Industry viewpoint from EPOCH.... is this any more insightful than what anyone else is saying??
Full report at epoch.com
Epoch's Viewpoint
We do not foresee the long-term bandwidth oversupply, or "glut," now predicted
by many industry analysts. Rather, we think investors' fears concerning an
imminent bandwidth glut in the long-haul and metropolitan portions of the network
are currently being fed by broader pessimism in the financial markets. We believe
the fundamentals of large, well capitalized data-network builders remain intact.
However, not all communications services networks are built equally. Networks
based on the needs of "yesterday's" market will be hard pressed to compete
effectively against the efforts of these new data-focused network builders. We
continue to foresee a rational market for bandwidth pricing over the longer-term
that will justify network builders' current capital investments in this critical portion
of the broadband and IP data services delivery chain. The return on investment
(ROI) is likely to be higher for network builders that focus primarily on data and
have architected their networks using open standards and are continually
upgradeable.
Key Points
Bandwidth Glut Concerns Are Overblown: We believe a glut of bandwidth does
not currently exist in either the long-haul or metropolitan portions of the network.
High-Capacity Bandwidth Is not a Commodity: Data connectivity, by definition,
lacks some of the key traits that define a commodity (liquidity, accessibility, price
visibility, etc.) Market pundits have erringly associated price compression with
additional capacity, and have drawn the mistaken conclusion that bandwidth has
achieved a state of "commoditization."
Economics Will Dictate a Rational Pricing Market: Deployed fiber does not
equal operational bandwidth. The costs associated with making fiber operational
are significant. The introduction of additional capacity in the network will be
dictated by networkers'/users' return-on-investment thresholds. This economic fact
necessitates a rational market for bandwidth pricing where supply and demand
continually seesaw based on broader market forces.
Demand To Keep Pace with Supply: Evolving macro trends in networking
systems and application development, as well as in the broadband wireless and
broadband services markets will continue to drive bandwidth consumption at a
pace that will equal or surpass current capacity forecasts.
The Future of Bandwidth
We do not foresee a long-term bandwidth oversupply, or "glut," now predicted by
many industry analysts and market pundits. Rather, we believe investors' fears
concerning an imminent bandwidth glut in the long-haul and metropolitan portions
of the network are being fed by broader pessimism in the financial markets. Rather
than attempt to put forth detailed projections of future bandwidth supply and
demand (we could cite projections that support either side of the argument), we
will look at the way sentiment concerning network infrastructure builders has
evolved over the last 18 months and explain the fundamentals underlying network
providers' service value. We hope to give investors a reference point from which
they can apply their own unprejudiced analyses concerning the future market for
bandwidth and networking service providers.
Where We Came from and Where We Are
In our opinion, fears about a future bandwidth glut are central to the recent
downward turn in the public valuation of next-generation network builders such as
Level 3 Communications (LVLT), Global Crossing (GBLX), MetroMedia Fiber (MFNX),
and Williams Communications (WCG). These concerns are not unfounded. But little
thought was given to them in early 1999 when the number of Internet users was
skyrocketing, e-commerce was exploding, and both industry and research analysts
were predicting the coming of innumerable potential bandwidth-hungry Internet
applications. The crash of the Victoria's Secret fashion-show website and the
inability to download the Starr Report (whether or not these systems deficiencies
were linked to a lack of bandwidth capacity), made infrastructure builders such as
Level 3 look like saviors to public investors. In knee-jerk reaction, the public
markets poured billions of dollars into the coffers of these aggressive
infrastructure builders to support their business visions.
The recent turn in investor sentiment concerning first-generation dot-coms,
business-to-business commerce enablers, application service providers, and
voice-based competitive local exchange carriers (CLECs) have subdued this
previous unbridled enthusiasm for a bandwidth-hungry world. Network builders,
however, have continued to pursue their aggressive infrastructure deployments.
While analysts concede that the Internet is not going to go away anytime soon,
looking at the amount of money currently being spent and the infrastructure
coming online over the next 12 months, investors have become increasingly
gun-shy. The motto "build it, and they will come" has changed to "build it, and will
they come?" Such fears are not new (articles on bandwidth-glut started appearing
in late 1998), but pessimism in the industry and financial markets and increased
attention from investors and the press have fueled these fears.
Bandwidth Glut -- Throwing the Bandwidth Out with the Bath Water
We do not believe there is going to be a long-term oversupply of bandwidth. In
researching this report, we revisited much of the analysis of this subject over the
last 18 months and find it amusing that research written in early 1999 looks very
similar to research being written today. Most use trite analysis or
apples-to-oranges comparisons.
For capacity projections, most analysis simply takes the number of fiber miles
currently being deployed and assumes a certain level of capacity based on future
developments of dense wave division multiplexing (DWDM) technologies. For
demand projections, hypotheticals are used, such as assuming a throughput rate
for every U.S. household based on the size of current streaming-media files.
Usually, these hypotheticals end with a curt statement such as "with the current
capacity assumed by these fiber deployments, this would allow for 1,000 billion
streams of the TV show Charlie's Angels all at once!!!" Most cite the continual
decline in bandwidth pricing, often falsely associating the falling cost of Internet
access or DSL connectivity as evidence that bandwidth is becoming a "commodity."
Associating local access or Internet connectivity pricing with general bandwidth
pricing (i.e., price/bit per second) at the core of the network is similar to comparing
the price of oranges to orange juice -- same denominator, different product.
Secondly, declining pricing is not a defining characteristic of a commodity, as the
term is defined in economic theory. Oranges and crude oil are commodities, and
yet their prices rise and fall based on the interplay of supply and demand. At
times, producing and selling these commodities is very profitable; sometimes it is
less profitable. Commodities are defined not by the existence of continual price
decline, but by the fact that there is full visibility into their pricing (on both a
current and future basis) and that individual units can be freely exchanged without
reducing the value of the commodity. Such price visibility and market liquidity
allows for the trading of futures contracts on anticipated price movements as well
as the existence of a liquid exchange market for these commodities.
By these economic definitions, bandwidth or long-haul data transit cannot be
considered a commodity. Visibility into pricing is extremely limited, as evidenced by
the fact that most (if not all) bandwidth deals are struck behind closed doors.
Bandwidth exchanges, which make promises of creating a liquid market for raw
bandwidth or capacity across specific routes, are currently in a rudimentary stage
of development (Enron, one of the most aggressive bandwidth traders, is said to
have executed only 50 trades in the first nine months of 2000). Also, bandwidth
capacity is spotty (i.e., connectivity is as much about location as it is about
throughput). Certain routes are less transited or have fewer competitive providers
than others and are therefore more expensive. This is not the case with most
commodities, whose prices are not tied to location. Finally, and most importantly,
pricing markets for goods and services are (usually) rational. Irrationality may have
pushed Internet stocks to unreasonable levels, but for the most part, the
push-and-pull between supply and demand that enables price discovery tends to
operate in a rational fashion. That said, investors must keep in mind that
bandwidth deployed is not bandwidth available. Raw (dark) bandwidth accounts
for less than 80% of the total cost of deploying an operational network. Lighting
dark fiber requires millions of dollars in electronics (switches, routers, etc.) to
become operational. Therefore, we believe additional capacity is more likely to be
brought online as these networks reach full capacity and the capital required to
fund these build-outs is more readily available to network operators and service
providers.
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