Exhaustion of Business Models is the Key Strategic Problem Faced by Telecom

“Exhaustion of business models” has been a key--perhaps the key--issue for the global telecom industry for at least three decades.

It might seem odd today, but several decades ago, global telecom profits were driven by long distance calling. For a variety of reasons predating VoIP, prices per minute of use plummeted globally between the 1970s and 2010.

That the business did not collapse was due to product substitution. Essentially, mobile services displaced the lost long distance revenues. Then text messaging became the first important “data” service, before mobile Internet access took the lead.

In the fixed networks part of the business, a similar displacement, or product life cycle, can be seen. Where voice once dominated revenue, revenue growth now is lead by high speed access or video entertainment services.

Now mobile voice and texting are losing their salience. In some markets, overall usage is declining, as is average revenue per user or average revenue per account.

That is the reason you hear so much about Internet of Things, connected cars, mobile payments or machine-to-machine services, mobile advertising or e-commerce.

Service providers know they must find big new revenue sources to replace lost legacy revenues.

In fact, there is relatively wide agreement that the historic business model--end users paying mobile operators for connectivity services--is itself exhausted.

That is why the search is one for services provided to devices, sensors, monitors beyond “people.”

That could include any number of new niche markets (vertical markets and apps). The 5G network will need to support a wide range of industry verticals but also a wide range of operator business models, including mobile virtual network operators (horizontal business models).

For fifth generation networks, there also will be a move to compete directly with fixed networks for high speed access.

DirecTV Would Create Triple Play for 47% of U-verse Homes

Though there are several reasons AT&T wants to acquire DirecTV, ability to rapidly supply linear video is among the key drivers.

AT&T has about 57 million high speed access locations, but only 30 million (53 percent) can get linear video service. The fastest way to create a triple play bundle for nearly half its consumer locations is to bundle DirecTV with U-verse.

Beyond that, DirecTV will throw off massive amounts of free cash flow, which is helpful for a firm that pays out most of its earnings in the form of dividends.

Eventually, DirecTV also would give AT&T the ability to create a triple play bundle out of region, where it does not have U-verse facilities. In those situations, AT&T would bundle DirecTV with mobile-supplied voice, messaging and Internet access.

Vodafone India Drops Roaming Fees As Much as 75%

In advance of mandates to lower roaming fees, Vodafone India has cut voice roaming fees as much as 20 percent, and text messaging rates as much as 75 percent. That is good for consumers but will hit mobile service provider revenues.

The rules on roaming fees are but one example of the profound impact regulators can have on communications markets, both enabling and shaping private actor decisions that directly affect end user welfare.

Investors and service providers also are speculating about what bottom line and top line impact might result from the recent Indian spectrum auctions that generated record $17.4 billion in spectrum costs for mobile service providers.

Observers say India’s carriers may have to raise prices (either for voice, or data, or both).

“While the costs of the industry are massive,” the average revenue per user (per month), or ARPU, of Indian telecom service providers is $2.96, compared with the international average of $35 to $40, according to the Cellular Operators Association of India.

The cost of acquiring spectrum in the recent Indian mobile spectrum auction were high enough that Bharti Airtel, Idea Cellular and Reliance Communications may take a sharp hit to earnings in 2016 and 2017, driven by interest charges on borrowed money spent to acquire spectrum, analysts estimate.

And most observers say retail end user costs are certain to rise, as the capital investment has to be recovered.

Bharti Airtel’s net profit could drop eight percent, starting in April 2016, US brokerage Morgan Stanley estimated. that would be mild, compared to what could happen at Idea Cellular and Reliance Communications.

Idea Cellular could see earnings before interest and depreciation drop 27 percent, while Reliance sees a plunge of 26 percent.

India’s Airtel provides more evidence that a mainstay product in the telecom industry--mobile voice--is following its cousin fixed network voice along the classic product life cycle.

Airtel's voice revenue per minute of use dipped 2.4 percent, compared to the prior quarter, while average revenue per user also fell in the quarter ending in March 2015.

Overall revenue grew 31 percent, year over year, due to mobile data revenues, counteracting the revenue pressure in the voice business. That also is part of a global trend, namely that mobile access to the Internet now is the revenue growth driver in many markets.

Idea Cellular, the third-largest provider by subscribers,  also reported a three percent quarter-on-quarter decline in voice revenue per minute.

The trend is long standing. Prices have been falling since at least 2007. Likewise, data revenues have been growing since at least 2006, in the Indian mobile market, while voice prices have declined almost steadily since then.

Some have criticized the Indian government for making government revenue a bigger priority than creating conditions where service providers can aggressively extend service. Calling taxes and charges “excessive,” outgoing Vodafone India CEO Marten Pieters said Vodafone pays 30 percent of gross revenue to the government.

FCC Rural Subsidies Might Not Find Takers: There Might Not be a Business Case

The Federal Communications Commission has increased Connect America Fund funding for “price cap” carriers by about 70 percent, but also raised the minimum required speeds to 10 Mbps, although the Federal Communications Commision has redefined “broadband” as a minimum of 25 Mbps.

The conditions include a requirement to serve all high-cost areas within a state, if a carrier accepts the funding. Predictably, not all potential affected carriers might support all of the requirements for funding.

In some cases, a service provider might conclude that the total impact of upgrades required to receive the high cost service area funds exceeds the revenue that can be earned by doing all the upgrades.

The new funding benchmarks range from $72.40 for 10 Mbps downstream/1 Mbps upstream service with a 100 gigabyte usage allowance, to $96.89 for 25/5 Mbps unlimited service.

High-cost fund recipients that are subject to broadband performance obligations are required to offer service at or below the benchmark rates to qualify for the subsidies.

The fundamental economic problem is that, in many areas, there literally is no traditional business case for providing service, at the rates which can be charged, and which most consumers would pay. When that is the case, even the subsidies might not be sufficient to create a positive business case for upgrading.  

That has been a problem in the past, and is one likely reason the amount of support has been raised.

If service providers decline to take the funding, other service providers will be allowed to bid for the the support. But that also is part of the subtlety: consumers might well prefer to buy mobile service, in place of fixed network services. And the cost of providing that service might be lower, using mobile, than using any fixed network approach.

No Consolidation Among Top-4 Mobile Operators is Possible; One Has to Fail

Even if one argues a four-provider U.S. mobile market is not sustainable, U.S. regulators have ruled out any consolidation among the top four suppliers. That means the market cannot consolidate to three strong providers by means of mergers among the contestants.

That leaves only one solution: one of the firms, or perhaps even a couple, would have to be so weakened that the top ranks shrink naturally to two or three providers, with a distant number four unable to keep up. Failure, in other words, is the only way the U.S. mobile market is going to consolidate.

That appears not to be the case in the video market.

Even 20 years ago it would have been possible to predict that, ultimately, both DirecTV and Dish Network would cease to be operating entities, and would have been acquired or merged with another entity. The logical candidates always have been Verizon and AT&T.

Now that AT&T has made the move to acquire DirecTV, half the prediction seems likely to be fulfilled. The issue now is what happens with Dish Network. Verizon likely has little interest, as Verizon thinks linear video is going to decline rather quickly.

That makes Dish Network exit options tougher. It never has seemed likely any cable TV operator would see the logic of acquiring Dish Network or DirecTV. If Verizon isn’t interested, the pool of buyers gets very thin, one might argue.

Likewise, some have argued that, long term, the U.S. mobile market simply cannot support four major national suppliers. But it is hard to see, at the moment, how that consolidation would happen.

In fact, the only scenario that would reduce immediately and clearly reduce the number of suppliers is the one development regulators will not presently support: Sprint merging with T-Mobile US, or either AT&T or Verizon buying T-Mobile US or Sprint.

In other words, none of the four leading national providers will be allowed to merge. That doesn’t mean there will not be acquisitions; there simply won’t be any mergers of the top four firms.

“I have always said on consolidation, it’s not a matter of if it’s when and how and now I’m going to add and who, because I think as we think ahead you need to think I still reiterate that in five years we will think it comical that we thought about the  industry structure as the four major wireless carriers,” said T-Mobile US CEO John Legere. “So I think you need to think about the cable industry and players like us as not competitors but potential partners and alternatives for each other in the future.”

That would not necessarily reduce the number of providers from four to three, as a firm such as Comcast would still remain in the market. But a Comcast acquisition of either T-Mobile US or Sprint would give the acquired company the heft to secure its number three spot in the market on a long-term basis.

On the other hand, it always is possible that Dish Network might also try to acquire T-Mobile US, to transform itself. That likewise would not immediately reduce the number of leading mobile providers.

So, like it or not, no consolidation of the U.S. mobile market is possible by means of any mergers among the top four providers.

Instead, one of the firms would have to be weakened so much that it essentially drops from contention. Weakened sufficiently, the number-four provider might well be acquired by a firm that has a different business model, and essentially does not compete directly with the leading three providers.

How Much Must Small Cell Costs and Backhaul Drop?

Ask yourself how much you would be willing to pay for an Internet connection to a $100 appliance (router, for example). At the low end of that range, one is looking at consumer-grade Internet access connections.

But put yourself in the shoes of an executive of an Internet service provider looking at big networks of small cell access points, perhaps with per-site costs in excess of $3,000, just for equipment, and not including site rent costs.

Consider a single macrocell, where backhaul could cost $24,000 a month, supporting perhaps 160 Mbps to 500 Mbps of capacity per site. How much capacity might a small cell require?

On the assumption a small cell only makes sense in a high-traffic area, the answer might be that the small cell requires as much capacity as a macrocell, in some instances. In other cases, perhaps a small cell only has to support a fraction of total macrocell bandwidth.

The issue is that traditional access using T-1 equivalents does not work. Small cells are going to require Ethernet bandwidth, between perhaps 100 Mbps and a gigabit.

As a rough rule of thumb, assume a small cell requires cost parameters about an order of magnitude less than a macrocell, with backhaul costs likewise scaled about an order of magnitude. That implies a maximum small cell backhaul cost of about $2,400 a month.

Greg Weiner, Vertix co-founder, argues that small cell sites would have to drop to about $100 to $250 per location to drive mass adoption. Again, that suggests something on the order of magnitude drop in costs is needed.

On the other hand, the cost of business grade gigabit connection is dropping dramatically, in some markets. Connections supplied by cable TV companies with dense fiber deployment (think Comcast) are one reason for thinking backhaul costs will drop to levels enabling mass small cell networks.

The One Disruptive Implication of Google Fi

Fi, the new mobile service by Google, has been criticized in some quarters for not being disruptive enough. With the caveat that many changes could come as the service develops, observers have argued that the retail pricing isn’t really all that unusual, not especially affordable, and that the selection of handsets is nil.

All of that might be true, for the moment. But there is one huge shift in retail packaging and pricing that Fi does represent, and it is odd that it comes from a firm such as Google, which might be presumed to favor unmetered or unlimited usage.

Generally speaking, telecom service providers have preferred metered usage based on consumption. Generally speaking, Internet app providers prefer unlimited and unmetered usage plans.

The reason is simple: access provider make more money when users pay for what they consume, while app providers arguably make more money when usage fees place no constraints on the amount of app usage.

The reason “buckets of usage” exist is that Internet service providers, mobile service providers and fixed network service providers are trying to slowly wean customers off of the notion that Internet access literally is “unlimited.”

Conversely, for those services whose demand is plummeting (voice and messaging), service providers now offer “unlimited” plans in place of the buckets or usage-based billing that once were the industry norm.

Again, the reasons are simple. With demand dropping, the network has plenty of spare capacity to support “unlimited usage,” especially when end user demand is highly predictable. Also, because of the high predictability of usage, and low bandwidth impact, unlimited plans can safely be offered because few customers will actually use very much of the resource.

Fi might be the first significant change in thinking about what sorts of plans are most “consumer friendly.”

Up to this point, the “consumer friendly” approach has been considered the uncapped or unlimited consumption approach. Now, Fi is arguing that it is the metered approach that is most consumer friendly. That is a huge shift.

In fact, most ISPs would prefer a metered approach for Internet access, as much as they would argue they benefit by offering “unlimited” use of voice and text messaging.

So, oddly enough, the real innovation Fi represents is a possible sea change in thinking about what form of retail packaging and pricing is most consumer friendly.