UK: TMT Trends: Predictions,2005 - A focus on the wireline sector

Forward

Welcome to the 2005 edition of Deloitte Touche Tohmatsu’s Technology, Media and Telecommunications (TMT) predictions for the global wireline sector.

2005 will be a particularly exciting year for the sector. Wireline will remain the dominant voice medium, and enjoy steady volume growth, but Voice over IP (VoIP) will grow its share of the market. Broadband will grow in terms of penetration, speed and quality of service. The steady deployment of fiber to the home (FTTH) promises to provide gigabit connectivity.

These predictions are the result of comprehensive research throughout 2004, the principal elements of which include:

• input from Deloitte Touche Tohmatsu’s member firms’ 5,000 Technology, Media and Telecommunications partners, directors and senior managers around the world;

• conversations with Deloitte Touche Tohmatsu’s member firms’ clients;

• dialogue with leading industry and financial analysts.

Accompanying each of these ten predictions is Deloitte’s bottom line: the suggestions to the sector for exploiting each key development that the coming year holds. We trust that this guidance makes this report a valuable reference for your company. On behalf of Deloitte Touche Tohmatsu and the TMT practices of its member firms, may I take this opportunity to wish you all the best for 2005.

Igal Brightman 
Global Managing Partner 
Technology, Media and Telecommunications

In 2005, the vast majority of voice calls will still originate and terminate on the PSTN (Public Switched Telephony Network), and PSTN operators are likely to continue to lead the market in call quality and overall reliability. Mobile and Voice over IP (VoIP) will steadily close the gap, but fixed operators will still enjoy billions of profitable voice minutes.

VoIP’s call volume and user base will increase significantly among consumers and businesses alike, but few enterprise customers will migrate completely. Although VoIP quality will continue to improve, for many it will still fall short of expectations, creating a slightly negative image in the marketplace. Variable reliability will likely hinder adoption and growth.

Larger talk-time allowances and growing address book capacity will steadily increase both the number and duration of calls over mobile networks – cutting into PSTN use. Incumbent operators are likely to come under increasing pressure from fast-growing, low-cost providers, which threaten to have the same impact on the telephone business that budget airlines have had on the transport sector. Incumbents typically respond to the threat by cutting prices, a strategy that plays right into the hands of more efficient, low-cost providers.

Broadband penetration will continue to grow, but profitability is likely to decline. In many countries, service providers will celebrate the fact that broadband connections finally outnumber dial-up – even though this may also represent the peak in customer acquisition. Broadband use will continue to revolve around PC applications, limiting the perceived value of a high-speed connection.

Broadband providers’ continued focus on price, rather than value, will result in price wars that increase churn and reduce margins. Overall demand for fixed-line bandwidth will grow steadily throughout 2005, driven by advances in processor speed (and file size), larger e-mail limits, and increased usage of digital photography and video.

Although convergence has received some bad press in recent years, there are many cases where convergence has created significant value. In 2005, we expect to see a number of new opportunities for fixed-line operators to generate revenue from convergence, including broadband games, virtual magazines, and consumer video over IP. Several operators will also launch converged voice services that feature fixed line pricing within buildings and mobile pricing when outdoors – theoretically reducing the customer’s overall phone bill. Despite the potential benefits, the initial rate of adoption is likely to be limited, with operators encountering a variety of technical hurdles, as well as conflict over the customer relationship.

Deployment of fee-based WiFi hotspots are likely to continue to outpace usage, with numerous companies fighting over a niche market that might actually get smaller in 2005. Yet overall adoption of WiFi will skyrocket, fuelling demand for broadband connectivity and other data services.

In 2005, the vast majority of voice calls will still originate and terminate on the PSTN (Public Switched Telephony Network). And while mobile and VoIP will both capture an increasing share of global voice minutes, the PSTN should continue to lead the market in call quality and overall reliability. The key advantages of five nines reliability (99.999 per cent call success rate) and superior sound quality will likely help PSTN operators fend off attacks from mobile and VoIP, which currently cannot compete on these terms.

In response to the pressure from mobile and VoIP, PSTN operators will probably offer increasingly generous, all-you-can-eat bundles of services – focused on low cost, not high quality. This questionable approach will accelerate margin erosion, and draw fire from new, low-cost providers – particularly VoIP operators – who can easily undercut PSTN prices without having to worry about network ROI, or even short-term profitability.

Most critically, the PSTN is likely to continue suffering from poor handset functionality, a problem that is deteriorating. Users are willing to pay a premium for mobile calls as it is more convenient to dial numbers stored in a mobile handset. At least 10 percent of all calls placed from within the home are currently made on mobile phones due to the convenience of dialing. Meanwhile, fixed handset functionality has remained largely stagnant, with R&D spending generally less than 1 percent of the development budget for mobile phones. This is an easy issue to address, and one that PSTN operators could readily overcome during 2005 – helping them recapture some of the traffic lost to mobile.

Fixed voice is still alive and kicking. With five nines reliability and the highest sound quality in the voice market, PSTN operators have significant opportunities to create value. Yet it’s clear the war of attrition with mobile and VoIP will only become more intense in the future. For PSTN to remain competitive, operators must act now to reinvigorate their business.

Cutting costs. In the short term, the easiest way to compete is reducing prices. However, this approach will be ruinous in the long term unless PSTN operators can also reduce their cost base. Operators that continue to focus on price-based competition without addressing costs will ultimately lose out to VoIP, which is inherently more cost-efficient.

Improving phones to drive network usage. Telephone operators have made massive investments in network infrastructure; yet handset development has fallen way behind. PSTN owners should commission phones that will stimulate call volume over fixed lines. Such devices must match or surpass the capabilities of mobile and VoIP handsets – particularly for key convenience features such as stored number dialing, text messaging and conference calling.

Building on strength. Operators should emphasize and expand their lead in quality and reliability – areas the competition will struggle to match. They must also do a better job marketing their superior capabilities. The move from analog to digital switches was a major step forward, but there are still ample opportunities to improve voice quality and functionality. Stereo sound, for example, could significantly boost call quality while proving difficult for non-PSTN competitors to copy.

VoIP will remain a niche product in 2005, but its importance to the global voice market will grow substantially. Fueled by the proliferation of broadband and growing public awareness, VoIP’s call volume and user base will increase significantly among consumers and businesses alike. PSTN operators will dabble in the market while a number of high profile VoIP pure-plays will emerge, sending ripples across the voice industry. Few enterprise customers will migrate completely, but even partial adoption will cause VoIP’s market niche to grow significantly.

Although VoIP quality will continue improving, it will still fall short of some users’ expectations, creating a slightly negative image in the marketplace. Key issues such as consistency and reliability will linger, further limiting adoption and growth. New features will partially offset the quality issues, but those functionality advantages will often go unexploited as vendors and customers continue to focus on price.

VoIP is likely to suffer some negative press during the course of the year. For enterprises, cost-savings may well be less than anticipated, slowing wider adoption. Instead of taking a chance on VoIP, many enterprises will focus instead on getting more value from the PSTN – hiring a professional negotiator or enforcing governance to drive costs down. An even greater number of companies will opt for a hybrid approach, using VoIP for internal communications and the PSTN for external traffic. Consumers will be deterred by the complexity and inconsistent quality of PC-based VoIP – and by the cost and limited availability of specialized VoIP handsets – causing most to stay with PSTN.

Another barrier to VoIP adoption will be the rise of VoIP spam, made possible by low-cost VoIP calls that are not subject to current telemarketing regulations. VoIP spam will be a limited trend in 2005, with little to distinguish it from traditional telemarketing, yet the press will likely have a field day publicizing this new "threat" to consumers.

VoIP will remain largely unprofitable in 2005, and the prospects for future profitability will be delayed even further by PSTN rate reductions – particularly for those routes that are currently the most expensive. The struggle for profitability will likely affect VoIP pure-plays as well as incumbent operators that offer VoIP (who will essentially be competing against themselves). In sum, few companies will make money from VoIP in 2005.

The VoIP industry faces a rollercoaster year ahead. To lessen the troughs the industry needs to address three main challenges: Improving quality. The voice quality of VoIP calls has improved markedly over the past three years, yet is still noticeably inferior to PSTN. To spur widespread adoption, the VoIP industry must bridge this gap in voice quality.

Delivering greater value. VoIP is currently most economical for VoIP to VoIP calls. To become mainstream, VoIP must deliver value for a wider range of call routes, including those that terminate on the PSTN and mobile networks. Customers – particularly enterprises – also need stronger evidence that VoIP is a good value. They want proven ROI, not just theoretical benefits.

Achieving profitability. Selling at a loss is one way to gain market share, but is clearly not sustainable. To ensure continued funding, all VoIP businesses – including pure-plays and incumbent operators – must demonstrate improving profitability.

Until recently, low-cost telecom operators were more of a nuisance than a threat to incumbents. However, some of these new operators are now worth billions and are growing fast – both in financial and geographic terms – with several years of profitable experience behind them.

In 2005, the performance of low-cost telecom operators will most likely become increasingly impressive and threatening. Through a powerful combination of low prices and low operating costs, these new operators are poised to have the same kind of impact that low-cost airlines have had on the travel industry.

Incumbent operators generally respond to the low-cost threat by cutting prices, a strategy that plays right into their competitors’ hands. As prices plummet, they should eventually reach a level that is not sustainable for incumbents, yet is still profitable for the more efficient, low-cost providers.

VoIP pure-plays represent a new breed of operator with even lower costs and potentially tens of thousands of customers per employee. However, their operating models have yet to be proven. 2005 is likely to serve as an important test for these newcomers.

Incumbent operators typically focus on technology-driven disruption; however, the greatest threat may actually come from competitors with innovative business models. To address the increasing challenge from low-cost operators, incumbents basically have two options:

Emphasizing features and service. Changing the basis of competition away from price by shifting market attention to superior service levels and functionality – two things low-cost operators can’t match.

Reducing the cost base. To compete on price, incumbent operators must become more efficient – most likely by cutting staff and moving operations offshore. Such decisions are never easy or popular, but in the long run are far more appealing than being driven out of business altogether.

Robust growth but falling profitability for broadband

Although broadband penetration will continue to grow, profitability will generally decline. In many countries, broadband providers will celebrate the fact that broadband connections finally outnumber dial-up – a very important and positive milestone for the industry. Yet broadband providers are likely to continue focusing on price, rather than value, undermining profitability. On average, customers at the end of the year will pay less money for more bandwidth than they did at the beginning, a price-performance trend that will drive customer churn – raising acquisition and retention costs, and cutting sharply into profits.

Throughout 2005, broadband use will continue to revolve around PC applications, limiting the perceived value of a broadband connection. The industry as a whole will fail to encourage the supply and sale of broadband appliances – consumer-oriented devices that connect to a broadband network (e.g. networked game consoles, WiFi music players, and high-quality video phones). At the end of 2004, only a small number of broadband appliances were available – largely targeted at early-adopters and other sophisticated technology users. More devices are likely to be launched in 2005, but it is highly probable that operators will generally fail to work with manufacturers to develop and promote them.

In 2005, broadband providers will face the dual challenges of improving market share and profitability. Broadband penetration rose dramatically in 2004; however, many of the gains were the result of sharp price cuts – an unsustainable approach in the long term. To succeed in the long-term, operators must focus on increasing profitability by:

Expanding the uses for broadband. Providers must expand the practical uses for broadband – beyond web surfing and e-mail – thereby increasing its value to consumers. They must promote the use of broadband appliances such as videophones, networked gaming consoles and home security devices.

Making broadband easier to buy. Incumbents still have an advantage in provisioning and support, which could be a key selling point given the technical complexity of establishing a broadband connection. Customers who have previously shied away from broadband may be willing to pay a premium for superior service and convenience.

Offering more payment options. Another way to drive demand without sacrificing profitability is to offer a wider range of payment options – including pre-paid service and pay-asyou- go – giving customers more flexibility in exchange for higher rates.

Selling services, not bandwidth. Many consumers find broadband jargon impenetrable and confusing. To foster adoption, operators must change the way they describe and sell broadband services – focusing on customer benefits, and using language regular people can understand.

Technology developments drive demand for fixed-line bandwidth

Overall demand for fixed-line bandwidth will grow steadily throughout 2005, and there are strong indications this growth will continue until at least 2010. Key drivers include:

• PC power. Intel founder Gordon Moore famously observed that processor speeds seem to double every 18 months. Moore’s Law has held true for the past 40 years, and is expected to remain valid for the foreseeable future. Increases in processing power tend to produce proportionate increases in file size – higher-resolution pictures, higher-quality music and video, and larger e-mail attachments – fueling demand for bandwidth.

• E-mail wars. Google recently introduced a free e-mail service that allows attachments of up to 10 megabytes, and gives each user a full gigabyte of total online storage – 200 times more than other free e-mail services offered at the time. The leading free e-mail providers have since responded by significantly increasing their own limits. The net result is that people are sending larger e-mail messages – and more of them – thereby consuming more bandwidth.

• Digital pictures and video. The incredible growth of digital photography and digital video is driving demand for bandwidth in two ways. First, by increasing the size of e-mail attachments. Second, by popularizing the use of personal web-sites, which typically include pictures and video for friends and relatives to download. Although personal web-sites are currently limited to a relatively small group of tech-savvy consumers, the activity will grow as the public becomes more technically sophisticated and as the tools become easier to use.

Operators must anticipate and nurture emerging applications that will drive demand for fixed-line bandwidth, then offer data and connectivity solutions that cater specifically to these applications.

Focusing on needs. A one-size-fits-all approach is becoming less and less relevant, given the increasing diversity of user needs, devices and usage. Services and pricing should be based on actual needs, not just bandwidth allocation. This approach should help customers recognize the value they are receiving, and allow operators to capture a greater share of the total value being created.

Working with vendors. In 2005, technology companies are likely to introduce a growing array of broadband appliances – fueling demand for bandwidth. Operators should work closely with these companies to sharpen the marketing focus, coordinate product and service launches, and maximize retail distribution.

WiMAX – a wireless data standard also known as 802.16, and apparent heir to WiFi (802.11) – is likely to remain on trial in 2005. It is a potentially disruptive technology, and has already had a significant impact on certain parts of the telecommunications industry. Because it can operate on unlicensed frequencies, fixed operators see WiMAX as an immediate growth opportunity, while wireless operators view it as a direct threat.

The first iteration of the WiMAX platform, 802.16a, is specifically designed for fixed applications and is a possible alternative to consumer DSL and cable. DSL operators will be among the first to launch WiMAX trials, using the technology to extend their footprint, which is currently limited to a few miles from each local exchange. WiMAX base stations can theoretically provide high-speed point-tomultipoint connectivity over a 50-mile radius, although in urban areas that range can fall to 3 miles or less. WiMAX will greatly accelerate broadband deployment in rural areas, small towns and suburbs.

WiMAX also represents perhaps the most potent and viable method for providing broadband connectivity to the developing world. Large countries such as India, which has 16 million villages spread over an enormous geographic area, may find WiMAX the only practical option for providing broadband services on a mass scale.

Testing the waters. WiMAX is likely to remain a question mark throughout 2005. Fixed operators will conduct WiMAX trials in rural areas, but may remain uncertain as to whether demand will ever cover the deployment cost. Cellular mobile operators will continue to study the technology as a supplement to 3G, but may well find it impractical for urban use (where mobile operators typically generate most of their revenue).

Before plunging ahead, fixed (and mobile) operators should pause to think about customer needs – and whether the market really needs another broadband technology. Most customers already face an overwhelming number of choices – fiber to the home, WiFi, 3G and many others – yet broadband use remains modest, and mobile data services have generated little interest. WiMAX is backed by some very large, very determined multinationals that will make it their business to convince operators they need WiMAX. But what really matters is whether customers need WiMAX. That should be the principal focus for 2005.

Although convergence has received some bad press in recent years, there are many cases where convergence has created significant value (e.g. online music stores). In 2005, fixed-line operators can expect to see an increasing number of new opportunities to generate revenue from convergence, including:

• Broadband games. Networked gaming on videogame consoles and PCs will increasingly drive demand for high-speed connections.

• Electronic magazine subscriptions. The internet gives publishers instantaneous access to a global audience without the expense or complexity of retail distribution. A number of niche magazines are already making a profit by offering electronic versions of their print publications – coupled with exclusive online-only content – generating new value from their existing material.

• Consumer video over IP. Millions of users are already making video phone calls from their computers. Improved availability of standalone, plug-and-play video phones will fuel the trend – drumming up new business for video phone manufacturers and broadband providers alike.

Operators should take a positive but pragmatic approach to convergence – clearly understanding how new, converged products and services will drive revenue and margins. Convergence will expand the practical uses for broadband, gradually creating new value for operators; however, selling bandwidth is only the beginning of the story.

Getting ahead of the curve. Operators must anticipate new trends and exploit them before forward-looking companies in other industries establish a dominant position. In the online music business, for instance, telecom companies only capture residual benefits because they didn’t get involved until late in the game. Meanwhile, the technology and media companies that pioneered the market are the ones reaping the lion’s share of the rewards.

Positioning for leadership. Fixed line operators are in an enviable position, with some of the fattest pipes into the home. Their top priority for 2005 should be establishing service packages and pricing plans that firmly position them as the gateway for all digital services – converged or otherwise.

In 2005, several operators will launch converged telephone services that feature fixed line pricing within buildings and mobile pricing when outdoors – theoretically reducing the customer’s overall phone bill. Converged phones will connect to fixed networks over Bluetooth or WiFi, switching to cellular mobile only when beyond the range of the wireless LAN.

Despite the potential benefits, the initial rate of adoption for these services is likely to be limited. Technical requirements will be far more challenging than operators expect, and even after those hurdles are cleared, disagreement over customer ownership is likely. Customers may be put off by that conflict, and by the limited selection of compatible high-end phones – as well as the significant investment required for in-building hardware. They may also suffer from a certain amount of bill shock – the psychological trauma of seeing all their fixed and mobile phone charges combined on one big bill – despite the fact that separate bills would add up to more money.

Remaining at arms length. Many experts believe all voice traffic will eventually be carried by mobile networks, and that fixed voice networks will ultimately disappear. However, the chances of this happening anytime soon are nil. In the interim, although various hybrids will emerge, the greatest value will be created by mobile and fixed services competing head-to-head. Hybrid offerings are unlikely to gain traction, and will tend to distract operators from what should be their principal focus – attracting and retaining customers to their own networks. May the best network win.

Although fee-based hotspots will struggle, global use of WiFi will continue to grow, creating significant revenue opportunities for telecom providers around the world. WiFi is a strong driver for fixed-line connectivity, increasing the connection’s value by making it easier to attach multiple devices. Wireless networking is creating new opportunities for fixed operators to sell, install and support WiFi infrastructures – particularly in the enterprise sector, where more and more companies are recognizing the simple elegance WiFi can bring to networking. It is also fueling demand for broadband in the home.

In 2005, several new innovations will extend the appeal and reach of WiFi technology. Streaming music wirelessly from a computer to a stereo system will give consumers yet another reason to invest in a WiFi network, while driving up demand for music downloads and internet radio. Other innovations will range from the simple (e.g. low-cost WiFi-enabled printers and scanners) to the exotic (e.g. networked control over lights and appliances throughout the home).

In contrast, deployment of WiFi hotspots are likely to continue outpacing usage. Fixed operators, mobile operators and pure-plays will all fight to serve a niche market that might actually get smaller in 2005 (due to increased adoption of GPRS and other mobile data services). Meanwhile, use of fee-based hotspots is likely to remain extremely low, except in a handful of business-centric locations such as airport lounges, business hotels and conference centers.

Operators should continue investing in wireless LAN, but must choose their investments carefully, preparing a rigorous and realistic business case to assess the likely risks and returns.

Enhancing the core product. Blindly deploying WiFi hotspots is likely to be a recipe for disaster. Instead, operators should consider how WiFi can be used to enhance the sale of their core product – network connectivity – along with other ancillary products and services. WiFi installation and support is another significant opportunity, both at the consumer and enterprise level.

Promoting WiFi devices. Prime opportunities include digital security for wireless LANs, and WiFi-based devices such as wireless home-security cameras and internet radios. Networked devices drive demand for connectivity and create new revenue opportunities for operators through resale margins and sales commissions.

Fiber to the home (FTTH) – a revolutionary technology long regarded by fixed operators as their most potent weapon – is expected to take a huge leap forward in 2005. Penetration and use will likely grow strongly throughout the year, with major deployments in Asia, the United States and Europe.

Optical component prices have plummeted over the last few years, making FTTH a much more viable investment. While fiber will remain significantly more expensive to deploy, most operators predict the technology will pay for itself by providing:

1. unequalled reliability and speed (up to a gigabit per second);

2. bandwidth to deliver a full range of services through a single pipe (including voice, data, television, radio and more);

3. low operating costs (fiber doesn’t rust, produces minimal electromagnetic interference, and requires no electricity);

4. scalable capacity that can rise with market demand – and a very long amortization period. By deploying fiber to the home, operators hope to gain a sustainable and insurmountable advantage over the competition.

FTTH deployment in the developed world is more or less a foregone conclusion, and every company in the TMT sector must have a strategy to deal with it. xDSL, satellite and wireless operators will likely be affected first, and must start taking action now. But media and technology companies will also need to prepare themselves.

Taking the long-term view. FTTH should be deployed in steady, sequential fashion, taking many years to become widespread. It may be even longer before consumers use more than a tiny fraction of its power. To succeed, operators must build their networks with low-cost operation in mind. They must also carefully manage investor expectations. FTTH is not a quick win – it is a long-term investment in a critical technology platform that will pay dividends for the next 50 years or more. 2005 is only the beginning.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.