Telecom Companies, Cable Operators Battle for Consumers

Transcription

1 Market Analysis Telecom Companies, Cable Operators Battle for Consumers Abstract: While there have been skirmishes primarily on the ILECs' turf, there will be an earnest battle between ILECs and cable companies for the minds and pocketbooks of consumers during the next five years. By Elroy Jopling and Alex Winogradoff Strategic Market Statements Cable operators (MSOs) will enter the voice market in strength through the use of VoIP over cable using the CableLabs specifications, using revenue opportunism to address a potential $80 billion voice market and defensively to offer a more comprehensive bundle of services to address competition from the satellite operators. Although MSOs have only garnered 2 percent overall of the consumer telephony base, the potential long-term impact is likely to be more significant as demonstrated in selected market where MSOs have achieved penetration rates exceeding 25 percent of the addressable market. Today, more than 50 telecommunications companies in North America are "trialing" or have initial deployment of broadcast (television) distribution services using the traditional telephony plant with the majority evolving to market introduction as standards are established and the subsequent reduction in costs is realized. The telecommunications companies' mainstream entry into broadcast distribution services will be delayed until the impact of the MSOs' voice play becomes more evident, specifically with successful VoIP introductions. The battle for the consumer will be a win-win situation for consumers, hardware and software vendors, and content providers; regionally, the telecommunications and MSO winners will vary based on a mix of factors, including technology, speed to market, and most importantly how they are able to adapt their culture and significantly ramp up their consumer knowledge to address a new converged market. Strategic Planning Assumptions Seven of the top 10 North American MSOs will have introduced VoIP telephony services by the end of 2004 (0.8 probability). Each of the RBOCs in the United States and two largest ILECs in Canada will have introduced a broadcast distribution service into selected markets by 2005 (0.7 probability). Publication Date:10 December 2002

2 2 Telecom Companies, Cable Operators Battle for Consumers Introduction When consumers think of cable television and telephone companies, they almost never think of a cable company as their potential provider of telecommunications services, nor do they think of telephone companies as providers of television or cable entertainment. Yet both of these products are identified as "necessities" by the average consumer followed by Internet access and mobile telephony a battleground in waiting! Telephony and cable deployments are now effectively at saturation, with both industries eyeing each other for potential expansion. Initial attempts during the late 1980s and 1990s by telephone companies at entertainment have been utter failures, while attempts by some cable companies at providing telephony services have been reasonably successful. However, it is the Internet that has become the first serious battleground with promises of future revenue as new applications are developed. Thus, the battle is now engaged and is likely to have broader long-term impacts on both markets than the current death struggle between the incumbent local exchange carriers (ILECs) and competitive local exchange carriers (CLECs; for example, AT&T and WorldCom). The"real"battlefortheconsumerwilltakeplaceovertheremainderofthe decade. The cable operators/multiple system operators (MSOs, organizations owning two or more cable systems) are gearing up to expand into the voice market beyond their current circuit-switched play utilizing Internet Protocol (IP) technology, while telecommunications carriers will enter the broadcast distribution market. To date, MSOs have entered selected markets with a voice offering. In total, they have garnered only a 2 percent overall market share of North American residential consumers. However, the potential success of an entertainment and communications bundle of services is demonstrated in markets where cable companies that are focused on quality communications services have captured 30 percent of their addressable markets, specifically Cox Communications, AT&T Broadband and EastLink Communications in Canada. Telecommunications companies have entered the broadband distribution market. Qwest has offered TV service using very high DSL (VDSL) for a number of years, achieving more than 50,000 users in an extended trial with selected markets. In Canada, every one of the ILECs have entered or announced plans to enter the market; Bell Canada, Aliant and SaskTel already offer services to selected markets. With the battle for the consumer, myths and misconceptions will abound. There will be rumblings of defeats and capitulation. In the spring of this year, SBC sold its Ameritech cable offering. Videotron and Cogeco, cable operators in Canada, discontinued planned entry into the voice market. This market capitulation will not stop the progression of the battle. Much market discussion will involve the technology of the battle. And in terms of the MSOs' usage of Voice over Internet Protocol (VoIP), what about losing voice in case of a power outage, or how will 911 calls be

3 accommodated? How can telecommunications companies deliver the bandwidth needed to the consumers will it be asymmetric DSL (ADSL), VDSL or fiber to the home (or some derivation of fiber to the curb or fiber to the neighbor)? The battle is at an early stage; technology issues will be addressed and setbacks will be followed by advances. The conflict will expand and intensify. The carriers are realizing they must bundle to reduce churn. BellSouth and Verizon have significantly expanded the scope of their bundling offers in markets where they are losing voice market share. SBC in particular has started bundling DirecTV with its voice services because of the strong showing of Cox Communications in their region. Is this too little, too late? As we are in the early stages of the battle, it is not too late. But it is "too little" to win the battle. Satellite distribution of television signals is not as feature-rich as cable and is not being profitable enough to provide the telecommunications company with enough margin. 3 The Battlefield The battle for the consumer's communications, entertainment and infotainment dollar is beginning to heat up. At the beginning of the 20th century, the telephone was the only communications device in the home. In the 1970s, the delivery of entertainment by cable began to address a wider selection of entertainment availability. In the 1990s, infotainment was addressed by Internet access. The spoils of the battle equate to $140 billion in North America in 2002, which includes revenue from voice, broadcast television and video delivered into the home; Internet access; and future offerings in security and home monitoring and networking. Figure 1 shows the battlefield consumer applications, buying criteria, and the major and minor combatants.

4 4 Telecom Companies, Cable Operators Battle for Consumers Figure 1 The Consumer Battlefield Fixed Wireless Buying Criteria Cost Selection Service Simplicity To Be Determined Satellite xdsl Cable Application Priority 1. Voice Local, Enhanced Services, Long-Distance 2. Television Broadcast 3. Internet Access 4. Video on Demand 5. Security 6. Home Monitoring and Networking Source: Gartner Dataquest (December 2002) Even though voice communications is an essential service, many of the ancillary nonessential services provide significant revenue and greater profitability. Although consumer long-distance revenue is decreasing (negative 2.4 percent compound annual growth rate [CAGR] through 2006), it still represents a $34.8 billion market. Enhanced voice services composed of voice messaging, call waiting and so on represent a $24.1 billion market growing at an 11.0 percent CAGR through 2006 and provides the highest gross margin percentage of the voice services. Basic local service what the customer pays for local access (plain old telephone service [POTS]) is relatively flat with a five-year CAGR of 0.6 percent but represents a $63.9 billion market in Voice services maintain the greatest percentage of the consumer wallet share. Total North American cable revenue is more than $50 billion. High-speed Internet access started in the mid-1990s and has grown to $8.7 billion in 2002, with a five-year CAGR of more than 30 percent. The introduction of Internet access represented the first time telecommunications companies and MSOs competed directly; it was effectively the beginning of the battle for the consumer. Satellite and fixed-wireless operators have entered the broadcast distribution market. Video on demand (VOD), security, and home monitoring and networking are other developing opportunities at the center of the battle field between traditional cable and telecom providers. None of these services will equate to the revenue potential of the voice and television distribution markets, but they do offer high gross margin opportunities to the victor. Although VOD is much publicized and introduced by the top 10 MSOs in North America, it will equate to only a $1 billion revenue market by the middle of the decade.

5 The consumer-buying criteria vary depending on the service they are acquiring. As these various services begin to be acquired in bundles, a new set of blended criteria evolves. Key components of this new criteria set will be cost, selection, service and simplicity. The complete list of criteria and their prioritization are yet to be determined as the bundling of the services is in the early stages. Only a few MSOs offer a triple play of voice, video and Internet today, and though they may have early indications of the criteria set it is too early to tell what will be the key determinants. The combatant able to define this criteria set is best prepared to win the battle. The primary combatants are MSOs and the telecommunications companies. Each of these incumbents previously had a monopoly on the service they offered the consumer. These lines are blurring, with each planning to get in to the other's market. Fixed wireless and satellite have much smaller penetration but can still have potential impact on the final outcome of the battle, especially in the case of satellite. 5 The Combatants To paraphrase the words of the Prussian Baron Von Clausewitz, a dean of Western warfare, "God is on the side of big battalions." When comparing the telecommunications companies with MSOs, this would seem to initially be the case. The wireline North American revenue of the telecommunications companies is more than $265 billion compared with the MSOs' $50 billion. The net income of Verizon alone is greater than the cable net income of MSOs in total. However, the fleetest of foot has won battles in the past, and with the consumer battle this may be repeated. The telecommunications companies have been happy to harvest the profits obtained from the consumer market and have expanded the market scope only slightly, specifically in the area of enhanced voice services and only recently broadband services. MSOs have been on an ongoing expansion mode, providing two-way transmission and increasing bandwidth closer to the consumer, which permitted MSOs to tap into the growing information market early and enhanced the Internet service providers (ISPs) and the dot-com explosion. While ILECs in the early 1990s had a viable technology, xdsl, the troubles cable companies had with the early versions of cable modems caused them to slow down their trials with video and DSL. In addition, the ILECs were concerned that xdsl would cannibalize their existing business data revenue. In the meantime, MSOs never slowed their development efforts around cable modems and continued to upgrade their networks, thus grabbing a commanding market position. Only after seeing the success of MSOs with their cable modem offerings and that the Internet wasn't just a fad did the ILECs react and enter the market in force. If the telecommunications companies continue this lethargic "wait and see" approach of addressing competition from the cable operators in the area of voice, their financial might and breadth of customer reach may not be enough to win the battle in the long term. MSOs have built on a standards-based approach (CableLabs), have already expended the majority of the investment required to upgrade their

6 6 Telecom Companies, Cable Operators Battle for Consumers network for voice, and today in selected markets are demonstrating they can take market share from the incumbent telecommunications company. Although much of the market discussion of the battle revolves around technology (for example, xdsl vs. cable, VDSL, DOCSIS and VoIP), these are only the enabling technologies. Much of the outcome depends on the inherent value proposition of the combatant's networks and corporate culture. For telecommunications companies and MSOs, these must change in this new market of converged services. Figure 2 shows the effective value proposition represented in how the telecommunications companies and MSOs built their networks. Figure 2 Telecommunications Companies' and MSOs' Inherent Network Value Proposition Telecommunications Companies Communications Essential Interactive Service Reach (Effectively 100 Percent) Service (Uptime and Response) MSOs Entertainment Nonessential Passive Service Selection Bandwidth Source: Gartner Dataquest (December 2002) Within a monopoly market, the telecommunications companies developed a plant that was based on interactive communications. It was an essential service with dictated regulatory levels of service required. From the regulator, the measure of the telecommunications companies was reach (universality) of service and customer satisfaction with uptime and response. With MSOs, the situation was much different. During the early 1990s, their service was effectively a broadcast-passive one-way service. The service was not deemed essential and customer service did not have the rigor imposed on the telecommunications companies. MSOs were interested in expanding their reach and providing breadth of services for the consumer, and this meant building more two-way bandwidth closer to the consumer. Figure 3 reflects the culture of the telecommunications companies and MSOs that evolved.

7 7 Figure 3 Telecommunications Companies and MSOs Corporate Culture Telecommunications Companies A Culture of Service "Harvesting" and Redirecting Profits to Business Services MSOs A Culture of Expansion Net Income Was Secondary to EBITDA Building for the Future Source: Gartner Dataquest (December 2002) The telecommunications companies developed a culture of service honed by decades of regulator supervision. No competition meant reaping the profits of voice, which was distributed as dividends to shareholders or transferred into expansion of other parts of business (for example, enterprise data). The telecommunications companies became adverse to the risk of expansion: Why should they voyage from the protective cocoon of a monopoly business? On the other hand, MSOs developed a culture of expansion, effectively a "build it and they will come." Customer service suffered and profitability was a future event for most MSOs. For telecommunications companies and MSOs, competition and new financial realities have caused them to rethink their culture. Who will win the battle for the consumer depends on how each is able to adapt to this new converged services market. The telecommunications companies must deploy a broadband distribution plant closer to the consumer to offer entertainment/television services or potentially lose the profitability from their voice revenue. MSOs must be able to present a more sound financial position to the investment community and a higher level of customer service. The winner of the consumer battle must have a business model that will combine all the elements of the value propositions of the telecommunications companies and cable operators. This best-of-breed business model will need to emphasize service above all else and will need to provide customers with communication, entertainment, product value and choice, service, simplicity, and flexible bandwidth solutions. Underpinning these offerings must be a financial model that is based on profitable revenue growth, controllable debt structure and free cash flow. Business Rationale for the Confrontation Telecommunications companies and MSOs will enter each other's market fornewrevenue,butasmuchasthisisanoffensivemeasureitwillbea defensive move to protect what they already have. The combatants find themselves in a position where they often feel they are in trouble either way.

8 8 Telecom Companies, Cable Operators Battle for Consumers MSOs Cable operators have expended more than $60 billion in the last decade in upgrading and expanding their network. This expansion has primarily been focused on fiber deployment closer and closer to the consumer. Their cable revenue has increased but profitability (net income as opposed to earnings before interest, taxes, depreciation and amortization [EBITDA]) for many remains in the future a legacy of the past that must be overcome. In today's financial environment, their networks must begin to generate greater profitability and free cash. VOD represents a new and profitable revenue source, but even by the middle of the decade this revenue source will represent only a $1 billion market. Voice represents an $80 billion market too great an opportunity to ignore. Voice had been profitable for the telecommunications companies but only because of massive monopoly investments; the same potential applies to MSOs and although making their plant two-way has already reduced a significant portion of the investment, they must sill bear significant capital expenditure. The MSOs' future voice play is centered on VoIP. Examining Cox Communications' success to date reveals the profitability potential. Table 1 compares Cox's contribution of voice compared with the other new services of digital TV and high-speed Internet. Table 1 Consumer Voice Contribution: Cox Communications' New Revenue Sources Digital TV High-Speed Internet Telephony Services Total Monthly Average Revenue per Customer Cost of Goods Sold Operating Expenses (For Example, Customer Care and So On) Monthly Average Contribution per Subscriber Contribution as a Percentage of Revenue Source: Gartner Dataquest (December 2002) Cox first launched telephony in It claims to have become the 12th largest phone company in the United States in five years by mining the channel capacity of their systems and utilizing them for entertainment and voice communications. Cable operators are also fighting the satellite operators on the entertainment and Internet access fronts. Cable operators are now finding that the number of new users is stagnating or decreasing. MSOs are finding the consumer is less likely to switch if the package of services is more extensive than just entertainment (for example, a triple play of voice, video and Internet access). Cox found that with its three-product bundle, customers were five times less likely to leave than others were. Internet access and voice become "sticky" elements of a bundle. Revenue growth must come from the MSOs' present customer base new services. Profitability will come from lower churn, precipitated by a move to all-inclusive packages, economies of scale and the mix of higher grossmargin services.

9 Telecommunications Companies The telecommunications companies have watched the cable operators capture less than 2 percent of voice consumers over the last five years. This lack of success has developed complacency with the telecommunications companies. Seeing the cable companies reaching a 20 percent, 30 percent or 40 percent market share seems decades away. Now, carriers are seeing the pace is beginning to speed up. However, MSOs don't have to obtain a 20 percent to 40 percent market share to have a serious impact. In fact, MSOs will likely take a page out of the leading CLECs' (predominantly AT&T and WorldCom) playbook by concentrating on the high-end customer, which provides the greatest margin. Telecommunications companies will likely be left with the low-end consumer and be saddled with universal service obligations that the cable companies and CLECs don't have a serious conundrum. The Gartner Dataquest " Rule" Everyone is familiar with the rule, but within the local exchange carriers (LECs) and ILECs consumer market, there is a more insidious rule: the " rule." The rule means that 20 percent of your consumers generate 120 percent of the gross profit/gross margin. A small segment of consumers (high-value customers) generate all the gross profit, which underwrites the remainder of the customer base that is unprofitable. The rule is not restricted to the consumer telecommunications business, but can be evident in any industry providing universal services and where rate increases to cover the higher cost of service is not permitted. The banking community found itself in a similar environment but reduced its impact by a breadth of add-on charges. The telecommunications companies similarly have introduced value-added services (for example, call waiting, call privacy, voice mail and so on) that generate the profit needed to underwrite and overcome uneconomic "carrier of last resort" obligations. Within individual telecommunications companies, the percentage of highvalue customers may be higher than 20 percent (25 percent, 30 percent or 35 percent); however, the overall impact is the same. A small percentage of the carrier consumer base provides the profitability of this market. If an LEC or ILEC loses 5 percent or 10 percent of its market share and this is part of the 20 percent high-value customers, the impact can be extremely significant, if not catastrophic. There are regions in the United States where MSOs have achieved telecom market share as high as 30 percent of homes passed. Cox and AT&T Broadband in specific U.S. markets and EastLink Communications in Canada are examples that the threat is real. In addition, this penetration level has been achieved with less costeffective feature-poor circuit-switched facilities, not the feature-rich lowercost VoIP infrastructure expected to be available by

10 10 Telecom Companies, Cable Operators Battle for Consumers Battle Plans The battle for the consumer is in the early stages of a battle that will be carried out during the next five years. Today, we primarily see the combatants marshalling their forces. MSOs The five largest MSOs in the United States AT&T Broadband (merged with Comcast), Time Warner Cable, Comcast Cable Communications, Charter Communications and Cox Communications represent 65 percent of the market's cable subscribers. All offer circuit-switched voice services. AT&T Broadband has 1.3 million telephony subscribers, representing a 16.5 percent penetration of consumers to whom they offer telephony services; in 55 communities addressed they have a 25 percent penetration. AT&T Broadband's average consumer telephony revenue is $ Cox Communications has the second-highest number of telephony customers at 651,000, representing a 17.0 percent penetration reaching as high as 30 percent in the initial markets they introduced the services to. All of these MSOs have been involved with VoIP trials with Comcast, forecasting service introduction in Philadelphia in the second quarter of VoIP will be a phased-in approach starting with selected and manageable markets, acquiring and market testing the technology, embellishing customer service strategies and tactics, and gaining bundling experience as they go. Large-scale deployment and penetration will be realized later in 2005 and Figure 4 shows overall MSO battle plans to grow wallet share and achieve consumer loyalty and dominance.

11 11 Figure 4 MSOs' Battle Plans: Introduction of New Services Home Networking Telephony Services Revenue Near Video on Demand Digital Cable Internet Access Cable Television Integrated PVR High-Definition TV Video on Demand T-Commerce Interactive Television Consumer Entertainment and Communications Wallet Share Consumer Interactive Experience T-Commerce = Television commerce, consumer acquisition of products via remote control Source: Gartner Dataquest (December 2002) MSOs have revenue opportunities that they will address before launching an attack on voice services, initially addressing the VOD market followed by high-definition TV and an integrated personal video recorder (PVR). As MSOs address these opportunities they hope to achieve a strongly differentiated service bundle that cannot be readily replicated by traditional telephone providers, gain greater consumer interactive/service experience and lock in a larger share of the consumers' wallets. During this time, MSOs will be waging battles on two fronts: one offensive (telecommunications) and one defensive (direct broadcast satellite [DBS]). Their entertainment competitors, the satellite operators, are increasing their North American subscriber base by 15 percent a year. Initially, their growth was in the rural areas, but they are now gaining market share in urban areas as well. MSOs are finding that they must expand their bundles to include products where satellite operators are weak Internet access, followed by VOD and voice. To combat this erosion, MSOs (for example, Cablevision) are also moving into the DBS business. Telecommunications Companies More than 50 telecommunications companies in North America are trialing or offering broadcast distribution services. In the United States, the major action is taking place with smaller LECs using Next Level Communications' VDSL deployment. SBC is reselling satellite service from

12 12 Telecom Companies, Cable Operators Battle for Consumers DirecTV. Qwest has been trialing Next Level's VDSL implementation in Omaha, Nebraska, and Phoenix, Arizona. Bell Canada offers satellite service through its wholly owned subsidiary, ExpressVu. Also, Bell Canada has an extended trial in a number of multidwelling units (MDUs) in Toronto. SaskTel has introduced an ADSL-based service. Trials and initial introductions abound. Similar trials and initial deployments are under way in Europe (see the Gartner Dataquest Perspective "Western European Operators' Plan for Video Over DSL" [TELC WW-DP-0132]) and Asia/Pacific (see the Gartner Dataquest Perspective "Telecommunications and Media Convergence in Asia/Pacific" [TELC-WW-DP-0243]). Although there is much action, there is no consensus as to how the battle should be waged, and there won't likely be a well-developed carrier-grade solution consensus for another 18 months. The International Telecommunications Union (ITU) has just recently released interconnection standards for the triple-play scenario. Figure 5 depicts the technology and marketing solutions being investigated, trialed or deployed. Figure 5 Telecommunications Companies' Battle Plans in Disarray Telecommunications Companies MSOs ADSL+ One Standard ADSL Many Technologies Nonconsensus VDSL Satellite Bundle Satellite Plus ADSL Fiber to the Home CableLabs DOCSIS Source: Gartner Dataquest (December 2002) The telecommunications companies are deciding what technology to deploy while the MSOs through CableLabs have defined the standard and hardware vendors are developing to these specifications. The telecommunications companies will need the impetus of the MSOs taking voice market share away before they will react en mass and in force (see the Gartner Dataquest Perspective "The Rise and Fall and Rise Again of North American Carriers" [TELC-WW-DP-0241]).

13 Even though the telecommunications companies' plans may be in disarray, the potential threat of losing voice revenue will finally energize the major North American players to enter the broadcast distribution market. 13 Gartner Dataquest Perspective ThebattlefortheconsumeristheMSOs'battletowin.MSOshaveaclear technology strategy and are moving faster than the telecommunications companies. MSOs will be waging a battle on two fronts (telecommunications companies and satellite operators), which may cause them to lose focus. Also, there may not be enough free cash flow to fund significant expansion into the telecom space. Their primary objective will be defensive to fend off the satellite providers; otherwise, they will begin to lose revenue and the "eyeball" cost advantage for purchasing content. However, the "grass is always greener on the other side," and the $80 billion voice market is too large for cable companies to ignore. While the cable companies are used to taking risks, the culture of telecommunications companies is a wait-and-see approach. They will have a tendency to react in force only when they have to. The nagging question is, "Will it be too late?" Regardless of which competitor gets to market first or has the best technology, in the final analysis it is the consumer that will dictate who will win the battle. They will make their decision primarily on price, product value and choice, service, and simplicity. As new services are introduced and they have a chance to evaluate products and providers, their satisfaction and buying decision criteria will evolve. A few MSOs are now gaining experience in what the successful bundle will be and what the key criteria will be for those converged services. These MSOs are beginning to understand their customers better and most importantly, beginning to understand the buying criteria for telecommunications services. The breadth of products, the perceived value proposition and the flexibility of the pricing of these products will be more important for all consumers than artificial bundling. While a well-targeted bundle that has a better-perceived price point will likely influence the average consumer, it is critically important that the high-end consumer will be able to tailor the bundle of services. What the telecommunications companies will have on their side is consumer lethargy to change, especially with voice, where the present model works. This is not true, however, for the price-conscious and the high-end customer. For the high-end customer, a "me too" approach will not be enough. For the most part, MSOs' networks are best prepared to implement entertainment and next-generation voice, video, and data, and have the entrepreneurial spirit and are risk takers, but don't have the financial stability or free cash flow that is needed to fight two battle fronts. The telecommunications companies have the financial capability, strong free cash flow, and the experience and systems to deal with mass-market telecom services, but they have a slow-response culture based on building consensus and long-range planning. Whichever competitor can most effectively evolve their culture to achieve a best-of-breed integrated

14 14 Telecom Companies, Cable Operators Battle for Consumers business model will be a winner. The key is flexibility to adapt to the everchanging needs of customers. There are likely to be winners and losers in both camps, and by the end of the decade they will likely look very much like one another. The real winner will be the consumer, who will now have more choices than they had before; selection will increase, service will rise, and prices will drop. Hardware vendors will win as capital expenditure increases. Software vendors will see increased requirements for operations support systems (OSS). Content providers will win, as they will have more vendors competing for their content. The battle for the consumer will be one battle where the number of winners far outweighs the number of losers. Gartner Dataquest Recommendations Telecommunications companies and MSOs must not underestimate their opponent; old concepts and experience regarding the antagonist must be shelved. Corporate culture must evolve: What was good enough before is not good enough in a new converged services market. But most of all, neither competitor must forget that the customer is the final arbiter of their success. Those that can profitably meet the "four Ps" of marketing while adapting to the changing needs of customer will be successful. MSOs MSOs have the luxury of being many years ahead of the telecommunications companies in entertainment and broadcast deployment, and thus, can wait until VoIP matures more as a technology. Introductions should be phased in selected markets where the greatest customer loyalty is exhibited build on success. Rigorous ongoing evaluations must occur from a technological position and consumer buying patterns. CableLabs provides an excellent vehicle to ensure a consistency of technological approach; what is not available is a consensus of the consumers' new and evolving buying criteria. Telecommunications companies have had a century to understand the voice market; MSOs must evolve a vehicle or mechanism to ensure collective consumer voice experience is shared. The past EBITDA-centric methodology of viewing success must be replaced with new equal weighting of revenue, net income and free cash flow. Average revenue per user (ARPU) must become more than a measure of revenue, but rather a barometer of relative wallet share achieved. Bundles are key, but more important is the breadth of essential products available to be bundled and the flexibility customers have to customize these bundles. With MSOs, the importance of marketing and consumer research cannot be overestimated. Telecommunications Companies Understand your consumer. Does the rule apply? When they ask their staff this question, most telecommunications companies' CEOs will find that an answer is not readily available. Defining who is your high-

15 value customers along with their buying behavior is key. In the broadcast distribution market, decisions must be made as to which markets to address, the related engineering economics and the capital expenditure required. An MDU approach may make sense to the engineer as the most cost-effective solution but may miss the telecommunications companies' high-value customers. Telecommunications companies must develop a technological migration strategy that drives broadband bandwidth closer to the key consumers. This strategy is not a one-technology exercise, but rather a five-year-plus strategy incorporating the migration from and inclusion of ADSL, VDSL and fiber to the home. With today's prices, the cost of this migration will be staggering, but equally profound is the cost deflation that will occur during the next few years as more hardware vendors are driven to the potential of the market. This technology strategy must be a six-month rolling evolving strategy that incorporates these advances. The telecommunications company will have to make the decision to enter the broadcast distribution in an environment where all the questions have not been addressed. A decision to not enter this market is an option if it factors in decreasing market share and continuous declining operating and capital expenditure. The concept of "harvesting" a declining market is viable as long as this is made as an overt decision, rather than a wait-andsee strategy. The precarious situation that traditional ILECs find themselves in relates in large part to their "provider of last resort" obligations. These obligations require ILECs to provide service to all customers at any cost. MSOs do not have that obligation and therefore can choose to provide service selectively and target the most profitable customers. Thus, unless these asymmetric regulations are changed soon there is not much hope that ILECs will be able to overcome their market disadvantage before MSOs and CLECs, such as AT&T and WorldCom, have stripped most highmargin customers from the ILECs. What ILECs will retain are low- or negative-margin residential customers that cannot be adequately serviced by ILECs unless prices or subsidies are raised substantially. Along with the engineering and financial decisions, the telecommunications companies will find themselves in a steep learning curve. Broadcast content acquisition will be required along with VOD, and digital rights management must be addressed. A new regulatory environment must be addressed. New OSS will be acquired. As with MSOs, the telecommunications companies must evolve their bundling strategy. 15 Key Issue How will opportunities in the public network service market be affected by competition, technology and evolving user requirements?

16 16 Telecom Companies, Cable Operators Battle for Consumers This document has been published to the following Marketplace codes: TELC-WW-DP-0272 For More Information... In North America and Latin America: In Europe, the Middle East and Africa: In Asia/Pacific: In Japan: Worldwide via gartner.com: Entire contents 2002 Gartner, Inc. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice