Software Drives Hardware Demand; Video Drives Internet Access Demand

“The value of software to stoke demand for new hardware was as old as personal computing itself,” says says Daniel Eran Dilger, who writes for AppleInsider.  “Everyone in the industry was already aware that Apple II systems first sold in the 1970s because of VisiCalc; that PageMaker had initially driven sales of Macs in the 1980s, that Office had primed Windows PCs in the 1990s.”

LIkewise, one might argue that Apple’s content ecosystem was among the reasons for Apple’s possibly improbable ascent and longevity in the consumer hardware business.

So it might be an unusual stretch to argue that efforts by telcos and cable companies to move from “mere” distribution to  “content ownership,” as Apple has moved from “mere” hardware to software ecosystem, are similar. Content and apps drive sales of hardware. Perhaps likewise, content drives sales of internet access (bundles, for example) and mobility (streaming video bundled with mobile internet).

Whether the path of application (content) ownership, or simply curation, is “better” might be a bit beside the point. Apple both curates and owns apps. It distributes through iTunes without ownership of content, but it also creates and owns Siri and other apps. On the other hand, creation of original content seems to be assuming new importance for Apple as it has for video distributors.

A distributor can wring only so much revenue and profit out of content that is freely licensed to multiple distributors. And Netflix now has demonstrated the power of original content to drive subscriptions.

Netflix also has shown the power of occupying multiple roles within the ecosystem: a “studio” (developing content) as well as a “network” (Netflix the branded “channel” like HBO) and also distributor (Netflix as a replacement for cable TV subscriptions).

In that sense, Verizon and AT&T are emphasizing different strategies with regard to video, for reasons related to their existing assets and positions in the current ecosystem. Verizon does not appear to believe that the video distributor business (linear or streaming) is as strategic as does AT&T.

There may be internal cultural factors at work. Some might argue that neither Verizon or AT&T have had overwhelming success with their homegrown video services, linear or over the top.

Verizon always has emphasized the “quality of its network” (fixed and mobile), it arguably has been difficult for organization priorities to deviate much from the “best network” mindset, with its emphasis on the network.

AT&T arguably has had the reverse problem: it has so many locations, and so many that are rural or low density, that it has struggled to develop a consistent business case for fiber to home upgrades, when capital has been needed to support the mobile business, which has driven growth for more than a decade.

The point is that opportunities for revenue growth in the near term are different. Verizon can grow by taking market share away from “bigger” competitors (in the fixed network business). AT&T, as the largest linear video distributor, cannot do so. For AT&T, diversifying elsewhere in the ecosystem offers higher returns.

Geographic coverage therefore explains and shapes strategy. Verizon’s fixed network passes far fewer households than AT&T, Comcast or Charter Communications. So strategy might follow beliefs about assets. Verizon might believe it will not benefit as much in the upside from such ownership as others might. AT&T, Comcast and Charter each pass between 50 million and 65 million U.S. homes. Verizon passes perhaps 27 million. Verizon has the smallest footprint of those four fixed network firms, by far.

That also means Verizon’s ability to create an base of subscribers--and audience--is smaller. Though all the firms believe video offerings are important, AT&T arguably has more to gain in the video area. It already is the largest U.S. video linear services provider, and with Comcast, are the biggest in content asset ownership.

So if a video subscription business benefits from scale, Verizon benefits less than AT&T, Charter or Comcast in the video subscription product segment.

On the other hand, Verizon can realistically hope to grow its revenues by taking video share and internet access share away from those other competitors as it deploys its 5G networks (fixed and mobile). Fundamentally, that was the strategic rationale for cable TV operators in the voice market: cable operators could simply take market share from telcos in an existing business where the telco had nearly all the market to itself (mobility aside).

But all four U.S. national mobile service providers now believe video services play an important role in their 5G strategies, with a range of views based on where each firm sees its own assets.

AT&T and Verizon believe advertising is going to be an important revenue driver for them; Sprint and T-Mobile US do not. That makes sense, so far, as AT&T and Verizon have much-larger customer bases, and “eyeballs” matter for advertising.

AT&T clearly believes most in content ownership; its strategy resembling that of Comcast most. The other mobile companies do not believe they can viably pursue that role, and Verizon claims it does not believe content ownership is necessary.

Can Cable Win, Long Term, Without Mobility?

Cable execs keep stressing they are communications companies--and arguably leading companies--rather than video entertainment distributors. But it might be hard to do that, long term, without a key position in mobility, which drives the bulk of revenue in the U.S. communications business, unless an alternative international growth strategy is the alternative.

The Sky purchase, though increasing Comcast exposure to video distribution, might suggest the early focus.

source: Infonetics

The issue for Comcast, as for some other firms, is whether a “fixed network only” or “mobile only” strategy is sustainable.

To be sure, cable companies are positioned to take market share in business services and consumer broadband. In fact, the whole growth story for cable companies in communications is “taking market share” from telcos faster than video revenue is lost.

But the bucket is leaking. Cable has to add new revenues simply to replace lost video revenues. Net growth beyond that replacement is the issue.

SNL Kagan forecasts residential cable industry revenues will rise from $108.38 billion in 2016 to $117.7 billion in 2026, a $9.32 billion increase over the 10-year period, even as video revenues shrink.

Commercial services revenues will push total industry revenue from $130.57 billion to $140.99 billion, a $10.42 billion increase, SNL Kagan suggests.

That forecast assumes consumer broadband subscriptions grow by more than eight million over the next 10 years, largely by market share gains at the expense of telcos. That is why fixed wireless and 5G mobile substitution are such a big potential change for telcos. If 5G reduces share losses to cable TV, the consumer revenue growth estimate for cable is too high.

The SNL Kagan forecast also is sensitive to the rate of linear video subscription losses. Basic video subscriptions are projected to drop by an annual compounded growth (CAGR) rate of 1.5 percent to 45.4 million by 2026. Accelerated losses, which most likely expect, will damage the overall growth forecast as well.

SNL Kagan anticipates total revenues generated from residential video services to fall at a CAGR of -0.5 percent over the next 10 years, totalling $55 billion annually in 2026. Again, that could be overly optimistic.

Advertising revenue is expected to grow at a 4.3% CAGR through 2026 to reach $6.3 billion, but is not a big enough contributor to offset bigger losses in the core services areas.

So the strategic issue is whether the cable industry can sustain a position at the top of service provider rankings without serious mobile revenues and profits, even if taking market share in enterprise and business markets will help.

That might be likened to the position CenturyLink finds itself in: it already earns more than 76 percent of total revenues from enterprise customers on its global networks and metro enterprise services.  

Its entire national footprint of mass market customers is essentially a drag on company profitability.

source: Seeking Alpha

Mobile remains the growth engine globally, but the relative scale and importance of the mobile, fixed broadband, and entertainment TV  markets varies hugely by country and region. In 2021, the mobile market will generate 87 percent of total connectivity and video revenues in Africa and 70 percent in the Middle East, compared to 50 percent in North America and 49 percent in Western Europe, according to Informa Ovum. The differences stem largely from revenues generated from fixed networks.

Cable dominates consumer broadband, has a strong, if declining video business and is growing its share of commercial revenues. But the other leading incumbents are fighting for their lives as well, and will not easily yield market share in voice and data, least of all AT&T and Verizon, which appear to be holding their own in consumer internet access share, for example, while most of the telco industry losses come from smaller providers relying mostly on digital subscriber line for internet access.

Almost without exception, such providers also have no mobile exposure. How long such firms can compete against cable, which arguably offers better value for consumers, is an open question.

Conversely, cable can compete against weaker telcos without mobile assets quite well. Whether cable can challenge AT&T and Verizon, though, is a bigger question at the moment, so long as no clear mobile strategy at scale.

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.

Have LTE Operators Already Found Their First Significant New Revenue Source?

Mobile connections for tablets might be developing as the first new revenue-generating "new app" of any significance for Long Term Evolution networks. In fact, the magnitude of those new revenue streams seems to be occurring faster than has been operator experience with third generation networks.

Mobile service providers, since at least the advent of third generation networks, have hoped for and touted the development of new revenue-generating applications, every time a next generation network is introduced.

That sometimes can take a while to develop. In fact, that has lead some observers to say there is no "killer app" for fourth-generation mobile networks, in the sense of some huge new revenue-generating application or feature.

In fact, in the near term, it might be logical to assume that “faster speed” is the closest thing to a new “killer app” that drives incremental revenue.

But one potentially new trend already might be developing for fourth generation Long Term Evolution networks, namely the additional connections to support tablet devices, and not necessarily new apps for smart phone users.

According to a survey sponsored by the GSM Association, about 33 percent of dongles, tablets or hotspots are 4G-enabled. That doesn’t mean all or even most of those devices are actively using 4G connections, but many do connect to the 4G network.

So some would argue that the first new 4G revenue source is network connections for tablets, which appear to offer a greater prospect for 4G growth than other data devices such as the traditional dongles.

On average, 4G operators surveyed by GSMA offered seven tablets in their data devices portfolio. Operators such as A1 Telekom (Austria), Polkomtel (Poland), MTS (Russia), STC (Saudi Arabia) and Telenor (Sweden) offered twice the number of tablets they were a year ago.

Australia’s Telstra, which launched its first 4G networks in the third quarter of 2011, recently noted a “really big swing in terms of tablet technology”. But tablets represented 24 percent of the operators’ mobile broadband customer base in the second half of 2012.

The introduction of shared data plans in developed markets, which allow, s users to attach several devices to a single plan and data allowance, is accelerating adoption of data devices.

Verizon Wireless CFO Francis Shammo says new customers often buy low end service plans, but then over a period of six months almost double the amount of devices that they put onto shared access plans.

Those additional shared data plans are boosting revenue per account. Even though many tablet users rely on WiFi as their main Internet connection, 4G LTE adn shared data plans will boost growth in broadband tablet data subscriptions, says Strategy Analytics.

Strategy Analytics forecasts global mobile broadband subscriptions on tablets will grow 800 percent from 2012 to 2017, as more than 165 million new tablets get connected to mobile networks.

But it would be odd, perhaps almost unprecedented, for 4G mobile networks to succeed wildly, which is what virtually everybody expects, without the emergence of some new qualitatively different experience or value driver.

It might be more important to say that "nobody knows" what such qualitatively-new experiences will emerge. But some might say it is unlikely 4G will remain "3G but faster."

About a decade ago, when the first commercial 3G networks were introduced, there was much talk about innovation and new applications the networks would enable, and the list looked remarkably similar to what people claim will happen with 4G.   

E-commerce apps, for example, were thought to be an important 3G innovation. That is claimed for 4G as well, with more conviction, perhaps. “The availability of 3G services is going to have a profound effect on electronic commerce,” it was said.

That also is said of 4G. It was said that “3G works better” than 2G, and that was true. It also is said of 4G, and also is true.

3G wireless was sometimes characterized as a wireless version of the Internet, encompassing Web browsing, e-mail and media downloads. That sounds like 4G as well.

Over time, though, a distinctive lead application does tend to develop, though it might take some time. Voice and texting were the lead apps for 2G, while Internet access and email have emerged as the "killer app" for 3G, it can be argued.

For 3G networks, smart phones finally drove significant consumer uptake for broadband data. But it took quite some time for that new driver to be discovered and popularized.

To be sure, there is a line of thinking that the value of 4G might initially accrue in large part from significantly-lower the cost per-bit costs to provide mobile broadband. Verizon Wireless, for example, believes the cost to deliver a megabyte of data on 4G with LTE will be half to a third of the costs of a 3G network.

It now appears that tablets could be the device, and mobile network access the application, that first drives incremental new revenue for LTE networks.

Device type prevalence % in selected LTE operators' data device portfolios (Feb 2013)

Source: Wireless Intelligence

5G Chickens Come Before Eggs

Big new markets always face a "chicken and egg" problem: investment is difficult when there are few potential customers, yet people have no incentives to buy when the service is not available. 

That is doubly true when network effects exist, where few suppliers mean few potential customers, but incentive to increase supply is quite low because there are so few customers.

Every next-generation communications network represents that sort of problem, and connectivity providers must always bet on the chickens.

The network must be built; the investments made, before customers can buy. That also means mobile operators have high incentives to get revenue-generating customers on that new network, as quickly as possible. That especially is important if the benefits to customers are not obvious.

You might find that an odd statement. Is not the whole point of 5G to supply order of magnitude faster speeds, to name one key example of benefit? The key word is "benefit."

So look at "benefits" from use of low-band, mid-band and millimeter wave spectrum. In many cases, low-band 5G will, in fact, not offer speeds much different--if different at all--from 4G. So there is little obvious consumer benefit.

Where mid-band or millimeter wave spectrum is used, speeds will be much higher, on the order of twice to three times as fast, on average. The problem? There are few consumer phone apps and use cases that can take advantage of such speed improvements. 

So supplier push rather than customer demand is going to drive early 5G subscriptions, since the experience advantages are going to be quite intangible in most cases. In many markets where 5G is launched using low-band spectrum, speed will not, in fact, be much different than fast 4G.

In other markets, where mid-band or millimeter wave spectrum also is used, consumer use cases will not be able to take advantage of the additional speed, with a few exceptions such as big file downloads, virtual reality or augmented reality. But how much time do consumers spend downloading big files? How many use AR or VR already?

And yet, 5G will be adopted. We do not know whether adoption will be faster, slower or at the same pace as 4G, but 5G will be purchased. One big reason is that 5G--though having eventual advantages for most consumers--has bigger advantages for mobile operators. 

Even if consumers might not experience much benefit at first, mobile operators will. 5G features lower cost per bit than 4G, which helps prop up the business model when more capacity has to be supplied at a relatively fixed price. 

Over the long term, consumers can only spend so much money on their communication services, so wallets budge only slowly, if at all. 

5G also has network features helpful either for cost containment or new service creation. 5G networks will be virtualized, which creates the ability to turn up virtual private networks (network slicing) rather easily, compared to legacy methods. 

In the radio network, virtualization allows mobile operators to contain radio network costs, since equipment from different suppliers increasingly will be mixed and matched with core networks. 

Longer term, 5G latency performance opens up potential space for a role in edge computing networks, vertical market applications and partnerships. 

And, as always, for some suppliers in each market, 5G represents a chance to preserve or upset existing market shares, if competitors cannot easily keep pace. 

Hence the paradox: Though 5G is, by design, supposed to have performance advantages over 4G for mobile service provides and customers, the early advantages will rarely be sufficient to drive consumer demand. Instead, supplier push will be at work. 

For customers, the advantages include faster top speeds and lower latency.  For mobile operators, the advantages include faster top speeds, lower latency, virtualized networks, which promise new features and lower cost, higher device density (supporting lots of sensors and internet of things devices) and lower cost per bit. 

That list is a clue to why 5G will be adopted, perhaps even more rapidly than 4G: it benefits mobile operators more than consumers. In fact, an argument might be made that 5G benefits mobile operators almost to the exclusion of consumers, at first. In the early going, using low-band spectrum, 5G might not be noticeably faster than 4G. 

When mid-band and millimeter wave spectrum is used, speeds will be much faster than 4G, but in ways that do not actually benefit the use cases most people have for their phones. Big file downloads will be faster, but what percentage of time do people spend downloading big files? 

At first, the early adopter desire to "get it first," where the driver is as much status as anything else, will be the driver. But there will be indirect drivers as well, such as the value of "5G comes with your new service plan." In many cases, 5G will be a "nice to have" attribute of a service plan, but it is the service plan that drives the switch. 

Perhaps that will change over time, as new use cases develop. But it might also be the case that 5G gets adopted because it provides value for mobile operators, who will create incentives to adopt 5G, even if the actual experience advantages might be hard to demonstrate. 

This can be seen in recent Opensignal measurements of speeds on new 5G networks. Where early tests of U.S. 5G rely exclusively on millimeter wave spectrum, the U.S. has the highest speed. 

Aside from big file downloads, the experience advantages are almost impossible to demonstrate. Faster might be better, but actual consumer smartphone apps cannot actually take advantage of the faster speeds, yet, since virtual reality and augmented reality are not yet widely used. 

Conversely, not that in some markets where low-band 5G has been launched, the speeds are almost identical to 4G, so there is no actual experience advantage. 

source: Opensignal

Compared to existing 4G, 5G in early days has doubled to nearly tripled real-world speeds in some cases, but had almost no impact on speed in a few cases. Again, the choice of spectrum, or availability, really do matter. 

Where low-band spectrum is the 5G choice, it sometimes does not life speeds very much. Where millimeter or mid-band spectrum is used, 5G speed advantages are clear, but app performance and user experience do not change much, with the exception of big file downloads.

source: Opensignal