The Business Case
ISP Market Conditionsfaster than virtually any other advancement in history. Internet access reached
50-percent market penetration in less than eight years of existence.The growth
rate in the United States is projected to be anywhere from 40 to 110 percent for
at least the next few years.The growth rate is even more impressive when you
measure bandwidth growth.
More importantly,much of the world has yet to be provided with Internet
access, particularly some of the world’s most populous nations such as India and
China.These nations, which count their populations in hundreds of millions if not
billions, have pent-up demand that is only increasing with the passage of time.
Even more attractive is the ever-increasing need for bandwidth. It has been
demonstrated that the dial-up connection is only an introduction connection to
the Internet. Users quickly lose patience with the slow speed of dial-up connections
and long for broadband access. Applications such as digital photography,
interactive content, and downloadable music only reduce the cycle-time for the
inevitable upgrade. Demand for Digital Versatile Disk (DVD) quality video and
other high-throughput applications has not even started its ascension, and this
drives the demand for connection speeds far higher than the 1.544 Mbps that is
now considered acceptable for a to medium-sized businesses.
Even residential users will require speeds exceeding those currently offered by
Digital Subscriber Lines (DSL), cable modems, and the like as they begin to
implement multiuser home networks, videoconference, and use collaborative
applications for business and pleasure from the home. Recreational activities such
as downloading feature films or efficiently trading entire albums will also drive
the need for additional bandwidth. Consumers will not accept the trip to the
movie store for that much longer, so the ability to access downloadable movies
100 times faster than anything that is currently available will be required to provide
almost immediate access to the majority of existing films and shows.
Internet connectivity has become almost a requirement for any business and
is quickly trending toward 90-percent penetration within the consumer market.
As the power of convergence is fully implemented, Internet connectivity will
become more of a necessity than connections to the Public Switched Telephone
Network (PSTN) are today. Access to telephone calls, high-quality television and
radio, as well as a multitude of other services will all be provided by a single connection.
The demand for value-added services is also increasing. Businesses and
consumers are having their Web sites hosted, data stored, and applications provided
across Internet connections.
If all of these reasons weren’t enough, the tremendous pace of technological
advance is providing faster and more reliable connections to meet the demands of
the consumer.These advances are providing new offerings such as wireless broadband
or private DSL-to-ATM (Asynchronous Transfer Mode) networks that solve
a host of problems. Customers will want to upgrade to these new services, which
will continuously push the revenue-per-user up for those service providers that
are able to add these new technologies to their product offerings.
ISPs that thrive in this environment stand to profit enormously. Normally
revenue-generating networks can become far more efficient at higher utilizations.
Those players with the largest user base will likely be able to develop impressive
economies of scale and develop barriers to entry that currently do not exist.Those
dominant players should also enjoy the best margins in a commoditizing business.
Figure 2.1 lists the services that are driving the demand for bandwidth.
Figure 2.1 Services That Are Driving the Demand for Bandwidth
Internet Access Internet Access
Interactive Gaming
Digital Audio
Voice over X
Managed VPN
Distance Learning
Managed Services
Cable Quality Video
Video conferencing
Video on Demand E-Commerce
Voice over X
ASP Services
Virtual PBX Service
Consumer Business
A second offering, CustomAuctions, enables members to buy or sell a wide
variety of telecommunication products through an online auction site. Items include
bandwidth, dark fiber, and minutes of capacity. Options include English-style auctions
(similar to EBay), reverse auctions (similar to Priceline.com), and sealed bid
auctions. RateXchange even provides strategically located delivery hubs to facilitate
participants’ access to each other’s networks. It is now possible to trade bandwidth
and fiber with no more difficulty or differentiation than steel or chemicals.
The result of these factors is lackluster income statements and very difficult
paths to profitability.The easily accessible capital that in many ways created the
current situation has now flocked to safer havens.The capital markets, venture
firms, and private investors that once courted the industry are now far more
selective in both debt and equity investments.The valuations of both instruments
have been severely impacted, virtually cutting off additional sources of capital for
the service provider space as a whole. Existing shareholders now demand profitability
in stark contrast to earlier requirements for market penetration.
Broadband—The Enabling Technology
Initially, the growth of broadband seemed to be the way to escape the strong
pricing pressures that dial-up providers faced. Significantly higher pricing was not
holding back explosive growth rates for broadband connections. Investors quickly
took notice, and capital flowed into the broadband segment. For a while, companies
such as Covad Communications, NorthPoint Communications, and
Rhythms NetConnections seemed like the exciting evolution of the ISP.
Unfortunately, as with dial-up access before, the realities of an undifferentiated
product and strong competition drove pricing down and demonstrated the inefficiencies
of their business model.
The reality of the DSL market is that providers must rely on the Incumbent
Local Exchange Carrier (ILEC) for the all-important connection to the customer.
This forces ISPs into the position of commodity resellers which puts them
in direct competition with their suppliers.The extreme pricing pressure inherent
in a commodity environment makes it difficult for new entrants into the DSL
segment to provide the low prices required by the market while still retaining
profitability. Additionally, many of the providers chose not to develop a sales
force, but instead contract yet another layer of resellers to bring their product to
market.The combination of these factors has already driven NorthPoint
Communications into bankruptcy and has put many others in financial jeopardy.
To date, the cable industry has been able to keep virtually all competition out
of their networks. It remains to be seen what the outcome will be, but all interested
providers should carefully study the lessons of DSL providers.While the
cable industry may not have to deal with direct competition on their infrastructure,
they will not be immune to the competitive access costs of other mediums
such as DSL, terrestrial wireless, or satellite. If they do not succumb to the pricing
pressures of the industry as a whole, they will see massive turnover within their
user base.They will face the same realities as all other providers and be required
to add additional services to drive revenue.
While broadband connections seem to be following the same economic pattern
as their slower counterparts, their significance should not be overlooked.
Increasing broadband access speeds will be the foundation for the value-added
services that will allow ISPs to differentiate their offerings. Bandwidth as a standalone
technology will not provide profitability for service providers, but the capabilities
of those connections and the advantages of packet-switched technologies
will allow ISPs to add services that are highly profitable.
The inherent capabilities of high-speed packet-switched infrastructures will
also perfectly position ISPs to capitalize on the shortcomings of legacy networks.
In addition to offering traditional data services, ISPs will be capable of aggregating
services that were previously provided by multiple disparate networks.
Examples include local service, secure point-to-point circuits, long distance, and
videoconferencing.
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