Tier-one telcos and cable companies have dramatically different strategic options than small telcos and cable companies, over the next decade.
The largest global telcos will be able to invest in the next generation of revenue drivers, ranging from connected cars to Internet of Things services, mobile banking or payments, for example.
Small telcos, independent Internet Service Providers and cable companies will not have those options, and will have to gain scale selling the legacy products.
In fact, if you ask what revenue sources large service providers will rely upon in a decade, “new” sources either will be significant, or tier one service providers will be significantly smaller, in terms of revenue, than they are at present.
Small service providers face a very-different set of options. A majority of current suppliers will not exist as independent entities in 10 years, as they will have been acquired by other firms.
For the remaining firms, revenue sources are likely to be very similar to the leading sources today: voice, data and video services sold to consumers and businesses. The reasons are quite simple: the new revenue sources will require scale.
And, by definition, the smaller firms do not have, and cannot gain enough scale, to create the new lines of business, nearly all of which are at the “application layer.”
No small telco, cable company or ISP can attain the scale required to run a profitable connected car, health monitoring, mobile payments or branded streaming video service.
Barred from a strategic path built on creation of big new revenue sources, smaller providers will have to combine to create scale economies around the existing set of services provided to consumers and businesses.
But if voice and messaging gradually become smallish revenue contributors, while video shifts to online delivery, what remains is high-speed access. In sort of reverse of the pattern of the last 10 years, where cable and telco firms moved to “scope” economics–selling more things to fewer customers–small service providers might have to revert to “scale” economics, selling fewer products to many more customers.
Beyond scale, there is an investment and profit margin challenge. And we have seen this before.
Before 2000, the economics of the dial-up Internet access business were reasonable enough to support thousands–then after mergers, hundreds–of profitable but still smallish ISP businesses.
But then came “broadband.” Suddenly, the dial-up business became unsustainable.
When Internet access was an app that rode on top of a standard unlimited use local voice connection, small ISPs could make a business case for service because they were not leasing access connections.
With broadband, independent ISPs suddenly found themselves required to lease wholesale capacity from facilities-based providers in order to provide service, which wiped out profit margins.
Something more profound than that is likely to happen over the next decade, as part of the shift to gigabit networks, which will require higher investment in access facilities.
Bigger cable companies and telcos will have to spend more, but can adjust. Whether that will also be true for wireless ISPs and smaller rural service providers is not so clear.
One might argue that even if gigabit networks become the norm in urban areas, rural bandwidth will lag.
To be sure, there traditionally is a gap between price-performance of urban Internet access and rural Internet access. That will allow rural and independent providers a shot at survival, if they can offer 100 Mbps or more, even if 1 Gbps proves prohibitive.
Keep in mind the precedent: the transition from dial-up to broadband meant an increase of two orders of magnitude in bandwidth.
The shift to gigabit networks likewise will require an increase of two orders of magnitude. But capital investment is only part of the challenge.
Revenue is the other important shift. The most-serious impact of Google Fiber is to create a new pricing umbrella and value-price relationship in the high speed access business.
When Google Fiber offers 1 Gbps for $70 a month, the implied price of a Mbps is seven cents a month. So a 100 Mbps service “should” cost $7 a month.
That is why Google Fiber prices 5 Mbps at the level of “free.” Using the same metric, 5 Mbps would cost 35 cents a month.
So in addition to investments required to boost Internet access bandwidth by two orders of magnitude, ISPs will face dramatic profit margin compression. Where today a small ISP might sell 6 Mbps for $25 to $30 a month, or 12 Mbps for $50 a month, those ISPs will operate in a market where the market price for 100 Mbps is just $7.
Tier-one telcos reasonably can hope they could create new revenue sources based on machine-to-machine or Internet of Things capabilities. Small service providers cannot do so.
So small providers will have to work very hard to gain scale (make acquisitions), while simultaneously investing in access networks to add two orders of magnitude more bandwidth, and accept margin compression of that anchor product to levels an order of magnitude lower.
But we have seen this sort of thing before. Independent ISPs, both dial-up and then broadband, competitive local exchange carriers, AT&T, MCI and many would-be satellite and fixed broadband entities have disappeared, squeezed between high infrastructure costs and paltry revenues.
Bigger service providers will charge ahead with new service creation efforts. Small providers will have to consolidate, gain scale and make a living off legacy services, in a context of higher capital investment and lower gross revenues.
Parts of this story already have been seen. The biggest providers will replace half of their current revenue sources by new revenue sources, over about a decade.
But smaller providers will have to rely on consolidation and efficiencies to wring profit out of a tougher legacy services business case, as the option to replace half of legacy revenues with new sources likely does not exist.
By Gary Kim