Whither the Phone Company?

There's something unsettling about being witness to the precipitous drop in status of a person or institution. Imagine a world in which "E Street Band" appears on a beer-stained flyer four times the size of "Bruce Springsteen." Or a future in which literature professors compare the cultural significance of the works of Dostoevsky with those of Danielle Steel. Or how about a dimension in which dogs walk people? You get the idea.

Alas, such is the fate of the once-venerable voice service. Time and progress have a way of turning things on their heads, and today voice, the dominant source of revenue for some of the world's largest corporations for the past 100 years or so, is no longer able to pull its own weight. Staggering declines in subscriber pricing over the past few years have brought us to the point where revenue generated from voice just isn't enough to pay the bills anymore.

SunRocket's disconnection a few weeks ago was just a harbinger of things to come. The VOIP startup was among the first to bite the dust because of its modest subscriber base, some 200,000 customers. Larger phone companies, temporarily enjoying larger economies of scale, will hold out a little longer; their fates, however, are similarly sealed. The one-trick pony known as the phone company is being marched to the far end of the coral as you read this, shortly to be put out of its misery.

Of course, this does not mean the end is nigh for the likes of AT&T Inc. (NYSE: T), BT Group plc (NYSE: BT; London: BTA), Telefónica SA (NYSE: TEF), and Verizon Communications Inc. (NYSE: VZ); it only spells the end of their business models. And in the latest report from Heavy Reading, Network Transformation: Moving Class 5 Services to IP Networks, we consider the ways in which these telecom giants plan to conquer the world of entertainment and data services, with traditional voice services, at best, tagging along behind.

Telecom operators have been tracking the demise of business-as-usual since the first voice call was placed on the Internet more than a decade ago, and ever since they have been rapidly (by telecom industry standards) transitioning their service portfolio from a solo performer into an ensemble cast. While voice will be no less important to the lives and businesses of subscribers in the future, it will be packaged with a host of other digital services, such as IPTV, which stands to be a greater source of profit for operators than voice.

The fate of the phone company has long been tied to a struggle for supremacy between the two major motivators driving operators to move subscriber services to IP: reduced operating expenses and additional revenue through new services. In VOIP's early days, the prospect of opex reduction was enough to induce some service providers to essentially trade out their TDM-based infrastructure for an IP-based one. This transformation was, by design, largely transparent to subscribers, enabling them to retain familiar features and even aging handsets. This initial attempt to deal with the drastic price reduction in calling plans was based on the premise that service providers could continue to make money by offsetting revenue losses through an equal or greater reduction in opex.

In the past year or so, however, some operators have come to question the financial efficacy of this strategy. The premise behind it is sound: An IP transformation has been proven over the years to offer some degree of improvement in annual opex – though a consensus regarding the significance of that improvement has yet to be reached, and is at least subject to fluctuations from carrier to carrier. However, it is also true that any opex saved through the decommissioning of TDM switches must come at the cost of capital outlays for replacing narrowband access equipment. While carriers are certainly anxious to reduce opex, the up-front expense related to access infrastructure investment changes the equation for many carriers, forcing them to delay or even suspend TDM replacement plans.

On reaching this point in their transformation project, some carriers begin to look toward additional revenue sources as the primary driver behind their network renovations. Several operators have already concluded that if they are to take on the expense associated with infrastructure upgrades, it makes the most sense to build a new network that is capable of delivering more than basic – or even enhanced – voice services. This was the motivation for major recent IP transformation projects such as AT&T's U-verse and Verizon's FiOS. Competitive reality also factored into these decisions: What sense did it make to rebuild a network to offer a single service when competitors, such as cable operators, were offering subscribers a package of services?

The answer to this question was obvious for telecom operators, and they chose to relegate voice services to simply one type of IP traffic that can be easily inserted into a broadband data stream. In some cases, voice is considered the least-important component of a multiservice offering, almost an afterthought to lucrative entertainment and data services. Which ends the ignoble decline of voice from headliner to lemming – and spells the subsequent extinction of the telephone company.

This does not mean, of course, that one or more service providers will not figure out a way to earn billions by delivering voice services exclusively. Given the differing demands of the billions of potential subscribers around the world, it would be naïve to think that at least one enterprising player couldn't come up with a voice-only offering that would attract enough attention to make the business model viable.

For the most part, though, voice faces a future in which it has been bumped from first-chair violin to second fiddle... or third... or even fourth.

– Joe McGarvey, Senior Analyst, Heavy Reading

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