Industry Voices—Competition, more than SD-WAN, pressuring enterprise networking revenue

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Atlantic-ACM
Enterprise networking revenue growth continues to slow, particularly among the largest U.S. carriers, despite increases in bandwidth demand. 

The change in revenue growth reflected in the chart below ranges from noteworthy to almost shocking. While some analysts point to technological shifts like the move to SD-WAN, the primary factor driving this slowdown is heated competition and the corresponding price declines. 

Going forward, competition will continue and technological shifts will start to play an increasing role in revenue pressure.

Reported revenue line item

2Q15 to 2Q16

2Q16 to 2Q17

- AT&T Global Business Fixed

-1.8%

-7.4%

- Level 3 North American Enterprise

5.8%

2.6%

- Verizon Enterprise Solutions (pro forma estimate)

-3.2%

-4.1%

- CenturyLink High Speed Bandwidth

8.0%

0.9%

- Windstream Enterprise Data and Integrated Services

4.6%

-2.9%

*Please note, reporting varies by carrier and the numbers above reflect different product mixes for different carriers, though all include IP-VPN and other data networking products.

Migration to SD-WAN is often noted as driving down Data Networking revenue growth, but at this point the direct effects are very limited. While there are certainly some circuits moving from IP-VPN to cheaper broadband-based SD-WAN, it is still a small fraction of the over 1 million IP-VPN connected sites across the country. Service providers who have introduced SD-WAN have site counts in the hundreds or low thousands, and direct or channel sales from equipment vendors are still in their infancy.

In the 2017 ATLANTIC-ACM Business Connectivity Survey, which polls over 1,400 customers and skews toward larger businesses, only 6% of customers said they were currently purchasing SD-WAN. Of the 6% currently purchasing SD-WAN, and an additional 9% who plan to purchase in the next year, only 13% of respondents expect to migrate away from IP-VPN circuits in the next 12 months because of SD-WAN substitution.

If anything, SD-WAN has increased confusion in the marketplace and slowed sales cycles. Customers are spending more time shopping for WAN/VPN services as they kick the tires on SD-WAN, and carriers are pricing down WAN services across the board in response. The impact of SD-WAN on IP-VPN circuit counts will be more critical in 2018 and 2019 as SD-WAN sites reach 100K+ and customers have sufficient experience and data analytics to feel comfortable disconnecting IP VPN circuits.

One technological factor that has, and will continue to, put some pressure on networking revenues is the transition from legacy data networking technology to Ethernet. Customers generally get higher bandwidth speeds when they transition, but the overall price paid stays flat or declines. Additionally, many of the legacy private line services that carry voice are not replaced at all. This effect will continue, as there are still many legacy services in the market. ATLANTIC-ACM estimates that retail private line service will be about half the size of layer 2 Ethernet transport services in 2017.

The most significant driver behind the declining revenue in the enterprise networking space is all too familiar in our industry: price pressure due to increased competition. Major players like AT&T, Verizon, and CenturyLink/Level 3 are locked in fierce competition to be the primary carrier of larger enterprises, and to a lesser extent midsized multilocation business customers. At the same time, cable companies continue to move upmarket, taking an ever-growing share of the coveted enterprise business, and alternative network providers and managed services providers like GTT, Masergy and TPx all show revenue growth in the declining market.

Cable carriers have been possibly the largest contributor to the increase in competition, offering high-bandwidth services at lower costs. ATLANTIC-ACM expects cable companies’ share of business data services—excluding broadband—to rise from 11% in 2016 to 13% in 2017. Comcast has aggressively entered the enterprise space, picking up a few large distributed retail deals, and continues to see above-market Ethernet growth as they expand their fiber footprint. Charter publicly outlined their strategy to gain share through price competition and saw enterprise primary service units grow 14.4% from the second quarter of 2016 to the second quarter of 2017. 

Going forward, ATLANTIC-ACM expects the aggregate of DIA, IP-VPN, Ethernet and Private Line services to decrease at a compound annual growth rate of about -1% from $26.8 billion in 2016 to $25.6 billion in 2022. In a market where core data services are dropping and competition continues, providers must keep a number of things in mind to succeed:

  • Embrace SD-WAN as a platform for maintaining relationships. SD-WAN itself is not a huge revenue driver, as each site typically costs only $100 to $300 per month. There are about 2 million multilocation business sites in the U.S., and if SD-WAN was adopted at one-fourth of those sites, an incredible feat by any measure, that would still only represent $1 billion or $2 billion. The greater revenue comes from the access sourcing relationship, whether it be on-net or managing wholesale links. Additionally, integrating virtual firewall, WAN Optimizer, network monitoring, and other virtual network functions with SD-WAN will provide sizable high-margin opportunities and set providers on a path to add value. 
  • Focus on what you do well. In ATLANTIC-ACM’s carrier ratings, the companies that consistently lead in customer satisfaction are those that are focused on a specific customer segment or product, such as FiberNet Direct, Lightower and Cogent. When it comes to offering new services, providers should be mindful of maintaining core competencies and customer experiences.
  • Continue network investment using a holistic approach. Construction costs are not declining, so fiber in the ground will remain a valuable asset. Initiatives in connecting business locations should align with opportunities in consumer expansion, wireless backhaul, wholesale services, and data center connectivity.
  • Grow margins through cost reduction via automation and lowering access costs. While SDN technology in carrier core networks enables additional features, namely Bandwidth on demand, its true value is streamlining service delivery and serviceability to lower costs for the carriers. Effectively sourcing broadband, fixed wireless, 4G wireless, and other cheaper last-mile access is essential to reduce prices to customers without affecting the bottom line.

It is a dynamic period in the telecom space, with enterprise cloud migrations reaching scale and new innovative developments such as SD-WAN, NFV, and intent-based networking picking up pace. Despite these technological shifts, successfully competing with core data connectivity will remain the driving factor determining winners among service providers.

Charlie Reed, a partner at Atlantic-ACM, is a FierceTelecom columnist. At Atlantic-ACM, he helps lead the firm’s Market Diligence practice, working on projects ranging from market sizing and forecasting to corporate strategy.