The Brave New World [Overview of 1998 worldwide telecom deregulation]
Bhawani Shankar, May 1998
telecoms-mag.com
Even for the telecom industry, which is used to seeing events hyped, the
past few months have been a ceaseless blur of conferences claiming to
unravel the mystique of deregulation. What exactly is this phenomenon
and what, indeed, was the dawn of 1998 supposed to bring? Do any of
liberalization's lofty implications have any immediate bearings on the
services customers get and pay for?
Despite the many hours of debate at the podium, the answer has to be
that there are as yet no telltale signs of this long-awaited, much-debated
deregulation. Change, however, is not totally absent. It emerges in
different ways, depending on the operator. Large, dominant incumbents
will stress that it is business as usual, but they are nevertheless preparing
new game plans. Newer and the so-called alternate operators may like to
believe that the free-for-all that was promised in Europe as of January 1
this year is theirs by right, and they will be more demanding when they
encounter resistance from their larger neighbors in arranging bandwidth
and interconnects. Tangible changes that are more relevant to end users
will take their time coming.
The European Commission, Europe's legislative body, passed a whole
range of directives aimed at achieving 1998 objectives. But the
Commission has not had a good record in enforcing directives within a
reasonable amount of time. According to the Yankee group, "Despite the
best efforts of the Commission, liberalization of telecom services in
Europe will continue at a very uneven pace and the gap between most
and least liberal nations will continue to be very wide for the foreseeable
future."
In fact, for an overwhelming number of customers in Europe, January's
deadline made little difference: Many markets, such as the United
Kingdom, have already made significant advances toward the European
ideal; at the other end of the scale are those, such as Greece, that have
deferred deregulation for up to five years.
Estimates of what customers can reasonably expect this year would need
to be based on several key issues. The first is an assessment of what the
incumbents perceive to be their realistic positions and threats, and how
they may react. In addition, the plans and objectives of competitive
operators will indicate what markets can anticipate. Both sets of results
would also need to be considered objectively in order to make a
calculated guess about the future.
Incumbent, Bent Double
For operators such as British Telecom (BT), still nursing its
disappointment over the MCI misadventure, it would seem that the
options are limited, but Chief Executive Peter Bonfield disagreed. "More
opportunities do exist, but we are not going to rush out and spend all our
money," he told a conference in London in late 1997. Speculation is rife
about what BT will do with the $7.4 billion that it earned by bowing out
of the MCI deal. New partnerships are being forecast with likely
candidates ranging from Bell Atlantic (currently acknowledged as the
most powerful Bell operating company), AT&T (still the largest U.S.
long-distance operator and brand name with which to reckon) and
Japan's NTT (full of technology and potential, but far from a surefooted,
streetwise international telco).
To make matters worse, the banking and analyst communities believe
almost without exception that the incumbent community is in for several
rude shocks over the short to medium term. "Incumbents will be at a
fundamental disadvantage. They have old technology, narrow product
ranges, higher unit costs, as well as regulatory restrictions," said Andrew
Harrington, the London-based managing director of Salomon Brothers.
"The majority will tend to be too complacent and there are sure to be few
big winners and some big losers," he cautioned.
In many cases, deregulation has meant price caps and these could remain
in force in some regions through the rest of the century. This was geared
to give competing operators sufficient financial muscle to invest in
technology and establish themselves before price caps are removed
entirely. "Being an incumbent is not easy," said Bonfield. "On the one
hand, shareholder value and price-earnings ratios are becoming key
performance indicators and on the other, the only way for us to move
forward is to move into international markets while retaining the United
Kingdom as a core business."
The incumbents need to be considered in the historical context of
deregulation. By the end of 1998, 80 percent of the world's telecom
markets are scheduled to liberalize. "This is a fundamental restructuring of
the world's fifth biggest industry," said Harrington, "and it has the full
backing of governments around the world." The combined directives of
the EU and the World Trade Organization (WTO), when fully ratified,
will cover more than 90 percent of global markets. While some
governments may drag their heels and attempt to extend protection of
incumbents through regulation, licensing, and various other measures,
they will have to ultimately open up. The political costs of resisting reform
are too high and as such, reformation is an irreversible process.
For instance, telecom deregulation is becoming a reality even in Japan,
which has resisted it for as long as possible. Given the free market status
of its dominating electronics industry, the protectionist telecom sector had
been a sad contrast to its more liberal competitors. Having posted fervent
opposition (on the grounds that it would dilute its ability to retain its
leadership in leading-edge technologies), the incumbent, NTT, is now
reconciled to the growing competition. In fact, now that the tables have
turned, NTT's stated opinion is that restrictions should have been lifted
sooner. "We have been slow in opening up the communications industry,"
said Jun-ichiro Miyazu, NTT's president, explaining the key difference
between Japan's electronics and telecom industries. "Where there has
been restriction, progress has been slow. Protectionism does not help
commercialization, and we understand that we can no longer survive in
that environment."
A New Paradigm?
Telecom analysts, awed by the ground-breaking changes, are at a loss
for words to describe what the outcome might be. The words "paradigm
change" have been offered and, whatever the possible interpretations,
there is general agreement on what tangible effects may be seen at an
industry level. For one, about 3000 new operators are expected to be
created over the next couple of years; all of these companies will try to
whittle away at incumbent market shares and create new markets.
The majority of these new operators will be investing in technology that is
more advanced, cost-efficient, and flexible than what incumbents own,
including higher level SDH systems, IP over ATM, and so on. In
comparison, incumbents will have no option but to retain PDH, copper,
and 800-MHz technologies in some parts of their networks. The
comparative cost-ineffectiveness of these technologies will have to be
reflected in bottom-line financial performance.
On the other hand, most alternative networks would be well capitalized
and have powerful backers. This means that new operators could offer
broader product ranges, have much lower unit costs, and be in a better
position to offer bundled services. As price caps melt away, the new
industry structure will, no doubt, give rise to a new economics. "In five
years' time, the telecom industry will look like any another free-market
industry," said Harrington. "Markets will become highly segmented,
marketing costs will increase, approaching those of popular branded
products in the retail sector, and the industry in general will have low
predictability."
Market segmentation trends are already apparent. Large incumbents are
grouping together to form consortia whose sole aim seems to be to serve
business customers. As experience has shown, this is where
the most revenue is at stake and this is where being big and global
counts. Low-revenue residential markets, on the other hand, are better
served by companies similar to the United Kingdom's cable franchisees.
Increasingly, residential markets will be served by cable operators or
similar companies whose accents are on a mix of telephony and
entertainment/interactive services.
In the business services area, the emphasis on network reliability and
end-to-end manageability will lead to the increased importance of owning
infrastructure. Leasing and interconnect arrangements will be the choice
of the typical reseller or small operator serving domestic or regional
markets. This is borne out in the case of WorldCom, which, in the early
days of its alliance with the long-distance operator LDDS, was more of a
reseller and rose to a $1 billion revenue level without owning significant
infrastructure.
WorldCom's strategy took a U-turn with its acquisition of MFS, a
company dedicated to high-revenue, city-centric business markets. As a
result, the international operator is estimated to spend about $50 billion
acquiring other telcos and building new fiber-based infrastructure. "We
are in the process of building the first, global broadband network," said
John Sidgmore, WorldCom's chief operating officer, adding that there is
more to come.
In fact, monumental changes are forecast in global backbones. The
commissioning of submarine cables and terrestrial fiber backbones over
the next two years will effectively quadruple the bandwidth on some
international routes and increase by an even greater factor on others.
Together with the fact that domestic services will benefit from the use of
SDH and other cost-efficient technologies, this is expected to lead to the
commoditization of voice. "We expect basic voice service tariffs to fall by
about 80 percent over the next five years," said Harrington. The billions
of minutes of voice traffic that will be carried on these networks by then
will mean that per-minute costs of plain old telephone service (POTS)
will effectively be zero. This will emphasize the value-add that service
providers will have to offer in addition to basic packages.
Strategic Choices
These prophecies only help strengthen the view that incumbents will bear
the brunt of the market rationalization that is to come. Conservatively, if
the market grew by 5 percent per year and incumbents lost 4 percent of
their market share and costs rose by 3 percent during the same period,
the scenario for 1997 to 2002 looks frightening for the dominant
operator. In this simplistic experiment, a telco's earnings could decrease
by about 4 percent by the year 2002. "Bear in mind that BT is losing
about 10 percent of its residential customers to cable operators in their
franchise areas and this estimate starts to look very cautious indeed," said
Harrington.
In the business sector, too, incumbents will fare perhaps only marginally
better. Operators such as WorldCom and Colt are already a formidable
challenge for them. The degree of their vulnerability becomes apparent
when it is considered that one of Europe's largest operators, Deutsche
Telekom, relies on business customers--who represent just 4.5 percent
of its customer base--for 41.5 percent of its revenues. In fact, 18 percent
of its customers generate about 70 percent of total revenues.
More bad news for the incumbents is in the shape of recent research
done by the France-based OECD, which has found that tariff falls do
lead to higher usage but not enough to compensate lost revenue. During
the period 1985 to '95, when telecom tariffs fell by about 40 percent or
more, telecom revenue as a percentage of GDP remained more or less
constant in OECD countries. For the dominant carrier used to high
margins and protected markets, revenue loss is inevitable--perhaps even
just--and incumbents can, at best, only attempt to minimize losses.
"An incumbent's survival strategy should include writing-off old
technology and assets, increasing investment in new technology, and
trying to manage market share loss by growing into new, international
markets," said Harrington. Today the problem with most strategies on the
drawing boards is the failure to recognize that such revenue loss and
other associated changes are inevitable.
The Global and the Local
In the short term, Europe is expecting a flood of new operators and
investment, primarily from the United States and the Asia-Pacific region,
originating from a combination of private and public operators.
Medium-size operators who have achieved significant success, such as
Ameritech in the United States, are eyeing Europe as an obvious market.
Bell operating companies have expressed their frustration with the U.S.
Telecom Act's seemingly empty promise of access to long-distance
markets. "Many state-owned and formerly monopolistic operators in
Europe are privatizing and they will need our marketing skills," said
Ameritech's chairman and CEO Richard Notebaert. "Our investment in
Europe already has a book value of more than $5 billion."
Over time, the distinction between public and private operators will blur
and perhaps in the period after 2002, the industry is expected to rise to a
new exalted status of equilibrium with four to five global supercarriers
and between 2000 and 4000 domestic and regional operators. The
so-called supercarriers are expected to be the world's backbone
networks and the primary carriers while the smaller, second-level
operators provide domestic and feeder services. Does that mean the
medium-size operators that are not tied-in with one of the larger
consortia are an endangered species? Ameritech's Notebaert feels
otherwise: "Even though Ameritech may not be part of a global consortia,
there's always room for us to participate. No matter how big an operator
is, everywhere in the world is just too big."
Bhawani Shankar is managing editor of Telecommunications
International.
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