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Virgin Media: a UK “Happy Piper”

As part of our increasing focus on ‘Digital Entertainment 2.0’, here is an analysis of Virgin Media’s recent investor day:


The last man standing in the UK Cable Industry, Virgin Media (VMED), appears to have turned the corner and now for the first time in two decades is actually providing a return to shareholders. Although it is outperforming BT, VMED is still trailing BSkyB - especially in terms of revenue and overall converged home market share growth. The big question is whether VMED has a sustainable competitive advantage going forward, and more generally, who will be the other industry winners and losers as VMED moves onto the front foot.

Virgin Media held their first Investor/Analyst day in two years a few weeks ago, with CEO Neil Burkett showcasing VMED strategy going forward and described its competitive advantage as having three arms: network, brand and people. Here are our two pennies’ worth:

The fatter pipe

Cable has always had a fatter pipe into the home than incumbent telcos. At its most basic, co-ax cable has around 750MHz of bandwidth compared to 30MHz for a copper pair. We fully agree that whatever BT does with the copper pair final mile, whether fibre-to-the-cabinet, bonding or whatever - co-ax will be a better technology. However, this logic reverses if BT ever did a mass roll-out of FTTH. But, despite the noise in the market, we can’t see this happening within the next 5 years. Having a fatter pipe is not the whole story, and the history of cable in UK has meant that different systems were deployed in different municipalities at a varying level of quality. VMED have spent the last few years upgrading all their plant and the fact that they feel confident in offering 100-meg broadband to the majority of their UK footprint seems to indicate that they have been pretty successful. Historically, coverage has been another of VMED’s Achilles heels. They are only able to serve 50% of UK homes, or about 13m households, with penetration currently of around 5m households. The biggest sign that VMED was back on the front foot was last year, when they announced a programme to pass another 500k households by the end of 2011.

Additionally, recently they did a deal with one of largest UK home builders, Persimmon, to provide hook up their new builds. People moving into these new homes are ripe for sign-up and VMED will have a presence in Persimmon’s sales rooms. If VMED manage to sign-up a few more house builders, they could easily add another 100k/pa to their footprint, although construction is still in the doldrums after the financial crisis.

Beyond these initial projects, VMED claim they will be looking for other areas where they can meet their target of £GBP300/home passed. Even applying strict discipline to this target, this could potentially open up another 2m UK homes. There is bound to be a regulatory bunfight over access to BT ducts and the access to the £830m government subsidy for rural broadband roll-out.

In short, VMED has a competitive advantage with their network in the short and medium term. This is especially true for raw bandwidth and internet connectivity.

However, a fatter piper into the home doesn’t really matter for linear broadcasting. BSkyB has an advantage, although it is not significant, with their DSAT service in terms of bandwidth. We do, however, suspect that VMED has a cost advantage with a sunk network cost versus rented transponders. But when compared to BT and others with their DTT based services, VMED have a significant advantage which will never be matched by DTT.

The over-hyped brand



Any advantage from the Virgin brand itself is much harder to believe. Admittedly, we’ve not seen the statistics, but we do suspect that both the BSkyB and O2 brands are much stronger in the UK and the BT brand is still loved by a particular demographic (although it’s questionable whether this demographic will ever get around to using advanced TV or internet capabilities is open to question).

People always claim ‘people’ are a strength



Again, we struggle to believe that VMED has a stronger team than, say, BSkyB. Even BT has strengths in key areas such as government regulation and lobbying which VMED would struggle to match. As Berkett himself notes, the key to strategy is execution - if his team can do it, that would be sufficient, but we wouldn’t go anywhere near claiming that this is a sustainable advantage over the others.

Of note here is the VMED claim that their field force is a key competitive advantage. We tend to agree here especially as home technology becomes more complex. BSkyB may have the best TV installers, but they can’t touch BT’s local loop infrastructure which will become more and more important over the next few years.

And the functional separation of OpenReach from Retail handicaps any plans BT has to improve in this area. Several other case studies - notably Verizon FiOS and the Australian NBN Implementation Plan - suggest that operational excellence here is both important and usually undervalued.

Overall, Virgin Media has some competitive advantages, but we think they may be over-egging them with respect to brand and people.

Using connectivity to drive growth



Having the best pipe is pretty useless, if there is no customer demand for it and you can’t claim a premium price. The good news is that Virgin Media is showing there is demand at a higher price - most of their on-net broadband base of 4m subscribers is on 10Mbps or above, with 800k on either 20 or 50-meg and 24k pre-registrations for 100Mbps even in advance of any promotional efforts.

Broadband alone was never going to be the key driver for a company where triple and increasingly quad-play customers are vital. That is why the launch of theirTiVo box, and the way it leverages VMED’s network advantage, is so exciting.

TiVo as a TV differentiator



We are enormously impressed by the TiVo box, and we have no doubt that this is a better product than either the Sky+ HD box or the forthcoming YouView box.

The User Interface looks great and vastly improves search and discovery. That is before the forthcoming tablet and mobile applications. Our favourite bit is that VMED now has total flexibility between nVOD based on their catch-up service, and user defined record+play through the PVR functionality - and it’s all done in a easy to understand way.

Of note here is that Berkett never seems to get carried away with the technology, but he rightly states the important differentiator between nVOD, OTT streaming and PVRs for on-demand viewing is about the content rights.

What sets the box apart is that there is an in-built modem with a dedicated 10-meg connection to the Internet on totally separate bandwidth to normal household access. No-one else will be able to match this fire power. There are rumours suggesting that the reason for the dedicated bandwidth is that there is content caching and p2p technology within the box which will further improve experience within cable network segments as penetration increases.

This follows a key principle of network theory - the cheapest and wisest place to put intelligence is at the edge of the network. It relegates BT’s Content Connect service to a second rate citizen before it is even launched.

That is before the all the other features and upstream benefits that the TiVo platform offers, especially in the area of audience measurement and advert insertion - which will become more critical as more TV consumption moves from linear to on-demand. In addition, the TiVo box has the ability to add applications, such as games, within a well-known flash-development environment.

The VMED plan that the TiVo box is a product for all their customers is eminently sensible and follows BSkyB’s simple-is-better philosophy. There is a 3-to-4 year timeframe to replace their current Liberate platform in all their homes. However, BSkyB definitely have a big head start with most of their c. 3m HD-boxes ready for the on-demand upgrade.

Curbing our enthusiasm, this is currently a strategic advantage, but it is one which is replicable over time. TiVo is a great partner, but whether they can keep up with the rate of industry innovation is another matter.

The coming convergence play



The third leg of the triple play is voice, with mobile being the quad - and this is the next area where VMED plan to improve. We don’t quite get their “mobile credits” play which seems to be a swapping of minutes between the home phone and mobiles - but perhaps the fog will lift when they actually launch.

Four things leap out at us, though:

  • VMED has lots of potential customers with only 14% of their homes taking mobile ,and there are multiple people in each home
  • they are putting their wallet where their mouth is - with a £40m handset subscriber acquisition investment over the next twelve months
  • on a statistically insignificant sample, the Virgin Media shop (near this analyst’s home in Leeds) always seems to have a lot of footfall, at least the equal of the MNO shops
  • VMED are capturing c. 15% of the UK contract gross adds which is exceptional performance for any MVNO in any country
Unbelievably, VMED is claiming that they can make the same Return on Capital as any MNO. We need to fire up the spreadsheet to analyse this further - this is staggering news and suggests the pricing of wholesale services by MNOs is too low. There were quite a few comments about WiFi as a differentiator for mobile data - whether in the home for offload and improved customer performance, or metro-WiFi with VMED putting equipment in their street cabinets. We remain to be convinced on this and see it more as a competitive realignment to the bundling of BT OpenZone with BT Home broadband.

Our current belief is that technically and user-experience wise WiFi is a poor second best to Femtocells - and the difference will only grow as the transition to 4G occurs.

We remain unconvinced on the VMED mobile play, but admit that they have made giant leaps from when they purchased Virgin Mobile.

Growing Virgin Media Business



We really couldn’t get too excited about this element of their strategy. For sure, they pass 95% of business, only currently have c. 5% market share of the B2B market, and their core network will have plenty of spare capacity during the day. But we don’t think selling big 1-gig pipes extremely cheaply is going to set the world on fire.

Firstly, most b2b customers want something else than big pipes. Secondly, BT, C&W or whoever can simply meet their price rather than losing customers - they also have sunk fibre connections to the buildings. And finally, we don’t think VMED has a sales distribution network anywhere near the size of the rest.

We’re sure that VMED has something else up their sleeves, or else the renewed push will come to nought. And we will see VMED reconsidering whether to sell the business or not.

Finances



Finances have always been the brake on this business since the collapse of the tech-bubble at the turn of the millennium, but they have really improved of late, and the disposal of the vmTV venture will only strengthen them further. It seems that they can both now invest for the future and give hard cash returns to the shareholders, which was unimaginable even 5 years ago.

We also sense that financial discipline is one of VMED’s strong points, and that they will avoid the temptation to go for any massive market capture exercise. They can probably deliver 5% growth in revenues and c. 20% growth in Free Cash Flow over the next few years without breaking into a sweat.

This is where we get worried. Our gut feel is they are wasting their opportunities - at a minimum they should be looking to match BskyB’s growth profile. BskyB and the rest can always outgun VMED with marketing spend - although we promise to scream if we hear the ridiculously misstated BskyB figures (including SAC) again.

Sooner or later, if VMED really have more compelling services, their customers will do their marketing for them. Advocacy is much more powerful than TV above-the-line branding. We wonder whether they really believe that is all the growth they can really capture, or if their lack of ambition is stock market expectations management.

Given this timidity, we don’t feel BskyB will suffer from a rejuvenated Virgin Media. But it certainly raises the bar for BT - there is nothing here to indicate anything but a continual slow drip of customers away from them. The endless hype of BT Infinity and YouView is looking more and more like the fable of the Emperor’s New Clothes.

Even worse is the situation for the other main home player, TalkTalk, where growth is grinding to a halt and the competitive situation is getting worse by the quarter. With VMED’s market capitalization of £5.5bn and TalkTalk’s of £1.5bn, I know where I would rather invest or, if I was a mobile operator wanting to have a home arm, buy.

(Ed. - more on these and other related topics in 2011 via our research and events programme).

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