Adam tempted; are small ISPs on the eve of destruction?

As a huge music buff and legendary rock star*, I have watched the systematic dismantling of the Allans-Billy Hyde music chain with more than a tinge of sadness.

Whereas most industries are seeing the creation of additional value through consolidation, Allans-Billy Hyde — which, as far as I know, was the largest music retail chain in Australia — is causing the destruction of consolidation value and, after US giant Guitar Center decided not to buy it, is handing market dominance back to the local music store.

This is in direct contradiction to trends in industries like supermarkets, where consolidation has kept smaller competitors on the torture rack, and has progressively turned the crank one turn after another. Ditto shopping centres, which have drawn shoppers like blow flies to a carcass, but left many independent retailers wishing that they had never signed that lease.

Even the airlines have seen major industry change, with Virgin Australia's latest investments significantly changing the dynamics of yet another industry where consolidation is seen as a vehicle for survival. In the airline, supermarket, and other industries, strength in numbers is the go — and the number is two.

The Sydney Morning Herald's quotation of former Ansett Chairman Rod Eddington says it all: "What we are seeing today, in the context of Virgin looking to take over Tiger, is a return to a two-horse race . But the horses are more multifaceted than they were before."

I'm not sure what it means for horses to be multifaceted — perhaps they have learnt to curse in Mandarin while running really fast — but his point is both clear and salient.

Seen through the lens of these other industry changes, it is hardly surprising that Adam Internet — which, along with Internode, has long dominated the South Australian independent-ISP market — has given into inevitability, and handed over the reins to Telstra.

That it was Telstra that was doing the buying was the most surprising thing to analysts like Paul Budde, who correctly pointed out that it's a big change of pace for Telstra, which has traditionally carried enough market heft that it could simply rely on long-term attrition to win customers.

Some will say that Telstra moved to buy out a competitor and strengthen its position in South Australia, while Adam Internet has itself attributed the threat of the NBN for its decision to sell. But there is more to the story, and those that see the deal as being purely about buying internet customers aren't paying attention.

Adam Internet, after all, has been quietly working to expand its business away from traditional consumer internet access, a traditional service that simply does not have enough in it to support long-term survival.

Those that see the deal as being purely about buying internet customers aren't paying attention … [Adam's recent major deal with SA Health] legitimises its expansion away from pure telco access services, and Telstra knows it.

A clear sign of this strategy came recently when Adam Internet was chosen over larger rivals by SA Health, which chose Adam Data Centre for a 10-year application-hosting deal that will not only boost the ISP's revenues, but marks its assimilation into the ranks of the so-called "big boys." And, when it comes to the NBN these days, if you're not playing with the big boys, you might as well stay home.

The deal legitimises the company's expansion away from pure telco access services, and Telstra knows it. In this context, Telstra's AU$50 million investment has not only bought it around 90,000 retail internet customers, but a ready-to-go South Australian data centre with at least one major anchor client, and with more sure to come in the future.

Many lamented the sale of Adam Internet as some sort of disaster for independence in the ISP sector, but their knee-jerk reactions belie the broader trends that are clearly evident in the telco sector. Those trends have one message: in the pre-NBN and NBN eras, there is no natural role for small upstarts without a direction. The real survivors will be those who have diversified their businesses well and truly past simple access services.

Telstra and Optus have known this for some time, having pioneered service bundles that combine broadband, mobile, pay TV, and other services. TPG, which I lauded last year for adding non-telco services like electricity retailing to its roster, is a good example: the company has also branched out into areas like back-to-base alarm monitoring and, more recently, a hosted video-surveillance solution for home and business monitoring.

If customers are going to gravitate towards ISPs that can bundle (and cross-subsidise) many services, what then are entrepreneurs to do? Do they have the right to expect survival? Is there truly no hope for the mum-and-pop ISP, started as a franchise or a way to make a few extra bucks by setting up a few routers in the garage?

Not necessarily. The NBN will make it easier than ever for companies that have big ambitions to get a leg up. Since the physical getting of access won't be so hard or capital-intensive, they'll be able to start small, then quickly ramp up as their business grows — and it's not as if they could afford to build new infrastructure.

The NBN will make it easier than ever for companies that have big ambitions to get a leg up. Since the physical getting of access won’t be so hard or capital-intensive, they'll be able to start small, then quickly ramp up as their business grows — and it's not as if they can afford to build new infrastructure.

The thing is, they'll have to have a long-term commitment to the sector, with plans to build value by adding services. Innovative pricing models — like the PAYG plans announced by AusBBS or TPG's unlimited-usage NBN plans — are a way of getting customers onboard, and there will be other innovative pricing ideas as well.

However, in the long term, the NBN's new dynamics will require more from ISPs. As FetchTV already knows, reselling pay TV and streaming video will be the first logical stepping stone for many ISPs looking to climb the value chain — but the ever more-demanding customer will come to expect extra services that require ISPs to have ever more-sophisticated rosters of product offerings.

Cloud services, for example, are quickly becoming a mainstream offering — and will become even more popular as the NBN brings higher usable bandwidth into people's homes. But this requires a robust data centre to work effectively — for example, the evolving data centre that Telstra got when it bought Adam Internet.

This dynamic alone should see more tie-ups between ISPs and data-centre operators down the track. After all, the trend towards service consolidation means that telecoms and hosting services are no longer discrete services, and are more like unified parts of the whole.

Companies like NextDC and Metronode may be building massive data-centre presences, but they'll need to look towards telecoms as an expansion path, not the least because it will give them more control over the nature and quality of the service they deliver. This would dovetail nicely with the plans of companies like iiNet, which has made no secret of its cloud ambitions and which would value a national data-centre footprint.

The days of the small, independent ISP may be numbered — but that doesn't mean the end of innovation. Just as many independent fruiterers and grocers have successfully fended off incursions from the supermarket giants by marketing super-fresh food, flowers, yoghurt, meats, and dry goods to their local communities, ISPs will still find opportunities, as long as they're willing to think outside the switching box.

* In this context, the word "legendary" may be interchanged with the word "imaginary".

What do you think? Is Adam Internet's sale to Telstra a tragedy for independence, or a victory for ISP reinvention? And who will be the next to go?