The impact of 5G and cloud on telco capex and opex
Communications service providers (CSPs) have become significantly leaner over the past decade. One contributing factor is that there has been a shift in the industry towards spending that was traditionally classified as capex being reclassified as opex.
The thinking behind this is to avoid the old attitude of “if you build it, they will come”, which is capital inefficient, technology-centric and not focused on business objectives, nuanced customer requirements or commercial flexibility. As such we are seeing more capital controls being put in place within CSPs and more accountability of ineffective use of capital when measured against business goals.
The rise in CSPs moving services to the cloud has exacerbated this trend as the spending they make with cloud service providers is on a usage basis in an as-a-service model.
If technology is treated as an operating expense, a company pays only for the capacity it needs and can adjust as requirements change. The same is true of some of the cloud-native software that CSPs now regard as essential for moving to a techco model. Consequently, large up-front capex software deals are becoming less frequent, and vendors are adopting shared success financial models for their solutions.
CSPs worldwide have been in a cycle of high capex, primarily due to the convergence of two expensive rollouts: 5G and fiber. 5G network investments have essentially amounted to the largest round of spending the industry has ever gone through, which currently only brings us to the non-standalone version of the wireless technology. Fortunately, the move to 5G standalone architectures will require a great deal less infrastructure investment and more IT spending, which on the whole is less extensive.
Fiber rollouts to support 5G, and to build full fiber fixed broadband networks, represent a large chunk of the infrastructure bill for most CSPs. One CSP head of networks told us that urban network densification for 5G required seven times more fiber miles than similar sized LTE deployments, because of the small cells and increased mesh of millimeter wave base stations to get full coverage propagation.
But data from MTN Consulting shows there are signs that capex and opex worldwide are now declining slightly. So while the trend to move some accounting items from capex to opex is happening, concerted efforts to bring down opex mean it is still falling. The contribution of process automation is the largest contributing factor to opex reduction.
When we look at the breakdown of the consolidated worldwide data for opex and how that spending falls into different categories, the past three years have seen something of a shift.
The largest change is the increased spending on cloud services, growing from 5% of total opex in 2019 to 12% in 2021. This has cannibalized some of the hosting opex, which is categorized under “networks”, and explains some decline in that sub-segment. We expect cloud spending as a percentage of total opex to continue to grow for the foreseeable future, also eating into the interconnect category.
Headcount reductions have impacted the staffing category, with the overall numbers of staff leaving the industry currently outweighing the expenditure on higher salaries of incoming teams in new IT-centric functions. The techco characteristic for bringing technology functions inhouse would reverse this trend if it is taken up more broadly across the industry.
Despite some high visibility news stories from operators, such as Vodafone pushing for its electrical energy to be 100% from renewable sources, overall power consumption by the industry is rising along with its cost. Between 2019 and 2021 the additional 2% opex rise in the energy category represented an additional $30 billion cost for the industry.
The operational cost of infrastructure dropped slightly between 2019 and 2021, reflecting operators’ divestment of passive infrastructure such as tower businesses to become more asset light. Leasing those assets back also represents an opex cost, but it is less than running and maintaining those assets themselves.
In addition, 2019 was a high water mark year for infrastructure investment with the rollout of 5G and full fiber fixed networks, and the 2021 numbers were inhibited by the pandemic in certain geographies.
One notable effect of falling capex and opex overall, set against very slight revenue growth over the same period, is that EBITDA (earnings before interest, taxes, depreciation, and amortization) is rising for CSPs worldwide. EBITDA is a good indicator of a company’s financial condition because it evaluates performance without needing to consider financial decisions, accounting decisions or tax environments. Our global consolidated data set shows that the profitability of the telecoms market has been climbing marginally quarter over quarter.
Given that this period covers the global Covid-19 pandemic, it is clear that the industry showed resiliency through extremely uncertain times. As revenue growth year-on-year has been very flat for CSPs for a decade, with just some small upward inflection, the focus on cost savings has been the chief driver of EBITDA margin gains through that period.
Network sharing CSPs are keeping opex under control chiefly through a combination of automation of network and business processes and by sharing both physical and logical network assets with other operators. Without these elements, opex would be rising significantly year-on-year and EBITDA margins would be negative.
There has been a pronounced uptick in the focus on automation generally to drive digital transformation for new business models and for software and process modernization in the 5G cloud era, and this is evident in the spending numbers.
The majority of network sharing for 5G to date is happening in radio access networks (RANs). But the rising cost of 5G is catalyzing the idea of network sharing, something that has been flirted with by many operators but never committed to fully. Passive infrastructure sharing, as well as active RAN sharing – both concepts familiar in the LTE era – are still applicable to 5G.
In mature markets like Germany, Japan and China, mobile network operators (MNOs) have announced slightly more extensive 5G network sharing agreements to try to control rising rollout, operating and maintenance costs. We estimate that the potential combined opex and capex savings in the case of active RAN sharing will be in the 30%-40% range. On top of this another 10%-15% could be saved by implementing a shared backhaul function to common data centers.
We have not seen any real commitment to core network sharing yet, but this could be the really impactful move, potentially saving another 25%-30% of total costs for individual MNOs. In markets where there are four MNOs a bold move like core network sharing is something of a problem, due to the competitive landscape. Any regulator which lets these markets consolidate may see an increase in network sharing and consequently a spike in profitability of all MNOs in that region.
But even if the commercial environment does not currently lend itself to network sharing, the technology involved in the 5G era certainly does. Network sharing for 5G is inextricably linked to many MNO strategies to transition their networks to the cloud, push content to the network edge and transform core network architectures to expose capabilities and data to third-party applications. The partnerships we are seeing between MNOs and hyperscale cloud service providers and the platform models being built with enterprises, systems integrators and infrastructure wholesalers are typical of the partner models of future techcos. The next generation of CSPs will not go it alone, on service models, on go-to-market strategies or on network build.
5G spectrum auctions enabled MNOs to purchase licenses for exclusive use of new frequency bands, many of which are in the higher spectrum bands towards the millimeter wave (mmWave).
This gives options to provide much higher throughputs and lower latencies than were previously possible using 4G spectrum. The cost of these licenses in many countries broke all previous records, and MNOs registered a great deal of disquiet. In addition to the license cost, delivering 5G on mmWave has several new challenges for MNOs which in the short term will affect capex and opex spending: Densifying urban RANs requires a significant amount more infrastructure within cities as the propagation characteristics of mmWave mean that the signal travels shorter distances and is less able to penetrate physical obstacles like buildings or trees. The answer is to build more RAN antennas in a denser mesh to achieve unbroken coverage, which in turn means more fiber, base stations, small cells and so on. Building propagation hotspot maps for these environments is a very complex task which requires specialist software and engineers to plan and optimize the 5G RANs to their fullest. Investment in 5G-specific antenna hardware such as massive MIMO has seen a spike in RAN equipment spending in recent years. The ongoing support of this equipment is an additional cost, as 5G is essentially an LTE overlay for many MNOs.
Much of the investment in next-generation networks is being rationalized against the prospective demand for new connectivity service models from enterprise customers. Many MNOs don’t see 5G delivering a significant uptick in revenue from their consumer customers when compared to LTE contracts. On average, the percentage of total revenues that B2B services (connectivity and beyond) represent, reached 30% in 2020 for many major operators.
But it is not all about the technology costs. As we have already mentioned there is also potentially a dynamic change in the cost of staffing for telcos transitioning to techcos. Our data shows that worldwide to Q4 2020 staffing costs dropped marginally, based predominantly on reduced headcount (see chart on p.29). But it could be that we see a rebound going forward as the cost per person of IT-centric operations staff are higher than those currently leaving the business.
For the first time in around a decade we are seeing reasonable growth in telecoms software systems spending in specific application areas. Systems which focus on service management processes have been especially in demand over the past 12 months as many CSPs shift their 5G IT investment strategy away from the heavily network-centric application areas and look to modernize service-level operations.
Our research shows that the systems categories shown in the pie charts have seen solid spending growth year-on-year 2020-21. For frame of reference the average year-on-year growth rate for all operational and business support systems (OSS/ BSS) is around 1%-2%.
5G services offer CSPs a huge opportunity to transform into techcos. Ericsson estimates that at least $700 billion of new and sustainable revenues can be unlocked, the majority in industrial 5G and B2B2X opportunities. Manufacturing, healthcare, transportation and retail offer some of the most exciting opportunities, as enterprises in these sectors look to adopt automation for cost savings, giving their customers better buying experiences to drive deeper insights into their own businesses and expand with digital offerings.
To move towards this opportunity CSPs are investing in a combination of automation, AI and cloud-native software systems. AI and automation are not just about cost savings. Without them, CSPs will not be able to deliver the next generation of services. As well as helping CSPs tap new business opportunities, AI and automation can help operators address many of their current challenges such as
improving customer experience, reducing costs and improving operating performance.
The significance of this change is currently being felt in some of the work we are doing with CSPs collaborating in TM Forum Open Digital Architecture (ODA) groups. We are seeing a focus in new IT development around zero-touch operations and enabling full automation for new service models. The calling cards of these kinds of developments are:
But while 5G remains the largest driver of telco IT spending currently, there are also several network technology and domain-centric drivers of investments for CSPs worldwide. A good example of this is in the B2B space.
CSPs are having success with software-defined wide area networking (SD-WAN) for enterprise service
models, which requires new software assets for management and orchestration, but also service management capabilities that businesses use for self-service ordering and provisioning.
The uptake of edge technologies, which is not necessarily 5G specific, is also driving spend on cloud-native systems to maximize the capabilities of edge networks for new business models such as cloud gaming over home broadband.
The market for consumer broadband is extremely competitive. The potential pressure from fixed wireless access has largely failed to significantly impact fixed broadband connections.
Favorable governmental and regulatory attitudes to the economic stimulus that comes with building fixed networks has seen ongoing build-out of Gigabit passive optical networks (GPONs) in many regions.
The global Covid-19 pandemic caused a spike in consumer spending on video-on-demand platforms and online gaming via consoles, PCs and handheld devices via a home broadband router. The future implications of the metaverse may be that a huge hike in network capacity is needed to provide this type of immersive virtual reality experience and fixed broadband is the only sensible answer.
In terms of IT spending to support such trends, we are seeing service providers re-evaluate their options for virtualizing equipment and functions in their access architectures. As such, they are spending on systems like network management and orchestration, SDN-centric management systems and software which allows them to cloudify their network operations.
Much has been said about the potential for 5G mobile private networks, but in many cases 5G radio may not be a logical solution. For example, automated industrial situations may have too much electromagnetic interference on a factory floor for millimeter wave 5G signals to propagate efficiently. In these situations cabling is the sensible answer, and fixed-line service providers may be in pole position
to win these enterprise contracts. As such, their spending on network planning and optimization software, on GIS asset management and inventory to deploy, install and maintain networks will increase, as will spending on service management systems like order management to automate complex B2B customer sales journeys. We are seeing a slight rise in these system deals now, which may indicate a more prolonged cycle of investment from CSPs that are not MNOs.
The enterprise market for mobile private networks and edge computing is still nascent but gaining momentum and promises to be competitive. MNOs will have to compete against other players which may prove key partners in delivering their solutions, so the future ecosystem will be commercially and competitively complex.
One area where we are seeing a complex supply chain is at the network edge. Spending in this area is picking up, and particularly for 5G, but these new sets of technology mean that the market has yet to settle down into a predictable pattern. We are seeing some co-investment strategies between CSPs and hyperscalers, such as Telenor and Amazon Web Services (AWS) building on their cloud-based strategy by co- investing in 5G and edge services for enterprise verticals.
Combining a cloud core and edge with industry vertical-specific service models in manufacturing, logistics and automotive is the point we’ve been waiting for with 5G. Ultra-low latency at the edge combined with a programmable cloud core promises to unlock the next phase of business diversification for CSPs.
There is a reasonable return on investment model for edge infrastructure, because it provides the low latency aspect for new service models in both CSP enterprise and consumer business units. There are concerns, however, around characteristics like increasing power consumption with edge deployments when energy bills are already around 20%-30% of telco opex.
And while the widespread adoption of 5G offers many benefits, it also creates new security concerns and challenges for enterprises. Because operators have taken steps to evaluate and minimize threats arising from 5G and software-centric networks in their own organizations, they are in a strong position to offer 5G security services to enterprises seeking to deploy their own advanced wireless networks.
Read our report Telco to techco: capex and opex implications to learn more.