To Be Vertical or Horizontal? That is the question

By Mika Skarp

As the acceleration of acceleration continues the last few years have seen an unparalleled pace of digitization. While many once traditional industries (think shipping for but one example) have gone completely digital, countless others have sprung up entirely, and indeed natively, from the digital economy. While some push back (and to the their peril), some of the most stalwart brick and mortar businesses are embracing the new digital normal with all of its opportunities with great enthusiasm.

Of course, in the very center of all of these changes, is another traditional, though constantly evolving industry known as telecom. And yet from where many of us stand it appears to be scrambling to follow what is going on rather than leading in its development. But what are the choices, and what is the right path forward?

In our efforts to make sense of how an industry ticks, it’s a good idea to try and break it down into as simple components as possible. And as we look forward we can simplify telecom and its strategic options with this question: Should its infrastructure be vertically or horizontally integrated? To answer that question, let’s take a look at telecom infrastructure writ large.

At a very high level, telecom networks have three distinct parts, namely Access, Trunk and Cloud. From a functional perspective these networks all take on three key roles, namely Transport, Processing and Storage.

On the 'component' side, what’s most telling are the differences. Take Access for example. This is one of the most regulated areas of telecom. However, the Cloud side of the industry is practically regulation free. And as such, while Access has not been globally consolidated, our Cloud infrastructure is already there and in the hands of an increasingly small number of very large players (think Google, AWS). Perhaps needless to say, but in arguably direct proportion to these factors, the Cloud business is growing fast while the Access side of the business is diminishing. That isn’t to suggest that Access is any less costly or demanding, it's just not very lucrative at the moment.

For its part, Trunk stays in the shadows (read: nobody gets very excited about fiber capacity records and new cable projects). However, and despite its apparent unsexiness, the Trunk business lies somewhere in the middle of the other two. It’s growing, profitable, very lightly regulated and truly global.

On the functionality side of the equation, we see these three amigos vacillating over time. Once centralized, Processing and Storage became distributed and are now becoming centralized again. Most forecasts now suggest that storage (in this case now singularly the Cloud) will be once again distributed in order to drive down latency.

Looking at these aspects of the telecom business along the decision axis of vertical or horizontal integration is telling. Horizontal integration would mean that Access, Trunk and Cloud players would merge together and benefit from significant cost gains. This could happen easily in China or the USA. We can easily imagine waking up to the news that Amazon and Verizon have decided to tie the knot, which would certainly amount to the largest merger ever. On the other side of the ocean, we can imagine a merger between China Telecom and Alibaba. From both the business and technology infrastructure perspectives these kinds of mega mergers would make a lot of sense, suddenly delivering a single orchestrated layer across all industry verticals.

Ironically, however, what we do see happening right now is a lot of vertical integration with different Access and Cloud players going after applications and content – think AT&T / Time Warner.  It’s no surprise that Access network operators are looking for growth from content and apps. This is a carryover from the old dream of convergence driven primarily by billing opportunities. In a nutshell it’s all about perceived customer ownership and their belief that customer relationship management (mostly around billing) is a core competency. I tend to disagree with this contention. We’ve seen the huge credit card companies and successive waves of new billing solutions eat away at any advantage they may have had in this area. The fact is that anybody can do huge amount small transactions.  Brand value is one thing, but it would be a stretch to say that in the most cases network operators represent brands that people love. A much more potent and realistic business opportunity lies in the Cloud companies’ drive to access consumer data through their consumption of content and reaping the advertising revenues that come of that. This is very much akin to the newspapers businesses of old and makes for a much stronger business case.

And as these tectonic shifts happen in the infrastructure space, content, and especially popular TV and movies, is still thought to be king. Perhaps in short term it is, but in ten years we may well be seeing a different picture (pardon the pun). At the rate things are going today there is such a dizzying array of verticals that can drive profit that it is impossible to do them all from content perspective. But one thing is certain; they all need the same infrastructure, Access, Trunk and Cloud.

All tolled, from where we stand, and when looking at the telecom world today, it seems logical that it’s horizontal integration that holds the most promise at the infrastructure level. This not only makes good business sense, and stands squarely on a solid business foundation of real core competencies, it’s also very good from the perspective of Net Neutrality. Political winds may change ever few years, but the fundamental principles of this important line in the sand will not dissolve at the hands of deregulation.  

Incidentally, and for readers interested in more, Cloudstreet was part of the European Union- funded T-Nova research project that built a demonstration of vertical integration. Here is a short video of what horizontal integration could look like.