Home - Key Questions - Fixed Networks: Section 1 - Question 7

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

Question 7: Will capital markets continue to give new telecoms operators preferential support?

Another crucial determinant of the dynamics of the new telecoms industry is the role played by capital markets and in particular stock markets. An important chain of causation that has had a crucial impact on the successful entry of the new operators has worked in the following way (to put it rather crudely):

• new operators purchase the latest technologies from specialist technology suppliers, installing state-of-the-art networks...
• simultaneously, there is an explosion in demand for data communications driven by take-up of the internet and data communications more generally...
• financial analysts forecast the future earnings of new operators based on factors such as market size, addressable markets, expected market share, their technological advantage vis à vis incumbents constrained by legacy systems as well as large, bureaucratic and unwieldy corporate organisations...
• as a result of the upbeat earnings forecasts of the favoured companies financial analysts give ‘buy’ recommendations...
• the share price of these operators soars against the background of unprecedented bull stock markets in the US and Europe...
• the market capitalisation of these new operators also soars...
• this gives them the purchasing power, based on the rapid appreciation of the value of their ‘paper’ (shares), to accumulate through acquisition and new investment additional network assets, sales capacities, human resources, rights of way, brand-names and customers...
• they then gain advantages of economies of scale and economies of scope⁽¹⁾...
• this further enhances their competitiveness by lowering their cost structure...
• encouraging financial analysts to become even more bullish about their future prospects...
• reinforcing a continuation of the whole (virtuous or vicious, depending on whose viewpoint is being examined) cycle.

(1) Economies of scope exist when a firm is able to sell two or more products or services more cheaply together than if they were sold separately. It is economies of scope that lie behind the preference of most large telecoms companies to sell ‘packages’ of services such as local, long distance and international calls, mobile and internet access.

It is precisely this ‘logic’ which has underpinned the performance of the most successful new operators, such as MCI WorldCom, which many financial analysts have branded a ‘must-own’ stock.

But will this ‘logic’ continue to function in this way, benefiting the new operators? It is possible to think of several reasons why this logical path may be broken (although how likely it is that the circumstances underlying these reasons will occur in reality is another story):

1. The ‘bull’ in the US and Europe may turn into a ‘bear’, just as the ‘bubble economy’ burst in Japan in 1990.
2. The supply of broadband capacity may grow more rapidly than demand and the elasticity of demand may not be sufficiently high, leading to lower profit margins and earnings growth for network operators.
3. Newer telecoms operators may emerge, taking advantage of newer technologies from specialist technology suppliers which leaves the new operators with legacy systems of their own (despite their attempts to ‘future proof’ their networks by building in unused capacity).
4. The new operators may find that their reliance on specialist technology suppliers, and their failure to build internal R&D competencies, is misjudged leading to the R&D-focused incumbents establishing a technology-led competitive advantage.
5. While reasons 1 to 4 may apply to the new operators category as a whole, the fortunes of individual new operators may be affected by reasons such as backing the wrong technologies (discussed in Question 5).

If you wish to express your views on questions such as these go to the Workshop (Area 1). To compare your visions with those of others go to Vision Check.