Fixed-line wholesale services have been in decline for several years. Against that backdrop, Rupert Wood explores the prospects for BT Wholesale
The decline has been in part because of the decreasing value of the basic retail services on which wholesale TDM services such as termination, origination, transit and wholesale private circuits are based. It is also in part because service providers have invested in their own infrastructure and have thereby by-passed wholesale offers in areas where the value of retail service has grown, such as ADSL broadband.

This picture is set to change, however, and the UK market, and in particular BT Wholesale, is leading the way. Analyst firm, Analysys Mason, forecasts that two key areas of fixed wholesale – managed network services and wholesale broadband revenue – will increase by 118% and 54% respectively between 2009 and 2013, even while other service areas of fixed wholesale continue their decline. Local Loop Unbundling (LLU) revenues, which will continue to rise until 2011, will start to decline again in 2012.

Provision of next-generation fixed broadband access requires massive investment for an existing facilities-based player, typically an unbundler. Subscale players will move back to wholesale access services, and may simply outsource all of their fixed networks. An economically rational equivalent of passive-access local loop unbundling will not be widely available for many years. Larger players will provide next-generation access using a mixture of Generic Ethernet Access (an active-line local loop product sold by Openreach) and an FTTx version of Wholesale Broadband Connect (an active-line product combining Generic Ethernet Access and Ethernet backhaul, sold by BT Wholesale).

We forecast that UK fixed wholesale service revenue excluding intra-operator revenue will start to grow again after years of decline. Overall growth will not be spectacular at 4% between 2009 and 2013, but the split of revenue shows significant changes.

Revenues from managed network services will more than double, from £812 million in 2009 (16% of the total market) to £1.77 billion in 2013 (33%). The other growth area will be managed broadband. This will decline in 2010, but then start to grow again, rising by 63% between 2010 and 2013. In next-generation access, managed broadband will be more dominant than passive access options such as LLU. Therefore managed broadband will increase in value as LLU declines by 27% between 2010 and 2013.

In April 2010, Orange threw in the towel as an independent broadband operator in the UK. Faced with a declining customer base and the seemingly insurmountable hurdle of next-generation access capex, it decided to hand over its infrastructure to BT, which will eventually integrate Orange’s platform into its own. This will mean transferring customers from Orange’s ADSL1 DSLAMs to one of BT’s services – either Wholesale Broadband Connect (ADSL2+) or Wholesale Broadband Connect fibre (a mixture of FTTC and GPON).

These are interesting times in the UK telecoms market. Despite some consolidation, the retail mobile and broadband spaces are still crowded, and EBITDA margins are generally about five to ten percentage points lower than those typically observed in the rest of the developed world. This historical feature, combined with the recession and the looming expense of LTE and fibre access upgrades, has focused operators’ minds on the need to rationalise network spend. Hence there has been a spate of network-sharing and vendor-outsourcing announcements, particularly among MNOs. But BT’s role in this rationalisation is also considerable.
Network focus is right

For fixed wholesale providers in general, there are two main areas of actual or potential growth: managed network services and wholesale broadband. Renewed growth will come so long as operators wean themselves off their historical dependence on traditional revenue sources.

Managed network services in this context means the provision of network management, maintenance and planning, along with associated middleware functions, to third-party operators. Contracts vary greatly in size and scope, but frequently involve the eventual integration of the outsourced network into the wholesaler network. In many cases integration effectively means phasing out.

Managed network services are currently the only major growth area, and the outlook is very positive: in FY2009/10 BT Wholesale won managed network service contracts worth £1.8 billion, up nearly 50% on the previous year.

The particular stresses in the UK telecoms market are making operators there early adopters of network sharing strategies. The retail mobile and broadband spaces are still crowded, revenues are stagnating and EBITDA margins are generally low. In addition, the recession has increased the pressures to reduce capital expenditure and stabilise cashflow.

Pretty well every competitor in the retail mobile and broadband area now stresses the need to ‘focus on the customer’. Market maturity and the looming expense of either LTE or fibre access mean that the need to stabilise costs is likely to be just the start of a trend.

European regulation has encouraged infrastructure-based competition in fixed broadband services, and has created a framework of remedies that enable entrants to climb an infrastructure ladder through resale, bitstream and local loop unbundling. Now that next-generation fibre access has to be confronted, the costs and risks of infrastructure-based competition are simply too high, although mobile operators still feel that the fixed broadband market is one in which they have to participate.

The Orange announcement will leave the UK mobile operators Vodafone and Orange as effectively virtual broadband providers using BT Wholesale, O2 with a small unbundling network infrastructure, T-Mobile with no fixed services but merged into Orange, and 3 with no fixed services at all.

Orange has for several years been an underperformer in fixed-line services in the UK. Once the UK’s largest ISP, it is now ranked fifth with a subscriber market share of just 4.6% at December 2009. So as a sub-scale unbundler, it makes sense for Orange to move onto the BT Wholesale platform, with a migration path for those end users that want it onto BT Wholesale’s fibre products. The same applies to O2 and to Cable & Wireless, which among other things manages the network of Virgin Media’s off-net broadband customers.

But what of the large unbundlers, Sky/Easynet and TalkTalk? These players currently use BT Wholesale services only in those exchange areas where they have not placed their own infrastructure. TalkTalk, the larger of the two, shows no immediate signs of opting out of copper unbundling.

The set of opportunities for fixed wholesale is not unique to the UK market. Outsourcing to a fixed-line player is part of the general logic of outsourcing, which applies to all mature markets: efficiency, not growth, dominates operators’ thinking. In the mobile space, the fixed wholesale market opportunity overlaps to a large extent with the market opportunity for the major vendors, especially Ericsson and Nokia Siemens, which offer a managed service wrap for management, planning and development of networks. The overlap, however, is not complete, and typically an existing wholesale operator takes over the contracting responsibilities of its customer. In the fixed space, vendors rarely have that level of presence, although Alcatel-Lucent’s recent five-year contract with BT to provide ‘performance management, design, network integration, installation and commissioning’ for 21CN shows how vendors are increasing their presence into this space too.

So long as there are increasingly sub-scale fixed voice players with legacy infrastructure in any given market, the opportunity to capitalise on a shrinking retail market will grow. Despite rapid consolidation in retail fixed broadband in the past two years in mature economies, smaller players continue to exist. So long as these have a rationale for staying in the fixed broadband market, the opportunity for fixed wholesalers will remain. Indeed, further MNOs may enter the market if they find that the mobile-only proposition puts them at a competitive disadvantage.

However, there are three reasons why the opportunity in the UK will be greater than in other markets.

The UK market is unusually competitive at the retail level. Six major retail players compete in fixed broadband (BT, Virgin Media, TalkTalk, Sky, Orange and O2), with several others including Vodafone also present, and five/six major players compete in retail mobile (O2, Vodafone, Orange/T-Mobile, 3, Virgin Mobile). This has led to EBITDA margins being typically five to ten percentage points lower than in most EU markets. These low margins in the UK make the need for outsourcing more urgent. The situation is made particularly pressing as the UK has experienced a more severe recession than many other European markets.
BT has an unusual status as a fixed-only incumbent. Hence MNOs that use BT Wholesale are not outsourcing to a direct competitor. Although the financial terms of BT’s February 2010 contract with O2 were not disclosed, the scope and scale of the deal suggests to us that it is the largest of these contracts so far. However, because O2 has historical connections to BT, it is less surprising that O2 should outsource to its former owner.

BT needs to recoup some of the cost of its all-IP core 21CN. BT’s 21CN now looks over-engineered and under-utilised. The original costing of the full 21CN transformation was set at £9 billion, although the core network transformation probably cost no more than 25%–35% of that figure. For BT’s retail customers, 21CN is a data-only network, but 21CN remains open for wholesale purposes as a voice–data converged core network. GTB

Rupert Wood is principal analyst with Analysys Mason