“The road signs all indicate that, basically, the sky is the limit for communication companies”. This was the prediction made in 1997 by William Moroney, president of a US-based group, the MultiMedia Telecommunications Association.
It was a promise of a new era where telecommunications traffic would expand at double-digit rates every year, thanks to the Internet revolution, flourishing e-commerce and new wireless communications technology. Such a prospect fuelled expectations of rapid growth in revenues and earnings, causing stock values to spiral upwards in a euphoric global telecommunications bubble.
But, as we now know, this bubble burst and ended in tears for many shareholders and investors. Many telecommunications operators, including France Telecom, MCI, Deutsche Telekom, KPN and BT are now striving to rebuild shareholder value, consolidate their balance sheets and win back the confidence of financial markets. Others, such as PSINet and Ebone, have disappeared altogether.
The prospect of ever-expanding telecommunications revenue was not entirely unfounded, though. Two decades of increasingly dramatic changes radically transformed the industry. The most significant stemmed from a fundamental shift in regulatory policy, as governments opened telecommunications services markets to competition, so compelling incumbent monopolies to make room for new entrants. New telecoms service providers appeared, such as MCI (formerly Worldcom), Level3, SFR, Vodaphone, Japan Telecom and Hanaro, and familiar names in one country emerged as new entrants in other countries.
Suddenly, consumers in most OECD countries had a choice, particularly for long-distance phone calls and mobile phone services and, increasingly, for local calls. In addition, state-owned carriers were privatised and a number of other steps were taken to infuse competition into the sector.
But although vital, liberalisation is only part of the story. In order to expand, markets need other pre-conditions, too: products, producers and consumers are just for starters, and technologically-driven markets need innovation, as well as investors willing to take the risk of financing sometimes large investments. Telecommunications had these conditions in abundance.
There was no shortage of technological innovation ready to reach the market. For instance, fibre optic cables and new transmission software made it possible to increase the carrying capacity of telephone networks. Cellular phones became more affordable and reliable. The Internet emerged from a network used by academics into a global infrastructure, all the while becoming faster and cheaper, and seamlessly linking all kinds of information resources. There were also hoards of investors ready to bet on the sector’s future. And mobile telephony and the Internet, in particular, struck a chord with consumers and their desire to stay in touch and become more mobile.
Yet, after a few years of euphoria, the industry landed back to earth with a thud. What went wrong? Despite expectations, telecoms traffic did not continue to increase at double-digit rates. Telecom operators that had banked their investments on a surge in traffic demand, found that their transmission capacity was terribly underutilised. And during 1996-2001, while telecommunications revenue in the OECD area grew by an average 7.2% annually, it slowed to 1.6% in 2001 under the pressure of the economic downturn. Preliminary indications for the United States and France suggest revenues may have been roughly flat in 2002.
But one of the pins that pricked the bubble was, arguably, the speed of innovation itself, as new, cheaper ways of improving communication emerged, like the extensive coverage of second-generation wireless networks, putting pressure on costly, long-term investments, like global mobile satellite systems. Other innovations like digital subscriber lines (DSL) failed to come quickly enough to the market at the local level to soak up the increase in capacity wrought by fibre optics at the backbone level.
The wider economic impacts of the burst of the bubble were limited, mainly because telecommunications services were not an enormous industry, valued at some 3.3% of all OECD GDP. Still, when a sector with annual revenues of nearly US$900 billion runs into difficulties, the consequences can be serious. In particular, there was a wave of default on debt payments among telecom carriers. Worldwide defaults on corporate bonds came to US$163 billion in 2002, of which 56.4% were in telecommunications – the worst wave of bond defaults since the 1930s. According to Bankruptcy.com, among the 15 largest public companies in the United States that went bankrupt in 2002, no fewer than eight were communications operators. In addition, there were economic effects elsewhere, as slower growth hurt equipment suppliers and technology firms upstream, while cuts in R&D spending could slow innovation.
In short, the reasons why the bubble inflated and then burst were more to do with unduly optimistic expectations, stock market exuberance, over-investment in certain technologies, non-core investment by some companies and poor management.
So, what might the future be for the telecommunications sector: prolonged decline or renewed growth? All indications point to the latter, though at a far calmer pace than before. It is too early to conclude that the telecom sector is about to become a “normal” industry that matures gradually, like electricity or railways have done. There are markets within markets, and, in truth, telecommunications themselves have never really stopped expanding, despite the bursting of the bubble. Consumer spending on communications has been rising faster than other types of spending, such as on recreation, education or even health (see Databank). Telecommunications will continue growing, since the climate of innovation and change, as well as demand for certain services, remain strong. While this growth is unlikely to repeat the upsurge in telecoms activity of the late 1990s, the outlook is not dim.
For now, telecoms firms will continue to operate by upgrading their networks for higher speed Internet and seeking new customers, conscious that these will always want to communicate more cheaply if new technologies allow. For instance, wireless access to fixed telecoms systems is emerging, with innovations like WiFi (Wireless Fidelity), whose impact on accessing fast Internet services via local area networks could bring benefits to both residential and (particularly small) business users, as well as those on the move. WiFi technology is having some teething problems, which need to be resolved if it is to be used for e-commerce, for instance. Nevertheless, it is in these twin areas of cellular mobile communications and Internet that new potential appears to exist, though it is also where the difficult challenges for the telecoms industry come into view.
Wired for wireless
Cell phones are almost everywhere in OECD countries these days, so much so that their presence makes it easy to forget just how recent a phenomenon they actually are. Indeed, some 60% of users in 2001 had only been connected since 1999. By 2001, there were 612 million subscribers in the OECD area, which is half the population and equivalent to 65% of all mobile phone users worldwide.
Revenues for cellular mobile services reached US$264.8 billion in 2001. This represented a tenfold increase from a decade earlier and reflected something of a revolution in terms of access to wireless communications services. And it led to a bonanza from a business viewpoint, since by 2001 a third of telecommunications services revenue was earned from mobile communications.
But although mobile telephony has grown, its impact on overall telecoms growth has been less than many investors expected. One reason is that, as prices fell, new mobile users, often using pre-paid cards, generated less average revenue than the early users. The fast pace of innovation in the telecommunications sector has also meant that new services have substituted for some older ones. So, e-mail frequently replaced fax, and some mobile calls substituted calls that would otherwise have been made from the fixed network.
Moreover, the dizzy speed of innovation and fast growth of some stocks led financial investors to overestimate the take-up and use of some technologies, like fibre optics. They also underestimated some basic market fundamentals, such as the time it would take new service providers to establish a competitive presence in local markets. After all, it is one thing to lay cables, another to win customers. On the other hand, some operators underestimated the ease with which new entrants could enter backbone markets with their own infrastructure and drive up competition, while eroding the previous high levels of monopoly pricing.
Few episodes illustrate the predicaments facing the industry better than the auction of UMTS (Universal Mobile Telephone Service) Spectrum. These so-called third generation (3G) mobile licenses were promised as a giant step forward in the quest to unlock the full potential of wireless communications. The UMTS auction in the United Kingdom raised US$33 billion. This was followed by an auction for UMTS licences in Germany, which raised nearly US$47 billion. But market sentiment changed and prices started to ease. In Italy, UMTS licenses raised US$11 billion in 2000 and US$2.5 billion in the Netherlands. The European Union had required in late 1998 that member states allocate 3G licenses before end-2001. But as attitudes towards the prospects of this technology cooled over the auction period, financial stringencies also affected the bidding power of telecoms after the bubble had burst.
3G probably has a future in broadband and, indeed, is being used in telemedicine. But recouping the race for licensed radio spectrum has left many firms overstretched and facing a hard period of adjustment, not to mention competition, as less expensive access technologies come on stream.
Regulatory measures have been suggested to facilitate the financial viability of 3G and accelerate the launching of services. A first proposal is to allow the sharing of infrastructure, specifically antenna sites rather than switching or transmission facilities. Another initiative under consideration would allow operators to resell their licenses through secondary market trading.
Beyond 3G, the cellular mobile market continues to grow and new innovations could yet surprise the industry in the way short messaging services (SMS) have done. Part of the problem is that no-one knows what innovation will come next, and investors are understandably cautious, with many focusing instead on expanding current markets, like winning new mobile phone subscribers and so on. But even this is a challenge.
Mobile Internet access is one area for promising potential, with the next several years likely to bring better, cheaper delivery of services. Until recently, cellular mobile Internet services lagged the speeds available over standard fixed lines, and this is reflected in the relatively small number of subscribers in the OECD overall. There are exceptions, like Japan which had some 40 million mobile Internet subscriptions by 2001, but to understand Internet trends to date, the clearest information concerns fixed networks.
By 2002, the number of Internet subscribers with access over a variety of platforms was more than 250 million and there were probably over half a billion users of these subscriptions. Moreover, the number of subscribers to these services grew by 22% in 2001 alone. The emergence of “free” Internet accounts, paid through telephone charges, helped spur this increase, though this model is now in decline as users demand faster, better (and more secure) services that are costly to provide.
The main source of development in the years ahead for the Internet is likely to be its access via broadband (high-speed) technology. For users accessing Internet by phone, with all its attendant frustrations of slow downloads, interruptions and above all, metered charges, broadband is already winning favour. In most countries, broadband is more expensive than dial-up, but it offers faster, always-on capabilities and enables transmission of larger volumes of data, including video services.
Broadband’s main quality is that it could finally enable all those transformations to take place that were previously promised but impossible to deliver with older technologies. Some doctors in Australia are already using it for telemedicine, including the transmission of X-rays. Meanwhile, fixed broadband networks and wireless extensions offer real hope for education and research, as well as electronic commerce and workplace organisation, including telework. Small enterprises should draw particular benefit from having affordable, always-on, connections to the Internet.
The development of broadband access networks is now moving ahead rapidly in many OECD countries. So rapidly, in fact, that more than 20 million broadband subscribers were added in OECD countries during 2002, taking the total to 55 million by the end of 2002.
In 2002 alone, the number of subscribers using DSL connections, that offer both speed and high-volume transmission over existing copper local loops, nearly doubled from 16 million to 30 million. The number of subscribers using DSL surpassed the number of subscribers using cable modems in late 2001. By the end of 2002, there were 23 million cable modem subscribers, up from 15 million a year earlier.
Compare these trends to other broadband access technologies, like two-way direct satellite, fibre-to-the-home, Ethernet local area networks (LANs), and fixed wireless networks. Some of these platforms offer the fastest broadband connections available, with some being more expensive and others less expensive than the leading platforms. In Japan, for example, commercial fibre-to-the-home connections offer speeds up to 100 megabits per second, which is many times faster than a typical DSL or cable connection in other OECD countries today.
But at end-2002, there were just 3 million subscribers using these other platforms in the OECD area. These technologies will continue to attract special uses, and some will appeal to businesses and residential users in remoter areas and outside the reach of terrestrial broadband networks. On the other hand, less expensive platforms such as WiFi mean that DSL and cable modem may not continue to be the main drivers of broadband growth.
Clearly, broadband, which is already one of the fastest growing communication services of all time, is still at a very early stage of its development, and opportunities for growth exist. But will it help the telecoms sector recover?
This depends on whether new innovations and expansion simply deflect demand away from other markets. But it could spur a steady recovery for those operators that clear their debt and restructure their firms, in particular to become flexible towards new innovations. Meanwhile, not all markets have been fully tapped. And this is where government policy comes in.
Sure enough, governments achieved a lot in the 1990s, as independent regulatory agencies were established with a mandate to open markets to competition, prevent incumbents from abusing their dominant positions and avoid collusion between operators. In the context of market liberalisation, 1998 was the turning point when, for the first time, countries with open entry into fixed markets and three or more mobile operators represented the majority of OECD countries.
Since that time more than half a billion fixed and mobile connections have been added to networks. Competition has increased too, even if privatisation has been slower than expected. And a majority of OECD countries have no foreign ownership restrictions.
However, progress in introducing local competition in some market segments has been sluggish. Even in the United States, one of the most advanced markets, the dominance of local incumbents has persevered for some services. In that country, and others, although there is agreement that there should be increased access to local markets by competitors, there is some disagreement on whether this should take the form of sharing existing connections or new infrastructure investment by operators entering the market with alternative platforms.
Japan provides one example of rapid progress. There, regulators, who required local loop unbundling in March 2000, have resisted pressure from incumbent operators like Nippon Telegraph and Telephone Corporation to keep prices high and competition access down. New entrants were providing over 60% of the broadband lines in Japan by end-2002 and new services such as Internet telephony were being rapidly adopted.
In the short term, restructuring in the telecoms business will be tough. And as in other sectors where entrants fail, the telecommunications sector will consolidate as firms go out of business or are acquired by others. This may reduce the number of competitors and push up prices for a while.
Although the necessary restructuring now underway in the industry is painful, governments and regulators should resist the temptation to provide relief to companies by easing competition requirements or providing financial help.
Our SMS message for governments is that demand for communications is set to grow further, albeit at a calmer rate than that experienced during the latter half of the 1990s. Even during the worst of the financial downturn in the industry, the size of the sector continued to grow and new opportunities abound in the area of fixed and wireless broadband access. The main challenge for governments is to keep markets open for infrastructure and service providers, while reducing the risk of corporate malpractice. The telecoms sector will take care of the rest.
OECD (2003), OECD Communications Outlook, Paris.
OECD (2003), OECD Economic Outlook, Paris.
Lenain, P. and Sam Paltridge, “After the telecoms bubble”, Working Paper No. 361, available online under Documentation on the OECD Economics web page (see link below).
©OECD Observer No 238, July 2003