Everyone Wants More Bandwidth—Who Will Pay for It?

The world's networks are overdue for an overhaul. This should come as no surprise, with more consumers using more devices to browse, share, stream and download—just about everything.

Global data use is now 11 times what it was in 2008. The growth of the Internet of Everything (people, processes, data and things) will further drive demand for bandwidth. Yet, most carriers have been slow to modernize in a meaningful way. The result is a patchwork of heterogeneous networks that are expensive to maintain and hard to adapt for new revenue opportunities.

The question for investors isn't if modernization is needed, but who will pay for it. The most likely scenario, say Morgan Stanley Research analysts, is that carriers will use their negotiating power to sway the big technology companies that provide the hardware and software infrastructure of global networks to help them upgrade at little or no cost to the carriers themselves. What’s in it for the tech providers? In a word: business. Carriers, bigger and more powerful than ever before, hold out the promise of future market share in new services, such as 5G and virtualization, as they upgrade their networks for users.

While some tech providers are relatively well positioned to help with such a transition—and many stand to benefit from its later stages—most could feel the short-term squeeze. “We estimate a 2% to 5% decrease in the overall technology provider profit pool,” says James Faucette, who covers the U.S. communications systems and payments sectors for Morgan Stanley. Faucette and his global research colleagues outline this trend and its ramifications in a recent report.

The problem in a nutshell: The surge in data (11x) hasn’t translated into proportional growth in revenues (3.5x) over the same period. More intense carrier competition to offer consumers basic services has pressured bottom lines. Meanwhile, popular over-the-top services, such as subscription streaming video, haven’t benefited the carriers directly, despite having increased data traffic significantly.

Carriers’ old networks aren’t helping. Today, they are primarily managed locally, with tech savvy (and expensive) staff distributed across the network, operating different equipment with disparate standards, some of which can incur other costs, such as energy and real estate. In fact, operational expenditures, at 10% of revenues, are proportional to carriers’ capital expenditures.

Transitioning to all-internet-protocol (IP) networks would streamline and standardize those operations. Essentially, all of the carriers’ data and services could flow through a single network, which could substantially cut costs—to the tune of $30 billion in global savings, Morgan Stanley estimates. All-IP networks would also be more agile. Their centralized management structure can accommodate quick, uniform changes, paving the way for further improvements, namely virtualization.

The Internet of Everything, though still nascent, is also driving the need for an upgrade. Carriers could stand to benefit, as more devices, from household appliances to medical equipment, connect to the same network. “This could be a $15 trillion market, but only with architectural changes,” Faucette says.

The real potential is with 5G. This next generation of mobile connectivity would offer higher bandwidth, better reliability and lower power drain—which is particularly key for the Internet of Everything. It also opens the possibility that telecoms could surpass cable providers, replacing broadband with 5G— without having to build out wired or fiber infrastructure, the Morgan Stanley report says.

While the benefits of network upgrades are clear, the sticking point for carriers is how to pay for it without jeopardizing dividends. Despite the need for more investment, carriers will likely struggle to meaningfully increase capital expenditure budgets over the next couple of years. Indeed, those budgets could shrink as revenue pressures increase due to competition. “Even if carriers were to increase capex, we don't think the increases would accommodate the changes needed,” says Faucette.

The most likely solution: Carriers will use their considerable negotiating power to persuade tech equipment vendors to pay for the lion's share of the upgrade. This would place upward of a 10% load on their services without additional revenue. Most providers could see their profit margins squeezed, but some have already positioned their product portfolios to support such a transition, with negligible impact to their bottom lines.

For more Morgan Stanley Research on global telecom and tech industry trends, ask your Morgan Stanley representative or Financial Advisor for the full report, “Network Modernization to Squeeze Tech Providers” (Nov 1, 2016). Plus, more Ideas.