Dialing Without Dollars
Price Pressures Could Wring Profit Out of Cable’s Booming Telephone Business
By Mike Farrell -- Multichannel News, 10/2/2005 8:00:00 PM
The idea that cable companies could convince 10% or more of the households in their service areas to sign up for telephone service was little more than a pipe dream two or three years ago.
Today, it’s reality for at least one operator, Cablevision Systems Corp. And at least one forecaster expects cable operators will also function as telephone operators for 19% of their customers by the end of the decade.
But as cable basks in what could become a new multibillion-dollar-per-year revenue stream, the profits that are associated with its new-found wealth are coming under attack. Backlash from SBC Communications Inc., Verizon Communications Inc. and other telephone companies trying to preserve their turf is the first wave. On the horizon lie low-cost Internet services — like Vonage Holdings Corp. or Lingus — and the specter that a totally free service like the one offered by Skype Technologies Inc. might catch on in the United States and lower the price of all voice communications to zero.
| The Phone Business is Picking Up … for Cable Operators | |||||||
|---|---|---|---|---|---|---|---|
| Based on recent gain, subscribers to cable telephone services could surpass 20 million by the end of the decade. | |||||||
| 2004A | 2005E | 2006E | 2007E | 2008E | 2009E | 2010E | |
| Source: Corporate Reports, Sanford Bernstein & Co. estimates and analysis. A=Actual. E=Estimate. |
|||||||
| Total Telephone Subscribers (In Thousands) | |||||||
| Comcast | 1,223 | 1,398 | 2,553 | 5,105 | 7,122 | 8,084 | 8,327 |
| Time Warner Cable | 220 | 1,098 | 2,554 | 3,336 | 3,795 | 4,250 | 4,505 |
| Cox | 1,305 | 1,667 | 2,137 | 2,499 | 2,659 | 2,757 | 2,825 |
| Cablevision | 282 | 712 | 964 | 1,036 | 1,053 | 1,064 | 1,074 |
| All Other | 565 | 610 | 880 | 1,498 | 2,489 | 3,443 | 4,015 |
| Total | 3,595 | 5,486 | 9,087 | 13,475 | 17,118 | 19,597 | 20,746 |
| … And Who’s Losing the Lines | |||||||
|---|---|---|---|---|---|---|---|
| Telephone companies’ projected individual losses to cable companies: | |||||||
| 2004A | 2005E | 2006E | 2007E | 2008E | 2009E | 2010E | |
| Source: Sanford Bernstein & Co. estimates and analysis. A=Actual. E=Estimate. |
|||||||
| BellSouth | 490 | 707 | 1,194 | 1,809 | 2,343 | 2,722 | 2,906 |
| Qwest | 413 | 519 | 778 | 1,183 | 1,512 | 1,711 | 1,796 |
| SBC | 1,146 | 1,657 | 2,709 | 3,996 | 5,014 | 5,678 | 5,976 |
| Verizon | 1,066 | 1,756 | 2,865 | 4,223 | 5,349 | 6,091 | 6,422 |
| All Other | 480 | 848 | 1,542 | 2,264 | 2,900 | 3,394 | 3,646 |
| Total | 3,595 | 5,486 | 9,087 | 13,475 | 17,118 | 19,597 | 20,746 |
PACKING IT IN
For now, the numbers from cable operators are good and growing. In the second quarter ended June 30, cable telephone subscribers numbered 3.96 million. That is 55.4% above the 2.55 million subscribers served a year ago.
Most subscribers are “circuit-switched” customers. This means calls were handled the same way that the telephone companies have for the past century: One call occupied a single telephone line for its duration, an inefficient way of handling calls. Comcast Corp. had 1.25 million “circuit-switched” customers, and Cox Communications Inc. had 1.5 million such subscribers.
But the bulk of the growth is coming from a new computer-like form of sending information. Voices are split up into packets of data so they can be packed together on high-speed lines and sent anywhere at the same time, using Internet-communication protocols.
According to a research report last week by Sanford Bernstein & Co. cable and satellite analyst Craig Moffett, new subscribers to voice-over-Internet protocol-based telephone communications are expected to reach 1.8 million in 2006 and 3.5 million in 2007.
Fueling the growth is cable operators’ ability to lower prices, because of the more efficient method of moving voices over the same pipes as packets. Cable operators are charging between $34.95 and $39.95 per month for VoIP service, a 60% savings against telephone company rates, according to Moffett.
And while he expects the growth pace to level off by 2007, when cable VoIP deployments are largely completed and the retreat from the traditional telcos winds down, he still sees cable phone capturing 19% of homes passed by 2010.
While Moffett predicts that pricing pressure will start in 2007, there are signs that it has already arrived.
Telephone companies, including such large players as SBC, Verizon and BellSouth Corp., are playing tit for tat, adding video programming to their existing phone and Internet-access services to create their own “triple play” of communication and entertainment services. SBC’s plans to send video to homes over fiber is known as Project Lightspeed; Verizon calls its FiOS TV.
And all three are focusing hard on revamping their pricing structures.
Nationwide, cable broadband service still had more subscribers (22 million) in the second quarter than the telephone companies’ comparable digital subscriber line services (15.6 million), according to Leichtman Research.
But DSL outpaced cable, adding 937,688 new customers to cable’s 866,101 new high-speed data subscribers. The Bells have been heavily promoting DSL to make up for dwindling numbers of “wired” telephone customers. For years, mobile phones have been supplanting second and even primary phone lines. Now, Internet-based services like Vonage are taking away lines as well.
Access line erosion is nothing new to the Bells — SBC and Verizon, for example, lost 1.3 million and 3 million access lines, respectively, between June 30, 2004, and June 30, 2005.
And while the Bells attribute most of those losses to customers dumping second and third phone lines for broadband (either DSL or cable) and wireless, the cable companies say the bulk of their new customers are dropping their local telephone company all together.
So who’s right? Both, according to Eastern Management Group executive vice president David Yedwab.
“In my own research, people will typically use a new service as a second line at least for awhile to see if it works,” Yedwab said. “While the all-you-can-eat bundle looks attractive, it really depends on the individual consumer.”
But Yedwab added that all signs are pointing to a growing price war between voice service providers.
“At this point, we’re concerned that pricing seems to be the major weapon,” Yedwab said.
So far, cable operators have managed to keep their voice services priced under $40, if that customer also buys the bundle of voice and video. The RBOCs, however, have turned up the heat with a flurry of promotional deals for unlimited local calls ranging from $49.95 per month from Verizon to $15.80 per month from SBC.
“Definitely there is competition for the first time, real competition,” Yedwab added. “But I think we’re still in the first of a many-act play.”
Acceptance of VoIP technology has been fast. In little more than a year, Cablevision has signed up nearly 500,000 customers to its VoIP service and is adding an average of 1% of its total homes passed to the service each month. To date, Cablevision’s voice penetration is about 10.7% of the 4.5 million homes its cables pass.
In contrast, it took Cablevision five years (1997 to 2001) to break the 10% penetration threshold for high-speed data services.
That growth has mainly been fueled by an aggressive price promotion, where Cablevision offers voice, digital video and high-speed Internet service for $89.85 per month.
But not every MSO is going down the discounting road.
Time Warner Cable, which launched its VoIP service across its 31 markets at the beginning of the year, offers phone service in three packages: $39.95 per month if the customer takes a three-product bundle; $44.95, coupled with high-speed Internet service; and $49.95 for a stand-alone voice service.
So far, that resistance to heavy discounting has paid off — Time Warner had about 614,000 digital phone subscribers as of June 30, or about 4% of homes passed. The company estimates that it will have more than 1 million cable phone customers by the end of the year, which would translate into penetration of 6.5% of homes passed, or 9% of basic subscribers.
Time Warner Cable senior vice president of voice services Gerry Campbell said that instead of pricing discounts, the MSO prefers to compete by offering more features in its voice offering like caller ID at no additional charge.
“Now we’re looking for features that go beyond that,” Campbell said, adding that the MSO is testing a caller-ID feature for the TV screen and a voice-recognition feature that would “whisper” the name of the party a customer is calling and ask if the customer wants the phone to remember that name and number.
Further complicating the competitive landscape are VoIP offerings from Vonage (which sells all-distance service for $19.95 and already has 1 million customers) and free or nearly free offerings from Skype, Yahoo Inc. and Google Inc.
While Yahoo and Google are still testing a peer-to-peer voice offering, the size and market power of those two giants cannot be underestimated. And Skype has a minimal presence in North America; although it says it has 5.7 million North American users, only about 260,000 are paying customers of its SkypeIn and SkypeOut telephone services.
Charter Communications Inc., which serves 67,500 telephony customers in St. Louis; Madison, Wis.; Greenville, S.C.; and Worcester, Mass., believes Skype and Vonage will certainly have an impact in the future. EBay’s willingness to pay $2.6 billion for two-year-old Skype raised eyebrows, of course. But Charter, like other MSOs, is focusing on more immediate competition.
“About 96% of U.S. households have wireline telephone service, and we’re going after that 96%,” said corporate vice president of IP product management Ted Schremp. “The 4% that use wireless or over-the-top [Internet VoIP] service, while important, we don’t view it today as challenging competition.”
Charter vice president and general manager of New England operations Georgia Griffith said that at least in her market area, she is keeping an eye on a different emerging competitive situation.
“We’re on the very fringes of the Boston” metropolitan area, Griffiths said. “What we’re watching is the interplay between Verizon and Comcast.”
CABLE’S PLAY
To build revenue and protect profit in its Raleigh, N.C. market, Time Warner Cable is working on adding features like three-way calling, local-only calling and offering a second VoIP phone line in addition to the caller ID-on-the-TV service, according to vice president and general manager of voice services Gary Fredericks.
Time Warner Cable currently uses Sprint Corp. and MCI Corp. as the backbones for its voice services. While that relationship helped Time Warner Cable roll out its phone service more quickly, Campbell said that the company is looking into ways it can carry some of that traffic on its own network. The object: not paying telephone companies to complete your calls.
“The game is to get as many customers as possible on your network and utilize that network to terminate your calls,” Campbell said.
Comcast has come to the VoIP game a little later than some operators, but plans to make the service available to 15 million homes by the end of the year. Comcast also said that it expects to have more than 1 million VoIP subscribers by 2006.
Comcast already has about 1.2 million circuit-switched telephone customers that it inherited as part of its November 2002 acquisition of AT&T Broadband. While it has lost about 100,000 of its circuit-switched phone customers, Comcast has not aggressively marketed the service. Comcast Digital Voice vice president of marketing Tom White says Comcast plans to eventually migrate those circuit-switched customers to VoIP.
“We really spent a lot of time getting ready for this,” White said.
In Comcast’s New England market, which has about 2.2 million cable subscribers and passes 3 million homes, the rollout began in Western Massachusetts and Boston in January. New England vice president of advanced products and services Doug Guthrie said the take-up rates for Comcast Digital Voice have been brisk.
“The acceptance has been huge, especially with customers that already have our data product,” Guthrie said.
On average, Comcast spokeswoman Jeanne Russo said that 75% to 80% of Comcast phone customers also take the data and video package. In contrast, about 1% of Comcast phone customers take the phone-only product.
Guthrie said that as one of the first markets to launch phone, the New England market has had some glitches, but Comcast has avoided any major problems because of its experience with the circuit-switched market. And the one early problem the company had with the VoIP service — unexpected “ringbacks” — was more a factor of customer confusion than a glitch in the network.
At Cox, which has had a circuit-switched service since 1997, the plan is to keep the landline service as well as launching a VoIP in new markets. Currently, the company has VoIP in eight markets — Pensacola, Fort Walton, Gainesville and Ocala, Fla.; Las Vegas; Topeka, Kan.; its central region; and Macon, Ga.
Cox Digital Phone director of marketing Mike Pacifico said that the technology has enabled Cox to launch in markets where the landline service was not economically feasible.
In the second quarter, Cox grew phone customers at a 30% clip and already has about 20% penetration of basic subscribers. In other markets like Omaha, Neb., penetration rates are in the 40% range.
“We’ve got some big markets yet to launch,” Pacifico said, like Las Vegas, where it passes 700,000 homes. “I don’t know where the ceiling is, but I don’t think we’ve reached that yet.”
While cable is increasingly encroaching on its subscriber base, the RBOCs are fighting back, and not just with lower pricing schemes.
RBOC FIGHT
BellSouth, which has about 21 million access lines in the Southeast, has a two-pronged approach to fight competitive cable offerings: it is the largest RBOC reseller of DirecTV Inc. DBS service, with about 394,000 customers.
BellSouth’s largest cable competitor is Comcast, which hasn’t fully rolled out VoIP yet, but it also competes against Time Warner Cable, Cox and Bright House Networks.
The company has greatly simplified the pricing of its broadband services, said director of product marketing Don Livingston. In the past, BellSouth had about 24 different price points for its broadband product bundles, which was confusing to customers.
“That was a little too hard,” Livingston said.
At the end of July, BellSouth slashed that number to three offerings — 3 Megabits per second for $42.95, 1.5 Mbps for $32.95 and 256 Kilobits per second for $24.95. In addition, BellSouth dropped its activation fees and spread out its modem rental charges over 10 months. The result, he said, is that broadband customers are not complaining of sticker shock when they receive their first monthly bill.
“It used to be that their first bill went for $165,” Livingston said. “Now their first bill is the monthly charge, plus $7.50.”
It had been BellSouth’s strategy to compete with cable VoIP communications by focusing on high-speed Internet customers, Livingston said. BellSouth has about 2.4 million DSL customers in nine states.
“If I’ve got you on BellSouth DSL, you’re less likely to go to a cable modem, and you clearly are not going to go to VoIP,” Livingston said.
SBC, the largest RBOC with 51 million access lines, has already dropped the price of its 1.5-Mbps DSL service to $14.95 per month when bundled with an any-distance voice package at $48.95 monthly.
“When you start packaging these things together, we are competing on price,” said SBC spokesman Wes Warnock, adding that the bundle of DSL and voice works out to $63.90, considerably below the $70 to $80 full price range for cable voice and data, but still above promotional offerings like Cablevision’s.
At Verizon, which has the most exposure to Cablevision’s voice offering, spokesman Eric Rabe said that the growth rates of cable phone are slightly misleading because they are building off a smaller base. Even with 500,000 customers, Cablevision’s phone subscribers represent less than 1% of Verizon’s total access lines. Throw in Time Warner Cable — which operates in Manhattan but has subscribers in 27 states — and the percentage is just 2% of Verizon’s 50.7 million total access lines.
Nevertheless, Rabe said, Verizon is taking Cablevision seriously and is pricing its services in the New York metropolitan market accordingly.
Rabe said that the popularity of cable phone is largely due to the pricing. When customers realize there is some downside — primarily that in an extended power outage, cable phone service will not work — they will choose traditional landline service.
“There is no reason why we think we can’t be successful against a Cablevision, for example, with the traditional phone product, which is more reliable, more stable and works in emergencies when the VoIP service doesn’t, as long as the pricing is there,” Rabe said. “But we can’t be priced $15 higher than they are. We’ve got to figure out ways to put a voice package together that will give people all-distance calling at a good rate and, frankly, we’re working on that.”
Before rates start dropping toward zero.
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