INTERNET PROFIT AND LOSS ACCOUNT

Abstract of presentation by Dr Tim Kelly¹ prepared for INET’98, Track 5, Globalisation and Regional Implications, Geneva, July 22^nd 1998

"IP is to communications what the PC was to computing … it’s that fundamental a shift"

Dan Schulman, AT&T WorldNet Services, quoted in Tele.Com, May 1998

This presentation attempts to evaluate the proposition that the coming of the Internet represents the start of a radical shake-up in the US$1 trillion telecommunications sector which is comparable with the revolution undergone in the computer industry in the early 1980s, associated with the advent of the Personal Computer.

The presentation begins with an account of how the computer industry was transformed in the 1980s. At the time, the industry structure could be characterised as being like "Snow White and the Seven Dwarves", in that IBM dominated an industry in which only seven or so other players had the resources to be able to offer a full range of services, and even if their combined revenues were smaller than those of IBM. The introduction of the PC had the effect of lowering the barriers to entry in the industry. Suddenly, it was no longer necessary to have research labs employing thousands of people, factories churning out disk drives, or marketing and distribution networks that spanned the globe to be able to compete. Indeed, possession of existing market share was almost a disadvantage. The companies that proved the most profitable in the following decade – Microsoft, Compaq, Dell etc – were for the most part start-ups with no major external investors. By contrast, IBM’s cumulative losses in the first few years of the 1990s exceeded US$15 bn.

Of the top 10 companies in the computer industry in 1985, three companies could be said to have thrived (H-P, Fujitsu, NEC), one to have undergone a painful restructuring which it survived, and is now prospering again (IBM), while the others have been merged (Burroughs and Sperry, Siemens with Nixdorf), acquired (NCR, Digital) or been bankrupted (Control Data).

The remaining part of the presentation looks at how the telecommunications industry is likely to survive a similar radical shift in its market structure. Many of the characteristics of the Internet revolution are similar to those of the PC revolution—for instance, lowering the barriers to entry, making existing assets an encumbrance rather than an advantage, radical challenges to the price/performance ratio of the industry’s products—but in other ways the situation is different. For instance, the "Snow White and the Seven Dwarves" structure does exist, but it operates at a national level rather than a global one. Of the top ten telecommunication service operators, five are national champions with only small national competitors, while the other five are US companies, some of which enjoy near-monopolies in their local area. A second difference is that the telecoms sector is dominated by service companies whereas in the computer industry, at least in the 1980s, it was hardware manufacture that generated most of the revenues.

The presentation reviews the threats to the traditional telecommunications sector at three main levels: retail pricing, wholesale pricing and network architecture. It reviews how individual operators are positioning themselves, defensively or aggressively, to cope with the Internet challenge, for instance by establishing or acquiring ISPs, offering Internet telephony services, or deploying overlay networks. The biggest challenge, arguably, lies in the price structure of telco services, where the Internet threatens to undercut existing margins, particularly for international services, as well as challenging traditional precepts such as usage-based, and distance dependent pricing.

Based on this analysis of threats and opportunities, the presentation goes on to look at which areas of the existing telecommunications market are likely to be under the greatest threat from new entrants from the Internet world. It is the markets for data and text communications, together with international voice communications, which are most at risk. But as well as competing for existing markets, new Internet players threaten also to steal future markets, notably for electronic commerce, content delivery and video-based information retrieval services. Indeed, the price advantage that Internet can offer may be the only way of making them commercially viable.

The presentation concludes by looking a three plausible scenarios for how the telecommunications sector will cope with the shift in market structure brought about by the Internet.

• The first scenario, "Integration by osmosis", foresees an evolutionary trajectory whereby the cash-rich telecommunication operators slowly acquire more and more parts of the Internet—such as ISPs, portal sites, or infrastructure nodes—thus that the Internet slowly becomes indistinguishable from other parts of the telecommunications sector;
• The second scenario, "Death by packet-switching", offers an alternative viewpoint in which IP becomes the dominant protocol operating over the world’s telecommunication networks, and bandwidth becomes freely available to such an extent that voice simply becomes a bundled service, too cheap to meter, which is sold as a loss leader for other video-based and data-rich services;
• A third scenario, "Content is king", envisages a future in which the actual transport of bits becomes a commodity service with the real money being made in the provision of content via the lowest priced delivery channel. In this scenario, neither the traditional telcos, nor the new Internet players, are in control of market destiny.

¹ The views expressed in this paper are those of the author and do not necessarily reflect the opinions of the ITU or its membership. Dr Kelly can be contacted by e-mail at Tim.Kelly@itu.int