Telus and Bell have confirmed they’re in merger talks, after BCE earlier announced it was mulling over its options earlier this Spring. Both companies are weakened by declining landline revenues as competition from Wireless and the Cable Guys and, to a lesser extent pure-play VoIP contenders, is heating up. This makes a lot of sense, but probably not for the reasons that your average reporter would think.

It has been known for some time that CableCos would move into the voice business, which thanks to VoIP and their co-ordinated efforts through PacketCable, was almost trivially easy to accomplish. Both of Canada’s major telecom service providers find themselves in a major uphill battle.

This slide, from Telus’ August 2006 Q2 investor conference call tells the story:

Things are not looking good on the home front. To make things worse, and while Telus contends that the wireline side is “stabilizing”, revenues are still dropping and this slide from the Q1/2007 investor call shows:

While it did indeed show that SkaterBoy is in fact Rocking it With IP (say hi Jill Schnarr!), what’s easy to see is that the base is eroding, both in terms of subscriber count and revenues. Their Broadband penetration is not so good, either. Bell Canada, with its larger service area and more densely-populated markets, appears to be doing better when compared to Telus, according to LightReading (see charts below), but they are at present weathering the storm .. not lighting the world on fire.

By comparison to Bell’s numbers here, Telus’ Broadband Internet subscriber base is a claimed 949,000 users as of the end of Q1/07.

Both companies are looking to data and wireless to grow the business. Wireless is a growth industry, of course, but I would contend that, when it comes to wireless subscription growth, we are in a bubble. Saturation has already caused wireless subscriber growth to begin to taper off, and as in the telecom bubble of the late 1990s, that drives up customer acquisition costs (since these companies would sooner pay more $$ for users than innovate in order to attract them). Perusing the Telus Investor Slides linked above reveals exactly that. Data is growing, but likely only within their existing base of wireline subscribers. And if that base continues to churn as fast as it is, that market will reach true saturation a lot sooner than wireless.

Launching broadband as a service is one thing. Broadband is, however, a commodity — as are residential and business subscriber lines. Telus, Bell, and all other ILECs are presently learning what happens when your basic services remains.. uh.. basic, and your only foils against competition are pricing and bundling. Furthermore, service innovation within the ILEC world has totally stagnated, insofar as new service development is concerned, as they’ve focused on pink elephants like IPTV (which, this author contends, won’t work) and Verizon’s IOBI (which suffers from huge capital costs for minimal incremental benefit). The fundamental problem for the Incumbents is simply making things scale on the telecom network. It wasn’t built for that, and even with IP upgrades grafted and forklifted into place, it still doesn’t have the bandwidth for compelling services. The Cable Guys have their own problems, but they get a free ride for now thanks to the fact that their delivery of TV entertainment is broadcast easily down their plain old copper wire — including High Definition.

The Incumbents need to bite the bullet and implement FTTH to get themselves out of this hole, but some analysts estimate the cost to be about $9650 per subscriber. That’s a purchase order that I would not be excited to sign, and more than a few pundits think that Verizon’s $23 Billion bet to wire up 18 million homes will kill the company.

So, while Canada’s two big incompetents incumbents are struggling with a sharpening decline in their base, the Shaw and Rogers folks are starting to kick ass, seeing growth on all fronts. Shaw, which started late in the telephony game, has been growing all of their services, with about 2M cable subscribers, 1.5M internet subscribers, and around 100,000 telephone customers. They’ve added the latter service with minimal cost impact and a very low customer acquisition cost, and the ARPU of a Shaw HD Cable customer with High-Speed Internet and one phone line is very near $200/mo. This is the holy grail of residential telecom. And while they start from a smaller base of customers, their capital cost to deliver multiple services is a lot lower.

So, what does this all mean? Current default logic in the Telecom arena is that all of the players need to be at least a Triple-Play and arguably a Quadruple-Play in order to grow their services and revenues, and defend their userbase. I think that I’ve presented a straw-man case illustrating that the Cable Companies, because their networks already do the harder thing (distributing realtime entertainment cost-effectively) with relative ease, have a decisive advantage leaping toward this, particularly because Rogers Communications already owns a wireless Service Provider.

Telus and Bell should and probably will merge in order to cost-optimize, lay off a bunch of redundant workers, and debt-finance the building of Fiber-To-The-Home. They will need to do so before they are, over the course of the next decade, eclipsed by the more nimble and more entertainment-oriented Cable companies. It will not be easy for Canada’s two incumbents to recognize their lot at the moment as dumb-pipe carriers, and the only network which it has been established can reliably and scalably deliver realtime entertainment and content is Fiber.

Cable Guys ultimately need to get there, too, as we’ll increasingly want to Time-Shift our media, but PVRs and HD are stop-gaps which are saving them from needing to make an early, costly, network upgrade. Besides, Cable Companies needed to upgrade their networks substantially for broadband, and did so during the 1990s, delivering Fiber to the neighbourhood (FTTN). Making that next leap, while costly, will not kill them.

Which leads to the following hypothesis:

Is now the time to merge Shaw and Rogers? As the only major Service Provider in Canada without a Wireless business unit, Shaw is the clumsy kid at the prom in the powder-blue suit. Definitely the smallest of the four, Shaw doesn’t have as diversified a business as any of the other three but has stuck to its knitting. It has also been busily snapping up smaller Cable Companies in the West, including my friends @ Whistler Cable. Mark Evans thinks this is a possibility, too, for the record, and the companies have a history of collaborating to achieve efficiencies. Jim Shaw and Ted Rogers, while officially rivals, often reveal a friendly candor and mutual respect. The idea is alluring.

The reality is that if Telus really wanted to cement its future, it should buy Shaw. But this would create a physical monopoly in the West, rather than the defacto monopolies which exist today, and the CRTC and Industry Canada would never allow it. But one other opportunity may lay on the horizon: If Telus and Bell merge, they will have to release some of their wireless spectrum back to the regulators. If this occurs, then the market may open up for another major wireless carrier to emerge in Canada: one funded by that quiet kid in the Powder-Blue suit. If the Quadruple-Play hypothesis is correct then this will allow Shaw to compete on a level playing field with a merged or non-merged Telus and Bell, and maintain parity with Rogers. And while it’s probably not a great idea to have wireless this consolidated over the long-term, this could allow Jim Shaw to build up some value in Shaw Communications prior to the inevitable merger with Rogers.

Convergence freaks tend to assume that all roads ultimately lead to all of your myriad services being delivered via a fibre-optic cable straight into a hub in your basement (or storage closet) regardless of whether your Service Provider came from Cable or from Telecom. I don’t disagree, but I do contend that its a twisted, heavily contentious road that’ll get us there. And fortunes will be made or destroyed in the process thereof.

Customer-owned Networks: ZapMail and the Telecommunications Industry First published January 7, 2003 on the ‘Networks, Economics, and Culture’ mailing list. By Clay Shirky

To understand what’s going to happen to the telephone companies this year thanks to WiFi (otherwise known as 802.11b) and Voice over IP (VoIP) you only need to know one story: ZapMail.

The story goes like this. In 1984, flush from the success of their overnight delivery business, Federal Express announced a new service called ZapMail, which guaranteed document delivery in 2 hours. They built this service not by replacing their planes with rockets, but with fax machines.

This was CEO Fred Smith’s next big idea after the original delivery business. Putting a fax machine in every FedEx office would radically reconfigure the center of their network, thus slashing costs: toner would replace jet fuel, bike messenger’s hourly rates would replace pilot’s salaries, and so on. With a much less expensive network, FedEx could attract customers with a discount on regular delivery rates, but with the dramatically lower costs, profit margins would be huge compared to actually moving packages point to point. Lower prices, higher margins, and to top it all off, the customer would get their documents in 2 hours instead of 24. What’s not to love?

Abject failure was not to love, as it turned out. Two years and hundreds of millions of dollars later, FedEx pulled the plug on ZapMail, allowing it to vanish without a trace. And the story of ZapMail’s collapse holds a crucial lesson for the telephone companies today.

The Customer is the Competitor

ZapMail had three fatal weaknesses.

First of all, Federal Express didn’t get that faxing was a product, not a service. FedEx understood that faxing would be cheaper than physical delivery. What they missed, however, was that their customers understood this too. The important business decision wasn’t when to pay for individual faxes, as the ZapMail model assumed, but rather when to buy a fax machine. The service was enabled by the device, and the business opportunity was in selling the devices.

Second, because FedEx thought of faxing as a service, it failed to understand how the fax network would be built. FedEx was correct in assuming it would take hundreds of millions of dollars to create a useful network. (It has taken billions, in fact, over the last two decades.) However, instead of the single massive build out FedEx undertook, the network was constructed by individual customers buying one fax machine at a time. The capital expenditure was indeed huge, but it was paid for in tiny chunks, at the edges of the network.

Finally, because it misunderstood how the fax network would be built, FedEx misunderstood who its competition was. Seeing itself in the delivery business, it thought it had only UPS and DHL to worry about. What FedEx didn’t see was that its customers were its competition. ZapMail offered two hour delivery for slightly reduced prices, charged each time a message was sent. A business with a fax machine, on the other hand, could send and receive an unlimited number of messages almost instantaneously and at little cost, for a one-time hardware fee of a few hundred dollars.

There was simply no competition. ZapMail looked good next to FedEx’s physical delivery option, but compared to the advantages enjoyed by the owners of fax machines, it was laughable. If the phone network offered cheap service, it was better to buy a device to tap directly into that than to allow FedEx to overcharge for an interface to that network that created no additional value. The competitive force that killed ZapMail was the common sense of its putative users.

ZapPhone

The business Fred Smith imagined being in — build a network that’s cheap to run but charge customers as it if were expensive — is the business the telephone companies are in today. They are selling us a kind of ZapPhone service, where they’ve digitized their entire network up to the last mile, but are still charging the high and confusing rates established when the network was analog.

The original design of the circuit-switched telephone network required the customers to lease a real circuit of copper wire for the duration of their call. Those days are long over, as copper wires have been largely replaced by fiber optic cable. Every long distance phone call and virtually every local call is now digitized for at least some part of its journey.

As FedEx was about faxes, the telephone companies are in deep denial about the change from analog to digital. A particularly clueless report written for the telephone companies offers this choice bit of advice: Telcos gain billions in service fees from […] services like Call Forwarding and Call Waiting […]. Hence, capex programs that shift a telco, say, from TDM to IP, as in a softswitch approach that might have less capital intensity, must absolutely preserve the revenue stream. [ http://www.proberesearch.com/alerts/refocusing.htm] You don’t need to know telephone company jargon to see that this is the ZapMail strategy.

Step #1: Scrap the existing network, which relies on pricey hardware switches and voice-specific protocols like Time Division Multiplexing (TDM). Step #2: Replace it with a network that runs on inexpensive software switches and Internet Protocol (IP). This new network will cost less to build and be much cheaper to run. Step #3: “Preserve the revenue stream” by continuing to charge the prices from the old, expensive network.

This will not work, because the customers don’t need to wait for the telephone companies to offer services based on IP. The customers already have access to an IP network — it’s called the internet. And like the fax machine, they are going to buy devices that enable the services they want on top of this network, without additional involvement by the telephone companies.

Two cheap consumer devices loom large on this front, devices that create enormous value for the owners while generating little revenue for the phone companies. The first is WiFi access points, which allow the effortless sharing of broadband connections, and the second is VoIP converters, which provide the ability to route phone calls over the internet from a regular phone.

WiFi — Wireless local networks

In classic ZapMail fashion, the telephone companies misunderstand the WiFi business. WiFi is a product, not a service, and they assume their competition is limited to other service companies. There are now half a dozen companies selling wireless access points; at the low end, Linksys sells a hundred dollar device for the home that connects to DSL or cable modems, provides wireless access, and has a built-in ethernet hub to boot. The industry has visions of the “2nd phone line” effect coming to data networking, where multi-computer households will have multiple accounts, but if customers can share a high-speed connection among several devices with a single product, the service business will never materialize.

The wireless ISPs are likely to fare no better. Most people do their computing at home or at work, and deploying WiFi to those two areas will cost at worst a couple hundred dollars, assuming no one to split the cost with. There may be a small business in wiring “third places” — coffee shops, hotels, and meeting rooms — but that will be a marginal business at best. WiFi is the new fax machine, a huge value for consumers that generates little new revenue for the phone companies. And, like the fax network, the WiFi extension to the internet will cost hundreds of millions of dollars, but it will not be built by a few companies with deep pockets. It will be built by millions of individual customers, a hundred bucks at a time.

VoIP — Phone calls at internet prices

Voice over IP is another area where a service is becoming a product. Cisco now manufactures an analog telephone adapter (ATA) with a phone jack in the front and an ethernet jack in the back. The box couldn’t be simpler, and does exactly what you’d expect a box with a phone jack in the front and an ethernet jack in the back to do. The big advantage is that unlike the earlier generation of VoIP products — “Now you can use your computer as a phone!” — the ATA lets you use your phone as a phone, allowing new competitors to offer voice service over any high-speed internet connection.

Vonage.com, for example, is giving away ATAs and offering phone service for $40 a month. Unlike the complex billing structures of the existing telephone companies, Vonage prices the phone like an ISP subscription. A Vonage customer can make an unlimited number of unlimited-length domestic long distance calls for their forty bucks, with call waiting, call forwarding, call transfer, web-accessible voicemail and caller ID thrown in free. Vonage can do this because, like the telephone companies, they are offering voice as an application on a digital network, but unlike the phone companies, they are not committed to charging the old prices by pretending that they are running an analog network.

Voice quality is just one feature among many

True to form, the telephone companies also misunderstand the threat from VoIP (though here it is in part because people have been predicting VoIPs rise since 1996.) The core of the misunderstanding is the MP3 mistake: believing that users care about audio quality above all else. Audiophiles confidently predicted that MP3s would be no big deal, because the sound quality was less than perfect. Listeners, however, turned out to be interested in a mix of things, including accessibility, convenience, and price. The average music lover was willing, even eager, to give up driving to the mall to buy high quality but expensive CDs, once Napster made it possible to download lower quality but free music.

Phone calls are like that. Voice over IP doesn’t sound as good as a regular phone call, and everyone knows it. But like music, people don’t want the best voice quality they can get no matter what the cost, they want a minimum threshold of quality, after which they will choose phone service based on an overall mix of features. And now that VoIP has reached that minimum quality, VoIP offers one feature the phone companies can’t touch: price.

The service fees charged by the average telephone company (call waiting, caller ID, dial-tone and number portability fees, etc) add enough to the cost of a phone that a two-line household that moved only its second line to VoIP could save $40 a month before making their first actual phone call. By simply paying for the costs of the related services, a VoIP customer can get all their domestic phone calls thrown in as a freebie.

As with ZapMail, the principal threat to the telephone companies’ ability to shrink costs but not revenues is their customers’ common sense. Given the choice, an increasing number of customers will simply bypass the phone company and buy the hardware necessary to acquire the service on their own.

And hardware symbiosis will further magnify the threat of WiFi and VoIP. The hardest part of setting up VoIP is simply getting a network hub in place. Once a hub is installed, adding an analog telephone adapter is literally a three-plug set-up: power, network, phone. Meanwhile, one of the side-effects of installing WiFi is getting a hub with open ethernet ports. The synergy is obvious: Installing WiFi? You’ve done most of the work towards adding VoIP. Want VoIP? Since you need to add a hub, why not get a WiFi-enabled hub? (There are obvious opportunities here for bundling, and later for integration — a single box with WiFi, Ethernet ports, and phone jacks for VoIP.)

The economic logic of customer owned networks

According to Metcalfe’s Law, the value of an internet connection rises with the number of users on the network. However, the phone companies do not get to raise their prices in return for that increase in value. This is a matter of considerable frustration to them.

The economic logic of the market suggests that capital should be invested by whoever captures the value of the investment. The telephone companies are using that argument to suggest that they should either be given monopoly pricing power over the last mile, or that they should be allowed to vertically integrate content with conduit. Either strategy would allow them to raise prices by locking out the competition, thus restoring their coercive power over the customer and helping them extract new revenues from their internet subscribers.

However, a second possibility has appeared. If the economics of internet connectivity lets the user rather than the network operator capture the residual value of the network, the economics likewise suggest that the user should be the builder and owner of the network infrastructure.

The creation of the fax network was the first time this happened, but it won’t be the last. WiFi hubs and VoIP adapters allow the users to build out the edges of the network without needing to ask the phone companies for either help or permission. Thanks to the move from analog to digital networks, the telephone companies’ most significant competition is now their customers, because if the customer can buy a simple device that makes wireless connectivity or IP phone calls possible, then anything the phone companies offer by way of competition is nothing more than the latest version of ZapMail.

———–

-Ian.

http://dailynews.yahoo.com/h/nm/20010111/ts/media_timewarner_dc_5.html

Thursday January 11 10:17 PM ET AOL Acquires Time Warner After FCC Approval

By Jeremy Pelofsky

WASHINGTON (Reuters) – Internet giant America Online Inc. on Thursday acquired cable and media conglomerate Time Warner Inc., becoming the world’s largest media company after winning conditional approval from the Federal Communications Commission.

Exactly a year and a day after the companies announced their historic marriage of old and new media, the five-member FCC unanimously agreed to let AOL and Time Warner go forward despite a dispute over what conditions to put on the companies.

However, the commissioners voted 3-2 to place restrictions on the new company’s advanced instant messaging system when it runs over Time Warner’s cable lines. They also voted to force further access to the cable pipeline by competing Internet services.

“These conditions are designed to protect the open competitive nature of the Internet,” FCC Chairman William Kennard said. “They protect consumers and avoid heavy-handed regulation by using a narrowly-tailored market opening approach.”

The FCC approval, after months of internal discussion at the agency, allowed the world’s biggest Internet services provider to close its $106.2 billion purchase of the media and cable conglomerate to create an unparalleled company spanning television programming, movies, magazines and cyberspace.

Time Warner has the second-largest collection of cable systems in the United States and an enormous publishing arm that includes Sports Illustrated and People magazines while AOL has close to 29 million Internet subscribers, including 2.6 million CompuServe members.

The two companies won antitrust approval from the Federal Trade Commission on Dec. 14 after agreeing to open cable television lines to several rival Internet service providers before launching AOL’s own service and allowing consumers a wide choice of content. THE NEW AOL TIME WARNER

The companies closed the deal late on Thursday and the new media and Internet behemoth will be called AOL Time Warner with headquarters in New York City. It will trade on the New York Stock Exchange under the symbol “AOL” .

Shares of AOL closed up $2.34 to $47.23 while shares of Time Warner shares rose $4.19 to $71.19.

“AOL Time Warner will lead the convergence of the media, entertainment, communications and Internet industries, and provide wide-ranging, innovative benefits for consumers,” Steve Case, chairman of the new company, said in a statement.

Prior to the combination, the companies had said they expected revenues of more than $40 billion in their first year, growing at 12 to 15 percent a year.

“We are hitting the ground running with a clear road map for creating value for our customers, business partners, shareholders and employees,” said Gerald Levin, chief executive officer of AOL Time Warner.

Although consumer groups had pressed hard for regulators to put strict limitations on the combination, one organization hailed Thursday’s action by the FCC as a step toward expanding consumer choice.

“What could have been a disaster for consumers now holds the potential to promote competition and consumer choice,” Gene Kimmelman, co-director of Consumers Union said in a statement. The companies had hoped for quick FCC approval once they got FTC clearance but communications regulators became locked in weeks of debate over details of its own set of conditions.

The conditions adopted did not appease all sides however. The two Republicans on the panel, Michael Powell and Harold Furchtgott-Roth, disagreed with attaching any conditions, while Democrat Gloria Tristani wanted tougher ones on instant messaging. CONDITIONS ON AOL TIME WARNER

If the new AOL Time Warner launches advanced instant messaging services like video conferencing across its high-speed cable pipeline, it will have to make it interoperable with rival instant messaging services, the FCC said.

But, the commission stopped short of forcing AOL to make its current popular instant messaging software that allows real-time chats via typed messages interoperate with that of rivals like Microsoft and ExciteAtHome .

“At the end of the day, I believe the record and the anti-competitive theory did not support mandating interoperability,” Powell said in a statement.

While Tristani pushed hard for the tougher condition she said ”voting in favor of the decision serves consumers better than lodging a dissent.”

The instant messaging conditions expire in five years but AOL Time Warner can petition the FCC earlier arguing that the conditions are no longer necessary because contracts with big competitors have been reached or an industry-wide standard for interoperability exists.

As for access for rival Internet service providers (ISPs) to the new company’s cable lines, which can offer consumers high-speed Internet service, the companies were required to allow consumers to have their pick of ISPs carried on the cable lines.

AOL Time Warner cannot pressure consumers to subscribe to its own Internet service and must allow the unaffiliated ISPs on thesystem to choose the content of their opening page. The rival ISPs can also have direct billing with their customers, according to the FCC.

Additionally, the FCC said it expects the new company to negotiate in good faith with small and regional ISPs as well as big ones. AOL Time Warner already has signed up EarthLink Inc., the No. 2 ISP in the United States, to offer its own Internet service.

Instead of subjecting AOL Time Warner to conditions on the nascent market of interactive television, the FCC said it will seek comment on the emerging technology.

However, the FTC antitrust authorities in its review of the deal prohibited the merged company from discriminating against content that passes through the systems provided by rivals like The Walt Disney Co.

“>http://www.apple.com/DTDs/PropertyList-1.0.dtd”> date-sent 979287848 flags 570686593 original-mailbox local:///Import/foib sender Ian Andrew Bell <hey [at] ianbell [dot] com> subject @F: Big Surprise.. to foib [at] egroups [dot] com ]]> 3425