"High expectations, low profitability” – Arthur D. Little’s global broadband report
By Andreas Hürlimann, Director, Arthur D. LittleDelivery of high-speed Internet access and services over high-bandwidth infrastructure (broadband) has rapidly become a defining feature of the communications landscape, and it represents the main engine of growth for telephone and cable operators across the world.
Its growth has been phenomenal: from the earliest deployments of the technology in the mid 1990s, total consumer expenditure on broadband is expected to have exceeded USD 30 billion in 2003. Yet the industry is complex and players face significant challenges in both getting the product and business model right and coping with such high growth. Given significant investments in technology, services and customer acquisition, the industry to date has been characterised by low profitability.
Arthur D. Little set out to address three principal questions:
The study incorporated perspectives from companies most actively shaping the broadband industry:
The current broadband market
The global market can be characterised as High Growth, with only Korea and possibly Hong Kong having reached “Maturity”. On the current trajectory, many markets could also see penetration approaching or exceeding 50 percent within five years. The United States, Korea and Japan combined today account for 50 percent of total worldwide subscribers. For most customers, access speeds are around 500kbits/s, with higher speeds (up to 8Mbits/s) becoming more widespread in the most developed markets.
DSL (which uses copper telephone lines) is the most prevalent technology for delivering broadband, although in certain markets (notably the UK, US, Korea, Austria, Switzerland, Netherlands, and the emerging markets of Malaysia, Venezuela, Columbia and Brazil), cable has established an early lead. Cable operators have been more innovative than their telephony competitors in building up their networks faster and in bundling broadband with cable TV or telephone products. But the availability of DSL – the technology is usually almost ubiquitous compared to the limited cable footprint – will increase and ultimately outpace cable access.
Challenges faced by industry players
Strategic challenge 1 (for NSPs and ISPs) - maintaining ARPU and margins
This presents a significant problem for the industry since, as markets develop, access fees have typically trended downward. The strong correlation between declining access prices and increasing penetration confronts operators in three areas:
Exhibit 2 confirms the trend towards lower ARPU at higher penetration, and the dilemma facing operators investing in additional bandwidth. ARPU is generally lower (adjusted for purchasing power) in higher penetration markets. And although some Asia-Pacific markets appear “above trend”, this is primarily a reflection of the greater access speeds on offer (with the average price per kilobit continuing downward).
Faced with this profile, operators must wonder whether the potential returns justify the substantial investment required.
NSPs and ISPs are increasingly looking to supplement revenues from basic access with additional services, in partnership with content and application providers (discussed under challenge 3 below). Currently, ISPs are "buying market share" in many markets by aggressively pricing broadband access in the expectation that the large customer base will eventually pay back their initial acquisition costs. We believe there is also scope to amend the prevailing "flat-rate" pricing model, including charging heavy users a premium reflecting the additional requirements generated for the network, or to reflect a guaranteed "quality of service" (e.g. successful connections and minimum access speeds). And a greater focus on costs is required to improve margins, with operators needing to sweat assets harder to achieve profitability.
Strategic challenge 2 (for regulators and alternative providers) - ensuring a basis for effective competition in the access market
Without strict regulatory controls, dominance by the incumbents is not surprising since they determine both timing and extent of network upgrades required to support broadband services. They also set the wholesale price and hence to a significant extent can determine their competitors’ margin (wholesale access can account for over 50 percent of the retail price charged by most ISPs). Since costs of customer acquisition, set up and service are typically higher for broadband, independent ISPs find it extremely difficult to make an overall margin, but they have few, if any, alternatives for wholesale access. This stems from a failure in many markets to fully implement an “unbundling” of the local loop (LLU), bit-stream access or to establish an infrastructure competition with the corresponding wholesale offer. There are clear correlations between competition among infrastructure providers, high broadband penetration and relative low access prices. In the most highly penetrated market Korea, Hanaro Telecom, Thrunet, Dacom, Onse and Dreamline all compete with KoreaTelecom via cable, DSL, LAN and wireless networks.
European regulators face an important challenge with broadband to ensure that competition is maintained long-term. They must push for lower wholesale prices as demanded by independent ISPs. However, the ISPs themselves also need to demonstrate greater discipline on pricing. To date, where wholesale prices have been reduced, ISPs have also looked to reduce retail prices, maintaining low margins.
Strategic challenge 3 (for content providers) - extract more value from a rapidly expanding new distribution channel
Content providers report significantly increased usage as customers migrate from narrowband to broadband. Usage levels in broadband households are typically about two hours a day - more than twice narrowband usage levels, and approaching TV viewing levels (typically about three and a half hours a day). The "always on" and flat rate pricing features of broadband are undoubtedly key drivers of usage, but the customer experience while online is also strongly enhanced by the higher access speeds.
Broadband represents one of the fastest growing new markets for content providers, but translating usage into revenue has proved challenging. We expect content providers to overcome their initial hesitation and embrace broadband alongside other media. We also expect content providers increasingly to distribute content directly to end users, without going through an intermediary or partner. Some content providers initially sought to offer services mainly in partnership with ISPs (e.g. with T-Online in Germany) that offer managed links and streaming services, and in so doing reducing their investment in hosting and delivery infrastructure and securing some marketing support. However, as the market builds, providers will offer and bill their services direct to the customer (e.g. BSkyB in the UK, with its skysports.com subscription service), excluding the ISP or NSP from any share of revenues. In such circumstances, we believe broadband represents an important and viable new market for content providers, with significant benefits likely for early movers.
Strategic challenge 4: For CPE providers, how to build added value as the market matures?
Falling prices, ease of use and standardisation of CPE have been important drivers of the broadband market. CPE manufacturers are now increasingly looking to increase the functionality offered, enabling greater value-added functionality for the "smart" home of the future.
Can the industry deliver profitability and build value?
Insights for the executive
Andreas Hürlimann is a Director of Arthur D. Little's Zurich office. He is the leader of the global Telecommunications, IT, Media and Electronics (TIME) practice of Arthur D. Little. His main areas of interest are strategic, organisational and operational questions relating to broadband and mobile operators. Andreas Hürlimann holds an MSc EE from the Swiss Federal Institute of Technology, Zurich, and has been with the telecommunications and electronics industry for more than 15 years.
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