Home - Key Questions - Fixed Networks: Section 1 - Question 3

Section 1: Questions regarding the incumbent telecoms companies and the new facilities-based operators

Question 3: How can telecoms operators differentiate their services from those of their competitors?

One of the most important structural features of the new telecoms industry is the key role played by specialist technology suppliers. These companies include the traditional telecoms equipment suppliers – such as Lucent, Nortel, Ericsson, Siemens, Alcatel, NEC and Fujitsu – and the new data networking equipment companies like Cisco. See Industry Mapping for a description of the role played by the specialist technology suppliers who occupy Layer I, the equipment and software layer, in the industry. The presence of these suppliers is the most visible sign of the process of vertical specialisation that has taken place in the industry.

How does the presence of specialist technology suppliers affect the way the new telecoms industry works?

The general answer to this question is that the suppliers specialise in researching, designing and developing the ‘network elements’ – including equipment and software –involved in the construction, operation and use of telecoms networks.

One indicator of their specialisation in the technology function is a relatively high R&D-intensity (i.e. R&D expenditure as a proportion of sales). As discussed in more detail in Question 4, while the top five incumbents – AT&T, BT, Deutsche Telekom, France Telecom and NTT – have an average R&D-intensity of about 2.5 per cent, the figure for the top five suppliers is around 11 per cent. Furthermore, there is strong competition amongst these specialists, not only among the large suppliers mentioned here but also from the huge number of medium sized suppliers and newer start-ups exploiting advanced technologies in niche areas. The industry as a whole, and its consumers and users, benefit from the economies of specialisation realised by the specialist technology suppliers.

One of the most important consequences of their presence has been to change the process of entry by new competitors into the industry. More specifically, by making the latest technology available to all who are willing and able to pay for it, they have significantly lowered the technological barriers to entry. This has meant that new operators have been able simply to buy the technology – such as switches, optical fibre transmission systems and billing software – without first having to develop in-depth technological competencies.

But the assistance given to new operators by the specialist technology suppliers has gone beyond mere technology. In many cases they have supplied the managers and skilled personnel needed to operate the networks, either voluntarily by agreeing to transfer staff or involuntarily through headhunting. In some cases they have even provided finance for the purchase of their equipment and software. The speed and success with which companies such as WorldCom, Qwest, Global Crossing, COLT and Energis have entered the market owe a good deal to the facilitating role played by the specialist technology suppliers.

But, paradoxically, the presence of such suppliers has been a mixed blessing

While incumbents and new operators alike have benefited greatly from the specialisation and the new technologies created by the specialist technology suppliers, there has also been a significant downside; namely, easy technological access has made it difficult for all the players to differentiate their services. And all else being equal, the lower the degree of differentiation between competitors the lower their profit margins.

In industries where the leading firms are relatively R&D-intensive differentiation can come about through R&D activities.

And successful differentiation, in turn, can lead to higher profit margins as well as, in the longer term, to shakeout and consolidation in the industry as the more successful R&D-led innovators grow at the expense of the less successful. Moreover, it is made more difficult for new companies to enter the market. This is precisely what has happened in industries such as motor cars, televisions and memory semiconductors.

However, in industries where the technologies come from independent specialists the possibilities for the users of these technologies to differentiate their products and services are accordingly restricted. The differentiation problem is even worse for the new operators since, as is shown in Question 4, they do virtually none of their own R&D. Apart from the telecoms industry, other examples of industries with specialist technology suppliers are the airline and financial services industries.

So how do the new telecoms operators compete if they cannot differentiate themselves on the basis of technology?

There are two answers to this intriguing question. The first relates to the new operators’ competition with the incumbents. Here the new operators are able to make strategic use of the fact that the incumbents are constrained by their legacy networks. Although the incumbents, like the new operators, are able to get access through the market to the latest specialist technologies they are burdened by the old technologies that make up parts of their networks. Companies such as Qwest, etc have been able to take advantage of technologies such as TCP/IP and self-healing SDH/Sonet rings in order to construct networks that embody the latest technologies end-to-end. Conversely, the incumbents, providing national coverage, find it impractical in most cases to start afresh with an entirely new network based upon the latest generation of technologies. This technological advantage that the new operators have enjoyed vis à vis the incumbents has featured prominently in evaluations done by financial analysts and has been a significant contributor to their estimates of attractive future earnings.

But how do the new telecoms operators compete with other new operators who are also unconstrained by legacy systems?

This deals with the second answer to the previous question. In this competitive environment there is no possibility of a technological edge, just as airlines, for example, using almost identical aircraft, do not engage in technological competition. As Bernie Ebbers, CEO of MCI WorldCom, has made clear in several interviews, the answer is that the new operators have to rely on their ability to construct superior forms of corporate organisation and use them to provide better customer care and quality of service.

While in order to do this they will again make use of key specialist technologies – including, for example, billing and customer care software systems – the same technologies will also be available to their competitors. In order to differentiate themselves in terms of customer care and quality of service, therefore, they will have to make better use of the same technologies than their competitors. Although, of course, this is what the new operators claim to do, it is less clear how easy it is to establish a competitive advantage in this way and how sustainable this advantage would be.

There is, however, another source of potential competitive advantage that an operator – whether incumbent or new – can turn to. This is to develop a superior understanding of the specific problems and needs of particular segments of customers and users. However, this poses further problems in that the operator needs not only the competencies to run and upgrade networks and sell telecoms services, but also to understand particular groups of customers operating under very different circumstances. The latter, obviously, requires new knowledge and a new set of competencies that may be difficult and costly to acquire. We will return later to the role played by customers and users in the new telecoms industry.

It may be concluded, therefore, that the issue of service differentiation is extremely problematical in the new telecoms industry with important consequences not only for the profitability and growth of particular companies but also for the processes of industry shakeout and consolidation.

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