Net neutrality offers operators more opportunities than threats

Net neutrality (NN), to date mainly an American discussion, has suddenly appeared on the political agenda in the Netherlands. What’s notable is the discussion originated in the mobile world, in contrast to the US. As NN is all about OTT (over-the-top: offering services over a data connection), one can conclude that in the US it’s mainly about video services (over fixed networks) and in the Netherlands it’s about communications services (over mobile networks). But NN isn’t just about OTT, it’s also about a technology switch: existing services (video/TV, voice/SMS) that no longer necessarily need to make use of a dedicated networked (as a managed service), but can also be offered over an (unmanaged) IP data connection.

We look at the financial impact on existing operators. OTT affects both revenues and costs at operators, and at the same time there’s both a positive and negative impact. This results in four possible combinations, which we outline below. All four can be linked to an important issue: the ‘dumb pipe’, structural separation, the infamous ‘revenue gap’, and the ‘smart pipe’.

1. Higher sales. Subscribers need a data connection for OTT services. Operators profit from this as they sell broadband subscriptions (fixed or mobile). Even more important, without the OTT sector, the entire broadband market would be worth much less. Without all these useful applications from the likes of Google, Apple, Microsoft and others, we’d all be fine with an old-fashioned narrowband connection.
2. Lower sales. The new OTT services often compete with managed services from operators. This is the key bone of contention in the entire NN debate. It’s also the main reason prompting operators to block or frustrate OTT. If it actually goes that far is still contested by operators, especially in the US; they don’t want any regulations ‘in search of a problem’. However supporters of NN, which point to the importance of innovation, do have examples of certain services or protocols being blocked.
3. Higher costs. Extra data traffic leads to higher network costs. Fixed broadband is a lucrative market, but warnings are sounding for the mobile broadband sector. Various operators and analysts are concerned about mobile broadband, due to the so-called ‘scissor effect’ or ‘revenue gap’. While traffic is growing exponentially, revenues are not keeping up, mainly due to operators selling flat-fee subscriptions. The assumption behind this is that costs are growing just as fast as data traffic, but that is highly questionable. Ericsson is really the only major player to bring up this question (see Ericsson Business Review, number 2 in 2010). Ericsson (‘busting the myth of the scissor effect’) concludes: “Don’t worry – mobile broadband is profitable”. The problem is the flat-fee subscription, but there’s nothing stopping operators, if needed, from increasing the cost with tiered pricing, based on speed or data allowances.
4. Lower costs. When subscribers use more OTT services, use of managed services declines, as do the related network costs. Furthermore, new opportunities are emerging by working with OTT providers. Skype is a good example, as it brings with it a large customer base and the associated network effect. The operator also profits from the use of a (cheap) international network and Skype’s technology.

Conclusions based on the above:

1. Operators (and politicans) shouldn’t forget that OTT providers have turned the broadband market into an enormous opportunity for operators – even if there is a chance they may end up a ‘dumb pipe’.
2. Competition between managed services and OTT service will remain sharp, and the question is whether this can be left to the market. One argument is that if an OTT service is blocked by operator A (fixed or mobile), the customer can always switch to operator B. But how real an option is that? How high is the barrier to switching? Furthermore in the mobile market, there are usually only three or four operators (spectrum is scarce), which all have a roughly similar offering. This seriously raises the question of whether the market can regulate itself, simply because there is too little competition. There is probably only one (ultimate) solution thinkable: structural separation, dividing the network from services. In other words, make sure the network operator doesn’t offer services itself. It remains to be seen if this is a realistic option. The fact is there are already here and there some wholesale-only networks, both in fixed (the Next-generation Broadband Network in Australia, Google Fiber in the US, CIF in the Netherlands) and in mobile (LightSquared in the US). Network sharing, such as the France Telecom and Deutsche Telekom joint venture in the UK, can also be seen as a first step towards structural separation. If their venture Everything Everywhere also lets in other service providers, and DT and FT allowed in third-party shareholders, the separation would be almost complete.
3. Operators are increasingly pointing to rising network costs in their political arguments. However, this isn’t the picture that emerges from their results. The only solution appears to be higher prices. While this isn’t the best option in a competitive market, it may be unavoidable if the growing costs really are reaching critical levels.
4. Lower costs are always good, but at the same time there are opportunities to give a boost to sales. Cooperation with OTT providers (so-called upstream partners) turns the ‘dumb pipe’ into a ‘smart pipe’. Both parties, operator and OTT provider, complement each other, while the end-user also profits. The list of such alliances and takeovers is growing quickly:

• Telefonica has acquired Tuenti (the ‘Spanish Hyves’), and Tuenti has started on an international expansion.
• Telefonica also bought Jajah, a VoIP provider. BT works with Microsoft’s Lync, and Skype has alliances with Verizon Wireless, KDDI and 3 UK.
• France Telecom has acquired stakes in Dailymotion (the ‘French YouTube’) and Deezer (streaming music, similar to Spotify).
• Comcast is also going to work with Skype, in the area of videoconferencing via the TV.
• The ‘connected TV’ market has a growing number of examples of operators adding OTT services to their broadcast/VoD portfolios, such as Telecom Italia, Telefonica and Liberty Global (UPC).

Conclusion

Whereas operators are mainly pointing to increasing costs for data traffic, in reality it’s probably more about revenue erosion due to lower sale of managed services. Of course a technology switch is painful. The business model needs to be revamped, with a rebalancing of old revenue sources (managed services such as broadcast TV, telephony, SMS) in favour of new sources (data traffic, revenue sharing with OTT partners). Still, operators are generating significant revenues in the lucrative broadband market, and if they know how to work with OTT players there are even more profits in reach. In short, there’s no reason for operators to fear NN, and they can even see an opportunity in it.