highlights...voice over internet protocol, voip, is another threat to suppliers of traditional local...

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HIGHLIGHTSKEY HIGHLIGHTS:

• Canada’s communications regulator, the CRTC, recently released its 4th annual “Report on Competition”. SeaBoard contends this latest report is a disappointing, backward-looking document which hasn’t measured or addressed the profound shifts taking place in the communications industry.

• The CRTC segments the communications market into: Long Distance, Local and Access, Mobile and Paging, Internet and Broadband, and Data, Private Line and Other industries. The Commission contends that each segment operates in a distinct economic sphere - there is little interaction or cross-elasticity.

• The two increasingly dominant segments of the Commission’s template, the Internet and Broadband, and the Mobile and Paging sectors, are growing not in islolation, but, rather, they are expanding at the expense of traditional spheres like Local and Long Distance. Newer competitive service plans include, for example, all features ‘free’ and some offer unlimited North American calling plans. Where is the ‘long distance market’ now?

• SeaBoard projects the wireless-only segment will be over 15% of what is now classified as the local wireline market by 2007, and as much as 25% within 6 years – this represents a profound shift in market dynamics.

• Exacerbating the shift in the market will be the impact of VoIP: We project VoIP will represent 15% of the landline base (as a full substitute) by 2010. This will take away not only basic connectivity revenues from the incumbent providers, but also the profitable calling features revenue – with the long distance market segment that the Commission is so careful to measure and assess being essentially non-existent by that time. • There is a clear danger that the Commission may invoke a heavy hand on the market and make further adjustments to the marketplace dynamics based upon its blemished picture and flawed interpretation of the market. A tainted assessment of trends and market forces will lead to poor public policy – such a movement could have significant implications for the industry and the country. • We recommend that Industry Canada convene an advisory panel, familiar with trends in intersectoral competition, which can assist the department and Commission to look at the market with a keener gaze. Such a panel could assist policy makers to see the shifts and recognize new patterns and new dynamics in the market. The panel could assist government to understand the implications of these new forces on the structure of the industry. The present course, pretending that the Commission’s “Report on Competition” is a valid and complete view of the market is fraught with peril. Navigating these waters with a faulty chart will not serve the industry nor the public good.

.....

These are highlights of a full report on the industry available to subscribers. For review copies for accredited media or information on subscription please contact SeaBoard Group.

Old Bottles, New Wine December 2004 - IGB Grant +1 514 849 3508 & Brian Sharwood +1 416 413 9381

OVERVIEW

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OVERVIEW

Last month, Canada’s communications regulator, the CRTC, released its latest ‘Report on Competition’, which purports to measure the extent of competition in Canada’s telecommunications industry and to report to Cabinet on the state of the Communications Industry.

It’s a disappointing document, backward- looking and it offers little insight. The Commission simply hasn’t picked up on the profound shifts that are starting to impact several of the markets it is “measuring’. Given this, there is significant risk that the Commission will draw the wrong lessons from its report and institute actions based on its misguided perception. This could be a perilous mistake.

The Commission segments the communications services marketplace to assist in its analysis: Long Distance; Local and Access; Mobile and Paging; Internet and Broadband Deployment; and Data, Private Line and Other. It sees these as distinct economic spheres that have minimal interaction or cross-elasticity. The CRTC appears to be using a technology-based template to drive its analysis – while maintaining that it’s thinking is technologically neutral. A curious, indeed paradoxical, mental stance that leads it down the wrong analytic paths toward conclusions that have little to do with the fundamentals of the industry.

Commercial interaction between the various discrete segments the Commission employs currently exists, and those interactions will only become stronger as the market continues to evolve. The two increasingly dominant segments – in terms of their potential impact – are the Internet and Broadband, and the Mobile and Paging sectors. Both are growing at the expense of the more traditional service spheres. An example of the cross segment erosion is the continent-wide free calling area that is common with many mobile and VoIP plans (did somebody say there was a long-distance market segment?).

The PSTN, the Commission’s focus in much of its competitive measurement, has become the lowest common denominator of connectivity – we, as a society, are moving on to higher orders of interconnection: a mobile connection model, and a high speed data model. It may be time to put the PSTN archetype behind us.

1A number that represents the level of support offered to manufacturers in recent years through such agencies as Human Resource Development Canada (HRDC), the Atlantic Canada Opportunities Agency, Northern Ontario Heritage Fund Corporation, and other, similar, provincial/regional and municipal bodies!2We note later that each and every small business in the county could have their technology hardware updated for less than 3% of that number!.

EXHIBIT 2: The Relative Importance of Small Business to the Canadian EconomySource: Statistics Canada, 2001 [61F0040XDB]

Number of Employee

1-4

5-49

50-99

100+

Number of Establishments

1,586,700

383,100

31,100

23,600

2,000,900 SMEs

Even in Nigeria, Africa’s most populous country, but not usually heralded as a leader in economic thinking4, SMEs are celebrated – as noted in the extract below from a World Bank (IFC) roundtable discussion: Even if there are controversies on definitions, what is not contestable is the contribution SMEs are making to the Nigerian economy. About 10% of total manufacturing output and 70 % of industrial employment are by SMEs. SMEs also promote industrial and economic development through the utilization of local resources; production of intermediate goods and the Transfer/ Transformation of rural technology. In fact SMEs are generally regarded as the engine driving the growth of this and other economies and provide the best opportunity for job creation and rural development. In most major economies, the critical role of SME is recognized and special agencies of government are created to provide support to SMEs. - (28 Nov 2001)

OVERVIEW:

This paper is a follow-

What is a SME/SMB?

SME = Small and Medium Enterprise. SMB = Small and Medium Business. They are also called small businesses, mom-and-pop enterprise, dark Satanic mills (Milton) and similar. These are the shopkeepers and merchants of Napoleonic (and Adam Smith and Josiah Tucker) fame5.

OVERVIEW

.

Old Bottles, New Wine December 2004 - IGB Grant +1 514 849 3508 & Brian Sharwood +1 416 413 9381

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The Commission notes, in passing, that a small portion (about 2% in 2003 by its measure) of Canadians already use only mobile phones, i.e. they have no landline. It commissioned the pollster Decima to ask Canadians if they would consider using only mobile phones: 15%1 said they would, with up to 28% of households with more than three mobile phones saying yes. In the same survey, almost half of households surveyed felt wireless service was as good or better than wireline service... It further noted that Microcell was acting as a mobile CLEC with its City-wide Fido service – yet it never seems to dawn on the Commission that these are signs that local telephone service from traditional providers may be under threat; instead the Commission frets about the appearance of market power.

As wireless technology evolves it is anticipated that more and more customers will elect to abandon their landlines for a wireless-only solution. SeaBoard’s projections suggest that wireless-only customers will represent over 15% of what is now classified as the local wireline market by 3Q 2007. Further, we project that wireless-only customers will be as much as 30% of the same market within 6 years. That is an erosion potential you cannot see by backward-looking, nor can you see it if you ignore your own evidence (the Decima survey).

Voice over Internet Protocol, VoIP, is another threat to suppliers of traditional local services. Again, the Commission notes, in passing, that several companies plan to offer local service over IP, but dismisses this with the comment that it is not likely to have any significant impact in 2004. This technology has greatly improved in quality and performance over the past 18 months – and the price is right. We project VoIP could take, as a full substitute, over 15% of the traditionally defined local market by 4Q 2010. In doing so VoIP will not only take away basic connectivity revenue from the telcos, but also highly profitable calling features revenue (voice mail etc.) and further erode the already soft long distance market. We could add that VoIP as a complementary service in addition to, rather than instead of, the present telephone, will represent a much higher penetration. A combination of wireless and ‘fixed’ VoIP services may well be the connectivity metaphor for next generation services. Will it be significant in 2004? No, we agree with the Commission – our forecasts suggest that Canada will have fewer than 70,000 VoIP customers by the end of this year. Is it an important number? We disagree with the Commission, in that we think that 70,000 is important. We note that most of those were signed up in the last quarter of the year. The ramp-up that we see in 1H05, when Bell Canada, Videotron, Rogers and Shaw will join Primus, Vonage and BabyTEL in offering VoIP services, will be significant. Significant, but missing from the Commission’s assessments and analysis – until we see the Commission’s reading of the 2005 market dynamics, in late 2006/early 2007. Late 2007 may be a little late to influence events, to shape the industry. The crest of the crisis will have passed. The Commission’s acknowledgement of the shift in the industry, an acknowledgement which must, perforce it seems, occur after their 2007 industry assessment, will be too late to shape or influence the market dynamic. While a passive Commission isn’t necessarily a bad thing (indeed, that would be our definition of a more ideal world), it is an odd position to find oneself in if you believed your mission was to influence events.

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EXHIBIT 2: The Relative Importance of Small Business to the Canadian Economy | Source: Statistics Canada, 2001 [61F0040XDB]

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:

This paper is a follow-SMEs, with exceptions, can be said to share some of the following characteristics: • A small geographic trading area • Entrepreneurial spirit, tempered by caution and prudence • No significant investment in business practice, operations or competitive research • Management by owner/ operators, rather than a professional management cadre.

INTRODUCTION

1Of all respondents – including those who haven’t a cell phone at present. One presumes that a question directed to cell phone users, rather than the entire survey base, would yield a larger result.

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The incumbent suppliers of local service face the prospect of significant customer attrition over the next five to ten years, as their current services suites erode due to competition from wireless, VOIP, and likely some CLEC’s offering present-day and VoIP services as alternatives to incumbent landlines (this being the market construct that Commission has long sought to foster). In looking at local wireline services in isolation, the Commission has, and will continue to miss this trend. Real competition for local voice services, taking account all competitors from other non-regulated segments, will be far stronger than today and the incumbents’ seeming dominance in this segment of the market will cease to matter. But it is happening in the Commission’s blind spot, the future, and not in the strong light of its gaze, the past.

The Commission does note that local service revenues are falling (by 3% from 2002 to 2003.) It also notes that EBITDA for wireline incumbents dropped by 19% in the same year. Yet it does not seem concerned to analyse why this has happened, what the consequences may be, or what it should do, or indeed, not do, about the matter. It also thinks, it seems, that it is too early to discern trends. It would be wrong in that estimation.

The long-term solution is clear. The end game is sustainable competition in a deregulated market. Local markets must be de-regulated. In assessing when de-regulation should occur, the Commission must take a much broader view of competition. Competition is a Darwinian metaphor. Freedom to compete, freedom to achieve success; and, importantly, freedom to fail. A ‘head-start’ metaphor, the Commission’s chosen market-assistance model, by contrast, creates frail ephemeral competitors – not robust competition.

The Commission should also be aware that many of the forces at work are irreversible – and these forces are stronger than dated, backward-looking statistics are likely to reveal. If deregulation comes too late, the position of incumbent local suppliers may be irretrievably damaged. The challengers, many of whom already think the incumbent local suppliers are slow, lethargic and impossibly steeped in tradition, will be delighted by the additional hobbles – don’t really need a regulatory hand-up. The new technology offers all the assistance they need.

In the short term there are challenges to be sure, but neither the mobile market nor the VoIP market need or have asked the Commission for long-term shelter. Indeed, the pure VoIP players think that neither the telcos nor the cable companies are threats to their business models. Canada’s cable companies are concerned because of their higher investments and bigger risks. A little trepidation is understandable given their engineering choices to substantially rebuild their networks to offer a higher-level of VoIP services. That choice was theirs, though. While there are some who argue the merits of forestalling potential competitive excess by government fiat, we note that laws to achieve that end, mechanisms for protecting the frail and punishing the rapacious, already exist. Canadian competition law talks to the issues of predatory pricing and market manipulation. The mechanism for checks and balance in this area are in place. We urge the Commission to refrain from additional draconian regulation. Let the market work!

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Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION

COMMISSION

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Finally, to assist the Commission in its future deliberations on local competition, and in the absence of the Commission’s own industrial trend analysis capability, we recommend Industry Canada convene, without delay, an expert industry advisory panel that is familiar with the trends in inter-sectoral competition that is taking place. Let such a panel assist the Department and thus the Commission to peer into the future as well as the past, to act more like Janus than Lot’s2 wife, to see through the mists and envisage the market as it evolves over the next decade before the CRTC finds itself compelled to enact further course corrections – lets help the Commission to look forward as well as backward. There are insights about what is going to happen. You have tea leaves – read them. That way lies better public policy. The current course? There be dragons and fearsome creatures and we will stumble into them – looking backwards.

THE REPORT OF THE COMMISSION

The CRTC competitive commentary reports on the market response to communications competitor initiatives in the segments of the communications market, as defined by regulatory dictate over the past twenty years: the long distance market, the local telephone market and the wideband access market.

Some market segments, the reports admit, have changed – the market for long distance services, once the hallmark of competitive challenge, has matured. The long distance voice segment and the innovations that Canadians and the Commission celebrated in the 1990’s, and that the Commission championed (indeed, crafted), have changed little in the past few years. Competitive inroads have been made, and the market characterized as hidebound and stagnant initially, achieved the sought-after dynamism for a time, but appears to have since stabilized. The slope of share shift has flattened.

Despite some success in shifting market positioning, the major market element upon which Canada’s regulator has invested much regulatory time and energy, the so-called market for local communications services, has shifted little - the market share held by the incumbent telephone companies shows only a slight decline from the hegemony of the past. Despite the heroic efforts of the Commission to create the conditions for a competitive environment, the vast majority of Canadians appear to be little tempted to stray from the telco fold. But there is good reason for this. The alternatives simply are not very attractive in their traditional PSTN form. We argue that we are seeing the signs of the slow death of analogue voice services...services that few3 are interested to provide, there is little nourishment available in the PSTN ‘toll’ model, with falling revenues and EBITDA. As noted later, in this report, there are better ways of serving the local market than traditional wireline. Significant competition awaits the sector, not from traditional suppliers but from other sectors, wireless and IP.

2Whose ‘looking backward’ rather than forward caused her to be turned into a pillar of salt – certainly not a result wewould wish upon the Commission.3Sprint, Eastlink and Primus are all active in this market, with some success in select areas, but the model isn’t asattractive as the new VoIP-based services for the broader, non-clustered market.

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1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION

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The Commission might see this apparent customer inertia as a failure of its efforts. They could see it as a failure of the market to respond to the rules it has painstakingly set. One can imagine that the Commission is agonizing about what else it can do to drive the market; perhaps, it is thinking, perhaps it should redouble its efforts?4 Perhaps more sweeping changes to the market structure? Perhaps a ‘heavier thumb’ on the market scale – maybe changes that would further distort market dynamics will achieve the objective? The Commission may also want to consider doing less...

We would counsel the Commission to forbear from further tinkering with market mechanics. We think that the Commission may well be considering more changes because it believes that the marketplace has failed to respond to the environment it has created. But has it? Is the Commission’s nirvana of a competitive local market, a market with ‘choice of local service provider’ as its hallmark, really a lost, hard to approach, Eldorado, tucked away in the inaccessible cliffs of a metaphorical Xanadu? Or is this treasure somewhat more accessible – needing only a shift in perspective to discern?

SeaBoard takes the latter position. The Xanaduvian ‘milk of competitive paradise’ is at hand. We think that the Commission believes, in its heart of hearts, its recent record is one of failure because its measurement modalities haven’t picked up the shifts that are already taking place.

The Commission is suffering from a problem of perspective. We believe that Canadians do have choice, that the country is served by an intense, increasingly competitive market – but the Commission can’t see or measure the dynamic with the tools it is using. The Commission’s analytic microscope is set at too granular a level; the magnification is too high.

Has the Commission failed? Perhaps. Before falling on its sword we would urge the Commission to refine the question: does the market show evidence of paradigm shift? Is there a more competitive ethos already extant in the market? We would argue: it can and there is.

4Indeed, the Commission states in its press release of 25 November that “...more needs to be done to ensure that we achieve our goal of sustainable facilities-based competition.”

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EXHIBIT 1: Hallmark of Competition: The Canadian Long Distance Market 1990-2004Source: SeaBoard Group and the CRTC, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION

1991 1993 19951997

19992001

Competitor Share

Incumbent Share0%

20%

40%

60%

80%

100%

Market Share

Competitor Share

Incumbent Share

THE PAST

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If the Commission has failed, this failure is not a failure of rules, nor is it a failure of the market; it is, rather, a failure of measurement mode. The Commission is using the wrong metrics; it is asking the wrong questions and looking at the wrong things. It is following the wrong spoor as it searches for the competitive beast.

As the Commission observes in its Report: “There are various means for measuring competition...there is no single or simple way of assessing the state of competition in a market. Specific elements of the monitoring exercise may need to change over time to take into account significant market developments, such as new technologies, changes in the market structure or in domestic or international regulations or agreements, or the introduction of new services”. While recognizing, in principle, the need to adapt monitoring as conditions change, we would argue that the Commission has done no such thing, but persists in its old ways.

As a result, the Commission may be on the verge of committing itself to a foolish course which would compound its failure – it may be on the verge of using flawed data to justify ever-more-draconian measures to achieve a hoped-for result at some time in future; a result we argue that is already at hand. We could argue that even the status-quo may be already too draconian. Maintaining the status-quo may lead to over-correction as much as a more active stance.

The potential for ‘over-correction’ is significant and the prospects for the industry, and even the country, could be profoundly negative. This paper will explore the genesis of the Commission’s stance on competition, its present definitional conundrum and discuss some broader visions of the state of competition in the Canadian communications market that may well allow the Commission to rest more easily in the glow of accomplishment, rather than wallow in its present state of unease and uncertainty.

SHACKLES OF THE PAST

Canada’s communications fabric was once a simpler, less variegated and altogether less colourful cloth. In the 1970’s and into the 1980’s data communications private line was a competitive service. Two competitors, CNCP and a national consortium of Canada’s telephone companies, battled each other for the attentions of Corporate Canada. Exhibit 2 below illustrates the competitive market share of that segment of the communications market that was open to competition in the mid 1980’s.

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EXHIBIT 2: Competitive Market Share, 1993Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION

Incumbant70%

Competitors30%

Canadian Communications Market 1993

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Competition blossomed in the Canadian communications market in the late 1980s and early 1990’s with the introduction of switched data and long distance competition. The transformations in the marketplace were profound. Canadians were confronted with choice; choices of service, choices of technologies and choices of provider – and they reaped the benefits of the increase in market voices, benefits such as:

• Price competition• Service options and flexible plans• Customer service improvements

The CRTC turned its attention to the ‘local communications’ market in the late 1990s. It wanted to ‘open-up’ the local exchange as it had opened up inter-exchange services. Rules were established within the Commission’s catechism of facilities-based competition.5

A new universe of competitor was conceived. The CLEC (Competitive Local Exchange Carrier) was born. Money was raised, equipment was purchased (or hire-purchased!) and facilities were buried. Canada’s urban streets were ripped up, again and again, and miles of fibre inserted.

The CLEC’s, alas, were unable to realize the success of the long distance competitors earlier in the decade: the business was harder, the costs were higher, the margins lower, and the sales cycles longer.

Exhibit 4, below, is a graphic portrayal of the fate of many of the earnest competitive companies attracted to the flame of the newly freed market for local competition in the early months of the present decade. The fact that the companies’ funding models and business plans called for continued investment amidst the telecom ‘nuclear winter’ exacerbated the shortcomings in business plans and execution. The resultant telecom carnage wasn’t a pretty sight.

Exhibits 2 (above) and 3 (below) illustrate the shift in share between the incumbent telephone companies and the new competitive entrants in the decade. The exhibits represent the communications market defined as long distance and IX data. Clearly the Commission’s changes in rule making had a clear impact in the market – a major success for public policy.

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EXHIBIT 3: Competitive Market Share, 2002Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION

5Canada’s CRTC believes that true, sustainable competition must, perforce, be facilities-based; a re-sale industry it contends would be ephemeral by comparison, a mere stop-gap, subject to continued margin pressures between wholesale costs and retail yields. Yet there are numerous examples of resellers in other industries who provide significant competition to their suppliers for many years. For example, off brand gas retailers have for years obtained their supplies from the same refineries that service their branded competitors. Internet travel agents have been so successful at selling the airlines seats that they have forced airlines to adopt their model. There are examples too in this industry in other countries where the resale model has been adopted with success (Australia being a case in point).


Canadian Communications Market 2002

Incumbant54%

Competitors46%

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Was the failure of the CLEC model a failure of the market? Was it a failure of a flawed regulatory structure? Was it a failure of unsound planning and poor execution? Or was it merely an artifact of the heady expectations of the century’s cusp coupled with the capital market flee from telecoms?

Obviously, in our view, it was a combination of all-of-the-above. A detailed discussion of the CLEC gold-rush chapter in Canada’s telecom history is beyond the scope of this paper, but an appreciation for the magnitude of the disaster helps to understand the CRTC’s sense of failure. This didn’t turn out ‘to plan’.

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EXHIBIT 4: Free to Compete: Free to Fail – The Dark Side of The Wall; Canadian CLEC tombstones Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


COMPETITORS

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Of course, would that the market were so simple, and so static. The market is far more complex than the Commission’s model reflects – the critical dynamic of interaction and substitution/cross-elasticity is totally absent. The siloed market matrix encourages epistemological mistakes, and may prompt changes in public policy to achieve an objective that is already at hand. The result of that additional change could be what we would term as regulatory overcorrection. Such governmental overcorrection would serve merely to exacerbate an already precarious evolution. The changes about to make themselves felt in local telecom economics have parallels in other industries (illustrated below). Such changes, driven mostly by technology, cause significant turmoil in a market – inappropriate regulatory initiative will have unknown consequences. Such new initiative might act to temper the reaction – like graphite rods in a nuclear core, but it may have an opposite effect. It could be pouring gasoline on an already fired market...or even the negation; smothering the nascent market dynamic altogether.

NEW TECHNOLOGIES BRING NEW COMPETITORS

At the end of the last century, many saw noteworthy opportunities for growth and profit from new technologies that enabled goods and services to be delivered by new means and at lower cost. The established players, companies that had traditionally dominated these markets, were, however, often not as effective at exploiting the new opportunities as the newcomers. In a number of instances, new technologies allowed new competitors to invade established markets at speed and left established suppliers struggling to survive.9

In the recorded music industry, for example, the market for the major recording companies (the majors) stopped growing and then shrank as consumers became able to get songs at no cost over the net. The majors’ reaction was to focus on preservation of their content by prosecuting the illicit web sites and even users. It was an outsider, Apple, with a strong technology background, that discovered how to profit from consumers’ new abilities to copy music, first with the iPod and then its iTunes music store.

Similarly, Kodak’s domination of the traditional emulsion film market has become immaterial now that digital cameras, in which Kodak has less than a 20% share (mainly at the low end), outsell conventional cameras. For Kodak this loss of market share is a double whammy because it used to sell conventional cameras to drive higher sales of film. With digital cameras, the profitable market lies with the ink and paper sales, where Kodak is a relatively minor player.

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Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


9Readers interested in exploring this dynamic may find Clayton Christensen’s work, The Innovator’s Dilemma (Harvard Business School Press, 1997), a useful primer on the impact of disruptive technologies on the established order.

KARL POPPER

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Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


10Sir Karl Popper – The Logic of Scientific Revolutions (1934; 1959) – pillar of the critical rationalism – would say if the theory doesn’t fit the facts, then the facts prevail; a new theory is required. One might suggest that the Commission has reached a point where the facts and their theories are at odds …

Both these examples come from unregulated industries where the incumbents’ potential response to changing technology was uninhibited by regulation. How much worse would the situation have been for those who had to consult a regulator for approval to take needed action, and then wait for an indeterminate period while the petition was heard, analyzed, countered by your competitors and then considered, before being able to take action, perhaps, to save the firm? Another disturbing aspect for incumbent suppliers is that the speed of adoption of new technologies and the extent of their impact appears to be increasing. Take the example of mail services. Mass communication by mail, which began with the introduction of the Penny Post in England in the 19th Century, saw virtually uninterrupted growth for more than 150 years. Voice services, over the telephone, itself had surprisingly little impact on mail volumes: perhaps because, for many purposes, users wanted a printed record. Newer technologies, such as cable and telex, either complemented postal services or had a minor impact on growth because these alternatives were relatively expensive and didn’t have the necessary ubiquity. Fax services had a much bigger impact, especially on business use of mail, but even so mail continued to be the dominant technology for inter-personal, business to consumer and business-to-business communications. However, in the early 1990’s, e-mail started to have an ever-increasing impact: mail volumes started to shrink, and fax all but disappeared as a business communications modality. Direct debiting and depositing and computerised on-line billing are exacerbating the trend away from the to’s and from’s of physical mail delivery. 150 years of ‘normalcy’ – then a profound shift in technology and a major paradigm shift for an industry. The outlook for the letter carrier-based mail service? : “junk mail”.

WHAT WOULD KARL POPPER DO10: IN SEARCH OF VERISIMILITUDE

How to correct the regulatory myopia? What is needed is a new paradigm – a paradigm that more closely reflects the underlying market realities. A paradigm not bound by historical market segment constructs. A paradigm that embraces the change that is being wrought by technology rather than one which ignores it.

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EXHIBIT 8: Wireless Substitution for Wireline | Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


In an additional filing to the Commission by the incumbent phone companies which includes StatsCanada survey data taken in May 2004 – regrettably, by it's timing, not taken into account – 3.7% of customers in Canada have only wireless access, up from .3.1% in 2003. The numbers are higher in areas where the CityFido program has taken hold with a jump in British Columbia from 4.3% to 5.9% from 2003 to 2004. The reasons for this are many including: • cost savings, • a desire to simply life by having all calls through one instrument, • simplified billing, • pay as you go billing and • a mobile life style.

As wireless technology has evolved, offering equal and then more features than are commonly available on fixed phones, and as calling plans become more and more competitive, it is anticipated that more and more customers will elect to abandon their landlines for a wireless-only solution.

There is increasing evidence of the trend to wireless as a substitute for wireline service. For example, recent projections of the US election results are said to have gone awry because pollsters relied on sampling wireline customers only, thus missing that part of the population that no longer has wireline service, only mobile.

More evidence comes from the Commission’s own report. In a study for the Commission, the pollster Decima asked Canadians if they would consider using only mobile phones: 15% said they would, with up to 28% of households with more than three mobile phones saying yes. In the same survey, a majority of households felt wireless service was better than wireline service.

The Commission also noted that Microcell was acting as a local CLEC with its Citywide mobile service.

All this evidence should have drawn the Commission’s attention to the need to change its model, to look forward rather than backward, and to see that local competition will be inter-sectoral rather than within the sector.

The Seaboard Group projects that wireless-only customers will represent over 15% of what is now the wireline market by 3Q 2007. We project further that such customers will represent nearly 25% of the local market within 6 years. Our forecast is shown graphically in Exhibit 8 below.

Wireless ReplacementInroads

0%

5%

10%

15%

20%

25%

30%

35%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

NAS

share total

NAS

Baseline Assumption

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EXHIBIT 8: VoIP inroads into traditional Local and Access base | Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


12For further information the reader is referred to “Its Your Call: The Many Flavours of Voice”, SeaBoard Group, July 2004.

13VoIP will also be used as an adjunct to traditional PSTN services by a large number of customers: see, “Its Your Call” op. cit.

Other customers have discovered the merits of running their voice services through a newer technology known as VoIP. Voice over internet protocol, VoIP, is another threat to suppliers of traditional local services. This technology has virtually overcome the voice quality issues that plagued initial offerings and “the price is right”12.

Again, the Commission has evidence of this type of inter-sectoral competition because it notes that several companies plan to offer local service over IP, but dismisses this with the comment that it is not likely to have any significant impact in 2004.

Seaboard projects VoIP could take, as a substitute13, over15% of the traditionally defined local market by 4Q 2010. The slope of this change is illustrated in Exhibit 8 (below).

We note that the ‘complete substitution’ effect does not represent the only effect of the VoIP market on the Commission’s Local and Access competitive market segment. We think that a more significant impact will be the shift of highly profitable feature revenues from the primary telephone line, delivered over the PSTN, and captured therefore in the Commission’s Local and Access market bucket, to the, mobile and internet-based services segments (where such services are often ‘free’).

Features like: Voice Mail. Call Display, Caller Line ID are offered by the telcos as premium services on top of the basic connectivity tariff as part of the Local and Access market bucket. Such services are not only profitable but constitute a significant portion of revenues for traditional carriers.

In both the mobile and internet market buckets, however, these highly profitable services for telephone companies are often ‘given-away’ free – along with long distance – to entice the customer to leave the familiar world of the PSTN for the bawdy byways of the internet and wireless universe.

If EBITDA of the incumbents’ wireline services are dropping now, what rates of return can be expected when mobile and VoIP services take significant market share?

VoIP Inroads

0%

5%

10%

15%

20%

25%

30%

35%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-

500

1,000

1,500

2,000

2,500

3,000

NAS

share total

NAS

Baseline Assumption

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EXHIBIT 9: Comparative Access Line Pathologies | Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


Exhibit 10 below compares and contrasts monthly prices of the telephone and the ‘telephone equivalent’ services offered through high speed internet and through wireless technology substitution.

Exhibit 10 shows a telephone line spend of $51.25, not atypical, made-up by an access charge of nearly 50% (dial tone) and layered with telephone features (voice mail, call display, etc.), long distance and ancillary fees and charges (directory inquiry, 911 charges etc.). Internet charges, if any, would be on top of these charges, and would be about $40 for high-speed access.

An internet phone service, in contrast, at first sight appears more expensive – it has an access charge of $40 (assuming a high speed account), and then a ‘telephony application’ running on top of that access for an incremental $20, for a total of $60. But that’s it. No other fees or charges. Voice Mail, Calling Line ID, and 500 minutes of North American Long Distance, all are included in the application charge. Moreover, the network access, the internet, can be used for a host of other applications and activities.

The third option shown, the mobile option, exhibits similar characteristics to the internet example; but in this case the network access charge is lower and the long distance charge higher – but only because our theoretical customer elected a continental unlimited-calling plan, the feature fees and the ancillary fees are higher than with traditional telephony – but unlike traditional telephony you now are truly mobile and fully portable. Not too large a premium – and a service that can easily substitute for the traditional landline (especially affordable if the traditional landline is sacrificed – then the modest premium is suddenly very affordable). A combination of VoIP AND mobile would appear to be able to negate the fear of cutting the telephone cord...

Economic Anatomy of a “Telephone” Line

$25.00

$40.00

$20.00

$7.50

$8.00

$15.00 $20.00

$3.75 $20.00 $5.00

$20.00

0

10

20

30

40

50

60

70

80

1 2 3

$/month

Internet

Ancillary

Long Distance

Features

Access

Telephone Internet Wireless

HELP©

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EXHIBIT 10: Industry Canada’s view on landline decline | Source: SeaBoard Group, 2004

Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


HELP REQUIRED?

That the CRTC is having issues grappling with the complexities that are presented by fostering and measuring competition in communications is not really a surprise. It is a complex, intricate and convoluted phenomenon. The CRTC may be too close to some of the issues to have the needed perspective. Fortunately the CRTC isn’t alone in looking after Canada’s interest in a strong, vibrant communications sector. The CRTC can look to Industry Canada for direction, for clarification, for vision.

In fact, Industry Canada in last month’s Report on the Telecommunications Industry (Industry Canada, Strategis, October, 2004) has produced data on the local telecommunications market that brings it tantalisingly close to providing important guidance.

In Section 3 of its report entitled Communication Paths and Convergence, Industry Canada examines wireline access lines and wireless subscribers, subscribers to broadcast distribution systems and the Internet Service Providers, highlighting their segment size, access services, and number of subscribers.

With the benefit of Figure 3.2, reproduced below, Industry Canada comments on the fact that the number of residential wire lines has declined by 1% since 2001 while the number of business wire lines has declined by 3.7% over the same period remained essentially static since 2001. Industry Canada further observes very fast growth in wireless with number of subscribers expected to exceed the number of residential wire lines shortly.

VoIP Inroads

0%

5%

10%

15%

20%

25%

30%

35%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-

500

1,000

1,500

2,000

2,500

3,000

NAS

share totalNAS

Baseline Assumption

CONCLUSIONS

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Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


In light of increasing numbers of households and growth in businesses over the period shown in the chart the decline in numbers of residential and business lines is more remarkable. Unfortunately, Industry Canada is content to observe the world as it is and does not attempt to explain why it is so. Had it done so it would likely have found a variety of explanations, including the fact that services like analogue voice are not isolated but are subject to competition from other segments. Technology has blurred the boundaries – the segments are now intermixed and impacting each other – and providing competitive discipline. Is there, for example, a link between rapid mobile growth and declining residential and business wireline numbers? Are businesses and residents abandoning dedicated dial up internet lines for high-speed internet connections? In other words, we believe a rigourous analysis of the Industry Canada data would bring to light the very issue with which we are concerned that the Commission is missing in its pronouncements - namely that the wire line business is indeed subject to competition.

Since neither the Commission nor Industry Canada appear to have looked behind the data available to them and grasped the changing nature of competition, we believe it may be appropriate for Industry Canada to convene, in the near future, an industry panel to advise them on this dynamic. The panel should be composed of industry experts. It should be charged with assisting the Commission and Industry Canada to discern patterns and trends that will assist both entities in assessing the implications to the industry, the health of which they are both charged with the responsibility of ensuring.

CONCLUSIONS

The nature of competition in local and access services is changing. It is no longer simply a battle between CLECs and the telcos, offering roughly the same services for minor price differences. The more formidable competitors come from other segments, notably mobile and VoIP. Unfortunately, the Commission’s model of competition, based as it is only on competition within a technology-defined segment, misses this important dimension.

The introduction of new technologies in other industries have led dominant suppliers to lose market share and profits very quickly as newcomers frequently appear more adept than incumbents. We fear this may be even truer of a regulated industry like telecom, where regulation handicaps the response of incumbents.

There are many reasons why customers will turn to using new technologies in place of traditional wireline solutions. Cost differences between wireline and wireless and VoIP solutions are narrowing, and may have turned in favour of the newer technologies for many customers. Quality has also improved and, most importantly, VoIP and wireless tend to offer more services for the same or less $ than wireline.

VoIP Inroads

0%

5%

10%

15%

20%

25%

30%

35%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-

500

1,000

1,500

2,000

2,500

3,000

NAS

share totalNAS

Baseline Assumption

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Number of Employee

1-4

5-49

50-99

100+


1,586,700

383,100

31,100

23,600

2,000,900 SMEs


What is a SME/SMB?


OVERVIEW:


INTRODUCTION


Already experiencing declining revenues and EBITDA, the incumbent suppliers of local service face a potential crisis over the next five years, as their business erodes due to competition from wireless, VOIP, and likely some CLEC’s. Other trends, such as the erosion of fax lines demand and dial up Internet lines will aggravate the situation. In looking at local wireline services in isolation, the Commission may well see a situation up to 2010 where the incumbents still have an apparent dominant share, but this will be of a shrinking business. Real competition for local services, taking account of all competitors from other non-regulated segments, will be much stronger and the incumbents’ dominant position has ceased to exist. The only question is the likely speed with which competitive forces will be deployed and the dominant market share lost.

The long-term solution is clear. Local markets must be de-regulated. In assessing when de-regulation should occur, the Commission must take a much broader view of competition. It needs to be more forward looking - more like Janus than Lot’s wife! The Commission should also be aware that many of the forces at work are irreversible and are stronger than statistics are likely to reveal. If deregulation comes too late, even within the status quo, it may decrease the intensity of competition and the benefits of a robustly competitive market – a hobbled giant is not match for a vigorous David.

In the short term there are challenges to be sure. But the mobile market has shown itself to be feisty and irascible – it little needs (or wants) a regulatory leg-up. The VoIP market has shown spunk too. None of Vonage, Primus or BabyTel, VoIP, all players in the Canadian market, has asked the Commission for shelter. Canada’s cable companies are understandably more timid – given their chosen implementation architecture, their bets are perforce far larger. While some might argue the merits in forestalling potential competitive excess by government fiat – we urge the Commission to refrain from sweeping deus ex machina moves seeking to create a market in its planned image – let any umbrella offered be temporary – let the universe unfold, a competitive market is emerging.

Finally, to assist the Commission in its future deliberations on local competition, we recommend that Industry Canada convene, without delay, an expert industry advisory panel that is familiar with the trends in inter-sectoral competition that is taking place. Let such a panel assist the Commission to peer into the future, to see through the mists and envisage the market as it evolves over the next decade before it enacts further course corrections – help it to look forward rather than backward. That way lies better public policy – the current course? There be dragons and fearsome creatures and we will stumble into them – looking backwards.

VoIP Inroads

0%

5%

10%

15%

20%

25%

30%

35%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-

500

1,000

1,500

2,000

2,500

3,000

NAS

share totalNAS

Baseline Assumption

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sREADINGFOR FURTHER READING:

It's Your Call - The Many Flavours of Voice, July 2004.

Beyond Ernestine: The Evolution of Canadian Business Communications; A SeaBoard Discussion Paper in Two Parts – Part One: “Your Call is Important to Us”; New Directions in Corporate Communications, September 2003.

Beyond Ernestine: The Evolution of Canadian Business Communications; A SeaBoard Discussion Paper in Two Parts – Part Two: “The Importance of Being Ernestine”; Empowerment of Small Business The Evolution of Canadian Business Communications, November 2003.

It's Not Your Parent's Phone: A Survey of Changing Patterns in Canadian Consumer Communications, August 2003.

Wireless Wonderland – Portable Numbers as Pistons of Progress, October 2003.

Get Shorty! – Canada’s Wireless Market – Through SeaBoard’s Looking Glass, February 2004.

Communications Pricing for Consumers, May 2003.

Welcome Minister, Bienvenue, July 2004.

CRTC Report on Competitionhttp://www.crtc.gc.ca/ENG/publications/reports/PolicyMonitoring/2004/gic2004.pdf

Industry Canada Telecommunications Reporthttp://strategis.ic.gc.ca/epic/internet/insmt-gst.nsf/en/sf05637e.html

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sSeaBoard Group

SeaBoard is an independent marketing and technology research company with offices in Toronto and Montreal. This white paper was prepared for SeaBoard clients and other interested parties as part of SeaBoard’s continued research on market trends and technologies.

SeaBoard would be pleased to arrange for briefings on any of the subjects covered in this white paper. For further information on briefing sessions, subscription to SeaBoard services, or to obtain additional copies of this or other white papers, please visit the SeaBoard web site at http://www.seaboardgroup.com, or contact us at mailto:[email protected]

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highlights...voice over internet protocol, voip, is another threat to suppliers of traditional local...

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