The Internet specialists

Burgeoning ISPs are forging partnerships with data CLECs and RBOCs so they can offer comprehensive services without the headache of building out their own facilities.

During the last two years, many experts have been wondering how most ISPs are going to survive in the early part of the next decade. The typical doom-and-gloom scenario goes something like this: An ISP collecting $20 per month in subscription fees spends about three-fourths of that on its own telecom costs. That doesn't leave much - if any - profit after rent, overhead, marketing and advertising expenses and infrastructure capital costs. The logical conclusion is that economies of scale can be gained only through merging with with another ISP (or two). Through consolidation, a mega ISP can start to provide content and earn advertising revenues.

Enter AT&T (with Tele-Communications Inc. and MediaOne), MCI WorldCom (with UUNet) and the RBOCs, bringing in size, dollars, one-stop shopping and an iron grip on the last mile. It seems that company size matters, and only companies with deep pockets and millions of paying customers can afford the upfront marketing costs and infrastructure development to compete effectively.

Despite these facts, however, the number of ISPs has grown from 4500 two years ago to 6000 today. And evidence points to an even brighter ISP future for the next three to five years. Figure 1 forecasts ISP connection revenues for 2001.

The secret of this success? Instead of simply consolidating, ISPs are building a network of partnerships with competitive local exchange carriers (CLECs), interexchange carriers (IXCs) and IP telephony carriers such as Qwest Communications to provide advanced services. Take DSL, for example. Across the U.S., ISPs are provisioning DSL access with the help of other carriers (Figure 2). CLECs especially have been instrumental in helping ISPs provision DSL.

More than $20 billion already has been spent by CLECs for capital expenditures, with about $13 billion invested directly for building out network infrastruct ure. Furthermore, the RBOCs (including GTE) spent more than $30 billion on capital expenditures last year, and CLECs spent $5.5 billion, or almost 20% of the RBOC's total. The 20 largest publicly traded CLECs have a market capitalization of approximately $33 billion, and together have raised $17 billion since the Telecommunications Act of 1996.

These CLECs need customers, and like the RBOCs, they want to recover their recent multibillion-dollar investments by upgrading or building new infrastructure. Therefore, CLECs and RBOCs are looking to make ISPs into DSL customers and partners. As DSL retailers, ISPs provide value-added services such as hosting; as wholesalers, CLECs or RBOCs provide the facilities. One result is a wholesale pricing model that has emerged for incumbent carriers and CLECs to provide fair, competitive prices for DSL lines. ISPs are able to provision DSL service to their customers at prices ranging from $250 per month to $39 per month (Tables 1 and 2).

E-commerce also is creating an enormous opportunity for ISPs, CLECs and the major incumbent carriers to provide value-added services to the business sector. Providing low-cost DSL at speeds ranging from fractional T-1 rates to 1.5 Mb/s also opens the door to a new level of service enhancements and revenue streams for ISPs. ISPs will be able to provision many new services in addition to hosting Web sites, including Web directory services for intranet and extranet users, unified messaging, Web directory management, multicasting, IP videoconferencing, voice over IP and Web network management.

Certainly, all ISPs won't look alike. The ISPs of the future will be specialist boutiques, serving a particular combination of the application-, geographic- or industry-specific needs of their client customers. And during the next few years, ISPs will provide the major incumbent carriers with much of the grease for the provisioning of new IP services, and some of the glue needed for maintaining customer account control.

The new business model

Re-engineering has been taken to heart by U.S. corporations, and ISPs are no different. ISPs are leveraging IT and taking its rapidly declining cost/performance benefits directly to the masses of small and medium-sized businesses.

For ISPs, the new business model will provide businesses with back-end system requirements, such as database management, Web hosting and Web directory management, programming, network security, network management, Web maintenance, network reliability and fast response times. Surely, small mom-and-pop businesses having trouble getting their LANs up and running will outsource their Internet network management needs to ISPs.

But increasingly, medium-sized businesses - and some larger ones - also are finding that outsourcing to an ISP can provide network reliability, scalability and 24-hour servicing, along with savings on staff, training and equipment. For example, Stargate, an ISP with $6 million in sales last year, provides Internet access service in the Pittsburgh area for USX and handles the computer firewall for another steel company, J&L Specialty Steel.

Furthermore, e-commerce is growing rapidly, which is only going to increase the diversity of specialist ISPs opening their doors to serve customers' unique business applications. Some of the circumstances driving the growing number of ISPs include:

- The trend toward continuous Web site operations. For most businesses, it's less of a headache and less expensive to outsource the management, maintenance and hosting of a Web site.

- The increasing number of businesses that require an online store presence with transaction capabilities for competitive reasons.

- The ease in which non-facilities-based ISPs now can enter the marketplace.

- The entrepreneurial activity surrounding the creation of new Web-based business models.

- The proliferation of virtual private networks (VPNs) for supply chain/extranet partnerships.

- The facilitation of brand development and the trend toward closer customer relationships.

- The rapid deployment of marketing and distribution channel resources on the Internet.

Do-it-yourself Internet

As each industry develops new ways of using the Internet, specialist ISPs will bring their own particular application skills to help those customers use the Internet to enhance their businesses. Some small businesses have modest needs that are easily met, such as setting up an online store and informational Web site. Other companies need ISPs that can meet the geographic and application needs that can arise as they grow their businesses.

For example, KinderView.com provides a Web-based day care monitoring service that allows parents to view their children via the Internet. The company is going nationwide with its monitoring service and has chosen Simple Network Communications because of the ISP's ability to offer service nationwide and provide reliable, secure, continuous video operations by rerouting Internet traffic to another national ISP's network if there are temporary failures.

E-commerce has a way of generating new opportunities for businesses to preserve and expand their customer base. For example, rather than be hosted on an ISP's Web site, some banks and insurance companies are looking into becoming ISPs themselves. In one hypothetical situation, a bank could offer free Internet access with a minimum-balance checking account, saving a customer $20 per month in subscription fees. Similarly, the bank could more powerfully cross-promote other products on its Web site rather than stuffing envelopes with special offers. In short, the goal is to get closer to the customer through customized service enhancements.

ISPs facilitate the creation of new revenue streams that otherwise wouldn't exist. For example, AMFM (formerly Chancellor Media), a corporation that owns and operates 465 radio stations, plans to start transmitting signals over the Internet by the end of the year. AMFM is working to set up ties with specialist ISPs to handle its emerging e-commerce requirements. AMFM wants to position its station Web sites as "highly trafficked Internet destinations" in order to become an "e-commerce streaming radio powerhouse." AMFM plans to use the Internet's interactive capabilities to transform its 66 million listeners into active members of communities and e-commerce buying clubs. In addition to gaining new advertising revenues, AMFM is planning to sell more than music and T-shirts through its Web sites.

In addition to radio, video also is proving that it has a market on the Internet. Millions of viewers visited Broadcast.com's site to see the Victoria's Secret online fashion show, Dennis Miller's HBO Webcast and Real Network's live birth on the Internet.

The problems with streaming video today are dropped packets, which are not retransmitted due to real-time streaming, and congestion, which occurs as more users log on to the same broadcast. In the near future, carriers (including satellite companies) will partner with application-specific ISPs to provide improved video broadcasting services over the Internet. An ISP will be able to use a carrier network to assign priority levels to broadcast traffic for direct transmission to the ISP's local distribution server. In turn, the ISP's servers then could broadcast direct to subscribers locally. If someone in Atlanta wanted to view a live event in San Francisco, a local server would provide broadcast service rather than video streaming across the country.

Outsourcing: always an option

Businesses today focus on their core capabilities and outsource those operations other partners can handle more cost effectively. The new breed of ISPs is no exception. Just as they provide specialized services to their customers, these ISPs outsource many telephony functions themselves. ISPs purchase many back office services, such as operations support system and billing functions, from CLECs and incumbent carriers. This enables ISPs to focus their efforts on marketing their services, conserving capital and launching services more quickly.

In the aforementioned case of a bank becoming an ISP, typically the bank itself doesn't want to become a facilities-based ISP in order to seamlessly and transparently provide Internet access services to its customers. The major carriers and the CLECs can manage the technological advances occurring in networking better. They can make network services and resources - such as modem banks, local points of presence (POPs), extra bandwidth, trouble tracking and network management - available to ISPs. In this way, carriers gain economies of scale inside their networks by servicing large numbers of users without having to become market application specialists for each industry or business. As a result, the carrier's network becomes transparent to the customer requesting services.

America Online, MindSpring and EarthLink already have outsourced their networks. AOL sold its ANS and CompuServe networks to MCI WorldCom, and it is using UUNet, Sprint and GTE Internetworking to provide private label service to their customers.

Other major carriers also are providing these services to ISPs. Another example is AT&T's recently announced Virtual IP and co-location services, which are designed to enable ISPs to launch service more easily. The Virtual IP service provides customer billing, client software, Internet access and private label customer care. It also offers 1300 dial POPs with ISDN and toll-free access. AT&T's co-location service provides routing management, network management, service monitoring and bandwidth on demand. It also includes global peering, managed or self-managed Web servers at AT&T co-location centers and connections to AT&T's IP backbone. This helps ISPs enter the market with less investment in infrastructure and back office functions.

With new product availability and service options changing network economics continuously, the telecom industry is growing at a rapid pace. Because of this growth, ISPs are partnering with CLECs and major incumbent carriers, putting them in a unique position to help many businesses handle their Web networking needs - from Web maintenance to DSL provisioning to VPNs. By working as partners, they further encourage the deployment of Internet access lines and a faster rollout of new services. Even more significantly, these ISP/carrier partnerships will help bring to market new products, new services, new companies, new distribution systems and new ways of conducting business.