choicesVol. 10, no. 7, August 2004 ISSN 0711-0677 www.irpp.org

Economic Policy and G

rowth

Yves Rabeau

TheSchumpeterian

Public Policy Implications

WaveTele

in

commu-nications

F ounded in 1972, the Institute for Research onPublic Policy is an independent, national,nonprofit organization.

IRPP seeks to improve public policy in Canada bygenerating research, providing insight and sparkingdebate that will contribute to the public policydecision-making process and strengthen the quality ofthe public policy decisions made by Canadiangovernments, citizens, institutions and organizations.

IRPP's independence is assured by an endowmentfund, to which federal and provincial governmentsand the private sector have contributed.

F ondé en 1972, l’Institut de recherche enpolitiques publiques (IRPP) est un organismecanadien, indépendant et sans but lucratif.

L’IRPP cherche à améliorer les politiques publiquescanadiennes en encourageant la recherche, en mettantde l’avant de nouvelles perspectives et en suscitant desdébats qui contribueront au processus décisionnel enmatière de politiques publiques et qui rehausseront laqualité des décisions que prennent les gouvernements,les citoyens, les institutions et les organismescanadiens.

L’indépendance de l’IRPP est assurée par un fonds dedotation, auquel ont souscrit le gouvernement fédéral,les gouvernements provinciaux et le secteur privé.

Yves Rabeau has a licence in commerce fromthe École des hautes études commerciales deMontréal and a Ph.D. in economics from theMassachusetts Institute of Technology. He is aprofessor of economics and management at theSchool of Management at UQAM. His researchdeals with telecommunications and energy andthe effect of new technology on businessmodels. He is the author of several books, andarticles in both academic journals and popularmagazines. He has acted as economic advisorto the governments of Canada and Quebec andalso to Canadian and foreign organizations andbusinesses.

This publication was produced under thedirection of Daniel Schwanen, Senior Economist,IRPP. The translation was by Michel Forand,copy-editing by Jeremy Leonard, proofreading byTim Niedermann, production by ChantalLétourneau, art direction by Schumacher Designand printing by Impressions Graphiques.

Copyright belongs to IRPP. To order or requestpermission to reprint, contact:

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All Choices and Policy Matters are available fordownload at www.irpp.org

To cite this document:

Rabeau, Yves 2004. “The Schumpeterian Wave inTelecommunications: Public Policy Implications.”Choices 10, no. 7 (August). Montreal: Institutefor Research on Public Policy.

The opinions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IRPP or its Board of Directors.

1

Table of Contents

2 Summary

3 Introduction

5 Schumpeterian Waves: Chaotic Growth inTelecommunications

11 Business Models: The “One-Stop,” or“Convergence,” Approach

15 The Schumpeterian Wave in the CanadianTelecom Sector

16 The Transformation of the TelecommunicationsIndustry

18 Regulatory Policy and the Schumpeterian Wave

22 Some Conclusions

24 Appendix 1The BCE Strategy

25 Notes

Economic Policy andGrowth/Politiques publiques et croissanceéconomiqueProject DirectorDaniel Schwanen

T his series comprises individual Choices and PolicyMatters studies on economic policy issues, includ-ing fiscal policy and factors affecting economic

growth. Topics recently covered include the brain drain,the effects of Canada’s aging population and Canada’sremarkable fiscal turnaround.

C ette série comprend des études Choix et Enjeuxpublics qui portent sur les questions de poli-tique économique, y compris les mesures fis-

cales et les facteurs agissant sur la croissance. L’exodedes cerveaux, les effets du vieillissement de la popula-tion canadienne, et l’amélioration remarquable de lasituation fiscale au Canada figurent parmi les sujetsrécemment traités.

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extravagant optimism of the players but also to poorchoices of business models. The end of the boom in theindustry forced several companies to go bankrupt. Othersstruggled to survive, in particular by selling assets to dis-mantle conglomerates based on the convergence or one-stop approach. The bursting of the bubble resulted in aconsiderable loss of financial wealth, large layoffs andthe abandonment of a number of investment projects.

At the same time, the innovation wave had verypositive effects on the organization of society, theproductivity of businesses and employee compensa-tion as the Internet quickly became a means of com-munications and a locus for trading goods andservices in the economy. Telecom users benefitedfrom substantial reductions in prices and from a pro-liferation of new services.

Could the waste of resources in the telecom indus-try have been prevented? Given network economics, Ibelieve the regulatory agencies, by issuing operatingpermits, could have promoted the principle of net-work capacity sharing — a well-known principle inthat industry — in order to avoid the enormous dupli-cation that took place. Actors in financial marketswould have objected to this type of intervention,arguing that market forces are a preferable mediumfor ensuring resource allocation.

To better prepare for the future, telecommunicationscompanies are refocusing on their traditional missionand are becoming highly efficient carriers in a highlycompetitive market. Others seek to occupy a specializedniche in the business services market. Finally, anotheravenue is that of the broker offering its customers asolutions package in partnership with other firms.

In Canada, greater competition and network eco-nomics did not generate optimal results — that is, a sit-uation where the interests of customers and telcoshareholders converge. It remains to be seen whether arelatively small long-distance market such as Canada’scan sustain several cost-effective competitors over themedium term. In the local market, the introduction ofcompetition proved to be a complicated process anddid not have the anticipated results. In my opinion,true competition in this market will be in the techno-logical realm. Wireless communications and cable dis-tribution can, thanks to new technical advances, trulycompete with the landlines of the exmonopolists.

Finally, by contributing to the demise of the notionof long-distance services, new business models based onIP communications will challenge the exmonopolists aswell as the regulators in their efforts to set rules gov-erning new technological discoveries.

Summary

T he emergence of digital information and theInternet represents a major innovation whichhas revolutionized the telecommunications

industry, as well as business practices and the lives ofcitizens in general. In addition, the introduction ofcompetition into the industry has magnified theimpact of innovations and made the industry morecomplex. A true Schumpeterian wave of innovationhas taken place — a phenomenon that occurs only afew times in a century.

The Internet revolution gave rise to a broad move-ment of unlimited optimism. Financial agents encour-aged unsustainable economic forecasts, thuscontributing to the development of a speculative bubblethat led to overinvestment in the telecom sector, amongother repercussions. These excesses have raised a num-ber of issues. Could this outcome have been avoided, atleast in part, through better management of macroeco-nomic policy? The regulation of the financial sector,corporate governance rules and bankruptcy laws havealso been singled out as possible factors. The debate onthese issues is ongoing. This paper attempts mainly toestablish whether, if telecommunications regulationwere better adapted to the new circumstances of theindustry with regard to both the technology and thecompetitive environment, this could have limited thescope of the excesses that took place.

The period of accelerated expansion of the telecom-munications industry was marked by the entry of newfirms that built transmission networks based onInternet technology. This technological advance, com-bined with the excess capacity that resulted from over-investment, contributed to significant price reductionsin long-distance and Internet services. The period wasalso marked by numerous financial transactions. Theexmonopolists formed alliances in order to better facecompetition, purchase new companies to access thenew technology more quickly and offer their cus-tomers one-stop access to all communications services.New entrants also made acquisitions — of exmonopo-lists, in particular — to increase traffic on their net-works. Some companies adopted the convergencestrategy by trying to combine content, transmissionand online transactions.

These transactions encouraged the companies to gointo debt, but they did not result in the anticipated syn-ergy, while price reductions affected revenues. Thus thedifficulties of the telecom sector are not due solely to the

Introduction

Innovation and speculation

T he past decade has witnessed a major socio-economic phenomenon. The digitalization ofinformation, the bandwidth revolution associated

with the use of fibre optics to transmit that informationand the emergence of the Internet are major innova-tions that have transformed the telecommunicationsindustry as well as business practices and the lives ofcitizens in general. In addition, the introduction ofcompetition in the telecommunications sector inAmerica and Europe has magnified the impact of inno-vations on the industry and made it more complex.1

There has been a true Schumpeterian wave of innova-tions, such as are seen only a few times in a century.

Schumpeter argued that long waves of innovationsboth create and destroy wealth.2 The net long-termimpact is positive because innovation remains thefoundation of broad social changes and of the produc-tivity gains that improve living standards in the eco-nomy. These gains, however, are achieved in theaftermath of major upheavals, both economic andsocial, that can go on for decades. New firms, as wellas already-existing ones, benefit from the wave ofinnovations and adopt the new technologies, while oth-ers disappear because they are unable to adjust to newmarket conditions and become obsolete. Market adjust-ments also contribute to the disappearance of certainoccupations, and some workers may find themselvesunemployed as a result. It may be noted that, followinga major innovation such as the advent of electricity, itoften takes decades for firms to adjust to the opportu-nities offered by the new technology and for citizens,in turn, to benefit from it.

At the same time, according to F. Hayek, the Austrianeconomist and Nobel prize winner, in a period of strongeconomic growth it is difficult for central banks to deter-mine the cost of capital (the “natural” interest rate) thatwill permit an efficient resource allocation in the

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The SchumpeterianWave inTelecommunications:Public PolicyImplications

Yves Rabeau

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Could this outcome have been avoided, at least inpart, though better management of overall macroeco-nomic policy, more stringent regulation of the finan-cial sector and a stricter governance regime forcompanies with shareholders that deal with financialmarkets? Had the regulatory regime governing thetelecom sector been better adapted to the new tech-nological and competitive environment, could it havelimited the scope of these excesses?

In the case of monetary policy, the current debateis centred on whether central banks should takeaccount of changes in the value of assets (such asstock market shares) in their decision-makingprocess. In the United States, the Federal Reserve hasdefended its interest rate policy,5 which had beencriticized on the grounds that stock market specula-tion and the impact of the drastic correction that fol-lowed could have been avoided in part through apre-emptive rise in the cost of capital.6 That issuewas also considered in Canada at a time when stockmarket shares were rising rapidly.7 Hayek’s theorysuggests that overinvestment occurred because thecost of capital was too low. Throughout the expan-sion period, however, productivity gains ensured thatthere was no inflationary push, so that the FederalReserve, in particular, felt it was justified in leavingrates unchanged. The debate in ongoing, and noconsensus has emerged.

Just as important are issues of financial marketregulation and corporate governance. The speculativebubble received some stimulus from the actions offinancial analysts, brokers, bankers and a few corpo-rate executives who played fast and easy with theprinciples of ethics or engaged in outright fraud.Some aspects of these issues will be discussed belowin the context of the telecommunications industry.But there is also a more fundamental debate onwhether the adoption of stricter rules or a more strin-gent enforcement of existing regulations might haveprevented stock market speculation or might at leasthave limited its scope. This is an ongoing issue,8

which has given rise to a reinforcement of the finan-cial market regulatory system. While this paper willnot discuss the question of governance regulationsproperly speaking or of governance itself, it willnonetheless refer to the lack of ethics displayed bysome players in the telecommunications industry andits consequences for the industry.

Bankruptcy laws add another dimension to themanagement of the legal framework within whichcorporations operate. These laws have a significant

economy. If the cost is too low, there is a risk thatinvestment demand will become excessive. Unrealisticexpectations about the future profits associated withthe new technologies generated by the wave of innova-tions can, if they occur when interest rates are too low,and even if there is no inflation, give rise to financialflows that will push stock market values to unsustain-able levels.3 High share values then encourage firms toincrease indebtedness and thus contribute to greaterspeculative activity in financial markets.

To some extent, this is what happened with theadvent of electricity in the 1890s. The companies thatadopted the new technology saw the value of theirshares increase substantially. When it became clearthat profits would only show up over the longer term,there was an abrupt adjustment in the stock market.4

This scenario more or less repeated itself between1995 and 2001 in the telecommunications (“telecom”)industry, despite all the knowledge accumulated inthe past century about the operation of markets, con-trol measures and the regulations aimed at ensuringthe proper functioning of financial markets, anddespite the broad dissemination of information com-pared with the situation a hundred years earlier.Innovation and the ready availability of credit canlead to excesses that are costly for the economy.

Innovation and the impact of competition in thetelecom industryThe bandwidth and Internet revolution gave rise to awave of unbounded optimism encouraged by a vari-ety of gurus, management consultants and financialanalysts. It was believed that demand for bandwidthwould increase almost indefinitely, reflecting newbusiness practices and a rapid transformation of soci-ety. Financial actors encouraged and supported theseunsustainable predictions, thus contributing to aspeculative bubble that resulted in, among otherthings, overinvestment in telecommunications andeventually led to a major crisis in this industry.

Economic policy in the aftermath of thespeculative bubbleThe telecom industry is currently undergoing a painfulprocess of restructuring and consolidation. In theUnited States, no fewer than 50 telecommunicationscompanies (“telcos”) have had to seek protection underbankruptcy law. Corporations formed by merger aredisposing of assets or have already done so. It will besome time before the overcapacity can be absorbed andthe industry can start showing positive results again.

The new models were based on future unlimiteddemand for bandwidth. All of the economic transfor-mations associated with the Internet would generate acontinuously growing demand for the transmission ofinformation on a worldwide scale. Gilder was a notableadvocate of this prediction in a “Newsletter” aimed atcorporate executives and investors, as well as in hisbook Telecosm,11 seen as the bible of the new age ofcommunications. Some believed that this predictionwas already becoming a reality, making it easier tounderstand why the so-called new paradigms were soreadily adopted:● Sales growth, rather than short-term profits, is the

best indicator of a company’s worth; profitabilitywill come later, as a bonus.

● The increased transmission capacity of the telcos,especially of new entrants using state-of-the-arttechnology, is an indicator of future profits andshareholder value.

● Among the financial indicators used to measure cor-porate performance, priority is given to net pre-taxincome, interest on debt and depreciation ratherthan profits.Other management concepts also emerged, including

that of “Internet time.” The use of e-commerce wasexpected to result in a radical and very quick transfor-mation of business practices, enabling companies toachieve in three months what took a year before theybegan using the Internet. According to telecom corporatemanagers, the design of products and their acceptanceby customers would take but a fraction of the time tradi-tionally needed to carry out these marketing activities.

In addition, the dot-coms, with Amazon and Yahoo!at the forefront, were expected to replace the compa-nies of the “old economy,” enabling consumers to maketransactions much more cheaply and quickly, andeventually resulting in faster growth in productivityand living standards. An enormous increase was antici-pated in both business-to-consumer (B2C) andbusiness-to-business (B2B) e-commerce. Consumer sur-vey firms and consultants began to revise their esti-mates of the importance of e-commerce on a monthlybasis, and there were predictions that it would reachtrillions of dollars by 2004.12

To these prophecies must be added the falsification ofdata on Internet traffic and on the financial performanceof some corporations. From November 1993 (when theMosaic browser was launched) until it turned over thenetwork to the private sector in April 1995, the NationalScience Foundation found that instead of doubling everyyear, traffic was doubling every three months. After

impact on the present and future behaviour of thetelecom industry in North America. It will be seenlater on that in an industry where there is significantovercapacity, the use of legal provisions allowing acorporation to restructure and reduce its debt can rep-resent a threat to competitors who honour their com-mitments to their creditors and their shareholders.

Finally, we must also ask whether some regulatoryprovisions applying to the telecom industry mighthave made it possible to reduce the scope of thespeculative bubble. If guidelines had been put intoplace by regulators when telecommunications servic-es were opened to competition and regulatory barri-ers in data transmission industries removed, wouldthis have helped to lessen the chaotic growth of theindustry? In particular, could the sharing of net-works, combined with the preservation of competi-tion in Canada and the United States, have led tobetter resource allocation, as has been suggested pre-viously?9 One may also ask whether the approachadopted by the Canadian Radio-television andTelecommunications Commission (CRTC) in openingthe door to competition helped the Canadian telecomsector to avoid a debacle similar to that observedsouth of the border.

Schumpeterian Waves: ChaoticGrowth in Telecommunications

Background: new paradigms and predictions

W ith the digital revolution and the emer-gence of the Internet, gurus such as G. Gilder, N. Negroponte and, in Canada,

D. Tapscott announced the beginning of the band-width revolution.10 They argued that the electronicexchange of information would transform the lives ofcitizens and how they communicate and deal withcompanies and governments, as well as how goodsand services are traded in the economy. The fewInternet companies that had appeared on the market(the “dot-coms”) would lead the way of the futurewith respect to new ways of doing business. All thecompanies active in the data transmission sector,from equipment suppliers to software and telecomservice providers, now constituted the “new eco-nomy.” Some gurus and financial analysts promotedthe “new management paradigms” of the “new econ-omy,” aimed at guiding the decisions of corporatemanagers and investors in this new environment.

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of its rivals. In the race for incremental innovation,equipment suppliers sold fibres with ever-increasingcapacity. Nortel’s multiplex technology made it pos-sible to transmit several wavelengths in a singlefibre, thus raising network capacity to very high lev-els. Carriers’ capital costs were growing at spectacu-lar rates — 34 percent at annual compound ratesbetween 1996 and 2000 — in several different areas(optical networks, routers, wireless, etc.).16 Capitalspending, another indicator of the investment surge,accounted for 15 percent of US GDP on a trendbasis. In the late 1990s and early 2000s, that sharegrew to 33 percent, clear evidence of aSchumpeterian wave of innovation.17

Toward the end of the innovation period (around1999), however, the telcos began to express concernsabout bottlenecks and equipment shortages, despite allthe networks that had been put into place. This wastruly the peak of the speculative bubble. Major equip-ment suppliers such as Nortel and Cisco had difficultymeeting the demand and were forced to adopt a formof rationing toward their customers, who then startedoverstating their equipment requirements in order toensure they could obtain the products they believedthey needed to meet their own market demand.

At the same time, the new entrants, who hadpoured into their own networks the funds they hadsecured in financial markets and who had low rev-enues, began to experience cash-flow difficulties.Suppliers such as Nortel aggressively financed thesecustomers’ equipment purchases. In the race to inno-vate, companies like Nortel and Cisco, which were atthe core of the Internet revolution, also acquired sev-eral high-tech firms which in their view offeredpromising products in this area. These acquisitionswere made at a time when all the dot-coms were sub-stantially overvalued.

Growth strategiesThe incumbent telcos, many of which had formerlybeen in a monopoly position, were now facing a com-plex environment. First, the introduction of competi-tion into the long-distance market forced them to dealnot only with resellers but also with newcomers whoinvested in equipment. In the United States, for exam-ple, AT&T faced competitors such as MCI, Sprint andWorldCom; in Canada, Bell and Telus had to contendwith Call-Net and Unitel (acquired by AT&T Canada),as well as a large number of resellers. Second, thanksto runaway financial markets, a new breed of actorappeared, the “bandwidth barons” — firms such as

management of the Internet was transferred to the pri-vate sector, some analysts extrapolated forecasts fromthose findings, even though it was clear that this rateof increase could not be sustained. Whereas the indus-try had assumed that Internet traffic would continue todouble every three months, in fact it has doubled everyyear since 1997. That mythical rate of growth never-theless served as the basis for predictions regarding alltypes of telecommunications traffic.13

The exaggerated figures on Internet traffic con-tributed to maintaining the speculative bubble in thetelecom industry. In addition, a few financial analystsembellished the performance figures of some corpora-tions in order to stimulate stock market transactions,while others recommended buying shares of compa-nies they knew were facing financial difficulties.14

Eventually, WorldCom-MCI, which owned UUNet,America’s largest service provider, acknowledged thatit had falsified its data on Internet traffic growth inorder to maintain the value of its shares on the stockmarket.15 Several brokerages agreed to pay substantialfines in order to reach out-of-court settlements inproceedings that had been filed against them by theUS government. All of these developments reflectedthe environment in which the telcos operated duringthe Internet boom.

Finally, an innovation wave — especially if it isencouraged by financial markets — is often accompa-nied by an entrepreneurial wave. The creation of newInternet companies, the entry of new players intotelecommunications and the development of manynew services was all evidence of the entrepreneurialvitality generated by the wave of innovations.Managers of traditional telephone companies weresetting up new telecommunications firms. Engineersand computer experts were leaving well-establishedemployers to start their own businesses. The appeal ofstock options at a time when markets were reachingrecord levels also contributed to the entrepreneurialwave. Venture-capital firms supported the creation ofhigh-tech companies by providing expert know-howand fresh capital.

The expansion of telecommunicationsInvestmentAs part of these developments, fibre optic networkswere built by new entrants into the industry — and,in their determination to compete, by the exmonopo-lists as well — each firm trying, from one year to thenext, to make its network more innovative, to extendit further and to give it greater capacity than those

In addition to making acquisitions, telcos alsoformed alliances with others, especially abroad: AT&Tpartnered with British Telecom; Sprint was part ofGlobal One, a vast partnership that included FranceTelecom and Deutsche Telekom and whose goal was tooffer a full range of end-to-end telecommunicationsservices to large multinationals.

New entrants associated with the “bandwidth barons”relied primarily on the deployment of large-scale fibreoptics systems to obtain funds in financial markets, butthey also strove to develop a client base and attracttraffic to their networks. For a few years, Qwest was amodel in that regard, as well as a beacon for investors.The company negotiated partnership agreements withseveral other firms and made a few strategic acquisi-tions in the United States and elsewhere, particularly inEurope. With the intensifying activity in mergers andacquisitions that took place in the late 1990s, Qwest wasable to acquire USWest, a local exchange telco, in com-petition with Global Crossing.

The merger was based on a promising businessmodel that combined new technologies with traditionalnetworks and entrepreneurial culture with monopolyculture — a model which, by being anchored in cus-tomer services, was to provide a stable revenue source.Due to the overvaluation of its capitalization caused byspeculation in the market, however, Qwest had to bor-row to complete these acquisitions and as a conse-quence faced significant debt-service costs later on.

A similar approach was followed by Global Crossingwhen it bought Frontier, a small local service telco.Global Crossing was seen by Gilder as the model of thefuture for telecommunications firms, along with aCanadian counterpart, 360Network.

The large European national monopolies and Japan’sNTT tried to transform themselves into global playersoffering their customers one-stop shopping by makingacquisitions, building new networks and taking part inthe activities of foreign operators.20 In addition, theEuropean companies assumed that the growing demandin telecommunications would spur a comparableincrease in mobile communications. Thus more than 100billion euros (the equivalent of Ireland’s annual GDP)was spent in acquiring licences for 3G mobile networks.

The bubble burstsThe warning signsThe first signs that the speculative bubble was about toburst appeared in 2000 with the collapse of a numberof Internet companies. These firms had been expectedto overtake the companies that were typical of the “old

Qwest, Global Crossing, Level 3 and GTS in the UnitedStates and 360Network in Canada. Unburdened by thepast, these newcomers immediately adopted the newtechnologies to build their networks. At the sametime, the exmonopolists had to open up their net-works to Internet service providers. The incumbentshad to offer local Internet service — an obligation thenew entrants were not subject to — and also had toopen up that part of their network to potential rivalsonce competition was allowed in local markets.

In the face of these developments in innovationand in the competitive environment, the traditionalcompanies used a variety of strategies. In addition toinvesting in their own networks to upgrade them andincrease their capacity, they also adopted a piggybackstrategy by buying out service providers. As well,firms such as Bell in Canada and AT&T in the UnitedStates adopted a one-stop service strategy (see below).The companies acquired new assets in order to com-pete in several markets at once. WorldCom, born ofthe merger of various telcos, also adopted the one-stop approach by integrating both vertically and hori-zontally. When it acquired UUnet and MCI, WorldCombecame the largest ISP in North America and a majorplayer in the long-distance market. However, a moveto buy Sprint in order to establish a presence in thewireless market was rejected by US competitionauthorities. These growth strategies based on acquisi-tions are discussed in greater detail below.

The wave of transformations was accompanied byanother major development in the telecom market.The exmonopolists, who until then had been veryactive in research and development — often throughsubsidiaries (as in the case of Nortel in relation toBell) or laboratories (as in the case of Bell Labs inrelation to AT&T) — virtually left the field of R&D,while equipment suppliers like Nortel, Lucent andCisco experienced vertiginous growth thanks to tech-nological advances and the support of financial insti-tutions.18 In Canada, getting rid of Nortel was astrategy that gave Bell an opportunity to improve itscash-flow position while creating value for sharehold-ers. Having become network operators and serviceproviders, the exmonopolists no longer had muchcontrol over the pace of innovation. It should bepointed out that by abandoning their foothold inR&D, the telcos helped to lower obstacles to entry intothe industry, since all new entrants now had access tothe most up-to-date technology offered by equipmentsuppliers.19 Thus the telcos can be said to have con-tributed to greater competition in the industry.

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time. In the United States, more than a dozennationwide backend networks were built; a similarscenario developed in western Europe.23 The down-side of Schumpeter-style innovation waves isdescribed in chart 1, which summarizes the real-lifeand financial dynamics of the firestorm thatengulfed the telecom industry.

The impact of overinvestment intelecommunicationsChart 1 shows that high levels of bandwidth overca-pacity led to a number of consequences for the tele-com industry and for financial markets.

● Dissipation of financial wealth: The losses experi-enced by North American investors following thecollapse of telco stock values has been estimatedat between US$2 trillion24 and US$2.5 trillion,25

with bank involvement in the sector estimated atUS$1 trillion.26 Several banks had to set aside highprovisions for bad debt in order to cope with thefinancial collapse of the industry. This huge finan-cial impact directly or indirectly affected all eco-nomic agents. In addition to the macroeconomicimpact of a decline in wealth on demand and sav-ings, one must also take into account longer-termrepercussions in terms of the losses experienced by

economy,” but they now faced a cash-flow crisis andseveral of them went bankrupt. Unrealistic predic-tions about e-commerce, exaggerated claims aboutadvertising revenues and Web site “hits,” a poorchoice of business models and a severe underestima-tion of real-life problems, such as the supply anddelivery of goods to customers, were the main factorsthat led to the spectacular failure of many dot-coms.21

This turning point was the first clear indication thatthere was no common ground between growth pre-dictions and the reality of e-commerce.

Warnings issued by Nortel in the fall of 2000 aboutits sales and profits signalled the beginning of a rapid

drop in the value of its shares. This was followed by thecollapse of financial markets (debt and equity) in 2001,which had a severe impact on the telecom industry.

A return to realityAll the players in the telecommunications industryand the financial sector soon realized that a widegap had developed between the supply and demandof bandwidth, on the one hand, and the servicesassociated with it, on the other.22 The problem wasnot that individual companies were installing toomuch fibre, but that too many companies were try-ing to build nearly identical networks at the same

Industry: Telecom

● Several newentrants

● Overinvestment● Mergers and

acquisitions

Industry:Equipment

● Excessive financingof sales

● Excess demand● Excessive innovation

Industry: Finance

● Low-cost capital● Excess supply of funds● Irrational forecasts

Dynamics

● Excess capacity● Drop in prices● Shortfall in sales● Bad business models

Results

● Collapse of share values

● Bankruptcies● Divestitures

Chart 1Schumpeterian Innovation Wave and Market Exuberance

sharply. Recession in the United States and economicslowdown in other industrialized countries also con-tributed to the decline in revenues.

● Financial pressures, adjustment and bankruptcies:Some of the companies that had acquired newassets at prices swollen by speculation ended upwith huge debts: it has been estimated that the tel-cos accumulated debts of US$1 trillion in Americaand Europe.29 With revenues remaining well belowforecasts, several companies found it very difficultto cope with debt-servicing costs, and this cash-flow crisis led a number of them to declare bank-ruptcy. Global Crossing and 360Networks areamong the new entrants that were forced to seekbankruptcy protection against their creditors.Others, such as AT&T, avoided that fate by aban-doning the one-stop model and selling variousassets in a painful process of restructuring. In addi-tion, because of a substantial decline in nominalvalues, several firms had to write off importantassets acquired during the technological boom. Thisresulted in substantial losses without a corre-sponding drop in the value of accumulated debt.Finally, the example of WorldCom illustrates the

pension funds and by households who self-manage their retirement savings. This is oneexample of the wealth-destroying consequences ofspeculative bubbles that accompany broad,Schumpeter-style innovation waves.

● Prices and revenues: With greater competition andconsiderable excess capacity on the one hand, andthe lower costs of data transmission brought aboutby IP technology, on the other, the laws of networkeconomics led companies to launch a price war (seechart 2). A market where monopolists could imposehigh prices and arbitrage was non-existent and wastransformed into a highly competitive marketplace.With prices falling at a quickening pace in the late1990s,27 bandwidth became the equivalent of a rawmaterial traded in the futures market.28 In the con-text of the price war, companies sought to increasetheir market share and to attract greater traffic onunderutilized networks; the net effect of this strate-gy was to reduce their revenues from services suchas long-distance. The traffic continued to increase(Internet traffic, for example, doubled each year),but the telcos learned that traffic expansion is notsynonymous with revenue growth when prices fall

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Chart 2Transformation of the Bandwidth Market

Bandwidth market (supply)

None Aggregate Arbitrage Financial products

Activities

High

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and cost

Multilateralmonopoly

Competition

Open competition

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The users of telecom services benefited from sever-al new services and from a significant decrease inbandwidth prices. For example, while Internet accesswas seen as a high-value-added product in the mid-1990s, under the impact of competition and the diffu-sion of Internet technology it quickly became alow-cost service within easy reach of households andbusinesses. An Internet subscriber can communicatewith someone located in any region of the worldwithout having to pay long-distance charges. Andwhereas the creation of a Web site was formerly seenas the preserve of large corporations, it is availabletoday to small businesses and individuals.

One of the major repercussions of the Internet rev-olution has been the transformation of business mod-els throughout the economy. Electronic datatransmission among companies through private net-works had already been a reality for some time andhad begun to have an impact on the business modelsof large multinational corporations.32 The dot-comshelped to spread awareness of e-commerce amongvarious economic agents. New companies createdprofitable business models from scratch based onelectronic data transmission.

The example of the computer manufacturer Dellremains the classic reference in this regard. The com-

perverse effects of speculation based on unrealis-tic data and forecasts. Faced with the expectationsof financial markets, with revenue growth that fellshort of their own predictions and with high debtcosts associated with the purchase of new assets,managers resorted to fraudulent practices in anattempt to avoid bankruptcy. This only served tomake bankruptcy even more spectacular and moredevastating for shareholders.

● Equipment suppliers: Faced with huge overcapacity,the telcos drastically reduced their capital expendi-tures. Equipment suppliers were confronted with asudden drop in business as a result. They had towrite off substantial inventory losses and experi-enced a significant decline in new orders becausemany of their customers found themselves in finan-cial difficulty or had gone bankrupt. They also soldor wrote off a number of assets acquired during thespeculative bubble, including several high-techfirms. Companies like Nortel, which had financedthe purchases of now-insolvent customers, facedadditional losses as a result. In just a few months,Nortel lost 98 percent of its capitalization, pullingin its wake several high-tech subcontractors.Today, carriers operate in a new environment

which requires them to delay the deployment of new-generation technologies, to lower their costs and todraw greater value from their existing networks.Equipment suppliers have been forced to revise theirproduct design and marketing strategies. For exam-ple, they must now offer equipment that bridges thegap between carriers’ traditional networks and thenew technologies.

Positive aspects of the innovation waveThe shareholders and creditors of telcos have sufferedthe consequences of the debacle that hit the industry.The inefficient resource allocation that characterizedthe Internet boom caused significant losses in theeconomy, since the money invested could have beenused to more profitable ends. At the same time, how-ever, the innovation wave had positive effects forthose who sought the new services offered on themarket. It also helped to increase productivity gainsin the economy30 and to lower the costs of productsand services sold in the marketplace. Consumersbenefited from lower prices, and workers who wereable to obtain wage increases without creating infla-tionary pressures were the winners of the technologi-cal boom.31 Chart 3 shows the positive effects of aSchumpeterian innovation wave.

Accelerated● Equipment suppliers:

investment in innovationand product development

● New services and applications

● Price reductions due tocompetition

● Cost reductions due to new technologies

Service and price performance

● More subscribers spendingmore time online and usingmore bandwidth

● More business applicationsfollowing major changes inbusiness models, requiringmore bandwidth

Improved

Increased

Innovation

Investment supply

Bandwidthdemand

● Increasedinvestment byincumbents

● Investment bynew entrants inIP technologies

Increased

Traditionalfirms

Internet firms

Chart 3The Schumpeterian Wave: The Impact of Innovationand of Broadband Networks

Business Models: the “One-Stop,”or “Convergence,” Approach

I n addition to overinvestment in carrier capacity,the choice of business models also contributed tothe transformation and difficulties of the

telecommunications sector. Many of the numerousmergers that took place in the industry did not gener-ate the expected results. Today, companies must dis-mantle conglomerates that were built up during theInternet boom because their strategies relied on busi-ness models based on vertical and horizontal integra-tion and because a good number of these modelseventually failed.

The choice of business modelIn a competitive regime, the one-stop strategy is aimedat enabling the company to establish a major presenceor even a dominant position in the market. This strate-gy is inspired both by the monopolistic culture of tradi-tional telcos, which are used to offering all services onthe market, and by the bundling of services as a mar-keting strategy designed to maximize the number ofsubscribers to an information distribution network. Asthe exmonopolists still had an important client base,substantial financial resources and a large asset portfo-lio, they saw in this approach an ideal strategy to meetthe growing competition.

In contrast with this approach, which is based on thefirm owning all the assets that delineate its field of opera-tion, is the broker, or syndication, approach. This strategyconsists in offering customers a full range of serviceswhile not owning any infrastructure — or owning onlysome key assets, such as a telecommunications network —and using the services of several suppliers who own othertelecom assets. A broker must have in-depth knowledge oftelecommunications in order to meet the needs of cus-tomers adequately and to be able to manage an entirenetwork of service providers. In the context of the frag-mentation and specialization of the computer market, thatis the model that IBM adopted recently when it created itsGlobal Services consulting service, in which specialistsdetermine the best solutions for customers, includingproducts from suppliers other than IBM. The companydoes not have to be a leader in all market niches butinstead focuses on its vast knowledge of computer tech-nology. IBM is now listening to its customers in a marketwhere it has lost the near-monopoly it once held.

In the past, traditional telephone companies wereused to operating in a world where they controlled the

pany deals with its worldwide clientele from its Website and forwards electronic orders to its network ofsubcontractors for the parts needed to meet cus-tomers’ needs. The product is delivered to the cus-tomer and much of the after-sale service is providedfrom the company’s Web site. In addition, Dell col-lects various types of information on its customers inorder to become familiar with their needs and todesign future products based on those needs. Thismodel enables the company to achieve a high level ofproductivity, to minimize transaction costs and thecost of interacting with other suppliers along thevalue chain and to provide personalized services toits customers.

In varying degrees and in different ways, tradi-tional firms of all sizes have adopted this businessmodel, made accessible by Internet technology andits public network. This has been reflected in, amongother things, lower prices for a variety of goods andservices, faster marketing of new, more efficientproducts and an improved relationship between cus-tomers and sellers. These are important gains for alleconomic agents.

Indeed, this transformation of the economy is farfrom over. Thanks to competition and to the growingavailability of Internet technology, in particular wire-less services, the digital revolution that is takingplace through telecom networks will, in the mediumterm, continue to change the way business is done,including in the public sector (and including, eventu-ally, the health and education sectors) and will thusbe a source of improvements in living standards.Major innovations evolve in ways that are difficult topredict and are spread over several decades beforetheir full impact is felt. A major mistake made by theanalysts of the digital revolution was to believe thatways of doing things in the economy and in societyin general would change quickly and uninterruptedly.

Last, the so-called new management paradigmshave disappeared from financial analyses and therehas been a return to traditional profitability bench-marks used to assess investment performance. Thedistinction between “old” and “new” economy, whichled to errors in forecasts, in investment decisions andin the choice of business models,33 has practicallyvanished from the vocabulary of analysts.

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merged entity. When corporate managers’ predictionsregarding the new company’s performance fail tomaterialize, the value of its shares begins to decline.The cost reduction measures taken by management toremedy the situation tend to hinder the new firm andto prevent its growth. The problems created by merg-ing different corporate cultures tend to complicatethe situation even further, eventually leading to thedisposal of assets and, at the very least, a partial dis-mantling of the conglomerate. As a consequence,shareholders are often the victims of unrealizedpromises made at the time of the acquisition.

Integration or syndication: the BCE exampleOverview: The BCE strategy was patterned after mod-els based both on the ownership of data transmissionassets by the provider of one-stop services and on the“convergence” among transmission capacity, elec-tronic data processing and content. Appendix 1 sum-marizes the main elements of this strategy, whichincluded the creation of new subsidiaries, the acquisi-tion of companies and the formation of partnerships.

“Connectivity, commerce and content” were thecatchwords used to describe the strategy behind theconglomerate built by BCE’s management. Thestrategy relied on the synergies among the differentassets making up the conglomerate, with the latter’sprofitability expected to exceed the combined profitsof its components. For example, through Bell

infrastructure supporting the services they offered.34

When the market is undergoing an expansion incapacity and in the supply of services, this strategyrequires the acquisition of numerous assets. AT&Tand WorldCom in the United States, and BCE inCanada, adopted this strategy. For newcomers, anacquisition strategy was seen as a means of quicklyestablishing a client base so as to increase the use ofthe networks they were putting into place. This wasthe direction chosen by Qwest and AOL.

Integration strategyThe so-called convergence approach is nothing morethan the traditional vertical-integration strategy.35 Atthe end of expansion periods, when companies havesubstantial liquidity, one often sees a significant pushto acquire assets aimed at creating vertical or hori-zontal integration. And yet, vertical integration as abusiness strategy has not had much success in thepast.36 A recent worldwide survey by McKinsey hasshown that over the period 1990-97, few mergersrealized the goals they were meant to achieve.37 Theresults indicate that only 12 percent of merged firmssucceeded in improving their bottom line. Mergers inhigh-tech industries have fared no better.

One of the factors behind these findings is the factthat the success of a merger is not determined bycosts or hypothetical economies of scale, scope ornetwork but rather by the growth in revenues of the

Chart 4BCE’s Convergence Strategy

Vertical integration/convergence

InfomediationHorizontal portal/SMEs

FacilitiesConnectivity

InternetHosting

Browsing

ContentHouseholds/SMEs

Synergies

Synergies

Value added

Creation ofvalue

Partners/acquisitions/

alliances

Banks, credit cards,suppliers

Bell/Nexxia/Sympatico-Lycos

● Transactions: fullleverage effect

● Leverage due to networkcommodities

● Interaction with customers● Externalities

● Scope● Leverage due to brand

name● Aggregator● Advertising

high

low

Acquisitions:The Globe and Mail, CTV, TQS, etc.

more advertisers. The better known the portal and thegreater its ability to capture Internet traffic, the more itwould attract customers by reducing transaction andsearch costs and the more it would tend to become amajor player in the market. This is a network effect sim-ilar to that used for Windows by Microsoft, a companythat succeeded in dominating the market. This is alsowhat was meant by the “leverage effect of a brand,” asexemplified by Bell, in this case. This concept was at thecore of the convergence strategy.

The content attraction effect was not as powerful ashad been anticipated, however, and the infomediationfunction became fragmented on the web; e-commercesuccess was achieved instead by specialized sites suchas eBay and Amazon. While it is still possible for ageneral infomediation function to develop on the Web,it will take several generations of Net users before itcan become profitable.

BCE found itself with assets that did not generate thevalue that had been anticipated when they were acquired.That is why the new management recently decided to sellthose assets. The costs associated with the transactionsand with the losses on the value of the assets could havebeen avoided, at least in part, if the company had adopt-ed the syndication strategy illustrated in chart 5.

The syndication strategy does not rely on buyingcontent assets, but rather on forming alliances or part-nerships with various content providers without invest-ing in the partner firms, except possibly in a few firmswhose products are deemed essential to the success ofthe strategy. Before any agreements are signed, potentialsuppliers can be made to compete so as to generate thebest quality/price ratios. The company can thus secure abroad range of content geared to the anticipated needsof its clientele. There is always the possibility of addingnew suppliers or terminating some agreements whenmarket needs change. The leading partner must be ableto monitor market changes efficiently, as well as tonegotiate with several suppliers and manage severalagreements simultaneously. The complexity of theseactivities imposes costs that must be assumed, but thesyndication strategy is far more flexible and less bindingfinancially than the vertical-integration approach.39

It is a strategy that is well known in the informationsector. An information transmission company — anewspaper, for example — must seek that informationfrom many sources. It may own some suppliers who aredeemed essential, but in general it will tend instead toconclude agreements with several subcontractors.Among Internet companies, the online brokerE*TRADE, for example, has adopted the syndication

Actimedia’s Sympatico portal, BCE hoped to convincecustomers to subscribe to The Globe and Mail and towatch various programs on the CTV network. Withthe conglomerate, Bell was to become a “pivotal”presence in the communications market.

The outcome of the BCE strategy is in accordwith the findings of the McKinsey study on mergersreferred to earlier. The synergies achieved betweenthe components of the conglomerate were not up toexpectations. As was the case generally in theindustry, the portal’s pulling power and the resultsof cross-marketing efforts focused on productsoffered on the Internet were less than anticipated. Inaddition, the costly purchase of Teleglobe was anill-advised acquisition. Investors were harshly criti-cal of BCE’s strategy.

Convergence — acquisition or syndication: The BCEexample serves to illustrate the convergence strategyin chart 4, which describes the situation of communi-cations companies that have adopted the so-calledtransmission and content convergence strategy.

The object of convergence strategy is to enable afirm selling communications services to climb thevalue-added ladder in order to achieve a higher returnon assets. In this model, the combination of connec-tivity and content is aimed at attracting an ever-growing number of customers and persuading them tomake multiple e-transactions. The company thusbecomes a sort of cyber-broker able to offer a broadselection of goods and services needed by customers.38

In chart 4, the lower part of the triangle illustratesBCE’s position before its major acquisitions. The com-pany owned a network (which, among other things,was equipped with Nexxia, a high-speed data trans-mission facility) and offered Internet services to busi-nesses and households through Sympatico-Lycos. Thecompany wanted to offer higher-value-added prod-ucts because competition had resulted in Internetaccess and other products (such as search engines andcontent hosting) becoming low-profitability services.That is why BCE adopted a strategy aimed at pushingit toward the top of the triangle, where higher-value-added activities are found. They included infomedia-tion activities that were designed to enable BCE, alongwith its partners (such as banks, for financial services,as well as various suppliers of goods and services), tobecome a super-broker offering its customers a broadrange of transactions. To achieve this goal, it was nec-essary to offer content that would attract more cus-tomers willing to pay to access that content. Thislarger customer base was also expected to attract

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that is not unexpected in mergers, even the perceptionof which can sometimes have a substantial impact. Thetensions between the two originating organizationsalso contributed to the failure of the transaction.41 InQuebec, the purchase of Vidéotron by Quebecor was aform of reverse integration, in which the contentprovider acquired the carrier. Quebecor and the Caissede dépôt et placement might well have been able tolargely avoid writing off assets if they had given prior-ity to the value of Quebecor’s content by simply nego-tiating its presence on several portals. There was nosignificant need from a content perspective forQuebecor to own transmission infrastructures in orderto achieve that goal, although there may have beenother reasons to do so.

ConclusionsIn addition to the excessive growth in transmissioncapacity encouraged by the bandwidth “prophets,”poor business model choices intensified the collapse ofthe telecommunications industry. As many other cor-porate managers did in past economic booms whenfinancial markets were very favourable, industry lead-

approach by using the services of several providers offinancial data and analysis. eBay, a profitableInternet company, uses the services of severalupstream access providers as well as those of severaldownstream companies responsible for delivering andinsuring the goods traded on its Web site and foroffering secure payment facilities and debt-collectionservices when required. eBay recently acquiredPayPal, a company it deemed essential to the conductof its business. In other areas, it operates throughagreements with several subcontractors and partners.Had BCE followed a similar strategy, it would proba-bly have better protected shareholder value.40 BCE’sdifficulties stem, not only from excess capacity in theindustry and from the drop in the price of servicessuch as long distance, but also from its choice ofgrowth strategy.

This analysis also applies to AOL/Time Warner andVivendi, which were the main proponents of the con-vergence strategy. In AOL’s case, not only did thehoped-for synergies not materialize, but there was alsoa problem stemming from the well-documented con-flict between different corporate cultures — a problem

Chart 5Convergence through Syndication

Syndication model

InfomediationTransactions

Portal consolidation

Portal

Internet commodities

ConnectivityHosting

Browsing

Syndication model

● Dominant leverage of the portal

● Content aggregation

● Alliances, partnerships,acquisitions

● Scope management

● Bell/Nexxia/Sympatico/Lycos

● Diversity of contents

● Supplier-intensive model Financialservices

Entertainment &leisure

Information

AT&T in the United States in 1984. Had Canada fol-lowed the example of its southern neighbour, Bell’slocal service would have become separate from itslong-distance service. Instead, the exmonopolists wereable to keep the part of their operations that wasrelated to local call, and thus maintained their controlover the last kilometre that the signal had to cross inorder to reach customers. Greater competition firstoccurred in long-distance services, and the membersof Stentor, an organization comprising all telcos thatoccupied a monopoly position, had to open their net-works to new entrants into the market. The elimina-tion of regulatory barriers between telephone servicesand cable distribution (the result of the CRTC’s land-mark decision 94-19) then opened the door to compe-tition between these two sectors of informationtransmission. Today, cable companies offer Internetaccess and data transmission services and can providetelephone services, and telephone companies are ableto offer broadcasting services.

The introduction of a competitive regime into themarket for local and long-distance services was a com-plex process, heavily laden with regulations. The exmo-nopolists had to distribute their costs and their assetsso as to set access rates for their networks. The restruc-turing of rates for local markets made it possible toreduce cross-subsidization in favour of the residentialmarket, without eliminating it entirely. In addition topaying for network access, the competitors of the for-mer members of Stentor had to contribute to the cross-subsidization associated with the local residentialservice. Adding to the complexity of the situation is thefact that new entrants into the local market are entitledto a “portable subsidy” paid with their contributions soas to offset the difference between costs and rates inthis market. In short, the CRTC interpreted its mandateas giving it the power to redistribute income in thetelecom market. All of these elements add complexityto the operation of the market and have been thesource of ongoing tensions between the new playersand the exmonopolists.

The CRTC’s approach, called “forbearance” whencompetition reaches adequate levels, led to the devel-opment of a competitive environment in the Canadianlong-distance market.42 Several companies did enter thelong-distance market, but they were mostly re-sellers;only a small number of newcomers developed true net-works across the country.43 With a few exceptions, suchas Fonorola, infrastructure investment was done mainlyby companies associated with US firms like Sprint andAT&T (which acquired Unitel).

ers thought that acquisitions were a promising avenuefor ensuring longer-term profit growth. These leadersnow look like apprentice sorcerers, with current man-agers often forced to dismantle the empires built bytheir predecessors in order to avoid the worst. Theshareholders and creditors of telcos were the losers ofthis venture into one-stop services and convergence.

The Schumpeterian Wave in theCanadian Telecom Sector

Scope of the phenomenon

T he magnitude of the innovation wave inCanada was not comparable to that seen in theUnited States. When the 1990-91 recession

ended, Canada was faced with a considerable budget-ary deficit and the burden of public debt weighedheavily on the economy. Tax increases intended toreduce the deficit dampened consumption growth sig-nificantly and the borrowing requirements of govern-ments generated pressures on financial markets. Thusfrom 1992 to 1998 average GDP growth in Canada(2.9 percent) was notably lower than in the UnitedStates, where GDP grew at an average of about 3.5percent. When the deficits subsided and the debt waslowered, Canadian growth began to accelerate in1998-99 when the speculative bubble was alreadyblowing itself out. Canada avoided the recession thatoccurred in the United States when the bubble burst.The collapse of the dot-coms, the spectacular bank-ruptcies of firms of the new economy, especiallyEnron, and the debacle in the telecom industry pulledthe American economy into recession in 2001.

The reversal experienced by the Canadian telecomsector was not as spectacular. A few companies, suchas AT&T Canada, 360Network and Teleglobe, a Bellsubsidiary, sought bankruptcy protection, and Nortelunderwent major restructuring. While this con-tributed to a slowdown of the economy in 2001, itdid not have the impact that the collapse of the dot-coms and of large corporations such as WorldComhad on the American economy.

Increased competition and the evolution ofthe marketIn the telecommunications sector, the CRTC’sapproach to increased competition did not lead tothe dismantling of the largest conglomerates such asBell and Telus, contrary to what happened with

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Canada divested itself of the residential sector (takenover by Primus) to concentrate on the lucrative busi-ness sector. Then, in October 2002, the companydeclared bankruptcy and the American parent decidedto withdraw from its subsidiary. Having rid itself of itsdebt burden, AT&T Canada changed its name toAllstream; it is too early to say whether the companywill succeed in becoming profitable.45 New entrantsinto the long-distance market have always maintainedthat the network access fees granted to the exmonop-olists by the CRTC are too high for new firms to beprofitable in that market. The difficult issues sur-rounding the profitability of the competitors of Belland Telus and network access fees will be discussedlater on.

As in the United States, Canadian consumers —households and businesses — have been the big win-ners in the increased competition and the technologi-cal boom. Thanks to competitive forces, they havebenefited from lower prices for long-distance servicesand Internet access. They have also been the benefici-aries of the new services offered in the market. Andthanks, among other things, to the cable distributionnetworks, Canadians now enjoy the benefits of com-petitive supply in high-speed Internet access.

The Transformation of theTelecommunications Industry

After the market correction

T he industry must now deal with the situationresulting from the speculative excesses ofrecent years and meet the needs of a customer

base whose goals are anchored in economic reality.On the demand side, the entire economy is pursuingthe move toward digitalization, but at a realistic paceand subject to cost and efficiency requirements. E-commerce will continue to make progress but it willreach levels substantially lower than those predicteda few years or even just a few months ago. On thesupply side, it has been estimated that the industryoperates at about 40 percent of capacity46 and thatexcess capacity will only be eliminated in 2006.

The industry is also threatened by factorsassociated with bankruptcy law. When companiesseek bankruptcy protection against their creditors,their transmission capacity does not disappear. If theyare able to come to an agreement with their creditors,they are then able to return to the market with a

Given the small size of its market and the dominantposition held by companies such as Bell and Telus,Canada has not seen a large wave of new entrants, incontrast to what took place in the United States, wherenew companies spread fibre optics networks across thecountry. Only 360Network can be considered aCanadian “bandwidth baron.” With spread of theInternet, several ISPs made their appearance inCanada, and some, such as iStar, had a brief success onfinancial markets. The larger telcos and cable compa-nies have contributed to the consolidation of theCanadian market, which does not have an ISP compa-rable to AOL that could concentrate Internet traffic andseriously challenge them.

The elimination of regulatory barriers betweentelecom services and cable distribution wrought bythe CRTC’s landmark decision 94-19 did not, howev-er, have all the outcomes that had been anticipated.Cable companies offer Internet access and data trans-mission services, but they have not, as many had pre-dicted, overtaken the telecommunications market.

The level of competition reached in the long-distance market was sufficient to convince the CRTCto withdraw and let market forces determine prices.The former members of Stentor lost significant mar-ket share when rates began declining precipitously.By 1999, approximately 25 percent of sales in thelong-distance market were made by the competitorsof the exmonopolists.44 Lower prices had a negativeimpact on the profitability of the former Stentormembers, and they had to work hard to preserve thevalue of their capitalization. The BCE strategy,analysed above, and the drop in prices in the telecommarket penalized the company’s shareholders.However, the presence of the former Stentor membersin the local market and the virtual absence of com-petitors in this market segment (see below) havegiven the exmonopolists a steady revenue flow thathas enabled them to stabilize their financial situation.By comparison, in the United States the companiescompeting in the long-distance market have not hadthis stable source of income and as a result have beenhit even harder by price wars.

New entrants into the Canadian long-distance mar-ket have found it very difficult to achieve profitability,as the example of AT&T Canada shows all too well.Thanks to the intervention of the federal government,the American company first acquired Unitel, whichhad already lost half a billion dollars, and wasallowed to hold 49 percent of the Canadian firm.Unable to become truly profitable, however, AT&T

petition. AT&T took advantage of these decisions tosecure a presence in local markets in eight states, andWorldCom, currently under chapter 13 of US bankrupt-cy law, offers local services in 33 states.49 If competi-tion continues to grow in local markets, it isconceivable that the RBOCs, which have the right to bein the long-distance market, will be allowed to buy acarrier.50 The US market would then look more like itsCanadian counterpart, with some firms present in bothlocal and long-distance markets. If a giant such as SBCCommunications or Verizon51 bought at cut-rate pricesanother giant currently under bankruptcy protection(WorldCom, for example), the new company would bein a position to make better use of network economicsand provide a more stable flow of income. This type ofconsolidation would lead to a telecom market with oli-gopolistic characteristics.

Consolidation also takes place when new competi-tors enter the market with the cash flow and expertiseneeded to offer specialized services. Thus IntegratedDevice Technology (IDT), a systems integrator, acquiredWinstar, a bankrupt carrier, for a fraction of its bookvalue ($42 million) and may be in a position to acquireat bargain prices other companies in bankruptcy or infinancial trouble.

Emerging business modelsFollowing the fall from grace of the convergence andone-stop concepts, the business models that are expect-ed to dominate are those requiring companies to spe-cialize more. Recent trends in market consolidationsuggest that three models will prevail in coming years.A first model is that of telcos that have refocused ontheir traditional mission and will, in a competitiveenvironment, become highly efficient, highly reliable,low-cost carriers offering platforms that are capable ofcombining various technologies available in the mar-ket. The refocusing strategy currently pursued by BellCanada can be seen as going in that direction.

A second model comprises firms occupying a spe-cialized niche, such as broadband services, in particularfor the international exchange of complex databetween companies or other organizations. By consoli-dating broadband networks and using its computerexpertise, a company like IDT could be moving towardthis model. AT&T Canada, renamed Allstream aftercoming out of bankruptcy, sold its residential servicesto Primus and now specializes in business services.

Finally, the third model, described earlier, is that of thebroker offering its clients a solutions package in partner-ship with other firms. This model encompasses, for

lighter debt load, while competitors that did not gobankrupt must continue to bear the cost of servicingtheir own debt. In Canada, for example, 360Networks,AT&T Canada and Teleglobe reached such agreementswith their creditors. In addition, investors can buyout bankrupt companies at prices that are muchlower than the cost of setting up high-speed trans-mission networks. A few carriers have already beenacquired at prices that represented only a fraction oftheir past value.47

These developments highlight the competitiveasymmetry that could emerge in the telecom market.To increase their client base, companies that werebought at cut-rate prices or that were able to ridthemselves of their debt burden are now in a positionto launch a new price war that could be fatal to com-petitors that had succeeded in surviving difficult mar-ket conditions. Indebted companies such as Verizon,Qwest or AT&T in the United States could, in turn, beforced to take refuge behind the protection of bank-ruptcy laws. One could then talk about a dominoeffect — a situation that some analysts had predicted48

and that would reinforce the dangerous trend towardlower prices caused by overcapacity, with damagingeffects on investors in the telecom industry. Thewealth-destroying process caused by past excessescould go on for some time before the industry returnsto stability.

Pursuing consolidationGiven the overcapacity and the economics of net-works — which require that fixed infrastructure costsbe amortized over the largest possible number of cus-tomers — the move toward consolidation that beganwith the bankruptcy of several carriers is expected tocontinue for some time. In the United States, theexmonopolists in local markets (the “regional Belloperating companies,” or RBOCs), in particular, findthemselves in a generally better financial situationthan other carriers and are in a position to buy atdeep-discounted prices long-distance companies thatare just coming out of bankruptcy or that are strug-gling to avoid falling into it. In resisting efforts toopen up the local market to competition (see theanalysis below), the RBOCs have already achieved amajor consolidation of this segment of the market byacquiring several smaller firms. That is how SBCCommunications, for example, has become a newgiant in the world of telcos.

Recently, some states forced the RBOCs to lowertheir wholesale local rates in order to stimulate com-

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In the long-distance market, however, competitionand network economics did not achieve optimalresults — that is, a situation in which the interests ofconsumers and shareholders converge. In local mar-kets, the introduction of competition turned out to bea complicated process and did not generate theexpected outcomes.

The legacy of the past and the increase incompetitionThe enhancement of competition in long-distanceand local markets assumes that regulatory agen-cies set the rates that new entrants must pay toaccess the networks of the exmonopolists. This isone of the major problems surrounding increasedcompetition. When an innovation wave is in fullswing, rate-setting is even more complicatedbecause the new technology based on IP datatransmission is substantially less costly than thetechnology associated with the networks inheritedfrom the past.

In theory, network access costs should reflect theprices that would obtain in a competitive environ-ment. But if the regulator allows an exmonopolistto claim its historical costs, new entrants do notpay only the marginal cost of the service receivedbut must also assume a part of the cost of deprecia-tion related to all investments already made by themonopolist. In a competitive market, historicaldepreciation is irrelevant since prices are deter-mined by current supply and demand conditions. Inthe United States, the response given to this prob-lem by the Federal Communications Commission in1996, when it opened local markets to competition,was to use an approach based on the costs of themost recent technology to set access rates withoutreference to monopolists’ historical costs.53 Therewas an outcry among the RBOCs, and theylaunched a legal challenge, which they won inpart.54 One of the arguments put forth by the exmo-nopolists was that they had invested in good faithand that their shareholders should not be the vic-tims of increased competition.55 This is a complicat-ed issue which illustrates another economicdimension of networks.56 A network in which a car-rier has invested substantial amounts of moneycannot simply be discarded without penalizingshareholders who invested in the company on thebasis of the information available at the time.

In Canada, the CRTC attempted to follow an inter-mediate course in this regard by allowing the exmo-

example, telcos that divest themselves of their carrierbusiness to concentrate on the supply of value-addedservices. The new AT&T management in the UnitedStates appears to be going in that direction. AT&T solda number of assets associated with the one-stop modeland wants to withdraw from the residential market inorder to focus on business services. In December 2002,AT&T, IBM and Intel agreed to create a joint venturecalled Cometa Networks, offering businesses an inte-grated network for wireless Internet access (Wi-Fi) inairports, office buildings and other public places. ThusAT&T and its partners have developed a value-addedpackage for businesses that must remain in Web con-tact with their managers when they are travelling.

Within a few years, the profile of the telecommu-nications sector will have transformed itself. After thewild years of the Internet boom, the industry will bemore closely anchored in market realities and morefocused on efficiency criteria.

Regulatory Policy and theSchumpeterian Wave

T he introduction of competition in telecommarkets was a major element in the innova-tion wave that took place during the 1990s.

Had the telcos maintained their monopoly posi-tion, they would have controlled the pace at whichnew technologies could be introduced into themarket. To recoup the historical costs of their net-works, they would have been tempted to slowdown their equipment upgrades. As a result,equipment suppliers would have had less incentiveto market products that are made ever more effi-cient through a whole series of incremental inno-vations. Moreover, had the regulatory system thatset service rates on the basis of cost plus a fairand equitable return been maintained, priceswould not have undergone the rapid downwardtrend that has been seen in the last decade. Thedegree of penetration of Internet technologythroughout the economy would be substantiallyless than it is today. This can be seen, for example,in the hesitation of some European countries inallowing competition in telecom markets, whichdelayed the conversion of their economies to digi-tal technology and reduced their competitiveness.52

Thus competition was a major contributing factorin the technological boom.

in the long-distance market before the Internetboom,58 in Canada network economics and the limit-ed size of the market may have played a part in theoutcome. Moreover, the exmonopolists, by beingpresent in both local and long-distance markets, mayenjoy some benefits in terms of rate-setting andbusiness strategies. The CRTC has adopted a numberof regulations designed to prevent them from shut-ting out rivals through predatory pricing policies.Nonetheless, Stentor’s former members are able totake advantage of bundling opportunities that arenot available to new entrants. Indeed, the tensionsthat have marked the television market are related tothe cross-subsidization that Bell is allegedly able tomake among its bundled service packages.

In conclusion, one may ask whether the way thatcompetition has been introduced into the telecomindustry in a market as small as Canada’s is such asto enable several competitors to be cost-effectiveover the long term. The Canadian experience is notconclusive at this point, and it raises a number ofissues that will be discussed in more general termsin the concluding section. It is to be hoped thattelecommunications, an innovative sector that isabsolutely essential to the proper functioning andcompetitiveness of the economy, will not follow theexample of commercial aviation, where it hasbecome very difficult to be profitable and where onemajor airline after another is seeking bankruptcyprotection to ensure its survival over the mediumterm. This model leads to a drying-up of the invest-ment capital needed to promote technologicalprogress, especially in the context of the currentlimits on foreign investment. On the other hand, asshown above, competition has been a determiningfactor in the innovation wave of the last decade. Forthe Canadian market, the approach that would servethe interests of both consumers and shareholdershas yet to be defined.

Finally, increased competition in the local telephonemarket in the United States and Canada has had rela-tively little effect. In Canada, the former monopolistsstill occupy approximately 98 percent of this market.59

The wholesale access rates set by the CRTC do notencourage resellers to try their luck in local markets.Instead, the CRTC’s approach is focused on encouragingpotential competitors to invest in equipment so theycan offer services at the local level. This strategy is notvery promising, however: except in high-density busi-ness sectors in downtown areas, it is not cost-effectiveto have competing networks in the local market. Under

nopolists to recoup a substantial portion of their his-torical costs and by using long-term incrementalcosts as a basis to set access rates. Understandably,this approach to rate-setting has led to pressures onthe part of new entrants, who argue that they arebeing forced to pay for historical costs that do notcontribute to their profits. To this difficult issue isadded the fact that the CRTC, by maintaining cross-subsidization in favour of residential subscribers asan income-redistributing measure, does not promotean efficient functioning of the telecommunicationsmarket. Rate restructuring should have led to theelimination of cross-subsidization and the CRTCshould have let the federal government take care ofthe matter of income redistribution. If the govern-ment believes telecom services should be madeaffordable to all, it may be appropriate to grant a taxcredit (similar to the GST tax credit) to low-incometaxpayers as a means of offsetting the higher rates.This way, new entrants would not be forced to con-tribute to a fund intended to cross-subsidize thelocal market. This would result in the elimination ofat least one source of tension in the telecommunica-tions market.

Companies such as CallNet Enterprises and AT&TCanada have always maintained that the accessrates to the Telus and Bell networks are too high tobe profitable for new entrants. AT&T Canada chal-lenged the CRTC’s most recent decision, which set aceiling for residential rates until 2006 and lowerednetwork access rates by 15 percent in May 2002.This reduction was far less than what AT&T hadrequested, but the Cabinet supported the CRTC’sdecision.57 On the other hand, the CRTC deemed thatcompetition in the long-distance market was declin-ing and that Bell, Aliant, Telus, MTS and Saskatelhad not honoured some of its decisions regardingcompetitors’ access to their networks. There werealso confrontations between cable companies andtelcos, in particular with regard to the provision oftelevision services.

Although 10 years have passed since competi-tion was allowed into the telecommunications sec-tor, there remains much tension between thevarious players in the Canadian market, and it isstill very difficult for new entrants to become prof-itable. Competition has had a number of beneficialeffects for users, but for shareholders the impacthas been less positive. While in the United States,major competitors of the exmonopolist AT&T, suchas MCI or Sprint, were able to achieve profitability

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government to regulate the railway industry in thefollowing century.61

During the Internet innovation wave, it becameclear that a trend toward overinvestment was devel-oping, especially when the bandwidth baronsappeared on the market. The chairman of theFederal Reserve cautioned investors about this dis-play of “irrational exuberance,” but his attempts atmoral suasion were not enough to temper investors’extravagant optimism. In fact, financial markets hadno interest in slowing down the wave of irrational-ity that gripped investors when the first publicofferings and corporate stock and debt issuesreached their peak. Moreover, financial analysts andbrokers did not hesitate to promote securities whichthey well knew had no value.62 As mentioned earlier,the question whether the Federal Reserve shouldhave raised its benchmark rate to calm this specula-tive wave remains open.

Given the demands of network economics andthe extravagant behaviour of financial markets, Ibelieve the regulatory agencies could, by issuinglicences for the operation of telecommunicationsnetworks, have controlled the deployment of newnetworks so as to prevent the waste of resourcesand the erosion of shareholders’ capital. After all,the telcos had long been familiar with the principleof infrastructure sharing. In an industry where net-work economics play a fundamental role in ensur-ing returns on investment, various forms ofco-ownership and “condominium” sharing of satel-lites, underwater cables and other types of infra-structure have long been in use.63 In particular, themajor international carriers have often sharedinfrastructure costs to avoid building costly dupli-cate networks. When a new network free of thedepreciation costs of past investments is estab-lished, it should clearly be easier for carriers toreach an agreement on sharing costs and capacity.This is the approach adopted by a number of publicinstitutions in Canada in recent years.64 When hear-ings were held on the granting of operating licencesto companies wishing to invest in a network or partof a network, the regulatory agencies could haveapplied the principle of capacity sharing to thedeployment of fibre optics networks in NorthAmerica. This approach does not imply that regula-tors are better informed than private investorsabout market conditions. The agencies could haverequested the companies to submit their investmentplans — and the information on which the plans

those conditions, competitors will apply a skimmingstrategy whereby they will offer specific services inthe lucrative market of large or medium-size busi-nesses; as a result, the market shares of new entrantswill remain very small. This was the strategy adoptedby MetroNet (later purchased by AT&T Canada) whenit decided to enter the local market.

In local markets, the answer is not in havingseveral networks compete, but in encouraging com-petition at the technological level.60 Cable compa-nies offer high-speed Internet access and can alsooffer Internet telephone communications. An exam-ple is Vidéotron’s Internet communications projectin partnership with Cisco, which could have beenbrought about through a merger with RogersCommunications but was abandoned whenVidéotron was bought by Quebecor. Had the projectgone ahead, a true competitive regime might havedeveloped between different technologies in thelocal market. Strong competition among wirelessservice providers already offers consumers a choice.Further progress in this area, with the eventualdeployment of 3G or even 4G technology, wouldmake it possible to bypass the local infrastructuresof the exmonopolists.

Networks economics and competitionTo be cost-effective, an investment project in costlyinfrastructures must assume a high rate of networkutilization. When a company deploys a communica-tions network, it seeks to secure the highest trafficvolume possible for that network. The marginal costassociated with gaining additional customers is neg-ligible, but the average cost is a function of infra-structure utilization rates. With compressiontechniques increasing the capacity of optic fibresand Internet technology, it is more necessary thanever to secure the highest traffic possible in order tomake the infrastructures cost-effective. In the con-text of a Schumpeterian innovation wave and amarket that is completely open to competition, eco-nomic agents tend to overestimate investmentrequirements considerably. Waves of excessive opti-mism of the scope described earlier have been seena few times in economic history. In addition to thecase of electricity in the 1890s mentioned above, asimilar phenomenon was observed with the unregu-lated construction of railways as part of the con-quest of the American West in the 19th century. Thedevelopment of competing networks brought abouta series of bankruptcies, which led the American

the financial difficulties of the telcos has sloweddown the pace of innovation, there has been talk forsome time now of voice transmission on the Internet,and companies such as Cisco Systems have investedsignificant amounts in the development of this tech-nology. Recently, the US company Vonage beganoffering, for a low, flat monthly fee, Internet tele-phone service in which the notion of long distanceceases to exist: subscribers can call anywhere in theUnited States and Canada as long as they have ahigh-speed Internet connection.66 Thus Vonage is atthe forefront of a new wave of innovations in theindustry. In Canada, Primus recently announced thatit plans to offer a similar service; Bell Canada, inpartnership with Cisco, also intends to enter theInternet telephone market. The Vonage businessmodel will challenge both the exmonopolists, whosenetworks are threatened by this technology, and theregulatory agencies, which will have to define rulesapplying to the new service.67 This process is alreadyunder way, as telcos in both the United States andCanada have asked the agencies to hold hearings onthe subject of Internet telephone service.

The speedy implementation of WiFi technologythrough the deployment of “hot spots” allowinghigh-speed Internet access in both countries consti-tutes another competitive threat in local markets.There is a risk, however, that this technology willsoon become obsolete because companies such asArrayCom, IPWireless, Navini and others are cur-rently developing 4G technology, a high-speed wire-less technology for Internet access that circumventsthe weak point of WiFi technology — namely, theshort range of the “hot spots.”68 The new technologymakes it possible to adopt a leapfrogging strategythat eschews 3G technology and to develop a nation-wide wireless network for high-speed Internet access,whereas the shortcomings of WiFi make it practicallyimpossible to deploy a nationwide network. That isthe route that a company like Nextel intends to taketo provide high-speed wireless services. This technol-ogy poses another major challenge to the networksof the exmonopolists. Technological advances are inthe process of achieving what complex regulationswere not really able to do — namely, introducing atruly competitive regime in local markets. Clearly,technological innovations will continue to transformthe telecom industry in the future.

were based — and could have discussed with themthe possibility of sharing infrastructures. The resultwould have been a better organization of the infor-mation on the investment intentions of variouscompetitors in the market, laying the groundworkfor analysing investor expectations under a differ-ent light. In particular, such an exercise could havehighlighted the overestimation of demand duringthe high-speculation period when each carrierbelieved it could secure significant market share. Inaddition, carriers investing in a shared networkcould have agreed to make it available to third par-ties for a fee. The rules set by regulators to controlnetwork access could then have been used to set arate schedule enabling other firms to access thenew network at a competitive price. Again, infra-structure costs could have been avoided.

Overall, this approach would have made it possi-ble to increase the cost effectiveness of projects byavoiding the waste of resources. In the process, theinvestment boom would probably have been lessextreme and investors’ interests could have beenprotected. From the point of view of consumers’interests, there was no need to have this hugeexcess capacity in order to lower prices and facili-tate the emergence of several new types of serviceson the market. For reasons mentioned earlier, how-ever, this type of intervention in the telecommuni-cations market when the Internet wave was at itspeak would have been poorly received by the finan-cial community, which would have argued infavour of a free marketplace to ensure an efficientallocation of resources. Moreover, some players inthe telecom industry have a reputation for not giv-ing in easily to this type of cooperation:65 as seenearlier, in the culture of the industry companiesprefer to own the assets that are the source of theservices they offer. However, the extravagance dis-played during the last innovation boom and theongoing tendency to consolidate should facilitate achange of attitude in the future on the part of car-riers. In Canada, for example, following the acqui-sition of Clearnet by Telus, the latter reached anagreement with Bell Mobility on sharing infrastruc-tures for their wireless services.

OutlookWhile the impact of the most recent Schumpeterianwave is still being assessed, technological advancesand the emergence of new telcos pose new chal-lenges to existing firms and regulators. And while

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even to new bankruptcies among carriers that muststill support high levels of debt.

Thus the industry remains in a state of flux. Underthe circumstances, Canadian regulators have actedresponsibly. Overall, they have made it easier fortechnological advances and reduced prices to takeplace. Greater competition in telecom markets hasbeen an important factor in the innovation wave thatmarked the 1990s, but even with regulatory over-sight, the impact of competition has not been entirelybeneficial. Natural market forces in an industry wherenetwork economics play an essential part did notresult in the type of efficient resource allocation thatwould have matched the interests of consumers withthose of investors. In my view, the regulatory agen-cies could have provided some guidelines to preventthe waste of resources due both to the unrealistichopes entertained by each competitor about increasedmarket share and to poor demand forecasts. Forexample, by encouraging the sharing or co-ownership of infrastructures, it would have been pos-sible to avoid losses while maintaining lower prices.

That said, the ability of the exmonopolists torecoup the historical costs of their infrastructureinvestments remains an important element in the ten-sions that exist between them and new entrants, inboth Canada and the United States. The approaches tosetting access rates for the networks of the exmonop-olists remain problematic. In addition, the incomeredistribution measures implemented by the CRTCtend to make the operation of the market more com-plex and often deprive exmonopolists of the flexibili-ty required to adapt to the new market conditions. InCanada, given the size of the market, it is far fromcertain that new entrants will succeed in becomingcost-effective.

In fact, competition in local markets remains veryweak and even non-existent in Canada and theUnited States. No regulatory model has been foundthat can solve this problem and achieve the desiredgoals. The issue of historical costs plays a role inthis, as do network economics, which suggest theexistence of a natural monopoly where traditionalcommunications are concerned. In this context, onemust ask whether the CRTC’s approach, whichattempts to balance the interests of new competitorswith those of the exmonopolists, does not lead to aneconomic impasse in the sense that it seeks to createa competitive regime where this is not naturallycost-effective and at the same time limits the flexi-bility of the exmonopolists.

Some Conclusions

O ver the past decade, the telecommunicationssector has experienced a Schumpeterianinnovation wave. This phenomenon had a

positive impact on social organization and on busi-ness productivity once the Internet quickly became ameans of communicating, disseminating informationand trading goods and services. Telecom users havebeen the beneficiaries of a substantial drop in pricesand a proliferation of new services.

Innovation waves also have a less positive dimen-sion, however. Overinvestment associated with aseries of incremental innovations and encouraged bythe financial sector led to the deployment of a hugesurplus in information transmission capacity relativeto demand. When growth in stock market values wasaccelerating, could a preventative intervention by thecentral banks have limited the scope of the specula-tive bubble, comparable to others that took place insimilar circumstances in the history of innovations?The debate on this point remains open.

The strategies used by the telcos during this peri-od were not based on particularly sound businessmodels, especially if one looks at them from theperspective of the entire industry rather than fromthe point of view of a specific company. It will be along while before the industry can eliminate theexcess capacity that resulted from these strategiesand that is still reflected today in a strong down-ward trend in prices. In addition, the one-stop strat-egy, or strategy of convergence between the telcosand the creators of content, which gave rise tonumerous acquisitions, turned out to be much tooexpensive overall, relative to a more flexible strat-egy based on syndication.

Today, the industry is gradually returning to amode of operation anchored in market realities. It isrestoring order in balance sheets and simplifyingbusiness models while trying to offer services andsolutions that are a closer match to customer needs.Efficient and reliable operators, companies specializedin specific niches or assemblers of best solutions intelecommunications: those are the business modelsthat are currently emerging in the industry.

At the same time, there is a risk for the industrywhen companies seek bankruptcy protection to elimi-nate their debt, because they are later tempted tolaunch another price war to reduce their excesscapacity. This can lead to financial pressures and

I believe that genuine competition in this mar-ket can occur at the technological level ratherthan through deregulation. Technological progressmay well be able to accomplish what complexregulation of the local market could not.Regulators must pay attention to the emergenceof Internet-based telephone services, which signalthe end of long-distance services as we haveknown them until very recently. WiFi technology,which makes possible high-speed wireless accessthroughout the United States and Canada, isanother source of competition, even though thistechnology is itself subject to early obsolescencesince other technologies will make it possible todevelop a nationwide network.

Thus competition between wireless and cabletechnologies will achieve true market outcomes.For example, if WiFi wireless Internet access tech-nology or — an even more promising prospect —4G technology becomes a widespread broadbandInternet access mode, true competition will developin the telecom market. Internet-based telephoneservices, made possible by recent technologicaladvances, may also bring about another wave ofcompetition and eventually contribute to the dis-appearance of the notion of long-distance tele-phone service.

In short, it is entirely possible that the theory ofnatural monopolies will make a comeback and thatanalysts will conclude that competition between tech-nologies is the most beneficial avenue for consumersand for telco shareholders.

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Appendix 1The BCE strategy

● Acquisition of means: Bell owned a network towhich it added a high-speed backbone through asubsidiary, Bell Nexxia. Bell then added anInternet portal with the financial participation ofLycos. The partnership with SBC Communicationswas aimed at securing additional liquidity in orderto make new acquisitions and offering productsdesigned by the American group. Bell also boughtan e-commerce service company (Emergis) and asystems integrator (CGI). Finally, BCE strengthenedits mission in information transmission services byshedding its subsidiary Nortel at a time when thelatter’s stock market value was high.

● Acquisition of content: With all of these basicassets in place, BCE proceeded to buy “content” byacquiring CTV, The Globe and Mail, TQS and theBell Centre (sports).

● Other fields of activity: In addition, Bell was pres-ent in mobile communications (Bell Mobility) andsatellite cable distribution (Bell ExpressVu). Thecompany’s strategy was completed with the acqui-sition of Teleglobe, which gave Bell importantcapacity in Internet transmission.

22 Between 1998 and 2001, for example, the number offibre optic cables in the ground grew five-fold. In addi-tion, technological advances in end-to-end fibre signalfeed increased the transmission capacity of each fibreduct one-hundred-fold. As a result, total transmissioncapacity was multiplied by 500. During the same period,however, demand only grew four-fold. See A. Odlyzko,quoted in “Special Report: The Telecom Crisis,” TheEconomist, July 20, 2002.

23 “Special Report: The Telecom Crisis,” The Economist,July 20, 2002.

24 Rosenbush et al., “Inside the Telecom.”25 Fransman, Telecoms in the Internet Age.26 “The Great Telecom Crash,” The Economist,

September 9, 2002.27 From 1998 to 2002, the price of a high-speed connection

between London and New York dropped 95 percent. SeeS. Rosenbush, R. Crockett, and C. Hadad, “The TelecomDepression: When Will It End?” Business Week, October7, 2002.

28 The Web site of the British company Bandex was amongthe first to offer an international meeting point forbroadband supply-and-demand. This helped to acceleratearbitrage in broadband, which tends to standardizeprices on a global scale.

29 “The Great Telecom Crash,” The Economist, September 9, 2002.

30 W.D. Nordhaus, “Productivity Growth and the NewEconomy,” Brookings Paper on Economic Activity 2(2002): 211-44.

31 M. Mandel, “The Painful Truth about Profits,” BusinessWeek, November 4, 2002. Also see M. Arndt, “Prices JustKeep Plunging,” Business Week, October 21, 2002.

32 L.-A. Lefebvre and Y. Rabeau, “The Impacts ofInformation Technology on Corporate Structures andStrategies: A Literature Survey and Emerging Models,”Industry Canada, cat. no. C. 28-1/114-1994E.

33 M. Porter, “Strategy and the Internet,” Harvard BusinessReview 79, no. 3 (March 2001).

34 Monopolistic telecommunications companies were oftendominated by the engineer culture, which consists ofchoosing the products needed by the market on the basisof their technical properties. See P.J. Kampas, “ShiftingCultural Gears in Technology-Driven Industries,” MITSloan Management Review (winter 2003).

35 Y. Rabeau, “The Source of the ‘Mirage’ and Ways of theFuture: Foolish Expectations and Dashed Hopes,”Canadian Media Research Consortium, Université Laval,July 2003.

36 S. Crock, “Old Economy or New, Vertical Empire Don’tWork,” Business Week, June 12, 2000.

37 M.M. Bekier, A.J. Ogardus and T. Oldham, “Why MergersFail’” McKinsey Quarterly no. 4 (2001): 6-10.

38 John Hagel III and Jeffrey F. Rayport, “The NewInfomediaries,” McKinsey Quarterly no. 4 (1997): 55-70.

39 K. Werbach, “Syndication: The Emerging Business Model inthe Internet Era,” Harvard Business Review, May-June 2000.

40 In the case of Teleglobe, BCE could also have signed apartnership agreement with this firm, in which it already

Notes1 Telecommunications “deregulation” is another term

used in this context. “Introduction of competition” ismore accurate, in my view, because it was accom-plished through regulation that differed from whatexisted previously and that was very complex.

2 Schumpeter’s theory is set out in Capitalism, Socialismand Democracy (1942).

3 F. Hayek, Monetary Theory and the Trade Cycle(London: Jonathan Cape, 1933). For an application ofthe theory to the current situation, see P. Woodall, “ASurvey of the World Economy: The UnfinishedRecession,” The Economist, September 28, 2002.

4 J.M. de Figueiredo, “Finding Sustainable Profitabilityin Electronic Commerce,” Sloan Management Review41, no. 4 (summer 2000).

5 Ben S. Bernanke, “Asset-Price ‘Bubbles’ and MonetaryPolicy,” remarks made before the New York chapter ofthe National Association for Business Economics, NewYork, October 15, 2002.

6 For example, see A.J. Schwartz, “Asset Price Inflationand Monetary Policy,” Working Papers, NationalBureau of Economic Research (November 2002).

7 Charles Freedman, “Wrap-Up Discussion, Informationin Financial Asset Prices,” Proceedings of a conferenceheld by the Bank of Canada, May 1998.

8 For example, see Yvan Allaire and Mihaela Firsirotu,“Changing the Nature of Governance to Create Value,”C.D. Howe Institute Commentary 189 (November 2003).

9 Yves Rabeau, L’industrie des télécommunications:problématique d’une industrie en évolution rapide(Montreal: Institute for Research on Public Policy,1995).

10 D. Tapscott, The Digital Economy (McGraw Hill, 1995).11 G. Gilder, Telecosm: How Infinite Bandwidth Will

Revolutionize Our World (New York: The Free Press, 2000).12 See the Nortel white paper, 10 Gigabit Ethernet

(January 2001), which quotes an IDC forecast in whiche-trade was forecast to increase from $269 billion in2000 to $2.6 trillion in 2004.

13 “Too Many Debts; Too Few Calls,” The Economist,September 18, 2002.

14 “Internet Traffic: The Power of WorldCom’s Puff,” TheEconomist, July 20, 2002.

15 S. Rosenbush et al., “Inside the Telecom,” BusinessWeek, August 5, 2002.

16 U.S. Communications Infrastructure at a Crossroads:Opportunities amid the Gloom (McKinsey & Companyand Goldman, Sachs & Co., 2001)

17 Woodall, “A Survey of the World Economy.”18 Martin Fransman, Telecoms in the Internet Age

(Oxford: Oxford University Press, 2002).19 Ibid.20 “Too Many Debts; Too Few Calls,” The Economist,

September 18, 2002.21 A.-L. Pernée and Y. Rabeau, “Growth Crisis in the

Digital Economy: The Quest for Business Models,”working paper 17-2000, Centre de recherche en ges-tion, ESG-UQAM, December 2000.

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tection for a given period so as to recoup networkcosts. In both cases, marginal costs are low: adding acustomer on a network costs very little, as does thecost of reproducing a known molecule. This compari-son has difficulties of its own, however: when theexmonopolists invested in their networks, they did notrun significant risks, precisely because they were in amonopoly situation. There could have been a riskoriginating from other technologies, such as wireless,but that risk only came later, with the recent boom indigital wireless, at a time when the exmonopolists hadalready recouped a substantial portion of their costs.

56 The technical question of access and interconnectioncosts is difficult to deal with because of the variousissues that have just been described; see I. Vogelsang,“Price Regulation of Access to TelecommunicationsNetworks,” Journal of Economic Literature 21, no. 3(September 2003).

57 D. Ebner, “CRTC Phone Rate Ruling Upheld,” The Globeand Mail, March 27, 2003: B5.

58 It should be recalled that AT&T lost its monopoly inthe long-distance market in 1984 and that the UnitedStates was almost a decade ahead of Canada in thematter of competition.

59 D. Ebner, “Battle Looms between Big Telcos, CRTC,”The Globe and Mail, April 8, 2003: B8.

60 Technological advances often provide an entry forcompetition in regulated services such as telecommu-nications. See A.E. Kahn, “Lessons from Deregulation:Telecommunications and Airlines after the Crunch,”AEI-Brookings Joint Center for Regulatory Studies,Washington, DC, 2004.

61 R.D. Stone, The Interstate Commerce Commission andthe Railroad Industry: A History of Regulation Policy(Praeger Publishers, 1991).

62 S. Rosenbush et al., “Inside the Telecom,” BusinessWeek, August 5, 2002.

63 In Canada, cities and school boards have adopted theco-ownership approach in the deployment of fibreoptic networks because they wanted to take advantageof network economics and reduce their telecommuni-cations costs. See A.K. Bjerring and B. Saint-Arnaud,“Est-ce que le Canada peut assumer un rôle de chef defile mondial lors de la prochaine révolution Internet?”Canarie, Ottawa, 2002.

64 Ibid.65 U.S. Communications Infrastructure at a Crossroads:

Opportunities amid the Gloom (McKinsey & Companyand Goldman, Sachs & Co., 2001)

66 The telephone is connected to an ATA box (analoguetelephone adaptor), which is in turn connected to theInternet.

67 T. Standage, “Beyond the Bubble: A Survey ofTelecom,” The Economist, October 11, 2003. Also seeKahn, “Lessons from Deregulation,” 22.

68 See “Move over 3G: Here Comes 4G,” The Economist,May 29, 2003.

had a financial stake. But this approach would havebeen rejected on the grounds that BCE feared that acompetitor would buy Teleglobe.

41 There are always exceptions that confirm the rule.Telefonica, a telecommunications company establishedin Spanish- and Portuguese-speaking countries, suc-cessfully adopted the convergence model by radicallychanging the corporate culture and placing customerneeds at the core of its operations. See ThierryOutrebon, “Telecoms: quels business models pourl’avenir?” conference presentation, France, March 2001.

42 F. Bertrand, Y. Rabeau, and D. Waldron, “CanadianTelecommunications Regulation and Competition:Lessons for Europe,” working paper 31-2001, Centre derecherche en gestion, UQAM, November 2001.

43 It has been estimated that between 200 and 250 long-distance resellers have offered services in the Canadianmarket since competition was introduced. See J.G. Rens, “Réflexions sur la décennie télécom: 1992-2002,” unpublished paper, 2003.

44 In 2002, the share of the market held by these com-petitors had reached almost one-third. See IndustryCanada, “Telecommunications in Canada — AnIndustry Overview,” figure 2-10. This reference tool isregularly updated and it is available on the Internet athttp://strategis.ic.gc.ca/epic/internet/insmt-gst.nsf/en/sf05637e.html

45 D. Ebner, “AT&T Canada Executives Tout RevampedBusiness,” The Globe and Mail, March 20, 2003: B4.

46 Rosenbush, Crockett, and Hadad, “The TelecomDepression.”

47 For example, an American fund bought Teleglobe forsome $200 million.

48 “The Great Telecoms Crash,” The Economist, July 18,2002.

49 Ibid50 S. Rosenbush, R. Crockett, and C. Hadad, “Telecom: At

Last the Depression is Lifting,” Business Week, January14, 2003.

51 S. Rosenbush, “Verizon: A Leader among the Bells?”Business Week, October 21, 2002.

52 Bertrand, Rabeau, and Waldron,“CanadianTelecommunications Regulation and Competition.”

53 This is the “forward-looking costs” approach asopposed to the historical- or “embedded-” costsapproach. See W.J. Baumol and G. Sidak, TowardCompetition in Local Telephony (Cambridge andWashington, DC: MIT Press and AEI Press, 1994).

54 It must be pointed out that one of the major argumentsused in court by the RBOCs, which succeeded in mak-ing the FCC’s decision null and void, was strictly con-stitutional: the FCC does not have the authority toimpose such a decision, as the matter falls under thejurisdiction of the states.

55 Another way of presenting the rationale for recoupinghistorical costs, suggested by a reader, would be to seethe exmonopolists as having incurred costs and risksin building their networks, so that, as in the pharma-ceutical industry, they should enjoy some form of pro-