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

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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

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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

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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?

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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

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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?

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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

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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

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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?

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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

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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

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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

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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

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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

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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

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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

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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

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PRICES IN 2000

SHORTAGE OF FIBER KEEPS PRICES “STICKY”

PRICE WAR OVER TRANSATLANTIC CIRCUITS SHIFTS TO US?

MORE COMPETITION EVENTUALLY KICKS IN -- DANTE STORY

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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

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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

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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?

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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

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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

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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)

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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

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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

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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

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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