The Covid lock down has put secure and reliable Internet access at the heart of critical infrastructure. The business and advertising revenues of Network Operators and Internet Service Providers have fallen sharply while the world seeks to work, learn and play from home. The funding assumptions behind current regulatory and governance structures are no longer valid.
As Lenin supposedly said: “There are decades when nothing happens and weeks when decades happen.”
At one level the planned merger of O2 and Virgin Business Media is another step in the convergence of fixed and mobile communications and content services around three or four competing national networks (BT-EE, Virgin-O2, Vodafone-City Fibre-Sky …). At another level it has been driven by the evaporation of cash flows and investment funding for current business models.
The new company may look like a threat to BT but will start life with £18 billion of long-term debt . It also faces a massive integration and investment task. But the news of the merger has reduced BT’s share price, dragged down by a content business which has fallen over a cliff, to little more than a junk bond.
Meanwhile the relentless pressure on our existing infrastructure is beginning to reveal the cracks. Contention ratios are said to be running at over 100:1 on networks promoted to customers at 20:1 for business and 40:1 to consumers. OTT services like Zoom get flakey at the early evening peak.
But broadband is now a core part of the critical national infrastructure. Businesses that have not been able to move their products and services on-line are, at best, in furlough. Central and Local Government cannot reach those not on-line?
If neither BT nor O2/Virgin can afford to accelerate their investment programmes to meet the next round of demand as we move out of lockdown, who can?
In my recent blog, When IT met Covid, I summarised the strain posed by rising demand in parallel with falling revenues. The relevant sections (3.1, 4.2 and 4.3) are shown below, in Italics.
The obvious conclusion is that we have to make it much easier for fibre roll-out to be funded directly by those who need it most – those whose homes, businesses, life styles, jobs and tax revenues depend on fast, resilient, secure connectivity.
For that to happen in time to prevent the UK losing global competitiveness Ofcom has to stop trying the predict and regulate the direction and pace of change.
It has to allow operators to charge up front for connections (the Swedish “model”) and/or offer fixed term contracts to enable low cost leasing finance.It should confine its activities to regulating on price, quality of service (including the resilience required of a critical infrastructure utility) and behaviour. Anything else will see the UK fall behind even further because BT and Virgin/O2 have to be part of the future alongside those who are building the infrastructure of the future City Fibre/Goldman Sachs, Gigaclear/M&G, Hyper Optic/George Soros and the growing number of property developers and local authorities commissioning networks to serve smart campuses, business parks and cities.
3.1 The world has moved on-line and the Internet is now a key critical infrastructure utility
A reliable Internet connection has overtaken a gas supply as the third critical infrastructure utility. It is not yet regulated as such. The “best efforts” principle is no longer sufficient. That will add weight to the moves at the United Nations to transfer “authority” from bodies like ICANN and the IETF to the ITU. The current internecine war within the Internet community over the sale by the Internet Society of the Public Interest Registry to a consortium organised by Goldman Sachs has led to the “discovery” by much of the on-line community that neither ISOC
nor ICANN have the governance structures they thought. The sale may have stopped but those outside the cyber-security community have finally discovered just how vulnerable the Domain Name System has become since attempts led by some of the Global Brand names (including Banks) and US and UK law enforcement to cleanse it were abandoned.
The underlying UK telecoms infrastructure, over which we access the Internet has coped much better than I expected with a net 30% increase surge in daytime traffic (mainly from home-based workers and their children replacing the previous business load). Meanwhile the evening peaks are lower because there are no major sporting events. But there has been a net fall is revenue for those who build and maintain the fixed and mobile networks over which most of use access the Internet. This is because the fall in revenues from business traffic
has not been balanced by increased revenues from consumer traffic. The main beneficiaries from the latter have been those providing subscription-based or pay-per-view/download content, games and social media (e.g Zoom , House Party ) services.
This means that the business and funding models assumed by regulators like Ofcom will have to change – perhaps into line with models common across Scandinavia – where many customers (residential as well a business) pay the cost of connection up front with subsequent charges to cover operating and equipment upgrades only.
I went on to look at the pressures on investors and why they are no position to consider new investment in networks following the business models assumed by Ofcom. We can also expect to see an end to Internet business models which assume revenues from advertising or the sale of data.
4.2 Investor priorities and On-line business models
Share prices have fallen around the world. Add the prospect of widespread dividend cuts and sovereign wealth and funds will no longer have significant cash flow for reinvestment. Investors who have also been hit hard by falling oil revenues may need to press those in which they have previously invested to deliver cash returns and not just growth. We have therefore already seen some cloud, business intelligence and AI businesses, like Domo , to lay off staff despite being backed by large, previously well financed, funds. This may also impact the business models of much larger players which have yet to show a profit, e.g. Airbnb and Uber. Even Amazon may come under pressure to deliver shareholder return and not just growth.
Meanwhile dramatic falls in advertising and market research spend may finally be about to force changes in the business models of on-line players, large and small. Some advertisers, which had been reviewing their on-line spend to avoid being associated with harmful content, have taken global decisions to increase their advertising of household brands. Others are changing focus.
But most have been cutting back sharply, leading to furloughs and layoffs in agencies large and small.
A UK example is Mumsnet , a free social media service, offering support and advice for parents, never more needed than at present. The collapse of advertising revenue means that it is having to consider a subscription service. This is not going down well with its audience.
Given that so many internet business models assume the value of collecting “big data” for market research and/or to help target advertising, this has profound implications for on-line business models which assume the value of information to sell to advertisers and/or “free” advertising funded products and services.
One set of questions concerns such as
Will there be a recovery next year? and “Can they survive that long, given the change in investor willingness to cover the gap?
Either way we well see a return to business models which begin modest operations that have the potential to scale fast on positive cash flow rather than on burning through investors funds until a profit is achieved. The supposed “traditional” Internet business model of “Begin small, test on the target audience, then repackage and scale hard on success.”
It does not help the players are having consider such changes in the year that sees both the EU Data Protection and Californian Consumer Privacy legislation begin to bite. Around the world readers and viewers are increasingly being given a choice whether to accept cookies or provide information on their activities – and are saying “No”.
Perhaps more important questions are:
“How much (extra) are consumers willing to pay for what, if there is no advertising subsidy or revenue from data sales?”
“Will they pay per item of service or by subscription?”
4.3 Infrastructure investment models and priorities
The squeeze on investors will impact infrastructure investment as a whole, except when funded by Governments themselves. There are many calls and predictions for Governments to switch from funding roads and railways and into broadband and/or 5G to support a world in which we many more of us telecommute to work, travelling to physically meet with colleagues and customers on two or three days a week only.
But the falls, perhaps permanent, in on-line advertising revenues, reduce the incentives for the internet giants to fund more than they are currently doing (mainly high capacity ultra-fast backhaul to link corporate clients to their datacentres and/or cut latency between then and the telcos who serve the public and SMEs). Even if they still have the funds.
Meanwhile the squeeze in revenues from business customers comes at the same time as incurring the need to invest in standby capacity and preventive maintenance to improve reliability now that the Internet is part of local, national and international critical infrastructures (see 3.1 above).
There are global falls in property markets and rental values as demand for retail properties, hotels and, to a lesser extent office properties, falls, high street and shopping mall properties come on the market and tenants ask for rent “holidays”. We can expect falls in residential values as properties bought by overseas investors are “released” to plug funding gaps as their investment portfolios come under pressure. This will lead to a drop in central/local government receipts from property taxes (business rates, stamp duty etc.) and the incomes of many pensioners and charities while attempts are made to try rebuild shopping centres around “social” enterprises and innovative, high risk, start-ups dependent on positive cash-flow rather than savings or venture capital.
It may also lead to those without high speed broadband connectivity (including in-building mobile reception) become unsaleable – thus giving added incentive to both property owners and local authority to seek to help pull through investment.
We are therefore likely to see a change in business models with customers (or property developers/managers/landlords) paying up front for connectivity (the Swedish model) instead of the “Ofcom model”. The business model on which current UK telecoms regulation is based assumes that the competitors to BT make a “risk investment” in the network in the hope/expectation that sufficient customers will renew their annual contracts for a decade or more to give pay back. Not only is the capital required very much higher, but investors also require a higher rate of return to cover that risk. Only when the network has the critical mass of customers necessary to attract leasing finance does the premium fall.
The time has come for Ofcom to regulate on price, quality of service (including the resilience required of a critical infrastructure utility) and behaviour and stop trying to predict costs and technologies, let alone business models and when operators can offer long-term contracts as a proxy for up front connection charges.