This Year is the Crossroads for Networking

There seem to be a lot of forces driving, suggesting, or inducing major changes in the networking industry.  As indicators, we have mergers at the service provider, equipment vendor, and content provider level, and we have proposed breakups of hardware and software at the equipment level.  Another hardware player broke itself to death, selling pieces to multiple parties.  To this mix, add in the fact that it’s clear that in the US, regulatory policy is going to shift decisively, and you have a recipe for some chaotic times.  Let’s look at what’s happening, and how it might all shake out.  I warn you that this is a long blog that covers a lot of territory, but this is our industry and we have to work through it thoroughly.

The heart of the present situation is the “Internet business model” that evolved from a time when (sadly) Wall Street analysts were framing (accidentally) the structure of the industry of the future.  In the ‘80s, when the Web was driving massive changes in consumer data usage, the Street took it on themselves to value ISPs based on their subscriber count.  One picked $50,000 per customer, for example.  Needless to say, it didn’t take ISPs long to realize that the key to getting a high valuation for your stock was to have a lot of customers.  This led to the “all-you-can-eat” and “bill-and-keep” model of Internet pricing, a sharp change from the traditional settlement model of earlier data services.

That current business model divides the Internet into the “top” and “network” players.  In a pure bill-and-keep world, the former players (including consumers) pay to attach to the Internet via their ISP, but not for what they send or receive.  The ISPs bill, and keep what they get, which from almost the first has meant that priority services are difficult to create, even if regulations permit it.  You can’t expect others to offer your traffic priority when you got paid for the feature and they didn’t.  The wireline world says that you can use unlimited data, and that’s sometimes true in wireless broadband too, but in both cases, you may have your speed throttled at some point if you go over a limit.  That’s the “all-you-can-eat” part.  The marginal cost of bandwidth is near-zero.

In this world, fortune has favored those in the top layer, the OTTs, because they provide the meat of the service.  What separates the Internet from the prior data services is that the Internet is really not a communications service but a content service.  However, it overlays on a communication/connection service, and the underlay (network) part is available to all.  OTT versions of underlay services (VoIP is an example, as is the Internet VPN) have competed with the service providers’ native services, and the ISPs have little ability to recover the cost of the incremental traffic generated either by cannibalizing their current services or carrying new OTT services.  The result has been a steady decline in revenue per bit carried.  That puts pressure on capex, which puts pressure on the network equipment vendors.

If content is the service, then it makes sense for service providers to want to buy content producers.  Comcast and NBC, AT&T and both DirecTV and Time Warner, are examples of buying yourself higher on the value chain.  So, arguably, is Verizon and Yahoo.  On the network equipment side, we’ve seen partnerships like the Cisco/Ericsson relationships and outright mergers like Alcatel-Lucent and Nokia.  That hasn’t solved the problem of capex pressure on buyers, and that means network operators are turning to lower-cost commodity hardware and working hard to avoid vendor lock-ins.

The lock-in piece is especially problematic to bigger vendors, who rely on symbiosis among their product lines to give them control of large deals.  This has been a worry for network operators for a decade, and it’s the driving force behind AT&T’s Domain 2.0 approach to dividing networking into pieces that assign vendors to limited roles.  Companies who try to take a big bite out of network functionality are hit hardest, and smaller players hardest of all.  Brocade had big dreams and big opportunities, but not big enough thoughts and execution.

The commodity hardware issue is an offshoot of a bunch of trends, not the least of which is the Facebook-driven Open Compute Project, but which also includes hosted routing and NFV.  If network equipment vendors are going to lose the hardware part of their revenue stream anyway, it could make sense to unbundle the network operating system software and sell it separately.  Otherwise there’s a rampant open-source market stimulus, and you lose everything.  Some vendors have already taken this approach, at least in part, including Cisco rivals Arista and Juniper.

Cisco is now reportedly looking at a revolutionary step, unbundling its hardware/software elements (Cisco says this is “unsubstantiated” which isn’t exactly the same as false).  I think that this move would represent a logical response to conditions, but I also think that if it’s done it will validate the commoditization of network hardware.  Just because Cisco will reportedly offer a code-named Lindt standalone network software stack to run on white-box gear doesn’t mean that everyone will buy it.  If you admit to commodity hardware, you admit to interchangeable software.  The capital burden of the hardware doesn’t lock buyers to you anymore.  True or not true in Cisco’s case, unbundling software from hardware has started among competitors, and is a sign of an industry facing pressures that can only mount over time.

I’ve outlined the business-model backdrop for all of this because the business model issue is what’s driving things, and that drive will continue.  Because the regulatory changes are very likely to impact the business model of the Internet, the future of networking will depend on how both providers and equipment vendors respond.

The latest round on the regulatory side is the undoing of the extensions in Internet privacy that were put into place by the Obama administration in its last days.  These rules would impose restrictions on how the ISPs themselves can collect and use personal data, and they were opposed by many from the first on the basis that they continued the policy of offering benefits to the “top” of the Internet that were denied to the bottom, or network, providers.  They were not in effect at the point of repeal, so what’s the impact?  It could be a lot.

Service providers are heavily regulated and thus regulation-driven in planning.  Having seen the writing on the wall with respect to personal data, they either stayed out of the ad game or dabbled in it by buying up OTT companies (Verizon and Yahoo come to mind).  If the ISPs have the same right to collect personal data without consent as the OTTs like Google and Facebook, then they could be competitors in the ad-driven or personal-context-driven services spaces.  Even more significantly, the overall regulatory trends both here in the US and internationally seem to be shifting toward a more balanced model (which by the way has been recommended by experts all along).  Such a shift might turn over things like prohibitions on paid prioritization and settlement.  It could change literally everything, and that is the point on which the future turns.

“Could”, because relaxing regulations in general could lead operators to believe they’ve been given a new lease on connection-services life, not a new opportunity to look beyond them.  Whether we’ll continue to see commoditization and consolidation or a new age in networking will depend on whether operators can see a clear path to those new opportunities.  If they don’t see one, they’ll fall back—and fall literally as an industry—on the familiar.

Both network equipment vendors and service providers are victims of decades of inertial, supply-side-driven, behavior.  They fear competition more than they seek opportunity, and that is true on both the seller and buyer sides.  Now we have what might be the killer opportunity, a chance for the turtle to grow muscular hind legs to overcome the inherent race disadvantage.  Will the operators seize that opportunity?  Will vendors encourage them?  We don’t know yet, and whether they do or not determines whether network equipment stays separate from experience-based services.  That determines whether it’s valuable, and whether vendors who provide it can prosper.

The key to vendor success in the future isn’t to divorce hardware and software to take advantage of and promote commoditization at the same time (at best a zero-sum game, and probably worse than that), but to focus on what operators are going to need to have to address their own problems (which vendors and operators know today) and opportunities (which both parties need to think about, in terms of where they are and how they might be exploited).

What are the impacts of being cleared to collect personal data?  First, the collecting has to happen, and if you’re not a party to the relationship directly (you don’t own Facebook or provide an alternative) then you have to be able to detect what’s happening from the outside.  What are the implications of using the interior data of a web relationship with a third party?  Second, you have to be able to monetize what you learn, which means that you either have to support ad-sponsored stuff or you have to offer paid services whose personalization is based somehow on collection of information.

The collecting part of this is really problematic because the interior data is already largely encrypted via https.  Further, it’s not clear that just having Congress void the FCC ruling on collecting private data would give ISPs the right to actually tap the conversation.  They would very likely have to limit themselves to learning things from the visible aspects of the relationships—the IP addresses that they necessarily see, and the DNS requests that they also see and in most cases actually field (your default DNS is usually set by your access provider, though you can override that).  What can be gleaned from the minimal data actually available.  Alone, not much—far less than the OTTs who provide the services being used would have available.  In combination, perhaps a lot.  If you know everything the user has going on, even at a superficial level, you have context.

Ad personalization is all about context.  Personalized services are all about context.  There is surely an event-creating process associated with getting data that new regulations would allow you to get, but the bigger problem is making it valuable.  The irony is that if operators had looked at the IoT opportunity sensibly, they’d have seen that the correlation of contextual information is the real gold mine in IoT too.  They might then have seen that common technology features could support IoT and their new ad opportunity.

New ad opportunities are nice, particularly if you see your current competition being created and funded by that source, but advertising is still at a zero year-over-year growth rate, and online advertising isn’t doing much better.  It’s also true that there is little opportunity for ISPs to snoop into web streams; all it takes is an HTTPS session to stomp that out.  There is an opportunity for operators to digest information they get from Internet addresses and, most of all, from DNS hits.  There’s an opportunity to correlate voice/SMS session data with other things like movement of the user, and to contextualize voice/SMS contacts with subsequent searching and other web activity.  Operators can share in that, but they can’t own the space because the actual providers of the services have the edge, those OTTs who have created social media and web video.

This is where the vendors need to start thinking.  Contextual data from a lot of sources, generated as events and combined using complex event processing, is the only way that the regulatory shift can really benefit the network operators, unless they want to actually compete with OTTs.  If that’s what they want, then they’ve always had the option.  Look at Verizon and Yahoo (again).

The contextual opportunity—both from the service context side and the IoT side—are also probably the last hope of operators and network vendors to pull the industry out of commoditization.  Even if you could improve operational efficiency with service automation, you don’t have anything more than a quick fix to the profit-per-bit problem.  Only new revenue can save you in the long term.  My modeling has consistently said that there is over nine hundred billion dollars per year in new opportunity that could be exploited by network operators.  None of it comes from enhanced versions of connectivity and transport services—it’s all from carrier cloud.  That’s already transforming vendor business, driving more data center switching while routing is under pressure.  If vendors think realistically about what carrier cloud will mean, they can be a player and even a driver in addressing that new revenue.  If not, then either another vendor will step up and win, or operators will go entirely to open-source software and commodity hardware.

Huawei’s sales were up this quarter, and profits were stagnant.  Even the network equipment price leader can’t make a business success out of the current market, and it’s only going to get harder to do that if “the current market” is what you think will save you.  On the other hand, the future is truly bright.