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The Evolution of the Telecom Carrier: CenturyLink and the Cloud

U.S. facilities-based carriers are seeing an unabated decline in traditional landline service revenue. Some, like AT&T Mobility and Verizon Wireless, have enjoyed rapid growth from their investments in mobility. But for a company with annual revenue on the tens of billions of dollars, it's not smart to bet the whole future on one growth engine. Portfolio diversification is essential, particularly synergistic diversification. This is the rationale for carrier interest in cloud-oriented services, whose revenues are projected to grow by more than 50% per year for the next 5 years.

One carrier that has made a recent entry into the cloud services market is CenturyLink, by virtue of its $18.8B merger with Qwest, rapidly followed by its planned $2.5B acquisition of co-location and hosting provider Savvis. By these actions, CenturyLink has made it abundantly clear that it wants to transform itself from a rural provider of landline SMB and consumer telecom services to a major cloud and business network services provider.

This transformation began in 2009, when Century Telephone, an independent local carrier (historically, ICOs weren't part of the Bell system) acquired another ICO, Embarq. Embarq was the landline local services arm of Sprint, which Sprint had agreed to spin off as part of its merger with Nextel in 2005. With very few exceptions, both CenturyTel and Embarq serve rural areas--unlike former Bell system properties, these are not often geographically contiguous. Neither carrier offered service outside of its local footprint. Combined revenues for the new company (CenturyLink) in FY 2010 were $7.04B.

On April 1, 2011, CenturyLink completed its merger with Qwest, which reported FY 2010 revenues of $11.73B. In addition to its 14-state local services footprint and customer base, Qwest also brings a number of in-region metro markets, like Seattle, Denver, Minneapolis-St. Paul, and out-of-region markets serving medium-large businesses in cities like New York, Dallas and Los Angeles. Compared to CenturyLink, Qwest has achieved greater success in the medium-large business services segment (served by the company's BMG organization), which generates approximately $3.9 B in annual revenue. Qwest's landline business services portfolio and customer base were two of several key factors driving CenturyLink's merger interest. Another important asset is Qwest's 16 data centers, which provide co-location, managed hosting and compute-on-demand infrastructure as a service (IaaS) services to business customers. Like CenturyLink, Qwest wholesales mobile services from Verizon Wireless.

On April 27, CenturyLink announced its acquisition of Savvis, a cloud services vendor headquartered in St. Louis with $973M in revenues, serving MNC (multi-national corporation) enterprises (particularly those in the financial services industry), federated/VANs (value added networks) and SaaS providers. Savvis operates 32 data centers; its product line consists of primarily of co-location, hosting and managed hosting services.

The chief architect of CenturyLink's ambitious plans for cloud services is Andrew Higginbotham. He is a ten-year CenturyLink veteran, and has led the team that developed the company's cloud strategy for the last two years. Higginbotham is the first head of the company's new Data Hosting and Cloud Services (DHCS) group, which will be headquartered in St. Louis after the Savvis close (anticipated to occur in 2H 2011). Like Qwest's BMG, DHCS reports directly to CEO Glen Post. Savvis' expertise, current product line/future roadmap, global reach and MNC customer base are clearly the foundation of Higginbotham's plans. But what happens next? Much of what follows is based on a 1:1 interview with Higginbotham that occurred on May 17, 41 days after the CenturyLink-Qwest merger close, and 29 days after the company's plan to acquire Savvis was announced.

DHCS Vision
Higginbotham's vision for CenturyLink is aggressive. He sees the company as becoming a "premier managed hosting provider...with premium cloud services". Achieving scale and functionality are near-term "major priorities". Ultimately, Higginbotham wants to provide a set of products, services and sales capabilities that can extend from enterprise customers to medium-size and eventually, small business.

In the near term, Higginbotham sees two infrastructure services as key product cornerstones

* Co-location and related managed infrastructure services. Some industry estimates see an 80X growth in this business between 2008 and 2012, with a 300% increase just in a single 12-month period.

* Managed Hosting. Custom and quasi-custom managed hosting services are enjoying double digit growth rates. For instance, Savvis reported a 25% growth rate in its managed hosting business during FY 2010. It anticipates that this service will make up almost 50% of its revenue in FY 2011.

Other cloud services are yet to be defined. Future cloud services will offer customers (1) faster time-to-market, (2) highly elastic capacity, (3) a pay-per-use model, and (4) the ability to treat infrastructure costs are as variable op-ex, not cap-ex expense. "Any cloud-based service will include these four key attributes," he said.

What's not clear from this extremely broad framework is the layer(s) of services DHCS plans to offer--will infrastructure services be "it"? Higginbotham did express interest in platform-as-a-service offers like location, presence or billing services (typically targeted to other cloud providers) and software-as-a-service. But apart from this, he declined discussing any specifics.

Higginbotham has long planned to provide his organization with a dedicated sales force, and sees the acquisition of Savvis and its sales force as key cornerstones. Given the rapid pace of CenturyLink’s acquisitions in 2011, it's not apparent how his organization's sales force will interact with (legacy Qwest) BMG’s sales force, or how joint sales opportunities will be planned, managed and compensated. For companies that use both BMG and DHCS services, there are also issues to consider such as contracting discount levels and contract terms and conditions.

In terms of reach, it's clear that Higginbotham wants to continue to serve US-based medium/large businesses and multinationals, and sees legacy Qwest's domestic and international footprints as key assets. Located in major business hubs, legacy Qwest has 24 international POPs (combination of MPLS, Internet and private line access), and Savvis has data centers in 5 cities overseas.

Going down-market, Higginbotham is very excited about the value that cloud can bring to small and medium businesses (SMBs), and for future opportunities for his organization to serve them, but he doesn't see current cloud portfolios as ready for the SMB market. "The SMB nut hasn’t been cracked yet"; to-date, cloud services "have been successfully adopted by the technically astute or those with sufficient scale/financial resources". Higginbotham believes that good SMB offers aren't simply scaled-down enterprise offers; they are fundamentally different. For example, he sees legacy Qwest BMG’s CoreConnect bundle as a "credible offer" to which future SMB-targeted cloud services could be added. As to geographic reach, he didn't disclose if DHCS will serve SMBs located outside of CenturyLink's current domestic small business (local) footprint.

On distributed cloud, a unique asset that carriers can bring to the cloud services market, Higginbotham is intrigued by the possibility of repurposing some central office space for use by DHCS (he declined further elaboration). Carriers' central offices (COs) provide many of the infrastructure basics that data centers require--highly secure, hardened facilities with diverse WAN connections, HVAC and backup power. And they are plentiful--most were sited and built before TDM trunks began to be installed in carrier networks (1963). Prior to that time, analog trunk technology limited the distance of reliable signal re-generation to no more than 20 (cable) miles. As COs migrate from TDM to IP switching, signaling and WAN technology, carriers need less floor space (in local COs) to provide network-centric services. Some competitors are examining the attractiveness of re-purposing freed-up space in COs for a variety of applications, including hosting extremely low-latency services, like gaming and UC. Given the wealth of potential backup locations, carriers could bundle these services with extensive business continuity functionality.

Relationship with (Legacy Qwest) BMG
Certainly there are important synergies between DHCS and BMG (the hosting and the legacy-Qwest business units). For example, during the CenturyLink-Savvis merger call, Savvis CEO Jim Ousley reported that 90% of its hosting customers also use the company's (re-sold) WAN services. Since Savvis' sweet spot is in serving multinationals (vs. legacy Qwest or CenturyLink, which predominately serve medium and small businesses), this acquisition is all about product line and revenue synergies, because it is a way to for the carrier to gain entree to these firms.

Another important question is the relationship between Qwest BMG's existing cloud business and DHCS. Higginbotham says the incorporation of Qwest's cloud business into DHCS has not been decided, with no future announcement date set. This means that in the near term, Qwest BMG's sales and service organization will continue to support the legacy offer. I also expect that planned near term enhancements to Qwest's legacy cloud infrastructure services portfolio will continue unabated. But longer term, in order to optimize synergies between similar products, at the very least I anticipate all IT-centric cloud services (like cloud infrastructure services) to move into Higginbotham's organization. This leaves an open question about where network-centric cloud services like hosted IVR and ACD, UCaaS and conferencing will reside. Other carriers with cloud ambitions face similar issues. At present most continue to keep network-centric and IT-centric cloud services in separate business units.

These are early days for the new CenturyLink, and the Savvis acquisition is ahead, not behind it; only so much can be disclosed right now. But Mr. Higginbotham has shared enough for current and prospective customers to identify some key areas to follow:

Product roadmap. Here are a few examples of issues prospective customers should keep in mind:

* Does CenturyLink see the Savvis acquisition as sufficient to be considered a de-facto premier cloud hosting provider? If not, what other plans does it have?
* Will CenturyLink only offer premier cloud services? How will these fit into SMB budgets, which are often very tight?
* What cloud services will CenturyLink offer in 2012 and beyond, and in what business units?
* Even if all cloud IT and network services move to DHCS, legacy BMG still is a major national WAN services provider. How (and when) will contracting, sales, service and support, and SLAs work on a cross-organization basis?

Market segmentation and go-to-market strategy. To date, no major service provider, whether in the cloud or the carrier business, has successfully served diverse markets equally well. Many specialize--for instance, despite the billions that can be made serving consumers, some network service providers (like PAETEC, Level 3 and Global Crossing) intentionally focus exclusively on the business services segment. Savvis' historic strength, and that of many of its competitors (IBM, EMC, etc.), is in serving multinationals. Aside from shaping its product strategy, market focus/prioritization is essential. The wider the market or geographic reach of an organization, the more it must consider a multi-channel approach. It is essential that CenturyLink enunciate these strategies, along with its product strategy, at deal close.

Longer term investments and tradeoffs. Prior to April 2011, CenturyLink lacked both cloud and mobile assets. Mobile networks are important for cloud, but are even more important for CenturyLink's primary business--as a network service provider (based on gross revenue, cloud services represent slightly more than 5% of the new company, i.e., CenturyLink+Savvis). Going forward, how will it balance future investments in cloud and mobility? There's not enough money to solve both deficiencies simply through acquisition--even CenturyLink 's largest carrier competitors faced that reality (AT&T's money is going to acquire T-Mobile U.S., so its cloud strategy is primarily organic; in contrast, Verizon made organic investments in mobility, so it elected to acquire cloud IT provider Terremark). Where will CenturyLink decide to double down?

Lisa Pierce is President of Strategic Networks Group, LLC., an independent analyst firm. She can be reached at [email protected]. She also serves as the resident telco-cloud analyst at Saugatuck Technology, a boutique analyst firm that focuses on cloud and open source. This article is based on her work at Saugatuck.