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True Contenders: Cable MSOs & Business Communications Services

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True Contenders: Cable MSOs

& Business Communications Services

V2M

v i s i o n 2 m o b i l e

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TM

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Table of Contents

SECTION 1

CABLE MSOs & THE BUSINESS SERVICES MARKET ... 3

SECTION 2

BUSINESS SERVICES OFFERED BY CABLE MSOs ... 4

New Technologies Enable Cable Operators to Create Business Services ...

5

Future Evolution of Cable’s Business Services Portfolios ...

6

SECTION 3

CABLE SECTOR STRATEGIES FOR BUSINESS SERVICES ... 8

Market Segmentation Strategies ...

8

Organizational Strategies ...

10

Network Strategies ...

12

Marketing Strategies...

13

Product Strategies ...

13

Wireless Strategies ...

15

Growth Strategies (M&A) ...

17

SECTION 4

COMPARATIVE ANALYSIS - TELCOs VS. CABLE MSOS ....20

Strengths of Cable MSOs in the Business Services Market ....

20

Weaknesses of Cable MSOs in the Business Services Market ...

21

Opportunities for Cable MSOs in the Business Services Market ...

22

Cable MSOs Comparison to Other Provider Sectors ...

23

SECTION 5

OUTLOOK & FORECASTS ...25

The Cable Sector’s Opportunity in Business Services ...

25

The Cable Sector’s Future Prospects in Business Services ...

26

Overall Outlook ...

28

s p e c i a l r e p o r t

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SECTION 1: CABLE MSOS & THE BUSINESS SERVICES MARKET

Cable system operators have evolved from deliverers of one key consumer service— multichannel television—to provide the full spectrum of telecommunications services, including Internet access and home telephone. Concurrent with the broadening of their product portfolios, the major cable MSOs (multi-system operators) invested tens of billions of dollars upgrading and extending their physical plant, implementing back office systems and processes to handle the new services, and cultivating marketing and sales experience within—and between—their respective companies.

With these new tools in hand and their historical consumer customer base virtually saturated, cablecos have set their sights on the market for business communications services. Heretofore the bastion of incumbent LECs (especially the RBOCs), competitive LECs, and a variety of national and regional business segments specialists, the commercial market has been practically virgin territory for the cable sector. Every gain in the business market adds incremental revenue on top of a cableco’s primary streams, the ones for which its network was originally built. Moreover, most of the major cablecos’ gains come at the expense of their biggest competitors: AT&T, Verizon, and Qwest.

The cable sector’s aggressive moves in business segments over the past decade, which have intensified since about 2005, have generated intense interest within the industry. Incumbent telcos recognize that the cablecos have network depth not unlike their own, as well as products for the smallest business segments that are quite comparable in their capabilities, threatening longstanding ILEC cash cows. CLECs perceive a new challenge to their own erstwhile revolution, forcing them to reevaluate their customer strategies and marketing tactics. Meanwhile, vendors envision a whole new category of operator customers that need their wares to power “business-grade” capabilities.

This report quantifies and analyzes this emerging battleground. Drawing on more than a decade and a half of NPRG analysis of the relevant sectors—CLECs, ILECs, Fiber Network Operators, and Wireless Service Providers, in addition to cable system operators themselves— the report spells out the who, what, and how much of the cablecos’ foray into the business services market.

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SECTION 2: BUSINESS SERVICES OFFERED BY CABLE MSOS

Cablecos serve businesses of every size, from one-person shops to massive data centers and offices of global corporations. Like their telco competitors, they offer products of every type, including video, voice, data, and advanced services. Although operators’ specific service selections vary, and no company offers every service, their typical product offerings and defining characteristics within the generalized service categories are summarized in Figure 2.1, below:

Figure 2.1

Business Services Offered by Cable MSOs

Source: New Paradigm Resources Group, Inc.

Services Offered

Cable modem high-speed Internet access

• Asymmetrical bandwidth (downstream faster than upstream) • Maximum speeds (downstream) typically range from a few Mbps to

30 Mbps or more Metro Ethernet

• Symmetrical bandwidth

• Maximum speeds typically range from 10 Mbps to 1 Gbps • E-DIA (Ethernet dedicated Internet access)

• EPL (Ethernet Private Line), a point-to-point service

• EVPL (Ethernet Virtual Private Line), point-to-multipoint service for hub-and-spoke architectures

• ELAN (Ethernet LAN), for multipoint architectures

• Specialized implementations of the above services for niche verticals: financial services, content/media, etc.

Voice over IP

• Single- and dual-line (i.e., entry level service) • Multi-line, up to 8 to 12 lines

• Trunk services, scalable to dozens/hundreds of lines: SIP, IP-PBX • Hosted services: IP Centrex

Traditional telephony, including TDM emulation • Voice T1 trunks and NxT1, T1 PRI, etc. TV for Businesses

• Cable TV (analog) and Cable Digital TV, including pay-per-view (a/k/a video on demand)

• Installed and engineered as required: for multiple rooms (hospitality, restaurant) or single room (office, waiting area)

Metro Wi-Fi

• Base stations distributed throughout a metro area to create a coverage umbrella and “roaming hot spot”

Mobile data

• Broadband-like speeds delivered wirelessly: 3G and 4G

• As of 1H 2010, offered by cablecos primarily through partnership with Clearwire and Sprint

Fixed Wireless

• Speeds akin to wired access lines (NxT1 and above) Managed Security

Web Hosting Remote Data Backup

• Storage up to ~10 GB • Retention for up to ~30 days

Not currently a central focus of Cable MSOs

Category Data Voice Video Wireless Managed Services and Applications Enterpise Network Planning and Design

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New Technologies Enable Cable Operators to Create Business Services

The cable sector has capitalized on a series of technical developments over the past two decades. CableLabs, a research and development organization modeled on Bellcore, the RBOCs’ R&D consortium, was founded in 1988 by leading cable system operators and has been the fountainhead of the sector’s new technology and services ever since. It completed its initial data networking standard, “DOCSIS” (Data Over Cable Service Interface Specification), in 1997. Standards-based cable modem equipment and services created an opportunity for cable operators to offer Internet access services and compete with Internet service providers (ISPs) and telcos—which were likewise trying to bring their digital subscriber line (DSL) broadband technology to the mass market—in the then-emerging service category. CableLabs subsequently announced improved, faster versions of the DOCSIS specifications in late 2001 (DOCSIS 2.0) and late 2006 (DOCSIS 3.0) that exceed the nominal maximum for comparable telco-provisioned DSL.

Figure 2.2 below illustrates the trend of these developments and speed gains over time. As of early 2010, DOCSIS 3.0-enabled business services based on operators’ existing cable plant have been launched for general availability in many markets at 30 to 50 Mbps downstream, and even upwards of 100 Mbps in a few test areas. Over the next few years, the average maximum available speed of HFC-based business services will continue to rise and by 2014 is projected to exceed 100 Mbps. This will help them keep pace with telcos’ DSL and Ethernet-over-copper services. Where even higher speeds are required, the sectors will compete using basically identical media and technology: fiber and Metro Ethernet.

Figure 2.2

Average Maximum Bandwidth of MSOs’ HFC-based Cable Broadband Bandwidth to Business Customers (1998-2014)

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Using DOCSIS as a foundation, CableLabs next developed telephony standards (dubbed “PacketCable”) to enable providers to deliver two-way voice calls. Enhancements in the mid-2000s made providers’ VoIP calling services compliant with regulations for emergency 911 services and law enforcement surveillance, while improving call clarity and reliability, making them robust enough to stand as head-to-head alternatives to traditional telcos’ consumer services.

In the consumer market, the cable industry holds a privileged position as the “second wire” into the home—the traditional phone line being the first—and so the combination of DOCSIS and VoIP had a natural mode of market entry. Using their existing networks of coaxial cable in residential areas, and bolstering them with billions of dollars of investments to increase backbone capacity, deploy fiber optic distribution rings, and re-engineer infrastructure to support bidirectional communications, cable MSOs have been able to bring the two critical telephony services to consumers completely independent of any incumbent carrier facilities.

Future Evolution of Cable’s Business Services Portfolios

Using basic Internet access—or video in some industry verticals—as a beachhead, Cable MSOs have aggressively moved further into the business services market with the introduction of voice services, most successfully as voice over IP. Data services have grown progressively more robust and support more varied applications, now including multipoint Ethernet and high-bandwidth, low-latency optical transport. Projecting into the near future, 2011-2014, cablecos are likely to introduce some of the same WAN services with support for truly national (inter-regional) networks and productize the 10GigE and 40 Gbps services that are now limited to projects done on an individual case base (ICB) in the largest Tier 1 metros.

Voice services, too, will become more sophisticated. In the near term, the large MSOs will be further developing their hosted VoIP services and engineering them to scale for use in the largest Enterprise scenarios. In the slightly longer term, 2012-2015, such hosted products could be coupled with the cablecos’ emerging wireless services (see Section 6) to create unified communications (UC) services that combine mobile data and voice with software-as-a-service (SaaS) or “cloud” platforms.

Like many providers in other industry sectors, cable system operators will continue growing categories of “advanced” or value-added services that can be sold to subscribers of their core services. The earliest such services were email and security tools. More recently, cable companies have added online storage and backup, as well as free or discounted general-business applications. Over the next 2 to 3 years, 2010-2012, a few of the large operators will look to follow the telcos’ lead and develop initial SaaS capabilities on a success-build basis for certain Mid-size and Enterprise customers; over time, these could be made more robust, scalable, and form the foundation of another push up-market by the middle of the next decade.

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Figure 2.3

Evolution of Cable MSOs’ Business Services

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SECTION 3: CABLE SECTOR STRATEGIES FOR BUSINESS SERVICES

At the corporate level, cable companies enter the business services market in order to maximize their return on capital already invested for other purposes—namely, to deliver video and “triple play” services. With in excess of 90% of United States households passed by at least one cable system, the costs associated with starting up local networks have generally been absorbed by the sector: legal costs to obtain a system franchise and negotiate regulatory hurdles, expenses to survey land and obtain rights of way, and general construction costs for buildings, equipment, network components, and labor. Through the mid-2000s, the larger cable MSOs invested additional tens of billions of dollars to increase distribution and access capacity, and to make their systems capable of bidirectional transmission. These investments are sunk.

To better their returns, operators can either sell additional or higher-margin services to existing customers or find new customers using existing infrastructure. In their traditional core customer base, consumers, they have introduced new services in recent years: cable modem Internet access and video on demand (VOD) in the late 1990s, packet-based telephone (VoIP) in the early-to-mid 2000s, and high-definition television (HDTV) in the mid-to-late 2000s. Adding new residential customers is more of a challenge, however. Cable systems pass a large majority of residential customers already, so consumers generally have access to their services; at the same time, competition from direct-broadcast satellite (DBS) and incumbent LECs is intense. The battle here is more one of limiting customer defections (minimizing churn) and making the most of the ones you have (increasing ARPU).

In contrast, the commercial customer segments are practically virgin opportunities for most cable operators. Every new business customer adds to the top line; the less an operator has to do to provision services for this customer, in the way of building out their network or deploying new equipment, the greater the impact on the bottom line.

Market Segmentation Strategies

Once the decision to enter the business services market is made, a service provider must identify which customers to target. A cable system operator can choose to pursue prospects based on the size of locations, focusing on either “large” customers or “small” ones; or it can orient its strategy around one or two industry verticals, or go after customers regardless of industry. In practice, strategies form at the intersection of the two dimensions (Table 3.1), and providers can pursue a couple of distinct segments simultaneously.

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Table 3.1

Service Provider Market Segmentation Strategies

Source: New Paradigm Resources Group, Inc.

Broad

• Corporate headquarters • Manufacturing facilities • Call centers

• Central business districts (CBDs)

• Telecommuters

• Home-based businesses • Small offices

• General retail outlets • Strip malls

Vertical Strategy

Focused

• Financial exchanges & Traders • Banks & Insurance companies • Hospitals & Medical campuses • School districts & Universities • Governments

• Media & Content providers • Branch offices: banks,

insurance, investments, etc. • Doctors’ offices & Outpatient

centers • Small schools

Large

Small

Size Strategy

Each provider defines these segments differently. Many classify prospects’ size by location headcount, similar to the “establishment size” used by NPRG, following the rationale that telecom products (access lines, customer premises equipment) frequently have specifications setting the number of simultaneous users. Others subdivide based on businesses’ typical monthly spending on telecommunications services, reasoning that it is a more accurate barometer of the complexity and scale of services customers actually need. Similarly, one provider may target all companies engaged in “financial services,” including insurance and analytical services, while another may so designate only securities exchanges, investment houses, and trading firms.

As relatively new entrants to the business services market, cable operators have employed extensive customer segmentation strategies to narrow their initial targets and deploy resources efficiently. Often, cablecos entering the business services market, or a portion of the commercial market, begin by targeting very small businesses which can utilize products originally designed for the consumer market. Where a cableco occupies a unique competitive position that enables it to address the needs of large customers—such as Cablevision in New York City—it can pursue more of an upmarket strategy. And an operator may have a dual strategy, going after customers both large and small—Cablevision, Cox, and Time Warner Cable all have distinct strategies in more than one quadrant of the matrix.

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Figure 3.2

Cable MSO Market Segmentation Strategies

Source: New Paradigm Resources Group, Inc.

Broad Vertical Strategy Focused Large Small Size Strategy Organizational Strategies

Service providers have any number of organizational options available to them, and indeed, even among the largest cable MSOs there is great variety and frequent change in how business services are treated within corporate organizations.

Management of business services can be retained at the corporate level, or most decisions can be left to local managers. When management is handled corporately, product specifications and availability tend to be implemented more universally throughout the organization, with market-level managers tasked with executing strategy rather than developing it. Pricing may vary from market to market but is set at the corporate level. Comcast hews pretty closely to this top-down approach. In contrast, the local markets for Cox and Time Warner Cable have more local autonomy. Time Warner Cable services available in New York City or Texas often are not offered in its other markets, for example, and local Cox offices have some freedom to extend promotional pricing on their own.

Relatedly, providers must also decide whether to organize their commercial market programs separate from their core consumer businesses. Maintaining a separate business services unit has several advantages related to the commercial market’s unique characteristics (see Section 1, “The Business Telecommunications Market”). Business services are more complex and may even be delivered over a network separate from an operator’s consumer one; the services are used more intensely and require more support to install and maintain; they are far more valuable on a per-delivery location basis; and therefore have a longer, much more delicate sales cycle. On the other hand, if a provider’s commercial customer base is not sufficiently large, keeping a separate business unit may be inefficient.

At present, the major MSOs manage their business services initiatives more or less independently from their consumer operations (Figure 3.2). The most fully separate are Cox Business Services and Optimum Lightpath, which are wholly-owned subsidiaries of Cox Communications and Cablevision, respectively; in OLP’s case, it runs a network entirely separate from its parent company’s consumer network.

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Figure 3.3

Business Unit Separation Among Major Cable MSOs

Source: New Paradigm Resources Group

As smaller and smaller MSOs enter the business services market, they are likely to manage these initiatives with less separation from their core (consumer) operations. They are smaller companies overall and serve fewer, smaller markets. These operators therefore do not have the scale to justify fully independent units. Too, businesses in their service areas tend to be smaller—almost entirely in the small business segment and below—and thus have less need for the portfolio scope or complexity of services that usually dictates the formation of a standalone business services unit. So while some operators have rigidly defined units to target consumer, wholesale, and separate business segments (Enterprise as opposed to Small business, for example), smaller operators may coordinate activities for some or all of the business segment together with their consumer operations (Figure 3.4).

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Network Strategies

Cable operators have extensive, web-like networks that run throughout their franchise areas, a particularly important advantage in approaching smaller businesses that are not conveniently located in a central business district. On the other hand, because their networks were designed and built with residential coverage in mind, they do not necessarily possess fiber exactly where it is needed.

A generalized cable system map is illustrated below (Figure 3.4). The operator’s existing fiber optic distribution network is shown with solid blue lines. It branches off and winds through residential areas (shaded green in the figure), connecting to neighborhood nodes throughout the city. Because the necessary physical plant is already in place, SOHO customers, and even larger businesses in the Micro-size and Small business segments, within these areas could be served immediately by the operator, and with no (or negligible) charges for network build.

When the network was originally constructed, fiber hit the edges of a few business areas that had some demand for the operator’s video services (e.g., districts with restaurants and bars), but it is either not dense or “clean” enough to support rapid provisioning of service to commercial customers. These areas are shaded yellow, and require small lateral builds (dotted blue lines) and/or cable upgrades to support delivery of commercial-grade services. The operator incurs more costs to initiate service to these areas, and typically requires new customers to pay for build costs, either as a lump sum upfront or amortized over the length of a contract.

Finally, there are areas where the network does not currently reach. These are concentrations of businesses (shaded red) that fall outside the operator’s targets in the smaller business segments; instead, these are manufacturing and Enterprise locations. Provisioning to the location would first require an extensive, costly build (dotted blue lines), and because it is targeting smaller businesses, the operator may not even have products of interest. These areas are thus passed over and left “undeveloped” for the time being.

Figure 3.5

Generalized Cable System Distribution Network and Addressable Footprint

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It is within this context that cable operators evaluate prospective opportunities in the commercial customer segments. If a location requires fiber-based service but is not on or very near the fiber network, the operator evaluates the scenario using “success build” criteria: would the return from the single customer opportunity be enough for the build to pay for itself and guarantee the provider some profit, or alternatively, could additional opportunities arising from the build be sufficient?

Marketing Strategies

In general, cable MSOs have leveraged the brand equity from the residential side of their business, albeit judiciously—creating an association with an established, well-financed operator can be a big plus when dealing with business customers, but being equated with “consumer-grade” services (and “frivolous entertainment”) can be an even bigger negative. The key components of cable MSOs’ business services strategies are:

• Recognition: Raise awareness of the operator as a business services provider;

• Empower Customer Choice: Present the operator as an alternative—the alternative—

to “the phone company”;

• Network Reach: Demonstrate that the operator has extensive reach, beating competitors

(except, arguably, the incumbent LEC);

• Network Diversity: Remind customers that because the operator’s network grew

separately from the legacy PSTN, it runs different routes than the incumbent LEC’s or even competitive LEC’s—it offers true physical diversity for disaster recovery planning;

• Quality: Establish that operator delivers enterprise-class service levels, e.g. VoIP is a

managed digital service rather than best effort over the public Internet; preempt any customer concerns about outages, network management, and tech support;

• Business Tools: Reinforce that products are designed for business customers (e.g.,

Metro Ethernet) and include business-specific tools (calling features like hunt groups, network security tools, etc.);

• Competitive Pricing: Taking care not to embrace “cheapness” and cede future pricing

power, illustrate what customers can save by choosing operator’s bundled packages or taking advantage of included features.

Of course, the Organizational and Market Segmentation strategies that a service provider chooses bear greatly on how exactly it markets to commercial customers. Operators that elect to target the SOHO and Micro Business segments rely on mass-market tactics, applying expertise and advertising scale accumulated over decades in the consumer market; those that focus on larger customers use more direct means. An operator that addresses the business market through a subsidiary may have more work to do educating customers about a new brand (such as Cablevision via Optimum Lightpath).

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supporting one or two voice lines, and including cable television for some industry verticals— are more or less technologically the same as the residential versions they’re based on. The difference, however, is that operators allocate resources (average load on the network, technical support, customer service) to handle the demands of business customers, and they price commercial variants accordingly, typically at a premium of 25% to 100% over comparable residential service.

Figure 3.6

Bifurcated Cable MSO Commercial Market Portfolio Targets

Source: New Paradigm Resources Group, Inc.

Up-market, in the Mid-size and Enterprise segments, cable operators lead with Metro Ethernet services, in most cases delivered optically over laterals from their distribution networks. Building new capillaries is more capital-intensive than provisioning service to residences or SOHO customers over extant coaxial access, but the overriding strategic principle is similar. Cable operators already use Ethernet or IP for transport of services within their core networks, so they can extend Metro Ethernet as a retail product without a great deal of development or network re-engineering. Leveraging Ethernet’s various service flavors and features—EPL for dedicated point to point, EVPL for point to multipoint, differentiated classes of service to handle applications efficiently, etc.—providers can support practically any client architecture using a single network.

On the voice side, cable operators have followed a pattern of initially buying services wholesale that they are not initially capable of delivering themselves. Then, as they develop in-house expertise, define more precisely the highest priority features, and grow their customer base for the service, they achieve the scale necessary to build an support the service themselves. In the early 2000s, this was the strategy followed by many large and small operators with residential and SOHO VoIP. More recently, they have relied on wholesale providers to supply hosted VoIP services; the largest operators view hosted VoIP as one of their top strategic priorities and are currently developing their own capabilities in the area.

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Wireless Strategies

One of the biggest profit drivers for service providers over the past decade has been wireless service. While most providers combat TDM access line erosion and downward pricing pressure on wired services generally, cellular penetration has increased and average revenue per user (ARPU) has risen with the growing adoption of mobile data services, powering much of the growth reported by major “wired” carriers like AT&T, Verizon, and Sprint. Wireless service in the business market can be especially lucrative for carriers: large contracts for corporate fleets with tens of thousands of users, high penetration of data services, and extended contract terms that can help keep customer churn low.

Figure 3.7

Cable MSO Product Portfolio Strategies to Enter Wireless

Source: New Paradigm Resources Group, Inc.

As illustrated in Figure 3.7, cable MSOs are presently pursuing three different strategies to address this “wireless gap.” For one, Cox Communications is in the process of building a wireless network and service of its own. The operator acquired spectrum at FCC auction in 2009 for more than $550 million, and it has committed more than $1 billion to the effort overall. It is relying on Sprint’s 3G CDMA network to get started, but in the long-term it intends to build its own wireless infrastructure, eventually offering 4G LTE, across much of its market footprint. Cox has targeted small businesses for the service, initially in Hampton Roads, VA; Omaha, NE; and Orange County, CA; however, with the exception of Hampton Roads, the service is not yet generally available, and the company is simply inviting customers

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Figure 3.8

Cox Wireless Pre-Launch Web Commercial

Source: Cox Communications website (unbelievablyfair.com, retrieved May 18, 2010)

The second strategy being pursued is partnering with others. Cablecos have entered into resale agreements with wireless carriers in the past, but in the current iteration, begun in 2008, Comcast, Time Warner Cable, and Bright House Networks invested directly in Clearwire, a company that has been building a national broadband wireless network since 2003. (Joining the cablecos in investing were Google and Intel, with Sprint Nextel purchasing a majority stake.) Clearwire itself is building out markets incrementally, about one to two dozen per year; the partner cablecos launch consumer service under their own brand shortly thereafter. Business-specific products or bundles are a key to their long-term strategy.

The three cableco investors aim to get the best of all worlds. They are immediately able to offer customers access to a national wireless network and the promise of faster 4G service where and when it is available. Although their investments have been significant, they tie up far less capital than if they tried to replicate the wireless network themselves, making funds available for other priorities. By sharing the network and investments across a number of parties, they minimize their downside risk; they also avoid direct responsibility for the ownership, management, and maintenance of wireless infrastructure. It also ensures a committed customer for their nascent wireless backhaul services, helping to build their wholesale business and expertise.

Finally, the third cableco strategy is utilizing alternative technology to build a localized, homegrown network. Cablevision, Comcast, and Time Warner Cable have all deployed Wi-Fi base stations in the New York metropolitan area. In early 2010, the operators extended access to each others’ customers. The maneuver is defensive in nature, an attempt to thwart the mobile data advantage held by Verizon and AT&T. Because it is being included as a free “bonus” to subscribers (both consumers and businesses), the operators obtain no incremental revenue; even where operators may offer Wi-Fi as an add-on, they cannot sustain a high MRC, certainly nowhere near the ARPU that national wireless carriers’ obtain from plans combining wireless voice, voicemail, and mobile data. The strategy amounts to a low-cost, low-risk gambit to fill the “wireless gap” in their portfolios.

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Table 3.9

Pros and Cons of Cable MSO Wireless Strategies

Source: New Paradigm Resources Group, Inc.

Homegrown Wireless • Cox • Spectrum: $550 million • Total: > $1 billion • CDMA (3G) • LTE (4G) • Control

• Don’t pay competitor (wireless carrier) to penetrate your territory • On-net coverage limited, roaming extensive • Lack of wireless culture, expertise • Unknown quantity in

wireless: will it fly?

Partnership/ Investment

• Comcast

• Time Warner Cable • Bright House • Comcast: ~$1.25 billion • TWC: ~$650 million • Bright House: ~$120 million • WiMAX (4G) • Minimize risk • Invest in next-gen technology (4G) • National roaming

option via partnership

• Lack of full control: decide by consensus • Loose integration into

product portfolio

Homegrown Wi-Fi

• Cablevision • Comcast

• Time Warner Cable • Build: $5-50 million

per market (varies by size)

• Wi-Fi Hot Spots (IEEE 802.11)

• Reduced Risk • Control

• Ease of deployment: attach Wi-Fi base station to generic broadband endpoint or tap into conduit midpoint • Hotspots more limiting to customers than wide-area 3G/4G coverage • Not substantial enough to replace nationwide cellular voice and mobile data for many business customers

• Low reward: currently a free bonus now (at best only a low MRC is sustainable) Technology Used Advantages Disadvantages Operators

Cost to Operator to Date

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however, cablecos could look to acquire either valued commercial customer bases or upmarket service capabilities—or both—by purchasing companies that have business market specialties. The most likely categories of potential targets are examined in Table 3.3 below, in roughly descending order starting with the “most likely” targets, CLECs.

Comcast has been the most aggressive of the cablecos as of early 2010. In late 2009 it announced its intention (and in early 2010 received regulatory approval) to buy CIMCO, a Chicago-based CLEC serving almost 20,000 access lines and generating $10-15 million annual revenue. Perhaps as or more important than its metro fiber or customer base, CIMCO possessed valuable technology and expertise in the Small and Mid-sized customer segments, as it served businesses with up to 250 employees. Then in the first quarter of 2010, Comcast announced that it would buy New Global Telecom (NGT), a provider of wholesale trunk and hosted VoIP services. Again, it brings customers and revenue to Comcast, if leveraged successfully, NGT’s large-scale VoIP expertise jumpstarts the cablecos’ aspirations to move upmarket beyond the Micro-sized business segment and approach bigger fish in the Small or even Mid-sized business segments.

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Table 3.10

Merits of Cable MSOs’ Potential Acquisition Targets

Potential Target

CLEC Hosted VoIP

Fiber Network Operator

Interregional Provider (e.g., IXC)

Wireless Carrier

MSO Rationale for Acquiring

• Acquire prime commercial customer base

• Higher-end business services to address gaps in portfolio • Higher-end business services to

address gaps in portfolio • Offer acquired customers a full

range of on-net services • Acquire prime commercial

customer base, particularly Mid-Size through Large Enterprise

• Add high-capacity fiber covering popular routes in central business districts • Coast-to-coast backbone and

extensive reach to Tier 1 and Tier 2 business districts • Acquire WAN platform (MPLS,

Ethernet VPLS)

• Acquire Enterprise customer base

• Solidify cableco presence in high-margin, high-growth wireless service categories • Market “quad-play” bundle

entirely on-net

Downside to MSO

• Legacy telco infrastructure not directly compatible with cable plant

• A second business VoIP platform could pose

integration challenge cablecos have yet to encounter

• Investors may view as low-reward application of capital • Acquired customers may be

interested only in extreme bandwidth services that yield lower margins

• Building own fiber may be preferable

• Buying/leasing long-haul capacity and services may be preferable

• Cableco organization may not currently be capable or supporting national enterprise service

• Federated strategy (with other cablecos) could accomplish similar results, with little or no investment required

• Buying a national or quasi-national wireless carrier would be enormous investment, diverting capital from core business

• Partnership with third-parties for mobile data (4G/WiMAX) does not require cablecos to carry infrastructure, network management burden • Emerging “roaming WiFi”

via federated cablecos could address mobile data gap in portfolios with far less capital • Management and investors

may prefer marketing resold or white-labeled cellular/mobile data service from a third party

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SECTION 4: COMPARATIVE ANALYSIS - TELCOS VS. CABLE MSOS

A wide array of service providers compete in the business services space, but the cable MSOs' vigorous pursuit of this market can rightly be viewed as a volley aimed at the incumbent telcos, the remaining RBOCs (AT&T, Verizon, and Qwest) foremost among them. In the past decade, the rivalry between cable MSOs and telcos intensified, and the distinction between their products and strategies blurred. Cablecos introduced consumer VoIP service, accelerating the technology substitution made manifest in the RBOCs' access line erosion. For their part, telcos entered the video entertainment business by launching fiber-to-the-home and residential triple-play bundles, cutting into the core cableco market already besieged by satellite (DBS) providers.

The cable MSOs bring specific strengths and carry a few weaknesses into the contest for business customers.

Strengths of Cable MSOs in the Business Services Market

• Pervasive network facilities: Cable systems snake throughout their communities,

running past residential neighborhoods and low-density commercial zones where other service providers historically have not possessed facilities of their own. Although there are important differences between the two, cable networks are comparable to ILEC networks in terms of reaching neighborhood shops, small office buildings, and other businesses that lie outside central business districts where facilities-based competition is most intense.

• Corporate muscle: The MSOs blazing the trail in the business services market are large

organizations of comparable scale to their telco competitors. As importantly, however, they are sophisticated marketers that know how to sell communications services successfully. Operators can reinvest profits from their established business lines, namely consumer video and Internet access, in their commercial services operations. They have the resources and expertise to advertise aggressively, to price optimally, and to acquire the technical and human resources to build more robust business services units. Financially, they are in a better position than the small CLECs of old to fund product development and subsidize short-term sluggishness in particular markets.

• Products adaptable to a range of business targets: With the advent of VoIP, MSOs

have products in their arsenals that are as attractive to SOHO and Micro-size businesses as they are to consumers. These segments alone account for more than three-quarters of business locations and one-quarter of business services revenue (see Section 1). With additional technological advances and enhancements for the commercial market, these products can be extended even further up the food chain to Small and Mid-size businesses—a lot of bang for relatively little incremental investment.

• Physical diversity: Cable systems were built entirely separate from the public

switched telephone network (PSTN) of the telcos. As a result, MSOs’ cable plant has very weak correlation to the telco network—unlike other facilities-based competitors, namely CLECs and fiber network operators—that ultimately engineer their networks between ILEC-owned central offices where their gear is collocated. This can be an extremely enticing selling point for businesses concerned about redundancy for disaster recovery or rapid failover purposes.

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Weaknesses of Cable MSOs in the Business Services Market

• Geographic constraints: The strategy of “clustering” systems, by which cablecos

have obtained operating efficiencies, creates certain disadvantages in the competition for distributed Mid-size and especially Enterprise business customers. Oftentimes, an MSO serves an entire market region but is not the franchise operator in all outlying towns or in neighboring regions: Time Warner Cable is predominant in Los Angeles, but much of adjacent Orange County is served by Cox; Comcast covers much of Chicagoland but does not serve nearby Milwaukee (Time Warner Cable) or Madison (Charter), WI.

Also, because no MSO operates in all of the largest markets, none can yet pursue a truly national strategy. They are unable, for example, to offer solutions across “NFL cities” (i.e., Tier 1 metros) as many CLECs have historically done. Without international network assets, the domestic MSOs are likewise currently unable to provide end-to-end solutions for multinational Enterprise customers as incumbent and competitive LECs like AT&T, Verizon, Global Crossing, and Level 3 routinely do.

•Cableco networks do not hit all telco points of interest: Originally engineered

to distribute downstream video, primarily to consumers’ homes, cablecos’ physical routes typically fan out in a “tree and branch” architecture from proprietary distribution facilities. These paths are in contrast to traditional telco network architectures that incorporate fiber transport links between telco central offices and other desirable locations, such as datacenters and large office buildings. As a result, the situation can arise where cablecos can have a presence in an area and be able to offer access but not have an effective route to a specific destination: for example, for a customer seeking a link from its building to a common telco interconnection point (e.g., a CO), or for a point-to-point link traversing a metro area. Thus MSOs sometimes must trench fiber to these off-net telco locations, which is costly, or splice fiber at an intermediate point, which has its own costs and degrades the quality of both parent and offspring routes.

• Relationships with business customers: Particularly at the upper rungs of the business

segments pyramid, cablecos have no or little history with business customers. With long sales cycles and complex scenarios sometimes requiring several service providers to contribute specific expertise or abilities to an overall solution, the Enterprise and Mid-size markets require experienced operator sales teams and demonstrated records of success—attributes that large telcos (both ILECs and CLECs) and integrator specialists possess far more than the MSOs do, at least at present. This is less of a shortcoming at the lowest rungs of the pyramid, where customers’ relationships with their telecommunications providers are less ingrained.

• Customer service and OA&M: Like the rest of the telecommunications industry, cable

MSOs have often been criticized for the quality of customer service they provide—and that’s largely been on the consumer side. Although several operators stand out in their customer

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varied, with complex topologies (point-to-point versus multipoint) and service characteristics possible. Technical impediments can be addressed with a little time and investment, but developing the human capital and organization to address the unique demands of the business market is more uncertain.

• Lack of a proven national wireless strategy for business: Wireless services have powered much of telecommunications providers’ profits during the past two decades, and they will continue to be the key battleground as mobile data becomes ever more ubiquitous and ultimately mission-critical to businesses. While AT&T and Verizon have consolidated their control of coast-to-coast wireless operations , cablecos have only dabbled in wireless, with no sustained success. Since 2008 the major MSOs have scrapped their former strategies in favor of new ones (see Section 4). The cable sector’s near-term fortunes in business market segments will not rise or fall on the success of these plans, but any aspirations to evolve into providers of a comprehensive portfolio of business services will require a respectable wireless option.

Opportunities for Cable MSOs in the Business Services Market

• Deliver scalable Ethernet to off-fiber locations: Customers continue to demand

greater bandwidth at lower per-unit prices, and the race among providers to deliver it is heating up. With providers in all sectors focused on their bottom lines and hewing to “success-based” fiber build out strategies, a large majority of business locations will remain “off-net” for the foreseeable future.

There are currently three main alternatives to fiber for higher bandwidth, and cable operators can make a case that they have the best one. ILECs and CLECs can use Ethernet over copper (EoC) technologies to provision bandwidth in the 10 to 50 Mbps range using multiple copper pairs; however, availability and throughput is limited by the quality of the copper and the distance between the customer site and the CO that serves it. Fixed wireless operators can deliver 100 Mbps or more to any location where they can obtain a clear line of sight and usable spectrum; some customers, however, may balk at an unwired solution because of past reputation. Cable’s DOCSIS 3.0 technology, deployed in roughly half of the footprint of top 5 MSOs as of mid-2010, enables downstream throughput of at least 50 Mbps, with more than 100 Mbps theoretically possible. Delivering DOCSIS over their existing coax gives cablecos the ability to make an end-run around the telcos, which must either build fiber or lease access from an ILEC.

• Develop scalable hosted voice solutions for the mid-market: Cable MSOs are

positioned to intensify their push upmarket and target the Small and Mid-sized business segments, opening up sizable revenue opportunities. To do so, they will need to establish robust midmarket voice services that scale to dozens or hundreds of lines. Such solutions could be paired with existing scalable-bandwidth services (DOCSIS over coax, Metro Ethernet over fiber) and the experience accumulated by MSOs’ business sales and engineering staffs. Cablecos can apply the model used previously with smaller business customers. They can modify and extend their existing technology, so as to keep development times and costs low; by ensuring upward scalability, they can maximize their addressable market.

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Hosted VoIP service scalable to meet midmarket needs is the best candidate for the sector. Pricing simplicity, based on either customer headcount or voice minutes of use, or both, has been an effective differentiator in this market for operators like Optimum Lightpath. By enabling customers to shift their voice systems offsite, technical staffs already stretched thin can implement and manage them more easily, thus doing more with less. And finally, there is tangible demand for such services, as telcos and wholesalers have been ramping up their offerings over the past few years. Hitting this opportunity squarely would be a coup for cablecos, because it would put their service offerings on a par with the telcos for a majority of customers in the Small and Mid-size business segments.

• Undercut telcos’ pricing for wholesale optical capacity on existing routes: In

theory, cablecos could grow their share of the metro transport market rather rapidly because they already have extensive fiber optic networks in place. So unlike startups that have to build networks from scratch, cablecos could sell from existing inventory. They can compete on price opportunistically: where they have available capacity, and where they can do so without impacting profitability. Because it is not yet integral to their business services units, let alone their overall corporations, their success does not hinge on generating a lot of traffic to fill empty pipes—they can therefore be selective in what customers they target.

This is likely to be more of a complementary priority rather than a top one for most operators, however. MSOs’ networks were not purpose-built to transport

• high-capacity customer traffic, and their business models are different than wholesale specialists’. An exception that proves the rule is the case of New York City, where geography and the dense concentration of businesses has given Cablevision (via Optimum Lightpath) and Time Warner Cable the opportunity to profit from high-capacity services. The limited availability of fiber for cellular backhaul in some markets also presents attractive economics, which Comcast, Cox, Time Warner Cable, and Bright House Networks have started developing. Even carving out a small chunk of the market would yield substantial new revenue from cablecos' existing networks, most of it at the expense of their telco competitors.

• Add wireless services, especially mobile data: Until very recently, the cable sector either ceded wireless service to others altogether or resold service from leading carriers. In either case, cable operators' biggest telco competitors were prime beneficiaries. The MSOs' change in strategy the past couple of years, if successfully executed, would not only fill a glaring and growing gap in their business services portfolios, it would deprive competitors of revenue.

Cable MSOs Comparison to Other Provider Sectors

Cable MSOs are the largest players in the entire telecommunications industry--except for the incumbent RBOCs. The five largest MSOs recorded total revenue of $77.0 billion in

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Figure 4.1

Comparison of Provider Sectors Active in the Business Services Market

Source: New Paradigm Resources Group, Inc.

Cable MSOs Comcast Time Warner Cable Cox Charter Cablevision $77.0 billion $12.7 billion 16.4% • Residential • Suburban & Urban • Web-like coverage throughout operating markets Tier 1 ILECs (RBOCs) AT&T Verizon Qwest $231.2 billion (wireline = $121.8 billion) $35.1 billion 15.2% • Ubiquitous, concentrated within Tier 1 and 2 markets • Focusing away from rural and less dense areas

Tier 2 ILECs (IOCs) CenturyLink Cincinnati Bell Frontier Comms. TDS Telecom Windstream $16.4 billion $2.2 billion 13.2% • Ubiquitous, mostly in Tier 2 and 3 markets, and including rural areas CLECs Level 3 One Comms. PAETEC tw telecom XO Communications $8.9 billion $1.0 billion 11.0% • Central business districts, mostly in Tier 1and 2 markets

Alternative Service Providers Airband Comms. Pangaea Networks SRP Telecom TowerStream Zayo Group < $500 million < $100 million > 20% • Central business districts, some focusing on Tier 1 markets and others on smaller ones • Wireless access across metro regions Leading Providers Total Revenue of Top 5 (2009) CAPEX of Top 5 (2009) CAPEX % of Revenue Location of Facilities

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SECTION 5: OUTLOOK & FORECASTS

The Cable Sector’s Opportunity in Business Services

Business services present the brightest near-term growth opportunity for cable operators for a number of reasons. Despite contracting in 2008-2009 due to the broader recession, the long-term trajectory for commercial wireline services shows solid growth and year-to-year stability. Enterprises are buying additional and ever-larger circuits, both to support wide area networks and to establish redundant facilities for business continuity and disaster recovery (BCDR) planning. A growing portion of smaller businesses seek more affordable bandwidth than TDM services offer, both to support VoIP and their growing dependence on “web-centric” applications: larger email attachments, audio and video conferencing, websites and e-commerce, and so forth. Businesses of all sizes are eyeing unified communications (UC) and cloud computing strategies that push the locus of some or all IT functionality offsite, necessitating more telecom bandwidth to access it.

Before the mid-2000s, the commercial services market had been broached by only a handful of cable operators, led by Cox Communications, Time Warner Cable, Cablevision, and Bresnan. Thus the market is mostly virgin territory for the sector, and a full-scale assault constitutes "new" revenue for the sector.

Figure 5.1

Cable MSOs' Business Service Revenue & Share of Total Business Services Revenue (2006-2015)

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and its sustained commitment to the market, and the rollout of new products, namely VoIP, to business customer segments.

Cable operators will not find success overnight, however, nor will their gains be found evenly across customer segments or geographic areas. In general, cable operators' greatest advantage relative to other current and previous competitive providers (e.g., CLECs and CAPs) is the broad reach of their physical plant, particularly in residential and light commercial (retail and small office) areas where they already pass nearly all customers at the curb and have a high penetration of last-mile access installed. It is, therefore, the large number of very small businesses with relatively small telecommunications needs, identified throughout this report as SOHO and Micro-size businesses, that are most at risk to cable incursions initially. Each of the Tier 1 cable MSOs has targeted these, and as lower-tier operators enter the business services market, they will do the same.

Within the forecast period (through 2015), cable operators will continue to find their greatest success with smaller businesses. Tier 1 MSOs will increasingly target customers with up to 100 employees using more scalable voice products such as hosted VoIP, enabling them to offer single-source solutions throughout the SOHO, Micro-size, and Small business segments. Sector revenues from business services will accelerate in the latter half of the forecast period as MSOs become more established as "full service" providers to all customer segments, they introduce SLA guarantees that parallel those offered by telcos, and as smaller operators enter the commercial market with full force. NPRG forecasts cable operators' business services revenue to reach approximately $9.5 billion by 2015, a 20.1% CAGR over the period. This will represent an aggregate market share of about 6.5% for the sector, a gain of more than three percentage points over 2010, and put cableco business segments' revenue on the same scale as pure CLECs.

The Cable Sector’s Future Prospects in Business Services

Although some cable operators have competed in the business services market for years, as a whole, the sector is still relatively new to the business and accounts for only a small percentage of total business services revenue. However, this does not mean that the cablecos current position is not significant--nor does it mean that they will not be exceptionally strong players in the near future.

The table below (Table 5.1) shows what various market share levels are worth for each business customer segment. For example, a 5% share of the $8.9 billion SOHO segment is worth over $400 million, so the table displays $0.4 billion there. The cable sector’s aggregate revenue from each segment is circled in red. For simplicity, only significant market share tiers are shown, so the value circled is the nearest approximation to the sector’s revenue (and thus share); where the estimate falls between two values, such as in the Micro segment, both are circled.

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Figure 5.2

Value of Market Share, by Business Customer Segment (2010)

= approximate revenue gained from segment by cable MSOs

Source: New Paradigm Resources Group, Inc.

Total Telecom Revenue from Segment (2010) $8.9 billion 6.9% $25.2 billion 19.4% $32.3 billion 24.9% $31.6 billion 24.4% $9.7 billion 7.5% $22.0 billion 17.0% $129.5 billion < $0.10 billion $0.25 billion $0.3 billion $0.3 billion ~ $0.1 billion $0.2 billion $1.3 billion

Revenue Within Segment for Various Market Share Levels

1% Share 5% Share 10% Share 20% Share

$0.4 billion $1.3 billion $1.6 billion $1.6 billion $0.5 billion $1.1 billion $6.5 billion $0.9 billion $2.5 billion $3.2 billion $3.2 billion $1.0 billion $2.2 billion $13.0 billion $1.8 billion $5.0 billion $6.5 billion $6.3 billion $1.9 billion $4.4 billion $25.9 billion Business Customer Segment SOHO Micro Small Mid-Sized Small Enterprise Large Enterprise TOTAL

The cable sector's greatest penetration to date is in the SOHO segment, at roughly 10%. In absolute dollars MSOs obtain similar revenue from Micro-size businesses (5-19 employees), but because it is a more valuable segment overall, cablecos' share is in the low single-digits. Cablecos' aggregate share among the segments of larger businesses is even less, at 1% or less.

Increasing the sector’s share of the total business services market from ~2.5% to 5% would double sector revenue from business services to about $6.5 billion. Claiming 10% of the total business market would amount to roughly $13.0 billion—equivalent to about 17% of the MSOs’ projected 2010 revenue. To put this 17% figure in perspective, it is just a bit more than how much Time Warner Cable registered in 2009 from on-demand programming, premium subscription channels, DVR and other equipment rental and installation charges— all areas of recent emphasis and drivers of growth—combined.

Relatively small incremental share gains in the midmarket segments hold the key to additional revenue. Growing share to just 5% of both the Small and Mid-sized business segments would equate to about $2.5 billion in additional revenue annually (more than $1 billion per segment); boosting it to 10% in those segments would net almost $6 billion more. Having a foothold within the smallest segments, cable system operators are in position to

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revenue will increase, pushing the curve upward (dashed line labeled "2013 (Baseline)"). Because we project a cableco emphasis on midmarket solutions and marketing that are closer cousins to their current small-segment focus, the curve may flatten out due to increased penetration in the Small and Mid-size segments and comparatively small gains among Enterprise customers.

Figure 5.3

Cable Sector Market Share Curve

Source: New Paradigm Resources Group, Inc.

The Bottom Line

Business telecommunications services can be a challenging market for providers. There is an enormous variety of technologies and products to support, and the needs of the largest customers are categorically different from those of the smallest. Indeed, the "business services market" is really a collection of heterogeneous customer segments, defined by size, industry, and even geographic location. In practice, it very often is true that no two customer solutions are exactly alike. This is very different from cablecos' traditional business.

Cablecos are poised to make substantial gains in the commercial services market thanks to a confluence of factors and some well-timed decisions on their part. Operators in the sector have extensive facilities-based networks in the nation's major metros, which have the greatest concentrations of businesses, particularly midmarket companies and enterprises. They already connect to or pass a majority of businesses in their franchise areas, and their existing fiber distribution networks allow them to readily build laterals where necessary. Following the rampant consolidation of the RBOC and CLEC sectors, there is a fortuitous opening for cable operators to position themselves as “the other guys,” a new but viable alternative in a market with dwindling choices. Past investments in system bandwidth and technology development (e.g., VoIP and DOCSIS 3.0) give cablecos the tools to compete in the demanding business market. In a few years, it may even be hard to remember a time when they weren’t diehard providers in the business space.

References

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