Wholesale minutemen

In fledgling, over-hyped markets such as bandwidth trading, the virtue of focusing on the here and now stands out. But it also can have its sacrifices if the market tectonically shifts and the early leader gets left behind. That's the position that Arbinet-thexchange, a Web-based spot market for buyers and sellers of wholesale voice minutes, finds itself in.

While other firms sharpen their focus on trading and transactions, look ahead to a derivatives market and jettison their pooling points businesses, Arbinet moves in the opposite direction. Arbinet focuses on the only market with real liquidity today: the buying and selling of voice minutes for international and domestic long-distance voice and fax calls.

Here's how Arbinet works: Paying members that have their gateways interconnected with Arbinet's New York-based switch anonymously submit bid and buy orders on a Web trading site. Arbinet's transaction engine matches up a “limit order” that details maximum price and minimum quality of service with sell orders. Calls are then dynamically routed through the lowest price path that meets the buyer's quality needs, and Arbinet handles the flow of money between parties (Figure 1).

“It operates like Nasdaq — the transaction happens when the call happens,” says Tony Craig, executive chairman of Arbinet.

Because carriers are looking to capitalize on excess bandwidth and find the cheapest path to terminate calls, Arbinet's business is growing, says J. Curt Hockemeier, president and CEO of Arbinet.

About 138 Tier 1 to Tier 3 and voice-over-IP carriers trade voice minutes on Arbinet's system, including seven of the 10 largest carriers worldwide. Minutes volume is at a run rate of about 3 million per day and 1.2 billion minutes annually, according to Arbinet.

Originally founded in 1993 by Alex Mashinsky, Arbinet evolved through several businesses before homing in on electronic exchange. Even then, it didn't have the business model right at first. That's because its revenues were based on a commission fee from buyers and sellers, and when the price per minute dropped, exchange revenues also fell unless volumes increased rapidly, says Stephen Young, a principal consultant at Ovum (Figure 2).

So Arbinet transitioned to more of an outsourced model that ties together negotiation, delivery, settlement and billing. In a model similar to packaged software, carriers pay an upfront license fee of $10,000 to join the exchange, and the capacity-based pricing model charges $750 per T-1 equivalent. The carrier is charged on lit capacity only.

As the price of wholesale minutes and bandwidth continues to drop, Arbinet sees itself benefiting because it replaces a carrier's fixed costs. “Carriers will continue to outsource switched minutes to avoid capex [capital expenditure] costs,” Craig says. “We cut the cost of getting to the commodity.”

Of course, providing a robust physical delivery medium comes with some “sunk” costs for the exchange. Arbinet spent $30 million on a carrier-grade operations support system. The company's New York switching center interconnects carriers, and Arbinet offers a PSTN+ product that enables carriers local access from any carrier hotel in New York through a FiberNet ring.

Although Arbinet is concentrating on building scale at its New York connection point, it is also doing a “smart build” in London, Hockemeier says. The company is establishing a virtual point of presence and leasing an STM-1 line to facilitate trans-Atlantic trading. Eventually, however, it hopes that members will provide the connectivity themselves. “We don't ever want to be long on bandwidth,” Hockemeier says.

According to Arbinet officials, the company's model presents advantages for carriers looking to end the one-to-one capacity trading processes that take place behind closed doors.

Besides being an alternative sales channel for sellers, Arbinet's exchange mitigates their credit risk. A recent agreement with GE Capital enables Arbinet to take on the financial risk of dealing with anonymous buyers. GE Capital underwrites the large carriers that trade on the exchange, although smaller carriers are required to put up collateral to cover their net position. Sellers also get paid in 15 days rather than the industry average of 66 days, Hockemeier says.

In addition, Arbinet's extensive code database protects buyers and sellers from having traffic moved at the wrong price, Hockemeier says, which is a problem worldwide as phone numbers proliferate. “If the codes don't agree, the traffic doesn't flow,” he says.

Despite its early lead in the market and a sophisticated trading platform, Arbinet does not expect to be cashflow-positive until the end of the year. The company has partly closed a Series E venture round that it expects will take it to that point, Hockemeier says.

According to an S-1 filed in March 2000, and pulled when the market soured, Arbinet posted a net loss of $14.1 million and negative net cash flow of $7.4 million for 1999. At that time, five service providers accounted for 85% of minutes traded through the exchange.

Bigger problems may lie ahead if, as Young predicts, the switched minutes market is overtaken by other forms of bandwidth trading. “The switched minutes market will become insignificant, and increasing liquidity will drive managed transmission to be the most important trading market,” he wrote in a recent report.

Arbinet, however, has not written a business plan to address the managed transmission services market. “It's very popular to want to talk about the new, sexy stuff,” Hockemeier says. Arbinet is more likely to move next into trading of circuits, he said. IP packets trading is another possibility that is further out.

“We have been fanatical about staying at home and knowing the minutes business inside and out,” Hockemeier says.

Arbinet-thexchange

Headquarters: New York, N.Y.

Top officers: Anthony L. Craig, executive chairman; J. Curt Hockemeier, president and CEO; Robert S. Vaters, executive vice president and chief financial officer; Alex Mashinsky, founder and vice chairman

Number of employees: 106

Date founded: 1996

Focus: Minutes exchange providing automated trading, delivery and settlement

Venture funding raised to date: $81 million

Annual revenue: Not disclosed

URL: www.thexchange.com