The Analyst's Corner: Next-gen service platforms--The business of bundling

Part 1 of two parts
Bundling communications services is an old-fashioned concept that makes  a lot of sense--especially if service providers keep their eyes on the prize

As Internet Protocol (IP) services become more and more mainstream--and as services like IP telephony become mainstream--so do the business models for bundling communications services together.

From Amazon.com

But the communications market often confuses the technical issues of service bundling with the business reasons for doing so. Also, there are a preponderance of billing, provisioning and management vendors in the market who sell their products by promising the new forms of service revenues that they enable.

The fact is that many of these systems lie fallow today, with service providers using a fraction of the capabilities that exist in their back offices. Many service providers are unwilling to break into existing revenue streams to create bundled services. The reason for this is that--capabilities aside--service providers are in business to make money.

Of course, the prevailing dot-com business models stress partnerships, market share, publicity and a "clear path to profitability" ahead of profitability. There must be a strong business reason for bundling communications services, and this is a point over which we have been called "old fashioned."

But stylish business approaches are going out of style, and suddenly the incredibly uncool telcos are the hippest thing in the Internet. For communications companies, bundling is a tried-and-true practice.

When Do You Bundle?

If you listen to technology vendors, service providers should bundle everything that they sell. By the same token, if you listen to service providers, every business should be a multibillion dollar opportunity. As with most things, the truth lies somewhere in between.

Most communications services yield revenues on the order of tens or hundreds of millions of dollars, so there must be a good reason to join services together and to sell them as part of a package. Often the reason for bundling is quite simple: profitability.

Stickiness and Churn

In some cases, a service provider wants to keep making money from an existing set of services by reducing customer churn. Churn is costly because the service provider must continually market its services to keep a fixed base of customers. Additionally, they face a fixed cost for administering a customer account--whether the customer is joining the service or leaving it. The marketing and administration costs of a high churn service make it inherently less profitable than low churn services. 

In a high churn business, service providers can use bundling as a way to make it more difficult for a customer to change their service provider. A "sticky" service forces a customer to give up something to change providers. Generally, sticky services are bundles of commodity services with high value services. An excellent example of a sticky service bundle is MCI's "Friends and Family" program from the 1980s. In Friends and Family, MCI offered deeply discounted long-distance rates to customers who registered a group of friends and family who were also MCI customers.

Friends and Family was a great success, because it resolved the issue of customer loyalty and churn with a simple service bundle of rate plans. MCI chose to face lower gross margins on long-distance services but to do so with the hope of having higher net margins on their overall service set.

Lower Cost of Sales/Higher Margins

In marketing, one of the best rules to follow is that there's no better customer than one who already buys from you. The reason for this is that service providers already have established trust relationships with their customers; every month they send out bills, and the customers pay. Once a service provider is selling one service, it is far easier (and far less expensive) to sell additional services.

Lowering the cost of sales for a set of services is a great way to make more money from existing accounts. A good example of this is in data services in which an Internet or virtual private network access service forms the basis for a host of managed services: managed routers, managed firewalls and security, and even commerce.

Looked at from another direction, it's easy to pile together some high margin services on top of a commodity service. These high margin services often--at low market penetrations--deliver comparable profits to the core services.

An example of a margin service is found in "enhanced services" delivered by local telephone companies. By now, we know that local telephone companies don't make a lot of money selling us dial tone, but they make a killing on things like Caller ID and voice mail. These services have such high margins, because they already exist on a telco's switches, and the cost of delivering them is virtually nil.

IP: The Merger of the Front- and Back-Office

Service providers choose to bundle services to keep customers happy and profits high in the face of competition. Now comes the technical part.

In the past, the decision to bundle services has been tempered by the technical reality of making bundles work within a telco's processes and infrastructure. A broad range of new technologies for Internet Protocol networks make IP the preferred delivery method for new communications services. One of the primary benefits of IP is that it provides a single underlying network for delivering and administering services.

In the IP model, front- and back-office services rely on a common set of information found in standardized directories and easily transferred using objects and standards such as XML. Each of these developments have created an environment in which vertical back office systems no longer limit a service provider's ability to deliver services in any type of bundle.

Because IP networks can use a single infrastructure for delivering and administering services, integration issues are no longer a limiting factor, and service providers can offer a cohesive set of network, managed services, telephony, Internet services and enterprise software--all from a single network.

Now that we've established the business reasons for bundling communications services, next month we'll talk more about the software "service platforms" necessary to make this happen.
Dan Taylor and Barton Taylor are Analysts at Giotto Perspectives, Boston, MA.
This column originally appeared on the internetTelephony.com website.

Visit the Giotto Perspectives website.

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From Amazon.com

Voice over IP Fundamentals
by Jonathan Davidson, James Peters, Brian Gracely (Contributor), Jim Peters
408 pages 1 edition (March 27, 2000)
$40.00
Order this book.

Voice Over IP:
Strategies for the Converged Network (with CD-ROM)
by Mark Miller
660 pages 1st edition (February 15, 2000)
IDG Books Worldwide; ISBN:
$39.99
Order this book.

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