We’re obviously at the “How low can you go?” point in telco capex. We don’t seem to be getting closer to answering the question, either, which has telcos and vendors alike very worried. There are major shifts at work here, created by major forces, and some of those forces are relatively new. The reaction of telcos, and the changes these will drive at the vendor and infrastructure level, are likely to be profound, and there are signs they’re coming along faster than expected. The question is whether the changes will actually change telco fortunes.
One example of a change is the AT&T decision to shift from Nokia to Ericsson. While this was announced some time ago, AT&T’s earnings call just revealed that the telco was going to write down Nokia gear at an accelerated pace in order to bring about the Ericsson transformation faster than usual for a market area with notoriously long capital cycles. The story I’ve gotten from various sources is that Ericsson made a heck of a deal, good enough to cover the cost of accelerated depreciation as deployment rolls on. Why would they do that, and why would AT&T take a hit on current earnings to take advantage of a future payback? The mindset of public companies has long been to focus on the current quarter.
And let’s face it, AT&T is breaking other rules too. Telecom is an industry that takes root in legacy technology and becomes a tree. AT&T has been perhaps the most aggressive of all the big telcos worldwide in terms of technology modernization. They’ve embraced white boxes and open-model networks (their DriveNets core is an example) to an extent that’s stunning for a market area that rarely does anything radical, they’ve reversed themselves on FWA and accelerated fiber deployment too. Again, you have to ask why.
All of this is happening in a climate of global economic tension. Globally, telcos have been sagging under the falling profits, to the point where in the EU they’ve asked for Big Tech subsidies. They’ve also been cutting staff, cutting capex, and taking all manner of steps that are designed to boost profits, and for many that’s been working. T-Mobile’s earnings were up 41%, for example. Of course, nobody believes that you can fend off profit problems totally through cost cuts; at some point you’d vanish as an organization. So what’s next?
If we want to make sense of all the zigzag news in the space, we need to start with a fundamental point I’ve been blogging about for decades, “demand density”. Any service geography has a basic cost to deploy, which is largely dependent on the size and geography of the area. Any service geography has a revenue potential which is largely dependent on the economic value of the consumers and businesses in the area. Years ago, I did some work to define the way the relationship impacted return on infrastructure; the higher the “demand density”, which is the big variable in the picture, the more likely an operator is to report good profit margins.
Operators like the EU operators, those in the high-density Asian countries, and Verizon in the US enjoy high demand density, and these operators have been less pressured by profits. As a result, they’ve been slow to take measures to address capital and operational efficiency. But there’s one truth about high demand density, and that is that it almost always results from high-density economic development in the target area. Fill in all the space with businesses and housing and you pass millions of dollars of opportunity with every mile of deployment. That’s great, but where do you go from there? You either have to assume everyone builds taller and taller buildings, and that population continues to rise, or you stagnate. Or, perhaps, you look to your neighbors.
AT&T has a seventh the demand density of Verizon when considering home-territory demographics. They’re more aggressive because they have to be. They’re planning even more tech aggression down the line, too, because they believe that rivals like Verizon are likely to focus on their territory for the simple reason that growth there is possible—there’s geography to fill in. Where in the US are we seeing states with higher populations and larger business counts? In AT&T’s native area. New consumers offer a better opportunity than old ones locked into contracts. So AT&T needs to be ready for a battle, and ready right now. Accelerated competition equals accelerated depreciation and accelerated readiness for a big competitive change? Maybe.
Generally, operators are now taking steps to boost their profits without the luxury of an increased total addressable market (TAM) or increased average revenue per user (ARPU). Even for those who, like AT&T, have favorable economic growth trends to surf, the time it would take for the benefits of these trends to manifest on their bottom line is a bit too long. We’re coming out of a depressed economic period globally, driven by inflation and higher interest rates. Steps like cutting staff, capex, and improving operations, but also including things like great phone offers to accompany mobile service switching.
This clearly isn’t leading to business as usual. All of this to prepare for a new period in the telecom market. But what does that new period look like? That’s something we can only guess at, but it’s a guess that’s buttressed by some visible shifts and forces, like the ones I’ve cited above.
The first thing to look at is a force, or perhaps more accurately the resistance to one. Inertia. Telcos have mastered the art of inertia, and they’ve built inertia into everything they do, like the financial inertia created by write-down periods. Inertia comes in different flavors, though. Financial inertia is something AT&T has demonstrated can be overcome, particularly given that telcos are often judged based on earnings before interest, taxes, depreciation and amortization (EBITDA). Cultural inertia is another issue altogether. Telcos will not move very far from connection services, they won’t decide to be public cloud providers or offer high-level stuff. We have MVNOs today because telcos don’t really even like to market or sell. They were born on the supply side of the tracks. They’ll want the new period to be one where they are even more supply-side. Talk revolution to this crowd at a meeting, and everything will stop for an emergency bathroom break.
AT&T has been a leading indicator in the kind of shift that keeps those meeting attendees in their seats. We’ve seen AT&T lead in infrastructure transformation, and they’re determined to continue that. But that’s an on-ramp to the new-period future, and is it reasonable to expect that they’re on the ramp and don’t know where the expressway goes? They believe, and they’ve said publicly, that their future is facilitating services. That means building up features from those of basic connection, doing the dog work of creating whatever is needed to create “connection-plus”, the on-ramp to future retail services. Any service delivered via a network has more than just a bit pipe piece, and a new set of services are likely to require new pieces that are not quite dumb pipes. AT&T wants to provide them.
Via Open RAN. Why is open-model 5G a good thing? One reason is that it would create competition for all the 5G elements, which would likely lower costs, but lower cost isn’t exactly aligning with a premature write-down of Nokia gear that’s costing you 17 cents per share in profits this year. Another reason is features. Vendors don’t like price-based differentiation. An Open RAN ecosystem might well generate some of those connection-plus assets even naturally. If a vendor were told by a big operator that these facilitating-service assets were essential to a deal, you can guess what would probably happen. Ericsson may have been willing to promise discounts to cover accelerated depreciation, and they may have promised connection-plus support too.
Promises, promises. The biggest question of all is whether Ericsson actually has any ideas here. AT&T already talked publicly about facilitating services. The Ericsson deal is done. Open RAN is what it is, which is what it has been, which isn’t enough. Ericsson will have to deliver something more than Open RAN has delivered. What might that something be? We still don’t know where the expressway is going. There are many possible choices, and we’ll cover two of them in follow-up blogs this week. We may not have to pick one out of the list though. It might be a case of both…or neither.
