We all believe that carrier networks are changing, and anyone who ever took a business course knows that industries are changed by changes in their profit picture or regulations. The business trends of the network operators is one of many issues that’s pushed under the rug when we talk about new technologies like SDN or NFV. A business case for either has to fit within the operators’ perception of their business. Or, maybe, in the perception of Wall Street. Most operators are public companies responsible to their shareholders. Most shareholders get their data from financial analyst firms and track the movement of big investors like hedge funds. What factors drive the Street’s view of networking?
First, and foremost, nearly all network operators are public corporations and their decisions are made so as to maximize their share price. That’s what companies are supposed to do; if they don’t do that they can be the subject of a shareholder lawsuit. That means that they will pay a lot of attention to “the Street” meaning Wall Street and the financial industry, and in particular the hedge funds.
The Street looks at company financials, and at things that could impact service base—both customers and ARPU (average revenue per user). They don’t look at technology trends, and they don’t grill CEOs on how much SDN or NFV they’ve deployed. In fact these acronyms rarely even show up in either operators’ earnings calls or financial analysis of the operator market.
One largely ignored point here, which I’ll address in detail in the next blog in this series, is that the Street is focused on EBITDA. If you look at the meaning of the term you see that depreciation of capital assets is not included. In fact, the Street is much less concerned about operator capex trends than about opex trends and revenues. On this basis, capital savings accrued through technology shifts to SDN and NFV would be uninteresting to the Street unless they were combined with improvements in opex.
Second, network operator ARPU (average revenue per user) and margins are decreasing, even in mobile services, and growth is happening at the expense of EBITDA (earnings before interest, taxes, depreciation, and amortization) margins because costs aren’t keeping pace. While mobile broadband has grown the subscriber base, that growth has come primarily through lower service costs. As a result, ARPU is falling for mobile and wireline services (a sampling of 8 global operators shows all have seen ARPU decline in the last three years) and total revenues are at risk. Operators are projecting the cross-over in 2017, and the business pressure behind all changes to infrastructure, services, or business practices are aimed at turning this margin compression around.
Keep in mind the definition of “EBITDA”. When you see financial analyst charts of operator profit trends, they always show the EBITDA trend, which you’ll recall excludes capex both in terms of depreciation and new spending. To turn EBITDA around you either have to boost revenue or reduce opex. Nothing else will impact the number.
Next, network operators have an “invisible product”. Users think of their network services in terms of Internet sites or mobile devices. The operator provides something whose visibility to the user comes only if it’s not working properly. It is very difficult to differentiate network services on anything but pricing plans and handset availability for wireless, and wireline services are differentiated more on their TV offerings than on broadband features.
This is a fundamental point for operators’ plans. Since five out of six operator CEOs think they’ve done about as much as they can to extend their customer base, the lack of feature differentiation means they have to look to growing by taking market share through pricing or incentives. Since new services are like “features”, that makes them look at profit management primarily through the lens of cost management.
But the top dozen OTT players have a larger market capitalization (total value of stock) that’s greater than the top hundred network operators. The Street would love to see operators somehow get onto a rising-revenue model, and they’d reward any player who managed the transition.
Mobile broadband is exacerbating, not fixing, all of the operators’ OTT issues. What every financial analyst says about networking today is that the real competition isn’t other providers of network services, but the OTTs. That implies that the prize not those featureless connection services but the experiences that users obtain with them. Mobility has made things worse by decoupling users from the baseline network services operators rely on historically, like voice. It’s now, through mobile video, threatening the live TV viewing franchises that are the best profit sources for wireline services.
Mobile infrastructure is expensive, too. Operators’ wireline franchises were developed in home regions, but credible mobile services have to be national or even (in Europe) continental in scope. You need roaming agreements, out-of-region infrastructure, and all this combines to create a lot of expensive competitive overbuild. Operators are looking for infrastructure-sharing or third-party solutions, and tower-sharing has already developed.
CxOs have more non-technology initiatives to address their issues than ones based on new technologies like SDN or NFV. Could a major oil company make money in some other market area, or a soft-drink company become a giant in making screwdrivers? Probably, but it would stretch the brand and the skill set of everyone involved. The focus of operators for the last decade has been to improve their current operations, not revolutionize it. That might frustrate those who would benefit from radical change, but it’s a logical approach.
The important thing is that it hasn’t worked. If you look at the IBM studies on the industry for that last period, you see recurring comments on making the industry more efficient in each one, and yet no significant gains have been achieved. It’s becoming clear to operators and Wall Street that you need to do something more radical here, and so technology change is at least viable.
But major IT vendors tend to push “knowledge” or big-data initiatives as having more impact than infrastructure change. In IBM’s most recent analysis, they rate the potential impact of knowledge-driven operational change at a thousand times that of changing infrastructure. On one hand, you could argue that “big data” has simply relabeled approaches proposed for a decade without success. On the other, since CxOs are reluctant to leap into the great unknown, even that sophistry would be welcomed.
As long as there are even semi-credible options more practical than re-engineering a trillion dollars’ worth of network installed base, operators are likely to consider them seriously. That puts the onus on vendors who want a network-centric solution; they have to make their approach look both “safe” and “effective” because it’s competing with something that’s a slight re-make of what’s been done all along and is therefore at least well-understood.
The current network vendors aren’t anxious to promote a new model and financial markets don’t like infrastructure players or infrastructure vendors. Operators themselves are unable to drive a massive technology change. In many geographies they could not collaborate among themselves to set specifications or requirements without being accused of anti-trust collusion. In some areas they are still limited in being able to make their own products, and in any case it would hardly be efficient if every operator invented a one-off strategy for the next-generation network. We need some harmonious model, and vendors. But existing vendors aren’t eager to change the game (any more than the operators are), and the financial markets would rather fund social-network startups than infrastructure startups.
There are major tech vendors who are not incumbent network players, and thus have nothing much to lose in the shift toward a software-driven future. There are a few who are pure software, some who are hybrid IT, and even some small players. While perhaps a half-dozen could field an effective NFV solution, none are currently able to overcome the enormous educational barrier.
Financial analysts don’t believe in a network transformation. None of the analyst reports suggest a major change in network technology is the solution to operators’ EBITDA slide. Other surveys of operator CEOs reveal that they believe they have made good progress in economizing at the infrastructure level, and one financial report says that capex has declined by about 11% over the last five years.
McKinsey did a report four years ago listing over a dozen recommendations on steps operators should take. None involved infrastructure modernization, and while the study predates SDN and NFV it shows that technology shifts were not perceived as the path to profit salvation. EY’s study a year later listed a half-dozen changes operators should make, and none involved transformation of infrastructure. EY’s 2014 study presumes the value of changes in technology would arise from improvements in network failure rates and other operations-based costs, not in lowering the network cost base.
If operators don’t feel direct pressure from the financial industry to transform infrastructure, the corollary is that they’ll have to convince the financial industry of the benefits of transformation. They can’t do that if they don’t have a clear picture themselves, and that’s the situation today.
Conclusion: Operators need to address EBITDA contraction to convince Wall Street that their business is trending in the right direction. On the cost side, that means addressing not capex but opex, which is the major component of EBITDA. On the revenue side, it means defining some credible service structure that’s not dependent on selling connectivity.
I have a very good friend in the financial industry, a money manager who understands the Street and who provided me with the Street models and reports I’ve used to prepare this. It’s worth recounting an email exchange I had with him:
Tom: “It looks like the Street would reward a reduction of x dollars in opex more than they’d reward the same in capex because the opex savings would go right to EBITDA and the capex one wouldn’t show up there at all.”
Nick: “Right and if they made a case for a high ROI for capex and could reduce OPEX at the same time it would make the Street all tingly inside.”
What this says is that NFV (and SDN) need to be validated in two steps: First, you have to improve operations efficiency on a large scale—large enough to impact EBITDA. Then you have to focus your validation of the capital equipment or infrastructure changes on a high-ROI service. Would you like to be able to make a business case for NFV that would “make the Street all tingly inside?” In my next blog I’ll discuss how this might be done.