The rise of virtualization shifts value from hardware to software but the business models for pricing that are far from clear.

December 15, 2014

4 Min Read
Telecom Faces Virtualization Pricing Issue

Concerns about capex cuts by big telecom players such as AT&T and Verizon are already hurting hardware/software vendor stocks in the US, but a bigger issue is looming for the entire telecom industry that could have greater long-term impact if not addressed.

With the advent of virtualization, much of the functionality and intelligence that drive value in the telecom vendor world are moving from hardware to software -- that is a reality the industry has already accepted. What isn't yet clear, however, is how the pricing of software will change in the new world of SDN and NFV, and how vendors formerly dependent on the sale of hardware will have to transform their business models.

Following his keynote at Light Reading's Mobile Network Secure Strategies event in early December, AT&T Inc. (NYSE: T)'s Chief Security Officer Ed Amoroso noted that his company expects to pay its security system vendors differently for using virtualized security software deployed in micro-domains throughout its network instead of hardware-based security devices. (See AT&T Adds Virtual Layer of Security and AT&T's New Security Strategy.)

But Amoroso admitted that it isn't yet clear exactly what that new payment model will look like and that this is something AT&T will be working out with its vendors in a way that is fair to both sides.

That dilemma also exists elsewhere in the telecom food chain as vendors are investing heavily to move to virtualization but aren't yet certain how virtual network functions (VNFs) will be priced, notes Caroline Chappell, Heavy Reading 's principal analyst for cloud and NFV.

It's a topic that came up multiple times at Light Reading's 2020 Vision Executive Summit in Iceland last week -- where specific conversations were off-the-record.

"There are issues today around pricing in general," Chappell notes. "One of the issues is basically what proportion of the cost is being charged for virtual function as compared to physical functions bundled with physical hardware."

Get up close and personal with vendor NFV strategies in our NFV elements channel here on Light Reading.

One of the reasons that network operators are looking to virtualize many functions in software that can run on commercial off-the-shelf hardware is to reduce their dependence on telecom-specific gear that is more expensive, both to buy and to operate, as well as less flexible.

"What you are hearing about are the business models that operators are expecting from vendors," Chappell notes. "What's awkward -- what the market is struggling with -- is that a company doesn't expect to be charged the same price for a virtual IMS as it pays for a physical IMS. But from the vendor perspective, the technology investment is still there."

The worst-case scenario, she says, is a dramatic drop in the overall value of the telecom vendor sector. The Heavy Reading analyst believes, however, that the industry will seek -- and hopefully find -- ways to make up for that.

One approach is to build new services on top of the software products, which could include NFV consultancy, migration, integration, orchestration and outsourcing -- all things with which service providers will need assistance.

Chappell points to Ciena Corp. (NYSE: CIEN)'s recent move to offer a virtual network functions marketplace as part of its broader move to software as an example of adding additional services to the software sale. (See Ciena Amps Up Software Play, Attacks VNF 'Agility Gap'.)

"Building more services on top of your products is one way to add value," she says. "In the software world, it's hard to add new features to a 'standardized' virtual network function such as IMS or a vEPC [virtual evolved packet core for mobile networks]."

Vendors can add value around such things as performance implementation, pricing flexibility, interoperability and ease of management, but not all aspects of these things will entirely be under the vendor's control, Chappell notes.

"Vendors may also add value through ecosystems -- the aggregation and integration of a broad variety of third-party VNF providers that operators would find it time-consuming to engage with and integrate themselves," she says. A number of vendors are already doing this, including Alcatel-Lucent (NYSE: ALU), Brocade Communications Systems Inc. (Nasdaq: BRCD), Cyan Inc. , Ericsson AB (Nasdaq: ERIC) and Metaswitch Networks , among others.

But Chappell admits the industry still has considerable work to do to determine what the new business models for vendors will look like and how some companies can avoid seeing much of their existing value shrink dramatically. It's an issue that the entire industry has a considerable stake in resolving.

— Carol Wilson, Editor-at-Large, Light Reading

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