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War of the Worlds - Part IV: Broadband's New Playbook
Telecom Divergence – Telcos will break away from the past, and each other
Three out of four categories of telecom revenue opportunity are underexploited. By that we mean that while telcos dominate retail connectivity, they are not fully addressing the potential of value-added retail and wholesale (both pure connectivity and value-added) categories (Exhibits 12,13).
Three out of four categories of telecom revenue opportunity are underexploited
Even optimistic scenarios suggest that retail connectivity, from legacy wireline through 3G wireless, will be a rough market for telecom. Alternative carriers will squeeze margins via leaner business models. Non-telecom competitors will co-opt new features telcos would like to provide. Price erosion will result from consumer substitution of increasingly-equivalent forms of broadband (wired, wireline) connectivity. Or telcos may sustain sudden shocks from VoIP-driven implosions of legacy margins. Or all of the above.
Telecom has the potential to play to its strengths, maintain a balance of market power vis-à-vis non-telecom industry competitors, and establish itself as an essential “marketplace” hub between connectivity and applications. And the likely side effect of capitalizing on wholesale opportunities is to strengthen the competitiveness of telecom’s own retail offerings.
In telecom, the term “wholesale” is burdened with the pejorative baggage that comes from reselling connectivity to direct competitors, i.e. other telcos. But the new wholesale opportunity is simply “not retail” – i.e. the market is not telcos’ direct competitors, and the offers of interest go well beyond reselling raw connectivity in two important ways:
- embedding communications as a critical feature, part of the “bill of materials”, of products and services retailed by others
- substantial value-added from performance tuning, back-office, provisioning, rights management, and service interoperation functions – in other words, not commodity level connectivity6.
Telecom’s wholesale opportunity is on a continuum from “infrastructure plus” to application- and content-enabling services (Exhibit 12), spanning examples such as:
- On-Net Service Level Agreements: end-to-end broadband service and performance guarantees beyond today’s ‘best efforts’ connectivity. This added value would be created through a combination of private peering, traffic shaping, and possibly even “tuned” CPE (customer-premise equipment), paid for by a combination of premium connectivity subscribers and the content provider.
- Digital Rights Management support: end-to-end content copy protection for application and content providers, in collaboration with device-based functionality. This functionality might also be packaged as network-based subscriber conveniences for simplifying the management of legally-acquired content.
- Advertising and Metering Support: network-based functions for targeting and customizing advertising delivery (any broadband content, including television), and measuring responses
Note that, individually, none of these functions are new but all are about the alchemy of turning network capacity into value-added capability.
Cable and independent value-added service providers (for example, Akamai – Nasdaq: AKAM) have toeholds to capitalize on content-related value-added services. Cable is positioned to do so through its DOCSIS7 architecture (e.g. reserved bandwidth for selected application classes) and television ad insertion/measurement infrastructure.
Akamai and other “CDN” (content distribution network) providers add wholesale value through a continuously expanding portfolio of technical improvements to network functionality. In essence, grafting on a suite of these value-added functions potentially transforms a telco into a next-generation ISP (internet service provider).
These wholesale opportunities exist in large measure because of the “value can reside almost anywhere” trend in architecting applications – demand for reliable, value-added network performance will increase in order to cope with the disparate sources, locations, and classes of traffic and rising commercial performance expectations. VoIP peering fabrics are one example today.
What was once satisfactory – best efforts service for streaming media, for example – may often require instead higher-value, content- and application-aware managed services, down to and including the subscriber end points.
New application architectures’ accelerating effects create both an opportunity and another challenge for telecom – if operating systems and middleware end up adding all the additional value to network infrastructure (for content delivery, application management and inter-working), then telecom’s wholesale connectivity business will be commoditized in parallel with its core retail position. The window of opportunity is not indefinite.
Telecom has the opportunity to demonstrate the strategic and architectural attractiveness of network-based wholesale services to application and content providers often wary of software platform (read, especially, “Microsoft”) agendas.
Media companies worry about this for several reasons. They don’t want to be locked in or be limited to a particular set of interfaces and endpoint devices, particularly ones from an erstwhile competitor, nor do they wish to inadvertently become “road kill” in technology industry standards battles. And they want maximum degrees of freedom over the management of intellectual property rights, in part because their agenda here is still uncertain.
Whatever the value-added innovations (performance, DRM, advertising, etc.), telcos’ content-friendly wholesale services would operate at two transparently-defined tiers: market neutral, and preferential.
“Market neutral” means that no advantage is conferred either to an individual application or content provider, nor to the telcos’ own retail subscribers. So network performance service levels, for example, would be enforced equally regardless of whether the wholesale customer is Yahoo! or a small independent music label. On the subscriber side, the telco would aim to, say, establish peering points with cable broadband systems to enable roughly equal delivered performance for all retail broadband subscribers, whether they are “owned” by the telco or not.
“Preferential” means the telco and the wholesale customer contract for features and performance outside or beyond the mechanisms provided to all services marketplace participants.
The purpose is, in essence, to establish a trading relationship whereby the telcos’ own retail broadband subscribers get something a cable competitor’s will not (preferential content access or pricing, for example). The content provider in turn pays a premium or permits preferential content access in exchange for more favorable or prominent presentation of its offers to the telcos large subscriber base. For example, today’s SBC/Yahoo! DSL relationship, while meager beyond co-branded resale, contains the seeds of this type of arrangement.
Why would any telco do both – why not just lock in preferential arrangements? Because preferential relationships are likely to be an earned outcome of successfully providing market neutral services to wholesale customers who end up having disproportionate market power – neither side will give away the store in advance. And because the vast majority of the wholesale opportunity is made up of many small, market-neutral slices, not a few blockbuster deals early in the formative stages of wholesale services’ business model8.
6 note eBay’s (Nasdaq: EBAY) recently-announced acquisition of VoIP and IM service provider Skype, and Microsoft’s (Nasdaq: MSFT) acquisition of start-up Teleo, a VoIP and PSTN termination company
7 Data Over Cable Service Interface Specification
8 The “large slice” trap is analogous to the explosion of content deals for ISPs in the early ‘90s – CompuServe and AOL, for example, fighting over, and vastly overpaying for, exclusive access to Time, Inc. online content at the same time as the online content model itself was still highly unstable.
Winning in Wholesale
In a scenario in which telecom emerges as a broadband winner with wholesale services, telcos would:
- treat wholesale customers like… customers: meaning understand demand requirements of broadband’s other key players (media, devices, retailing) and institutionalize both a selling process and value-added network features to serve them
- use tradeables for preferential content access: trade telco-engineered preferential network performance and promotional exclusivity in reaching captive broadband subscribers for differentiated (earlier in the release window, etc.) access to content and applications
- show up for standards meetings: telcos are usually found way in the back row or are absent all together from a wide array of market-influencing forums, both technical – where internet equipment and software vendors do the heavy lifting, and strategic – where media, cable, and advertising are most visible. In part, this is because telecom has had no point of view to offer, other than through the narrow regulatory prism. This is no longer compatible with a wholesale services agenda.
- diversify network types: tailor the convergence agenda to market segments and their use cases – the future of connectivity is to offer the medium (fixed, nomadic, mobile) and performance (speed, symmetry, reliability) appropriate to what a given segment will pay for, not a one-size fits all converged network
For the first time in telecoms’ history, the diversity of ever-cheaper network technologies threatens to bid away much of the classic scale advantage of having one ubiquitous, uniform network.
In the US, for example, satellite radio alone has the potential to destroy 3G wireless’ already-shaky economic viability by efficiently stripping away high-value application demand (broadcast music, video), leaving wireless carriers with… connectivity and the hope that there are other valuable forms of content
- slash customer acquisition costs: both as a proportion of the rebalanced wholesale/retail business mix, but also by substituting leaner retail models and their more valuable brands for inefficient telco retail – e.g. home networks sold at Wal-Mart kiosks; Coca-Cola, or whatever, replacing “BellSouth” for youth segment branding, etc.
Market Forces
For the first time in telecoms’ history, ever-cheaper network technologies threaten to bid away much of the scale advantage of having one uniform network
The “services marketplace” (see, again, Exhibit 12) is the top tier of the wholesale market opportunity and involves completely reinventing the wholesale services business model – delivering a continuously expanding portfolio of value-added infrastructure not just to individual wholesale customers, but institutionalizing these capabilities in a marketplace.
Here, service innovators meet subscribers, supported by wholesale infrastructure they could not source or create elsewhere. Market participants enjoy lower marketing costs and “frictional losses” because buyers (application and content providers) and sellers (value-added infrastructure, direct subscriber reach) are natural complements for delivering higher-performance end-to-end solutions for broadband subscribers.
Despite content providers’ market power, their subscriber reach and technical capabilities are simultaneously enhanced by having access to ready-made network infrastructure “friendly” to their technical requirements and intellectual property policies.
The goal of the marketplace then is to position a telco as the value-added intermediary by way of its superior network infrastructure, connecting subscribers with application and service innovations in a ‘new’ (to telecom) economic model (Exhibit 14). Ironically, it is the emerging generation of “service creation environments” from software vendors such as Microsoft (Nasdaq: MSFT) which provide much of the toolkit enabling the construction of industrial-grade value-added wholesale services (Exhibit 15).
There is, in short, an IBM-style “on demand” wholesale services opportunity which, if unaddressed by telecom, will rapidly move from opportunity to yet another threat. Without large-scale telco initiatives, the market will naturally fragment and be captured by a combination of the aspiring content providers doing more by themselves, vendors of the underlying IT infrastructure (e.g. Microsoft), and specialist service providers.
Telecom Divergence
Telcos can neither look to the past, nor all look generally alike and expect to win the competition for broadband value.
Once expected to be a matter for telecom alone, broadband functionality is becoming an integral part of how media, software, and consumer electronics, and their retail distribution businesses make money. These industries are already staking their claims over broadband-related profits. Their business models will be increasingly interdependent with telecoms’, whether competitively or coöperatively. Either way, multi-industry competition guarantees an exponential increase in the uncertainties to which telco strategists must adapt.
We’ve outlined three dangers for telecom: sticking too long with an obsolete playbook, redoubling efforts only in retail connectivity especially with high-cost “me too” offers, and becoming mired in complex architectural distractions while competing industries pragmatically slice away at the broadband value chain.
But we’ve also highlighted a range of opportunities in which, with proactive telecom leadership, potential competitors can be turned into allies and customers.
Being on the precipice of a major industry disruption demands much more in the way of telecom strategy than straight-line extrapolation of today’s business models adjusted for new technologies and services. Meeting these demands requires retooling telcos’ strategy and business development functions to:
- Understand adjacent industry environments, their potential directions and implications for connectivity providers
- Build hypothetical multi-industry scenarios which identify how value might be redistributed with what qualitative and ranged quantitative effects on telecom’s business economics
- Replace a historical mainstay of planning, gap-closing revenue forecasts extrapolated from existing service offers, with a focus instead on targeted revenue contributions from next-generation offers – the former has the effect of reinforcing the focus on, and trapping resources in, businesses undergoing secular decline.
- Shift the emphasis of infrastructure investment way from technology-driven, gradual architectural reform that is distant from actual service demand, and instead emulate the cable industry model (translated to wholesale services) of services-led infrastructure investment, albeit under an overarching architectural framework.
Finally, telecom’s path forward would be well served by some clearing of the air – realistically acknowledging “the elephants in the room.” Not just the imminence of industry disruption, not just the fact that M&A is unlikely to offer a solution (media or software combinations are likely out of reach), not just the fact that telecom cannot continue to rely on proxies for business model innovations, but that there is strategic opportunity in the patient, organic accumulation of multiple “small slices” of next-generation revenues, not just through boardroom-level Big Moves.
Freeing itself from its past remains telecom’s greatest challenge.■
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12 October 05
