There are some questions you would never have asked. “Should telcos become banks?” is surely one of them, but as this Light Reading story shows, the question has been asked. Orange, surely a telco, has already taken the step, which prompted the story. A lot of people have written about the topic, with almost all taking the “are they nuts?” position. Well, maybe they’re not.
The purpose of a business is to make money. The purpose of a public company is to make money for its shareholders. If the business happens to be in a field where their future success is critical to the whole of society, as a telco might be, for example, then you could think that interest would trump shareholder value. Wrong. Business executives worldwide have an explicit legal obligation to guard shareholder interest.
So, what, you might wonder, does this have to do with telcos becoming banks? Well, suppose that the cherished and societally beneficial business of our hypothetical public company was at risk because the important mission that launched it was no longer profitable? What can they do but find a way to boost profits, right? Right, and thus we come to banking. Whatever else is true, banks are generally profitable.
There’s also a lot of precedent behind Orange’s move, not so much in the specific area of banking but in the broader area of profit-boosting outside the lines of their original business. For a decade or more, operators (and in particular, EU operators) have been spending money in emerging markets. Not for reasons of philanthropy, but because return on investment in those emerging markets was better than it was in their core markets.
I got my first “profit-per-bit is declining and will cross into negative territory” pitch from a telco executive in the US almost a decade ago, around the time that we started to see telcos investing in markets far from their home turf. The predicted crossover was sometime around 2015, but with aggressive cost management the operators have staved off the inevitable…for now.
The core of the problem is what’s come to be known as the “Internet model”, which is also called the “all-you-can-eat” model. You pay a flat fee and get whatever bandwidth you want. In the early days, that didn’t seem like a bad bet for the telcos. They’d been facing a future where fiber technology was making bits more available, and voice calls didn’t seem likely to consume them. Unless they retained protected monopoly status, which regulators pulled from them about this same time, it was clear that they needed consumers to consume something other than voice. The Internet was a good answer.
The Street helped them along, too. I remember a UBS conference where they told Wall Street insiders that an Internet customer was worth $50,000 in valuation of their stock. Memorable financial melt-downs like MCI and Enron were facilitated by this kind of thinking. So was the idea of giving Internet users unlimited access for a flat fee. After all, access speeds limited how much the users could draw on that deal, and how many HTML pages could a user eat anyway?
Video changed everything, in part because it was itself the major source of new traffic, but also because video services were the perfect product of the over-the-top players, and video ads the perfect way to pay the bill without the user being asked to shell out money. If there’s a transport resource with artificially low cost, you ship on it. I don’t doubt for a moment that the tech industry and even world society has benefitted from the result. Still, the exploitation of the Internet as a vehicle for delivering services that ISPs didn’t get paid for, at least not proportional to the traffic they carried, was problematic for the bit-pushers.
As return on infrastructure declines, the investment that a telco could make in the network earns a declining profit, eventually none at all. We now have a telco industry full of players trying to respond. Buy a media company and climb the value chain on video—Comcast and AT&T. Invest in Latin America’s infrastructure—Telefonica. Become a bank—Orange.
The impact of the loss of return on infrastructure is already impacting vendors, too. How many of the telecom equipment giants are posting record profits? Nearly all are actually in year-over-year revenue declines, sustained only be more and more cost-cutting. The problem is that cost management vanishes to a point, because that’s what happens to companies who stay with that strategy. You cannot cut costs enough to overcome static pricing combined with exploding usage.
And, of course, consumers and in fact most in the industry don’t care. Take 5G. Everyone wants to believe that they’re getting ten times the performance from 5G as from 4G. All these new and wonderful applications will be enabled, and lives will be changed. How much will they pay for this? Surveys say that users really don’t expect to pay anything extra at all. Do you then wonder why I’ve been skeptical about 5G claims all along? We expect companies to invest in losing more money.
We’re seeing consolidation in telecom now, a sure sign of an industry facing profit implosion. That will serve to cover the declining return on infrastructure for a time, but only for a time. We’re seeing some countries, like Australia, take a shot at a semi-nationalized industry, reversing the deregulation trend of 30 years ago. That’s proving very difficult to manage. Is there no hope? Of course, there’s hope, but not in following the same old path down the same old drain.
The biggest positive factor that we can point to in the telco profit squeeze is spread of misery. The OTTs are also getting squeezed, and their problem may be as bad or even worse. The “Internet is free” theme has focused the OTT industry on ad sponsorship, and the global ad spend has been fairly static, which means that every new thing we think ads are going to pay for is picking the pockets of the providers of the old stuff. Already, content producers like the networks are having to add in more commercials and shorten the viewing seasons because of revenue loss. What will we stream if there’s no budget for content production? The telcos can expect to see some tormenting, disintermediating, services eat their owners.
But right on the heels of that comes the second big factor, which is when all else fails, pay for what you want. We don’t want a world without the Internet, without video, without social media. Is a market that’s already happy to drop a grand on a smartphone going to drop Facebook because they won’t shell out ten bucks a month to keep it? We already see a pay model for OTT streaming emerging, though there are still ad-sponsored services available. A shift to a broader pay model for online content seems inevitable, given the fixed ad spend.
That could benefit operators, who have a long-standing pay-for-service approach and little or no experience in ad sponsorship. It could also benefit OTTs who can shift their approach. This is the issue that operators should be exploring. If there is an opportunity for paid services emerging, they need to be ready to capitalize on the shift. If they’re not, then they’ll continue to see profit erosion.
These positives are balanced by a big negative point, though. The big problem that the telcos-as-banks proposition poses is that any shift to realize profits from something other than infrastructure will inevitably impact infrastructure investment. I’ve noted many times that a telco can’t compete for OTT services if their services have to bear the losses created by the underlying delivery network and competitors don’t have that burden. That’s true whether network losses are offset by OTT services or by banking. This is why I believe that the open network model, a model that builds connection services from commodity elements, both hardware and software, will be the driver of the future of what we call “networking”. These may not be enough to return network services and return on infrastructure to levels that meet telco internal rate of return targets, but they should be enough to prevent infrastructure from being a loss of a magnitude that other profitable services can’t offset.
We’ve accepted that this is a free-market problem, accepted it from the ‘80s when telecom spun away from government-owned or regulated-monopoly status. We just need to acknowledge that it’s a problem that has to be solved, or we might find ourselves with more banks than ISPs.