Overview

On January 1st, 1998, the $160 billion European telecommunications service market was opened to all comers. Even though this market opening was carefully planned and well anticipated by most players, the magnitude of changes since then are stunning. Consider the following:

• Since January, the number of European countries allowing basic voice service competition increased from three to thirteen.

• Certain European carriers are now offering interconnection to their national networks at rates lower than two cents a minute.

It seems like everybody and their brother are building a brand spanking new pan-European network. Hardly a month goes by without a new announcement of a buildout. MCI WorldCom, Viatel, Global Crossing, Level 3 Communications International, Hermes Railtel, Global TeleSystems (Esprit), Cable & Wireless, Global One, AT&T/BT and Qwest/KPN all are involved in building facilities and pursuing partnerships to offer services continent-wide. As evidenced by these international partnerships, the management of telecommunications is indeed moving from tight state control to industry control.

The changes are even more pronounced when examined on a country by country basis. Most observers of European telecommunications agreed that many new competitors would enter the market, and the competition would slowly take market share away from the Post Telephone & Telegraph (PTT) administrations. New broadband services (such as high-speed Internet access and videoconferencing) would begin to emerge, brought on by innovation and investment in upgrading backbone and access networks. However, the changes have been more radical than expected. Beleaguered on all sides by hungry new carriers, hostile regulators, and unsentimental customers, the former monopoly service providers—the PTTs—have been affected in unexpected ways:

On November 12, 1998, The New York Times reported that Deutsche Telekom planned to cut its long distance prices as much as 63 percent. While price cuts have certainly been anticipated by analysts, especially in light of the low interconnect rates set by regulators, most expected drops to the tune of about 15-20 percent a year.

British Telecom (BT) has lost 16 percent of its overall market share, and 50 percent of its international calling share, over the past 14 years. While this may not seem too severe upon first glance, it should be noted that the only wireline competition for BT between 1984 and 1991 was Mercury, and the international simple resellers (ISRs) did not effectively begin offering services until 1995-6.

France Télécom has lost 51 percent of its mobile market share.
In this report, Insight examines two major issues: how deregulation is affecting the European telecommunications market, and how international calling is being affected by various market trends (new facilities-based carriers, callback, international resale, and Internet telephony). The report provides a historical background, outlines the changes in regulation and international settlement rates driven by the World Trade Organization (WTO) agreement, details the present market environment in Europe, and forecasts the size of these markets. In addition, the study considers the strategies of the niche players, predicts their effect on prices and their long-term percentage gain of market share.

Background

The European telecommunications market has traditionally been dominated by state-owned monopolies. When the transmission of voice calls was the only real consideration for telecommunications networks, this was thought the best means for providing service. Though charges were typically set at inflated rates well above cost, regulated monopolies would ensure universal service and provide employment. High charging was not always viewed as terrible by the average citizen, because it was essentially a form of taxation, and the wealthier individuals (and countries) where most of the traffic originated from would be charged the most.

In the US, justifying AT&T’s high prices was more difficult, since AT&T was a private corporation, and the prices only benefited the management and owners. This led to the Federal Communications Commission (FCC) allowing competition first in long distance service, and eventually in other services, as specified in the Telecommunications Act of 1996. But Europe’s high prices and monopoly atmosphere also affected the US, whose citizens made a much higher percentage of trans-Atlantic calls than their European counterparts. This meant a large traffic deficit whereby US carriers paid large amounts to foreign telcos for terminating calls. Several International Telecommunications Union (ITU) and US economic think tank studies pointed out the need for changing inflated international accounting rates and moving to a cost-based system, and the US applied increasing pressure on Europe (and other countries with high charges) to change their policies.

Though the theory of deregulation and open competition was appealing to some prominent European players, poorer countries were reluctant to surrender the additional income, and made it difficult for deregulation to move through the ITU. Largely because of this reluctance, even though divisions of the European Commission began drawing up rules for deregulation in 1987, it has developed in different ways among different countries. For example, the UK and several other countries were deregulated in the 1980s, with full competition arriving in the early 1990s; other European countries became deregulated in 1998.

The slow move towards deregulation encouraged the emergence of innovative small companies trying to meet the demand for cheaper international calling between illiberal states. A popular method that the (often US-based) companies used for bypassing these charges was callback. Callback provides, often at lower quality, a service 40 to 80 percent cheaper than that of the national carrier.

Instead of calling destination country B directly, a customer in country A would place an uncompleted call (e.g. one ring) to country C. A computer at the callback operator, located in country C, would call back the customer in country A, asking for the destination number in country B. The callback operator would then place the call directly to country B. This entire process usually uses the traditional circuit-switched public switched telecommunications network (PSTN).

At the same time, another form of competitive international carrier emerged, known as ISRs. Whereas callback operators arbitrage the cost of calls in one direction versus the opposite direction, ISRs arbitrage the per minute/per call cost of leasing international circuits versus retail calling charges. Many of these resellers, after successfully targeting niche markets, grew into carriers with their own facilities.

The Consultative Committee on International Telegraphy and Telephony (CCITT) branch of the ITU traditionally set rules for the conveyance of international traffic on behalf of only one international carrier, and were accustomed to developing policy in this manner. When these competitive carriers emerged and became stronger, the playing rules were slow to adjust. In addition, many countries made it difficult for any competition to develop, even on a resale basis, placing bans on callback operators from operating in their countries.

In summary, European deregulation was provoked by three major forces:

The conflict between the government and the industry within each European country;
The emergence of competitive resellers offering cheap international rates; and
The pressure to change from already deregulated countries.
The Future of International Arbitrage

Since widespread deregulation occurred in 1998, the market for international European calling has changed. With falling rates and the emergence of mammoth telcos with a worldwide reach, the avoidance of inflated accounting rates does not seem to be a business with much life in it. Because of the inherently contingent nature of the market—callback’s success depends on the existence of high phone charges—most analysts have expected it to be a transitory phenomenon at best.

But like the phoenix of myth, international arbitrage has reemerged from near oblivion in a new form to remain a factor. The most potentially lucrative (but somewhat problematic) area for the type of international arbitrage that callback previously offered has become the transfer of voice over the public Internet using the Internet Protocol (IP). In an IP telephony scenario, customers dial into a local access node, where a gateway converts the voice into packets, and routes the call over the IP network to another gateway at the destination. Companies have emerged to offer transport, authorization, intelligent routing, bandwidth exchange, and settlement services to service providers and end users.

One might think that IP telephony will be the same fleeting phenomenon as callback, i.e., a contingent arbitrage opportunity. However, if the supposition of some (that IP equipment and transport costs are cheaper than the equivalent ones in the PSTN) proves to be true, and quality issues can be resolved, then IP telephony will indeed be the wave of the future.

The Future of the European Market

In this report, Insight takes into account in its market model how European telecommunications has transformed. Over the last few years, the carriers selling services in the European market were best classified under the following categories:

• Incumbents;

• ISRs;

• International wholesale carriers;

• Local service providers (CATV companies, CLECs);

• Global alliances;

• New full service operators; and

• Others, including switchless resellers, aggregators, IP telephony providers and callback operators.

With market forces rather than regulation becoming the guiding force for telecommunications providers today, it is best to classify service providers in a slightly different way that more accurately describes their activities. The new categories are:

• Incumbents;

• CLECs;

• Long Distance Operators; and

• Others, including switchless resellers, aggregators, IP telephony providers and callback operators.

Insight divides the European calling market by the following segments:

• Local lines;

• Local and national calls;

• International calls;

• Wholesale; and

• Leased lines.

Full five year forecasts are given for the UK, France, Germany, and Italy. In addition, Insight shows how much new CLECs, long distance operators and other carriers will likely penetrate the market in these countries.

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