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Next-Gen Telcos: Take Your Partner

Modern telecommunications is full of paradoxes, and nowhere more than in the disconnect between investment and revenues. Big telcos are continuing to invest huge sums in their networks: In 2007, five fairly representative telcos – Verizon Communications Inc. (NYSE: VZ), Orange (NYSE: FTE), KT Corp. , NTT Group (NYSE: NTT), and Telia Company – spent a whopping $50 billion among them, mostly on the construction of next-generation access and core networks. Yet ask them what new service revenues that investment will support, and things start to get pretty vague. If things stay vague, the long-term survival of big telcos is in doubt.

One thing is clear: Future growth won't come from today's core money-earners, telephony and Internet access.

Let's start with telephony. Its decline is an established and accelerating trend in wireline networks – especially for the big incumbents. Last year, for instance, France Telecom saw its base of retail consumer lines in the intensely competitive French market fall from 23.2 million to 17.7 million, as customers deserted to other providers that are typically offering VOIP-oriented packages. FT's wireline telephony usage revenues fell from $2.7 billion to $2.2 billion over the same period.

But that decline is now starting to hit wireless, as well: In the six months to September 2007, Vodafone Group plc (NYSE: VOD) saw voice revenues in its four core European territories decline from £7.4 billion to £7.2 billion, and because (like all cellular operators) it is even more dependent on telephony than its wireline peers, Vodafone's revenues barely rose in real terms over this the period.

The dismal telephone message is not lost on telcos. In a survey carried out for our latest report, "Reinventing the Telco: A Heavy Reading Progress Report," we found that 91 percent of the 361 industry respondents (including more than 130 telco respondents) do not believe that telephony will survive as a standalone service.

That vote of no-confidence means that telcos are putting all their hopes for the future in a broader package of services, usually including Internet access and IPTV – the much-vaunted triple play. In fact, our survey found that almost half of respondents expect complex packaged services of this type to be the biggest source of telco revenue in five years' time – far from where it is today.

But can triple play really get telcos out of the revenue hole? In broadband access, ARPU is down in many territories as a result of price-led competition and lower-cost inputs, while new customer acquisition is slowing as many networks saturate. Competition between flat-rate broadband wireless and wireline packages is also beginning to bite. It would be foolhardy to expect vanilla Internet access not to follow the same ARPU and revenue decline as telephony as it matures. In the most advanced markets, that decline is already underway.

That leaves TV and content, where telcos have high hopes but little reason to expect the moon. Consumers spend a lot less on entertainment than they do on communications, and it would be rash to imagine that telcos will miraculously invent a new range of services that induce customers to spend far more on entertainment than they do today. Moreover, consumers have an increasing appetite for free entertainment – but telcos are still at ground zero when it comes to advertising revenue, which they themselves recognized in our survey.

Small wonder that most big, established telcos are seeing low growth – or in most cases, no growth at all in real terms, at least in developed markets. Only where incumbents have acquired telcos in still-developing regions, or are being artificially buoyed up by excessively lenient regulation, is there any real growth going on. Neither prop will be there for long, and these short-term remedies are simply putting off a gaping revenue hole that all telcos will be looking into in the not-so-long term.

What to do? It would be foolish to imagine that there is any magic button telcos can press to stop the slide. Yet there are ways in which they can at least begin to address the issues. Most of all, we believe, they have to be much more open to working with third parties that can help them realize the value locked up in their assets.

In this regard, the single most encouraging data point from our survey came in answer to a question that asked telcos to name the factors that would be most important to their future success. Top of the list for telcos – higher than a rapid transition to all-IP NGNs, or fixed/mobile convergence, or launch of new services and content – was partnering with third-party service providers. That is both surprising and heartening, as it suggests that the average telco is at last getting the central message that must define their future: You cannot act alone.

But recognizing what needs to be done and executing that effectively are two very different things. For big telcos especially, partnering is not a core skill, and expectations may not be realistic for what it can bring.

Most telcos have recently come to believe that they can and should persuade third-party service providers to pay for a variety of telco service "enablers." Our survey found that telcos think the most important enablers are the ability to bill, authorize, and identify customers, but they cite a range of other assets that they could sell to Web-based service providers, including security, per-application or per-subscriber QOS, presence, location, knowledge about subscriber devices, and high-level exposure of call control and other specialized software.

Whether those third parties will actually pay to use these resources remains a distinctly open question. There is a huge amount of bridge-building to be done, much mutual suspicion to overcome, and above all a need for some real, successful case studies. Yet telcos do have one strong suit: a proven ability to get customers to spend money, something that most Web-based service providers, including vaunted newcomers such as Facebook , have barely begun to demonstrate. If the telco ability to sell, bill, and add revenue-earning features to services could be effectively melded with the ability of Web-based entrepreneurs to create compelling service ideas, the benefits could be felt throughout the service value chain.

In the end, the future of telcos, at least in wireline, probably does rest in their ability (or lack thereof) to sell new kinds of capabilities to consumers in partnership with the hugely creative industry that has grown up on the Web. If they can't or won't do so, it's hard to see any future for them that doesn't involve divestiture, acquisition, consolidation, and breakup. The stakes are high, and either way, we at Heavy Reading will continue to track this story as it unfolds.

– Graham Finnie, Chief Analyst, Heavy Reading

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