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Potentially Huge Profits...
First, and perhaps most importantly, the growth of an interactive communications
network can reach a point of critical mass where, from the consumer’s point
of view, joining it becomes a virtual necessity. During the past fifty years,
social and business communications have become so dependent upon the telephone
that it is very difficult to maintain friendships and conduct business without
one. From the point of view of the network’s owners, critical mass is reached
when the fixed costs of the network’s installation and maintenance are covered
by the existing base of subscribers, and the marginal cost of adding additional
subscribers is less than the revenue derived from them. From this point onwards,
the profits generated by the network accelerate. Indeed, without regulation or
the advent of new technology to sustain competition, the network might naturally
revert to a single owner who can extract monopoly rents from consumers. To be
the owner of a communications network which has reached this point of critical
mass is to own a license to print ever-increasing amounts of money.
... But Huge Profits Will Attract Fierce Competition...
Reality check: few if any ISPs will reach this point. Indeed, many will go
out of business long before they come close to it. In a deregulated environment
in which technology is advancing rapidly, and developers of new technology are
able to procure considerable financial backing, the possibility of mouth-watering
profits will attract considerable competition from both existing telcos and new
entrants into the market.
Compared to their established rivals (many of whom are ex-government telephone
monopolies providing Internet access at least partially via the existing telephone
network), new entrants’ costs are typically lower, their bureaucracy less
stifling and hence their culture much more entrepreneurial. Given their generally-trimmer
overheads, new entrants can undercut their established rivals’ prices, prevent
them from reaching critical mass and thereby constitute a potentially very damaging
threat to them.
In their own efforts to achieve critical mass, new ISPs must either replicate
existing networks with more up-to-date (i.e., fibre-optic) technology, negotiate
access to existing networks or build entirely new networks using very different
(i.e., satellite) technology. Each of these alternatives is risky and requires
billions of dollars of venture capital. Indeed, established telecom companies
providing Internet access services possess a range of potential or actual competitive
advantages over their new counterparts. They typically have large cash flows which
they can use to expand and modernise their network. They also boast considerable
brand recognition and (often) depreciated networks from which to leverage their
Internet, mobile and other activities; usually control the critical final gap
between the network and the user; and, most importantly, they retain a stranglehold
over what is often new ISPs’ biggest cost: the connection to the incumbent’s
national network.
For neither established nor startup ISPs, then, does critical mass come easily
or cheaply. It is quite possible that competitive dynamics will drive prices inexorably
towards costs, making the achievement of network critical mass impossible and
producing ever-thinner margins (combined with constant or growing fixed costs)
as time passes. As has already occurred in the personal computer industry, startup
ISPs have launched price wars with established companies in order to win market
share: indeed, a few have offered “free” Internet access. Competition
among ISPs, then, may turn Internet access and telecommunications more generally
into commodities with low margins. In commodity-based industries, competitors
offer a basically-homogenous product which is distinguished largely in terms of
its price. To survive in such an environment, ISPs will need a very large base
of customers and resultant strong cash flows. Hence their (and telecom companies’)
attempts to diversify into other networks and form joint ventures.
... Necessitating Network Diversification and Joint-Ventures...
Given positive production externalities, it makes sense in the short run for
the owners and operators of interactive communications networks to do whatever
it takes to reach the point of critical mass. ISPs and telecom companies, even
those which occupy very strong competitive positions, thus have an incentive to
expand their operations into cognate fields and make alliances with competitors
and companies in related industries. The purpose of these actions is to attract
sufficient numbers of new subscribers to reach the point of network critical mass.
Owners of one network have skills and assets which can under certain circumstances
be applied profitably to another and perhaps even different networks. Electricity
companies, for example, which possess a network of wires and cables, a large base
of customers and the explicit information and implicit knowledge to make it all
work, can often enter the telecom industry at relatively low cost: telecom wires
and cables can simply be superimposed on the existing network. Similarly, technological
developments are enabling the transmission of digitised data over networks originally
intended to carry voice traffic.
Because deregulation and technological developments have made them possible,
examples of network diversification abound. Japan Telecom, a national long-distance
operator, is owned by three railway companies. In Germany, three regional energy
monopolies are positioning themselves to compete with Deutsche Telekom. The Dutch
electricity company, PneMega, has diversified into water and waste services; and
the former electricity monopolies of the Irish Republic, Italy, Scotland and Spain
have developed substantial telecommunications and Internet businesses. And in
France, Générale des Eaux, the country’s largest water company, is building
a telephone business with SNCF, the state-owned rail company. Their consortium
aspires to become the main rival to France Télécom.Australia’s biggest telecom providers and ISPs, Telstra and Cable &
Wireless Optus, are also the country’s biggest cable TV operators. They
are trying to develop technology which will combine free-to-air television, pay-TV
and access to the Internet. The logic is to move the personal computer and its
Internet connection (which exists in approximately 25% of Australian households)
out of the study into the lounge room, and combine it with the TV (which exists
in virtually all Australian households).
Publishing and Broadcasting Limited (PBL),
owned by Australia’s wealthiest family and already one of the country’s
biggest Internet players, recently partnered News Limited in an alliance with
telecommunications firm One.Tel (which is a mobile phone business and ISP). PBL
also owns half of the ninemsn.com Web portal with Bill Gates’ Microsoft.It is likely that Internet critical mass in Australia will require a much higher
penetration rate than the one which exists at the moment. Internet entrepreneurs
must therefore entice several million additional Australians to go on-line. Through
network diversification and joint ventures they are trying to integrate Internet,
pay-TV and free-to-air TV networks, build bigger audiences on the combined network,
achieve critical mass and thereby increase revenue and profits. Efforts to achieve
critical mass also help to explain why some Internet companies and ISPs are distributing
hardware, software, information and Internet access and e-mail services free of
charge: all of these efforts are, in effect, attempts to achieve network critical
mass.
... And “Bundling” of Services
Another way to build network critical mass is to provide additional uses to
which the network can be put. In Australia, the Packers’ strategy is to
use the Nine Network, datacasting, Internet access and cable-TV to build a mass
TV-Internet audience. To do so is to build a revenue base for a range of interactive
services, such as banking, insurance, financial planning and travel services,
retail transactions, advertising and subscriptions.
Not just network economics and government deregulation, but also technological
developments are encouraging the combination of networks and the bundling of services.
Mobile phone and computer technologies are continuing to converge rapidly, putting
the Internet at mobile users’ fingertips. The objective is to create a hand-sized
and mobile gadget which will allow the user to check e-mail, surf the Web, make
telephone calls and plan one’s schedule. Over the past few years, mobile
phone, computer and Internet companies have collaborated to produce the required
infrastructure, resulting in an orgy of mergers, joint ventures and bundling of
services.
Conclusion
To be the owner of a communications network which has reached the point of
critical mass is to own a license to print ever-increasing amounts of money. As
shown in this report, however, the achievement of critical mass is by no means
a simple matter. Indeed, there are strong grounds to expect that few if any ISPs
will reach this point; that many will go out of business long before they come
close to it; and that governments will regulate the profits of any which do approach
it. Part IV sets out how professional and amateur investors
have responded to these risks and potential rewards.
 
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