Wednesday, April 26, 2023

Beyond Connectivity? Some Do Better than Others

Connectivity service providers might be said to suffer from envy about the valuations earned by application providers compared to mobile operator or telco valuations. After all, a public market valuation creates, or limits, currency that can be used to grow the business. 


On the other hand, firms in distinct industries have different valuation ranges, based in part on revenue growth prospects. And that is where practitioners simply must acknowledge that connectivity operations and asset valuations are closer to those of other capital-intensive, relatively slow-growing businesses including energy utilities, airports, seaports, toll roads, gas and oil pipelines. 


Provider

Expected Revenue Growth Rate

Expected Profit Margin

AT&T

1.5%

10%

Verizon

1.0%

12%

NTT

2.0%

11%

Telefonica

1.0%

9%

Orange

1.5%

10%

BT

1.0%

11%

Deutsche Telekom

1.5%

12%

Telecom Malaysia

2.0%

8%

Jio

3.0%

15%

Vodafone

2.0%

10%


For the better part of two decades, connectivity providers have struggled to recreate themselves as faster-moving entities with higher growth profiles, with mostly modest success. At the very least, firms have tried to position themselves as more-diversified entities with bigger roles in other parts on the internet ecosystem beyond connectivity. 


For the most part, investors harbor few illusions in that regard. Indeed, connectivity assets are valued precisely when they offer the expectation of steady cash flow and some scarcity value. That is the thinking behind private equity and institutional investor interest in “alternative assets” that are relatively uncorrelated with other traditional equity and bond assets. 


The logical implication, however, is that connectivity CxOs--and those who advise them-- probably should stop suggesting that connectivity roles and value are something they are not. 


Which is to say, high-growth vehicles. That does not mean connectivity providers cannot take on additional roles in the value chain: they can. It does mean that even when successful, those assets will likely earn a higher valuation when eventually separated from the connectivity assets. 


In other words, assets often are awarded higher valuations when separated from ownership by entities with lower valuation ratios. Pure plays often are rewarded by higher valuations, compared to the value they bring to owners who have other roles and valuations. 


That might have significant implications for business strategy. If and when connectivity providers move to take on different roles within the value chain, it might also be realistic to assume that, at some point, those assets bring the highest and best value to the owners when the assets can be spun out or sold. 


In other words, moves to create assets in other parts of the value chain should be viewed as assets in a portfolio that always are available for sale, at some point, and not a core operating holding. 


The clear exception is when the new operations are significant enough in magnitude to warrant becoming the foundation of the company’s long-term business. 


We rarely see this in the connectivity business, though. Typically, the newer lines of business are sold or spun out. A connectivity firm does not become a content provider; a retail data center business; an application provider; an entity that earns its core revenue from facilitating transactions, rather than selling connectivity services. 


Firms might change, over time, the services they sell, or the connectivity roles they play. But we have yet to see major evolution away from “connectivity services” to some other permanent role, as the primary revenue driver, for any tier-one telco. 


To be sure, lots of firms might boast significant revenue from services and products other than connectivity. But those always seem to be “nice to have” operations that complement the existing core business.


And even estimates of non-telco revenue can change quickly, as for example when AT&T divested its content, linear video and advertising operations. AT&T's latest quarterly report focuses strictly on connectivity service revenue and operations. In a short year or two period, AT&T can be said to have scaled its “non-telco” revenue back from 19 percent to near zero.  


Even the commonly-cited sources of such “non-telco” revenue are suspect. Jio, for example, is said to make such revenue from home broadband on a fixed network. That makes sense only if Jio is narrowly considered to be a “mobile services” provider, with “non-telco” revenue including any sources on a fixed network. 


That would not be the definition used for other “integrated” providers with both mobile and fixed operations. The same might hold for Telecom Malaysia, BT or KPN. In other cases, non-telco products might also count revenue earned by service provider internal operations that use e-commerce or mobile payment mechanisms. 


Were we to eliminate all other connectivity services, even firms with lots of initiatives in content, apps or devices might show significantly less revenue contribution from non-telco sources. 


Still, JioMart, an e-commerce platform, JioSaavn, the music streaming service and JioMoney could represent 11 percent or more of total non-telco Jio revenues. 


Company

Percentage of Non-Telco Revenue

Examples of Non-Telco Products

Vodafone

18%

Mobile payments, e-commerce, cloud computing, advertising

Jio

30%

Home broadband, DTH, fiber-to-the-home, smart home solutions

Telecom Malaysia

12%

Fixed-line broadband, data center services, cloud computing

Deutsche Telekom

15%

Mobile payments, e-commerce, cloud computing, advertising

BT

10%

Fixed-line broadband, data center services, cloud computing

Orange

14%

Mobile payments, e-commerce, cloud computing, advertising

KPN

11%

Fixed-line broadband, data center services, cloud computing

Telefonica

13%

Mobile payments, e-commerce, cloud computing, advertising

NTT

17%

Mobile payments, e-commerce, cloud computing, advertising

China Mobile

20%

Mobile payments, e-commerce, cloud computing, advertising

China Telecom

18%

Mobile payments, e-commerce, cloud computing, advertising

Verizon

16%

Mobile payments, e-commerce, cloud computing, advertising

AT&T

19%

Mobile payments, e-commerce, cloud computing, advertising


The point is that common citations of “non-telco” revenue tend to be inflated. Connectivity providers “are who they are.” Diversification moves beyond the connectivity function contribute a non-zero amount of revenue. But even that amount tends to be overstated. 


Tuesday, April 25, 2023

Connectivity Provider Margin Compression Since 1980

Margin compression is a problem of long standing in the connectivity industry. Generally speaking, profit margins have declined over time, partly because of new competition, partly because of better technology, partly because of government rules promoting lower prices. 


Generally speaking, profit margins were highest in the monopoly era, when telecom companies operated as sanctioned monopolies. As newer markets have operated in a competitive manner, profit margins have been lower, even if mass market adoption has been helped by those lower prices. 


Product

Years

Profit Margin (%)

Fixed-line Voice

1860-1980

50-70

Mobile Voice

1980-2000

30-50

Internet Access

2000-2010

20-30

Content Services

2010-present

10-20


Calling rate trends clearly show the impact of competition and better technology (including voice over IP calling and messaging substitutes; substitution of email and texting and messaging for voice communications). 


Voice Calling Price Changes (Per Minute) Since 1980

Date

Product

Rate (in USD)

1980

Local

0.25/min

1985

Local

0.20/min

1990

Local

0.15/min

1995

Local

0.10/min

2000

Local

0.05/min

2005

Local

0.02/min

2010

Local

0.01/min

2015

Local

0.005/min

2020

Local

0.002/min

1980

International

$1.00/min

1985

International

0.80/min

1990

International

0.60/min

1995

International

0.40/min

2000

International

0.20/min

2005

International

0.10/min

2010

International

0.05/min

2015

International

0.02/min

2020

International

0.01/min

1980

VoIP

N/A

1985

VoIP

N/A

1990

VoIP

N/A

1995

VoIP

N/A

2000

VoIP

$0.05/min

2005

VoIP

$0.02/min

2010

VoIP

$0.01/min

2015

VoIP

$0.005/min

2020

VoIP

$0.002/min


One can see the same trend for home broadband or wide area network data transport prices. 

To the extent that WAN transport revenue has not plummeted directly, it is because volumes of data to be moved have increased so much. 


But there have been other effects, such as the displacement of most traditional telcos as meaningful providers of WAN data transport, compared to private networks operated by hyperscalers and other long-haul data transport specialists.


Year

Data Transported (in petabytes)

Cost per megabyte (in USD)

1980

0.01

$100,000

1985

0.1

$10,000

1990

1

$1,000

1995

10

$100

2000

100

$10

2005

1,000

$1

2010

10,000

$0.1

2015

100,000

$0.01

2020

1,000,000

$0.001

"What Comes Next?" Will Eventually Matter

Whatever comes next as the key revenue driver and source of profit for connectivity providers, the key product will necessarily have to be a “communications” product of some sort. Since 1860, when “telephone service” was invented and commercialized, the key driver of industry revenue and profits has been some connectivity service.


Between 1860 and 1920 the primary revenue driver was the ability to place a local phone call, though subscriptions were not likely greater than about 10 million by the end of the period.


Starting in the late 1920s the ability to make international calls became a major revenue driver and the driver of industry profits. That continued to be the case until the late 1970s. But competition in long distance disrupted profits.


After the early 1980s, mobile phone service emerged as the driver of industry revenue growth, and finally the dominant revenue source and profit driver for the global industry. 


And while mobility services now drive a clear majority of all revenues, on fixed networks there has been an evolution from voice calling to internet access as the key revenue item. 


“What comes next?” is a logical question, as hard as it might be to envision a time when mobile phone services were not the industry revenue driver or its key source of profits. As computing eras have given rise to new products and value drivers, the connectivity business has moved through eras where the dominant revenue model has shifted. 


Right now I am hard pressed to envision what core connectivity service emerges to displace mobility as the industry revenue and profit driver. But replacements eventually will be developed. 


That evolution has happened in the connectivity business and the computing business as well. 


Computing cycles used to happen only on mainframes or minicomputers. Then we shifted to personal computers, then to client-server models, then to smartphones and embedded instances (calculators, cash registers, elevators and an ever-wider range of consumer electronics. 


Well over half of all computing cycles now happen on phones, according to Statista and IDC estimates. 


What comes next as an era of commuting is not so easy to categorize, though a new computing era is sure to arrive. One way some of us might point to what is coming is to argue that “the next 10,000 startups will essentially be based on “take X and add artificial intelligence.” 


Some might argue we now are in the era of cloud computing. Others will prefer the term “mobile computing.” Terms such as “pervasive computing” or “ambient computing” have been floated as well. 


Whatever the preferred term, computing now is highly distributed. Some might note that up to 46 percent of computing cycles happen on cloud computing fabrics. 


In both computing and connectivity industries, a next era will develop. The logical path seems clearer for computing, though, where applied artificial intelligence seems to underpin every major trend and development: metaverse, augmented reality, search, content consumption and creation, robotics, automation, advertising and shopping and education. 


Beyond the ability to make a phone call, international calling, mobile phones and internet access have been the key shifts in the connectivity business since 1860. As hard as it might be to contemplate, something else eventually is going to emerge. 


Edge computing, private networks, fixed wireless and internet of things might help. But none of them presently seems sufficient to achieve the mass scale to displace mobile phone service as the industry revenue and profit driver.


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