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Will the Cloud Kill Telecom Vendors?

There are many big questions in telecom these days, and this is one that’s on my mind right now. Over the past few months, I’ve participated in events or briefed with leading vendors in our space, namely Avaya, ShoreTel, BroadSoft, Aastra, Metaswitch, Mitel, Interactive Intelligence, and this week Cisco. Every analyst has their own core circle of vendors they stay close to, but I’d say that’s a pretty fair representation of who’s driving telecom.

To varying degrees, all of these vendors have a cloud story, and the more I hear it, the more I start to wonder what it really means. Don’t get me wrong—I’m a big fan of cloud communications and I think it’s the next curve that everyone pretty much has to jump over to. Whether they will succeed is another question, but the trend is as clear as day.

My first question to all the vendors is about the motive—is this a defensive measure to protect the installed base, or an offensive measure for growth and access to new markets? Of course, it’s a bit of both, and no forward-thinking vendor can afford to ignore the cloud. It’s not a fad, it scales just fine, and the economics are undeniable. We’re still in a weak economy, and cost rules, so there’s a ready market for cheaper communications solutions. I get that.

Telecom vendors—just like telcos—know that their model has to change. For a few years, I’ve been writing about how vendors have transitioned from hardware to software, and more recently how they’re trying go from software to the cloud. This is the big picture path of evolution, and vendors know it. Mitel in particular, has been on this road, and based on their current direction with virtualization, I’d say they’re betting the farm on the cloud. There’s nothing wrong with that, as most vendors are a few steps behind, and if they’re right, Mitel will be in good shape.

In my view, there are two factors driving this trend. First is the fact the businesses are looking to save money, and they have reached a comfort level with the cloud that allows them to consider doing their communications this way. To me, this is akin to going with your cable provider for VoIP. Before Vonage came to market, the concept of using your cableco for telecom was pretty far-fetched. What do they know about telephony? Why would I trust my home service to them? How can they possibly do as good a job as my telephone company? These were very legitimate questions back then, but we all know how that turned out. As most of you know, there really isn’t that much magic to VoIP once you have the right network in place. Cablecos now own the VoIP market, and landline telephony has become an albatross for the telcos.

Cloud communications is no different, and the changes happen more quickly now. Businesses have been relying on the cloud for other applications, and with voice being just another app in a data network, it’s just not that big of a leap any more. We’ve reached the point now where the costly physical network infrastructure that telcos have built their business around matters less, and is being rivalled by Internet networks, both public and private.

In response to this, telecom vendors are rushing to market with hosted or cloud-based solutions. I see this being a short-term response to ensure customer loyalty, but with long term consequences. There is much better money to be made selling hardware and premise-based solutions, but as communications shifts from being a product to a service, that model is in jeopardy. Instead of getting your money up front with an equipment purchase—which may or may not be capitalized—these vendors will shift to the SaaS model of getting monthly revenues from seat licenses. This stretches out the ROI timeline and changes the economics of running the business. Vendors now require longer-term relationships to make money, and run the risk that eventually customers will realize it’s cheaper to own than rent, and then we’re back to square one.

This brings me to the second factor driving cloud adoption—Google. They are simply too big to ignore, even if Wave did not catch on. As I’ve written elsewhere, with Google Voice, they now have all the pieces to offer pretty much what any telco vendor can do, but at nominal cost. Businesses aren’t quite ready to go down this path yet, but they will find a market, and since Google does not have to monetize this, they can keep tinkering until they find the right value proposition. Nobody does the cloud as well as Google, and they know that once the trust of businesses has been gained, they will win their share of customers.

Nothing legitimizes this threat as much as the recent launch of Microsoft Office 365. They see the writing on the wall, and know that the days of lucrative software licenses are numbered. When Microsoft offers a cloud version of its core product, you know it’s important. No telecom vendor can compete head-on with both Google and Microsoft, so they have to keep pace.

My concern is that these cloud-based offerings will achieve a sameness after a while, with little to choose from. I’m sure the last thing vendors want to see is a downward spiral in pricing where nobody makes money. It’s a great scenario for customers, but this isn’t the business that telecom vendors really want to be in. On one hand, they have to play this card or risk being taken out by Google or one of their own kind, but if this becomes a commodity business, these vendors will lose whatever leverage they still have with customers.

The bigger problem I see is that cloud offerings shift the power and value away from the vendor and over to the cloud host or data center. The efficiencies here come from the ability of the cloud to scale and keep costs down for end users. Communications offerings from vendors—whether just VoIP or some variation of UC—risk being reduced to yet another data application in the overall cloud platform. This form of virtual infrastructure is pretty far removed from the business telecom vendors know—and invented—but now they look be sitting a few notches lower in the IT value chain. Rather than driving communications for businesses, they could become just another plug-in component that most any vendor can provide.

Telecom vendors are not in that spot today, but it’s a scenario I could see unfolding if they are not careful. They have worked hard to become high-value, trusted partners for businesses, but the cloud could quickly marginalize all that. While they cannot afford to ignore the cloud, they also need to be mindful of keeping their value proposition strong, and not get trapped into a pricing game. Things will never revert to their legacy days, but telco vendors need to find ways of adding value in this new world. Adopting a cloud solution definitely keeps them in the game, but they have to play by other people’s rules, and to prosper they need to figure out how to break the rules or create new ones.

This article of mine originally ran today on 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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