Spark's high risk broadband strategy

Spark turned in a decent first year result earlier this month. The edited highlights are:

Total operating revenues up 4.1 percent to $1.793 billion,
Mobile revenue up 4.4 percent , and
IT services revenue up 19.3 percent, and
Broadband revenue up 1.5 percent.

The last number is the lowest increase, but the most interesting. Let’s focus on it.

When he announced the results, Spark chairman Mark Verbiest said revenue performance are good. His next comment was more telling:

“…it is clear the intense ongoing price competition, particularly at the lower end of the market, is driving margin pressure and reinforcing the need to increase our focus on our brand assets, as well as continuing to tightly manage operating and capital expenditure.

That’s chairman-speak for “it’s a tough market, we’re not as profitable as we have been”.

This shows up further down the results. Spark’s revenue is up 4.1 percent, but costs climbed faster at 4.3 percent. Which means profit, or to be exact Earnings before interest, income tax, depreciation and amortisation, was up 3.5 percent.

Squeezed

In other words, Spark’s margin is a touch lower. The squeeze is on.

Now that’s always going to be the case in a competitive market. Squeezed profits can be a sign that competition is working.

All telecommunications sectors are competitive. The market is brutal.

Even so, Spark made huge progress in mobile connections. It put on six percent more customers than the year earlier.

Spark also managed to hang on to its broadband customers. The 675k broadband customers it had at the end of December 2016 is the same number as at the end of 2015.

There is one big difference. In late 2015, all Spark broadband customers were on landlines. Most were still copper connections at that time.

The proportion of fibre connections was rising then and continues to climb.

Fibre preferred

As Spark Managing Director Simon Moutter says: “…fibre is the preferred broadband technology for customers who use large amounts of data.” And so it should be¹.

Yet hidden in the late 2016 broadband customer figures are many fixed wireless broadband connections.

According to the half-year results, Spark had 138,000 UFB fibre broadband connections on 31 December 2016. Elsewhere the company says it has a total of 178,000 fixed and wireless broadband connections.

Which means in less than a year Spark has switched 40,000 customers from land-based to fixed wireless broadband. That’s about six percent of all Spark broadband customers.

Spark’s fixed wireless broadband marketing continues. No doubt the number of customers on this service will rise in 2017.

Better margins

It’s not hard to understand why Spark is keen to push fixed wireless broadband. The margins are better. Much better. That makes pushing fixed wireless a tempting broadband strategy.

Spark pays around $40 a month to use landline broadband connections. The lion’s share of that money goes to Chorus, which owns the copper network and most fibre networks. Some also goes to the other fibre companies.

When Spark sells a fixed wireless connection it gets to keep that $40. It returns some of that money to customers in the form of lower prices, but it keeps a lot of it.

In other words it gets a higher margin for each fixed wireless connection than it does for a landline broadband connection.

It isn’t straightforward. Spark had to buy wireless spectrum from the government, then build and maintain a network of fixed wireless capable towers. None of that was cheap.

Yet it still gets a better margin from fixed wireless. That’s already showing up in the company results. Although, for now, the effect is small.

Risks

Spark faces two risks pushing a fixed wireless broadband strategy.

First, fixed wireless technology may struggle to deliver on its promise.

Spark’s first fixed wireless customers climbed onboard Skinny’s Wireless Broadband offer. At first speeds were higher than on entry-level fibre plans. But customers share wireless bandwidth. As more users climb on and data use increases, speeds drop.

There are already reports of users getting poor download speeds at peak times. One reader told me of a relative who was only seeing a few megabits per second. If that’s happening when there are 40,000 customers, the problem will get worse if Spark reaches 100,000 fixed wireless customers.

Low-use customers

Spark needs to be careful to sell fixed-wireless broadband to low-use customers. For the most part that means people who won’t notice or bother about slow connections. Many of these people are happy with a bare bones connection.

The first fixed-wireless plans had low monthly data caps, which left less scope for congestion. You wouldn’t, after all, be able to stream a whole season of a popular TV show and have plenty left for everyday internet with 40GB.

With unlimited plans congestion is more noticeable. Spark isn’t helping the problem by pushing its Lightbox and cutting a deal with Netflix.

Spark can get around this. It can limit numbers in any given area to reduce congestion. It can add more antenna. Spark can also boost the speed. Last year the company showed 1Gbps wireless in Christchurch.

This will help. One day network speeds will ramp-up further. When that happens Spark can use more bandwidth to serve fixed wireless.

Spark needs to be careful managing demand against capacity. If there are widespread reports of poor performance, consumer confidence in the service could collapse. Worse, if there’s a huge fuss over performance, that could damage Spark’s wider broadband reputation².

Regulation

There’s a second risk with Spark’s fixed wireless, but it’s a subtle one.

Fixed wireless services are vertically integrated. That is, one company handles everything from when data leaves a device until it reaches remote internet servers.

The whole point of building the UFB network was to offset the old Telecom NZ vertical integration. A structurally separated network, which service providers buying wholesale internet connections is competitive.

Fixed wireless is less competitive. Only Vodafone could compete with Spark. 2degrees doesn’t own enough bandwidth for direct competition although it could offer a watered-down alternative.

This returns the market to a duopoly. Regulators don’t like that. Customers don’t like it. If they don’t like it a lot and make enough noise then governments won’t like it.

Attention regulator

In other words, Spark’s fixed-wireless broadband might attract regulatory attention. That may not be an immediate prospect. It won’t ring any alarm bells while only 40,000 customers use wireless. Even so it could yet come and hurt Spark.

For now Spark’s fixed wireless broadband is going well. It keeps Spark ahead of its rivals. More than two out of five New Zealanders buy broadband from Spark. The number has drifted down in recent years, but fixed wireless has slowed that drift.

Simon Moutter deserves credit for finding ways to repair margins as competition bit. But it isn’t without risk. The first 40,000 customers was the easy part. Getting that number to, say, 100,000 will be harder.

Bill Bennett has written for Spark in the past and now edits a magazine for Chorus.

Spark is doing a good job working with fibre companies to ease the upgrade from copper. The street-in-a-week campaigns appear to be paying dividends. ↩︎
One way this can happen is if someone decides to publish an average speed across all Spark broadband products and compares this with rivals. That was exactly the approach Ookla took when compiling numbers for the PC Magazine country report on broadband I wrote in 2013. ↩︎