Qwest: A New Predator on a High-Fiber Diet. 3/6/98 Gartner Group analysis
[No ASND reference. ASND win at Qwest was a significant win.]
J. Baylock
Premium Analysis
06 March 1998
Qwest is one of several new second-tier IXCs seeking to demonstrate that bigger, better
and less expensive long distance networks can be built in the late 1990s. Enterprises
fearing too much industry consolidation should take heart.
Core Topics
Networking: Network Services and Network Service Providers, Europe
Networking: Network Services and Network Service Providers, United States
Key Issue
Which network service providers will deliver the most effective interenterprise and interactive-consumer network
services?
Enterprise network managers have more than a little reason to fear that the worldwide carrier
consolidation in progress will stymie long-term declines in bandwidth pricing. Access and broadband
circuits are particularly susceptible to monopoly or oligopoly pricing dynamics; however, technical
innovations in fiber optic glass and fiber electronics based on SONET, ATM switching, and IP
gigaPOP and teraPOP routing offer hope that the entrepreneurial spirit which created the current
crop of acquisition candidates is not dead. We believe Qwest Communications has the three
requisite elements - right of way, capital and an entrepreneurial spirit - to try to exploit the exploding
demand for bandwidth. As a self-described "predator," Qwest's strategy is to build a low-cost
transport network, test an assumption that large IP networks can cost-effectively carry a variety of
traffic types, and maintain a friendly posture toward the remaining RBOCs. We believe Qwest, and
others like it (see Note 1), can exploit the exploding capacity demands of enterprises and the
Internet, and thus be justly rewarded.
Qwest Communications
Headquarters: Denver, Colo.
Web Location: www.qwest.net
Ownership: Public
Financial Data: 1997 revenue of $696.7 million (fiscal year ends Dec. 31)
Note 1
New Generation of Competitive IXCs
Digital Broadcast, St. Louis
Frontier, Rochester, N.Y.
Level-3, Denver
Qwest Communications, Denver
Williams Comm Group, Tulsa, Okla.
[All ASND customers I believe]
Related Research
ENS Research Note SPA-IPT-1357, "IP Telephony: An Application Without a Need," July 29, 1997
ENS Research Note SPA-ISP-1297, "Internet Access, the 'Free Lunch' in Telecom Reform," Feb. 19, 1997
Qwest is in four businesses. The fiber route construction business was crucial to Qwest's
development of low-cost routes, but this business is mature and will slowly decline as the 16,000
route-mile network development progresses. The fiber route construction work has provided Qwest
with a profit center from its sales of dark fiber at $1,300 to $4,000 per fiber mile vs. later-stage
costs of about $370 per fiber mile, which funds its own construction ($370 per fiber mile is the rough
cost shown on Qwest's own books). The "carriers' carrier" business, consisting of capacity sales
to other carriers, is about 40 percent of Qwest's nonconstruction revenue and we expect this will
grow as a percentage in the short term since fail-safe capacity is in demand from other carriers and
ISPs (see Note 2). Capacity swaps, such as a recent trans-Atlantic swap with Teleglobe, also help
Qwest expand its reach beyond its right of way. In switched services, Qwest has established agent
relationships for selling to residential customers and plans to continue addressing them through
channels. Of interest to enterprises is the business segment, which currently accounts for only 20
percent of nonconstruction revenue via a nascent direct channel. Due to Qwest's incomplete
network, small enterprises have been its target market, but the vendor is now moving up-market into
the Fortune 500 in advance of its physical network being completed nationally (expected 2Q99, 0.9
probability).
Note 2
Qwest Nonconstruction Revenue
Mix (estimated)
YE97 YE2000
Carriers' Carrier 40% 10%
Residential 40% 30%
Business 20% 60%
Source: GartnerGroup
Today, Qwest is deploying voice and data services on its growing base of Nortel DMS-250
switches, OC-192 (10 Gbps) SONET gear, cross-connections and the most modern glass available
(supporting eight-color WDM). Qwest recently let a contract for ATM/frame relay switches to
Hughes Network Systems. The final carrier-scale VOIP gateway contract has not been awarded
yet. The balanced emphasis on ATM and frame relay vis a vis IP is the intriguing, experimental
aspect of Qwest's strategy. On the one hand, the company will offer frame relay and ATM services
competing on price. We expect Qwest will use a 15-percent to 20-percent under-market strategy
similar to that being used for its voice services, which is enough to incent users to switch, in our
experience. On the other hand, Qwest is building as big an IP network as can be built in 1998 to
push the technology envelope and test various pricing assumptions. Cisco is the initial vendor for this
network, but Qwest's main funding source (Anschutz Corp.) has also joined the Juniper Networks
funding cabal that is challenging Cisco at the high-end of the routing market.
Qwest's most interesting experiment is VOIP services. By taking advantage of the enhanced service
provider "loophole," Qwest can grow VOIP as fast as the VOIP gateways grow since it is a
facilities-based carrier and as yet has no cannibalization concerns. We believe Qwest must execute
its "controlled demand function" plan to bring on VOIP traffic quickly, but not too quickly or it will
risk giving the technology and its own brand a bad reputation. We believe VOIP is not as mature a
technology nor as inexpensive to deploy, sell and bill as its advocates (Qwest included) believe, but
at least Qwest is positioning itself to balance traffic between circuit and packet transport as needed.
Qwest's Strategy, Strengths and Challenges
Strategy
To leverage a low-cost transport provider position to build a full portfolio of long-distance
services
To experiment with very large IP networks to test long-term cost and pricing assumptions in
the IP services markets (i.e., including voice over IP)
To maintain an "RBOC-friendly" position to keep dedicated access costs down and position
itself for an acquisition and also act as an exit strategy pending the RBOCs' unhindered
entrance into the long distance market.
Strengths
A strong balance sheet based on low-cost right of ways, construction subsidiary and capacity
swaps
Attract and retain talent with low-exercise price stock options
No installed base of services to cannibalize with aggressive pricing
New infrastructure, including Operations Support Systems (OSS) - e.g., no year 2000 issues
Enhanced service provider tariff loophole
Capacity
Challenges
No brand name
Immature direct and indirect channels
Need to build a robust data networking and OSS infrastructure
International capacity swaps are becoming rarer
Access strategy is tenuous for the large-enterprise segment
Enterprise inertia regarding carrier contracts
Need to fill a large network in a timely fashion
Acronym Key
ATM Asynchronous transfer mode
ISP Internet service provider
IXC Interexchange carrier
POP Point of presence
RBOC Regional Bell Operating Company
SONET Synchronous optical network
VOIP Voice over IP
WDM Wave division multiplexing
Bottom Line: While Qwest's carrier business is at only a $150 million annual run rate, the
foundation is being laid for a big carrier business. Enterprises should expect aggressive pricing from
Qwest will overcome its lack of a brand name and fill the network quickly, but should only start with
commodity services in 1998. Mid-1980s' rules apply - enterprises should assess Qwest's network
management systems and procedures as well as its aggressive price before signing any contracts.
Related Articles:
ENS Research Note SPA-IPT-1357, "IP Telephony: An Application Without a Need," July 29,
1997.
ENS Research Note SPA-ISP-1297, "Internet Access, the 'Free Lunch' in Telecom Reform,"
Feb. 19, 1997.
This document has been published by:
Service
Date
Document #
Enterprise Network Strategies
23 February 1998
C-03-5607
North America Network Service Providers
23 February 1998
C-03-5607
External Services Providers Government
23 February 1998
C-03-5607
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