PRICING FOR ADVANCED NETWORK CONNECTIONS NET@EDU ANNUAL MEETING, TEMPE, FEB 7, 2000 ROBERT COHEN...

PRICING FOR ADVANCED NETWORK CONNECTIONSNET@EDU ANNUAL MEETING, TEMPE, FEB 7, 2000

ROBERT COHEN

COHEN COMMUNICATIONS GROUP & ECONOMIC STRATEGY INSTITUTE

FEBRUARY 5, 2000

2/7/2000 COHEN COMMUNICATIONS GROUP

2

PRICING FOR ADVANCED NETWORK CONNECTIONS

WHAT HAS HAPPENED TO PRICING? WHAT FRAMEWORK CAN WE USE TO

UNDERSTAND PRICE CHANGES? SOME ATTEMPTS AT FORECASTING

• LARRY ROBERTS’ TECHNOLOGY ANALYSIS

• MY ANALYSIS OF PRICING TRENDS AND FORECASTS -- MARKET + TECH


3

BUSINESS BROADBAND ACCESS PRICES ARE LOWER

0

1000

2000

3000

4000

5000

6000

LOCAL CARRIER

ATM ACCESS PRICE IN DOLLARS

OC-3 ATMACCESST-3 ATM ACCESS

T-1 ATM ACCESS


4

WILL THEY CONTINUE TO DECLINE?

1. IN 2000 -- UNLIKELY 2. AFTER 2000 -- CERTAINLY AND

MAYBE QUICKLY

• WHAT WILL DETERMINE PRICES?

• HOW MUCH WILL TECHNOLOGY, DEMAND AND MARKET STRUCTURE DETERMINE THE RESULTS?


5


6


7


8

MAIN CONCLUSIONS

DWDM HALVES COMMUNICATIONS COSTS EVERY YEAR -- LINKED TO THE 4X/YR GAIN IN NET TRAFFIC

NET “EFFICIENCY” DOUBLES EVERY 21 MONTHS IN FUTURE, SO TRAFFIC WILL DOUBLE EVERY 8 MONTHS

ACCESS COSTS SHOULD DROP 50% EVERY YEAR


9

SHORTCOMINGS OF TECHNOLOGY APPROACH

TAKES A DECADES-LONG VIEW OF CHANGES, BUT

CAN’T ESTIMATE ACTUAL PRICE BEHAVIOR

CAN’T INCLUDE MARKET FACTORS WHAT ABOUT NEW CHANGES IN

ECONOMIC BEHAVIOR?


10

PRICING INFLUENCES

NET USE• DEMAND ELASTICITY

(%D/%P) MAY NOT BE -2, BUT CLOSER TO -1.3

• DEMAND MAY CHANGE DUE TO CONSTRUCTION OF NEW NET FIBER WITH LOWER COST

• NET USE WILL GROW AS APPS INCREASE; A BIG B2B FACTOR -- DE OF -2 ?

• NET APPLINCES WILL CHANGE DEMAND

MARKET FACTORS• 70% OF NET BACKBONE

CONTROLLED BY 3 CARRIERS

• WILL NEW ENTRANTS CHALLENGE GRIP?

• LOCAL ACCESS MARKET NOT COMPETITIVE

• SHORTAGE OF FIBER OVER NEXT 9 MONTHS

• ROLE OF WIRELESS NETWORKS IN CARRYING NET TRAFFIC


11

MEASURING PRICING DIRECTLY

EARLY EFFORTS: HOW RBOCS PRICE MAIN PATTERN: WITH HIGHER

BANDWIDTH SERVICES• PRICES DECLINE RAPIDLY, THEN

PLATEAU– ALLOWS FOR SLOW EARLY ADOPTION, LATER

DEMAND INCREASES WHEN SERVICE IS POPULAR -- RBOCS RECAPTURE COSTS

• SLOWER, LESS PROFITABLE SERVICES DISAPPEAR


12


13

FORECASTING DEMAND

INITIAL EFFORT: BASED LARGELY ON FIRMS SHIFTING BROADBAND APPLICATIONS TO THE INTERNET• ASSUMES TRADITIONAL LEASED LINES

ARE REPLACED BY BROADBAND NET

HOW BIG DOES INTERNET GET? WHAT IS THE PRICING IMPACT?


14

US Internet/Intranet Growth Displaces Line Growth

-40

-20

0

20

40

60

80

100

120

140

160

1996 1998 2000 2002 2004 2005

(Bill

ions

of D

olla

rs)

Internet and IntranetScenario 3

Internet and IntranetScenario 2

Scenario 2-Scenario 1

Broadband

Long Distance

Local Access

Leased Lines


15

DATA DISPLACES VOICE

SPENDING ON INTERNET RISES TO ABOUT 50% TO 75% OF VOICE TOTAL

LEASED LINES, LOCAL ACCESS LINES FADE

PRICE IMPACTS CAN’T BE ESTIMATED • A SHIFT-SHARE ANALYSIS OF SPENDING


16

Size of Internet/Intranets and Wired Networks

0

50

100

150

200

250

US HI I+I US HIWirelineless I.I

EuropeanHI I+I

EuropeanHI Loc/LD- (BB+LL)

Japan HIInternet -Intranet

Japan HIwired less

II

Bill

ions

of D

olla

rs

1996

2005


17

WHAT DRIVES PRICING?

1. LARRY ROBERTS IEEE COMPUTER 1/00 -- TECHNOLOGY, MAINLY THE SHIFT TO “CAPACITY ENGINEERED” NETWORKS

2. MARKET STRUCTURE: 70% OF BACKBONE IS CONTROLLED BY 3 FIRMS; PRICES ARE “STICKY”

3. A THIRD WAY -- MARKET BEHAVIOR PLUS TECHNOLOGY CHANGES


18

COUNTING BANDWIDTH

ESTIMATED GROWTH OF SPECIFIC NET APPLICATIONS BY REGION• CORPORATE & CONSUMER NET USE,

ECOMMERCE, SECURITY• ADJUSTED DEMAND FOR PRICE

CHANGES USING EXPERT OPINIONS• CHECKED INITIAL ESTIMATES AGAINST

AGAINST ACTUAL TRAFFIC FLOWS


19

US TRANSATLANTIC INTERNET TRAFFIC

0.01000.02000.03000.04000.05000.06000.07000.0

1998 1999 2000 2001 2002

TERA

BYTE

S PER

MO

NTH

Baseline

2000 Price Change

Larger Price Drops

Japanese Recovery


20

INCORPORATING PRICES

PRICES FOR BANDWIDTH ON INTERNATIONAL LINKS WERE KNOWN -- AN ACCESS PRICE

AS DEMAND INCREASES, PRICES SHOULD CHANGE, ESPECIALLY IF TECHNOLOGY IS REDUCING THE COST OF INFRASTRUCTURE

• DIFFERENT PRICES GENERATE ALTERNATIVE GROWTH SCENARIOS


21

MOST EXTREME PREDICTIONS OF PRICE DECLINES FOR INTERNET

T-1 AND E-1 CIRCUITS

0.01

0.10

1.00

10.00

1997 1998 1999 2000 2001 2002

MO

NTH

LY C

OS

T P

ER

ME

GA

BIT

IN

TH

OU

SA

ND

S O

F D

OLL

AR

S

ASIA

US

EUROPE


22

PRICES IN 2000

SHORTAGE OF FIBER KEEPS PRICES “STICKY”

PRICE WAR OVER TRANSATLANTIC CIRCUITS SHIFTS TO US?

MORE COMPETITION EVENTUALLY KICKS IN -- DANTE STORY


23

FIBER SHORTAGE IMPACT

ADDITIONAL NET CAPACITY WILL NOT GROW AS FAST IN 2000

• FIBER DEPLOYMENT LIMITED UNTIL 9/00

• NEW COMPETITORS SLOWED

• MOORE’S/ROBERTS’ LAWS NOT OBEYED

FAR GREATER PRICE CUTS COULD OCCUR AFTER THE SHORTAGE

• WE ARE IN A “PLATEAU” PERIOD


24

TRANSATLANTIC PRICE WAR

FEB 1999 -- T1 ACCESS: $4000 FROM MCI, BT, ESTABLISHED PLAYERS• $2000 FROM NEW ENTRANTS

FEB 2000 -- LEVEL 3 T1 ACCESS $600 • LEVEL 3 UNDERCUTS ALL OFFERS

• CUT-RATE COMPETITORS CAN’T KEEP UP WITH THE CUT, SHIFT BUSINESS PLANS

• LEVEL 3 HOPES TO HAVE EDGE GAINING TRANSATLANTIC BUSINESS

– COULD CUT PRICES FURTHER


25

CAUSES OF TRANSATLANTIC PRICE WAR

HUGE AMOUNTS OF NEW CAPACITY COMING ON LINE

• TERABIT CAPACITY IN NEWEST LINK LARGE JUMP IN DEMAND EXPECTED DUE TO B2B,

ASP MARKETS BIG COMPETITIVE BATTLE

• IF NEW ENTRANTS GAIN FOOTHOLD, THEY MAY BE VERY PROFITABLE

• WHAT IF SERVICE PROVIDERS OVERBUILD OR CUT PRICES TOO RAPIDLY?

• PARALLELS WITH US RAILROAD OVERBUILDING: ARE THERE “JAY GOULDS” OF THE INTERNET?


26

DANTE’S CIRCUIT COSTS UNIVERSITY-BASED INTERNET COSTS IN EUROPE

HAVE FALL DRAMATICALLY COST FOR 1 MB PER YEAR

• 1997 -- 200,000 ECU• 1998 -- 150,000 ECU• 1999 -- 30,000 ECU• 2000 -- 10,000 ECU OR LESS

• MIGHT FALL TO 3,000 ECU BY 12/01?

COMPETITION PLAYED A BIG ROLE IN PRICE CHANGES: MORE PLAYERS TO BARGAIN WITH DUE TO HUGE BUILDOUT OF NEW FIBER RINGS

CORPORATIONS DECIDE TO BE .COMS


27

SIMILAR TRENDS IN US? SIMILAR DEPLOYMENT OF BACKBONES &

COMPETITION FOR CUSTOMERS • BIG SURGE IN BROADBAND TO SERVE B2B

ALSO INTERESTING IS WHETHER NEW SERVICES ON NET CREATE A NEW ECONOMICS

• CORPORATIONS NOT ONLY USE NET MORE BECAUSE IT IS CHEAPER, BUT AS RELIABILITY OF NEW SERVICES (ASPs, OTHERS) GROWS & PRICE OF SERVICES DROPS, DEMAND FOR NET-BASED SERVICES GROWS

• IMPACT: ACCELERATE DEMAND FOR NET ACCESS, PROVIDE BIGGER GAINS FOR BIG BANDWIDTH, SERVICE-BASED ISPs

• BIG CHANCE FOR NEW CARRIERS: LEVEL 3, QWEST


28

GROWTH OF US ECOMMERCE TO 2002

0

50

100

150

200

250

300

350

1997 1998 1999 2000 2001 2002

US $

Bill

ions Services

UtilitiesWhole & RetMfg NondurMfg Durable

Source: Forrester Research, Inc . Sizzling

Intercompany Commerce (July 1997)


29

ROLE OF NET APPLIANCES

PDAs & OTHER APPLIANCES ATTACHED TO NET CREATE NEW LEVEL OF DEMAND

• NET NO LONGER DESKTOP-DOMINATED

FORCES GROWTH OF CONVERGENT NETWORKS, NOT SHIFT OF VOICE TO WIRELESS, VIDEO TO WIRED

• LARGE, NEW DEMAND FOR BROADBAND CAPACITY ALSO DRIVES DEPLOYMENT

• LOWERS ACCESS COSTS


30

PRICING DURING 2000 BROADBAND ACCESS PRICES WILL NOT DROP

RAPIDLY IN 1ST HALF 00 AFTER THAT, DROPS COULD BE HUGE

• PRICE WAR COULD DEVELOP• NEW COMPETITORS GO AFTER JUGULAR OF

ESTABLISHED CARRIERS?

NEW APPLICATIONS MAY CREATE A NEW LEVEL OF DEMAND FOR NET SERVICES

• PRICES DROP NOT ONLY BECAUSE OF ADVANCES IN SILICON, BUT BECAUSE THERE IS AN ECONOMICS OF SERVICES PROVIDED BY THE NET

• GROWING DEMAND FOR SERVICES ALSO LOWERS ACCESS PRICES


31

BARGAINING FOR ACCESS

NEED BETTER INFORMATION• NETWORK ARCHITECTURE

• BROADBAND PRICING

• ACCESS ALTERNATIVES

• HISTORY OF CONTRACTS

MORE INTELLIGENT BARGAINING• CREATE ALTERNATIVES WHERE THERE

ARE NONE BY DEVELOPING “VAPOR” BIDS

• FIND COMPETITORS, GET THEM TO BID


32

KEY POINTS TO CONSIDER

BUSINESS TO BUSINESS GROWTH & NEW INTERNET DEVICES SHOULD RESULT IN HUGE NEW IP DEPLOYMENT

• INCREASED COMPETITION

• MORE POPS, BETTER ACCESS

BY 2001-2002, BUYERS SHOULD BE IN A STRONGER BARGAINING POSITION

• PLAN FOR THIS SHIFT IN BARGAINING POWER

NOW TO OBTAIN BETTER ACCESS PRICING LATER

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