Dow Jones Newswires -- July 5, 1999
SMARTMONEY.COM: Cooking Up A New Telecom Recipe
By Tiernan Ray
SmartMoney.com
NEW YORK (Dow Jones)--If you own a telephone, get set to be a connoisseur. Just as most restaurants offer menus instead of whatever the chef feels like making that day, the telephone network is about to replace the "specialty of the house" -- plain old telephone calls -- with more complex and sophisticated products. Rather than one flat offer, phone companies want to provide a host of prix fixe choices to customers, merging voice with options such as email and perhaps, someday, video on demand.
To do so, however, they need to make some interesting changes in the gear that runs the telephone lines -- changes that could be quite lucrative for Cisco Systems (CSCO) and the other suppliers of networking equipment.
One of the most familiar concepts drummed into the heads of a sweaty, media-drenched public is that one of several high-bandwidth services will soon be coming to your world, and that the forces of cable modems, digital manufacturers will bid for your business in a fight to the death. That may be true, but the myth is that the phone companies in some way care what you, the customer, ultimately choose. They don't. The fact is, the phone companies have all become 'telecommunications service providers," which means that rather than running phone lines to your home or business, they simply want to run lots of lines that provide many, many different ways of accessing the Internet. It's called "price discrimination" by economists: offer a bunch of different products, and see who'll buy what.
Doing this for consumers is relatively easy for the phone companies. As exemplified by AT&T (T), most carriers will have a smorgasbord of different technologies, including phone lines, cable and perhaps wireless. And there are ways to create different products within each technology.
For example, most people today think of cable service as one thing -- a 1.5 megabit-per-second connection to the home. But most cable modems have a far higher maximum throughput, on the order of 40 megabits per second. While not every network can handle that much data for each subscriber, in future cable operators would like to play Let's Make a Deal with you and see how much you'd pay to get, say, 2 megabits per second -- or 3, 6 or more.
New cable gear will help them do that. Cisco has part of the solution. It sells a piece of cable equipment, the 'headend," that sits in the cable office and helps AT&T and others assign different levels of bandwidth to each subscriber. 3Com (COMS) officials say that the next version of the "open" cable modem spec, called DOCSIS 2.0, will let subscribers basically turn up the volume on their side. Want your cable modem to go to 11? Get out your wallet.
Phone companies have a far larger problem when it comes to giving businesses different kinds of bandwidth. For one thing, the Fortune 500 would like to dictate what they want and at what speed, rather than being force-fed a menu of different dishes at different prices. To provide that kind of flexibility today is really expensive. It's as if every restaurant had to buy new ingredients every time some fat-cat food critic came in demanding his favorite dish. To do this, phone companies need to fix the most recalcitrant part of their networks, the local loop, the part that connects each customer's office to the phone network.
Local phone companies or competitive access providers (so-called CLECs) connect to their customers in metropolitan areas over a fiber "ring." Companies such as Advanced Fiber Communications (AFC) traditionally provide equipment for this, but the problem with the old equipment is that its menu of options is limited. These boxes see the network as bundles of little T1 lines, a digital phone line that runs at 1.5 megabits per second. But customers might ideally want a connection more like their local data network -- say, 10 million bits per second.
The solution may lie in a company called Omnia Communications, purchased by Ciena (CIEN), a purveyor of fiber optics equipment, back in March. Omnia is suggesting, essentially, that phone companies replace the existing local loop, like the stuff AFC sells, with so-called pure optics.
Optical fiber is great because it can essentially be split into as many different connections of infinitely varying speed as is desired by the customer.
Like having an infinite basket of ingredients. That means a phone company could conceivably provide as many prix fixe options for bandwidth as it can dream up. Want 10 megabits? Sure. Want 20? You can do it -- cheaply -- if you've gotten the old phone gear out of the way.
There's a lot of activity in this area right now. You may have heard about all the big router companies lately -- Nexabit being purchased last week for a billion dollars by Lucent Technologies (LU), Juniper Networks (JNPR) going public, Avici severing its relationship with Nortel (NT), and Tellabs (TLABS) buying NetCore for $575 million, etc., etc. This stuff won't fix the local loop. That job falls to companies such as Optical Micro Machines of Research Triangle Park in North Carolina.
With funding from a bunch of venture capitalists, OMM is using an exotic technology called MEMs, for micro-electromechanical systems, to create a very mundane piece of equipment with practical applications.
MEMs create little mirrors on chips to switch beams of light. OMM is hoping to sell phone companies what it calls an 'optical add-drop multiplexer," a kind of switch that, again, will allow phone customers to connect to the public network at whatever speed they wish, rather then being limited to arbitrary speeds that are a legacy of the phone network. Bruce Graham, a partner with the venture firm Bessemer Venture Partners in Menlo Park, says of OMM's switch: "Lucent and Nortel need this right now; they've already got a problem with delivering bandwidth on demand using existing equipment." One to watch, should it go public. Another is Atmosphere Networks of Cupertino, California, also private.
Where is it all heading? Some think we're headed for the age of the transparent LAN. The network inside of a company is called its LAN, for local area network. As the public network becomes more flexible, companies will feel as if the Internet is just an extension of their own network. The difference is, spending for routers and switches will fall to service providers such as Qwest Communications (QWST) instead of corporate CIOs.
That's when the prix fixe will really start in earnest. As long as the Internet looks to businesses like something foreign, it can't be fully trusted. But if it looks just like their own routers and switches, that might present Qwest, MCI WorldCom (WCOM) and other companies with a chance to truly create tantalizing new services besides just connecting phone calls. First, it will be different flavors of Internet access, at different speeds. I wrote recently about Application Service Providers (ASPs), which are offering to host commercial software on their networks for businesses in exchange for a subscription fee. That trend could be accelerated by the transparent LAN, if it comes about. But other services will probably arise too. If you assume companies will connect more and more using the Internet, to trade and to connect their operations for e-business, as IBM's Lou Gerstner puts it, then being the monkey in the middle of that relationship should be good business for the phone companies for a while to come.
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