At Loose Ends – what happened to the Telecom Industry?

An essay by Warren Montgomery (


Much has been said and written about the boom and bust in internet (.com) related businesses.  The amount of real money made and lost in those though and their impact on the US and world economy is dwarfed by the boom/bust cycle that took place in telecommunications and data networking in the late 1990s and early part of the 21st century.  In hindsight what happened was:


The remainder of this essay provides some of the reasons behind these cycles and what was going on inside this industry.


1.   Beginnings: A conservative, predictable industry?

Telecommunications is a 100 year old industry with a history of continuous if not steady growth and predictable demand for equipment and services.  Before the mid 1990’s, communications services (minutes of usage, leased lines, etc.) were growing at steady, predictable rates in North America and Europe that only somewhat exceeded the growth in population.  This makes sense after all, there is only so much to talk about and only so many phones a person can use, and in these countries the penetration rate of the telephone had mostly peaked, leaving a slow steady growth due to population growth and growth of a few new services.


Data communications was barely significant in a sea of voice, and while the developing world offered explosive and unpredictable growth rates their purchases made up such a small part of the overall market that most companies were unaffected by it.  In this climate, forecasters at service providers like AT&T, Bell South, British Telecom, etc. projected their network usage, revenues, and expenses out for years with reasonable accuracy and projected equipment purchases to meet those needs.


 Equipment suppliers like Lucent, Nortel, and Alcatel had also been participating in this industry for many years and saw a market for equipment driven by two forces:

During the early 1990s, the equipment makers could already see the end of the equipment replacement cycle driven by the replacement of electro-mechanical and analog switches with digital and the remaining analog transmission with digital fiber links.  The business forecast wasn’t all that bright, and equipment makers were scrambling to find new sources of revenue, such as the rapidly growing, but still small market for data communications equipment, or to anticipate the next equipment cycle.  Optical switches, Packet switches, and revolutionary software technology had all been proposed as candidates for triggering another replacement cycle, but the hard reality was that the economic justification for replacing the digital switches still being deployed was weak for any of these.


In short this was an industry considered by all to be stable, predictable, and more than a bit dull.  Most of the companies in this business had employee policies that encouraged lifetime employment and focused on employee retention and development.  Earnings were paid to shareholders in large dividends on stocks which rarely moved much and the stocks were favorites of retirees, institutions, and anyone else seeking long term predictable and stable income and growth. 


2.   1996, a very interesting year.

While you can point at a lot of events in the mid 1990s as contributing to the beginning of the boom, the year 1996 marked the tradition from “steady and predictable” to “high fligher” for many.

2.1.        Telecom, meet the Internet

The Internet had its origin in the Arpanet going back to the 1960’s, but had up until the 1990s been largely ignored outside of academia.  Interestingly enough, AT&T, GTE, and many others in the telecom business were connected to the early internet and had a continous history of internet related and internet like research going on in their laboratories.  This activity though was insignificant compared to the barrels of money being brought into both service providers and equipment suppliers by the traditional telecommunications market.  By 1996, however, the public internet and the use of IP based communications inside of businesses had become significant enough to begin to get noticed and had some interesting effects. 


2.1.1.   The dialup effect

The internet in this era for most people meant AOL and it’s competitors who provided access through dialup connections using phone lines.  Of course the usage of those connections was quite different from ordinary phone calls in that internet connections were connected for long periods of time and the heavy users spent hours each day dialed up.  The introduction of this kind of traffic in a carefully engineered voice network made a big difference in network usage and the required equipment.  Local service providers were forced to upgrade switches and augment capacity to cope with the beginnings of what would become an explosion of demand.   The resulting uptick caused equipment sales by Lucent and Nortel in particular to begin to rise.  The other major voice network suppliers such as Alcatel and Siemens benefited much less from this.  Much of their installed base was in Europe and other parts of the world where dialup internet access did not experience the same boom.  What the boom did, though, was raise the demand projections everywhere and put equipment companies on a track to expand to meet it.

2.1.2.   Cisco envy

While the total sales of internet communication products and services was still small compared to voice, the growth rate and stock market valuations enjoyed by companies like Cisco, Ascend, Bay Networks, and others were quite noticeable.  These were no doubt the envy of executives in the voice telecommunications business who started to turn their companies towards becoming more like the new data communications industry.  Stock options and bonuses became part of the compensation package, and revenue growth became a key objective.

2.1.3.   Voice over the Internet?

Voice over the internet or VOIP had been around for a while.  It was only in the mid 1990’s, though, when data communication speeds became high enough and connectivity ubiquitous enough that it began to look feasible as a serious communication technology and not just an interesting toy.  Many people could then start to look at the components of an IP network seriously and project to an era when IP switches would replace circuit switches and IP phones would replace phones.  Unfortunately as in most cases of new technology few looked at any of the fundamentals or even at whether the comparisons were apples to apples, but enthusiasm for an IP based world as replacing a circuit switched world was clearly building.

2.2.        The AT&T Trivestiture

One landmark event of 1996 was the split of AT&T into AT&T, Lucent, and NCR.  AT&T employees had already been through one breakup which had little impact on what most of them did, so few really appreciated the significance of the event at the time.


 It is interesting to trace the reaction to the breakup among the employees of AT&T.  When the breakup was announced, most people with any kind of choice wanted to remain with AT&T.  Beyond the continuity of the name, AT&T carried with it the large and predictable long distance business, while the new company (which had no name and no identity) had a very uncertain future.  Even Wall street initially commented that the equipment company was overvalued in the projected valuations of the pieces.  When the name was announced, it was regarded by some as a cruel joke by the management of AT&T – “loosends”, with a big red 0 as a logo.  During the spring and Summer of 1996, however, a curious thing happened.  Wall Street started to look more seriously at the emerging growth of the telecom industry fueled by the internet effect and promise of explosive growth outside the US, and employees started to see a lot more promise in Lucent and sentiment almost completely reversed.


Lucent’s entry as an independent business significantly changed the equipment business as Lucent became a more effective competitor with carriers other than AT&T and AT&T and the former Bell companies became even more open.  This was in a sense the beginning of a fierce competition with a sure outcome of a small number of survivors.


2.3.        The Communication act of 1996


The Communication act of 1996 had many impacts, many of which have yet to be fully felt.  For this story though the big impact was creating the opportunity for local competition.  This created an explosion of new companies setting out to build networks using every available technology.  The same kind of opening was taking place in many other parts of the world with exactly the same effect – many new companies entering into the market.  This really created two impacts:

2.3.1.   New Companies need New Networks

What had been a small and steady state business for equipment was now looking powed for a growth spurt as all the new competitors put in orders to build their networks.  Equipment makers saw double digit increases in their sales over each of their next 2-3 years as a result.  Now again there are only so many telephone conversations one person can have in a day and only so much equipment needed to support them, so some in the industry recognized this as a glitch – a temporary boost, but many were much more interested in demonstrating that they could get at least their fare share of the business than worrying about how long the gravy train would last.

2.3.2.   The rate squeeze is on

With lots of new companies competing for business, pressure on rates is inevitable.  In effect what happened to telecommunications service providers is not unlike what happened to major airlines after deregulation allowed many aggressive low price competitors to enter the business.  Falling prices and rising expenditures were never a good mix, but the service providers could stave off the squeeze by selling new services.  Wireless, voice mail, caller ID, Call screening, VPN, . . .  Of course this just added to the equipment demand.

2.4.        Telecommunications, meet wall street.

Just as Wall Street began to notice Lucent crawling out from under the shadow of AT&T, Wall Street began to notice the whole industry.  Suddenly this lethargic business was projecting 20% revenue growth, and the stocks were all bargains.  This had to be better than investing in the .com space because telecommunications companies had real products, real revenue, and real customers.  Lucent, Nortel, Cisco, Alcatel, Sprint, Worldcom, and many others became core components of everyone’s portfolio.  With that kind of attention, of course the stocks all went up.  Nobody was selling and everyone had to buy them. 


Wall Streets attention had another effect, though, which was that the smell of big profits and fat stock options was very nice, and management in all of the companies knew that they needed to keep up that 20% a year growth if they wanted to keep getting them.  This set the stage for the boom.


3.   The Best Industry and best time in History.

The years from 1997 to 2000 were golden times for the industry.  The internet driven expansion of local networks continued.  Infusions of cash and investment drove modernization in Europe and new growth in Asia.  The wireless industry continued to defy all projections of a leveling off and grow at unbelievable rates.  Equipment suppliers grew at 20-50% a year and service providers continued to enjoy solid profits, in spite of falling margins.  Stock values swelled from the boom meant that the big companies could go on buying sprees with cheap stock, and the little players didn’t mind getting bought out when everyone was getting rich on the buyouts. 


In late spring of 2,000, the Supercom trade show was overflowing the cavernous Georgia Convention Center in Atlanta.  Big name bands played to crowds of convention goers eating gourmet hors d’ouevres and gulping down free drinks everywhere in the city and anyone who looked like they might use a phone or a computer terminal some time could get a ticket.  Billboards everywhere in the city proclaimed the merits of Lucent, Ericsson, Cisco, Alcatel, or others.  A colleague stared out over the cavernous exhibit floor and said to me that this had to be the best industry in and the best time to be alive in history.


3.1.        Stock Market Madness

Telecom stocks were big components of growth portfolios.  This is what makes this cycle much more serious than the .com boom and bust.  The Stock Market was setting records every day and in spite of many voices starting to say it couldn’t last growing 30% a year.  Stocks soared on acquisition rumors, positive comments, or just because it was Tuesday.  Employees and managers in the industry got used to those returns and didn’t wonder too much about what the downside risk might be.


Everyone had to be in this industry.  Companies whose main business was energy or finance, suddenly because carriers or bandwidth traders to take advantage of the reflect glow.  Even the now infamous Enron became a player, and at the time, it was all good.

3.2.        20% or bust

The demand of the stock market for continued returns caused everyone in the industry to set ambitious goals.  Everyone had to grow at least as fast as the market to maintain their place in the favorites of wall street.  Results were checked quarterly, monthly, and even daily for signs that anything was going to be amiss, so of course nothing ever was.  Equipment suppliers bent over backwards to get new sales booked, extending credit to carriers with shaky financial positions and offering discounts and concessions against future sales just to get the revenue booked in the current reporting period.   Few dared question the demand for 20% growth because it was obvious that it could be achieved, or so everyone thought.

3.3.        IP Fever, 3G Madness

The most significant technical aspect of the boom years was that the internet, or more accurately internet protocol or IP, really did overtake voice in some metrics of communication.  Furthermore the leading suppliers in the IP world really did start to convince the service providers that the future was about IP, and everything else was “old world”.  Did this put the squeeze on the equipment makers – of course not.  It simply caused every product to launch it’s own evolution to an IP future, and strategic thinkers in all of these companies to go on buying binges with cheap stock  in order to acquire the R&D, products, and customers needed to compete in a VoIP world.  None of which of course really addressed the serious technical issues of how to make VoIP seamlessly replace circuit voice, or the business question of what an IP based telecommunication industry would really look like – i.e. whether it would look like the carrier voice industry or something very different.  Nevertheless, equipment makers were pouring billions into producing softswitches, converged switches, quality-of-service networking, and other elements needed for an IP industry


The other fever beginning to overtake the industry was something called 3G wireless.  Wireless services were clearly growing more rapidly than than good old home and office phones.  The wireless industry was on a much shorter cycle of technology upgrade than was ever seen in the rest of the industry, having gone through an analog service and being in the midst of competing digital services.  The holy grail of wireless was and is something called the 3rd generation or just 3G, which promises:

The existing boom and visions of what could be brought in by expanded data capacity drove a frenzy among service providers to get licenses and suppliers to get customers.  Financially many of these deals made little sense – licensing fees that would require carriers to collect thousands of dollars per customer just to break even, but in this era stock valuations were about customers and revenue, not profits. 


Technically 3G made sense, but also presented substantial challenges.  Like the case of VoIP, thousands of staff-years of  development had to be duplicated in a small amount of time just to get back to the kind of service people now enjoyed.  As in the case of VoIP, there were also serious business issues around just what kind of market would be created by a worldwide standard with open high speed data capabilities.

4.   The Light at the End of the Tunnel – an oncoming Train


Somewhere during 2000, the industry began to unravel.  The reasons and signs should be clear by now:

It’s not clear that any one of these factors triggered the decline, but all fed on eachother in a spiral of declining business, bankruptcies, and plunging stock values that took place from late 2000 and continuing through 2001 and into 2002.

4.1.        CLEC gut check

The competitive providers or CLECS, were perhaps the first to feel the pinch.  Having put out a lot of money for new equipment they needed a solid customer base to pay for it and turn a profit.  Most didn’t have it and as prices for services fell, there was little to fall back on.  As CLECs folded, they left equipment manufacturers holding bad loans and billions worth of now unneeded equipment.


The big embedded service providers felt the pain too, but mainly in their falling stock prices.  They had customers, equipment that was paid for, and people to run the networks.  They simply put the brakes on rapid plans to convert to VoIP and other new technology projects and shed people and unprofitable acquisitions.

4.2.        3G Unplugged

No, 3G didn’t go a way, but when it became apparent that the price being paid for it was too high, many providers scaled back deployment plans into trials and pushed out schedules while deploying more incremental technology.  The bright spot in the telecommunications bust though is that customers kept buying wireless phones.  They learned to use them in new ways.


4.3.        The end of the Internet Boom

The surge in internet subscribers began to slow down in the late 1990s.  By 2001, there were probably as many people switching from dialup service to broadband (Cable or DSL) as there were new users.  What this meant of course was the need to deploy new equipment in local telephone networks to cope with the traffic cut back sharply, adding to the woes of equipment suppliers already stuck with returns from CLECs  Cable and DSL continued to grow, but nowhere near at the rate that was required to satisfy the unrealistic business models of the service providers, so another wave of bankruptcies and consolidations took place there, slowing deployment and new equipment purchases.

4.4.        Time to pay the piper.

The result of all the pain on the service provider side was soon felt on the equipment vendor side as well.  Instead of rising 20%, sales fell 20-50%.  Providers reacted by downsizing and writing off  unsold equipment and bad acquisitions with special charges that dwarfed the profits of the boom.  The stock market reacted predictably, punishing the whole industry as a financial pariah.  As in the case of the service providers, while the market value pain for the big players was severe, they had reserves and a customer base to survive.  The new entrants, though, trying to get service providers to buy into new technologies and new suppliers, were in a very bad situation – few prospects for sales, no way to raise capital, and a glut of products on the market.  In 2001, the reaction to full trade show floors changed from one of seeing evidence of the strength of the industry to that of seeing too many fish in a pond that’s drying up.

5.   After the fall, what we learned and where we are going

Is this the end of an industry – hardly.  The world needs to communicate and continues to buy billions of dollars of equipment and services every year.  There will be lots of survivors in the industry and yes, VoIP and 3G will eventually be broadly deployed.  Let’s start though by summarizing some hard business lessons

5.1.        All that glitters might be  just a pop up ad.

The boom/bust cycle is the oldest one in investing.  Many thought that through computer control of just in time inventory we would be able to escape this.  The telecom boom bust is a good illustration of why we can’t.

  1. Always be suspicious of any industry projecting growth at greater than that of the population or the economy as a whole forever.  Sure, many industries have spectacular growth spurts, but sooner or later everyone who wants a cell phone, a PC, or a pet rock has one and then your growth is limited to replacing the existing product and selling to the net population growth.  For most that’s not going to be 20%.  Telecommunications is an area where penetration of the product was near ubiquitous before the boom – everyone who wanted a phone had one.  Big growth just had to be short lived, as of course it was.
  2. Beware of fevers.  The boom in stock market valuations, 3G wireless license prices, prices for acquisitions, and just about everything else in the industry was driven by a fever (“got to have it”) mentality.  In retrospect, we were all just lousy shoppers paying way over list price for something that just wasn’t worth it. 
  3. Beware of mortgaging the future.  The 20% or bust mentality of course came true – 20%, then bust.  It always does.  The lesson here is companies need to be honest about what they are really selling, and auditors and investors need to be ruthless in seeking out and preventing those little white lies told with future discounts, vendor financing, and express revenue booking.


5.2.        A different communication industry

In the dust of the boom and bust, one thing that is clear is the communications industry will ultimately look quite different than it does today.  Here’s where I don’t have 100 years of history or overwhelming evidence, but the clue is in the statements above about how the new technologies will change the industry.   The key questions here are what the introduction of wireless and internet communications will do in the long run:

  1. The decline of the wired telephone.  Until recently everyone in a developed company need a wired telephone in their house and in their office, and in every hotel room, conference room, etc.  The handwriting is on the wall though that this will simply cease to be the case.  Many people with wireless phones now have thousands of minutes of  “free” calling that cause them to question why they are paying for a wired phone.  The wireless phone is less vulnerable to infrastructure failures and far more flexible, and at today’s cost no more expensive.  As broadband internet takes over the job of providing internet connectivity, more and more people will simply pull the plug.  Already in a recent survey in Chicago, not a city known as a technology leader, 20% of the respondents consider their wireless phone their primary phone.
  2. Internet Communications, not just Telephony.  The second major change is that the internet is enabling a broad spectrum of different kinds of communication.  An IP Phone “call” may include data, instant messaging, shared applications, video, and other special features.  It’s not tied to the limitations of a 3Khz or 64Kb/s fixed connection.  I predicted 6 months ago that the rollout of Windows XP, with well integrated IP messaging and IP Telephony, would create a whole new form of communication.  I still believe this is happening, even if the initial numbers of users is still small.  This is the perfect case for “viral” marketing – those who don’t have a broadband connection and VoIP will begin to look bad dialing into conferences with those who do using only their 3Khz voice phones while others enjoy high quality stereo audio, shared graphics, video, and other goodies.


What does this mean for the equipment and service industries.

  1. For service providers the news isn’t good.  Declining numbers of voice lines and traffic going to VoIP and wireless spell falling revenues and profits.  Wireless companies will see growth, but in a continuing climate of intense competition for customers and a generic product.  a real 3G standard will simply make it easier for customers to switch, so yes, there will be traffic to be carried at a profit, but you had better be ready to stay competitive and handle high churn rates.
  2. For unconventional service providers, new opportunities.  The greater capabilities of 3G and IP Telephony open up new opportunities for value added services.  They will be able to take advantage of widely available smart terminals with multi-media capability to create new kinds of services, but there will be a  battle between building services into servers with relatively little intelligence in the endpoints and distributing the service entirely in the servers.
  3. For equipment providers the news is mixed.  A next generation “class 5” switch has been a driving goal of many companies in the industry, but in this world it doesn’t seem likely.  Wired telephony carriers with declining revenues will find little motivation to replace their switches, while wireless and IP based service providers serving smart endpoints will need a different kind of “class 5”.  The class 5 switch of the future will provide presence, security, and a proxy for smart terminals that are not always on and connected, but not the set of services and capabilities in today’s local digital switches.
  4. On the other hand there will be plenty of new infrastructure required to support a growing set of smart endpoints, wired and wireless, and great opportunities to supply servers, and QoS enabled transport infrastructure for these networks.