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Broadband in Europe: Revenue Machine or Trojan Horse?

Europe's broadband markets are growing faster than anyone predicted two or three years ago (see HR Tracks Europe's Need for Speed). Service providers, vendors, and (dare I say it) many analysts have consistently undercooked their forecasts.

In 2004, service providers in Western Europe added an astonishing 15 million broadband customers, a 65 percent increase year-on-year. In 2005, 20 million more will climb aboard the broadband wagon. By the middle of 2007, about half of European households will have some kind of broadband connection.

It's not the first time a market has confounded expectations by growing more quickly than anyone anticipated. In 1990, when the European cellular mobile market was just hitting the elbow in the growth curve, pundits were predicting that cellular penetration would top out at around 40 percent or 50 percent of the population. But the market, driven by pre-paid mobile price packaging, just kept on growing and growing, and now almost everyone in Europe except the very young and the very old has a mobile phone.

So it is with broadband.

Some still argue that there natural limits on broadband penetration, defined by price, reach, and, above all, PC ownership. Yet all of these "natural" limits are being circumvented. Prices are falling fast in many countries, and new price packages based explicitly on the mobile "pre-paid" model have been successful in Germany, Italy, and the Netherlands, amongst others. DSL can reach over 90 percent of households in most countries. And PC ownership continues to rise, driven by much lower PC prices, easier to use operating systems, and, of course, broadband itself: For the average household, broadband Internet is the single most compelling reason to own a PC. And for the most determined hold-outs, pioneering triple-play operators like FastWeb are developing a big segment of customers that don't own a PC at all.

As a result, it's now a near-certainty that every European household that has a line of some kind will ultimately be a broadband customer – and in our view, that means 90 percent of households will be broadband households by (at the latest) 2015.

By any measure, that is a huge opportunity for vendors, service providers, and Europe as a whole. Yet universal broadband also presents an enormous challenge, and it's a challenge that must be addressed if European service providers are to fully reap the rewards of the broadband revolution.

Simply stated, carriers are challenged to prevent overall direct revenues from fixed-line services from falling over the next five to 10 years.

In many European countries, the market for business communications services is already flat or even declining, despite the fact that, on any reasonable measure, business communications has got much better in the past five years. Enterprises have simply replaced legacy services based on leased lines and expensive managed data offerings with lower-cost services based on IP and the Internet.

The dilemma ahead is that this decline could spread to the much larger residential market.

For now, the huge rise in broadband customers is masking an alarming decline in broadband pricing, as lower costs, regulatory pressures, and intense competition conspire to shrink monthly ARPU (average revenue per user). Visit any given selection of broadband service provider Web pages and the value proposition in most European countries is crystal clear: downstream speed versus monthly price. As we note in the most recent Heavy Reading report – Next-Generation Broadband in Europe: The Need for Speed – many providers are increasing the speed in the hope that this will stabilize prices or persuade customers not to trade down to cheaper packages. Yet that is at best a temporary (if unavoidable) fix in a price-led market.

The other element in fixed network revenues is, of course, telephony. Yet here the dilemma for full-service providers is even starker, because VOIP over broadband will – explicitly or implicitly, depending on price packaging – reduce expenditure on telephony. And since telephony remains the most important source of "usage-based" revenue in fixed-line communications today, its loss will contribute to an absolute decline in fixed-line revenue unless it's replaced by something else.

From this point of view, those offering flat-rate VOIP as part of a triple-play broadband package could end up having the same impact on European fixed-line networks that the Trojan Horse had on Troy. To be sure, it may improve the revenues of individual providers, and perhaps reduce churn. But it certainly won't improve market revenues as a whole.

Unfortunately, VOIP cannot be sidestepped or ignored; at the recent CeBIT Show in Germany, it was the acronym du jour. Dozens of small companies from China, Taiwan, and elsewhere were displaying shelf-loads of low-cost Skype phones, mikes, and other VOIP paraphernalia that will (or should) have chilled the marrow of established telcos and their providers.

So what's the solution? For most, there's a one-word answer: video. Just about every broadband provider of any size in Europe is either already offering video services, or is planning to do so this year. Video on demand and broadcast TV are attractive because telcos and other BSPs don't provide those services today, and it therefore represents an entirely new source of revenue. Moreover, it's seen as essential in the battle to combat a rejuvenated European cable TV industry.

Yet the economics of telco video are problematic. In some countries, such as Germany and the Netherlands, customers are used to very low-cost, multichannel TV. And everywhere, content owners must be paid, putting margins under pressure. The truth is that, on any reasonable estimate, video revenues won't replace legacy telephony revenues, and certainly won't replace telephony margins.

In reality, European telcos and other broadband service providers must stop obsessing about video services and the triple play, broaden their minds, and think harder about the overall context in which applications are developed. In particular, they need a platform such as the IP Multimedia Subsystem (IMS), which offers a better basis on which to build, deploy, support, and charge for a wider and wider range of new high-value applications.

— Graham Finnie, Senior Analyst, Heavy Reading, is author of the report, Next-Generation Broadband in Europe: The Need for Speed.

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