Telephony ONLINE recently offered an insightful opinion article exploring the strategic positioning of network owners and their long-term strategic alternatives for monetizing their infrastructure. Network owners have historically monetized their assets by selling transport services and by offering self-managed services on their network. For example, telecom network operators offered voice services; cable network operators offered video services. More recently, service providers have bundled multiple services; voice, video and data services.

The trend toward multi-service networks is the leading edge of what we see as a long-term trend; consumers and enterprises are demanding an increasingly diverse set of services that enable them to communicate, to interact with content and to move money. The emergence of Internet protocol based networks - which enable services to be separated from the networks over which they are delivered - has only accelerated the trend.

We are dubious that incumbent network operators have the requisite skills and organizational flexibility to respond to the increasingly complex needs of their customers. But if network owners do not build and control these new services, they risk being relegated to providing highly-commoditized transport services. The threat, while long-term, is considerable. The typical network operator reaction is to erect “walled gardens” of services and content to abstract other IP-based service providers away from the network operator’s customers. But that didn’t work for AOL, it hasn’t worked in the wireline world and the walled garden is predictably and rapidly crumbling in the wireless world as well.  So what is a network-operator to do?

We believe that the answer starts with understanding that network operators control considerable assets and capabilities that go well beyond their networks. Telephony ONLINE mentions subscriber information, payment infrastructure (billing), quality of service management capabilities and the ability to make services available on multiple networks as key leverage points. To this list, we would add a list of the unique capabilities and data elements that are inherent in network infrastructure, like location data, presence, usage history, and latent data on the social graph their networks connect (who calls who, emails who, etc.). Some of this will give privacy advocates nightmares, and telcos and cable operators have already been chastised by privacy advocates with dire consequences for packet sniffing enabling technology vendors like NebuAd. Privacy issues aside, the opportunity for the network operator is to expose these services through a service oriented architecture to a community of application developers who can leverage the assets inherent in networks and innovate at a rate and at a level of quality that network operators could never hope to achieve on their own.

The operational and strategic challenges facing the network operators are non-trivial. Adopting a service oriented architecture to open their billing, consumer data, location and other “services” to a community of application developers requires skills and a business philosophy that runs counter to command and control history of network operators. Network operator back-offices are typically a mess with multiple billing, customer resource and other systems all managing the same group of customers. But with no viable path to control the third-party services delivered over their networks and lacking the capabilities to innovate on their own, we see little choice for network operators in the long-term. They must open up their infrastructure and allow others to innovate on top of it; they must become a platform.

Does this mean that network infrastructure is no longer valuable? No, not entirely; network assets will always have inherent value, particularly in geographic markets where network capacity is constrained so that raw transport is still valued. Despite that, the trend is clear; value is moving away from networks toward the services that are delivered over them. Network operators can either leverage their strengths to facilitate the delivery of these services by third parties, or face the prospect of service innovators cannibalizing the network operator’s proprietarly delivered service business for years to come.

From an investors perspective, the dilemma of the network operator is our gain. We actively seek opportunity to innovate using the network assets of others without having to pay for access to the capabilities of their networks. Likewise, we are always on the lookout for ways to leverage data that the network operators may be opening up; location data being a good example. We encourage you to share your thoughts on this trend and to share any business plan ideas that align with the concepts outlined here.

The Catalyst Code by Dave Evans and Richard Schmalensee is dominating the water cooler talk at Meritage. It’s rare that a business strategy book really hits the mark, but The Catalyst Code does as it was written for the 21st century VC and entrepreneur.

With unprecedented levels of broadband connectivity and the widespread adoption of the Internet, businesses today are able to bring together different sets of customers to allow them to interact in ways never before possible. This is what the authors call a multi-sided business platform. Getting customers to interact on such a platform is a catalytic reaction. Rather than creating new products or services, catalyst companies figure out how to allow participants in an ecosystem to interact more efficiently (or in some cases to interact for the first time), creating enormous value within the ecosystem. Meritage has invested in five catalyst companies to date and is a huge believer in the premise that multi-sided businesses have the ability to transform industries. A perfect example is our portfolio company Pipeline Financial Group. Pipeline is an electronic securities trading platform that allows institutions to trade large blocks of shares directly with one another: no more need for a broker. By doing so, institutions avoid the $20 billion annual cost resulting from brokers “front running” their orders.

Catalyst companies offer tremendous opportunities as they’re often rooted in huge industries; however, they also have special challenges. First and foremost, the company must attract the various participants into the ecosystem at the same time – you can’t conduct one sided transactions in a catalyst company! Pricing also becomes very tricky: do you charge all customers using the platform or do you consider subsidizing or even (gasp) paying a key customer group for its participation? The idea of subsidizing a customer always gives VCs the chills: Pets.com and Vonage spring immediately to mind. But these infamous companies were single sided businesses subsidizing their only customer with no second-side of their market. In a catalyst company, there are at least two and sometimes more distinct customer groups, and it may be necessary to incent the customer group that can start the catalytic reaction. Our mobile search company Mobile Content Networks is doing just that. MCN has numerous distribution agreements with leading wireless carriers and hardware manufacturers including Sprint, DoCoMo, Nokia, Yahoo! Japan, Tele2 and SMART. MCN does not charge these distribution partners to implement its search technology. These partners are the key to reaching the consumer, and MCN now reaches over 365 million mobile subscribers. This reach is a huge asset and one that MCN is monetizing through advertisers. Had MCN charged either the carrier or consumer for search, it likely would have failed. Instead, MCN charges the participant in the ecosystem who is the most motivated to reach the consumer: the advertiser.

As Bill Gates comments in the book, this is “how breakthrough businesses can be built in today’s economy”. We agree. Catalytic investing is one of the most promising investment areas and we continue to aggressively pursue these ideas. If you haven’t read The Catalyst Code – do it and join the 21st century!