THE INTERNET SHAKEOUT IS ON THE
WAY: As use of the Internet expands,
the industry must evolve in line with
economic realities, or perish
A shakeout is under way on the Internet as the free-for-all
culture of cyberspace yields to economic realities.
Consolidation is the watchword among the thousands of
businesses formed over the past few years to provide access,
network and content services on the global computer network.
Even as use of the Internet continues to expand rapidly, many
of the businesses involved in this technology revolution are
struggling to survive.
The acquisition last week of CompuServe Corp., one of the
pioneers of online information services, in a three-way deal
with WorldCom Inc. and America Online Inc. (AOL) may be
just the beginning, industry executives predict.
The deal is a ``trendsetter,'' says John Chambers, chief
executive of Cisco Systems, the leading supplier of
networking equipment for the Internet.
``If you look at the U.S. interstate highway system, you don't
see hundreds of parallel roads,'' he says.
Similarly, the information highway will not require large
numbers of duplicate services, he predicts.
Under the terms of the US$1.2-billion CompuServe deal,
WorldCom, one of the fastest-growing voice and data
communications groups in the world, will acquire
CompuServe's extensive networks as well AOL's ANS
Communications data network.
Combined with WorldCom's existing UUNet Internet
backbone, the deal will make WorldCom one of the largest
owners of high-capacity Internet data links.
Meanwhile, AOL will acquire CompuServe's 2.6 million
subscribers, consolidating its already substantial lead as the
world's largest Internet access provider.
With a combined membership of nearly 12 million, AOL also
emerges as a content superpower -- the world's biggest
reseller of online publications.
The CompuServe breakup reflects several significant Internet
industry trends:
- Leading telecommunications companies are moving in as
national and global Internet service profiders (ISP), threatening
the viability of thousands of local access services.
- Investors are beginning to put a high market value on
ownership of the Internet backbone -- the high-capacity
networks that carry the bulk of Internet traffic. While the
backbones generate little revenue from public Internet traffic,
growth in new commercial services such as private Internets
(company-wide networks called intranets or extranets, linking
companies to customers and suppliers) is strong.
- Market forces are also sorting out the vast numbers of
Internet publishers, or content providers, as a handful of the
most popular Web sites grab the lion's share of Internet
advertising revenue.
It is in the content arena that market-driven consolidation on
the Internet is most pronounced. New entrants face formidable
barriers and existing sites must spend heavily to stand out.
Only two years ago, creators of Web sites expected to gain
global recognition by word of mouth promotion.
``It was possible back then because no one big cared about
the Internet,'' says Jerry Yang of Yahoo!, an Internet navigation
service he co-founded in 1995.
With minimal marketing expenditure, Yahoo! has become one
of the best-known sites on the Internet and the company has
a market valuation of US$2.3 billion.
But the days when this was possible are long gone. With tens
of millions of sites on the Web and more being added daily,
``the threshold {cost} of making an impact on the Web keeps
on rising,'' says Stuart Skorman, chief executive of online
video retailer Reel.
As use of the Internet moves beyond early adopters, the use
of traditional media -- television and magazines -- to promote
Web sites is also becoming imperative.
``When you want to go for the mainstream, you have to go for
the mainstream media,'' says Christos Catsakos, chief
executive of E*Trade, an online stockbroker that has just
launched a US$25-million TV advertising campaign.
To attract new users to their sites, Web publishers must also
pay the gatekeepers -- navigation services and other heavily
used sites, such as Netscape Communications' home pages
-- for promotional links.
AOL, for example, stands to earn US$50 million from a deal
with CUC International in exchange for giving the discount
shopping club pride of place on its service.
Online bookstore Amazon.com has committed much of the
proceeds from its stock offering earlier this year to become a
preferred bookstore on AOL, Yahoo!, and Excite, another
navigation service.
And we are close to game over for retail startups on the
Internet, say analysts at U.S. investment bank Morgan
Stanley. It may already be too late for new entrants to make
their mark on the Internet, they suggest.
Moreover, the rules of the game are changing. Push
technology, which automatically delivers Web content to
subscribers' PCs, could further narrow the opportunities for
newcomers by encouraging readers to select a handful of
online sources for regular use.
Meanwhile, consolidation among the thousands of companies
that offer dial-up Internet access services also appears
inevitable.
Already, the ranks of small outfits with only a few hundred or a
few thousand subscribers are thinning.
As many as 90% of the approximately 4,500 ISPs in the U.S.
may disappear over the next five years, according to a recent
study by market research company Gartner Group.
In Europe too, the ISP market is consolidating. The
CompuServe deal strengthens an alliance between AOL and
German media company Bertelsmann, which jointly own AOL
Europe.
Together, they will have 1.5 million European subscribers,
overtaking the 1.4 million users of Deutsche Telekom's
T-Online service.
In Britain, which has more than 240 ISPs, ``there are far too
many small ISPs eating at the table of connection without
differentiated products,'' says Andrew Bottomley, director of
research at Durlacher, a British research firm.
Price has so far been the biggest driver of consolidation. With
the largest ISPs, including AOL, offering flat-rate access for
US$20 a month in the U.S., it is difficult for small operators to
remain competitive while covering their costs.
Differentiation is becoming the key to survival in this
commodity business, but the largest ISPs seem to have the
advantage. AT&T, the largest U.S. telecommunications
company, is expanding its Internet networks and using
technology from the telephone system to ensure instant
recovery in case of a failure.
In the consumer arena, @Home is using TV cable systems to
provide high-speed Internet access to avid users and those
who work at home.
But ``most smaller ISPs will not survive,'' says Paul Sagawa of
consultants McKinsey & Co. ``Those that do will deliver
superior service to clearly defined customer segments.''
Even as the ISP industry is consolidating, the future of
Internet backbones is in flux. These high-capacity networks
carry most long-haul Internet traffic.
In the U.S., backbone providers include WorldCom, with its
expanding networks; MCI, which is in the process of merging
with British Telecommunications; BBN, recently acquired by
telecom company GTE; Sprint; PSINet and AT&T. All have
extensive networks that overlap and interconnect at various
points.
Outside the U.S. there are several national and regional
backbones, most of which are maintained by telecom
companies such as BT, France Telecom and Deutsche
Telekom in Europe.
The legacy of the Internet's roots as a U.S. government-funded
network linking universities and government labs is still evident
among backbone providers. Most, for example, still maintain a
peering arrangement whereby they exchange traffic without
charge. None of the U.S. operations is believed to be
profitable.
However, there are signs of change. UUNet, owned by
WorldCom, announced earlier this year that it would begin
charging smaller ISPs for access to its backbone network.
If other backbone operators follow suit, the economics of the
Internet, which currently depend on a free ride on backbone
networks, could change rapidly, increasing costs.
PSINet, the U.S. pioneer of commercial Internet access, is
taking the opposite tack. This month the company announced
a plan to provide free peering access to a new high-capacity
backbone network.
``Telecommunication carriers appear to be tightening their grip
on Internet access for small ISPs,'' says William Schrader,
PSINet chairman.
``We seek to preserve an open future for the Internet.''
Altruism aside, there is no settlement system in place to
enable backbone providers to charge ISPs, or each other, for
the use of their networks.
Moreover, some backbone operators are content to take
``freeway'' traffic on their networks with the expectation of
being able to charge for special services in the future.
Telecom operators, in particular, are looking at their Internet
networks as a potential source of new revenue as
technologies progress to enable the combination of voice,
data and video communications on the Internet.
This will be the next stage in the development of the Internet,
says Chambers of Cisco.
``I don't need seven cables coming into my home -- cable TV,
satellite TV, three voice lines, {digital high-speed line} for the
computer and another line for the fax machine. All this will
soon go on to one line,'' he predicts.
The notion the Internet may eventually subsume the telephone
and broadcast networks is what is keeping the industry on its
toes. The current wave of consolidation is just the start of the
Internet industry's evolution.
*** Infomart-Online ***
North America,Canada
The Financial Post
Author: Louise Kehoe, Paul Taylor and Nicholas Denton,
Financial Times
September 18, 1997 |
