Bandwidth feast, profit famine: capacity oversupply is still making life difficult for wholesale providers. Most expect a further shakeout in the market; all are focused on trying to stand out from the crowd

Between 2001 and 2003 international backbone capacity in the EU grew by 167 per cent, according to TeleGeography, the research arm of PriMetrica. In the EU accession countries it grew by 293 per cent over the same period. The city of Prague, for example, has demand for just five per cent of the long-haul capacity connected to it. "The challenge operators face is to offer ever more capacity at declining prices per bit. This is a fundamental condition of the industry, where carriers have to look at the price curve over time rather than at the price point of the moment in making their decisions," says Peter Kjeldsen, an analyst with Gartner.

TeleGeography reports that prices on most long-haul routes in Europe and the US fell by 10-30 per cent in 2003, but it argues that, at the same time, deployments of internet capacity in those regions increased by 60 per cent, suggesting that demand can--at least in part--offset price declines.

The people at the sharp end are less sanguine. Many note that prices have continued to fall, passing levels expected by most operators in the US and Europe. "Obviously, as you approach zero, you have to ask yourself when do these price declines stop. You have to assume we won't pay customers to connect to us," says Christian Moeller, regional president of Sprint, Europe, who argues that the toughness of the market makes it a business for those with scale.

"Prices are still falling, but we do see some stabilisation," says Floris van den Broek, VP of European marketing at Level3, on a more up-beat note. "We would expect that prices are bottoming out because there is a cost of equipment involved that is significant."

The companies that came out of administration have been blamed by their more financially continent peers for pricing irresponsibly, but they deny the charge. "Hand on heart, we can say we haven't been cutting prices," says Rob McLeod, senior vice president of marketing at Viatel, which has around 7,200 route kilometres of European backbone and went into administration in 2001. McLeod says that Viatel spent some time examining pricing in the European market when it was planning its relaunch at the start of this year and that it always covers its costs. "We have been having discussion with some customer where we have said 'look, point-to-point [the business] doesn't make sense, but looking at the entire network requirement is a discussion we can have'", says McLeod.

MCI, formerly WorldCom, also insists that it is not price dumping. "We always try to do competitive pricing, but we have a very clear profit goal. We're not going to sell at low margins," says Henrik Liungman, director of business operators at MCI's EMEA wholesale division.

However, even if players like Viatel and MCI are not cutting their own throats, there is certainly bandwidth available below cost in Europe. "We're seeing 2.5G wave prices that certainly don't reflect the replacement cost of the line cards. Wave prices currently reflect excess inventory where the equipment cost has been written off or is considered sunk," says Rob Schult, an analyst with TeleGeography.

From a global perspective, some pockets of the market are still relatively underserved and, so, price resistant. However, even routes such as India to the Middle East have changed over the last six months, according to Siddartha Ray, the CEO of Data Access, an India-based buyer of long-haul capacity. "We believe that pricing on undersea routes from India will fall by a factor of 5-6 in the next few months," he says. Ray adds that Data Access avoids making long-term commitments on buying capacity because he expects prices to keep shrinking. "Literally everyone who owns subsea cable capacity is desperate to generate cash so that at least part of operations and maintenance is covered," says Ray, who expects to be able to cut his own variable costs by 10-15 per cent each year as bandwidth costs come down, adding that, of course, end user prices will, too, fall in line with this.

The fierce challenge that pricing in the wholesale transport market represents is the reason why many players seek to stay away from this market, or keep a relatively low profile. Sprint, for example, which does enjoy the relative luxury of an overall mixed portfolio of services including mobile, "made a deliberate choice not to be in transport", says Moeller. Transport services include wavelengths, fibre, and SDH for private lines. "Transport doesn't offer a viable business--[that is] long-term value and decent returns for "Sprint," says Moeller, without expanding on what 'decent return' means. He points out that even if Sprint were to acquire physical assets for little or no investment, just the operating costs associated with them would make running transport services across them unattractive. Those players that do offer bandwidth services, such as Colt, stress that this is not the only string to their bow. "It is important to have the right product mix. You can't offer just pure bandwidth, you need to offer managed data," says Peter Metz, managing director of Colt's wholesale division.

The same but different

"Carriers that focused exclusively at providing wholesale backbone services to other carriers found that strategy untenable, which is why we see so many of them now expanding their product portfolio to serve the retail market," says TeleGeography's Schult.

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However, that is not to suggest that carriers are no longer willing to address the wholesale business. "The notion that if you're in wholesale you're doomed is a wrong one," says Stephen Young, an analyst with Ovum. "If you have high volumes, you can get a lot of revenue; it's also a good platform to approach retail if you want to do that." Ovum estimates that the European wholesale market was worth around US$41 bn in revenue during 2003.

The issue for those that are in the wholesale business is not how to generate some business, but how to make it a good business. Sprint's--partial--solution to the pricing issue is to offer quality of service on its IP connectivity. "The difference here is that 1Mb of [IP connectivity] is not the same," says Moeller. He argues that the quality of the connection is defined by the customers connected to the network since a provider with very few customers connected needs more hubs to get to the most important destinations, which, in turn increases packet loss and jitter.

Analysts agree that network topology can make a difference. "Awkward questions will be more easily answered by wholesale operators with less equipment between client and destination," says lain Stephenson, an analyst with Ovum. Unsurprisingly, other carriers take the same approach as Sprint. "We think the number of hubs has an impact, as does the location and the capacity per hub," says Vladimir Pal, head of wholesale market management at Colt. MCI believes that you can charge more for the right network topology and level of security.

Unlike Sprint, Colt does not yet have a complete IP network in place, though it will have a complete VoIP network by Q4 of this year. "We are seeing more and more IP in the market. In the future, there will be global IP networks giving reasonable quality, but there will still be commodity products like bandwidth," says Pal. MCI also expects to, in time, run everything on the same IP backbone layer, though Liungman says that there are "no concrete plans" in place yet.

One of the questions for the hard-pressed wholesale operators has to be whether the cost of moving to an IP network can be justified. In theory, a single network offers great cost savings. BT recently announced, for example, that its new IP network would bring it cost savings of around [pounds sterling]1 bn over five years. However, in practice, moving from circuit-switching to IP can be more complicated than it appears at first sight. "Circuit switching does not allow for the same degree of statistical over-booking of the network as IP does--which can give IP significant cost advantages. However, delay sensitive data packets, such as voice or video, make statistical overbooking a challenge, which, in turn, could undermine some of the cost advantages of using IP," says Kjeldsen.

Consolidation

"It is very clear that there has to be some structural consolidation," says Moeller. "[And] if you are not in the game today, there is very little reason to join it. It is very, very difficult to reach the scale in both traffic and operators if you are not among the top players." Moeller stresses that Sprint is in the wholesale business for the long run. "We still believe we have a very viable business, but we can see that it would be a challenge for many others," he says, drawing an analogy between the international container business and wholesale capacity sales. The container business began with a plethora of regional operators that gradually amalgamated into a few global players.

However, despite some acquisition deals, there appears to be stasis in the wholesale market at the moment. "There have been lots of opportunities for consolidation, but not much has happened. A lot of networks duplicate each other, and even if they don't the cost of integrating networks puts potential buyers off," points out Young. There are some operators that are looking to buy, such as Level3, but they have specific aims in view. "We are still examining potential take-over targets," says van den Broek. "[But] buying backbone is not the prime intent, we are looking more for synergies," he adds, without elaborating on what these synergies might be.

There have been rumours that Vodafone has begun proceedings to sell its German fixed-line business, Arcor, which it bought by default as part of the overall Mannesmann package and had originally planned to spin-off on the stock market. The German magazine Wirtschaftswoche recently reported that UBS and Goldman Sachs are representing Vodafone in "very early talks" with private equity houses. However, Vodafone has denied that it has started the sale process.

If Arcor, which has both retail and wholesale customers, can find a buyer it would not necessarily mean the start of consolidation in the sector overall. Private equity groups are not interested in offering network services. It may be, as Young points out, that "the equilibrium between supply and demand needs to be restored. Some fibre will remain dark."

RELATED ARTICLE: The mobile backhaul wholesale opportunity

"The biggest growth area [for wholesale providers], next to IP, is mobile backhaul," says Henrik Liungman, director of business operators at MCI's EMEA wholesale division. He adds that MCI is not looking at pure backhaul but at services that target the needs of mobile operators such as particular routing schemes to facilitate the completion of roaming calls.

One of the factors behind this interest is the recent move by the GSM Association on QoS. "The GSM Association has put definitions out on QoS and how they want to standardise. It is not commonplace yet, but we would expect QoS classes are going to be more and more used," Floris van den Broek, VP of European marketing at Level3.

Colt is also planning new wholesale services for mobile operators--the details of which are still under wraps--with the launch due at the beginning of next year. It stresses that doing well in offering services to mobile operators demands a lot of interconnects, something that analysts agree with. "Setting up services for mobile operators like calling line identification is as about having the right commercial relationships in place as it is about the network," says Stephen Young at Ovum. (Calling line identification allows mobile users to see the number of the person calling them, which encourages them to take a call and so increases mobile operator revenue.)

However, even if wholesale operators can move into charging more for IP services, or services tailored to the needs of mobile operators, there remain major issues of oversupply in the market. For providers like Sprint, MCI and Colt there is also the problem, as Ovum points out, that domestic markets are dominated by their respective incumbents. This means that around US$25.5 bn of the overall European wholesale pie of about US$41 bn is either not addressed by them, or is difficult to slice into.

written by Ouida Taaffe

Ouida Taaffe, features editor

(otaaffe@horizonhouse.co.uk)

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