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This is the last regular issue of Netwatcher
in 2000; our December issue is our technology forecast.
Thus, it’s time to reflect on the year we’ve had, and to
introduce the question that will dominate our industry in at least the
next year—perhaps for many to come.
The question is “where is data networking going?”
To most, the answer to this question
is self-evident—through the roof! Maybe that’s even the right answer, but it should be clear
from the performance of the stock market that our justifications for
that view at least are being called into question.
We as an industry do not understand the factors that are moving
the data market, and thus may not even understand how that market is
moving.
The biggest problem—the one that
will probably be recognized in retrospect as the problem of our
time—is the over-hyping of the Internet.
We’ve talked about the factors that led to this exaggerated
view of the Internet and we won’t belabor them here further, but the
core issue is that most expected that the Internet was going to be the
long-term driver of data networking, public and private.
Since a network concept can impact the industry to the extent
that it sustains itself profitably, it should be clear that the impact
of the Internet in the near term is in jeopardy.
ISPs are talking on Wall Street, after all.
We need to look more closely at networking, to look beyond the
flashy deceit of the Internet.
Corporations have been doing data
networking for decades, just as they’ve been doing voice networking.
We can predict corporate voice growth with reasonable confidence,
so why not data? Or,
failing to get an exact prediction, could we not at least get some idea
of what issues are really driving the market? Let’s try.
First, we’ll look at factors that
are weighing on dollar demand for wide-area data services by businesses.
The primary ones are:
1. Growth of business
activity. Most business data traffic and nearly all mission-critical
traffic is associated with the completion of business transactions.
For some businesses (banks, for example), this type of activity
makes up virtually all the data networking interaction of the largest
number of employees. In
general, this metric would drive up demand in proportion to the growth
rate in business transaction volumes.
On an overall market basis, the growth rate in the GDP
approximates this factor.
2. Enhanced information
content in jobs.
In some industries, workers are using more information in
fulfilling their routine job requirements.
Brokers, for example, may draw on large quantities of data to
support individual customer calls.
In many retail sectors, customer service personnel are given a
larger amount of information to better serve customer satisfaction
goals. This factor has
added about 6% to demand growth.
3. Mandated reductions in
response time.
Productivity goals have become more aggressive, and with that has
come a desire to reduce the time workers spend waiting for information.
This has been a major factor in the expansion of WAN
expenditures, contributing nearly 13% annually.
4. Extranet relationships
with customers or suppliers. The actual execution of
retail transactions or the transportation of commercial transactions
coming out of sale (shipping advices, etc.) requires very little
bandwidth, even to support a mass consumer market.
In fact, the presentation of the graphics on a homepage involves
more data transport between business and consumer than the entire
back-and-forth transaction flow. In
truth, the greatest dollar service impact comes not from Internet or
online sales, but from online marketing.
Revenue gains here have been about 5% per year, industry-wide,
but remember that we’re talking about the gain relative to the entire
business data networking budget, not to growth within a sector.
5. Knowledge worker
information support.
This sacred cow of analysts is another of the many market
boondoggles. Overall, about
15% of workers in the marketplace can be considered to have a flexible
information content to their job—they’re “knowledge workers”, in
short. Their actual call on
data has proved to be very limited, and they represent only about 2%
revenue growth to data carriers.
Add all this up, and you come up with
a data revenue growth rate of on the order of 26% to 32%, depending on
GDP growth for the period, which is the current market experience.
If we saw this as a CAGR to be sustained for a decade, we’d be
looking at a ten-year revenue gain of over 1200%; pretty respectable.
Of course, we probably aren’t.
All of the factors listed above have demonstrated weakness in the
last year or two. Competitive pressures, technology changes, and other elements
have combined to reduce the unit cost of transport, allowing increases
in traffic to occur without compensatory increases in revenue. Nowhere is this more obvious than the Internet, which moves
about the same number of bits per hour as the total of corporate data
networking combined, and yet earns its carriers a tenth of the revenue.
Public data networking today
generates about $90 billion per year worldwide in revenue, with more
than half of that in the US. We
believe that credible trends in the five areas of demand cited above
would generate only about a doubling of US revenues, and a tripling of
market revenues overall. In
short, doing more of what we’re already doing in data networking
isn’t going to make anyone rich.
What, then, could make people rich
from data revenue? We think
it would have to be one or more of the following things:
1. Business process
re-engineering that trades a non-communications cost for a data network
cost.
Videoconferencing as an alternative to travel is an example of
this.
2. Substitution of
electronic delivery of a media product for conventional retail
distribution, which means
content networking.
3. Exploitation of new
service paradigms such as
application service provider networking, storage networking, etc.
We would argue that all of these are
cost-shifting strategies. Cost-based
factors to drive network service revenue growth always appear
unattractive, since robbing Peter to pay Paul is best accepted from
Paul’s perspective. There
is also a question of whether the impact of a cost shift strategy on the
shifted-from industry would generate a large negative consumption blip
as the activity in that industry declined.
This might offset some of the incremental gain.
Nevertheless, cost-shifting as a strategy has a big
advantage—costs are real and objective, so the only issues involved
are insuring the trade would be favorable (making videoconferencing
cheaper than travel) and altering buyer behaviors to induce willingness
to take advantage of the new cost structure.
Unfortunately, this cost-shift
analysis assumes that the only impact is on the target cost.
In the real world, the formulation of a cost-shift strategy like
any of the three above would probably involve making a
price-to-opportunity analysis. Cheaper
communications makes cost shifting easier, after all. But cheaper communications makes communications cheaper,
not just the target application. Offer
a user video bits at a rate they’re willing to pay, and those crafty
little users turn them into audio or data bits to undermine the revenue
stream of those services. Result;
carriers can generate a net loss out of a supposed gain, even if the
buyers do in fact adopt the new cost-shift paradigm and, in our example,
consume video. It all
depends on how much downward pressure on old revenues are created by the
pricing paradigms needed to develop new revenue sources.
The Internet is most vulnerable to
problems with cross-service pricing and bandwidth arbitrage, because it
is based on a single-fee, usage-independent, pricing paradigm.
This has virtually eliminated any realistic chance of building
per-service incremental pricing models such as most new service
applications would require. We
don’t see much of a chance of anything developing in the near term to
take the pressure off the ISPs.
The death of the CLEC market model,
particularly with respect to competitive voice services, has left
virtually all of the new-gen voice players scrambling for somebody to
sell to and a mission to support or tout for that buyer population.
The market that seems to be emerging is the premises voice or PBX
replacement market. The
fact that this market has been ignored up to now reflects the fact that
it is not as glamorous, not as large, and is more easily disproved than
the carrier switch replacement market.
It’s tempting to view the current vendor shift as
last-death-throes opportunism (which, in most cases it probably is), but
we have to repeat a comment we first made almost exactly two years ago,
in our October, 1998, issue; “There is a population of about 800,000
sites potentially interested in IP voice systems….”
We need to revisit the questions of this market to assess the
chances that new-gen voice players will survive there. For our
Internet readers, this article is reserved for our subscribers only!
Amid problems with falling market
share, executive turmoil, spin-offs, and questions on accounting
policies, the once-invincible Lucent is now starting to look quite
vulnerable. We looked at
Lucent last spring, when the final assimilation of Ascend was occurring,
and by our own measure the future for Lucent looked bright.
We noted at the time that Lucent’s traditional rival Nortel
appeared in paralysis, and Cisco—the new-age rival—seemed mired in
the Internet hocus-pocus.
Neither Nortel nor Cisco appears to
be setting the marketplace on fire these days, but both are certainly
doing better than Lucent. The
question now is whether Lucent can pull itself together and play again
with the big boys. We think
that the answer is “Yes”, but that the process of re-invention and
revalidation won’t be easy for Lucent, nor perhaps for its customers.
In June of 1999, we laid out five
rules that we thought Lucent had to follow in the post-Ascend period in
order to sustain its momentum in the market.
The first question we should answer, therefore, is how Lucent did
with respect to these points.
Rule number one was “Thou shall
not mess up thy incumbent voice market”. Our concern was that Lucent would be driven too much by fear
of press disdain and jump into a set of programs that would accelerate
the discrediting of existing voice infrastructure.
Since Lucent was an incumbent in this space, and derived a lot of
revenue from it, we believed that sustaining its credibility was
critical for Lucent’s success.
Well, it’s pretty clear that Lucent
didn’t obey this rule. The
company seemed to embrace IP voice as much as Cisco did, an indication
perhaps that Lucent was so preoccupied with counterpunching with Cisco
in the so-called “new-generation voice” space it lost sight of the
old (and profitable) generation.
The second rule we offered was “Thou
shall not stick thy head in the sand, media-wise”.
By that, we meant that Lucent would have to develop an IP story
that was attractive to the press, while insuring it didn’t become
threatening to its own dominant position in voice and TDM.
We can’t say that Lucent blew this one completely, but it
surely didn’t make its positioning of IP, TDM, and ATM clear in
concert.
The problem that the positioning
muddle created was the out it gave the media to interpret Lucent’s IP
initiatives as an indication of a policy shift toward IP.
That exacerbated the truth—that there was some rush to
glamour at the expense of existing technologies—and made it look like
Lucent was serving up its customer base for an IP-driven auction.
Rule number three was “Thou
shall love ATM with all thy heart, because that’s what you bought.”
It’s here that we believe one of the two major failures
occurred. Lucent paid big
bucks for Ascend, and nine out of ten of the thoughtful in the industry
would have said that the value proposition that justified that purchase
was the Cascade ATM product family that Ascend had acquired. Ascend switches were in almost all of the major carrier
accounts. All Lucent needed
to do was reverse the tragic lack of attention Ascend gave to ATM after
its acquisition of Cascade, and they’d have been a big player in
things like the modernized RBOC infrastructure simply by virtue of their
core switches.
In the organizational chaos that
ensued during the summer of 1999, Lucent seemed to forget it bought ATM
at all. OK, guys, you
don’t necessarily have to believe in ATM, but you do have to be
consistent in reflecting your strategic views on the technology front
and on the acquisition front. If
IP wins it all, don’t buy an ATM company, and vice versa.
You booted this one, Lucent, plain and simple.
The fourth rule, “Thou shall
extend thy Ascend TNT products more into the facility VPN space, because
connectionless routing and the Internet is the land of iniquity.”
The Internet wasn’t (and isn’t) making service providers
money. You can’t sell to
a market that has limited revenue unless Wall Street is willing to
capitalize that market endlessly without hope of return.
Recent market trends shows that Wall Street is completely
unwilling to do that, and that ISPs are now in nearly as much trouble as
CLECs. Lucent needed to get
its Ascend IP products directed at the facility VPN market, the market
where incumbent IXCs and ILECs were likely to invest. Ascend had, in fact, an excellent VPN architecture for these
facility IP services in the Cascade IP Navigator. Well, that technology sure dropped from sight during
1999!
Lucent got frightened by the Internet
hippy kingdom, and they threw away their whole IP story after having
abandoned ATM for it. A
strong VPN-oriented evolution to the TNT would have created an access
product focused more on DSL and perhaps even APON, because facility VPNs
(unlike tunnel VPNs) serve fixed sites.
That might have positioned Lucent for the next issue—regulatory
factors.
Our final rule for Lucent was “Thou
shall not forget that the FCC sets the business framework, not the trade
press”, and the failure of Lucent here was the second—and
perhaps greatest—of its problems.
Nobody should have understood the US regulatory environment more
than Lucent. Nobody should
have realized better than Lucent that the RBOCs would deploy ATM-based
fiber remotes to provision DSL customers.
Lucent had perhaps the dominant market position in the existing
digital loop carrier systems that these ATM remotes would replace.
Lucent had premier ATM technology in house.
Lucent released not an ATM-based fiber remote for DSL, but an
IP-based DSLAM!
ATM access modernization is expected
to result in nearly $35 billion in spending between now and 2005, by our
accounts. How much of this
could Lucent have gotten with a responsive product linking TNT, fiber
remote, DSL, and digital loop carrier technology?
We think perhaps more than half.
How much will they get now?
Zero unless they field a product not yet announced, because they still
don’t have the right equipment.
We’re sorry to say that Lucent
managed to follow none of the five rules.
Each of our readers will have to judge the extent to which they
think this failure contributed to Lucent’s problems.
Our view is that every factor cited by any company or outside
source as a justification for Lucent’s slump can be attributed to
Lucent’s failure to address these five rules.
Even with a restatement of results
after their “discovery” of an issue in their financial reports,
Lucent is a $30 billion or more company.
Something that big doesn’t sink quickly, and most companies
that size don’t really sink at all.
At the writing of this section, Lucent stock had slumped to about
$18 per share. In any kind
of acquisition or merger it would be worth at least twice that.
To ask if Lucent will survive is foolish, but to ask if it will
return to its former market position is not.
To say that Lucent now has to go back
and comply with our five rules is presumptuous, but that never stopped
analysts (including us). More
to the point, it wouldn’t be effective, because you can’t rewind
life and the marketplace. Lucent
needs new rules and we, with presumption equal to the levels of June of
last year, will provide them. For
the good of our readers, we’ll forego the ten-commandments language
this time.
Rule number one is get the
management team revamped quickly.
Lucent needs a permanent CEO and a new crop of senior managers.
We think about 30 slots are going to have to be changed out.
Do anything less than this and market confidence, at the minimum,
will be at risk. More to
the point, Lucent was the victim of a widespread and destructive set of
market myths. The carriers of this condition will have to be removed or the
organization will fall into its old patterns.
What Lucent needs to do is to get
resignations from all the key division/unit personnel, dated sixty days
hence, and then say that only the specific intervention of the new CEO
can save them. For some of
the more…ah…involved of the group (and we won’t assassinate
characters lower than the CEO level), quick departure is the order of
the day. You’ve got till
mid-December on this one, Lucent.
Rule number two is launch a broad
product initiative aimed at the RBOCs’ modernization.
Look at the stock market, gang!
Nobody but the RBOCs are doing well in the carrier space.
With unequalled access to capital, and with a huge competitive
and revenue motivation in their broader unregulated services markets,
the RBOCs will be the big spenders of this decade.
If you want to make money as a seller, sell to the buyers who
have money. This means, in
particular, aggressive movement into the ATM fiber remote space.
Lucent can’t do much here with
acquisitions given their low stock price, and that may be a blessing
because there’s not much out there worth acquiring. Alcatel and Marconi have apparently the only products that
are really able to address RBOC needs in the outside plant DSL
provisioning space for now. Lucent
could field one in six months, by our reckoning.
Field it, Lucent! Announce
it today!
The final rule is develop a strong
public-IP-beyond-the-Internet position. IP services will rule for decades to come, but it’s clear
that routers won’t be the big winners in that IP-dominated future.
In fact, it’s even clear to Wall Street.
Lucent needs to step forward with a strong position on the future
of public IP services in non-Internet applications, because these
applications can break the pricing model deadlock that’s killing the
ISPs.
Lucent still has both the market
position and the technology collateral to do this.
Ascend, Cascade, and Lucent product elements can flesh out a
fairly nice story here, with minimal enhancements.
Some of that story needs to be in place by mid-January so it can
be shared at ComNet and later shows.
Get on it, Lucent.
Lucent has one asset here that’s
almost beyond price; it’s already taken about as much of a stock and
credibility hit as the market can dish out.
Its competitors still have a significant downside risk.
This is a great time to be aggressive in positioning, and yet
conservative in terms of how long it will take for the market to realize
the kind of demand revolution that the network equipment vendors have
long been promoting. Tell
the world that huge networking changes are three years out, Lucent.
You’ll be around then, no worse for wear relative to today’s
position. Most of your
competitors will have fallen a long way by that time.
Market position is relative, isn’t
it?
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