Tuesday, May 09, 2006

Is the fall of telecomms finally at hand, or can it be averted?

The fall of the incumbent telecommunications giants has been oft-times predicted. Now it may actually be imminent and in retrospect it might have been going on since ’97. Yet there may be a way out.

The current flurry of mergers and merger rumors surrounding traditional telecommunications vendors such as Marconi, Ericsson, Lucent, Alcatel and Siemens is pointing us to a big problem in telecommunications. These companies were ready to declare themselves recovered from the post millennium downturn, or as we may refer to it: the dotcom bubble. Over the past few years they shed lots of staff, wrote off their bad-debts, and were on the road to making modest profits again. In many ways they regained the position of safe utility stocks. Now why would they choose to merge?

Merger in the case of Marconi was forced by the kiss of death from their biggest home market customer BT who left them out in the cold when handing out contracts for its ambitious 21CN project. This drove them into the arms of Ericsson. Now BT seems to be establishing the model for what ails the other companies. After announcing its milestones and chosen vendors very publicly, silence reigns now... Has anyone heard of any equipment actually being purchased by BT for 21CN? There certainly are not any announcements on BT’s corporate website nor have the vendors boasted about any actual revenue from BT.

Cash flow is the lifeblood of all industry and it is largely missing in that sector of the telecoms market related to the infrastructure vendors. That is the problem of the whole telecoms vendor community: Very few purchases are actually made, certainly not enough to keep the large vendors going. One can wonder if these companies have any resources left to do any innovation. At any rate they have lost a lot of innovative power by letting go of so many staff and have little money to pay for the next round of innovation.

The paragraph above seems strange in the light of the hype on triple-play. All the telecommunications operators are shouting at the top of their voices that this is their future. Unfortunately triple play seems to be today’s buzzword solely by elimination: They have not been able to get any other IP-based business case to work! Broadband Internet used to be the big thing until (perceived) competition drove down prices to a point where there is very little profit in offering broadband lines. It is also notable that broadband has cannibalized the dial-in market. Competition from VoIP operators is doing nothing but put pressure on the call minutes market. The likely result, flat-rate phone charges everywhere, will further erode this revenue stream, as the incumbent operators cannot force their worst customers to pay more but their best customers will flock to lower costs.

So the only way that seems to be left to the incumbent operators is the continued flight forwards – but to where? Putting all the eggs in one basket one can claim reduced costs and adding in TV and other media may add appeal to the whole bundle. To marketers it seems tempting to sell the broadband access as a loss-leader and recoup money with the services. But will this produce any new profits? Not likely. The costs of this operation are likely to be enormous and the returns are likely to be minimal.

There certainly are theoretical advantages to having one user provisioning data base and process and having all your services using the same (IP) infrastructure. But an incumbent player will see that the transition costs of this operation are likely to be enormous as it impacts virtually all processes in the company. The current triple-play plans call for an expensive upgrade to the access infrastructure. The triple-play plans also create a single-purpose access network, hampering alternative business plans for this investment.

One can make a broadband infrastructure single-purpose by making the broadband so asymmetric that one can only use the majority of the downstream bandwidth for streamed media, and that is what those ADSL2+ offerings are doing. A 24-40MB/s offering will typically have 768kb to 1Mb upstream capacity. As anyone looking in their windows network properties can see, regular web-browsing takes about 10% of upload capacity to the download capacity. So when web-browsing in an interactive way with 1Mb per second upstream we will generally see about 10Mb/s on the downstream. The remainder of the bandwidth may only be used for one-way streaming video into the home as it only needs bandwidth in one direction and thus does not compete for the already full upstream bandwidth. This single-purpose bandwidth is planned to carry the operator’s IPTV offering.

Now the operators are in for a twofold surprise:

  1. The cost of content is significant and will always be so if you are not the creator/owner of the content (e.g. Disney, Warner, BBC, Endemol).
  2. The content owners have every opportunity to go after the customers directly and thus moving around the access provider.

The packaging of service to counter media cost is exactly that faced by existing broadcasters: How much income can I generate to offset the media license costs? New successful content come along rarely, and new TV broadcast companies even more rarely. I would assume, or hope, this has already occurred to the business development people at the telcos. Which explains why despite all the press-announcements on IPtv and triple-play there has been little transfer of money. Money so sorely needed by the telco vendors.

In the mean time people are not communicating less, quite the opposite. The total volume of electronic communications, be it old-style telephony, cellular mobile communication, IP-based communication is on the rise. But with the old telco bears holding down the old fort and losing out on the new services they have to let an ever larger piece of the total communications pie to smaller or at least younger players; VoIP players, both Standards-based as well as proprietary Skype, IM companies like Google, Microsoft, Yahoo! , etc.

I like to compare the old telecos to Polar Bears, strong and all-powerful in their domain of frozen polar wasteland. However the ice-caps are melting and this leaves them with an ever shrinking domain while the rest of the world is taken over by the competition. This goes on until the ice sheet has melted completely and the bears drown.

The vendors are in the death grip from their customers, the telcos. The old vendors cannot sell to the newer players because of their product offerings and the way they and those players operate. The problem is that the telcos will generally purchase from a big company. A big company needs a steady stream of revenue to stay big and competitive. The operators are faced with diminished revenue streams need a convincing business model to invest, so they delay purchases. Where delay used to give breathing room, it does no longer have that effect. In the face of smaller competitors delay only means more revenue loss. Hence an even better business case is needed. Better business cases are generally made by newer technology. But as the technology companies are not receiving any money to fund their R&D, this is not forthcoming, and the death cycle continues.

If this cycle will be broken before the vendors kick the bucket is anyone’s guess. However I guess the chances are slim. This situation seems to have gone on for too long. Mergers will keep the management and shareholders busy for a while until they have to face the fact that there simply is not enough revenue to keep the merged company going. At this point the operators may have run out of options completely as their vendors are no longer there to help them out of their own holes and they too will have to face facts.

So with the final meltdown of the old telecoms business possibly being imminent one may wonder when it all started and what went wrong. In retrospect it might have been going on since ’97 when the Internet reached the mainstream and the possibilities of an open data infrastructure became apparent to those who got on this new superhighway.

The operators have been late to recognize the possibly offered and even later in recognizing the threats, such as rapidly diminishing revenues and market share. One can not blame the Internet for all the current telcomms troubles. Its presence set something in motion but the telecommunications industry seems to have brought much of their current ordeal upon themselves. A constant short-term view by the management combined with a lack of understanding, or common sense, has led them down this slippery path. Why has it taken over a decade to get to this point? That just proves that something with a lot of mass may take a long time to topple.

After all this doom and gloom, is there a light at the end of the tunnel? Going blindly forward I only perceive the light of the oncoming train. I do see opportunities for operators willing to stop their train and turn into another direction. But that is a subject for another time.

Paul Sijben, Sijben@eemvalley.com

Thanks to Scott Cadzow and Lennart Damm for reviewing this piece.


At 2:08 PM, Anonymous Scott Cadzow said...

Note that a review does not imply endorsement


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