Stratification, Not VerticalIntegration Future of Communications

Posted: 01/2000

Stratification, Not Vertical
Integration Future of Communications
By David Friend

If someone told you that Microsoft Corp. (www.microsoft.com)
was in the computer business, you’d wonder where the person had been for the
past 15 years. Indeed, Microsoft, as everyone knows, is a software company, not
a computer company. Yet the distinction would have been lost not too long ago.
Twenty years ago, most software was made by IBM Corp. (www.ibm.com),
which epitomized the computer industry. Now the industry has stratified–there
are companies that just make PCs, companies that just make disk drives,
companies that just make operating systems, companies that just make
applications software and so on. The big vertically integrated companies have
succumbed to a stratification of the industry.

As we look at the telecom industry, the same trends are emerging. AT&T
Corp. (www.att.com) is still, however, a little
like the old IBM–vertically integrated. After all, it just purchased
Tele-Communications Inc. (TCI) and MediaOne. Those are companies whose products
directly serve the end customer. But AT&T also is still a huge network
operator that sells wholesale minutes to the rest of the industry.

Just as an automobile company would never consider making its own steel,
AT&T will probably end up focusing on the end user and buying increasingly
more of the infrastructure from other companies. That’s what the CLEC and
next-gen telcos are doing, and they can use the competitive marketplace to beat
the big vertically integrated companies in their niches, just as Microsoft beat
IBM at software and Compaq Computer Corp. (www.compaq.com)
beat IBM at PCs.

It’s too early to tell how the communications industry ultimately will
stratify, but there are a few clear layers already taking shape. You can readily
see the analogies to very mature industries such as the automobile industry. The
"steel mills" of the telecom industry are the long-haul fiber
operators that are building cheap commodity transport to every corner of the
earth.

They sell to the "car companies" of the telecom industry–the
RBOCs, CLECs and consumer long distance providers–which all are struggling to
differentiate their products from each other to retain customers. Then there are
companies such as FaxNet Corp. (www.faxnet.com),
that sell services to the RBOCs, CLECs and the like which offer high margins and
help retain customers. FaxNet is like the Bose stereos or Magellan global
positioning systems (GPSs)–upgrades that offer buzz and profits to an otherwise
undifferent-iated automobile.

So, I predict that the telecom industry will stratify into three kinds of
businesses. On the bottom there will be carriers that actually own and operate
the fiber, satellites and other infrastructure. At the top will be service
retailers like the RBOCs, ISPs and CLECs. And in the middle will be companies
that create innovative services and products that are layered on top of the
network and sold to the consumer through the re-tail channels.

It’s hard to imagine how vertically integrated companies will survive in this
industry. With everyone laying fiber, the business of moving bits from point A
to point B is going to be unbelievably competitive. Only the lowest-cost
providers will survive. Enhanced service providers such as FaxNet, on the other
hand, enjoy healthy margins and relatively little price competition. However, it
is in a mad race to innovate new services or risk losing key customers. It’s a
different kind of business, a different kind of culture, with a different kind
of employee. It’s hard to imagine how one company could do both. And being an
effective retailer is different still. It’s where the services and the transport
come together and get packaged for the consumer.

While the major carriers are competing for new acquisitions that enlarge
their networks, the LECs and CLECs are busy trying to compete with each other
for end customers. They’re busy looking for packages of services to sell at
retail. They’ve all discovered the Internet as a service they can sell to their
customers, but the LECs have been slow to grasp that they are in the
communications business and not the telephone business. They are struggling to
avoid being also-rans in an industry dominated by giant ISPs that didn’t even
exist a few years ago. They’re a little like the railroad companies that missed
the chance to be in the airline business because they saw themselves as railroad
companies, not as transportation companies. And they’re so in love with their
big switches and infrastructure that they miss the essential fact that they
primarily are retailers.

LECs should sell everything the consumer wants to buy–transport, voice mail,
Internet access, fax services, whatever. I do believe that the RBOCs and LECs
should be selling long distance services and they’ll do well at it. However,
they shouldn’t be laying fiber around the world as some of them already are
doing. Similarly, they should not be hiring software developers in the hopes of
developing innovative new services. In fact, I don’t think they even should be
running the platforms on which enhanced services operate. Enhanced service
providers can offer a development-centric culture that attracts top engineers
and is focused on innovation software expertise.

LECs and CLECs can’t keep up with the feverish level of innovation in
enhanced services and shouldn’t be trying. It’s like expecting Sears, Roebuck
and Co. (www.sears.com) to invent and
manufacture all the products it sells. Their job is very apparent–integrate all
the different services, from international long distance, pagers, Internet
access and cell phones to e-mail, fax services and messaging. Wrap it up with
top-notch customer service and state-of-the-art billing and you’ve got a company
that will keep its customers and have enduring value.

Carriers, if they are going to survive, have to focus on driving down costs
and driving up quality. When you’re dealing with a commodity, those are the only
things that count. Ask the U.S. steel companies that got creamed by Japanese
companies during the 1970s and ’80s.

One thing is for sure: We’re at the beginning of a complete reshaping of the
industry. After 50 years of relative stability, the telecom industry is being
morphed into just the "coms" industry. And in five years, virtually
every long-term player in this market will look completely different. One
wonders which of today’s names will still be recognizable, or even in existence.

ROUNDTABLE

On broadband …

"Broadband will change everything we do and how we do it. … It’s all
about convergence; it’s all about voice, video and data. Broadband is the last
straw we need to make the Internet truly powerful."

-Robert Locklear, technology director, Cisco Systems Inc.

"We’re moving into phase two of broadband in which it becomes more
dynamic. Performance is a real issue in broadband. Try to have your own
facilities if you can. Try to have your own content if you can."

-Robert P. Ollerton,
director of engineering development, Splitrock Services Inc.

"The broadband industry is in its infancy and regulatory restraint
continues to be warranted at this time."

-Deborah A. Lathen, bureau chief, Cable Services Bureau, FCC

"There are only two ways to get broadband to all homes in America … an
upgraded, rebuilt cable system and an upgraded, rebuilt phone system. The
upgraded, rebuilt telephone network is not being encouraged in the same fashion
[as cable]. That’s not a good thing for consumers."

-Duane Ackerman, CEO and chairman, BellSouth Corp.

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