2. Telecom Industry Review and Analysis
2.1 Growth in The Telecommunications Industry
2.1.8 Driver: telecom equipment vendor financing
Building up telecom infrastructure requires huge capital investments. However, it takes time to sign up fee-paying subscribers and to build up revenue streams from telecom services.
To obtain the necessary capital for network deployment becomes a critical issue, particularly for new telecom service startups. Naturally, telecom service providers sought financial assistance from telecom equipment vendors. The financial assistance could range from investing money in the company, accepting startup company stock in exchange for equipment, or making loans with flexible payments towards the purchase price of the equipment. In a promising telecom market where service operators looked at promising future and equipment manufacturers enjoyed tremendous revenue growth, “vendor financing” was a common practice among telecom equipment suppliers. In a highly competitive telecom equipment market, “vendor financing” was also essential for major telecom equipment manufacturers to win contracts from telecom service providers. With this easy source of capital, new startups as well as incumbent telecom service providers further accelerated their network buildups to expand their market size and to compete for market share. This buildup, in turn, fueled the
demand for telecom equipment and resulted in revenue growth for telecom equipment vendors (Rosenbush, et al., 2001).
Table 5 summarizes the business drivers that brought about the explosion of growth in the telecommunications industry.
Table 5. Summary of Business Drivers for Telecom Boom
Business Drivers Results
Telecommunications Deregulation
New CLECs, ILECs, cable and mobile wireless carriers; demand in new network infrastructures and network upgrades
E-Commerce Demand in IT and networking products
High Speed Internet Access Demand in high speed Internet access and core equipment
Packet Technology Demand in IP NGN products
High Growth of Mobile Communications Global demand of mobile equipment
New Digital Economy
Market shares are top priority and bandwidth drives demand; continuous infrastructure investment
Acquisition Strategy High market valuation; abundant capital for start ups
Vendor Financing Available capital for faster network buildups; more capital spending 2.2 Gloom in The Telecommunications Industry
Many factors contributed to the slowdown of the global economy, which started the third quarter of 2000. However, the telecom industry has certainly been one of the major contributors to this economic downturn. In this section, we look at the history of the telecom industry to see what “business draggers” have slowed down the telecommunications industry.
Over the years, too much capital was invested in the telecom industry, which resulted in too many companies producing too many products. The telecom network was overbuilt, and
narrow or even negative profit margins dampened capital spending among telecom service providers. Decreased spending further created a downward spiral effect on the telecommunications industry for both service providers and manufacturers (Cheng, et al., 2003).
In this section, we summarize various business draggers, including the 3G license auction, uncertainty of 3G profitability, network over-build and brutal price competition, the heavy debt of telecom startups and dot-coms, bad loans of telecom vendors, second-hand equipment, B2C and B2B investment spending cuts by corporate America, and write-offs on acquisitions which all contributed to the downturn of the telecommunications industry.
2.2.1 Dragger: 3G license auction
From 1994 until now, the U.S. government has received spectrum bids totaling more than
$41 billion. Envisioning the potential fiscal income to the government, and inspired by the success of GSM, a few European telecom regulators chose to award their 3G licenses based on the auction mechanism. In 1997, the British government hired game theorist Ken Binmore, a London University economics professor, to help design a 3G auction. In April 2000, five licenses sold for an incredible $35.4 billion, shocking everyone. It left even the free spending mobile industry breathless (Foroohar, 2001).
The impact of the UK spectrum auction quickly spread to other European countries. In August 2000, the total take for the German auction was a record $46.1 billion. In 2000, carriers across Europe paid $110 Euro billion for 3G licenses. (See Table 6) Inevitably, this prohibitive amount of money had to come from global financial markets.
Table 6. 3G License Costs
Country Issue date License Costs in Billions License cost per Capita
Finland * 3/99 $0.0 $0.0
Spain 3/00 0.5 11.2
Britain 4/00 35.4 594.2
Japan ** 6/00 0.0 0.0
Netherlands. 7/00 2.5 158.9
Germany 08/00 46.1 566.9
Italy 10/00 10.0 174.2
Austria 11/00 0.7 86
Norway 11/00 0.9 20.5
S. Korea 12/00 3.3 69.6
Australia 3/01 1.2 30.3
Singapore 4/01 0.2 42.6
*Granted without compensation
** Granted to the provider at no cost pending review
In addition to auction bids, these carriers had to spend huge amounts of money to build 3G network infrastructure. The high licensing expenses put these telecom carriers in deep debt even before they started to build their 3G networks, let alone generate any revenue. Coupled with the fact of dropping average revenue per GSM user and the uncertainty of 3G launch dates and consumers’ acceptance of 3G services, bankers and financial analysts became concerned about the future financial soundness of European mobile service operators. Fearing the lack of payback capability of these mobile operators, banks hesitated to lend to these telecom carriers. Stock market analysts realized that mobile operators could no longer sustain high enough profitability to justify their high valuation. Alarmed investors began profit-taking actions by selling mobile service stocks. As a result, stock prices of financial institutions that had financed or invested heavily in the telecom industry also plunged. Doubt about mobile
rippled across different industry sectors on different continents (Foroohar, 2001). In retrospect, it appears that the financial burden created by European 3G licensing auctions triggered the global economic slowdown.
2.2.2 Dragger: uncertainty about 3G rollout and profitability
In anticipation of a continued fall in average revenue per user, second generation wireless service operators looked to 3G broadband services as the next promising opportunity for business growth. Wireless equipment manufacturers competed to invest heavily in the R&D of 3G system equipment and handsets. Spending by most of the major wireless equipment manufacturers on 3G products and system development curved upward steeply (Foroohar, 2001). As 3G equipment manufacturers continued to promote and encourage 3G capabilities and full-color video wireless handsets, wireless service providers, investors, and consumers became excited and anxious for the arrival of 3G.
However, in auctioning 3G licenses, the U.K. and Germany in April and August of 2000 required the licensees to pay prohibitive auction bids. Wireless carriers and investors became seriously concerned about the availability date for 3G network systems and the potential profitability of 3G services. They found that 3G standards had not been finalized, a few interfaces had not been defined, and the technologies of 3G system equipment and handsets would not be mature until the end of 2002 or 2003. Japan had to postpone its initial 3G service launch from May till October of 2001. Since experimental 3G systems were based on an unstable 3G standard, their service offerings could be only a subset of full-blown 3G services. Besides disappointment over the delay of 3G availability, there exists competition from 2.5G substituting technologies, i.e., GPRS and EDGE, which can offer similar wireless data services. These concerns about 3G have created a negative impact on the stock market performance of the mobile service industry.
2.2.3 Dragger: network overbuild and brutal price competition
As a result of telecommunications deregulation in the U.S. and some European countries, many new telecom service operators were established, causing an excessive over-build of telecom networks in almost all telecom markets. According to Solomon Brothers (Hu, 2001), worldwide telecom carriers spent over $35 billion to build up to 100 million miles of fiber optical network in 1999 and 2000. The utilization of such broadband optical networks, however, only reached 5%. As technological enhancements in optical communications advanced, new generations of telecom equipment e.g. DWDMs, and routers etc., with larger capacity, faster speed, and lower per unit costs kept coming on the market, pushing telecom operators to purchase them just to stay competitive. This excessive capacity inevitably resulted in price competition, and prices for long distance data transport fell 20% to 50%
annually (Foroohar, 2001).
By 2000, most telecom service providers had expanded their capital investment and operating expenses, substantially exceeding the growth rate of their service revenues.
Additionally, the price war further eroded service operators’ future prospect of profitability (Henry, 2001). When bandwidth became excessive and demand lagged behind never-ending investment requirements, investors began questioning the validity of the business model of the telecom service industry.
2.2.4 Dragger: heavy debt among telecom startups and dot.coms
In the past few years, global telecom service operators, particularly in the U.S. and Europe, had access to abundant capital through financial institutions, stock markets, and vendor financing for their network buildups and expansions. Consequently, they accumulated heavy debt. Total carrier debt reached 91% of sales compared with only 29% in 1997 (Henry, 2001).
As the capital market felt the rising risk of these heavy debts, it balked at its over-optimistic investment practices and instead focused on the bottom line of the telecom start-ups and
Internet related companies. Investors looked for profit, not subscriber numbers or market share. The resulting downward spiral effect on startups and Internet dot-coms was tremendous. Some analysts estimated that U.S. and European telecom carriers might have
$700 billion in debt and more than $100 billion in junk bonds that will either end up in default or be restructured (Elstrom, et al., 2001). The impact of the heavy debt of telecom carriers became a major contributor to the tumble of global stock markets in the 3rd quarter of 2000.
2.2.5 Dragger: bad loans by telecom vendors
As more telecom start up companies experienced bankruptcies and failures, defaulted loans provided by telecom manufacturers caused serious financial damage. For example, the five leading North American equipment makers alone had $4.8 billion worth of vendor financing on their books. Nortel Networks had $1.6 billion; Cisco had $475 million; and Lucent Technologies Inc. had $1.3 billion. As telecom service providers failed, vendor-financed bad loans dragged the telecom manufacturing industry down (Rosenbush, et al., 2001).
2.2.6 Dragger: second-hand equipment
With the abrupt slow-down of the telecom service industry, telecom equipment purchases came to a virtual standstill. These purchase cuts created excessive inventory problems for networking equipment suppliers and computer server manufacturers. Compounding these inventory problems, the bankrupt dot-com companies flooded the second-hand equipment market with many used or “near new” routers, servers, and other networking gear which they sold for only one-tenth of the original price. The supply of second-hand equipment worsened the sales of new telecom equipment. For example, Cisco Systems’ inventory ballooned a further 29% in the second quarter of 2001 to $2.53 billion after a massive 59% increase in the first (Miller, et al., 2001). Due to their mutual dependence, the telecom equipment industry collapsed following the telecom service industry in this economic slow-down.
2.2.7 Dragger: B2C and B2B investment cuts
Global stock investors not only scrutinized the profitability of telecom service and equipment industries, but also began using the evaluation criteria of the “old economy” to scrutinize the financial health of all Internet related companies and investment activities of the
“new economy”. Consequently, not only investments in dot-com companies, but also spending on B2C and B2B hardware and software quickly fell. Most US corporations reported spending only one-third of their original projections in 2001 (Miller, et al., 2001).
The impact of these cutbacks in capital spending on telecom and information technology equipment started a downward spiral for the telecommunications industry and across all related downstream industries.
2.2.8 Dragger: write-offs of acquisitions
Acquisition had been one of the most effective strategies that telecom manufacturers employed to expand their business portfolios; however, many of those acquisitions were done under the assumption of sustained market growth. Some were worth very little after the economic slowdown. From January 2000 to February 2001, Nortel spent $17.1 billion on acquisitions. Then, in June 2001, Nortel announced a $12.3 billion write-off, which was primarily associated with those acquisitions as “impaired assets”. Cisco also took $289 million in write-offs for impaired assets. Although Cisco took a relatively small write-off compared to Nortel, there were still huge potential write-offs for Cisco as well as other telecom manufacturers in light of their past acquisition investments. As the economy slowed down, these “impaired assets” further deepened the financial crisis in the telecom manufacturering industry (Lashinsky, 2001).
Table 7 summarizes the business draggers that undermined the telecommunications industry boom.
Table 7. Summary of Business Draggers Undermining the Telecom Boom
Business Draggers Results
3G license auction bid
Heavy financial burden on 3G telecom operators;
financial institutions hesitated to continue to support telecom carriers; triggered the global telecom industry slowdown
Uncertain 3G profitability outlook
Created a negative impact on the stock
performance of the mobile profitability service industry
Network overbuild and brutal price competition
Investors began to question the validity of the telecom service industry’s business model and profitability
Heavy debt among telecom startups and dot.coms
Short on investment capital, most of them ended up in bankruptcy which contributed to the tumble of global stock markets
Second-hand equipment Cut sales of new telecom equipment Bad loans by telecom
manufacturers
Caused severe financial damage on telecom manufacturers
B2C and B2B investment cuts Generated a downward spiral effect on the telecom and related industries
Write-offs on acquisitions Deepened the financial crisis on the telecom manufacturing industry
2.3 Telecommunications Industry’s Latest Developments and Possible Next Steps
After the telecommunications bubble burst in late 2000, the overall industry was damaged severely. The giant telecom carriers and manufacturers underwent large scale downsizing and were forced to reverse their financial forecasts and growth prospects. Many companies folded.
Further, questionable accounting practices and bankruptcies dampened investors’ confidence in the telecommunications industry. For telecom service operators, lack of capital meant delays in network enhancement and new service development. The impact on telecom equipment manufacturers will likely be huge write-offs in accounts receivable and shrinkage
of future revenues. Hence, more telecommunications consolidations may be forthcoming. The short-term outlook for the telecommunications industry will be bleak until existing losses are recovered. Is, however, the information revolution dead? Will the telecommunications economy thrive again? If so, when? In this section, we will examine the internal innovation and external forces and trends that may push the telecommunications industry back on track in the future.
2.3.1 Adopting supply chain management
The strategy for a growing economy is investment for expansion. However, for a shrinking economy, the strategy has to be cost cutting and improving efficiency. Focusing on core competency and outsourcing non-core functions has become a global trend across industries.
Dell Computer’s success strategy in the PC industry is a role model for the telecommunications industry. In this horizontal integration business model, overall operational efficiency is gained through supply chain management across all levels of suppliers. Sharing information with upstream suppliers on market trends as well as products ordered by end customers on a near real-time basis can increase production planning efficiency, reduce inventories, and speed up product delivery by upstream suppliers as well as downstream telecommunications equipment vendors. Pursuing Supply Chain Management can push costs down, drive up demand, and improve the telecommunication industry’s financial performance. In the current over-supplied telecom market, more outsourcing and partnership formation will occur in the industry, and supply chain management systems will be the key enabler for such horizontal integration.
2.3.2 Generating new revenue with SMS and MMS
In light of the uncertain 3G perspectives and many wireless carriers’ difficult financial situations, it might take several years before 3G wireless platforms can be established to deliver on promised multimedia services. Meanwhile, wireless carriers are looking for killer
applications to generate new revenue based on the existing 2.5G GPRS data platform.
Currently, SMS (Short Message Service), a text-based messaging service, has become quite popular among cellular phone users. Greetings, jokes, stock quotes, weather/flight information, and bank statements are among the many kinds of SMS services offered by wireless carriers. An enhancement to SMS is MMS (Multimedia Message Service), which allows subscribers to transmit pictures, music or video clips, as well as file transfers among mobile phone subscribers. Fortunately, such enhanced multimedia service can be offered based on the existing 2G wireless network infrastructure. It means no huge network investment is necessary to generate potentially substantial revenues for wireless carriers.
Moreover, once subscribers become familiar with and accustomed to the MMS services, they will demand faster transmission speed and wider bandwidth. By that time, broadband 3G technologies will be driven by market needs rather than a new technology looking for opportunity. The promising interactive Multimedia Message Service not only can help generate additional revenues, but can also prepare a smooth path for evolution to third- generation wireless communication (Cheng, et al., 2003).
2.3.3 Emerging wireless-LAN technology
While 3G promises to offer broadband wireless Internet access data services in the future, IEEE 802.11 wireless LAN technology is becoming increasingly available in the enterprise and public hot spots (e.g. airports, restaurants, hotels, and other public places). In addition, with the growing penetration of ADSL/cable modems into the residential market, there is a growing need to connect multiple PCs and peripherals in homes. As installation becomes easier and prices fall, wireless LAN will work well as a home network. The popularity and quick proliferation of wireless LAN can be attributed to the following factors:
1. Need to access the Internet outside the office or home
2. Popularity of notebook PCs and PDAs
3. Availability of enterprise virtual private network applications 4. High data transfer rate (e.g. 11 Mps or 54 Mps),
5. Affordable equipment prices
6. Compatibility with existing LAN protocols (IP compatible)
7. No operations license or frequency usage fees required (ISM band)
Although LANs have some potential in the wireless data service market, wireless LANs also have several disadvantages for broadband wireless Internet access, and such limitations constrain wireless LAN from becoming a broad-based public service offering. For example, LAN lacks large area coverage for seamless service; small base station coverage restricts high-speed mobility service; it lacks features such as roaming, security, and privacy protection that are expected from a public telecommunications network. These situations may improve since a few fixed-line carriers are planning to deploy wireless LANs on a large scale.
The emergence of wireless LAN has changed the landscape of existing wireless service competition, and it has negatively impacted the deployment of 3G networks. However, since the strength of 3G is in its wide-area coverage and high-speed mobility, wireless LAN could potentially complement 3G networks by providing subscribers with a variety of service capabilities in the future.
2.3.4 3G Business models for wireless services
In the 2G arenas, subscribers create their own voice content and the wireless carriers simply build wireless networks to establish connectivity between subscribers. Because 3G technologies target interactive multimedia services, business models for 3G carriers become much more complex. First of all, 3G wireless carriers need to make sure that they provide appealing information content and service capabilities, either homegrown or developed
through partnership with ICPs (Information Content Providers), in order to attract subscribers to the multimedia services. Second, because 3G handsets must process, store, and display large amounts of data, they must have specially designed operating systems (e.g. Symbian), faster CPUs, larger color displays, and more battery capacity. Consequently, the 3G-handset prices run as high as $800 dollars (Baker, 2002). Furthermore, information services face language and format compatibility issues. For example, German travelers in Spain can check weather and movie schedules back home in Berlin, but unless they understand Spanish, they can not utilize information provided in Madrid. Because the delivery of a 3G-multimedia service will involve wireless network infrastructure, information content, and CPE (customer
through partnership with ICPs (Information Content Providers), in order to attract subscribers to the multimedia services. Second, because 3G handsets must process, store, and display large amounts of data, they must have specially designed operating systems (e.g. Symbian), faster CPUs, larger color displays, and more battery capacity. Consequently, the 3G-handset prices run as high as $800 dollars (Baker, 2002). Furthermore, information services face language and format compatibility issues. For example, German travelers in Spain can check weather and movie schedules back home in Berlin, but unless they understand Spanish, they can not utilize information provided in Madrid. Because the delivery of a 3G-multimedia service will involve wireless network infrastructure, information content, and CPE (customer