Editor's note: Two months ago, the depth of the subprime mortgage crisis was unknown, the US was strongly denying that its economy was in a recession, and many analysts were still predicting a mild upward macroeconomic trend for 2009. At that time, FibreSystems Europe commissioned this article discussing the state of the economy and what it could mean for future telecoms spending. The market crash occurred after this article was written but before the issue went to press. We are publishing the article now regardless because the author’s opinions and recommendations remain highly relevant in the current environment of economic uncertainty.
The subprime mortgage crisis in the US, a weak economy in Europe and high global oil prices have all spurred fears of a worldwide economic recession. Telecoms operators, vendors and components suppliers need to consider this in their planning if they are to maximize profitability.
Naturally, the first question is: are we really heading for a recession? Technically, there is no recession in the US – at least not yet, according to the government’s definition of a recession being two consecutive quarters of negative growth in gross domestic product (GDP).
The US economy rebounded in the second quarter, helped by one-time federal stimulus packages. But although the US government would have us believe otherwise, this doesn’t necessarily mean the economy is strengthening. No-one knows the true depth of the subprime mortgage crisis, but credit has been tightened, house prices are still in decline and the bailing out of troubled mortgage firms will have an impact on the economy’s future.
The low valuation of the dollar has inflated US exports in the short term, but this cannot be expected to prop up GDP in the long term. The US Department of Labor indicates that unemployment is rising and inflation for staple goods pricing is high. Billionaire investor Warren Buffet, who in contrast to the government makes far more money than he spends, thinks the economy is already in recession by “any common-sense definition”, and consumer polls indicate that most people agree.
Concerns about worldwide recession may have begun in the US, but it’s a similar story in Europe. Ireland has already had two consecutive quarters of contraction, while Germany, Britain and Spain are expected to slip into recession by the end of the year.
The politics of economics
You would think that whether a country is in recession or not would be known with precision, but unfortunately it is not that simple. The definition of recession serves like an “idiot light” on the car dashboard that turns on to warn you that the engine has already overheated and seized. Establishing a discrete point at which an economy goes into recession is like arbitrarily deciding that turtles travelling at 0.05 km/hour are officially slow, while turtles travelling at 0.051 km/hour are not.
Nevertheless, whether we are technically in recession or not is important because perceptions of economic health can have a psychological impact on consumers, business planning and the economy itself. Governments will spend a lot of money to avoid having their economies slip into “official” recession, even if a general slowdown is already apparent and crossing into “official” status would make little real difference.
Government GDP reports, like the quarterly financial reports of telecoms vendors, can be manipulated in the short term. Governments influence GDP by approving economic stimulus packages, changing the way GDP is measured, and by considering “bail outs” of errant financial institutions. In a similar manner, telecoms vendors can change revenue recognition policies, use aggressive discounting, and implement special sales incentives to manipulate their short-term financial performance.
These measures impact short-term reported financial results, but do not directly improve real financial or economic performance in the long term. However, creating a perception of economic wellbeing can materially impact the economy in an indirect sense by influencing consumer and business willingness to spend, therefore potentially reducing the length or depth of a downturn.
The present economic slowdown will be nothing like the telecoms meltdown of 2001. The bursting of that bubble was a simple case of supply and demand: hype substituted for real demand, with the result being a serious problem of oversupply. Planning was heavily influenced by wishful thinking, amplified by a positive feedback loop based on what sometimes appeared to be baseless vendor self-promotion regurgitated for a fee by some of the more “optimistic” quantitative financial and industry analysts. That hype was great for getting almost any development business case approved internally, but it was no basis for real market planning.
The risk now is that a prolonged slowdown in the macroeconomy will affect capital availability and slow consumer and business spending. Network operators will still need to invest in the network to enable profitable new revenue streams, but the performance of the overall economy may moderate the degree and pace to which this investment can be justified.
In this scenario, service operators will have to jump higher hurdles to justify expenditures to the chief financial officer (CFO), because the CFO will in turn have to jump higher hurdles in justifying these expenditures to stockholders and the financial community. Operators that are already weaker financially will generally be more affected.
Some products and services will be affected more than others. Operators will continue to upgrade networks to satisfy capacity and quality of service demands, as the long-term fundamental drivers of demand for telecoms services are solid. However, the economy may well influence the timing, rate and degree to which operators take the plunge on major network transformation projects, such as a migration to converged packet/optical networks and to all-IP radio access networks.
The long-haul DWDM market is less cyclical than it once was, because sales of transponders to support capacity upgrades now form a higher percentage of revenues. Subsea transmission, though very hot right now, remains more cyclical, and will slow down after a few years.
The demand for fixed-line broadband services is unlikely to decline much due to an economic slowdown – the internet has become such an integral part of the daily lives of businesses and consumers. Fast-growing demand for multimedia services and growth in peer-to-peer applications with more symmetric bandwidth requirements will spur continuing upgrades. Metro networks for backhauling those services will continue to scale regardless of the macroeconomy, and the sheer volume growth in data will help to keep storage-area networking strong.
Planning for uncertainty
However, a soft economy could slow consumer spending on expensive smartphones and portable devices, and reduce demand for non-essential services like mobile TV or mobile video-on-demand. These factors could, in turn, moderate the rate of growth in mobile broadband services and wireless backhaul.
The mobile broadband revolution will continue, but a prolonged economic slowdown could potentially reduce the degree, rate, and manner in which mobile operators migrate from time-division multiplexed to IP-based radio access networks, or how quickly or completely they decide to migrate from 3G to LTE (long-term evolution – a project to develop 4G mobile standards) or pursue full convergence.
Whether the economy is in official recession or not does not really matter, it is definitely a bit slow and unstable, and operators are watching this closely. Service providers have many good reasons to be spending right now, as fundamental demand is very good for telecoms – and which operators will survive and thrive depends to a significant degree on what network investments they make next.
In assessing the impact of the economy, it is important to start with an assessment of potential changes in consumer demand, then consider how the subsequent reactions of business planning and the financial markets will influence operators. Operator plans will determine how the equipment vendors and components suppliers should react.
Operators need to be prepared in case an economic slowdown gets worse and persists. They can do this by carrying out more substantive primary research to determine which services they offer will have “staying power” with subscribers in a downturn, and which of their planned new service revenue opportunities would face the fewest barriers to adoption. Vendors need to ensure that they do not unduly sacrifice the competitiveness of “bread and butter” products in favour of investing aggressively on higher-risk parts of the portfolio. Components suppliers need to second-guess their vendor customers, and do similar analysis of the root sources of demand if they are to ensure profitability.
Operators, vendors and component suppliers need to make assumptions about the future and, where possible, form contingency plans based on the various possible economic outcomes. Then they will have to cross their fingers, while continuing to watch the economy closely.
Maximizing profitability is often not about winning a race to market, it is about offering the right services and underlying products with the right features at the right price point and time. Getting that equation right is hard enough in a stable economy, but in a shifting and uncertain macroeconomic environment like we have now, maximizing profitability over the next year or two will be extremely difficult.
This article originally appeared in the Oct/Nov issue of FibreSystems Europe magazine. To receive these articles as soon as they are published, subscribe now.