Moore’s Law Underpinned Huge Gambles in Video Business

Moore’s Law arguably has underpinned business models across the computing, software, consumer electronics and communications industries for decades. Despite concerns that Moore’s Law–the observation that transistor density doubles about every 18 months–would cease to operate at some point, so far that concern has been misplaced.

Reed Hastings is among CEOs who recently have relied on a continuation of Moore’s Law as the underpinning of a radical change in strategy, shifting from shipping DVDs using the postal service to streaming.

As logical as that decision might seem in retrospect, it was a gamble. Hastings had gambled before. Not many recall that the original Netflix business entailed selling DVDs.

When Netflix was launched in 1998, “I would guess that 95 perent of our revenues were coming from the sales of DVDs ,” said Marc Randolph, former Netflix CEO.

But Netflix already could see a major change was needed. “it was obvious to us that this was not a sustainable business,” said Randolph. “It was inevitable that at some point in the near future we would have Amazon entering the DVD business.” And Walmart and other mass market retailers.

“All of which would have crushed our margins and slowly but surely driven us out of business,” said Randolph. And remember, in switching to DVD rentals, Netflix sacrificed 95 percent of its revenue.

The decision to focus on streaming also was a gamble. In 1998, some argue, it would have cost Netflix as much as $270 to stream a single movie. By 2010 it might have cost about five cents for Netflix to stream a movie of equivalent image quality.

That is why DVDs by mail was necessary. Netflix could not build a business on streaming. But Hastings considered Moore’s Law.

“We took out our spreadsheets and we figured we’d get 14 Mbps to the home by 2012, which turns out is about what we will get,” said Hastings. “If you drag it out to 2021, we will all have a gigabit to the home.” That meant streaming delivery was indeed possible.

Nor is that the first time a major video innovation was built on assumptions about Moore’s Law.

Back in the mid-1980s, when standards for high-definition TV were being debated, the lead proposals were for hybrid analog-digital systems, using as much as 45 MHz of spectrum, where standard television used 6-MHz channels.

Tom Elliot, former Tele-Communications Inc. SVP, recalls the potential disruption of the cable TV business model. Elliot estimated at the time that it would take 15 years to recover the investment in early proposed hybrid versions of high definition TV.

The problem, as Elliot saw it, was that the hybrid system would in turn soon be eclipsed by all-digital TV, requiring two major generations of investments inside of 15 years.

Elliot recalls TCI SVP John Sie coming into his office and asking how the company could avoid being “run over” by broadcasters and consumer electronics firms. Elliot recalls arguing that Moore’s Law would hold, though many at the time argued progress was about to flatten.

So the big gamble was on Moore’s Law. If the law held, then it would be only a matter of time before decoders roughly corresponding to a “mainframe in the living room” could be built for consumers.

That amount of processing power would allow an all-digital signal representing perhaps 100 MHz of raw, uncompressed video to be encoded, and then decoded on the fly, by a consumer terminal the industry could afford. Virtually nobody thought that was feasible.

The big gamble was Moore’s Law holding, allowing both low-cost decoding and use of standard 6-NHz TV channels.

Almost nobody but Elliot, and later TCI,  actually thought it could be done. He recalls that position as being “really lonely.”

But Elliot knew Moore’s Law. He had talked to clean room techs. Yield might be an issue initially, but if Moore’s Law held, an affordable set-too was economically possible, even if–at the time–that required the equivalent of a mainframe in the livingroom.

Elliot was proven right, as controversial as the call was at the time.

So Moore’s Law has been the foundation for transformative business decisions more than once.

TCI gambled its future on digital TV built on Moore’s Law.  Netflix likewise gambled its business on access bandwidth. Both were bold, dangerous business decisions, built on assumptions about Moore’s Law continuing to operate.

What is the Most-Important Big New Opportunity for Telcos?

If you had to make a bet, right now, about the most-promising big opportunity for tier-one telecom providers–something big enough to replace about half of all current revenue over about a decade–what would you choose?

The decision matters. With fixed and mobile revenue slowing, flat or declining, the “next big thing” will matter. To be sure, there are lots of smaller and important things to be done.

But nothing might matter more than discovering big new markets and services to drive growth beyond today’s leaders. After all, the industry already has watched revenue leadership shift from fixed voice to mobile and voice to data. Video services will help, in some cases. Expansion out of market will help as well.

But organic growth still has to hinge on a new wave of services yet to be created, even if out of region expansion, video or fixed-mobile integration also drive additional revenues.

Right now, it would be hard to name a category of services with more potential than Internet of Things, as fuzzy as that concept might be, since IoT represents many potential new markets and services.

With the Internet of Things at the peak of its hype cycle, we will all be hearing predictions of non-linear growth. Many forecasts, for example, call for deployment of 20 billion or 30 billion IoT units by 2020. That implies potential new Internet connections of as much as the same number.

A few years ago, some analysts had predicted that, by 2020, the market for connected devices would be between 50 billion and 100 billion units. The point is that projections already have proven too optimistic.

None of that is at all unusual. Big new business opportunities are tough to pin down, in terms of concrete business models. Think of the Internet itself. In mobile, creation of sizable and concrete 3G and 4G revenue models took time.

But IoT remains in an early stage. For example, a recent survey of executives found they lack a clear perspective on the concrete IoT business opportunities, as promising as the field might be.

Semiconductor executives surveyed in June 2014 by McKinsey said the Internet of Things will be the most important source of growth for them over the next several years—more important, for example, than trends in wireless computing or big data.

Those hopes might be misplaced, though. “For players in the traditional semiconductor market, the Internet of Things may spark some growth, but it certainly will not change two percent industry growth today to the 10 to 15 percent growth we had in the 1980s,” one industry executive says.

If so, that might imply that hopes for massive new service provider revenues might also be excessively optimistic, at the moment. Whether that also means service provider hopes are misplaced is the issue.

Important innovations in the communications business often seem to have far less market impact than expected, early on.

Even really important and fundamental technology innovations (steam engine, electricity, automobile, personal computer, World Wide Web) can take much longer than expected to produce measurable changes.

Quite often, there is a long period of small, incremental changes, then an inflection point, and then the whole market is transformed relatively quickly, but only after a long period of incremental growth.

Mobile phones and broadband are among the two best examples. Until the early 1990s, few people actually used mobile phones, as odd as that seems now.

Not until about 2006 did 10 percent of people actually use 3G. But mobiles relatively suddenly became the primary way people globally make phone calls and arguably also have become the primary way most people use the Internet, in term of instances of use, if not volume of use.

Prior to the mobile phone revolution, policy makers really could not figure out how to provide affordable phone service to billions of people who had “never made a phone call.”

IoT might prove to mimic that pattern. And that is the optimistic scenario. Not all innovations prove to have such impact.

Still, the reason the industry needs to create viable and big business models around IoT is that it now is the single best hope for replacing about a quarter of all current revenues.

We might reasonably expect video entertainment, mobile data and out or market expansion to produce additional revenue representing about a quarter of the size of existing firm activity.

The issue there is that some of those gains are “zero sum.” Gains by one contestant come only at the expense of another contestant, and do not represent net market growth. IoT is among the few big new revenue sources that actually grow the market.

And that is why IoT reall matters, for service providers and many others.

Invest or Harvest? It Often Depends on Network Platform

In an industry that changes so rapidly, it often is useful to remember just how much has changed in telecommunications, globally, in a few short decades, and how busincess choices are affected by the scale and pace of change.

The broad context is that service providers have to make key decisions about when to harvest, and when to invest, in various products in their portfolios, as end user demand changes.

Consider use of fixed line voice, across a range of nations.

In the United States, customers buying fixed network voice now number about 42 percent of the population. In Italy, that figure is just 37 percent.

In the United Kingdom, customers number 59 percent of the population, 60 percent in France and 45 percent in Germany. Some might argue the numbers are that high in substantial part because of rules on line bundling related to purchases of high speed access, namely that purchase of a voice line is required to buy high speed access.

The main observation is that fixed network voice is a product in the declining phase of its adoption cycle. That poses key questions for suppliers.

How much more innovation should be attempted for fixed network voice? How much should harvesting” be the dominant strategy?

Some will argue for increasing investment to change the value proposition and therefore allow price increases. Others might argue for harvesting the legacy revenue as long as possible.

Contrast that with mobile adoption (measured in terms of active accounts), which stands at 106 percent in the United States, 159 percent in Italy, 140 percent in Germany, 117 percent in France and 130 percent in the United Kingdom.

Those adoption figures might suggest a similar “harvesting” strategy, but that would not be correct. Mobile, unlike fixed networks, are replaced about every decade. For that reason, a first generation or second generation network sells a different product than a third generation or fourth generation network.

In the mobile services sphere, “investing” in the next generation–not harvesting–is the typical, and arguably correct strategy.

In developing countries, strategics are just as clear.  In India, fixed voice adoption is just two percent of the population, but mobile adoption is at 91 percent. In Brazil, where fixed voice lines are purchased by 22 percent of people, mobile is bought by 137 percent of people.

The point is that it typically does not make sense to invest very much in fixed networks, when a similar investment in mobile will produce outsized revenue gains.

Mobile voice is approaching a peak of adoption in many countries, even in many developing nations. So how does the “invest or harvest” decision play out?

In some ways, Voice over LTE can be viewed as an investment in “next generation” voice.

In other ways, VoLTE can be viewed as a cost-saving measure, allowing operators to eventually decommission 3G networks (often used to support voice services) nd redeploy 3G bandwidth to support 4G.

Mobile Internet, on the other hand, remains a major growth opportunity in developing nations, while some forms of mobile Internet access, in most developed markets, already are nearing a peak.

Mobile Internet access adoption is 100 percent in the United States (again, measured in terms of active subscriptions), 113 percent in Japan, 130 percent in Sweden and 110 percent in South Korea.

Mobile Internet access (using third generation platforms, generally)  has a bit more growth left in other countries, including the United Kingdom, where adoption is at 77 percent, France, at 64 percent adoption, Germany, at 51 percent adoption and Italy at 74 percent take rates.

But it is fourth generation Long Term Evolution that will be the potential growth driver in most developed countries. LTE represents four percent of U.K. and French mobile Internet accounts, five percent of German accounts, three percent of Italian and Spanish accounts and four percent of Netherlands mobile accounts.

In the United States, LTE represents 23 percent of all mobile accounts in service, in Japan 22 percent, in Austria 20 percent. In India and China virtually all the growth lies ahead.

Fixed high speed access connections represent a harder-to-describe situation, as service is purchased “per location,” not “per person.” The key implication is that adoption “per person” is not as relevant measure, as the issue is more accurately “adoption per household.”

Fixed broadband adoption “per person” was 36 percent in the United Kingdom, 38 percent in France, 34 percent in Germany, 23 percent in Italy and 29 percent in the United States. But consumers buy fixed network high speed access “by location,” not “per person.”

In 2012, for example, U.S. household adoption of high speed access was 73 percent. As a percentage of population, high speed access stood at 29 percent. Obviously, “per capita” adoption doesn’t accurately reflect the number of people able to use the services.

In 2013, high speed access per household stood at 93 percent of households in South Korea, 90 percent in Switzerland, 83 percent in Japan, 82 percent in Canada and 75 percent in the United States.

In other words, “per capita” or “per person” measures of fixed network high speed access do not accurately portray the true state of adoption.

The point is how much has changed over just a couple of decades. Fixed network voice, the driver of industry revenue, already is becoming a relatively limited driver of total revenue, as the product is purchased by less than half of all households.

Meanwhile, revenue gains are paced by Internet access, video entertainment and mobile services. In some cases, it still makes sense to measure adoption and revenue on a “per account or per household” basis. Fixed network Internet access and video entertainment provide examples.

Increasingly, though, the more-important metric is revenue per user, revenue per account or revenue per device, as more services are sold in the mobile domain.

But revenue per account also makes more sense for fixed network services when the primary retail packaging is a bundle of three or four services.

And traditional “invest or harvest” decisions have a different context in the mobility business, where whole networks are replaced about every decade. For a mobile service provider, it will always make sense to invest in the next generation. Harvesting is a temporary expedient until the older platform can be retired.

source: Akamai

source: Ofcom

Why Quadruple Play?

In one way, it is obvious why telecom and cable TV service providers in many markets are shifting product lines and retail offerings to quadruple play bundles. Doing so allows the service providers to boost gross revenue and average revenue per account, while reducing churn.

Quadruple play offers also tend to provide a better platform for growing market share and therefore boosting subscriber numbers.

With such clear advantages, the grand strategy of offering a bundle of fixed network and mobile services requires little explanation.

Still, even when contestants agree on the value of the bundling strategy, larger firm growth imperatives can be quite disparate. Verizon Communications, for example, has bet $130 billion on its ability to grow almost entirely within the U.S. market.

AT&T, with its bid to buy Iusacell, the Mexico-based mobile service provider, at a minimal cost of about $2.5 billion, is following through on its different growth strategy, which is expansion into international markets.

That strategy has been in place for some time. AT&T reportedly considered a purchase of Telefonica, but Spanish regulators quickly moved to signal disapproval.

America Movil and partner AT&T also were rebuffed in 2007 in an effort to buy Telecom Italia. More recently, there were rumors that AT&T was considering buying Vodafone, a huge transaction that would have created the globe’s biggest communications service provider, at least in terms of market capitalization.

The $48 billion AT&T bid to buy DirecTV, on the other hand, is an important, but more limited gambit to create a nationwide quadruple play offer, something virtually no other service provider can do, at present.

To be sure, any U.S. service provider attempting to offer quadruple play services nationally would have to do so using wireless networks (satellite, mobile, untethered), as no single firm can afford to build a nationwide fixed network, even if the Federal Communications Commission would allow it–and the FCC will not allow it.

If and when Verizon Communications puts a national strategy into place, it also is likely to lean heavily on the mobile network, though likely with an emphasis on over-the-top streaming video rather than linear video. That is one area where AT&T and Verizon disagree on near-term strategy.

AT&T believes linear video still has legs. Verizon is less convinced, at least where it comes to its own involvement in entertainment video. Specifically, Verizon argues the skimpy profit margin from linear video will eventually be made worse when OTT streaming becomes a widespread alternative.

Still, there is another reason why many leading service providers are turning to quadruple play bundles. Competition and product substitution in the fixed network voice, mobile voice, mobile messaging, linear video (in some markets) and even high speed access (in some markets) product lines is making the whole business more challenging.

Whatever synergies might exist between fixed and mobile network assets, the simple fact is that revenue growth in some markets now virtually requires the revenue lift a quadruple play can provide, simply because, in a growing number of markets,  some or all of the revenue sources are stagnant or declining.

In other words, “scale” (selling more units) is becoming difficult to impossible, within each product segment. “Scope” (selling different products) therefore emerges as the rational strategy, within each market.

So far, AT&T and Verizon also disagree on how much room remains for market share gains in the original market. AT&T, which has grown primarily through acquisition, sees future growth hinging on additional acquisitions outside the traditional core market.

Verizon, which generally has grown organically–even though Verizon itself was formed from the merger of Nynex and Bell Atlantic–does not yet see the same need to expand internationally.

If Verizon strategic thinking changes, the reasonable prediction will be that international expansion will come primarily on the mobile side of the business. Both domestically and internationally, telecom industry revenue growth is driven by mobile services.

Nearly 80 percent of AT&T’s pre-tax income during the first six months of 2014 came from its mobile business. At Verizon, the mobile segment contributed 68 percent of revenue  in the third quarter of 2014 and 50 percent of earnings (earnings before interest, taxes, depreciation, and amortization).

Globally, mobility has been the revenue growth driver for decades. In 1998, mobile accounts were about a fourth of all voice lines in service globally. By 2001 mobile had just about reached parity with fixed, and by 2002, and ever since, mobile lines have surpassed fixed voice lines in service.

By 2009, mobile voice accounts in service stood at 67 percent adoption, compared to less than 18 percent adoption of fixed voice service, globally.

In fact, use of fixed voice lines peaked in developed markets in 2001, and had begun declining by 2002. In the U.S. market, use of fixed voice lines peaked in 2000.

Globally, use of fixed lines peaked in 2006, even if use in developing markets grows slowly.

But the mobile market is maturing as well. According to researchers at Ovum, global mobile connections will grow by a compound annual growth rate of less than four percent between 2012 and 2018, while global revenues will grow at less than half that rate.

Average revenue per user also will decline. Global mobile connections will grow from 6.5 billion in 2012 to reach 8.1 billion by 2018, while annual mobile service revenues will rise from US$968 billion to US$1.1 trillion.

However, global service revenues will contract in 2018 for the first time in the history of the mobile industry, declining from 2017 levels by one percent or US$7.8 billion, Ovum predicts.

Does that mean service providers will abandon expansion by acquiring out of region mobile assets? Not likely. It does mean they will pick their opportunities, though.

The ability to offer quadruple play services will be a more-important part of the screening process, in many cases.

by Gary Kim

In Europe or U.S., Investment and Competition Sometimes are Inversely Related

Predictably, AT&T has been criticized in some quarters for pausing gigabit access network investment until certainty about high speed access regulation is settled. To be sure, all participants in regulated, or potentially regulated markets, take actions to bolster their chances of winning an argument. That is as true for Google as it is for AT&T.

Uncertainty or regulations that reduce return on invested capital have a direct impact on deployment of next generation networks, many would argue. And it appears we need look no further than Europe for proof.

Incumbent market share across the EU-27 in 2010 was 38 percent. In other words, competitors had gained 62 percent share of the fixed network market.

But that degree of competition has come at a price. The EU is in danger of failing to make its announced goal of 30 Mbps by 2020, a target that originally was set before the launch of Google Fiber, which has changed market dynamics and investment in the U.S. market, for example.

So regulators should ease up on IT and telecommunications companies to allow them to compete with rivals around the world, said Guenther Oettinger, new European Union digital economy commissioner.

“So far, we have ensured that consumers benefit from the liberalization of telecoms markets,” Oettinger said.  From now on our actions must be more geared more toward allowing companies to make fair profits.”

That represents a huge change in thinking. The main point is not that the EU has decided to take a “North American” or “U.S.” approach. Instead, the big shift is the recognition that promoting competition and promoting investment can become rivalrous and mutually-exclusive goals.

In theory, regulators try to create regulatory frameworks that simultaneously promote both competition and expedited investment in next generation networks. In practice, almost any set of policies will be criticized.

That was the case in the United States prior to the Unbundled Network Element Triennial Review. Competitive local exchange carriers were thrilled about their ability to get wholesale access to incumbent telco switching and access facilities at healthy discounts.

The incumbent telcos predictably were unhappy.  As AT&T Chairman and CEO Michael Armstrong said in a 1998 speech, “no company will invest billions of dollars to become a facilities-based broadband service provider if competitors who have not invested a penny of capital nor taken an ounce of risk can come along and get a free ride on the investments and risks of others.”

After a rules change that eliminated mandatory access at highly discounted rates, competition in the consumer segment of the U.S. voice and high speed access market shifted to a war between U.S. cable TV operators and telcos, both of which owned and operated their networks.

Some competitive providers made incremental gains where they were able to focus on business customers, not consumer accounts.

Some will point to the Verizon FiOS upgrade as a direct response to the change in wholesale rules. Verizon Communications did not begin the massive investment in fiber-to-home facilities until after the 2003 rules change that ensured Verizon it would not have to sell wholesale access to FiOS except at negotiated commercial rates.

Others might note that the unregulated cable TV industry, by 2003, had gained a two-to-one advantage over telcos in high speed access market share, a development some observers attribute to the differences in regulation of telco and cable TV wholesale rules, between 1999 and 2003.

Simply, cable TV operators have never  been required to sell wholesale access to their networks. Between 1996 and 2033, telcos were required to do so at significant price discounts to retail. After 2003, when the mandatory wholesale rules were lifted, high speed access market share quickly equalized in two years.

To be sure, non-facilities-based competitors were not happy about the 2003 triennial review changes, as the switch in policy favored the cable TV companies, who had facilities in place, and essentially eliminated the profit for consumer service providers using wholesale access.

But some would say the switch to an emphasis on “facilities-based competition” has succeeded, as per-capita investment in U.S. access networks has been substantially higher than in the EC region; about twice as high, by some estimates.

It now appears that a decisive change in thinking has happened. EC authorities are worried about lagging investment in next generation networks, and are prepared to take steps to promote investment, not just competition.

The larger point is that policies matter. Both competition and investment in next generation networks are important. EC regulators now are thinking about how to promote investment, not just promote competition.

That remains a valid framework in the U.S. market as well, as the network neutrality framework is debated. Uncertainty jeopardizes investment. So do rules that jeopardize financial return from long-lived capital investments.

by Gary Kim