The relationship between consolidation and innovation in the telecom sector is driven by IT convergence and technology empowered customers. Consolidation in search of synergies, cost savings and restructured offerings are driving change and possibility. Rick Ducey, David Gross and Chris Versace explain
Consolidation is moving at a fast clip. Bell Atlantic, NYNEX, GTE, AT&T, BellSouth, MCI, Pacific Telesis, Ameritech, and Southwestern Bell will be crammed into just two companies. Alcatel, Lucent, Newbridge, DSC, Ascend, Cascade and potentially part of Nortel will have collapsed into one. Nokia and Siemens have become Nokia Siemens Networks in order to reach both financial and technological scale and so, be able to compete with Ericsson but also fend off low cost competition from companies such as Huawei in China. Meanwhile Nokia has been slowly gobbling up small companies such as Loudeye, which will give Nokia a set of online music capabilities equivalent to that of Apple: devices (Nokia's new N-series handsets), a service, and licenses to a very large catalogue of music from all majors and many independents. A more recent acquisition by Nokia is the announced purchase of gate5 AG, which will give Nokia the ability to offer maps, routing and navigation applications for their mobile devices as well as offer potential tie-ups with some of gate5's existing customers (GPS navigation software is used by companies such as Siemens, Volkswagen, and DaimlerChrysler).
While on the face of it, recent rounds of consolidation may appear to result in potentially less competition and raise concerns about less market-based incentive to innovate, we would argue that there is a change afoot in these companies in response – to some degree – to competitive pressures, but the overriding factors include planned service offerings as, at long last, the convergence of transport technologies is happening. Case in point, T-Mobile is piloting a dual mode handset that allows for calls to be seamlessly transitioned from its cellular network to an in-home WiFi network. Another example is the bundled service offerings that Verizon has through its Fios product offering, which is slated to be expanded further in 2007, once the company begins to include Verizon Wireless service in the bundle.
So the question to be asked is: Does all telecom consolidation mean the end of innovation? We say no.
Key to understanding this puzzle is seeing that the pressure on telcos to innovate will no longer come just from switch makers and telcos competing against one another in the marketplace, but rather from other market segments such as semiconductor firms, MVNOs and enterprise customers themselves. And not only will innovation continue, so will competition. Consolidation does not mean the end of competition, because telecom carriers are not the only companies building new networks.
Fixed-mobile convergence
There is an important, if desperate, strategy behind the moves such as those by Nokia/Siemens and Vodafone Group to converge fixed and wireless services as important precursors to developing new revenue streams. This type of restructuring creates new possibilities for new service offerings and revenue growth at a time when both are sorely needed. Of course, they are not alone in this endeavour, as we see Deutsche Telekom, France Télécom, Telefónica and Telecom Italia also organizing around new service offerings such as dual-mode mobile phones and WiFi phones with one number, to leverage their wired and wireless assets. These service offerings call for several new technologies, be they hardware (WiFi chips inside of handsets) or software (clients and user interfaces) as well as strategic relationships among vendors (with WiFi router companies like Netgear for example) and other solution companies (like Skype). And the MVNO segment will challenge the incumbents with their innovative approaches to brand marketing and added value.
Chip driven innovation
Telecommunications increasingly depends on the semiconductor industry to push it forward. This is because the phone companies are more exposed than ever to shifts in global and corporate equipment purchases. The US RBOCs, for example, have deployed very little VDSL to date, but chipset supplier Ikanos has sold over 10 million ports just concentrating on the European and Asian markets. These high shipping volumes overseas have cut port prices and, in turn, have made it much more cost effective for telcos to consider replacing some ADSL2+ cards just months after installing them. Similar price reductions in routers and Ethernet switches have crossed over from the commercial market, which still accounts for well over half of the product sales for those segments. This means that the chip companies will continue to drive the pace and direction of innovation to a large extent in the telecommunication industry, regardless of the level of consolidation among service providers.
Historically, most data networking vendors, from Extreme to 3Com, have designed their own ASICs, and then built a box around that semiconductor architecture. But over the last five years, while telecom companies have been getting bigger, transistors have been getting smaller. This has allowed the cost per bit of most equipment ports to fall, but it has also pushed up the cost to design a new custom chip from scratch, because so many more components have to be integrated onto each die.
As chip pricing has fallen below certain levels, new applications have opened up. For example, Bluetooth in handsets would not have happened with $20 chipsets but when the chipset average selling price (ASP) passed below $5, the adoption rate in handsets, laptops and in other areas began to take off. We're seeing the same with WiFi chips and will likely see the same with mobile TV as well. Also, smaller sizes allows for smaller form factors or more functionality in 'current' form factors, or ones that are slightly smaller. This rings true for smartphones as well as mobile phones, but also MP3 players, laptops and more, as the size of chipsets, storage, batteries and the like have shrunk themselves and/or as companies have designed certain components amid more integrated packages.
While price/performance has continued to improve, it has done so with merchant silicon vendors shipping their products across multiple customers. With the fixed development costs of proprietary ASICs increasing, it has become very difficult for a start-up equipment vendor to reach break-even production volumes without being able to sell its designs to someone else. As a result, innovations that were once developed by box makers like Extreme, Juniper, and Bay Networks are now coming out of communication chip suppliers like Broadcom, Marvell, and Atheros. Thus, to see where markets are headed, it is critical to understand the technology roadmaps of semiconductor companies, as they are influential in setting the pace and direction of innovation.
Built to last ten minutes
Today's global market for hardware means that AT&T and Verizon are using many of the same products as France Télécom and Deutsche Telekom, and cannot dictate product requirements the way AT&T used to be able to do with Western Electric. The global hardware market has already taken a toll on the RBOCs' OSMINE process, which is increasingly becoming outdated and outmoded, because few PTTs force vendors to go through such a strenuous software integration process, and because element management systems have evolved to the point that little benefit is achieved by running everyone's systems through Telcordia before implementing them in a live network.
With merchant silicon condensing upgrade cycles, global requirements taking many product development decisions out of the Bells' control, and more software-based enterprise equipment sneaking into telco networks, the major phone companies are increasingly expecting to toss out a lot of their hardware soon after it has been installed. The staid class 5 switch, ADM, and cross-connect markets were built on tightly integrated manufacturing processes, slow upgrade cycles, and limited competition among suppliers. And the pace of change in these hardware markets dictated RBOC purchasing procedures.
MVNO consolidation and innovation
Successful new MVNOs, whatever their focus, will both accelerate the global phenomenon of the 'hyper-segmented market' and drive much-needed product and marketing innovation. In that regard, we view them as a good thing. Our concern, however, is that there is likely to be an eventual tear in the MVNO universe much the way a number of companies targeting the Internet in 2000 went bankrupt, were bought or simply vanished after the pop of that Internet bubble. With that said, we do not expect all of the MVNOs that are in the planning stages to launch, nor do we expect all of the launched MVNOs to survive.
Near term, we would expect MVNOs to foster greater churn in a battle for market share, particularly as they reduce pricing plans in order to stimulate demand. Consumers who are planning to switch mobile carriers in the future are primarily looking to improve two aspects of their mobile experience: price and service. Handset selection, customer service, data services, and unique content are all secondary considerations, even for those consumers who currently use advanced mobile features like data/content or messaging. This approach is likely to stimulate demand in niche markets and drive overall wireless consumption. Longer term, however, we would argue that wireless operators will fight these new players with more sophisticated marketing and targeted promotional offers. Our view is that eventually quality of service, price and scale will be the determining factors for successful wireless carriers, be they MVNOs or more traditional wireless network operators.
The experiences of MVNOs have underscored two things in particular. First, a virtual wireless venture can turn a healthy profit when planned, launched and operated effectively. Second, however, the downside risks of the MVNO marketplace are very real, and some companies may be underestimating the scope of the effort. The challenges can be overcome, but success involves skills, resources and operational systems that are not necessarily within the core competencies of some of the players getting into the virtual wireless game. For instance, looking at the UK, of the 15 or so MVNOs entering the market in 2006, at least 40 per cent will fail, and 10 per cent will seriously under perform against expectations.
Conclusion
At the end of the day, the pressure on telcos to innovate will no longer come from switch makers and telcos competing against one another in the marketplace but rather from other market segments, including enterprise users themselves. Consolidation does not mean the end of competition, because telecom carriers are not the only companies building new networks or offering services.
The telcos have invested capital on broadband and wireless, and launched new business products because DSLAM port prices have fallen 90 per cent since 2000, and because enterprise customers choose which hardware they want on their internal connections. If the phone companies do not provide the technology they demand, corporations will just keep their lucrative traffic on their own networks. This is why many new protocols, particularly Ethernet and IP, were deployed widely in enterprise networks before they were fully embraced by telcos.
Rick Ducey, David Gross and Chris Versace, BIA Financial Network, Chantilly, VA USA. Rick Ducey can be contacted via tel: +1 703 802-2995; e-mail:
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