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In my last column I touched on some of the challenges and realities facing the telecom sector in tough times. There’s more to talk about, and in the couple of short weeks since that column, the stream of bad news has outpaced the good news. While it’s easy to be totally pessimistic, there are signs of hope, and I want to step back and look at some of the broader implications in this column.

Let’s start with reality — many large and well-known companies are hurting, either in the form of job cuts or financial performance. The fortunes of vendors go hand-in-hand with service providers, so the problems go well beyond a few companies not hitting their targets. This isn’t a complete list, but notable major service providers include BT, Telefonica, Vodafone, Virgin Media, and India’s BSNL (News - Alert).

On the vendor side we have household names like Nokia Siemens, Nortel, Mitel Inter-Tel, Motorola and Intel. By virtue of its sheer size, Google’s woes must be noted, and it’s debatable whether you consider them a vendor or a service provider. Regardless, they’re a major bellwether, and are arguably the most important barometer as to where the world of Web 2.0 is going.

For the most part, these developments are to be expected and are widely followed. No doubt other majors will report similar scenarios any day now, and I’m sure things will get worse before they get better. The same holds true for smaller vendors, who are more vulnerable to these scenarios, and often react quickly to preserve capital. Many are heavily dependent on the SMB sector, which is cost sensitive by nature and will cut spending faster than enterprises. Notable examples would be BroadSoft and Counterpath, both of whom recently reported job cuts.

Consolidation is another outcome when business slows down, and well known moves include SightSpeed going to Logitech, NMS going to Dialogic, M6/VocalData going to BroadSoft, and NextPoint going to Genband. Each of these warrants further discussion, and I just wanted to cite a few cases showing how a down economy leads to some attrition. Others will invariably follow, as smaller vendors simply don’t have the financial resources to withstand a prolonged slowdown. The credit crunch will work its way through the whole food chain, and we all know how cyclical the telecom sector can be.

With that said, some companies continue to perform well, and we need to know there are signs of hope out there. Two companies come to mind for me in this regard— MetaSwitch/Data Connection, and Interactive Intelligence (News - Alert). Both have been on a good run lately and have benefited from having a clear market focus and a well defined value proposition. In my mind, having customers is what matters most, and they are doing very well on this count. Despite a modest cut in headcount, I would still say BroadSoft is in a similar position, and am confident they will come out of this downturn in good shape. Other mid-tier companies that seem well positioned based on what I’ve been seeing include Acme Packet and AudioCodes.

Moving further down the food chain, another positive indicator is new funding. I talk to many start-ups in Canada and the U.S., and everyone talks about how hard it is to raise money in this environment. No surprise really, but I see lots of innovation out there and start-ups who recognize emerging opportunities in social media, mobile applications, Web services, mashups, etc. They are way ahead of the big vendors and service providers, and if they can hang on long enough for the market to catch up, their vision — and risk — will be validated. Here are three such examples to consider — Ifbyphone (News - Alert) just raised $4.6 million, IntelePeer raised $18 million, and iSkoot raised $19 million. Incredibly, Ooma raised $16 million in late September. That’s a column unto itself, and all I can say is that they must have been fortunate in their timing. A few weeks later, and I really wonder if this would have happened. Regardless, they’re still in the game, and it’s another sign of hope that money can still be found.

So, what does this mean for service providers? I see two angles here; one is market-wide, and one is situation-specific. A great example of the latter comes out of Canada, which just completed a spectrum auction to allow new providers to enter the wireless market. Not surprisingly, cable operators were aggressive buyers, and two are worth citing here — Videotron in Quebec and Shaw in Western Canada. Both acquired enough spectrum to become strong competitors in their regional served markets. On the same day that Videotron announced its ambitious plans to build a wireless network, Shaw announced it was not going to move forward and build a wireless network at this time. Both are chasing a similar market opportunity, but their situations are just different.

On a market-wide level, service providers must respond to subscriber demand. Some behaviors are changing due to the economy, and some are not. The demand for smartphones and wireless broadband seems recession proof, although this is largely because they have a long way to go before saturating the market. Regardless, this is where consumers still want to spend money, and the iPhone continues to defy gravity. My view is that the demand — and the novelty — is still so strong that consumers can justify the expense and cut back on other things to find the money. I also think that as luxuries go, the iPhone is not that expensive, and it’s become so integral to our lifestyles that people don’t think of it as a luxury. Furthermore, the iPhone simply delivers too much value and utility, and if there’s one area you can spend money and feel good about it, this is the place. As the iPhone moves into the business market, I think we’ll start seeing similar behavioral patterns, many of which have already become established with RIM.

I believe this trend will continue as mobile applications evolve and emerge, supported in large part by the booming third-party developer programs. Examples would be Google Maps on the iPhone, Qik streaming video on Blackberry devices and the Android (News - Alert) G1 phone.

Conversely, as these devices evolve to become the center of our communications experience, other areas will suffer. For telcos, landline and long-distance businesses will continue to decline, and with wireless, I expect there will be less long-distance calling there as well. Mobile operators have managed to minimize the availability of mobile VoIP, and the benefits of services like Truphone, Rebtel and fring will remain largely outside the mainstream. As a result, mobile carriers will likely see an increase in SMS activity to offset the drop in expensive long-distance calling.

Perhaps the greatest challenge facing service providers is pricing. Everyone wants to lower their costs, and raising prices today would be a very risky strategy. To stay competitive, service providers need to keep adding value just to maintain revenues, or they must offer solutions that reduce costs. The rising adoption of SIP trunking is a great example of providing cost savings for business customers, and operators need to recognize this is a better strategy than sticking with expensive T1s that have limited upside for the emerging 2.0-style services.

Another differentiator can be offering solutions that allow businesses to keep using their fully paid-up legacy phone systems, but to adopt IP-based services in a manageable fashion. Very few businesses are in a mood for forklift upgrades these days, so service providers need to be more practical. Vendors such as AudioCodes with their Mediant MSBG, and Genband with their G9 series offer intelligent media gateways that can support Unified Communications (News - Alert) applications within a legacy environment. These solutions allow businesses to keep their network expenses down, but enabling them to deploy productivity-enhancing applications today. In turn, service providers keep their customers, and position themselves well for when the economy improves and customers are ready to migrate further along the IP path.

Nobody has all the answers, but it seems to me that service providers and vendors need to work in tandem since they need each other to survive. Both are ultimately beholden to subscribers, so it’s in their shared interests to serve those needs. I’ll be looking for more examples like this, and hope to share these with you soon.