Category Creation in the Connectivity or Digital Infra Spaces?

Startups have advantages and disadvantages that well-established legacy firms do not face. No internet service provider, mobile operator, cable TV provider or video streaming firm has to convince buyers there is a problem that firms in the category can solve. 

Hilton, Marriot and Hyatt do not have to explain to buyers what they do. Airbnb had to convince people. So did Uber. So did Google (with search). That is called category creation. 

Category creation often is a task that firms in emerging new markets must cultivate, to raise money, create valuation expectations, attract business partners and customers. 

The concept is that some big new class of problem is solved by a new category of solution providers. Solving  a different problem, with a different solution is foundational. 

Think about HubSpot, IKEA, Pixar, Netflix, Google, Airbnb or Uber. 

That often also means solving a problem buyers did not know they have. 

“It's difficult to create a category without inspiring others and getting them to realize they had a  problem they didn't know existed or that fundamentally changes how they interact with the world,” argues Michelle Snyder, digital investor, has said.

In that regard,  a category of one creates buyer risk. It actually is helpful, when creating a new category, to have competitors in the same category. 

“From the start, you must base your efforts on some broader market, consumer, or societal change that you believe will fundamentally change how we should look at the world,” says Sapphire Ventures. “Providing that macro context elevates the conversation beyond a product pitch from your company, and helps create a sense of inevitability for your vision.”

Firms in new categories often are valued at richer multiples than firms in legacy categories. They also can grow revenues faster than firms in related older categories and definitely reap rewards in terms of equity valuation. 

“Category creators are a small part of the Fortune 100 list of fastest-growing companies—but they account for much of the group’s growth,” say Eddie Yoon, principal of the advisory firm of Eddie Would Grow, and Linda Deeken, founder of Deeken Strategies. 

source: Harvard Busienss Review 

In many cases, startups are virtually required to create a new category. “In Silicon Valley, creating a new exciting category is the holy grail of what most companies are trying to achieve,” says Al Campa, Rocket Scale CEO. 

Building a business when customers and ecosystem par;ticipants already understand the problem to be solved is one matter. But building a category is different. By definition, the new category falls outside existing understanding. That understanding has to be created.

Clearly-understood new categories also reduce buyer risk. “There are always a few consumers who want to be the first among their friends to try a new product, but this is a surprisingly rare behavior,” says Peter Thomson, a digital strategist. 

Most buyers, though, are very risk averse.  

As a practical matter, that often requires bringing together thought leaders, practitioners and competitors together. In part, the reason is simple: market participants must be convinced there is a big new problem the category solves. Think of the aphorism “a rising tide lifts all boats.” 

Think of the practical marketplace value of any industry consortia, forum or association that works to promote the value of any particular industry segment. By framing a big problem in an innovative way, the whole category is boosted. 

That is particularly true when markets must be convinced a big new problem exists that has an important new solution.   

“Category creation becomes a self-fulfilling prophecy,” Sapphire Ventures notes. “When you’re able to both identify the disease and deliver the cure,  it creates a defensible moat around your business.”

“The intermediate goal for creating a new category is starting a conversation in the market that includes you,” Sapphire says. 

How many firms in the data center, Wi-Fi, wide area or local access connectivity or mobile businesses can you think of that ever created a new category, in the same sense as Uber, Airbnb, Google (search), Amazon (retailing)  or Meta (social networking).

"Value" Remains the Paramount Business Issue for Connectivity Providers

Very few observers would likely characterize the connectivity business as “robust,” “consistently high margin” or “well positioned for growth.” Management challenges therefore reflect the realities of margin pressure, average revenue per unit declines, high degree of competition, key product demand that is dropping and relative loss of ability to control or shape new application development. 

Nothing better summarizes the strategic context than the fear that the connectivity industry is becoming a “dumb pipe” commodity business with higher costs over time. That is a recipe for trouble. 

The by-now classic illustration is any depiction of revenues earned by connectivity providers and others in the internet ecosystem (devices, apps, e-commerce, advertising, content), compared to the more-nascent ecosystem in 2010. 

source: Kearney 

The illustration is somewhat unfair, in the sense that every industry has, or can have, a different valuation, using any multiple of value compared to revenue, price or earnings. 

source: Kearney 

As a consequence, many obvious challenges center on retail pricing, operating costs and business models. Those issues, in turn, are shaped by the disaggregated, layered model of computing, which then also disaggregates “value.” App creation and ownership are separated from ownership of connectivity assets. 

At a high level, that means network ownership is not aligned with application or service ownership. No business relationship must necessarily exist between the owner of an access network, or the supplier of premises connectivity, and the creator and supplier of any application or service that simply requires internet access. 

Other challenges grow from the best effort nature of internet access, using either Wi-Fi or access networks. By definition, IP transmission is not deterministic. That makes consistency an issue. 

And while much internet value is created by ecosystems, connectivity providers have not yet been able to place themselves at the center of ecosystem organization, in the same way that some device, application or transaction platform suppliers have been able to accomplish.

Lots of effort has gone into activities that connectivity firm owners hope will rectify these deficiencies, sometimes centering on creation of more disaggregated revenue models based on use of application programming interfaces, participation in ecosystems or unbundling and disaggregating portions of the network function itself. 

It all remains a work in progress.

"Down and to the Right" Versus "Up and to the Right"

Down and to the right is a reasonable depiction of internet service provider, capacity provider, mobility or telco legacy revenue per unit trends of the past several decades. That applies to wide area network capacity, internet transit prices, voice prices, long distance calling prices, text messaging rates, or mobile network minutes of use or data usage charges. 

That is distinct from the “up and to the right” depiction of the fortunes of growth industries, firms and products. At various points, internet access and home broadband, for example, have been “up and to the right” products. 

Which is another way of noting that business strategy is different for legacy and declining products compared to new and growing products. Think of “S” curve and its strategy implications. 

When a product is late in its life cycle, it is nearly pointless to invest too much, as no matter what one does, the product is destined to be replaced. So firms harvest revenues as long as they can. 

source: Strategic Thinker

The opposite has to be done for the newer replacement products: one has to invest in them. All that raises a question: is the move to try and monetize network functions using application programming interfaces (APIs) a move that helps connectivity providers extend the revenue production of declining products or propel the average revenue per unit of new products? 

To the extent it might represent both, how much does it create value, compared to how much it could destroy value? In other words, can monetizing API access to network features create big new revenue streams faster than it can commoditize the same?

In the former case, slowing the rate of revenue decline for some products might be described as “winning.” In the latter case, accelerating the rate of revenue growth constitutes winning. 

APIs might enable either outcome. If this all feels somehow reminiscent, think of the adoption of TCP/IP by global service providers as the “network of the future.” IP created layers of functions that are connected by APIs. 

So the network of the future necessarily separates application creation and ownership from network transport and access functions. 

Has that helped or hurt? And whom has it helped; whom has it helped?

Competition or Investment: Choose One

Many European internet service provider leaders claim the business model is unsustainable, as profits are too low, scale is suboptimal and costs are stubbornly high. Some might note that European policymakers have, for decades, prioritized competition over investment. 

If policymakers decry low investment in advanced facilities, their own policies are partly to blame, as competition leads to lower retail prices, which creates disincentives for further investment. 

U.S. policymakers took the same path in the early days of access network competition, in the wake of the Telecommunications Act of 1996, which opened the local loop to full competition for the first time. The primary early strategy was generous wholesale discounts of around 30 percent, plus the ability to buy a fully-provisioned wholesale service.

That led to a quick expansion of retail competition, lead by AT&T and MCI, at that time, the two big firms that were not already in the local access business.

But policymakers reversed course after several years, as the massive reliance on wholesale mechanisms reduced incentives for investment in new facilities. 

In other words, policymakers always must make a choice: do they want more competition or more investment? “Choose one” is the unfortunate realm of choice. 

European service providers have been complaining for decades that government policies intended to support competition have worked to the detriment of creating a climate conducive to capital investment. 

That now is said to apply both to 5G and advanced mobile networks as well as fiber-to-home facilities. 

But there are other issues as well. The European internet access business has a “very low” return on capital employed. Telefonica CEO Jose María Alvarez-Pallete says European ISPs have rates of return “barely beating cost of capital.”

But that also is shaped by competition policy, which has resisted consolidation. “The average European mobile operator covers five million people, where the average U.S. operator covers 107 million people,” says  Alvarez-Pallete. 

That is not to say that the benefits of competition cannot be obtained when the number of contestants is quite low. In the U.S. market, robust competition exists with about two main contestants in fixed networks and three main contestants in mobile markets. 

That might be the best expected outcome long term. But European ISPs say policymakers must essentially reverse course. 

Competition or investment: choose one.

Beyond "Public" Digital Infra

For some, digital infrastructure means data centers, cell towers and optical fiber networks. For others the category includes software, computing hardware and devices, artificial intelligence and other  information technology. For investors, operating companies, asset owners and many others in the category, the definitions matter. 

source: IDC 

For investors, it changes the classes of assets that are investable. For operators the definitions shape business strategies. For asset owners, broader definitions change the scope of potential buyers. For everyone, the definitions can affect equity or asset values and multiples. 

source: YTD2525 

Likewise, broader or narrower definitions shape firm strategies for all others in the ecosystem: who “customers” are, how marketing and sales efforts are structured, what product development has to happen. 

For most firms, a practical definition will be narrower. But it seems inevitable that with the emergence of artificial intelligence as a trend at an inflection point, that the category will see practical changes, with more asset types emerging as part of the digital infra marketplace. 

Not to be ignored either is the amount of competition for the narrower class of assets, higher valuation multiples that put pressure on upside profits and the sheer emergence of new asset classes closely related to traditional digital infra. Also, existing asset classes could emerge in new form as part of digital infra markets. 

Historically, “public” assets such as communication networks or data centers have been distinct from “private” assets such as computing hardware or operating systems; end user applications and software. 

We should see a growing trend of greater inclusion of other asset classes beyond “public” infra.

So ISPs Want a Massive Shift to "Collect Calling" for Content Delivery?

Virtually no observers of the Western Europe connectivity business would challenge the notion that the business model is challenged. Typical complaints include consumer resistance to pay for connectivity; competition that is ruinous and government policies that incentivize competition more than investment. 

Infrastructure financing was a significant theme of connectivity provider and regulator talks at MWC Barcelona, as you would expect. 

The argument normally is phrased as a matter of “fairness,” a handful of hyperscale app providers “causing” more than half of all data usage by an ISP’s own customers. But that matter also can be looked at through the lens of the way access providers always have compensated each other for traffic imbalances. 

Keep in mind it always has been the networks that compensate each other. Think back to the say connectivity networks used to work in the voice era. Calls necessary involved at least two parties and locations. 

Resources were consumed on each end of the connection. In most cases, the charging model was “calling party pays,” with a healthy dose of “both parties earn revenue.” Though the calling party paid for long distance charges, the terminating party also was paid for use of the network. 

In the era of internet content delivery, one has to ask “who is the calling party?” Is it the ISP customer who asks for delivery of content? Or is it the content owner who responds to a consumer’s or customer’s request? Is the “request” a different session from the content delivery? Or is the content delivery a response to the calling party’s request? 

In other words, are we talking about “fairness” or “calling party pays?” And what is the traffic source and sink? 

soruce: flylib

It might seem obvious that a content provider is the “source” while the requesting subscriber or user is the “sink.” But that transaction or session only happens because a customer or user of one ISP has asked for that content from an app provider on another network.  

In other words, which party placed the call? And which charging method should apply? It’s complicated because there is no internet access equivalent to the call “minute of use.” There is no rating system in place we can use to track and then allocate network usage charges when sessions and data flow between ISP domains. 

In an era where networks mostly are used for content delivery, asymmetrical traffic demand is assumed.

Think back to the era when network traffic was mostly voice. By definition, traffic flows were nearly symmetrical. No matter which party called, and which party was called, capacity resources were virtually identical. It did not matter which party talked, and which party listened. Network resource consumption was essentially identical on each end. 

In principle, there are three ways to account for usage by customers on two different networks. The calling party can pay; both parties can be paid or the receiving party can pay. The only other pattern is that a third-party sponsor pays (toll free calling, for example). 

In the fixed networks business the general pattern has been calling party pays. In the mobile business both parties have paid, in the form of usage allowances being depleted on both ends. And calling parties have paid for toll charges. 

In the internet access business, the general pattern has been both parties pay, in the form of usage allowances that are paid for and consumed. Proposals to tax a few hyperscale app providers retain the “both parties pay” scheme, but also add a new layer of “some app providers also pay.” 

Many analogies could apply. Placing a long distance call might be one analogy. Even when resources are used on both ends, it is the caller who pays the charge. Applied to internet content delivery, it is the ISP customer who invokes the data delivery who might be viewed as the entity that pays. 

The other approach--receiving party pays--only applies for special circumstances similar to a “collect call,” where the called party agrees to pay the charges normally paid by the party placing the call. 

The proposal to tax a few hyperscalers is equivalent to collect-call billing procedures, where the party initiating the call is not billed, but the party at the other end is billed instead. One might say that proposals to tax a few hyperscalers are a form of billing similar to the “collect call,” where the calling party is not billed. Instead, charges are borne by the called party. 

That is not to say such practices are inherently flawed. It simply is to note that the “both parties pay” is the most-widely-used pattern for mobility networks, even when calling party pays also is used and collect calling is conceivable. 

Even if we agree that calling party pays is reasonable, who is the calling party? Connectivity provider calls for payments by a few hyperscalers are more akin to “collect calling.” 

That might seem workable to many. But the additional charges borne by the entity paying for the collect call still must account for such charges in their business models. And those higher costs will be borne by business partners, retail customers or users. 

Gains by ISPs will be offset by losses by content or app providers. So higher costs will accrue to advertisers, sponsors, retailers and users and subscribers of such services. There is no “free lunch.”

Is Australia's Home Broadband Market Saturated?

Is home broadband in Australia close to complete saturation? If so, that implies the home broadband business in Australia now is virtually a zero-sum game. What one internet service provider gains is offset by an equivalent loss by some other contestant.

In such markets, it is not only tough for internet service providers to grow revenue by adding subscribers, but the revenue growth model has to be based on the ability to increase the revenue each provider gets from its customers.

Typically, that involves getting customers to buy more-expensive plans, almost always based primarily on higher speeds, though the value of bundled features often is hard to separate from higher-speed access.

New data from the Australian wholesale connectivity provider NBN shows a slight dip in wholesale accounts supported by the network. For some observers, that is the key statistic. It might indicate that demand for home broadband is nearly saturated, or is saturated. 

Assume the NBN represents the whole home broadband universe, representing 8.7 million accounts. There are some satellite accounts, but too few to affect the analysis (fewer than 21,000 total accounts nationally). 

If there were some 10.9 million dwelling units in Australia in 2021, and about 178,000 new units are added each year, then in 2023 there are about 11.3 million dwellings in early 2023. 

source: id.com 

That implies a take rate of about 77 percent. The slight dip in current subscriptions suggests that demand is about as high as it can get. 

source: ACCC 

Some see a market share shift from larger internet service providers using the NBN (Telstra, TPG, Optus) to smaller ISPs, a trend that was consistent in 2022 and 2021. 

It appears that the smaller ISPs are succeeding in the ways smaller providers often do. Anna Brakey, commissioner of the Australian Competition and Consumer Commission. “Some smaller providers are offering consumers different options to meet their specific needs, such as tailored plans and discounted pricing options, network performance graphs, Australia-only call centers and gamer-optimized plans,” she said. 

But the main observation might be the drop in total subscriptions in a developed country market, which is unusual.