Convergence of Market Forces Is Future of SpotMarket

Posted: 11/1999

Convergence of Market Forces Is Future of Spot
Market

Downward pressure in the spot market on rates is having a decisive impact on the
fundamental structure of the industry. As rates decline, the industry adjusts contract
structures and trading mechanisms on its own in the spot market, while regulators must
account for these rapid changes. These two evolutionary paths eventually will meet to form
the spot market of the future. Below are two examples of this phenomenon, one from the
minutes market, one from the bandwidth market.

Graph: DS-3 Bandwidth RTBX*RPI and RTBX*RFP-360 Indices

In the minutes market, high-volume routes such as Japan and Germany have experienced
tremendous declines over the past year. The usual suspects for this trend can be cited
(liberalization, competition, technology advances and access to capital), and declines in
the top 20 routes average about 50 percent during this period. Now it is clear that this
gray market activity is directly impacting settlement rate reform and some suggest we can
expect major settlement rate adjustments in line with spot-market pricing in major country
routes.

In the bandwidth market, we have witnessed a similar decline in the most competitive
markets. In our Revealed Price Index for U.S. coast-to-coast DS-3 bandwidth, we have seen
a 30 percent decline over the past year. DS-0 channel pricing throughout the United States
commonly has fallen from 5 cents per channel mile to 2.5 cents during the last six months
alone. The Revealed Forward Price Index points indicate that the market could be
stabilizing on these routes.

The impact of this rate movement is a decreased demand for long-term indefeasible
rights of use (IRU) agreements with most demand centered on one-, two- or three-year lease
agreements. In fact, carriers are even demanding shorter-term commitments.

By contrast, international private line (IPL) pricing still has a way to go until this
impact is felt. DS-0 mile pricing for trans-Atlantic and European continental routes has
declined from 45 cents to 20 cents per mile. Clearly, this decline will continue until IPL
agreements are negotiated with similar terms as a U.S. domestic private line.

There is a barrier, however, to the market’s evolution. Without adopting a switch-based
"bandwidth exchange" such as RateXchange, contract lengths cannot grow shorter
because provisioning new agreements takes 60 to 90 days and it incurs high marginal costs
every time a circuit is put up or taken down. As pricing structures shift to accommodate
the market, from cost-plus-required-rate-of-return to demand-based pricing, volatility
will increase. This volatility requires a web-based exchange for flexible term trading and
risk management.