Making sense of broadband

So many broadband providers disappeared after the dot-com boom that casual observers might think broadband itself has met with indifference from Internet users. Nothing could be further from the truth, according to experts at McKinsey.

9 min read
So many broadband providers disappeared after the dot-com boom that casual observers might think broadband itself has met with indifference from Internet users. Nothing could be further from the truth; in fact it has enjoyed striking growth throughout the world in the past three years. This expansion has implications not only for providers of broadband access and content but also for companies beyond the telecommunications and media sectors. The number of broadband users around the globe rose impressively during the past 36 months. By mid-2002, we estimate, operational broadband networks had a reach of well over 300 million households in the world's 20 largest economies. More than 40 million households and businesses actually subscribed to broadband, and more than 100 million people around the world had access to it. In certain markets, it is on track to become one of the fastest-growing technology-based consumer offers ever. In the United States, broadband will likely reach the 25 percent penetration mark more quickly than either PCs or mobile telephones did.

Active residential lines are spread fairly evenly across the Americas, Asia and Europe, though only a few countries--Canada, Germany, Japan, South Korea and the United States--account for 84 percent of the total. Market penetration is most advanced in South Korea, where more than half of all households subscribe; and Belgium, Canada, the Netherlands, Sweden and the United States have all reached penetration rates ranging from 10 percent to 25 percent. The vast majority of broadband connections are made over upgraded telephone or cable TV networks, though even faster newly laid fiber-optic ones are doing well in a handful of markets that include China, Italy and Sweden. Other technologies are proving valuable for particular customer segments: satellite for people in remote areas, to name just one.

Surprisingly, the market has continued to grow well even when conditions elsewhere in the telecom and Internet sectors were dire. During the first six months of 2002, the number of new subscribers increased by a quarter overall, while in 9 of the top 20 economies it increased by at least half. Even the more mature markets of Canada, South Korea, Sweden and the United States expanded by as much as a third.

That strong growth seems likely to continue. Our research shows much untapped demand for broadband. Only in the most highly penetrated markets--Canada, South Korea and the United States, for example--do those who have already switched outnumber those who are likely to do so. Moreover, the more price-sensitive users are likely to switch if prices fall, and in countries with lower narrowband penetration, many customers are going directly to broadband without first subscribing to the narrowband Internet.

The experience of today's leading broadband markets suggests that most others will develop in three phases: launch, expansion and saturation. Each phase has its particular challenges for network operators and its own market dynamics, and each offers varying prospects for companies outside the telecom and media industries. Mature markets will offer the widest range of opportunities for these other businesses, but they should prepare now: Broadband markets can grow fast, and key customers may be among the earliest to switch.

Most countries are still in the early phase of broadband development, with fewer than 10 percent of all households subscribing. Leading the demand for the technology are a small number of early adopters attracted by high-speed Internet access--often no more costly than their current extensive use of narrowband--and by the convenience of keeping their telephones free while they surf. Supply, however, is constrained: Incumbents tend to delay any serious move into broadband until it starts competing for their valuable customers and even then incumbents need time to make networks available to the population as a whole. Prices, given the early adopters' willingness to pay, therefore remain near their fairly high initial levels.

During the launch phase, broadband's impact on industries outside the telecom and Internet sectors remains limited. But this period isn't likely to last more than three years, and in the meantime, managers should anticipate the technology's potential effect on their Internet-related business.

Belgium, Canada, Japan, the Netherlands, Sweden and the United States are now in the expansion phase, when the number of subscribing households rises to 40 percent of the total, from 10 percent. Demand is fueled by "modern networkers"--people who find the utility and convenience of broadband attractive but are less "techie" and more price-sensitive than early adopters are. Supply becomes easier: Most people can subscribe to at least one broadband network, and many also have a choice of one or more competitors. Customer segmentation, sales and marketing, and mass-market provisioning become vital to the operators' success. Prices are likely to become more differentiated, in line with different customers' needs, and eventually to fall, thus attracting new subscribers.

During this phase, companies in general should start tailoring their Internet-related business to the needs of broadband users. One option is to join with leading broadband operators to form partnerships that will help sell the technology. The partners might share sales and marketing skills, retail channels and customer relationships; they could also co-market broadband with Internet services or help tailor it to their particular industries and market niches.

South Korea, parts of the United States and some smaller markets in the Asia-Pacific region (including Hong Kong and Singapore) are reaching the saturation point. At this level of penetration, more than 40 percent of all households have broadband, supply becomes nearly ubiquitous, and potential customers have access to at least two competing networks. Potential customers who still don't have broadband are waiting for prices to fall or for content and services to improve.

The time needed to reach saturation varies according to local conditions, such as Internet penetration and competition. But our research suggests that many markets now in the expansion phase will likely become saturated within three years. Much depends on how well the operators manage their sales and marketing, customer churn, and content and service strategies. During this phase, the largest access providers can play a crucial role in expanding the market by stimulating new, possibly "killer," online content to be provided over their networks. Access providers that fail to do so risk stiffer competition for a stagnating market and, perhaps, price wars.

So far, however, faster and better access to the Internet is the sole killer application of broadband.

Strong infrastructure-based competition, notably from independent cable companies, characterizes the markets with the most robust penetration and competition. But in many markets, cable has yet to achieve its full potential, either because cable networks belong to incumbent telecom companies that don't want to cannibalize their voice and data traffic, or because the core TV business of the cable companies is subject to regulations that make it hard to accelerate broadband's diffusion. If the technology's full potential is to be unlocked in these markets, regulators must ensure that infrastructure-based competition flourishes there.

At the saturation point, a critical mass of subscribers allows broadband to provide a viable platform for a range of applications that can be used not only by Internet-related businesses but also by businesses generally. This is therefore the phase when companies beyond the strictly network and Internet realm will have the greatest opportunities from broadband.

What happens next?
Broadband is already beginning to make real money for the leading network providers--usually incumbent telecom operators and cable TV companies rather than start-ups--that survived the first round of the broadband battle. In otherwise flat markets, these providers earned $20 billion in revenue from broadband Internet access in 2002, and are now reaching sufficient scale to make it profitable. For these companies, broadband access will remain an important source of growth for years to come.

Few have yet made a return on their up-front investment, but analysts at Bear Stearns, Daiwa Institute of Research, and Goldman Sachs estimate that the broadband business of KT (formerly Korea Telecom), the most advanced player in this field, has had a positive EBITDA for two years, and they expect it to have a positive cash flow this year. As other broadband markets reach South Korea's proportions, their local network operators are likely to perform comparably. In the United States, the operating margins of the major cable providers' broadband services may exceed those of conventional TV services this year.

So far, however, faster and better access to the Internet is the sole killer application of broadband. To make serious profits from it, network providers must find something that excites customers more. Admittedly, there are some noteworthy gaming ideas and lots of pilots for video-on-demand, and interest in home networking (in which several devices in a home or office tap one broadband line) is now growing.

But nothing has so far appeared that from a commercial point of view will disrupt markets in the way the Internet itself has. Network operators, rather than striving to find new killer applications on their own, will have to collaborate with businesses in other fields to stimulate new content and applications. Such partnerships will probably involve the development of new business models to share revenue fairly.

Yet even without new applications, a bigger broadband market will affect any enterprise that now uses the Internet for business, since broadband users spend more time online, engage in more e-commerce and are generally more satisfied than their narrowband counterparts are. As a result, Internet users with broadband access are rapidly coming to dominate the figures for time spent online and the quantity of data downloaded. Moreover, the diffusion of broadband appears, surprisingly, to accelerate the growth of Internet access: Several operators report that 30 percent to 50 percent of their new broadband subscribers hadn't previously used the Internet at home.

As the number of broadband users and of points of use per home increases, people change the way they spend time online: More of them, for example, adopt wireless home networking, a popular Christmas gift in the United States in 2002. And we observe that once the number of subscribed homes in an area reaches critical mass--from 25 percent to 50 percent--people seem to use the Internet not just for chat and e-mail, which are based on text and simple graphics, but also for "peer-to-peer" applications involving the exchange, among many homes or among many places in a single home, of digital music, video and large data files.

The broadband Internet thus becomes a more important marketing, sales, distribution and communications platform for all industries. The challenge will be to find a business model that can tap into the market for hitherto (largely) free peer-to-peer interactions. Subscription-based revenue sharing and volume-based pricing could be two avenues to explore.

Broadband users spend more time online, engage in more e-commerce and are generally more satisfied than their narrowband counterparts are.

Media and entertainment are the industries most obviously affected by this trend. Broadband offers a new distribution path for video-based entertainment, a medium for new interactive-entertainment services (such as interactive TV) that need a lot of bandwidth, and a way to integrate several media over a single connection. The Milan provider FastWeb, for example, can now supply 100,000 paying households in Italy with true on-demand video, high-speed data and digital voice, all delivered over a single optical-fiber connection. As mature markets reach scale with large online audiences, broadband may start to realize some of its underlying--and long-hyped--potential for advertisers.

It isn't clear yet exactly what kind of content and services nonmedia companies might provide through broadband. But it is already changing the architecture of many companies by enabling them to centralize their data and applications and to give fast access to distant users. Its spread will also steadily accelerate the acceptance of teleworking and the provision of teleservices of all types: As universities drive their curricula online, for instance, remote-learning services will improve greatly and new educational possibilities will arise.

And in a variety of areas, including financial services, health care, the public sector and retailing, we are beginning to see broadband used in ways that on a larger scale could alter the way markets work. The use of interactive video to deliver professional banking-advisory services is one such example; others include the use of high-speed data transfers to separate service "factories" from customers in accounting firms and to enable health care professionals in a number of locations to share X-rays and CAT scans.

Leaders in every industry--not just telecommunications and media--should keep a close eye on the development of broadband in their markets to be ready for the moment when this technology starts to refashion their own value chains.

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