Appendix A: Overview of Wireline Industry
The wireline industry is broken down between cable, fiber, and digital subscriber line (DSL). Each of these offer the same service of delivering an internet connection through a physical wired medium. They differ in terms of the type of physical medium, underlying technology, and costs economics.
DSL is the oldest technology. It runs off telephone copper pairs and owned by the traditional telephone companies – think CenturyLink or AT&T. Cable came after, and runs over coaxial cable, allowing for better download/upload speeds – think Charter or Comcast. Fiber is the newest, which brings fiber optics right to the customer’s premises. Fiber offers the potential for orders of magnitude improvement in speeds, will cost less to maintain, but still early in its product adoption for consumers.
In terms of market share, cable is well in the lead and will remain so for years to come. The table below summarizes the results. In general, cable is taking share from DSL, and fiber is taking share from cable. This trend will continue.
The industry is characterized for its oligopolistic nature. In each geography there is typically two providers with large stable market share. This dynamic is not a phenomenon but due to the high capital nature of the business. Once a company invests the capital to lay out the infrastructure, there is a big disincentive to duplicate that investment. In rural areas, investments often need to be subsidized by tax payers in order to proceed. An example is the Connect America Fund (CAF-II), where 10 telecommunications carriers will receive nearly $9bn in subsidizes over 6 years to buildout broadband to 23 million Americans. After this build out is completed, the probability for a second entrant, not subsidized by tax payers and with less financial strength, is unlikely. Aside from the financial hurdles, there are additional barriers such as gathering the rights-of-way, and risk the incumbent will lower the price after the build out is complete. All in all, this creates the existence of competitive advantage with return on invested capital in the mid-teens.
Appendix B: Industry Map
Wireline providers service two categories of customers: enterprises and consumers. The above diagram shows the map for the enterprise customer, which is slightly more complex than the consumer diagram. The enterprise diagram provides more insight on the dynamics of a typical wireline provider.
The above diagram breaks the Wireline Carrier and IT Services as two separate components. However, they both fall under one corporate entity. The separation is to show the functional differences of these separate departments.
Wireline providers have a specific division, referred to as IT Services, whose focus is on serving enterprise customers. Businesses often demand more than just an internet connection. They need a VoIP phone system, cloud hosting, a secured network, and additional network reliability. IT Services can be thought of as an integrator of IT services, but not a manufacture of the underlying products. As an integrator, IT services often needs to purchase routers from Cisco, phones from Polycom, PBX systems from Broadsoft, and hosting from a local data center.
The key ingredient used in all IT services is the physical internet pipe. This could be fiber, cable, DSL or perhaps wireless. Building this physical network is the core of wireline providers, represented as Wireline Carrier in the above diagram. Wireline providers whose network is based on DSL technology are referred to as Telcos. Wireline providers whose network is based on cable technology are referred to as Cablecos. Worth noting, there is fiber built into both DSL and cable networks. For example, DSL telcos would extend fiber optics to a street corner, then rely on copper pair between the street corner to the customer’s home (referred to as the “last mile”). True end-to-end fiber extends the fiber right to the customer’s home.
Wireline providers traditionally owned the data centers but recently have been divesting these assets to focus only on their core wireline business. Although we have listed Data Center and IP Transit Providers in this map, it by no means a holistic view. It is meant to show how and where, in general, these partners connect to the Service Provider (Wireline Carrier).
In the consumer segment, customers generally call the wireline provider directly or alternatively order services online. Consumer requirements are less complex, often requiring only a single internet connection. The simplicity is why consumers can interact directly with the wireline provider as oppose to an IT Service integrator.
Wireline providers rely on purchasing three primary ingredients: fiber, switches, and routers. Switching and routing hardware vendors include names such as Alcatel-Lucent, Adtran, Juniper, and Cisco. In general, the buyer/seller relationship does not favor the hardware vendor or the Specialty Contractors. We will discuss this further in our section on Competitive Advantage.
Appendix C: Competitive Advantage
There are three drivers which have and should continue to ensure the steady profitability of wireline carriers: a one-to-many relationship with its supplier and customers, a track record of disciplined rivalry, and economies of scale. A good starting point in understanding how the industry works (who’s retaining the profits), is by looking along the industry map, and considering each pair of relationships. The relationship between,
- Wireline Carriers vs. Contractors
- Wireline Carriers vs. Hardware Vendors
- Wireline Carrier vs. Enterprises Customers
Wireline carriers have a one-to-many relationship both as a buyer and a supplier. This has structurally allowed them to capture more value as a buyer, while simultaneously charging more from their customers. Across the United States, there are many wireline carriers. However, there is typically only one or two that control each state. Local enterprises often have no choice for alternatives and must accept the price and service that is offered. This effect is magnified in rural communities where on occasion service interruptions span for weeks with no recourse. As improvements in speeds are offered, they typically come hand-in-hand with price hikes.
Their relationship with contractors and hardware vendors is one of the same story. Regional carriers are typically not in competition with one another, rather operate with high degree of coordination. This is possible due to mature product offering in a homogenous industry. Collectively they decide when upgrade cycles occur, and control this final buying decision. As an example, north of the border, one of the main wireline providers intelligently chose to defer their fiber investment by nearly a decade.
The second factor driving profitability is the level of rivalry. How fiercely do firms compete with one another along dimensions such as price, service, new product introductions, promotion, and advertising?
Historically, there has been little rivalry due to the oligopolistic structure of the wireline industry. Rather, there has been high degree of tacit coordination amongst peers in regards to upgrade cycles, service offerings, and pricing. Example of such is coordination between wireless and wireline carriers include,
- The co-marketing, co-development agreement among Verizon Wireless and cable giants Comcast and Time Warner Cable (among others)
- The allowance to form bundled products using each other services for better customer lock-ins
Of the variables influencing the degree of rivalry, incumbents are in a very favorable position in terms of concentration (Herfindahl-Hirschman Index > 1000), homogeneity (very similar corporate philosophies and common goals), and demand variability (given product maturity).
The third factor driving steady profitability is regional economies of scale. To a greater extend, Cincinnati Bell benefits from this scale beyond its wireline peers. It does so because it has a concentrated geographic footprint. Unlike some of its peers, it has strategically maintained a contiguous footprint. CBB is able to capitalize on this by having a dense fleet of wireline technicians and support staff that can support local customers. Its concentrated footprint allows it to efficiently deploy sales and marketing. For example, an advertisement targeting CBB’s entire footprint would be meaningfully more efficient than that of a national peer.
Additionally, the economics required to justify an investment in their Fioptics network is more favorable with greater customer density. For example, how much potential sales can be spread across the fixed costs of the planned network? How much can we oversubscribe? How quickly can we reach a cost breakeven? All of these favors a denser network footprint.
Appendix D: Wireline Business Model
The value proposition of a wireline carriers is one of delivering simple, reliable, internet, television, and phone services in a bundled package. The revenue streams are through a monthly subscription for access to the internet/television/phone network. There is typically two separate customer segments: wholesale and retail. Wholesale caters to businesses and other service providers, while retail focuses on consumers. Customer relationships are driven by acquisition strategies involving the bundling of internet, TV, and phone services. The retention of customers are motivated by increasing speeds, and in turn increasing the average revenue per customer (ARPU). The primary channels to connect with customers are through local call centers and online portals.
On the expense side – the cost structure is driven by building out, supporting, and maintaining its network, in addition to sales and marketing expenses. It key partners are various contractors who build out the physical wireline infrastructure and network architects who build out the digital network that rides on top. Key activities include monitoring and maintaining the reliability of the network, and scaling it up as needed. Finally, the key resources are around its physical wireline network, in conjunction to the financial resources required to fund the continued maintenance and expansion of this capital-heavy endeavor.