Posted: 05/1999

Europe: ISRs’ Wonderland
By Robert Rosenberg

Beleaguered on all sides by hungry new carriers, hostile regulators and unsentimental
customers, the former European monopoly service providers–the PTTs–have been affected by
deregulation in unexpected ways. Most have had to slash long distance prices more than
three times the anticipated 15 percent to 20 percent. (Bonn, Germany-based Deutsche
Telekom AG, for example, announced in November that it had cut prices 63 percent.) Some,
such as British Telecommunications plc, London, have lost at least 50 percent of their
international calling share. And now various arbitrage opportunities, including Internet
protocol (IP) telephony, threaten to further erode prices and the incumbents’ dominance.

Graph: International Calling Market Shares of New Entrants 1998-2003

Callback operators and IP telephony providers, who largely are from the United States
(as well as a few from the United Kingdom and a handful of other countries), sell to
customers in other countries through local agents using the public switched telephone
network (PSTN) or the Internet to connect to their hubs. Deregulation has opened the doors
for new operators, who establish facilities in the countries where their customers are.
The first of these to arrive in Europe and other regions in the early stages of
deregulation were resellers, or, following the UK designation of an international simple
resale (ISR) license, simply ISRs.

Whereas callback operators arbitrage the cost of calls in one direction vs. the
opposite direction, ISRs arbitrage the per-minute/per-call cost of leasing international
circuits vs. retail call charges. This activity progressively was deregulated over the
years.

In the late 1950s, the International Telecommunications Union (ITU) conceded that
multinational corporations could lease private circuits for conveying data, then voice,
between company sites, provided that all sites were of companies 51 percent or more owned
by the lessor.

This license was further extended to allow data, then voice, communications between
members of closed-user groups. Closed-user groups only were vaguely defined by the
European Commission, and a challenge in the European Court by London-based Esprit Telecom
Group plc–recently acquired by Global TeleServices Group Inc., McLean, Va.–led to the
court ruling that the widest possible interpretation had to be given to what was a
closed-user group.

The definition was stretched further by Viatel Inc., New York, which successfully
claimed that since it had only 30,000 customers, and there were more than 250 million
telephone customers worldwide, its customers had to be classified as a closed-user group.
There was, of course, no way of controlling who they called, just the insupportable
assumption that they were calling other Viatel customers.

Largely on this tenuous basis ISRs moved from the United States, where the Federal
Communications Commission (FCC) long had permitted unlimited voice resale, to Australia,
Europe, Hong Kong, Japan and New Zealand. Their primary offerings were discounted
international voice calls, at rates 10 percent to 40 percent below the incumbents, which
nevertheless gave them generous margins.

A blurring of boundaries between callback and ISR was seen among some operators.
Viatel, for example, consolidated traffic onto leased circuits through regional hubs as
its traffic volumes grew. By the early 1990s, callback and ISR operators were using
whatever mix of leased and switched facilities gave them the best margins and were, if not
permitted, at least not disallowed.

For most of the 1980s and early 1990s there was a concentration of European ISRs in the
United Kingdom, some with outposts in continental Europe. A smaller number of ISRs
operated from Sweden. As competition among them developed, and margins narrowed,
successful resellers began to target market niches, such as busness segments and
expatriates. They also began to offer national long distance as interconnect prices
allowed them positive operating margins, as well as a means to capture customers and their
more profitable international traffic

Opportunities

Analysis by Insight Research Corp., Parsippany, N.J., suggests that almost 30 percent
of the European market is available to new fixed operators in the period to 2003. It will
be shared by about 200 new operators of all kinds in each major European country (at least
initially–before the inevitable mergers and acquisitions), based on the United Kingdom
having about 200 licensed operators in all sectors.

For resellers and callback operators specializing in the international traffic markets,
at least 35 percent of the market is available. The entire U.K. reseller sector has 3
percent of long distance presently, and 16 percent of international calls by revenue,
rising to 8 percent and 23 percent respectively by 2002.

The major cross-border traffic flows in Europe are between France, Germany, Italy and
the United Kingdom, the largest being from Germany to France at 400 million minutes. The
average retail price of an intra-European call is US35 cents, leaving generous margins for
all types of carriers for the next four to five years.

The main opportunity for switchless resellers is in calling cards to consumers. The
corporate branded calling card also represents a significant market sector for the top
card resellers. The bulk of this European calling card market (98 percent) today is
prepaid telco cards, but this will fall to 76 percent in 2001 as rechargeable remote
memory cards gain popularity.

The most potentially lucrative (but somewhat problematic) area for international
arbitrage has become the transfer of voice over the public Internet using the IP. In an IP
telephony scenario, customers dial into a local access node, where a gateway converts the
voice into packets, and routes the call over the IP network to another gateway at the
destination. Companies have emerged to offer transport, authorization, intelligent
routing, bandwidth exchange and settlement services to service providers and end users.

If IP telephony quality issues can be resolved, and if IP equipment and transport costs
are cheaper than the equivalent ones in the PSTN, then IP telephony will indeed be the
wave of the future.

New-Entrant Marketing Strategies

It still is possible for low-cost resellers and callback operators to enter
international calling markets based solely on price advantage, but even these operators
know that the price/quality trade-off applies. Most choose to sell their services
indirectly through agents positioned in markets they know and understand.

A big part of the answer to being a successful telecom service provider in competitive
markets is to analyze, segment and target the market. Most facilities-based carriers and
resellers have found that the cost of direct marketing to multiple segments is prohibitive
and so directly market only to one or two segments (usually to major corporations and
other carriers), and sell to other segments through networks of agents and switchless
resellers.

Against the powerful entrenched position of the incumbents, new operators would do well
to heed the simple maxim: Price wins customers–quality keeps them.