The Financial Times

Surviving and Thriving in the Telecommunications' Nuclear Winter

With continued price erosion, rising costs, and an unprecedented capital backlog, most players will have to upgrade their networks.

Par Pratap Mukharji and Paul Smith

First published on mai 30, 2005
min


Despite the recent burst of announced mergers, totalling more than $100 billion so far, the telecommunications industry isn't likely to break out of its "nuclear winter" anytime soon. Continued price erosion, rising costs, and an unprecedented capital backlog will persist in a complex regulatory environment. Bain & Company analysis shows that every major US carrier still faces a significant decline in operating profit between 2006 and 2009. The wave of consolidation makes the need for convergence more urgent, as cost-effective, internet-based networks become a vital way for carriers to provide new services and manage the welter of legacy systems without breaking the bank. But the strategic "how's," "when's" and "why's" will differ for each. Telcos must weigh two sets of decisions, depending on whether they are one of the new mega-players, a large regional carrier like the Regional Bell Operating Companies (RBOCs), or predominately a wireless player. One decision relates to what to do about consumers and small businesses versus larger enterprise customers. The other is how to evolve the core long-haul transport network versus the "last mile" local access network. Moving to an integrated network could produce cost savings exceeding 40 per cent, our research shows. IP networks not only eliminate big switches and make more efficient use of bandwidth, they also save on office space, staff, and complexity. So what's the issue? First, it takes scarce capital—money that carriers could use instead for upgrading wireless networks, laying fiber optics, or deploying digital subscriber line (DSL) service to consumers. Second, telcos can't shut down their old networks until their customers have migrated to the new IP networks. But migration also raises the risk that customers will switch providers. Carriers are developing tricks to "fool" existing customer networks that they are still on an old frame-relay network when the underlying transport has moved to an IP network. As evidenced by their M&A activity, SBC, Verizon and Qwest understand that the future of telecom hinges on serving enterprise customers on converged networks. Carriers like AT&T and MCI are attractive both for their advanced networks and their access to enterprise decision makers. But for "local" phone companies, the battle is over the share that consumers spend on communications services. Their challenge is to sell high-bandwidth services like high-speed data (DSL), video on demand and interactive services. The problem is that this is tough over existing twisted copper. To fix this, Verizon has been running high-bandwidth fiber optic cable right into homes—a spectacular solution with a spectacular tab. In 2003 estimates ran to $2,000 per home. Yet DSL's cost also started high: $1,300 per home in 1999. Now it's down in the low hundreds. Can we expect the same to happen to fiber? Probably. SBC and Bell Canada have been exploring less expensive, but more technically complex "fiber-to-the-neighbourhood" solutions. These put sophisticated electronics into small, street-side boxes that "hop" fiber signals to the copper network for the last several hundred feet. They're betting that they can deliver equivalent services for a fraction of the costs. Which solution will win? Probably a mix. Certainly for new construction, it's economical to install fiber. But if SBC and Bell Canada's hybrid solutions can reliably deliver high bandwidths (and trials are promising) then it could reshape the consumer communications landscape. Telcos face three choices: Invest now to create an all IP-based core network. Our work indicates that 80% of the benefits will be cost reduction and 20% in revenue enhancements. Or invest soon and create a high-bandwidth access network, probably many times more expensive than the core network upgrade, but with the bonus of supporting a huge range of services and generating an effective defence against high-speed cable. Here the benefits percentages are probably reversed. Finally, do nothing, which basically is a bet that your wireline business will eventually be cannibalised by wireless services. Again, choices also relate to the changing positions in the telecom hierarchy. Thus: Large exchange carriers, with no access network and no wireless assets, have plunged ahead. AT&T and MCI pursued aggressive plans to converge their core transport networks, along with new IP-based managed network service offerings. The open questions facing their new owners are: Will they continue to see the value in this migration? Will they have the capital to continue network convergence fast enough? And, can they smoothly migrate customers? If you are Sprint, it's clear that wireless gets first claim, meaning core network convergence, while necessary, gets pursued less aggressively. If you are a legacy RBOC, like Bell South, or a new integrated player like Verizon or SBC—with a huge investment in access networks and capital-hungry wireless subsidiaries—the choices get tougher. These companies have larger cash flows. Yet, they still must fund some kind of consumer access network upgrade. They can neither afford to lose the video war to cable or satellite companies, nor can they allow IP offerings from upstarts like Vonage to circumvent their networks. Thus, RBOCs have concluded they don't have the luxury of choosing between upgrading bandwidth and improving wireless networks. They must do both, while looking for higher value services and content to run through their core transport networks. Before the industry's nuclear winter thaws, most players will have to upgrade their networks, a decision conservative telcos have resisted making. Why? Because sooner or later, spring will arrive in the form of demand for higher value services on blazingly fast new networks. Pratap Mukharji is a partner with Bain & Company based in Atlanta, and a member of Bain's telecommunications practice. Paul Smith leads Bain's telecommunication practice in North America.

Despite the recent burst of announced mergers, totalling more than $100 billion so far, the telecommunications industry isn't likely to break out of its "nuclear winter" anytime soon.

Continued price erosion, rising costs, and an unprecedented capital backlog will persist in a complex regulatory environment. Bain & Company analysis shows that every major US carrier still faces a significant decline in operating profit between 2006 and 2009.

The wave of consolidation makes the need for convergence more urgent, as cost-effective, internet-based networks become a vital way for carriers to provide new services and manage the welter of legacy systems without breaking the bank. But the strategic "how's," "when's" and "why's" will differ for each. Telcos must weigh two sets of decisions, depending on whether they are one of the new mega-players, a large regional carrier like the Regional Bell Operating Companies (RBOCs), or predominately a wireless player.

One decision relates to what to do about consumers and small businesses versus larger enterprise customers. The other is how to evolve the core long-haul transport network versus the "last mile" local access network.

Moving to an integrated network could produce cost savings exceeding 40 per cent, our research shows. IP networks not only eliminate big switches and make more efficient use of bandwidth, they also save on office space, staff, and complexity. So what's the issue? First, it takes scarce capital—money that carriers could use instead for upgrading wireless networks, laying fiber optics, or deploying digital subscriber line (DSL) service to consumers. Second, telcos can't shut down their old networks until their customers have migrated to the new IP networks.

But migration also raises the risk that customers will switch providers. Carriers are developing tricks to "fool" existing customer networks that they are still on an old frame-relay network when the underlying transport has moved to an IP network.

As evidenced by their M&A activity, SBC, Verizon and Qwest understand that the future of telecom hinges on serving enterprise customers on converged networks. Carriers like AT&T and MCI are attractive both for their advanced networks and their access to enterprise decision makers.

But for "local" phone companies, the battle is over the share that consumers spend on communications services. Their challenge is to sell high-bandwidth services like high-speed data (DSL), video on demand and interactive services. The problem is that this is tough over existing twisted copper.

To fix this, Verizon has been running high-bandwidth fiber optic cable right into homes—a spectacular solution with a spectacular tab. In 2003 estimates ran to $2,000 per home. Yet DSL's cost also started high: $1,300 per home in 1999. Now it's down in the low hundreds. Can we expect the same to happen to fiber? Probably.

SBC and Bell Canada have been exploring less expensive, but more technically complex "fiber-to-the-neighbourhood" solutions. These put sophisticated electronics into small, street-side boxes that "hop" fiber signals to the copper network for the last several hundred feet. They're betting that they can deliver equivalent services for a fraction of the costs.

Which solution will win? Probably a mix. Certainly for new construction, it's economical to install fiber. But if SBC and Bell Canada's hybrid solutions can reliably deliver high bandwidths (and trials are promising) then it could reshape the consumer communications landscape.

Telcos face three choices:

Invest now to create an all IP-based core network. Our work indicates that 80% of the benefits will be cost reduction and 20% in revenue enhancements.

Or invest soon and create a high-bandwidth access network, probably many times more expensive than the core network upgrade, but with the bonus of supporting a huge range of services and generating an effective defence against high-speed cable. Here the benefits percentages are probably reversed.

Finally, do nothing, which basically is a bet that your wireline business will eventually be cannibalised by wireless services.

Again, choices also relate to the changing positions in the telecom hierarchy. Thus:

Large exchange carriers, with no access network and no wireless assets, have plunged ahead. AT&T and MCI pursued aggressive plans to converge their core transport networks, along with new IP-based managed network service offerings. The open questions facing their new owners are: Will they continue to see the value in this migration? Will they have the capital to continue network convergence fast enough? And, can they smoothly migrate customers?

If you are Sprint, it's clear that wireless gets first claim, meaning core network convergence, while necessary, gets pursued less aggressively.

If you are a legacy RBOC, like Bell South, or a new integrated player like Verizon or SBC—with a huge investment in access networks and capital-hungry wireless subsidiaries—the choices get tougher. These companies have larger cash flows. Yet, they still must fund some kind of consumer access network upgrade. They can neither afford to lose the video war to cable or satellite companies, nor can they allow IP offerings from upstarts like Vonage to circumvent their networks. Thus, RBOCs have concluded they don't have the luxury of choosing between upgrading bandwidth and improving wireless networks. They must do both, while looking for higher value services and content to run through their core transport networks.

Before the industry's nuclear winter thaws, most players will have to upgrade their networks, a decision conservative telcos have resisted making. Why? Because sooner or later, spring will arrive in the form of demand for higher value services on blazingly fast new networks.

Pratap Mukharji is a partner with Bain & Company based in Atlanta, and a member of Bain's telecommunications practice. Paul Smith leads Bain's telecommunication practice in North America.