The challenges for wholesale network operators

Amid the political fighting over LightSquared and whether or not it will interfere with GPS, there’s a far larger issue: Can the nascent carrier really build a business as a wholesale carrier? History offers some perspective that maybe it can’t.

A blast from the past.

This “next-generation digital wireless technology…will be offered across the country to meet the explosive demand for high-speed access to the Internet” via a “wholesale business plan” that is “an unparalleled opportunity for minority and other small business entities to enter the wireless business.” Of course I’m talking about NextWave’s business plan, circa 1999, which was simply one step on the path to an exit from bankruptcy and a sale of its spectrum assets to Cingular and Verizon.

I wouldn’t be the first person to make the comparison between NextWave and LightSquared, but it is worth noting that LightSquared has recently attracted a great deal of political backing precisely because of its wholesale business plan. For example, various public interest organizations noted in an FCC filing in support of LightSquared that “compelling public interest benefits… would flow from a new mobile broadband entrant, particularly one offering a wholesale network that can extend the reach of the smaller, rural and regional mobile carriers, as well as access to connectivity for a wide range of innovative new devices, applications, services and retail providers at the network’s edge.”

Relying on rural wireless won't save wholesale operators
However, this says nothing about whether deploying a new wholesale mobile broadband network is any more feasible today than it was for NextWave a decade ago, when a wholesale business plan was basically a way to sidestep the real challenge in creating a profitable wireless business, namely acquiring end users. Certainly smaller carriers would benefit from gaining wholesale access to a new LTE network, but those players aren’t going to fill up a network by themselves. Thus, as even LightSquared’s supporters admit, the viability of a new wholesale player is dependent either on two things. First, on one or more major carriers using the network to substitute for its own network build-out, or on new entrants with a substantial customer base deciding that offering wireless service is important for their future business success.

The balance of power isn’t in LightSquared’s favor.

The problem for a wholesale-only player is that it really has no leverage to establish a profitable business relationship with major potential partners. We’ve seen this in the case of Clearwire, where it has been all but impossible for Clearwire to secure an advantageous deal with Sprint. While Sprint can happily keep high margin voice and SMS traffic on its own network, Clearwire must handle vast amounts of data traffic in exchange for a very modest proportion of Sprint’s overall ARPUs.

Clearwire (s clwr) attempted to develop both a retail presence and a diverse wholesale revenue base to create some of that leverage, but it has been forced to curtail its retail operations due to a lack of money. And still, despite having signed a range of wholesale agreements, the overwhelming majority of its wholesale customers are from Sprint. LightSquared has a similar challenge, having signed a deal with Sprint that is even more one-sided, in that LightSquared must pay Sprint (s s) $9 billion to host its network for the next 11 years, while Sprint has no obligation whatsoever to buy LightSquared’s capacity.

When it comes to wireless, retail customers offer leverage.
None of this is to say that there can’t be a successful wholesale wireless offering or that a network sharing arrangement isn’t a cost effective way to create a 4G network. Wholesale relationships and network sharing agreements can work well when the balance of power is roughly equal. Take for example Tracfone’s MVNO relationships with multiple established carriers in the US, or the network sharing agreements between mobile operators in Europe. However, unless a new startup has some compelling leverage, there is no reason for an established operator to sign anything other than a one-sided deal.

History repeats itself.

A fashionable argument is that the supposed spectrum crisis means that wireless operators will have to use wholesale providers because they simply won’t be able to find alternative sources of spectrum. However, that flies in the face of what we’ve seen over the last year, when Clearwire, NextWave, DBSD and TerreStar have hardly seen a rush of buyers for their spectrum assets.

Another argument is that these wholesale providers will find a ready market amongst new entrants looking to offer their own branded wireless services in the near future, because devices and services will be “always connected”. However, there is little evidence that consumer electronics providers are queuing up to offer their own wireless services, and any attempt by a major player like Apple to develop such an offering would create massive disruption to existing distribution relationships.

As a result, it’s increasingly difficult to see a sustainable place in the market for dedicated wholesale players like Clearwire and LightSquared. Even DISH Network’s prospective 4G network is a challenging proposition, but it is not reliant on wholesale bandwidth and will leverage DISH’s existing 14 million customers. However, DISH would be well advised to secure other major partners before rather than after it commits to a large-scale buildout.

Tim Farrar is President of Telecom, Media and Finance Associates, a consulting and research firm in Menlo Park, CA, which specializes in technical and financial analysis across the satellite and telecom sectors.