In a fundamental sense, much capital investment previously described as "growth" capex (infra investments supporting capacity, speed, new products such as SD-WAN or
One almost-perverse reality in the connectivity business is that legacy products often are more profitable than the newer products intended to replace the legacy offerings, even as demand for the legacy products dwindles.
Almost perversely, the strategic rationale for many investments, such as next-generation mobile networks or fiber-to-home, is driven less by expectations of highly-profitable new services but by the necessity of doing so to remain in business.
To be blunt, "you get to keep your business" is the investment rationale, more so than "you will boost revenues significantly." In fact, even when new products or services are created, profit margins will be lower than for legacy products.
Cable TV companies and telcos face precisely that problem with video streaming services, compared to linear video, for example. Telcos faced the same problem with VoIP and messaging. Home broadband and mobile internet access seem to be faring the best, though each of those services is precisely a "dumb pipe" offer: access but not apps; bandwidth but not "services;" flat fees for usage but not participation in app and service revenue models dependent on internet access.
There are several reasons why products with declining demand are more profitable than newer services, starting with the strategy of “harvesting” the products. Since the investments to create legacy products often have already been amortized, there is relatively little additional capital investment or operating cost required to run the business supporting those products, compared to building infrastructure and demand for new products.
Also, revenue upside from more-advanced products can actually be lower, per unit or per user, than the legacy products. Cloud computing, for example, lowers the cost of creating new software products. Open source and multimedia, general purpose networks do too.
Legacy public switched network voice was generally more expensive to create as it used proprietary technology to create a single-purpose network. Voice over IP is generally less costly as it uses a multi-purpose network, more open platforms and more-generic hardware, with resources that can be more centralized (so less investment is required).
In a classic example, service provider profits and gross revenue from VoIP can be lower than what was the case for legacy voice products.
Almost perversely, profit margins from selling digital subscriber line home internet access, though an “inferior” product, might actually be higher than selling home broadband using fiber-to-home or other platforms.
Service providers used to make high profits from text messaging, but they have almost no ability to monetize the multimedia messaging alternatives such as WhatsApp. In principle, one might ask why development of new products makes sense, if the financial returns are low.
The issue, strategically, is that harvesting does not solve the “what is my business of tomorrow” problem. As with any industry, connectivity services have product lifecycles. Each product eventually faces declining demand. So a company that only harvests will eventually go out of business.
So new products, even when they feature lower-profit margins, must be created.
One is left with the almost-inescapable conclusion that often, when new products are envisioned as substitutes for legacy products, they become “features.”
Voice communication once was the primary value provided by a mobile network. These days, though, voice is more often a feature of a mobile service.
A mobile service unable to handle voice calls or text messaging features would not be a competitive product, but service providers earn less revenue from voice over time.
Voice and text/multimedia messaging might be an essential feature of the service. But spending lots of effort and money to create a new voice and messaging experience might not produce satisfying financial returns.
In other cases, such as upgrading networks from DSL to FTTH, the strategic rationale is quite clear: a telco has no future without that upgrade. But the actual revenue and profit impact might vary quite a lot in the near term.
In other cases, such as the transition from linear to streaming versions of entertainment video, the outcome for service providers remains unclear. In the transition from dial-up internet to DSL and cable modems, a whole class of internet service providers was forced out of business, as success shifted to ownership of access facilities.
It’s an open question right now whether connectivity service providers will retain a role, and what sort of role, in a future where most video entertainment has shifted to streaming delivery. Can network service distributors be disintermediated, and to what extent?
Will distribution shift to the streaming video providers who go direct to consumer? And will that shift the connectivity provider role to that of mere sales agent? It remains unclear.
The broad point to be made is that new substitutes for legacy products are not uniformly as revenue producing or profitable as the legacy products, often because demand has shifted away, because new forms of competition limit pricing power or because the new products require high levels of investment.
“Doing nothing” is a strategic death sentence for any copper-access-based fixed network provider. But upgrading to FTTH is not a panacea, either. FTTH creates a sustainable platform for competing, but is not an automatic net generator of higher revenue and profits.
In a nutshell, that is the problem with much technology innovation. Some strategic imperatives that allow a firm to remain in business are not automatically going to solve the business problem of replacing legacy products.
VoIP is not a strategic answer if the product itself faces declining demand (people shift to mobile phones for calling, for example). And there are cases where changing demand actually destroys a business opportunity. Dial-up ISPs went away when home broadband emerged, for example.
Nor is it clear what roles might be left for connectivity providers when a fuller shift to video streaming has happened.
The point is that investments in new platforms, networks and services, often without huge expectations of higher revenues and profit margins, is a necessity in the connectivity business. In a business sense, almost all infra capital investment is for "maintenance" rather than "growth," in a fundamental sense.
5G has to replace 4G, often less because revenue will be higher but because additional capacity must be added to remain competitive and meet customer desires for data consumption and app experience. The same holds for FTTH.
