re: Bandwidth Trading, a Risk Management Business
From the May 2000 Lightwave Magazine's Fiber Exchange supplement:
pennwell.shore.net
Also, a discussion on colo spaces from the same source titled Location, Location, Location, at:
pennwell.shore.net
The bandwidth trading article is copied below for posterity, following Fiber Exchange's editorial comment on the same subject. Enjoy.
FAC
======editorial begins:
pennwell.shore.net
editorial
Will online trading go offline?
This month's cover story looks at the future of bandwidth trading, both near
term and over the horizon. Near term, the online bandwidth exchanges have
already proven their viability. In the more distant future (although perhaps not
as distant as first appeared), the creation of commodity trading in the
bandwidth market promises the same efficiencies currently enjoyed in fields
such as energy. The question these two visions of the future pose now is
whether they are mutually exclusive. In other words, once you have commodity
trading of bandwidth, will the need for the current online brokerages cease to
exist?
I believe the mere existence of these online exchanges in the current
marketplace indicates that their run is by no means over. On the face of things,
there seems little reason why the online reverse auction services these sites
provide should have any participants. After all, we're told bandwidth demand
continues to skyrocket, and the current frenzy of infrastructure development
can barely keep pace. With the world beating a path to the doors of the
carriers with bandwidth for sale or lease, why should these carriers bother to
auction off their wares at discount rates?
Reality, of course, is frequently different from what we're told. With dense
wavelength-division multiplexing offering ever-increasing bandwidth on the same
fiber, the potential for dormant capacity lurks in every network. This factor
becomes even more significant when we realize that each new generation of
equipment brings the per-bit cost of bandwidth down to new lows-leaving
networks built on older equipment suddenly obsolete from the point of price
competitiveness. What's an older carrier to do? Dump bandwidth via online
exchanges or other avenues as quickly as possible, perhaps.
As I once heard an observer say in reference to the online brokerages, a sale
is a sale is a sale. As long as they can offer discounts anonymously-and
therefore keep their "normal" contract-bound customers from squawking-why
shouldn't carriers explore other avenues of reaching the market?
The advent of companies such as LightTrade that have an eye on providing the
pooling points for a commodities-type market should certainly give the online
brokerages some pause. Still, with Band-X and RateXchange establishing
switching centers of their own, there's no reason why they couldn't expand this
aspect of their business to create their own pooling points. Even without this
evolution, I believe that carriers will always want an alternative route to the
market. Who knows-bandwidth commodity speculators may soon bid beside
carriers in a reverse online auction in the not-too- distant future.
Stephen Hardy
Editorial Director &
Associate Publisher
=========risk management article begins:
pennwell.shore.net
cover story
A RISK MANAGEMENT BUSINESS
By Kathleen Richards
Talk of bandwidth becoming a commodity has swirled around the telecommunications industry for years-too much fiber going in, supply and demand imbalances, rapid price erosion on high demand routes, and disappearing margins. Despite these discussions, trading bandwidth using risk management in a commodities market was never even considered when most wholesale carriers' developed their business models.
Like many market developments in the
communications industry, bandwidth trading is happening at the speed of light.
CIBC World Markets (New York City) estimates that 20% of the total $80
billion wholesale market, or $16 billion in revenues, may be traded "in some
fashion" by 2004. This development stands to benefit carriers as suppliers and
buyers of capacity, according to the equity researchers, although wholesale
carriers that aren't the low-cost providers in their markets may feel a pinch.
As online bandwidth exchanges launch real-time trading models and as
utility-offspring Enron Broadband Services (EBS) promotes a commodities
trading model similar to what is used in the natural gas and electricity markets,
it's time to pay close attention to commodity trading and learn fast.
Online portals
Web-based bandwidth exchanges such as Band-X Ltd. (London) and
RateXchange Inc. (San Francisco), intermediaries that match buyers and
sellers of wholesale capacity and related services, first appeared in 1997. Such
Web-based platforms for matching suppliers with potential customers followed
the natural progression of many industries to develop a model for
business-to-business electronic commerce. As applied to the
telecommunications industry, the idea was to eliminate some of the
supply-and-demand inefficiencies of the market. Carriers could sell excess
capacity on high-demand routes or gain capacity on-demand quickly and
anonymously at market prices-without incurring the traditional costs of lead
generation, upsetting other wholesale customers who may have paid a higher
price, or enduring a laborious negotiation process.
In theory, the online exchanges could widen wholesale carriers' bidding market
and speed up the provisioning process. That would allow carriers to bypass
traditional sales methods, in which it often took months to establish contracts,
and customers could be locked into leasing or buying the maximum amount of
capacity possibly needed-leaving much of it idle-for years.
In a broad sense, the online bandwidth exchanges operate as a matchmaking
service. Carriers and service providers that are members of the exchange
indicate what "good" they want to buy, lease, or sell-minutes, bandwidth, dark
fiber, rights-of-way, local loop, colocation. The portal provides a transparent
view of the market, for example, carriers' current bandwidth prices per bit on
high demand routes, to help members find the "best" match. The exchange is
paid a commission or percentage per transaction. In most cases, the buyers
and sellers work out the details of the contract or negotiation. How many deals
are actually closed on each exchange remains proprietary information.
In the early stages, many carriers and service providers used online bandwidth
exchanges primarily for lead generation and market intelligence. Today, online
exchanges are launching new services such as online auctions, real-time
bandwidth trading, and Internet-protocol (IP) transit.
Since its inception in 1997, RateXchange has signed up 5,500 members and
processed 1,000 transactions, says Ross Mayfield, company founder and
president. Starting this spring, RateXchange will offer three major services: lead
generation, auctions, and since April, a real-time bandwidth exchange (RTBX)
for one-month spot and one-year forward trading of time-division multiplexing
(TDM) capacity between New York and Los Angeles. The company's first
delivery hubs (digital-access crossconnects) are located at 60 Hudson St. in
New York City and One Wilshire Blvd. in Los Angeles, both interconnection
points of hundreds of carriers. RateXchange plans to deploy delivery hubs in 10
domestic and four international cities-London, Frankfurt or Amsterdam, Hong
Kong, and Tokyo-by the end of this year. The 14 hubs will give the company
the ability to trade 91 routes, according to Mayfield.
Standardized contract
The RTBX service uses a standardized contract that carriers must agree to
before any trading takes place with credit, settlements, delivery, and billing.
The physical delivery is within 48 hours. RateXchange charges a 4%
commission split between the buyer and seller on the commodity. "The value
of it," says Mayfield, "is that as a neutral third party, we don't make buyers,
don't own a network and never will, and we don't compete against our own
customers, which means that this market is fair and open to all."
The online trading model allows large carriers to trade with smaller parties, and
in the case of RateXchange, all trading is anonymous, which eliminates
channel conflict for carriers unloading bandwidth at market-clearing rates. On
March 20, RateXchange's parent company, NetAmerica.com Corp., closed on
$32.7 million in private placement funding that will be used to speed up the
construction of its connection points. The lead investor was Quantum Partners
LDC.
Wholesale carrier bandwidth
Similarly, online bandwidth exchange the Global TeleExchange Inc. (GTX)
based in McLean, VA, is planning to build a carrier-class Asynchronous
Transfer Mode (ATM) backbone network for real-time execution and
provisioning of wholesale carrier bandwidth and minutes. GTX announced a
$25-million agreement with Lucent Technologies to build its virtual real-time
exchange (VRTX) system. The current plan is to deploy exchange points in
New York and London in the first half of 2000 and additional systems in cities
in North America, Europe, Asia, and Latin America during the second half of
this year.
The first and largest online exchange, Band-X, continues to introduce innovative
services. Band-X has 10,000 members worldwide and provides international
services. The company offers facilities-based switched minutes, point-to-point
capacity, routed IP, facilities colocation, recruitment, "dig coordination," and
reverse auction services through its Website.
Band-X's IP routing service, launched in February, allows Internet service
providers to buy IP capacity based on independent quality-of-service (QoS) and
pricing information. The service has attracted the interest of many major
carriers. Level 3 Communications, INS, Cerbernet, Abovenet, Speedport,
Nildram, and Telia are already connected, although the latter two were in the
testing stages at press time. Ebone, UUnet, Cable & Wireless, Teleglobe,
Iaxis, and several others have agreed to the service but were not yet
connected.
The suppliers and buyers interconnect to Band-X's Cisco routers near the
company's hub in London Telehouse-which is also the London Internet
Exchange. Band-X monitors connected suppliers' networks every half-hour
based on four parameters-round trip time, throughput, number of hops, and
packet loss. The QoS information is available along with market pricing on
Band-X.com. The idea is to offer carriers a low-risk and flexible way of buying
IP bandwidth, says Richard Elliott, founder and director. Buyers can select
different suppliers every month based on quality and price statistics.
Market maker
While several online exchanges are beginning to utilize a commodities trading
model, the trading model proposed by EBS, the communications unit of natural
gas and electricity utility Enron Corp.(Portland, OR), has caught the attention
of financial analysts.
In December, EBS launched a TDM bandwidth trading service between New
York and Los Angeles. Available in DS-3 (44.736-Mbit/sec), OC-3
(155.52-Mbit/sec), and OC-12 (622-Mbit/sec) units, the bandwidth is traded in
monthly increments based on three quality specifications already recognized in
the telecommunications industry--errored seconds, severely errored seconds,
and unavailable seconds. The trades are handled by a neutral third party at
pooling points in key cities. The first trade occurred in December between
Global Crossing and EBS. To date, EBS has conducted trades with other
carriers and a large Wall Street bank.
EBS offers bandwidth on-demand and peak and off-peak bandwidth; the
provisioning can take place in near real time. EBS plans to deploy a London
pooling point by mid-year and another 10 pooling points in domestic cities.
Although EBS announced plans to trade bandwidth on an IP-based route from
San Jose, CA, to Vienna, VA, last December, the company is now waiting
until hardware that will support IP metrics measurement is developed. Those
products are expected by 2001.
"We expected to see a hundred or so trades in 2000, and 2001 is the first year
we expect to see liquidity in this market," says Tom Gros, vice president of
international bandwidth trading at EBS. "This is a brick and mortar version of
commoditization," says RateXchange's Mayfield. "It is only a forward contract,
not a spot contract-there is no centralized open price discovery. The credit,
settlement, and the payment are worked out on a one-off basis for each trade."
Risk management success
The EBS trading model has been viewed favorably by analysts, however. The
company operates a physical network-EBS is deploying an 18,000-mi
IP-based fiber infrastructure-and is focusing part of its communications
business on broadband content. The biggest factor may be that Enron Corp.
has a history of proven success in risk-management. Parent Enron used a
similar risk management model to become the market leader in commodities
trading in its energy markets. According to a February report on Enron Corp.
by equity research analysts at J. P. Morgan Securities Inc. (New York), Enron
captured more than 20% of a $100-billion wholesale electricity market in
1999-a market that like bandwidth trading didn't even exist in 1996. In their
report, the J.P. Morgan analysts note the similarities between photons and
electrons: "Capacity cannot be stored, marginal cost of transmitting a bit of
data is virtually zero, and the delivery network is vast and complex. Demand for
capacity is highly volatile, unpredictable, and growing rapidly (the only point of
departure from electricity)."
J.P. Morgan Securities estimates that bandwidth intermediation (defined as
trading, risk management, and financial engineering of contracts for data
capacity) will grow to a $50-billion global market by 2005. Figure 1 shows the
forecast for the domestic market of traded data bandwidth.
In the telecommunications industry, EBS is evangelizing the concept of
bandwidth commodity trading in an effort to spur market principals to agree on
measurable benchmarks and a universal contract with standard terms and
conditions. "The key things that have to occur are for the industry to come
together and agree on a standard contract, and standard specifications," says
Gros. "The Enron proposal will provide the initial framework for discussion in
the industry."
Indeed, industry associations are beginning to act. In February, Comptel, a
telecommunications industry association representing 315 carriers and
suppliers, met with risk traders from the financial community to discuss the
development of benchmarks and standard terms and conditions for bandwidth
trading. A subgroup of 13 market principals is scheduled to meet again to
further discuss trading issues, says Gros.
EBS's closest competitor in terms of trading expertise, Williams
Communications, the communications unit of utility Williams, is also
participating in defining a market model, although according to analysts'
reports, it is not clear that the carrier has embraced the concept. In February,
Williams announced that Sharon Crow, one of the first basis traders in natural
gas and a five-year company veteran, would head its bandwidth trading effort.
"We believe that the bandwidth market will become more liquid over time,"
says Amy Latham, a company spokeswoman. "We do not currently believe
the time is right to create a spot market to trade bandwidth in the same way as
crude oil, gold, or pork bellies. The main reason for this is that bandwidth is
sold at different service levels, at different speeds, over different routes, and in
different protocols. The industry needs standards, systems, and participants
for trading to be successful."
In Williams' view, the requisite standards are common units of measurement,
classes and quality of service, premiums and discount margins, remedies for
default, credit security, pricing, and benchmarks. The systems required for
trading include the hardware and software to conduct physical and financial
trades, as well as policies, procedures, and instruments. In addition, all major
suppliers and customers would need to participate.
Over-the-counter brokers
One indication that bandwidth commodities' trading is emerging is that
over-the-counter brokers are starting to pay close attention to the bandwidth
market. Ron Banaszek, manager of the Bandwidth Markets Group at
commodity broker Sakura Dellsher Inc. (Greenwich, CT), says carriers initially
will need consulting and trading advice from intermediaries in the financial
community who have risk management experience in commodities markets.
While many in the telecommunications industry lack commodities trading
expertise, some feel that the financial community lacks an understanding of
the business needs of carriers. "The foreign-exchange brokers whose market
had disappeared are desperately searching for somewhere with little or no
experience with telecoms," says Band-X's Elliott. "They are definitely a 15th
horse in a three-horse race."
For better or worse?
Bandwidth trading exists today. Liquid commodities trading, which allows the
market to determine pricing based on supply-and-demand imbalances and
facilitates the transfer of risk with forward contracts, is in the initial stages. A
lot of work remains, however. The industry as a whole needs to move toward
standardization and the physical interconnection of communications networks
to facilitate bandwidth trading. When standardization and interconnection are in
place, and transaction volumes increase, the uncertainty associated with the
buying, leasing, and selling of today's bandwidth could be replaced with a risk
management model based on market forces. |
