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Is Telecom Overbuilt?
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The straight
story on supply and demand.
By Holly Logan
There are 39 million miles of fiber optic strands buried across
the United States. Yet only 20 percent of those strands along the
busiest routes are actually lit.1 Does this mean the limping telecom
industry is faced with ominous overcapacity issues? Not necessarily.
Perhaps an historical perspective is in order. The American telegraph
system was unprofitable for its first 15 years in operation. It
wasn’t until its ultimate use was explored —managing the railroad
system—that it became a thriving venture. Consider, too, the railroad
industry at the end of the 19th Century. Most of the rail built
west of the Missouri River was constructed in advance of demand.
But along the way, cities and hence, businesses were built, resulting
in economic gain for society.
Back in the present, the industry dynamics that may explain what
looks like oversupply are as follows:
- Cost
of entry is expensive. It is standard for carriers to
lay 10 to 20 years of fiber in the ground each time they
build a physical network
- Some
estimates are that capacity levels lead demand by 30%
to 50% to avoid strains on systems and long waiting times
for customers
- For
bandwidth users, excess slack is needed for unexpected
demands in data traffic, network recovery and redundancy
- Large
players à la Global Crossing and Qwest mitigated overcapacity
by putting more fiber in the ground than demand dictated.
They’d sell off over capacity to other players to cover
construction costs up front
- Internet
penetration in the U.S. is 59.8%, leaving 40.2% of unwired
potential (Nielsen/NetRatings)
- Household
broadband penetration is 9%, leaving vast potential here
as well (Spring 2001 Ownership Report from Statistical
Research)
- There
are 118.3 million wireless customers in the United States,
or about 42%. (The Cellular Telecommunications & Internet
Association) In some countries, this figure exceeds 90%.
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Clearly, the
infrastructure and constructed cable available today is not all
for naught. But the question remains “When will supply and demand
be in line with one another? Or perhaps more appropriately, what
events will lead to this alignment?”
According to a September study published by Tulsa-based TeleChoice,
Inc., if the number of businesses using the Internet increases by
20% per year and Ethernet adoption increases 5.5% per year, then
all fiber optic capacity in the U.S. will be used. Some observers
comment that in light of current economic conditions, this scenario
is unlikely.
Another view is presented by Assistant Professor Patrick Moreton
of Organization and Strategy at Washington University’s Olin School
of Business. Professor Moreton’s specific research interests include
competition in telecommunications and new technologies, price discrimination
and product bundling. “This country has a rich media environment.
Much of the information currently on paper can be moved to the Internet—news,
and the yellow pages (for example). True, the existing paper-based
technologies meet existing needs, but the Internet is just a more
economically efficient way to solve these needs. This migration
to the Internet will take bandwidth and hence will utilize some
of the excess capacity.”
Price elasticity also plays a role in consumption. According to
a report from Washington, D.C. research group TeleGeography, among
companies provisioning Internet services, for every 50% fall in
the price of bandwidth, some ISPs are purchasing 100% additional
capacity.
WHAT OVERCAPACITY?
When you say the word “overcapacity” to local sources interviewed
for this article, the qualifier is exactly what segment of
telecom you mean. “Is there a glut in long-haul and intermediate
distance capacity? Absolutely,” asserts David Solomon, chairman
and CEO of NuVox, formerly Gabriel Communications. “But where the
real opportunities lie are for the CLECs (competitive local exchange
carriers) who offer premium service to small- to medium-sized customers,
which we define as anywhere from three to 125 employees. That describes
more than 50% of the companies in America today. Gabriel was founded
on the premise that fiber in the ground was becoming more plentiful.
But missing in the value chain was world-class service built around
offering high quality telephony service, broadband access and bandwidth
that can accommodate data needs. We concentrate on the service and
sales aspect, and purchase last mile connectivity when needed from
ILECs (incumbent local exchange carriers). With this as a business
model, our customers get a better product at a lower cost, and one
bill from one vendor.” NuVox (the new name is Latin for “new voice,”
the product of a merger with Trivergent last November) serves 30
U.S. markets with this model, and has annualized revenue growth
since January 2001 of 137%.
“The demand for most services is strong and steady,” adds Chris
Altvater, president of 11-year-old FiberNet, an independent telecom
rep that sells consulting services and products from NuVox, XO,
Nextel, AT&T Qwest, McLeod, Sprint PCS and Voicestream. “FiberNet
targets the small- to medium-size business. Demand for high-speed
Internet has been growing. A year ago, 128k sounded pretty good.
But now anything between 256K-512K is the entry point for integrated
customers. To illustrate, a T1 could cost about $1,000 to $1,200
a month. Somewhere between dial-up and T1 is that 256K-512K range
that could run $79 a month.” A bundled, cost effective offering
from FiberNet is 5 to 20 lines of voice, a T1 and high-speed Internet.
PRICING
As more fiber is lit and companies get closer to recouping high
initial costs, pricing may act accordingly. According to Joe Laszlo,
broadband analyst with Jupiter MediaMetrix, in countries with high-speed
Internet access available nationwide, such as South Korea, prices
are $20 to $25 per month for broadband, compared with $40 here.
Laszlo estimates prices will drop dramatically here in 2002 to 2003
as networks are upgraded and competitors enter the market.
On the other hand, local phone service is likely to show less reactivity
from new competition. Even though cable operators such as Cox and
AT&T Broadband are able to provide local phone service, they’re
still reliant on last mile twisted pairs going directly to the consumer’s
home. For this, they have to lease access to the legacy lines laid
by the Baby Bells.
If pricing in telecom services is driven by the laws of supply and
demand, don’t expect radical change. “Within telecom, there’s a
correction going on in supply and demand,” says NuVox’s Solomon.
“But telecom needs have slowed commensurately with the economy.”
ECONOMIC VS. SOCIETAL GAINS
Getting back to the railroad example, while the U.S. borrowed European
money to build the rail system, the railroad ultimately went bankrupt.
We were left with solid infrastructure, but the original bondholder
didn’t do so well, relates Professor Moreton. “Telecom is a good
thing for economic development as long as everyone recognizes that
for now, accounting profits may be short term,” he qualifies.
On the investor side, there are winners and losers alike, says Randall
Grigg, managing director of DecisionPoint International, an investment
bank focusing on mergers and acquisitions. “This is a classic case
of supply and demand getting out of whack. Supply took off without
good, solid business fundamentals, and society has reaped the benefits
of getting the infrastructure in place. But as the IPO activity
and cash raised for the past four years illustrates (see related
chart on page 42), the returns on those investments have waned.
The problem is there’s no longer a viable IPO market for investors
who want to exit. You have a tremendous amount of venture investment
locked up, and many companies going bankrupt. The implication is
that these investors will lose everything.” To get the personal
investors off the sidelines, Grigg says that broad economic recovery
and the end of the consolidations, bankruptcies and layoffs will
be needed. He adds that regarding the September 11th disasters,
history has indicated that increased military spending can result
in technological innovations and gains in the telecom sector.
WHO’S STILL STANDING?
With the telecom industry in contraction mode, what will determine
which providers survive? Professor Moreton sees some first mover
advantage. “If first also means biggest, then the first movers will
have the lower average costs, and lower costs are what will matter
in a business with few opportunities for product differentiation.”
From the financial perspective, Grigg indicates that sound capital
structure, cost containment, focus on ROI, professional management
teams, the ability to execute on an intelligent business plan and
traction with customers will be the bailiwick of the fittest.
Solomon adds that serving a real customer, delivering premium
service, focusing on a niche and solid management are NuVox’s blueprint
for growth. “People in the telecom industry in St. Louis understand
this business,” he says referencing the long standing SBC and GTE
pres-ence in the region, as well as the dearth of new companies.
“There’s a great knowledge base in St. Louis.”
1The process of “lighting” a network involves installing
switchers, routers and other equipment needed to run it.
Holly Logan is a St. Louis-based free-lance writer who recently
relocated from New York City. |
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