Three strikes or you're out: cable operators need to deliver on 'triple play' if they are to compete with telcos

The days of monopoly service provision in European telecom are gone. Though a number of alternative operators would object to the argument that the monopolies are dead, consumers have certainly seen great benefits from a steep fall in voice charges and a widening range of services.

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There are, however, still some relatively sheltered corners of the telecom market. Until recently, cable operators had a service that telecom operators--despite their much larger last mile footprint--could not compete with: TV into the home. That appeared to give cable operators a good starting point from which to expand into offering telecom services in the newly deregulated markets. They had the revenue streams to fund network expansion.

On this basis, all of the major European cable operators borrowed extensively to build out the network bi-directionality that telecom services demand. They also restructured equally extensively when their debts became more than their balance sheet would support. Telewest, for example, reported a net loss of [pounds sterling]2.2 bn [[euro]3.3 bn] in 2002. They have now either finished this process, or are close to doing so, which means that they are potentially back in the business of telecom service expansion.

The market, however, has moved on. Telecom operators are moving into TV provision and investors are less forgiving of massive infrastructure build-outs. The question for the cable operators is: given that DSL providers can start to offer home TV services, do they have a pressing need to compete with DSL by offering internet and voice? Many observers argue that, certainly over time, they do.

The one-stop shop

"If the operators do not have the funding to build out telecom services, they will, ultimately, face some competitive challenges, though it would probably be 4-5 years before they see real loss of market share," argues Aizaz Shaikh, media and telecom analyst at BNP Paribas in London.

Some incumbents--notably Deutsche Telekom--are moving toward providing TV over DSL. DT is also considering a domestic VoIP strategy, announced by Kai-Uwe Ricke, the CEO of DT at a recent press conference. However, the German incumbent has yet to embrace a full 'triple play'.

One of the reasons for this may be that the cable operators are still very much fragmented. Particularly in the central European cable TV market, relatively small-scale operations are the norm. Iain Stephenson, an analyst with Ovum, considers, for example, the German market to be "the worst example of how to build a cable network in the world". The French market expressly forbade cable companies to service more than eight million subscribers each. This law was recently rescinded, triggering a take-over of Noos by UGC and the announcement by France Telecom and Canal+ that they would merge their cable activities with the aim of attracting a new, controlling, investor.

The concerns about concentration of broadcasting power that lay behind the original French ruling were not the only barriers to growth and rationalisation in the European cable industry. When the first cable networks were laid, bi-directionality was not required, which is why many stretches of cable need to be upgraded before internet and voice services can be offered. At ish, for example, a German cable company that serves North Rhine Westphalia and that was recently acquired by Kabel Deutschland, only around 1.1 million of the four million households served by the company have bi-directionality. Of these 1.1 million, just 11,000 take internet access services.

"The question is not whether the build-out of the telephone business depends on the build-out of the network," said Barbara Krueger, a spokesperson at ish, prior to the announcement of the take-over. "Further build-out of the network will depend on the economics. Where could the necessary investments be amortised?" In the case of ish--and German cable operations in general--the answer to that question depends, in turn, on the demographics of a particular urban region and also on the level of last mile connection that the cable operator has. ish had direct customer access to just 40 per cent of its cable households, and these are not necessarily conveniently located in one area--which obviously lessens its interest in building out the network to offer telecom services.

"Kabel Deutschland faces a formidable challenge in financing and coordinating the huge network upgrade and service implementation required to present an effective and viable challenge to DTAG's grip on the consumer market. The proposed investment, spread across 15 million homes--assuming that two million are already upgraded--amounts to just [euro]11 per subscriber home, per year," argues Jonathan Doran, a senior analyst at Yankee Group in a recent report.

Unfortunately for cable operators, the actual costs of linking subscribers is estimated to be considerably higher than that sum. "Putting in bi-directionality normally costs upwards of a few hundred Euros per subscriber, though this figure varies widely, depending, for example, on whether the operator is dealing with multi-dwelling units or connecting in a semi-urban environment," says Shaikh.

As things stand, Kabel Deutschland does not offer voice services--though its recent acquisitions, ish and iesy, do. "We will very carefully examine whether it makes sense to extend the offer on the basis of the experience of ish and iesy," says Kathrin Kleinjung, the spokesperson for Kabel Deutschland. "The three acquisitions have yet to be approved by the cartel authorities, so the process of integrating these businesses has not yet begun. Our goal is to be able, on the basis of a single, Germany-wide technical platform, to make the development of new programming attractive to content providers, so that we can offer customers an interesting product," adds Kleinjung. As this suggests, the focus at Kabel Deutschland will be on providing a good digital TV offering, rather than on locking horns with telecom providers. The company does not state whether cost is a lever in this decision.

Still at the beginning

IDC estimates that only around 8.4 per cent of European households have DSL-based broadband [internet] connections, as of the end of 2003, while around three per cent had internet access via cable. "We estimate that a bit more than half of Western European households are passed by cable networks. The number of households that can get cable internet is much lower," says Jan Hein Bakkers, senior research analyst at IDC. However, the modest overall level of access should not suggest that the cable operators do not take 'triple play' seriously. "Where you have triple-play, you can offer a higher customer value proposition. The bundling strategy can provide an ongoing bundle benefit and we see value in expanding this," says Anders Leideman, senior vice president, telephony business line at UPC, the pan-European cable operator.

Cable operators are cagey about the actual ARPUs they generate--though Point Topic estimates that European cable operators charge between US$35 and US$65 a month for internet access. They are even less enthusiastic when it comes to discussing costs. The issue with telecom services, however, has to be whether they would just be a loss leader, tempting the consumer into a 'store' where there is a range of higher margin products on offer, or a viable in their own right. "Margins on voice are slim, but good enough," argues Stephenson at Ovum. "The cost of implementing user connectivity has come down a lot," he adds.

In Europe, none of the cable operators have telecom service footprints that serve more than a minority of their subscribers. "We currently offer telephony in five European countries. We did also offer it in the Czech Republic, but just in one limited region with under 3,000 subscribers and partly over fixed wireless. Those subscribers have been acquired by Czech Telecom, as the spectrum licences for the service were expiring," says Leideman.

One of the questions for cable operators has to be whether--as in the case of NTL and Telewest--to deploy relatively expensive circuit-switched voice technology that has strong QoS and smooth interoperability with other circuit-switched networks, or whether to use softswitches to offer VoIP services. "We are running extensive technical trials of VoIP, including live trials in our Rotterdam network, and we are also working on open standards for the use of VoIP in cable networks," says Leideman. He argues that using VoIP potentially offers UPC three main advantages--lower customer premise equipment capex, the "medium to long-term benefits of a common voice and data network infrastructure", and the ability to "add features to the voice and bundled services more easily". "In terms of general strategy, we will investigate launching voice across our networks once we have a fully mature VoIP architecture, but I can't discuss when that will be. We should see the start of commercial VoIP services some time this year or in 2005," adds Leideman.

Telewest and NTL in the UK both offer bundled 'triple play' services. They are also expected to merge after Telewest completes its financial restructuring (which is slated by the end of the second quarter of 2004) to better compete with satellite services. As things stand, around 17 per cent of Telewest's subscribers take the full 'triple play', though broadband internet access is its fastest growing offering.

Perhaps because of the remarkable fragmentation of the network in Germany, consolidation there is not considered to be a function of network topography.

There is little doubt that cable companies with big footprints and long-standing relationships with content providers will be better positioned to strike a good deal on content than small ISPs. However, they cannot rest on their programming laurels, as the example of Cablecom, the dominant cable provider in the Swiss market demonstrates. "The majority of the company's future revenue growth is expected to be derived from increasing telecom services," Moody's the debt ratings agency remarked in a recent research note. Moody's goes on to point out that "Cablecom could face increased competitive and pricing pressures as penetration levels for new services further increase."

written by Ouida Taaffe

Ouida Taaffe, features editor (otaaffe@horizonhouse.co.uk)

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