Irrational Telecom Exuberance and the Meltdown (07-10-2002)

In October 1998, I was shown the charging bear, but like everyone else who saw it with me, I failed to get out of the way.

I was attending the Computer & Communications Industry Association's (CCIA) Fall meeting in Toronto. As usual, this forum was rife with flashy presentations touting all manner of whizbang services and technologies, each of which was going to take the world by storm.

Late on the first day, a consultant (name and affiliation sadly long forgotten) presented the results of a recently concluded quasi-telecom consumer study. His presentation was simple, low tech, and very compelling. He used two old fashioned projectors and two screens. On the left screen he showed a simple black on white vertical bar chart that depicted the maximum amount per month that his study had determined the average household would be willing to spend on telecom and related services. The figure was $150 -- U.S. or Canadian, makes no difference. This leftmost image remained static for the remainder of his talk.

On the righthand screen he introduced a succession of services and showed a series of stacked bar chart slides on the same scale as the static image on the lefthand screen. As each service was introduced, the right screen added both the service and its approximate monthly cost to the stacked bar chart. He started off with basic local telephony, added a long distance allowance, then added basic and premium CATV or satellite TV service, then cellular telephone service and then Internet access. Already, the right hand stacked bar chart exceeded the left screen's average monthly maximum.

Then he continued showing slides that added broadband, then video on demand, and some other services and their costs all of which, at the time, industry believed the average Joe would be unable to live without. By the time he had finished, the stacked bar chart on the right was more than twice the size of the one on the left.

His point was clear but, I fear, it was lost on me and the world at large until fairly recently.

What actually happened and is still happening, however, is something neither he nor anyone else was willing or able to predict. Today there is serious downward pressure on some basic service prices, most notably for inter-exchange carrier (IXC) services (i.e., long distance) -- an area of endeavor where monopoly is a distant memory. As real competition increases for other basic services, such as local telephony, the combined effect will be to decrease the average family's telecom-related expenses to the point where there actually will be room in their budget for modestly priced broadband and other emerging services.

The same is true of corporations and government agencies. Just because new services are being offered does not mean that budgets will automatically expand to cover their cost. Absent extraordinary items, such as new initiatives necessitated by Homeland Defense and the like, IT-related budgets rarely increase dramatically over time. What has happened, and will continue to happen, is identical to what is happening to the average family's budget.

As a Federal Government case in point, in 1998, when GSA competed its FTS2001 requirements to replace the then 10-year-old FTS2000 telecommunications services contracts, the price of a minute of long distance to the government was just North of 5 cents per postalized minute. This price point was the result of ongoing competition during FTS2000's period of performance since, when these contracts were awarded in 1989, the price of a minute of long distance was almost 30 cents. By the time the 8-year FTS2001 contract runs out, 18 years after FTS2000's award, a minute of long distance will cost the government about 1 cent. With billions of minutes being used annually, even with demand growth, 18 years of per-minute price erosion has yielded dramatic savings -- money that agencies were able to use to embrace new telecommunications services without budget increases or new appropriations.

As one might expect, the downward pressure on prices and the competition for large accounts is brutal. On top of that, tracking price erosion for IT and telecommunications commodities is now a sub-industry. This sub-industry exists to help large consumers of telecommunications services ensure that the prices they receive are consistently commensurate with both their consumption levels and those of their peers. Without going into too much detail as to how a telecommunications provider supports such price erosion, consider the following. In Fall of 1999, Worldcom's then boss, John Sidgmore, provided the following breakdown of telecommunication costs for what was then MCI: 49% Selling G&A (SG&A); 34% for Access; 11% for the OSS; 3% for switching, which was decreasing; and 3% for Transport. It follows then that, no matter how much capacity one adds to a network, how one aggregates transport, modernizes switching or improves OSS (billing, etc.) functionality, that absent phenominal traffic growth, cost and price reductions are going to have to come largely from reductions in the cost of sales. (Hopefully this will continue to manifest itself in fewer and fewer marketing calls around dinner time from folks trying to get us to switch carriers). The other major portion of a long distance cost lies in the still largely monopolistic area of Access where, because of the recent meltdown, competition has actually decreased from 'precious little' to something less than a 'scintilla,' whatever that is. It is easy to understand why Worldcom chose to fraudulently capitalize some of its Access costs, since this cost element must now be the largest part of the government's per minute price under FTS2001.

To be viable, therefore, providers of emerging telecom services must build their business cases and price points around the slowly emerging addressable portion of the average family's and any other entity's relatively static budgets. The opening of this window of opportunity, however, is firmly governed by the rate of competition-enabled price erosion. Unfortunately, as Access grows percentage-wise as a cost element, and the competition in that area dwindles, the outlook is not rosy for a rapid return to exuberance with respect to emerging telecom services. Moreover, allowing the large Access providers such as Verizon and SBC Communications to compete for long distance business in certain states and to possibly even acquire an IXC or two (a sort of reverse Qwest/US West type deal) is unlikely to do much to maintain or reduce prices to consumers or anyone else. The real hope, of course, is the wholesale adoption of voice as data.