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When You Accumulate Anomalies, Get Ready for a Paradigm Shift: That’s Coming for Telcos, Cable

Thomas Kuhn, in his foundational book The Structure of Scientific Revolutions might teach you to look for anomalies in business, not just science. The theory is simple enough: under normal circumstances, knowledge grows incrementally.

When an established paradigm is about to break, people keep running into anomalies–facts that don’t fit the existing paradigm.

We are at the beginning of just such a period, in terms of the dominant retail paradigm for any access provider in the U.S. market, and many other markets. For more than a decade, the triple play has been the key retail strategy in the fixed network access market.

There are several reasons for that reality. Single-purpose networks (the old telephone network, the old cable TV network and others) had a different business model than today’s multi-purpose networks.

In the past, one service, delivered on a purpose-built network, worked when there essentially was no competition, allowing take rates as high as 80 percent to 95 percent.

In an era characterized by multiple-purpose networks that can deliver any popular service (voice, video, data, messaging), no service provider can expect to get penetration rates as high as in the past.

To use a couple of obvious examples, telcos never again will have 90 percent voice share, or cable TV providers 85 percent video share. In a two-provider market, each of those contestants might expect to get about half of whatever market remains.

In other words, each might get as much as 40 percent voice share, and as much as 35 percent video share (assuming satellite gets reasonable share).

Those figures also show the extreme danger of stranded assets: if a network is built to pass 100 percent of homes, but only 40 percent to 50 percent are buyers, half the investment produces zero revenue.

The triple play bundle developed because selling three services to a smaller number of customers still produces as much revenue as selling one service to most homes can generate. Service providers also figured out that bundled service customers do not churn as much.

In recent days, many fixed network Internet service providers (including Google Fiber) have argued that video entertainment is essential to make the fixed network investment work.

Even if Google Fiber does not sell voice, it relies on high speed access and video to make the business case work. Telco and cable TV rely on the triple play.

There are anomalies, however. Netflix and many other streaming video services might indicate the market is at an important inflection point.

And that matters because it threatens to undermine the value of the linear video component of the triple play. That is potentially hugely disruptive.

All ISPs relying on a video-plus-Internet access retail package would face revenue issues if streaming gains traction faster.

Fewer and fewer consumers actually rely on fixed network voice, many continuing to buy largely because doing so allows purchase of other desired services (video and Internet access) at better prices.

And consider what could happen once fifth generation mobile networks go commercial, offering every end user at least a gigabit of Internet bandwidth, and as much as 10 Gbps.

At that point, voice would face huge competition from mobile, video would face over the top streaming and high speed access also would face substitution from mobile high speed data.

That would undermine the economics of the triple play.

The huge issue is what fixed network service providers would do to cope.

In the wake of the Comcast decision not to bid for Time Warner Cable, some suggest Comcast itself must prepare its own over the top streaming service, as it cannot grow through acquiring more fixed network customers and assets.

That also would be hedge against an eventual diminution of the linear video revenue stream. Verizon and AT&T have very different views about the future for linear video. Verizon thinks OTT will destroy the linear business faster, while AT&T thinks the decline will be more gradual. But both can conceive of a future where the strategic product is high speed access.

Those are big anomalies: all three constituent parts of the triple play bundle, are under threat. So the next decade is going to even more thrilling, from a service provider perspective, than the last decade.

New Era of Abundance Approaches: Consumer Bandwidth 1 Gbps to 10 Gbps

In one sense, Google Fiber was a breakthrough, offering a symmetrical gigabit service for $70 a month. But scale matters in telecom.

So, in a flash, and despite all skepticism, the U.S. high speed Internet access business is about to enter a period of abundance.

Comcast is upgrading virtually its entire customer base–21 million homes–to gigabit speeds by the end of 2015, with 18 million homes able to buy service at 2 Gbps, also by the end of 2015. That is 21 million U.S. homes.

So a relative trickle of neighborhood level investments now will be massively disrupted, in one move, by the biggest supplier of high speed access in the United States.

Other Internet service providers will have to respond, even if they elect to upgrade at lower levels. But that is not all.

Consider what already is envisioned for fifth generation mobile networks:

  • bandwidth of up to 10 Gbps per device or per user

  • latency of one millisecond

  • seamless ability to use any available access network

  • bandwidth 1,000 times greater than 4G

Some might gasp at predictions the coming fifth generation mobile network standard (5G) will feature bandwidths up to 1,000 times greater than today’s mobile networks.

But that three orders of magnitude leap–by perhaps 2020–is coming. And consider the irony: if 2 Gbps is the fixed network standard, for the first time ever, mobile network bandwidth will be five times greater.

That has never happened before. As many forecasts for fixed network bandwidth suggest a very widespread gigabit capability is coming, use of millimeter frequencies and small cell architectures will underpin the 5G 10 Gbps standard.

Even if the first versions of 5G routinely deliver only a gigabit, the implications are quite substantial. For the first time, mobile Internet access headline speeds will equal fixed network speeds.

So one big implication is that bandwidth abundance is coming. Even if no present user requires a gigabit, local access bandwidth will cease to be a constraint for Internet experiences.

That era of abundance also will reveal new bottlenecks, however.

In fact, latency is going to leap to the top of problems affecting end user experience.

That means we will be turning attention back towards the edge of the network, as that is one way to reduce the latency of cloud-based services.

But the key change, in 2015, is that Internet access abundance is going to become a reality shortly, with all sorts of expected, and likely unexpected, implications for everyone in the ecosystem.

Some platforms will be unable to keep up. One thinks of satellite and fixed wireless, for example.

Mobile access will become a full substitute for fixed access for the first time.

The end user estimation of price-value relationships is going to evolve. Price per bit is going to plummet.

Internet service provider profit margins will be under pressure. App providers will not have to worry about bandwidth constraints.

Nokia Networks has shown the ability to transmit mobile signals at 10 Gbps peak rates over the air at 73 GHz using Nokia mmWave gear at the Brooklyn 5G Summit, jointly organized by Nokia Networks and NYU.

NTT Docomo and Nokia Networks earlier had shown the ability to transmit at 2 Gbps rates in the 70 GHZ band, using Nokia Networks mmWave technology, in an indoor setting.

“Utilizing higher frequency bands including millimeter wave is key to deliver extremely high performance in 5G,” said Seizo Onoe, NTT DOCOMO CTO. “We believe that high-frequency spectrum shall be used not just for small cells as a means to complement the existing network, but also for building solid area coverage through coordination with existing lower frequency bands.”

Of all the potential changes, the equivalence of mobile and fixed access, in terms of headline speed, will be most significant, early on.

As mobile became a full equivalent of fixed voice service, with the added benefit of mobility and text messaging, so it is conceivable that the entire value proposition for fixed networks could be devalued.

A business with lots of business challenges could become even more challenged, in that respect. A change in primary value is likely to occur, as a result. Fixed access will evolve to support the applications where it has an advantage, such as bulk data backhaul, support for small cells or heavy linear video consumption.

Abundance often creates many new advantages and problems. So it will be for ISPs, cable companies, telcos, satellite and fixed wireless providers.

What are Implications of 1,000 Times More Bandwidth?

It can be argued that Microsoft, Netflix and Google have built their business success on an understanding of Moore’s Law. For Microsoft, the insight might have been that if Moore’s Law made hardware cheap, what would a software business look like?

For Netflix, the insight might have been that if Moore’s Law applied to bandwidth services, it would be possible to launch a streaming service that was sustainable.

For Google, an understanding of Moore’s Law might have meant it could create the world’s first big ad-supported technology business.

Communications service providers have seen the impact of Moore’s Law as well. The business impact of voice over IP and instant messaging has already been felt.

The revenue impact of changes in the video subscriptions business is about to hit.

Well aware of how Moore’s Law operates, service providers likely are about to see yet another wave of Moore’s Law-induced change of business context.

Consider what already is envisioned for fifth generation mobile networks:

  • bandwidth of up to 10 Gbps per device or per user

  • latency of one millisecond

  • seamless ability to use any available access network

  • bandwidth 1,000 times greater than 4G

In the fixed network business, something similar is happening.

Comcast plans to offer 2 Gbps symmetrical Internet access to perhaps 18 million homes out of 21 million.

Some might gasp at predictions the coming fifth generation mobile network standard (5G) will feature bandwidths up to 1,000 times greater than today’s mobile networks. That three orders of magnitude leap–in perhaps five years–is breathtaking. It implies potential bandwidth of 10 Gbps.

Similar breaktaking leaps are happening in the fixed network as well.

Though it seems almost laughable that fixed network bandwidth could grow at rates close to that of Moore’s Law, that seems undeniably to be happening.

Comcast in May 2015 will introduce Gigabit Pro, a new 2-Gbps symmetrical residential Internet access service in  Atlanta, with an expected introduction in additional Comcast markets nationwide.

Comcast currently expects the service to be available to about 18 million homes by the end of 2015.

That service is not likely to be purchased by many consumers. The Comcast 500-Mbps service now costs about $400 a month, so there is no telling what the price for 2-Gbps might be.

The larger point is that, based simply on historical precedent, widely-available gigabit speeds (which is likely going to be different than the speeds most consumer choose to buy) should be available in the U.S. market by about 2016.

source: CableLabs estimate

The implications potentially are far reaching. At the broadest level, consider what is happening as cable TV operators now make more money from “dumb pipe” Internet access than the legacy video subscription business.

Likewise, by 2013, U.S. telcos had lost more than 60 percent of the voice lines they sold in 2000. In fact, voice revenue has become a small part of overall revenues, which are lead by Internet access, business services and mobile.

In fact, a  U.K. survey found that 33 percent of mobile phone users claim they do not use voice at all.

“Voice” or “making phone calls” were not on a list of the top 10 most-used mobile phone features in a recent poll of 1,000 people in the United Kingdom, conducted by Oxygen8.

With diminishing voice, messaging and soon video “application” revenues, telcos will  make most of their revenue from “dumb pipe” Internet access.

That explains the feverish search for new revenues related to connected cars, Internet of Things or machine-to-machine services.

Mobile payments, carrier VoIP, carrier instant messaging, advertising, data centers, hosting and software as a service have not proven to be sizable or transformative new revenue sources for telcos. At least, not yet.

Even assuming big new application revenues are discovered and commercialized, the dominance of “dumb pipe” high speed access is hard to ignore.

Beyond that, the climb to gigabit speeds will pose operating cost and capital investment challenges. In any scenario, high speed access will continue to be the single biggest revenue source for any telco or cable TV company. It is likely relatively soon to become the single biggest revenue source for most mobile service providers as well.

And if you thought mobile substitution has been a problem, it could get worse.

Even in the U.S. market, mobile Internet access already is  a viable substitute for fixed Internet access.

About seven percent of U.S. residents own a smartphone but do not buy fixed network high speed access service at home, and therefore rely on their smartphones for access. That data point provides some evidence about consumer ability to substitute mobile access for fixed Internet access.

About 15 percent report they have a limited number of ways to get access to the Internet aside from using their phones, according to a study conducted by the Pew Research Center.

The point is that telecom executives will have to redouble thinking about what their businesses must look like as Moore’s Law continues to operate. To a greater extent than many realize, big thinking is necessary.

If one argues Microsoft assumed computing cycles would be nearly free; Netflix concluded bandwidth would be nearly free and Google decided all computing and bandwidth would be nearly costless, so too telecom executives have to grapple with what that implies for their own businesses.

The simple choice–be the low cost bandwidth provider or a supplier of valuable applications–is false. Telcos will have to be providers of low-cost bandwidth AND providers of valuable apps. No other approach will generate sustainable revenues and profit margins.

But an understanding of the business impact of Moore’s Law is essential.

U.S. Mobile Market Remains Unstable, No Chance of Stabilization Yet

Is the U.S. mobile market anywhere close to stable? Almost certainly not.

T-Mobile US unveiled a new set of initiatives aimed at attracting business customers, and an expanded program to take consumer share from other U.S. mobile carriers, as part of its Uncarrier 9.0 announcement.

Where T-Mobile US had been offering to pay early termination fees for customers who switched, T-Mobile US also now is offering to pay off any remaining phone payments owed as part of device installment payment plans.

Sprint earlier this month launched new programs to encourage switching as well, moving before T-Mobile US to offer reimbursement of early termination fees and remaining payments for device installment plans.

All of that is only the latest examples of profit margin compression in the telecom business, earlier seen in the long haul capacity and long distance voice segments of the business.

With some observers wondering how long the U.S. price and promotion war might moderate, or end, the answer seems to be “not yet,” even if no price war lasts forever.

Under other circumstances, a reasonable expectation might be that we face at least another year of unusual efforts at price disruption, to be followed by a period when the leading contestants have adjusted enough to show they can weather the attack, and the attacker or attackers find they have gained share, but now have to switch to improving profits.

The reason is that, at some point, firms find they must concentrate on profits, and have to scale back profit-losing efforts to add customers and gain market share.

So under other circumstances, one might argue the price war will last as long as T-Mobile US and Sprint believe they can continue to add net new customers every quarter, gaining market share, while tolerating margin compression.

Under other circumstances, another likely predictor of stability is a shift in market structure with a clear number one, a number two that has no easy way to displace the top provider, and a number three provider large enough to sustain itself in that position, with the number four supplier far behind the other three.

The reason for that prediction is that, In a classic oligopolistic market, stability occurs when the market structure features a pattern featuring a top supplier with about 40 percent share; a number two supplier with about 30 percent share and a third supplier with about 15 percent.

We are not too far from that pattern, in one respect.

In terms of revenue share, Verizon in early 2015 has about 39 percent share, while AT&T had 33 percent.

One might argue both Verizon and AT&T will lose much incentive to engage in promotional behavior when AT&T no longer believes it can catch Verizon, and the number three contestant no longer really believes it can catch number two, for example.

The number-three supplier, in terms of revenue, is Sprint, at about 15 percent revenue share. It is almost precisely where one would predict the number-three supplier would be.

The issue is that T-Mobile US has about 12 percent share, and is fighting to grow.

Of late, T-Mobile has been rapidly gaining share, with the intention of supplanting Sprint at the number three position.

The problem is that U.S regulators seem unwilling to allow an acquisition of T-Mobile US by Verizon, AT&T or Sprint. That means only a new contestant could do so. And that means the classic oligopoly structure cannot form.

Among the variables are Dish Network’s need to enter the market or sell its spectrum; Comcast’s expected entry and then any future moves by a large Internet player (Google, Apple or another firm). The point is that the U.S mobile market does not presently resemble a stable oligopoly market, not do the medium term competitive prospects suggest the market will assume such a form.

That means, no matter how long the immediate marketing war lasts, the market will remain unstable, unable to assume a stable market share structure.

Strategically, Comcast is expected to enter the market, at some point.

Dish Network also either must enter the market as an operator, or forfeit the rights to spectrum that presently accounts for as much as 80 percent of its total market value.

And then there are the other contenders, including Google, which it is believed soon will be entering the mobile market, and Apple, a perennial potential actor in the market as well.

Regarding Dish Network’s possible moves, none would seem to reduce the leading suppliers from four to three, which would allow a stable structure to emerge.

Even if Dish simply sells its spectrum (and if regulators allow it to sell to Verizon or AT&T, something that is questionable), there is no net change in the number of suppliers.

In fact, Dish Network might yet actually move ahead and become a service provider, adding one more contestant.

Were Dish to become a wholesale capacity supplier, the number of retail suppliers would not be reduced.

And most observers believe Comcast will enter the market within a couple of years, at the very least. And then there are the “wild card” scenarios, where a firm such as Google or Apple decides to enter the business–either by acquiring one of the top four suppliers or by creating a new retail venture.

The point, one might note, is that no stable structure can emerge until the top three market share spots represent 85 percent market share, with a generalized 40-30-15 pattern.

It is hard to see that happening any time soon. For that reason, the U.S. mobile market is likely to remain unstable, with margin compression a continuing reality.

Unexpected Net Neutrality Consequences

Unintended consequences are a constant reality for any specific piece of legislation, or any specific rule making. So it will be with network neutrality.

“Managed services,” or “specialized services” (think carrier voice,  linear video subscriptions or text messaging) now might emerge as a key development for service providers, should network neutrality rules become more popular, or survive legal challenge. The reason is that such services are exempted from the rules.

Oddly enough, the argument that network neutrality is needed so the “Internet doesn’t become cable TV” will have the perhaps-unintended consequence of increasing the value of such managed services for Internet service providers.

In other words, it is likely a rational Internet service provider, with the requisite scale, can make higher profit margins on a managed service than from commodity high speed access.

It therefore makes sense that rational actors will shift effort towards managed services.

Consider that, from 2010 to 2013, U.S. mobile data pricing (per unit sold) declined by only single digits year over year. In the first nine months of 2014, data pricing dropped by 77 percent, according to industry analyst Chetan Sharma.

Whatever profit margins might once have been, one can argue those margins are dropping, even if suppliers are selling more units.

Average (mean) mobile data consumption increasedto about 2 Gb a month in 2014. That single-year increase is unusual. Sharma notes it took 20 years for consumption to reach 1 Gb per month usage levels.

In addition to plunging prices (less revenue per unit sold) and higher usage (more network cost), marketing costs have grown as competition has become more intense.

Overall U.S. operating expense rose 20 percent, year over year. Income was flat while earnings grew three percent.

That is likely to convince larger ISPs to create new products where bandwidth is simply an enabler of a service, and not the actual product sold to an end user. Linear video services and carrier voice services or text messaging require bandwidth and network services, but the product purchased by the customer is not “bandwidth.”

Ironically, March 1 to 7, 2015 is “National Consumer Protection Week” in the United States, a time when the Federal Trade Commission and 89 partners including nonprofit groups, businesses, and federal, state and local government agencies across the country will spotlight their efforts to protect consumers.

The irony comes because new Federal Communication Commission rules on network neutrality, regulating Internet access as a common carrier service will have the effect of ending the FTC’s ability to apply consumer protection rules to Internet access services.

“We do not have authority over common carriers,” said FTC Commissioner Maureen Ohlhausen. “There are significant issues about our ability to protect consumers under Title II.”

In the past, “to the extent network neutrality is an issue, the FTC has been able to address them,” said Ohlhausen. “We are consumer protection enforcers; we can do that.”

The FTC recently took action against a mobile service provider advertising “unlimited access” that actually throttled users of the plan, after a certain threshold of usage was reached, for example.

Under Title II, the FTC is barred from acting, however.

That is likely only the first “unintended consequence” that will surface once the 332-page document is formally released. The FCC has argued the new rules will not lead to rate regulation.

FCC Commissioner Ajit Pai does not agree. “For the first time, the FCC will regulate the rates that Internet service providers may charge and will set a price of zero for certain commercial agreements.”

Of course, much hinges on whether the new rule survives legal challenge, and whether Congress acts to restore a Title I framework.

Unintended consequences are highly likely.