WAVE Report

NGN 2001
By John Latta
WAVE Issue #0150 11/5-9, 2001


This is the 15th year of "John McQuillian's conference." It remains the forum to hear, in blunt terms, about the hot issues in networking. As our prior reports on NGN and NGN Ventures have stated, these are top quality conferences and NGN 2001 followed form. Without hype and the reality of a cold shower, John McQuillian again demonstrated that this is the best conference to gain insights into the state of networking and telecommunications.

As John stated in his opening remarks - this is a very complex time. Last year, in spite of the Internet meltdown, there was still excitement in the air. This year, with the telecom, stock and terrorism meltdown, there is no excitement in the air. The focus is on survival. John's conference focuses on disruptive technology and challenging the established forces. In telecommunications the establishment has won. The rebels have died.

The conference began with a mock debate between the revolutionaries (David Passmore) and the establishment (John McQuillan). Here are some tidbits from the debate (mostly from John):

2 years ago a startup company with 30 engineers, no products and no income was worth $500m. Now the valuations are only 2X income and for that same evaluation the income must be at $250m per year.

In 1999 - 2000 there were 890 NGN financings and it is likely that <10% will survive.

Within the NGN sector, over only the last year, which consists of chips, optical, NGN vendors, Majors, DCLECs (Data CLECs) and ILECs (Incumbent Local Exchange Carriers) there has been $1T in lost market value. While all categories, except ILECs, have lost from 81% to 98% of their value, the ILECs have lost only 10% of their value.

The net earnings on the NASDAQ totaled $150B for the years 1996 to 2000. In 2001 all of those profits were lost. This dramatically decreases the amount of capital for investment in public broadband infrastructure. Reported on later in the conference the ILEC capital spending in 2002 will drop from 5% to 20%. The decline in CAPEX by the ILECs will be at least $10B in 2001.

There has been a meltdown of the telecom service providers:

  • Telecom Act of 1996 was a failure,
  • ILECs failed to invest in NGN,
  • CLECs (Competitive Local Exchange Carriers), ISPs, BSOs (Broadband System Operators), DLECs failed,
  • AT&T has a huge cable debt, PTTs (Postal, Telegraph and Telephone organization) (Europe) are burdened with huge 3G debts, and
  • ILECs are still standing but are seeing declining voice revenues

There is a bandwidth glut:

  • Huge over-investment in fiber,
  • Rapid price erosion,
  • Commoditization of bandwidth, and
  • Deferral of new services.

As a result Corning is closing a fiber plant for 3 months.

Web Commerce has failed:

  • 100's of dot coms are gone,
  • Internet data centers are hurting,
  • Enterprise e-business efforts are less frenzied and less ambitious, which results in,
  • Highly skeptical and impatient investors.

Next Generation Telephony has failed:

  • Early VoIP (Voice over IP) was Internet call bypass not real telephony,
  • ILECs have been slow to adopt packet voice,
  • The early adopters of VoIP are on shaky ground, as a result,
  • There is less opportunity for VoIP given the low voice prices.

The limits of IP have become evident:

  • QoS (Quality of Service) has been a flop,
  • Traffic management is critically dependent on well-behaved TCP sources,
  • Almost no multicast deployment,
  • The security is primitive to none,
  • The addressing paradigm is broken,
  • There is a routing table explosion and as a result
  • There is less credibility in the IETF processes including the new standards such as MobilIP.

In telecommunications there is now only one game in town - the ILECs. However, the ILECs face a major challenge. The income from voice services is declining at a rate faster that replacement services can be found. 2001 is the first year since the depression, which the number of fixed phone lines has decreased.

This was a sad conclusion. We have just passed through an era with incredible investment in innovation, high expectations and great energy in technology. Yet, in this sector what is left - only 4 ILECs which have monopoly status and who are not innovators in technology use or services. The clock for a change has been set back many years.

The current environment is chilling. The VC environment is no longer about risk. Venture Capital is an oxymoron. Innovation is out. Gaining return in times where no company dares go public is the driving criteria.

Conference presentations

The first keynote was from Mike Volpi, SVP Cisco. Four months ago, Mike was responsible for Cisco's corporate strategy and oversaw 75 acquisitions in one year. Now he is responsible for Internet Switching and Services. His talk was "Time for Reinvention: Creating Shareholder Value in the New Internet World." Based on this talk there was no question that Cisco "got religion" on shareholder value.

The Internet Age was described in two chapters:

Chapter One - Beginning

  • Value Creation Meant - Go for First Mover Advantage; Build it and they will come;
  • Strategy Implied - Bricks and Mortar are Dead; Companies were run like VCs - take a portfolio approach to technologies and business;
  • Leadership Metrics Were - There were no measures on revenue but proxies such as eyeballs, page views and subscribers which drove the view that growth was much more important than profits.

Chapter Two - Now
  • Value Creation Meant - Create customer Satisfaction and Loyalty; Return the business to Simplicity and Solve Customer Problems;
  • Strategy Implied - Build a Sustainable Competitive Advantage, which means Focus, Discipline and making Major Market Bets;
  • Leadership Metrics Are - Financials (DCF (discounted cashflow), NPV (net present value) and Profit Growth) and specifically profitability

Successful companies must build shareholder value.

It will take 15 - 20% broadband penetration for the infrastructure to shift and create content just for broadband. With the penetration at only 5%, on a worldwide basis, much remains to be done. In the US the level of penetration of broadband to stimulate content which uses it is 12 - 24 months away. (I believe this may be optimistic.)

The Crossing the Chasm analog was used. "At Cisco we forgot how to cross the chasm."

The key attribute of a company, in order to Cross the Chasm, is to:

  • Build customer solutions for a few customers;
  • Replicate the solution and
  • Hope that this applies to a broader market and many.

The anatomy of a breakaway strategy includes:

  • Recognize the new reality of the market,
  • Know the competencies and challenges,
  • Redefine strategy to focus on key markets,
  • Make a small number of "deep" bets,
  • Realign resources with strategy and
  • Embrace a profitability discipline.

An interesting example of a company that is practicing many of these attributes in the consumer market is AOL. (We found it very interesting that Cisco would single out AOL to illustrate this point.)

Core competencies should be applied to the new Internet world with the following emphasis:

  • Rules of the game - Innovation and Profitability
  • Direction - Customer Success, Market Focus and Best-of-Breed Solutions and
  • Execution - Commitment and Customer Loyalty.

Special emphasis was placed on customer success. This includes:

  • Focus on creating shareholder value for your customers;
    • Demand generation
    • Productivity and
    • Efficiency
  • Foster customer intimacy
  • Leverage all available Cisco (your company) Assets.

The closing quote from John Chambers was fitting: Deal with the world the way it is, not the way you wish it was."

This all seems so simple but the mind shift has been enormous. Jack Welch did this while he was at GE. IBM practiced these principles in the 1960s and 1970s. It appears that AOL is doing this today.

Ethernet

This is a very pro Ethernet crowd. What was surprising was the momentum building for Ethernet to the home. Yet, this was not without controversy. We went to a number of sessions that described Ethernet and will summarize them here. Further, there were statements made about home networking, in particular DSL, which will be also included here.

**1000BaseT NIC cards will reach $100 by the end of 2001.

The implementation of broadband to the home using the local telephone loop was, in part, driven by the FCC (Federal Communications Commission). That is, the use of a splitter to separate voice from data and the use of a DSLAM (Digital Subscriber Line Access Multiplexer) enabled the service components to be separately built and operated. This enabled the DCLECs to use UNEs (Unbundled Network Elements). However, with >60% of the costs of an ILEC being spent on OPEX (operating expenditure) such an architecture is expensive. Specifically, an architecture should promote integration at both the CO (Central Office) and the premise in order to minimize costs and operations. This has not been done. The criteria should also be NO TRUCK ROLLS. This was described by one speaker as the Broadband Local Loop.

The objective of data to the home should be to "crush" all the cost elements with an objective of bringing DSL service to $10 or $20 per month. In order for ILEC broadband to make money for the ILEC, in terms of CAPEX, any installation must achieve a 15% penetration rate related to where the CAPEX was spent. If the investment also lowers the OPEX the penetration rate, initial broadband attach rate, may go as low as 10%.

An area where the ILECs are getting hit is in disconnects, the removal of phone lines. This is happening as 2nd phone line users are halting this service and going to cable modems for broadband.

CON - Ethernet to the Home

"Ethernet over copper is dumb." This is using Ethernet as transport to the home. For example, Ethernet needs 4 wires and is baseband. This implies greater instillation costs and the fact that these 4 lines cannot be used for anything else. Ethernet using FTH is the only media that makes sense. One very interesting statistic was cited:

If all the telephone service technicians were directed to just install home Ethernet using FTH it would take 15 years to accomplish. There is no way this will happen.

PRO - Ethernet to the Home

The IEEE standards effort is working on the following:

  • 802.3 Ethernet in the First Mile Study Group
    • Point-to-Point Ethernet over copper and fiber
    • Point-to-Multipoint Ethernet on SM fiber (PON)
  • 802.af DTE Power Study Group
    • Electrical Power over Cat5 cabling
  • 802.3ah PHY management at Customer Premises
    • Remote management of Ethernet - especially the home

"The consumer market is the next killer app for Ethernet."

Wow, what a juxtaposition.

Who ever heard of the consumer being an application?

AOL Keynote

On the second day of the conference, Ted Leonsis, Vice Chairman, American Online gave the keynote. His many messages illustrated why they are the number one online provider.

The basis for AOL was communities. This transitioned in the 90's to the media model and now are making another transition to a utility model.

On 9/12 - 13 AOL experienced the highest sign on rate ever. There were over 1B ISM on 9/11. The events of the last two months have taken AOL back to its roots. That is, the Internet is the best way to communicate and form communities. $50m was donated to those impacted by the attacks in the first 2 weeks. However, there was a significant slide in the advertising market after 9/11. But the good news is that AOL has seen early signs of a ramp up in advertising in the last two weeks.

AOL has always had as its focus the consumer. We listen to main street not Wall Street.

AOL handles in one-day 2X the number of messages that the USPO does.

In 1993 there were 7,000 simultaneous customers online and last night there were 5m simultaneous customers. To provide a context, a cable network with a <1% share will have 600,000 simultaneous viewers. The online usage is up to 1 hour/member/day. AOL is seeking to be an integral part of people's lives just like the television is. Their objective is to make the applications they provide like utilities and this reflects the new model. For example, this quarter was particularly strong for interactive shopping. One of their secrets is that Love@AOL is the #1 application. They work with Roper to understand their users. Here are some recent results.

75% of the online users say the Internet has made their lives better,
79% get information about products for purchase online,
55% buy online,
62% send or receive pictures online,
72% get maps or directions online, and
61% use instant messaging.

There are now 31m subscribers worldwide and 2.2 subscribers per household.

AOL believes that online is entering its 3rd wave.

  • Wave 1 - What were we thinking?
  • Wave 2 - Much Smaller Expectations and Shakeout
  • Wave 3 - Get Ready it is time for the Real Thing

Many of the early assumptions, as the Internet era began, and Wave 1, included:
  • 500 channel cable systems,
  • Convergence of TV and PCs,
  • Plentiful Bandwidth,
  • Life After TV and
  • Hollywood would go High-Tech.

This led to ridiculous conclusions that did not happen.

For example, Time Warner made a big bet with its Full Service Network in Florida. To AOL this was a dream that they could not afford. AOL had a project called CyberPark and at its peak there were 1,400 on the staff. They made a decision to chase the consumer and not what the industry was doing. As they look back and ask the question - why the failures? It was one missing commodity: bandwidth. There was also a talent problem. The world of technology and creative arts were not working together. Those with technical experience did not work with the arts and those in the arts did not understand the technical aspects. It was too early for these promises, integration and infrastructure to happen.

One element of the business they could not respond to was the notion that it is free. In fact, the concept of free on the Internet is unique to the Internet and does not work in any other business model.

In the Internet crash 480 Internet companies went down. $1T in market cap was lost. Leonsis' son asked him - where did it go and he could not answer him. To show how absurd this became a picture of individuals was shown with a dot com company related to each piece of clothing. Ted joked that a hat.com represented that it would be more successful that a shoe.com because it was farther up the food chain. Now what has happened is that the pendulum has swung violently past the reality of the market. Ted stated that he felt confident that AOL knows what works. It is about meeting the needs of the mainstream. It is not the technical that will appeal to consumers. If you think the first 30m subscribers are not technical wait until the next 30m.

AOL sees the potential for a major consolidation in the online industry. They are at a turning point. The next 12 - 18 months will be a period of great transformation.

AOL has just completed 12 months with its AOL TV. They consider this very successful. It built on the concept of community around the TV and did not attempt to make the TV into a web terminal or PC. Communities have value with the television.

75% of AOL members shop online and they spent $20b. They see the prospect of getting to $1T in online spending on AOL. Further, they see that the local market is as important as the national market. For example, 88% of the money spent is spent with firms that are <20 miles from home.

AOL is agnostic on transport. They are surprised that the ILECs have not been more aggressive in promoting DSL.

Predictions:

  • AOL expects to add 12 - 18m in the next year;
  • AOL will be introducing AOL branded phones for IM and e-mail;
  • Utility Expression in the Home
    • Broadband will be like Electricity and Water - it must go in every room of the house;
    • AOL has a goal of 24X7X365 in the home;
  • AOL: will be pushing broadband adoption very aggressively;
  • 2002 will be the year that broadband will take off - the key to changing the online business will come when 10% of the users have broadband;
    • AOLs first broadband supportive software comes with AOL 7.0;
  • AOL now has 3m Broadband users and expects to get to 10m "very quickly;"
  • Once AOL reaches critical mass, => 10%, there will be extensive broadband content for its customers;
  • There is one gaping hole in the AOL broadband strategy - they do not know how to build broadband communities - their objective is for the consumers to do the work of forming the communities and not the vendors.

IP Network - Internet at the Crossroads

Last year it was the old stodgy incumbent carriers against new technology and opportunity. IP was a field of dreams to absorb streams of new technology. Optics was at the forefront and the all-optical backbone was only on the horizon. What a difference does a year make. Now there was serious discussion on the limitations of the IP foundation of the Internet and the implications this could have. We only summarize some of the key points made during this session.

One view

The future of the Internet is about applying overlays to the network. Examples include CDN (Content Delivery Networks) and MPLS (Multiprotocol Label Switching). It was predicted that by the end of 2002 that the traffic volume in the overlay networks will exceed the "vanilla IP" traffic.

One of the reasons that overlays are more important than changing the IP core is that the change process has become too difficult. A strength of the IETF, in its early days, was the ability to respond faster than ISO. The Internet was the source of innovation and networking developments. Now, the IETF is too big and the process too difficult - it has become an ISO. This is the reason we are seeing small groups form around Overlay network concepts. It has just become too difficult to change the core and overlay developments will go on outside of the IETF.

Counter View

An underlying premise of the Internet has been KISS - Keep it Simple. This is the reason that the IP network is relatively simple. Attempts to change the core have failed: MBONE (Multicast Internet) and QoS. What must drive our future efforts to change the core include:

Who need the changes?
Will they pay for the usage spawned by the changes?
What is the cost of the changes - implementation, operations, investment, and more.

When many of the proposals are looked at in this vein they just do not make it to implementation. Changing the core is hard. For example, a change which is spawned by necessity is the transition of IPv6. This cannot happen overnight and the long-term transition will be difficult and painful for some. In this change to the core the cost is high but the long-term benefit survival of the Internet. In looking to overlays the following must be considered:

The network will never do everything that everyone needs;
An overlay is fine but it does not have to be over IP;
An overlay is fine but it does not have to be on a network.

This speaker concluded - overlays are a really really bad idea.

Meltdown - Panel

We summarize points made by a very cogent panel on the current and potential economic environment.

  • In the 5 year Internet period the investment community paid for virtually everything and the consumer/users got it for free. There is not business.
  • The ILECs are brain dead. Consumers do not know what they want.
  • Massive consolidation lies ahead and only a few large players will remain in both the equipment and services sectors.
  • Wall Street has essentially said - "You tricked me. I do not believe you anymore."
  • How do monies get attached to broadband demand? There are no good answers. (Note how this is in concert with what AOL said). The answer to this is about applications and content finding customers. This will take time.
  • The question was asked - If you could buy as broadband network what would you do with it? The panel had no answers. This goes back to a related question - What a people willing to pay for broadband? Unfortunately this is a question left to the bankruptcy courts to address.

There is a structural problem in the communications industries.

  • The industry has reset to monopoly service providers as the only viable players;
  • All the infrastructure development by the competitors has gone under bankruptcy;
  • The assets will end up at 15 on the $ or less;
  • The equity owners are out but the debt holders are in and basically own the assets;
  • However, the debt holders do not want this responsibility and the assets will be sold.

It was reported that many, including members of Congress, think that the Telecommunications Act of 1996 was horrific. The down side is that there is not consensus on how to replace it. Currently Congress and the public are preoccupied. It is expected that in 6+ months that this issue will get addressed.

One suggestion on the panel, which was well received, was that the US make a national statement on Broadband. In fact, this is happening in municipalities that have passed bond issues for broadband. An example cited was Palo Alto. The feeling was that such implementations would not follow the weaknesses of the local loop (DSL) or the cable plant but could well use PON (Passive Optical Network). Now this is broadband. In fact, it was suggested that E-PON was the technology - Ethernet PON.

Day Three

There is now, for the first time, in the history of this conference an over abundance of infrastructure technology. The canyon has been crossed - we must now take this technology and make money with it. As a result, we must look at the networking world with new eyes. Technology has become a small piece of what we measure in the market today. A major piece is now - what kinds of services do we sell that will generate revenue? At the same time many of the premises and expectations we have had in the past are being challenged:

  • Will QoS ever work in a datagram world?
  • Is IP the one true way for networking to be implemented? We may have to admit that connection based networks have a role after all.
  • An all-optical backbone might not be a good idea after all.
  • IPv6 will be a long and slow journey.
  • It has become very hard to change the Internet.
  • It is likely that there may never be a wholesale upgrade to the Internet.

In contradistinction with past NGN conferences there was a decided shift to services and much less on infrastructure and technology.

For the first time, this conference had no new technology to crow about.

The AOL presentation could not have happened 5 years ago - it just did not fit the mind center of this conference. Yet, today, AOL represents the reverse of a service provider. AOL listens to the customer.

The technology story has become an old one. Now is the time to move on. We must take the technology that exists today, use it and make money with it.

More from the Conference

FTTH (Fiber-to-the-Home) Session

Japan has begun installation of 100MB services. Orders are being taken 6 months forward. The cost for service is $35/month.

A new group has been formed for FTTH for promotion - www.ftthcouncil.org

Communities are taking initiative to install FTTH within their communities.

Tax relief for broadband installation, such as HR267/S88, could create a great incentive for national rollout and rural area service.

The ILECs and others are pushing for "New Wires, New Rules," for FTTH government (de)regulation. That is, no UNE requirements.

Telecordia is working on a specification for a "fiber OS" and the results are due in 2002.

One speaker represented that in Greenfield deployments that FTTH, PON dialect, is the LEAST cost implementation.

Maintenance cost of fiber is 1/10 that of copper.

Daniel Island, Charleston, SC is one of the early sites (developments) that will have complete FTTH.

It is expected that The first ILEC will begin deployment of FTTH in 2002. By 2003 - 2004 many of the ILECs will move to FTTH for targeted installations in with their regions and, most likely new homes.

SBC described Pronto, it major digital system upgrade, which is to bring DSL, and more, to homes and businesses in its geographical area. What was most interesting is that this description was laced with a discussion of the regulatory relief it needs to accomplish this. Key points from the presentation include:

  • Currently SBC has 1.2m DSL customers.
  • SBC estimates that cable has 70% of the broadband market.
  • SBC spends $10b a year in capital investment. However, in the coming year this will be reduced by 20%,
  • SBC justifies its investments based on ROI (Return on Investment), thus, its needs a clear path to profitability (this is a lead in to the regulatory relief being asked for).
  • Pronto was defined in 1999 with an expected total capital spending of $6b. It is planned that 80% of the homes served by SBC would be able to receive DSL at a rate of 1.5Mb/s.
  • The implementation was based on taking fiber to the neighborhood within 12,000 feet of each customer served. SBC will create a digital loop in 5,000 gateways to accomplish this.

SBC's ability to operate effectively is being constrained by three regulatory issues (and by implication, its ability to implement Pronto) which include:

  • When SBC is in the data business it must do this through a separate subsidiary;
  • When SBC creates a new service it must be able to offer that same service on a wholesale basis to others; and
  • SBC must unbundled its service components to its competitors.

All of these constraints create a playing field in the market that is not level. Cable does not have such restrictions.

SBC wants to do fiber to the home but the economic impact of these regulatory conditions make it unprofitable. Specifically SBC needs to be able to offer a full suite of services with its fiber deployment in order to generate enough income to accomplish the ROI. This includes at a minimum: video, telephone; LD (Long distance) and Internet, as a packaged service to the consumer. There should be no unbundling. By implication unbundling would allow other companies to cherry pick the customer base from SBC.

A video issue, for example, arises if SBC offers video within a subdivision. To do this it must obtain local franchise, and these franchises imply that the whole community will get the same service offering. This is uneconomical if the same infrastructure does not exist throughout the community and that SBC is not subject to these regulatory conditions. In particular, FTTH is only economical, on a home basis, when there is a Greenfield. These most frequently occur in new developments and will be restricted to a small part of a community.

SBC is doing a trial near San Francisco of a FTTH. This will be online next year.

In their trials of broadband they are experimenting with: VoD (Video on Demand), video conferencing, home networking, distance learning and more. These may or may not be viable businesses.

WAVE Comments

This is a nice neat package presented by SBC - we will do a lot for our customers with broadband, if you just help us get regulatory relief.

Not that easy.

Points to Consider

Politicians, industry and especially competitors do not believe SBC. None of the ILECs can be trusted to not abuse their monopoly position. Granting "regulatory relief," as outlined above, is only an extension of its monopoly position. SBC can do anything in terms of service, quality and pricing while they still retain a lock on the market served. No matter how it is couched, the ILECs are still a monopoly seeking to protect and enhance that position.

The ILECs demonstrated under the Telecommunications Act of 1996 that they will be ruthless against competitors to protect their monopoly. Best case in point were all the barriers they erected in front of the CLECs and DCLECs to keep them from the market.

Entry into the LD market by the ILECs, under the Telecommunications Act of 1996, is based on verification of competition in the area where the entry is made. Even now, 5 years after the act was passed, very few ILECs have gotten LD permission. Many of the applications to the DoJ just did not meet the criteria for competition.

Asymmetry in regulation for a cable company or FTTH implementer is not the same as that being sought by SBC. In particular, many companies seeking to upgrade to FTTH serve small areas, including a subdivision or a town. However, SBC is asking for the same rules for its complete region. This is not the same as a local competitor which may have the same level of market flexibility but the area served is likely to be quite small.

The ILECs have shown no creativity in providing data services to consumers. Thus, it is highly questionable that the ILECs will be able to serve as the ISP with competitive broadband services. This is also a core competency issue. Illinois Bell bought cable companies but this was not their core competency and they did not do well. To say that SBC can rival AOL in broadband applications is not credible and there is no assurance that SBC will open the network for others to economically offer such services.

11/21/01