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TeleChoice Analysis: TeleChoice has published numerous books and white papers that focus on the information needs of service providers, and new categories of technologies and solutions. Additionally, several TeleChoice executives contribute articles in leading business and industry publications.

TeleChoice - TeleSparks

On occasion, we will share with our friends throughout the industry our views on major events and issues in the telecom industry.
We will use TeleSparks as the primary vehicle for sharing these (usually highly opinionated) views and we welcome your feedback.

TeleSparks is authored by Danny Briere, TeleChoice Chief ExecutiveOfficer, with input from others throughout the TeleChoice organization.

To subscribe to TeleChoice TeleSparks and Digest, tell your friends and colleagues to email join-TeleSparks@list.telechoice.com with "JOIN" in the subject of themessage.

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TeleSparks Archive

TeleChoice TeleSparks - Industry Rx

+=+=+The News+=+=+

On October 10, ICG emerged from Chapter 11 bankruptcy. 
On October 15, Williams Communications (re-christened 
WilTel) emerged from Chapter 11. McLeod, Covad, and 
others have previously emerged from bankruptcy. XO,
Global Crossing, 360 Networks and others appear 
headed for emergence. Worldcom seems confident of its 
ability to emerge, although clearly many oppose that move.


+=+=+The TeleChoice Take+=+=+

No part of the telecom industry will recover until the carrier 
segment recovers. There’s a painful three-step treatment 
process required for the carrier industry to recover:

1. Carriers must restructure their balance sheets.
2. Carriers must consolidate down to reasonably 
few players.
3. Carriers must learn to offer profitable data services.

Until this process is complete, the entire industry 
will continue to suffer almost unbearable pain.

The Diagnosis
Regular readers of this newsletter know that we believe the 
industry’s ills have been misdiagnosed as a fiber glut. The 
real problem is a company glut - too many carriers 
competing for the business of too few customers, and the 
related overspending required to establish these 
companies and their networks. There’s a second disease 
which can’t successfully be treated until the first is 
eradicated, which is carriers’ continued failure to structure 
data services to be profitable.

Free Market Optimism - an Unhealthy Lifestyle 
We can easily trace the onset of problems back to 
1995. In that year, two major forces converged to create 
unbridled optimism and the launching (and funding) of 
hundreds of new telecom companies. 

The first force was the Internet. In 1995, the Internet as a mass
market medium was validated by the entry of Microsoft with 
the free Internet Explorer browser, and AT&T with the first 
consumer-oriented flat-rate dialup Internet offer. This of course 
led to the Internet boom, the training of the American populace 
to use networks for everything from academic research to 
buying bobble-heads to habitually stealing licensed 
commercial music. It, of course, led to "insatiable" demand for 
network capacity.

The second force was competition. In 1995, it became clear 
that Congress would pass legislation to open monopoly local 
telecom markets to competition in exchange for freeing the 
Bells to compete in long distance. Although that Telecom Act 
didn’t become law until 1996, the funding of new competitors to 
the Bells began in earnest in 1995.

Americans’ love for our free market economy is a beautiful thing. 
Our embracing of competition, our belief in the ability of the 
"little guy" to overcome seemingly insurmountable odds is noble. 
Our desire to join in the hunt, to put our own savings at risk to help 
fund innovation and competitive solutions has helped drive this 
country to its technological and economic leadership position. 
However, in this case, our optimism, our love and our cash 
funded irrational behaviors that will continue to cause pain and 
decay for at least a few years yet to come.

What did we do wrong?
In overly simplistic terms, we can think of the carrier/service 
provider industry in two parts. The carrier part is all about 
operating networks. The service provider part is all about 
offering services to end customers. There are fundamental 
economic laws that come to bear in each of these segments 
that we all completely ignored.

The carrier business, as with most asset-intensive 
businesses, is an economies-of-scale business. The cost of 
building out a network is relatively high. The baseline costs of 
operating a network (24x7 network operations center, 
interconnect agreements with other carriers, etc.) are also 
relatively high. To operate profitably, carriers must have 
enough traffic on their network to amortize those costs across 
enough units of capacity that the cost per unit is low enough to 
be competitively sold at a profitable price. In simple terms, 
this means that a carrier must have some minimum threshold 
of revenue (which can also be measured in market share) to 
cover all of its fixed costs plus all of its incremental (tied to 
number of customers, number of units sold) costs. Historically, 
this minimum market share threshold has been in the 10-20% 
range. With the price declines of the past couple of years, this 
threshold actually rises and is likely at or above 20% today.

Conversely, the service provider business, as with most 
customer-centric businesses, is an economies-of-scope 
business. The cost of acquiring a customer is relatively high. 
And the cost of supporting that customer (customer service, 
billing, collections, etc.) is relatively high. In overly simplistic 
terms, to be profitable, you need to collect more money from 
customers than you spend to provide service to those 
customers. At the low end of the market, consumers have 
well-defined finite telecom budgets, so your costs per 
customer must be similarly limited. In practice, this really 
can only be achieved when basic costs (brand-building, 
billing system operations, customer service operations, etc.) 
can be spread across millions of customers. Mathematically, 
there’s only room for a small number of such competitors. At 
the high end of the market, enterprise telecom/datacom 
budgets are high, but so is the cost of winning and supporting 
these highly sought customers. In practice, this means that to 
profitably serve these customers you need to capture a very large 
share of their telecom spending - which practically means that you 
have to have a very broad portfolio of services and solutions that 
meet these customers’ needs.

Unfortunately, we lost sight of these realities in the booming 
late-1990’s. We funded too many carriers and we funded too 
many service providers. Specifically, although TeleChoice 
believes that the right amount of fiber was constructed, it was 
built by too many companies. 
Our initial mistake fueled further damages. These new entrant 
players weren’t naive or stupid. They realized that their 
survival depended on their ability to win customers and 
revenue. With the glut of competitors, none of whom had 
time to establish true differentiating capabilities, the only 
way to compete was on price. In short, the irrational pricing 
declines we’ve seen in the telecom industry haven’t been 
caused by a glut of capacity, but rather by a glut of 
competitors.

What’s the Cure?
In very simple terms, to fix the industry, we first need to 
eradicate two fundamental problems:

- We need to wipe out the overspending from our system. 
More clearly, we need to eliminate from the industry cost 
model the money that was wasted in establishing too many 
competitors and building too many separate networks. 
Unfortunately, for those of us who participated in funding 
these companies, that means writing off our mistakes. 
These companies were funded through a combination 
of debt and equity. By its nature, equity is a higher risk 
form of funding (for which we, as investors, expected a 
higher return) than debt financing, so as this "wiping out" 
(euphemistically called balance sheet restructuring - but 
most often accomplished through Chapter 11 bankruptcy) 
happens, shareholders will often be left with nothing while 
creditors are left with pennies on the dollar. Until this excess 
cost is wiped from the system, consolidation likely cannot occur.

- With balance sheet restructuring, some companies may be 
able to redefine themselves as niche players with modest 
revenue and market objectives, but this will require behavior 
changes which will be difficult for many to swallow.

- We need to reduce the number of broad market 
competitors to a number that can sustain profitable levels of 
market share and revenue. This could potentially happen 
through company failures and liquidations (as happened in 
the DSL space), however current trends indicate that 
companies are successfully raising enough capital to fund 
their way through Chapter 11 bankruptcy. Therefore the 
reduction must occur through mergers and acquisitions.

- Since no one will make the mistake of acquiring a carrier 
with an unhealthy balance sheet, and no creditor/shareholder 
will exchange their ownership in a restructured company for 
equity in a company with an unsustainable balance sheet, 
this will need to wait until balance sheet restructuring occurs.

- With these two fundamental problems resolved (overfunding 
and too many competitors), the industry will be able to 
rationally act to resolve other critical problems, including 
injecting rational concepts (like usage-based pricing and 
customer incentives to shift traffic off of the peak) into their 
data service offerings to transform them into profit contributors. 
(See the May 2002 TeleSparks for a discussion of many of 
the key issues.)

+=+=+What's Next? +=+=+

What Can You Do?
Balance sheet restructuring is a painful reality that all carriers 
and service providers will need to face in one form or another. 
The more interesting strategic questions surround the issue 
of industry consolidation. If you are a carrier, service provider, 
or a creditor to one or more of these players, please carefully 
consider your role in the industry consolidation.

Specifically, consider this:

- If you are a creditor, please recognize that it is highly unlikely 
that the companies you’ve funded will be sustainable beyond 
restructuring. There are some exceptions (AT&T, Worldcom, 
Verizon, SBC, BellSouth and Qwest all have sustainable market 
positions). Everyone else will likely need to participate in 
consolidation in order to avoid Chapter 7 in the next few years. 
Please consider what you can do during and beyond the current 
balance sheet restructuring to drive this consolidation and 
therefore to place your investment in a vehicle with the greatest 
likelihood for sustainable value creation.

- If you are a carrier or service provider, seriously consider how 
you will participate in the consolidation of the industry.

- Are you positioned to be a consolidator? Can you muster the 
currency required to acquire the pieces that would complement 
your position and achieve profitability? For carriers, this almost 
definitely must be focused on acquiring customers and revenue. 
For service providers targeting enterprise customers, this likely 
involves acquiring new services and capabilities to improve 
competitive position and increase your economies of scope.

- Are you positioned to be a consolidatee? If you aren’t 
positioned to acquire others, then have you considered 
what you must do to position your company to be acquired 
by another to create a sustainable combination? Have you 
identified the companies you should be courting? Have you 
evaluated your capabilities and organizational structure to 
identify changes that could make you more attractive? As 
you’re making necessary cost cuts, are you careful to not 
lop off pieces that are attractive to acquirers?

- Have you considered redefining yourself as a niche player? 
If so, have you identified the practices that need to change to 
reduce your costs and focus your activities to achieve a 
sustainable position in that niche?

- If you are a vendor selling to carriers or service providers, 
have you evaluated how your products will be positioned 
in a consolidating industry? When two (or more) companies 
combine, will the combined company have good reasons to 
choose your technology over those in use by the other 
participants in the combination? Should you be developing 
capabilities that will specifically ease the integration activities 
by the consolidating players?

The ability to cut through the confusion and fear in the industry, 
to look through today’s fog to perceive tomorrow’s potential 
futures, to logically and sensibly and bravely ask and answer 
the critical strategic questions, and to understand your strategic 
options and act accordingly has never been more critical. 
Let us know if we can help.

+=+=+Need Some Help? +=+=+

TeleChoice helps companies everyday better position their 
firms and products for success, whether re-examining 
fundamental business strategy or clearly communicating 
unique position and value in today’s tough marketplace.
Contact us at info@telechoice.com or visit ( http://www.telechoice.com/)


+=+=+About TeleSparks+=+=+

On occasion, we share with our industry 
friends our views on major events and issues in telecom. 
We use TeleSparks as the primary vehicle for sharing these 
(usually highly opinionated) views, and we welcome your 
feedback. Feel free to forward these on to others, but please 
copy us on the messages so we have a sense of the extent 
of distribution of our views.

TeleSparks is generally authored by Russ McGuire, 
TeleChoice Chief Strategy Officer, with input from others 
throughout the TeleChoice organization. You may contact 
Russ (rmcguire@telechoice.com) or your favorite TeleChoice 
contact to share your thoughts on these matters.


 

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