Most everyone in the networking industry has heard about the efforts by some European operators to get the EU to approve a plan that would require big tech to contribute to the cost of Internet infrastructure. I blogged about this earlier this week, in fact. Fewer know about another EU question, which is consolidation in the telecom industry. Light Reading did a piece on this, and if you think about it, the consolidation and subsidization topics are related.
The telecom industry has evolved more, perhaps, than any other piece of tech, and it’s likely due for some more evolution. Every step along the way has changed it, but one simple truth is that none of them, or even all in combination, have changed it enough.
A century and more ago, the big concerns were that the new world of telephony would be stalled either by the high “first cost” of getting service into place, or by a host of incompatible operators who would make universal calling an impossible dream. The result was either the establishing of a regulated monopoly or the creation of an arm of the government (the “postal, telegraph, and telephone” or PTT) to handle the new service.
In the 1980s, we had a wave of deregulation and privatization that sort-of-broke this model. I say “sort-of” because now the fear was that the giant telephony players would, if released into the free market, use their incumbency to exploit customers. They ended up having to wholesale elements of the infrastructure they developed under regulatory protection (which had no meaningful effect) and being restricted with regard to what services they could offer “above” the service of connectivity, which has had a very bad effect.
Roughly a decade ago, we started seeing issues in operator profit per bit. The revenue generated from connection services was falling and so was the cost of creating those services, but the latter was falling more slowly than the former. Early warnings of a loss of interest in investing in infrastructure proved premature because operators cut costs, but the primary area cut was the high-touch opex elements—a human operator, phone books, an information number to call, and prompt field service support. All these things kept the financial wolves at bay, but they combined with regulatory barriers to discourage operators from thinking the obvious; that you could improve profit per bit by raising revenues too.
Profit per bit needs improving, because public corporations, which is what most operators turned into, are responsible to their shareholders. They sustain their share price either with a promise of future growth or a promise of an attractive and stable dividend. Most telcos have long since passed the point where their basic connection services have much growth potential, and the benefits of cost-cutting are largely plucked too, which means that cash flow and dividend payouts are at risk. In the US, we’ve seen both AT&T and Verizon take major stock hits this year, and EU operators are asking for subsidization and consolidation relief.
What we’re seeing now in Europe, where demand density and competition levels are high, is a growing realization that something has to be done. One possible solution is to get the Internet, which is largely responsible for the profit-per-bit problem because of bill-and-keep policies, to adopt some settlement mechanism to help operators sustain infrastructure. Another is to consolidate, meaning let operators combine to increase efficiency. Both are hot potato issues. I’ve talked about the settlement issue earlier this week, so let’s look at consolidation.
Why could a smaller number of operators be helpful? The positive of consolidation is cost management. Multiple operators serving the same geography have to deploy multiple infrastructures, and staff multiple organizations. Consolidation reduces the burdens of parallelism in both cases. However, consolidation also limits competition for the obvious reason that a big competitor could buy up others and end up as a virtual monopoly. Competition is seen as essential in ensuring consumers aren’t victimized on service pricing.
Competition doesn’t always work, though. Multiple players and regulatory policies don’t create competition, opportunity does. If profit per bit is under pressure the opportunities are limited. Small competitors, the very players who are logically acquisition targets, are the ones most at risk if the markets get marginal. Add in higher global interest rates and you can almost bet that small operators will have a hard time. So do we let them go out of business, which means they’re not competitors any longer, or do we let somebody buy them, which also removes them as competitors? Seems like competition, in a tough economy, isn’t really one of the options. It also seems to me that having somebody bought is better than having them fail.
It’s very possible that the EU’s position on consolidation is a factor in encouraging them to support some form of subsidization. The only sure mechanism for keeping smaller competitors in business and independent is to ensure that they are at least profitable, and the signs industry-wide say that’s going to be challenging without some new source of revenue. However, as I pointed out in my blog earlier this week, subsidization needs some mechanism for settlement, and coming up with the right approach, or even a workable approach, could be a significant challenge. If the EU tries and fails, you can be sure that the players it’s trying to save from acquisition/consolidation will be among the first casualties.
Couldn’t anti-trust actions and sensible regulations applied to proposed M&A could address the issue of competition? Generally, studies and modeling have suggested that an optimum market really needs only three or four competitors, and my own modeling suggests that even one broad-based wireline competitor in a given market area is difficult to sustain because of the high cost of infrastructure. The problem is that the nature of competition and opportunity depend on demand density at the local level.
Imagine a town of five thousand people sitting in a very rural area that has perhaps another five thousand scattered over an area ten miles radius from the town. Is there an opportunity to deploy competitive infrastructure? Not if you have to support three hundred square miles of geography to serve ten thousand people, but if you could focus on the town, it’s likely there is something to work with. In market geographies where settlement is fairly dense, there would be more places where competition could work than in areas where settlement is sparse, so one policy can’t fit all.
We can see examples of this in the US, which has vastly different demand densities across its national geography. Light Reading also reported that T-Mobile is looking at the possibility of deploying fiber to support about four million subscribers. The specific locations being considered aren’t described, but I’d bet that they are the same sort of places that Google’s fiber investments have targeted, which are pockets of opportunity in a wider area where opportunity is limited. It may be that T-Mobile, who offers FWA as an alternative to wireline, saw that there were pockets of local demand density that can justify fiber as they planned out FWA, which needs a reasonable level of demand density to support profitable operation too. This demonstrates that multiple operators may not even be directly competitive while serving the same “market”, if they target specialized local conditions. So, as was the case with big-tech subsidies, this is a complex problem for regulators to deal with.
But speaking of demand density, the fact that EU operators are pushing for regulators to offer some innovative changes in policy to ensure their profitability is a bad sign. EU demand density is four or five times that of the US and ten times that of Australia or Canada. Infrastructure should be more profitable in high-density areas, which could mean that competitive overbuild is truly having an impact. You could make a case for consolidation, then.
The question we’re left with is whether we’re trying too hard to make connection services profitable enough to sustain not only a major incumbent but also competitive rivals. There’s no differentiation to featureless bits. It’s interesting that operators haven’t demanded regulators lift restrictions on offering advanced services, restrictions that apply to many of the big players. Advanced services, services beyond connection, are the long-term hope of avoiding financial challenges. An enlightened strategy there could eliminate the need for subsidies, reduce the pressure for consolidation. But it’s also interesting that where there are mechanisms that would enable operators to offer advanced services, they’ve either held back or they’ve tried and failed. I still believe that the best solution to the problem of profit per bit is to encourage operators to participate more in higher-level services that are differentiable. I’m a champion of AT&T’s notion of creating what are essentially wholesale service elements, “facilitating services”, that would be offered to OTTs to build from, but likely would eventually form the foundation for some of AT&T’s own higher-level services. These could be the long-term solution to everyone’s problems.
That makes the final, and perhaps biggest, question whether any form of short-term subsidization or consolidation relief could actually hurt longer-term operator stability. Can you make a commodity business of bit-pushing a success without ever-increasing financial relief in some form? I have my doubts, and if that short-term relief encourages operators to believe they can stay forever in their connection-services comfort zone, then it’s a bad idea.
You can’t have something fundamental like the telecom/ISP space fail. It’s possible that the operators are crying wolf here; they’ve been talking about profit-per-bit declines since at least 2012. It’s also possible that there are basic issues that need to be addressed, and that they’re trying to give regulators and governments fair warning. It’s certain that the operators need to follow an old motto I trademarked with ExperiaSphere; “Think Outside the Bit”.