Carriers, standalone CDNs squeeze one another

Telecom carriers are beginning to radically shake up the market for content delivery networking (CDN) now crowded with standalone players, according to Yankee Group senior analyst David Vorhaus, who predicts the current pricing pressure in the CDN sector will accelerate carrier participation in the space, either through acquisitions or partnerships they may or may not be preludes to acquisition.

“The encroachment of carriers is absolutely the most transformative thing happening in the CDN space,” Vorhaus said in a Webcast today.

In a recent assessment of CDN players, the Yankee Group already ranked AT&T (NYSE: T) and Level 3 Communications (NASDAQ: LVLT) in fourth and fifth place, respectively, in terms of the quality of their offerings. But in talking about carrier participation in the CDN space today, Vorhaus said, “What we’ve seen thus far is only the tip of the iceberg.”

Carriers are inexorably moving into the CDN space not just because it’s becoming an increasingly vital part of their business but because they have certain innate competitive advantages there. During the company’s second-quarter earnings call, Level 3 executives, while reporting pricing pressure in their CDN business, argued that it will be remedied eventually by the cost structure they enjoy as a carrier. Jim Crowe, the company’s chief executive officer, emphasized the advantage that carriers wield over standalone CDNs simply by owning their own underlying transport infrastructure. “Over time, if you're not a carrier with your own low-cost source of bandwidth, you're going to end up as a reseller,” Crowe said. “Resellers can grow to a certain size, but then because they don't control such a large portion of their cost, they get squeezed.”

Vorhaus agreed in general that CDNs have already begun to squeeze. CDN market leader Akamai Technologies has significantly dropped its typically premium prices lately for existing big-name customers, something Crowe hinted at in the earnings call as a tactic of incumbents trying to keep their market share. And Akamai’s biggest competitor, Limelight Technologies, which reported sequentially flat second-quarter revenue, is expecting third-quarter revenue to be sequentially flat as well.

But while Vorhaus said he also agrees that carriers will dramatically alter the CDN landscape, but he doesn’t agree entirely with Crowe’s characterization.

“The discussion is more nuanced than that,” Vorhaus said. “I don’t expect all the players that don’t have underlying assets to be totally squeezed out. Players like Akamai and Limelight have strong technologies and customer bases; they’re not going to let that happen.”

As core CDN functionality becomes increasingly commoditized, consolidation in the space – which today includes roughly 30 players, Yankee said – will heat up significantly in the next 18 months. CDNs are responding by adding a range of ancillary services to their core CDN offerings, including content management, analytics reporting, security, ad insertion, metadata extraction and encoding/transcoding. Carriers, meanwhile, are bundling CDN with transit services.

As carriers and standalone CDNs converge into the market from opposite directions with complementary service bundles, they will increasingly form partnerships with one another, Vorhaus said, as Global Crossing has with Limelight and EdgeCast. The more ambitious carriers will build their own CDN or acquire one.

Alcatel-Lucent’s recent acquisition of Velocix indicates that vendors are noticing this trend and are already moving to get ahead of it. Velocix powers the CDN that Verizon Communications uses for internal purposes. (Verizon has also tailored it IP transit services for CDNs but hasn’t entered the CDN space outright.) So the Velocix buy gives Alcatel-Lucent an entrance into the CDN space within a network that is already very familiar (Verizon’s FiOS). The question is how it will position Velocix’s CDN within Alcatel-Lucent’s product offerings outside of the Verizon account.

“No one knows yet [exactly how Alcatel-Lucent will use Velocix] because Alcatel-Lucent doesn’t know yet,” Vorhaus said.