Good news, bad news

Good news, bad news. Anna-Maria Kovacs has long been one of the few Wall Street analysts to really understand the FCC regulatory process and its implications for the telecom industry. In today's note ahead of the FCC meeting expected to take up VOIP issues, she nails the crucial business implications of the VOIP regulation debate:

  • If the application vendors can ride free and the telco and cable network providers are not allowed to block them, then the application vendors will have a huge cost advantage vis-à-vis the carriers they ride. The carriers will have both network and marketing costs, while the pure application vendors will only have marketing costs. In such an environment, the guest’s end-user rates can be much lower than those of the host. The problem would be most extreme for the telcos, who have an existing revenue base at risk and who lack video revenues to help support at least a portion of their network. But even the cable-network providers would be at a disadvantage vis-a-vis the pure application vendors.
  • The good news would be lots more end-user choices and lower prices. The bad news would be the threat to the financial viability of the underlying carriers who make that competition possible.

What Anna-Maria has realized is that the VOIP debate is about two visions for the future of the Internet. It's the same point captured in James Seng's layers diagram, and has been a recurring theme in my writings over the past few years. Vision 1 presumes that applications will be tied to connectivity platforms. Vision 2 innovation and economic activity booming when those layers are de-linked. (In case you're unclear, I believe in Vision 2.)

Naive expressions of Vision 1, like yesterday's Wall Street Journal editorial, simply ignore the lessons of the Internet and telecom competition over the past two decades. The best case that can be made for tying applications to network infrastructure is the one Kovacs lays out: it's the only way to pay for the network. The critical question is the one raised in her last sentence: whether the network is financial viable based on connectivity revenues alone. (Anna-Maria is just setting out the possibilities; I don't know whether or not she believes this viewpoint is accurate.)

I'm convinced that network operators can do quite well based on their access revenues alone, without any need to suck value out of the application and content layers. The hard part will be replacing legacy infrastructure and shifting to a new cost structure. The Bells spend tens of billions of dollars each year on capital expenditures, and turning that oil tanker around won't be easy.

Yesterday, in his New America Foundation speech, AT&T CEO Dave Dorman described some of the pain AT&T has gone through over the past five years in migrating from five separate networks to one massive IP network. It's a multi-billion dollar annual project, which is still ongoing. But AT&T believes that pain is necessary to position itself for the emerging all-IP, converged telecom world. I think they are dead on.

The incumbent local phone companies haven't yet made the same commitment AT&T has. Instead, they are pushing a vision that removes the pressure for change.

UPDATE: Right after I posted this, I read Ted Shelton's analysis of the economics of starting a VOIP telco.  He pegs the initial capital costs at just $8,000.  This illustrates the discontinuity I'm talking about. [Werblog]

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