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TeleSparks: Profitable IP Services?
May 30, 2002
TeleChoice, Inc.
http://www.TeleChoice.com
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The News
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Recently, a tremendous amount of focus has been on
rescuing the telecom industry and the economy as a whole
by incenting massive deployment of broadband services
through regulatory and legislative relief.
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The TeleChoice Take
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Driving massive deployment and adoption of broadband
services without addressing the fundamental pricing flaws in
the IP services that those broadband services primarily feed
is likely to represent a "fatal cure" for the most
"successful" IP
carriers.
The primary driver for the adoption of broadband access
services is the additional bandwidth available for IP applications.
In other words, broadband access represents a faster
"on-ramp" for IP services; however, IP services are generally
not profitable. We believe this lack of profitability is not an
issue of economies of scale but fundamental flaws in how IP
services are priced and packaged to consumer and business
customers.
Current Situation
Although IP services have been a high-growth area for most
service providers, IP service businesses are almost universally
operated at a loss. The problem has been compounded with
increasing broadband adoption, with broadband users
representing exponential increases in IP traffic load without
representing corresponding increases in revenue.
The broadband value proposition to customers has been
compelling, but the business model for providers has
proven shaky at best. Consumer and small business
customers have been lured to upgrade from 56k dialup at
$20/month to 512k DSL at $50/month -- nearly 10x the
bandwidth for 2.5x the cost. Mid-sized to large business
customers have more recently been lured to upgrade from
1.5Mbps T1 connections at $500/month to 100Mbps
Ethernet connections at $1,000/month -- 67x the bandwidth
for 2x the cost. Although the technology-driven cost
advantages to DSL compared to dialup and Ethernet
compared to T1, combined with economies of scale can
and, in some cases, have made the broadband access
business profitable, the IP service businesses being fed
by those broadband pipes are increasingly financially
challenged.
The real issue is that the entire IP services pricing
structure was defined at a time and by players that were
not well positioned to create a sustainable business
model. Over time, continued competitive intensity has
only amplified an initially flawed strategy.
Very simply, the problem with IP services is in network
utilization. Although peak-utilization will be 100%, at least
for a fraction of a second, average utilization on IP
networks is much lower, typically 10% to 30%.
IP applications tend to be very bursty -- the faster the
access speed, the more bursty the traffic. Virtually all
significant IP applications adhere to a file-transfer model
(email, the web, even P2P Napster-like applications),
meaning the traffic pattern is one of a burst of traffic
(as the file is transferred) followed by an extended period
of relative inactivity. Faster connections simply translate
to shorter bursts (at full line rate) and a greater ratio of
idle-to-burst time. Although aggregation of multiple
customer connections results in some level of statistical
multiplexing, IP traffic at any point in the network remains
bursty and relatively unpredictable.
Since a user's perception of network performance is
driven by his experiences at the peak ("I'm paying for
a high-speed line, why isn't this file downloading
faster?"), networks must be designed to perform
reasonably well at that peak instant. The net result
is that service providers must design their networks
with enough resources (switch/router capacity,
network capacity) to handle the peak load
reasonably well. Of course, as we all know,
providers don't build their networks with enough
capacity to handle all the peak load, so some
packets get dropped resulting in the "best-effort"
quality of service for which IP is notorious.
So What?
The real impact is a double whammy on the IP
services business model. On one hand, the
providers must spend way too much money
(CapEx and OpEx) building and operating a
network big enough to operate "OK" during
peak instants, but end up with a network that
doesn't operate well enough to carry
performance-critical traffic (at premium price
points).
No Single New Technology Solution
Fixing this problem doesn't require a newfangled
technology solution. In fact, a handful of different
available technologies are already available,
some of which have been around nearly a
decade that provide the technical ability to
address this problem. Frame Relay, ATM,
IP Diffserv, and MPLS are the most well known
standards-based approaches to smoothing out
traffic flows. Each technology provides
mechanisms for prioritizing packets (or frames
or cells) and identifying which ones must get
through with high performance and which can
afford to be buffered for a short period of time
until the peak instant in the network passes and
capacity is available. The result is a lower
traffic peak, requiring less network capacity.
The real problem isn't a technology problem;
it's a service definition/pricing problem. Although
the technology capability has been available for
a long time, we are not aware of any service
provider effectively using it to define its customer
offer to incent the kinds of behavior necessary for
profitable services.
Think about it. Voice traffic is much more predictable
and much less bursty than IP traffic. Yet long ago,
voice carriers learned it made business sense to
incent customers to move some traffic to off-peak
times. Remember the days when a daytime call
cost 25 cents, but a call after 10pm only cost a dime?
The net result had at least two positive impacts
on the service business model. Some traffic that
used to happen during the day was moved off-peak,
allowing carriers to build less capacity into their
networks. Additionally, new traffic (and new revenues)
actually happened late at night that wouldn't happen
at the daytime rates. Since these off-peak calls
could use capacity that otherwise would be sitting
idle, much of that incremental revenue flowed directly
to the bottom line.
Data services and, specifically, IP have failed to
adopt similar approaches. One challenge is that
IP traffic will shift from peak to off-peak very rapidly,
so defining standard peak and off-peak times of the
day doesn't really make sense. However, by
prioritizing packets in the network, the same effect
can be achieved on a much shorter cycle.
If service providers offer a meaningful discount for
each packet marked low priority, they can reduce
their network costs and perhaps even gain some
new price-sensitive traffic. However, perhaps more
importantly, by truly providing a premium quality of
service, providers stand a chance of gaining customer
confidence in carrying premium traffic at a premium
price. We have done some initial calculations of the
impact under different scenarios and the financial
impact on IP service profitability can be dramatic
(see the "Super Broadband Deployment Initiatives"
whitepaper, linked below).
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What's Next?
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We believe IP services are headed for a crisis situation.
Solving this crisis will be critical for the survival of today's IP
carriers.
Most equipment in the IP service networks already supports
traffic prioritization, so this problem may be solvable with little
or no additional investment in the network. However,
significant implications around existing customer agreements
and software systems changes need to be addressed.
What Can You Do?
We strongly encourage you to stop and consider the
implications of this situation on your business.
Specifically, consider these key issues:
- If you're a service provider, assess what it would
take for you to restructure your IP offers along the lines
identified here. Feel free to call us if you'd like to better
understand what we have in mind. Start talking to your
customers about their desire for/openness to tiered pricing
on a packet-by-packet basis. Will customers increase
low-priority traffic if discounts are available? Will they use
your IP service for performance-demanding applications if
premium services are available? Are they willing to
restructure their current service agreements to accommodate
these changes?
- If you're an IP equipment vendor, understand how
this redefined service offer would be implemented by your
customers. Can you provide assistance to existing and new
customers in making this transition? How can you simplify
the implementation of features that exist in equipment already
installed in your customers' networks? Can you help your
customers to model the economic benefits of this change using
your equipment? Remember the greater the financial success
your customers achieve in operating services using your
equipment, the greater their appetite will be for additional gear
in the future.
- For software vendors, what role can you play in fixing
this critical problem? Does your product represent part of the
solution? By making an incremental software investment, can
service providers unlock latent profitability in the huge
investments they've already made building out their networks?
Through challenging times such as these, strategic focus
is critical. Making wise product/service decisions and
effectively communicating the value of these changes to your
customers will be critical to your success. Let us know if we
can help.
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For Further Reading
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If this topic interests you, we recommend you download
the following white paper for free from the TeleChoice Website
( http://www.telechoice.com/inprint_whitepapers.htm
):
TC Perspectives: Super Broadband Deployment Initiatives
( http://www.telechoice.com/inprint_RegMailer3.htm
)
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Need Some Help?
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TeleChoice helps companies everyday better position their
firms and products for success, whether re-examining
fundamental business strategy or clearly communicating
unique position and value in today's tough marketplace.
Contact us at info@telechoice.com.
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About TeleSparks: On occasion, we share with our industry
friends our views on major events and issues in telecom.
We use TeleSparks as the primary vehicle for sharing these
(usually highly opinionated) views, and we welcome your
feedback. Feel free to forward these on to others, but please
copy us on the messages so we have a sense of the extent
of distribution of our views.
TeleSparks is generally authored by Russ McGuire,
TeleChoice Chief Strategy Officer, with input from others
throughout the TeleChoice organization. You may contact
Russ (rmcguire@telechoice.com) or
your favorite TeleChoice
contact to share your thoughts on these matters.
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