Internet access--and replacement of 4G by 5G--happens.

One fundamental rule of thumb is that, in mature markets,  service providers must plan for a loss of about half of current revenue every decade or so. That might seem shocking, but simply reflects historical developments.

Nor is that rate of change unusual. In the digital consumer electronics business, it might not be unusual for an executive to predict that half the products that drive sales volume in 10 years “have not been invented yet.”

What is new for the telecommunication business is that product replacement now is a fundamental issue, even if for 150 years the only product was voice.

source: IBM

In 2001, in the U.S. market, for example, about 65 percent of total consumer end user spending for all things related to communications and video services went to "voice."

By 2011, voice represented only about 28 percent of total consumer end user spending.

Over that same period, mobile spending grew from about 25 percent to about 48 percent. Again, you see the pattern: growth of about 100 percent (losses of 50 percent require gains of 100 percent, to return to an original level,  as equity traders will tell you).

Video entertainment spending likewise doubled.

In the U.S. market, one can note roughly the same pattern for long distance and mobile services revenue. Basically,mobile replaced long distance revenue over roughly a decade.

At one time, international long distance was the highest-margin product, followed by domestic long distance.

That changed fundamentally between 1997 and 2007.

Over that 10-year period, long distance, which represented nearly half of all revenue, was displaced by mobile voice services.

In the next displacement, broadband is going to displace voice.

That is not yet an issue in some regions that still are adding mobile and fixed network subscribers, but already is an issue in most developed regions, where voice and messaging revenues already are declining.

source: STL Partners

Though some might continue to hope that higher Internet access revenues will offset voice and messaging revenue dips, the magnitude of voice revenue declines will be so sharp that in many markets, even additional Internet access revenues will be insufficient in that regard.

In fact, rates of revenue growth have been dropping in all regions since at least 2005, according to IBM.

At least so far, ability to fuel growth by extending service to customers with low average revenue per user will continue to drive revenue growth, even for legacy services, for a while. The only issue is when saturation is reached in each particular market.

When that happens, the same pressure on voice and messaging revenue already seen in mature markets will be seen in presently-growing markets.

Those changes can be hard to discern, as the top line obscures changes in revenue contribution from the largest sources. Voice, messaging and long distance services have fallen dramatically. Consumer fixed network usage of voice no longer drives financial results, its place taken by internet access (broadband). 

Mobility now drives growth in most markets, and especially the data services component of mobile revenues. Subscription growth still is highly meaningingful in developing Asia and Africa. 

source: Delta Partners 

Basically, 5G mostly prevents telco revenue from declining. It does not drive revenue growth. If we expect continued declines in fixed network voice, then broadband and other new services will have to be relied on for most of the growth, in most markets, by most operators. 

The lucky scenarios will happen when mobile-first operators actually are able to drive higher ARPA in the 5G era.

Where Growth is Most Needed: at the Margin

Growth is the paramount issue for the glocal telecom industry; perhaps most obvious in saturated developed markets, but eventually an issue for every market, including those that are growing fast as more human beings use mobile phones. 

Growth was not always the primary objective. In the monopoly era, telcos were a slow-growth utility with guaranteed rates of return and not expected to “grow” revenues very much. They were expected to support high-quality voice services at affordable mass market rates. 

In the competitive era all that has changed. Telcos compete for sources of capital along with all other industries; face competition as do most firms and also face fundamental disaggregation of the value generation mechanism, which also means less revenue upside from the core business. 

source: Arthur D. Little 

As helpful as projected telco growth drivers are in the edge computing, internet of things, private networks and 5G areas might be, they are not likely to generate revenue growth at a rate faster than the attrition of legacy service revenue. Essentially, telcos are running on a treadmill that will reach an unsustainable pace. 

Enterprise and business services have always represented close to half of total revenues and are expected to be a key upside driver in the 5G era. 

On a global basis, telco revenues have experienced low-single-digit growth since 2014, faster in Asia; slower in Europe. North America has been perhaps the strongest-growth area among developed regions, where mobility revenues grew at 3.5 percent annually between 2008 and 2018, for example, compared to Asia mobile revenue growth of 6.4 percent and negative growth in Europe of -4.4 percent. 

That is the good news. The bad news is that some analysts expect mobile revenue growth to go negative in North America as well, with global mobile revenue growth slowing to below one percent per year.

There is a widely held perception that rapid growth of IoT devices will, in turn, drive connectivity revenue for operators. European Telecommunications Network Operators (ETNO), in its 2019 Annual Economic Report, estimates that the number of IoT connections in Western Europe will increase from 78 million to 433 million in 2023, but IoT connectivity revenues will increase from EUR 1.5 billion in 2017 to EUR 4.1 billion in 2023.

While helpful, that is not sufficient to replace half of all existing revenues over 10 years. The volume simply is not there. One might make the same argument about edge computing or private networks: the incremental revenue will not be large enough to offset a 50-percent loss of existing revenues. 

Service provider edge computing revenues will be helpful, but at relatively low magnitudes. Private networks likewise offer upside, but not at a level sufficient to really move the revenue needle overall, for large telcos. 

For large telcos, perhaps the good news is that--although mostly a zero-sum game--replacement of 4G accounts by 5G accounts could easily drive most of the replacement revenues over the next decade. That will not supply much growth, but likely is the only feasible way for telcos to replace half their present revenues, assuming average revenue per account does not change in a negative way. 

 “Lose half of 4G accounts and replace them by 5G” would represent most of the revenue transformation necessary over a decade. 

What then needs work is a way to replace lost fixed network revenues with other new sources. And that is where IoT, edge computing and private networks, plus other new revenue sources, really do matter.

Rational Supply Chain Behavior at the Firm Level Leads to Irrational Systemwide Impact

The supply chain distortions exacerbated by the Covid pandemic were not unprecedented. The same sorts of things happened during the Great Recession of 2008, when demand changes arguably were the big impetus. 

“Output in the steel industry dropped by an unprecedented 30 percent and prices by about 50 percent from June 2008 to December 2008,” McKinsey notes. Demand side behavior concatenates through the value chain. 

 source: McKinsey

But supply side behavior also matters, and could be a key issue as the recovery from Covid continues. As we have seen with shortages of all sorts of things--computer chips, lumber, toilet paper, boats, container ship capacity, port unloading--supplier effort to compensate for shortages can overshoot, leading to supply excesses. 

Chip shortages have lead to shortages of new vehicles, as new cars and trucks cannot be built without ample chipset supply. That, in turn, has lead to shortages of used vehicles. The logical course of action, when possible, is to stockpile inputs. We might be seeing that in the retail grocery area, for example. 

But stockpiling can be inefficient, can exacerbate supply shortages, might contribute to inflation, and also eventually leads to oversupply, as manufacturers step up production to meet demand which is inflated by stockpiling behavior. It corrects, but not without damage. 

Grocery retailers are stockpiling goods in an effort to avoid shortages and keep retail prices lower, but in doing so will inevitably increase inflation rates, as the stockpiling will increase shortages, which increases scarcity, which leads to higher prices. Rational behavior at the firm level still leads to irrational results for the market. 

source: McKinsey 

The point is that both shortages and excess inventory are problems that firm behavior tends to exacerbate. 

SMB IT Spending to Return to Pre-Covid Levels in 2022

One legitimate question we all should have is what changes are relatively permanent post Covid and which trends revert to the mean (back to pre-Covid states). Most might agree that various attempts at “digital transformation” have accelerated. The issue is whether we have simply accelerated temporally, but at similar rates, or whether the rate of change has increased. Nobody seems to believe demand has decreased. 

Analysys Mason suggests that on at least one metric--the volume of information technology investment--Covid caused a change in investment. Analysys Mason also believes the rate of investment will return to pre-Covid levels in 2022. 

Many industries will be making bets about the level of demand for all sorts of  products as “normalcy” returns. 

source: Analysys Mason 

Irrespective of investment levels, virtually everyone expects more growth for cloud computing solutions. In some respects, that is a simple reflection of the fact that computing architecture has changed. Cloud or remote computing now is the norm, as apps are nearly universally expected to be consumable using internet networks.

Global Fixed Network Average Downstream Speed is Now 106.6 Mbps

With the caveat that “average” anything related to the internet can obfuscate as much as illuminate, “average” global mobile speed in June 2021 was 55 Mbps downstream and 12.7 Mbps upstream. “Average” fixed broadband downstream speed was 106.6 Mbps and upstream was 57.7 Mbps. 

source: Speedtest 

Methodology does matter, though, as different sources report often-disaparate figures. 

Telco Content Execution Risk is a Bigger Issue than Strategic Miscues

There is a difference between execution risk and strategic risk. In the former instance a firm or person might have had the right idea, but chose the wrong set of actions. In the latter instance a firm or person chooses an incorrect plan. 

But telco efforts to diversify into content or media--though panned--actually have been a success, by standard innovation rules of thumb. 

Most efforts at innovation of any kind fail. The general rule of thumb is that eight to nine out of 10 efforts will fail. The corollary is that only about one in 100 innovation efforts will create a truly-significant positive change in outcomes. 

Telecom firms sometimes make moves that later are viewed as mistakes of execution or strategy. We might be wrong about such conclusions, in substantial part. 

Consider Verizon’s sale of 90 percent of its  AOL assets, or AT&T spinning out its DirecTV and Warner Media interests into external entities. Both those moves are viewed by many as examples of telco failure. But how many other innovation efforts by either firm, or all other providers, have generated billions of dollars in incremental new revenue, so quickly? 

How many generate billions in incremental cash flow for any single firm? Answer: almost none. 

Some will argue diversifying into content is not a good strategy for connectivity providers. But in 2017 50 telcos around the globe generated more than $90 billion in content revenues, mostly from video services. 

Neither AOL nor Time Warner and DirecTV had the strategic impact Verizon or AT&T hoped for. In the former case lack of scale was an issue; in the latter case the issue was attendant debt burdens. The argument can be made that Verizon simply did not invest enough, or that AT&T invested too much (took on too much debt). 

Still, the incremental boost of revenue and cash flow in both instances was arguably much better than any other moves either firm made in new lines of business. Either firm’s investments in internet of things platforms or services, while also strategically important, produce revenues and cash flow that pale in comparison to what each firm was able to accomplish in content and video, in comparable time frames. 

Organic growth in core connectivity services cannot contribute much, in a growing number of connectivity markets, to revenue. The phrase terminal decline has been applied to legacy connectivity services, for example.  And that leads to a search for new revenue sources.  

source: GSMA Intelligence 

A few cable TV companies also have transformed themselves from video distributors into content owners, mobile service providers, business connectivity providers and leading suppliers of broadband access as well. 

The notion that connectivity providers “cannot” master the content business is incorrect. It can be argued that telcos have had more financial success in content than in their roles as app store providers, equipment manufacturers, computing suppliers or data center suppliers. 

Though legacy telcos do participate to some extent in the enterprise phone system business, system integration, virtual private network and other connectivity lines of business, they often do so as lesser providers in segments dominated by others (either communication specialists or information technology providers). 

The point is that telcos arguably have been more successful in video entertainment than in all other diversification efforts of the past four decades. 

source: GSMA 

In 2018 nearly half of telco executives surveyed by EY cited television and video services as among the top three best ways to grow new revenues. The alternative is failure, if present revenue and profit trends continue. 

Global telco revenue growth rates remain stubbornly close to one percent per year, below the long-term rate of inflation. If one were looking any key component of telecom revenues, one would see a historical curve reminiscent of a standard product life cycle, with declining demand, declining profits or both. 

Product maturation, product substitutes and changes in value are issues telcos have dealt with for a couple of decades already.  So if the core business is under strategic attack, what strategy is called for?

The range of options have not really changed much in four decades. Telcos can run today’s business more efficiently; grow the current business through acquisition or innovation or get into new lines of business. 

All three have worked for various providers; at various times. The biggest single revenue driver was entry into the mobile business. First voice subscriptions for business users; then consumer users; then text messaging and now internet access have provided waves of revenue growth in the mobile segment. 

The larger point is that most innovation efforts fail. Content and video services have been among the successes, not the failures.

Actually, AT&T Did Quite Well in Content and Video Subscription Businesses

Many will criticize telco failures to "innovate." Many will pan diversification efforts such as that made by AT&T into content ownership and entertainment video services. By one reckoning, AT&T actually did quite well.

Many will criticize telco failures to "innovate." Many will pan diversification efforts such as that made by AT&T into content ownership and entertainment video services. By one reckoning, AT&T actually did quite well.

It actually took only a handful of attempts before AT&T was able to emerge as a significant provider of video content, video subscriptions and internet access. In fact, it did not actually take many tries before AT&T and Verizon actually created roles for themselves in content and video. 

On June 24, 1998, AT&T acquired Tele-Communications Inc. for $48 billion, marking a reentry by AT&T into the local access business it had been barred from since 1984. 

Having spent about two years amassing a position in local access using resold local Bell Telephone Company lines, AT&T wanted a facilities-based approach, and believed it could transform the largely one-way cable TV lines into full telecom platforms. 

That move was but one among many made by large U.S. telcos since 1994 to diversify into cable TV, digital TV, satellite TV and fixed wireless, mostly with an eye to gaining share in broadband services of a few different types. 

By some accounts, TCI was at the time the second-largest U.S. cable TV provider by subscriber count, trailing only Time Warner. TCI had 33 million subscribers at the time of the AT&T acquisition. As I recall, TCI was the largest cable TV company by subscribers. 

For example, in 2004, six years after the AT&T deal, Time Warner Cable had just 10.6 million subscribers. In 2000, by some estimates, Time Warner had about 13 million subscribers. That undoubtedly is an enumeration of “product units” rather than “accounts.” Time Warner reached the 13 million account figure by about 2013, according to the NCTA. 

Since 1994, major telcos had been discussing--and making--acquisitions of cable TV assets. In 1992 TCI came close to selling itself to Bell Atlantic, a forerunner of Verizon. Cox Cable in 1994 discussed merging with Southwestern Bell, though the deal was not consummated. 

US West made its first cable TV acquisitions in 1994 as well. In 1995 several major U.S. telcos made acquisitions of fixed wireless companies, hoping to leverage that platform to enter the video entertainment business. Bell Atlantic Corp. and NYNEX Corp. invested $100 million in CAI Wireless Systems.

Pacific Telesis paid $175 million for Cross Country Wireless Cable in Riverside, Calif.; and another $160 to $175 million for MMDS channels owned by Transworld Holdings and Videotron in California and other locations. 

By 1996 the telcos backed away from the fixed wireless platforms. In fact, U.S. telcos have quite a history of making big splashy moves into alternative access platforms, video entertainment and other ventures, only to reverse course after only a few years. 

But AT&T in 1996 made a $137 million  investment in satellite TV provider DirecTV. 

Microsoft itself made an investment in Comcast in 1997, as firms in the access and software industries began to position for digital services including internet access, digital TV and voice services. In 1998 Microsoft co-founder Paul Allen acquired Charter Communications and Marcus Cable Partners. 

Those efforts, collectively, are well within the “one success in 10” rule of thumb, for any single firm, and close to it for the entire industry. More significantly, the amount of revenue generated by those efforts come well within the “one in 100” rules of innovative success for “blockbuster” impact. 

AT&T, remember, continues to own 70 percent to 80 percent of its former Time Warner content assets. It continues to benefit from the cash flow of DirecTV and its fixed network video services. It continues to drive cash flow from HBO Max.

And all that was achieved with far fewer than 10 attempts. By standard metrics of innovation, that clearly beats the odds.

What most will miss is the difficulty of making successful change in any organization, on a routine basis. As a rule of thumb, only about one in 10 efforts at change will succeed. Quite often, only about one in 100 successful innovations is truly consequential in terms of organization performance.

source: Organizing4Innovation 

That means we must tolerate a high rate of failure before we can hope for successful change. And we must fail quite a lot before we encounter a successful innovation with the power to change a company's or a whole industry's fortunes.

Of all the innovations connectivity providers have attempted--and been criticized for--how many have had industry-altering implications? Not many. Fixed network voice; mobile phones; internet access and possibly entertainment video subscriptions have been transformative.

Deregulation, privatization and competition have been historically transformative. But one might argue that was something that "happened to" the connectivity business, not necessarily an innovation of the industry itself.

Yes, we have seen many generations of business data networking services and business phone systems and services. But few have revenue magnitudes so great they change the fortunes of the industry or whole firms. In 150 years, only mobility and internet access have had clear industry-altering implications.

We all are familiar (even when we do not know it) with the sigmoid curve, otherwise know as the S curve, which describes the normal adoption curve for any successful product. We are less familiar with the idea that most innovations fail, whether that is new products, new technologies, new information technologies or business strategies. 

S curves apply only to successful innovations.

Most new products simply fail. In such cases there is no S curve.  The “bathtub curve” was developed to illustrate failure rates of equipment, but it applies to new product adoption as well. Only successful products make it to “userful life” (the ascending part of the S curve) and then “wearout” (the maturing top of the S curve before decline occurs). 

source: Reliability Analytics

Though nobody “likes” to fail, there is good reason for the advice one often hears to “speed up the rate of failure.” The advice is quite practical. 

Only about one in 10 innovations actually succeeds. Those of you who follow enterprise information technology projects will recognize the pattern: most efforts at IT change actually fail, in the sense of achieving their objectives. 

source: Organizing4Innovation 

“We tried that” often is the observation made when something new is proposed. What almost always is ignored is the high rate of failure for proposed innovations. About nine out of 10 innovations will probably fail. Most of us are not geared to handle that high rate of failure. 

Unwillingness to make mistakes almost ensures that an entity will fail in its efforts to grow, innovate or even survive. 

Those of you who follow startup success will recognize the pattern as well: of 10 funded companies only one will really be a wild success. Most startups do not survive. 

 

source: Techcrunch 

Connectivity providers are not uniquely free from the low success rate of most innovations. Innovation is hard. Most often efforts at innovation will fail. Even smaller efforts will fail nine times out of 10. An industry-altering innovation might happen only once in 100 attempts.

The more failure, the more the chances for eventual success. Many would consider telco initiatives in content and video subscriptions to have "failed." It is more accurate to call them an innovative success, given the relative handful of attempts to lead that business.

AT&T continues to own 70 percent of its former Time Warner content assets. It continues to benefit from the cash flow of DirecTV (about 71 percent ownership) and its fixed network video services. It continues to drive cash flow from HBO Max.

And all that was achieved with far fewer than 10 attempts. By standard metrics of innovation, that clearly beats the odds.