How Does the Telecom Manufacturing Model Fare Against That of Software?

A shift is beginning. In the growing world of cloud and services, software stands to be a key differentiator for the industry. For example, 5G is the first “G” in telecoms that paves the way for Communications Service Providers (CSPs) to operate and work solely in the software layer. Though very subtle, what is happening is an increased consumerization of telecom technologies, a significant market change that will soon knock on telecom C-level executives’ door. The underlying force propelling that is the ongoing Internet-plus-telecoms technological convergence. With this convergence, the industry is at the beginning of a profound structural shift because it will almost certainly warrant a revisiting of existing monetization models. Specifically, as discussed in ABI Research’s Software Is the Name of the (New) Game in Telecom, going forward, how future services will evolve will be determined to an increasing degree by “intangibles” (e.g., software and services).

The genesis of software innovation is the Internet world, and it is a novel environment for Network Equipment Vendors (NEVs). NEVs are hardware companies whose structure is geared towards producing integrated equipment that offers superior engineering performance. The monetization model for NEVs depends on the trio of network equipment, (on-premises) perpetual software licenses, and a degree of managed services around owned logos. With the growing importance of cloud, software, and white boxes, as discussed in ABI Research’s White Boxes and 5G Mark a Departure from Physical Box Rigidness, but at What Cost? report, this commercial model is much more challenging. That may well mean that NEVs face a strategic challenge of the first order on two strands: one, what new capabilities, resources, and monetization models do they need to compete in the future, and two, more pressingly, how can they complement their asset-intensive processes with services and software offerings?

With the ongoing cloudification of telecom equipment (see ABI Research’s report Cloudification of Telecom Technologies and Equipment), the commercial imperative from a NEV’s perspective is stark: depart from a finite supply of equipment, enhanced by feature-differentiation and characterized by scarcity, to monetization models based on cloud software where the supply is essentially infinite. That, in effect, means that NEVs must revisit their existing business lines to maintain margins and remain profitable. In other words, for NEVs, network hardware will not be as significant a component as it once was and it will not fit the previous model of what a NEV had to operate as, at least from a business model perspective. For example, existing asset intensive environments where Capital Expenditure (CAPEX) models and unit production predominate must be accompanied by human-intensive processes and a sales model anchored on ‘as-a-service’/consumption economics, as reflected in ABI Research’s report ‘Tis the Time for Consumption-Based Economics in Telecoms.

Today, selling Software-as-a-Service (SaaS) instead of product is the default mode for almost all software. In fact, the first stand-alone product to be “servicized” was enterprise software (the cloud). Software promotes a recurring revenue model that is more consistent and predictable akin to that of Adobe, Google, and Salesforce, to name a few vendors. Slowly but surely, ecosystem cloudification stands to “servicize” telecom products like the operator’s core and their access networks. This has many implications for existing telecom commercial models. For example, software is a completely new type of ‘good’ in that it is both infinitely differentiable yet infinitely copyable; this means that any piece of software is both completely unique yet has unlimited supply, leading to a theoretical price of US$0. But by combining the differentiable qualities of software with hardware that requires tangible assets and equipment to manufacture, NEVs can potentially cultivate robust core competencies. Apple, as discussed in ABI Research’s insight How Do Modular Software Architectures Impact on Telecom Value Chain?, is a case in point.

For a CSP or enterprise buyer, the difference between buying equipment and buying software is that the former entails the creation and transfer of ownership of a product. Software discourages ownership because the kind of exclusivity, control, and responsibility that comes with ownership privileges is missing. There are advantages from a balance sheet perspective: now CSPs pay for software in a rough approximation for their usage over time—an operational expense—as opposed to a fixed-cost basis. This improves Return on Invested Capital (ROIC) measurements. For suppliers, revenue becomes much more predictable. The software approach is unique because over time the product enterprises/CSPs pay for today will be better in the future. This is in direct contrast to equipment that deteriorates or a traditional software support contract that is limited to a specific version. So increasingly, tech companies are organized around this notion of both constant improvements and constant revenue streams. Consequently, there are bets for NEVs to make today if they are to become a ‘tech company’ tomorrow.

Going forward, networking equipment to keep digital content moving at high speed and high bandwidth will be in high demand. But to implement networked solutions, CSPs will need a range of services, as ABI Research reflected in The Prospect for a Services-Led Model in Telecoms. Manufacturing can and does undergird services. In fact, in most services businesses, what is manufactured is a modular component of the overall offering. But the linchpin will be software. At present, software to Ericsson, Huawei, and ZTE, is simply one part of a hardware-based offering. NEVs build many software assets but do not view them as a unique business. Rather, they are buried inside hardware and sold as an add-on feature. A first step for NEVs to become a software business is to obtain a software developer mentality. Further, most of the workflows NEVs have built revolve around hardware, hardware-enabled services, and a perpetual license business model. But cloudification of cellular networks marks a path to commoditization for those business lines. Therefore, it is logical to deduce that, eventually and unavoidably, hardware companies are going to have to jump to software and services.

A software business is much more difficult to manage. The skills required in managing software companies are very different from those that drive network equipment companies. For example, at present, NEVs have no experience building a labor-based business inside an asset-intensive environment. NEVs are experts at managing factories. An understanding of cost of goods sold, inventory turns, and supply chains is key to success. But a human intensive business is different. In a software world, NEVs do not manufacture a product and then sell it. They sell a capability and, oftentimes, they sell knowledge. They create it at the same time they deliver it. The business model and the economics are entirely different. Furthermore, a software business is a scale economic business. An investment is made upfront to develop a software product and then the marginal cost of producing each one is very small. So there is no such thing as a toe in the water for equipment companies to become software businesses. When they take the plunge, it’s a full body immersion.

For NEVs, a software business is a bet on a few dependencies, starting with their willingness to use their balance sheet. They can get into software, but first they must make a commitment to carry the infrastructure and loss until a contract that could extend over five or ten years becomes profitable. It’s a bet on their ability to drive economies of scale—to consolidate dispersed point solutions into centralized repositories. It’s also a bet that NEVs should change their business processes in sales, marketing, and customer services. Changes that enable those processes should occur within the products themselves. NEVs must add new layers of capability that enable the next generation of customer interactions on a profitable, real-time, high-volume scale. Finally, NEVs should learn how to be disciplined—how to negotiate profitable contracts, price their skills, and assess risk. NEVS must acknowledge that this is the kind of capability they cannot simply acquire. The bet they are really making is in their own commitment to invest both the years and the capital, then build the experience and discipline it takes to succeed.