Cable telephony - parasite or profit?
Fred Goldstein, March 2004
Cable operators should team up with CLECs and ISPs to become their last mile access wholesalers, rather than leave all of the VoIP business to providers who don't pay them anything.
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The options open to competitive carriers continue to grow narrower, as the Powell FCC and he DC Circuit Court conspire to shut out Competitive Local Exchange Carrier access to the Unbundled Network Elements that the Telecom Act ostensibly provided for. Powell, however, seems to think the the existence of VoIP is enough competition, since it theoretically can be used over both ILEC-provided DSL and cable modems, the currently-blessed duopoly. CLECs are left with few options, unless they are fortunate enough to be able to become cable overbuilders, or have a protective state commission that independently enforces the law. While there are still avenues by which a CLEC can make money using some unbundled network elements, the FCC and DC Circuit have conspired to create enough regulatory uncertainty to put almost anyone's business plan in doubt.
Cable companies are the other winners for now, very well positioned to compete with incumbent LECs in both voice and data markets, but most have been slow to do so. Cable modems, to be sure, are practically standard equipment. But cable telephony remains surprisingly elusive. Perhaps the cable companies have been waiting for the technology to mature. In the late 1990s, TDM-based dedicated cable telephony systems (such as Tellabs 2300 and Arris' Cornerstone) became available. Using telco-standard GR-303 attachment to a central office switch, they provide high-quality dialtone service. Several million lines have been deployed, but they are no longer in fashion for new installations.
PacketCable vs. parasitic VoIP
A newer standard, PacketCable, has been adopted by Cable Labs and provides for high-quality telephone service across a cable modem infrastructure. PacketCable uses VoIP, with prioritized bandwidth (a feature of DOCSIS 1.1, a now-common cable modem standard) to ensure call quality. Because it is a competitively-produced standard for high-volume products, PacketCable is very inexpensive to deploy. It adds perhaps $50 to the price of a cable modem; it needs no head end terminal of its own, simply a compatible VoIP telephone switch to attach to the Cable Modem Termination System. (Other telephone switches can use it through a gateway. PacketCable is based on MGCP, a fairly popular VoIP standard.)
But that's not where the excitement is. The action is moving instead to parasitic applications of VoIP, the best-known provider of which is Vonage. For a company with only a modest number of subscribers (about 100,000 as of this writing), Vonage is scaring the industry like a mouse in the elephant cage. Not only does it have other startup competitors, but big companies such as AT&T and Qwest are also planning to get in on the act. Parasitic VoIP runs over DSL or cable. It doesn't take advantage of PacketCable's prioritization, so its quality is not guaranteed. It doesn't connect to the CMTS at the head end; it usually requires some amount of public Internet connectivity. It's not installed by the cable company, or even with the knowledge or consent of the cable company. It's just an application running over the braodband service that the subscriber is already paying for. It's parasitic in a technical sense because it feeds off of bandwidth that the subscriber has already purchased, rather than having its own.
From a customer perspective, PacketCable offers a higher-quality service, capable of meeting "lifeline" standards. "Embedded Multimedia Terminal Adapters", as phone-equipped cable modems are formally known, are even available with built-in batteries, substituting for the line-powered service used by traditional telephony as well as most of the proprietary cable telephony systems. Services like E911 work perfectly well, since the cable operator is able to provision the service with the necessary information. PacketCable telephony service is typically offered under tariff, with the cable operator having CLEC status.
Parasitic services today operate as "information" services, not requiring CLEC certification; they typically work with CLEC wholesalers to provide PSTN connectivity and telephone numbers. Their service quality is more erratic. They are more likely to use compressed voice, and because they do not get priority, their voice packets can be discarded when congestion occurs anywhere between the subscriber and the PSTN gateway. At best they sound almost as good as Plain Old Telephone Service; at worst they sound like "bad cellular". Connection quality can change within the course of a call. Fax support is sometimes built in; other modems however are unlikely to work well at all. The main attraction is price: They have no local loop costs, because the subscriber is paying the entire cost of the underlying broadband service. They are currently able to avoid paying the switched access charges that long-distance carriers pay to the LECs at both ends of a call, because they take advantage of the "exemption" that was created to allow dial-up Internet (and other information service) access to be calls to be placed as local. (This is on the table again in the FCC's pending VoIP rulemaking.) So they usually feature either unlimited-use or large block-of-time domestic long distance plans.
Cable operators can team up to compete
Cable operators should look at PacketCable as an opportunity. Many are not prepared to go into the telephone business on their own; it's not their specialty. Legally, they are not required to open up their networks to competitive telecom operators or ISPs. But from a business perspective, they should! Cable companies can allow third-party CLECs to rent access to their networks in order to provide service over PacketCable, in effect providing wholesale local loops. The CLECs will then be responsible for hauling and switching the calls from the CMTS back to the PSTN, making the necessary arrangements to interface to ILECs, handing the customer support calls, installing the eMTAs at customer premises, and doing all of the other heavy lifting. For this, a CLEC should be willing to pay a decent fraction of the ILEC unbundled loop rate! It's a win-win situation. The CLEC gets bypass the ILEC en route to the subscriber, and gets a high-quality connection. The cable company gets incremental revenue, say $5-10/month per CLEC telephone subscriber. It's less than they'd get if they provided the full telephone service, but it's a lot more than they get from Vonage or other parasitic operators (i.e., zero).
CLECs, of course, are often affiliated with ISPs, and would often like to sell data services as well. As I've noted before (including in a 1999 Multichannel News opinion piece that unfortunately is no longer on line), cable companies should voluntarily open up their networks to competing ISPs, to provide additional sales channels they can use against the ILECs, and to reduce the incentive to overbuild. So an ISP-CLEC might want to provide the cable modem and PacketCable service together, paying the underlying cable company for the privilege.
There are some minor technical details that would need to be worked out in each case, but there is already ample precedent for multi-ISP cable modem networks. Multiple CLECs on a cable plant should be even easier. This is a win-win situation for everyone except the ILECs.
With all the fuss about high-speed data and digital video, it may be that the final leg to cable's long-promised tri-legged bundle is the one that costs the least and yields the most profits, even though it isn't nearly as sexy as digital video and high-speed data.
And that explains why the cable industry is preparing to uniformly and aggressively deploy voice over Internet protocol services (VOIP) in the coming year to reach as many as 39 million homes by 2005 and nearly double that by 2008, according to Morgan Stanley estimates.
In fact, the cable industry already has positioned itself to discount bundles of VOIP and high-speed Internet access as a substitute to fully matching telephone company discounts on their standalone data services, which should bring VOIP to a $35 per month price point within five years, Morgan Stanley analyst Richard Bilotti said.
The meteoric prospects of voice-over broadband universally surfaced in bullish remarks made during the most recent quarterly cable company and industry analyst reports.
"The ability to undercut telephone company voice pricing (and to potentially deliver new value-added telephony services) using voice over Internet protocol should position the cable companies well to win triple-play customers," declared Merrill Lynch analyst Jessica Reif Cohen in a Nov. 3 report to clients.
There is rapidly mounting evidence that telephony services can vault cable operators well beyond their most serious recent telephone company and DSL provider competitors.
Telephone companies have similar motivations to grow their share of high-speed data and to expand into video services in order to protect their core revenues, she said. But cable operators will have an easier time of getting into the voice market than the telecos will getting into the video market if for no other reason than it costs as much as seven times less (or $150 to $300 per subscriber for cable) than it costs telephone companies per subscriber to upgrade in order to drive the advanced service.
There is a prevailing concern that rollout of voice services will necessitate a boost in capital expenditures that will cut into cable's long-promised free cash flow. Mr. Bilotti estimates initial deployment will cause total capital expenditures to rise 10 percent to 15 percent.
Once established, these voice businesses have high profit margins and low costs. Long-term cable operators are expected to be able to generate up to 35 percent profit margins on IP telephony, assuming a monthly fee of $35 per subscriber.
But it is as a bundled product where telephony will be golden. Combined with data, the incremental initial return on revenues are all in excess of 50 percent.
In fact, some on Wall Street are suggesting that voice over IP telephony can be such a powerful growth driver as the third potent force in a bundled product, that it can increase cable valuations by 50 percent over the next several years,
"For cable operators, VOIP spells opportunity," Ms. Cohen said.
"Cox Communications has been the most successful in deploying phone service, achieving high penetration with good margins while lowering video churn-and it has done so by deploying conventional circuit-switched service on its fiber-coaxial network, rather than waiting for Voice over IP telephony.
Cox's telephony business currently has a cash flow margin of about 40 percent, with penetration of above 30 percent of telephone-ready passed homes passed and about 50 percent of basic subscribers in its most mature telephony markets. It will use telephony as a way to economically enter smaller markets beginning in 2004.
"Cox has established that, when done right, cable gets a big share of the telephone marketplace," Ms. Cohen said.
Telephony may just be getting off the ground across the board, but Cox has been offering the product since 1996 and Comcast, through its acquired AT&T Broadband systems, has been offering it since 1998. But unlike the past, all future launches of telephony will be Internet Protocol-based. Analyst forecasts call for IP telephony to be launched in 35 percent of homes passed in 2004, rising to 35 percent in 2005.
Jason Bazinet of JP Morgan said that "heavy discounting, tiering and bundling data with voice over IP telephone all offer an opportunity for cable operators to maintain unit growth and share dominance."
However, individual cable operator telephony strategies widely vary, but collectively point to a major telephony rollout beginning in 2005.
Here's where major cable operators stand now:
Cox will expand its trial in Roanoke, Va., into a full-blown launch, with long-distance service offered on a more standard, per-minute basis, reflecting the maturity and robustness of Cox's back office and billing systems, which is capable of billing for telephony in one integrated bill.
Cox views telephony as a way to economically enter smaller markets in 2004 to expand its telephony footprint from 46 percent by year's end to close to 100 percent by mid-2005, at a cost of about $325 to $350 per subscriber.
Cablevision Systems has an estimated 10,000 subscribers signed up for its Optimum Voice service on Long Island. It is offering unlimited local and long-distance minutes for $34.95 a month to its 1 million-plus cable modem subscribers. And It will be ubiquitous throughout its service area by year's end.
It has moved from trial to full-scale rollout faster than any other operators.
Cablevision disclosed during its recent earnings report that some 37 percent of its telephony subscribers have disconnected all other land line service; 29 percent are using the services as a second lone replacement; and 33 percent are using it as an additional line.
Time Warner Cable is expanding its rollout, having signed 3,000 voice over IP telephony customers, or about 3 percent of its basic subscribers in the market, in Portland, Maine since the service was launched in mid-May. It has trials running on its Digital Phone IP telephony service in Portland, Maine, and New York and North Carolina later this year. It also is offering unlimited local and long-distance minutes with features for $39.95 per month.
The features, designed to move consumers past conventional telephone services include voice recognition, short code dialing, fixed and wireless number sharing, and videophones.
"We will begin a much broader and much more aggressive deployment of voice services over our entire platform next year," Time Warner chief executive officer Richard Parsons said during the company's recent third-quarter earnings call.
Time Warner management said they expect to achieve the telephony rollout with only a modest negative impact on its earnings before interest, taxes, depreciation and amortization margins.
Comcast will begin building on the 1.36 million telephony customers it inherited from AT&T as it completed system upgrades. The company recently began outlining ambitious rollout plans to move past its voice over trials. But, Comcast officials say they will continue to be focused on improving the telephony efficiency and profitability--not simply the number of units.
It will extend its trials to Hartford, Indianapolis and Springfield, in addition to its ongoing trial in Philadelphia. Management sees telephony as a potentially important source of growth beginning in 2005.
"The biggest development for our long-term growth is the work we have done in the last six months, getting our voice over IP telephony business ready for prime time," said Comcast Cable president Steve Burke on the company's recent earnings call. As the biggest telephone operator over a cable plant, he said, "the IP phone business should have very attractive economics and could be a very large business for us," Mr. Burke said. |
