FEATURED IN: CABA Home and Building Automation QUARTERLY, Autumn 2001
                by: Michael Greeson, Parks Associates

Parks Associates will release its latest primary consumer research on the residential consumer in mid-September, entitled Bundled Services & Residential Gateways. The report is comprised of a July 2001 survey of 2,500 U.S. households as well as an analysis of the primary data. Below is an examination of the Sufficiency Paradox.

Introduction
As new broadband access technologies begin to compete with DSL and cable for the residential market, and as consumers are offered greater choice in selecting a broadband provider, the battle for the last mile will become increasingly intense. Service providers must identify ways to differentiate their service offerings or they will likely lose significant ground to those competitors who do. The pressure to differentiate has led service providers to consider offering new types of services, hoping to supplement their legacy offerings and offer service bundles that provide variety and value to the end-user.

What does a multi-service, multi-competitor environment mean to the residential consumer? A better selection of services, greater customization - simply stated, variety and value! What does this mean to the individual service provider? Heightened competition, constant pressure on margins and, to add insult to injury, the threat of higher churn! (Most U.S. consumers would jump ship to a bundled service provider for a savings of only $20 per month! See Figure 1.)

Figure 1

It's About The Real Estate, Stupid!
Given the competitive environment, survival in the early mass market may depend upon a service provider being the first "to own the residential real estate" (that is, to have its customer-premised equipment (CPE) deployed to initiate a broadband service). To paraphrase, "It's about the real estate, stupid," and if a service provider can be the first to place branded (or co-branded) equipment within the residence, this will go along way toward securing the consumer relationship against competitors and provide a platform for the delivery of new services as they become available.

But whether or not the service provider therein "owns" the residential relationship and is able to withstand competitive pressure may ultimately depend upon the type of CPE that is deployed. And herein lies the dilemma: when service providers go about deciding which type of CPE they will deploy, they must balance:

1. The imperative to avoid deploying too simple of a device, one which may demand costly upgrades or even replacement when new services are made available and which may leave the consumer relationship extremely susceptible to churn;

2. The imperative to avoid deploying too advanced of a device, one that while future-proofing the consumer relationship, nonetheless supports services that may never generate a dime in new revenue, and therein result in the service provider standing millions of dollars at the edge of the network.

I characterize this dilemma as the sufficiency paradox. Sufficiency, at least in this context, can be understood as the median below which the consumer jumps ship to another service provider, and above which the service provider strands millions in an end-user device that enables services for which there is no demand.

If service providers cannot resolve this strategic tension, their chances of success in the residential broadband services market are limited.

The Many Faces of the Residential Gateway
Multi-service networks demand multi-service CPE, and it is the residential gateway (RG) that has of late received the majority of attention from service providers. A residential gateway, as defined by Parks Associates, is a network interface device that terminates a wide area network and connects to end-user devices directly or through a home network. In additional to features common to all gateways, an RG should include an embedded broadband modem, routing capacity, and security features. The different types of RGs are outlined in Figure 2.

Figure 2

Keep in mind, selecting a particular type of RG at this early stage of the market is no simple decision. An inadequate understanding of consumer interest, for example, could mean losing market share on one hand, and stranding millions on the other. In that spirit, let's take a moment and examine a few of the residential CPE deployment scenarios:

(1) If a simple broadband modem is deployed, then high-speed data is the only service that can be offered. But if a service provider seeks competitive differentiation and customer retention (over both the short and long term), a device more intelligent than a simple modem must be deployed: limited services mean more room for competitors to move in on the real estate. Simply stated, if you're deploying broadband modems only, you in no way "own" the residential real estate; you're merely "leasing" it until a better offer comes along.

(2) If the CPE is a Virtual Residential Gateway (a co-located broadband modem and a router with a firewall), then high-speed data service could be accentuated with revenue from remote software upgrades for the home PC, or even revenue from the sale of home networking technology. If the CPE is a Web-Centric RG (a single box solution which incorporates the broadband modem with a router and advanced security features), similar services could be offered.

However, as the consumer begins to better understand the convenience and costs savings associated with receiving bundled services from a single provider, the existing provider either has to upgrade or replace the CPE to enable multiple services or risk losing the customer to a competitor. This may mean a costly truck roll, perhaps even for each individual service that is brought online. The initial service provider in this scenario may have the early advantage, but they may end up having to upgrade CPE under duress; if not, others can (and will) move in on the real estate. Here's a unique way to think about it: if a service provider is merely deploying broadband modems or Virtual or Web-Centric RGs, it is merely "leasing the real estate with an option to buy."

(3) If the CPE is a Multi-Service or Set-Top RG (which includes a broadband modem, router, security features, plus at minimum either voice or video functionality), a host of legacy and next-generation services can be offered. New service bundles could include high-speed data, legacy or packetized voice services (which means the potential of adding virtual voice lines as well as PBX-style features), broadcast TV, and digital entertainment services (including Near-VOD, VOD, PPV, PVR, etc.). In such a deployment scenario, the CPE may be used originally for data and video but can be remotely upgraded to enable voice or other services. A more advanced CPE, certainly. A higher cost, definitely. A guarantee of future loyalty, perhaps. Penultimate stickiness and ownership of the residential real estate is still not absolute. Think of it this way: If you deploy a Multi-Service or Set-Top RG, "you may own the building but you don't own the land."

(4) If the CPE is a Whole-House RG, the consumer could receive virtually any broadband service via any wide area network that serves the home. Any network, any service - the optimal solution for delivering legacy and next-generation services to the home, and generating multiple new revenue streams.

Although Whole-House RGs are currently associated more with structured-wiring installs in new homes, devices are now coming to market that promise to take up less space than a DVD-player, interface with every wide area network, and distribute the content anywhere in home, wirelessly or without new wires. But in exchange for such extraordinary functionality, a Whole-House RG requires a much higher level of investment on the part of either the service provider, end-user, or both. These devices are more expensive (priced between $1,000 and $20,000, depending upon the functionality, networking, and customization involved). In such a deployment scenario, the consumer relationship is about as sticky as it can be, and the real estate is as close as possible to being "virtually owned" by any single provider.

Well, then - the choice is easy, right? The best strategy would be to deploy Whole-House RGs to every residence within reach of a service provider. A company could limit the functionality of the device, at least initially, to delivering only specific legacy and first-generation services such as telephony, high-speed data, and digital video services. And within the next three to five years, as new services come on board, the provider could simply configure and enable the services remotely because the hardware/software to support these services was embedded within the Whole-House RG at the start.

Sounds reasonable. But then why aren't more service providers deploying these devices in mass? Why doesn't every new home start or high-speed data or digital cable subscription come with a Whole-House RG? The simple answer: to deploy these devices on a mass scale would require significant additional investment above and beyond what is required to deploy a simple broadband modem or router; capital which (i) is very hard to come by at this time, and (ii) if invested, would have to be recovered by charging the end-user upfront or by cashing in on the demand for new value-added services once they are brought online). Either way, this strategy involves more significant capital commitments with no certainty that once new services become available the end-user will embrace them (read "cough up the monthly service fee").

Conclusion
Especially in this uncertain economic environment, the desire to own the virtual residential real estate in a sufficiently sticky fashion must be balanced against the desire not to strand a ton of capital in a device that never pays for itself. Selecting the appropriate strategy for balancing these disparate priorities depends upon:

1. Which services the provider is going to offer the residential market;

2. When these services are going to come online;

3. Aligning new service bundles and price points with expressed consumer preferences;

4. And weighing these three priorities against the costs and benefits associated with:

1. a minimalist (modem-only or Virtual or Web-Centric RG) strategy as opposed to:

2. a mid-range (Multi-Service or Set-Top RG) strategy; or

3. a high-end (Whole-House RG) strategy.

Determining which RG strategy is most appropriate, and the form(s) of RG to be deployed, must be the logical outcome of reconciling the need to be the first and best with the need to not strand capital. Preferences drive consumption, and understanding the subtleties and nuances of consumer preferences is a precondition to easing this tension, identifying a market, and efficiently leveraging resources in such a way that risk is reduced and margins are optimized.