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Section 3: Questions regarding the specialist facilities-less service providers

Question 11: Will the specialist facilities-less service providers survive?

Important questions arise regarding the future of specialist facilities-less service providers. As is shown in Industry Mapping 3: Companies by Layer these are companies that do not have their own networks but depend on those of others in order to provide services primarily in Layers III, IV and V.

Since the liberalisation of telecoms markets - beginning in the mid-1980s in the US, UK and Japan – such companies have played an important role in the new telecoms industry. This category of player includes several types of company such as:

But when is it necessary for specialist facilities-less service providers to integrate backwards and build or buy their own networks?

There are prominent examples of companies that began without facilities but then decided to build and buy their own networks. One of the most prominent was WorldCom that began life as a reseller of long-distance services and then after several years began to construct its own network. The reason for the change in strategy was the realisation that the opportunity for arbitrage inherent in resale would increasingly be squeezed by market forces.

WorldCom began operations in 1984, the year that AT&T was divested by the US authorities. At that time resale was highly profitable. Excess capacity existed in the network services market since original new entrants such as MCI and Sprint were building their own networks at a time when voice was the main form of traffic and was only growing slowly. This meant that attractive wholesale rates were available.

On the demand side, however, the price of long-distance calls was high, partly because AT&T had been a high-cost monopoly carrier and faced no competition. However, while this meant initially high profitability for WorldCom, Bernie Ebbers and his colleagues realised that this would soon change as capacity utilisation grew due to enhanced demand for carrying capacity for voice and, increasingly, data and as competition reduced long-distance rates. By building and buying its own network (through merger and acquisition, funded by a rapidly rising share price) WorldCom would be able to avoid the high charges levied for the use of the infrastructure of other carriers. Interestingly, other new operators, such as Qwest and Level 3 that entered some five years later, decided from the outset to construct their own networks.

However, there are also prominent examples of service providers who initially owned their own partial networks - partial in the sense that they still depended on the facilities of others - but then decided to sell these and become specialist facilities-less service providers.

One of the best examples involved AOL and Compuserve who owned their own partial networks but then sold them to WorldCom. Under the deal WorldCom acquired AOL’s network and also the network of Compuserve the rest of which – i.e. the services part - was then absorbed by AOL. AOL decided that its distinctive competencies and advantages lay in the areas of information and content and not in the running of networks, an area where its needs could be adequately met through the efficient markets which existed.

More recent examples illustrate the attraction of having, from the very outset, nothing whatever to do with owning and running networks. One example is Freeserve that has now become the largest ISP in the UK, outdoing the incumbent, BT, and AOL Time Warner which is a significant player in Europe. Freeserve was established by Dixons, a leading retailer of consumer electronics including PCs. Freeserve provided the UK’s first ‘free’ internet access, that is no charge was levied by the company as an ISP although the user still had to pay the cost of the local call which was based on time. Most of the carrying and connecting – i.e. the telecoms function – was provided by Energis, the new operator subsidiary of the English National Power Grid, and its acquired subsidiary, the ISP Planet Online. Under a revenue sharing agreement sanctioned by the regulator, Oftel, Dixons and Energis shared local call revenues with BT who provided most of the local access.

A second example of a specialist facilities-less service provider, also from the UK, is Virgin’s mobile subsidiary established by Richard Branson. This company began offering services in the UK in the latter part of 1999. However, all of the mobile network services are provided by One2One. This mobile operator, together with Orange, were given the third and fourth mobile licences in the UK to challenge the incumbents – Vodafone and Cellnet (now wholly-owned by BT) – that earlier had been awarded the first two licences. Interestingly, Virgin’s mobile subsidiary is 51 per cent owned by Virgin and 49 per cent by One2One, a company that was acquired in 1999 by Deutsche Telekom. If Virgin succeeds in this venture it will have proved that it is possible for a specialist facilities-less service provider to compete profitably with rivals that own their own networks.

In Virgin’s case, One2One is both a rival, offering identical competing services, as well as a supplier of its mobile network services. In this case the explanation for success, if it comes, is the consumer brand-name that Virgin enjoys which gives it a certain amount of market appeal. Dixons, as a well-known high-street retailer and with many easily accessible outlets, enjoys a similar brand-name advantage.

But do examples such as those of AOL Time Warner, Freeserve and Virgin Mobile provide supporting evidence for the hypothesis that being a specialist facilities-less service provider is a viable long-term business strategy?

Or will counter-evidence emerge in due course from network operators who, with a base in the network layer (i.e. Layer II, see Industry Mapping) and owning and controlling their own networks, decide to vertically integrate into the services layers? Vertical integration was discussed earlier in Question 6.

Will these network operators enjoy a competitive advantage in the provision of services through having access to cheaper networks and perhaps through having direct control of their own facilities, therefore being able to provide superior services such as reliability, security and flexibility?

Or will the specialist facilities-less service providers be able to count on strong competition in the network facilities market to be able to compete effectively with the network operators when offering services?

If you wish to express your views on questions such as these go to the Workshop (Area 2). To compare your visions with those of others go to Vision Check.