Is CenturyLink Acquisition of Level 3 a Mistake, or Sound Strategy?

There is no shortage of critics of AT&T’s bid to buy Time Warner, no shortage of those who also think CenturyLink’s effort to buy Level 3 Communications is a mistake. Many in the policy community likewise considered the Comcast acquisition of Time Warner, the AT&T acquisition of T-Mobile US and the merger of Sprint with T-Mobile US profound mistakes.

One might even find a few who think, well after the Comcast acquisition of NBCUniversal, that deal was a mistake.

Perhaps even some who doubt Windstream’s acquisition of EarthLink will make much sense. Windstream reportedly is in talks to buy EarthLInk. Windstream, based in Little Rock, Arkansas, had a market capitalization of about $653 million, while Atlanta-based EarthLink was valued at about $572 million.

To be sure, there are antitrust concerns at the heart of many of the proposed acquisitions. But even when antitrust is not a key issue, many believe some of the proposed deals are unwise.

Lack of synergy, lack of value creation or execution risk are common complaints. CenturyLink plus Level 3 Communications only makes a bigger company losing money, some argue. AT&T does not need to own Time Warner to reap the benefits of content acquisition, others argue.

Execution risk is an issue; always is. But an argument can be made that accepting even moderately-high levels of risk is a necessity for all tier-one service providers, for structural reasons.

In monopoly days, service providers owned 100 percent of the applications they sold. In the internet era, service providers own some of the apps customers use. Strategy in the internet era is to capture at least some of the value of the applications business, as total ecosystem revenue is moving to apps, and away from access.

And that is the key to understanding some of the mega-mergers. Smaller service providers often do not have the options tier-one providers have available to them. CenturyLink, for example, does not own mobile assets. Neither does Windstream.

Also, both CenturyLink and Windstream, plus Frontier Communications have followed similar strategies. All originally were rural service providers and all three have pushed to become providers of services sold to business customers. None arguably have the scale to become major players in digital advertising, mobile advertising or mobile content.

With that option off the table, the former rural carriers have taken a path that is open to them, namely shifting the center of gravity of their operations from lower-revenue-per-account consumers to more-lucrative business customers.

If the transaction clears, CenturyLink will earn 88 percent of revenues from business customer services.

Since about 2010, both Windstream and Frontier have earned most of their money in the business segment, despite the continuing preponderance of consumer accounts.

In its second quarter of 2015, Windstream had revenues of $1.4 billion. Consumer revenues  represented just $314 million--about 22 percent--of total revenues.

Frontier Communications total revenue of about $1.4 billion as well, with consumer revenue of about Total residential revenue was stable at $615 million for the second quarter of 2015, while total business revenue was $621 million. So a bit more than half of revenue was generated by business customers.

You might argue that moving into brand new lines of business is better, if it can be done. But where it cannot be done, then shifting operations to higher-revenue customers makes sense, where it can be done.

The telecommunications business is harder than it used to be, but not only because competition now is the rule. The emergence of the Internet means the access and transport functions are only a part of a bigger ecosystem.

As consultants at PwC point out, telcos and access providers operate in the “network” part of the full value chain. But most of the value will come elsewhere, from services and apps able to provide the intelligence and control for processes that modify real-world activities.

That is why moving up the value chain is so important, and why many access providers are investing in Internet of Things, machine-to-machine communications and industrial Internet, if rather cautiously.

Will Oligopoly Still be the Outcome, As New Platforms Emerge?

Capital-intensive industries tend to produce oligopoly market structures. Even some industries that are scale-intensive or moderately capital intensive also tend to do so, it seems. Look at Apple’s market share , for example.

So one reasonable question in the global access business is to ask whether technology platform advances can reduce capital investment hurdles enough to break the “oligopoly” market structure.

If so, then a wider new competitors might expect to break into the top ranks. If not, then only big firms can hope to do so.

At the moment, in several markets, it appears the latter thesis will be tested. In India, the entry of Reliance Jio already is rearranging market structure, forcing consolidation. In the U.S. market, Comcast and Charter Communications are getting ready to enter the market. In Myanmar and Singapore,  new competitors are being authorized.

So far, no breakthroughs in platform cost have occurred that could challenge oligopoly structures, though. In other words, the zero sum game continues to prevail, and one contestant’s gains will come at another’s expense.

It is unknown how much new fixed wireless and mobile platforms might change possibilities for non-oligopolistic market structures, on a marketwide basis. But it might be reasonable to suggest that the new platforms will lower provider cost, but not enough to overcome oligopoly assumptions.

That is not to underplay the potential importance of several new platforms, as well as continued advances by hybrid fiber coax networks. Lower platform costs are helpful in increasingly-competitive markets where capital and operating costs must be lowered.

Lower costs are required to serve rural customers as well. But, at least so far, none of the platforms seemed poised to break the background setting that business models assume costs high enough that oligopoly is the outcome.

In addition to devices, oligopoly also seems to prevail in the consumer applications market.

According to comScore, in the United States, the top seven apps, and eight of the top nine apps are owned by Facebook or Google.

Indeed, one might ask whether it is possible for any new apps providers to displace Google and Facebook, either.

Some might argue that stable oligopolies are possible somewhere between two and four providers, with many arguing three strong contestants is the optimal sustainable outcome. That four or more providers exist in many markets is considered by many a “problem” in that regard, generally called the rule of three.

Most big markets eventually take a rather stable shape where a few firms at the top are difficult to dislodge.

Some call that the rule of three or four. Others think telecom markets could be stable, long term, with just three leading providers. The reasons are very simple.

In most cases, an industry structure becomes stable when three firms dominate a market, and when the market share pattern reaches a ratio of approximately 4:2:1.

A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest, according to the rule of three.

In other words, the market share of each contestant is half that of the next-largest provider, according to Bruce Henderson, founder of the Boston Consulting Group (BCG).

Those ratios also have been seen in a wide variety of industries tracked by the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.