There has to be a Pony in Here Somewhere

As the old story goes, a kid was found whooping and hollaring in the stable when mucking out the stalls. When asked why, the child says “With all this **** around, there must be a pony in here somewhere.” 

One wonders if Internet service providers might just want to whoop and hollar at some point about net-connected TVs and online video in a broader sense, despite the obvious business model challenges the applications now provide. 

The number of online video viewers will grow from 563 million at the end of 2008 to 941 million by 2013, according to ABI Research. Ways to watch online video on standard TVs will be a key enabler of that growth, which explains why firms such as Cisco, not in the past associated with such consumer technology, will be entering the market for devices that allow watching of online video on standard TVs, rather than PC screens. 

While today’s consumer is most likely to watch online video on the PC screen, over time more and more consumers will watch over-the-top video delivered to the living room, ABI projects. That's one reason Netflix will be introducing a net-connected HDTV from LG Electronics at this year's Consumer Electronics Show. The device will connect directly to the Internet, without the need for a PC or other device, a Wi-Fi or other hard-wire connection from the PC or similar intermediary box to the TV. 

Netflix will tailor the TV to access the Netflix online service offers 12,000 movie and television titles. Yahoo  and Intel Corp. separately plan to announce support from several major consumer-electronics companies to sell TV sets that come with widgets that make it easier to call up Web content on TV sets using ordinary remote controls rather than computer keyboards. Yahoo's Widget Channel is an example of that. 

It seems unlikely such net-connected TVs will be a major mass market success any time soon, though. The additional hardware cost will be as much as $300 initially. And then there is the obvious challenge of user experience. Not many broadband connections will have the latency performance--nor assured bandwidth--to deliver large pictures on HDTV screens. 

On the other hand, such devices are a perfect example of an application that really would benefit from quality assurance of the sort ATM was designed to provide, and that traffic shaping, edge caching and other forms of assured content delivery also provide. 

Real-time services require traffic shaping and network management. Net-delivered video to HDTVs is going to prove the thesis. Right now, ISPs are mucking out the stalls. Someday, they will find the pony. 

Small Business: Big Segment

There are several reasons why small business customers are becoming more important to communications service providers of all types. For starters, there is more pressure in the consumer market, chiefly pressure on fixed voice lines and associated revenue-driving features. 

For many service providers, the small business segment is important for the same reason trans-national enterprises are more important for tier one providers.  As growth gets harder "in territory," providers must find new customers "outside of region." And costs being what they are, it is easier to expand out of region when serving business customers. And most of those potential customers are in the small business segment. 

Small business and mid-sized business customers are a key driver of growth strategies for incumbent and attacking providers alike. Smaller business customers have been the key segment for competitive local exchange carriers, value-added resellers, long distance resellers, many Internet service providers, managed service providers and Interconnect companies for decades, in some cases. 

Long Tail Doesn't Apply?

As observers have started to track sales of digital goods more closely, some apparently-contradictory evidence has started to appear about the "long tail" theory of sales in the digital domain. The concept: cheap digital distribution changes the retail sales function, allowing profitable sales of low-volume titles or items on a scale not possible in a physical distribution strategy. Most observers instinctively would agree. 

The key prediction has been that online distribution would allow niche businesses, content and goods to thrive in a digital distribution context impossible to sustain in a physical distribution context. As commonly understood, perhaps an additional 20 percent increase in volume should be feasible, as well as a change in "mass culture" that would fragment demand. 

But some sales data contradicts the notion. A new study by Will Page, chief economist of the MCPS-PRS Alliance, a music royalty collection organization, suggests that online sales success still relies on big hits. The study found that 80 per cent of all revenue came from around 52,000 tracks. For albums, of the 1.23 million available, only 173,000 were ever bought, meaning 85 per cent did not sell a single copy all year.

Frankly, the long tail now appears, in one sense, as the triumph of hope over experience. Many "wanted" online distribution to change purchasing patterns. The notion was that once huge variety was available, tastes would change. It isn't so clear why it is assumed "tastes" will change with different distribution. It is clear why fulfillment will change with cheaper distribution. But efficient, or better, distribution still should result in a "long tail" of demand that is the same as a distribution-induced "short tail" of demand. 

The reason derives from the theory itself. The idea behind the "long tail" is not actually new, and dates back to an Italian economist, Vilfredo Pareto, who in 1906 coined the Pareto Principle, popularly known as the 80-20 rule. Basically, the idea is that in much of life and nature,  roughly 80 percent of the effects come from 20 percent of the causes.

The same concept is known as Bradford's Law. 

As implied by the theory of the long tail, online distribution should allow retailers to sell small volumes of hard-to-find items, instead of selling a smaller number of highly-popular items. Most people can grasp that. What isn't so clear is why that expected distribution curve will be a "new" Pareto curve, instead of validating the existing Pareto curve. 

Under any normal set of circumstances, a Pareto distribution is what one would expect to see. Some have pointed to music sales at Rhapsody, an online music service. Of the 735,000 items for sale, 39,000 account for 78 percent of sales, while 796,000 titles represent 22 percent of sales. 

Likewise, Netflix data suggests 20 percent of total rentals are of "tail" or low-volume titles, while 80 percent of rentals are basically "hit movies" one would expect most people to be interested in. 

Is that confirmation of the operation of a Pareto distribution? Yes. Does it represent incremental sales of 22 percent that might not occur in a physical distribution scenario? Yes. Are the results unexpected? Not if one expects to see a Pareto distribution. 

Is the idea wrong, or useless? Not really. A Pareto distribution can assume a 70-30 pattern, for example, suggesting a bigger role for niche products than before. That represents an important shift of opportunity for providers of niche services and products because of online or Web distribution. 

But the long tail might not mean a revolution. Forrester Research, for example, estimates seven percent of retail sales in 2008 will have been made online, up from 3.2 percent in 2007. What does that mean? Most sales follow a Pareto curve: 97 percent of things sold still are sold the traditional way. There will be further shifts, of course.

But Pareto would suggest online sales will settle in at around 20 percent of total sales, at best, on a sustainable basis. 

Business Fixed Lines Up, Not Down

Fixed voice lines used by consumers appear to have fallen since June 2000. Overall fixed voice lines have fallen as well since then. All that would lead a rational observer to conclude that fixed voice lines sold to small and medium-sized businesses have fallen as well. But that is not in fact correct. 

Fixed voice lines sold to business customers have increased from about 45.7 million to about 64.6 million in December 2007, according to the latest Federal Communications Commission data. 

What is not clear is the degree to which mobile voice lines have affected overall enterprise or SMB voice lines in service. Since 2001 wireless voice accounts in service have increased from 124 million to 249.3 million. A reasonable assumption is that business use of mobile voice has accelerated since 2001. 

Researchers at IDC reported in 2006 that surveyed IT managers think nearly 30 percent of their supported employees use their mobiles as their primary work phone. About 41 percent of wired voice lines are used by business customers. If the same percentage of wireless devices likewise are used primarily in business mode, then there are about 102 million wireless devices used in a business mode. 

Surprising SMB Trends

Service provider prospects in the small and medium-sized business market appear to be relatively immune from economic disruption, though it would be an obvious prediction that some enterprise communications needs have decreased because of reduced headcount. 

Despite the highly-publicized wave of enterprise layoffs in November and December 2008, generally unreported is another  trend: smaller businesses are not generally participating in the waves of highly-reported downsizings. In fact, there is new evidence that hiring actually increased throughout 2008, while 75 percent of small business CEOS plan to increase hiring in 2009. That, in turn, is important for service providers as much communications service demand is created by headcount. 

A survey conducted by online payroll service SurePayroll has found that nearly four out of 10 small business owners have not seen their business negatively impacted by the down economy, and an additional four percent indicated that their businesses are actually doing better. 

Still, 18 percent of surveyed SMB CEOs have seen a significant drop in revenues while 42 percent have seen small decreases. That is not especially helpful for anybody, but does not suggest communications services will be hit by reduced headcount. 

According to SurePayroll's monthly tracking surveys, small business hiring actually increased every month between January 2008 and November 2008 (December data are not available yet). What is significant is that the U.S. economy was in recession for that entire period. 

Separately, Entrex Inc, a Chicago firm that markets information on privately held companies, conducted a survey which found 72 percent of small and medium-sized business CEOs plan to increase the number of full time employees in 2009. Also, despite all the news regarding staff reductions, the remainder of the survey respondents indicated they would maintain the current number of full time employees. 

SurePayroll surveys show that,  year-to-date, small business hiring is up 3.3 percent nationwide.

One can argue there could be some weakening of business fixed line buying, but available evidence so far is that business lines in service have increased since 1996, not decreased, though propelled by increased buying of special access circuits more than voice lines. Still, increases in the number of small businesses over the last 10 years have increased SMB voice line buying. 

In 2002, for example, there were 23.3 million small business firms in operation. In 2004 there were 25.4 million small businesses in operation. In 1988 small businesses employed 87.8 million workers. In 2004 small businesses employed 115 million workers. That doesn't mean smaller businesses will fail to take measures to contain their operating costs. It is to suggest they do not seem to be any more willing to cut back on key communications capabilities than in past recessions.

Consumer and IT Spending in Recessions: The Record

Recessions affect consumer spending unequally. During the 1990–1991 and 2001 to 2002 downturns, for example, U.S. consumers changed their priorities, instead of making across-the-board cuts.

Daily amenities such as eating out, purchases of personal-care products and apparel buying tended to suffer, according to analysts at McKinsey & Co.

But categories such as groceries and reading materials, which substituted for more expensive options, actually benefitted from higher spending, as did insurance and health care. Spending on education showed the biggest increase.

What one probably cannot glean from this particular set of data is that "communications" and "multi-channel video entertainment" spending does not change much.

During recessions, tech spending has historically fallen more than gross domestic product has, say McKinsey researchers. "Our research covering economic downturns in 50 countries over the past 13 years indicates that information technology spending typically fell five to seven times farther than GDP, with the most severe declines in hardware (which fell eight to nine times GDP and less severe ones in software and services, falling three to to five times GDP, McKinsey says.

The decline was much larger during the 2001 downturn because spending on computing and telecommunications equipment as a percentage of GDP (IT intensity) had previously soared to historic levels. A boom in tech start-ups, along with Y2K fears, promoted a spending surge on communications equipment, servers, and a range of other products.

When the economic slowdown arrived, start-ups foundered, many companies had too much tech and telecom capacity, and spending cuts across the economy were severe, McKinsey notes. Chastened by that experience, many companies have since
pressured their CIOs to manage IT more effectively.

As the economy enters the current slowdown, the growth of IT intensity is closer to its historic trend, even slightly below the 10-year average. Still, "it does seem likely that the sector’s experience could be more in line with historic trends than it was in 2001."

Broadband: Where We're Going

It's tough to maintain meaningful metrics in the communications business, in large part because the essential business inputs change over time.

Telephone company "access lines" and "basic cable subscriptions," once useful metric s, no longer adequately capture business performance. So we have the substitute "revenue generating unit."

Something along the same lines now will happen in the broadband access area, where counting "lines" once made sense, but increasingly will not capture business performance.

For starters, "average" speeds and "prices" will not be so useful as higher speeds become commonplace, rendering "average" price less meaningful than perhaps "average price per Mbps of service." Also, as wireless broadband becomes more prevalent, we routinely will begin to exceed 100-percent broadband penetration per household, in at least most households.