The Flat-Rate Paradox and the Search for New Business Models

Just when you thought it was safe to stream all the video you want and download all the huge files your heart desires, pay-as-you-go charging models are back stalking the land and pressurizing “all-you-can-eat” flat-rate plans.

In April, Time Warner started billing some customers based on how much bandwidth they used. As you can imagine, customers were unhappy when it was announced that the company would expand the trial run of this new billing system. The company relented, but not before saying it really has no choice and needs to come up with a new way of doing business because the current model simply isn’t viable.

Crocodile tears time? Well not really, but we do need to take a look at the paradox that has gotten cable, DSL and mobile broadband providers into this conundrum.

By offering a flat rate for all-you-can-eat data, providers are significantly lowering the barrier to entry for many customers who otherwise might not have signed up. This is especially true for today’s smartphones such as the iPhone. When people hear horror stories of bills for downloading applications and movies, they are very put off using the service. So flat-rate billing has been one of the keys to growth, especially for Apple’s App Store.

So service providers go the flat-rate route and build up their customer base. But here’s the paradox:  more customers on your network downloading ever more data creates the need to invest in more backhaul or cell infrastructure at great cost to the operators. So for every new app on the App Store or every movie clip, the service providers get nothing but cost – the ‘over-the-top’ (OTT) provider gets the benefit. So service providers are entering a “screwed if you do, screwed if you don’t” world where it’s becoming very hard to recoup these capital investments in network upgrades. This is the same paradox (with a good deal of regulatory messing too) that has slowed the move from copper to fiber on the world’s access networks. 

It’s All about the Apps

So we have a position where all of the new value is being created by OTT players like Apple with none of it going to the underlying providers, be they cable, DSL or broadband.  That’s at the heart of the net neutrality debate. But it’s clearly not sustainable if two parties are involved in providing a service but one gets all of the revenues and the other gets all of the costs.

It’s the same thing with mobile advertising. If the advertiser is getting money from a client to deliver mobile ads, what does the phone company get out of it? If all they get are more costs from more data going over their network, don’t expect them to get excited.

Let’s start with the customer who simply won’t put up with huge and unexpected data bills. A recent example that came up at Management World in Nice was a guy travelling abroad and using a neat mobile app to check in online with his airline - when the bill came in it cost the traveler $75 for the roaming charges to check in. Here’s a more personal example:  in the first week of having my shiny new UK-based iPhone, I managed to run up over $100 in charges by downloading a few e-mails while on a trip to the U.S. 

So good luck Time Warner, but in reality, I’m not sure that you can put the flat-rate genie back in the bottle. We also see mobile broadband providers rolling out bronze, silver, gold or platinum packages with differing data volumes and quality of service included with each, but that’s exactly what the customer, application, web and handset developers don’t want to see.

The Two-Sided Business Model

So what’s the answer? If flat-rate versus pay-as-you-go is an unresolved paradox, how can service providers share in the revenue they are enabling with content developers, application developers and the like?

At last month’s T8 World Summit, which ran alongside Management World in Nice, over 30 CxOs spent time discussing this business challenge. Service providers today are now in danger of falling quickly into the black hole of being only a bit carrier, but there’s still time to salvage their fate. What we were discussing was opening up new services, not aimed at end users this time but at other application and service providers who want to get access to customers and have a range of enabling services available to them. These range from simple transport and other basic services like cloud computing, authentication, security, billing, customer care, etc., all available on a virtual basis.

So instead of just a one-sided business model where you get revenue only from end user customers, the idea is to move to a two-sided business model where application or content vendors and other companies from verticals like government or healthcare supply revenue for the use of those enabling services.

Think of it this way: FedEx will get a parcel from point A to point B. If you also want them to handle the customs process, they’ll do that too for an additional fee. It’s up to you what you want them to do and what you’d like to do as the customer.

The best current example of this is Amazon, whose cloud computing model I’ve talked about before. Not only do they have a massive computing infrastructure for the delivery of goods to customers like you or me, they’ve also extended their internal trading platform to allow third parties to sell their own wares. And they offer a slew of value-added services on top of the basic platform, such as handling payment, delivery and more, allowing the business to decide what to pay Amazon for. They now make a great deal on their income from enabling these third-party traders to do business.

For a small merchant, dealing with Amazon is an easy decision because they are getting access to a global market and very sophisticated services using a single large infrastructure. But that analogy breaks down a bit with telecom and cable companies because they are very fragmented - you’d potentially be dealing with over 1,000 providers to cover the world.

This tells me there are three possible scenarios to all of this: First, it’ll never happen because it’s just too difficult. Second, it will happen because everyone will agree on a set of standards, so a two-sided business model could be ubiquitous. Or third, we’ll see the emergence of intermediaries who sit between the guys who provide the enabling services and the guys who want to use it.

Clearly you don’t have to be a phone company to provide this type of service, but it’s exactly the phone – and cable guys – that need to take a look at how Amazon or Google are leveraging their massive service infrastructures.

A senior telecom executive once said to me, “we had the equivalent of Google in our labs years before they got big”. Five years from now, it would be really easy to see the same missed opportunity for telecom and cable companies and instead of becoming key enablers of the digital economy, they were looking the wrong way and saw applications and ‘OTT’ service companies as the enemy rather than their best potential customers. 

Amazon grasped that nettle when they opened up their platform to companies that competed with them at the retail level. But in doing so they not only tapped into wholly new revenues from merchants, they grew their own retail business too because the end customer saw the range of goods available on Amazon growing to nearly always have whatever they wanted – so they made Amazon their first choice for online shopping.

Phone companies and cable companies are really good at a lot of underpinning service issues. They were, after all, the very first ‘online’ service providers. But getting your head around being an enabler, means working closely with people you may regard as the competition at the retail level. Making a fundamental change to your business model is not easy if your company is run by accountants or committees and not charismatic leaders.

It’s not really a surprise that Amazon, Google and Apple all have strong and visionary leaders – anyone care to mention a similar name in telecom?