Columbia Business School
DÉJÀ-VU By John Kasdan
I was asked by Kurt Ruderman to give the keynote speech at the KMI 2002 Fiberoptic Submarine Systems Symposium. Dr. Ruderman asked me to address the following topic: “Global Crossing, 360 networks and other new companies have failed to meet their revenue targets and are bankrupt. ... Relate what went wrong in telecom to the history of other industries.” This is an expansion of the talk that I gave on that subject. The first thing to realize is that the fate of the telecoms, submarine and land-line, was tied to the incredible economic conditions of the late 1990’s. A speculative bubble, it is now clear, was underway, largely driven by the mantra, “the internet changes everything.” The unexamined belief that internet usage was doubling every few months seemed to imply exponentially increasing revenues, and that, in turn, justified astronomical market valuations for companies that had little, if any, current revenue. Then, as a second stage of the cycle, those market valuations encouraged hordes of doctors and
dentists to seek out start-ups for venture funding, producing yet more inflated IPOs and more telecommunications capacity. It is important to remember just how powerful a bubble can be. At the height of the canonical bubble, Dutch tulips, a single tulip bulb, albeit an especially rare one, sold for the value of one or two Amsterdam canal houses. Yet in the first few months of 1637 the value of the bulbs had dropped by 99%. Such a collapse would have seemed incredible a few years ago, yet since then we have seen statistically similar declines in many telecommunication and telecom equipment stocks. So the first thing to understand is that stock prices and revenue estimates were unreasonable during the 90’s and that we will probably never see anything like a return to those levels. Depressing though it may be to realize that the value of most telecom stocks in the 90’s was irrationally high, that is not the end of the bad news. I want to suggest that telecoms, submarine 8
fiber optic systems included, is a type of industry which has, historically, had severe financial problems. The telecommunications industry is characterized by requiring a complicated and expensive infrastructure. Cables, especially submarine cables, are expensive and even more expensive to deploy. In addition, switches, routers, management and billing systems all are costly. Furthermore, much of this infrastructure represents what economists call sunk costs. Sunk costs are costs of entering a market which cannot be recovered when, and if, the entrant decides to leave. For example, although cable may be reusable, the cost of laying it is not recoverable. Thus, in the economic sense, there are sunk costs in submarine fiber optic systems. Moreover, the marginal cost of the product being sold, the transportation of bits, is usually extremely low; close to zero. In fact that is the case except when there is a capacity shortage. And with the build out of the new communications companies during the 90’s, it would seem that there are not going to be capacity shortages in the near future. That structure, high sunk costs and a product with low marginal cost, has been found in the past in several other industries. In the 19th century railroads had to undertake the building of their lines and the purchase of rolling stock. Although the rolling stock might be recoverable by using it on other routes, the cost of laying tracks was sunk. But once the road was