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TBR SPECIAL REPORT

Wi-Fi poised to disrupt cellular model

Chris Antlitz, Telecom Senior Analyst (chris.antlitz@tbri.com)

June 16, 2015

Wi-Fi becoming viable alternative to cellular Wi-Fi is becoming a viable alternative to traditional cellular service, not only offering data, but also voice and text services. The prevalence of hot spots, in residential and commercial buildings as well as in public locations, is making Wi-Fi coverage readily accessible across large swaths of urban and suburban areas. A new breed of operator is emerging to capitalize on Wi-Fi, including cable operators such as Cablevision, startups such as Republic Wireless and Scratch Wireless and Internet companies such as Google. Wi-Fi operators pose a significant challenge to incumbent telecom operators because Wi-Fi service is relatively low cost to provide and the quality of service has been greatly enhanced due to innovations in handover technology, security and seamless authentication. Most Wi-Fi operators charge a nominal subscription fee for service, but in some cases Wi-Fi service is being offered for free with the cost being subsidized by a variety of business models, such as analytics and advertising. This is hugely disruptive to the traditional cellular business model.

Wi-Fi economics beat cellular Wi-Fi is far more cost-effective than cellular and can provide “good enough” service at a fraction of the cost of cellular service. Wi-Fi operators are able to tap into the vast existing Wi-Fi footprint, which reduces or outright eliminates the need to invest in their own infrastructure. There are tens of millions of Wi-Fi hot spots in the U.S. alone, spanning residential, commercial and public areas. Wi-Fi also uses unlicensed spectrum, which is free compared to the well over $100 billion U.S. operators have invested in licensed airwaves to provide their cellular service, plus the several hundred billion dollars in capex required to build out their dedicated infrastructure to operate on those airwaves. The economics are therefore hard to compare because they are so vastly different. Since Wi-Fi is relatively inexpensive to provide, Wi-Fi operators are able to offer their services at substantially lower costs compared to cellular operators. In the U.S. the average revenue per user (ARPU) for a postpaid smartphone subscriber on a Tier 1 operator’s network is $60 per month. Compare that with a Wi-Fi operator charging a fraction of that amount and the competitive threat becomes readily apparent. For example, Cablevision’s Freewheel Wi-Fi Only service, which offers unlimited talk, text and data via Wi-Fi, costs $9.95 for existing

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Cablevision Internet subscribers and $29.95 per month for non-Cablevision Internet subscribers. Even a non-Cablevision subscriber would save 50% per month by opting for the Freewheel plan. This amounts to $360 in savings per average subscriber over the course of a year for a non-Cablevision Internet subscriber. Other cable operators are likely to follow Cablevision’s lead in offering their own Wi-Fi plans. Comcast, for example, is likely to announce a similar offering either in 2015 or 2016. The service would leverage the cable operator’s over 10 million residential hot spots and 400,000 public hot spots that are part of the CableWiFi Alliance. Comcast has been rapidly deploying dual gateway SSID routers to its customer footprint in preparation for its Wi-Fi service release. Cable operators view Wi-Fi services as accretive to their core pay-TV and broadband businesses and as a churn reducer.

Wi-Fi operators offer value-add in the software layer Though some Wi-Fi operators build out, own and operate their own networks, they are also able to piggyback on existing Wi-Fi hotspots to offer service to a greater coverage area. The true value a Wi-Fi operator provides lies in the software layer, whereby a company ties together the security, handover, coordination and other features so that its subscribers can have a seamless, secure and optimized user experience similar to that provided by a cellular offering. An operator that can pull these features together into a cohesive and optimized platform that is truly hot-spot-agnostic is best positioned to win over cellular subscribers. Republic Wireless and Scratch Wireless are two operators that employ this model, owning the software layer and leveraging existing hot spots to provide the service. This model enables Wi-Fi operators to charge far less than competing cellular offerings for access.

Shortcomings of Wi-Fi being addressed Wi-Fi is not a perfect technology and does have shortcomings that will need to be addressed before it can fully challenge cellular. Some of these shortcomings include coverage gaps, congestion, software issues, lack of device selection and security. Proponents of Wi-Fi are collaborating actively to address these shortcomings, and even some standards bodies are jumping into the fray to improve the technology. Though there are tens of millions of Wi-Fi hot spots across the U.S., there is not currently, and will not be anytime soon, contiguous Wi-Fi coverage to provide a truly mobile experience. The only areas that are close to providing contiguous Wi-Fi coverage are the urban cores of major cities. This limits how many end users would be interested in leveraging a Wi-Fi service instead of cellular. TBR believes the biggest subscriber gains by Wi-Fi operators will be from major cities initially, with more users opting for the service beyond those locations as Wi-Fi service improves. This bodes well for Wi-Fi infrastructure vendors, which will be actively selling Wi-Fi gear to operators as they build out their footprints. TBR estimates there is potential for tens of millions more Wi-Fi access points to be deployed in the U.S. market alone over the next decade as operators expand their coverage zones to address the bulk of the population. In the interim, some Wi-Fi operators such as Republic Wireless are offering a hybrid service that utilizes Wi-Fi first and then uses cellular as a backup when a user is not in a Wi-Fi zone. Republic Wireless buys wholesale capacity from Sprint and then resells that capacity to its subscribers in small increments to tide them over and ensure they have contiguous mobile coverage. This is similar to a

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mobile virtual network operator (MVNO) model in that Republic is buying and then reselling cellular capacity from a cellular operator. Another major issue that needs to be addressed is tying together the fragmented patchwork of Wi-Fi access points in a seamless way to provide continuity of service. This can also include coordinating Wi-Fi with existing cellular networks to ensure seamless handover. This is one area where software plays an integral role because Wi-Fi access points need to be coordinated and optimized to prevent dropped service and they need to have uninterrupted authentication to ensure the user has access to hot spots in his or her location. Standards bodies are playing a key role, encouraging seamlessness and improved coordination between access points. The Hotspot 2.0 program is one such initiative that encourages consistent Wi-Fi roaming whenever a user is in a coverage zone. Wi-Fi networks can become overwhelmed when too many users are feeding off the network. The lack of control Wi-Fi operators have over this compared to the control cellular operators can exercise from their network operations centers will need to be addressed. Simply adding more density to a location will not work due to interference issues. Instead, Wi-Fi proponents are focused on improving network management software, hot spot coordination and capacity optimization to address this issue. Security also plays into software. Wi-Fi networks are not as secure as cellular networks, and operators will need to invest in and deploy encryption technologies to address this issue. Wi-Fi operators need to find a seamless way to secure hot spots on the front and back end of the network across any Wi-Fi access point, regardless of who owns and operates that access point and the backhaul infrastructure. Lack of device selection is another hindrance to Wi-Fi adoption. Wi-Fi operators tend to have limited device options, which is a drawback to these services. Nearly all of the most popular handsets are not compatible with Wi-Fi calling. This includes most models of Apple’s iPhone and Samsung’s Galaxy series. This will likely be a short-term issue, however, because all smartphones are Wi-Fi compatible for data and can become Wi-Fi voice compatible by adding an over-the-top (OTT) application. The trend right now among Wi-Fi operators is to preintegrate a Wi-Fi calling and text application onto select devices that are sold by that operator. TBR believes this model has limited runway and the operator that eliminates the preintegration process and makes an OTT app that puts its service on nearly any smartphone will have a competitive advantage.

Cellular still has a future in a Wi-Fi First world Though Wi-Fi is expected to alter the mobile service landscape significantly over the next decade, cellular will still have a role to play. Cellular will likely become the de facto fallback to Wi-Fi, meaning that a user’s device will fall back to cellular whenever it is outside a Wi-Fi zone. This hybrid model is called Wi-Fi First. This approach will be pervasive in rural and some suburban areas, where the economics of using cellular to provide access is more favorable compared to using Wi-Fi. For example, it is more cost-effective to have a cell tower blanketing rural areas compared to having mini Wi-Fi zones within that footprint. With that said, most of the Wi-Fi zones will be located in urban and most suburban markets. Cisco estimates over three-quarters of all mobile traffic is generated indoors, be it at a home or in a workplace setting. This augurs well for Wi-Fi replacing cellular because most of these locations are

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already covered with Wi-Fi. This implies that up to one-quarter of all mobile traffic is outside of a Wi-Fi zone, which is space that may be best suited to leveraging cellular. Cellular will also be utilized for mission-critical use cases, such as healthcare and government solutions that require a high degree of security, mobility and reliability. Traditional telecom operators will continue to service these needs.

Cellular operators have a love-hate relationship with Wi-Fi Though Wi-Fi poses a significant threat to cellular operators’ business models over the long term, these companies have been embracing Wi-Fi in their own way for years. Primarily leveraged as a data offload conduit, Wi-Fi has helped service providers ease bandwidth constraints on their cellular networks, particularly as smartphones became mainstream. Some service providers are even deploying their own Wi-Fi networks to accelerate and encourage data offload, while others are taking it a step further and offering Voice over Wi-Fi, such as T-Mobile. TBR envisions a world where cellular operators coexist with and compete against Wi-Fi. In some cases, cellular operators will lean even more heavily on Wi-Fi to improve their indoor coverage and provide supplementary outdoor capacity where there is congestion on the cellular network. Though this approach will help optimize network performance, it will not help these incumbent operators lower their cost structures to a point where they are price-competitive with pure Wi-Fi operators.

Balance of power shifting in vendor community Network vendors face a significant long-term challenge from the balance of power shift from cellular to Wi-Fi. Network vendors derive the majority of their revenue from selling the pipes and software that enable cellular networks to function. As more emphasis is placed on Wi-Fi as the de facto access of choice for both operators and end users, network vendors will see lower demand for their cellular products. Aggregate telecom-related capex will tip more toward Wi-Fi operators, which will be actively building out footprints and investing in middleware and back-office systems such as OSS and BSS to handle the influx of subscribers onto their platforms. Vendors that are best positioned to benefit from a Wi-Fi First world are Cisco, HP, Ruckus Wireless and Ericsson. All of these vendors sell Wi-Fi infrastructure and solutions and are currently involved with Wi-Fi operators. Those vendors that are dependent on the “old” cellular model, which is driven by high capex and ARPU, will struggle the most and face declining revenues unless they evolve.

Conclusion Wi-Fi offers the lowest-cost, highest-impact way to deliver connectivity. The ability to leverage unlicensed (free) spectrum, minimal backhaul requirements and the endemic footprint of hot spots across the U.S. makes Wi-Fi a considerable threat to cellular. Wi-Fi operators are jockeying for market position currently and trying to scale up by taking subscribers from cellular operators. Though the market is in the early stages of development, the significant end-user and operator cost savings inherent in using Wi-Fi for all communications purposes, mixed with the improving technology on the back end, make Wi-Fi a viable and highly disruptive alternative to cellular.

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Technology Business Research, Inc. is a leading independent technology market research and consulting firm specializing in the business and financial analyses of hardware, software, professional services, telecom and enterprise network vendors, and operators. Serving a global clientele, TBR provides timely and actionable market research and business intelligence in a format that is uniquely tailored to clients’ needs. Our analysts are available to further address client-specific issues or information needs on an inquiry or proprietary consulting basis. TBR has been empowering corporate decision makers since 1996. For more information please visit www.tbri.com. ©2015 Technology Business Research, Inc. This report is based on information made available to the public by the vendor and other public sources. No representation is made that this information is accurate or complete. Technology Business Research will not be held liable or responsible for any decisions that are made based on this information. The information contained in this report and all other TBR products is not and should not be construed to be investment advice. TBR does not make any recommendations or provide any advice regarding the value, purchase, sale or retention of securities. This report is copyright-protected and supplied for the sole use of the recipient. Contact Technology Business Research, Inc. for permission to reproduce.