Why is broadband cheap in the north? (as published in Sunday Times)

10 January 2010

Broadband is a complicated subject. Whilst I’m a big fan of keeping things straight and simple, there is always a danger of over-simplifying reality in order to appeal to a broader audience. The real challenge is to explain very complicated matters in a manner that is understandable to everyone in the room, including the guys in the corner struggling to breathe.

So here goes at explaining why broadband is so cheap in Europe and the USA.

Let’s start by pointing out that 2 of the heaviest cost components of data are local connectivity (connectivity within your country) and international connectivity (connectivity outside your country). Both of these portions have evolved very differently in Europe and North America. I’ll start with Europe, or more specifically the European Union (EU).

The EU has a GDP of 2,980,000 Euros per square kilometer. SA has a GDP per square km of 270,000 Euros. In other words, for every kilometer covered in the EU region, the potential return on investment is 11 times higher than in SA!

To make that simpler to understand, South Africa telco’s must connect Jhb to CT, with the intervening 2000km interrupted by the odd cactus, diamond mine and Bloemfontein. Compare that to the space between Liverpool and London! 5,000,000 million people at a GDP per capita of 40,000 Euros!

Any country that has a high GDP and population density has a natural advantage in providing cheaper telecommunications to its citizens. If companies have a higher rate of return on their investment they can invest more and charge less. This applies to most of Europe and East Asia.

Of course this does not explain the entire discrepancy between SA and the EU, and anyway, I hear you ask, “What about the USA, they have much bigger spaces?”…

Ok, let’s move to the States. The global telecommunications industry, especially in the USA, went through a massive boom-bust cycle from 1997 to 2002. According to Bankruptcy.com, telecoms operators comprised 8 out of the 15 largest public company bankruptcies in the United States in 2002: Worldcom (assets of $104 billion), Global Crossing ($48 billion), Adelphia Communications ($22 billion), NTL ($13 billion), XO Communications ($8 billion), Williams Communications ($6 billion), McLeod USA ($5 billion) and Asia Global Crossing ($4 billion).

And that’s just the States! In 2003 Deutsche Telekom reported a net loss of 24.6billion Euros, the largest in European corporate history. Both France Telecom and Vodafone reported losses of over 20billion Euros in 2002, and at the time France Telecom could boast the highest corporate debt on earth ($70billion)! The global telecoms industry wrote off over $2.6trillion in 12 months…

Ever heard of Global Crossing? They get the credit for coining the statement “Data consumption will double every 100 days”. Apparently one of the junior accountants used this assumption in his most optimistic financial scenario forecast and the CEO loved it so much he based his entire business model on it!

So whilst the rest of us spent the 90’s innocently listening to What is Love by Haddaway, Global Crossing was pouring over $50billion into undersea cables connecting North America to 3 continents (Asia, Europe and South America) and fibre-optic cables in North America, in the process connecting over 200 major cities on 4 continents.

As it turned out, the assumption was wrong.

In 2000 Global Crossing was valued at $48billion. It filed for bankruptcy in 2001, the biggest bankruptcy in USA history (until 6 months later when WorldCom went bankrupt). 2 years later it emerged with a valuation of $1.25billion, the afore-mentioned assets intact, and virtually no liabilities. Whilst under bankruptcy the company slashed its long-term debt from $11billion to $200million, but it still retained the assets that were purchased with this debt.

The result? The core infrastructure needed for transmitting data between Europe, Asia, South America and North America was installed for free, courtesy of the investors and creditors of Global Crossing. Furthermore, tens of thousands of kilometers of fibre-optic cables were laid in the USA, also for free.

On to the biggest bankruptcy in USA history, until Lehman Brothers in 2008 that is…

WorldCom. In July 2002 WorldCom went bankrupt, taking with it the debt incurred for building the world’s biggest Internet backbone, UUNet, which single-handedly carried a third of the world’s Internet traffic , as well as 6000km of fibre-optic cable into businesses across the USA.

In April 2003 WorldCom wrote down its physical assets (no goodwill included) by $70billion. These were physical assets, paid for in hard cash, and ultimately written down by 75%! WorldCom emerged from bankruptcy in 2004, freed of $35billion in debt, renamed as MCI Inc and was eventually acquired by Verizon Communications in 2005 for $8.4billion.

A great line from the NY Times in 2003: “Thanks to WorldCom, we are closer to knowing how much demonstrably dumb money went into the telecom industry at the century’s end.”

Another lesser-known consequence of the overinvestment in infrastructure in the USA was the disappearance of AT&T as an independent company. Founded in 1885 Alexander Graham Bell, it was acquired by SBC in 2005 after being caught up in the hype of infinite demand for bandwidth. At one stage AT&T was laying “2,200 miles of cable per hour” on the back of the Global Crossing and WorldCom forecasts, the end result being massive write-downs and the eventual absorption of the 120 year-old industry legend into SBC.

And guess who were the biggest suppliers to WorldCom and Global Crossings? Lucent Technologies and Nortel Networks. Both bankrupt.

Does this sound familiar to you? Sub-prime maybe? In fact it is very similar. Both the telecom and credit bubbles were grounded on false assumptions, namely “Data consumption will double every 100 days” and “House prices will always rise”. The result in the telecoms industry was massive overinvestment in infrastructure followed by massive write-offs, lay-offs and bankruptcies. The silver lining was a surplus of high-tech capacity which resulted in fast broadband connections and cheap prices for consumers.

Between Global Crossing and WorldCom a total of R2,46trillion (in today’s Rands) was spent on broadband infrastructure which benefited every continent in the world except for Africa, Australia and Antarctica.

Keep in mind that African countries north of the Sahara can easily access the global communication grid due to the close proximity of the north African coastline to Europe and the Middle East. This is borne out by the fact that 5 of the top 8 African countries in terms of broadband penetration are north of the Sahara. Sub-Saharan Africa, on the other hand, is effectively cut-off off from the grid by virtue of geography. We can’t lay lines across the Sahara, so the only route is under the sea. And we haven’t had a sub-Saharan version of Global Crossing yet! (Although Global Crossing did plan for an undersea cable circumventing Africa, called AfricaOne. Sadly for us, they went bankrupt before the cable was laid.)

From the above it is apparent that both Europe and the USA have a massive competitive advantage when it comes to broadband. South Africa must contend with a lower population density and GDP per capita, and at the same time does not benefit from the glut of undersea and local capacity created by the likes of Global Crossing and Worldcom.

  1. Europe has an 11 times higher return on investment for laying telecommunications cables in the ground.
  2. The USA has tens of thousands of kilometers of fibre-optic cable already in the ground, connecting businesses and homes, which was effectively paid for by the shareholders and creditors of companies which are now bankrupt.
  3. North America, Europe, Asia and South America have a subsidised undersea cable system on which to rely for cheap international bandwidth. Again, this subsidy was kindly provided for by investors and creditors in Global Crossing.

So try apply a little perspective the next time you’re sitting in New York City surfing the net at 10Gigs/sec and paying $30 a month, uncapped. The only way you get to this broadband nirvana is if someone along the way dies. Probably Telkom. And in the end you’ll be paying anyway because the government will have to ride to the rescue with a bail-out, using taxpayer money.

Works Cited

Krapf, Eric. “What is the future of WorldCom’s fiber? What if WorldCom’s already-constructed fiber routes to 6,000 buildings in metro areas suddenly came on the market? (Access Networks).Business Communications Review. CMP Media, Inc. 2002. HighBeam Research. 3 Sep. 2009 <http://www.highbeam.com>.

Nextel snags WorldCom wireless assets in court.(News).” RCR Wireless News. Crain Communications, Inc. 2003. HighBeam Research. 3 Sep. 2009 <http://www.highbeam.com>.

Knight, Fred S.. “Carriers–no quick fix. (Memo).” Business Communications Review. CMP Media, Inc. 2003. HighBeam Research. 3 Sep. 2009 <http://www.highbeam.com>.

Internet World Statistics, www.internetworldstats.com

Country GDP and population statistics, www.wikipedia.com

Global Crossing Emerging From Bankruptcy, Brian Bernstein , http://www.crn.com

TURMOIL AT WORLDCOM: THE OVERVIEW; Want a Piece of WorldCom? Contact the Company’s Bankers – New York Times.” The New York Times. 2002. HighBeam Research. 3 Sep. 2009

Christopher Stern. “WorldCom Fades Into History; Reorganization Complete, Telecom Company Now Becomes MCI Inc.The Washington Post. Washington Post Newsweek Interactive Co. 2004. HighBeam Research. 3 Sep. 2009 <http://www.highbeam.com>. <http://www.highbeam.com>.

Edward J. Romar, University of Massachusetts-Boston, WorldCom Case Study Update 2006http://www.scu.edu/ethics/dialogue/candc/cases/WorldCom-update.html

Corporate Breakdown,  THE BUBBLE THAT BURST, THE RISE AND FALL OF THE TELECOM INDUSTRY, Petra Kjell, 2003

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