Excellent background material from McKinsey & Co: (Sorry I could not find the URL) Note that if Airtouch/Vodafone is confident that they can sell the service to their customers, GSTRF should be okay and a buying opportunity over the next 90 days. Iridium is apparently toast.
The future of satellite communicating
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A $50 billion bet
New systems will provide the next generation of mobile phones and high-speed data networks
What could interrupt the launch?
— ANDREW L. EVANS, JOHN S. ROSE, AND RAMESH VENKATARAMAN
The McKinsey Quarterly, 1998 Number 2, pp. 7—17
Satellite communications are set to take a new direction. Almost $50 billion will be spent over the next six years on a breed of system that will take satellites out of the back room of telecommunications and into the mainstream. Supported by leading companies such as Motorola, Hughes, and Alcatel, the systems will play two main roles in telecommunications: they will support the next generation of mobile telephones that will work almost anywhere on the planet, and they will allow worldwide access to high-speed data networks, especially the Internet.
Why is this renaissance happening now? What exactly will the systems do for customers? Why are so many smart people and companies throwing such enormous amounts of capital into the sky? And what do these systems mean for terrestrial operators? These are some of the questions we aim to answer.
THE RENAISSANCE OF SATELLITE COMMUNICATIONS
Satellites have been used in telecommunications since the mid-1960s. For a decade or so, they carried the bulk of international telephone calls, which they still do on routes to small and developing countries. In addition, VSAT (very small aperture terminal) networks provide essential communications for large companies, big ships, and disaster relief. But the use of satellites on any wider scale has been ruled out by their traditional disadvantages (high cost, expensive and bulky terminal equipment, and annoying delays in voice transmission), and by advances in competing media such as undersea fiber-optic cable.
The signs now, however, are that satellites are about to emerge as a powerful force in communications, as they have already done in television broadcasting. Three factors explain why:
Technological advances are improving the price/performance ratio of satellite communications systems. Important breakthroughs are taking place in almost all aspects of satellite design, construction, and operation as the digital revolution that has affected so many other industries sweeps through satellites. These enhancements are boosting system capacity and power and consequently cutting the cost per telephone call, enabling satellites to fulfill more telecommunications functions.
Structural changes in terrestrial telecommunications are creating both the demand for satellite communications services and the environment in which they can play a useful role. On the demand side, the rapid rollout of mobile telephony services is fueling a growing desire among people to stay in touch. Even by 2000, when there will be more than 350 million cellular users worldwide, cellular networks will still cover only a fraction of the Earth's surface (Exhibit 1).
Within areas that are nominally covered, there will remain holes where services are not available. Satellites have the potential to fill these holes, and to cover vast land masses — such as Russia, the interior of the United States, Africa, and China — where populations are not dense enough to justify building cellular networks. The spectacular growth of corporate computer networks and the Internet is also boosting demand for ubiquitous and fast access, something that terrestrial networks will be unable to meet for some time.
On the supply side, deregulation is creating an environment in which new operators can compete in offering satellite services. The International Telecommunications Union estimates that by the end of 1998, about 90 percent of revenue from telecommunications services worldwide will come from deregulated markets. Thus, the traditional satellite communications industry structure, based on state-owned operators and international consortia such as Intelsat and Inmarsat, and co-funded by the world's telecommunications carriers, will no longer be the only model on which global satellite companies can be built. This structural change creates opportunities for companies other than the traditional telecommunications operators, such as Iridium, Globalstar, Hughes, and Teledesic, to participate on strictly commercial grounds, transforming the industry's clubby atmosphere.
The end of the cold war. It might seem odd to invoke an event that happened almost a decade ago as a leading driver of change in the satellite industry. Yet many next-generation satellite systems have their origins in the collapse of the Iron Curtain and the need to find commercial uses for a technology that had mainly been used for military purposes. Hardly surprising, then, that many backers of new satellite services — and many of the systems themselves — are rooted in military technology.
THE SYSTEMS
Two new types of system are in development, each of which will provide a range of innovative services (Exhibit 2).
Global mobile personal communications services (GMPCS) will offer voice, fax, low-rate data, and messaging services to mobile handsets similar to those used in today's cellular networks, anywhere on the planet. Iridium, Globalstar, and ICO are the main GMPCS systems. All are expected to be in service by early 2000.
Broadband satellite services (BSS) systems are intended to provide flexible capacity on demand for high-volume telephony, video conferencing, broadcast video, and high-speed Internet/data services. They too will operate anywhere on the planet, but use fixed or bulky portable terminals rather than mobile hand-held devices. BSS systems are still in development and will not be operational until 2001 at the earliest.
Global mobile personal communications services
The powerful global capability of GMPCS has caused some cellular operators to worry that it will lure away their most valuable business customers. Some GMPCS operators have fueled these fears by outlining strategies based on skimming the cream off the cellular market. Such concerns are misplaced, however. Satellite operators will find it difficult to compete in this way; indeed, the wisest will join forces with cellular operators to secure their cooperation.
To begin with, most of the distribution channels through which GMPCS operators would have to sell their handsets are owned, controlled, or strongly influenced by cellular operators. Infuriating them by poaching their best customers would reduce satellite companies to developing their own channels, a massive challenge given that each generation of GMPCS satellite has a limited service life (only five to seven years in Iridium's case), so that even one year's delay in establishing distribution could mean grave financial loss.
Moreover, cellular companies will probably enjoy the advantage of superior performance. Because satellites orbit so high above Earth, it will sometimes be difficult to make calls with some of the proposed systems. An individual trying to make a call in a modern building with triple-glazed windows, say, might not be able to get a line even when standing by a window. No business customer would accept such a limitation, especially when the terrestrial service works so much better. Neither would a cellular operator permit its networks to fill in for the satellite operator in such circumstances if that very operator were trying to poach its best customers.
There is another even more serious problem for satellite operators: their infrastructure is much more expensive than a terrestrial network. Customers will obviously want to use the cheapest and best option available, so they will resort to the expensive satellite network only when necessary.
For all these reasons, GMPCS operators are unlikely to try to compete head on with terrestrial cellular systems. Instead, they will aim to become adjuncts to them, filling in when customers leave the area covered by terrestrial networks.
For cellular companies, the real worry is not that they will be unable to compete with satellite operators, but that they will fail to embrace satellites' capabilities quickly enough. Despite their low call volumes, satellite networks are set to become important additions to terrestrial networks, for two reasons. First, by using dual-mode handsets that work on both cellular and satellite networks, wireless companies that enter partnerships with GMPCS operators will be able to extend their coverage to the whole of the Earth's surface. Those that do not will risk being left behind, especially in the important business segment. As many cellular operators have found, coverage is a key buying factor for many customers.
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GMPCS operators are unlikely to
try to compete head on with terrestrial
cellular systems. Instead, they will
aim to become adjuncts to them
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Second, satellite calls will be highly profitable. Cellular operators will take a cut on every call customers make when they roam on to a satellite network, just as they do when customers use a GSM network.1 These calls will be charged at premium rates but incur low marginal costs. In fact, the margins on roamed calls in the GSM world are so attractive that some operators now derive almost one-fifth of their revenue from roaming. Cellular operators should recognize this and promote the adoption of satellite roaming services in their territories. If they do so successfully, and market dual-mode handsets effectively, the profit for both sides could be considerable.
Broadband satellite services
Despite the publicity it has received, Teledesic, the 288-satellite BSS operator backed by the entrepreneur Craig McCaw (formerly of McCaw Cellular, the leading US cellular network sold to AT&T), Bill Gates, and Prince Alwaleed of Saudi Arabia is just one of nine proposed BSS systems (Exhibit 3). Most leading commercial satellite makers are backing BSS, including Hughes, Loral, Alcatel, and Motorola.
Many of the systems are still at the planning and fund-raising stage. If all were to be built, between $35 and $40 billion would be needed. Gates and McCaw have put only $10 million each into Teledesic so far, while Prince Alwaleed has invested $200 million. Even with the $100 million committed by Boeing and the recent boost from Motorola, there is a long way to go before the project reaches its funding goal of $9 to $13 billion.
The question still holding back investors is whether BSS will ever make money. While estimating demand in markets that do not yet exist is difficult, we believe there are four market segments that broadband satellites would appear ideally placed to serve, and that are likely to be large enough to be profitable:
Dedicated point-to-point connectivity. This is the provision of a temporary or permanent communications link between two fixed points, rather like the leased line services offered by telephone companies. Satellites will be competitive in specific portions of this market, including lines over large distances (where telephone operators still price by distance); lines in countries that have yet to open up their telecommunications industries and have high costs and poor service; and lines needed temporarily (for a special event, say).
Shared connectivity. BSS will be able to supply companies that require short-term links on demand for transaction-based data such as credit card validation, or that need to distribute information such as point-of-sale updates across large branch networks. In both cases, BSS systems could be competitive because their channel resources would be shared between many users.
Transport. BSS could carry, on a wholesale basis, telecommunications traffic from one part of a country to another for operators in countries where the national infrastructure is limited, and where developing terrestrial backbone networks would be expensive. Although BSS's capacity will be small compared with that of the United States' fiber-based backbone, it will be greater than many small countries can afford.
Fixed telephony. Using BSS to provide basic telephony in remote regions of the world, or in countries whose telecommunications infrastructure is underdeveloped, would be like using the proverbial sledgehammer to crack a nut. But as low Earth orbit satellites spend much of their time over countries where demand for more sophisticated services is weak, it might be better to fill them with basic low-margin telephone traffic than to leave them empty.
Together, these four segments could generate sufficient revenue to make some BSS systems economically viable, provided there are not too many competing operators.
THE INTERNET IN THE SKY
As well as the bread-and-butter markets described above, it is possible that BSS systems could earn additional income from building an “Internet in the sky.” Satellite systems may not have the necessary cost structure to serve customers seeking a fully interactive Internet service, but they could be used to distribute broadcast and pseudo-broadcast content (that is, content that is the same for the many people who access it) if this content could be sent not just to one customer, but to many customers at the same time (a point-to-multipoint distribution model).
Say you log on to the Web, and you want to check the news on CNN. You point your browser at www.cnn.com, instructing the network to send CNN's home page. You are not the only person in the world who visits the CNN Web site. In fact, there are lots of people who want to download the CNN home page, many of them at exactly the same moment as you. So instead of transmitting the page individually to each user, the satellite network instructs every computer that has asked for it to wait a second or two while it collects the requests. It then broadcasts the home page once to everyone who wants it.
Software would give each individual Web user the impression of a fully interactive service, even
though that user was actually receiving partly broadcast content. Because BSS is designed with high capacities in mind, even the most complicated Web page with extensive graphics will download at the blink of an eye.
The cost savings of moving to a point-to-multipoint model for Internet content could be substantial. But they will depend on the nature of information collectively requested from the Web (Exhibit 4).
If we were all to browse the same sites, then the savings would be huge and the cost per user next to nothing. On the other hand, if we all wanted different Web pages at different times, the savings would be negligible, and we would be better off using the telephone network, as we do today. It is difficult to predict where the economic balance will lie. In the recent past, only a few sites accounted for the bulk of Internet traffic. However, this is changing over time as our use of the Internet becomes more sophisticated.
This is all fine in principle, but will it work in practice? From a technical point of view, the answer is almost certainly yes. Many of the technical developments on which this model hinges are already under way. But there are two reasons why it might yet fail.
First, if terrestrial telecommunications operators were quickly to roll out alternative high-bandwidth access solutions such as cable modems and xDSL services, they could pre-empt the Internet in the sky. Second, we cannot know for sure whether the economics will work until the services are launched. If users' content preferences were to diverge, the eco-nomics would start to look uncertain.
WHY BACK SATELLITE?
Fifty billion dollars is a lot to invest in markets that do not yet exist, so why are investors prepared to take the risk? Five commercial and economic factors explain their motives (Exhibit 5):
As we have argued, there are plausible circumstances in which some of these systems could succeed economically. Moreover, the breakeven level for both GMPCS and BSS systems represents only a few percent of projected terrestrial telecommunications demand (Exhibit 6). Eight million subscribers does not seem much when set against the 350 million or more cellular phones that will be operating in the early years of the next century. Even though the target market may appear to be set to shrink as terrestrial systems are built out, increased cellular coverage and usage will boost demand for mobile communications, which in turn will help boost demand for satellite services. There are also many lucrative specialist areas that satellites are uniquely positioned to serve, such as the maritime, aeronautical, transcontinental trucking, and rural communications markets.
Some backers have non-monetary motives for investing. Many investors will secure exclusive service provider distribution rights in attractive geographic territories in return for their investments. Vodafone and AirTouch, for example, are backing Globalstar; both have received exclusive distribution rights for many of the territories in which they possess cellular franchises. In the previous phase of the satellite industry, service providers were highly profitable even if relatively modest in scale. Many investors expect the service provider roles for the next generation of satellites to be similarly profitable, and possibly larger.
Other backers have won lucrative equipment contracts in return for equity investments. Motorola secured contracts to design, build, and operate the entire Iridium system in return for an initial investment of $500 million. These contracts will earn Motorola about $5 billion in revenue — an excellent deal, provided the project is a success. Similarly, Qualcomm has won contracts to supply key components of the Globalstar system, while Motorola will also be one of the primary contractors to Teledesic in return for a $100 million investment.
There is an option value in participating in first-generation systems. As with other technologies, the price/performance ratio of satellites will continue to improve. Future generations of satellite systems will be able to offer even greater capacity and better service at still lower cost. Migrating the customer base from one generation to the next will be a lot easier than winning it from scratch, just as moving cellular customers from analog to digital services was less difficult than building the analog customer base in the first place. Moreover, by participating in the market, the new breed of satellite operators will learn much about what customers really want from satellite systems — knowledge that will prove invaluable as they roll out second-generation systems early in the next century.
The amounts of invested capital per investor are fairly small. The capital involved in satellite development might appear immense, but it is relatively modest compared with an estimated $250 billion a year invested in terrestrial networks. Most systems have spread their risks by syndicating capital requirements among numerous investors. For many incumbent operators, the resulting exposure of $100 to $200 million is small compared with their capital bases. If a system were to fail, few investors would suffer greatly.
THE COUNTDOWN
Satellite operators' immediate priority is to proceed smoothly to a commercial launch. This is by no means guaranteed. It still remains to overcome investors' caution about the risks of an industry that is at such an early stage of development. And there is no guarantee that enough spectrum in the appropriate frequency bands will be allocated within the timescales required, especially for GMPCS operators. Insufficient or too expensive spectrum capacity could cause an operator to fail.
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Despite the obstacles, satellites will eventually make their mark
on the way we communicate
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Neither can operating licences be taken for granted. Although telecommunications markets are being deregulated, satellite operators may have to enter partnerships and exclusive service operator distribution agreements with local compa-nies — all of which will exact a toll for their services — in order to gain service operator licences. Moreover, some smaller countries still depend on high international call charges for a large portion of their income, and are nervous about satellite services that might bypass their own networks.
But despite the obstacles, satellites will eventually make their mark on the way we communicate. Today's fixed operators must therefore consider how to embrace the satellite revolution.
Cellular operators' main challenge will be to integrate GMPCS into their own services. Some, including Vodafone, AirTouch, and Deutsche Telekom MobilNet, have already selected a satellite partner and agreed the geographic regions in which they will distribute its satellite services. For cellular operators that have yet to select a partner, the first task will be to do so, and quickly. The launch of GMPCS could raise customers' expectations of geographic coverage to the point where “anywhere on the planet” becomes the norm. Operators that cannot offer global availability will be at a disadvantage, especially in the business market.
Signing up a GMPCS partner might look straightforward — after all, there will be at least three of them — but it may prove complicated in practice because many of the agreements signed so far have granted exclusive service provider rights in return for equity investment. Cellular operators could find that their choice of GMPCS supplier is actually quite thin, or that a large equity investment in their preferred operator is required to seal a deal. It is even possible that in some markets, such master distributorships may already have been taken for all three systems. In this case, the also-rans may have to make do with a less lucrative role as second-tier distributors.
For fixed operators, the issue is less urgent, because they will be affected largely by broadband systems that will take another two years to reach commercial service. Their most important decision will be how to exploit BSS strategically. They could use BSS in several ways:
• As a component in their networks, to increase the capacity of their national backbone networks at a stroke (for developing countries), or to provide access in remote regions (for all countries).
• As a way to offer next-generation VSAT services, using the greater capacity of modern satellites to target new VSAT clients such as car dealerships, banks, and retailers, and to upgrade services to existing VSAT clients.
• As a way to enter new markets by exploiting the systems' global capabilities to bypass incumbent telephone companies in other countries, and providing consistently high service where an existing network is not up to date.
• As a way to target multinational companies, which might value global satellite systems' ability to offer excellent service and a single customer network anywhere in the world.
Whatever the uncertainties, it is a safe bet that terrestrial operators that fail to take advantage of current satellite developments will be ruling out future business opportunities. For just as we regard satellite television as a natural alternative to cable and terrestrial broadcasting, so we will come to view satellite communications as obvious facilitators of our telecommunications needs.
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Notes
Andy Evans, formerly a consultant in McKinsey's London office, is vice-president of strategy and marketing at FLAG Telecom; John Rose is a director and Ramesh Venkataraman is a principal in the New York office. Copyright © 1998 McKinsey & Company. All rights reserved.
We would like to acknowledge the contributions of Chris Munnelly and Carlos Kirjner to this article.
1. GSM is a major international cellular standard that has so far been adopted in more than 100 countries across the globe. One of its key features is that it allows customers to “roam” onto other countries' networks when they travel abroad.
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