5/98 tele.com article. Stuck in the Middle [Info about ASND PSINet modem sales]
Excerpts: ""UUNet now has over 300,000 dial-up ports and is adding over 100,000 ports per quarter. "Every single time we turn around we seem to be adding more ports than before," Boast says."
"PSINet recently ordered 50,000 modems from Ascend Communications Inc. (Alameda, Calif.) and expects to expand its count another 50 percent over the next few months, Kraft says."
teledotcom.com
The consumer ISP market is splitting into
wholesale and retail, with local and
long-distance providers struggling to find
their place in between.
By Anne Zieger
Anne Zieger is a freelance writer based in Gaithersburg,
Md. She can be reached over the Internet at
azieger@erols.com.
In some industries, might makes right. That's been the case in
the data networking business, which calls for huge capital
outlays for equipment on a 15- to 30-year life cycle. Upstart
companies hoping to capture a share of this juicy market must
contend with the behemoths, including the long-distance
carriers and multinational
stalwarts like IBM Global Services, which operates a vast
private network.
The Internet service provider business was supposed to work
the same way. Conventional wisdom held that only ISPs that
"vertically integrated"--providing the entire ISP package from
network to marketing to tech support--could achieve low
enough costs to stay in business. Even if smaller companies did
get a foothold, the argument ran, they could never beat the
telephone companies to the consumer dollar, given the telcos'
formidable marketing muscle and their long-term relationships
with those customers.
It turns out that vertical integration hasn't helped the big
providers get established in the Internet market after all. Selling
consumer Internet services isn't easy, even for companies rich
in networking strength and flush with cash. Most of the big
established providers have turned in a lackluster performance
in attracting customers to their consumer Internet service
offerings.
Telcos and long-distance providers have worked hard to
duplicate the market share they enjoy in the telephony world,
but they haven't succeeded.
"The telcos have tried to vertically integrate, but it's hard to do
if you have the costs that they have," says Daniel Taylor,
managing director of telecommunications research for the
Aberdeen Group Inc. consultancy (Boston). "They're trying to
recoup an incredibly high overhead structure, and they can't
support it."
Future tense
Internet service provider annual revenues could hit $7 billion to
$8 billion over the next few years, according to estimates by
several industry analysts. While those figures don't add up to
much for telecommunications giants, they're very concerned
about what will happen down the line, when packet-based
networking may edge out circuit-switched networking as the
standard for the public network (see "Who Knows?").
They're keeping an especially wary eye on IP-based voice services, which are projected to siphon $63 billion away from
the conventional telephony market by 2002, according to
research firm Killen & Associates (Palo Alto, Calif.). Virtual
private networks, Internet faxing, and other advanced
applications, meanwhile, are becoming increasingly important.
As Internet technologies take on a more critical role in the
networking business, carriers are struggling to establish a
position in all of the important IP niches. In theory, carrier
ISPs should have little trouble winning over consumers. For
one thing, the carriers have extraordinary reach into U.S.
households, as much as 97 percent in the case of some local
service providers. In reality, though, it has taken a battery of
acquisitions, partnerships, and retrenchments to establish them
as volume players in the consumer Internet world.
Over the past two years, several local providers and all three
of the major long-distance companies--AT&T, MCI
Communications Corp., and Sprint Corp.--tossed their hats
into the consumer Internet ring. They played alongside a
handful of national and regional facilities-based players, such
as PSINet Inc. (Herndon, Va.) and Netcom On-Line
Communication Services Inc. (San Jose, Calif.).
It didn't take too long for the facilities-based players to
become disenchanted with their progress. PSINet dropped
out of the consumer market completely, handing off its Pipeline
service to MindSpring Enterprises Inc. (Atlanta). America
Online Inc. (Dulles, Va.) exchanged networking subsidiary
ANS Communications (Elmsford, N.Y.) for $175 million plus
the consumer customer base of CompuServe Inc. (Columbus,
Ohio). More recently, Sprint handed over its 130,000 Internet
Passport subscribers in exchange for a 30 percent stake in
EarthLink Network Inc. (Pasadena, Calif.), while rival
long-distance giant MCI struck a deal selling subscriptions
under the Yahoo! Inc. (Santa Clara, Calif.) brand.
Despite their economies of scale, the facilities-based players
haven't turned in a stellar performance. Even the carriers, with
strong consumer relationships in hand, haven't burned up the
track. AT&T WorldNet Services (Bridgewater, N.J.),
perhaps the biggest success in the carrier-based ISP market,
has garnered only about 1.1 million customers over the past
two years. That's not bad by Internet standards, but it pales in
comparison to the carrier's performance in its established
businesses. "AT&T's long-distance service has more churn in
a week than the number of customers it has for WorldNet,"
Taylor says. "By telephony standards, it's not much."
Shifting energies
While the carrier-based ISPs struggle, another group of
facilities-based providers has shifted their energies into
reselling ports and bandwidth to smaller ISPs. They may be
following the lead provided by the long-distance market,
where resellers are playing an increasingly important role.
Over the past decade, resellers and alternative providers of
telecommunications services have more than doubled their
share of the consumer portion of the long-distance market,
from 7.1 percent in 1988 to 17.8 percent in 1997, according
to market watchers at The Yankee Group (Boston).
Long-distance churn is at an all-time high, with 25.3 percent of
U.S. households having switched carriers in 1997, according
to The Yankee Group.
Some facilities-based ISPs have had their sights set on the
wholesale market from early on in the game. UUNet
Technologies Inc. (Fairfax, Va.) planned to resell its services
to other ISPs "basically from day one," according to Dave
Boast, vice president of dial access. Three and a half years
ago, UUNet began ramping up the number of dial-up ports
available to ISP customers, kicked off by a major reseller deal
with Microsoft Network (Redmond, Wash.).
At the time, UUNet began adding 5,000 ports per quarter,
both to meet the Microsoft demand and to prepare for the
future. Today, the WorldCom Inc. subsidiary has 60 reseller
customers, including Microsoft, EarthLink, and America
Online. UUNet now has over 300,000 dial-up ports and is adding over 100,000 ports per quarter. "Every single time we
turn around we seem to be adding more ports than before,"
Boast says.
Waste not, want not
PSINet kicked off its wholesale dial-up business in July 1996,
after it traded off the consumer business to MindSpring. "The
network was built and sitting there 24 hours a day, but the
commercial usage was during business hours," notes John
Kraft, vice president of carrier and ISP services, who came
over from MCI to jump-start PSINet's dial business. "Why let
the network sit unutilized?" PSINet wholesales its network to
71 ISPs, including EarthLink, WebTV Networks Inc. (Palo
Alto, Calif.), and Flash.Net (Dallas). That business represents
700,000 dial-up users. PSINet recently ordered 50,000
modems from Ascend Communications Inc. (Alameda, Calif.)
and expects to expand its count another 50 percent over the next few months, Kraft says.
The success of these wholesalers is reflected in the fact that
competitors are joining the market in droves. Last month, GTE
Internetworking (Irving, Texas) kicked off an ISP wholesale
program called DiaLinx, under which the company will resell
its national dial-up network to companies like MindSpring.
Another national networking company that has gone wholesale
with a consumer ISP-friendly option is Apex Global
Information Services Inc. (AGIS, Dearborn, Mich.). In March
AGIS kicked off InterDial, a dial-up product targeted at
corporations and ISPs.
All told, there are more than 100 ISPs wholesaling their
networks today, says Taylor of Aberdeen Group. "The resale
business is going to keep growing," he says. "Why look at the
Internet as any different than telephony? It's
telecommunications--whether you're selling voice is almost
irrelevant."
The wholesalers are pinning their hopes on the growth of
companies like MindSpring, one of the early winners in a
business where profits have proven virtually nonexistent.
MindSpring, which posted its first quarterly income this past
December--a before-tax profit of $498,000--owns only a
fraction of its infrastructure (see "The $500,000 Question,"
Financial Track, April 1998). The ISP has built its own
network in the Southeast, a point of presence in New York
City, and two "mega-POPs" in California. MindSpring buys
the rest of its connectivity through PSINet, WorldCom's
GRIDNet International subsidiary, and GTE Internetworking.
Mix and match
By owning just a portion of its network, MindSpring can
operate much more efficiently than if it had to build out as its
enrollment grows, says Mike McQuary, president and chief
operating officer. "By using third-party providers, we can do
the build vs. buy decisions on a city-by-city basis," McQuary
explains. "If we can make better margins with a third-party
provider, we'll let that party have the business. At the point
where we can make better margins ourselves, we go out and
build. Our adage is, 'If you can't beat 'em, use 'em.' "
Because MindSpring doesn't need to focus on networking
decisions, staffers have more time to cultivate relationships
with consumers. The company spends an average of $35 to
acquire a subscriber, undercutting telcos significantly,
McQuary notes.
While MindSpring can't begin to touch the telcos' marketing
budget, it doesn't have to do so to keep growing its business.
Instead, it builds business through word-of-mouth
recommendations and one-to-one marketing. "From our
perspective, a lot of the best marketing takes place very close
to the ground, where you can get out and talk to people about
the Internet and what your service is," McQuary says.
"Facilities-based ISPs have advantages on the mass-market
front, but we're able to exceed what they do on the local
front."
Bigger prizes?
While resellers have grown their market dramatically,
integrated carrier ISPs have been stuck in neutral, neither
shifting into serious reseller mode nor pursuing the emerging IP
markets at full tilt. As sexy as the Internet market may be,
carriers are fighting for a much bigger prize--the future of the
almost $200 billion domestic long-distance and local services
markets.
Shaken loose by the Telecommunications Act of 1996, the
already cutthroat competition in the U.S. market has grown
even more frenzied, spawning a new wave of consolidation.
Despite the carriers' existing strengths in data networking,
they're too busy with other tasks to wrestle for a still-emerging
chunk of an immature market.
Take MCI, for example. One of the pioneering backbone
operators, MCI's data, Internet, and IT services now account
for nearly a quarter of its $19.7 billion in annual revenue. At
the same time, though, the carrier is in a critical phase of the
megamerger with WorldCom, an immense deal whose
complexity will occupy executives until at least midyear.
In the meantime, MCI has effectively turned over the keys to
Yahoo!, one of the earliest and arguably best-known brands in
the consumer Internet world. The new product, Yahoo!
Online Powered by MCI Internet, sells for $14.95 a month
initially and stays at that rate if the consumer goes with MCI's
long-distance service.
Sprint, for its part, is preoccupied with the rollout of its
billion-dollar PCS service to the top 100 U.S. markets, not to
mention key alliances with European telcos. "We had two
unbelievable growth areas with significant potential and
absorption of losses, and we'd maximized our investments in
those two markets," says Jim Dodd, vice president of Internet
services at Sprint.
Although Sprint the network carrier has some significant
financial advantages, Sprint the ISP marketer may have fewer,
concedes Dodd. "Owning networks and a lot of facilities can
be a significant advantage if you can get to a certain scale and
get a lot of customers on a national basis," Dodd says. "But a
consumer today doesn't see a compelling difference in a
company that owns facilities unless there's a really strong
difference in performance, technical support, and uptime."
That's where the deal with EarthLink comes in. EarthLink is
12 to 18 months ahead of Sprint in the development of
important consumer applications such as personal home
pages, multiple e-mail accounts, and streamlined software,
making connections extra-simple, according to Dodd. "When
the mass of consumers come in, in addition to the Sprint brand
you've got to have a set of services that makes you better than
the other phone companies and the other pure technology
companies," Dodd explains. "EarthLink gives us that
capability."
Forging ahead
Although things have been tough for carrier-backed ISPs, it's
far too soon to count them out. The carriers aren't planning to
drop out of a market with such a promising future, and they
certainly haven't run out of tricks. "The telcos were late in the
game, but we clearly see that they're catching up now," says
Julia Pickar, an industry analyst with Zona Research Inc.
(Redwood City, Calif.). "The evidence I see is that they're
getting wiser in the business and enriching their offerings,
folding Internet provision into regular telephony provision and
offering one-stop shopping deals."
AT&T WorldNet, for example, has refined its flat-rate,
$19.95 a month service, capping that all-you-can-eat service
at 150 hours a month. Around the same time, the company
announced the AT&T OneRate plan, offering discounted
long-distance service to consumers enrolled in WorldNet.
To build subscriber volume further, WorldNet has struck deals
with more than 150 partners, including educational software
and game developers, hardware manufacturers, and scores of
other independent software vendors. Those independent
developers include Netscape Communications Corp.
(Mountain View, Calif.) and Microsoft Corp.
"One of the things that we've tried to do is not to use
traditional channels," says Tom Shoemaker, vice president of
product marketing for WorldNet. "We're not just picking one
partner and putting all of our eggs in one basket. We've tried
to understand the dynamics of the marketplace."
Efforts like AT&T's aren't likely to bear fruit until the great
wave of consumer Internet acceptance crests, analysts say.
But when that happens, ISPs backed by big-name carriers
should develop a commanding lead, some market watchers
contend.
"The fact is, telcos are mass-market companies, and they're
used to selling to 100 percent of a market," says Boyd
Peterson, a telecommunications analyst with The Yankee
Group. "When you start talking about a mass application,
that's where phone companies will have a leg up. Phone
companies are going to have a lot more success with your
aunt."
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