5G Leaky Bucket Problems

What happens with legacy services is arguably more important, near term, than what happens with new services created by 5G networks. The reasons are obvious: the new services represent smallish revenues while the legacy services represent most of the total revenue.

Small percentage declines in core legacy services have more revenue and profit margin impact than all the new services put together. The image of a hamster running on a wheel might not be appetizing, but that is the situation connectivity providers face.

Or, if you like, a leaky water bucket where new water is poured into the bucket as water continues to leak from holes.

Most connectivity service providers serving well-served and nearly-saturated mass markets would be happy if annual revenue growth chugged along at about a two-percent rate. Service providers in some markets can expect higher growth rates, but the global average will probably be in the two-percent range. 

Given some deterioration in legacy lines of business (negative growth rates), growth rates in one or more new areas might have to happen at higher-than-two-percent rates to maintain an overall growth rate of two percent. 

And that is the problem for new 5G services in the edge computing, private networks or internet of things areas, for example. The new revenue streams will be small in magnitude, while even a modest decline in a legacy service can--because of the larger size of the existing revenue streams--can pose big problems. 

Many service providers, for example, expect big opportunities in business services, which underpins hopes for private networks, edge computing and IoT. But revenue magnitudes matter. 

Consumer revenue always drives the bulk of mobile operator service revenues. And revenue growth is the key issue.  

But it will be hard for new 5G services for enterprises and business to move the revenue needle. 

Edge computing possibly can grow to generate a minimum of $1 billion in annual new revenues for some tier-one service providers. The same might be said for service-provider-delivered and operated  private networks, internet of things services or virtual private networks. 

But none of those services seem capable of driving the next big wave of revenue growth for connectivity providers, as their total revenue contribution does not seem capable of driving 80 percent of total revenue growth or representing half of the total installed base of revenue. 

In other words, it does not appear that edge computing, IoT, private networks or network slicing can rival the revenue magnitude of voice, texting, video subscriptions, home broadband or mobile subscription revenue. 

It is not clear whether any of those new revenue streams will be as important as MPLS or SD-WAN, dedicated internet access or Ethernet transport services, for example. All of those can be created by enterprises directly, on a do-it-yourself basis, from the network edge. 

source: STL, KBV Research 

In the forecast shown above, for example, services includes system integration and consulting, certain to be a bigger revenue opportunity than new sales of connectivity services. 

And though it might seem far fetched, the lead service sold by at least some connectivity providers might not yet have been invented.  

At least so far, 5G fixed wireless is the only new 5G service that is meaningful and material as a revenue source for at least some mobile operators. Even if network slicing, edge computing, private networks and sensor network support generate some incremental revenues, the volume of incremental revenue will not be as large as many hope to gain.

It is conceivable that mobile operators globally will make more money providing home broadband using fixed wireless than they will earn from the flashier, trendy new revenue sources such as private networks, edge computing and internet of things. 

source: Ericsson 

Wells Fargo telecom and media analysts Eric Luebchow and Steven Cahall predict fixed wireless access will grow from 7.1 million total subscribers at the end of 2021 to 17.6 million in 2027, growth that largely will come at the expense of cable operators. 

source: Polaris Market Research 

If 5G fixed wireless accounts and revenue grow as fast as some envision, $14 billion to $24 billion in fixed wireless home broadband revenue would be created in 2025. 

The point is that the actual amount of new revenue mobile service providers can earn from new services sold to enterprises is more limited than many suspect.

How Big a Deal is Edge Computing as a Revenue Driver for Connectivity Providers?

Edge computing possibly can grow to generate a minimum of $1 billion in annual new revenues for some tier-one service providers. The same might be said for service-provider-delivered and operated  private networks, internet of things services or virtual private networks. 

But none of those services seem capable of driving the next big wave of revenue growth for connectivity providers, as their total revenue contribution does not seem capable of driving 80 percent of total revenue growth or representing half of the total installed base of revenue. 

In other words, it does not appear that edge computing, IoT, private networks or network slicing can rival the revenue magnitude of voice, texting, video subscriptions, home broadband or mobile subscription revenue. 

It is not clear whether any of those new revenue streams will be as important as MPLS or SD-WAN, dedicated internet access or Ethernet transport services, for example. All of those can be created by enterprises directly, on a do-it-yourself basis, from the network edge. 

The point is that even when some new innovations are substantial generators of revenue and activity, it is not automatically connectivity providers who benefit, in terms of direct revenue. 

One rule of thumb I use for determining whether any proposed new line of business makes sense for tier-one connectivity providers is whether the new line has potential to produce a minimum of $1 billion in annual revenues for a single provider in some definable time span (five years for a specific product. 

By that rule of thumb, tier-one service providers might be able to create edge computing revenue streams that amount to as much as $1 billion in annual revenue for some service providers. But most will fail to achieve that level of return in the next five to seven years.

That is not to say "computing at the edge" will be a small business. Indeed, it is likely to account for a growing part of public cloud computing revenues, eventually. And that is a big global business, already representing more than $400 billion in annual revenues, including both public cloud revenues as well as  infrastructure spending to support cloud computing; the value of business applications and associated consulting and services to implement cloud computing.

The leading public cloud computing hyperscalers themselves represent about $72 billion or more in annual revenues already. All the rest of the revenue in the ecosystem comes from sales of software, hardware and services to enable cloud computing, both public and private.

source: IoT Analytics

It is likely a reasonable assumption that most public edge computing revenue is eventually earned by the same firms leading public cloud computing as a service.

Perhaps service provider revenues from edge computing could reach at least $20 billion, in about five years. By that standard, multi-access edge computing barely qualifies as "something worth pursuing," at least for tier-one connectivity service providers.

In other words, MEC is within the category of products that offers reasonable hope of payback, but is not yet in the category of “big winners” that add at least $100 billion to $200 billion in global service provider revenues. 

In other words, MEC is not “mobile phone service; home broadband. Perhaps it will be as big as MPLS or SD-WAN. For tier-one connectivity providers, perhaps MEC is more important than business voice (unified communications as a service). 

source: STL, KBV Research 

As with many other products, including Wi-Fi, SD-WAN, MPLS, 4G or 5G private networks, local area networks in general and  enterprise voice services, most of the money is earned by suppliers of software (business functionality) and hardware platforms, not end-user-facing services. 

The reason is that such solutions can be implemented on a do-it-yourself basis, directly by enterprises and system integrators, without needing to buy anything from tier-one connectivity providers but bandwidth or capacity. 

So one reason why I believe that other new connectivity services enabled by 5G likely do not have the potential to substantially move the industry to the next major revenue model is that none of those innovations are very likely to produce much more than perhaps one percent of total service revenues for the typical tier-one service provider. 

The opportunity for big public connectivity providers lies in use cases related to the wide area network rather than the domain of indoor and private networks. That is why the local area networks industry has always been dominated by infra providers (hardware platforms) and users who build and own their own networks (both enterprise and consumer). 

And most of the proposed “new revenue sources” for 5G are oriented towards private networks, such as private enterprise local area networks. Many of the other proposed revenue generators can be done by enterprises on a DIY basis (edge computing, internet of things). Some WAN network services--such as network slicing--attack problems that can be solved with DIY solutions.

Edge computing is a solution for some problems network slicing is said to solve, for example. 

None of the new 5G services--or new services in aggregate-- is believed capable of replacing half of all current mobile operator revenues, for example. And that would be the definition of a “new service” that transforms the industry. 

All of which suggests there is something else, yet to be discovered, that eventually drives industry revenue forward once mobility and home broadband have saturated. So far, nobody has a plausible candidate for that new service.

Edge computing might be helpful. So might network slicing, private networks or internet of things. But not even all of them together are a solution for industry revenue drivers once home broadband and mobile service begin to decline as producers of at least half of industry revenues.

It already seems clear that others in the edge computing ecosystem--including digital infra providers and hyperscale cloud computing as a service suppliers--will profit most from edge computing.

The Lead Product Sold by Access Providers in 10 Years Might Not be Invented Yet

Some might think it is mere hyperbole to argue that connectivity service providers literallly must replace half their current revenue every decade. But that has historically been the norm in the competitive era of connectivity. To use the most-obvious examples, nearly all revenue and profit in the period before 1980 was earned selling voice. Does anybody think that is the case today?

Instead, globally, mobile service is what drives both revenue and revenue growth. On the fixed networks, internet access (home broadband) drives revenue, not voice. In developing markets, mobile subscriptions still drive growth. But in developed markets internet access is the revenue growth driver.

In the enterprise wide area networks market, X.25 once drove revenue, followed by frame relay. ISDN and ATM nver caught on. Now it is dedicated internet access, Ethernet transport or MPLS that are key revenue generators. And MPLS is being replaced by SD-WAN.

The colloquial way of expressing this is to say "my top revenue-producing product in 10 years has not been invented yet." Again, that might seem hyperbolde. But think about 4G, 5G and 6G. Each successive next generation network was introduced 10 years after the prior generation. And each successive generation displaced prior generation customer accounts,

Part of the reason for revenue change of that magnitude is product obsolesence. The other issue is declining average selling prices.

This graph of mobile termination rates--the fee a mobile network charges another network for completing an inbound call--illustrates a couple of principles relevant to the connectivity and computing industries. To the extent that computing costs are driven by chip-level capabilities that double about every 18 months, cost-per-operation drops over time. 

source: iconnectiv 

In other words, the cost of executing a single instruction or operation will fall rather sharply every decade, as they essentially fall by half every two years. In this example of mobile termination rates, costs fell from seven cents per minute to less than two cents per minute over a decade, or more than half--and close to three times--in 10 years. 

All other things being equal--such as holding traffic volumes steady--that means termination revenue would have fallen by close to three times, and clearly more than half, over that decade. In practice, since call volumes rose, the decline was likely less, in absolute terms. 

For example, the global number of mobile subscriptions grew about 52 percent between 2010 and 2019, so there were more people making mobile phone calls. But per-minute charges dropped faster, close to 100 percent lower in some countries. 

Other charges also declined. Between 1997 and 2022, for example, the cost of U.S. mobile 41phone subscriptions dropped by 50 percent. So the actual rate of decline for recurring service was not as fast as the decline of calling costs per minute. 

The actual change in revenue sources was complicated. Revenue was boosted by additional subscribers, replacement services (mobile internet access in place of voice and messaging) and higher possible usage in some cases. But revenue was diminished by lower average unit rates for subscriptions, calls and text messaging. 

That illustrates a second point about revenues in the connectivity business: about half of all current revenue earned by a service provider will be gone, every decade. That might sound like an exaggeration. It is not. How many service providers sell ISDN, X.25, frame relay or ATM anymore? At one time, each of those services was, or was supposed to be, a key driver of wide area network data revenues. 

How many access providers sell dial-up internet access anymore? And, over time, what is the typical downstream package purchased by half of all customers? At one point it might have been 1 Mbps or less. At some point that changed to perhaps 10 Mbps, then 100 Mbps, then higher. The point is that in each generation, the “product” changed. 

International and national  long distance calling rates show the same pattern. 

source: FCC 

source: U.S. Department of Justice 

The general point is that revenue sources changed over that decade, as they tend to do every decade. 

In fact, calling revenues now are minor enough that it is difficult to find statistics on calling volume or revenue, as internet access now drives revenue models. 

Mobile Operator Questions About 5G Payback Model Reflect 4G Experiences

Many in the mobile ecosystem ask the question “how will we make money from 5G? Fixed network operators have been asking themselves similar questions--"how do we get a payback from fiber-to-the-home?"--for several decades.

For mobile or fixed network operators, competition and changing demand make payback models uncertain and challenging. Where facilities-based competiton exists, the infrastructure cost per customer account always rises.

Stranded assets are the reason, though more an issue for fixed networks. In a monopoly market, the single provider might hope to get close to 98 percent take rates. In a competitive market with two equally-capable providers, each provider might hope to get 50 percent share of the installed base.

That effectively doubles the network cost per customer, as revenue is earned from about half of locations passed. In markets with three or more facilities-based competitors, cost-per-account increases more.

Demand changes also effect payback models. Fiber to the home once was underpinned by the assumption that there would be high demand for up to three services (voice, video and internet access).

As demand for fixed network voice and linear video subscriptions declines, the business model increasingly is built on home broadband. Voice and linear video help, but both are expected to keep declining.

But that has key revenue implications. Where a home location might have been expected to generate revenue of $80 to $200, the growing reality is that a location is expected to generate perhaps $50 in home broadband revenue, and then some amount of voice or other revenue from some locations.

Basically, revenue expectations--average revenue per customer or location--are effectively cut in half. That forces changes to the payback model on the cost side. Basically, costs must drop.

Those savings can come from intrastructure cost declines; operating cost drops; higher subsidies; lower maintenance costs; lower headcount and overhead or any combination.

The key point is that revenue assumptions for fixed networks increasingly are founded on lower gross revenue assumptions; revenue from additional sources; shared costs between mobile and fixed networks and more importance attached to defending market share or taking market share.

The parallel question asked by mobile operators--"how do we make money from 5G?--embeds some of the same issues faced by fixed network operators.

What the question likely means is less an uncertainty about revenue drivers and more a concern about the distribution of value within the ecosystem: will mobile operators reap a fair share of 5G benefits (higher revenue, higher profits, higher market share, lower operating costs)?

Looking only at consumer retail costs--exclusive of experience advantages such as higher speed; lower latency; new services or capabilities--it is not yet completely clear that average revenue per 5G account is higher than 4G ARPA.

5G has proven to generate higher ARPA in some markets, however.

It is a virtual certainty that 4G and older connections will be replaced by 5G. So the baseline for 5G revenue is 4G revenue. Beyond that, there is expected upside from private networks, network slicing (virtual private networks), edge computing and new enterprise connections to support internet of things use cases. 

To be sure, many wonder whether “we can charge more for 4G?” The long-term answer is not yet knowable, but the practical answer might well be “yes.” 

And that can be true even when direct tariffs for 5G are not that different, if different at all, from 4G tariffs. Some mobile operators do not charge a premium for 5G, but expect to gain market share, which drives higher 5G revenue.

Other service providers provide incentives for customers to use 5G but with a price increase coming in the form of unlimited usage. The actual driver of higher revenue per account is the shift to a higher-priced “unlimited usage” tier, not 5G as such, though such plans include 5G access at no extra charge. 

And though we have not seen it much, if at all, some mobile operators might decide to institute speed tiers for mobile service that mimic the ways access is sold on fixed networks. Customers might be offered lowest prices for lowest speeds; mid-tier pricing for mid-tier speeds and premium prices for the higher speed tiers. 

But there is another sense in which the question of “how will we make money from 5G?” can be understood.

Customers got value in terms of higher speeds when 4G was introduced. Mobile operators expected to sell more data, which would generate more revenues, and also create new services that would further increase revenues. 

But tough competition in many markets meant that mobile operators were not able to charge a price premium for 4G access. So the benefits went largely to consumers, according to ING analysts. “They got more data, better speeds and often paid less,” ING says. 

Governments also raised billions in revenue from spectrum auctions.

So one way of understanding the question about 5G revenues is the distribution of value and revenue for mobile operators within the 5G ecosystem. The downside for mobile operators is lower recurring revenues from 5G, compared to 4G. 

“Operators do not want to repeat these mistakes” seen in the transition from 3G to 4G, ING notes. But some might argue that the long-term trend will be difficult to break. 

source: Statista 

source: Strategy Analytics

source: Researchgate  

Taking market share, shifting customers to pricier accounts and increased usage charges are the immediate ways mobile operators have boosted 5G revenues over 4G levels. 

Longer-term pricing trends, though, might be difficult to change, as prices have been declining since 1996. 

On the other hand, the whole reason we see a next-generation mobile network about every 10 years, since 3G, is that capacity demand by customers keeps climbing. And while mobile operators can increase effective capacity using small cells and better radios, at some point an increase in spectrum is required. 

Also, as modulation and coding gets better with each successive generation, the cost to deliver a bit drops, allowing mobile operators to supply data consumption demand at lower costs. 

So another way to look at the payback model is to ask “what happens to your business if you do not upgrade to 5G?” Defending existing market share is a legitimate business outcome. 

Creating a more-efficient data network that supplies demand affordably also is an important business outcome. And to the extent 5G network capabilities are required to support dense internet of things networks, edge computing networks and network slicing, not investing in 5G forsakes any revenue opportunities in those areas. 

In many ways, that is akin to the value of fiber-to-home networks. In many cases, higher revenue per account is not expected. The business value instead comes from consumer market share gains, market share defense and the ability to compete in those markets. 

There is incremental value in terms of backhaul support for mobile small cell networks or business-grade services for smaller businesses. There is value in reduced operating expenses and possibly headcount. 

In other words, there are lots of ways 5G contributes to overall business value for mobile operators that go beyond direct tariff increases.

For Most Telcos, Net Revenue Gain Comes not from 5G but Elsewhere

For the foreseeable future, net changes in telco revenue can happen only at the margin. Over the next decade, mobile operators, for example, will replace half their 4G accounts by 5G accounts. So the issue is whether average revenue per account stays the same; increases or decreases. 

Assuming at least a stable ARPA, the balance of revenue changes will come in fixed network services. And there the issue is whether new revenue sources offset expected losses in consumer and business service revenue. 

Keep in mind that revenue-neutral product replacement is necessary, but will not help telcos grow total  revenues. Product replacements only swap legacy revenue for new sources, as in the example of 4G accounts being replaced by 5G accounts. 

All things equal (operating costs; marketing costs; capital investment; revenue per account), swapping 5G for 4G results in zero net revenue gain. All revenue growth beyond zero must come in other areas. 

On a global level, revenues appear flat. But revenue contributors change substantially every decade. In fact, telcos routinely lose half of present revenues every decade. That seems unthinkable, but has happened. 

“Over the last 16 years we have grown from approximately 25 million customers using wireless almost exclusively for voice services to more than 110 million customers using wireless for mostly data services,” said Lowell McAdam, former Verizon Communications CEO.

It is an illustrative comment for several reasons. It illustrates Verizon’s transformation from a fixed network services company to a mobile company. But the comment also illustrates an important business model trend, notably that of firms in telecom needing to replace about half their current revenues every 10 years or so.

In the U.S. telecom business, for example, we already have seen that roughly half of all present revenue sources disappear, and must be replaced, about every decade.

According to the Federal Communications Commission data on end-user revenues earned by telephone companies, that certainly is the case.

In 1997 about 16 percent of revenues came from mobility services. In 2007, more than 49 percent of end user revenue came from mobility services, according to Federal Communications Commission data.

Likewise, in 1997 more than 47 percent of revenue came from long distance services. In 2007 just 18 percent of end user revenues came from long distance.

Though revenue attrition has been clearest for fixed network voice, the same process has been seen for mobile voice, text messaging, long distance revenues, mobile roaming and business customer revenues overall, in many markets. 

We can disagree about how much new revenue some communications service providers will have to create over a decade’s time, to replace lost legacy revenues.

If global telecom revenue is about $1.6 trillion to $2 trillion, and assuming about half the revenue is earned in mature markets, then the revenue subject to disruption ranges from $800 billion to $1 trillion.

Half of that represents $400 billion to $500 billion. That, hypothetically, is the potential amount of global revenue that might be lost, and would have to be replaced. The good news is that most of the replacement will come as 5G displaces 4G subscriptions. 

What is equally certain is that a huge amount of revenue from new services will be necessary, even if consumer purchases of Internet access--and replacement of 4G by 5G--happens.

One fundamental rule of thumb is that, in mature markets,  service providers must plan for a loss of about half of current revenue every decade or so. That might seem shocking, but simply reflects historical developments.

Nor is that rate of change unusual. In the digital consumer electronics business, it might not be unusual for an executive to predict that half the products that drive sales volume in 10 years “have not been invented yet.”

What is new for the telecommunication business is that product replacement now is a fundamental issue, even if for 150 years the only product was voice.

source: IBM

In 2001, in the U.S. market, for example, about 65 percent of total consumer end user spending for all things related to communications and video services went to "voice."

By 2011, voice represented only about 28 percent of total consumer end user spending.

Over that same period, mobile spending grew from about 25 percent to about 48 percent. Again, you see the pattern: growth of about 100 percent (losses of 50 percent require gains of 100 percent, to return to an original level,  as equity traders will tell you).

Video entertainment spending likewise doubled.

In the U.S. market, one can note roughly the same pattern for long distance and mobile services revenue. Basically,mobile replaced long distance revenue over roughly a decade.

At one time, international long distance was the highest-margin product, followed by domestic long distance.

That changed fundamentally between 1997 and 2007.

Over that 10-year period, long distance, which represented nearly half of all revenue, was displaced by mobile voice services.

In the next displacement, broadband is going to displace voice.

That is not yet an issue in some regions that still are adding mobile and fixed network subscribers, but already is an issue in most developed regions, where voice and messaging revenues already are declining.

source: STL Partners

Though some might continue to hope that higher Internet access revenues will offset voice and messaging revenue dips, the magnitude of voice revenue declines will be so sharp that in many markets, even additional Internet access revenues will be insufficient in that regard.

In fact, rates of revenue growth have been dropping in all regions since at least 2005, according to IBM.

At least so far, ability to fuel growth by extending service to customers with low average revenue per user will continue to drive revenue growth, even for legacy services, for a while. The only issue is when saturation is reached in each particular market.

When that happens, the same pressure on voice and messaging revenue already seen in mature markets will be seen in presently-growing markets.

Those changes can be hard to discern, as the top line obscures changes in revenue contribution from the largest sources. Voice, messaging and long distance services have fallen dramatically. Consumer fixed network usage of voice no longer drives financial results, its place taken by internet access (broadband). 

Mobility now drives growth in most markets, and especially the data services component of mobile revenues. Subscription growth still is highly meaningingful in developing Asia and Africa. 

source: Delta Partners 

Basically, 5G mostly prevents telco revenue from declining. It does not drive revenue growth. If we expect continued declines in fixed network voice, then broadband and other new services will have to be relied on for most of the growth, in most markets, by most operators. 

The lucky scenarios will happen when mobile-first operators actually are able to drive higher ARPA in the 5G era.