Verizon is disrupting the long term equilibrium of the market… (WRKoss)

I’m hoping that WRKoss doesn’t get a real job ’cause I’m liking his posts 😉 This is a long post describing why he thinks that Verizon is doing the right thing. He draws parallels between US and Russia in the cold war. He mentions that Russia eventually bankrupted itself in this process. The final paragraph is interesting because he states that VZ can get away without developing applications (they can buy them) and then tee’s up the Net Neutrality debate.

I believe that the likes of VZ are acting on the “if we build it, they will come mentality”. They have a couple challenges:

  1. They only have so much cash for development of networks and applications. Even if they could become good at applications (which many doubt) they are limited in what they can do because the $Capex for the network is extreme.
  2. IP technology separates applications and network too well. Coupling an application to the network will be tough, and will most likely require Gov’t regulation. ( ie Net Neutrality)
  3. The access line is important, but it isn’t everything …. Goog/YHOO/MSN spend the majority of their time on applications. Goog even goes further to develop their own data center hardware and core networks.

The VZ’s of the world better be able to live off of connectivity revenues. They’re not gonna get much else. They’re gonna go bankrupt like Russia if they think that applications are gonna be greater than 10% of their revenue.
— iain — full post follows —

Verizon is disrupting the long term equilibrium of the market…: “

In 2003 I
had breakfast with Kent Takeda (a colleague at Internet Photonics at the time)
and Ross Ireland, then SVP/CTO of SBC. Our breakfast was at The
Watermark Hotel
, Ross would soon be retiring from SBC, but I did not know
that at the time. I distinctly remember
our conversation concerning fiber deployments by the RBOCs. In 2003, the debate in the telecom industry
was what method would be used to deploy broadband to the end-user as SBC,
Verizon and BellSouth had issued a common RFP for a fiber to the premise
solution (i.e. FTTP). There was a good debate in the industry as to
what would be the appropriate solution: FTTC, FTTH, or FTTP. Ross said that he believed the solution would
be a mix of many technical solutions. Service Providers would deploy fiber to the nodes (FTTN) and then
use DSL or WiMAXX or some technology to make the final connection to the
end-user. He was fairly convinced that
the high cost of running fiber to the home would make that strategy prohibitive,
except in greenfields and locations with lower build out costs for fiber.

I left
the breakfast thinking that fiber to home was a Gilder
dream
because the cost of running fiber would be too high and there was no
real market driver to force service providers to spend billions on fiber
deployments, when post-bubble and consolidation debt levels were already high. Service providers would continue to
accelerate DSL deployments and eventually some sort of wireless broadband
solution would come along (the latter assumption
proved correct)
. In 2003, there was
still a negative stigma associated with the technology bubble of the 1990s and
the billions wasted on service providers and the failure of the Telecom Act of
1996. As such, the idea of spending
billons on a new network infrastructure was not a subject that many people
wanted to hear about.’ The war in’ Iraq was
a more
prominent issue.

Comcast Strikes First:
In November
2002, Comcast closed their purchase of ATT Broadband for $52B and the
assumption of ~$24B in debt. When the
telecom market fell apart in 2001, I remember the overwhelming feeling was that
the cable companies were going to win. The cable companies had upgraded HFC pulled to the
home, they had the video portion of the service offering complete, perfected over the years including deep
relationships in Hollywood, Disney, Madison Ave,
as well as the home number of chairperson of the local cable franchise
board. Cable companies were now offering
voice and cable modems were trumping DSL for data. It was over. This
was the general mood inside cable companies and the worry inside the
traditional telecom service providers.

In
October of 2003, just ten months after closing the ATT Broadband deal, Comcast
announced faster
downstream speeds
. Comcast showed
the power of their HFC infrastructure by doubling the downstream bandwidth for
broadband customers from 1.5 Mbps to 3 Mbps. Less then a year later, Comcast added a 4
Meg downstream option
. 2005
witnessed two more salvos in the data speed battle from Comcast, each
announcement focused
on speed
and creating more ultra
fast service tiers
for data. The
response by Verizon to the Comcast strategy was a fiber to the premise strategy
marketed as FiOS.’ ‘

Assumptions and Suppositions:
To frame
what is evolving in the US Service Provider Market and develop a hypothesis for
the future, I going to state several assumptions without providing the
background details:

  • Service Providers are all converging towards a common set of service offerings. They are approaching service homogenization from different heritages of expertise (i.e. mobile, wireline voice and cable TV).
  • Voice is not a free service, but it is a $24.99 a month flat rate service. All service providers know or can provision voice as a service. There is very little service differentiation in voice applications.
  • Municipal WiFi networks are nice, but their real impact (i.e. profits) will be felt by service providers who cannot provide 50-100-200 Mbps data service to end-users.
  • Broadband data service will become a flat rate service similar to voice – the competitive aspect will be the service speed.’ Data services may be priced alike, but they will not be alike in terms of speed and capacity.

The Approaching Equilibrium Disruption:
Everyday
that Verizon pulls more fiber, adds more subscribers is problem for cable
service providers and to a lesser degree mobile service providers. In the 2003 to 2006 time frame, data service
(i.e. broadband) was a game between DSL and cable modems. It was game played in the sub 10 Mbps data
rate battlefield. As Verizon pulls more fiber
to the premise, the game is changing. With each end-user connected to fiber, a massive conduit of potential
capacity is in place.

As
Verizon began deploying FiOS, they came under typical scrutiny concerning
subscriber take rates, video franchise licenses, capital cost, drag on
earnings, does it really work questions, deployment cost and time required to
install by field technicians. Put all
that aside as it is a short term view of the current state and does not
consider the long term affect that fiber to the premise has on the market. Every subscriber that FiOS wins begins to
slowly disrupt the equilibrium of the service offering capacity in the market. The data game is no longer a sub 10 Mbps
war. The data rate war is now a 20 to
100 Mbps war. As Verizon adds to the
their customer base, they can be the company to announce ‘free upgrade to 20
Mbps service for all FiOS customers
’ followed a few months later with ‘new 30,
40, 50 Mbps tiers of service for FiOS customers
.’ This is the equilibrium disruption. Every service provider in the Verizon
footprint that is not pulling fiber to the premise must alter their plans. Everyday they are losing ground to Verizon. Verizon’s fiber to the premise is going to be
a massive driver of investment by cable service providers, CLECs and ILECs in
the Verizon footprint.’ ‘ ‘

I am in
the process of reading a wonderful book called The
Cold War
, by John Lewis Gaddis. It
is a revisionist history of the Cold War based upon research material made
available over the last ten years by the Russian and American archives. There is an interesting geopolitical parallel
to this discussion and being interested in geopolitics I am always looking for
similarities. When the US
used the U2 spy plan to reveal
the Potemkin Village
of Soviet nuclear armed missiles as well as the outcome of the Cuban Missile
Crisis of 1962, it altered and motivated Soviet military policy. The Soviet Union launched a massive
military-industrial campaign that would last decades to equal and then surpass
the nuclear strike capability of the United States.’ This policy also led to the collapse of the Soviet Union
when their economy collapsed under the
investment burden when the foreign policy of the Regan Administration massively raised the stakes of the military investment race.

When I
look back on the immediate years follow the collapse of the telecom bubble, I
think a similar event happened inside Verizon. The Verizon leadership team may not have been conscious of the parallel,
but the result appears the same. In
2002-2003, pundits were writing reports that the cable service providers had
won. The war was over. The cable companies had video – the
traditional telecom service providers did not. The cable companies had cheap VoIP – the traditional telecom service
providers did not. The cable companies
had the investment for high-speed broadband completed – the telecom service
providers did not. The Verizon
leadership team was motivated to play for the end-game and not take a short
term view. If the game is speed and
capacity for applications, Verizon seems to be taking the approach to get the first two completed and worry about
applications later in the game.’ ‘ ‘

I know
there are people who argue that all that bandwidth to the end-user is
meaningless because telecom centric service providers are nearly
inept at creating new revenue generating applications
to supplement their traditional
sources of service revenue. I agree –
but with fiber pulled to the end-user, Verizon can buy the applications if they
cannot build them. Fiber to the premise
also provides Verizon with a massive strike capacity in the data rate war. If applications reside outside the service
provider network, Verizon is still in a strong competitive position because
they have a massive conduit to the end-user to fill with applications. This then leads us to a net neutrality debate
– but that is for another day.’ ”

As
always, thoughts and comments welcome, whether private or public.’

/wrk

(Via Technology and Geopolitics.)

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