Posted: 8/2003

SHAPE UP OR SHIP OUT
International Wholesale Voice Faces
Next Wave

By Nicholas Topham

The
last major strategic shift in the wholesale voice market occurred in the
mid-’90s, when the European telcos entered the refile market and brought
fundamental change to the structure of the business. The value of the average
wholesale minute has since declined by some 85 percent even though volume has
more than doubled during that time. However, the prognosis presented in a new
report, "Wholesale Voice: A Strategic Map for Wholesale Carriers,"
published by BroadGroup suggests the market is due for another shift, and
carriers need to radically realign their strategies or face exit.

The report suggests, in the
"scramble" for minutes of international telephony traffic, the process
and systems created for an ITU-regulated environment were slower to evolve than
many of the operators with which the carriers interconnected. Given the
inability of systems and processes to address the market dynamics, coupled with
rapidly declining margins that would not sustain the cost of interconnecting a
host of small operators, carriers have since drastically rationalized the number
of their interconnects and the traffic profile they wish to attract.

Although the outcome of these
changes has brought significant benefit to their businesses including a reduced
the risk of bad debt and reduced costs — predominantly sales, general and
administrative costs — a new market space has been created for aggregators that
operate "owned" infrastructure into the developed world markets with
established interconnects into the access infrastructure.

Aggregators now are taking on the
financial risk of interconnecting with niche retail operators and single-route
operators (SRO) that may be low volume but are implementing effective
operational and management systems and processes to reduce the cost of serving
this market. BroadGroup calculates the aggregator layer has added an average of
30 percent to the cost of termination for the niche retail operators and SROs.

European carriers, for example, are
reaping between 1 percent and 2 percent net margin on increased volumes, and
accounting on a marginal basis that assumes no operating costs for the network
infrastructure used. That is, international wholesale is a "free ride"
on the retail IDD cost base. The aggregators’ margins are not dissimilar, but
include operating costs.

Carriers now confront a new and
unwelcome reality. Given the mix of traffic between liberalized and
non-liberalized markets, in which wholesale value remains, and the
implausibility that wholesale traffic only uses excess capacity upon the retail
IDD infrastructure, the wholesale business in liberalized markets is operated at
a loss and is producing a negative effect on the retail IDD cost base.

Only consolidation in the
liberalized markets can deliver enhanced net margins on a more efficient
operating infrastructure through reduced SG&A and modern systems and
processes that can support the evolving market environment.

A key challenge is to develop a
business model that is inclusive and non-threatening to the interest of the
carriers, and does not undermine value by eroding access to unique destinations.
At the same time they will need to tread a careful path from a regulatory
perspective. However, the birth of a new business model is economically
inevitable, and represents a direct threat to aggregator disintermediation.
Collectively these changes will alter significantly the current wholesale market
structure, and throw into question the viability of SROs and VoIP operators once
consolidation occurs.

The next "spin of the
wheel" will be collaboration, consolidation and differentiated markets to
deliver vast volumes at low margin. A new model resulting from consolidation
will emerge that will feature structural change with many players exiting the
market. The current status quo is not a realistic option, and the critical
importance of defining new wholesale voice strategies becomes more compelling
than ever before.

Nick Topham is managing director
of Telco Resource Ltd., an adviser on "business turnaround,"
acquisitions and market development in the telecom, media and technology sector.
This article is based on his report, "Wholesale Voice: A Strategic Map for
Wholesale Carriers," published by BroadGroup in June.