Decoding the Process of Commoditization and De-Commoditization in Telecoms

On March 26, 2020, Microsoft announced its intent to acquire Affirmed Networks. Microsoft competes at the Infrastructure-as-a-Service (IaaS) level by providing raw cloud compute for a multitude of applications and business process workflows for enterprises. Microsoft has locked the enterprise space, in part due to its extensive presence in on-premises Windows server deployments. On the other hand, the overall leader in the market is Amazon Web Services (AWS), the first to offer cloud computing and IaaS dating back to 2008. AWS predominates among social media and content startups that seek scale from the onset without upfront Capital Expenditure (CAPEX) investments in their own data centers. Furthermore, AWS has struck several partnerships with Communications Service Providers (CSPs) to help accelerate their data center consolidation and migration to the cloud. Verizon and Vodafone are two examples.

Affirmed Networks is a relatively new vendor in telecoms that competes with an offering that constitutes a low-end market disruption. In other words, Affirmed Network’s solution does not create a new market. Rather, Affirmed Networks offers a fully virtualized, cloud-native core network solution based on improvements on simplicity, portability and product cost. In theory, the value proposition for CSPs is streamlined network operations, cost reduction, and the ability to create and launch new services in a rapid fashion. Relevant to telecoms in general—and this acquisition in particular—is Microsoft’s prowess in cloud and, to a lesser extent, business process workflows and its strong Artificial Intelligence (AI) and Machine Learning (ML) capabilities. What benefits does this acquisition bring to an industry whose positioning remains anchored to hard-to-duplicate network assets and voice telephony?

In an economic sense, a commodity is a good that is traded as if it is fungible—one unit is indistinguishable from another. From a business perspective, a commoditized product has no (engineering) differentiation. There is no reason why a vendors’ offering should be regarded as unique to that of its competitor(s). The hyperscaler’s (e.g., Amazon, Google, Microsoft) strategy has long been to have their (software) core cloud offering at the center and commoditize their complement to extract the most value. Commodity providers compete prices down. Microsoft and Amazon, for example, deliver on convenience and scale by providing a global-scale platform—predicated on Azure—on which enterprises create apps and manage their technology assets. By contrast, in telecoms, Network Equipment Vendors (NEPs) have captured value by positioning themselves in a spot in the value chain where performance for cellular connectivity) was not good enough. For example, 4G and its predecessor, 3G, redefined the state of voice, data, and messaging by offering incremental enhancements.

That not-good-enough circumstance mandated interdependent (optimized and proprietary) value chain architectures. NEPs have engineered highly specialized voice telephony products based on scale-based cost advantages. But ultimately, and unavoidably, vendors that excel in the race to engineer the best possible products in terms of performance find themselves designing products that are too good. Arguably, 5G is an embodiment of than notion. 5G’s functionality is overengineered for consumers. What drives this point home is Nokia’s recent assertion that the industry should no longer look at data and voice as (growing) services but as service enablers for the impending 5G ecosystem. This is evidence of overshooting. This dynamic shifts the basis of competition from proprietary architectures in the not-good-enough circumstance and toward modular designs. Modularity has a significant impact on the industry’s structure and “all-in-one” approach because it enables nonintegrated vendors to design and sell “best-of-breed” simpler solutions.

Thus far, NEPs have competed strongly with an interdependent architecture in a very telco-specific landscape (intramodal competition). Going forward, as demonstrated by the acquisition in question, they will have to compete with non-traditional telecom entities (intermodal competition). That, for all intents and purposes, may well mean that in the long run NEPs may have to strike a balance between interdependence and modularity. That is to say that vendors may have to “decouple” their vertical chains to compete effectively with granular business models considering two market forces: one, overshooting (e.g., 5G for consumers); and two, new entrants in the market (e.g., Microsoft). The process of commoditization and de-commoditization is reciprocal. There is value eroded in a specific part of a value chain, but there is new value being created in another part. That value could be created vertically a layer down/up where functionality is not good enough—e.g., Internet Protocol (IP) Internet for industrial use cases. Alternatively, new value emerges horizontally in adjacent processes/markets where a better strategy is to sell bullets to the combatants.

The industry is at an inflection point between a past of strong consumer-centric growth and a future of rapid change and unprecedented 5G- and cloud-based innovation. If the industry moves in the direction of subscriber-only growth, we must face the fact that we may miss the next wave of value creation. ABI Research asserts that NEPs, as the most integrated vendors in the industry (core and RAN), are in a very attractive position if they play their cards right. They could stake to where the next wave of value will be but first they must come to grips with how to flexibly couple and decouple their interdependent architectures for enterprise and industrial businesses. If NEPs can begin to sell low-latency and secure connectivity equipment they could eventually complement low consumer growth with the more profitable industrial opportunity. In other words, IP technology is not adequate for industrial connectivity. Consequently, in a not-good-enough world, with a base layer of high-quality 5G communications, NEPs can go head-to-head with hyperscalers and win the war.

In a best-effort world, one where there is performance surplus, it will be speed, convenience, and customization that will win the day. In these circumstances, a better strategy may be to sell bullets to the combatants. IBM made a similar move with its mainframe business. The fact that IBM decoupled its vertical architecture led to a new market where complex, nonstandard integration generated new growth. Similarly, CSPs’ continued efforts to cloudify their operations will give rise to a new consulting and integration business in the high end. This is where NEPs can play a key role to integrate specialized processes with general-purpose hardware. Furthermore, the continued convergence of “loose” IP data networking with mission-critical and low-latency voice communications further highlights the emergence of new “pockets” in the value chain where non-standard integration needs to take place. This can no doubt be a remarkably profitable space for NEPs, but on the condition that they transition and position themselves in the right place in the value chain, as discussed in the ABI Insight 5G Provides an Unlimited Window to Move from the Short Tail to the Long Tail (IN-5743).

In ABI Research’s view, NEPs must trigger that transition now by building a cogent case to channel resources that are conducive to new commercial transactions with hyperscalers and industrial sectors. This is not trivial, as it will need to be done in a simultaneous fashion. Vendors should continue to meet the needs of CSPs while pursuing new markets that now seem insignificant or do not yet exist. This may take time, but the direction is clear: “old” value is being eroded while simultaneously “new” value is being created. NEPs stand to benefit enormously if they have the foresight to see ‘where’ in the value chain lies new growth and ‘how’ they can capture it. This report goes some way in articulating the “where”. As for the “how,” ABI Research posits that vendors must avoid a situation where their strong capabilities translate into disabilities. And, as it is always the case in business, new capabilities will either need to be created or bought. To date, Nokia and Ericsson have both created and bought, whereas Huawei and ZTE have created. Whether created, bought, or both, obtaining new capabilities will not come without challenges, particularly an across-the-board organizational retooling along three dimensions: resources, processes, and values.