The Dawn of the Great Communications Race

21 Mar 2003

To most consumers, the Great Communications Race has not been evident in everyday life. We still struggle to remember those pesky one-to-three digit codes that identify cities and countries. The telephone still works as storms quash our lights and silence our televisions. In fact, it seems the armies of phones have grown – recently disembodied from the wires that remain stubbornly fixed to the walls of our houses and offices. Phones lie beside plates of food and on bar tops. Phones hang from the ears of people rushing to catch planes. Phones ring from pockets and purses. Phones seem to be ubiquitous. They are connected by the Public Switched Telephone Network (PSTN) and enhanced by the recently adopted sibling, wireless networks.

But there is a new participant in this marathon, unseen and soft-spoken. Fleet and nimble groups of data networks are growing here and there without need for the central command posts of the giant switched networks. They are apostates growing in numbers, teaming together, extending territories and participating with new and more powerful gear.

A couple decades ago, Local Area Networks (LANs) were comprised of computers connected to printers and other peripheral devises within a room or small office environment. The common culture among these LANs was Ethernet. While each network operated autonomously, the devices connected by the respective networks shared a common protocol that allowed the devices to move from network to network and operate effectively in any LAN. But a device in a network could only cover short distances to reach its baronages – typically a few hundred feet. Slowly, Ethernets expanded in terms of both reachable distances and types of devices that could interconnect.

Today, Ethernets and their data network semblances (we will refer to these as TCP/IP networks) can reach across nations and even continents. This is made possible by the development of new data communications protocols and the evolution of the Internet, a complex of interconnected data networks that now reach virtually everywhere the public switched telephone network (PSTN) can reach and beyond.

Presently incumbent telephone companies are distracted by a sprint race of sorts – a race between the fixed networks and the wireless networks. Revenues from traditional voice conversations managed by fixed networks are eroding; volumes of traffic are rising more slowly than the decline on prices. For example, between 1990 and 1998, average long distance prices in the US fell by almost 7% per year (after adjusting for inflation) while calling volume increased on average by 5% per year. Thus, the incumbents rightfully attribute to the encroachment of wireless communications into the PSTN. And more current data should show a widening gap. But the major risk is not in one party losing the sprint. The more significant threat is from the nimble participants hidden in the homes and offices of every country in the world. Both wireless and fixed telephone networks are vulnerable to the encroachment of data networks that can appear from all sides and at any time.

It’s easy to miss the import of the marathon over the sprint. The prospect of data networks overtaking the telephony we all rely on today seems remote in light of the present integrity of the telephone system. Only the PSTN is adorned with published directories, information operators, organized numbering systems, and electrical power that seems immune to the ravages of raging storms. Wireless networks, while lacking the universal directories and number information services, have the advantage of mobility. They look and feel like telephones albeit with enhanced functionality.

Data networks, on the other hand, are accessed through computers that have no telephone number in the regional numbering plans, have no printed directories, and don’t attach to the wall telephone jack without special accommodations. Data networks are estranged cousins to the PSTN, connected only through a few equally estranged services such as Net2Phone, Deltathree and Phonefree.com. These companies intercept traditional telephone calls locally, remove the voice data from the PSTN, send the voice through data networks, and return the voice data back into the PSTN at the terminating end of the call.

Businesses are more familiar with voice over data networks. Indeed, many employees of companies using advanced data communications in lieu of the PSTN are unaware that their conversations are entirely disassociated from the PSTN. Business communications systems may use familiar telephones plugged into traditional telephone jacks that have been rewired to send voice data through private data networks that connect the various branches of the company. These same telephones are routed through the PSTN to connect with the outside world. Increasingly, telephone companies are losing revenue on the portion of the calls that avoid the PSTN.

In the past, the telephone companies have recaptured some of that revenue by leasing the very lines that interconnected the devices on the data network. But increasingly the connections within data networks are privately owned and operated, or owned and operated by government entities that make them available to the public directly or indirectly – thus undercutting the revenues of the incumbent telephone companies. For example, the Government of Alberta in Canada is financing the construction of the SuperNet, a vast data network that will connect 422 communities throughout the province with a broadband data network. The government will own the network and has contracted with a private company to operate the network. SuperNet will connect the LANs of the schools, libraries, hospitals, provincial government offices and municipalities using Ethernet over MPLS (EoMPLS). Commercial customers (ISPs, for example) will be able to use SuperNet in the rural areas where private markets have failed to create competitive broadband networks. The revenue loss to incumbent telephone carriers in Alberta is not devastating, but is significant.

Such encroachments on the PSTN signal the beginning of the marathon race. There are several forces in motion that suggest that the traditional telephone companies will either change their business models dramatically or lose the race. In a series of articles to follow over the next few weeks, the forces that can determine the winner of the race will be exposed and critically examined. We will address the evolution of technology and the strengths and weaknesses of evolving data networks versus the time-hardened circuit-switched networks of the PSTN. The impacts of changing economies of scale and scope will shed light on the ways that the communications industry might consolidate and fragment as the marathon continues. Labor market changes and the rise of company-sponsored training are evolving in ways that favor new and different commercial applications of communications. The age-old struggle between proprietary designs and open standards is taking on an ever greater importance in communications. And the development of new devices fueled by zeros and ones is reminiscent of the explosion of electrical devices fueled by electrons during the past century – many mutants will die a quiet death while a lucky few will survive among the fittest. Financial markets, political forces, legal and regulatory concerns will all have their say in the outcome. Each will be examined and evaluated in the coming series.

So that the author’s opinion (some will say, bias) about the winner of the race can be taken in proper perspective, it is only fair that the conclusion be stated at the outset. Data networks that operate much like the Internet will win but not without some major financial and organizational restructuring of the communications industry. The PSTN as we know it today will find its way to the graveyard and lay alongside the telegraph, the horse and buggy, the mechanical calculator, and carbon paper.

Whether the demise of the PSTN implies doom for incumbent telephone companies is another matter. The final article in the series will address the changes that, in the author’s opinion, each player related to the communications industry must make in order to thrive. Remember, Japan was on the losing side of World War II but thrived in the post-war economic boom – Russia had the inverse experience. The war was not the determinant of eventual success. Success was determined by how each country transformed in the face of a more powerful force – the Industrial Revolution. The challenges of the Information Revolution will sort the real winners from the losers.

Next week, we take a close look at the competing infrastructure technologies that underlie the PSTN and the Internet. We will evaluate the advantages and disadvantages of each.

Dr. Richard Emmerson, Founding Director – PriMetrica