Service Provider Featured Article

The last time Yours Truly caught up with Ray Alderman, Executive Director of VITA (the VME International Trade Association), he was giving me a stern lecture on telecom consolidation in the $6 billion embedded computing industry.

 

Recently, Alderman updated me and gave me some further perspective on what’s been happening to the telecom business since the turn of this century, and how China may be preparing to throw a colossal monkey wrench not just into the telecom business, but the whole global economy.

 

“In many respects we’re still living with the consequences of the telecom industry collapse that occurred around April of 2001,” says Alderman. “First came the consolidation of the Telecom Equipment Manufacturers [TEMs] and the sell-off of their facilities to the Contract Electronic Manufacturers [CEMs] at amazingly low prices. Obviously, the number of mergers and acquisitions skyrocket during such periods of consolidation. In the wake of various ‘creative’ accounting and financing deals, we now see such strange link-ups as Alcatel-Lucent (News - Alert), Nokia-Siemens, and Ericsson-Marconi. Despite consolidation, manufacturers continue scrambling to lower their cost of sales, reduce their fixed-cost infrastructure, and slash inventory levels and associated carrying costs.”

 

“Interestingly, Nortel is still hanging on as an independent company,” says Alderman. “Even so, many people lost their jobs and many facilities have been sold off. Back around 2004 Nortel decided to focus on product development and customer service, and began a five-year plan to divest itself of almost all of its manufacturing capabilities, selling most of its big plants to Flextronics, which now makes Nortel hardware as an outsourcer.”

 

I mentioned to Alderman that some pretty unusual hyphenated names were showing up among Telecom Service Providers [TSPs] too, appearing almost in parallel with the consolidation of the TEMs.

 

“Yes, next came the consolidation of the TSPs,” says Alderman, “which peaked from 2003 to 2006. We now have ATT-Bell South, Sprint (News - Alert)-Nextel, Verizon (plus everyone else), and Qwest. Voice-over-IP in particular hasn’t been a darling on Wall Street. Although IP Communications continues to make slow, steady inroads in the enterprise, too many Vonage (News - Alert) wannabes burst onto the scene early on, and scores of them continue to flounder and vanish without a trace to this day. Other, larger, more conventional TSPs subsist on voice-over-PSTN revenues, but a relentless 100,000 or so landline telephones have been disconnected every year for three years to June 2006, according to a national consumer group called Choice. They say residential landlines are down to about 11.3 million, but mobile phones have surged past 19.8 million. The pricing of cellular services is in a race to the bottom, and the services themselves seem to be designed mostly for indulgent teenagers who can tolerate a lack of quality of service.

 

By now Yours truly was cringing, waiting for Alderman to explain how this all impacts on the hardware guys, the bus, board and chassis makers of the world that sell components found in the communications infrastructure of both service providers and enterprises.

 

“Thirdly, consolidation and cut-throat pricing ultimately leads to devastating effects for the telecom board and box vendors,” says Alderman. “Indeed, we’re seeing a consolidation of the whole telecom component supply chain. Both the CompactPCI (News - Alert) form factor in the 1990s and now AdvancedTCA and MicroTCA have been subject to marketing hype and overly optimistic sales forecasts. I mean, in the case of Intel (News - Alert) you’ve been seeing $50 million in annual board sales instead of a hefty piece of the $20 billion forecast by analysts and press pundits not so long ago. Reality checks keep coming. Intel sold off its Modular Communications Platform Business to RadiSys for 0.5 times sales on September 7, 2007 and Motorola, one of the oldest names in the business, followed suit on September 28th by selling their Embedded Computing and Communications Group [ECC] to Emerson (www.emerson.com) for 0.67 times sales.”

 

But perhaps Ray Alderman’s most interesting observation concerns China and its gargantuan efforts to put on the most spectacular Olympics, ever.

 

“Right now, many Wall Street analysts are looking at China with ominous expectations,” says Alderman. “They predict that China’s GDP will sink back to a less sizzling three to four percent per year. China has working like crazy for the last 7 or 8 years, preparing for the Olympics in Beijing, and their GDP has grown at 10 to 11 percent per year. However, some analysts are saying that over half of China’s GDP has been going into their infrastructure projects such as bridges, roads, power, sewer, streets, buildings, and telecom. All through the past seven to eight years, China has been buying and stockpiling lumber, plywood, concrete, steel and telecom equipment. In the next six months, most of the infrastructure projects, especially around Beijing, will be completed. At that point they will no longer need large quantities of these materials, nor will they need any more telecom gear.”

 

“What about future growth?” I asked.

 

“The Chinese government plans to pipe the Olympic games, using video, audio and text, though their new telecom system to other cities in China, and to mobile phones around Beijing and throughout the country,” says Alderman. “Once the Olympics are over, their telecom system will have enough capacity and bandwidth for the next 10 years or more. Additionally, these financial analysts say that Beijing will shutter their manufacturing plants about four to six months before the games to clear the atmosphere of pollutants. Anyone who has been to Beijing knows that you normally can’t see across a city street there because of the pollution.”

 

“We can’t escape the fact that a large portion of telecom demand has been in China and other developing nations for a year or more, with only a small amount of demand being seen for advanced services — data, video, mobile TV, and so forth — in developed countries,” emphasizes Alderman. “That perspective comes from the latest dismal financial reports from Ericsson and comments made by their CEO last month.”

 

“These phenomena are collectively being called ‘Y2Olympics’, because many people expect to see consequences similar to what we experienced after Y2K: a complete collapse in demand for certain technologies and materials, especially telecom equipment,” says Alderman. “In this instance, a further collapse in telecom demand is a distinct possibility.”

 

I remarked to Alderman that I didn’t see how things could get worse. Alderman said I was wrong, that the times for the telecom business could get even more ‘interesting’ (to borrow an old Chinese expression):

 

“After that, around 2010, I expect the FCC to unbundled mobile devices from mobile services,” says Alderman, “so you’ll be able to buy a phone in a store and then choose what service provider gives you the best mix of features, quality and value. When that happens, competition will go into super high gear, which will be great for consumers but not for any provider forced to deal with dwindling margins and a rabid dog-eat-dog landscape.”

 

Okay, I get the hint. Time to put my head back in the sand.