Rita, Katrina, Oil and the Economy

“Commentators at the positive end had already started writing their “why the world economy survived Katrina” pieces within a week or so of the disaster. The (economic) question is – will US consumer confidence (and market confidence generally) survive Rita? I leave for others the shorter term questions around whether the US authorities learned enough from the Katrina debacle to ensure that far more Americans personally survive Rita. As I write, Texans are evacuating. A second Cat. 4/5 storm in the Gulf within a few days is a very different thing for public sentiment to cope with than a single, not unprecedented event – two Cat 4 storms in a year last happened in 1915, when 275 died in Louisiana when Lake Pontchartrain broke its banks and 275 in Galveston, Texas a little later … Even if, as we all hope, Rita passes or fades without the dramas and human suffering of Katrina, the fact that it existed at all is going to change how people feel, and potentially push them toward saving for a rainy day rather than spending. If so, the world economy may be in for a storm of its own.”

Continue reading Rita, Katrina, Oil and the Economy

Warming up the energy debate

A recent New Scientist editorial sets out a handy scoring mechanism for energy sources: “We want them to have a small environmental impact, yet be able to supply energy on a huge scale. We want costs to be low, the method of generation to be safe and for there to be plenty of available fuel. The International Energy Agency estimates that two-thirds of the extra energy demand over the next 25 years will come from developing countries, so whatever sources we choose must be tradable worldwide. Also, in the post-9/11 world, we want energy sources that cannot be abused by terrorists or rogue states.”

Continue reading Warming up the energy debate

Structural Separation won’t go away, however much Telstra would prefer it to

[Piece I wrote in the Exchange newsletter]

Paul Chapman’s Ex Cathedra of 14 February 2003 pointed out some flaws in the precipitate decision to pull the plug on the inquiry into structural separation of Telstra. In my opinion, the flaws run much deeper than Paul set out.

Senator Alston’s intemperate little tirade in the AFR set out four major reasons for rejecting the separation:

  • Nobody else has done it
  • It’s all too complex (because the network is complex)
  • No-one would have incentive to upgrade the network.
  • It would destroy shareholder value and increase prices for consumers

I argue that all of these are wrong.

Nobody else has done it

Leaving aside the point that if it was a good idea, there isn’t any particular problem in being first, it simply isn’t true that incumbent telcos haven’t been dismembered by their shareholders (private or government). Many have separated out their mobile arms, there is the famous case of the break-up of the US Bell system, and the degree of accounting separation mandated by European regulation requires almost as complete separation of functions (and consequent transparency of wholesale pricing) as Senator Alston tells us “can’t be done”.

It’s all too complex

An interesting point that Senator Alston shares with the Communications Union (strange bedfellows)! The simple fact is that, while many “complex” services are provided by the network infrastructure, it is still relatively easy to define a boundary: if the network provides it, it goes in the network company, and is wholesaled to all comers including the new retail company; if not, not. The many services (such as voicemail) that can be provided either way, can be provided either way.

Incentives to upgrade the network

Let’s assume that we break up Telstra into a successor retail company (let’s call it Telstra) and a network company (let’s call it Telecom Australia). Telecom has enormous economies of scale, and a near monopoly of local and long-distance network provision, sells to all comers (as above) including Telstra, and has a regulated rate of return on capital plus a USO contribution – read an almost guaranteed income stream above its WACC for any capital expenditure it makes so long as it sticks to knitting core network products. Do we think Telecom won’t invest in the network?

Shareholder value and prices

This is the biggie. It is true that Telstra and all of the banks that made submissions to the inquiry said that shareholder value would be destroyed, but even a little thought tells you that these are not disinterested parties in this game. Telstra clearly hates the idea, while all of the banks who submitted are hoping for a slice of Telstra 3, the only big payday any of them can see on the horizon, and aren’t going to royally PO the two decision makers for who gets the fees on that deal. The fact is that in all these shareholder value models the answer you get is entirely dependent on the assumptions you put in, and any good modeller can get the answers he or she is asked for within a very wide range of valuations (believe me, I’ve done a wardrobeful of these).

Despite vast apparent sophistication, the models submitted all boil done to one assumption: the actual process of separation would cost a lot, would essentially just divide Telstra’s earnings between the two successor entities, and the competition benefits wouldn’t be substantial or long-term (otherwise they would eventually create increased shareholder value more or less whatever the costs). As already noted above, the fact that many privatised telcos around the world have indeed broken themselves up to create shareholder value indicates that it is relatively easy to alter these assumptions. MMO2 was broken out of a fully integrated British Telecom in under two years and at relatively low cost, and a group of venture capitalists subsequently submitted a bid to create more value by breaking the network out of the remainder.

If you change the balance of these assumptions only a little, there is no net present value loss of long-term cashflows, and thus no need for increased prices (or compensation to shareholders). The key elements of a value-creating break-up are keeping the one-off costs down – primarily ensured by building the achievement of this into the compensation packages of those tasked with the job – and getting some real competitive benefit in the wider market.

My prime assumptions for a model that would deliver increased shareholder value and benefits to customers are very straightforward:

  • Telecom is a regulated utility with a good if not spectacular return, and almost risk-free debt profile, a substantial fraction of Telstra’s current revenues, and is set fair to replace Commonwealth bonds as the bellwether of the market. Whether in private or Government hands, it is subject to substantial direction of its affairs, which costs us some discount on its share price, but would still be a “must-have” to most investment funds.
  • The new Telstra has ALL of Telstra’s current revenues, but a higher cost profile (as say half of its earnings are now Telecom’s). It has an almost unregulated monopoly in many parts of the market, and its (still) multi-billion dollar profits are made with a low capital and debt profile. It will be a stellar performer in the next bull market, and its managers, freed from the horrendous complexities of the Capital Planning cycle and all that engineering stuff can work hard to make it even better.
  • The other retail players can finally get real discussions with Telecom on planning horizons and wholesale pricing, knowing they are no longer opening the kimono to their biggest competitor. Telecom, as a result, finally gets better forecasting data to plan its own operations than has been available to it for more than a decade.

Anyone really prepared to believe with Senator Alston that this future is unachievable?

Will Global Convergence in Telecoms Lead to Global Oligopoly?

[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?

Mobile

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.

Infrastructure investments

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