African Dumb Pipes Fallacies

The conventional industry stance has long been for telecoms operators to strive to avoid becoming bit-pipes. We says this thinking is misguided – for African telcos, connectivity is where the money is.

Telcos, the reasoning goes, must eschew a business model that primarily relies on generating revenue from providing Internet connectivity, while other market players use that same, expensively-built Internet infrastructure to offer services.

There are some legitimate concerns in support of that stance. Acquiring spectrum and building 4G networks is costly – yet the price pressure on data connectivity is high, either from stiff competition or some form of regulatory action. Financial markets have long appeared to value eyeballs-focused Internet services and algorithms much higher than the underlying infrastructure such services require.

From Line Corp and WeChat to Dropbox, it has now become common for a web-based provider to emerge from seemingly nowhere to build up a market valuation at multiples that are superior to those bestowed on telecoms operators. Arguably most galling for telcos are the so-called “Over the Top” (OTT) players, who not only need telco connectivity, but leverage it to offer services that undercut telcos core revenue lines, most notably voice services.

Missing the Forest for the Trees

All the same, our numbers suggest that the anti- bit pipe conventional thinking is misguided – certainly in the African context. For one, the potential of the connectivity business in Africa remains significant. Research conducted for our “Future of African Broadband” report series shows that revenue from retail broadband connectivity will continue to account for about 45% of all revenue generated in the African Internet consumer services ecosystem. Including enterprise and wholesale connectivity, the provision of connectivity to consumers and businesses will continue to generate close to 55% of all Internet services revenues in Africa through the next five years.

Of the 10 African markets we analyzed in depth, only in Nigeria (an unusual mix of still underdeveloped connectivity market and strong digital service spend) and in Tanzania did Internet-based consumer services generate more revenue than connectivity .

The provision of connectivity services is admittedly not as glamorous as fintech or IaaS; nor is it the fastest-growing opportunity in the African Internet ecosystem – digital services, cloud services and other segments are rising faster, though from a smaller baseline. But connectivity is a foundational requirement for all those other services, and its revenue performance reflects as much.

For all the concerns around the commoditization of connectivity, margins are also better on the connectivity side – for providers able to control the bulk of their network value chain. One African operator estimates that its gross margin on data connectivity services is close to 90%, while mobile money and other digital services have margins around 60% and 45% respectively.

The other argument in favor of a focus on connectivity is that it remains what telcos do better than anyone else – and the quality of the connectivity (certainly for mission-critical applications) is an increasingly fundamental driver of customer decision.

Losing the Digital Home and the Digital Enterprise

In their quest to escape the dumb pipe trap, many tier-1 mobile operators have invested heavily in content or tried to build their own OTT assets. In the process, they have let their core connectivity services deteriorate. Others have largely ignored critical sub-segments of the connectivity business, such as the potential of FTTH or data center connectivity. They are losing segments with critical upside – mid to upper-income digital homes, office parks, SMEs in central business districts, data center gigabit connectivity – ~80%+ of Africa’s last mile fiber revenue opportunity.

In the continent’s largest FTTH markets (South Africa, Kenya, Nigeria), the top three mobile operators control less than 20% of active FTTH connections. Their position in the fast-growing metro segment is relatively marginal, with metro players such as Liquid Telecom, EOH, or Broadbased Communications dominating that segment. Of course, this is a shortcoming that can be fixed later through acquisitions, but that path is bound to be pricey.

This analysis is not an argument against telcos offering digital services. For some selected services, there’s strong market potential, the mobile operator can do it well, and there are few alternatives. Rather, this is an argument for prioritizing excellence in connectivity services and a more discriminating and disciplined approach on digital services. Telco digital services strategy, in our view, should be focused on stimulating broader demand for connectivity, with deeper dives reserved for a small number of adjacent areas with substantial upside, and where the telco can leverage its inherent strengths to add value.

There’s nothing wrong with being a dumb pipe. As long as it’s good, reliable, and delivered smartly.

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