In the preceding two posts, I've applied Christensen's view, of how technology based products and services are disrupted, to fixed and mobile telephony. While 3rd party VoIP is not yet dominant in fixed telephony, it's made enormous progress and most people can see the writing on the wall. But what happens to the lower layers as the value chain modularizes?
In the computer industry, we've seen all sorts of specialization. But we've also seen companies, like Dell, focus on operations and make money in a layer that R&D-centric businesses avoid like the plague.
Back in February, Craig Moffett and Amelia Wong of Bernstein Research wrote an interesting paper, The Dumb Pipe Paradox which was distributed to Bernstein Research clients (but unfortunately doesn't appear to be available on the web). In March, Craig testified on this subject before the Senate Subcommittee on Communications. At the time, the press reports I saw didn't adequately reflect what was in the original report, for example this from the San Francisco Chronicle:
... financial analyst Craig Moffett of Bernstein Research articulated the dilemma phone companies face as they plan these upgrades.
More recently this from Bill St. Arnaud prompted me to write to Craig Moffett and get a copy of the original report. It's great stuff !!!
Quoting from Craig's original report:
Our conclusions regarding the economics of “dumb pipe” status are, we suspect, quite counter-intuitive (and starkly counter-consensus). In short, the economics of such a scenario, as measured by purely financial metrics, are actually better than those of the business today.
- Revenues would fall significantly
- Operating expenses would fall even more significantly
- Operating cash flow would therefore fall more modestly, while operating cash flow margins would actually expand
- Capital expenditures would fall sharply
- Free Cash Flow would actually increase
- Capital employed in the business would also fall sharply, yielding much higher ROI and ROE
To be sure, our analysis ignores potentially painful milestones on the way to such a “raw connectivity” future, such as the stranding and subsequent write downs of a huge portion of Comcast’s current asset base. Growth prospects in this “end game” would likely also be lower than today’s (although not necessarily). Nevertheless, our analysis leads to the surprising conclusion that a disintermediated business would, on most financial metrics, at least, actually be a better business than the current one.
Behind these counter-intuitive findings is a simple, and perhaps more intuitive, truth. In a high fixed cost business, it’s not such a bad thing to be the low cost provider.
Wow! Dell's operations focus allows them to make money as the low cost provider of what others consider a commodity. Similarly in telecom, there is money to be made being the low cost provider of dumb pipes.
Note: The report discusses both Telcos and CableCos and concludes CableCos would win in the pipes business. But that is very much an artifact of the US regulatory environment. Think what might be achieved if we had competitive access to first mile rights-of-way.