Learning from America's Telecom Travails

As Europe slowly develops a competitive local-phone market, it's looking across the Atlantic to see how not do it

By Andy Reinhardt

Europe should have been a golden opportunity for telecommunications startups. The enormous market -- bigger than in the U.S. -- suffers from relatively poor-quality phone service, high prices, and surly customer support. Indeed, the sclerotic, consumer-unfriendly nature of European telecom monopolies led directly to the huge success here of wireless alternatives -- which, unlike in the U.S., are often cheaper and more innovative.

The same should have held true for alternatives in wired communications. But unfortunately, just as networks in Britain and across the Continent are being thrown open to competition for local data and voice services, capital markets have dried up from the global technology slump.

On top of that, the sorry track record of so-called Competitive Local Exchange Carriers (CLECs) in the U.S. has cast a pall over the prospects for similar enterprises in Europe. Investors are understandably nervous about the gaggle of U.S. telecom startups, including San Francisco-based Northpoint Communications, that have filed for bankruptcy in the past few months.


  Despite the gloom, however, experts on the European telecom scene remain hopeful. A small group of analysts and telecom executives who gathered in late April in the Czech spa town of Karlovy Vary argued that the lessons learned from the U.S. will encourage development of more orderly -- and successful -- local competition in Europe. "I would hate it if people concluded that local service is a natural monopoly with no prospects for competition," says Gavin Young, a contributing member of the DSL Forum, a global industry group that sets standards for high-speed digital subscriber line data service.

Perhaps it was the setting that prompted attendees to take a longer view. The centuries-old Mittel Europa resort town, where the infirm still flock to sip rusty mineral waters from 11 hot springs, is light years away from the rough-and-tumble world of competitive local-phone access. Yet its very timelessness and languor reminded conference attendees that change happens more slowly in Europe than in America. Young and others noted that U.S. regulators and investors may have simply moved too fast in encouraging local competition by telecom startups -- and then walked away before the seedlings had taken root.

Europe should benefit from getting into the game a few years later. The technology for providing speedy data communication over conventional copper phone wires is far more advanced than it was when the U.S. experiment got under way in 1996. Not only is DSL equipment less expensive than it used to be but it's also "denser" -- it takes less space and uses less power -- and is more easily managed. That translates into lower costs and easier installation for startups elbowing their way into the market. What's more, gnarly technical problems such as how to allocate spectrum on crowded copper wires have long since been ironed out by international standards bodies.


  Equally important are the financial lessons from America. The rapid rise and fall of companies such as Northpoint and Covad Communications highlights how many U.S. startups were founded on shaky business models. Most of them offered fast Internet access over phone lines owned and operated by the entrenched local-phone monopolies, then wholesaled their services through Internet service providers such as Earthlink and Concentric Networks.

In the end, that meant they controlled neither the customer relationship nor the underlying infrastructure on which their business depended. The result was a financial squeeze that left CLECs unable to lower their basic costs or to boost their revenues through the sale of pricier services, such as Web-site hosting.

In Europe, by contrast, startups realize they must control their own destinies. Instead of offering just access to the Internet -- and facing the dreaded prospect of becoming the digital equivalent of sewer and water systems -- they have to move up the food chain and sell higher-margin services, such as e-mail and browsing, online data backup, hosting, and security directly to consumers and businesses. And eventually, they'll have to graduate into offering digital voice service over DSL -- a technology that's just now coming into its own.


  American startups, under pressure from their venture capitalists, favored rapid growth in their subscriber base and geographic coverage, at the expense of profits. Indeed, the more customers they served, the more money they lost. Europeans instead will "go deep," says the DSL Forum's Young, focusing on a broad range of lucrative services in defensible business niches and aiming to operate efficiently from the get-go.

They'll also watch the bottom line more carefully. Leonard Conn, the former chief technology officer of DSL-provider ConnectSouth, which shut down in late March, says too many CLECs in the U.S. "were misled by the pied piper of easy money" during the Internet bubble and failed to build sustainable businesses.

Their worst offense, it turns out, was offering too-easy credit to their resellers, the ISPs, whose own businesses were often built like a house of cards. Covad, for instance, had to write down millions of dollars in bad debt when its customers were unable to pay their bills -- a fiasco that cost CEO Robert E. Knowling his job and helped sink Covad's stock price. "That's what killed 'em," Conn says. "Not the fundamental business opportunity itself."


  European telecom startups have the luxury of avoiding the worst mistakes of their American counterparts. Like the sick of Karlovy Vary, they'll take it slowly. But that doesn't mean the capital spigot will be turned on again anytime soon. Analysts figure it'll be at least 2002 before investors open up their wallets again, especially given the overall debt crisis in European telecom.

That's a shame, because Europe is ripe for competition in high-speed telecom services. When investors finally regain their courage, they'll find fertile opportunity for DSL in Europe, eagerly cultivated by startups that have the benefit of five years of American experience and a sadder but wiser view of the market.

Reinhardt attended at the telecom soiree in Karlovy Vary, Czech Republic

Edited by Douglas Harbrecht

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