Utilities have great opportunities to participate in telecommunications and thus improve their profits and stock price. Many utilities have already profited from building and leasing either dark fiber, or "lit" fiber optic capacity. We suggest here utilities can and should use bandwidth markets or exchanges to lease or sell their telecom assets. We also discuss trading bandwidth as a commodity.
Utilities can participate in bandwidth markets in several ways. Utilities can "sell" the telecom assets they have or build. We will use the words "sell" and "buy," though typically companies sign leases that last different time periods, usually one, three or five years. Utilities can also buy assets or services using bandwidth markets. Finally, utilities can, more in the future than now, actively trade bandwidth contracts; similar to the way they may presently trade commodity energy contracts.
Electric and gas utilities, with some notable exceptions, have not adopted telecommunications as their core business. In these circumstances, it makes sense to do some functions in which the utility has strengths and to outsource other functions. Many utilities have great strengths in dealing with natural monopolies, complex regulations and a deregulatory environment, in dealing with rights of way, in raising and using capital, in complex and large scale construction projects, and in laying and maintaining cables through rights of way for various distances and into commercial buildings and residences. Many utilities are relatively weak, however, because they are geographically isolated, may lack full telecommunications expertise, may not make very rapid decisions in an extremely fast changing technical business, and may avoid entrepreneurial risks (and thus profits).
Utility strengths often suggest a strategy where utilities plan telecommunications systems, deal with regulatory issues, raise necessary capital, and build fiber networks (especially where they can have near monopolies), or lit fiber systems. Carriers could also prepare to lease or do joint ventures with rights of way, pole attachments, or networks. Such projects also avoid utility weaknesses, because there are large but relatively few necessary decisions, there is opportunity for early sales and repayment of borrowed money, and sales can be reasonably outsourced.
The utilities that have built telecom systems are among the most successful utilities. Williams has succeeded greatly twice, first in building and selling 11 of its 12 pipeline fibers to LDDS (now Worldcom), and now again, rebuilding the gas pipeline right of way fiber optic system throughout the US and acting as a wholesale carrier's carrier. The Montana Power Company sold its electric generating capacity, and now its transmission capacity and built fiber optic systems. Its stock rose from 17 to 58 within the last two years. RCN has partnered with utilities in building networks, and its stock rose from 10 to 75 in the last two years. Citizens Utilities Company of Delaware stock rose from 8 to 17 in the last two years.
Many nonutility companies have done what utilities could have done in building and lighting fiber networks. Those companies include Metromedia Fiber Network, Inc. (stock up from 7 to 90 in the last two years), NextLink (stock up from 27 to 270), Qwest (stock up from 10 to 70), Level 3 (stock up from 45 to 130), and Global Crossing-Frontier (stock up from 10 to 60).
In the period from 1993 to 1999, Value Line's Telecommunications services index of industry relative strength rose from 90 to 150. Value Line's Electric Utility relative strength sank from 60 to 45.
Fiber and bandwidth opportunities still exist in areas that are not yet "saturated" with fiber and bandwidth. Further, fiber and bandwidth have become such vital drivers of the new economy that it is hard to determine what "saturation" would be. Fifteen to twenty years ago, Sprint directly buried 12 fibers (not in conduit) and thought it had more than the world would ever use. Three years ago, Qwest started burying two conduits, 96 fibers, and thought it had more than the world would ever use. Two years ago, Level 3 started burying 8 conduits (each one of which could today be equipped with 1000 fibers), along the same cross-country Union Pacific Lines Qwest used. Denver has spawned yet a third company (along with Qwest and Level 3) that will build one of the world's largest networks. Aerie says it has 15,000 miles of pipeline and other rights of way and will connect 192 US cities, thus overbuilding Sprint, Qwest, Level 3, and Williams. Finally, last year, Level 3 and Nextlink started burying 24 conduits in five loops for Denver's local traffic network.
We have yet to hear a builder of dark fiber networks who says it built too much. Utilities still have a huge opportunity where major networks are not yet installed.
Utilities that have telecommunications products and services, but do not make telecom their chief focus, have strong reasons to outsource some or most sales efforts to bandwidth markets. Utilities have had a captive market, so are not marketing experts. They can avoid building large sales forces and reduce sales costs. Utilities are often geographically isolated, while bandwidth markets may not be. In the future, markets and not individual companies will have major influence on market prices.
Unlike utilities that relied on lifetime customers, telecommunications companies added new definitions to the word "churn." As Newton's Telecom Dictionary says, "Long distance users change their preferred carrier as often as some of them change their underwear . . . Some users have found ways to switch their long distance service often enough so that they never pay for a long distance phone call." No wonder utilities can use help selling telecom services.
Ecommerce is revolutionizing all sales. GM, Ford and Chrysler opened their automobile parts purchasing exchange. Enron opened its Internet energy trading market in September 1999 and became the biggest ecommerce site in the world in three months, trading over $20 Billion of energy. Utilities would be very ill advised to build sales forces like the RBOCs, during the same time the RBOCs will have to fire most of their salespeople. (RBOC is a regional Bell operating company, so-called "Baby Bells."}
The New York and Chicago stock and commodities exchanges are the most efficient markets in the world, but online trading is revolutionizing them. Electronic Computer Network and Internet trading are forcing these exchanges into consolidation, merger, and closing trading pits. The French MITEF opened a traditional open outcry trading pit and computerized trading system simultaneously on a new product. Within two months the trading pit closed. In light of these facts, utilities should surely not plan to sell the industrial product of bandwidth, which is tailor made for ecommerce, with a large direct sales force.
Most of the so-called "bandwidth markets," or "bandwidth exchanges," including Arbinet, RateXchange, Band-X, Min-X, and AIG list exclusively, or almost exclusively, international switched long distance minutes for voice conversations. Utilities do not trade switched minutes. To the extent these other markets list bandwidth circuits, they typically list small capacity such as T1s (which can carry 24 voice circuits) or DS3s. Bandwidth Market lists circuits of all sizes, from T1 to OC192 speed.
Concerning United States bandwidth listings on the Internet, at the time of this writing, Bandwidth Market lists over 300,000 bandwidth circuits. Arbinet lists none, RateXchange lists about 300, Band-X lists about 6, and Min-X lists none. Enron lists about 4 or 6.
Several bandwidth markets have sites on the Internet, planning to use or using a system of "offers" and "bids." Sellers "post" or state offers to sell the services or products, while buyers can state a "bid" or agreement to pay a certain amount for stated services. When other exchanges list bandwidth, they typically state a speed, a city pair and a price. Bandwidth Market, on the other hand, allows parties to list many more details. (For example, parties may specify address, city, state, country, zip code, CLLI code (alphabetic abbreviation for telecom location), LATA (Bell company regional location), NPA-NXX (country or area code plus next three digits of phone number), collocation descriptions, names of companies with which the circuits can interconnect or "peer" at each end of the circuit), speeds, terms of contract, quality measures including latency (time of travel on the circuit), restoration time (affected by SONET rings or meshed circuits), jitter, Bit Error Rate, packet loss rate, and large spaces for companies to state additional terms of the contract.)
Bandwidth markets typically are compensated, if and only if a deal is done, by a percentage commission. They make arrangements with sellers to avoid or minimize "channel conflict," for example, by agreeing to forego commissions if the seller is already negotiating with the potential buyer.
Bandwidth Market, at www.bandwidthmarket.com, allows simultaneous sorting of over 300,000 circuits by country, state, city, address, speed, and date of posting. Contracts can be standardized. Prices, visible throughout the world 24 hours a day can be changed in real time. Communications are by automatic and manual emails. Auctions can be used. Sophisticated ecommerce sales and trading is available already for a modest commission.
Most utilities served a franchise area, frequently a state or a few states. Telecommunications, and Internet sales, are global. Telecommunications are not valuable unless they connect far beyond states and regions. A traditional sales force will be geographically concentrated in the franchise area, but the buyers may not be. Internet markets can be effective regardless of local, national, or international scale.
From the "last mile" to the home or business, to the core of the network bottlenecks can develop that will quickly change the value of bandwidth. The circuit between two cities that had a shortage before the installation of a terabit router (1,000,000,000,000 bits per second) will surely not have a shortage the day after. Europe is installing petabit networks (one quadrillion bits per second, a million times as fast as a gigabit network). "Bits" of information, unlike commodities such as corn, cannot be stored for a significant time. Companies that react slowly, or need layers of bureaucratic decision making to change a price, will be destroyed.
Now, the telecommunications market is very inefficient, with a large spread between the asking price and the bidders' willingness to pay. Watching bandwidth markets, managers can react much faster. Bandwidth markets can supply necessary information, in form of sales or no sales, that are necessary for managers to decide where to build, how much to build, how much to sell, and at what price. The markets will reduce the "spread" and increase economic efficiency.
All of the discussion thus far deals with standard networks, used by end users, and sold in standard or ecommerce ways. Formal commodities trading involves some other factors that we now discuss.
Enron and Williams companies have both endorsed bandwidth commodities trading. Dow Jones will have a bandwidth index. Numerous conferences have discussed bandwidth trading as a commodity--and it will happen for reasons including the following. Enron had a $20 billion success with Internet energy trading. Enron has made a very large investment in buying a bandwidth network so it can be a market maker, buying and selling its own and others' bandwidth. Many commodity traders looking for the next new commodity after energy commoditization think bandwidth will be the new commodity.
Commodities trading in bandwidth is just beginning, with a small number of such trades so far. Contracts are not completely standardized. Trading or pooling points are just now being established. Switches are being built and installed. Some are concerned about buying from or selling to Enron or Williams, or through their switches, because of their networks and market intelligence and experience. A limited number of routes will be traded in this way, while most traffic goes elsewhere.
Assuming bandwidth trading develops into the future, one can expect the principles established on the major trading routes to diffuse to other network routes throughout the United States and the world. In twenty years, one might envision the full panoply of options, swaps, and derivatives operating for hundreds or thousands of bandwidth routes throughout the world. At that time, however, one should not expect fat profit margins on bandwidth.
Most of the markets have web sites with registration procedures. Talk to the managers, figure out what you want to buy or sell, with what terms and at what prices. On some sites you can post your own circuits, long distance minutes, or other opportunities. On others, talk to the managers or populate on line databases.
Talk to the managers to determine contractual terms and conditions, procedures during a sale, use of your contractual terms, use of any switches or routers associated with the market, and flow of payments.
One cannot predict the needs of the next customer. To post ten circuits to try out a system misses the customer who needs your eleventh or twelfth circuit. To post T1s may miss the customer needing OC3 or dark fiber.
If you have installed dark fiber, is there some price at which you are willing to sell (and perhaps build more)? Dark fiber, like everything else in telecommunications, becomes obsolete--as multimode fiber evolves to single mode fiber, to single mode non-dispersion, to LEAF, to fiber without the "water window," and so on. Almost all major fiber builders of the past may ask themselves if they held on too long, for too high a profit margin and price, waiting to sell lit bandwidth while the next generation came to build more dark fiber.
How do you set prices? AT&T built a monopoly network, in a politically regulated system favoring many cross subsidies. Prices were based on cost of network, plus a regulated rate of return, adjusted by subsidies. Costs were divided by numbers of miles and prices were developed. Systems were expected to last 20 or more years, with depreciation and bond payouts to match. Much of that system remains, including per mile pricing, while the underlying assumptions have disappeared.
Costs of network may be nearly irrelevant--especially if the network has been grossly overbuilt by the next generation, or if a company controls a bottleneck. Bandwidth markets assume very little regulatory constraint except for certain long distance taxes and charges and remaining local loop RBOC tariffs. Competition is very rapidly replacing monopoly, even in the local loop with DSL versus cable modem, versus future MMDS wireless. The number of competitors (even if using the same network such as Qwest's backbone) can be as important as new routes. Political subsidies are very hard to maintain in a competitive environment. Systems do not last 20 years. The turnover is like that for computers, and bandwidth is growing much faster than computer performance is.
What will replace old pricing models? There can be only one answer. Market prices determined by supply and demand. Some companies will thrive on cheap networks built in the right places, and others will fail with expensive networks built in the wrong ones. Pricing by cost, and pricing per mile is obsolete. Pricing assuming 20-year amortization, depreciation, and payouts to bondholders is obsolete. Planning and pricing must assume rapid decline in both the cost of providing, and the revenue from selling bandwidth.
As bandwidth, in the long-term future, does become a commodity, bandwidth pricing will be more like corn pricing. Providers will not control the price at which their bandwidth sells, any more than a farmer controls the cost at which his corn sells. All the people, taking all their individual actions, will set prices collectively acting through markets, and providers will react to the market prices.
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Howard Holme is President of Bandwidth Market, Ltd., a two-year old, Internet based, privately held, Denver, Colorado company. He received an AB in History with distinction, and Honors in Humanities from Stanford University in 1967, and a Juris Doctor from Yale Law School in 1972. He will speak at the UTC Conference in Phoenix, June 26, 2000 at 1:30 PM. You can reach Bandwidth Market at Suite 2400, One Norwest Center, 1700 Lincoln St., Denver CO 80203-4524, 303.894.4480, sales@bandwidthmarket.com. The web site is www.bandwidthmarket.com.