The Telecoms Future

Francis McInerney, VC and author, describes the future of the wired Internet, a future vastly different than the one most are expecting.

by Alex Goldman ISP-Planet Managing Editor [June 7, 2004]

We heard Francis McInerney, co-author of Futurewealth (see our review of the book here) and venture capitalist with North River Ventures, speak at the Stupidnet conference, where we also picked up a copy of the book. A few months later, having read the book, we called him to see what he might predict for the future of wireline and wireless telecommunications.

In 2000, the book described three alternative futures for the telecoms industry: deleveraging, government intervention, or recession. Describing the recession scenario (which is what happened), the book says:

Information technology drove the 1990s boom. We don't think that consumer Internet connections can grow 30 percent per year or more at current modem speeds. Today's Internet has limited entertainment value. The PC market is also near saturation until faster networks unlock the Internet's entertainment potential: a three hundred dollar PC cannot connect to the network any faster than a thousand dollar PC can. Price cuts alone, therefore, will not reinvigorate the PC market. Consumers are not looking for second-rate PC simulation. They are looking for—and will pay for—first-rate entertainment. They want point-and-click simplicity. Not until real-time, full-motion video and CD-quality music is available will Internet growth return to its torrential pace.

In the boomtime days of late 1999 and 2000, the authors even suggested that some people would disconnect from the Internet (a prediction that came true, much to the surprise of many), claiming, "a recent survey indicated that people are not using their PCs or the Internet. We attribute this to the 'encyclopedia effect,' parents buying computers to facilitate their children's education."

An alternative to the recession
Instead of a recession, McInerney would have preferred deleveraging. We ask him what he means by the word, and how deleveraging differs from structural separation.

"Structural separation is a regulatory thing where either the regulator or the government decides to separate one piece of a network from another. It could separate wireless from wireline, or local from long distance."

His point is that there is usually no economic logic behind structural separation.

"Deleveraging, properly done, is understanding what you need to have, what assets and operations, to serve customers. If Verizon or SBC would do an assessment of how customers experience the network, they would sell off what's outside the customer experience. It's not radical surgery, cutting off your arm because of an infection in your finger."

Unfortunately, Verizon and SBC are not designed the way the Futurewealth authors would recommend. The book argues that an organization must be designed to deliver customer service. "It must be shaped like a soccer ball," says McInerney. So that information enters and is absorbed quickly, like the ball receiving an impact and moving as a result.

The telcos do not move quickly, of course. "The telco is like a lead ball. It cannot deliver customer service."

The telco is structured to survive in the old regulatory niche. "The common carrier has the DNA of a regulated monopoly. It has debt because in the past, the industry had guaranteed rates of return, therefore bankers would tolerate debt. Say the rate of return was 8 percent and the telco could borrow at 6 percent. More debt is better if there's no risk—no risk for the customer, carrier, or bank."

Now, however, the carriers are swamped by debt and are trying to eliminate it with their free cash flow. That won't work, McInerney argues. But deleveraging would work, he says.

"Verizon seemed to think that James Earl Jones on TV was brand. After many years, they've realized that the customer relationship is the brand. Seidenberg's team could go further. It could happen tomorrow (though I've certainly heard nothing to suggest it will). They could sell off large parts of the business—COs, wires, cables, repeaters. Do this, and several things happen. The balance of power in the vendor community changes. Also, people like SBC and Verizon have very strong balance sheets and the incentive to build on their brand."

The vendors are an important part of this equation. "I've argued and our book argued that excess capacity was never the problem; it was untapped demand. People told Nortel not to focus on long distance and optical technology, but on replacing the local loop. They were replacing the heart in a man with no blood. That operation was not going to succeed."

The boom, McInerney notes, suffered from a herd mentality. "People would tell me I could not say that every CEO was making the same mistake, and I said, 'you never heard of 1939?'" In 1939, he says, "every world leader (except maybe Roosvelt) was making the same miscalculation about the same thing at the same time. Going into World War II, you had empires—British, French, Japanese, German, and even Dutch—and that's not what came out."

You will inherit the Internet
He predicts change in the wireline industry, on a scale similar to what happened to the world as a result of World War II, but he does not expect to see consolidation.

"Everyone lines up on a story that's easy to understand, a quick response to an apparent problem." Anyone who expects consolidation is reading the news, but not digging deeper. "A lot of the independent telcos across the U.S. are doing very well. The owners are often the richest people in their communities. If people look at what companies really do, why customers are loyal, and what the costs of switching really are, they would not expect these companies to disappear."

On the other hand, some overrated companies might disappear. "One company I've never understood the model of is AOL. I used them, found I had no idea why, and I dropped that. I use a browser to see what I need to see, have e-mail programs—why would I spend money on AOL? I have no concept of what I'd get. I use a cable modem. I have as much bandwidth as I'll get these days, and I'd like more. If I had 10 Mbps, I'd take TV from websites. But I don't know what cable TV looks like after that."

In the future, McInerney expects the bandwidth to arrive, and change the living room completely. If the cable companies and phone companies are not ready to serve that demand, perhaps some of the other companies he praises in the book, such as SONY, Disney—or even one of the companies he likes the most: Wal-Mart, Dell, or Cisco—will do so.

"People, including children, could have four or five devices each. Who knows what mass storage will bring us. There will be consumable disposables—devices will be part of the consumer budget every year—and when that happens, the network load is simply stupefying."

But Verizon is not ready for this. "They haven't even thought about it."

You need to be able to build, but be profitable quickly. "It's not like the AT&T network, where you need a huge buildout of plant before the customers will come, because that buildout needs huge amounts of debt. In the modern world, people like Wal-Mart are asking how to make a company profitable from unit one. It's based on a model profitable from one store, like scaling a national network from one CO."

"So," we ask, "that means that ISP-Planet's readers will dominate the future?"

"Yes, they will."

— End