[This was published in the handbook for the ITU’s global Telecom ’99 conference]
The telecommunications market is used to continuous change, but the changes currently under way are of an unprecedented scale. Despite the massive increases in traffic from both voice and data applications, the supply of infrastructure capacity is growing at an even greater rate, with new operators being introduced alongside traditional monopolies, and an explosive technological change that has increased the traffic capacity of a single optical fibre by a factor of 3,000 over the last six years. Although liberalisation has brought a huge increase in the number of telecommunications operators (telcos) in the competitive markets, the industry has already entered a phase of consolidation that may lead to a very few huge operators dominating the global market within the next ten years.
Just on a year ago (on 27 October 1998), the London Financial Times printed two stories side-by-side about new telcos that had each, at that point, invested around US$650MM in new network infrastructure in the UK and Europe. One, Colt Telecom, had revenues of US$260MM in the previous quarter, and their shares had soared to value the company at over US$6.5Bn; the other, Ionica, had revenues of US$6.5MM in the previous quarter – later that week they went into administration and subsequently out of business altogether.
Not so long ago, there were around 200 telephone companies in the world, each a monopoly in its own area or country: now many major countries (eg UK, Germany) have many hundreds of licensed operators either building networks or reselling the networks of others. There are perhaps tens of thousands of telcos now operating in the world. However, the different fates of Colt and Ionica suggest that not all of these licensees will still be around in ten years time. So, what are the likely outcomes for operators in different parts of the market?
This paper examines the competitive pressures and likely outcomes in a number of specific market sectors:
- international telephony services
- national long-distance telephony services
- city fibre operators
- local loop: broadband cable, and wireless
- mobile: including the prospects for additional competition through UMTS
- data services
- the technical convergence between dumb ATM and smart IP as unified transport mechanisms for all of the above
The vanishing international niche
A great many of the new telcos (eg more than 250 in the UK alone) are exploiting what is undoubtedly a short-term arbitrage niche: the difference between the incumbent operator’s headline rates for international voice calls and the actual cost of delivering that traffic to distant countries.
The clearest example here can be taken from the transatlantic routes from the UK to north America: BT’s headline collection rate is around US40¢ per minute (though they would be the first to point out that customers can get up to half this discounted with option schemes & favourite numbers), whereas BT’s cost to deliver that traffic to AT&T or MCI is SDR0.04 – about US7¢ – per minute. Note that, in this case, the much-hyped Internet Voice Protocol is irrelevant: the current cost of landing Internet voice traffic in the US is in most cases higher than the actual cost to BT of landing uncompressed standard voice. Many resellers offer rates on the same route down to around US8¢ per minute – some go even lower.
On even longer routes, similar economics apply: eg for UK to Australia, the lowest cost resellers also sell minutes at US8¢ or below – and this to any caller, with no minimum fee or expenditure, purely by buying a prepaid card from a newsagent or corner shop – even lower rates are available to higher-spending customers. In the reverse direction, some major suppliers in Australia charge less for calls to the USA and UK than they do for calls to most cities within Australia.
Over the past year, there have been a number of cases of incumbents beginning to react to the loss of international call market shares by drastic changes in their headline rates: Deutsche Telekom, for example, reduced many national and international rates in February by up to 60%, while Telstra in Australia recently cut many of its international rates by more than 50%. Even though there is a rapid increase in traffic following from these huge price cuts, the smaller operators cannot easily upscale without significant investment, and hard-won market shares can be lost overnight to operators who are even 1¢ cheaper!
If the most efficient incumbent operators reduced their headline rate to cost plus, there would be very little headroom for discounters and resellers to sell at rates noticeably below that of the incumbent. Until now, the incumbents have preferred to keep margins and lose market share through a slow process of tariff rebalancing, but in almost all cases it is open to them to change this stance at any time, with regulatory controls on prices generally capping price rises, not controlling price cuts. Timescales for such a change may be very short in the most competitive markets, while in more protected markets such as India the big shifts in pricing might be in the five to seven year range.
Once the shift to cost-plus pricing is made, the international arbitrage niche is no longer open to the many thousands of current operators, and likely would be reduced to a few high-volume, low- margin players with strong international connections into many high-traffic countries.
The death of distance
Similar pressures will come to bear on those new telcos who set out their stalls on the basis of reduced rates for inland long-distance traffic, either as retailers or carriers’ carriers (wholesalers) – essentially again this is a business based on arbitrage between long-distance and local interconnection charge rates. Because of the high volume of calls and lines within major cities such as London or Sydney, local calls within these cities often pass through more than one main switching centre (double-tandem), while in rural areas there may be large numbers of long-distance calls that entirely fall within the area of only one such switch. The push by regulators everywhere for cost-based interconnect then leads to one of two long-run conclusions:
- most calls within big cities like London become long-distance, or
- the distinction between local and long-distance calls on cost grounds is lost.
The first of these being implausible, given the likely reaction of customers to such a change, the latter is inevitable, the only question is when? The answer might well be before ten years is up in the competitive markets, though as with the parallel international market discussed above, there may be longer timescales in the more protected territories. Again, some entrepreneurial operators are already anticipating this change: for example, Atlantic Telecom, a wireless local loop operator in Scotland, already offers its business customers the whole UK as a local call area.
If the arbitrage opportunities fade away, then the economics of the telecoms market tend to favour those who can carry at least one end of a call all the way to the customer on their own network, thus having no short-run incremental costs per minute on that leg of the call. This will therefore favour integrated telcos who own comprehensive network infrastructures.
Once again, the consolidation of the large number of existing long-distance telcos in competitive markets into a very few high-volume, low cost operators has to be expected within a very few years - and in the most developed markets this is already under way. Those that remain will be part of larger multi-market telcos who also own major sources and sinks of traffic: local loops, city fibre, or mobile networks.
The local loop: cable, and wireless
The big cities provide sufficient density of traffic sources and sinks to keep a number of competing local exchange carriers (CLECs) in business. The best established of these (MFS – part of MCI Worldcom - in north America and Europe, and COLT in Europe) already operate a policy of selling access to these pipes at a price low enough to not make it worth further players building further competitive networks – and that maintains the oligopoly position and hence potential profitability of these companies.
In turn these operators have used their position of strength in the major cities to maintain rapid expansion into new cities and countries, and to acquire smaller city fibre operations to extend their reach. They have also been building long-distance fibre nets to link the cities and keep more of the traffic, and more of the value chain, in their own hands. Their policies have effectively ’pre-consolidated’ this niche!
The broader market version of city fibre comes with other alternative local loop operators. As with the city fibre market, the large investment costs associated with these operations mean that there are significant first-mover advantages, and this can be compounded by local authorities and others seeking to limit the number of operators carrying out disruptive street-digging operations. There are rarely more than two or three local operators in any one geography outside the major business and financial districts, making these operations a bottleneck for origination of traffic – in fact, for any individual customer, it is unusual for there to be more than one operator with physical connection into the premises.
Given the forces set out in the previous sections of this paper, the larger long-distance and international operators are using their current high margins and cashflows to buy into the local loop. In the USA, for example, all of the major long-distance operators have been acquiring local loop operators (and vice-versa), with side forays into mobile, broadband, city fibre, and satellite operators. Many of these have been huge multi-billion-dollar deals: AT&T/TCI, AT&T/MediaOne, Bell Atlantic/GTE, SBC/Ameritech, Worldcom/MFS, Worldcom/MCI, US West/Frontier/Qwest/Global Crossing, and more … Interestingly, some of these deals have involved the integration or reintegration of previously demerged operating units, such as US West and MediaOne.
The most advanced market here is the UK, where the initial 100+ broadband cable licensees have already consolidated into only three substantial players, each covering more than 5 million homes in their franchises – CWC, NTL and Telewest. The current round of further consolidation, with NTL buying CWC, may well lead to a single company (NTL) controlling almost all of broadband cable operations in the UK. The combination of multi-channel TV and cheap telephony probably creates enough of an attraction to get the broadband operators a market share that may one day repay their enormous debts. However, the combined cable TV and telephony product has a tendency to attract mid- to low-spend telephony customers: these may be persuaded to make big use of the internet, but only if it’s very cheap! The broadband players therefore need high penetrations of homes passed to keep the creditors from the door. On the other hand, once built, these systems will always be around as a competing infrastructure: even if the original builders go under, the infrastructure will eventually end up in the hands of another operator who will not have the same debt overhang to service, and can therefore be competitive at even lower price levels. In a number of European countries with historically high cable penetration, the incumbent telcos are generally being forced by the EU to divest their huge cable operations, potentially creating a similar situation at a stroke. At the time of writing this paper, bids are being written for Deutsche Telekom’s massive cable business – by the time of the Forum, we will know what the outcome is, who has acquired this position, and whether they have indeed managed to do that without massive debt leverage!
The wireless local loop has been much touted as an alternative means to cherry-pick high end customers. The base figures look impressive: down to ca US$25 per home passed vs US$600 or more for cable. However, even US$25 per home passed combined with the less than 2% penetration achieved by Ionica after two years of operation translates into more than US$1250 per customer connected. Add the much higher cost of equipment on the customer’s premises (CPE), and the wireless operators need customers who spend considerably more than the UK average of £stg21 per month on communications to make back their investment. Being recommended by Which? as a Best Buy for pensioners (as Ionica was) is unlikely to help achieve that goal.
However, it is possible to make a profit from WLL operations. Over the same period that Ionica was spectacularly proving that not every telco idea is a good one, Atlantic Telecom was launching service across Scotland. The parallels between the two operators were strong:
- both launched initially in one region (Ionica in Anglia, Atlantic in Strathclyde) and subsequently expanded to other neighbouring regions
- both offered two lines, data access, voicemail and CLASS services
- both nominally targeted higher-spending customers
- both projected themselves as much bigger companies than they in fact were.
The distinctions between them were perhaps more important:
- Ionica packaged its service with an emphasis of price – as ”BT-15%”, with the slogan “Air is cheaper than wires”
- Atlantic sold a minimum bundle of all features, two lines, plus 600 local call minutes per month (with the whole of Scotland being defined as local), all of the messages being on the value of the bundle, not on discounting
- Ionica pushed the image of a big telco by spending big: purpose-built headquarters building, purpose-built billing and customer care systems, video wall in the network management centre (NMC), …
- Atlantic pushed the image of a big telco by marketing its name (which even before launch had people in market studies identifying as “major” and “reliable”), and by judicious spending on local TV advertising: its headquarters is an office over the shopfront in Aberdeen of its original local cable operation.
After three years of operation, both companies had very similar market shares in their original regions, but Atlantic had close to double the average expenditure per customer of Ionica, and much lower costs per customer served. Ionica was flat broke, Atlantic is expanding into England and Wales.
In sum, despite the high levels of consolidation and the plethora of new technologies, every decent-sized town can expect there to be at least three local loop operators in ten years’ time: the original incumbent local loop operator, a broadband cable operator, and a wireless local loop operator. Just exactly how many companies actually operate in different geographies will not increase the level of competition for the individual customer’s business, though the consolidation in competitors may reduce costs sufficiently to make all three viable in the longer term.
The bigger question is: how much can the future of mobile systems compete in the local fixed market?
The current main mobile network providers can fairly safely be expected to be around in ten years in some form or another, although some of the older transmission technologies may fade away. The Finns’ (and other Scandinavians’) astonishing record of 60 mobiles per hundred people and rising may be repeatable elsewhere, but revenues per customer will fall inexorably toward those of the fixed network. One result will again be consolidation. The mega-merger of Vodafone Airtouch has created the first global mobile operator: will there be more, or is it more likely that mobile operators will be reintegrated into multi-network telcos, as has begun to happen eg in Italy and Sweden, where both Telecom Italia and Telia have moved to reabsorb the mobile operations that they had previously spun off?
The newer services (UMTS and satellite phones) may have an impact here in bringing new operators to the market – the one part of the operator spectrum where this may be true. UMTS will require new alignments between telcos, fixed or mobile, and content providers/packagers, perhaps resulting in additional “operators”. For example, the current relationship between Virgin and One 2 One in the UK may pave the way for a UMTS bid.
Although new players may be enticed to enter, the advent of next generation mobile networks could still fuel further consolidation. “Everyday 50 – from just 1p a minute – it could make using your BT phone a thing of the past.” This is Orange’s strapline for their heavily promoted proposition to poach fixed line voice traffic. This may not be considered to be much of a threat at the moment by fixed telcos. However, with the advent of next generation networks which will offer more speed and capacity, there will be a compelling logic for mobile operators to increase their portfolio of “cut the cord” propositions in order to drive traffic onto their expensive new networks. This added competitive pressure could well fuel a further round of consolidation.
Even where regulators are willing to offer new entrants licences for UMTS, the high cost of entry, limited spectrum, unproven technologies, uncertain demand for 3rd generation services, and competitive disadvantage of not having cash-flow from a 2G network may limit the demand for licences. Some UMTS licence winners may have difficulty achieving economic returns and be forced to exit, either by selling the operation or returning the licence to the regulator as has happened with some of those who overbid in the personal communications systems (PCS) auctions in the USA.
The future of satellite phone consortia has been eclipsed by troubles with Iridium. Whilst there is proven demand for full geographic coverage for some specialist applications, perhaps the reality of the market place has been perceived too late by the numerous consortia attempting to launch and run satellite services.
Although the UMTS licensing may create a number of new operators in many countries, it is likely that the consolidation phase will arrive very soon after!
Data & the internet
Big consolidation moves are already under way in internet and other data service providers – and many of these are being bought by the traditional companies who were touted as the potential victims of the Data Wave: from Nortel/Bay Networks to Bertelsmann and barnes&noble.com. Many upstart (or even long-standing) service providers are being acquired by traditional telcos (or by new entrant telcos looking to broaden their base). Right now the rate of growth and the turbulence in this market are still leading to more new companies being formed than are swallowed up by acquisition or by failure – not least because currently these companies seem to be able to get further funding from many sources even if their business is an out-and-out failure with few customers & no earnings.
Interestingly, the shape of Internet service structures in individual geographies are currently sent in different directions dependent on the shape of the traditional telephony businesses. In areas where tradition has been for local calls to be bundled into the fixed charges for telephony, then the dominant mode is for a further fixed monthly fee for internet services. However, where local calls are charged for, the new dominant mode is for the internet service to be ‘free’, in fact funded by contributions from the local call charge. Since the launch of Freeserve in the UK on this basis, access to ‘free’ internet services have grown to be nearly 20% of all traffic on BT’s main network.
This major dichotomy between modes of payment for internet service is unlikely to survive, as it is already coming under pressure from both sides, with customers on each side of the divide wanting some of the benefits of the other. It is also unlikely that the unholy alliance between the (mildly anarchistic) netheads and the burgeoning commercial use of the net can continue without some realignment.
We can expect the Internet to split into two types of package:
- the Internet Classic - designed for the low-cost user, students and anyone else who’d rather wait than pay (run by enthusiasts for low or no margin)
- Internet Premier – for the business, cost-insensitive user requiring integrated voice and data services guaranteed for delivery in cycle times that make delays invisible to a human user (run by BT/AT&T, AOL, MCI Worldcom, etc, and costing much the same per minute as a ‘phone call – but see The Death of Distance above).
There is a possible third flavour arising from experiments with digital broadcasting technologies as a means of delivering internet services through the TV set to the remaining mass of users who are still resistant to computing from home. The jury is still out on these services, and likely to remain so for some time, as it is far from clear that the ‘killer application’ exists, or that this market segment is prepared to pay enough for the service to make it viable. The most interesting side debate in this part of the market is over the question of whether such services are made more or less attractive by the provision of so-called ‘walled garden’ services via interactive TV, in which specific content providers (banks, grocers, etc) subsidise the provision of interaction in return for exclusive access to the customers for specific services.
One thing seems clear – this part of the market is also likely to consolidate into a much smaller number of much bigger players over the next ten years.
The Integrated Voice, Data and Video Backbone
Current public switched network architecture leaves telecommunications companies vulnerable to attack from networks that can also deliver multiple broadband services. New technologies are poised to radically change the industry, making broadband, packet networks even more attractive to customers.
PA believes that eventually all of our telecommunications needs will be served by a single broadband packet network. Once all media is converted to packets and share this network, there will no longer be a reason to tie services to the infrastructure that carries them. The choices in pipes will therefore be simple; how fat? and, mobile or fixed?
The new networks being built today are indeed very ‘fat’: technology coming from the labs to the market this year will make it not just feasible but sensible to install 80-colour x STM256 dense wave -division multiplexing (DWDM) to fibre optics. This gives more than three terabits (that’s 3,000,000,000,000,000 bits) per second capacity on one fibre: way more than enough to carry all the traffic in the world’s busy hour on one fibre. PA knows of at least thirteen operators or consortia building pan-European fibre backbones with up to 40 fibre pairs on each route. The resulting capacity on any one route (eg Paris-Frankfurt) would enable every single citizen in Paris to simultaneously be sending streaming video to Frankfurt. This may well be approaching the nirvana of long-term excess capacity.
Science fiction from 2001: A Space Odyssey to Blade Runner to Star Trek all points to similar seamless communications infrastructures. In this future world, the network will necessarily be ‘dumb’ because communications appliances and content sources that connect to it will control the flow of data.
Every indication points to Internet Protocol (IP) as the network protocol of choice, and new telco competitors are making heavy bets that this is the case. Incumbent telcos, burdened with legacy infrastructure, have traditionally been slow to fully embrace IP, but some of the players have begun to make significant moves in this direction. For example, BT has ordered an all-IP backbone (from Nortel) for its new network in Spain, while Telstra has let a number of contracts recently for the development of a Data Mode of Operation (DMO) for the Australian network backbone.
However, the bulk of traditional incumbent telcos are still very resistant to the coming change, and continue to spend huge amounts on developing the obsolescent circuit-switched telephony network. For this reason, PA believes IP to be a threat to long-term growth in the traditional telco sector. Those incumbents that are left behind in the race to IP will likely find that the price of catching up is to lose their independence to the bigger operators who can bring economies of scale and scope together with pre-defined processes and marketing packages that will enable rapid change.
PA concludes that technical developments in almost all network infrastructures are bringing economies of scale which are larger than the theoretical (and practical) economic benefits of wider competition; in economics terms – a ‘natural monopoly’. Those who invest big and invest early, particularly in local infrastructure, gain massive advantages if they get it right.
Even if the investors get it wrong, as with Eurotunnel or the railways, the physical facilities built by any operators are likely to survive the process of consolidation – but likely in the hands of owners who bought from the receivers at less than cost (and use that to price low). The infrastructure is most likely to end up in the hands of those who already own large sources and sinks of traffic (see arguments throughout this paper) – and those operators will likely have those sources and sinks in many of the major countries and regions of the world.
The Global Oligopoly?
The techno-economic forces described are likely therefore to bring about a rapid consolidation of the currently burgeoning competition into a very limited number of high-volume, low-margin players in each market in each country. Equally likely is that each of these will form part of a transnational conglomerate / consortium or company. As in the automobile or oil markets, different operators may dominate in different fields or different countries, but plausibly only 5 to 7 such transnationals may take the lion’s share of markets across the globe. The track from hundreds of telcos to tens of thousands took perhaps 20 years: the fall back to 7 may take a lot less time!
It is an interesting question as to who these 7 operators might be. The major incumbent telcos have clearly been trying to use their massive market positions and cashflows to punt at this, but the history of the alliances, partnerships and cross investments here has not been happy. Certainly MCI Worldcom, with worldwide investments in international, long-distance, city fibre and internet markets, has a strong chance of being there. The BT/AT&T joint venture will certainly be there if it holds together. It now looks like France Telecom and Deutsche Telekom will make separate plays, though GlobalOne would be in there if it manages to mend the massive cracks. In another part of the forest, Microsoft is using its cashflows and technical position to make its own play. But what about Asia – surely players with Japanese or Chinese core investors should appear in the last 7? If not around NTT, which is breaking up just when scale looks like the name of the game, then what about Toyota, Fujitsu or Mitsubishi? What about Coca-Cola, or Citicorp? What about News Corporation, or Sony? Can Vodafone Airtouch move from global mobile to global oligopoly through wireless data and broadband wireless?
If these questions weren’t big enough, there are some even bigger questions raised when considering how these huge players might be regulated in a world where regulation is national or even regional in scope. If huge global corporations control the communications backbone of a nation, where does the power lie? If, like News Corp, the corporation is ultimately resident offshore (and exports its profits there), how can that be controlled?
The picture of the future world that we have set out in this paper may not be the eventual outcome, but governments, regulators, telcos and their customers, all need to think about the issues raised, and what they might need to do if it does come to pass.
David Roffey, PA Consulting Group , August 1999