Vertical Mergers Likely to Lead Next Round of Industry Consolidation

Virtually everyone expects a serious round of U.S. industry consolidation, in 2017, in the mobile, content and content distribution markets. Sprint, T-Mobile US and Dish Network are among firms usually mentioned as potential actors (either as buyers or sellers). Comcast, Altice and Charter Communications also often as seen as potential players.

Up to this point, most industry mergers have been of the “horizontal” variety, intended to provide additional scale. But that strategy has nearly run its course. At some point, antitrust concerns prevent further scale of that sort.

There is an equally-important consideration.

Some would argue the more-important mergers are of the vertical variety that move access providers up the value stack into content, applications, transactions or advertising. Scale helps with costs and gross revenue.

But scale does not help a participant escape a lower-value role in the ecosystem.

Other than Comcast, only AT&T has made major moves in that regard. So the next round might well be focused on vertical combinations, the salient possible exception being a horizontal merger between Sprint and T-Mobile US.

Even a move by cable TV operators into mobile facilities ownership is more a vertical diversification move (expanding business operations into different steps of a single ecosystem) than a scale move designed to increase mass in an existing business category.

There are many reasons for that likely outcome. First, there normally are limits to the amount of market share allowable in any horizontal combination that makes any provider a bigger market share presence in a specific industry segment (mobile, fixed access, cable TV). The broad rule of thumb has been that no single provider in the fixed segment is allowed to serve more than about a third of total U.S. homes.

The other angle is that virtually all would-be market leaders coming out of the access or content distribution business know they have to acquire bigger profiles in the higher-value, more-sustainable content production, applications and services portions of the ecosystems.

In that regard, a move by a fixed network provider into the mobile segment is not a scale move (more of the same), but a vertical move into a new part of the ecosystem.

source: Financial Times

In Special Access Markets, Competition Exists, and Has Worked

Competition works. Over the last decade, cable  operators and independent business access specialists have dramatically changed market share in the special access (business data services) business, even if new services sold by cable operators are not, in some ways, identical substitute products.

To be sure, in the monopoly era, incumbent telcos were dominant providers of special access services, holding 92 percent of the market for special access services in 1980, for example. All that has changed.

The total market for special access services, roughly $40 billion annually, according to the Federal Communications Commission, now has non-telco providers holding about 61 percent market share (a bit less after CenturyLink’s acquisition of Level 3 Communications).

Time division multiplex (T1 and DS3) services accounted for roughly $25 billion of the total market in 2013, of which incumbent telcos accounted for about $16 billion.

In other words, telcos held about 39 percent of the total special access market in 2013.

source: FCC

As of the end of 2014, four of the five largest cable operators alone accounted for about $8.8 billion of the total special access market, including more than half of special access services based on Ethernet technology, even without counting Cox’s business revenue.

Some will argue, or note, that Ethernet (the next-generation service) is not the same as legacy T1 or DS3. Customers do not seem to care.

The two largest cable companies have small business special access market share in the 35 percent to 40 percent range, according to the FCC.

Price and performance tell the story. Cable services frequently offer scores of megabits per second service for as little as $70 a month. T1 service at 1.5 Mbps often costs around $200 a month.

Higher-speed services (150 Mbp) cost less than that. DS3s (45 Mbps) might cost

$1,000 to $12,000 a month.

Since about 2014, Comcast Business grew revenues by 39 percent, Charter Business by 30 percent and Mediacom Business by 22 percent.  

Comcast Business grew revenues by 70 percent since 2013 and 182 percent over five years, according to researcher Anna-Maria Kovacs of the Georgetown Center for Business and Public Policy, who authored a study for the Federal Communications Commission.

source: FCC

Cable operator Mediacom grew revenues by 38 percent in the last three years. Since 2014, Cogent grew 18 percent and Level 3’s North American operations grew eight percent.

In contrast, during those two years, the business revenues of AT&T and CenturyLink each shrank by six percent  and those of Verizon shrank by nine percent.

Windstream, which combines incumbent and competitive business operations, shrank revenues by seven percent.

Comcast Cable’s share of the small-business market within its footprint is 40 percent, in the medium-business it is 20 percent  and it is five percent in enterprise, a customer segment Comcast entered in late 2015.

In other words, business data services competition has exploded. In 2013 there were 491 facilities-based companies providing special access  in the enterprise market.

Competitive providers--not including cable providers--earned $23 billion of the $45 billion in BDS revenues in 2013.  

Verizon "Very Confident" in Spectrum Position

Most informed observers outside of Verizon believe it will have to boost its spectrum assets. But Verizon continues to insist it is “very confident” with its present and potential spectrum assets, according to Matt Ellis, Verizon CFO. “We have significant opportunities to continue to grow within the spectrum holdings that we currently have; we’re refarming spectrum as we've talked about for a while; we still have the AWS-3 spectrum; and then unlicensed,” said Ellis.

It is not an unrealistic position. Even if, historically, gaining new spectrum has been the main way mobile operators have added new capacity, using smaller cells is the other typical way additional gains have been achieved. With the fiber deep architectures Verizon is pioneering in Boston, it is creating the backhaul infrastructure to do just that: add small cells to reuse existing capacity.

So, in terms of the physical options, Verizon does not absolutely need more spectrum to add more capacity. On the other hand, there is no advantage to Verizon to claim otherwise, even if it believes it might, or will, add more spectrum in the future.

Verizon maintains bargaining advantage over potential sellers if it continues to insist it does not need to buy additional spectrum assets from would-be sellers, especially to support 4G operations.

Keep in mind that the usable capacity the smaller providers (T-Mobile US and Sprint) can wring out of any amount of raw spectrum is greater than can be deployed (all other things being equal) by AT&T and Verizon, which have many more customers to support.

source: Allnet Insights

AT&T Adds Gigabit Service in Eight More Metro Areas

AT&T plans to add eight more metro areas to its AT&T Fiber service, reaching at least 75 major metros with the fiber-to-home, gigabit per second service.

AT&T now markets gigabit connections to 4.6 million locations across 52 major metros. AT&T expects to add two million locations in 2017, and plans to reach at least 12.5 million locations by mid-2019.

Some critics will point out that the deployment is neighborhood by neighborhood, and not a “ubiquitous” deployment. That is a simple case of selling gigabit connections where there is enough demand to warrant the investment. Even Google Fiber, which did build in the same way, found insufficient demand to continue. AT&T expects its deployments to be sustainable.

Some observers characterize AT&T fixed network investment plans as “running away” from that business. Some of us would disagree. AT&T, it is undoubtedly true, will not drive most of its future revenue growth from its U.S. fixed network. That will tend to come from international expansion, mobile services related to new 5G services and internet of things (connected car and other verticals) and consumer video delivered using wireless networks (satellite and mobile).

The issue is how to target capital investment to drive financial returns, obviously. In that regard, using DirecTV to deliver linear video nationwide has worked far better than ubiquitous fiber to home or fiber-to-the-neighborhood in making AT&T the market leader in linear video, nationwide.

Some would say AT&T is targeting its capex to use a range of platforms--fiber, mobile, fixed wireless, satellite--to produce the best mix of financial returns, without abandoning its traditional access business, in region, but also without stranding capital in assets that do not product revenue.

In U.S. Market, Internet Access is Broadband; Phones are Smartphones

In many markets these days, there is very little functional difference between “internet access” and “broadbamd internet access,” as there is very little distinction between a “mobile phone” and a “smartphone.”

In the case of internet access, though, there is one important observation to be made, namely that buying of fixed internet access seems to have passed its peak, as mobile broadband continues to grow, suggesting there is product substitution going on.

For those of you who live in a developed market, when was the last time you met anybody who uses a dial-up connection to the internet? For most of us, the answer is that we cannot remember the last time we saw anybody using a dial-up connection, or actually know somebody who buys such a connection.

source: Pew Research Center,  source: Pew Research Center data

source: Pew Research Center

source: Pew Research Center

Smartphone Sales (Percent of Total, 4Q 2016)
China	96
India	50
US	96
Indonesia	68
Brazil	92

source: Gartner

"What if Computing and Communications were Free?" Still Are Key Questions to Ask

Though it is not something anybody really thinks about on a daily and routine basis, virtually every business, in every industry now operates in a context where “computing and communications are nearly free.”

Even if it is not yet true everywhere on the planet, for everyone, computing and communications are shaped by Moore’s Law, which means those products and capabilities ultimately will be so affordable people do not have to worry about using the tools.

That is a good thing, in a broad sense, if often challenging for suppliers of computers and other computing devices; as well as suppliers of communications services. Bill Gates and Reed Hastings, though, are among the executives who correctly figured out how to leverage those trends.

For Gates, the insight that free computing would be a reality meant he should build his business on software used by computers.

source: Deloitte University Press

source: plot.ly

Reed Hastings came to the same conclusion as he looked at bandwidth trends in terms both of capacity and prices. At a time when dial-up modems were running at 56 kbps, Hastings extrapolated from Moore's Law to understand where bandwidth would be in the future, not where it was “right now.”

“We took out our spreadsheets and we figured we’d get 14 megabits per second to the home by 2012, which turns out is about what we will get,” says Reed Hastings, Netflix CEO. “If you drag it out to 2021, we will all have a gigabit to the home." So far, internet access speeds have increased at just about those rates.

Not that often are huge businesses built on such bets.

The "original insight" for Microsoft was the question: "What if computing were free?" It was an apparently crazy question at the time.

“We saw that the power of these machines would go up very, very dramatically, and we felt we could write software that would exploit that power," Gates has said.

Hastings essentially asked a similar question: what would our business look like if bandwidth were nearly free?

Some might even argue that an understanding of Moore’s Law, in the 1980s, also “saved the cable TV business” from a disaster that would have been caused by high-definition TV with bandwidth requirements of up to 40 MHz per channel, in a business set up to support 6-MHz channels.

For telecom executives, as for computing hardware suppliers, the key insight is the absolute imperative of value-added services, content, transactions or retailing and advertising as drivers of revenue beyond access.

Nothing is Going to Prevent Internet Access Prices From Falling

It is helpful to remember some historical facts whenever a regulatory policy is changed in a way that critics argue “will lead to higher prices.”

And that lesson is that internet access prices decline over time. That seems to be the case for fixed or mobile internet access, and certainly has been true for transport prices. Sometimes observers focus only on retail prices, not consumption. That is important, as users tend to consume more data over time, buying tiers of service that are faster, and often have higher retail prices.  

In other words, in addition to retail price declines, quality of service keeps improving (looking only at speed) while volumes consumed keep climbing as well. So cost per megabyte or cost per gigabyte matter. Now is it crazy to argue that prices are going to fall further, as much more supply, and more-efficient platforms are introduced.

Such price changes are clear in both consumer and business realms, as well. Consider T1 prices, DS3 prices or Ethernet prices.

For some observers, maybe nothing matters but the absolute level of prices. That is nuts. Businesses used to pay a coupe of thousand dollars to many hundreds dollars for a T1 line. Now Ethernet connections running a couple of orders of magnitude faster than that sell for scores of dollars.

As with our computing devices, quality has to be accounted for. A given amount of money buys substantially more than it used to.

source: Extreme Networks

source: Deloitte University Press