"bandwidth," one of the hot buzzwords of the Information Moment -- is fast becoming a commodity
From the N. York Times:
Jumping Off the Bandwidth
Wagon
Long-Distance Carriers Regroup
By SETH SCHIESEL
n a dingy warren of cables and wires in New York
City, phone calls are starting to look a lot like pork
bellies.
There, in his cramped office above the Pulse Night
Club, Alex Mashinsky, 33, has created an electronic
trading floor for telephone service that resembles
nothing so much as the international market for
traditional commodities.
Communications
carriers from around
the world, including
giants like AT&T and
Nippon Telegraph
and Telephone, link to
the Web site for
Mashinsky's company,
Arbinet
Communications, to
trade unused
long-distance
telephone minutes
from New York to
every corner of the
globe. On Friday, a
minute to Israel sold
for as little as 8.4
cents, while a minute
to Hong Kong cost as little as 4.6 cents.
Although it is tempting to hold up Arbinet as a creator
of a new communications landscape, in fact it is only a
stark symptom of a much larger shift in the electronic
world: While consumers and regulators focus on the
communications bottleneck in the so-called last mile of
wire to homes and businesses, long-distance
communications capacity -- or "bandwidth," one of the
hot buzzwords of the Information Moment -- is fast
becoming a commodity.
Deregulation, rapid advances in optical technology and
generous capital markets have combined to create an
explosion in communications supply -- a supply that
exceeds even the surging demands in communications
unleashed by the Internet. Accordingly, long-distance
prices are falling sharply. On Friday, AT&T sold its
biggest business customers a minute of telephone time
to Israel for 35.4 cents, less than a third of the cost
three years ago, and a minute to Hong Kong for 27.2
cents, down 57 percent. The big gap between the retail
marketplace and spot markets like Arbinet's cannot last
for long.
More significantly, for the companies and investors
alike, margins in some parts of the communications
business are following suit, as long-distance bandwidth
for both telephone and data services turns from scarce
to plentiful.
The shift is driving many of the strategy reversals and
multibillion-dollar deals that have become almost
commonplace in the industry. It explains AT&T's burst
into the cable television business and the continuing,
soap-opera-like bidding war between Qwest
Communications International and Global Crossing for
the Frontier Corp. and U S West.
At the same time, the fierce competition in the
long-distance arena only highlights its relative absence
in local markets. That, in turn, reinforces the almost
overarching value of local communications networks --
and is prompting some investors to rethink their
portfolios for the digital future.
A New Profit Formula
The changes in the long-distance industry are
undermining what is perhaps the fundamental rule of
telecommunications economics -- that margins stick to
assets.
After AT&T began to face significant competition
about two decades ago, it became clear that long-term
profits in the business stemmed largely from controlling
physical assets like fiber optic lines, copper wires and
communications switches. For years, the cost of running
a network was a big part, perhaps a third or more, of
running a communications business. A major
component of making money was keeping the continuing
network costs low, and the main way to do so was to
own the network.
That is one reason Sprint emerged from a venture of the
Southern Pacific Railroad, which could use its railroad
rights-of-way to lay fiber-optic lines. It also explains
MCI's original name, Microwave Communications Inc.;
by using microwave links it had developed, MCI could
provide long-distance services for less than AT&T.
(MCI eventually built its own fiber optic network, to
help the company compete more broadly.)
Most of the hundreds of other new long-distance
companies that emerged after the 1984 breakup of
AT&T, however, leased communications capacity from
others, and few have had consistent profits and growth.
Drawing from that experience, new companies like
Qwest, Level 3 Communications, Global Crossing, IXC
Communications and the communications units of the
Williams Companies and Enron, two energy giants,
have been founded -- and financed -- on the logic that
owning physical assets was essential. Each of the
companies is building a new fiber optic long-distance
network, some in the United States and some globally.
Combined, the first three have raised or borrowed
more than $10 billion over the last three years, mainly
to build their new networks. At the same time, new
optical technologies have been expanding the capacity
of existing networks by factors of 16 and 32, with a
potential of 160.
To grasp just how much bandwidth is being created,
consider this: According to Telegeography Inc., a
research firm in Washington, in 1997 the world's public
telephone networks carried 81.8 billion minutes, or
155,632 years, worth of international phone calls. The
newest optical systems can transmit the digital
equivalent of all of those calls over a single fiber in
about 11 days.
Hence the new carriers'
predicament: Their
investments are alleviating
the very scarcity that made
their original business plans
so attractive.
The problem is not that a
glut of bandwidth has been
created. It is clear that new, bandwidth-hungry services
will fill all of the available communications pipes.
However, the big profits in the industry are migrating
away from raw bandwidth and toward the applications
that use it.
An early sign of how prices would turn volatile as
bandwidth supply played leapfrog with demand was in
the market for T-3 Internet lines, which can carry 45
million bits of digital information a second.
When they first became widely available in 1995, the
lines sometimes cost less than $20,000 a month; buyers
included corporate customers and Internet service
providers. But as the use of the Internet exploded,
demand outpaced supply, and prices shot as high as
$70,000 a month in early 1996.
Since then, however, prices have fallen consistently, by
about 10 percent a year, as new and existing carriers
have built up their networks. T-3 lines now cost about
$50,000 a month, and many in the industry expect the
trend to continue or even accelerate.
"People have been thinking about bandwidth from a
Malthusian standpoint: 'How do I ration this?"' said
Daniel Smith, chief executive of Sycamore Networks, a
communications equipment company, whose previous
business, Cascade Communications, another equipment
maker, was bought by Ascend Communications in 1997
for $3.7 billion. "And now we're saying, 'How do we
think about this from a standpoint of plenty?"'
Many of the nation's communications carriers have
come up with an answer: They need to evolve up the
digital food chain -- from mere bandwidth suppliers to
providers of advanced services -- to maintain their
profit margins in the future. They are scrambling to
acquire direct links to homes and offices -- not for the
assets per se, but because in the next century, margins
in the communications business will stick to services
and customers.
"If anything, the cost of communications is falling faster
than the cost of computing, so assume unlimited
bandwidth," said Howard Anderson, managing director
of the Yankee Group, a technology consulting firm in
Boston. In that case, he said, "you are either the
application service innovator, or you're dead meat."
Moving to Plan B
The shift has shred business plans across the industry
and helped fuel the paroxysm of takeovers reshaping
the communications landscape.
AT&T provides a classic example. Many strategic
subcurrents have been at work behind AT&T's $90
billion leap into the cable TV business, from a need to
protect its long-distance base to the simple desire to
shake the company out of a torpor. But at the root has
been a quest for sustainable profits, and the brain trust
at AT&T's headquarters in Basking Ridge, N.J.,
decided that such profits were not to be found merely in
the long-distance business.
Having a long-distance network is "a necessary, but not
sufficient, condition to succeed in the future," said
Frank Ianna, president of AT&T's network unit. Instead,
AT&T concluded that it again needed to connect
directly to its customers. "That's where there's the least
amount of competition," he explained, referring to local
markets, "and that's where you have the ability to
differentiate from your competition."
AT&T is betting that owning cable lines directly into
customers' homes will allow it to deliver interactive
television, high-speed Internet services and local phone
service -- all products that should support higher
margins than its core long-distance service.
MCI Worldcom, the No. 2 long-distance provider, after
AT&T, has almost the same philosophy, but with a
focus on serving business customers. It, too, sees its
future in services and applications, not simply
bandwidth. And it also wants to own the direct link to
the customer.
"Our story is very different from offering raw
capacity," said John W. Sidgmore, vice chairman of
MCI Worldcom.
In Worldcom's evolution from communications nobody
to industry titan over the last decade, the company's
deal to acquire MFS Communications in 1996 looks at
least as important strategically as its acquisition of
MCI last year. The MFS deal gave Worldcom not only
direct, local fiber optic links to business customers, but
also the Uunet Internet operation run by Sidgmore.
Uunet, coupled with MCI's corporate data
communications operation, is now driving MCI
Worldcom's growth, by developing the advanced data
applications, like intranets, demanded by big business
customers and delivering them worldwide.
Since MCI and Worldcom announced their merger in
the fall of 1997, telephone service revenue has dropped
from 68 to 61 percent of the combined company's
overall sales, while Internet and corporate data
services have grown from 22 percent to 30 percent. In
the first quarter of 1999, telephone service revenue
increased only 7 percent over the comparable 1998
period, while data services sales grew 30 percent and
Internet revenue 60 percent.
At Qwest, the shift in focus toward the top of the food
chain has happened in fast-forward, and some investors
have found it unsettling.
When the company first offered shares to the public in
1997, it was seen on Wall Street as a bandwidth play.
Investors expected Qwest to concentrate on using the
latest technology to build a long-distance network with
more, and cheaper, capacity than those of companies
like AT&T or MCI, letting the upstart take market share
away from slower, less-advanced competitors.
Over the last year, though, Qwest has repositioned
itself as -- surprise! -- a provider of advanced
communications services for end users. This year
alone, Qwest has announced partnerships with
companies including KPMG, BellSouth, Siebel
Systems, SAP America, Hewlett-Packard, Oracle and
Automatic Data Processing's Brokerage Services unit
to develop high-margin applications like software for
sales forces, aimed at various market segments//cut for
space.
And now, Qwest is making an unsolicited run at
acquiring Frontier, a long-distance company that also
owns Globalcenter, one of the biggest Web-hosting
concerns, and U S West, the regional Bell company
based in Denver. U S West is the slowest-growing
Bell, but it still has millions of customers, whom Qwest
needs for the new services it is developing.
Qwest is trying to wrench Frontier and U S West from
the grasp of another erstwhile bandwidth play, Global
Crossing. While both Qwest and Global Crossing have
made cases for why their deals make sense, their
sudden transformations have left some investors
scratching their heads.
"It's created confusion," said Eric Strumingher, an
analyst at Paine Webber. "Qwest and Global Crossing
have represented themselves as growth companies, as
nimble companies based on modern technology and that
had the most flexibility. Now they're attempting to
combine with a company that was not representing
itself like that, and is in fact not like that. That is the big
source of the indigestion."
Divergent Philosophies
To James Q. Crowe, perhaps the most prominent
executive still carrying the flag for the pure bandwidth
strategy, this is all tantamount to heresy.
Crowe is chief executive of Level 3,
which is building a national fiber
optic communications network
based on Internet systems and the
latest optical technology. Crowe
says he has no intention of selling
advanced services to consumers. He says that through
shrewd investments, he can sustain a technical
advantage over his competitors. That, in turn, would let
Level 3 sustain a cost advantage, enabling the company
to persist as a wholesaler of long-distance bandwidth.
"I think I can drop prices faster than anyone else can
keep up with and have margins that are sustainable,"
Crowe said. "If you can get a six- or nine-month
technical advantage over your competition, you can
have a long, long, long life."
The stock market has hardly abandoned Crowe's world
view -- shares of Level 3 are up 56 percent this year --
but others in the industry say he is ignoring the
commoditization of bandwidth at considerable peril.
"I respect Jim and I've worked with Jim, but I think he's
absolutely, completely dead wrong," Sidgmore said. "It
really is black and white. The fact of the matter is that
if you just stand back and think about it, Jim is not going
to invent any new technology. It's coming from Lucent
or Cisco. And do you think they're going to give anyone
an exclusive? If you wanted to give someone an
exclusive, it would be the company that could buy the
most product; it would be MCI Worldcom or AT&T."
But Level 3 is different from those companies -- if not
from Qwest or Global Crossing, in their original guises
-- because it has no existing customer or revenue base
to protect. That, Crowe says, will keep his company
more focused.
"History tells us that when you get bigger and bigger
and more and more vertically integrated, you break
businesses apart," Crowe said. "That's like starting a
computer company in 1980 and saying the model is
IBM." Integration is also the exact opposite of
government policy and market activity in, for example,
the power business, which is splitting into distinct
segments that generate electricity, transport it over long
distances and then deliver it to users.
Indeed, some communications experts think that
consumers will suffer as carriers seek vertical
integration -- offering advanced services as well as
raw communications pipelines -- to fight off the
margin-eroding tides of commodity pricing.
"As someone on the buying end of it, rather than the
selling end of it, I'd like the companies that provide
bandwidth to do a really good job of that rather than do
what the local telcos have done, which is bring
services into their networks," said Robert M. Metcalfe,
one of the founders of the 3Com Corp., the big data
networking company.
Metcalfe, now an industry consultant, contends that the
Bell companies, which dominate local communications,
have done a poor job of making advanced services
available to consumers, even as they try to fend off
competition.
For investors, it may not really matter who is right.
Even some people who own or recommend the stocks
of companies like Level 3 acknowledge that the pure
bandwidth strategy may not endure for the long term --
but add that many such companies will probably be
acquired in the next few years anyway, perhaps as
foreign carriers expand into the United States.
Still, some professional investors are shifting their
focus to the remaining points of scarcity in the
communications business -- local assets and expertise
in advanced services, especially on the Internet.
That is why Michael J. Mahoney, director of
telecommunications investment at Dresdner RCM
Global Investors, likes MCI Worldcom but is also
becoming more bullish about local communications
companies.
"We have a decent position on the local side," he said,
"and if anything, we're steadily growing in our affection
for the local side." Mahoney particularly likes GTE,
which is trying to merge with Bell Atlantic, and SBC,
which appears close to completing its deal to buy
Ameritech.
Mashinsky of Arbinet, the communications exchange in
New York City, watches the new world of
long-distance evolve every day on his computer screen.
To him, the shift is clear. The future is not in electronic
pork bellies; it is in the fiber optic equivalent of
processed meats.
"Over the last three years, $402 billion was invested in
telecom worldwide, and a lot of that went into
infrastructure," he said. But many of the entrepreneurs
"have not been able to fill up their networks, because
there are too many people building networks.
"So a lot of these guys are refocusing," Mashinsky
added, "and saying that if we want to retain our
margins, we have to get a hold of some customers and
add some value." |
