Amazon "Chime" Illustrates "Value" Problem

“Everybody” knows that the telecom industry has a “perception of value” problem. A new conferencing service launched by Amazon illustrates the problem.

Before your head blows off, this is a conferencing service normally purchased by businesses, offered by Amazon Web Services.

Amazon Chime will be sold direct, and by partners Level 3 Communications and Vonage.

Level 3 will offer Amazon Chime as part of that firm’s “Unified Communications and Collaboration Services” portfolio.

Vonage now includes Amazon Chime in its business communications plans at no additional cost.

Three observations, here. AWS is the app creator and owner, not a “traditional” communications service provider or a unified communications specialist or enterprise voice provider. That is just one more example of over the top suppliers becoming substitutes for traditional telecom suppliers.

Level 3 is a distributor of Chime, not its creator and owner. That illustrates the growing role of access providers as conduits for third party apps, with obvious implications for business model, revenue and profit opportunities.

Finally, Vonage offers the service at no extra charge, showing another key trend: increasingly, service providers offer features and value, but not direct revenue-generating services.

In part, all those developments are part of one bigger reality: all apps now are conceptually created and delivered over the top, no matter who the owner. That is just the way the internet and IP networks work.

That also means more of the telecom business--by revenue, accounts, volume of data--is in the “dumb pipe” category. That is what internet access is, after all: a dumb pipe connection to all the resources of the internet.

Coupled with the decline of the traditional “apps” telecom provides (voice, messaging, content), there is a growing “value” problem, as the highest value lies with the OTT apps people and businesses want to use, not the suppliers of “access” to those apps.

Value, increasingly, is at the root of the telecom industry’s growing revenue problems.

"Layer Zero" Illustrates Broader "Value" Problem for Telcos

The industry audience listening to a talk by Marcus Weldon, Bell Labs president, about the drivers of future value in the next era of telecommunications drew immediate laughter when Weldon talked about where telecom sits in the end user’s estimation of value.

Go to 08:30 minutes into the video if you just want to hear the discussion of where telecom sits in the perception of value. Or watch starting at about four minutes in if you want to hear the Bell Labs vision of how "value" will be created in the next era. 

 
The point is that we work in an industry that once was considered layer one of a seven-layer model with “applications” at the top, but now is said by a growing number of observers to be at layer zero. 

Sure, the open systems interconnect model was created to illustrate the way modern programming should be done, but the idea has come to illustrate the "dumb pipe" problem as well.

To the extent that value is found "higher in the stack" at layer seven, then the logical corollary is that things happening at layer zero do not have as much value. 

Telecom's Layer Zero Problem

Telecom, if we are honest, is a business in trouble because its value to customers and users is no longer something we can take for granted. That is what the phrase “dumb pipe” is all about, if a bit of a misnomer.

Voice, text messaging, video content and other services sold by access providers often have a layer seven function as well as encompassing the lower functions, because those services literally are applications sold to the customer, not access to a cloud that sells or provides the services to a customer.

“Best effort” internet access turns out to be the first real “dumb pipe” product generally and widely sold to customers.

But, in an era where computing-based products provide the value that drives consumers to buy internet access, the access itself can be viewed as a low-value function.

“Layer zero” might only be a reasonable description of “internet access,” but the apt concern is that, over time, more of the former applications value supplied by telcos simply is removed to third parties in the cloud.

These days, even Bell Labs presentations show a “layer zero” that is “free Wi-Fi.” And Bell Labs is not alone. These days, cabling, mobile access, fiber to the home and so forth often is considered layer zero.

The point is that access networks arguably have lost lots of value in a world where Wi-Fi, accessed “for free,” is available as layer zero, with the price point being among the key business issues for telcos and other access providers.

The point is that the old telco business model is being destroyed, and a new model has to be created, as the old “buy our services to use voice, send messages and watch TV” increasingly is not relevant, in terms of end user value, as those things can be done using over-the-top apps.

When rational people with deep insight into the telecom business predict shocking levels of industry consolidation, that is simply a reflection of the rapid deconstruction of the global telecom business model.

source: programmerhelp404

source: Bell Labs

Internet Access--Good, Deployed Fast and Also Cheap--Pick any 2 (UNLESS)

There’s an old adage in marketing: “good, fast, cheap: pick two.” At least for most physical products--virtual or software products are different--that adage illustrates basic trade-offs.

Quality tends to cost more. Rapid availability of new products tends to cost more.

So products can be made available at less cost if they are “not as good” or “take longer to deliver.” In the area of physical or tangible products, speed, quality and cost tend not to align (intangible products often can break these rules).

You might say the worst of all worlds is to supply an intangible product (internet access) using a capital-intensive manufacturing process (building physical access networks).

One clear example: business models in competitive markets where facilities-based competition is possible.

As a rule of thumb, a third entrant in a fixed network access market has to hope for market share of about 20 percent to survive. On the other hand, the two existing suppliers then can hope to sustain share of perhaps 40 percent each, assuming each is equally skilled and the third provider is able to stay in business.

And that is why fixed network business models, where facilities-based competition exists, is so difficult. Monopolists enjoyed an easy time of it. Cost per customer (amortizing full network cost over the customer base) and cost per passing (the cost to build the whole network) were almost the same number.

In other words, if it cost $1000 per passing to build the network past 100 locations, then at 100-percent penetration (customer take rate) cost per customer was the same: $1,000. At take rates of 95 percent, cost per customer still was only about $1053.

At 20 percent take rates, the same network has a cost per customer of about $5000. At 40 percent take rates, cost per customer still is $2500. In other words, in a facilities-based scenario, cost per customer can range up to 1.5 times more than in the one-provider market, and up to five times more in a three-provider market.

And that assumes only a maximum of three competitors. In the 5G era, it is not clear how many total competitors will operate in any single market, in large part because mobile substitution will be possible for every key consumer product.

In a facilities-based, competitive market, there could well be three or more key competitors, with varying investment costs.

The point, to refer back to the basic marketing adage (fast, cheap, good: pick two), is that unless major innovations are discovered, fixed network internet access is not ever going to be good as well as cheap and rapidly deployed.

PIck two of three, that will be your choice, as a supplier. That is why there is intense work going on with 5G fixed wireless. In some developed markets, it could be the sort of innovation that breaks the limits. Perhaps customers can be supplied good access, cheap and with fast deployment.

That would truly be something new in the fixed networks access business.

Is There Enough Capital for All Telcos Must Do? Probably Not. UNLESS.

Aside from all the other strategic issues telecom executives will face in the coming decade, capital allocation will be a huge issue. Simply put, there might not be enough capital to do all the things service providers might prefer.

But there is a huge caveat. There might be ways to make massive acquisitions if the assets become cheap enough. Really cheap.

In other words, if global service providers collapse from about 800 to about 100 by 2025 or some similar date, that suggests most will either be acquired, or simply go out of business.

You might doubt there is enough capital to accomplish that scale of acquisition, so fast. You'd likely be correct.

But there is one scenario where massive consolidation is possible, and the survivors are not buried in unsustainable debt.

if asset values absolutely crash, and most sales are of the "distress" variety, that will mean most service providers have found their business models are not sustainable, their equity value will drop, and, at some level, become cheap enough that huge acquisitions cost far less than they do now.

The corollary is that there will be relatively few buyers, as the reason asset values have dropped so much is that the business model has broken.

The even-worse scenario? Most buyers simply stay away, as the assets are not worth buying. So there is a scenario where most of the 700 or so "vanished" service providers simply go out of business, without a buyer stepping in.

Under that latter condition, the global industry shrinks about 85 percent, but survivor debt levels do not become unsustainable, as most of the competitors simply vanish.

Unless that catastrophe happens, it is hard to see how enough capital will be available to do all the things service providers must accomplish.

With revenue growth difficult to stalled in developed markets, while “profitless growth” is more the issue in emerging markets, multiple competing uses of investment capital are going to collide.

Fundamentally, capital has to flow to horizontal acquisitions to grow revenues and attack costs by attaining greater scale.

source: Deloitte

But service providers also must make investments “up the stack” (content; IoT apps, services and platforms) to avoid becoming dumb pipe suppliers of internet access.

At the same time, service providers also must invest in 5G and other next-generation platforms (more optical fiber, network virtualization, spectrum licenses, small cells, advanced radios, applied artificial intelligence.

And such capex does not change that much, over time, either in aggregate or as a percentage of revenue, with higher spending tending to come in waves as next-generation network projects are launched.

source: IEEE

source: McKinsey

But such spending is only one part of “capex.” In most cases, forecasts of network spending include spectrum purchases, not necessarily investments in radios and cables.

Much of the “other capex” has to be paid for by borrowing (although share issuance or other one-time mechanisms such as assets sales sometimes are possible).

source: US Global Investors

Scale will be one “sink” for capital.  If you assume a massive consolidation wave is coming over the next decade, then huge amounts of capital will have to be deployed “buying assets” to gain scale. Such horizontal expansions will involve buying other firms, in other geographies.

But 5G and virtualized networks also are coming, and will command a share of capex as well. Though investment in networks is often how we think about service provider capex, acquisitions are going to compete strongly for a big share of capex. That means debt loads are going to climb, as no service provider can support network capex and big acquisitions without borrowing.

Acquisitions to achieve scale and next-generation network investments help service providers remain solvent in the current business (access services). Such horizontal investments to “bulk up and gain scale” do not fundamentally address the issue of changing business models.

Simply put, all legacy sources are declining, or set to decline. So scale postpones, but does not eliminate, the need to create a new sustainable business model. Sooner or later, even scale will not help grow the business.  

There are “really big” and “big” gambles to be made. The “really big” issues center on business model innovation, while the merely “big” gambles center on the payback from various investments (virtualized networks, 5G, fiber in the distribution and access network, spectrum, horizontal and vertical investments).

The “really big” issue is whether the access provider business model is sustainable.  All other issues are important mostly as they relate to that issue of survival.

How Costly is Internet Access, Across Countries, Really?

It never is easy to compare prices for internet access across countries, partly because of currency fluctuations, but mostly because prices have to be considered in context: what other goods cost locally, which plans are compared and which plans most people buy, for example, really matter.

Absolute prices are one thing. What something costs, in any local economy, can vary dramatically. The easy example is what US$10, or euros, will buy, in any local economy.

Most comparisons are made on “absolute” price measures, not adjusted for local prices. So one study of prices shows typical monthly prices between $45 a month to $65 a month for access at speeds between 25 Mbps and 50 Mbps.

source: newamerica.org

This chart from CB Insights shows typical internet access speeds and typical prices in a number of countries. With the caveat that it matters how one chooses a single speed or price to characterize access in any country, as well as stating prices in uniform terms across countries (purchasing power parity), South Korea remains the outlier, with faster speeds and lower prices than most.

source: CB Insights

And even when using the PPP method, prices (megabits per second per dollar) vary across countries.

But even adjusted for purchasing power parity, prices can be deceiving. According to the International Telecommunications Union, on a “percent of gross national income per person” basis, developed nation fixed network internet access costs about 1.7 percent of GNI per person, compared to levels an order of magnitude higher in developing markets.

So comparing prices is difficult. Beyond all that, there is the matter of “effectiveness.” To the extent that fast internet access matters for economic development and social well-being, most observers will argue that “more” is “better.”

But it is next to impossible to prove causation (better broadband creates more or faster economic growth). Yes, there are correlations. Richer nations have faster broadband, generally at lower cost, depending on the metric used to measure. But one might argue that correlation is not causation.

In other words, richer countries have faster broadband because they can afford faster broadband more easily. So wealth leads to faster internet access. Faster internet might help support economic growth (something we act as though it were true), but only when other foundations are present (stable legal framework, stable currency, critical mass of developers, investment capital available, literacy high, educational levels high, other sources of comparative advantage are present).

Profits are the Key Issue, Even as Telecom Revenues Grow

It is no secret that nearly all of the telecom industry’s global revenue growth has come from emerging market mobile. So anything that affects emerging market mobile necessarily affects the global industry as a whole.

That will be a challenge, as the ability to grow revenue is lagging the ability to make profits on that revenue.

In other words, “top line” revenue growth conceals a clear danger: profits are not growing as fast as top line revenue or account growth.

And though both “new revenues” and “lower costs” are key issues for telecom suppliers, revenue is the bigger challenge.

In any business, if the top line revenue cannot--for any combination of reasons--be increased, then cost basis has to be adjusted downward, to maintain a sustainable bottom line. If, after doing so, the business model remains challenged, market exit is the only other option.

And that is what is likely to drive the whole global business for the next decade.

Does the emerging market mobile business face a “new era?” And if it does, given that global telecom industry growth has been driven by emerging market mobile, does that portend a change in global telecom growth as well?

In brief, here is the thesis laid out by James Sullivan, J.P. Morgan head of Asia equity research (all of Asia except Japan): emerging market mobile now is revenue challenged, unable to generate new revenues at rates that justify current investments.

Since revenue cannot be increased, “asset restructuring” is necessary, to adjust the cost base. In emerging markets, that means surviving competitors will not be able to own their own facilities.

Emerging market mobile has faced several challenges, all based around limited revenue growth and higher capital investment that have grown faster than incremental revenue.

As mobile data revenues have grown, they have cannibalized voice revenues. Rapidly-increasing capital investment and operating expense have lead to declining earnings.

Source: J.P. Morgan

“Profitless growth” is perhaps one way to characterize the trend.

Sullivan will flesh out the thesis as one instructor among many appearing at the Industry Transformation Boot Camp, 18 September to 22 September, 2017 in Bangkok,  including Spectrum Futures and PTC Academy components.

Sullivan sees signs that the restructuring has begun. You might look at India’s mobile market, where a huge consolidation of suppliers is underway.

The core thesis is that emerging markets have “no choice but to fundamentally change the structure of industry assets through the unification of networks via nationalization, centralization under a regulated return utility, or more aggressive commercial network sharing,” Sullivan argues.

For policymakers, there are a few fundamental options. In addition to nationalizing the networks, regulators could return to “regulated common carrier” models or oversee a reduction in capex by promoting network sharing.

That would presage a “new era,” indeed. Nationalization or a return to regulated rate of return would certainly lead to a reduction of physically-separate networks. Assuming no nation anymore can afford to run mobile networks on a permanent loss basis, and if revenue is too low, while costs are too high, then fewer assets is the solution.

That would create, in the mobile segment of the industry, the same pattern that exists for the fixed networks industry in many markets, where an authorized wholesaler supplies access capabilities to multiple retail providers.

In other markets, private actors might agree to share the cost of new investments, to reduce costs for each contender, as has been done for towers and radio infrastructure.

If Sullivan is right, the mobile market will be organized and regulated in very-different ways within a decade or so. For starters, the number of facilities will shrink drastically, which will have ripple effects across the whole ecosystem.

Still, “assets” are only part of the issue. Revenue models still must be addressed, and so far, nobody has sustainably proven how “access services” remains profitable, over time, when average revenue per account continues to drop.

Beyond that, there is the other key issue: whether top-line revenue growth can continue, and if so, what will propel that change.