Reemergence of "Structural Separation?"

Structural separation of retail opeations from network ownership was a bigger idea several decades ago than at present, even if a handful of markets have moved that way in a formal sense in Southeast Asia, Australia, New Zealand and the United Kingdom.

The key idea is to create an independent network faciltiies supplier and allow all retail service providers to use that one platform.

Whether mandated by regulators or as a business choice, wholesale access remains contentious in both fixed and mobile segments of the business. Over the decades, one has heard much criticism of the “I build it, you get to use it” argument from facilities providers selling wholesale capacity and services to retail competitors. 

Such complaints happen in a variety of settings, including mobile and fixed network wholesale; whether featuring mandated pricing set by regulators or market mechanisms; and by business strategy and market share (attacking or smaller facilities-based suppliers often see greater advantages than dominant providers). 

It remains unclear how attitudes of underlying carriers could change in the future, if greater functional separation of mobile or fixed assets were to occur, especially if it is not mandated by government authorities. 

In other words, if the ownership of access or core network  facilities continues to evolve, with greater ownership by private equity, institutional investors and other “patient” investors, how much could attitudes shift?

If “core” network assets are only partially owned or even divested by dominant retail suppliers, do attitudes also shift? If core infrastructure no longer is considered strategic by dominant suppliers--as unlikely as that might seem--do most, if not all retail service providers wind up having similar attitudes about the value of wholesale access and their business models?

As an example, what if BT Openreach is fully separated from BT? How does BT’s valuation of core network assets (access, especially) evolve? Does BT not acquire the same positon as any existing wholesale customer of Openreach?

Beyond that, what emerges as the core competency of a dominant retailer once ownership of the scarce access facilities is no longer an issue? The perhaps obvious answers are market share itself, installed name, brand name awareness and value, influence on the regulatory process, other complementary assets and so forth. 

Right now, the mobile virtual network operator business model provides some baselines. 

MVNOs are not legal in every market, but in some markets represent  significant portions of the installed base and market share. That is especially true in Europe. 

source: McKinsey 

Margin potential varies. Simple branded “resellers” who add little additional value also face the least risk, at the cost of expected profit margins. Basically, this business model relies on sales and marketing skill, as the basic “product” is sourced completely from a facilities-based service provider, with no fundamental differentiation. The reseller is not able to set its own retail prices. 

An MVNO operating as a “service provider” assumes more risk, for more potential reward.  A service provider operates its own direct billing and customer care operations and can set its own prices. Revenue is typically earned on outbound traffic. 

The “asset light” MVNO earns revenue on both outbound and inbound traffic, and is obliged to pay the underlying carrier on a pattern similar to the “service provider” MVNO. The main advantage is that this type of MVNO is free to add any sort of additional value and differentiation. 

A “full MVNO” itself supplies all of the infrastructure except the radio access network, which is leased from a facilities-based mobile operator. This model offers perhaps the highest ability to differentiate the user experience, with the highest amount of risk, however. 

As a rule, an MVNO has to have operating costs 30 percent or more lower than the host provider’s cost structure. Perhaps for that reason, the full MVNO model is rarely chosen. The center of gravity is arguably either the service provider or asset light approach. 

Much can hinge on the anticipated gross revenue and  profit margins to the wholesale services supplier. Bulk accounts have their attractions. If some customers want to defect to a lower-cost mobile virtual network operator--and that is the primary attraction for nearly all MVNOs--then supplying access to a retail competitor still makes business sense.

The underlying carrier makes revenue off a “lost” customer account. Some argue that asset-light MVNOs can earn higher profit margins than facilities-based retailers. 

source: Oxio 

If a dominant mobile service provider could achieve margins between 15 percent and 20 percent as do other light MVNOs, but avoid capex and opex, further boosting margins, would that not be a reasonable choice? 

And if so, the historic value of owning scarce access assets decreases substantially, perhaps nearly entirely. So the business model becomes more disaggregated.

Structural separation, in past decades mostly viewed as a regulatory solution, might eventually become a preferred marketplace solution.

"Digital Infrastructure" Can Mean "Everything" But Then Means "Nothing"

Digital infrastructure is a term increasingly used by suppliers of connectivity services. But digital infrastructure arguably includes the rest of the information and communications ecosystem as well. To the extent that digital infrastructure includes connectivity, computing, applications and services as well as devices, it is synonymous with “internet ecosystem.”

source: AIIB

When used in the more-narrow sense of “connectivity infrastructure,”however, some connectivity assets are of growing interest to private equity, institutional investors and others, as a form of alternative investment providing diversification. 

As investment organizations sometimes desire to hold assets such as land or real estate, they now sometimes wish to own infrastructure assets that throw off predictable cash flows, have business moats and stable and recurring demand. 

That interest on the part of buyers also  accounts for service provider interest in monetizing some parts of their access infrastructure, steps that might not have been deemed wise decades ago, when ownership of scarce facilities was viewed as a primary source of business advantage. 

  

source: AIIB

But digital infrastructure now sees a confluence of supply and demand interest as much private equity views investments in digital infrastructure the same way other long-lived infrastructure (transportation, utilities, real estate) is seen: reliable providers of long-term cash flows. 

So in addition to investments in infrastructure related to  clean energy, water, and wastewater, some investors see digital infrastructure as part of the mix. 

The capital-intensive nature of these assets also creates barriers for competition, while demand growth is robust. Still, infrastructure investing--digital or not--is an asset class expected to  deliver low returns, but also with low volatility. 

At the same time, interest in alternative asset classes and low dividend yields on bonds contribute to the interest in digital infrastructure asset investment, and the trend to monetize such assets on the part of service providers. 

In substantial part, there also is corresponding interest on the part of infrastructure owners to monetize assets, driven in large part by increasing capital requirements and declining return on investment. 

In Asia, for example, communications infrastructure faces higher capital intensity and yet lower returns on invested capital. In that sense, communications infrastructure faces potential  investment gaps similar to those of other infrastructure categories. 

source: AIIB

That accounts for the prevalence of interest in “capital light” business models, public-private partnerships, wholesale access service models and privatization of assets. 

"Asset Light" Still Does Not Solve Big Problems in the Access Business

Many might lament that the access networks business would be a lot easier if only access networks did not cost so much.

So a reasonable and long-term argument can be made for divesting some fixed assets in the asset-heavy connectivity business, especially those that seemingly offer no business model advantages. Cell tower ownership is among those categories of things. Though essential for the mobile business, little strategic advantage can be gained from owning tower assets. 

At the other end of the spectrum, ownership of scarce fixed network assets has traditionally been deemed a source of business advantage. Such assets are quite expensive to replicate, and therefore form a competitive moat against new competitors. 

So business advantage, to the extent it can be created, then changes if an asset light approach is possible.

The paradox seems to be that the “asset light” approach works better for some business opportunities and entities than others. Asset light works fabulously for application providers, who then get access to potential users without the burden of investing in access networks. 

The problem is that the access business itself remains stubbornly dependent on capital-intensive networks, especially in the case of “fixed” services. Mobile businesses, based simply on the number of deployed infrastructures, are inherently more asset light than cabled networks. 

source: EY 

Of course, all that arguably changes when regulators decide to implement wholesale-based access regimes. By allowing network access, at mandated prices, to all retailers, the scarcity value of the access network is diminished, and advantage must be sought in other areas such as product packaging and marketing skill. 

Since the whole purpose of competition policy is to create supplier incentives to improve product quality and quantity while reducing retail prices, we might as well recognize that lower prices in the core access business are somewhat inevitable. The corollaries are pressures on gross revenue and profit margins as well. 

A competition policy that leads to higher prices, reduced quality and quantity would be deemed a failure. 

All that leads to constant pressure on firm leaders to seek new ways of reducing capital investment and operating costs. And many advocate an “asset light” approach that reduces need to invest in physical networks. 

McKinsey 

In practice, that has meant reliance on one wholesale network and retail competition all using the single network. The mobile virtual network operator business strategy likewise is built on leased access to existing networks. 

One might say this is akin to the “fabless” approach to the microchip businesses, where an entity designs a chipset, but then outsources its manufacturing to a third party. In that analogy, high value is earned by embedded intellectual property. 

The issue for access providers is that it is quite hard to create similar embedded value if relying on a wholesale access and asset-light approach. By definition, differentiation is hard to achieve when every competitor uses the same network, with the same capabilities, at common prices. 

So the “secret sauce,” to the extent it can be created, has to rest elsewhere. The search for enduring value “elsewhere” explains much access provider activity.

Will Any Telco Eventually Become a True Platform?

One often hears advice that firms should try to become platforms. Whether that is possible, in almost all cases, is the issue. Platform as a business model varies from the use of the term in the computing industry. 

As a business model, a platform is a marketplace or exchange. It means revenue is earned by a fee or commission on a sale of a third party good or service, not the direct ownership and supply of that product. 

That is quite different from the typical business model for most businesses, for centuries. Most businesses create a product and then sell those products to customers. All connectivity providers do the same. 

To become a platform would mean, at the very least, shifting from creating and selling connectivity services to creating a marketplace for others to sell and buy connectivity services. No firm in the communications industry has done that, ever. 

Some data center operators have created ecosystems of colocated firms. But the revenue model still is real estate. Data center operators do not actually earn revenue (commissions or fees) for purchases by tenants of the data centers. The business model remains “real estate.”

The advantages of a platform business model, assuming one can be created, are the ability to scale, lower transaction costs for buyers and sellers, as well as the creation of new distribution channels for sellers and buyers. Most platforms must create ecosystems of suppliers as well.  

source: Platform Business Model 

Some note that asset ownership patterns are different for platforms: they are said to be asset light. 

Platforms also might help to make resources and participants more accessible to each other on an as-needed basis. In that sense Amazon Web Services is a platform. Social media companies also are thought of as platforms, aggregating people and interests and then building revenue models based on advertising and commerce. 

Indeed there are conceptually many forms a platform can take. Marketplaces for services or products are one set of forms. 

But payment or investment platforms also are possible. Any peer-to-peer payment service or app might be viewed as a platform. A stock exchange also is an investment platform. 

source: Applico. 

Social or possibly communication networks can be platforms, especially when communications occur in the context of a social network. 

Software development platforms also can be created, whether based on operating systems, application program interfaces or open source.

Content platforms might include gaming, other forms of content or overlap with social platforms. 

The big hurdle for a connectivity provider is that it must essentially get out of its current business--selling connectivity services--and become something else. If it is possible, that new model would involve creating a marketplace for others to sell and buy services from each other. 

That would be among the most-difficult of all business strategy transitions, as it changes the answer to the question “what business am I in?”

Frictionless Business is Partly about Productivity

Business friction is anything that prevents a potential customer from buying your product or service. In a broad sense, friction applies to every part of a business: strategy, product development, technology, distribution channels, marketing, customer service, governance, human resources, capital resources, information technology, customer segmentation and supply chains. 

The immediate thought is that frictionless business involves only “efficiency,” with the least resource input for any given level of output. Frictionless business actually also applies to “effectiveness,” the ability of a business or organization to achieve results that matter. 

According to the U.S. Bureau of Labor Statistics, for example, the productivity (efficiency) of industries including fixed networks, computers and peripherals, communications equipment, semiconductors and non-farm businesses actually saw increased friction (lower productivity) between 2000 and 2017, compared to the 1997 to 2000 period.

source: U.S. Bureau of Labor Statistics

Only the mobile service provider business saw higher productivity over the same time frames. Keep in mind that “productivity” is a combination of output and input--goods and services volume produced compared to the hours required to create those products--along with end user demand. 

Friction can result from any combination of changes in either supply or demand. In the case of fixed network services, much of the fall in productivity comes from reduced demand for the products, and hence lower sales volumes. Even as inputs have been trimmed over time, the lower capital investment or operating costs have not fallen equally fast. 

There is a greater amount of stranded assets, for example, as the percentage of homes or businesses buying legacy services drops. That means the overhead cost of the network has to be borne by fewer paying customers. 

Adoption (percentage of potential customers who actually do buy) also matters. These days, “everybody” uses a mobile service. Less than half of households buy even a single fixed network service from any supplier. 

Frictionless business is the sum total of all actions any business can take to overcome friction, creating and keeping customers, increasing the volume of products sold to those customers with acceptable profit margins, maintaining or increasing market share with superior return on investment. 

Frictionless business reduces every barrier to business success, allowing firms to operate more effectively--doing the right things--as well as efficiently, with minimal waste and maximum productivity. 

Companies that operate with less friction are able to achieve superior results with less resource intensity. To the extent that cloud computing represents a more effective way to deliver internet-based apps and services, as well as providing cost savings and flexibility, it represents a move in the direction of frictionless business. 

To the extent that hyperscale and other data centers are required to support cloud-based apps, and to the extent that cloud apps represent higher value for customers and users, higher revenues and profits for suppliers, featuring new products available at lower costs and with different business models, data centers represent a move in the direction of frictionless business. 

source: Wall Street Journal, Synergy Research

Friction matters for employees and workers as much as it does for companies. One sometimes hears it said that income inequality or wealth inequality is the result of “greedy” people. But worker compensation is directly related to productivity, itself an indicator of friction.

Where friction is least, compensation is highest; where friction is greatest, compensation arguably is lowest. In food services and accommodation, for example, compensation change is directly--one for one--related to changes in productivity. Mining has negative productivity. In the short run, compensation outstrips gains in produced goods. 

Information technology nearly always has the highest improvements in productivity, with comparably lower changes in compensation. That is partly because production is “asset light.” Digital goods are easy to create and reproduce, compared to physical goods. 

Higher usage (demand) is not related in a linear way to the costs of producing the next incremental units. 

source: Bureau of Labor Statistics

How Much More Can Tier-One Connectivity Suppliers Become Asset Light?

Occasionally over the last few decades, it has been proposed that telcos consider ways to become asset light operators. That advice--to monetize assets--continues to be offered. The issue is what portions of the infrastructure can be spun off or sold. 

In the U.S. market, asset light was recommended for competitive local exchange carriers, at one time able to buy “unbundled network element-provisioned” wholesale services at as much as a 40-percent discount to retail prices. 

In many international markets, mobile virtual network operators are a less-risky way to enter a new market. 

In Europe and other markets, bitstream and other forms of unbundled local loop access have been created to allow asset-light wholesale entry into the telecom market. 

From time to time, observers have speculated on the degree to which it might be possible for new competitors to use unlicensed spectrum assets such as Wi-Fi to create competition for mobile or fixed internet access. At the very least, cable operators and outfits such as Fon argue that a shared Wi-Fi network allows offloading of local mobile phone traffic, thus reducing purchases of wholesale mobile connectivity. 

In specialized areas, such as cell tower facilities, many mobile operators have concluded that sharing the cost of base stations with competitors or selling such assets (with leaseback) is a way to unlock value while becoming a bit more asset light. 

The new issue is whether it is possible to unbundle even more elements of a connectivity provider’s asset base, such as optical fiber facilities serving business customers. Attice, for example, recently sold 49.99 percent of its  Lightpath fiber enterprise business to Morgan Stanley Infrastructure Partners. 

Others have suggested that CenturyLink sell its optical network assets, or at least separate the consumer from the enterprise business. Right now, the enterprise part of CenturyLink accounts for 75 percent of revenue, the consumer business just 25 percent. 

source: S&P Global

Some assets are easier to separate than others. Cell towers and data centers are discrete assets many telcos have divested. In principle, the wide area networks could possibly be divested, though owner’s economics would still be an argument in favor of retaining that portion of their networks. As always is the case, volume improves the economics of owning assets. 

In principle, other new assets, such as small cell installations or backhaul facilities, might be candidates for infrastructure sharing, especially when it is possible to separate the value of facilities from the use of those capabilities to support the core customer experience. 

The issue is whether some operators might become so good at creating and monetizing intangible assets that they can risk shifting in the direction of asset-light or non-facilities-based operations on a wider scale. Few tier-one telcos have felt it was wise to divest access networks.

Access network assets remain quite scarce and therefore valuable in most markets and arguably are the hardest parts of the infrastructure to consider divesting. 

“If telcos do not reconfigure their value chains, other parties may step in, as disaggregated telco assets are being valued differently,” consultants at Arthur D. Little have argued. The problem is that creating more value remains a huge challenge, as the ability to enter new parts of the value chain, though risky for any participant, is asymmetrical. 

Connectivity represents about 17 percent of the revenue earned annually by firms in the internet value chain. The bad news is that connectivity share is dropping.

U.S. Mobile Market Share is Unstable, With or Without T-Mobile US Merger with Sprint

Market share in the U.S. mobile market has in many past years depended partly on whether one counted subscribers or revenue. In 2019 AT&T was biggest, measured by accounts. In the past, in some years Verizon was biggest if one measured by revenue. 

By 2018, AT&T arguably was the leader in both revenue and subscribers. 

This look a 2018 revenue shows AT&T leading in revenue and subscribers, overall.

source: Statista

One could make an argument that Verizon lead in postpaid accounts, though. 

source: Cowen and Company

Perhaps ironically, whether the T-Mobile US merger with Sprint is approved or denied, U.S. mobile market structure will remain unsettled and open to share changes of some size. The reason is that, longer term, markets tend to take an unequal share distribution. 

With or without a T-Mobile merger with Sprint, U.S. market structure is unstable, using some classic rules of thumb. Heavily capital intensive industries serving mass markets often take an oligopolistic shape, if not a monopolistic shape. 

At best, only a few firms are sustainable. 

Most stable markets are led by a few firms. In fact, many stable markets take a particular shape. As the PIMS database suggests, a stable industry structure eventually tends to take a shape where the number-two provider has half the share of the leader, while the number-three provider has share half that of number two. 

That tends to produce a market share distribution of something like 4:2:1. So far, that tends to be true for physical industries that are asset heavy as well as internet and applications businesses that are asset light. That might be why it so often seems to be the case that a market follows a rule of three. 

More importantly, in many markets, just two firms have 80 percent of profits. 

So with, or without, a merger of T-Mobile US with Sprint, the U.S. mobile market would have an uncomfortably unusual market structure. The gap between AT&T and Verizon is not wide enough to be stable, for example. 

When the market structure 4:2:1 or something close to it prevails, competitors two or three do not have incentives to launch price attacks against the market leader, as the leader has the resources and incentive to do whatever is required to beat back a price attack. 

Could Edge Computing Facilities Eventually Help Telcos Become More Asset Light?

The fixed network communications business never will be asset light. On the other hand, the long-term business model almost certainly benefits from becoming less asset intensive, when possible, as this helps lower sunk costs and reduces capital spending.

Edge computing raises a couple of interesting questions, in that regard. Assuming that the best option for most telcos is not to become "edge computing as a service" providers, but instead focus on becoming neutral host providers of edge computing facilities (racks, security, air conditioning, cross connect), new issues around recurring revenue, profit margins and asset creation arise.

At least in principle, edge computing colocation could be a logical line extension for many tier-one connectivity providers. The investments might be incremental, and produce additional revenue.

The other question is whether the edge facilities business could be positioned as an asset for eventual sale, as has been the case for cell towers.

Cell towers and stand-alone data center facilities were easy to separate from the rest of the connectivity business, and could be sold.

That is not so easy when edge computing racks and infrastructure are inside telco buildings and real estate, unless those facilities have been nearly entirely replaced as elements of the communications infrastructure. 

On the other hand, network virtualization could be a way for telcos to position much of their former central office infrastructure as non-core assets, though they might still need to become tenants, if most local central offices were sold. Much as they sell owned towers and then become tenants, the same could, in principle, be done with most central offices once virtualization is possible. 

At least for fixed network operations, those former CO locations would still be needed as aggregation points for the local access network. 

If an entire local access business cannot or should not be sold, the question might then be asked: how much of those physical “access” assets could be positioned for sale? Generally speaking, COs and access networks have been considered mission critical assets, with connectivity providers benefiting from ownership of those facilities. 

So there are some possible new questions. 

To what extent does edge computing infrastructure, like the data center business, create recurring revenue, and to what extent might such assets become mission critical for connectivity providers? 

Even if mission critical, could such assets be packaged for possible eventual sale, using the same sale and lease-back mechanisms previously used for cell towers? 

To the extent that edge computing is integral for connectivity service operations, to what extent could those functions be supplied as a “buy rather than build” input? 

Those could become more interesting discussions at some point, as most service providers seek to become a bit more asset light, if only to reduce the sunk costs of their businesses.

What Roles for Telcos in IoT?

Just about every participant in the mobile ecosystem (from chips to operating systems to hardware, apps and networking services) has to think about the potential upside from massive internet of things adoption. 

Device and app suppliers arguably have an easier time conceiving of new value they could provider. 

Smartphones normally contain some common sensors, including accelerometers, gyroscopes, magnetometers, GPS, ambient light sensors, proximity sensors and other potential sensors that might eventually enable IoT applications. Other capabilities of phones, such as use of their radios, can help establish traffic conditions, using the phones as proxies for vehicles. 

But there are some valuable bits of information smartphones will not be directly able to sense, such as road conditions. So Pirelli envisions smart tires, which are capable of sensing and communicating road information to apps and other drivers. 

source: Pirelli

Opportunities for connectivity providers are harder to see, beyond supplying the mobile or fixed connections. Some believe that tier-one telcos could handle the life cycle management of IoT sensors. Hardest of all, but more lucrative, connectivity providers might create IoT apps themselves in a few areas, most likely around transport, cars and other vehicles, which require untethered communications. 

There are obvious issues to be overcome. Life cycle management will include replacing sensors and batteries. That might be conceivable for portable sensors, but there also are other obvious channels (electronics retailers, large retailers). Replacing embedded sensors does not seem to be an area where big telcos or internet service providers necessarily have a natural advantage. 

That might be something better suited in many industry verticals to the service operations already in place to support industry-specific equipment. In other words, if a consumer has a heating or cooling system sensor problem, is a telco the logical company to come fix the problem? How about sensor issues on an industrial robot, or a sensor on a vehicle? 

source: IBM

Many believed telcos could be viable suppliers of some types of computing infrastructure as well, and that rarely has worked as well as hoped. Still, the general thinking is that IoT presents a range of potential roles for access providers, beginning with the connectivity function. 

Moving towards platform opportunities, perhaps access providers create application program interface capabilities allowing third parties to add communications to their services and apps, though, as always, specialists seem already to have established themselves in this role. 

To greater or lesser degrees, some access providers might develop vertical industry capabilities or perhaps domain-specific solutions. Perhaps one logical avenue is IoT for internal use for asset management and security. 

In fact, the telecom industry is among the top-four industries for use of sensors and monitoring systems, Tata Consultancy Services found. 

source: TCS

As a rule, we should expect all access providers to build first on the connectivity function. Only a relative few will attempt other roles as platforms or solution providers.