The Inevitability of Service Provider Consolidation

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Consolidation in the communications service provider industry has always been present, but it seems as if the trend has been accelerating lately. In the last few weeks, we have seen Windstream acquire Paetec, Time Warner acquire Insight, and CenturyLink buy Savvis. This recent uptick in acquisition activity comes on the heels of a year in which we have already seen a dizzying array of consolidations where large communications service providers continue to get larger. However, even though the headlines seem to gravitate to these larger transactions, the trend is not just isolated to the large regional and national players—small and mid-sized service providers are actively consolidating too. In fact, over the last decade, the number of independent local exchange carriers (ILECs) has consolidated from 857 to around 760—meaning that approximately 100 companies were swallowed by “bigger fish” or simply combined to create larger entities.

Why is Consolidation Happening?
Will this trend continue? Will it continue to accelerate? Is it healthy for the industry? Let’s review the secular trends that are driving this activity, and revisit these questions at the end.

1. Increasing Competition
   According to JSI, access lines reported by U.S. ILECs decreased by over 11% in 2010 to around 100 million lines—less than half of the200 million lines at the industry’s peak a decade ago. These losses, driven by wireless substitution and cable voice service offerings, are fundamentally changing the economics of network service delivery. This means that,on average, the total number of lines have reduced in half while the costs of service delivery have continued to rise. Competition continues to become more intense, and service providers see consolidation as a means of driving both economies of scale and scope.
   
   
2. Emerging New Technologies and Increasing Consumer Bandwidth Consumption
   Closely related to line erosion, the increasingly competitive service provider environment is making it necessary to implement new technologies. The advent of 4G wireless and DOCSIS 3.0 is forcing the hand of wireline service providers to upgrade their networks to compete. Most agree that broadband speeds of 100 megabits per second (Mbps) will be commonplace in the near future, and reliability and latency have to meet the requirements of high-quality video and business services. To meet these challenges, fiber needs to be pulled deep into the access network—often all the way to the premises—a labor and capital intensive exercise that benefits from increased size and resources.
   
   
3. A Changing Regulatory World
   The National Broadband Plan and USF/ICC reform are changing business underpinnings of many service providers. The historic operational subsidy models that benefits rural providers for years are being replaced by capital incentives. The result: service providers need to get more efficient, both in terms of running their networks as well as in the speed with which they roll-out new products and services. Consolidation provides them with the new scale to find new efficiencies, and in some cases to shed some of the remnants of a changing business model.

Reacting to the Change
Not only is each of the aforementioned secular trends happening today, but each is barreling down on service providers like an accelerating freight train. Debating whether consolidation is healthy for the industry is really a moot point—the change is happening and taking place rapidly among service providers both large and small. As these trends happen, smaller companies are getting creative about their partnerships.

For example, a few weeks ago Calix announced its role in TMS—a consortium of service providers in Kentucky, Tennessee, and Alabama that has joined together to facilitate the implementation of advanced broadband services like IPTV through shared expertise, resources, and buying power. Others have been acquiring business services oriented CLECs as complements to their business—expanding the scope of their potential offerings as well as their scale. Even very small cooperatives have been teaming up to drive necessary new efficiencies and scale.

Service Provider consolidation is happening – and it’s inevitable. For the same reason that Walmart can dominate retail and Google can own search, scale drives efficiencies that, in turn, can be used to create new value for customers in terms of price, convenience, and innovation. Is this healthy for the industry? The answer is likely “YES” … as long as consolidation continues to drive new value to the customer. In a world where competition continues to increase almost universally, it will only be in corner cases where consolidation leads to worse value overall (otherwise the service provider will lose the customer relationship altogether). Certainly there may be cases where customer intimacy declines because of consolidation, but the same could be said of areas where Walmart expanded—and ultimately consumers voted in favor of the scale model with their wallets.

When will the need to consolidate strike you as a service provider? Perhaps it has already, and perhaps not for many years to come. In any case, the underlying drivers for consolidation are real. Your role as a service provider is to do whatever drives the most value to your subscribers and shareholders, and with a Calix Unified Access portfolio as the backbone of your network, you’ll have plenty of resources at your disposal to ensure that you are in a position to make the right choice.