"Move Up the Stack or Not?

Generally speaking, future telecom strategies come in two basic flavors. The first is the “be the low cost access provider” strategy. Among the key issues: can an entity gain enough scale to offset low average revenue per account? Can the entity cut costs fast enough, and continually, and still survive?

The other is the “move up the stack” strategy. Both are risky.

“Carriers have at various times tried to market their own devices, build portals for apps and entertainment, and provide outsourced IT services,” Strategy& notes. “The results, however, have been mostly disappointing.”

There’s a sort of simple way to plot strategic choices. Only a few of the larger entities will have the ability to really transform their business models and “escape” the “access provider” model.

For most service providers, some version of the “low cost provider” strategy will have to do, as there is not going to be enough capital or other resources to do anything else.

To be sure, there will be lots of fancy language about how former access providers can  transform their value, roles and revenue. All such thinking involves some form of “moving up the stack,” as hard as that might be. To be sure, there are things devices and networks supply, at the bottom of the stack.

source: Bell Labs

As always, though, the higher-value opportunities lie in the platform functions (if such a role can be created) and the actual outcomes or apps used by potential customers and users.

In the consumer space, consider the role played by video content and associated subscription services. Many point out that gains by “streaming” services that are a substitute (however imperfect) for linear subscriptions, so far, have failed to fully replace lost linear revenues.

There are analogies. IP voice services or apps have not displaced lost legacy voice and messaging services. So the point is not whether over the top (OTT) video subscriptions ever will directly recapture linear video revenue levels.

If the voice and messaging experience provides guidance, OTT video entertainment will not do so. So why bother? Because doing nothing leads to a worse outcome. Even if gross revenue and profit margins for OTT video dip from linear levels--even dip significantly--that incremental revenue and profit is important.

There appears to be nothing access providers can do to prevent erosion of voice, messaging and linear video revenue sources. And there is growing pressure on internet access revenues and profits as well.

But how sustainable is a future characterized by ever-smaller voice, messaging and video revenues, with perhaps flat internet access revenues? The point is that, even at the risk of lower margins and gross revenue, owning content assets is arguably more sustainable than not owning such assets.

The same observation can be made about legacy and emerging business and enterprise revenue sources. It is not likely that average revenue per unit for any class of connectivity services sold to businesses will grow, in the future.

So unless a service provider believes it can keep reducing cost to match declining revenues, a dumb pipe business model is risky. To be sure, moving up the stack also is quite risky. But unless you believe service providers can perpetually “cut their way to success,” value generation “up the stack” is going to be necessary, no matter how difficult.

When Advice to Move Up the Stack is Mistaken

Business strategy for larger tier-one service providers arguably differs from what is possible and prudent for smaller providers and specialists in the connectivity business. Arguably, in a business that increasingly is saturated and growing slowly (perhaps less than one percent per year, globally), revenue growth has to come from something other than legacy and traditional communications services.

source: GSMA 

As this chart suggests, tier-one service providers are betting on growth outside their legacy communications core, and many have made substantial progress. 

It has not been easy. Historically, it has been difficult for tier-one telecom providers to grow revenue in products and services outside core connectivity. 

That entails higher risk than traditionally might exist, but arguably is necessary as the traditional growth engines sputter. It always is difficult for any firm or industry to move away from its perceived core competency, but it arguably is easier for a firm or industry higher in the stack to move downwards than it is for any provider in the value chain to move upwards.

In other words, it should be “easier” for Google, Alibaba, Facebook, Microsoft or Apple to move “down the stack” than it is for China Telecom, NTT or AT&T to move up the stack. 

That said, it can be argued that some firms have been more successful than others, and perhaps the adage that “having too much money” is dangerous for any startup or big established provider is apt. It might be the case that Comcast and T-Mobile have been more successful with their acquisition strategies than others because they were relatively capital starved.

Some might argue those sorts of firms also benefit because they are less bureaucratic, and therefore more likely to make decisions less encumbered by internal political concerns, and to make those decisions faster. 

Specialist providers and smaller firms rarely have the human or financial capital to do much other than concentrate on core connectivity services, so the advice to “move up the stack”  towards applications is unwise. 

Similar advice to “move into adjacent areas of the value chain” likewise is unwise, and for the same reasons: small firms do not have the human or financial capital to do so, and could not achieve scale even if those other issues were not constraints. 

The point is that the oft heard advice to move up the stack or across the ecosystem is mostly applicable only to large tier-one firms. Smaller firms and small firms generally have to choice but to find a niche and stick to connectivity services.

Why Have Cable Companies Wrung More Value From "Up the Stack" Investments than Telcos?

Why have cable TV companies have been so much more successful with their diversification or "move up the stack" strategies and investments, compared to telcos? One rarely hears of cable companies making strategic or technology investments that later prove to be ineffective, or which are divested.

It is a truism that value is moving up the stack, and telcos and cable have invested in software, hardware and services that are intended to help with that value-creation process. Still, cable tends to reap more rewards from its investments, compared to telcos.

One might argue that is because U.S. cable operators are more careful with their cash, being a smaller segment of the industry with a smaller supplier base, smaller revenues and resources than telcos.

https://seekingalpha.com/article/3981296-revenue-trends-telecom-sector

One might argue cable takes a practical approach, never investing in “moon shots.” But the structure of the two industries was quite different. Cable operators are able to focus on competing with telcos as the threat of competition from other cable operators is nil to non-existent.

Cable companies do not compete against each other in any single territory, as do mobile companies or satellite firms. That means there is less pricing pressure and less margin compression.

That also means it is easier for cable operators to collaborate on developing new technology or software, compared to telcos. Each cable operator realizes the odds of any new technology being deployed against it, by other cable operators, is virtually zero.

Every mobile operator knows other mobile operators will use any new capability against all the others, minimizing the comparative advantage.

Many telecom specialists do compete against telcos and cable in the fixed network business services segment (system integrators, interconnect firms, competitive local exchange carriers), and there is some--and growing--independent internet service provider competition as well.

Telcos mostly have been incumbents facing market share attacks in voice, messaging, internet access and business services. Cable has been an attacker. So telco investments are more risky: telcos have to invest in new lines of business they do not understand. Cable only has to take market share in businesses that are well understood.

Also, cable platforms, whatever the original limitations, have been “broadband” since their inception. Telco platforms have been “narrowband,” and the costs of upgrading both types of platforms were disparate: it cost cable far less to upgrade to reliable, gigabit internet access speeds, compared to telcos wanting to do the same.

Cable companies also have had lower operating costs than telcos, in large part the complex legacy of telcos having had cost structures shaped by monopoly conditions. The cable industry  began life “capital starved,” with important implications for business outlook and culture.

On the other hand, the separation of apps from access has meant the core telco apps, traditionally bundled with network access, can be delivered “over the top” by third parties. At the very least, that increases competition in the app realm. At worst, “access” becomes a dumb pipe function with less value.

Also, cable operators have had other advantages in terms of securing a role in the applications business. Consider that potential apps in the communications business are virtually infinite. Potential apps in the cable TV business are quite finite.

So it made sense for Comcast to buy NBCUniversal, and gain control of a differentiated revenue stream that also lies at the heart of its cost structure, in an adjacent part of its core and well-defined ecosystem.

Though AT&T is attempting something similar with its acquisition of Time Warner, many other telco acquisitions have not proven so successful. Telcos have bought computing companies, data centers, home security, mobile advertising, banking and other assets with mixed results. Many started their own app stores or OTT voice and messaging apps, with mixed results.

Compared to cable companies, telcos had to guess at what might work. What has worked is “horizontal acquisitions,” in both telco and cable segments of the business.

source: Deloitte

source: Deloitte

The point is that there are any number of reasons why vertical, up the stack efforts arguably have been more effective when attempted by cable companies, compared to telcos.

Singtel Moves Up the Stack, and it Still is Very Hard

You would be hard pressed to identify any single "telco" that is having more success in the application realm than Singtel, even if app success is arguably still dwarfed by success in the "access provider" realm.

Long term, app success will prove crucial for "access" providers, for the simple reason that access revenues and profit margins will continue to face pressure. It will not be easy.

It always is harder to move "up the stack" than "down the stack." And as we already are seeing, many app providers are proving they can successfully move down the stack. 

Google is the single biggest brand to demonstrate that trend (Google Fiber, Wi-Fi and other access initiatives; as well as a big role in "transport, data centers and cloud computing." But there are others. Facebook, Amazon and Microsoft have shown they can master key skills lower in the stack.

Moving up the stack is much harder. If you are looking for some evidence that can be successful, one almost always finds oneself looking at Singtel or Softbank. Singtel might be the better example, as Softbank started as an app company and then become a big communications services provider.

Singtel remains primarily a "communications" company, though it is pushing aggressively to create competence and scale in digital apps.

Singtel has business advantages and disadvantages based on its small domestic market. Larger service providers might rationally build growth strategies on capturing more of a large domestic market.

Singtel cannot do that, as its domestic market is limited. But inability to grow domestically also means the strategy of expanding internationally makes fundamental sense.

So it is that Singtel owns 100 percent of Optus in Australia, 47 percent of Globe in the Philippines, 35 percent of Telkomsel in Indonesia, 23 percent of AIS in Thailand, 32 percent of Bharti Airtel in India, as well as minority stakes in a number of mobile firms in Africa.

More significantly is Singtel’s strategy of investing both in “access” assets (mobile service providers) but also digital content and app assets.

Singtel’s digital life division focuses on its Amobee digital marketing business, HOOQ regional premium video, and DataSpark advanced analytics and intelligence capabilities.

Singtel also makes investments in many firms through its Innov8 corporate venture capital fund.

Singtel also owns digital lifestyle services AMPed, Dash, HungryGoWhere, Insing.com, and NewsLoop in Singapore.

Though it is true that scale matters for most telecom business opportunities, Singtel has proven that even a relatively small operator can create scale. Singtel also is among global leaders in trying to leverage related applications that build on its core telecommunications assets.

That is among the most-difficult challenges any telecom services company faces. Now that nearly all applications are created “over the top,” telecom service providers have limited ability to influence, control or own the application layer.

And yet, strategically, nothing might be more important than creating a viable role in the application layer, for at least some leading apps.

As Mobile Goes, So Goes Telecom

In the past five years, the telecom business has entered a period of slow decline, with revenue growth down from 4.5 percent to four percent, EBITDA margins down from 25 percent to 17 percent, and cash-flow margins down from 15.6 percent to 8 percent, according to McKinsey consultants.

Competitive boundaries are shifting as core voice and messaging businesses continue to shrink, partly under regulatory pressures, but also because social media is opening up new communications channels.

Among U.S. telecom companies, for instance, landline and mobile voice now account for less than a third of total access, down from 55 percent in 2010, while data revenue has risen from 25 percent of total revenues in 2010 to 65 percent today.

The issue is what to do. In the near term, horizontal mergers to increase scale are the most likely move by most firms.

In at least some cases, service providers will try to move into other segments of the value chain, either “up the stack” in the direction of applications, in some other cases perhaps “down the stack” (or backwards into the value chain), if one considers devices to be “down the stack” (I would put devices up the stack, but that is a matter of preference).

A third of the 104 respondents to a McKinsey survey were preparing to move into adjacent businesses such as financial services, IT services, media that are “up the stack” moves into parts of the ecosystem other than access and communications services.

To be sure, many of those planned initiatives will fail to be launched, in the end. The point is that one long-term solution to industry revenue shrinkage is to get into adjacent businesses elsewhere in the same value chain.

source: McKinsey

Is Verizon Strategy Built on 5G Connectivity Revenues?

With the exception of its buying Vodafone’s interest in Verizon Wireless for $130 billion, most of Verizon’s acquisitions have been far smaller. The overall pattern might indicate that Verizon spends most of its acquisition funds on network assets.

So it probably is not surprising that the choice of Hans Vestberg as the next Verizon CEO suggests to most observers an investment priority on 5G assets, not content or other “up the stack” assets, or even operating efficiencies.

Some of us would not necessarily agree with that view. It is true that Verizon sees itself as the leader in network quality and a first mover where it comes to each next generation network. Iin its acquisition strategies, Verizon has emphasized connectivity assets.

The issue is whether the choice of Vestberg suggests Verizon will focus its revenue growth plans on connectivity services, or has something else in mind. Some of us would argue that Verizon has something else in mind.

Verizon has for some time been acquiring “up the stack” assets. Verizon sees its solution and platform assets as being built on top of the network platform, so the Vestberg pick likely indicates Verizon retains that view. But Vestberg also is considered a merger and acquisitions expert, so it is possible to suggest that Verizon believes it has to pair its 5G leadership with clever picks of firms and assets that can supply value “up the stack.”

There is another way to look at what might otherwise be called a ”5G first” strategy, and that is to look at the revenue lift that strategy might provide, compared to alternative investments of capital.

And the essential reality is that incremental 5G revenue is unlikely to provide all that much revenue lift.

If Verizon is successful using its 5G network to attack a fixed wireless opportunity worth about $7.5 billion, and  internet of things connectivity revenues of about $5.4 billion, that implies something like $13 billion annually in incremental revenues, in perhaps five years time.

Here are the assumptions: Verizon believes it can address about 30 percent of  U.S. homes, mostly out of territory, using 5G fixed wireless.

If there are some 130 million U.S. homes, that implies access to about 39 million potential new accounts, a significant new opportunity if one assumes each new account could generate $80 a month in recurring revenue.

Were Verizon to get 20 percent of potential customers as new accounts, 5G-based fixed wireless could generate $960 per account, per year, on a base of 7.8 million locations, it could realize $7.5 billion a year in additional annual revenue.

That is about 5.5 percent incremental revenue lift for Verizon. That is interesting, but not transformational in any way.

GSMA has predicted that connectivity revenue will be about five percent of the total IoT revenue opportunity.

That might work out to as much as $50 billion in annual global revenue. Verizon’s opportunity is a fraction of that. If U.S. revenues are a third of total, that implies $16.5 billion in connectivity revenue. If Verizon gets a third of that, it might realize $5.4 billion in annual incremental revenues.

Again, that is nice, but hardly transformational. Verizon might believe it will do much better than that, longer term.

So some might argue that something else must be at work. And that likely is a move into other parts of the value chain built on 5G, including internet of things apps, as the amount of new connectivity revenue from IoT likewise will be interesting, but not transformational.

The point is that incremental new revenue Verizon can drive directly on 5G connectivity services is not so large as to constitute a growth strategy.

Consider that, if approved, the AT&T acquisition of Time Warner might generate $31 billion in incremental revenue for AT&T, immediately.

There are “size of debt” issues, but Time Warner is a “book revenue now” gambit, in addition to changing AT&T’s business sources profile.

For Verizon, additional acquisitions arguably are necessary, eventually. The reason is simply that both Verizon and AT&T have gotten most of their revenue growth from acquisitions, not internal and organic growth.

source: Deloitte

Since 2013, AT&T has dramatically changed its revenue profile by acquiring DirecTV, immediately becoming the largest U.S provider of linear video.  International acquisitions, though smallish, also indicate where AT&T could go next, beyond content.

Verizon’s biggest deal since 2013 was acquiring Vodafone's stake in Verizon's mobile business for about $130 billion in 2014. But debt load from that deal also limit Verizon’s ability to make other big asset purchases.

source: AT&T

Although the appointment of Hans Vestberg as the new CEO of Verizon has been interpreted as a focus by Verizon on “5G,” as opposed to some other strategy, such as getting into content ownership in a bigger way, beyond the Oath brands.

That might not necessarily mean Verizon has in mind a strategy something like “doubling down” on connectivity services as a driver of growth, which is one way the strategy might be interpreted.

Instead, 5G investments are “only” the way Verizon keeps its claim to be the quality network leader, where it comes to connectivity services, while actively making acquisitions to build its “up the stack” assets in internet of things areas, for example.

What Options for Telcos Moving Up the Stack into Connected Car Markets?

To the extent that Comcast’s acquisition of NBCUniversal offers a possible blueprint for how a telco moves up the stack, we are left to apply those lessons in other realms. In principle, telco efforts to get into complementary app or service businesses have taken several forms.

That will be relevant as at least some telcos enter connected car markets.

Perhaps the most common is the acquisition of smaller firms who have capabilities a telco can apply internally, to its own business. That is a vertical approach. Telcos acquiring or launching their own over-the-top IP telephony services or app stores provide other examples.

Some initiatives are quasi-horizontal, and quasi-vertical, intended to serve a broader range of potential customers than “current customers,” but also to add value to the carrier’s connectivity services.

IT consulting, mobile payments, banking, home security or over-the-top content services provide examples.

Bigger initiatives have tended to be of the horizontal type: data center operations, computing equipment.

It is not yet clear how moves into “connected car” or “smart cities” markets will happen. But a few observations from the way Comcast has used NBCUniversal, and how AT&T might use Time Warner, are instructive.

The acquisitions, though partly “vertical” (theme parks) are mostly “horizontal” (the content is sold to competitors, as well as sold internally, to Comcast cable TV operations).

That is akin to a connected car service or platform that can be used by every car manufacturer or fleet operator, smart lighting or parking services that can be deployed by any municipality or system integrator.

What Comcast has not done is acquire NBCUniversal and then make that asset a “captive,” “Comcast-only” asset. In part, that is because the law requires Comcast sell content even to other video distributors.

Though it will likely make sense to acquire some smaller assets that are “captive” and used vertically by by a single firm (provisioning tools, billing platforms, interfaces), the bigger upside will come from horizontal apps or services that can be broadly used by virtually all potential customers.

In other words, any future moves up the stack will do best when they are like other widely-used apps, offered independently of the owner’s own access platform.

Connectivity will drive some revenues. But most of the upside will likely come from "up the stack" applications and services offered horizontally (all carmakers, all fleet operators, all other access providers).

source: McKinsey

source: PwC

source: PwC

source: Juniper Research

How Feasible is "Orchestration" as a Business Model?

“Rather than continuing down the road of being a connectivity provider, CSPs need to transition to become an intelligent service orchestrator ,” says Bengt Nordström, Northstream managing director. “Taking a connectivity and wholesale approach in 5G, or becoming a reseller to the edge, will put CSPs in danger of seeing revenues dry up.”

“Becoming an orchestrator” is viewed by some as a move up the stack to becoming a “service enabler,” presumably allowing additional value creation and revenue generator possibilities. 

source: Ericsson 

Also, there is a less customer-facing understanding of “orchestration” that involves the internal operations of the access and transport network itself. In that sense, orchestration is about automation more than service creation, the creation of end-to-end service more than occupying a new role in the value chain.   

Orchestration makes sense, no matter which definition is used. But one form is easier than the other. Orchestrating the internal operations of the communications network is one thing, taking on a new role in the value chain, ecosystem or functions stack is a different matter. 

The issue is how feasible it is that the access provider becomes the app orchestration supplier, “positioning themselves as the key to enabling a wide range of services through their ability to connect a complex ecosystem of new digital offerings,” notes Nordström. 

Otherwise, 5G is likely to turn out as did 4G, with much of the new value reaped by over the top app, commerce and content suppliers, not access providers. 

source: Ericsson 

“For many CSPs (communication service providers), the aim of digital transformation programs is to empower them to become service enablers or service creators, which increases their commercial enterprise opportunity,” Ericsson says. 

But it might also be fair to point out that this requires moves akin to becoming system integrators, especially integrators with vertical market domain expertise. Some might note that others in the value chain already have staked out this position, requiring access providers to muscle out other existing competitors. 

Connectivity providers might assemble multi-cloud access capabilities, for example. But most access executives would be happier with a more-developed role as service creators. 

Also, in the internet era, it has proven easier to move down the stack than up the stack. That is to say, it has proven easier for entities with domain knowledge to add lower layer functions to create new offers, than to assemble new offers from below. 

In itself, the advice to “orchestrate” makes operational sense. All virtualized networks require orchestration. Whether the use of the term also extends to business role, and the odds of succeeding in such roles, is a different matter.