It should be clear to everyone by now that the EU is going to provide some mechanism to subsidize telcos for carrying OTT traffic, at least the major players. It is less clear (but should be) that this is going to have a seismic impact on the industry. Perhaps the lack of clarity can be attributed to the hype on all sides of the issue, so the most important question we should be trying to answer is “how do we dig through the chaff to find the wheat?” Let’s give it a go.
All this talk about subsidization stems from discussions literally decades old, emerging from some of the basic tensions that were created by the dawn of the worldwide web. Consumer data services were in one sense a boon for operators, because the improvements in network technology were making long-distance calling increasingly competitive and leaving operators with an “access” business that could never replace lost long-distance revenue. In another sense they were a major threat, because early Internet access didn’t impose any data charges. The absence of usage pricing encourages usage.
Up to the time of the Internet, operator interconnection for all services was done based on settlement. Even voice calls involved payment by the calling operator to the called operator, a “termination charge”. Data services (packet-switched data based on the CCITT X.25 standard and interconnected via X.75) were settled. There was no “bill and keep”, the model that emerged with the Internet.
Even in the early days of the web, the risk of an imbalance in revenue versus costs arose around the subject of peering. “Retail” ISPs serving users were net sinks of traffic, and they were also the most costly piece of the Internet. A “wholesale ISP” who focused on connecting net sources of traffic could peer with the retail players and essentially consume their capacity while keeping revenues from the content providers. What we have now with the over-the-top (OTT) players is the successor concept. You pay a CDN provider to deliver stuff to the retail ISP edge to get to the customer. You don’t pay the customer’s ISP.
Early on this distortion in cost and revenue was recognized. I’ve noted in the past that I’d co-authored an RFC (Savvis’ CTO was the prime author) on “brokered private peering”, which would have established a paid peering mechanism that was designed to help balance revenue and cost, and also encourage features and QoS. The problem was that “the Internet” was perceived as being somehow independent of infrastructure, separate from other networks. Consumers wanted good, cheap, Internet and what they saw of the Internet was really only the OTTs. No wonder the OTTs won the lobbying wars with regulators, and what emerged was net neutrality.
The real question here is just what the thing that’s popularly called “net neutrality” really is, and means. The goal, leaving aside the politics and lobbying, was to create a fertile field in which Internet companies could grow, and support a whole new set of rich consumer and business services on the Internet. Which, of course, meant “over the Internet”. At the same time, regulatory provisions tended to bar the telcos from participating in these new service opportunities for fear they would use their incumbent power to stall other more innovative players.
Where we’ve ended up with this approach is that we’ve created a traffic-generating industry (OTTs) and a traffic-carrying industry, with the former offered all the new opportunities for service revenues and the latter increasingly pressured by declining profit per bit. Competition among “access providers” targeting the consumers of OTT services has run into the problem that you can’t really differentiate access services by any means other than price, and consumers are unwilling to pay proportionally for capacity. If you get “basic” 100 or 200 Mbps Internet for $40 to $60 per month, you might willingly pay $100 to $120 for gigabit services. Streaming video is the big consumer of bandwidth, and obviously we have more and more providers of that, consuming more and more bits. Since streaming doesn’t even require gig bandwidth to deliver, many users are quite happy to stream over basic Internet, so there’s not even much of a chance of selling higher access speeds, just a chance to carry more traffic for the same money, which is what trashes profit per bit in the first place.
My friends in the EU tell me that we will either see subsidies like the ones by the OTTs paid to the telcos, direct government subsidies, or some impact on the consumers. The impact could come in the form of data caps on broadband access, price increases, performance degradation, or some combination of these measures. Any of these things could have a chilling impact on the Internet.
The basic truth here is that no business is going to operate at a loss, or even to operate in such a way that they have no chance of improving revenues and enhancing their stock price. Most telcos, having been regulated monopolies, have tended to be considered “value stocks”, paying a dividend rather than promising a lot of share appreciation. They need to be able to sustain a dividend rate that’s attractive and also sustain their share price. Telcos have done a pretty good job of managing costs over the last two decades, but the problem with cost management is that you can only reduce so much. Operators have already taken most of the accessible opex reductions, and the maximum capex reductions they could hope for would drop costs only by about 4.7 cents of every revenue dollar, and that would take five years to fully realize.
There is no question that at some point they’ll need to either raise more revenue or be subsidized in some way. To claim that they can sustain operation without either of these two things is simply wishful thinking. Those who, like me, believe that subsidies aren’t the best answer are believing that revenue is, then. But operators have proved unwilling or unable to think beyond the basic connection-service models, and even those who can rise above (literally) those services somehow seem to mess up their efforts. However, they are making some progress, particularly those in the EU where competition is more acute. The consortium of operators who launched a personalization and identity initiative had the right idea even if they likely still picked the wrong target.
Telco intransigence doesn’t excuse regulatory myopia, though. Regulators focused so much on preventing telcos from monopolizing new OTT opportunities by taking advantage of their financial and market power, that they discouraged any form of innovation. Neutrality rules are often blowing in political winds, and any major new service revenues will require significant capital commitments that would be at risk if the winds changed. Whatever the EU decides here, and however regulators worldwide respond to their moves, it makes no sense to offer a market sector a helping hand while nailing their shoes to the ground. The regulatory structure of the industry has to conform to whatever policies on subsidies any jurisdiction comes up with.