Remember the Dumb Pipe?

I recently read an article that warned that the big ISPS need to embrace artificial intelligence, software defined networks and cloud infrastructure if they don’t want to become a ‘dumb pipe’ provider. It reminded me that the small ISP industry heard this same warning a decade ago. Small telcos and cable companies were all warned by numerous industry experts that they were fated to just become dumb pipes.

After a couple of years the dumb pipe phrase passed out of our conversations, but the issues that led to that warning were all still in play. Even a decade ago we knew that services other than broadband had a dim long-term future.

A decade ago we saw landline penetrations dip below 90% from a high of around 98%. There were dire warnings everywhere that voice would soon be dead and that voice margins would evaporate. Since then we’ve seen a steady market decline of about 5% of total market share annually, but that means that even after a decade that landlines still have a nationwide penetration rate of about 40%. The decline hasn’t been spread evenly and I have clients with voice penetration rates ranging between 20% and 55%.

We also knew a decade ago that cable TV was going to be in trouble. Netflix had just gone online with pay-per-view movies in 2007, but nobody understood then how powerful online video would become. The real concern then was that small video providers were already seeing annual programming rate increases that neared double-digits and everybody feared that the public would not tolerate large annual rate increases forever. For most small providers this was the first time they had ever had to annually raise rates for a product and nobody was comfortable. But the lure of programming is strong, and even after a decade of rate increases that have easily doubled cable TV prices the national penetration rate is around 68% for traditional cable TV – not drastically below the 75% penetration of a decade ago. It turns out that the public still likes the programming more than they hate the rate increases.

The real fear of becoming a dumb pipe a decade ago was that small ISPs would have to survive on nothing but broadband revenues. A decade ago small ISPs had broadband penetration rates in the 40% to 50% range and when they did the math they didn’t foresee that as enough revenue to replace the shrinking landline and video revenues. Many small telcos were so sure about the downfall of the small ISP industry that of them sold their businesses, fearing they’d never see a higher valuation.

However, since then we’ve seen broadband penetration rates continue to grow and roughly 84% of homes nationwide now pay for a broadband connection. Rising broadband penetration rates settled the fears of many small ISPs who are still in business.

Interestingly, many small ISPs have not raised broadband rates since a decade ago. It’s been hard to justify raising rates when the big ISPs also didn’t raise rates. Urban broadband that was overpriced a decade ago looks like more of a bargain after a decade of steady rates.

The good news for small ISPs is that the big ISPs are now poised to significantly raise broadband rates. In November we just saw Charter raise the broadband price for bundled customers by $5 per month – an increase that is unprecedented in the industry. Wall street analysts are telling the big cable companies that the market can bear broadband rates as high as $90, and they seem to be listening. As the big ISPs raise broadband rates, small ISPs will be able to ride the coattails and edge rates higher – knowing that for them that rate increases will go straight to the bottom line.

I don’t see any small ISPs who are worried about becoming the dumb pipe – because most of them are already there. If they still offer cable TV, they do so for customer convenience because the product has no margin. Small ISPs continue to lose landline customers, but they now understand that they can survive on broadband and related products like managed WiFi.

The main issue facing small ISPs these days is economy of scale. It’s clear that when broadband represents most of the margin of an ISP that profits come by controlling costs. The best way to control costs is not by tightening the belt, but by gaining customers to better spread existing costs. I see many small ISPs doing the math and aggressively pursuing new broadband customers. Far from fearing being a dumb pope provider, I see small ISPs enthusiastically embracing that role and growing their customers and their margins.

2 thoughts on “Remember the Dumb Pipe?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s