Academic journal article The McKinsey Quarterly

Builders for a New Age

Academic journal article The McKinsey Quarterly

Builders for a New Age

Article excerpt

A handful of suppliers will battle for the right to transform the world's communications networks

Who will win depends on where "edge" functonality resides - in the core network or on the customer premise

A report on telecom equipment providers.

Incumbent Telephone Companies in developed nations have a problem: their networks are not set up to handle today's boom in digital data. Most existing networks were designed solely to carry the voice traffic that is now a diminishing part of the communications business.

Managing that problem is top of the agenda at many large communications carriers.(*) Most are looking to the telecom- and data-networking equipment industry to deal with the challenge of converging data, voice, and video networks, and to help them make the transition from traditional circuit-switched networks(**) to networks based on Internet technology [ILLUSTRATION FOR EXHIBIT 1 OMITTED].

In response, the $250 billion equipment industry is consolidating as manufacturers jockey for position in the fast-evolving public network. Companies that have long prospered from providing equipment for traditional telecommunications are now scrambling to offer the cutting-edge devices that enable computers to talk to each other. Newcomers, meanwhile, are maneuvering to get their innovations into the public carrier market as quickly as possible. In 1998 alone, Northern Telecom of Canada (Nortel), North America's second-largest equipment provider, snatched up Bay Networks, a leading maker of Internet protocol (IP) equipment, for more than $9 billion in stock; Alcatel Alsthom of France (which, like Nortel, has hitherto sold mostly traditional equipment) bought core network provider DSC Communications; and Tellabs, another traditional equipment supplier, bought Ciena, a maker of leading-edge optical network technology.

With these acquisitions, the future shape of the telecom and data-networking equipment industry is starting to emerge. It is clear that only a handful of equipment makers will have the global reach and technology scale to succeed. Indeed, US observers are already talking of a "big three" in data networking: Lucent, Nortel, and Cisco Systems. To that list can be added European competitors such as Alcatel, Siemens, Ericsson, and Nokia. These titans all of which will have IP-based packet-switching network technology at the heart of their value propositions - will have to fight multiple battles in three distinct network segments. The winners will be those able to build, and persuade users to adopt, a compelling product platform from which they can influence the deployment of functionality, or "intelligence," in the network.

Three key segments and their emerging battles

The long-distance and local telephone companies that provide most of the telecom and data-networking equipment industry's revenue are reacting with increasing urgency to the shifting ratio of voice and data traffic. By most counts, data traffic volume pulled even with voice traffic volume on the public network in early 1997. Many experts believe that if the Internet continues to grow at its present pace, voice traffic will amount to less than 5 percent of the total communications business by 2004.

The shift to data traffic has left local and long-distance telephone companies looking for ways to develop their voice networks so that they can handle a mix of voice and data more effectively. SBC Communications, for instance, has said it will spend $600 million over the next three years to transform its network to IP, while Sprint has already spent $2 billion to retool its network. Carriers also want to develop new business models for the IP-based "killer" applications such as fax- and voice-over-IP, virtual private networks (VPNs), and multimedia conferencing - that will drive much of the communications industry's revenue growth (see the boxed insert, pp. 98-9). To help them do so, and to manage the transition from voice to data more smoothly, equipment makers are broadening their product lines and rapidly developing data-networking solutions. …

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