Data Consumption Continues to Grow. Why Are Network Equipment Makers Struggling?

Data consumption continues to skyrocket, growing at about 50% per year. Average usage in mobile now exceeds 4GB per month in the US, with video an ever increasing percentage of that. Fixed broadband isn’t standing still either, with the typical Netflixing household consuming north of 200GB per month.

You would think these would be boom times for the major suppliers of network equipment to the operators. This is a market where three players — Ericsson, Nokia, and Huawei — split about $125 billion in annual global mobile network capex. But in reality, Ericsson and Nokia have been struggling of late and the forecast isn’t all that favorable. Ericsson’s mobile network business declined 10%+ in 2016 and they forecast a decline of 2-6% for 2017, indicating in their annual report that the addressable market for networks is flat to down 2% in the 2016-2018 period. Nokia’s numbers are a bit better, in part because 2016 was the first year of full reporting post the Lucent acquisition, but they nevertheless project flat-ish sales for networks this year. Cisco has had a rough time of it as well, announcing a cut of 1,100 workers this week, on top of a 7% workforce reduction in 2016. By contrast, Huawei’s revenues from network operators grew 24% in 2016, although nearly 60% of that business comes from Asia-Pacific (40% China).

Given the continued robust growth in data consumption, why is the network business so crummy and will the picture get any brighter? It is difficult to find any one reason for the relatively flat market. Our analysis boils it down to six broad factors.

1. The global nature of the business. The major suppliers do business in 100+ countries and with hundreds of operators. There are some parts of the world where network spend has gone way off. In Europe, for example, much of the 4G LTE buildout is complete but follow-on work, related to increases in network capacity, has not been as robust as anticipated. Additionally, the macroeconomic environment in certain regions, such as the Middle East and Latin/South America, has been challenging. There has also been operator consolidation in large markets, such as India, which has affected the addressable market.

2. Their share in growth markets under-indexes. The major 4G LTE buildouts in markets where Ericsson and Nokia are strongest, such as North America and Western Europe, have peaked, and those markets are now driven more by harder to project capacity enhancements and small cell deployments. Huawei’s share is stronger in geographies where there is still a large 3G/4G buildout.

3. Network operator revenues have flattened. The U.S. market is symptomatic. Although there is continued growth in data consumption, prices have declined and mobile revenues are not growing. This is playing out similarly in numerous geographies, putting put pressure on capex spend, with operators pushing their vendors harder on price.

4. The Huawei factor. We don’t see this in the US market because Huawei has been largely kept out of the network equipment business here but Huawei has taken significant share from Ericsson and Nokia and has also been very aggressive on price. Huawei now leads the global market, with 30% share, compared to 28% for Ericsson and 24% for Nokia, according to Dell’Oro Group.

5. Not capturing fair share of the fixed broadband market. Although mobile capex is flat to down in some markets, fixed line (broadband) capex is seeing an uptick, driven by fiber deployments, DOCSIS 3.1 upgrades and, in some geographies, spending on G.fast and PON. Ericsson and Nokia’s share in fixed under-index that of mobile. Nokia’s recent acquisition of Gainspeed is a signal of its efforts to grow that market segment.

6. Cost structure has not kept up with network transformation. We are in the early innings of a major transformation in networks from a hardware to a software-driven model. This impacts the equipment suppliers in three ways: they need to lower their cost structure, evolve the skill set of their workforce, and recognize that the competitive playing field will expand.

Even though the picture is currently mixed, with Ericsson especially under some pressure, I am bullish on the long-term prospects. I’ve spent time with senior level executives at the major equipment suppliers in recent months and they all recognize the business will be fundamentally different in five years than it is today.

In some ways, we’re in a bit of a ‘pause period’ before the next big wave of opportunity. First is IoT and the ability to connect the billions of devices that are projected. This market is materializing but growing more slowly and more unevenly than thought. So it’s a long game. Second, the transformation from hardware to software. The suppliers will have to keep in lockstep with their customers, the operators, on this one, and capture their fair share of this market going forward, which will undoubtedly feature a larger and more competitive playing field. There is still lots of work to be done to determine how to price for a software/cloud/network slice world. Third, a lot of resources are starting to be devoted to 5G, but it will be a couple of years before 5G-related spending begins in earnest. Finally, with much of the growth in traffic coming from video, equipment suppliers will need new technologies and offers to capture their fair share of this opportunity.

This transformation will also involve a new suite of potential customers, partners, and competitors. The Ericssons and Nokias of the world will need to do more business with major ‘webscale’ companies, such as Google, Facebook, and Amazon. A more open, software-centric network environment means there will be more competitors and lower barriers to entry but also the opportunity to partner with best of breed firms. Ericsson and Cisco are still, for example, in the early innings of their partnership. Another example is managed services and the broader world of OSS/BSS, where the network equipment suppliers will have to take share from (or work with) firms such as Amdocs, IBM, Accenture, and Oracle.

The future of the network equipment market won’t be one where three firms carve up some 80%+ of the revenues. But there’s plenty of market opportunity, as long as they capture their fair share.