WhatsApp, Carriers!

A lot has already been written about Facebook’s purchase of WhatsApp – the simple but popular over the top (OTT) messaging app – from the seemingly exorbitant purchase price, to the existential threat that messaging apps pose to social networking services like Facebook, to the privacy implications of the purchase. Nevertheless, it seems fitting that the first post on OTT Nation be dedicated to one of the biggest deals of the year related to the OTT phenomenon.

WhatsApp, as most know by now, is a cross-platform OTT messaging (and soon to be voice call) app for mobile devices. Basically, the app allows its users to avoid paying wireless carriers additional fees for text messaging (SMS), so long as they have access to the Internet (e.g., through their data plans or via free wifi) and can get the people they want to converse with to also install WhatsApp. WhatsApp accounts are tied to telephone numbers, which makes adding other users who also have the app very easy. According to Bloomberg, OTT messaging apps may have already cost wireless carriers across the globe close to $33 billion of high gross margin revenue.

Unlike many folks in the U.S., I was quite familiar with WhatsApp prior to the big announcement because of a family member’s decision to exclusively go with OTT messaging instead of being forced to pay $20 a month for text messaging on AT&T. I suggested WhatsApp after doing a bit of research, as it seemed to be the most popular OTT messaging app worldwide. Although I also started using WhatsApp, I still kept my text messaging plan, as most people I know either use SMS or iMessage (or both).

But now I’m thinking about finally dropping my text messaging plan – and I would not be surprised if a lot of other people were thinking the same way.

It seems fairly likely that the WhatsApp deal represents the tipping point for OTT messaging service use. Facebook has global scale and mind share, and already people who never even considered OTT messaging as a replacement for SMS are starting to think about which cross-platform messaging app they should be downloading. If Facebook starts promoting WhatsApp, or if WhatsApp more seamlessly integrates Facebook’s services into its messaging experience, usage of OTT messaging could easily skyrocket. But even if WhatsApp doesn’t become a dominant service globally by way of Facebook, the fuse appears to have been lit for OTT messaging, generally.

Obviously, this is a problem for the wireless carriers, who stand to lose a material percentage of their average revenue per user (ARPU) unless they can raise their data rates in a way that offsets these revenue losses. But the carriers have long seen the writing on the wall with respect to their text messaging and voice services, and I believe that this deal will finally get them to start acting proactively regarding OTT services.

Just like Mark Zuckerberg wants them to.

What do I mean? The answer lies in Zuckerberg’s plans for how Facebook and the wireless carriers can work together to get customers to pay (or hand over) value for the services they jointly provide or distribute. These plans differ depending on whether a market is emerging or developed (or somewhere in between).

The Emerging Markets Game Plan

In the emerging markets, Zuckerberg appears to believe that the provisioning of a “free” package of services – such as messaging, social networking, and search – by the wireless carriers will help drive subscriber growth for data services over the long run, as well as create demand for higher end data services and digital content.

At this year’s Mobile World Congress, Zuckerberg talked at length about how to get the next couple of billion people to start paying for data services. He first noted that more than 80% of people in the world live in an area where there already is 2G or 3G service. However, a large number of these people simply don’t see why they should spend their $1 or $2 of disposable income to purchase data plans, despite actually being able to afford such services.

So how do you demonstrate the value of these wireless data plans to prospective customers? Well, people know Facebook. And they know WhatsApp. According to Zuckerberg, if you provide Facebook and WhatsApp, they will come. And then you have a paying data service customer to whom you can also “up-sell” other products and services. (Zuckerberg probably means both “up-sell” and “cross-sell.”)

The vision in Zuckerberg’s own words:

“All of the different [free] services that we talked about, with all of the different kinds of up-sells and things that we think that we have the ability to do if we work with a carrier deeply and plug into their systems deeply to make all these flows really efficient and use all the knowledge that we have about customers that both we and the carrier have.” (emphasis added)

In other words, getting access to a bundle of OTT services, including WhatsApp and Facebook, becomes an “on-ramp” (Zuckerberg’s words, not mine) to the Internet and all its glory, which subsequently leads to the entirely rational consumption of more products and services via the Internet. Especially when Facebook and the carrier “partner” work closely together to determine what types of products or services the particular end user would like at any given time based on what they know about that user. The vision really entails a close knit partnership with carriers, where Facebook provides retail and behavioral targeting infrastructure in return for a cut of the proceeds, whether from sales, ad revenue, or payments fees.

This partnership model makes a lot of sense for the emerging markets over the medium to long run. Zuckerberg is well aware that wireless carriers in such markets won’t put capital into building out world class infrastructure unless they have some opportunity to share in the wealth that will undoubtedly be generated by OTT service providers. Thus, big OTT service providers like Facebook see an opportunity to work with the carriers to provide services that optimally utilize carrier infrastructure and give carriers a cut of some of the profits. In return, companies like Facebook get more economies of scale, become fixtures to end users as a result of their close partnership with the carriers, and thereby generate outstanding profits with very litte capital investment compared to what it takes to build out infrastructure.

For the developed world, this type of partnership approach doesn’t necessarily work.

The Developed Markets Game Plan

It’s no accident that the WhatsApp announcement came just before Mobile World Congress. Zuckerberg apparently had the carriers in mind, as evidenced by his reported hosting of a number of “the top phone companies” executives who were in Barcelona. These executives weren’t shy about expressing their displeasure over OTT providers who threaten to turn them into “simple pipes.”

Unlike in the emerging markets, the wireless carriers in developed markets have already spent tons of money building out infrastructure in markets close to saturation from a subscriber standpoint. Now it’s about fighting for market share, maintaining ARPU, coming up with new services to charge for (e.g., mobile payments), and diversifying into the retail distribution of content and other services. Competition is heating up, with all sorts of partnerships potentially forming between wireless and wireline providers, multiple service operators (MSOs), satellite companies, fiber + wifi companies, and even big tech.

OTT service providers, who threaten to steal away carriers’ revenue from core services (e.g., text messaging and voice) and potential services (e.g., multichannel video programming and location based services) simply can’t play the “if you build it, they will come” card because most end users in these markets are already there, demanding more value for the subscriber fees they hand over to the carriers.

In light of this reality, it appears that Zuckerberg will: (1) play the traditional OTT service provider game, which is to ride on top of all the carriers’ infrastructure and ignore the carriers’ grumblings about declining revenue; (2) partner with carriers to push Facebook’s OTT services in exchange for a cut of the up-sells and cross-sells to come; or (3) make exclusive partnerships where carrier partners subsidize customer access to Facebook OTT services in order to differentiate themselves from competitors.

In the U.S., for example, Facebook might implement strategy 2 by convincing AT&T and Verizon to make WhatsApp the default messaging app on their wireless services. Then, when WhatsApp begins to dominate as a result of these partnerships, which also keeps Facebook.com in a dominant position, AT&T and Verizon can participate in the future profits that Facebook derives from content distribution through the utilization of their content distribution networks (CDNs) and payment services (Isis).

This strategy could work if Facebook is able to achieve the scale that it thinks it can reach in terms of number of user relationships worldwide. As Ben Thompson of stratechery has pointed out, Facebook the company is a lot more than just Facebook.com, just as Google the company is more than just Google.com. As companies like Facebook and Google gain more and more users, they gain negotiating power that can be applied to the distribution of content, similar to the way the MSOs and satellite companies have had negotiating power in the past for their multichannel video bundles. One could easily see an OTT service provider like Facebook becoming a primary distribution channel for paid and ad-sponsored content.

Strategy 3 could be implemented in markets where there is decent competition and a need for wireless carriers to differentiate themselves from the pack. In the Bloomberg report about Zuckerberg’s phone frienemies, it was mentioned that Deutsche Telekom is considering an alliance with WhatsApp. Such a partnership would be similar to the deal DT did with Evernote last year, where their mobile and wireline customers were eligible to receive 1 year of Evernote Premium for free. DT recently expanded this program to 12 additional countries. Presumably, Evernote is being paid by DT for providing these OTT services on a fixed rate per user basis.

It remains to be seen which way Zuckerberg will go in the developed markets, but one can assume that he is discussing the possibilities with the carriers behind the scenes.

Conclusion

Facebook’s acquisition of WhatsApp should be the ultimate wake-up call to wireless carriers, and all other communications infrastructure providers, that OTT services have reached a tipping point globally. Now it’s up to these infrastructure providers to adapt and transform in order to deal with the disruption that is occurring. Perhaps it’s time they started working with their OTT frienemies rather than fighting them.