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How Should the Government Regulate Internet Interconnections?

lead pic (3)Thanksgiving greetings from Austin and Dallas, where the Jesuit Rangers played a terrific playoff game against Rockwall High School.  In the end, Rockwall prevailed, but Jesuit kept it close through the third quarter.


uberconferenceBefore we dive into this week’s topic, I wanted to give a quick shout-out to my friends at Uberconference (not a client, just a huge fan – more on their product here).  Many of you who worked with me know that I have dropped Citrix GoToMeeting for Uberconference and have high respect for the entire Switch Communications (formerly Firespotter Labs) team led by Craig Walker of Grand Central/ Google Voice fame.  They have shaken up the conference calling scene with inexpensive innovations and been rewarded with strong adoption.  Sprint announced this week that they were integrating Uberconference into their Google Apps suite of services.  Kudos to Sprint and Uberconference for the move.


In addition, StepOne (who is a client) announced their Care Profiler product this week to wide coverage.  I think the best quote comes from Silicon Angle who called Care Profiler a “CT Scan for customer service.”  I have mentioned StepOne several times in this column, and believe that deep contextualization can be a game changer for Communications Service Providers.  StepOne translates correlated data points into action, and in the process drives up satisfaction and drives down calls to care.  More on StepOne here.


DARPA, NSF, and the Commercialization of the Internet

With the President’s support for increased regulation now publicly known (see his statement here and the corresponding Washington Post article on how this scuttled a near-term deal here), I think it’s worth two Sunday Briefs to discuss practical ways to resolve two critical elements of the Net Neutrality debate:  a) interconnection agreements, and b) paid prioritization.

DARPA Vector Logo.epsThe Internet was not invented in the Silicon Valley by Apple, Cisco, Facebook, Uber, Netflix or Google.  It was born out of the efforts of the Defense Advanced Research Projects Agency (DARPA), an organization established by President Dwight D. Eisenhower in 1958.  While it would require the rest of the column to outline the series of events that took place (see a good history here), it is interesting to note that IBM belittled the idea of the Internet in the 1960s, and that AT&T at the time had no commercially available “long lines” to handle Internet networking.  Here are pictures of the 1971 and 1977 DARPAnet nodes:

arpanet 1971 alternate


Despite repeated efforts by Democrat Montana Senator Mike Mansfield to curb DARPA’s efforts (see more on the Mansfield Amendments of 1969 and 1973 here), DARPA’s network lived on, and made its next major leap with the development of Transmission Connect Protocol/ Internet Protocol version 4 in 1982 and 1983.  At this point, TCP/IP v4 became the standard for all military networking (and would stand as the standard for more than 20 years).  The launch of NSF Net in 1986 quintupled the number of Internet nodes, paving the way for the invention of the World Wide Web.  The first commercially available Internet offerings did not appear until the mid-1990s, when the National Science Foundation ended its sponsorship of the Internet backbone.


Without the government’s sponsorship (and especially that of the defense and academic computer science communities), there would be no Twitter, Google, Netflix, Groupon, etc.  However, without commercialization, the Internet would have been a costly private network (and there would have been no iPhone).  Bottom line:  The Internet was a government invention in the 1970s and 1980s, but commercialized and financially sustained through entrepreneurs in the 1990s and beyond.


Connecting Networks is a Messy Business

Transitioning from a government-run to a fully commercialized state has not been easy.  Companies like BBN Planet, CERFNet, UUNet, SprintLink, and Internet MCI carried traffic for emerging brand names through dial-up connections.   Many other Internet backbone companies emerged during the dot.com boom.  To connect server content to customers, all of these networks had to interconnect.  As a result, peering policies were developed.


Peering relationships have been the topic of debate since the development of commercialized Internet.  The cartel forged by the original Tier 1 Peers (who exchanged information between themselves at a settlement free rate but charged others for access) stood for nearly a decade.  With the advent of large fiber-backbones in the late 1990s, new networks emerged and faced a constant struggle to “break in” to the economic club.  Genuity was acquired out of bankruptcy by Level3 in 2003.  UUNet was acquired by MFS who was acquired by WorldCom and eventually Verizon.  Internet MCI was acquired by Cable & Wireless through the MCI/ WorldCom divestiture and was eventually sold to Savvis which is now a part of CenturyLink.  SprintLink still exists largely as an IP backbone for Sprint’s wireless division.  Tier 1 IP status had cache and real economic value.


The concept of peering is not as straightforward as many have represented.  The standard used in many agreements is called “hot potato routing” which, as the name implies, involves handing off content to the destination IP provider as soon as possible.  If the customer is in Tuscaloosa, Alabama and the desired server content is in Mountain View or Sunnyvale, California, under hot potato routing, the Alabama Internet provider would be responsible for picking up the traffic at a peering point (e.g., in Palo Alto at the Palo Alto Internet Exchange) and transiting it to Alabama.  If the content is a web page, it’s likely not a big deal, but if it’s a multi-GB video, the type of routing makes a difference.


As the growth of YouTube and Netflix has proliferated, the argument of “where to interconnect” has intensified.  Cable companies, who largely operate private backbones with leased or owned fiber, want to have Level3 or Cogent meet them as close to their facilities as possible.  This practice is called “cold potato routing” and is the framework for the termination of voice minutes between VoIP and circuit-switched providers.


netflix logoWhile Internet traffic continued to grow in the 2000s, it wasn’t until Netflix had accumulated a sufficiently large streaming library (~2010) that cable companies (and Verizon and AT&T) began their demands for paid peering.   This started a three year feud between Level3 and Comcast that eventually resulted in a settlement (a brief history from Telecompetitor can be found here).


While the details have not been disclosed, it’s likely that Level3 agreed to carry traffic further into the network and have a handoff point closer to the customer.  Using the Tuscaloosa example, instead of having Comcast transit traffic from Palo Alto/ Sunnyvale to Tuscaloosa, the parties likely agreed to connect in Atlanta or Birmingham.  At the same time, Netflix likely began to store some of their more popular content on servers in Atlanta to minimize their costs to Level3.


netflix number of streaming subscribersThis solved some short term problems, but Netflix continued to grow far faster than broadband subscribers as a whole (see nearby Statista chart and this page for more data).  With Netflix continuing their rapid ascent (according to Sandvine, Netflix has grown from single-digit peak-period US Internet traffic in 2010 to 35% today), many additional interconnection ports need to be added.  If they are not added in a timely manner, service quality degrades.


Note:  Degradation applies not only to downloaded packets but also to upload acknowledgements or “ACKs” that the download packets were received.  Slow upstream acknowledgement will result in delays in release of additional downstream packets.   See this article from Ars Technica on the upload packet phenomenon.


According to the Sandvine study cited above, fifty percent of today’s peak (7-11 p.m.) traffic comes from two sources: Netflix and YouTube.  But traffic constraints are only going to get worse with the rise of HBO, CBS, and Dish/ Disney over the top services.  Many in the Internet community have voiced concerns over the impact of increased congestion on interconnection points and have called on the government to act quickly.


To solve this problem, the FCC needs to do several things:


  1. Separate interconnection policy from other parts of the current Net Neutrality debate (paid prioritization, open access, increased reporting, etc.). Interconnection policy involves establishing the correct size and speed to existing traffic, while many/ most of the other issues involve the possible prioritization of traffic within a given port size).
  2. With #1, determine whether there is enough bipartisan support to enact separate legislation. Nothing survives a court challenge like fresh legislation, and there are likely filibuster and veto-proof majorities to enact basic rules with Comcast, Level3, Google, and Netflix support.
  3. Determine the most sustainable business model (settlement free vs. paid peering). While I, like most of you, support a settlement-free model, I can imagine a scenario where a paid peering model (using a low but fixed and predetermined rate based on the size of the broadband service provider) might spur additional last mile investment.
  4. For settlement-free models, the FCC should implement rules around:
    1. Server proximity to broadband service providers in the top 50 US markets (e.g., Netflix must house the top X,000 programs on servers within YY fiber miles of Time Warner Cable’s head end facilities).
    2. Forecasting requirements (and consequences for Google and Netflix if they over-forecast demand) for both upstream and downstream ports.
    3. Broadband service provider fulfillment requirements (XX calendar days to fulfill forecasted demand).
    4. Independent monitoring and expedited dispute resolution.
  5. Form a timeline to include wireless providers in the equation.


While there is a lot of emotion around the concept of paid prioritization, establishing long-needed interconnection rules represents the final step in transitioning from the DARPA/ NSF academic model to a fully functional commercial model.  The FCC plays an important watchdog role here, and needs to be clear how changes will improve the streaming experience.


There will be no Sunday Brief next week due to the Thanksgiving holiday – we will resume the Net Neutrality debate with a discussion of Incentives-based Paid Prioritization in the December 7th Sunday Brief.  However, we are taking your nominations for the top ten events of 2014.  Please submit your responses to sundaybrief@gmail.com (all responses will be anonymous) and we’ll publish the results.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).


Thanks again for your readership, and have a terrific week!

Is it Still an Android World? (Nov 2014 edition)

** EDITOR’S NOTE:  It is recommended that the first two pages of the attached document are printed prior to reading this article.  **


opening pic (4)Texas high school football playoff greetings.  The “second season” has begun in the Lone Star State, and my son’s team (Jesuit Rangers) made it through the first round with a solid 59-7 victory over the (Richardson) JJ Pearce Mustangs.  It’s a fun time to be a high school football parent.  On to Rockwall (a fitting name for a tough opponent).


Thanks to you, we have had a surge in Sunday Brief subscribers over the past month (over 70).  Some of you may have been added later than the standard “next week” interval.  If you need to catch up on any back issues, they are at www.mysundaybrief.com.  Keep the references coming.  We have added 198 net new subscribers this year and hope to top 1,200 total e-mail subscribers before the year is out.


This week, we will focus on changes in the handset marketplace since our last look (June 1, 2014).  At the end of the column, there will be a homework assignment for next week’s column.

Is It Still an Android World? 

Verizon-HTC-Touch-Pro2-officialFor five years, The Sunday Brief has been tracking the pricing and positioning of all wireless phones.  It has been an action-packed journey.  Hard to believe, but in late 2009 Verizon’s flagship smartphones were the EVDO Rev A enabled Blackberry Tour and the HTC Touch Pro 2 (running Windows Mobile).  Traditional phones outnumbered smartphones at Verizon stores by 2-1.  The Samsung Galaxy had not been introduced, and Verizon’s iPhone introduction was nearly 18 months away.


iphone 6 plusFive years ago, AT&T was basking in iPhone 3GS exclusivity. Many smartphones were just beginning to receive Wi-Fi radios, and six of the top nine smartphone devices were made by Blackberry.  Samsung was a fledgling smartphone provider specializing in the Windows Mobile operating system, and Android was completely unknown.  You can take a more extensive trip down memory lane by looking at the last two pages in the attached.


Today, the situation is quite different.  The traditional subsidy model is being challenged by one based on monthly payments.  The iPhone 6 and 6 Plus were simultaneously launched across all of the “Big Four” with T-Mobile and Sprint receiving certain Wi-Fi product or bundle treatments – another break from Apple’s past.  We now talk about the quality of Wi-Fi calling and the availability of 802.11 ac in the latest devices.


The most dramatic change, however, is occurring in how we pay for a device.  Instead of cost sharing at point of sale (customer pays part of the device when they switch carriers or renew), the wireless carriers have begun to offer monthly installment plan models (AT&T offers a 30-month option in their payment plan, while the other carriers offer 24-month options).  In exchange for shifting device costs to the consumer, service plan prcing has been cut or more data has been added to current plans and pricing has remained flat.  Once the device has been fully paid off, consumers are under no further contract obligations.


Monthly payment plan options  combined with pooled data pricing (and unlimited voice and text) have become the norm at T-Mobile.  They no longer offer subsidized device pricing.  It’s also interesting to note from the attached charts that they offer substantially fewer (10-16 less) devices than their peers.  Store representatives are better versed on more devices, and can match plans to specific customer needs.


Dealing With Device Inventory in a Monthly Installment World

Monthly plans have heightened inventory obsolescence risk.  In subsidy models of the past, the lure of “free” devices could usually clear most units.  This was especially helpful as carriers upgraded networks.  Older devices could be quickly jettisoned, leaving less “This phone does not have LTE capabilities” discussions and disclosures in the buying process.


Apple even jumped on the bandwagon, adopting the carriers’ $199.99, $99.99, and $0.99 pricing strategy to affect an orderly device transition.  “Free iPhone” offers have been cited by Verizon Wireless in several conference calls as the driver of gross additions (although in the case of the free iPhone 4S, customers would not be able to have an LTE or XLTE experience).


Customers who want (or are a member of a family who is joining ) a monthly AT&T pricing plan face the following dilemna:  Purchase the latest and greatest iPhone 6 for $21.67/month for 30 months, or last year’s iPhone 5s for 15% less or $18.34/month.  For $3.33 more per month (or $100 across 30 months), most consumers are going to splurge and get the latest version.  That creates serious problems for previous iPhone models.


Nowhere is this more evident than at Sprint, and is one of the reasons why they had to create “iPhone for Life” plans:


iPhone Model                   Carrier                  Monthly Plan Pricing (24 months)

iPhone 6 Plus                     Sprint                    $25.00

iPhone 6                              Sprint                    $20.00

iPhone 5s                            Sprint                    $20.00 (0% discount to iPhone 6)

iPhone 5                              Sprint                    $22.92

iPhone 5c                            Sprint                    $18.75

iPhone 4s                            Sprint                    $18.75 (6% discount to iPhone 6)


As this chart shows, it is going to be very difficult to clear any iPhone 5, 5c, or 5s inventory through monthly payment plans.   They will have to be sold through the traditional subsidy model.


trade in screen shot t-mobileThe situation becomes even more complex with increased Early Termination Fee (ETF) activity and aggressive phone trade-in pricing.  In an effort to get a many customers on the latest devices (and networks), the carriers (particularly Sprint and T-Mobile) are making aggressive offers to replace customers’ existing handsets.  This is especially important to Sprint as most trade-in devices are not Sprint Spark capable (Sprint’s custom tri-band 2.5 GHZ/ 1900 MHz/ 800 MHz configuration).


Here is a sampling of iPhone trade-in value ranges from Sprint’s and T-Mobile’s websites (see Sprint’s list here and T-Mobile’s trade-in pricing tool here):


Model                                  Sprint Range      Sprint Median                   T-Mobile Range

iPhone 4S 16 GB               $59-111                     $55                                    $25-205

iPhone 5 16 GB                  $115-200                   $200                                  $104-131

iPhone 5C 16 GB               $87-303                     $200                                  $83-121

iPhone 5s 16 GB                $190-303                   $300                                  $163-214


Both Sprint and T-Mobile are being aggressive in their trade-in offers (and, from two store visits this week, my Sprint iPhone 4S 8 GB is worth slighty more in-store vs. on-line at both Sprint and T-Mobile).   While AT&T and Verizon are not as aggressive on trade-in values as Sprint and T-Mobile, the point is still the same:  More in-cycle buybacks leads to an elevated supply of used devices.


The evidence of increased supply of secondary devices started to show up in AT&T’s third quarter earnings when they announced that 462,000 gross additions came from Bring Your Own Device (BYOD) sources.  While some of these represent “family shifts” (during the switch, one member of the family gets a new device and everyone else gets the hand me down), many of these are reflections of the growing supply of secondary devices from sources like eBay, Gazelle and Glyde.


Bottom line:  Wireless carriers are moving to monthly payment plans (although Verizon and AT&T will continue to offer traditional subsidy models for the foreseeable future).  This creates inventory obsolescence pressure on older models in the line-up.  In addition, ETF and trade-in programs are driving additional supply into the market.  This leads to a wider selection of devices using a wider array of networks.


What does this mean to Apple, Android, Microsoft, and Blackberry?  Each new device launch needs to be materially better than the previous one.   If customers cannot justify the difference, they will increasingly bring their own device.  That creates customer experience issues for each wireless carrier.


Yes, it’s still an Android (and Apple) world.  2015 needs to be the year that Microsoft becomes a relevant player in mobile.  New CEO Satya Nadella is already planning on scrapping the Nokia name (see article here).  Now it’s time to use their increased market capitalization (MSFT touched $50/ share on Friday and surpassed Exxon in equity value) and software expertise on beating Apple.  Absent Microsoft’s innovation, the handset market will continue to show duopolistic characteristics.


Next week, we’ll discuss your comments to the following question:  “How should the government engineer the Internet?”  Please submit your responses to sundaybrief@gmail.com (all responses will be anonymous) and we’ll publish the results.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).


Thanks again for your readership, and have a terrific week!

Key Insights from This Week’s Third Quarter Earnings (Part 4)

The Sunday Brief:  Key Insights from This Week’s Third Quarter Earnings (Part 4)


tomb-unknown-soldier-picture Veterans Day greetings from Seattle and Dallas.  Thank you to all who have served and are continuing to serve.


This has been a week filled with earnings news.  Before diving into Sprint’s and cable earnings, however, a quick shoutout to Scottsdale-based Telesphere as they were acquired by Vonage this week for $114 million ($91 million in cash and $23 million in Vonage stock).  This transaction represents a 2.3x return for Greenspun, Rally Capital, and Hawkeye Investments, the three principal fund sources over the past six years.  Kudos to Clark Peterson and the entire Telesphere team on a successful exit.


Sprint:  Down, But Are They Out? 

Sprint reported dismal earnings on Monday.  As a result, the stock dropped 24% this week ($1.48/ share), and is down 55%, or $5.75, year to date.   In an interview with Bloomberg BusinessWeek, incoming CEO Marcelo Claure stated “I was aware of the challenges facing the business, but not to the level of detail I saw when I became the CEO.”  Interestingly, a similar statement was made by Dan Hesse during first quarter earnings in 2008 (see here for the BusinessWeek article).  Some things never change.


The difference between Sprint’s and the industry’s performances is stark, as shown in the postpaid retail net additions trend in the table below:

net adds through 3Q 3014

In the last four quarters, Sprint’s three largest competitors have grown 12.6 million retail postpaid wireless subscribers.  Sprint has fallen by nearly 1 million.  Over the past eight quarters, Sprint’s three largest competitors have grown 19.8 million retail postpaid subscribers. Sprint has fallen by 3.4 million.  Statements made by (CEO) Dan Hesse and (CFO) Joe Euteneuer on numerous earnings calls in 2013 and early 2014 indicated that Sprint would turn the corner as soon as the construction dust settled from their network upgrade (Vision) project.  The dust turned out to be toxic, and customers (particularly wireless phone customers) continued to flee.


As if that weren’t bad enough, Sprint apparently loosened credit standards to juice tablet and family plan growth earlier this year, which drove up monthly retail postpaid churn to 2.18% on the Sprint platform and 2.22% overall.   According to the earnings call commentary, it will take six months to run the involuntary pig through the churn python.


There were additional problems  as well.  Equipment Installment Plans (EIP) were supposed to provide short term cash flow relief due to their popularity, but only amounted to 20% of gross adds in late summer.  Net promoter scores were touching on the lowest levels ever seen by Sprint.  And the wireline unit, once a supplier of cash ($120 million in 3Q 2013), became a cash consumer (EBITDA negative) in their most recent report.


Bottom line:  Things were bad, but are they better now, and can Sprint stay healthy?  Without a doubt, Sprint was healthier in September and October than they were during the summer.  But achieving net add positive status when others are growing 3-5 million net new subscribers per year only causes Sprint to fall behind less.


The Verizon and AT&T pricing actions discussed last week hurt Sprint’s ability to recover quickly.  Reorganizations and work force reductions create short-term operations disruption.  And Sprint’s potential competitive advantage, a large holding of data-friendly 2.5 GHz spectrum, is less valuable in a world where SIM card swaps (as opposed to new device purchases) are the expected way to switch carriers.  Having “special” spectrum (versus 700 MHz spectrum) is not an asset in a SIM card swap world.   There are more headwinds facing Sprint than revenue pressures caused by postpaid retail phone losses.


One of the leading telecom analysts, Craig Moffett, put Sprint’s value in perspective earlier this week when he wrote:


Today, Sprint trades at 8.6x 2015E EBITDA, despite rapidly declining revenue and subscribers.  T-Mobile trades at 6.1x ‘15E.  If Sprint were to trade at the same multiple as T-Mobile – something that we would view as overly generous given that T-Mo has already proven its strategy works while Sprint hasn’t – then Sprint would trade at $1.95/ share. 


sprint stock 2008 This lower share value would mirror the drop in Sprint’s stock during the first year of Dan Hesse’s tenure (Jan 1 2008 = $13.13 per share; Dec 31 2008 = $1.83 per share, an 86% drop – see nearby chart).  As mentioned earlier, Sprint’s stock is only down 55% so far this year.  While no one is predicting additional declines, the last time we saw a stock price decline this steep was in the first year of Dan Hesse’s tenure.

Sprint’s value cannot recover until their competitive advantage is established.  This includes in-home/ in- building  coverage for 2.5 GHz spectrum (not just 800 MHz spectrum), something that Sprint is attempting to get right for 3-5 unannounced cities in the next several months, and hopefully replicate across the country in 2015/2016.  It also includes stronger relationships with partners such as the cable industry and the new and improved Level3/ tw telecom.  Sprint has been unsuccessful in their single-threaded strategy, and a partner-dependent recovery plan is needed.


Without in-building partners, Sprint cannot be competitively advantaged.  If others have in-building and in-home partnerships and Sprint does not, Sprint will be competitively disadvantaged.  The laws of physics drive this result (2.5 GHz spectrum does not penetrate as easily as 600 MHz or 700 MHz spectrum).


The Cable Industry:  Third Quarter Observations

With all of the changes occurring in the wireless industry, we’ve been derelict in our analysts of the cable industry.  The following table outlines one of two key metrics the industy is currently tracking:

commercial services revenue trends cable

Two surprising trends emerge.  First, Charter has largely been going about their business growing their High Speed Internet (HSI) penetration by nearly 600 basis points over the last eight quarters.  Their penetration now exceeds Comcast’s and is tied with their one-time acquisition target Time Warner Cable.  Charter did this by separating their bundle offerings into a) triple play, which stands at 32.6% penetration, up slightly from 32.2% in 3Q 2013, and b) stand-alone HSI which is approximately 10% of the total residential Internet relationships.


The most interesting statistic in Charter’s earnings is the relationship between Video and HSI subscribers.  In 3Q 2012, Charter had 4.0 milion Internet customers and 4.3 million video subscribers. Those figures are now 4.7 million and 4.2 million – over 500,000 more Internet than video relationships.  Time Warner Cable has also seen a similar change, but Comcast and Cablevision still maintain parity between their video and HSI relationships (more data available upon request).


The second observation above is that everyone is continuing to grow data even as penetration rates reach (or in Cablevision’s case exceed) 40%.  Time Warner Cable is set to have their best High Speed Internet growth year since 2010, thanks in large part to increased competitiveness in Los Angeles and New York City and favorable demographic shifts to the Carolinas and Texas.  As the chart above shows, Comcast, even with their very large footprint (54.4 million homes and businesses passed as of 3Q 2014), has grown their Internet penetration by 370 basis points over the past two years, on par with Verizon’s FiOS growth.  Without revisiting the profitability of HSI (we’ve talked about this in several earnings review columns), it’s safe to say that between faster speeds (leading to higher ARPUs) and scale efficiencies, additional growth continues to be very profitable.


While High Speed Internet is the primary bright spot on the residential side, there’s a lot to cheer about with cable’s commercial services business.  The table below shows the growth of commercial services across four leading cable providers (Cox Communications is not included as it is private):

commercial services revenue trends cable

Including Cox, Brighthouse, and the remaining Top 10 cable providers (and reclassifying some of Cablevision’s small business HSI revenue as commercial services), the cable industry represents approximately $11 billion of annualized business revenue growing at 20% per year.  While economic pressures exist in the business environment, it’s the competitive pressure from cable that is halting Verizon, AT&T and CenturyLink’s business growth.


Cable’s remaining constraint is their inability to deliver a single (global?) network management platform to medium and large enterprise customers.  This service suite would include associated cloud services (infrastructure as a service, desktop as a service, etc.).  As a result, they need to rely on their relationships with large systems integrator partners to drive additional penetration.   Following the closing of the Comcast/ TWC merger, it is expected that the next cable move will be to jointly invest in a network monitoring and management provider.  This, combined with an HP (EDS), Amazon, and/or an IBM partnership, would put cable broadband into a new league and open up a large and profitable addressable market.


While the headlines will be on regulatory approval and the increasing threat of Over the Top (OTT) services, the most important metrics to watch are High Speed Internet and Commercial Services growth.  This is where cable is either extending their lead or taking market share.


Next week, we’ll publish our semi-annual comparison of wireless devices (formerly known as “It’s An Android World”).  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).


Thanks again for your readership, and have a terrific week!

Key Insights From This Week’s Third Quarter Earnings (Part 3)

Cropped Almost HomeGreetings from Kansas City and Dallas.  This was a week of stunning victory and disappointing defeat.  For those of you who read this column but do not follow baseball, the World Series went to the seventh game for the first time since 2011.  Despite media reports that this would be the least watched World Series, it wasn’t (Game 7 drew 23.5 million viewers and was Fox’s highest ratings outside of Super Bowl weekend).  And, even though they won, the San Francisco fan base managed to turn it into an occasion to loot and pillage (more stunning footage on Giants’ fan reaction here).   It was a run that few Royals fans will ever forget, and a testimony to the admonition to “never … ever … ever give up.”  Kudos to the Giants on their third World Series victory in five years.  Hopefully we will see you next year.


The Royals remind me a lot of T-Mobile.  For years, pundits tracked the decline of T-Mobile as they slipped behind the market (the Royals lost 90 or more games for 9 out of 11 seasons from 2002-2012).  But then, the AT&T merger failed to transpire, and T-Mobile received cash, spectrum, and a roaming agrement as a result.  The Challenger Strategy was born.


While many (including myself) thought the Challenger Strategy was an attempt to market network expansion only, it ended up being more.  Here were the original planks of the strategy (see original announcement here):


  1. A $4 billion network modernization and 4G rollout
  2. Adding 1,000 direct salespeople to sell to businesses
  3. Increasing advertising
  4. Growing the MVNO (wholesale wireless) channel


john legereThat was February 2012.  There were 37,000 cell sites to upgrade and progress to track.  This looked like a traditional upgrade network/ grow data ARPU/ find-a-way-to-survive-at-the-low-end of wireless model.  T-Mobile reported third quarter earnings on November 8, 2012 to little fanfare.  Newly announced CEO John Legere (pictured nearby) promised that the proposed Metro PCS merger would be a transformative event, and that T-Mobile would be the market leader in Bring Your Own Device (BYOD).  T-Mobile had a new manager (who publicy looked a lot like previous managers – see here) with farm team promise.


Then came 2013.  The Uncarrier strategy was launched and “Challenger” was jettisoned.  The iPhone is introduced on T-Mobile’s network.  Simple Choice plans are introduced.  Jump! (equipment exchange plan) is introduced.  International roaming is included.  Momentum builds, and T-Mobile has a winning record (600K+ year-over-year postpaid subscriber growth) for the first time in recent memory.  Unlike Royals manager Ned Yost, who is a man of few words, John Legere speaks out at every moment possible, grabbing headlines like “A 10-gigabyte, 5-device shared data plan, when Joe Schmoe Junior starts to watch porn on his phone, isn’t going to work. “


Like the Royals, the 2012-2013 season was a glimpe of what could be.  T-Mobile needed to build momentum, but also needed to best in something.  Their competitive advantage needed to translate into more wins, and to catapult them into the playoffs.


In 2014, T-Mobile could have focused on being best in a metric (postpaid net adds) through a well-defined tablet strategy (it’s a part of their plan, but not the main source of postpaid net adds).  They could have focused on dominating a particular segment like prepaid (they overtook Sprint in this category in the second quarter).  While T-Mobile is very good at serving this segment, it’s not as lucrative as postpaid, and meeting Apple’s phone commitments would require a significant postpaid acquisition effort.


T-Mobile decided to focus on the fan (customer) experience.  Deliver what they want (lower ticket prices, better/ unlimited food, a refurbished ballpark) and they will return with their friends.  More fans = more fun = more wins = more fans.  It was a cycle that was worth a shot.

T-mobile latest statsBoth T-Mobile and the Kansas City Royals entered their respective  2014 seasons with high hopes but fairly low expectations (The Sporting News predicted in March that the Royals would make the playoffs, but would lose to the Yankees in the Wild Card game – see here).   In April, T-Mobile set what now seem to be low expectations for the 2014 season of 2.8-3.3 million net additions and $5.6-5.8 billion of operating cash flow (EBITDA) – actual results are in the nearby picture.  As of last week, the new expectation is 4.3-4.7 million net additions and $5.6-5.8 billion of operating  cash flow (EBITDA).


We are in the late innings of 2014.  In baseball, we would call for the closer to notch the save and collect the win for the team.  (For those of you who have not followed the Royals this season, they reinvented the middle relief process with the “gradual” close – Herrera in the 7th, Davis in the 8th, and Holland in the 9th to great success.  It even prompted them to be featured in The Economist).


T-Mobile is relying on a backlog of iPhone demand, increased network capacity, and aggressive trade-in promotions to win the year.  Unlike the Royals in Game 7, they have the lead going into the seventh inning, but their well-funded competitors have lots of hitting power.


The swings at T-Mobile began to be felt in October.  At the beginning of the month, division rival AT&T began to increase their higher end data plans, introducing 30 Gigabytes (GB) of shared data for $130 (unlimited voice and text charges extra).  Sprint doubled the data offered in their plans to offer 60 GB of data for $130.  For a family of four, this would involve consuming 500 MB of data per family member per calendar day.  That’s a lot of video consumption, and much higher than averages of 1.5-3.0 GB per month for each of the Big 4 wireless carriers.  (Note: a similar storyline is playing out in the commercial services wireless space between Sprint and AT&T/ Verizon.  More on this in a future Sunday Brief).


Starting October 22, Sprint introduced a 1 GB plan for $20/ mo. (with unlimited voice and text, the cost would be $70/ mo. for a 2-line plan sharing 1 GB of data).   This is 20% less than AT&T’s $25/ mo. and 50% less than Verizon’s $40/ mo.


Not many phones will share 1 GB of data, however.  This is why AT&T increased it’s low end family plan speeds from 2 to 3 GB ($40) and from 4 to 6 GB ($70).  With unlimited voice and text, two people sharing a data pool would be charged $90 for 3 GB of shared data and $120 for 6 GB.  Given their focus on the 10GB family plan users, this change was as inevitable as having the designated hitter swing on a 3-0 count.  However, to those who have not been closely following the game, this action (and Verizon’s price reductions on higher pooled plans) seemed to indicate a price war.


mobile share pricingAs we have stated several times in The Sunday Brief, AT&T’s plans represent a change up.  The comparable ARPU to traditional subsidy-based plans for the 2-line shared examples would be $90 + 2 smartphones x $21/ mo. AT&T Next charge = $131/ mo. = $65.50 in ARPU (larger plan would be $161 and $80.50 respectively).  If one goes back to AT&T’s 4Q 2013 operating report (so before their announcement of the 10GB for $100/ four lines for $160 plans), postpaid ARPUs were pretty steady in the $46-48 range for the previous two years.


Embedded in this $46-48 is some amount of subsidy (the vast majority of new AT&T gross adds in 2012 and 2013 were on subsidized and not monthly device payment plans).  Analysts have spent a lot of time trying to determine the exact amount, but it is likely $9 or so (averaging in the cost of the latest iPhone/ Galaxy with accounts who are no longer in plan and therefore are not under subsidy).  This leaves $37-39/ mo. to cover service costs.


In 2012 and 2013, average smartphone data consumption for AT&T and Verizon was less than 1 GB per user (lower in 2012 and growing in 2013 with the advent of the Galaxy 4 and iPhone 5/5c/5s).  As these figures have grown, so has the nature of their networks (LTE is “3 to 4 times more efficient” according to Verizon’s latest conference call transcript).   Supporting 6 GB of data for $70/ mo. equates to $15/ GB if the plan only uses 78% of their alloted data ($15/ GB happens to be the overage charge for the 6 GB plan).  And to get to 3 GB of data for two users, a customer needs to be either a) streaming music, or b) watching video on a somewhat consistent basis.  Even normal (teenage) Facebook or Instagram usage will not yield 3 GB of data.


The bottom line is that Sprint and AT&T are stepping up to the plate to battle T-Mobile for their sweet spot customers as 2014 comes to a close.  At least AT&T can make money at these levels given their scale and LTE network density (we will discuss Sprint next week after they announce earnings).


legere now recodeT-Mobile has good relief, but is it good enough for AT&T’s giant bats?  Will T-Mobile join Alex Gordon at 3rd base?  They need a hit, and iPhone 6 backlog is not going to do the trick.  Neither is the soft SIM card in the iPad (John Legere’s explanation of this during his Re/Code interview this week is superb).  Neither is free streaming music.  All they need is a single (or a wild pitch).  What will it be?


Next week, we’ll continue our discussion of third quarter earnings with a focus on wireline/ cable and Sprint.  Until then, if you have friends who would like to be added to The Sunday Brief, please have them drop a quick note to sundaybrief@gmail.com and we’ll subscribe them as soon as we can (and they can go to www.mysundaybrief.com for the full archive).


Thanks again for your readership, and have a terrific week!