SMART Letter #64
Avoiding Permacession
December 16, 2001
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SMART Letter #64 -- December 16, 2001
Copyright 2001 by David S. Isenberg
isen.com -- "where economic growth goes in a recession"
isen@isen.com -- http://isen.com/ -- 1-888-isen-com
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CONTENTS
> How Networking Advances Screwed Up the Economy
by Roxane Googin
> Two Scenarios for the Future of Telecommunications
by David S. Isenberg
> Copyright Notice, Administrivia
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How Networking Advances Screwed Up the Economy
by Roxane Googin
[For the last two years Roxane Googin and I have
participated in a small early-September telecom conference.
In 2000 I wish I had listened to her with my wallet (in
addition to my ears). In 2001, her warnings extended to
the larger economy. I convinced publicity-shy Googin that
her message needed to reach beyond her community of
portfolio managers, that it needed to reach policy makers,
corporate strategists and other decision makers if we're to
avoid a Japan-style permacession and get the communications
revolution -- and economic growth -- back on track. Below
is what Googin said early last September -- David I]
"I run a strategy advisory service for portfolio
managers. I listen carefully when people talk about
the Internet because it is the leading edge of the
new telecommunications paradigm, and telecom is one
of the world's largest businesses along with oil and
automobiles. The telecom business has been rendered
economically dead because of a real important piece of
progress that has come out that acted differently than
anyone planned.
"I spoke earlier about how the best network is one that
is totally generic so that you can't tell one bit from
the next. That is the beauty of how the Internet works.
You can project on to it what you need to do. Also the
network is infinitely extensible, [because] we have
ongoing continuous improvement in the underlying
technology. Two examples are Moore's Law and DWDM.
"I walked out of this conference last year [in September
2000] and told all of my clients to sell every stock
that they owned as fast as they could. And raise cash.
The reason for that is . . . a system that behaves like
that is an economic horror show. It is going to repel
capital because any system that is totally generic has
no barrier to competitive entry. You can't
differentiate yourself. One that is infinitively
extensible means that you are going to be stuck in a
Malthusian swamp, where your cost of selling will be one
inch above the marginal cost of production.
"The goodness of the new network on one hand is a
nightmare economically on the other. It is a paradox.
And just like oil, society is going to benefit the most
if bandwidth is the cheapest. But if bandwidth is so
cheap, no one is going to be there to build the
bandwidth. So what I saw happening is that the cat had
been let out of the bag, the genie was out of the
bottle, and people were building these networks and we
were headed for this huge train wreck whereby capital
would start pulling away from this industry once they
realized that this was going to happen.
"So the attackers with the new technology were going to
starve to death because they have to build this huge
network. As prices come down, the network has to be
bigger before you are profitable so the new technology
they were building would be working against them.
"On the other side, the incumbents are slowly going
bankrupt, some quicker than others. I'm talking not
only the BTs and the DTs and the FTs and the NTTs and
the ATTs and the Worldcoms and the Global Crossings but
the Incumbent Local Exchange Companies (ILECs) too
because their SONET-based networks have a very high cost
of provisioning.
"But even though the attackers are starving, they are
forcing marginal bandwidth prices below the ILEC's cost
of provisioning -- not only replacement but also
provisioning. So the ILECs are going to get squeezed
because they have this complex labor intensive
infrastructure that is no longer supported by the
economic base.
"In this kind of nightmare scenario, nobody wins. It is
just a big mess because the attackers are going under.
Meanwhile, they have crippled the incumbents. We are
witnessing the perfectly predictable outcome of this
process: no equipment sales, and no more progress. No
one planned this, but it is too late to turn back.
"The other problem is the phone companies don't own their
gear -- it is leveraged. That is, they bought it forward
in time. These guys have 20/30 years bonds outstanding
against their SONET gear, because this was never
supposed to happen.
"Those 30-year bonds that were funded on the assumption
of continued SONET operations will never be paid back.
The insurance companies, those widows and orphans owning
those bonds, the asset that they were buying against
will not be economically viable in two years, much less
twenty.
"So not only is the ILEC capital base being rendered
useless, but now the ILECs are supposed to reinvest in a
bunch of new gear. They are not doing it because they
can't.
"This is what I envisioned when I walked out of here last
year. And now it is happening. DT just fell below its
offering price in 1996 for the first time. NTT
continues to slide, France Telecom, British Telecom,
they're at multi year lows. And it continues to get
worse.
"We live in interesting times.
"So what happens next? One thing that I do for my
clients is I predict trends. I never predict the
future. There is a difference.
"We need to restructure the entire industry, but how? We
want it dirt cheap because then it can be as good as it
can be for all the other economic things that it is
supposed to do. But it can't be so cheap that it repels
capital.
"This need to restructure telecom is dragging the rest of
the economy down. The economy isn't weak because of
high interest rates, but everyone is watching as
Greenspan cuts rates. If interest rates had been 22%
and he took them down to 3, then you could say interest
rates caused this. But interest rates have nothing to
do with it. This is technology problem, so interest
rates aren't going to impact it one way or another.
"You can go to Japan and see 11 years of decline with
zero-percent interest rates. So we have to fix the
problem. This means restructuring the debt and owning
up to what the real issues are. This owning-up hasn't
been done yet.
"Then we have to reallocate the assets to the right
parties. Unfortunately some markets don't behave in a
traditional market way. Typically common-good markets,
like transportation systems, tend to be regulated
markets, because the capital outlay upfront is
associated with an unknown return in the future. This
regulation is rather contentious, whether it is the old
telecom, the airlines, or even trucking. There are just
some markets that don't behave well, and I'm afraid that
this is one of them. So we have a lot to think about.
"Time is of the essence. The reason that we are in this
downward spiral is because telecom is draining the
vitality of the entire economy. On the margin, this is
where our last decade of growth came from, and now it
has stopped. It would be helpful if policy-makers knew
the problem from this perspective.
"I can explain the problem, but I don't think I'm
qualified to solve it. I hope it doesn't take 3 to 5
year to fix, because we are all going to be living on
our cash balances in the meantime.
"I am convinced that our capital markets aren't going to
recover until we figure out what to do. Optimistically
enough, I think as soon as we do figure out what to do,
they will jump up a lot, because they are a discounting
mechanism. But their immunity to recent tax cuts and
interest rate cuts tells me, on the down side, that this
is something that everyone might benefit from putting
their heads together to figure out.
"I think that our government is going to have a very hard
time. I think that they will get involved, and I am
afraid that they might side with the wrong people. It
is up to all of us to try to think about how we can pull
together to make some sub-optimal solution come out of
this, since there is no optimal solution.
"Finally, I observe that this move toward unlimited
supply extends beyond bandwidth. Think about the
symbiotic relationship between open source software and
the Internet, and how they work together, and how the
Internet helps foster the open source movement, and what
economics this [synergy] starts to impact. The
incumbent software business is a very large business,
and it could be negatively impacted by open source
software. I'm not passing a judgment on open source
software. I happen to like some of it. But it is a
fact that it will be impacting our markets. Not as big
as the telecom issue because the business is smaller,
and it is not leveraged. But it will redefine economics
well beyond the bandwidth sector."
[Roxane Googin edits the High Tech Observer, a pricy little
sheet published by Global Investment Research. You can
learn more about it by calling GIR at 203-791-3830.]
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Two Scenarios for the Future of Telecommunications:
Re-verticalization vs. Economic Reset
by David S. Isenberg
Roxane Googin's thinking suggests two scenarios.
Let us call the first scenario RE-VERTICALIZATION. It is
heir-apparent to the "official future". The alternative
future called Re-verticalization is a big-telco-controlled
future, in which the incumbent telcos (and their henchmen,
the content industry) continue to thwart the deployment of
new technology and the advent of new competition. To do
this, the open, end-to-end Internet is gradually whittled
away by a multi-front campaign employing massive lobbying,
scare tactics, endless litigation and other techniques
available to the big telcos. The idea that telecom
facilities are Common Carriers" (i.e., open to all comers
under public and equitable terms) is replaced by a regime
of Private Commercial Arrangements in which big players are
selectively advantaged and small, innovative players are
squeezed out. With no competition and weakened demands for
new services, the big telcos are no longer reminded that
their networks are completely obsolete twenty years before
they're depreciated.
The Re-verticalization scenario can play out in two main
ways. The first is stable and ugly -- the telcos and their
allies in government and industry use the new technology to
keep the lid on potentially disruptive communications
technology, to ensure that innovation within and around the
communications network is predictable and approved. This
would create a chilly environment for potentially
threatening innovation and keep the world safe for
incumbent businesses. The result would be permacession,
or, perhaps verrrrry slow growth, depending on where you
think economic growth comes from.
The second play-out is unstable, but a bit more heartening.
In this alternative future, advanced technology, such as
that which already exists, will be suppresses, but it will
be impossible to suppress it all. Forward-looking
countries, such as Canada, Sweden, and a handful of others
will deploy new communications technology and will reap its
benefits in compounded rates of economic growth.
Furthermore, in incumbent-telco-dominated countries like
the United States the behemoth telcos will move too slowly
to dominate the entire value space. Pockets of new
telecommunications will form (e.g., municipal fiber builds,
wireless community networks) and grow faster than they can
be surrounded, usurped and shut down. The news of advanced
telecommunications and economic growth from other countries
-- and from within -- will travel. This could resolve
peacefully (e.g., via policy shift) or cataclysmically,
because not only is economic growth at stake, but
fundamental human rights are too.
But Googin suggests a second scenario. Let's call it
ECONOMIC RESET. In this alternative future, the United
States, indeed the countries of the developed world, belly
up to the fact that the telecom plant became worthless
before it was fully depreciated, that advances in
communications technology have rendered existing telecom
infrastructure obsolete. This requires either (a) decades
fighting to stay out of bankruptcy court and decades in it,
or (b) a collective act of will to put the debacle behind
us. The latter collective act of will is to reset the
value of the worthless assets to near-zero, where they
belong.
Googin finds an analogy in the Savings and Loan Crisis of
the late 1980s. The causes of the S&L debacle were
different, but there was a big similarity -- the changes in
the economic underpinnings of the S&Ls were too fast for
the S&Ls to react to within the context of their
established business model. The massive institutional
insolvency that resulted, Googin says, will be seen again
in the demise of the world's established telcos. The S&L
bailout of 1989, piloted by President George Bush Senior,
effectively excised the infected parts of the economy. The
solution was not any prettier (or any fairer or more just)
than the problem, but it let the United States get on with
business; it let the wounds heal. Could it happen again?
The U.S. might once again have the right president for the
job.
But the telcos, the government and incumbent network-based
businesses are living in the re-verticalization scenario.
They do not yet apprehend the economic devaluation of what
just yesterday was the most advanced network that money
could buy. Further, they might not be able to see the
imperative for change until their business model is in
cardiac arrest. The play is in motion but the score is not
tallied -- the telcos' accountants have not been called.
If the telcos succeed in the courts, in government and in
the court of public opinion, they may never be. It could
take a decade of permacession before we know the source of
our pain.
Meanwhile, humanity stands on the threshold of building an
omni-functional network that embodies the highest
principles of democracy, expression and entrepreneurialism.
Freedom-loving people should hold it dear. Should we delay
its construction to preserve yesterday's moribund
businesses? Must we endure permacession until the
incumbent telcos have played their last card?
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COPYRIGHT NOTICE: Redistribution of this document, or any
part of it, is permitted for non-commercial purposes,
provided that the two lines below are reproduced with it:
Copyright 2001 by David S. Isenberg
isen@isen.com -- http://www.isen.com/ -- 1-888-isen-com
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