March 1999

Equipment Vendors Get A New Face

BY DAVID GREENBLATT

Equipment vendors are now better suited than ever to take advantage of the tremendous opportunities in the telecom industry. Just as the advent of the PC allowed Microsoft to leapfrog many of the large, traditional software manufacturers, new telephone technology (particularly IP), emerging business strategies, and deregulation can enable new companies to make a place for themselves in the large telecom industry. So, why should - and perhaps more important - how can an equipment vendor now join the influx of companies breaking into the next-generation telecom industry?

Deregulation is one of the major reasons why companies who may have once wanted to provide telecom services but couldn't, now can. Five years ago, if you were to approach a telecom equipment vendor with the possibility of expanding their revenue stream by providing a service in addition to selling hardware, they would have turned the opportunity down. In recent years, however, many companies have taken part in takeovers, mergers, acquisitions, and strategic alliances. These new ventures have afforded companies opportunities never before realized. What once may have been perceived as a "conflict of interest" may now be viewed as strategic planning.

ENABLING FACTORS
Equipment vendors are a prime target to take advantage of these new opportunities for several reasons.

Resource pool: Given the tremendous expense incurred by equipment vendors for R&D, these vendors have firsthand knowledge of the breaking edge technology in switching, IP telephony, bandwidth monitoring, and the other components of the next-generation telco. The older legacy telco organizations are at best constantly trying to catch up and gain an understand of this new technology. The equipment vendors' comfort level can be used to involve them - actively or passively - in the formation of a next-generation telco.

Focus: The equipment vendor generally does not have existing commitments and contracts that could potentially dilute their focus. They are able to start fresh, building a business through relationships with other emerging next-generation telcos. These companies are able to move quickly. Completing a contract with an emerging telco can take as little as a few weeks, whereas completing a contract with the country's main PTT (post, telephone, and telegraph administration) can still be in processing several months after the start of negotiations.

Network accessibility: Whereas the cost of building the network was traditionally an obstacle in the face of any emerging player, today prices for leased fiber and satellite connections are dropping around the world. In some instances, it is possible to build a lesser quality connection by using the free network: the public Internet. Thus, utilizing a cheaper or more accessible network is another factor that helps the equipment vendor make an inroad into the telecom industry.

Funding: Certainly, we should discuss the funding aspects of the business. There are quite significant costs in building a telco. Traditionally the old maxim held true that the only ones who can get money are those who don't need it. Thus, an existing telco could find it relatively easy to float a bond issue to pay for network expansion. The new entrant was essentially dead - unable to get the ear of the bank.

Today financing has changed in the high-technology world. There is an understanding among the entire investment spectrum that a new order is being established in many areas - and that betting heavily on an upstart can have a sizable upside. One only has to witness some of the Internet offerings and their values for a vivid example of this opportunity. Access to funds can play a big role in getting the equipment vendor to the next step - that of becoming a major player in the telco industry.

So there we have it - access to technology, alliances with other emerging telcos, a new and cheaper network, and financing. These factors all combine to create a winning scenario for the equipment vendor wishing to become a next-generation telco.

IMPLEMENTATION
The premise is that you are an equipment vendor who is interested in becoming a next-gen telco. How would you go about actually doing it?

Let's assume that the company has knowledge of, access to, and an inventory of many of the necressary components. For example, say you manufacture some sort of router enabled for IP telephony. Clearly, this sort of router/gateway could be used as an alternative for voice communications for a small to medium-size enterprise.

1) You would start by forming some strategic alliances. A good beginning for a router company would be an alliance with a phone company. This relationship would give your router company access to a switch and hopefully to competitive rates for calls that still must be terminated on the traditional Public Switched Telephone Network (PSTN). Such an alliance should be relatively easy to establish, as it is a basic buy-sell relationship.

Another advantageous strategic alliance would be one with the larger ISPs. These companies have the direct relationships with the corporation and often are the ones that sell and place the router on the customer premises. This relationship will require little business structuring, although the ISP would probably like to benefit from the revenues of the new telco. Thus some sort of rate chart and a recurring revenue stream generated through commissions will have to be created for the ISPs you wish to partner with. Further, it is likely that you will have to compete for this alliance with others - after all, you aren't the only one interested in becoming a next-generation telco.

2) Your next step is to find a network to utilize. If you pull the voice off of the ISP's network, you have the "originating leg." So, that's done. For termination using IP, you have to buy or lease capacity. Note that there is something in the industry knows as an IRU (Indefeasible Right of User) - in effect, this is a 20-year irrevocable rental of the bandwidth. This could still be quite expensive, especially if done for a large number of routes.

Alternatively, a relationship could be made with a satellite company to use their bandwidth. This is a somewhat more competitive area, and therefore bandwidth should be available at much more competitive rates. However, there are the issues of delay in going up and down from the satellite, and the connection can be erratic when the weather is adverse. These possible weaknesses must be considered when deciding what network to employ.

3) Let's talk about financing. With the popularity of anything involving IP, options
for financing abound. Probably the best strategy would be to use the more expensive "private money" to hone the strategy of the company and build the initial organization. After 6-12 months, a decision could be made to go for additional private funding or to execute an initial public offering (IPO).

Regardless of the financing route chosen, the ultimate goal should be to get large funding. The costs of becoming a large telco player are far too high to be done without a large funding source. If you can overcome this hurdle, you will be well on your way to… who knows, maybe you'll be the next Microsoft.

At any rate, your equipment company has now entered into the telcom marketplace and can hope to take its own portion of the profits to be made there.

David Greenblatt is the chief operating officer of the Net2Phone division of IDT. He has helped make the Net2Phone service and its technology a well-known brand in the exciting and exploding world of Internet telephony, and he welcomes your feedback at [email protected]. Net2Phone routes millions of Internet phone calls and faxes each month. For more information, please call 800-CALLIDT, or visit their Web site at www.idt.net.