ETNO Demand for Hyperscaler Payments Raises Issue: How Broken is the ISP Business Model?

Is the connectivity service provider market broken? If so, what is the reason and what are the solutions? Those questions are inevitable as the European Telecommunications Network Operators’ Association continues to argue before EU regulatory bodies that some form of revenue sharing (taxes, essentially) need to be levied on hyperscale app providers to make the service provider business model work. 

The basic argument is that hyperscalers impose most of the costs of building and operating an access network, but that internet service providers cannot “recover their costs” because of asymmetric bargaining power with the hyperscalers. 

Not to be flippant, but that is akin to electricity providers arguing that they do not have the power to levy fees on the manufacturers of air conditioning or heating systems, light bulbs or lamps to support the electricity delivery business model. 

Electrical utilities recover such fees--and support their business models--by charging customers for consumption of electricity. Historically, so did telcos, though the role of government subsidies and price regulation also was key. 

As always, the problem is complex and not simple to resolve. Large ISPs argue that their business models are unworkable without direct revenue contributions from third parties. That is the gist of the argument. 

Some of us might put the emphasis elsewhere. ISPs are admitting their business model is structurally flawed and essentially broken. So the issue is how to remedy the problem. And ISPs might not like the eventual answers.

One potential answer is to nationalize the former incumbent telcos, making them government-owned entities again. Another answer is to allow the markets to return to monopoly structures by allowing most of the competing firms to fail. 

Nor can big ISPs avoid questions about the soundness of their own cost structures; marketing practices and efficiency. Ignoring for the moment differences in market scale, U.S. ISPs between 2014 and 2020 reduced the amount of capital investment; European telcos saw capex burdens grow. 

To be sure, some of the change might be transitory. Japan’s costs climbed while South Korea’s capex first climbed, then dropped, presumably because of the spike caused by early 5G deployment. 

Still, one “easy” solution is for ISPs to charge their own customers based on volume consumed, as remains the case for electricity, fresh water, natural gas. In fact, nearly every commodity purchased by consumers is based on volume of consumption, whether that is groceries, gasoline or clothing. 

Eventually, that basic line of reasoning might eventually lead back to price controls and rate regulation, which ISPs almost always oppose. But inability to charge based on volume of consumption is among the root causes of business model instability. 

ETNO and others always point out the valuation differences between hyperscalers and access providers as though that necessarily shows a problem exists. It is a false analogy.

Different industries often have different valuations. And those expectations are based on revenue growth. Hyperscalers grow fast, telcos do not. That is why the valuation differential exists.

That difference in growth rates arguably explains most of the valuation difference between firms, and between industries. One might as well say that ISPs have lower valuations because they grow more slowly.  

source: ETNO 

If one dislikes slow growth, and that is a structural matter for any industry, then leaders need to ask how, and if, they wish to continue. With private assets, there always is something else to do. Assets can be bought, sold, recombined or swapped. Assets then can be deployed elsewhere. It happens all the time. 

To be sure, capital investment is driven by usage. 

Heavy usage is an issue for ISPs. Traditional methods of conquering heavy-usage problems rarely work: profiling and capping heavy users; capping applications; quota tiering; unlimited plans; and throwing more money into capacity. On the other hand, ISPs do not, strictly speaking, use metering mechanisms to allow their customers to regulate their own usage. 

Speed tiers or usage tiers help to some extent by creating proxies for usage rating. That is a choice ISPs make. They could make other choices (though the choices might not be easy or simple). 

But that is a business problem for an ISP to settle, not others. ISPs might have “blamed the government” for imposing costs in the monopoly era. They might blame third party hyperscalers in the modern era. Those are excuses. 

ISPs control their own operating costs to a substantial extent, though of course some would say legacy costs remain embedded uncontrollably in their cost structures (pension costs imposed under monopoly schemes, the “residue” of monopoly era expectations, for example). Though true, those also are excuses. 

Large ISPs might rightly argue they cannot control their costs as much as they would like because there are labor unions to contend with, environmental regulations and so forth, and that is correct. Most large industries could say the same, though. And none of that relieves executives in any other industry from taking action to protect the soundness of business models. 

The proposed ETNO solution likely is unworkable. In some instances, it might be unlawful under current regulatory regimes. In countries where “network neutrality” is law, it would have be undone. 

By definition, charging the owers of some apps and services, while not charging others, violates the core of net neutrality rules. 

And, to be sure, ISPs never really have wanted network neutrality in any case. But many unexpected developments could occur, if the ETNO position carries the day.

Supply and Demand in Several Forms Shapes Customer Experience

Typical customer experience on any retail connectivity network--mobile or fixed--fluctuates over time, in part because of the way networks are designed to operate and in part because network usage varies over time. 

Network capability increases in a stair step fashion. Networks are built. Demand gradually increases, stressing network capacity. So an upgrade happens. Demand slowly builds again. Then another upgrade happens. 

source: Cloudtp 

Something of the reverse happens to older platforms: as the networks become saturated, experience decreases. A next-generation network is launched and experience on the new network is better. 

Paradoxically, experience on the legacy network also can improve, up to a point, as users migrated to the newer platform, freeing up capacity on the legacy network. 

As one example of how loading affects a new platform, Verizon’s 5G typical performance dropped when more customers started using the network.  That is more likely to happen when the new platform is bandwidth constrained, as the early Verizon 5G coverage network was limited by use of low-band spectrum. 

User experience on 2G networks when 3G was launched, or 3G experience after 4G was launched provide examples of how legacy network experience can improve after a replacement network is launched. 

Up to the limitations of each platform,  as users migrate to the next-generation platform, there is less contention for resources of the legacy network. So users who remain on the legacy platform can have better experiences as there is less contention for those resources, up to the limits of the platform. 

In some markets, for example, the 3G network winds up used mostly for voice connections, while data demand is shifted to 4G. In some markets, for a time, 4G will increasingly be used for voice, while 5G handles the bulk of data activity, as more users switch to 5G. 

There also is a demand effect. As more users migrate to mobile services as their primary voice connection, customers who remain users of fixed network voice tend to have good reasons for doing so. So aggregate customer satisfaction among those users can increase as well. The less-satisfied customers already have left. 

The process then plays out further, as the performance gap between legacy and newer networks widens. Eventually, it makes sense to decommission the older legacy networks. In the mobile business, that means shutting down older networks entirely and repurposing the spectrum resources.

In the fixed networks business it means either decommissioning the public switched network entirely or replacing copper access with optical fiber; upgrading hybrid fiber coax networks to newer versions of DOCSIS; or substituting fixed wireless or satellite connections for copper access. 

But marketing also plays a role. Some of us buy gigabit per second fixed network access though we do not really need it. More of us will buy symmetrical connections even though we really do not need it. Those supply side effects will change demand curves. 

The point is that end user experience on a network is shaped by both demand and supply actions, including marketing, not just capital investment to upgrade the networks. Also, user experience on a new network will decline with network loading, while experience on the legacy networks can improve, as loading decreases.

Ericsson Completes Vonage Acquisition that is Puzzling in Some Ways

Ericsson says it has gotten final approval to complete its acquisition of Vonage. The stated goal of the transaction intent has been to allow Ericsson “to expand globally in wireless enterprise,” Ericsson has said. But the deal has seemed puzzling in some ways. 

Does Ericsson really need Vonage’s cloud-based platform for enabling enterprise voice, messaging and video? If not, what does it see as the acquisition’s value? Some of those questions might remain even if one agrees with Ericsson about the intended target use case.

“Vonage’s presence in the Communication Platform as a Service (CPaaS) segment will provide Ericsson with an opportunity to access…a market (this) is expected to reach USD 22 billion by 2025, growing at 30 percent annually,” Ericsson has said. Some believe the market is a bit smaller, while others believe it is bigger. Some believe the market is substantially bigger.  

But it is a niche market; the successor of the older “private branch exchange” or “business telephone system” market. The market also is highly fragmented and arguably more fragmented than the “phone system” market CPaaS replaced. 

One reason the market is fragmented is that it is inherently hard to obtain scale in a market based on application program interfaces rather than computer hardware. Also, the market includes smaller organizations, not only enterprises. As always, that limits the ability to control unit costs. 

And, as was true of the business phone system market, enterprises often find it costs them less to “do it yourself” using owned software and hardware solutions, rather than “rent” capabilities as a service. Can Ericsson succeed in transforming a significant portion of a “recurring services” business model into a “owned platform” product model? And is that even desirable?

Right now, the Vonage Communications Platform delivers about 80 percent of Vonage’s total revenues. 

In a broad sense, the acquisition might be viewed as part of the move by public network infrastructure providers to directly supply enterprises with mobile platforms intended for use as local area and private networks. 

Some might be a bit confused about the move, though. It is not so clear that Ericsson actually needs Vonage for core technology (unified communications platform), including the ability to “voice enable” or “messaging enable” any application.

Ericsson notes the community of developers who support the platform. Ericsson might see the 120,000 or so enterprise customers as valuable references and also a way to gain insight on how to serve the market. 

Historically, though, the hardware-based forerunner of CPaaS was the business phone system. And that market has tended to move towards decentralization rather than centralization over time, as limited scale and high distribution costs force larger suppliers out of the market, with specialists of smaller scale taking their place. 

To be sure, Ericsson has had a history of exploring “as a service” models. But those efforts tended to center on new use cases beyond core public network communications, such as entertainment services. 

Ericsson might see something others do not. Ericsson might have the resources to leverage Vonage assets to support what it already plans for private networks. But it might also be chasing a niche market with limited upside. 

Or so it has seemed to at least some an odd fit.

There is a reason the business phone market, and its successor CPaaS market, has not been easy for larger firms to lead. Fragmented markets tend to lead to fragmented supplier structure. That is something Ericsson almost certainly will have to overcome.

Post-Covid Spending Reversal Could Affect Connectivity, App, Device Sales

Consumer technology sales boomed during the Covid pandemic as at-home workers, students and consumers shifted spending from services and experiences to digital technology. Now the shift is going the other way, as consumers spend more on services (experiences such as travel, restaurant meals, hotel stays) as stay-at-home restrictions have eased.  

source: CTA 

That trend reversal could affect home broadband net additions, mobile phone sales, mobility subscriptions, streaming video subscriptions or other data center, connectivity and app trends built on more stay-at-home pursuits. 

source: Morningstar  

ESG is a Case of "Feeling Good," Not "Doing Good"

Do indiscriminate environmental, social and governance policies actually harm developing countries? Some say yes. ESG actually harms development in the global south. 

In fact, says one study, climate policies will increase poverty.   

As has been the reality for many decades, the advice given by some developed world leaders to developing nation leaders makes some rich nation citizens feel better about themselves, but stands in the way of developing nation efforts to improve social and economic well being. 

Much the same can be said about other well-intentioned but harmful practices, including foreign aid, which can make life worse for the people of the developing world. In fact, some argue, foreign aid often exacerbates problems. Paradoxically, efforts to help can make matters worse. 

More harm than good is not a rare opinion about outcomes, anymore. In the construction of policy it helps if ends and means are aligned. Outcomes we desire have to be supported by means that actually work.  

What matters is doing good, not “feeling good.” Too many policies allow us to feel virtuous, but actually make lives worse for the people we impose policies upon.

Are ISPs "Owed" Money from App Providers or Only ISP Customers?

Can telcos and other connectivity providers really escape their role in the value chain? Pointedly, are access providers unfairly victimized by apps their customers use?

In the monopoly era of closed networks, the case would have made more sense. No app could operate on a public telecom network without the approval of the network owner. And consider video entertainment services that are traditionally the most bandwidth-intensive apps used by people. Were TV broadcast networks or cable operators victimized by customers watching lots of television?

In the open, internet era, that logic does not hold. Any lawful app can operate on the internet, in a permissionless manner. That is a wildly different business model for internet service providers. 

Customers are not users. An ISP can set and modify the business relationship with its access customers. No ISP can control or profit directly from any of the non-owned apps any customer chooses to use. 

Heavy usage remains an issue for ISPs. Traditional methods of conquering heavy-usage problems rarely work: profiling and capping heavy users; capping applications; quota tiering; unlimited plans; and throwing more money into capacity. 

But that is a business problem for an ISP to settle, not others. 

Asked another way, consider an analogy: can electricity providers, fresh water and wastewater providers escape their roles in value chains and ecosystems? Are energy providers victimized by their customers? Should appliance manufacturers share in electricity payments because some applicances use more energy than others?

Are transport providers (airlines, shipping lines, road and pipeline owners) unfairly victimized by customers whose reasons for traveling can vary? Or is the issue the fair market price for customers using transport?

Such questions matter because business strategy matters as connectivity providers try to grow revenues, maintain or boost profit margins and obtain higher market valuations. 

The stark reality is that if connectivity service providers are “utilities”  or “infrastructure” in the same mold as electricity, natural gas, railroads, airlines, shipping companies, sanitation and water firms, with high capital investment requirements and slow growth, then it will be exceedingly difficult to dramatically change industry valuations, revenues or profits. 

To boost valuations, connectivity providers might have to grow beyond their present infrastructure roles. And that has proven difficult to impossible, historically. 

Connectivity interests such as the GSMA are fond of pointing out value differences between access providers and app providers who use access networks. Over time,GSMA  points out, the value of apps and services using the internet has grown as a percentage of total value chain revenues, compared to enabling infrastructure, connectivity or user interface revenues, for example. 

Public market valuations of app providers have grown faster than valuations of access providers, some point out. 

That is true, but misleading. Industry valuations differ for all sorts of reasons, and utility industry valuations tend to be lower than those of consumer-facing or business-facing industries, for example. 

And while it is true that all internet apps, services and business models depend on internet access, so do all other industries rely on transportation networks, wastewater and freshwater networks, as well as electricity and energy networks. 

The fact that industry valuations for sectors that use electricity, communications, transport and other energy and sanitation services are different, or higher, than valuations of utilities, reflects something about the financial value of those industries. 

The argument that some other industries should be revenue sharing with connectivity service providers is like arguing that appliance manufacturers should be sharing revenue with electricity providers. Some appliances, after all, consume lots of energy, requiring electricity providers to invest more capital. 

In EU homes, for example, the most energy is consumed by heating and cooling operations, followed by lighting. But for electricity providers, the customer relationship is with the residents of homes, not the manufacturers of appliances, according to Grist.

Likewise, internet service providers have a customer relationship with the businesses and consumers who want internet access. There is no such relationship with the apps and services consumers or businesses interact with and use.

 

If global gross domestic product is about $100 trillion, and  annual connectivity provider revenues amount to perhaps $1.6 trillion, then connectivity service providers represent about 1.6 percent of global gross domestic product.   

The industry would prefer different and bigger roles in the internet ecosystem, to be sure. But it continues to prove difficult for connectivity providers to take on additional value-generating roles. 

Doing so by organically growing capabilities is slow and generally unavailing. Growing by acquisition is financially difficult as equity multiples in the connectivity business tend to be lower than multiples in other adjacent parts of the value chain. 

Earnings multiples in the telecom industry are far lower than in most other industries, for example.  Enterprise value to revenue multiples  might appear more comparable to other industries. 

Mobility assets are easier to describe than fixed assets these days, but even mobile valuations are lower than many other industries, though higher than oil and gas exploration and airline transport.  

Most of the economic activity generated within the internet ecosystem happens elsewhere: components, devices, infrastructure, applications, advertising and commerce. 

Connectivity providers must create new roles elsewhere in the ecosystem to significantly alter their revenue, profit and valuation profiles.

Connectivity Providers Cannot Escape Their Role in the Value Chain

Connectivity providers might not like their role in the internet ecosystem and value chain, but it cannot be wished away, as one occasionally hears from policy experts looking at tourism-driven economies. 

As with other economic realities--nations with lots of cheap energy, mineral abundance, productive farmland, good seaports, high educational attainment, social cohesion, strong rule of law, abundant clean water and other resources--nations must begin with what advantages they have been given. Or cope with the disadvantages of not having those things. 

source: Kearney

It is always possible to “zoom in” and emphasize some parts of the value chain (data centers, subsea networks, access networks (mobile and fixed). But by some measures, the “digital economy” might represent nine percent of U.S. economic activity, for example. Connectivity is a fraction of that. 

Most of the economic activity generated within the internet ecosystem happens elsewhere: components, devices, infrastructure, applications, advertising and commerce. If global gross domestic product is about $80 trillion, annual connectivity provider revenues amount to perhaps $1.6 trillion, or about two percent of global GDP.  

source: Bureau of Economic Analysis 

As with other utility-like industries, the value of goods and services produced using electricity, roads, railways, airports, bridges, communications networks and other energy networks is vastly more than is spent on the infrastructure services and facilities themselves.

Economic activity directly supported by connectivity keeps growing. E-commerce, though, is still only about 15 percent of all retail commerce, and connectivity get  none of that in a direct sense. 

If you have been in the connectivity business long enough, you have heard executives talk virtually continually about how they will emerge as leaders in new adjacencies or parts of the value chain. 

You also know how hard that is to accomplish. You also will have become accustomed to equity analysts arguing such efforts should be resisted, even as other analysts argue such diversification is necessary. 

Wishing it were not so does not help.