And Let the Cable & Telco Price Wars begin!

Here is a snippet of a note I sent recently to a friend. I have sent variations of this note for the past 5 years to cable/telco executives, past clients, colleagues, cable research analysts, friends etc. After my note, is a note from Trefis on Verizon's unbundling & price wars.??

  • The BIG problem over the medium term is that for the 1st time in 100 years in the US, there are two big pipes (Cable??HFC Vs Verizon FiOS/ATT uVerse??FTTP) that are going be coming to the house offering pretty much the same things. Here are some implications for that:
  • Cable??will no longer will be a natural monopoly and consumers will have a choice.??
  • The choice for consumers will lead to 1) Volume Erosion 2) Price decline
  • Price declines are going to be especially problematic in Sunk cost industries (e.g. Airlines). Here is the typical process when huge sunk costs are made:
  • Company A (e.g. Verizon) spends $10BN building a??cable/oil/machinery plant. They assume a price of $100/customer to make the $10BN investment pay off. Company B (e.g. Cox) spends $8B building a similar plant for $8BN and they assume a price of $80/customer to make the investment pay off.??
  • When the marketing begins, Company B starts at $80 and customers starting gravitating to Company B. Company A is stuck and they have this huge sunk cost. The CEO of Company A fires the executives currently in charge of the marketing since they are not meeting??their??plan. The new executive at Company A comes in does the analysis and tells the CEO that??their??pricing is wrong and they need to drop it to $70. CEO seeing the writing on the wall agrees. Basically, the $10BN investment will not meet its investment hurdle rate and ultimately new equity will have to be issued or some other mechanism (e.g. transfer of cash from higher paying projects) where the shareholders take a hit for the failed project. The cycle continues onto Company B and so on.
  • So, given this larger trend of price competition and moving away from monopoly trends, cable companies would need to play its strengths of being the most cost efficient operator i.e.??They should try to be the Virgin/Southwest in providing the pipe compared the American Airlines (Verizon/ATT).??
    • Being the most cost efficient player basically means that the player with a lower cost structure basically wins the market.
    • If cable companies have a lower operating cost per customer e.g. Say $20/customer and Verizon has $30/customer, the Verizon basically can cut the price only to $30 and anything below that means they are losing money on an operating basis and they need to withdraw from the market. However, at the same time, cable companies can always have $10/customer $30/customer in market clearing price vs $20/customer in cable operating costs.??

    ———- Forwarded message ———-
    From: Trefis <noteoftheday@trefis.com>
    Date: Wed, Jun 8, 2011 at 12:31 PM
    Subject: Verizon is Unbundling TV in FiOS Packages to Capture Broadband Demand


    Verizon is Unbundling TV in FiOS Packages to Capture Broadband Demand

    Verizon recently announced new FiOS package bundles that allow customers greater flexibility and cost savings while choosing a plan by adding flexibility to its national triple play packages. [1] The goal to give customers greater flexibility – for instance those who want Internet and voice services but don't need cable TV. So what does this indicate for Verizon and competitors like AT&T, Comcast and Time Warner Cable? Below we take a quick look.

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    Our price estimate for Verizon stands at $34.48, which is slightly below the current market price.

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    Focus on Tapping Existing Coverage Areas??

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    Verizon and AT&T could initially justify the high up-front costs for building out its fiber-optic networks by offering more expensive bundled packages in order to generate higher average revenues per user. However, Verizon recently announced its plans to shift its focus on bundling voice and Internet services while giving subscribers the option to leave TV out of the package.

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    Show Chart for Verizon's Broadband Internet Market Share

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    This move indicates that the company's focus has shifted to connecting a higher proportion of homes in existing coverage areas – or "number of homes passed" in industry jargon – to its FiOS network. For Verizon, these homes can be easily and inexpensively connected to its FiOS network because the infrastructure is already established.

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    Verizon is taking a more flexible strategy that allows users to choose what services they want and in particular noted that increased demand among younger users for higher broadband speeds but no TV option was part of the decision to roll this out. [1] This also makes sense because the company earns a much higher margin on broadband services than it does on cable TV services. Consequently, we believe that the company will push these plans to sustain its broadband subscriber growth shown above.

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    The rationale of increasing the breadth of suitability is further complemented by the fact that TV viewing habits of consumers are changing. This implies that there has to be a trade-off between the time spent viewing video on the Internet verses TV. This further implies that having the flexibility to chose from multiple broadband and TV tiers and forming a more personalized bundle may appeal more to consumers and help them decide this trade-off.

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    See our complete analysis for Ver
    izon
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    Notes:

    1. Verizon's Bundle Builder shows the power of??broadband, June 6 2011, GigaOm [???] [???]

    ???? ??

    Have an insight you want to share with the Trefis audience???Email us at??content.questions@trefis.com??


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