Digital Anxiety Drives Digital Investment

Digital strategy and business model often are inextricably intertwined. A 2021 McKinsey survey of executives shows business processes got a big push in a digital direction in 2020. But the concern goes much further than simply operating internal processes more efficiently or effectively. Whole revenue models seem vulnerable as well. 

source: McKinsey

It is not hard to understand the anxiety. Most businesses these days are susceptible to disintermediation by the internet (taking out “middlemen” in the value chain). That applies to any participants whose function in the value chain is primarily distribution. 

So most products and services are susceptible to internet-based selling and distribution. 

source:  Edzai Conilias Zvobwo 

Beyond that, the potential for new products to displace demand from older products is intrinsically bound up with internet-based production models. Content-based businesses (music, video, print) were early to encounter such product substitution. 

But most industries now face some form of product substitution or re-creation based on digital re-imagination and delivery. Packaged software now has morphed into on-demand software as a service. Computing hardware is increasingly virtualized as well. 

Cameras, music players, watches, pedometers, medical devices, navigation devices and computing devices have seen markets rearranged by product substitutes. 

A wide range of smartphone-enabled marketplaces have been created for transportation, lodging, clothing and many other consumer or business products. 

All of those trends can disrupt gross revenue, profit margins, customer loyalty and customer expectations. As always, lower profit margins create a need for lower operating costs. 

source: McKinsey

So it is not surprising that so many enterprise executives say they believe digital transformation is so important. Markets, revenue and profits are seen as vulnerable to disruption. 

Data Center Traffic Now Equals Internet Traffic

For most of the last 10 years, data center to data center traffic has been a huge part of demand for wide area network transport capacity. With heavy consumer demand for web apps of all types, including streaming video, you would expect IP networks that support consumer access to carry a significant amount of traffic. 

In 2021, for example, internet traffic overall, which includes business-to-consumer and business-to-business traffic, will be roughly equivalent in magnitude. That is part of a trend that has been in place for nearly a decade, where data center to data center traffic has grown as a percentage of total traffic flowing over wide area networks. 

source: Cisco 

The implications for suppliers of WAN connectivity are significant. It now is possible to capture any demand related to public connectivity revenue simply by focusing on data center to data center connectivity. 

In other words, trends in WAN traffic and value have come to resemble the general pattern of global telecommunications, where enterprise or business demand is about equivalent to consumer demand. That does not necessarily correspond directly to revenue shares, but there is a correspondence. 

It also is possible to illustrate the value of interconnection (network effect) by examining data flowing between organizations and servers within a data center. Much of that traffic represents interconnections and data flow between collocated entities within any single data center. 

source: Cisco 

Pre-internet, connectivity providers were the main actors in collocation activity. These days computing as a service suppliers and application providers are a much bigger factor. Connectivity providers might still represent about 64 percent of interconnections, but enterprises represent 34 percent.

source: Equinix Global Interconnection Index

As suggested by the Equinix Global Interconnection Index, private interconnection happens routinely between enterprises, network, cloud and other information technology providers. 

source: Equinix

Digital Business and "Digital" are Not Synonymous

Digital business remains the top business priority of enterprise boards, a survey by Gartner confirms. Some 58 percent of boards said digital technology initiatives are the single biggest strategic business priority. What that means might vary. 

If digital business “is the process of applying digital technology to reinvent business models and transform a company’s products and customer experiences,” then simply digitizing existing processes is not what boards might mean. 

source: Simon Torrance 

Aside from the perhaps-obvious goals of creating new products, services and experiences, digital business more fundamentally includes “reinventing how they interact with their customers, employees and partners” and “creating disruptive business models.” All that requires a clear understanding who customers are, what they want and how revenue is generated from those customers. 

That begins with understanding the dynamics of the core business, more than understanding how technology is applied. Make a mistake with the former and the latter, in all likelihood, will amount to almost nothing. 

That remains true for efforts to create platform business models or “platforms” in the connectivity business, for example. 

source: Simon Torrance

Among the other issues, at least for connectivity providers, is the reluctance of equity and financial markets (more accurately “opposition”) to fully value mixed or conglomerate business models. In other words, the valuation of a connectivity asset is one thing. The valuation of a digital infrastructure asset is another thing. The valuation of a software asset or marketplace or exchange is something else as well. 

There always is pressure to create clear assets that can earn the appropriate valuation, typically because the other assets get a higher valuation multiple than the core connectivity assets. That makes it hard for lower-value connectivity assets to add higher-value functions and assets under one umbrella, as financial markets will always demand separation. 

Among the practical solutions is to allow separation, but retain an equity interest in the separated assets, allowing an owner to participate in the equity upside and the cash flow. That portfolio model will not be instinctive for connectivity asset owners, but is one way out of a conundrum. 

Ideally, a firm would like to participate in faster-growing, higher-valued parts of the ecosystem, without facing constant pressure to spin out those assets so they can be valued appropriately. 

Any connectivity provider that finds success in any higher-valued line of business will face pressure to divest, spin out or sell such assets, relegating that firm to the original core business, albeit with one-time upside from asset dispositions. 

That “create to sell” mentality typically does not fit with a connectivity provider mindset, capital and  human resource assets or manager time frames (which are often far shorter than required to create sizable new assets out of the core). 

But even in the core connectivity business, patient capital might be necessary. That accounts, in some part, for the roles now played by “more patient” capital and the involvement of private equity in many connectivity settings.

Platform Business Models are Not Generally "Line Extensions"

 

Platform business models are quite distinct from those generally used by msot businesses throughout history. The revenue model is relatively rare, even now. So "becoming a platform" is much harder than most believe, as it requires creating a different revenue model than an incument now uses, and supporting different customers, or existing customers in different ways. 

Where Does Millimeter Wave Add the Greatest Value?

There was a time when millimeter wave spectrum was considered too limited for widespread consumer communications, as useful as it was for point-to-point trunking and backhaul. That has changed. Now we look at where and why it is useful for enterprise, service provider and consumer use cases. That's a big change. 

5G Adoption Seeingly Follows Old Consumer Electronics Adoption Pattern

5G seems to be following a traditional consumer electronics rule of thumb, which is that adoption reaches an inflection point at about the point that 10 percent of households have bought. 

According to researchers at Omdia, the important inflection point for 5G is is “the point where 5G starts being revenue positive.” Omdia says about 14 percent of 5G networks have reached that point of 10-percent subscriber penetration. 

Of 150 mobile operators with at least some 5G coverage by June 30, 2021 only 21 had managed to get to a point where at least 10 percent of their subscribers had regular 5G access, according to Omdia. 

The reason 10 percent seems to be the trigger, one might argue,  is that it is the point where early adopters have become customers and users, setting the stage for behavior to extend to the majority of consumers. 

source: Engineering.com 

One can see an example in cell phone adoption by U.S. households. About 1994, household adoption reached 10 percent or so, after a longer period of slow adoption. An analogous pattern happened with smartphone adoption as well. 

 

source: Our World in Data 

The adoption pattern perhaps is easier to visualize with a longer time frame. Here is a chart showing cell phone adoption in the United Kingdom.

source: Our World in Data

A wide range of physical products have shown the same pattern. Automobile adoption shows adoption accelerating once the 10-percent threshold was hit. 

source: Our World in Data

Telco FTTH Assault Will Intensify

The growing rule of thumb for telcos pondering fiber-to-home upgrades is whether the business model works, especially in a context where internet access is the mainstay of the business, and a major support for what remains of the voice business, is the take rate. 

The consensus is that when take rates are about 40 percent, the FTTH upgrade is worth doing. That might also have been the case in years past, but many telcos had enough leverage (debt) that priority for available cash flow had to be debt reduction, rather than network upgrades. 

source: S&P Global 

Now that most telcos have deleveraged themselves, more cash flow is available for other purposes, including network investment. This is true not only for AT&T, but for other fixed network providers as well. 

This is perhaps most obvious in the cases of Windstream and Frontier Communications, for example. Lumen Technologies has divested about half its largely-rural fixed network assets, though some would note this actually will reduce free cash flow, albeit allowing Lumen to concentrate on a footprint that is smaller and better suited to FTTH business cases. 

source: S&P Global 

The potential big change is market share possibly to be gained by AT&T. Frontier Communications arguably will be a significant potential source of net account additions as well. 

source: S&P Global