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TIME Europe, September 27, 1999
Europe Gets Wired
The days of the fully integrated national phone company are over. That's good news for upstart challengers and European consumers
For over a century following their invention of a method to manufacture seamless steel pipes, the company founded by Max and Rheinhard Mannesmann in 1890 made its reputation and the lion's share of its revenues as one of the world's largest engineering firms.
Today the company is reaping 87% of its profits from services that run through an altogether different type of pipe — the fiber optic kind that serves as a backbone for the telephone company of the future. Mannesmann got its start in 1992 as a mobile phone operator in Germany, stealing a march on its giant rival Deutsche Telekom.
Today Mannesmann is Germany's largest mobile phone operator and its second largest phone company. It is one of the new breed of telephone operators in Europe, many of which started out in sectors as diverse as steel, cosmetics, construction, energy and luxury goods. They are mounting serious challenges to century-old "legacy" phone companies saddled with old-fashioned networks and bloated workforces. "We can make decisions quicker, are better at handling our customers and have lower costs," says Lars Berg, head of Mannesmann's telephone business, which operates under the brand names Mannesmann Arcor and o.tel.o inside Germany.
He should know. Before he joined Mannesmann Berg was chief executive officer of Telia, Sweden's dominant carrier. He is crafting a strategy that includes exploiting markets in countries where the firm already has a presence — Germany, Italy, Austria and France — and entering new markets like Switzerland, the Netherlands, the Czech Republic and the U.K.
Consumers and corporate customers alike will soon reap the benefits of an explosion of pan-European Internet and mobile services. At present, users are charged high and confusing rates for calls received when they are abroad since the calls must be passed between phone companies. Once its unified pan-European network is in place Mannesmann will be able to offer lower costs and simplified tariffs.
And pan-European high-speed data networks will help corporations remain competitive in the global marketplace, offering an alternative to the expensive phone lines needed to link far-flung factories and offices. European firms have been paying at least 10 times more than American competitors to rent phone lines that cross borders.
Mannesmann is not just competing against existing national phone companies. New entrants such as Colt, Global TeleSystems (GTS), KPNQwest, Level3, MCI Worldcom, RSL Com and Viatel are building high-speed pan-European networks that will be used for the communication services of the future. These networks promise to offer better, cheaper and more innovative services because they are competing against each other and they are using a technology that is radically changing the economics of the phone industry.
That technological shift will be a major theme at Telecom 99, a big industry trade fair in Geneva from Oct. 10 to 17. It involves phone networks abandoning the old circuit-switching technology in favor of something called Internet Protocol (IP) packet-switching technologies, which make more efficient use of the transmission "pipe" or network. For example, a phone company moving the information on a CD-ROM — the equivalent of the contents of an eight-volume encyclopedia set — from New York to Los Angeles over a traditional switched telephone network pays about $27 in transmission costs. Over an IP network the cost to the operator is about $2, says Colin Williams, CEO of Level3 International, which is building an IP network spanning the U.S., Europe and Asia.
The huge difference in cost is due to the fact that circuit-switching technology used in a traditional telephone network opens and maintains a line whenever a call is made, regardless of whether someone is sending a huge data file or making a simple phone call. The result is wasted capacity. IP networks divide the information into pieces, place it in electronic packets with electronic addresses and then fill the pipe with the packets. The packets not only fill the pipe but also are directed along the way by routers, special computers that read the address information and direct each packet along the fastest route to its destination. Then — all within a fraction of a second — the pieces of information are reassembled, ready for receipt by fax, computer or listener. The development has not gone unnoticed by traditional phone companies, which are trying to build IP networks to run on top of their legacy systems.
Most are having trouble extending their networks beyond national borders, but they have the upper hand in their home markets. Despite the opening of Europe's telecommunications market to full competition last year, Europe's dominant phone companies still hold the lion's share of their national call markets, according to telecommunications consultancy Dataquest. France Telecom has 97% of the market and BT still has 76% of the U.K. market, which liberalized 15 years ago.
Legacy phone networks, which consultancy Datamonitor estimates are worth $1 trillion, won't disappear overnight. But phone companies can no longer afford to be rooted by the notion that voice is a medium for which there is no substitute. According to Christian Huitema, an Internet pioneer now working as a chief scientist for applied research at Telcordia Technologies, homes soon will only have one communications outlet — a data plug. Data traffic today yields smaller revenues than voice, but it is expected to match voice by 2007, according to Datamonitor. If that is not enough of a shock to phone companies, industry pundits are predicting that voice may even cease to exist as a service per se, gradually being subsumed into other services like videoconferencing or thrown in free.
The new environment calls for a new breed of phone company executive who moves fast and is willing to take risks. Unlike traditional telcos, most of which until recently have not had to report to shareholders, Itzhak Fisher, president and CEO of RSL Communications based in Hamilton, Bermuda, has always had to keep an eye on the bottom line. When Fisher sought backing from Ronald S. Lauder, chairman of cosmetics company Estee Lauder International, Lauder asked Fisher how much he was worth. The answer was $400,000. Lauder said he would put up the millions needed to start the company only if Fisher would invest every penny he had. Five years later RSL has operations on four continents, reporting 1998 revenues of $886 million. It owns deltathree.com, a provider of international voice services over IP that bypass the traditional phone network, and in August it announced that it will broaden its fixed and wireless service offerings to include data and Internet access services.
Against this backdrop of heightened competition traditional phone companies have spent the last four years in a frenzied, defensive effort to form alliances with each other. For example, the Swedish operator Telia, Dutch phone company KPN, Swisscom and AT&T joined forces to form Unisource, which offered voice and data services to multinationals. But the alliance is disbanding as the partners go their own way, and part of its network snapped up by Energis, a scrappy U.K. utility company with grand visions in Europe.
KPN, one of the founding members, has abandoned attempts to tie its future to traditional phone companies, instead partnering with Qwest, one of the most aggressive new U.S. phone companies. "KPN has understood that there is more opportunity as a player in the new paradigm than to try and protect the old one," says John McMaster, CEO of KPNQwest, a joint venture formed between KPN and Qwest Communications International in November 1998. It operates a high-capacity European fiber optic IP network which is interconnected to Qwest's U.S. fiber network to deliver multimedia, data and voice services.
KPN is one of the best examples of a legacy phone network embracing change. In addition to linking up with Qwest it has aggressively cut rates at home, expanded into Eastern Europe and launched a telecommerce branch. The playing field at home, though, is growing more crowded. Although they may not yet be household names, new entrants in Europe's national markets are proving to be adept at marketing and promotion. The larger new entrants in Spain are spending more, but Jazztel was the first to splash out with a large advertising campaign to promote the company's brand, and its prepaid calling cards are linked with the Barcelona Football Club.
The new entrants are also excelling at finding new outlets for their services. French retailer and distribution company Pinault Printemps Redoute is probably best known for its recent takeover of Gucci but it is also making inroads into the French consumer market for telecom services through its wholly owned subsidiary, Kertel, formed in December 1997. The company's initial strategy was to resell telephony services through PPR's various retail channels, rather than the provision of telecom services. However, the firm found French wholesale prices too high, so it secured a license to build its own infrastructure network. Its national tariffs, according to consultancy Yankee Group Europe, are on average 40% below those of France Telecom, with discounts for calls to overseas locations as high as 70%.
Kertel's first products, launched in June 1998, were prepaid and rechargeable calling cards sold in PPR-owned stores as well as Carrefour, Casino, Continent, Monoprix, Prisunic, Teleciel and Shell. Its cards can be customized by its partner store chains so that the retailers become virtual service providers, building on their brand and saving Kertel the expense of creating its own brand. Carrefour, for example, now claims more than 1 million telephony customers. The Kertel calling cards are also linked with the retailers' loyalty and credit cards, changing the way consumers think about buying telephony services.
But the new entrants are not having an easy ride. ESAT Telecommunications, Ireland's second largest phone company, has lodged legal complaints with European Union antitrust authorities no fewer than five times about barriers in Ireland's phone market, including interconnection rates. Although the Commission backed ESAT during the three years it took to handle its complaint, it recently did an about-face on the precedent-setting case, which would have required Europe's dominant phone companies to compensate new entrants for all the years they overcharged them.
According to Bernard Amory, a lawyer in the Brussels law firm of Jones, Day, Reavis & Pogue, the Commission's u-turn sends the wrong message to traditional telcos at a time when the industry is wrestling with a key competition issue — breaking the dominant carrier's ironclad grip on the local loop, the part of the network which reaches consumers' homes. Local loop issues are in fact high on the agenda in the Commission's 1999 review of telecom competition.
Cable television networks are providing one source of local service competition. Cable systems operated by UPC, an Amsterdam-based company whose backers include Microsoft, offer phone, Internet access and cable television services in 12 European countries. In order to expand their services and provide even more competition for the major local telephone service providers, these new entrants are looking for partners with mobile networks.
Tim Kelly, head of operations analysis at the International Telecommunication Union in Geneva, predicts that rather than focusing on size, the most successful phone companies of the future may be those that break up into companies targeting different sectors of the market. "The days of the fully integrated incumbent telco are over," gloats Level3's Williams. "They will have to focus on their strengths, but it is tough to figure out what they are." Maybe they will find some answers at Telecom 99.
With reporting by MAIRI BEN BRAHIM/London
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