Lessons from Google

Google reported after the bell yesterday, and while the company reported a quarterly profit gain of 17% the numbers were below estimates because of higher costs.  The Google results point out two issues that will not only haunt Google but also haunt the whole OTT or “Internet” sector; the  limitations of advertising as a revenue stream and the sensitivity of the business model to cost increases.

Early OTT business models were compelling because they were essentially a license to print money.  You created a portal, you made it attractive in some way, you placed ads on it for a fee, and you raked in the bucks.  “The Internet” was your conduit to the consumer and it was “free”.  The problem of course is that any easy model will have a zillion imitators, and you quickly have to differentiate yourself.  You also have to address the fact that the potential ad spending you’re competing for isn’t an enormous number.  In 2011, for example, online advertising is expected to generate about $30 billion, with search taking about $20 billion.  Verizon alone takes in over $100 billion in revenue.

Google under Schmidt was pushing itself to be what the Street wanted, which is the mission of any public company.  Google under Page may be trying to be what the Valley wants, the dynamic and exciting company that led the Internet revolution.  It’s too late for that, unless you accept that a “Second Revolution” in the Internet has to be one that adapts the players to a more realistic business model, one that allows a better balance of ROI and excitement.

The growing regulatory concern over online privacy is creating yet another threat for the OTT guys.  The US and EU have similar regulatory goals but the EU is typically more consumer-protective, and is more likely to do something quickly and advertisers there are pushing ahead with a US-like plan.  Anything that limits online tracking limits the relative value of online advertising, and that means that players like Google have less cash to throw at infrastructure of any sort and a greater need for return on what they do spend.  Thus, regulatory trends are working against the online giants’ top-line opportunity and also threatening to push their tolerance for incremental spending to open new markets to even lower levels than now.  Since “now” sent Google down nearly 6%, that’s bad.

Google’s worries and other near-term earnings stuff aren’t spooking the Street much; while futures are down this morning they’re not collapsing.  That’s a good indicator that nobody really wants to bet strongly against the recovery, and also proof that the Street probably doesn’t grasp the details of what the Google trends mean.


RIM Tablet Woes, Juniper and Alcatel-Lucent’s Directions

Economic news is largely lacking today but the markets appear to be headed for another downturn, driven perhaps again by speculative short selling ahead of earnings season.  Monetary and economic data worldwide isn’t suggesting any problem at this point, but it does seem to me that the stock market is trending a bit ahead of the baseline economic story.  Our model, which is still dabbling with stock pricing, suggests that markets are overpriced about 2% at the moment.

In tech, tablets are again in the news as RIM prepares their launch of the Playbook, a tablet that diverges from the iPad mold in that it’s based on 7-inch form factor, and from the Android craze because it’s based on RIM’s QNX operating system.  I’m not really too hopeful about Playbook, frankly.  It’s not form factor or OS that’s the problem as much as the need for RIM to straddle a very high fence with its tablet.  You can’t win in the tablet space, or even play well, without a strong consumer value proposition.  RIM can’t hope to get any near-term traction with Playbook without tapping the Blackberry base.  How do you do both, particularly at a relatively late date at the dance?  Seven-inchers would be cheaper by nature (they’ve generally proven to be) but RIM has waited until the pricing on 10-inch tablets seems to be coming down.  Given that the iPad has set the 7-inch form factor as the consumer standard, that means an uphill sell.

To add to the problems, Playbook is getting almost universally bad reviews, with the problems attributed to haste and hurry.  Well, gosh, RIM, what were you thinking here?  The instant the iPhone hit the market, every handset player had to realize that the whole wireless device market was a new game defined by a new player.  Even before the iPad hit, RIM should have realized that Apple was going to continue to be a game-changer, and the instant it first appeared RIM knew it had to respond.  So hurrying to get something out?  Not unless they waited a year before starting.  The simple truth is that you can’t launch something whose sole goal is to compete with something else.  You have to have an affirmative goal to support a doctrine of affirmative buyer choice or you get fuzzy on both your value proposition and your differentiators, which is what RIM has done.

While we don’t typically cover management changes and executive hires, I do think it’s significant that Juniper has announced a new VP (from Cisco) in a new position. Nawaf Bitar has been brought in as SVP and GM of Emerging Technologies, which Juniper describes as focusing on the intersection of software and systems.  The reason this is interesting to me is that Juniper has demonstrated excellent engineering and, in Junos Space and Junos overall, insight in the creation of a software layer in networking.  They’ve under-exploited their assets, though, and thus risked being preempted by a player with less reality but more sex appeal.  With the service provider market finally demonstrating some service-layer deployments (Verizon’s DMS most recently) it’s clear that Juniper’s rivals won’t be quiet for long.

Juniper’s number one rival isn’t Cisco, it’s Alcatel-Lucent, and that company is now said to be exploring the sell-off of its enterprise communications business.  But Cisco’s not out of the story; they might well be essentially doing the same thing in a different way.  There are strong signs that Cisco wants to push its own unified communications and collaboration stuff through service provider channels rather than directly to the enterprise.  The UC space has been troubled essentially from its moment of birth, one of those “it-will-be-next-year” kind of markets.  The problem is that what’s driving UC is the commoditization of voice by IP, and you don’t get very far asking enterprises to capitalize a declining space.  UC-as-a-service has been the inevitable winner, but of course PBX incumbents never wanted to hear that.  They hear it now.


Three Cloud Dimensions

The cloud is in the news, in no small part because it’s earnings season and companies need to balance the need for publicity and the need to comply with SEC rules on “quiet periods”.  Cloudiness is always a good way to get some positive ink.  At any rate, we’re seeing three specific trends embodied in three announcements, by Red Hat, Lenovo, and Nimbula.

Red Hat, leveraging its acquisition of cloudbuilding-tool provider Makara, is looking to jump on what’s always been a critical truth about cloud computing; PaaS is the most logical offering.  A middleware vision (built around JBoss) supported by good cloud tools would empower developers to migrate applications to a form where they’d be cloud-optimized.  This reflects a second critical (and largely ignored) truth; applications that aren’t developed at least with the cloud in mind may not be optimal in cloud environments.

The Lenovo announcement of support for a cloud-ready client on its laptop systems is reflective of two other trends.  First, tablets and smartphones threaten to eclipse laptops as client devices for reason of simplified application management—thin clients are easier.  By sticking a thin-client capability with full security onto a laptop, Lenovo hopes to exploit the fact that while access to enterprise apps through thin clients is a priority for many enterprises, road warriors still need to have productivity apps running locally.  Laptops with the right tools can offer both capabilities.  Second, Lenovo is envisioning all of this within a mediating platform it calls Secure Cloud Access, which allows users to be linked to cloud or local resources based on profile information.  I think this is an important trend because “cloud computing” to be effective has to recognize the special value of local resources.  Whether users abandon local processing and storage for hosted resources is a choice the market still hasn’t made definitively, and may never make in a uniform way.  Every resource is part of the cloud, or the cloud isn’t a true resource pool.

The third announcement, from software player Nimbula, is their Director offering.  Cloud computing requires a “director” function to create the abstract virtual resource pool and to assign work (applications or components) to resources and then insure they are connect-mapped to the user.  The company characterizes this as a cloud OS but that misses the mark; it’s a cloud management or abstraction element.  The reason we think the announcement is important is first that it marks a breaking out of specific cloud components, and thus will likely help people understand what’s really involved in cloud computing and second that it probably represents the starting point in what will surely prove a long series of cloud-specific announcements that target hybrid and private clouds as much as (or more than) public ones.

In economics today, we’re seeing the usual stock rebound after short-selling; some tech companies including HP have made positive pre-announcements and the notion that every player would, like Alcoa, miss on their numbers may be fading.  The market is jittery, there are still plenty who want to capitalize on that by pushing on prices at any hint of bad news.  Whether there is really any long-term reason to worry likely won’t be known for a couple weeks at least, when we’ll have a cross-section of industries reporting and a broader notion of economic movement.


Cisco’s Consumer Reorg: Not the Right Path

Cisco announced today that it would be “restructuring” its consumer business, dropping the Flip video line and focusing its home networking activities to gain better profits.  The steps neither fix Cisco’s problems nor demonstrate with certainty that Cisco doesn’t know how to fix them, but they do seem to show that (dropping Flip notwithstanding) Cisco can’t quite let go of the “bits suck” mindset.

Over the years, we’ve seen many vendors who seem to believe that demand for something necessarily forces someone to meet the demand, regardless of profit levels.  I’ve used the phrase “bits suck” in public talks to illustrate the view that somehow demand for capacity sucks dollars involuntarily out of provider pockets.  Cisco’s play on the theory has been video; promote telepresence to replace voice calling, encourage teens to generate a ton of video to upload and view, and the demand will raise your total addressable market by driving up the capacity the network needs.

What’s killed this approach is usage pricing, and if there’s anyone left who doesn’t believe that’s now inevitable I’d like to sell them a bridge.  Yes, this kills the original Cisco value proposition for Flip, but it also kills broad-based telepresence.  You can’t replace voice with video unless the video bits cost the same (not per bit, but per call) as voice.  That can’t happen at current equipment and operations cost price points, and Cisco as a provider of equipment and operations tools should see that.

There’s a way out for Cisco; the “service layer”.  Maybe they see that, and maybe they’re working to address the opportunity there, and to pull through service-layer success into the network.  Maybe someone else will do that, in which case we’ll finally see who “the next Cisco” really is.


Mergers and Reorgs and Bulls/Bears

An industry consolidating is an industry commoditizing at the product/service level, and that’s obviously happening in telecom.  The AT&T bid for T-Mobile has now been followed by a Level 3 bid for Global Crossing; both are subject to regulatory approval, of course.

The simple reason for all of this is disintermediation, the fact that operators have become disconnected from mounting service revenues from advanced services while still committed to carrying traffic and supporting connectivity.  If you go back to the old days of Custom Local Access Special Services (CLASS) you may recall that even in the ‘90s it was this group of services (which included Call Forwarding, Voicemail, etc.) that generated the highest ROI, and you may also recall that it was this class of services that gave rise to what became known as the Advanced Intelligent Network (AIN) architecture for voice services.

Operators have been groping, for the past four or five years, for an architecture for the “Next-Generation Advanced Intelligent Network” or NGAIN.  We’ve had a chance to review the approaches taken by operators in three major global regions, and there’s a significant amount of commonality in the ideas presented.  What’s also interesting is that all of the players seem to be basing their NGAIN plans on cloud computing principles and software technology frameworks rather than on network equipment.  IBM and Microsoft seem to be more an inspiration to vendors than Alcatel-Lucent or Cisco or Juniper.  I won’t bore you with why I believe that’s the case; it’s not like I’ve not commented on this before.

Verizon’s Digital Media Services group announced its bid for an in-house NGAIN-like approach, focused on digital video.  The company wants to offer everything from transcoding and content delivery network management to rights management and (of course) wireline and mobile multi-screen delivery.  By grabbing all of these elements, Verizon raises the bar for competitors like (you guessed it) Level 3, who must now capitalize their own comparable approaches.  The question that VDMS isn’t answering is whether the elements of their media architecture will be componentized enough and flexible enough to serve related applications that need information coding, rights management, LBS, etc.

In software, Adobe has launched a new (intermediate) version of its Creative Suite software, version 5.5, to attempt to reignite an upgrade cycle that the economic downturn largely killed.  But at the same time they announced an annual and month-to-month license for all the CS5.5 components, creating something very like a SaaS model without the requirement for cloud hosting.  The goal here is clear; expand the market for Adobe products by making them available to those who don’t expect to need the products every day forever.  The risk is first that some of the current buyers might migrate to that occasional-use category and second that somebody will hack the licensing links and thus make a “temporary” license function forever.

I think this is an interesting development because it shows the strengths and limitations of the cloud as a software delivery framework.  Software as a service is clearly more flexible as a model to support casual and occasional use of something, but the fact that performance of that “something” is then tied to central hosting and network connectivity is enough of a potential problem for some apps that players like Adobe are adopting a license-hosted rather than software-hosted delivery framework.  Thus, it’s an endorsement of hosting rights rather than hosting functionality, and that could be profoundly interesting as an industry trend.

In telecom equipment, Cisco has added an MPLS optical blade to the CRS3 to give a nod to the overall operator desire for more agile optics in the core.  In that respect, they now offer much of what Juniper announced with its own optically empowered label switch, the PTX.  The difference in the two approaches is that Cisco’s does really seem to be architected for “supercore” applications, where Juniper’s PTX could in theory have a much broader mission, including in the metro and as a cloud connector.  Since Juniper hasn’t acknowledged that particular mission set, though, the Cisco approach is at least a viable competitor and perhaps a better strategy for those who are committed to the CRS line already.

Google announced a rather sweeping reorg, one that gives its business-unit heads much greater autonomy and that suggests the company really does intend to transform itself from an ad-revenue-dependent OTT player to something broader.  It doesn’t show much about what that broader something might be, though, and at the same time as the reorg, Page said that he was linking everyone’s bonuses for the year to Google’s social success.  Given that most Google people will have nothing to do with that success, the move seems to undo some of the “independence” that the reorg would have accomplished.  It also raises the question (asked by some commentators already) over whether Google is getting so obsessed with Facebook that it can’t see straight.  All OTT plays are transient; there can be no enduring success exploiting fads.  Google needs to develop an exploitation engine, not try to catch up on a social trend that’s already objectively peaked.

In geopolitics, the Middle East enters what we have all along believed the critical phase of its dissent.  It’s easy to spawn revolution and hard to create governments and societies based on them.  Egypt, whose hopeful revolution was a model for so many, now seems faced with an authoritarian military rule simply because it can’t transition out of it.  Libyan rebels clearly cannot win without outside military intervention, and so the AU is trying to broker a peace that would be acceptable only under two conditions. First, if one presumed that the government believed that the West could sustain military action there indefinitely and prevent their routing rebels, and second if one presumed that the government didn’t intend to honor any peace and would simply wrap up the rebels when NATO stopped flying missions.  A sad but not unexpected turn.  Democracy requires more than a lack of authoritarianism to emerge, but the world hasn’t learned that, apparently.

Economically, the earnings season is about to start and we’ll see whether companies have been able to capitalize on some improved economic signs without hiking their costs and killing any bottom-line benefits of the improvement.  Transitioning out of a cost-reduction-based earnings growth period into normal economic growth is tricky for a world where financial results can be viewed only myopically because of regulatory changes to kill off past bubble excesses.  We’ll find out now whether the juggling has worked in the last quarter.


More FCC Activism?

The FCC, continuing on a relatively rare activist track, has ordered wireless operators to establish reasonable data roaming agreements among themselves, something that is seen as increasing wireless competition and thus potentially reducing retail rates.  It’s also ordering utilities to simplify access to utility poles and conduits and to price usage fairly.  The problem is that both these things are considered by some (including Republicans in the FCC) as extending beyond the FCC’s powers.

The key point with this set of arguments isn’t the issues (which we’ll get to) but rather with the fact that they both raise questions on how the FCC can operate and where it needs Congressional action.  The Communications Act of 1934, amended by the Telecom Act in 1996, regulates “common carrier” activity most tightly and offers the FCC considerable power there, but much of broadband, cable, and mobile services are outside that common carrier area.  Given that there’s an increased interdependence among television broadcasting, the Internet, mobile and wireline voice, and broadband services it’s hard to rationalize the separate “Title” regulations of the Act that so differentiate rules and the power of the FCC by service type.  What some of the appeals over FCC rules may end up doing is illustrating (by means of a court opinion) that we need a completely fresh communications act.  A good one would help, but with Congress unable to get past dogma to even pass a budget, getting a good one seems out of the question.

With respect to the specific orders, there is likely to be some benefit to a more open broadband wireless market.  Small players today are unable to leverage spectrum available in rural or even suburban areas because that spectrum doesn’t cover enough geography to be useful to customers and roaming agreements may or may not be available.  That said, we can’t come up with any good examples of cases where roaming was denied; the issue is more one of the price and the FCC’s order doesn’t set prices (it can’t, for non-common-carrier services) but simply demands “reasonable” ones.  That distinction not only threatens to make the order ineffective, it threatens to make it illegal because demanding any sort of pricing standard may exceed the FCC’s powers under the Act.

The “utility” rule is also problematic, but we think more in how it might impact the industry.  Few companies today would be interested in getting into the broadband market on a wide geographical scale; the cost is high and the ROI is low and falling.  Some communities might seek to either establish muni-broadband or to sponsor or encourage in-community services, and where demand and willingness to pay are high enough, local broadband projects might in fact be spawned, encouraged in part by this ruling.  The justification for this order, we think, is more clear and thus it’s less subject to overturning, but it does raise the risk of having broadband inequality grow rather than shrink, putting more demands on universal service funds to level the playing field and making the issue more political.

You can see from this why I think there’s at least a possibility that the T-Mobile buy by AT&T might have a regulatory underpinning.  Companies like T-Mobile are far more capable of funding appeals to the FCC for “unreasonable” roaming pricing.  You can also see that the order adds more fuel to critics of the current FCC—it’s yet another extension of the agency’s powers.  But is it?  As Genachowski pointed out, virtually every FCC order is challenged by somebody based on whether the agency had the power to act.  The FCC historically wins more than 90% of those appeals.  Even the current FCC has kept that average, but we’d have to agree with critics that the one they lost (the Comcast order) has a lot in common with the mobile broadband order and also the neutrality order.  The latter is already being tested on appeal.

In economic news, fear of a US government shutdown over the budget impasse in Congress aren’t weighing much on stocks; perhaps investors think that government is something we need a break from!


More Transition Proof in Telecom

Lots of interesting and potentially pivotal happenings in tech, and perhaps the most interesting thing is that the real meanings of all of these happenings are more important than the surface topics!

AT&T wants to buy T-Mobile, which is no surprise given that DT has been looking for years at selling its US property and that AT&T wants to own the world in the mobile space.  What is a surprise is that Verizon seems resigned to the deal getting regulatory approval, which suggests it’s not actively lobbying against it.  So why would Verizon consent (or at least acquiesce) to its biggest competitor getting even bigger?  That’s one of those below-the-surface points; two, in fact.

One guess at the biggest reason is that T-Mobile and Sprint are the two players most likely to consider pushing the FCC to create reasonable, open, broadband roaming requirements.  All the smaller cellular operators would like that, but only two have deep enough pockets to fund a campaign, and clearly T-Mobile is one of them.  Remember that the appeals of FCC orders on unbundling were funded by the IXCs until the RBOCs bought them?  The same dynamic could be at work here.

As a related point, healthy competition is key to regulators in the US wireless market.  It may be that Verizon reasons neither Sprint nor T-Mobile can make an effective go of competing.  Problems with the financial position of the second-tier players could then spur regulators to act.  Obviously T-Mobile’s stability and endurance wouldn’t be in question if AT&T bought them.  Could Sprint then capitalize on the new dynamic?  Would a cable company, or even Verizon, buy them?  Could the FCC accept a duopoly instead of its cherished notion of three key players?

Or could Verizon just be bluffing?  That’s the second point here.  By asserting they think the deal could go through, Verizon might hope to marshal public policy groups’ opposition to the deal.  Regulators are certainly uneasy about this kind of consolidation.

Which brings both issues to the same point; competition.  There’s a fundamental problem here in that telecom is very expensive and has a relatively low rate of return on investment.  That makes it an industry that isn’t naturally competitive.  To demand that there be three or four major competitors isn’t realistic if that number can’t be sustained by the available revenues or by the trends in return on infrastructure.  The FCC may now have to face reality; multiple parallel wireless networks are always going to be more costly than one single network, or two.

For the equipment vendors, this should be a stark warning.  The investment in wireless or wireline infrastructure depends on making a profit on that investment, not on the “traffic demands” of the network.  Consolidation is a signal that ROIs are falling, that network equipment sales will likely be impacted by the ROI trends, and that differentiation is moving elsewhere.

Which brings us to Cisco.  The company has been a major disappointment to Wall Street for years now, and there’s been ongoing grumbling about a breakup of Cisco or drastic changes in style and management.  That now may be coming to a head as CEO Chambers promises a make-over, admitting that the company’s “execution” has fallen short.  Interesting comment, given that any failure can be said to be an execution problem.  What will happen to Cisco will depend on how it defines “execution”.

Make no mistake about it; Cisco cannot go back to being a switch/router company.  Price per bit trends make it clear that telecom switching, routing, and access equipment is going to be under tremendous price pressure, creating a market that not only Cisco can’t win in, likely nobody really can.  To say that Cisco should divest its consumer division and get back to basics is to say that it should lay down with a rose on its chest and await the inevitable.  Chambers has the germ of the right idea with “adjacencies”.  The problem lies in the way that notion is acted upon.

Two developments in the market reflect the fact that there’s something more than moving bits going on; Alcatel-Lucent has announced an OpenTouch middleware package for UC/UCC and Verivue has announced a new content delivery framework.  UC/UCC isn’t a big market-maker in the telecom space and certainly won’t make Alcatel-Lucent rich, but the fact that Alcatel-Lucent thinks UC middleware is important may mean it realizes (finally) that middleware overall is important.  Yes, I know that its Open API program and developer stuff seems to demonstrate a middleware commitment, but the problem is that the underlying platform for developing service-layer assets is only implied by that activity and not revealed.  Maybe now they’ll reveal it.

Verivue’s announcement is more directly aimed at the service layer.  CDNs are increasingly important not because they’re a good business (Wall Street is increasingly down on all the independent CDN players) but because some CDN elements are essential in an ISP content monetization strategy.  What makes Verivue interesting to me is that their CDN platform is based on virtualization, which makes it cloud-compatible.  Service providers and ISPs of all types tell me that their content monetization strategies have to be based on cloud technology, component re-use, and a higher-level understanding of how content distribution fits as a part of a general service-layer architecture.  Verivue can answer those questions, I think.  However, the cloud element of their capability isn’t the keystone of their positioning.  That likely reflects the “Cisco problem”; nobody wants to be strategic when that means embarking on a longer selling cycle.

Consolidation in the vendor space is inevitable, for the same reasons that it’s happening already in the carrier space.  Unless vendors step up to the reality that systemic, strategic, complicated changes are needed to create a new revenue model for operators, their fate is sealed at all levels.

In economic news, Portugal and possibly Poland are the latest to join the group of nations in Europe with sovereign debt problems.  Portugal has requested EU help, and many now think Poland will have to do the same.  The EU has raised its funds rate slightly, and now there may be some concern that the recovery in Europe may be impacted by debt and Euro issues.  Add that to the expected near-term weakness in Japan and you have what might seem a problem in the world economy.  But here in the US we see improved retail sales and jobless claims, and more general optimism.  Certainly the US has the market mass to buck some headwinds elsewhere, but I do think current Street optimism should be tempered just a bit.

Long-term, the economic recovery depends not on spending or funding or exchange rates.  It depends on not having another financial-industry scam-fest.  For all the talk about reform, we’ve made less progress there than needed, and my major worry continues to be the impact of financial excess on world economies.  Let’s hope I’m not right to be worried.