5G Economics: Where is the Industry Heading?

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1Q 2019 | IN-5406

Recent market developments denote a trend of vendors focusing on value-based business models that are intrinsically characterized by different economic principles and utility on offer. The examples that attest to this development are numerous; 3GPP has proposed a service-based architecture for next-generation 5G core; Ericsson recently announced that, going forward, they are focusing on “value-based business models” as illustrated by the recent launch of their AI-based Operations Engine; and Nokia is embracing cognitive capabilities to pursue growth in 5G, customer experience, and data monetization. Apple, meanwhile, is doubling down on the services narrative, an opportunity poised to be the growth machine in the coming years.

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5G Economics

NEWS


Recent market developments denote a trend of vendors focusing on value-based business models that are intrinsically characterized by different economic principles and utility on offer. The examples that attest to this development are numerous; 3GPP has proposed a service-based architecture for next-generation 5G core; Ericsson recently announced that, going forward, they are focusing on “value-based business models” as illustrated by the recent launch of their AI-based Operations Engine; and Nokia is embracing cognitive capabilities to pursue growth in 5G, customer experience, and data monetization. Apple, meanwhile, is doubling down on the services narrative, an opportunity poised to be the growth machine in the coming years.

 

Services represent a departure from transactional business, which is subject to external market factors, and a turn toward a recurring revenue model that is more consistent and predictable. These strategic imperatives have a ripple effect in many other forces that shape the competitive landscape, not least the product pricing, utilities derived from products versus services, and the stiff competition that arises from product proliferation and increasing service-centricity.

Economics of Products Versus Services

IMPACT


The telco industry is consistently being disrupted by internet-based innovation. Vendors and mobile service providers are probing new growth avenues and business models that look beyond where the money is in the value chain, to where it will be in the years to come.  An increased emphasis on software-centric networks like 5G, which favor services, calls for industry awareness, and growth strategies that zero in on economics of products independently of services. The price of a product is typically based on production costs so, and as commoditization sets in, the prices of products relative to those of services fall, which leads to a loss of pricing power. Equipment deployed on-premises continues to garner big upfront fees for vendors. The increasing shift to subscription-based cloud offerings, however, further emphasizes the importance of service economics; while there will be margin erosion in the short term, it comes with the promise of predictable long-term revenue.

 

In contrast, service activities are largely based on value to customers. A gradual shift to a service-based sector will eventually give rise to commercial arrangements that do not have the inherent stickiness that cross-product sales within telecoms do. It thus follows that the weakening of a tied pricing structure where service economics is bundled with product economics is a natural effect of market developments. Vendors that do not separate the two will be highly vulnerable in a highly competitive telecoms market. Netcracker, for example, is a vendor that offers a flexible pricing plan for its recently launched Netcracker Business Cloud platform. The entire stack is available as a service, with no commitments on the part of the client to pay for integration or data migration cost.

 

The eventual spread of value-based and service-oriented engagements brings multiple products, system integration and maintenance, and related services to the market. This multiplicity affords telcos both the option of maintaining various sources of supply and a high degree of relative bargaining power, which can potentially restrict the size and scale of any service provider in any given location. Therefore, to succeed in setting up operations that align with value-based models, vendors need to either forge strategic partnerships that leverage partners’ capabilities or possess some technological competences such as a break through innovation that competitors do not possess. However, it remains to be seen how mobile service providers will mix and match products and services, and whether they will integrate systems themselves rather than relying on one of the big three vendors.

Value-Based Business Models

RECOMMENDATIONS


With the emergence of value-based offerings, the industry is at the beginning of a profound strategy shift from a vendor perspective. A continuing disaggregation of telco radio architectures into finer-grained elements (see IN-5346) will naturally result in the proliferation of multiple competing products, which, in turn, will directly impact on market prices. The prices that will prevail are a function of the quantity of products brought to the market and the demand for the take up of those products. In that world, vendors must own the interaction point with the client be they telcos or enterprise. In other words, in addition to selling a transaction, a vendor must also make a material and positive impact on the recipient of the service in order to create long-term value.

 

Long-term value, or utility, is a measure of usefulness that accrues to the adopter of a good now and in the future. The relative utilities of products and services will emerge as being different, especially as telcos increasingly seek services and inputs of strategic significance. The salient point is that both products and services have some value but, given that value is a function of scarcity, it follows that the value derived from products (subject to commoditization and consumption-based models) and services eventually diverges, and therefore it should be priced differently. The stakes for flexible pricing structures are even higher when we consider the imminent technological convergence of 5G and distributed compute (cloud). High-growth services of the future will be digital in nature, so MSPs and vendors who understand how to price and deliver those services are best positioned to deliver convenience at scale (see IN-5376).

 

Commercial engagements anchored on services require both the provider and the recipient of the service to be in the same location. The demand side in telecoms continues to conduct the bulk of their core services--such as high-end research and strategizing--in their home countries Hence, any service-related input that is of high value and that offers a technological edge will need to be supported by a thorough knowledge of local conditions. Most large vendors have a local presence in the markets they serve, but emerging smaller challengers (Mavenir, Altiostar, and Parallel Wireless in radio domain, for example) should consider standardized and tailored services characterized by nimbleness and proximity. Further, 5G is a local technology and, as such, it should be accompanied with business models that aim to monetize it within close proximity of consumers or enterprises.

 

At first, the overall ability of services to carry the weight of large infrastructure vendors may be restricted, but in the long term, services will play a significant role in the future growth of telecom vendors. Apple’s rhetoric has already fully focused on the services story, with the company recently announcing that it would break its profit margins on products and services. It is a matter of time before the services narrative gathers momentum among telecom vendors, but before that, the industry must come to terms with the dynamics of service economics. On one hand, for large infrastructure vendors (Nokia, ZTE, Ericsson) products will continue to be an indispensable means to monetize services.  On the other hand, these vendors must establish flexible service business models that yield results independent of products.