By MEGHAN FULLER
Manufacturers that produce a given product are rarely the people who push for its commoditization-and for good reason. In a commodity market, products are homogeneous; price is the only differentiator, and brand has no value. Those who were in the business of power and gas did not want to see its commoditization, and neither do carriers in the telecommunications market. However, according to a new report from analyst and consulting company Ovum (London), bandwidth commoditization-and trading-is no longer a case of 'if' but 'when.' Driven by investor fright, the need to mitigate high risks, and pressure from financial intermediaries, carriers "will be dragged kicking and screaming to the party."
Bandwidth trading is logical, claims Stephen Young, principal analyst at Ovum, because those carriers who do not adopt a trading model "will be left with spare capacity. They will be left with capacity they haven't sold because they haven't taken a pragmatic approach to the market." Investors are becoming squeamish, and they will force the pace of the market.
"Eventually, as more and more carriers are compelled to trade in order to offload their surplus inventory, the investors in carriers will begin to say, 'Well, why aren't you doing it? Why are you left with all this capacity? Why aren't you building better knowledge of your forward price curve? Why aren't you making rational economic decisions based on what we know is going to happen to price in the future? Why have you staked the farm, if you like, on a wish rather than on more solid information and a more pragmatic approach?'" explains Young.
Once a vocal opponent of bandwidth trading, Williams Communications Group Inc. (Tulsa, OK) now views trading as a means to mitigate their financial and asset-based risks. "We see it more in terms of risk management," explains Louis Hunsucker, senior bandwidth trader for Williams Communications. "Bandwidth trading for us is not another sales vertical or some way to cheaply offload capacity."
Williams Communications' bandwidth trading and risk management group works alongside the network planners to help answer critical questions-"Where are we long and where are we short on routes? Where do we have spare capacity, and where do we have no capacity? We help them make the build and buy decisions," says Hunsucker.
Bandwidth trading does present certain infrastructure challenges that have yet to be overcome, particularly interconnectivity. "Not everyone is interconnected," explains Hunsucker, "so I cannot buy or sell to everyone who would like to trade bandwidth."
Interconnectivity cannot occur without the creation of telecom hotels-with actual and virtual pooling points-in major cities served by carriers and service providers. "What we think is going to be the main form of trading," says Young, "is city-to-city pairs or connections that link various cities. The reason for that is they are the most heavily trafficked routes where there is a lot of infrastructure. They are the routes where you can actually do the physical trades because there are going to be pooling points at each end of those routes in telecom hotels," he adds.
Carrier Enron Broadband Services Inc. (Portland, OR) has already established 25 pooling points in key metro areas-18 in the U.S., six in Europe, and one in Asia. "That's a key initiative for us," says a company spokesperson, "to use these pooling points as aggregation points for buyers and sellers of bandwidth to increase the efficiency of network interconnections both locally and over the long-haul."
Certain key conditions must occur before a bandwidth trading market is widely embraced-contracts must be standardized, pooling points established, and market liquidity achieved-and when this occurs, an actual, physical trading market will emerge followed by a financial market, related to but separate from the underlying bandwidth capacity.
Managed transmission services between major cities will become the key contract bought and sold as a commodity, driven by the growing demand for bandwidth and increased competition along city pair routes, which results in greater liquidity. According to Ovum, the products most likely to become commoditized and tradeable are SONET/SDH and wavelength services. Analysts predict the worldwide physical market for such managed transmission services will reach $120 million this year but will jump to more than $5.6 billion by 2006. The North American market alone is expected to generate $1.4 billion over the next five years.
Non-legacy carriers will be the first to adopt bandwidth-trading practices, claims the report, citing Global Crossing Ltd. (Hamilton, Bermuda) as one such network operator that has already carried out experimental bandwidth trades. When contacted, however, company representatives declined to comment and indicated that they are still evaluating the market. While Global Crossing is by no means alone in its wait-and-see approach, Ovum predicts that the freefall in bandwidth prices and the need to squeeze more revenue out of existing assets will eventually force both non-legacy and incumbent carriers into the trading marketplace.
Eventually, financial trades will exceed physical trades. "Once the market be comes liquid and telecom products become tradeable commodities, a financial market will emerge, de-linked from physical delivery," explains Young. "In creasingly, investors will require that carriers have forward contracts and hedging contracts."
As in the energy markets, each bandwidth contract will be traded several times before any services are actually delivered, a phenomenon known as the churn ratio, or the correlation between the number of trades and the number of physical contracts. The churn ratio is also related to market liquidity-the larger the physical market, the greater the liquidity; the greater the liquidity, the greater the churn ratio. Ovum estimates worldwide revenue for the financial market to reach $170 million this year. By 2006, however, that same market could be worth more than $64 billion. The North American financial market could be worth as much as $20 million alone.
While the market is making strides toward achieving the conditions necessary to support physical and financial bandwidth trading markets, it will not happen overnight.
"It's about how much supply there is on a particular route and how much demand there is on a particular route," says Young. "Obviously those two are pretty closely related, because the investment-and therefore the infrastructure-is going in on the routes where there is a lot of demand. The demand is driving the supply. And then you need to get into a situation where there is an excessive supply over demand, and that will actually encourage the trading to take place," he adds.
The folks at Enron, really the first to champion a bandwidth-trading model, have been instrumental in the development of several commodity markets-including natural gas and electricity-and they see the bandwidth market moving more quickly toward commoditization than those did, says a company representative.
"There is a kind of danger there for people to say, 'Well, it's not happening now so therefore it's never going to happen,' or 'What's going on is almost invisible, therefore it's never going to take off,'" explains Young. "If you look at other markets where commoditization has taken place, the pattern is that you have very sort of low levels of activity which explode extraordinarily rapidly; the growth becomes exponential. Be cause you are not particularly conscious of it at the moment doesn't mean it's not going to happen," he adds.