June 21, 2001 4:20 PM PDT

Is fiber-optic construction creating overkill?

Telecommunications carriers have laid thousands of miles of fiber-optic cables in the ground, but now some analysts suggest the companies have dug themselves into a deep hole.

Carriers have spent billions of dollars building networks they are only partially using because there isn't enough traffic to send through the cables they installed. As a result, companies have reduced their spending on equipment, cut prices and seen profits plunge, touching off a chain reaction in the telecom sector.

In recent months, equipment giants Cisco Systems, Lucent Technologies and Nortel Networks, among many others, have issued profit warnings and announced reorganization plans as a result of poor sales to these carriers that are reluctant to buy. Despite the evidence of a communications sector slowdown and signs of a fiber-optic glut, some carriers have forged ahead with their plans to complete or even expand their networks.

On Thursday, Global Crossing and Qwest Communications International both announced the completion of new fiber-optic networks, for example.

Some analysts and industry executives refer to the oversupply of fiber-optic capacity as simply planning ahead, or as a glut that may eventually be corrected. Others regard it as a sort of long-term boondoggle.

"The telecom industry has invested itself right out of a business," said Mike McCue, chief executive of Tellme Networks, a voice-activated Internet service that works with many communications carriers. "They've laid so much fiber in the ground that they've basically commoditized themselves. They are going to get into massive price wars with everyone and it's going to be a disaster."

Optimists, however, believe the issue of optical overcapacity is overblown. Qwest Chief Executive Joe Nacchio has disputed claims of a fiber glut made by the media and Wall Street. He does not see installed-but-idle fiber as a sin, instead calling it a cost-saving measure.

"For every dollar you spend to dig up the ground, put a conduit in, pull fiber and splice it, you spend one to two dollars of capital in order to make that network operable and serviceable," he said. "You don't spend more money to prove that your first investment was incorrect."

Nacchio also pointed out that Qwest operates its networks near 85 percent of their capacity.

Many industry observers believe that less than 5 percent of the fiber put in the ground is in use. Future applications and new Internet users may one day fill these networks, but for now most experts say they will handle only a fraction of their capacity.

Making matters worse for carriers, the lack of network traffic has forced them to cut prices for use of their networks.

According to RateXchange, an electronic broker that helps carriers trade bandwidth capacity, a connection running at 155 megabits per second from Los Angeles to New York cost about $45,000 a month last October. That price fell to $35,000 in March and is expected to slip to $2,450 in January 2002.

Russ Matulich, senior vice president of sales at RateXchange, estimates that a 155mbps connection could handle about 42 million minutes of calls a month under ideal circumstances, and that current optical technology could increase this capacity eight to 10 times more.

"You could do all the world's long-distance with two or three strands of fiber, and there's thousands of strands in the ground" now, Matulich said.

Origins of a glut
The recent spending spree was caused by a combination of regulatory permissiveness and plenty of investment capital. The Telecommunications Act of 1996 made it easier for carrier start-ups to challenge entrenched players. The capital markets made it easy to raise money through stock and bond offerings. As a result, dozens of new fiber-optic networks were installed starting in the mid- to late 1990s.

see special report: Digital Darwinism Some analysts say the upstarts merely took advantage of the opportunities before them. "They did it because they could," said Drake Johnstone, a communications industry analyst at Davenport & Co., a Richmond, Va., equity research firm.

The oversupply of fiber-optic cable largely is limited to long-distance networks, which were built first. Carriers are still constructing networks within cities, where there is demand.

Capital equipment spending by telecommunications carriers grew 36 percent from 1998 to $77.1 billion in 1999, according to research by Robertson Stephens, and jumped another 35 percent in 2000. But Robertson Stephens expects spending to fall 13 percent by the end of 2001 from the previous year and reach $74.4 billion by 2003, a fall of about 29 percent.

Other research draws the same conclusion. Epoch Partners, a San Francisco investment bank, predicts spending will fall by 6 percent this year, and Banc of America Securities forecasts a 9 percent drop.

The drop in spending means carriers will spend less to use their networks, because it costs more to activate the networks than to leave them inactive. And that means there's more fiber not being used.

When will it go away?
So the question remains: Will the carriers use all the fiber currently installed underground? Davenport's Johnstone believes that will not happen for at least another 10 years--if ever.

Widespread failures by many carrier newcomers could help dampen the excess capacity, analysts said. The subdued environment might also force carriers to work with the capacity they have and buy capacity from other providers rather than spend the money to light their own dark networks.

The content and applications in the future could require more bandwidth, filling today's networks with new traffic.

"Technologies are being honed right now that are going to grab that extra bandwidth," said Yankee Group senior analyst Courtney Quinn, who believes that videoconferencing and streaming media applications will soak up capacity once more people use them.

However, while Internet traffic is increasing and more homes and business are installing fast data connections, telecom equipment is becoming more efficient at sending data down the same hair-like strands of glass fiber.

Carriers now aim to upgrade their long-distance networks, or networks that run between cities, to transmit data at about 10 gigabits per second, up from the current 2.5gbps, which is roughly 39,000 times faster than a standard 56kbps modem.

Industry analysts say that overcapacity is a fact of life in the telecom industry. Robert Rosenberg, president of Insight Research, points out that the stress on the network varies day to day, and telecom carriers seek to prepare themselves for the heaviest traffic conditions.

"You can't just switch to just-in-time bandwidth; that's not how telecom networks are built," he said.

Johnstone believes the oversupply can't last, regardless. "Over time the supply and demand imbalance will even out and pricing will stabilize," he said. "It's kind of a self-correcting mechanism."

 

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