Advisor

Google’s entry into any market is cause for existing players to pay attention and potentially be alarmed, so it’s no surprise that the news that Google will become an MVNO and provide wireless services has many forecasting doom and gloom for the existing mobile operators. Before we can jump to those conclusions, I think it’s wise to consider the different scenarios that, given what Google has said, and what they’ve historically done in mobile/telecom, have some level of credibility.

Let’s start by reviewing, briefly, the challenges that MVNO’s have traditionally had to solve. I think they fall into four buckets: distribution, customer service, devices, and brand. I think Google is in a very different place than the vast majority of MVNOs when it comes to these four topics, given their objectives and their starting point.

For distribution, Google’s original Nexus web-based distribution experiment failed, I doubt they’ll try that again. They might try using their physical “stores” in Google Fiber cities, although this isn’t likely to get them enough customers to provide meaningful scale and impact. They might also strike a distribution deal with big box retailers, like Best Buy or WalMart.

However, given Sundar Pichai’s comments, I wonder if Google isn’t actually negotiating with the mobile operators to sell the service in their own stores or through their distribution channels. This would be unusual, but not unprecedented.

When it comes to customer service, mobile operators employ tens of thousands of service reps in both owned and outsourced call centers around the world. I doubt that Google has a desire to establish that kind of customer care infrastructure. Again, it’s possible that they may limit this experiment to Google Fiber markets, in which case, they may be able to leverage the care resources they’ve put in place to support Fiber, or, perhaps, they are going to leverage the mobile operator’s existing customer care infrastructure, as with distribution. Again, this isn’t typical for MVNO’s, but I imagine the operators would seriously consider the potential incremental revenue this would generate.

MVNOs have often struggled to get deals with OEMs for devices because they can’t commit to enough volume to make it work. In recent years, Sprint, for one, has tried to help MVNOs overcome this challenge with their BYOD program and their custom-brand, white label program, but if Google wants to innovate in software, hardware, and connectivity, this won’t be an option. Of course, for Google this also isn’t the same problem as it is for other MVNOs, since they will likely pair the service with a new Nexus device, which gives them a unique position with OEMs. This likely is easily solvable for Google.

Most MVNOs in the market are new brands that must invest significantly to establish a position with a narrowly targeted segment. Google doesn’t have this problem. If anything, Google’s issue will be ensuring that only the right customers for their experiment are the ones that choose their brand for wireless.

Second, I think we need to clarify Google’s objectives with this experiment. Google wouldn’t be investing in this experiment if they didn’t think it would create direct or indirect value for their business. That being said, I doubt that Google believes they can make money competing with Verizon, AT&T, and the others with traditional cellular service.

As with Google Fiber, they may believe that Mobile Operators are constraining use of the Internet and applications and that they can introduce “innovations” that the existing players need to respond to, changing the overall trajectory for the industry.

Net neutrality, or to use the Google Fiber terminology, providing openness and choice, managing the network in an open, non-discriminatory, transparent way and giving users a choice of multiple service providers, may be an objective. Clearly Verizon and AT&T are going to resist the FCC’s new rules and Google may want to have market pressures to combine with regulatory pressures to ensure that the operators adopt “open” policies.

Another target may be the strong trend away from unlimited plans. The FCC’s new rules actually are likely to accelerate the move away from unlimited since it takes away the option for Mobile Operators to throttle unlimited plans. Any customer that doesn’t have unlimited has to stop and think about whether or not to watch that YouTube clip while on the go, or before they do just about anything bandwidth intensive when not on WiFi. This constrains use of the Internet and therefore impacts Google’s core business.

Finally, let’s not ignore what Pitchai presented as Google’s objectives during the interview. Although improving WiFi to cellular interworking and making problems like dropped calls less painful are noble goals, I don’t think that pressuring Operators to implement those types of improvements would truly justify Google’s attention. I think, more likely, as Pichai hinted, maybe this isn’t about traditional cellular service at all. Maybe this really is about the Internet of Things – clearly a space that Google is investing in at the device and software level. Maybe Google wants to make sure that the beyond-WiFi connectivity is being developed in a way that serves Google’s objectives.

So, with that as a framework, let me propose three different potential scenarios for what Google might really do.

First, this really could be like Google Fiber – disguised as an “experiment” but really a new business, competitive entry into the mobile service space. The biggest challenge with this scenario is that Google will be dependent on the mobile operators for at least network capacity, and that’s never the position you want to be in when you’re trying to disrupt the operator’s business (just ask the CLECs of the late 1990s who tried to resell RBOC service under the Telecom Act of 1996). Next, if Google were to pursue this approach, at least all operators not providing Google’s underlying service, would drop or deprioritize Android devices in their portfolios, seriously hurting Google’s momentum and leadership in the smartphone OS space. I can’t imagine that Google would see enough potential upside from this approach to offset the serious downside it would have on their core business.

As a second scenario, let’s take Pichai’s comments at face value and assume that this truly is a smartphone- and/or tablet-centric experiment, working closely with the operators. In that case, it would look a lot like Nexus. I wouldn’t be surprised to see Google rely heavily on their operator partner(s) for distribution and customer care. I also would expect the scale to be limited, meaning it would have relatively limited retail impact on the operators. I also wouldn’t be surprised to see Google want to move it around, so maybe each new Nexus device launched is a new MVNO on a different operator or set of operators. Google would effectively be proving out new/unconventional approaches to connectivity offers (e.g. unlimited) in a way that proves out to the operators that there’s market demand (enough to be a threat) and that the economics can work (so that it’s attractive).

The third scenario is that this really isn’t about smartphones and tablets at all, but it’s really all about IoT. Google obviously is making big investments in hardware and software for IoT, so it would be natural for them to invest to get the “beyond-WiFi” connectivity to work for them as well. AT&T has had meaningful success with IoT, and I think Verizon still has serious hopes for the space, so they might not be the first to open the door to Google’s entry into being a connectivity service provider here, but I think other operators may be more than happy to have Google’s wholesale business and to help define the de facto standards that others likely need to adopt.

Of course, all of this is pure conjecture. I have not been privy to any discussions between Google and mobile operators. There’s more that we don’t know than we know, at this point. However, I think these three scenarios outline a solid framework for anyone to consider the impact on the industry as a whole, or their particular business.

This should be fun to watch!

Just as Sundar Pichai did, I think it makes sense for us to look historically at Google’s forays into mobile and connectivity. I think there are three historical precedents to consider: Android, Nexus, and Google Fiber.

Android
Google followed Apple into the smartphone market. You can either say that, together, they created the smartphone market, or you can say that they significantly disrupted an existing market dominated by RIM (Blackberry), Microsoft, Palm, and Nokia (Symbian). Google had virtually no meaningful relationships with any of those four, but Android was a key element in the destruction of what had been a very strong relationship with Apple.

Including Apple, four of the five market leaders all had an integrated hardware/software approach to the market. Google chose an “open” or “ecosystem” model, similar to Microsoft’s successful approach to the PC market. In fact, the initial announcement of Android was made by the Open Handset Alliance, made up of 34 companies including OEMs, Operators, Developers, and Chipset companies.

Today, by far, Android is the dominant smartphone operating system. In his talk last week, Pichai claimed that 8 out of every 10 phones shipping around the world are running Android. Google has built a strong relationship with OEMs and, somewhat less directly, with Mobile Operators, to get Android to market. It is important to remember how critical Android was for Operators to have a competitive response to AT&T which had the exclusive on the iPhone. Verizon particularly rode the Droid horse hard until they gained access to the iPhone.

It is also important to note that Google’s Android play has always been focused on their core business model – increasing how much time each of us spends online, with Google providing web-based services and enabling monetization by 3rd party developers that ultimately drive advertising dollars for the company. (Advertising represented $59B of their $66B in 2014 revenues.)

Nexus
In January 2010, Google partnered with HTC to launch the Nexus One smartphone running the latest release of Android. The phone introduced some new features, but mostly it was an attempt by Google to demonstrate how strong a “pure Google” device could be. At least to some extent, it was an attempt to get the OEMs to stop modifying the Android platform. As you may recall, at the time, there was a fair amount of noise in the marketplace about fragmentation in Android (multiple operating system versions, different screen sizes, user interfaces, etc.) relative to the monolithic iPhone.

With the Nexus One, Google also tried to introduce a new approach to the market, selling an unlocked phone at full price, only available for purchase via a website, and with customer service only available via online support forums. None of these experiments were successful and undoubtedly contributed to the lack of success for the phone itself.

The second Nexus handset, the Nexus S (based on Samsung’s Galaxy S platform) was more successful. It introduced the Gingerbread version of Android (2.3) and had hardware specs that were impressive, including NFC. In fact, the Sprint version of the Nexus S became the launch device for Google Wallet. For this second Nexus device, Google stepped back from selling only on the web, selling as a full price unlocked device, and providing support through forums. Instead, they adopted the traditional industry models – sales and support primarily through the Mobile Operator channels.

Google has continued to partner with OEMs to introduce new Nexus phones, often using each new model as an opportunity to introduce new capabilities that perhaps the OEMs and Operators weren’t yet ready to place a bet on otherwise. It’s important to note that Google had to work hard to make sure that this program didn’t alienate the OEMs and Operators on whom the company was dependent. With each Nexus, Google partnered with a different OEM, and made sure that versions were available for the major operators.

To some extent, Google has used the Nexus devices to continue to push openness and capabilities that can enable mobile devices to be used for more and more applications, ultimately driving their core business.

Google Fiber
On February 10, 2010, Google announced plans to build an experimental fiber network, delivering 1GBPS, which they characterized as “100 times faster than what most Americans have access to today”. In their press release, they said “We’ve urged the FCC to look at new and creative ways to get there in its National Broadband Plan – and today we’re announcing an experiment of our own.”

As with Nexus, they made a big deal about the scale being not too small and not too big, saying that they would deliver the service to as few as 50,000 and as many as 500,000 people. They said their goal “is to experiment with new ways to help make Internet access better and faster for everyone” and they specifically called out enabling developers to come up with next generation apps, test new deployment techniques that they would share with the world, and provide openness and choice, managing the network in an open, non-discriminatory, transparent way and giving users a choice of multiple service providers.

They seemed (at least initially) to not want to offend existing broadband providers, saying “Network providers are making real progress to expand and improve high-speed Internet access, but there’s still more to be done. We don’t think we have all the answers – but through our trial, we hope to make a meaningful contribution to the shared goal of delivering faster and better Internet for everyone.”

With that initial announcement, they invited communities to express interest and more than 1000 did, with many doing crazy things to try to win the network for their community. I live in the Kansas City area (the winning city), and although Google Fiber is not yet available in my neighborhood, it has been a big catalyst for innovation across the metro area.

As has been well documented, Google’s entry into broadband also forced the existing broadband providers to improve their offers (speed, capabilities, and/or price). As Google Fiber has pushed into new neighborhoods and suburbs, the competitors have had to respond. Google is coming to my neighborhood this year and that has caused AT&T to expedite construction on their GigaPower infrastructure and for Time Warner to build out outdoor WiFi using streetlight mounted antennas. Everyone is offering special deals with multi-year commitments. We’ve seen similar competitive responses as Google has announced Fiber projects in additional cities.

Of course, Google Fiber is no longer a friendly, sub-scale experiment intended to help the broadband providers. In December 2012, Eric Schmidt said “It’s actually not an experiment; we’re actually running it as a business,” and he announced expansion to additional cities.

As with Google’s other telecom initiatives, the primary focus continues to be the core business. Google Fiber, both directly and indirectly, is driving more overall Internet use, and that helps drive Google’s services and advertising revenues. It’s also important to note that Google has traditionally not had a strong relationship with broadband providers, so they likely felt free to take a more disruptive approach to the market than with Android and Nexus.

In my next post, we’ll take this historical perspective, combined with Pichai’s comments, and combined with an understanding of the challenges that MVNOs traditionally face, and try to speculate on what a Google MVNO might actually look like.

In a recent consulting engagement, I was asked about the strategic issues facing U.S. mobile operators. I think I answered reasonably well, but it made me realize that the topic deserved a more thoughtful updating based on recent activities. With that in mind, I’d like to provide a high level outline of what I think are the biggest issues. I think each of these could be a future article in and of themselves.

1. Duopoly, The Rule of Three, or the Rule of Four
Perhaps the biggest strategic issue being played out right now is one of industry structure. Each quarter, Verizon and AT&T become stronger. Their strong balance sheets, fueled by rich cash flows, enable them to strengthen their hand. Meanwhile, the other two national operators (Sprint and T-Mobile) fight it out for third place. The Rule of Three claims that any market can only support three large generalists, implying that only one of those two can survive. Boston Consulting Group takes it a step further with their Rule of Four implying that perhaps two is the right number. American regulators would apparently block a combination of Sprint and T-Mobile, believing that a market with four competitors is better for consumers than a market with three competitors. But, in the long run, will that ultimately result in the failure of both #3 and #4, and in the short run, will it cause behaviors that damage the entire industry?

2. Wildcards: Google, Dish, América Móvil
Over the past few years, Google has done an admirable job of shaking up the broadband industry with the introduction of Google Fiber. In markets where the company has announced plans to build out local infrastructure, existing competitors have had to respond with improved offers to customers. Now, Google is rumored to be preparing to offer wireless services. Would they have a similar impact on the wireless competitive space, or are the disruptive moves already being introduced by T-Mobile and Sprint significant enough that Google’s impact would be muted? Meanwhile, Dish Networks has been spending tens of $billions accumulating a rich treasure chest full of spectrum which they are obligated to begin building out for wireless services. What will they do and how will that impact the competitive environment? Finally, América Móvil has spent the past few years preparing for a major global strategic shift. They already have a strong foothold in the U.S. prepaid market as an MVNO (TracFone), but their relationship with AT&T has been significantly altered perhaps positioning them for a more aggressive move into the U.S. Any of these three potential new entrants could have significant impacts on the American mobile market and must factor into the strategic scenarios for the four mobile operators.

3. Licensed versus Unlicensed Spectrum
As we’ll discuss more below, spectrum is the lifeblood of any wireless network. The global mobile industry has been built on licensed spectrum. Licensed spectrum has many advantages over unlicensed spectrum, including the ability to use higher power radios with better signal-to-noise resulting in greater range, throughput, and performance. Lack of unmanaged contention for the airwaves results in predictable and manageable performance, all resulting in higher reliability of each connection. The industry has invested hundreds of $billions to build out networks that provide a wireless signal for the vast majority of the U.S. However, the cost to build out a wireless network with unlicensed spectrum is a small fraction of that to build with licensed. Companies offering services with unlicensed spectrum are also unburdened by the regulatory requirements placed on Commercial Mobile Radio Service operators. The Cable MSOs have been most aggressive in shifting their focus from licensed to unlicensed spectrum. After decades of positioning to participate in the traditional cellular industry (winning spectrum in auctions, investing in Clearwire, partnering with Sprint, etc.), in 2012 Comcast, Time Warner, and others sold their licensed spectrum to Verizon and aggressively started building out a nationwide WiFi footprint using unlicensed spectrum. About a month ago, Cablevision introduced their Freewheel WiFi-based smartphone service to compete with mobile operators. Expect others to follow.

4. Spectrum Portfolio
Although mobile operators are toying with unlicensed spectrum, their strategies remain very centered on licensed spectrum. To effectively meet the growing demand for capacity, all operators will need more spectrum of some kind. However, not all spectrum is equal and operators know they need a balanced portfolio. There are a variety of criteria that factor into the attractiveness and utility of any given spectrum, but the easiest to understand is simply whether the spectrum is low-band, mid-band, or high-band. Low-band spectrum has a frequency less than 1GHz and provides the best geographic coverage (the signal travels farther) and in-building penetration (the signal passes more easily through walls). However, at these lower frequencies, there tends to be less spectrum available, and it has generally been made available in smaller channels, limiting the capacity (the amount of bandwidth that can be delivered to customers). High-band spectrum generally has a frequency above about 2.1GHz and, while it lacks the coverage of low-band spectrum, there’s generally more of it and it generally comes in larger channels providing lots of capacity. Mid-band spectrum (between 1GHz and 2.1GHz) provides a compromise – reasonable (but not outstanding) capacity with reasonable (but not outstanding) coverage. In the early 1980s, as the local telephone monopolies covering most of the country, Verizon and AT&T received free 800MHz low-band spectrum in each market they served. In 2008, the FCC auctioned off 700MHz low-band spectrum. Of the national players, only Verizon and AT&T had deep enough pockets to compete and walked away with strengthened low-band spectrum positions. Today, these two have the vast majority of low-band spectrum and T-Mobile and Sprint are hoping that the 2016 600MHz incentive auction will help them begin to balance their portfolios and are demanding that the FCC enact rules to avoid another Verizon/AT&T dominated auction process. All players have reasonable amounts of mid-band spectrum (with AT&T and Verizon again using their strong balance sheets to further strengthen their positions in the recent AWS auctions). The majority of Sprint’s spectrum is high-band 2.5GHz spectrum.

5. Network Technologies
Mobile operators face a number of strategic decisions over the next few years related to network technologies. There are enough uncertainties around the key decisions that each operator has a slightly different strategy. Two of the biggest decisions relate to small cell deployments and migration to Voice over LTE (VoLTE). AT&T has the most comprehensive strategy which revolves around their broader Velocity IP (VIP) Project, which they hope will free them from much of the regulatory oversight they currently endure in their monopoly wireline footprint and therefore provides tremendous financial incentives. This is driving a relatively aggressive small cell deployment and a moderately aggressive VoLTE plan. Verizon has been the most aggressive of the national players in deploying VoLTE, while (until recently) being the most hesitant to commit to significant small cell deployments.

6. Cash Management

6a. Capital Expenditures
None of this is cheap. It takes deep pockets to acquire spectrum and even deeper pockets to build it out. In a technology-driven industry, new network architectures will always require significant investments. As price wars constrain revenue, while demand for capacity continues its exponential growth, CapEx as a percent of revenue will likely become a significant strategic issue for all operators.

6b. Expense Management
Operating expenses and overall cash flow also can’t be overlooked. Growing demand for capacity and small cell deployments require increasing backhaul spend (although the shift to fiber for macro sites has helped bring that under control for most operators). But the biggest issue will likely continue to be the cost of providing smartphones and tablets to customers. As an illustration of how significant this cost is for a mobile operator, in Sprint’s 2013 Annual Report, the company reported equipment net subsidies of nearly $6B on service revenues of just over $29B (over 20%). In 2012, T-Mobile introduced equipment installment plan (EIP) financing as an alternative to subsidies and early in 2013 announced that it was eliminating all subsidies. Since then, the other three national operators have similarly introduced device financing. From an income statement perspective, this helps T-Mobile’s earnings since the device is accounted as an upfront sale, typically near full price. However, T-Mobile and their competitors have introduced zero-down zero interest (or close to it) terms, and they are discounting the monthly bill for the customer by roughly the same amount as their monthly equipment financing payment to keep the total monthly cost to the customer competitive with the traditional subsidized plans. The net result is that T-Mobile (and their competitors who have all followed suit) are taking on the financing risk without significantly improving their cash flow. For 2014, T-Mobile reported just over $22B in service revenues (a 17% increase over 2013). They also reported equipment sales of $6.8B (a 35% increase and 30% of service revenues). But, they also reported the cost of equipment sales at $9.6B (an increase of 38%) and they reported that they financed $5.8B in equipment sales (an increase of 75% over 2013 and 26% of service revenues). As of the end of 2014, T-Mobile had $5.1B in EIP receivables (an increase of 78%). That’s a lot of cash tied up in customer handsets. The strategy has worked in terms of attracting customers to switch to T-Mobile (which is why their competitors have had to respond), but it’s less clear that it’s been financially beneficial for the company in the long run. Verizon, for one, seems unconvinced and has been unenthusiastic about device financing. I believe this will continue to be an area of strategic deliberations at all mobile operators.

7. Plan Types
This shift from subsidized devices is also part of a disruption in how the industry views plan types. For decades, the industry focused on postpaid phone plans. These plans were subsidized, but the customer was locked in for two years, “ensuring” that the operator earned back their up-front investment in the device. Because operators, for the most part, managed this business with appropriate discipline, only prime credit customers could get a subsidized device and these tended to be fairly profitable customers. Those that didn’t qualify settled for a prepaid plan where they purchased the phone upfront at or near full price, which provided better cash flow early in the customer life, but less profitability over time. Eliminating subsides also eliminates the 2 year service plan (although the long term device financing still provides customer lock in) blurring much of the distinction between postpaid and prepaid. The number of people with multiple wireless devices is also increasing as we are carrying iPads and other tablets, as automakers are integrating wireless connectivity into the cars we drive, and as we move towards a day when virtually any product with a power supply will be wirelessly connected to the Internet. Different operators are taking different approaches to how to structure their plans to accommodate these changing customer behaviors within their business models, and I’m sure it will continue to be a topic for internal debate and discussion as the industry models evolve.

8. Commoditization
In many respects, wireless service is increasingly viewed as a commodity by customers. Operators continue to trumpet their network differentiation, but to the consumer there is generally the perception that all operators offer the same devices, in the same ways, and support those devices with networks that work reasonably well just about everywhere we go. Over the past 6 to 12 months, T-Mobile and Sprint have been very aggressive about reducing pricing or offering more for the same price, in a successful effort to take customers away from Verizon and AT&T. Those two larger operators have had to respond with lower prices or increased buckets of data. The operators may be denying it, but it sure looks like a commodity market to me, and I imagine that’s a discussion that’s happening in each operator’s strategic planning meetings.

9. Quad Play or Cord Cutting
For well over a decade, there’s been an ongoing strategic debate within the industry about whether a combined wireless and wireline bundle is critical to market success. At times, some players have decided that it will be and have taken actions, such as the strategic alliances between cable MSOs and wireless operators (Sprint, Clearwire, and Verizon), or advertising campaigns focused on integration across multiple screens (TV, computer, phone). So far, there’s little evidence that it really matters. Consumers take what landline voice, broadband, and video services they can get from the duopoly of cable provider or “telephone” provider and then they can choose from a competitive landscape for their mobile needs. For the last few years, it appears that none in the U.S. industry have seen any need to focus on a quad play future. In fact, the focus has been more on cord cutting and over-the-top players. However, in Europe, there’s a very different story playing out and it is driving massive industry consolidation. Especially while wrestling with the questions about commoditization, operators will once again question the benefits of a differentiating bundle.

10. Re-intermediation
Another common tactic to combat commoditization is to “move up the stack.” In the mobile industry, that would be “move back up the stack.” The introduction of the iPhone, followed by Android devices, led to the disintermediation of the mobile operator from much of the value chain. Prior to the iPhone, operators carefully managed their portfolio of phones, telling OEMs what features to build and it was the operators who largely drove demand for different devices. Operators collected the vast majority of revenues in the industry, directly charging the customer for the phone, the network service, any applications, any content, and any value added services (such as navigation or entertainment). The iPhone (and then Android) enabled better apps and content, provided a better marketplace for buying them, and provided an open connection to the Internet for a wide variety of over-the-top services. Although the operators had poorly managed the apps/content/services opportunity and therefore they didn’t have much “value add” revenue to lose, they clearly lost the opportunity to be more than just the underlying network. Over the past several years, the industry has tried to claw its way back up the stack. Operators pursued “open” strategies, introducing APIs for app developers and other tactics to try to be a “smart pipe” rather than just a “dumb pipe.” They have also tried to encroach on other industries by offering new mobile-enabled services, such as mobile payments and home security/automation. These efforts have not yet had meaningful success, although AT&T’s progress with Digital Life is promising. If operators want to escape the commodity “dumb pipe” trap, at some point they will need to figure out how to reclaim more of the stack.

Obviously, the mobile industry is dynamic and I expect these 10 topics to drive significant strategic decisions across all operators in the coming months and years. If you’d like to discuss any of these topics, drop me a note.