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Are Service Providers Giving Up on Landline too Soon?

Interesting times in the carrier space, for sure. While most readers of this column are focused on the business market, it’s hard to ignore what’s occurring in the consumer space right now. Being based in Toronto, I happen to be struck by the similar trends shaping on both sides of the border. Over the past few days, we’ve seen earnings reports from major telcos and cablecos, and these businesses seem to be going in opposite directions.

In the U.S., for example, Verizon and AT&T are telling similar stories. Wireline losses continue to mount, and wireless is driving most of the growth. Heavy investments in fiber to capture video and power Internet users are necessary, but will take some time yet to become major bottom line producers. Verizon, in fact, lost $198 million in Q2—this time last year, they made $1.48 billion. Not surprisingly, to stem the tide, layoffs continue. Their job rolls are about 25,000 employees lighter from last year, and they anticipate another 11,000 will take early buyout offers. Wireless growth aside, the story is similar for Canada’s major telcos, but the losses aren’t quite as steep.

Cable, on the other hand, is booming. IPTV rollouts from the telcos aren’t hurting them as much as they’re hurting the telcos by winning away landline phone subscribers. At this point, I’m just going to focus on the U.S. market, as the dynamics differ from Canada in a key way. U.S. cablecos are not in the wireless game to the extent that Canadian cablecos are. Rogers is actually Canada’s largest wireless operator, and the other three MSOs of note are all on the verge of making major wireless entries.

In essence, the traditional telcos are evolving into mobile operators, whereas the cablecos are building a pretty strong hold around the home environment. It all lines up rather neatly, actually. The triple/quad play bundles are clearly a winning strategy, and the convenience makes sense for the consumer. All the home services are rolled into one package—TV, Internet and home phone. The cablecos have managed to do this very well, whereas only a fraction of telco subscribers can say the same. When you think about the technical challenges behind these services, the outcome really isn’t surprising—it’s much easier for cablecos to add telephony than it is for telcos to add IPTV. Let’s not forget long distance—well, actually you’d better. This used to be a cornerstone of telco profits, but no more. Sure, there is some money to be made with international calling, but domestic long distance is now an oxymoron, as everyone pretty much offers it for free.

So, where does this leave carriers? They really are in a precarious spot, at least in the U.S. On the defensive side of the ledger, they seem to be conceding the landline business outright. The trend is only going in one direction, and they’re been taken down by three forces. First, they’re losing subscribers to cablecos—this is the toughest loss of all. By definition, incumbents will be the last players to offer VoIP, simply to avoid cannibalizing their core subscriber base. So, while they stayed on the sidelines, the cablecos simply walked in and took the business away. OTT operators like Vonage got the ball rolling, but it’s the cable operator’s world now, and the OTT’s just live in it. Bottom line—the cablecos did a great job figuring out how to offer VoIP. In the early days, there was a question of trust as to whether consumers would take them seriously as telecom providers. Nobody feels that way today.

There are two other factors to consider in the demise of telcos. The second is wireless substitution, which will continue to drive landline losses. However, at least here the telcos have a fighting chance of keeping their subscribers. Finally, there is the white flag scenario, where incumbents are simply exiting the landline business. Divestitures such as Verizon selling off wireline operations to Frontier Communications illustrate how this trend is unfolding.

Now, it looks like the telcos have all their eggs in one basket. Wireless has been their savior, and the growth story simply gets better when you layer on mobile broadband, and game-changers like the iPhone, iPad and Android. Subscriber growth remains healthy, the smartphone market is far from saturated, margins are good, and demand exceeds supply. Countering this, of course, is the endless catch-up that operators need to do in terms of expanding network capacity and transitioning to the all data worlds of 3G and 4G.

As a result, the world of telcos is much different now than ten years ago. The diverse base of services and revenues is gone, and the competitive landscape is far more challenging. Wireless is a great business, but I would argue that telcos have shifted from a position of strength to weakness. By conceding wireline to cablecos they have lost the foundation of their traditional relationship with millions of households, and it’s hard to see how they can win this back.

Wireless can be a fleeting market, given the competitive options, especially from MVNO’s and prepaid plans—which have no contracts. Profits attract competitors, and the wireless market will only get more crowded, not less. Furthermore, telcos have less leverage with wireless than wireline. Ever since Apple disrupted the status quo with the iPhone, the balance of power has shifted away from carriers to the handset vendors. The mobile device is now a more powerful driver of demand than the service itself, and a mobile operator’s success depends heavily on partnering with the vendors, with the right models, at the right times. For better or worse, the cablecos do not have these problems.

If there’s one thing that telcos can count on at present is the seemingly insatiable appetite for mobility and the cool gadgets we’ve become addicted to. Circling back to Canada, I’d like to cite a feature article in last week’s Financial Post that talks about how out of control our spending is around these services. This really isn’t news, but the article provides a nice breakdown about how much it’s really costing to use all these services. To some extent this reflects the downside of bundles, where the monthly bill for everything amounts to sticker shock.

That aside, the main message here is that we’re spending much more today to talk—and communicate—than ever before. Despite how IP has led to lower basic subscriber costs and eliminated a lot of long distance and extra feature charges, our bill is now orders of magnitude higher. Even more telling is how little impact our weak economy has had here. We’ve simply become too addicted to these services, and demand is proving to be inelastic. When times get tough, we cut back on a lot of things, but mobility doesn’t seem to be one of them.

So long as the scenario holds, telcos will survive. I’m leaving IPTV out of the equation here—it’s too early to tell if this will turn out to be a major or minor revenue producer. However, despite good growth from wireless, I don’t see them building off this strength to invest in what remains of their landline franchise. That’s the part that concerns me, as I still think there is value in this service, and with some creative R&D and partnering, I believe there are ways to reinvent landline. I just don’t think it’s good business to abandon landline service in the pursuit of quick, easy profits from mobility. That scenario will not persist indefinitely, especially if consumer backlash takes hold in an attempt to pare back these huge monthly phone bills. If that day comes, and the landline franchise is all but gone, the trusted telcos we grew up with may go the way of the rotary phone.

This article of mine originally ran today in my Service Provider Views column on TMCnet.

By Jon Arnold, Principal, J Arnold & Associates

Jon is also co-founder of Intelligent Communications Partners that focuses on the smart grid space.

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