Much has been written, said, and conjectured about the state of the national and global economy. Much has been speculated about the effects on the real economy of this financial crisis sparked by Lehman Brothers. Primarily, the automotive sector and the manufacturing industry in general appear to be massively affected. From insane reports of losses of tens of billions from reduced working hours through to factory closures, the full spectrum of shocking news is represented. However, how is this crisis affecting the telecommunications industry? Little in the current media landscape can be found on this topic, although in our view the medium and long-term effects could be just as drastic as for other sectors of the economy. In this article, we would like to address the impact of the crisis on network operators.

The question of why network operators are currently barely being considered in the news coverage of the crisis is initially easily answered. The crisis affects the manufacturing sectors of the economy more directly, rapidly and with more piercing force. Network operators’ business models are still based on higher percentages of sales, supported by long-term contracts of 24 months in most cases. The end users can’t easily get out of these contracts, and by no means do they want to.

For today (mobile) communication and Internet use belong without a doubt to the basic needs of every household, rather than the optional luxury goods segment. People simply do not make fewer telephone calls in times of economic adversity. Private consumption savings are made on large, new purchases rather than on sausages, cheese and telephoning. Therefore, plummets in demand and sales figures are expected to be insignificant, if indeed there are any at all. Over the last weeks this has been substantiated by Telefónica as well as Deutsche Telekom’s good and partially impressive annual accounts for the last business year.

In our view, the affects of the financial and economic crisis for network operators will emerge in the medium-term. This is due to the need for renewed investment in infrastructure in the sector, which has been pressing for a long time now and brings with it a considerable amount of financing. This investment is attributable to rapidly snowballing data volumes, which will increasingly bring the fixed network and mobile infrastructure to its limit.

For a long time after the dot-com bubble burst, we asked the question about which application the UMTS broadband network should use, and we have now finally arrived in the phase of „mobile data uptake“. Surprisingly, however, innovative applications are not responsible for this exponential growth. In fact, attractive and high-performance cell phones that have been developed, such as the Apple iPhone, Google G1 mobile and Notebook UMTS sticks, are key drivers for the massive hike in mobile internet use. Next Generation mobile technology such as HSPA+, (already being field tested at o2 Germany), will accelerate this trend further.

Unfortunately, however, this makes the next problem for the sector apparent: today networks geared to voice services still need to be optimised and upgraded due to increasing data flow. This bottleneck forms the so-called mobile backhaul, at the stage when the traffic of data between the base station and the gateway to the packet network and voice switched network occurs, and which today is mostly based on hired E1 carrier lines. This increasing bandwidth can only be met by hiring additional carrier systems or by increasing the capacity of radio relay systems, which means that operating costs will rocket. The best alternatives for this connectivity can be found mostly in Ethernet-based backhaul solutions, which will raise almost neutral costs with increasing data bulk, but will bring with them significant initial investments.

However, mobile networks are not alone in approaching a bottleneck. YouTube, Flickr and Co. are concerned that for fixed networks the data demand is growing far quicker than the additional supply provided. As it is occasionally declared, by 2010 there could already be bottlenecks in the Internet and the backbones of network operators.

In addition, should the demand for IPTV services take on the relevant orders of magnitude, neither ADSL nor VDSL would be able to meet the requirements of this service, given that here the distances between DSLAM and the consumer are in most cases too big to produce the required 50MBit/s bandwidth. Fibre to the home (FttH) or cable are seen as relevant technology, which in this case could meet this demand. Yet the potential deployment of both technologies – fibre as purely „build“ and cable as „buy“ acquisition strategies – involves enormous financial capital, which may currently be scarcely available.

Thus, from a technical perspective the solutions for mobile and fixed networks are indeed known, but merely from a technical and not a financial point of view. In particular, as mentioned at the start, the current financial crisis means that adequate financial capital is not readily available. Equity financing of around €40 to €50 billion for a 50 percent populace supply of fibre technology from the operating cash flow is even less of a possibility due to the issue of scale.

Furthermore, even with adequate funding business cases for fibre seldom appear in black. For instance, fibre investment is only worthwhile in cities. And only then, if entire blocks of houses are covered by one operator. Then finally the infrastructure provision investments themselves, at €1,000 per housing unit, can be quickly exceeded in densely populated areas. Furthermore, adding to complications, many households are currently already supplied with DSL and the advantages of an upgrade to faster bandwidth are only slowly beginning to be recognised and demanded. Yet the willingness to pay more for this additional speed wanes the more time passes.

In our view there is only one solution for this problem: shared infrastructure. A joint investment, borne by operator consortia and realised as a joint venture, for example, would make investments become more attractive and reduce the dependence on restrictive banks considerably. A large share of the investments could even be financed by the operating cash flows.

Therefore, network operators are less affected, in terms of sales and costs, by the current economic crisis. In fact, the effects will be felt through hindered access to financial resources, potentially putting the brakes on innovation, and therefore ruining margins in the medium-term. Due to outdated technology, high profits will be scarce. Only a change of heart, accompanied by novel business models based on shared infrastructure, can overcome these hurdles in the next 24 months. We will be watching intently to see which network operator will open up this round of negotiations.

Comment by Jens Meyer, 5th March 2009