With 68% of homes in Western Europe and 77% in the US expected to have broadband by 2012, the battle between internet service providers (ISPs) is intense. Our ISP economics assessment* to 2012 reveals they are unlikely to survive using current business models.
Two main factors are squeezing profit margins: robust price competition and a swell in traffic, which is pushing up bandwidth costs.
In Western Europe monthly user revenues have fallen over 30% in the past five years while price rivalry has eroded ARPU from broadband subscriptions.
Screen Digest predicts that ARPU in Western Europe will continue to decrease from €21 in 2007 to €17 by 2012, more sharply than in North America, where it will see a marginal drop from €27 in 2007 to €26 in 2012 (see chart).
The decline is particularly acute in Western Europe where the regulatory environment has fostered strong rivalry, especially in the local loop unbundling (LLU) sector. By contrast, the US enjoys higher ARPU, which reflects a different regulatory approach that has weakened competition, principally in rural areas.
Such is the pressure on margins in Western Europe, that even before a host of other ISP expenses have been taken into account - like mounting data costs, heavily subsidized end-user hardware, staffing and network equipment - many ISPs' balance sheets are already looking slim.
Screen Digest analysis reveals that in the Europe's Big Five, DSL providers, which dominate the region's broadband market, were left with monthly returns of around €6 to €7 once line fees were paid to incumbent telcos.
This has fallen from over €16 in 2002 and could slide to as low as €5 by 2012 if pricing trends continue, meaning some ISPs could struggle to maintain profitability.
The big losers of the margin squeeze are the pure-play ISPs which are facing severe competition from new entrants that are backed by revenue from another core segment, such as pay-TV and mobile phone companies.
These large players have transformed broadband access into a cheap bolt-on as part of packages. As such, stand-alone broadband provision is increasingly becoming unviable.
Rising data costs are a second factor straining ISPs"š margins. An explosion in usage of online content services delivering ever larger files is behind the traffic upswing. This is set to intensify with mass consumption of online video via platforms bringing it to the living room TV.
The key to survival is increasingly becoming ownership of the network. However, only those providers with the deepest pockets can afford to build out their own infrastructure close to end users with an eye on operational savings and future benefits.
The internet as a whole is unlikely to break, but the sustainability of many ISPs' current business models are being challenged where competition has led to unfeasibly low retail prices and the cost of traffic is booming.
In addition, ISPs face the prospect of continuing price rivalry in the next generation broadband market, particularly in Western Europe, which is unlikely dramatically to alleviate pressurized margins.
To help bolster revenues, providers are likely to look more to bundled services, a rethink of user payment models and new ways of monetising the content running through their pipes.
James Garlick, analyst, Screen Digest