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The TeleChoice Take
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The assumption that carriers’ financial problems are caused by
an oversupply of bandwidth or fiber is not just dead wrong
it’s dangerous. Wrong analysis leads to wrong solutions that can
do more damage than the original problem.
Over the past couple of years, TeleChoice has performed the
most extensive analysis ever published of long haul fiber supply
and demand between major U.S. markets. The results provide a
clear picture of the baseline situation, a flexible modeling tool
for examining future supply/demand under different scenarios, and
the ability to marry these scenarios with financial modeling tools
to understand the economic impact of these different scenarios.
Current Situation
The baseline for this analysis is July 1, 2001. The TeleChoice Model
for Advanced Capital Planning (MADCAP) models the dark fiber and
lit capacity of the 29 carriers that control the fiber on the major
routes connecting the Top 12 telecom markets. MADCAP then
matches that supply with the demand for transport capacity on those
22 routes resulting from end-user technology and application
adoption trends. The July 2001 baseline uses the best data on
supply and demand drivers available directly from carriers and
from other resources.
Based on this analysis, as of last summer, it was completely
inaccurate to assume a vast glut of lit capacity, as many in the
business press were claiming at that time. In fact, of the 22
routes modeled, only 4 had enough excess capacity to be
considered in "glut." Of the remaining 18 routes, 14 were at
"full" capacity (at or above the threshold where carriers historically
have created new capacity), and the other 4 were approaching
that threshold.
Bottom line, the industry was effectively managing the amount of
lit capacity to meet the current market demands and was far
from a "glut" scenario. If anything, the past 10
capital-constrained months of operation have made this situation
more true. Carriers are creating new capacity solely based on
new demand from customers.
The fiber situation is less clear. Although only 22% of the fiber on
these routes had been lit as of last July, this is a reasonable amount
and should not be viewed as foolish overbuilding by the industry.
Most of the constructed fiber in this country has been built in the past
5 to 7 years. Obtaining rights of way, managing construction
projects, and digging up people’s backyards is an expensive and
painful process -- one no carrier wants to have to repeat every
few years. Therefore, fiber construction projects are designed
to provide enough fiber to optimally meet demand for the next
20 years. Within this context, at roughly one quarter of the way into
this 20-year cycle, 22% (or today’s 23% to 25%) is a reasonable
level of utilization.
Future Scenarios
TeleChoice never intended to predict the future levels of supply
and demand. However, we have created a tool enabling anyone to
plug in different assumptions about demand and supply drivers
(e.g., business and consumer adoption of new broadband
technologies and implementation of new transport technologies) and
to understand the resulting impact on demand for lit transport
capacity, supply of lit capacity, and demand for dark fiber on a
route-by-route basis. Obviously, these are answers of extremely
high interest to all players in the industry.
Although we’re sure you have your own scenarios you’d like to
run (contact us if you’d like to learn how), to satisfy overall
burning curiosity we have used MADCAP to model a set of
very interesting future scenarios.
In short, the factor that has the greatest impact on future
bandwidth demand is the level of adoption of new broadband
services by business customers. Specifically, metro ethernet
services represent an order-of-magnitude increase in capacity
available to typical business users and, therefore, represent
tremendous increases in the demand placed on long haul
transport networks.
Consider three contrasting scenarios around the one variable
of business adoption of metro ethernet services:
1. If Yipes’ bankruptcy filing is a leading indicator of the
complete collapse of the metro ethernet services market (which,
of course, we don’t believe) and business broadband
connectivity continues to be driven by DSL and TDM
connectivity options, the 18 "healthy" long haul routes will continue to
be managed to balance supply/demand, the 4 "glut" routes will
achieve supply/demand balance by 2005, and the amount of fiber lit
on these 22 routes will increase to nearly 30% by that year.
2. However, if the new entrants, RBOCs, and IXCs have even
slight success with their current and future metro ethernet
offers, achieving adoption rates of 2.5% of Internet-connected
business locations by 2005, then ALL the fiber will need to be lit on 11
of the 22 routes in our model.
3. Further, if service providers have moderate success with
metro ethernet services so that 5% of connected business locations
use these services, only 2 of the routes will have ANY unlit fiber
left.
Although all 3 of these scenarios are relatively conservative
compared to the historical pace of adoption of new broadband
services, we imagine 2 of the 3 are beyond your wildest imaginations
of the amount of fiber that will be lit over the next few years.
No Harm, No Foul? So what? Even if it’s wrong to say there’s a glut
of fiber or a glut of capacity, the carrier segment is clearly
under tremendous financial pressure. Being factual about
the supply/demand situation doesn’t magically fix the
economics. Where’s the harm in pointing to the wrong problem?
For starters, focusing on a mythical suspect keeps us from catching
the right offender. If we spend all our time trying to fix a problem
that doesn’t exist, we aren’t spending enough time trying to fix the
very real problems in the industry.
So What Is the Real Problem? If you’re with us so far, you might
now believe that the problem ISN’T that too much fiber was built or
lit. The fundamental problem is that too many COMPANIES were
funded to build and light that fiber. More precisely, on any given
route, there were too many construction projects required to build
the right amount of fiber.
We can clearly see the two-fold impact of this mistake:
1. It cost way too much money to build the right amount of capacity.
2. There are way too many players competing to get to a
sustainable market share level, resulting in fierce and irrational
price competition.
Dealing with the first issue, consider the Chicago-Denver
route. Approximately 800 fibers are constructed along that route,
and by our analysis, this is actually about the "right" amount of
fiber. However, that fiber was constructed by 8 different companies.
If the capital markets had rationally funded that
infrastructure opportunity, that fiber should’ve been built by 2 or
3 different companies. Since we estimate the cost of the fiber
and related materials is approximately 20% of the total cost of
each construction project, then, as an industry (and, considering
the impact on the capital markets, as an economy), we overpaid
by 150% in putting that fiber in the ground. Since carriers funded
their construction projects through a combination of debt and
equity, this has resulted in the tremendous debt levels seen in
the industry today.
Once these competing players were in the market, they had
established a tremendous cost basis that needed to be covered
through network revenues. This business is very much driven by
scale economics -- to achieve a competitive per-unit cost position,
a player must achieve a certain level of scale and utilization.
Scale comes from lighting the fibers (which is expensive);
utilization comes through sales.
Historically, in asset-intensive industries, sustainability has
required approximately 15% to 20% market share,
which mathematically tends to result in no more than 3 successful
major players in each market. With anywhere from 8 to 10
new competitors on each route, obviously not all of them can achieve
a sustainable level of market share. The result has been frantic
and irrational competition for each point of share, resulting in
the precipitous price declines we’ve seen for transport
capacity.
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What's Next?
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If you believe the problem is oversupply, the only way to fix it is
to create tremendous levels of new demand. However, this isn’t
an oversupply problem.
Since the problem is there are too many competitors and as a
combined entity they spent too much to create the right amount
of capacity, the solution is a bit more complex and painful. There’s
no way to recover the $tens of billions that were wasted by
inefficiently building our fiber networks. That waste will need to
be written off sometime by someone -- the sooner the better for
the recovery of the industry. Similarly, the number of
competitive players will need to be significantly reduced -- to at most
3 to 5 major players -- before we will see a return to
rational competitive behavior. This reduction can happen
through shutting down and liquidating current players or
through combining multiple smaller players into a single sustainable
new competitor. Unfortunately, the individual best interests of
lenders and investors stand in the way of this process happening
very quickly. (This topic was covered in some depth in the first issue
of TeleSparks which is available at
http://www.telechoice.com/inprint_telesparks.)
Beyond these fundamental structural issues, the industry must
address other critical issues. The current offer/pricing structure for
IP services is flawed and cannot lead to profitable growth. In fact,
our financial analysis of the implications of this flaw under
different MADCAP scenarios indicates that this issue
becomes devastating under the high-demand growth scenarios
that would be favored by those trying to "fix" the industry problem
if they believe the problem is a fiber/bandwidth glut. We will cover
this topic further in an upcoming TeleSparks issue.
What Can You Do?
We strongly encourage you to stop and consider the implications of
this situation on your business. Specifically, consider these key issues:
- If you’re a carrier, carefully evaluate what it will take for you
to achieve a sustainable scale position, and what impact the
coming structural disruptions will have on your business. Where
should you focus your efforts? How can you best weather the
likely extended period of uncertainty and consolidation? Are
there portions of your business you should exit/outsource? Is a
strategic combination the best way to achieve sustainability and
the objectives of your stakeholders?
- If you’re a technology vendor, consider how these issues affect
your opportunities. How can you best overcome the extended
inertia within your customer base caused by ongoing uncertainty?
Can you position your solution as an enabler of consolidation, easing
the integration of merged companies or acquired assets? Does
your technology simplify the transition from owned to
outsourced operations? Can you be part of the solution to
accelerate your customers’ path to sustainability?
- For both carriers and technology vendors, what role should you play
in fixing the fundamental challenges with today’s IP services?
Through challenging times such as these, strategic focus is
critical. Clearly defining and crisply communicating how you are part
of the solution will be essential in retaining or regaining confidence
from your customers, investors, and employees. Let us know if we
can help.
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For Further Reading
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If this topic interests you, we recommend you download several
white papers for free from the TeleChoice Website
( http://www.telechoice.com/inprint_whitepapers.htm ):
MADCAP Report Overview and Methodology
( http://www.telechoice.com/action_analysis.asp )
TC Perspectives: Super Broadband Deployment Initiatives
( http://www.telechoice.com/inprint_RegMailer3.htm )
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Need Some Help?
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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. +=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+=+
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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TeleSparks (Archive)