July 19, 1999 1:30 PM PDT

Bandwidth glut may threaten profits

One development has gone unnoticed amid the hype that surrounded Qwest's merger battle for US West: After almost three years, the long distance provider has finally finished its own domestic high-speed network.

The completion is no small feat. With 18,449 miles of fiber-optic cable laid across the United States, the high-tech network provides stiff new competition for traditional long distance network companies like AT&T or MCI WorldCom.

But the proliferation of similar high-speed networks by competitors Level 3, IXC Communications, and Frontier Communications is forcing Qwest to look at other business opportunities to keep the profits pouring in.

Industry observers say the huge amount of new capacity coming online and the competition between these new players is sharply driving down prices and slowly eliminating profits.

"The [bandwidth] market right now is transitioning from an abundance of demand to an abundance of supply," said Ross Mayfield, vice president of marketing for RateXchange, an online bandwidth exchange where carriers sell excess capacity. "It's a matter of where the innovation is, and recently the innovation focus has been on the networks."

Technological advances have made some of these networks more efficient, allowing companies like Qwest to remain in the black. But new competition and margin pressure is pushing providers into new business like Web hosting, local and long distance phone service, and high-speed Internet service.

In the last year, the average price for hauling a megabyte of data over domestic or international lines has fallen by 25 percent, according to RateXchange's market data. The price erosion has taken its toll--Frontier announced late last month that it would not meet Wall Street's earnings expectations because of falling profits in the long distance market.

The average wholesale price for a minute of telephony service similarly fell by almost 30 percent.

"This market will be very difficult for players who do not expand their scale and scope," Qwest CEO Joe Nacchio told reporters yesterday.

Networks everywhere
For many years, the large carriers like AT&T and MCI WorldCom dominated the long distance market for voice and data transmissions. This control, in addition to widely varying international regulatory systems, created huge inefficiencies and high prices.

"For a long time, the prices and margins for international telecommunications were better than the drug trade," Mayfield said. "Because of competition, those margins are falling and have almost disappeared."

Much of that competition, both domestically and internationally, is coming from a handful of upstart telecommunications carriers in addition to Qwest. These companies have been busily building new fiber-optic networks designed to carry huge amounts of corporate and consumer data traffic as well as long distance voice calls.

As of March 31, Level 3 Communications had completed more than 1,300 miles of their network and another 4,000 are under construction. The company expects to finish its proposed 16,000-mile network during the first quarter of 2001.

IXC has completed 12,900 miles and expects to have 16,400 miles of fiber in the ground at the end of the year, according to a spokeswoman.

Frontier expects to finish its 20,000-mile network by year's end, and Williams Communications is constructing what will be a 32,000-mile network in 2000. Enron Communications also is building a nationwide network.

A commodity trade
Price pressures and new competition are slowly creating radical new models for buying and selling bandwidth, which has traditionally been negotiated as long-term contracts between carriers.

RateXchange and several other online competitors have provided one way for carriers to quickly sell their excess capacity for several years.

The companies have created an anonymous marketplace, where the carriers can bring short-term contracts--1.5 gigabytes between San Francisco and Los Angeles, say--and sell it at a market-clearing prices. In this market, all bandwidth is created equal--and by the same token, there is no brand name associated with any purchase.

By staying anonymous, the See special report: When worlds collide carriers can undercut their own prices to sell excess capacity quickly, Mayfield says. It also speeds transactions--traditional long-haul network contracts can take up to 6 months to complete, while the parties haggle over price, quality of service, and network testing. These considerations are all taken care of before the networks are thrown into the RateXchange system.

Meanwhile, an even more ambitious project is being launched by Enron, a natural gas utility now entering the market with its own communications network.

Enron wants to create a bandwidth futures market, in which buyers can lock in the price of future contracts, allowing sellers and buyers to hedge against the risk of volatile prices. The company has done the same thing for natural gas utilities, and says that at least 5 of the top 20 telecommunications companies in the United States are close to signing up.

"By creating a more efficient market for bandwidth, we can tremendously reduce the risk associated with buying capacity," said Thomas Gros, vice president of Enron's global bandwidth division.

It's much the same commodity model used in the futures market for pork bellies or orange juice. But creating a futures market relies on everybody's bandwidth being approximately the same, an idea resisted by companies like Qwest or MCI WorldCom, which are spending millions of dollars to brand their networks.

It is these branding efforts and companies' increasing efforts to create packages of services that go far beyond wholesale bandwidth that has prompted many analysts to be skeptical of Enron's efforts.

"No company is trying to accelerate the commoditization of bandwidth," said Jilami Zeribi, a telecommunications analyst with Current Analysis. "Here you've got companies who have spent an exorbitant amount of money on their networks, and they need to get the most bang for their buck."

Analysts and industry players say the next stage will likely be a spurt in the demand for network capacity, as the consumer high-speed Internet takes off and new applications like videophones become widely available.

"I can't imagine there ever being a point of overcapacity," Zeribi said. "To believe that we'll even come close to meeting the kinds of demands that the Internet and other services are creating would be very surprising."

News.com's Corey Grice contributed to this report.

 

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