Lower Prices are a Feature, Not a Bug, for Policymakers

Lower prices are a policy feature, not a bug. Government policy promoting competiton is designed to create lower retail prices. So it should not be surprising that pressure on average prices per user or customer or account now are a major service provider concern.

What else would you have expected? Lower prices are the intended outcome of competition policy.

To what extent is it correct to characterize legacy service provider revenue trends as “down and to the right?” Obviously legacy services such as fixed network voice, mobile messaging and voice and linear entertainment video generally show that pattern. 

What we often forget is that the very objective of introducing competition for connectivity services, and the government policies to support that objective, are intentionally designed to create lower prices. The objective of policy is a “down and to the right” pattern. 

In other words, “down and to the right” is not a bug, it is a feature. It represents the outcome policy intends, and is not a defect of policy. 

source: United Nations

The other angle is that a proven way of increasing ARPU is to increase speed, despite another clear trend: over time, speeds grow but prices remain relatively flat, or even decline. In other words, the cost of a 300-Mbps connection is the same, or less, than a 512-kbps connection three decades ago. 

Over the short period of 2007 to 2017, for example, U.S. typical speeds grew by two orders of magnitude, while prices dropped. 

At the moment, up to 80 percent of U.S. locations can buy internet access operating at least the gigabit per second level.  

source: Versa Technology 

The global pattern is not always transparent. If one looks only at total service provider revenue, that tends to grow each year, in large part because new customers are added in growing regions (Asia, primarily, but also eventually in Africa). 

So global service provider revenues will grow 14 percent between 2022 and 2027, according to researchers at  Omdia. Monthly average revenue per user will fall by four percent. So the pattern is more customers, each paying less than the “typical customer” used to pay. Revenue might ber “up and to the right” but ARPU clearly is “down and to the right.”

source: Omdia 

Every management team seems to emphasize that value can be enhanced, preventing further commoditization. You can make your own assessment of how effective such efforts have been, or could be. 

Disposable income is among the other limitations. It will be hard to boost ARPU very much in lower-income countries. If policymakers succeed in reducing the cost of connectivity to perhaps two percent of gross national income per capita, that further limits ARPU upside. 

source: S&P Global Market Intelligence 

In other words, the goal of policy in developing countries is to actively reduce ARPU. The objective is precisely “down and to the right” pricing. 

Until recently, home broadband was the major product line producing “up and the right” results, but growth now has slowed in mature markets. That pattern looks more like “flat and to the right.”

When service provider executives talk about a transition from “telco to techco” they essentially are saying such moves will change the revenue picture to “up and to the right.” 

Service providers in emerging or younger markets have advantages, in that regard. They can still hope to rely on mobile subscription growth and uptake of mobile internet access to fuel their continued “up and to the right” growth prospects.

Mature market executives who own infrastructure assets have no such luxury, and strategic options often hinge on whether mobility revenues exist. Contestants in mobile or fixed businesses who operate using wholesale access, rather than owning infra, have other options. 

Competitors with Infra-based business models complain about higher capital investment requirements and limited abilities to monetize those investments, not without basis in fact. 

Still, we often forget that the whole point of introducing competition in access markets is to drive average costs “down and to the right.” It is a policy feature, not a bug.

Are FTTH Payback Models Sustainable? What's Good for Private Equity Might Not be So Good for Operators

Some of us would admit to being surprised at the payback models  for fiber-to-home deployments, the degree of business moat protection some believe FTTH offers, and therefore the value of such digital infrastructure assets, compared to other assets such as cell tower sites, data center or edge computing assets. 

Looking back over 25 years of business model assumptions, it is quite startling how much the underlying assumptions have changed. Subsidies now play a bigger role, offering in some cases a 20-percent to 30-percent reduction in capital investment in rural markets. 

On the supply side, though demand is not altered, private equity investment now means more capital is available to accelerate build timetables. 

But the most-shocking change are the revenue assumptions for consumer locations. These days, the expected revenue contribution from a home broadband account hovers around $50 per month to $70 per month. Some providers might add linear video, voice or text messaging components to a lesser degree. 

But that is a huge change from revenue expectations in the 1990 to 2015 period, when $150 per customer was the possible revenue target. In some cases, revenue up to $200 per home location was considered feasible. 

Expectations now hinge almost exclusively on consumer home broadband. 

“Our fiber ARPU was $61.65, up 5.3 percent year over year, with gross addition intake ARPU in the $65 to $70 range,” said John Stankey, AT&T CEO, of second quarter 2022 results. “We expect overall fiber ARPU to continue to improve as more customers roll off promotional pricing and on to simplified pricing constructs.”

Lumen reports its fiber-to-home average revenue per user at about $58 per month.

Recent presentations also have shown fiber-to-home home broadband average revenue per user of about $63. 

source: Frontier Communications 

Granted, most larger ISPs believe they can boost ARPU over time, by adding features, adding speed tiers and moving customers to higher-priced plans with higher usage allowances. 

Market share or installed base is the other huge assumption. Can most providers expect to get 20 percent take rates or as much as 50 percent? And what other assumptions about operating cost are necessary to create a sustainable business case at 20-percent share? 

Most incumbent telcos deploying FTTH have been able to get 40-percent market share after several years of marketing. But is a terminal rate around 40 percent to possibly 45 percent (or even 50 percent) reasonable in most cases? If not, where is that possible? 

On the supply side, capital investment benefits from government subsidies and to some extent infra cost declines, though construction costs are stubborn. So while some larger ISPs hint at per-passing network costs as low as $600, others report costs closer to $1,000 per passing, with connection costs of $550 to $600 per customer. 

source: Matt Nicholson Lewis 

The point is that even with subsidies, lower infra gear costs and new investment sources, the demand expectations for consumer services have been slashed as much as two thirds over the past several decades. Many ISPs no longer expect revenue contributions from voice or entertainment video sources, and must build their demand models based solely on internet access. 

The largest ISPs might still expect some revenue contribution from voice or video services, but seem to be modeling higher expectations for business connectivity or contributions to mobile infrastructure cost models. In other words, the cost of small cell infra is aided by the consumer FTTH investment. 

Ultimately, we will see whether  FTTH really underpins a business that provides a competitive moat, while throwing off predictable cash flow. It seems more likely that private equity could succeed in transforming a legacy copper-based access business into a fiber access business, with a boost in equity multiples that will justify the effort.

That might well be a different question than asking whether FTTH really is a real estate or infrastructure asset on par with airports, toll roads, electrical and gas utilities. Much of the bet relies on limited competition. The argument that the first FTTH provider in a suburban or urban market gets 40 percent market share is likely correct. 

That has a reasonable chance of being correct even if two equally competent providers operate their own FTTH networks in a market. 

Some believe the first-mover advantage in a rural market could be substantial enough to support higher market shares. 

But it remains a valuable exercise to ask whether the FTTH business model is sustainable on an operational business on the revenue scales now being seen. 

That is a different question than asking whether a private equity buyer can boost multiples--and then sell the asset--by replacing copper access with optical fiber access. 

As a matter of operating economics, it still seems unclear whether FTTH networks generating only $50 to $70 per month in residential revenue are sustainable, assuming legacy provider cost structures. A small, lean upstart should have an easier time, as embedded costs are lower than those found at legacy firms. 

Decarbonization in Perspective

Many people seem apocalyptic about decarbonization. Sometimes we might need the benefit of longer timeframes and more longitudinal data. Granted we almost always can do better, but the historical relationship between energy consumption and gross domestic product, with implications for carbon emissions, have changed.

https://ourworldindata.org/grapher/co2-emissions-and-gdp-per-capita?time=1750..latest&country=~GBR 

Granted, progress is perhaps most notable in advanced economies. But the point is that we are making progress, and likely will be making greater progress in coming years. 

source: Our World in Data

Category Creation in the Connectivity or Digital Infra Spaces?

Startups have advantages and disadvantages that well-established legacy firms do not face. No internet service provider, mobile operator, cable TV provider or video streaming firm has to convince buyers there is a problem that firms in the category can solve. 

Hilton, Marriot and Hyatt do not have to explain to buyers what they do. Airbnb had to convince people. So did Uber. So did Google (with search). That is called category creation. 

Category creation often is a task that firms in emerging new markets must cultivate, to raise money, create valuation expectations, attract business partners and customers. 

The concept is that some big new class of problem is solved by a new category of solution providers. Solving  a different problem, with a different solution is foundational. 

Think about HubSpot, IKEA, Pixar, Netflix, Google, Airbnb or Uber. 

That often also means solving a problem buyers did not know they have. 

“It's difficult to create a category without inspiring others and getting them to realize they had a  problem they didn't know existed or that fundamentally changes how they interact with the world,” argues Michelle Snyder, digital investor, has said.

In that regard,  a category of one creates buyer risk. It actually is helpful, when creating a new category, to have competitors in the same category. 

“From the start, you must base your efforts on some broader market, consumer, or societal change that you believe will fundamentally change how we should look at the world,” says Sapphire Ventures. “Providing that macro context elevates the conversation beyond a product pitch from your company, and helps create a sense of inevitability for your vision.”

Firms in new categories often are valued at richer multiples than firms in legacy categories. They also can grow revenues faster than firms in related older categories and definitely reap rewards in terms of equity valuation. 

“Category creators are a small part of the Fortune 100 list of fastest-growing companies—but they account for much of the group’s growth,” say Eddie Yoon, principal of the advisory firm of Eddie Would Grow, and Linda Deeken, founder of Deeken Strategies. 

source: Harvard Busienss Review 

In many cases, startups are virtually required to create a new category. “In Silicon Valley, creating a new exciting category is the holy grail of what most companies are trying to achieve,” says Al Campa, Rocket Scale CEO. 

Building a business when customers and ecosystem par;ticipants already understand the problem to be solved is one matter. But building a category is different. By definition, the new category falls outside existing understanding. That understanding has to be created.

Clearly-understood new categories also reduce buyer risk. “There are always a few consumers who want to be the first among their friends to try a new product, but this is a surprisingly rare behavior,” says Peter Thomson, a digital strategist. 

Most buyers, though, are very risk averse.  

As a practical matter, that often requires bringing together thought leaders, practitioners and competitors together. In part, the reason is simple: market participants must be convinced there is a big new problem the category solves. Think of the aphorism “a rising tide lifts all boats.” 

Think of the practical marketplace value of any industry consortia, forum or association that works to promote the value of any particular industry segment. By framing a big problem in an innovative way, the whole category is boosted. 

That is particularly true when markets must be convinced a big new problem exists that has an important new solution.   

“Category creation becomes a self-fulfilling prophecy,” Sapphire Ventures notes. “When you’re able to both identify the disease and deliver the cure,  it creates a defensible moat around your business.”

“The intermediate goal for creating a new category is starting a conversation in the market that includes you,” Sapphire says. 

How many firms in the data center, Wi-Fi, wide area or local access connectivity or mobile businesses can you think of that ever created a new category, in the same sense as Uber, Airbnb, Google (search), Amazon (retailing)  or Meta (social networking).

"Value" Remains the Paramount Business Issue for Connectivity Providers

Very few observers would likely characterize the connectivity business as “robust,” “consistently high margin” or “well positioned for growth.” Management challenges therefore reflect the realities of margin pressure, average revenue per unit declines, high degree of competition, key product demand that is dropping and relative loss of ability to control or shape new application development. 

Nothing better summarizes the strategic context than the fear that the connectivity industry is becoming a “dumb pipe” commodity business with higher costs over time. That is a recipe for trouble. 

The by-now classic illustration is any depiction of revenues earned by connectivity providers and others in the internet ecosystem (devices, apps, e-commerce, advertising, content), compared to the more-nascent ecosystem in 2010. 

source: Kearney 

The illustration is somewhat unfair, in the sense that every industry has, or can have, a different valuation, using any multiple of value compared to revenue, price or earnings. 

source: Kearney 

As a consequence, many obvious challenges center on retail pricing, operating costs and business models. Those issues, in turn, are shaped by the disaggregated, layered model of computing, which then also disaggregates “value.” App creation and ownership are separated from ownership of connectivity assets. 

At a high level, that means network ownership is not aligned with application or service ownership. No business relationship must necessarily exist between the owner of an access network, or the supplier of premises connectivity, and the creator and supplier of any application or service that simply requires internet access. 

Other challenges grow from the best effort nature of internet access, using either Wi-Fi or access networks. By definition, IP transmission is not deterministic. That makes consistency an issue. 

And while much internet value is created by ecosystems, connectivity providers have not yet been able to place themselves at the center of ecosystem organization, in the same way that some device, application or transaction platform suppliers have been able to accomplish.

Lots of effort has gone into activities that connectivity firm owners hope will rectify these deficiencies, sometimes centering on creation of more disaggregated revenue models based on use of application programming interfaces, participation in ecosystems or unbundling and disaggregating portions of the network function itself. 

It all remains a work in progress.

"Down and to the Right" Versus "Up and to the Right"

Down and to the right is a reasonable depiction of internet service provider, capacity provider, mobility or telco legacy revenue per unit trends of the past several decades. That applies to wide area network capacity, internet transit prices, voice prices, long distance calling prices, text messaging rates, or mobile network minutes of use or data usage charges. 

That is distinct from the “up and to the right” depiction of the fortunes of growth industries, firms and products. At various points, internet access and home broadband, for example, have been “up and to the right” products. 

Which is another way of noting that business strategy is different for legacy and declining products compared to new and growing products. Think of “S” curve and its strategy implications. 

When a product is late in its life cycle, it is nearly pointless to invest too much, as no matter what one does, the product is destined to be replaced. So firms harvest revenues as long as they can. 

source: Strategic Thinker

The opposite has to be done for the newer replacement products: one has to invest in them. All that raises a question: is the move to try and monetize network functions using application programming interfaces (APIs) a move that helps connectivity providers extend the revenue production of declining products or propel the average revenue per unit of new products? 

To the extent it might represent both, how much does it create value, compared to how much it could destroy value? In other words, can monetizing API access to network features create big new revenue streams faster than it can commoditize the same?

In the former case, slowing the rate of revenue decline for some products might be described as “winning.” In the latter case, accelerating the rate of revenue growth constitutes winning. 

APIs might enable either outcome. If this all feels somehow reminiscent, think of the adoption of TCP/IP by global service providers as the “network of the future.” IP created layers of functions that are connected by APIs. 

So the network of the future necessarily separates application creation and ownership from network transport and access functions. 

Has that helped or hurt? And whom has it helped; whom has it helped?

Competition or Investment: Choose One

Many European internet service provider leaders claim the business model is unsustainable, as profits are too low, scale is suboptimal and costs are stubbornly high. Some might note that European policymakers have, for decades, prioritized competition over investment. 

If policymakers decry low investment in advanced facilities, their own policies are partly to blame, as competition leads to lower retail prices, which creates disincentives for further investment. 

U.S. policymakers took the same path in the early days of access network competition, in the wake of the Telecommunications Act of 1996, which opened the local loop to full competition for the first time. The primary early strategy was generous wholesale discounts of around 30 percent, plus the ability to buy a fully-provisioned wholesale service.

That led to a quick expansion of retail competition, lead by AT&T and MCI, at that time, the two big firms that were not already in the local access business.

But policymakers reversed course after several years, as the massive reliance on wholesale mechanisms reduced incentives for investment in new facilities. 

In other words, policymakers always must make a choice: do they want more competition or more investment? “Choose one” is the unfortunate realm of choice. 

European service providers have been complaining for decades that government policies intended to support competition have worked to the detriment of creating a climate conducive to capital investment. 

That now is said to apply both to 5G and advanced mobile networks as well as fiber-to-home facilities. 

But there are other issues as well. The European internet access business has a “very low” return on capital employed. Telefonica CEO Jose María Alvarez-Pallete says European ISPs have rates of return “barely beating cost of capital.”

But that also is shaped by competition policy, which has resisted consolidation. “The average European mobile operator covers five million people, where the average U.S. operator covers 107 million people,” says  Alvarez-Pallete. 

That is not to say that the benefits of competition cannot be obtained when the number of contestants is quite low. In the U.S. market, robust competition exists with about two main contestants in fixed networks and three main contestants in mobile markets. 

That might be the best expected outcome long term. But European ISPs say policymakers must essentially reverse course. 

Competition or investment: choose one.