Will the AT&T/TW Deal Offer Operators Another Pathway to Profit?

The deal between AT&T and Time Warner hasn’t yet to be approved but it seems pretty likely to happen.  In any event, just the attempt is big news for the industry.  Many see this as a new age for media companies, but there are many questions of whether a conglomerate like this is the answer to telco woes or just a slowing of the downward spiral.

The theory behind the “this is the age of conglomerates” position is that 1) owning content and distribution makes you powerful and 2) Comcast has already done this with NBCUniversal.  The second proves the first, I guess.  Let’s leave that aside for a moment and examine the question of whether the parts of the deal are solid, and whether the whole is greater than their sum.  We’ll then move on to “what it means for networking.”

Content is indeed king these days, and TV or movie content in particular, but it’s a king facing a revolution.  The big factor is mobility and the behavioral changes that mobility has generated.  People are now expecting to be connected with their friends in a social grid almost anytime and anywhere.  We all see this behavior daily; people can’t seem to put their phones down.  Yes, this does create some interest in viewing content on that same mobile device, but that’s not the big factor driving change.

The first real driver is that if your day is a bunch of social-media episodes punctuated by occasional glimpses of something else, then you’re probably less interested in 30- or 60-minute TV shows and they frown on using phones in movies.  It’s also harder to socialize a long TV program because everyone probably can’t get it and because you really only want to share a specific moment of the show anyway.  Mobile users live different lives, and thus need different content paradigms, perhaps even different content.  YouTube or SnapChat or Facebook video is a lot closer to their right answer than broadcast TV or going to a movie.

The second driver is a negative-feedback response to the first.  The most coveted consumers are the young adults, and as more of them move to being focused online the advertising dollars follow them.  Television offers only limited ad targeting, and as a result of the mobile wave TV has been losing ad dollars.  To increase profits, the networks have to sell more ads and reduce production costs, which is why a very large segment of the viewing population (and nearly all that coveted young-adult segment) think that there are too many commercials on TV and that the quality of the shows is declining.

What this means is that buying a network or a studio isn’t buying something rising like a rocket, but something gliding slowly downward.

That may not be totally bad if your own core business is gliding downward faster.  The online age has, perhaps by accident, killed the basic paradigm of the network provider—more bits cost more money and so earn more revenue.  With the Internet in wireline form, there’s no incremental payment for incremental traffic generated, and the revenue generated by a connection isn’t proportional to speed of connection.  Operators have been putting massive pressure on vendors to reduce their cost of operations since they don’t have a huge revenue upside.

Developments like SDN and NFV were hoped-for paths to address cost management beyond just beating vendors up on price, but operators don’t seem to be able to move the ball without positive vendor support, and even the vendors who’d stand to gain from a shift from traditional network models to SDN or NFV don’t seem to be able to get their act together.  The vendors who disappoint operator buyers the most are the computer vendors, who should be all over transformation and who seem mired in the same quicksand as the other vendors.

Why are vendors resisting?  Because they want to increase their profits too, or want an easy path to success and not one that puts them at risk.  That attitude is what’s behind the AT&T/TW deal, and it was also the driver for Comcast’s acquisition of NBCU.  New revenue is a good thing, and buying it is safer than trying to build it, even if what you’re buying also has a questionable future.

Both Comcast and now AT&T have two decisions to make, more complicated ones than they had before their media buy.  The first question is whether they try to make up their network-profit problems with media profits, and the second is whether they try to fix their acquired media risk or their current network risk.

If the future profit source is media, then the goal on the network side is just to prevent losses.  You minimize risk, but also minimize incremental risk and first cost.  You answer the second question decisively as “I bet on media!”  The network is a necessary evil, the delivery system and not the product.

If the future profit source is the network and media is intended to provide transitional coverage on the profit side, then you have a big question on the priority front.  Do you push hard for network profit improvement now, when you still have air cover from your recent media deals, or do you work on media to extend the period when media can profit you as you need it to?

This all comes to roost in the issue of AT&T’s ECOMP.  It’s one of the two dominant carrier architectures for next-gen networking, and since AT&T has promised to open-source ECOMP and Orange is trialing it in Poland, it’s clearly gaining influence.  When AT&T’s future depended completely on network profitability, ECOMP was probably the darling of senior management.  The question now is whether it will remain so, not only for AT&T but for other operators.

Could the TW deal be viewed as an indication that AT&T isn’t confident that ECOMP will fix the contracting profit margins created by declining revenue per bit?  It could be, though I don’t think that’s the dominant vision.  TW represents a plumb that AT&T would hardly want to go to a rival, right?  (Think Verizon, rival-wise).  But if network profits could rise quickly, would AT&T care about that as much as they’d care whether other operators were leveraging the same architecture as they are?  If they cared about that, would they open-source their solution?

I don’t think AT&T will intentionally shift its focus to advancing media and forget ECOMP.  I’d estimate that TW would represent only about 15% of the revenue of the combined company and just a bit more of the profit, so TW can’t fill the revenue-per-bit hole for very long.  However, the TW deal could spark a run of M&A by telcos, and everyone I know on the Street tells me that you don’t do a big acquisition then let it run by itself.  Management focus follows M&A, particularly big M&A.

Could this deal slow SDN and in particular NFV?  Yes, absolutely, though candidly NFV has been more than capable of stalling its own progress without outside help.  It could also help focus proponents of a new architecture model for networks, focus them on a realistic business case and a realistic pathway to achieving it.  It could even accelerate interest in a higher-level service model as the driver of that architecture, because content and content delivery is a higher layer.

A final note; there aren’t enough big media companies out there to allow every telco or cableco to buy one.  Those who can’t will have an even bigger problem than before, because other network providers with media-boosted bottom lines will be available for investors.  When any M&A frenzy subsides, those who lost at musical chairs may be even more dedicated to improving infrastructure efficiency.