Telecosm - Ike Elliott

Why Ted "Tubes" Stevens Should Step Aside

Ted Stevens, U.S. Senator from Alaska, is running for re-election and won the Alaska Republican Senate primary last night.  That's bad news for his Republican party and even worse news for the country.  It's time for the 84-year-old Senator to call it a career and step aside.

Why?

• He's one of the most notorious pork-barrel spenders in the Senate, having long been a staunch defender of the Universal Service Fund regime that redistributes billions of dollars a year to rural areas in support of basic telephone service for rural Americans.  That Universal Service Fund system has been in need of reform for over a decade, but Stevens, representing a state that receives massive subsidies from the fund, has repeatedly helped block attempts at reform.  Even more notorious was Stevens' vociferous defense of the "Bridge to Nowhere," in which he even threatened to resign from the Senate if funding for the bridge was redirected to rebuilding New Orleans after Hurricane Katrina.
• He's under indictment for receiving roughly $250,000 in gifts from Veco, an oil company.  The case goes to trial next month and will almost certainly cripple his chances for reelection.

For a silly sample of the Senator's style, here's an excerpt from a recent speech by the Senator on 'Net Neutrality, in which he attempts to explain how the Internet can become congested, and describes the Internet as a "series of tubes":

Ryan Kane has a hilarious post on the Semi-Politico blog with a music remix of the Senator's speech. 

Bottom line: it's past time for the Senator to step down.

Can The Rockies Do It Again?

Can the Colorado Rockies make the Major League Baseball playoffs?  Stranger things have happened...and they did, just last year.

Consider this:  exactly one year ago, the Rockies were 6.5 games behind the division-leading Diamondbacks, and 4.5 games behind the wild-card-leading Padres.  The Rox came back and won the wild card, and then swept the playoffs to reach the World Series.

After last night's 7-2 victory of the San Franciso Giants, the Colorado Rockies stood just 6 games behind division-leading Arizona.  The team has been playing great since the All Star Break, winning 24 of their 38 games.  Can the Rox repeat last year's miracle and ride a big second-half surge to the playoffs?

This year, the Rockies are too far out of the wild-card race (15 games behind Milwaukee), but being 6 games back in the division race, the division title looks like it is within reach if the team can keep playing at its current level. 

On the other hand, the pitching rotation doesn't look as strong right now as it did last year.  Tonight, Livan Hernandez pitches again, and he has looked...well, let's just say today's Livan Hernandez is not the same as the one who pitched so well in the World Series a few years ago.

Worthless Guidance? Neutral Tandem's Sandbagging Ways

Neutral Tandem, the wholesale provider of tandem switch interconnection services, exceeded estimates and raised guidance when it announced earnings earlier this month. The company announced revenue of $28.6M in the 2nd quarter, continuing a steady stream of quarter-over-quarter revenue increases.  However, like many public companies, Neutral Tandem's guidance doesn't really tell us much. 

The company raised its prior guidance for the full year 2008 to somewhere between $117M and $121M in revenue, higher than prior guidance of $112M to $116M.  To put this into context, let's look at the company's revenue results by quarter for the past eight quarters:

Neutral Tandem	3Q06	4Q06	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08
Revenue (millions)	$  13.7	$ 15.0	$ 17.6	$ 20.5	$ 22.6	$ 24.8	$ 26.2	$ 28.6
QoQ Change		$   1.3	$   2.6	$   2.9	$   2.1	$   2.2	$   1.4	$   2.4

The company has been adding new revenue in the range of $1.3M to $2.9M per quarter over the past two years, so the new guidance of $117M to $121M in 2008 revenue looks to be in the bag.  The company already had $54.8M in revenue in the first two quarters, so to make the low end of guidance, they need to add an average of $1.5M in new revenue for each of the next two quarters.  To reach the high end of guidance, they need to add an average of $3M in new revenue for each of the next two quarters. 

This range of performance on revenue growth of $1.5M to $3M in new revenue per quarter covers almost the entire range of quarterly revenue growth throughout the company's history.  The company is basically telling us "We won't perform any worse than the worst quarters in our history, and we probably wont' perform any better than the best quarters in our history, but between those two extremes, we can't tell you where we will land." 

So, why raise guidance at all, then?  Well, it was pretty clear by the end of the 2nd quarter that the company was going to blow away their previous revenue guidance, so the company had to revise guidance.  To say nothing would cause the street to assume that the old guidance still stood and that the company was forecasting a revenue slowdown because they didn't raise guidance. 

But the company was sandbagging with that old forecast, anyway, and the street knew it.  The table below shows that at the low end of the previous guidance, $112M for 2008, that at the end of the 2nd quarter all the company needed to do to make guidance was repeat it's 2nd quarter revenue of $28.6M for two more quarters, for zero revenue growth in the second half.  That certainly wouldn't be enough to get anybody excited.

All figures in millions
Forecast 2008 Revenue	$  112	$  116	$  117	$  121
Remaining Revenue	$ 57.2	$ 61.2	$ 62.2	$ 66.2
Average Quarterly Revenue Needed In 2nd Half To Achieve Forecast	$ 28.6	$ 30.6	$ 31.1	$ 33.1
Actual 2nd quarter Revenue	$ 28.6	$ 28.6	$ 28.6	$ 28.6

Neutral Tandem isn't alone in their sandbagging ways, so I don't really mean to pick on them alone.  Their 2nd quarter earnings were actually pretty good.  I'm just pointing out that most public companies bracket their guidance with ranges that they are absolutely certain they will meet, at least at the time they make the forecast.  Yes, now and then we do actually find surprises in guidance, but to be honest, most of the time I find guidance to be of limited value. 

      

Podcast - August 26, 2008 - New Global Telecom. Guest: John Guillaume

How does the largest wholesale hosted IP PBX service provider think about the market?  Today's podcast interview is with John Guillaume, Senior Vice President of Product and Marketing for New Global Telecom.  Listen in as John gives us some insight into NGT, their recent work with Microsoft, and the their perspective on opportunities in wholesale VoIP services. 

  (About 35 minutes)

Download guillaume_ngt_interview.mp3

VoIP on a Plane: Cool, Disruptive, or Dangerous?

The news that Andy Abramson successfully used Phweet to skirt the rules prohibiting the use of VoIP on airplanes has certainly created a stir.  Reaction of commenters has been wide-ranging:

• Some thought it was a cool demonstration of how hard it is to control what happens on an IP network.
• Some reacted with revulsion at the thought they would have to sit next to loud talkers for the duration of the flight.  Some called for the creation of "talking" and "no talking" seating sections on the plane.
• Some even thought that the use of VoIP from a plane would make it easier for terrorists to coordinate plane-based attacks. 

I'm not sure about that last one...Internet chat should certainly work about as well as VoIP for a terrorist's purposes. 

The more interesting question is whether it is rude to talk on a phone (or PC or PDA) while sitting next to somebody on an airplane.  I don't know.  Suppose you are in a middle seat and you strike up a conversation with the person to your right.  Is that rude to the person you are talking with?  It would be pretty easy for the person on your right to give clues to you that they would like to end the conversation, though. 

The bigger question is the impact to the person on your left.  Suppose you are happily chatting with the person on your right for an hour or more.  How does the person on your left feel about that?  Should you ask them or just assume that you should limit your conversation, assuming the person on your left would be annoyed with an extended conversation? 

These questions of airplane courtesy are important because they bear a similarity to the question of VoIP on planes.  My take:  you should get a pretty solid read on what your seatmates are willing to put up with before doing any extended VoIP calls. 

What do you think? 

VoIP is Still Disruptive

There is one thing about VoIP fanatics that you can count on:  show them a "rule" and they will find a way to break it.  That's what Andy Abramson and Joanna Stern did last night.

American Airlines is launching a wireless Internet access service called Gogo, provided by Aircell, on some of their flights, providing unlimited Internet access for the duration of the flight for about $13 per flight. Unlimited, that is, except for this little gotcha from their terms of use:

"No Voice Applications.   You will not use any type of voice application (including, without limitation, voice over Internet protocol) without written permission from Aircell."

Various motives have been ascribed to Aircell for this restriction, including a desire to keep people from bothering other passengers by engaging in an interactive conversation with somebody not on the plane, or, more likely, a desire to preserve ridiculous profit margins on pre-existing in-flight telephone services.  Whatever the motive, Joanna and Andy were determined to break the rule.

Joanna Stern, News Editor for Laptop Magazine, was on an Aircell-equipped American Airlines flight last night, and decided to try a VoIP call, inviting Andy Abramson to join her using SightSpeed.  Well, Aircell blocked that call but it didn't stop Andy.  He kept trying, and guessed rightly that Aircell wouldn't be blocking Adobe Flash.  Knowing that Phweet's VoIP application used Flash audio, he invited Joanna into a Phweet conversation and they happily had an extended VoIP conversation for most of the remainder of the flight. 

This reminds me of those locked iPhones from last year...it wasn't long before there were a dozen or so work-arounds for unlocking an iPhone so that it could be used with a non-AT&T network.  Where there is a will, there is a way.

Kudos to Andy and Joanna for proving that you can't keep a good VoIP down.

The Fate of Over-The-Top Business VoIP

This week I've been exploring over-the-top business models for residential (Vonage) and business (8x8) markets.  Over-the-top residential VoIP services are really hurting right now, so it made me wonder whether over-the-top business VoIP services would follow suit.  The answer: yes and no. 

As commenters on this blog have pointed out, Vonage is hurting for several reasons:

• Vonage offers only VoIP service, and generally can't compete with the triple-play of VoIP, Internet Access, and cable TV services offered by the cable companies.
• Also, the cable guys do piggy-back marketing, where a single mailer sells all three services in the triple-play, which can reduce the cost of sales for the cable companies.
• Vonage doesn't own the network so they can't control the quality of the network, and the cable guys do, so Vonage VoIP services are sometimes lower quality than competing cable services. 

Vonage has had a few other mis-steps (patent lawsuits, bungled IPO, etc.), but I think the three bullets above capture the biggest causes of their troubles.

How many of these troubles transfer to 8x8, who is betting on the over-the-top business VoIP market?  Well, for one thing, the video part of the triple play isn't of interest to many businesses.  Yes, some businesses could use cable TV services, but not as many as Comcast would like.  I paid a visit to the Cablelabs campus recently, and yes, they had a half-dozen TVs in their lobby, but consider the context.  Having a TV blaring in your lobby just isn't a requirement for many of your larger businesses.  Restaurants? yes.  Barber shops?  yes.  Law offices? not so much. 

So, cable's triple-play assault on the business market will appeal to some market segments, but the attaction will not be universal.  My guess is that the triple play will get the most traction on the small end of the small-to-medium business segment, as measured by site size. 

However, businesses will be very interested in the double-play of Internet access and phone service.  That bundle has been finding traction for a good while now, as demonstrated by Cbeyond.  (In fact, Cbeyond has created a triple play of their own, adding wireless phone service to the traditional double play bundle). 

8x8, on the other hand, doesn't offer the Internet access piece.  Nor does 8x8 offer wireless phone service, though they do have a way for you to save money on international wireless calls with an 8x8 plug-in on some phones. (The software notices that you dialed internationally, and places a call to an 8x8 VoIP gateway instead of calling the destination directly, siphoning the minutes off to a cheaper network).  So, 8x8 doesn't offer the complete bundle like Comcast or a Cbeyond, and as a result they are at a disadvantage, but not as deep a disadvantage as Vonage, since many business customers don't care about video. 

The second big disadvantage for 8x8 is that they don't own their own network and don't manage the quality of the voice packets on the network.  That will be a problem for customers with skinny or congested Internet access services.  The inconsistent audio quality will cause some customers to be dissatisfied with the service, which will contribute to customer churn rates.

Net-net, once 8x8's subscriber base comes to be dominated by business customers instead of residential customers, I expect their churn rate to be lower than Vonage's but higher than Cbeyond's.  Churn will be lower than Vonage because business customers churn less by nature, and because the video part of the triple play doesn't have universal appeal in the business segment.   Churn will be higher than Cbeyond because Cbeyond manages quality and offers a broader bundle, while 8x8 does not manage quality.  The long-term prospects for 8x8's business VoIP service depend on how low they can drive their churn rate.  The lower churn goes, the higher 8x8's subscriber base will be. 

VoIP Business Models and Churn: Cbeyond versus 8x8

Yesterday, I voiced my fears that the residential over-the-top primary line replacement VoIP business model is dying.  SunRocket died last year.  Vonage is struggling now.  What are the chances that the illness afflicting over-the-top residential players may spread to over-the-top business service providers? 

The chart below shows some of the business model choices of VoIP service providers:

When deciding to offer VoIP service, one of your first choices is around your network.  Are you going to build your own network?  For the cable providers, this was an easy choice.  They already owned their own network and just needed to extend its capabilities a bit to support VoIP service.  The problem for most companies, though, is that they don't already own a network, and networks are very expensive to build.  So most VoIP service providers choose to use somebody else's network.

When using somebody else's network, there are two choices:

• You can pay a network owner to use their network to connect to your customers.  This usually takes the form of buying network access from an ILEC or CLEC on a wholesale basis, then reselling that network access to your retail customer.  CBeyond and Unity Business Networks do this.
• You can assume that your customer already has public Internet access, and that somebody else is selling that to the customer, so you can just ride that existing Internet link for your VoIP application. This is called an over-the-top VoIP service, and Vonage and 8x8 do this. 

For the service provider (and the customer) there are trade-offs in this choice.  For one thing, riding somebody else's network, instead of reselling it, is free, so the service provider sheds the entire cost renting somebody else's network to get to the customer.  The savings is passed on to the customer, but the customer is left to buy their own Internet access a la carte, so that eats into the savings from the customer's perspective.  The big negative, though, is that when your VoIP service provider rides somebody else's network infrastructure, the quality of the voice service is unmanaged. 

What does it mean when I say that an over-the-top VoIP service is unmanaged?  It means that packets carrying audio for phone calls have no priority of packets associated with web browsing, email, and file transfers.  A burst of non-voice traffic can cause voice packets to be delayed or dropped.  If your Internet access has limited capacity, or if your higher-capacity Internet access is sometimes heavily utilized, then the quality of your phone calls will audibly suffer.  Some over-the-top service providers try to compensate for this with technology that can adapt to packet loss, such as adaptive codec technology, but even this technology can't make up for a heavily congested Internet link.

Since business customers are often more demanding than residential customers when it comes to voice quality, many business service providers avoid the over-the-top business model, choosing instead to rent somebody else's network.  By doing this, the service provider gains control of the Internet access, and can prioritize voice packets over other kinds of traffic, so that the quality of phone calls can be preserved. 

However, renting somebody else's network definitely increases costs for the service provider.  Renting a T1 in most U.S. cities of any size, even on a wholesale basis, can cost anywhere from $100 to $400 per month, depending on the city.  Longer distances can cost even more. These costs have to be passed on to the business customer.   In addition to rental costs, the service provider has to deploy an Internet Access Device on the customer premise, and often has to perform internal wiring and phone installation services, so there is a big labor and equipment cost element.  So, if you want to control service quality for your customers by renting somebody else's network, you are buying into a lot of extra work and extra cost.

However, when it comes to customer retention, the extra cost of renting a network and managing quality can be worth it.  Network renter Cbeyond's monthly customer churn in the 2nd quarter was 1.3%, while over-the-top provider 8x8 had churn of 3.5%.

There are several factors involved in the disparity between these churn numbers.  For one thing, buyers of managed services are often larger and more stable, so they don't go out of business as much as smaller businesses that buy over-the-top services.  Also, 8x8's 3.5% churn number includes churn in their shrinking legacy residential customer base, which is higher than the churn rate in their growing business customer base.  However, I think the bigger factor is that installing infrastructure at your customer's site, and then managing that service, can increase the stickiness of the your service, because your customer knows you, has met you, and your customer knows that replacing you involves a lot of work on everyone's part.   Over-the-top service providers can be ditched pretty quickly, though...the customer doesn't even need to change their Internet access to make a switch.

Does that mean that 8x8's over-the-top business services are doomed to face the same issues as residential VoIP services like Vonage?  More to come tomorrow. 

The Death of Over-The-Top Primary Line Residential VoIP

I fear we are witnessing the death of over-the-top primary line residential VoIP.  The largest player in the space, Vonage, is spending $65M per quarter just to keep their subscriber base from shrinking.  Another large player, 8x8, decided at the end of 2006 to focus on a business product, and while their residential subscriber counts temporarily benefitted from the 2007 SunRocket bankruptcy, 8x8's residential subscriber counts are now declining.  Could it be that in order to survive in primary line residential VoIP, you need to own your own network and offer the voice-video-Internet triple play? 

From the beginning of the residential VoIP primary-line-replacement market, upstart competitors like Vonage and 8x8 have emphasized cost savings as the primary attaction for subscribers, with a wink-wink understanding that service availability and audio quality may not match plain old telephone services.

Today, this basic value proposition is under assault:

• Cost-sensitive buyers are being siphoned off by ultra-low cost VoIP services like Skype, which don't even pretend to be a primary line replacement service. 
• Middle-market and quality-sensitive buyers are being enticed by the higher audio quality of "digital cable" voice services (which are really VoIP services), along with a total cost of service savings on a bundle of voice, video, and high-speed Internet services.

This leaves Vonage in a pickle, as they try to retain subscribers while simultaneously trying to create a new and better product suite, one capable of winning new subscribers away from the cable companies. 

The deeper question, though, is for 8x8.  The company has been successfully re-focusing on business VoIP services since 2006, making their loss of residential market share less painful.  But cable service providers are now rolling out business VoIP services of their own.  Will the cable companies come to own the small business VoIP space, much as they have come to own the residential VoIP space?  Can 8x8's Virtual Office offering compete against the cable companies?   

Telecom Earnings Roundup

It's dangerous to read too much into short-term results like quarterly earnings, but it can be useful to try to inform your perspective on which long-term strategies are working, and which ones aren't.  Now that most of the public telecom companies have reported 2nd quarter earnings, it's time to speculate about what it all means. 

Rob Powell has an excellent summary of the winners and losers, here.  He concludes that colocation is hot, owning your own fiber is good, the slow economy is not having broad effect in telecom, and that competition among CDNs is heating up. 

Dave Rusin agrees with Rob Powell that Time Warner Telecom was one of the big winners, and gets more specific by saying that not just any fiber, but metro fiber is the big reason why TWTC is doing well. 

I tend to agree with both Dave and Rob.  Here are a few additional observations:

• Focus counts for a lot in telecom strategy.  Internap lost focus with its Vitalstream CDN acquisition, and it is showing in the company's financial reports.  The AOL-Time Warner merger was possibly the worst telecom merger ever, and the results were still dragging Time Warner Inc. down in the 2nd quarter, many years after the fact.
• Intellectal property can also count for a lot, these days.  That's part of why Skype and 8x8 are holding their own despite being "over the top" service providers, leveraging somebody else's network.  However, that doesn't explain why Limelight is doing well despite losing an intellectual property lawsuit to Akamai, and despite being hit with a second patent lawsuit by Level 3.  However, the Limelight intellectual property story hasn't reached its conclusion, yet.
• I agree with Rusin that metro fiber is a great asset, when connected to the right buildings.  I would say that copper is not completely dead yet, though.  Hybrid Fiber-Coax architectures still have some life left in them, and the cable guys are going to continue making noise, not just in residential markets but also in the small-medium enterprise market.  After all, the main difference between FiOS and the cable HFC architectures is where the optical-to-electrical conversion is done.  FiOS does the conversion at the home, while HFC architectures do it in the neighborhood.  Over time, the advantage goes to the passive optical networks due to lower operating costs and higher bandwidth ceilings.  However, here in 2008, the cost differences are not as clear.
• Competing on price alone is a difficult strategy, as shown by Cogent's earnings.  $4 per Mbps for wholesale Internet access is mighty low, and if the trend continues it will be hard to sustain the business on those kinds of prices.  Far better to have your own fiber and be one of a very limited set of service providers serving a building.  This helps you hold the line on prices in the long run.
• VoIP as an over-the top primary line residential replacement is nearly dead.  Vonage is investing $65M per quarter to win almost exactly the same number of subscribers as they lose each quarter, and Vonage is the main remaining over-the-top residential primary line replacement player.  The cable guys now own this space.

I made a list of 2nd quarter winners and losers, mostly cribbed from Rob Powell's list, but with few of my own additions for the companies I track that Rob does not.

Winners:

• Time Warner Telecom
• Global Crossing
• Equinix
• Savvis
• Switch and Data
• Comcast

Holding steady:

• AT&T
• Verizon
• Level 3 Communications
• XO
• Limelight
• 8x8
• Skype
• Cablevision
• Charter

Losers:

• Internap
• Paetec
• Akamai
• Cogent
• Vonage
• Time Warner Inc.

Time Warner, Inc., was a loser mostly because it was saddled with AOL, which posted disappointing results.  Now that Time Warner Cable is spun out, the cable unit will be evaluated on its own in future quarters. 

Telcos, Cablecos, and Bandwidth Leadership

In yesterday's post, we saw that the cable companies won the 2nd quarter 2008 battle for high-speed Internet subscribers, netting nearly four new subscribers for every one new subscriber added by the telcos.  And this happened even though the cablecos are at a supposed disadvantage to Verizon's new fiber-to-the home service.  Verizon can certainly offer faster Internet connections where FiOS is available, but it was clear in the second quarter that just offering the fastest connections wasn't enough to win more subscribers than the competition. 

Of course, the FiOS footprint doesn't cover all of the U.S. yet, so that's certainly part of the explanation as to why Verizon isn't winning more business.  As the FiOS footprint expands, Verizon will enjoy a stronger tailwind, helping it to turn the tables on the cable companies.  However, the 2nd quarter results show a cause for concern for Verizon's fiber-to-the-home strategy.

The cable companies won the 2nd quarter based on aggressive marketing, relying heavily on promotions and price competition to drive subscriber retention and growth.  And they succeeded, in spite of a growing perception that cable high-speed Internet products are slower than telco fiber-based Internet services.  It's as if the cablecos fired a warning shot over the bow of the telcos, saying that speed alone will not necessarily win the day, and that the cablecos are ready to fight tooth and nail to win and retain customers with all of the other tricks in the marketing toolkit.

The truth is this: while the highest-speed Internet services grab headlines and generate attention, most people arent' going to buy the highest-speed packages as soon as they become available in their area, reasoning that the a 20 Mbps (or higher) service isn't justified by the higher cost.  Verizon is viewed as the product leader for its FiOS service, and that perception counts, but product leadership by itself won't automatically create market-share gains for Verizon. 

I think that's part of why cablecos such as Comcast are taking their time in developing their own fiber-to-the-home answer to Verizon's FiOS service, and instead are opting to buy time with a "faster, but not fastest" DOCSIS 3.0 service on their existing hybrid fiber coax plant. They know that it takes more than just a headline-grabbing speed offer to win this game.    

Consumer Broadband Update

Now that all of the big telcos and cablecos have reported their second quarter results, it's time to update the trend reports on subscriber growth for U.S. broadband Internet subscribers.  There were two big stories in the 2nd quarter:

• Overall broadband Internet subscriber growth is slowing down, and
• Cablecos are adding a lot more subscribers than the telcos.

Here are the stats for the big six telcos and cablecos:

High Speed Internet Subscribers	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08
AT&T	12,861,000	13,300,000	13,800,000	14,109,000	14,600,000	14,693,000
Verizon	7,190,000	7,471,000	7,751,000	8,013,000	8,276,000	8,330,000
Comcast	12,432,000	12,438,000	12,888,000	13,586,000	14,078,000	14,357,000
Time Warner Cable	7,254,000	7,451,000	7,684,000	7,900,000	8,204,000	8,412,000
Cablevision	2,118,000	2,168,000	2,220,000	2,282,000	2,343,000	2,395,000
Charter	2,517,300	2,639,200	2,586,200	2,682,500	2,768,200	2,787,500

High Speed Internet Subscribers	1Q07	2Q07	3Q07	4Q07	1Q08	2Q08
Telcos	20,051,000	20,771,000	21,551,000	22,122,000	22,876,000	23,023,000
Cablecos	24,321,300	24,696,200	25,378,200	26,450,500	27,393,200	27,951,500
QoQ % Growth		2.5%	3.2%	3.5%	3.5%	1.4%

High Speed Internet Subscriber Growth	YOY Gain	%YOY Gain	QoQ Gain	%QoQ Gain
Telcos	2,252,000	10.8%	147,000	0.6%
Cablecos	3,255,300	13.2%	558,300	2.0%
Total	5,507,300	12.1%	705,300	1.4%

The 2nd quarter subscriber growth rate was 1.4%, versus 2.5% in the 2nd quarter last year.  The lower subscriber growth rate follows three consecutive quarters of subscriber growth above 3%, so the drop is abrubt and sudden.  What gives?

Many have been quick to point out that U.S. broadband subscriber penetration is approaching saturation, and that is certainly a factor, but I don't think it explains all of the drop.  I think some of it is related to a softer economy.  And, I think that some of the drop is seasonal, since last year's second quarter growth rate was lower than the three following quarters.

The other big headline is that the cablecos are kicking some telco tail in the high-speed Internet category, with the cablecos adding 558,300 subscribers in the 2nd quarter, versus the telcos 147,000 additions.  This is kind of surprising because Verizon's fiber-optic Internet service, FiOS, is widely regarded as a superior offering to the competing hybrid-fiber-coax-based services from the cable companies.  What's behind the cable victory in the 2nd quarter?

At least a couple of factors are at work here, but the big one is that Verizon's DSL services declined by 133,000 subscribers in the 2nd quarter.  It looks like FiOS is cannibalizing some of the DSL customer base.  I can't tell for sure from the 2nd quarter release but the spinoff of local exchange assets in three New England states may have also had an effect on this.   But AT&T also showed lower growth, so isolated Verizon events don't explain the overall trend.

The other factor in the cablecos' favor is that Comcast and the other cable companies have apparently ramped up their marketing efforts, and it appears to be countering the telco surge. 

It will be interesting to see the third quarter numbers to see if the cable victory in the second quarter was a fluke, and to see if the subscriber growth slowdown trend continues.   

Forbearance: Virtue or Vice?

Dave Rusin over at Telecom Straight Shooter has a series of posts about "forbearance," which is basically a fancy word for the FCC giving regulatory relief to incumbent local exchange carriers so that they don't have to sell wholesale access to their networks at regulated prices any more.  Mr. Rusin lines up firmly on the side that claims forbearance is a good thing.  Even though I usually lean libertarian and against regulation, this is one of a number of cases where I make an exception, and I generally don't favor forbearance. It's a tough call for me because there is some merit in what Mr. Rusin says.

Let's give Mr Rusin's arguments in favor of forbearance the floor first, with some excerpts from his posts:

• "Why I favor granting forbearance is that I believe it will provide an impetus to build out fiber optic facilities to homes and offices."
• "Here we are - it’s 2008, yet after 12 years of deregulation some 90% of business buildings are still served by one provider's infrastructure, that being Ma Bell."
• "Artificially regulating wholesale prices hinders growth, it does not encourage growth or investment."
• "The same FCC that denies forbearance is the same FCC that said cable company infrastructure is closed to competitors and new fiber deployments by ILECs are closed to others."
• "By granting forbearance, in the short term, wholesale prices will and should go up thus generating higher profits.  As higher profits are generated, new capital will flow into the market for a share of this new found profit opportunity."
• "Generating more true facility based competition in the long run will lower the price per bit to the consumer."

Mr. Rusin also makes the argument that the U.S. is falling behind in the global broadband race, and he blames the FCC's forbearance policy for reducing the incentive to invest in new facilities.

I get that...there is some basis for the economic argument for forbearance.  However, I'm still glad that the FCC denied Qwest's latest forbearance petition.  Why? 

Several elements are largely missing from Mr. Rusin's arguments:

• Network construction is a capital-intensive business, so there is a large barrier to entry for any would-be facilities-based competitor: how do I raise the capital necessary to construct a network to compete with the incumbent, expecially when that incumbent has a network that has already been bought and paid for during the monopoly era?  That's the real reason why facilities-based competition has been largely limited to cherry-pickers that mostly target large office buildings for fiber optic deployment, or cable companies that originally paid for their networks with non-telephony services like cable TV, or wireless access options.   It has been hard to cost-justify new wireline network deployments when your incumbent competitor has already paid for their network. 
• Today, regulated wholesale access to the ILEC networks is largely focused on yesterday's technologies:  twisted pair copper and circuit switches.  Competitors who want to advance into today's technologies (fiber optics and routers) have to deploy their own facilities or buy wholesale access on an open and unregulated market, for the most part.  In many cases, regulated wholesale pricing on the old copper plant is not stifling investment in new fiber optic infrastructure. Rather, many companies are investing in fiber optic deployments where they make economic sense.
• The reason the Telecom Act of 1996 and the FCC mandated wholesale access to the copper plant was because the plant itself was built on the backs of American consumers and businesses through a government-granted monopoly.  This is quite different from the cable plant (which was built by private entrepreneurs) and the newer consumer fiber optic deployments such as Verizon FiOS.   The government should not mandate wholesale access to cable networks or to the newer fiber optic networks because they were not built based upon monopoly economics.  However, the old copper plant was built on a government-granted monopoly and it remains the only ubiquitous phone network in the country, for the time being.  Wholesale access to this national resource is necessary while alternative neworks are constructed and deployed.
• The FCC's test for whether to approve a forbearance petition is based on the development of significant competition in the market for which forbearance is requested.  The objective is to make sure that consumers and businesses are protected against the kinds of price increases that result from monopoly economics.  In the recent Qwest case, the FCC rightly found that insufficient competition had developed to provide adequate consumer and business price protection.

In the end the root of the problem is this:  if you've got one circuit of limited capacity connected to a building, then there is often insufficient incentive for a competitor to deploy a second circuit to that building, because the competitor will have to either charge less than the incumbent (usually not enough to pay for the network deployment costs) or provide a much better service (usually more capacity) in order to win the customer away from the incumbent.  In order for the competitor to change their minds and deploy a second circuit, they need one of two things to happen:

1. Prices need to go up enough to justify the new circuit deployment, or
2. Demand needs to go up enough for the customer to want a newer and higher capacity circuit (for which we presume the customer would have a greater willingness to switch providers and pay a higher price)

While providing forbearance relief will result in higher prices, I don't think the prices will be sufficiently higher to suddenly justify a new fiber optic deployment to just about any building. That's why Verizon's FiOS isn't being deployed over the entire Verizon footprint...Verizon knows that they will never get an appropriate return on investment by deploying to some locations. 

Instead, I think it is the relentless increase in bandwidth demand that will cause more and more buildings to merit fiber optic deployment... and we are seeing this happen, with Verizon's FiOS deployment as exhibit A.  These kinds of new fiber optic deployments will continue, with or without the FCC granting forbearance.   

Meanwhile, why continue to deny forbearance? 

• It encourages the development of competitive service providers, some of whom have gained enough critical mass to raise the necessary capital to invest in their own facilities.  I hope more competitors reach that critical mass.
• It ensures low-cost access to basic telecommunications services for consumers and small to medium sized businesses.
• It prevents incumbents from reaping an economic windfall from a network that was paid-for by the monopoly telecom era.
• It does not impede deployment of new fiber optic networks in any significant way.

No doubt, the day will come, and should come, when forbearance petitions will be customarily approved.  That day should wait until competition has a stronger foothold, in my view.   

The Gift Of Work

After a five year stint during which I divided my time between consulting, family, and non-profit work, I have decided to return to the full-time work force.  I have been privileged to find fun part-time work with some terrific clients for the past five years, and it enabled a once-in-a-lifetime chance to spend a ton of time with my two boys as they grew into their teen years.  The past five years have also given me the freedom to help raise over $1M in donations for Global Hope, a charity providing homes and care for abandoned and orphaned children in Romania and Kenya.  However, it is time to turn the page. 

Some of you probably suspected that's what I was preparing to do when I started this blog last October, and if so, you guessed right.  But you are probably wondering why I would choose to work full time again, when a great many people would gladly jump at the chance to make ends meet by working part-time. And it's true, there have been wonderful benefits from being the master of more of my own time.  The time I have spent with my family has been priceless.

So why change it?  For me, it's about being put to my highest and best use.  How can my time on this earth be best spent?  It's a question I ask myself all the time.  Five years ago, the answer was simple: my kids were 8 and 11, my wife wanted to start a new career, and a non-profit that has done a world of good for dozens of children was in desperate need of new leadership.  I weighed those opportunities against the opportunity to continue in a senior role at Level 3 Communications and, with a ton of support from colleagues at Level 3 and from my friends, I launched into a part-time consulting practice as an interim phase allowing me the time to focus on other needs.

Now, the boys are 13 and 16 and my wife is established in her career and new leadership is ready to take the reins at the non-profit, and I'm itching to get back into full-time work in telecom.  To be totally honest, I think that work is a gift, and I've missed it.

I discovered telecom early in my work life, and it was a truly lucky find for me.  Not everyone gets to work in a job that they love.  Sure, there were days when the work wasn't fun, and sometimes those days turned into weeks and months of drudgery, but more often than not, I was excited to go to work.  My telecom roots are with MCI and Level 3, companies with reputations as upstart competitors, which suited my personality well.

But why not just stick with part-time work?  The truth is that part-timers are never really full members of the team, and that daily interaction with a team that you respect and admire is a big part of the reward I get from working.  Also, part-timers often don't have full ownership of a task or function.  I miss that, too.  Lastly, I'd be telling a white lie if I left out the fact that I am looking forward to the full-time paycheck.

So, sometime between here and January, I hope to join a great team and put my shoulder to the wheel again.  If you are interested in talking with me about an opportunity, please contact me at ike@practiq.com.

      

Level 3 Takes The Lead In Revenue Per Employee Race

Of the nine companies I track in the "revenue per employee" metric I started a few weeks ago, it looked like Equinix was the leader at nearly $189,000 per employee.  However, in a comment on this blog, Paolo Gorgo points out that with Equinix's latest quarterly financial report has trimmed the company's revenue per employee to about $169,000 per employee per quarter, propelling Level 3 Communications into the lead with its $179,715 per employee per quarter.  Thanks, Paolo, for the alert!

Vonage Improvement Not Enough To Escape Danger

Vonage reported second quarter earnings this morning, and posted better churn numbers than last quarter, down to 3.0% monthly churn now.  Churned subscribers nearly completely offset 230,832 gross subscriber additions, yielding a net gain of 2,080 subscribers for the quarter.  Last quarter, churn was at 3.3%.

We are seeing the effect of the churn ceiling in action, here.  At a 3% churn rate, and with average gross subscriber additions of 230,000 per quarter, Vonage will hover right around their current 2.6 million subscriber count, indefinitely.  And, if recent trends hold, it will cost Vonage agout $65M per quarter in marketing expenses just to keep their subscriber count at the 2.6 million level.

That's why it's so important for Vonage to either reduce churn more, or win more subscribers per marketing dollar, or both.  Vonage has pinned their hopes on new CEO Marc Lefar to get the job done, since he has a good record of churn-fighting at Cingular.  I hope he succeeds, but honestly, I'm skeptical that anybody can turn Vonage around and restore it to its high-growth glory days. At this point, mere survival is a win for Vonage.

Level 3's Business Markets Group

Following up on Dutch's Friday comment about Level 3's Opex Margins and Revenue per Employee:

"A much more useful discussion would be: given Level 3's current revenues come from business units that are almost exclusively wholesale in nature and given the Company's need to grow revenues in the corporate / enterprise segment, what happens to Level 3's cost structure & OpEx margin (and yes, Revenue per Employee) if it's to be successful in growing it's presence in the Corporate/Enterprise segment?"

Good question.  I think you have to start with looking at how much of Level 3's revenue comes from the business markets group, as of the 2nd quarter:

BMG is about 25% of Level 3's revenues right now.  Last quarter it was 26% of revenues.  So, the current trend is not toward BMG becoming a much bigger slice of the pie, but let's suspend disbelief for a few minutes and assume that Level 3 is successful in achieving significant growth in the BMG in the future.  What might that mean to Level 3's Revenue per Employee?

I don't think it will make much of a difference, to be honest.  Even if you assume BMG revenue doubles over the next two years, to $482M per quarter, and even if you assume the BMG is only as efficient as Time Warner Telecom's $111K quarterly revenue per employee, and even if you assume that Level 3 achieves no additional efficiencies in revenue per employee in any of the other three market groups, I think you still get something like only an $8K drop in Level 3's overall quarterly revenue per employee.  I think this scenario is also wildly unrealistic.

A more realistic scenario would assume that Level 3 makes gradual gains in efficiency in all four of its market groups, and that each market group contributes annual revenue growth of 11% plus or minus 4%.  In that kind of future, Level 3's revenue per employee can be expected to continue to grow, even if BMG becomes a bigger slice of the pie.

Digging Deeper on Level 3's Revenue Per Employee

Last week we saw that Level 3 Communications' revenue per employee is approaching $200K for the first time in the company's history, and we saw that this is a whole lot higher than Verizon and AT&T, both of whom have about $100k in revenue per employee.  However, comparing Level 3 to AT&T and Verizon on this metric isn't really all that useful, as Dutch Brinkert pointed out in a comment on Friday's post.  As Dutch put it:

"Interesting analysis although I'm not sure these numbers (revenue per employeee) really surprise nor are meaningful when you take into account the differences in the business models between LVLT which has a relatively small number of customers who each generate relatively large amounts of traffic/revenue compared to T and VZ who both derive signifcant revenue streams from many, many customers who individually generate comparatively little traffic/revenues and require lots of hand-holding (think of all the folks working down at your local Verizon Wireless or AT&T store working to support your $100 a month wireless bill and your kids $5.99 a month unlimited text package).

Because LVLT has the vast majority of it's business in wholesale markets (Voice, transport, CDN, IP) one would expect their revenue per employee to be higher than T and VZ and suggesting that a measure like this represents a valid measure of managerial effectiveness is superficial."

Dutch makes a great point: it's hard to compare revenue per employee across wholesale and retail business models in any meaningful way, and that the metric is maybe not such a great measure of managerial effectiveness.  And I don't suggest that is is a good measure of managerial effectiveness.  However, revenue per employee does give us a peek into the employee productivity that should be expected from different telecom strategies. 

Level 3 took a largely wholesale approach early in its history, selling bandwidth, internet, colocation, and voice services to large carriers, service providers, and media/content companies.  The company only added a business markets group to their portfolio when they saw that Verizon and AT&T were consolidating many of their would-be customers, and that T and VZ planned to continue their vertical integration strategy, making it highly unlikely that they would outsource much of their network business to Level 3.  So, Level 3 pragmatically decided to buy more metro assets and business customers and created their own business markets focus.

Over time, if Level 3 is successful in growing their Business Markets Group, it might serve to dilute the apparent efficiencies Level 3 is enjoying in the form of low SG&A costs as a percentage of revenue, as compared to some of their peers.   However, I am guessing that even if Level 3 is successful in business markets, the dilution in revenue per employee will not be so severe that SG&A efficiency ceases to be an advantage for Level 3.

SG&A efficiencies, as measured by metrics like revenue per employee, derive from several sources.  Yes, wholesale strategies, in scale, should be more efficient than retail strategies, but more broadly, the source of SG&A efficiency is focus.  A focused strategy, in which the product suite is carefully guarded against bloat, and in which the sales force carefully targets their customers, can really help to contain expenses.   

To illustrate, let's look at how a few other Level 3 competitors stack up on the revenue per employee metric:

	Employees	Quarterly Communications Revenue (millions)	Quarterly Revenue Per Employee
Equinix	911	$      172	$188,804
Level 3	5,965	$   1,072	$179,715
Global Crossing, Limited	4,936	$      630	$127,634
Cogent	431	$        52	$120,650
Time Warner Telecom	2,859	$      318	$111,228
Paetec	3,900	$      404	$103,590
Verizon	235,000	$ 24,124	$102,655
ATT	310,000	$ 30,866	$ 99,568
XO	4,416	$      361	$ 81,748

Note: For companies on this list other than Level 3, AT&T, Verizon, Paetec and Equinix, revenue is from the first quarter because the companies had not yet announced actual second quarter earnings yet.  I did use Paetec's estimated 2nd quarter revenue range from their announcement last week to estimate revenue per employee for Paetec. 

Equinix tops the list with $189K in revenue per employee.  The company bill itself as "the leading global provider of network-neutral data centers and Internet exchange services for enterprise, content companies, and network service providers."  So, like Level 3, they are not entirely wholesale, but largely so, and they are certainly focused in their strategy.

Level 3 does well, though, in the revenue per employee metric, when compared against a broader group of companies.  I think this due to their largely wholesale focus and their tighter product and sales focus.   

The further down the list you go, the lower the revenue per employee.  Also, as Dutch pointed out, you get more retail focus lower on the list.  I'd also point out that as you go further down the list, you generally get a broader product portfolio and/or sales focus.   

I believe Dutch correctly diagnosed the primary cause of the disparity between Level 3 and AT&T in revenue per employee: wholesale versus retail strategy.  I think that you can generalize that even further, though, and say that companies with a tighter focus should rise in the revenue per employee rankings.

Dutch asked a number of other excellent questions in his comment on Friday's post, so I encourage you to check it out.  I'll try to offer some opinions on them later this week.   

8x8 Continues Successful Makeover

VoIP provider 8x8 announced earning yesterday, and it is clear that they are continuing a successful transition from consumer VoIP services to business VoIP services.  Revenue held steady at $16.3M last quarter, the same as the previous quarter, but the revenue mix continued to tilt more toward business services, so margins and earnings improved.

The company shifted their focus to business services in December, 2006, so we have had about a year and a half to see how the strategy shift is working.  The chart tells the story...consistent growth in the higher-margin business services, offset by a gradual shrinking of the consumer VoIP base. 

The chart below shows that business services now account for 56% of of overall 8x8 revenues:

Churn is also improving, though it is still too high at 3.5%. 

Kudos to 8x8 for recognizing early that the consumer VoIP market would become a competitive meat-grinder, dominated by the multi-service cable bundles.  8x8 was smart to shift to business services.

Level 3's Revenue per Employee Beats AT&T, Verizon

Yesterday, we saw how Level 3's communications revenue per employee is approaching $200K for this first time in the company's history.  That's good news, but how does it stack up against Level 3's competitors?

Level 3 often compares itself to AT&T and Verizon as national telecommunications companies, though when you really look under the hood there are vast differences between Level 3 and the big telcos.  For one thing, Level 3 doesn't have any consumer businesses, plus Level 3 doesn't sell any wireless phone service.  Where the companies do compete head to head is mostly in business telecom services and in wholesale.  Plus, when you compare revenues, Level 3 looks tiny in comparison to AT&T and Verizon. 

However, when you look at revenue per employee, Level 3 looks pretty good:

	Employees	2Q08 Communications Revenue (millions)	Quarterly Revenue Per Employee
ATT	310,000	$           30,866	$        99,568
Verizon	235,000	$           24,124	$      102,655
Level 3	5,965	$             1,072	$      179,715

Why should it be that Level 3 is generating close to twice as much revenue per employee as the biggest carriers?  Shouldn't the greater scale of AT&T and Verizion create more efficiency, and better revenue per employee that Level 3? 

More to come next week...