High-capacity circuit price decline not wholly XO’s fault

As competition in the wholesale industry has ramped up in the past 12 to 18 months, the price of high-capacity circuits has been dropping at an equivalent pace. Many are quick to blame XO Communications, which entered this segment in February promising to beat all competing prices for wavelength services. Research firm TeleGeography Research, however, disagrees, saying that prices of high-capacity circuits actually began falling well before XO announced its best price guarantee.

Rob Schult, research director at TeleGeography said that in the late ‘90s there were so few gigabytes traversing cities that it was extremely expensive to purchase. With the advent of new private cable infrastructures in the early 2000s, including Level 3 Communications, Global Crossing, Flag and others, private systems were built with the sole purpose of adding this global bandwidth capacity. As result, a tremendous amount of fiber became available and underutilized. Although demand took a while to catch up with the supply, this is where the market is currently at today, and this increased demand – more than anything – is what’s to blame for the price drop.

“Since there are more and more applications carrying more and more bandwidth, there are more customers,” Schult said. “I think part of the reason you see a price reduction is because they anticipate a greater volume of sales. Because they introduced this new technology, they feel they can reduce the price to the customer, still make a margin and generate volume. I think that is what is driving it.”

Long-haul routes provide the clearest indicator of wavelength price declines. The median price of a 10 Gb/s wavelength from Chicago to Los Angeles fell 38% in the last year alone, 53% in the past two years.

“I would say that there is a disconnect between the lower capacities and the higher capacities, Schult said. “Some of the lower capacities, like T1s and DS3s, are almost commodities. Those prices have been so low for so long, they’re almost at a floor. But it is the higher capacities that people are starting to demand more of. The new technology introduced into the market is enabling them to be more competitively priced.”

All but one carrier that TeleGeography has studied has significantly lowered its prices over the past two years. The company’s researchers attributed this to the reduced costs due to the deployment of new, lower cost transportation equipment, as well as the experienced industry consolidation and subsequent reduction in recurring operating costs.

As companies battle XO on price, other niche providers look to enter the market with new optical gear and competitive pricing, a position both Schult and Roland Thornton, executive vice president of Wholesale Markets for Qwest, agree won’t get them far in the main stream, global market.

"We have seen some pricing adjustments; it has become very competitive, but only in certain areas,” said Thornton. “Because we have very healthy competition in wholesale and we have very sophisticated customers, they are going to continually try to drive the best price they can. I have heard of smaller players who are offering prices that do not seem realistic or sustainable. They won't be in business very long selling below cost. But I have only heard of this, I haven't seen it."

Schult said that of those niche players that enter the market, those with a smaller network will be better off, but still won’t retain a large chunk of the market. Judy Reed Smith, CEO Atlantic-ACM, which tracks the wholesale market, agreed that these companies wouldn’t have a large affect on market dynamics.

"You can always find small players who are trying to gain share and will drop prices on their piece of the networks," said Smith. "Usually that doesn't affect the overall pricing in the market."

The only caveat, TeleGeography’s Schult said, is that no company is 100% exposed to the effects of a drop in prices of bandwidth anymore. XO, whose press release stating its commitment to beating any price expedited the price drop, would actually be more at risk because they don’t have the business diversity seen in other companies such as Level 3.

TeleGeography said that the steady pace of technological innovation by equipment vendors and operational improvements by carriers would ensure that the cost per bit of transporting data would continue to decline. While it is unlikely that prices will collapse as they did in the first half of the decade, the downward trend will continue.

“Probably 18 months to two years back, they are starting to say, ‘OK, what is the next step; how do we upgrade our equipment; what is the next generation of equipment to implement across networks to achieve this reduced cost per megabyte?’” Schult said. “That is completely the goal. For every network engineer out there, to make the investment, they have to justify that the cost per megabyte is going to drop by however many percent, and they have to say that assuming a price decline, we are going to improve our margins going forward.”