July 2003

Service Providers In Transition

BY SAMEER PADHYE & DOUGLAS FROSST

Service providers are living in interesting times. Customers are demonstrating an increasing desire for ubiquitous access to information and communications. Increases in computing and networking speed and capacity have enabled fundamental shifts in business and personal productivity. Business models are shifting as people take advantage of opportunities presented by these changes, in some cases building new companies oriented around communications and rapid delivery of specific information.

At the same time, economic forces have service providers focused on such near-term issues as revenue, debt reduction, and free cash flow. Virtually all communications services continue to experience usage increases, but changes in competitive intensity and buyer behavior have put service margins and revenues under pressure. All of these factors, plus changes in the telecommunications industry, have forced service providers to seriously evaluate how they fundamentally manage their overall businesses.

Industry Forces
There are three major industry forces operating now that are pushing service providers towards a new way of doing business. And, while all of these forces have occurred before in the communications industry, they have not existed concurrently. These forces are changes in regulation, networking technology, and customer behavior.

Regulation
The first is the external and sometimes unpredictable force of government regulation. Communications services back as far as postal mail in the 1800s have had to deal with this phenomenon. Regulatory changes have been responsible for some of the most significant changes in communications services, such as the 1984 break-up of AT&T or the privatization of various European telecom services. But most of these changes occurred during periods when other industry forces were relatively weak.

Networking Technology
The second major force is the global shift in networking technology. Over the past few decades, communications networks have become increasingly interconnected. These interconnections have strengthened the development of networking standards in order to ease the connectivity effort. But the proliferation and acceptance of these standards has also reduced the proprietary aspects of networking services, affecting the inherent competitive advantage for service providers. Technology changes have been a major force in the past, such as the shift from analog to digital switches. But again they have occurred during periods when other forces were weaker, allowing them to be more readily digested.

In addition, the industry is currently assimilating significant technological change. New technologies provide opportunities for new services and considerable operational savings. Networks are being transformed from circuit- to packet-based, consolidating multiple communications services onto a single network. The pace of change has increased as well, resulting in shorter product lifecycles and the emergence of several potentially disruptive technologies. While providing opportunities, this is also creating challenges to current operational models.

Customer Behavior
Perhaps the biggest force operating today is that of the customer. In the absence of regulatory and technology forces, this would have far less impact. But regulatory changes and a ubiquitous, increasingly interconnected and standards-based network allow users to take apart the value chain. Widely available services face rapid price erosion, while scarce and essential services could command a premium, but also attract competitive entries.

The Transition from �Time and Distance� to �Bandwidth and Services�
In order to increase revenue and profitability, the industry and market forces described above have pushed service providers to consider a serious change in their business models. In regulated telecommunications markets, resources such as long-distance links were expensive and limited. Business models based on time and distance were developed to manage these resources. Calls were charged based on where you called and how long you talked. As data services emerged, they naturally followed this time and distance model. In fact, throughout the entire history of communications, the progression has been to start as expensive and limited services. As a result of economies of scale and technological improvements, prices dropped, the addressable market expanded and usage increased.

While the time and distance model worked for many service providers, customers did not really like it. Dr Andrew Odlyzko, Director of the Digital Technology Center, and Assistant Vice-President for Research at the University of Minnesota addresses this issue in a paper entitled The History of Communications and its Implications for the Internet. According to Dr. Odlyzko, users prefer simpler pricing models because it protects them from suddenly large bills and reduces the need to calculate the value of each transaction.

As customer requirements change, service providers adjust to a new business model built around bandwidth and services. For example, mobile phone plans are now structured around blocks of minutes (the bandwidth) and calling features (the services) as opposed to the �time of usage� and �distance called� model when they debuted.

Like any business transition, the shift from time and distance to bandwidth and services has its challenges. The current economic situation only increases these challenges. IT and telecom budgets are flat or under scrutiny in many organizations. And, in the face of challenging marketplace, service providers will need to look at delivering bandwidth and services that move value from other existing expenditures. Doing this involves a more vertical and niche focus than has been typical for communications services.

The Customer Value Chain
As we experience significant change in the telecommunications industry, as well as a slowdown in the global economy, it is crucial to understand the customer�s problems from an economic perspective. Where do they spend their time and resources? What is keeping them awake at night? By answering these questions, carriers will identify the specific bandwidth and services that can improve the customer�s value chain -- translating to competitive advantage and additional revenue for the service provider.

The telecommunications value chain can be deconstructed at various points. The following is a look at three of these points and the resulting service provider opportunities.

Optical Services
Some customers have sizeable bandwidth requirements and place a high value on control of their network. This could be an engineering firm with large amounts of data to transfer between sites, a financial company with high priority, redundant storage needs, an organization looking for network transparency across a local campus area, or a research and education organization running grid-computing applications. An option for these customers is to lease their own fiber. This could be in the form of unlit or �dark� fiber, or specific wavelengths, also known as �dim� fiber. These are referred to as customer-owned or asset-based networks. The benefit to the customer is the ability to control all aspects of the network and have ultimate flexibility with network characteristics.

The service provider also obtains significant benefits from this model. In a time when capital expenditures are under a magnifying glass, asset-based networks move most of the capital risk to the customer. The service provider can focus on network operations and management, instead of capital management. By reserving a few wavelengths for themselves, they can continue to develop and offer value-added services. Or they can focus on the bandwidth part, leaving the services to the customer or third parties, such as content or application service providers. This model has been followed with success in many other industries, such as transportation.


Virtual Private Networks
For many customers, the network is a foundation for the business itself. But, operating the network is not a core competence. In addition, as a result of outsourcing, globalization, and increasing reliance on partnerships, organizations are no longer monolithic entities. Terms such as networked virtual organization (NVO) are being used to describe these relationships. These organizations may need to rapidly connect to new locations or securely and selectively link to other companies. In addition, communications is moving from traditional hub-and-spoke style to a mesh or any-to-any format. These changes in organizational and application behavior are creating pain points in the network that identify opportunities for service providers.

Utilizing the wide range of virtual private network technologies, service providers can deliver targeted combinations of bandwidth and services to alleviate these network issues. By focusing on customers with the greatest potential for improvements, they can more readily manage the transition from existing time- and distance-oriented solutions, reducing the impact of revenue cannibalization.

Carriers can leverage this first group of customers, using these same VPN technologies to consolidate existing networks in a step-by-step fashion. Each step creates additional service opportunities, through geographic reach, added service functionality, or reduced cost. Eventually, the scope and economies of scale will provide the foundation for a broad set of bandwidth and services across the entire customer base. This cycle of targeted services followed by leveraged capital expansion has been applied with success in many capital-intensive industries.


IP Telephony
At first glance, IP telephony is just a technology transition. Voice and fax communications across an IP network are indistinguishable from those across a TDM network. But it is this interchangeable aspect that provides a significant opportunity.

Voice communications are an important part of any business. Technology advances in the recent past have enabled a greater connection and utility between phone numbers and identity. Phone numbers are increasingly identified with an individual as opposed to a location.

Service providers can use a variety of IP telephony services to connect the various parts of an NVO, extending phone identity wherever it�s desired. Calls and voice messages can be seamlessly transferred between parts of the organization, while appearing to the customer as a single company. Employees can assume their telephone identity from anywhere a network connection exists: their office, a conference room, hotel room, or client site. Additional information such as phone directories, client data, or urgent business notifications can be delivered directly to the IP phone, further improving productivity. Rather than just a replacement for TDM voice solutions, IP telephony enables significant revenue opportunities for the service provider.

SUMMARY
The transition to a bandwidth and services business model provides enormous opportunities for carriers. Historically, there was a strong economic relationship between the flow of goods and the flow of information. The spread of communications is unraveling this bond (see Blown to Bits, by Philip Evans and Thomas S. Wurster, Harvard Business School Press). As the prime movers of information, service providers are uniquely positioned to explore the value chain of information flow, and to develop new economic models that benefit them as well as their customers.

This article was written by Sameer Padhye and Douglas Frosst of Cisco Systems, Inc. Cisco is a leader in networking for the Internet. Cisco�s IP-based networking solutions are the foundation of the Internet and many corporate, education, and government networks around the world. Cisco provides a broad line of solutions for transporting data, voice, and video within buildings, across campuses, or around the world. For more information, please visit www.cisco.com.

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