Analysing the Evolution of Industry- The

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ANALYSING THE EVOLUTION OF INDUSTRY: THE

RELEVANCE OF THE TELECOMMUNICATIONS INDUSTRY1

Martin Fransman

Department of Economics and

Institute for Japanese-European Technology Studies

University of Edinburgh

25 Buccleuch Place

Edinburgh EH8 9LN

Phone: +44-131-650-4061

Fax: +44-131-667-4340

e-mail: [email protected]

1 Several scholars have influenced this study, though are not implicated by its conclusions. Dick Nelsonand the group working with him on the long term evolution of a number of key industries have, throughtheir discussions, helped me to formulate and clarify some of the issues discussed here. Brian Loasby, alsothrough discussion, has stimulated my thinking and influenced the direction of my thought. SteveKleppers work on industrial shakeouts and Dick Langlois and Paul Robertsons on modular systems andthe economics of networks have also been sources of stimulation. Finally, I am endebted to the work of

G.B. Richardson, particularly his 1972 article in The Economic Journal.


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There is a fundamental unity of action between the laws of nature in thephysical and moral world. This central unity is set forth in the general rule, towhich there are not very many exceptions, that the development of the organism,whether social or physical, involves an increasing subdivision of functionsbetween its separate parts on the one hand, and on the other a more intimateconnection between them. Each part gets to be less and less self-sufficient, todepend for its wellbeing more and more on the other parts, so that any disorder inany part of a highly-developed organism will affect other parts also.

This increased subdivision of functions, or differentiation, as it is called,manifests itself with regard to industry in such forms as the division of labour,and the development of specialised skill, knowledge and machinery: whileintegration, that is, a growing intimacy and firmness of the connectionsbetween the separate parts of the industrial organism, shows itself in such formsas the increase of security of commercial credit, and of the means and habits of

communication by sea and road, by railway and telegraph, by post and printing-press. (p.201)

we say broadly that while the part which nature plays in production shows atendency to diminishing return, the part which man plays shows a tendency toincreasing return. The law of increasing return may be worded thus: An increasein labour and capital leads generally to improved organization, which increasesthe efficiency of the work of labour and capital. (p. 265, emphasis added)

Alfred Marshall, Principles of Economics.

INTRODUCTION

What does an analysis of the telecommunications industry have to offer the growing

literature on industry evolution from an evolutionary/institutional perspective? The first

answer is that it provides another example of industry evolution to compare with the

increasing number of industries that are receiving attention from this perspective. A

number of scholars have called for just such an extension. For example, reacting to the

strong body of literature in this field which emphasizes the product life cycle model and

the related concept of a dominant design in a number of industries, Nelson (1998) has

argued: Some writers clearly believe [that the applicability of these ideas is] universal.

I confess some skepticism about that. The story seems to fit best industries where the

product is a system, and where customers have similar demands. It is not at all clear if


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the notion of a dominant design fits the experience of the chemical products industry

where often a variety of quite different products are produced for similar uses, or

pharmaceuticals where customer needs are divergent and specialized. (p.324) Theimplication is that more detailed studies are needed of other industries, a point that is

supported by Klepper (1997) who has made major contributions to this literature:

Additional products need to be studied, particularly less traditional products whose

evolution might be more likely to depart from the product life cycle. (p.176)2

A second benefit from studying the evolution of the telecoms industry, as the present

study emphasizes, follows from the role played in this industry by specialist suppliers.

Kleppers (1997) study suggests that various processes of specialization may be causally

connected to the absence of typical product life cycle patterns in a number of industries

and, correspondingly, to the absence of shakeouts as he defines them, although Klepper

does not reach any definitive conclusions on this matter. Nevertheless, he concludes that

a particularly fertile area for further research is tracing the evolution of firm

specialisation, including the circumstances underlying it, in a range of products.If, in

fact, the horizontal structure of the market co-evolves with the vertical structure, as the

review of the products [in this paper] would suggest, then this research would be

particularly valuable for understanding why some products do not evolve according to the

product life cycle. (p.177) The present paper deals with the issue of specialisation

through the study of the telecoms industry.

Thirdly, the study of the telecoms industry raises in a rather stark way the conceptually

difficult questions of what is meant by an industry and how we should define that

industrys boundaries, which in turn will determine the limits of the analysis of any

industry (i.e. to put it more concretely, what needs to be included, and what can

legitimately be left out, in an evolutionary analysis of any industry?) An examination of

the evolutionary/institutional literature reveals that, while the concepts of the firm and

market are widely used (even though on closer inspection there is often lack of clarity

2 The implicit equation of product and industry in the quotation is an issue that is taken up later in this

paper.


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or even overt disagreement regarding what is meant with the use of these concepts), and

while there is a well-developed literature on the boundaries of the firm, the same cannot

be said for industry and industry boundaries. This matter is closely related to that ofthe level of aggregation that is appropriate in the evolutionary analysis of industries

(whether the analysis is statistical or formal-theoretical or appreciative-theoretical) that

Dosi, Malerba, and Orsenigo (1997) have recently raised: there is a problem of

interpretation of statistical data and in particular of aggregation. The data that are

available and the regularities that are observed refer actually to entities and phenomena

that are defined at different levels of aggregation and at different time scales. For

example, in the life cycle approach, the emphasis is sometimes on narrowly defined

products and other times on industries. But how would this approach consider, for

example, mainframes and personal computers? Are they to be taken as different products

with distinct life cycles or as variants of the same basic product and of the same life

cycle? Probably the interpretation of patterns of evolution would turn out to be quite

different in the two cases. (p.17)

Other examples of aggregation problems also need to be considered. For instance, to go

back to our earlier quotation from Klepper regarding the importance of specialisation, is

it necessary to include an analysis of specialist suppliers, if they exist, in order to

understand the evolution of even an industry that is narrowly defined around a product?

The issue of appropriate industry boundaries is obviously central here. For example, in

one of the few studies that explicitly poses the problem of industry boundary his

subheading reads Defining The Boundaries Of The Traded Software Industry

Mowery (1996) opts for traded software in three areas: operating systems, applications

tools, and applications solutions. But this, as he points out, presents problems. To begin

with, determining the boundaries between computer services and computer software,

even in the traded software sector, may be virtually impossible. (p.5) Even more

problematical is his observation that Rapid hardware diffusionhas tended to erode

vertical integration between hardware and software and until recently appears to have

reduced the competitive significance of economies of scope among different standardized

applications, limiting the tendencies toward producer concentration that might otherwise


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be even stronger in an industry such as this, whose costs are primarily

fixed.[Furthermore,] the expanding installed base of ever cheaper computers has been

an important source of dynamism in and entry into the traded software industry. (p.6)

For these and other reasons, Mowery concludes that applications software is an example

of an industry that does not adhere to a model of technology life cyclesin which the

emergence of a dominant design in an industry is followed by a gradual decline in

entry. (p.11) These issues, it seems, raise in stark form the question of where the

boundaries of this particular industry should be drawn, and, if appropriate boundaries

are thought to be problem-contingent, what kinds of problems require what kinds of

boundaries. For example, Groves (1996) account of the new horizontal computer

industry and its boundaries driven by his own purpose to make sense of the

competition problems that Intel faces - includes not only operating systems and

application software in his definition of the industry, but also semiconductors and sales

and distribution.

As these examples make clear, a key question is how far we need to go in terms of the

boundary that is appropriate for the analysis of any industry. This question is central in

the present study of the telecoms industry. The approach that is taken here, to anticipate

the crux of this paper, is that this question can only be answered with reference to what

Schumpeter has called (though in a more general context) the prime movers or

fundamental impulses or engines of the system3. It is not claimed, however, that this

approach offers a panacea. Apart from the additional complexity that it adds, it raises the

difficult problem of how the industrys dynamics or driving forces are to be identified.

At present, the authors only answer to this problem is that a good deal of knowledge of

the industry is necessary. But this, clearly, is inadequate in view of the interpretive

ambiguity that is likely to arise, even among those knowledgeable about the industry,

regarding what the driving forces of the industry are.

3

Capitalism, Socialism and Democracy (1966), p.82-3.


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THE EVOLUTION OF THE TELECOMMUNICATIONS INDUSTRY

The analysis of the evolution of the telecoms industry is divided into two parts. In thefirst, the evolution of the industry is briefly described. The second part contains an

analysis of the dynamics or driving forces of the industry as well as an analysis of the

implications for industrial structure.

PART ONE: DESCRIBING THE EVOLVING TELECOMMUNICATIONS

INDUSTRY

Natural Monopolies With Different Forms Of Organization Governing The Relationship

Between Carriers And Their Suppliers

Until the 1980s the conventional wisdom was that the telecoms industry should be

regarded as a natural monopoly. This meant that for reasons of efficiency, namely the

primacy of economies of scale, telecommunications services should be provided by a

single monopoly carrier. Although this was the conventional wisdom in all countries,

fundamentally different forms of organization evolved governing the relationship

between the government-owned monopoly telecoms carrier and the supplier/s of its

equipment (mainly switches and transmissions systems). Amongst those countries that

were industrially large and sophisticated enough to have their own telecoms equipment

suppliers, the U.S. and Japan represented the polar extremes.

More specifically, while vertical integration was the dominant form of organization in the

U.S., a characteristic that was only to end in September 1995 when AT&T voluntarily

trivested itself, in Japan a cooperative form of organization evolved whereby a family

of four main suppliers catered for the needs of the monopoly carrier, NTT. Britain was

more similar to the Japanese pattern, although its experience with cooperation was not

nearly as happy as the Japanese. (For an analysis of the origins of these different forms


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of organization, see Fransman (1995).4 Most smaller industrialized countries (Sweden

being a major exception) and developing countries, lacking indigenous equipment

companies, obtained their telecoms equipment from the major global suppliers whocompeted vigorously in these markets.

Dynamism Under Natural Monopoly

Whilst the conventionally-trained economist might suppose that the industrial structure

just described would be un-innovative and inefficient, it is worth stressing that this was

not the case. For example, the real cost and price of calls tended to fall significantly in

most countries, telecommunications services were rapidly diffused and included universal

service, and, most significantly, there was a rapid rate of both incremental and radical

innovation. Indeed, most of the fundamental innovations that are driving the so-called

Information and Communications Revolution of the 1990s were made during the natural

monopoly period up to the mid-1990s. Examples include digital switching, optical fiber

(although some of the fundamental breakthroughs came from the glass industry), digital

transmissions systems, cellular mobile systems, packet-switched networks (though some

of the key initial innovations come from the computer community), and satellite

communications.

Why was there so much innovation under natural monopoly? Part of the answer has to

do with the success of long term fundamental but mission-oriented research undertaken in

places like AT&Ts Bell Laboratories, NTTs Electrical Communications Laboratories,

BTs Martlesham Laboratories, and France Telecoms CNET. Another part of the

answer lies in the non-market competition, but competition nevertheless, that existed

between the carriers of the major countries and their laboratories, vying for the prestige

of being first and best in particular areas. Coinciding with this competition were

4 G. B. Richardsons (1972) comment are relevant apropos this apparently conflicting choice of form oforganization in the U.S. and Japan: Theories of industrial organization, it seems to me, should not try todo too much. Arguments designed to prove the inevitability of this or that particular form of organizationare hard to reconcile, not only with the difference between the capitalist and socialist worlds, but also withthe differences that exist within each of these. We do not find the same organization of industryin the

United States and Japan. We ought to think in terms of the substitutability of industrial structures. (p.896)


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important forms of international cooperation, such as the regular international switching

conferences, which were important sources of information and stimulated processes of

search and experimentation.

A further part of the explanation lies in the political and other pressures that were put on

national carriers to improve their provision of telecoms services which were, after all,

vital, though in different ways, for everyone. Finally, the institutions of regulation were

also important. In addition to constituting a source of pressure for improvement,

regulation also helped to make knowledge created in the telecoms industry more open

than it would have been in a market-regulated industry. One notable example is

AT&T/Western Electrics patents for the transistor which were made almost freely

available to whoever wanted them (including small and then-insignificant companies like

Sony). (See Fransman (1995) for further details.)

Part-Liberalization In Some Countries From The Mid-1980s

In the mid-1980s a sea-change occurred with part-liberalization of the telecoms industry

in the U.S., Japan and Britain. In the U.S. AT&T was broken up into one long-distance

company, the reconstituted AT&T, and seven regional holding companies providing

regional services, the so-called Baby Bells. Furthermore, long-distance competition was

admitted with MCI and Sprint being the main original new-entrants. In Japan, three long-

distance competitors emerged to challenge NTT, namely DDI, Japan Telecom, and

Teleway Japan. In the U.K. a duopoly was established with Mercury, a subsidiary of

Cable and Wireless, as the new entrant.

However, although some competition was introduced, the liberalization was only partial.

While there was some competition in long-distance services it was limited by regulatory

restrictions on the number of new entrants and the absence of regulations requiring the

incumbent to open its networks to interconnection by new entrants at cost-based prices.

In general, local access (access to offices and homes) and local services remained


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monopolized by the incumbents. International accounting rate agreements ensured that

international rates were determined by an international oligopoly of national incumbents.

Although liberalization was only partial, this stage produced some important structural

changes that were to become important influences shaping the further evolution of the

telecoms industry. Amongst these were the new business opportunities that were opened

up, largely for powerful national business organizations hitherto denied openings in the

telecoms industry. As Douglas North (1996) has argued, organizations such as these are

also action groups which, through their actions, drive institutional change. And this

they did, helping to shape the new rules of the game that influenced the subsequent

evolution of the telecoms industry.5

The Context Provided By The Information And Communications Revolution

The decade from the mid-1980s was marked by an explosion in demand for new

information and communication products and services. From the point of view of the

telecoms industry, most important were mobile telecoms services and the Internet. Both

created rapid growth in relatively new markets and at the same time generated new

business opportunities for incumbents, original new entrants, and new new entrants

alike. From the late 1990s, the Internet became particularly important and, indeed,

became a new paradigm within both the communications and the information industries.

5 Institutions are the rules of the game of a society or more formally are the humanly-devised constraintsthat structure human interaction. They are composed of formal rules (statute law, common law,regulations), informal constraints (conventions, norms of behavior, and self imposed codes of conduct), and

the enforcement characteristics of both. Organizations, too, specify the constraints that structure humaninteraction inside the organization but in addition they are action groups. They are composed of groups ofindividuals bound by a common purpose to achieve objectives. They include [firms and other economic,political, social, and educational bodies]. Organizations in pursuit of their objectives are the primarysource of institutional change. (North, 1996, p.12, emphasis added) While there are many problems withNorths conceptualization of institutions and organizations, for present purposes they are useful largelybecause they allow a causal connection to be made between the economics of new entry (expected marketshare, rates of return etc) and the political processes that accompany new entry and the possibility of newentry. These political processes in turn structure the institutions, in Norths sense, which have played animportant role in shaping the evolution of the industry. Key issues in the industry, such as how the industryshould be regulated, how regulation should change over time, what specific regulations are needed, howregulation itself should be organized, who should be given licenses to operate and according to whatcriteria, etc are examples of institutional change in the Northian sense, all of which are subject to

determining political processes.


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Based on the triad of technologies contained in packet-switching, IP (internet protocol),

and the World Wide Web, the Internet, as is discussed later, provided an alternative

infrastructure for most telecoms services, including services such as voice and video-conferencing.6 The rapid growth in markets, the improvement of existing technologies

and the emergence of new substitute ones helped to fuel new entry and intensified

competition in the industry.

Further Liberalisation And Globalisation

The latter 1990s saw a further round of liberalisation, this time on a global scale. In the

U.S. the Telecommunications Act was passed in 1996 with the intention of introducing

competition at the regional and local levels (although this legislation soon became

bogged down in litigation as the Baby Bells successfully challenged the attempt to prise

open their markets). From January 1st 1998 the European Union officially opened all its

telecoms markets to competition (some markets having been opened earlier) although in

practice liberalisation is not yet complete in a few of the major European countries while

other countries were given extra time to liberalise. In 1997 the World Trade Organisation

(WTO) concluded an international agreement committing most countries in the world to

telecoms liberalisation.

Equally importantly, for the first time incumbents such as AT&T, NTT 7, BT, Deutsche

Telecom, and France Telecom began to globalise their activities and become new new

entrants in each others markets. Furthermore, with the notable exception of NTT, a

latecomer to the global race, these incumbents also established global alliances aimed at

providing multinational corporations with end-to-end services.

The late 1980s and early 1990s also saw the emergence of new breeds of new new

entrants. Two groups are particularly important. The first consists of industrial

companies and utilities that saw the growth and liberalisation of the telecoms industry as

6 For further details see Fransman (1998b).7 The complicated situation in Japan which in December 1996 resulted in the decision to allow Japans

largest carrier, NTT, to globalize is examined in Fransman (1997a and b).


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an opportunity for profitable diversification. The second group is made up of

entrepreneurs, usually without any background whatever in telecommunications, financed

by venture capital financial institutions8

. The modus operandi of the entry of both thesegroups, facilitated by one of the most important dynamic characteristics of the telecoms

industry, is analysed in the following section.

By 1995, as is shown in Figure 1, the size of the global telecommunications market was

estimated to be $519 billion (the table also showing the most important sub-markets).

PART TWO: THE DYNAMICS OF THE TELECOMMUNICATIONS INDUSTRY

The main argument of the present paper is that there are five determinants that together

constitute the driving forces behind the evolution of the telecoms industry and therefore

determine its dynamics. These five factors also determine the structure of the telecoms

industry. In this paper the definition of industrial structure suggested in Afuah and

Utterback (1997) is followed, namely to refer to barriers to entry, the nature and sources

of substitutes, the number and kinds of rivals, suppliers and customers (p.184). (The

important problem of the meaning and definition of industry, industrial structure and

industry boundary is considered further in the conclusion to this paper. 9)

DYNAMIC 1: QUASI-VERTICAL SPECIALISATION

THE SIGNIFICANCE OF SPECIALIST SUPPLIERS

The present organisation of the telecoms industry may be described as one of quasi-

vertical specialisation. One of the most important characteristics of the industrialorganisation of the telecoms industry is the role played by specialised equipment and

software suppliers. As noted in the last section, the equipment suppliers evolved in

8 To return to Norths definition of institutions, reference here, strictly speaking, should be to financialorganizations. However, as is shown later, the role played by capital markets in the evolution of thetelecoms industry constitutes one of the crucial rules of the game (in a general, rather than game-theoreticsense) under which the industry is evolving. Therefore, capital markets may also be thought of asinstitutions in the Northian sense.


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different ways in different countries. In Japan and Europe, although the monopoly

telecoms carrier did a significant amount of equipment-related R&D, the activities of

equipment research, design and development were, from the outset, left largely tospecialist equipment companies. It was in this way that companies like NEC, Fujitsu,

Ericsson, Alcatel and Siemens emerged as telecoms equipment suppliers (although all of

these companies are diversified beyond the telecoms equipment market). In different

countries, however, the pattern of co-operation between telecoms carrier and equipment

supplier/s differed. In Japan, for example, right from the outset in the late 1800s the

Ministry of Communications insisted on a degree of competition between its suppliers, a

form of industrial organisation that has been referred to as controlled competition10. In

Germany, on the other hand, Siemens was in effect the only supplier to the Deutsche

Bundespost and did the lions share of telecoms R&D.

In the U.S., however, "from the time that Alexander Graham Bell co-operated with

instrument-maker Thomas Watson in producing the first telephone sets, it was the same

organisation that both developed the telecommunications network and developed and

manufactured the equipment that it required. This pattern was firmly established in 1880,

when the American Bell Telephone Company purchased Western Unions telephone

supplying subsidiary, the Western Electric Company of Chicago. According to an 1882

agreement, American Bell restricted itself to purchasing all its telephone equipment from

Western Electric, while the latter agreed to limit its activities to supplying American Bell

and its licensees.11 This vertical integration of network operation and equipment

production in AT&T continued until the companys voluntary trivestiture in September

1995 into one company providing telecoms services, the new AT&T, one providing

equipment, Lucent, and one providing computers and computer services, essentially the

former NCR that had been acquired in a hostile take-over by AT&T in 1993.

9 In the conclusion it is suggested that there is no consensus in the literature regarding the meaning anddefinition of these terms and that this may be a drawback for the analysis of industry evolution. Somesuggestions are made using the present example of the telecoms industry.10 See Fransman (1995).11

See Fransman (1995), p.24.


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Why these different forms of industrial organisation in the different countries? The basic

problem that needed to be solved, as G. B. Richardson (1972) has analysed, was one of

organising complementary but dissimilar activities (dissimilar in the sense that networkoperation, on the one hand, and equipment design and manufacture on the other, required

different sets ofcapabilities12). That in AT&T these activities were organised inside the

same company, while in Japan and Europe they were separated in different companies, is

a reflection of Richardsons observation that It will be clear, in some situations, that co-

ordination has to be accompanied by direction [i.e. within a firm], by co-operation or

through market transactions, but there will be many others in which the choice will be

difficult13. It is worth adding, however, that apart from AT&T in the U.S., in all the

other countries the form of organisation adopted for co-ordinating the activities of

network operators and equipment providers was one of co-operation (in Richardsons

sense14) rather than a market-based relationship.15

Distribution Of R&D Between Carriers And Specialist Equipment Suppliers

With the increasing intensity of competition in the 1990s has come a tendency for a

greater proportion of telecoms industry R&D to be undertaken in equipment companies,

rather than carriers. In 1995, for example, while the global top eight carriers (including

NTT, AT&T, Deutsche Telecom, France Telecom and BT) spent a total of $7.5 billion on

12 I follow Afuah and Utterback (1997) here in making competencies + firm-specific assets = capabilitiesor resources [in the Penrosian sense], p.183.13 Richardson (1972), p.896.14 According to Richardson (1972), The essence of co-operative arrangementswould seem to be the fact

that the parties to them accept some degree of obligation and therefore give some degree of assurance with respect to their future conduct. But there is certainly room for infinite variation in the scope of suchassurances and in the degree of formality with which they are expressed. (p.886). In Fransman (1995) Ihave analyzed in detail the form of co-operative organization that evolved in the Japanese telecomsindustry, which I called controlled competition.15 This raises the question of the causes behind AT&Ts voluntary trivestiture in September 1995, whichresulted in the U.S. falling in line with Japan and Europe in this aspect of its industrial organization of itstelecoms industry. While this matter is too complex to analyze fully here, it is worth noting that one of thereasons officially given by AT&T for the trivestiture was the difficulty that its equipment divisions werehaving in trying to sell equipment to AT&Ts competitors who in some cases suspected that these divisionswould give competitive preference to their mother company. It is likely, however, that a related reason wasthe realization that as an independent company the equipment divisions (that later became Lucent) wouldbe able to take greater advantage of economies of specialization. In addition, the trivestiture allowed the

management of AT&T to give greater focus to the companys core telecoms services businesses.


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R&D, the top eight equipment companies (including Lucent, Ericsson, Northern

Telecom, Siemens, Motorola, and NEC) spent $23.4 billion.

The Emergence Of Specialist Data Networking Equipment Suppliers

A significant new trend that emerged from the late 1980s, on the back of the explosion of

Internet-related demand, was the rapid growth of a new breed of companies producing

data networking equipment for the Internet and IP (internet protocol) networks more

generally. Many of these new companies emerged through the activities of individuals

involved in designing and building the early computer networks, like the ARPANET, that

led to the development of the Internet. These companies include Cisco, 3Com, Bay

Networks, and Cabletron. It is highly significant that in 1996 these four companies

together spent $9.6 billion on R&D, compared to the $7.5 billion spent the previous year

by the top eightcarriers (NTT, AT&T etc). Cisco, the largest of them, only started in late

1984 as a venture by a group of Stanford University computer scientists. By March

1998, Cisco had grown into the third-largest company on Wall Street; with a market

value of $71 billion it was worth more than General Motors, making it the fastest-

growing technology firm in history16. Significantly, although some of the major

telecoms-related companies claimed that they had successfully integrated computer

competencies into their portfolio of competencies this was the official reason AT&T

acquired NCR, and the Japanese companies NEC and Fujitsu were both computer and

telecoms equipment producers none of them has made much headway in the rapidly

growing markets for data networking equipment.17

16 The Economist, March 28th, 1998, p.98.17 The difficulties that established firms often have in reconfiguring their competencies and routines inorder to produce new products competitively is now a well-established finding in the evolutionary literatureon firms (see, for example, Henderson and Clark, 1990). In this case the firms concerned (e.g.AT&T/NCR, NEC, Fujitsu) were significant players in computer markets, in addition to having importantcompetencies in communications networking, and a rigorous story still needs to be told to explain why theyfailed to enter successfully the markets for data networking equipment. It is likely that an important part ofthis story will be the significance of the circuit-switching paradigm in traditional telecoms products asopposed to the packet-switching on which the new data networks were based and, in the case of theJapanese companies, the relatively slow adoption of distributed client-server systems and the greater use of

proprietary mainframe platforms.


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The Emergence Of Specialist Software Suppliers

Also important to the dynamic of competition in the telecoms industry has been theemergence of specialist software suppliers. For instance, it has become apparent that

billing systems can play an important role in the competitive struggle. One famous

example is the Friends and Family option offered by MCI in a bid to attract customers

away from the dominant incumbent, AT&T (which involved offering cheaper rates on a

few frequently-called numbers). Billing systems can offer customers more information

about the services they are using and how they are charged, which may allow a carrier to

differentiate its product. More generally, billing systems can be integrated with the

carriers other information systems, such as network operation and management, giving

the carrier far more details about customer behaviour and therefore allowing for a more

sophisticated marketing of customised service packages. These packages, in addition to

the conventional fixed-wire voice service could also include mobile service, Internet

access, video-phone, as well as home banking and shopping.

The Consequences For Industrial Structure Of The Availability Of Specialist Suppliers

The availability of specialist suppliers is a particularly important determinant of industrial

structure (as defined above) and it is for this reason that it has been singled out as one of

the main driving forces in the telecoms industry. What impact does the availability of

specialist suppliers have on the structure of the industry?

The first effect is on entry barriers. More specifically, while barriers such as the amount

and cost of capital needed for entry, management and marketing competencies,

regulations, and brand name and reputation of the incumbent remain, the availability of

specialist suppliers has significantly lowered technology barriers. Original new

entrants, such as MCI in the U.S., DDI in Japan, and Mercury in Britain, as well as new

new entrants like WorldCom and Quest in the U.S. and Energis, Colt, Ionica and Esprit

in Britain, have been able to enter to begin with without any R&D capability to speak of.


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Two processes, both emerging from the specialist suppliers, have facilitated this

technological ease of entry. The first process has involved both the sale of telecoms

equipment and software to the new entrants as well as significant development work doneon their behalf to customise equipment and software systems to meet the entrants

specific requirements.18 The second process works through labour markets and involves

the entrant hiring staff who have accumulated knowledge, skill and experience in a

specialist supplying company and who accordingly are able to operate, manage, and

develop the new entrants network. These two processes, working together, have

considerably eased the entry process. The contrast with other industries, such as motor

cars, where technological and organisational barriers are far higher, is great.

The second component of industrial structure defined earlier is the nature and sources

of substitutes. Here too the specialist suppliers have played a key role. Several

examples will highlight this point. One example is Voice-on-the-Internet (VOI), a

substitute for conventional telephony over circuit-switched lines, which with its far lower

costs (the result of Internet tariffing) is already beginning to reduce standard telephone

charges by the established carriers. Some estimates suggest that by 2002 as much as 13

percent of voice calls may be made over the Internet19. VOI was pioneered in 1995 by a

small Israeli-owned start-up called Vocaltec. Vocaltec is now working with Deutsche

Telecom in Germany to introduce VOI.

A second example is a possibly radical breakthrough called Power Line. Essentially,

Power Line involves the provision of data communications, including VOI and Internet

access, through the electric power cables that are already connected to firms and homes,

thus avoiding the need to dig up streets (as with optical fibre cables) or establish radio

base stations (as with mobile or fixed radio access connections). Power Line works

through radio frequencies being transmitted through electric power cables. Relatively

18 In a personal interview, a senior executive from WorldCom explained to me how the company, which in1997 achieved global prominence when it snatched MCI away from BT in a takeover bit, while doingvirtually no R&D, works extremely closely with traditional suppliers like Northern Telecom and Alcateland new suppliers like Cienna. The size of WorldComs network and its buying power guarantees it theclosest attention from its suppliers with the result that the company does not feel it necessary to make in-house R&D a priority.


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cheap enabling technology is required at the electricity substation (serving 250 homes)

and at the customers electricity meter. The original innovation was made by an engineer

working with Norweb, the electricity company that supplies the Manchester andYorkshire areas of Britain. (Apparently, the engineer persisted with his research after

being told my his managers that the project was not feasible and should be ended.) In the

event, Norweb obtained the commanding patents for Power Line. However, Norweb,

lacking the technological competencies, also entered into a strategic alliance with

Northern Telecom (Nortel), the established Canadian telecoms equipment company

which went on to develop the necessary technology to make Power Line both

technologically and economically feasible. Although it is too soon to tell whether this

new technology will be a serious substitute for other alternative telecoms transmission

and local access technologies (Norweb and Nortel claim that it is significantly cheaper

than the other alternatives), the example is a good illustration of the importance of

specialist suppliers as a force driving the dynamics of the telecoms industry.

The third component of industrial structure is the number and kinds of rivals [and]

suppliers. From what has already been said it is clear that the specialist suppliers have

had, and are continuing to have, a significant impact on this component too. The fourth

and final component, customers, are dealt with below.

The Question Of Shakeout

Specialist equipment suppliers also have important implications for another aspect of

industrial structure, not included in the definition we have used here by Afuah and

Utterback (1997) but emphasised by Klepper (1997) and Klepper and Simons (1997),

namely the process of shakeoutwhich was briefly discussed in the introduction to this

paper. More specifically, by making most of the network technologies available to all

entrants able to pay the market price, specialist suppliers may have circumvented a major

19

Business Week, April 6, 1998, p.49.


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source of shakeout20 that has occurred in industries such as motor cars, tires, televisions,

and penicillin, namely increasing returns to innovation, which may accrue to the early-

entering incumbents. Correspondingly, the availability of specialist suppliers and theaccess to technologies that they supply has also had the effect of shifting the thrust of

competitive strategies away from equipment-oriented R&D towards the achievement of

other objectives such as service differentiation (that may depend on software

development), speed of response to market opportunities, reliability of services, security,

etc.

The issue of shakeout, however, raises an intriguing question regarding the future

evolution of the telecoms industry, namely, will this industry experience shakeout as

defined here? With the liberalisation and globalisation of telecoms markets there has

been a significant increase in net entry (i.e. entry minus exit) of firms. In Britain, for

example, by 1998 the national regulator, Oftel, had granted 20 licenses to fixed link

public telecommunications operators (which included companies like WorldCom, AT&T,

Deutsche Telecom, France Telecom, and NTT), 56 licenses to international facilities-

based services operators, and 78 licenses to international simple resale operators (who

provide services based on capacity leased from other carriers).21 (These figures exclude

entrants into the mobile, cable, and satellite markets.) How will net entry change over the

next five years? How many of the players will be left in the market in five years time?

These are key questions requiring an understanding of the dynamics of the industry.

Klepper and Simons (1997) conclude that

Our findings suggest that shakeouts are not triggered by particular

technological developments but are part of an evolutionary process that is

driven by continual technological change. Technological innovation

20 According to Klepper (1997) a product [i.e. industry] is deemed notto have experienced a shakeout ifthe number of firms never declined below 70% of the peak number, or if it did but subsequently recoveredto over 90% of the peak. (p.165)21 Authors calculation based on data from Oftel. As far as the author is aware, there are no reliablestatistics regarding net entry rates for the major industrialized countries. One of the problems regarding


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apparently contributes to a mounting dominance by some of an industrys

early-entering firms which eventually makes entry untenable and steadily

drives out smaller firms with relatively high costs and low quality.(p.381, emphasis added)

While the process of full competition has not been going long enough in the telecoms

industry for this industry to provide further evidence against which to test this

Klepper/Simons hypothesis, from the ex ante viewpoint of the present it seems at least

possible that, whether or not a shakeout as technically defined here emerges in the future,

the presence of specialist equipment and software suppliers will limit mounting

dominance by some of the industrys early-entering firms and will provide increased

viable options for smaller firms by providing them with both cost and quality competitive

advantages. In short, it may well turn out that the telecoms industry is more in line with

the second group of industries referred to in Klepper (1997, p. 168-174) which do not

conform to the conventional product life cycle pattern of entry and exit and which do not

experience shakeouts as defined, industries that include petrochemicals. Significantly, as

Klepper notes, these latter industries are also characterised by the presence of specialised

suppliers of one sort or another, though not necessarily confined to equipment suppliers.

DYNAMIC 2: FOUR KINDS OF COMPETITION

Many of the applications of the product life cycle model to the evolution of particular

industries have emphasised the importance of technical change as a driving force (see,

e.g. Klepper (1997), Klepper and Simons (1997), Utterback and Abernathy (1975),

Utterback and Suarez (1993), and Afuah and Utterback (1997). Particular attention has

been paid to the process of convergence around a dominant design in product technical

change and, once this has occurred, to the priority assigned to process technical change.

Although competition between technologies is undoubtedly an important part of both

these statistics is that they should measure effective entry i.e. refer to firms that have not only been

granted licenses but have made credible entry into telecoms markets.


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product and process technical change, this competition per se has not received

prominence in most of the explanations.

In the present analysis of the telecoms industry, however, it will be argued that

competition between technologies is so important as to constitute the second dynamic

driving the evolution of the industry. But competition between technologies, as will be

shown, is also intricately tied up with competition between networks and competition

between services, as well as the more conventionally recognised competition between

firms.

Complementarity Between Technologies And Network Assets

Although there are always specific technologies embodied in network assets, it is

necessary to separate conceptually network assets from the ongoing process of technical

change because they (i.e. the assets) are often the object of further technical change. The

example of asynchronous digital subscriber line (ADSL) technology illustrates this point

as well as highlighting some of the processes driving the co-evolution of technologies,

firm strategies and competition.

One of the main advantages enjoyed by the incumbent telecoms operators is their existing

extensive networks with greater geographical coverage than any of the entrants, whether

original new entrants or new new entrants. These networks, however, embody different

generations of technologies that are, nevertheless, designed to be compatible and

interoperable with one another. Accordingly, while part of the incumbents networks are

state of the art (for example, using digital or ATM asynchronous transfer mode -

switching and SDH/SONET transmissions), other parts consist of old technology, such as

the copper cables that still connect the metaphorical last mile to most homes. Although

the upside to the use of these old technologies and the assets in which they are embodied

is the low fixed cost of using fully-depreciated assets (albeit counterbalanced by possibly


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high running costs), the downside is the limited capacity (bandwidth) provided by these

assets.

It was in order to address this bottleneck22 that a wave of research was undertaken

globally, particularly by incumbents, to develop ASDL technology, a technology that at

first was thought to be of limited relevance. A good deal of this research in the early

stages, such as that undertaken by BT in conjunction with trials in the vicinity of its

Martlesham Laboratories, was done in order to establish the viability of ADSL for use in

a hoped for killer application, namely video-on-demand (VOD) over copper telephone

lines. As things have turned out, however, much of the demand for VOD appears to be

still-born but ADSL (now called XDSL, to include later generations of the technology)

has been significantly improved through a process of rapid incremental change and is

now seen as a competitive technology for the transmission of data at sufficiently high

bandwidths to allow, for example, voice and video over the Internet to be received in

homes where the last mile is connected by copper cables.23

Competition Between Technologies

XDSL also provides an example of competition between technologies that, as will shortly

be shown, is an important driver of other aspects of telecoms industry evolution. The

main site for the battle between XDSL and its rival technologies is the local access

market. The crux of the matter is portrayed in the following extract from a partisan paper

by BT in response to a document by the industrys regulator, Oftel, the paper carrying the

22 As scholars of innovation and technological systems have noted, techno-economic systems produce aninternal dynamic that influences the innovation process and through it the future evolutionary path of thesystem. This dynamic is created by the incentives and focussing mechanisms that arise in addressingsystemic bottlenecks that impede the systems performance. Tom Hughes uses the military terminology reverse salient to describe this process (see Hughes (1984). A similar analysis is contained in Rosenberg(1976). XDSL provides a telecoms example.23 Interestingly, at the Competitive Carrier Forces conference held in Versailles in March 1998 attended bythe author, one of the main meeting points for members of the industry, XDSL was branded by one of thespeakers as the incumbents technology, and was portrayed as a negative force with the potential toincrease the staying-power of incumbents who were otherwise seen as uncompetitive, bureaucratic,anticompetitive, and reactionary forces in the industry! For present purposes, however, the XDSL exampleprovides an instance of the co-evolution of technologies, firm strategies, competitive process, and industrial

structure (in terms of the effect on entry, exit, shakeout, the positioning of rivals etc).


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underlying message that BT faces effective competition even in the UK local access

market which in terms of market share it appears to monopolise with a share of 90

percent. (This extract also raises the important related issue of the impact of technologieson the definition and boundaries of markets through the effect of the technologies on the

substitutability of telecoms services.):

When analysing the market for access from the point of view of the

customer wishing to obtain access to the telecommunications networks in

the UK, there are a number of products that can reasonably be regarded as

substitutable. Analogue lines [based on copper cables], ISDN lines

[integrated services digital network capable of carrying voice, data, text,

and video], telephone lines offered by cable TV companies, fixed and

mobile radio access and PCN [another mobile service] are all currently

available alternatives. The cost of access to the customer may vary

depending upon the technology used, and the different means of access

may be regarded as more or less substitutable, taking into account

functionality, price and the speed of delivery.the different technologies

are likely to become more and more substitutable and the degree of

substitutability over time needs to be taken into account when determining

whether a number of different alternatives are in the same market, and

whether that market can be described as competitive. (BT, 1996, p.19)

While this observation is standard fare for those in the telecoms industry, from the point

of view of evolutionary analysis the significance lies in the co-evolutionary processes

that are at work. These processes are worth spelling out at a general level. There are at

least seven distinct technologies that can be identified which are involved in the process

of local access. These are: optical fibre, copper/XDSL, co-axial cable TV, fixed radio

access (which uses radio to provide access on fixed lines), mobile cellular and PCN,

satellite, and power line (involving the use of electricity cables, as discussed above). The

first point to make about the co-evolutionary process is that the evolution of each of these

seven technologies is co-determined by each of the other technologies in that the


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performance parameters that the technology must meet in order to remain viable is

determined by the performance of the competing technologies. For example, within

certain cost and price limits, XDSL using copper cables must be able to carry comparablebandwidth to that available over optical fibre or co-axial cables.

But competition between these technologies is also influenced by the firms (their

strategies and their competitive fortunes) with a vested interest in the technologys

development and performance. For instance, as noted in the last footnote, it is the

incumbents who have a particular interest in increasing the performance of copper cables

through XDSL since these cables still form an important part of their network. For this

reason XDSL has been referred to as the incumbents technology. On the other hand,

new entrants have usually entered on the basis of later generations of technology and

therefore have different technological vested interests. For example, MCI in the U.S. was

an early adopter of optical fibre as it rolled out its network to compete with AT&T. In

Britain, Ionica, a new new entrant based in Cambridge, created its network on the basis

of fixed radio access, with a radio connection covering the last mile and linking the

customer to the fixed network. In this case the technology was developed for Ionica by

Nortel, the Canadian equipment-maker, but clearly Ionica has a vested interest in the

future progress of fixed radio access technology. (Ionica has recently run into difficulties

leading to speculation that it may become one of the first major examples of exit in the

U.K., though these problems have not been specifically technological in nature.) In

Japan, DDI, the main original new entrant competing with NTT, based its network on

microwave radio (partly to overcome rights-of-way problems) although the bandwidth

constraints of this technology subsequently created problems for the company with the

explosion of Internet and IP (internet protocol) demand for bandwidth.

From these examples it is clear that the causal influences shaping the evolution of each of

the technologies are closely bound up with the factors influencing the firms which

support these technologies. In turn, the evolution of these firms is determined by their

success in the various selection processes that define winners and losers, an outcome that

is partly dependent on the capabilities of the firms (i.e. their competencies and


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complementary assets) and the strategies they have formulated. However, while this

brief and partial account of the co-evolutionary process is very much at the general level,

far more detailed research is necessary to show precisely how specific technologicalchanges have come about under the influence of the co-evolutionary process.

Evolutionary studies of industries have thus far, for understandable reasons, generally not

delved too deeply into this detailed complexity.

Competition Between Networks

Telecoms networks are complex systems made up of aggregations of different

generations of technologies. While in the last section competition between different

micro-technologies was discussed, it is also necessary, in order to understand the

dynamic of the telecoms industry, to analyse competition at a higher level of aggregation,

namely between networks and the services they provide (and are constrained from

providing). The reason is that in many instances these networks provide alternative ways

of providing similar services. The networks also complement one another in various

ways. For this reason it may be suggested that the telecoms industry as a whole may be

understood as being based on a network of networks, an overarching network consisting

simultaneously of complementary and competing sub-networks that are interconnected

and interoperable.

The Evolution Of Packet-Switched Networks

An important example illustrating this point is the evolution of packet-switched networks

that eventually, together with other complementary innovations, facilitated the emergence

of the Internet, an outcome totally unforeseen by the original creators of these networks.

Packet-switching is essentially a technology used for the transmission of data. It involves

the breaking up of data (in the form of bits) into packets which are then given an

address header enabling the packet to be routed in the way that is most efficient at the

time, different packets from the same data set possibly taking different routes to the final


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they had already decided to develop a packet-switched network, TRANSPAC, which

improved rapidly and is the centre-piece today of the companys data network.

The subsequent evolution of packet-switched networks was influenced by many other

factors including the PC revolution beginning in the late 1970s and the consequent

emergence of client-based distributed computing, the related proliferation of local area

networks connecting computers (LANs), the facilitating evolution of the TCP/IP and

other protocols, and an explosion in user demand for services such as electronic-mail and

later World Wide Web applications (which depended on another key complementary

innovation, namely the technology on which the World Wide Web was built (facilitating

the subsequent production of Web browsers) originally developed by Tim Berners-Lee at

the CERN physics laboratory in Switzerland).

By the mid-1990s, packet-switched networks were able to offer substitutes (with varying

elasticities of substitution) for most of the services offered by telecoms companies using

conventional circuit-switched networks. Accordingly, there is currently increasing

competition between these two kinds of networks. Nevertheless, some important

distinctions remain as a result of the original purposes served by these networks. More

specifically, having originally been developed for the purposes of voice communication,

circuit-switched networks are real-time based and therefore currently offer the best

quality of voice reception. On the other hand, packet-switched networks, though near-

real-time, still exhibit a slight delay, the result of packets arriving at different times and

orders. Whether packet switching and transmission technologies will ever improve so as

to offer a more perfect substitute for circuit-switched voice remains an open question

currently.

For present purposes, this example highlights the role played by competition between

networks and the services they provide as a driver of the evolutionary process in the

telecoms industry.


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Competition Between Services

As we have just seen, different networks may support different, competing, services. Afurther example is fixed versus mobile telephony, the latter offered over land or satellite

based networks. However, there is not necessarily a one-to-one correspondence between

network competition and services competition. Competing services may also be offered

on the same network. For example, both packet-switched and circuit-switched networks

can offer voice, fax, and e-mail services that to some extent, for some purposes, are

substitutable services. It is for this reason that a conceptual distinction between

competition between networks and competition between services is necessary. From the

co-evolutionary point of view, it is clear that the outcome of competition between

services will have knock-on implications for the relationship between networks and

technologies.

Layers Of Competition

To facilitate the conceptual distinctions required, it is helpful to think of layers of

competition (the generic layer model, incidentally, playing an important conceptual role

in telecommunications design thinking more generally). While the lowest layer consists

of competition between micro-technologies (i.e. the alternative building-blocks of

telecoms systems), the following layers, in ascending order, consist of competition

between networks, competition between services, and finally, competition between firms.

Competition Between Firms

Competition between firms more specifically, between incumbents, original new

entrants, and new new entrants may therefore be thought of as overlying the other

layers of competition. As already stressed, the relationship between the layers is not

necessarily one-to-one. For example, incumbents may have circuit-switched, packet-

switched, mobile, and even cable and satellite networks as part of their overall network,

although new entrants typically have a far narrower range of networks. Similarly,


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different firms will offer different combinations of services and will depend on different

combinations of technologies. Furthermore, to make matters even more complex, the

competition between technologies that according to the present layer model takes place inthe technology layer, may also simultaneously take place within the firm layer. This

happens with inter-technology competition within firms. Examples studied in detail by

the present writer include the battles between supporters of space-division switching and

digital time-division switching within firms like AT&T and NTT, which were in

principle similar to the rivalry that took place between proponents of silicon-based

semiconductors and III-V compound semiconductors such as gallium arsenide in

semiconductor firms like NEC, Fujitsu and Toshiba.24 Once again, there are important

implications of these kinds of competition for the co-evolution of firms, services,

networks, and technologies.

DYNAMIC 3: THE ROLE OF FINANCIAL INSTITUTIONS

Financial institutions also play a key role in the dynamics of the telecoms industry,

particularly in the current phase of rapid expansion, liberalisation and globalisation. In

the sense of Douglas North (quoted earlier), financial firms play a dual role in the

evolution of the telecoms industry. On the one hand, they are Northian organisations,

action groups with their own vested interests, seeking to make profit from financial inter-

mediation. As action groups, however, they also collectively play a crucial role in

assigning market values to the competencies and complementary assets of both telecoms

operators and their specialist suppliers. These market values, based essentially on the

present value ofexpected25 future net earnings, play a crucial role in the evolution of the

industry as will shortly be demonstrated. On the other hand, financial firms are also

24 See Fransman (1995) for details.25 A perennial debate in the telecoms industry, as in all other industries, relates to the rationality of theprocedures financial analysts use in order to arrive at their strong buy/buy/hold/sell recommendations,conclusions which are not necessarily free of self-interest (even if these are explicitly declared) and whichthemselves often come to constitute a key part of the set of information which investors use to make theirbuy and sell decisions, which in turn drive the process of company valuation. The interpretive ambiguity(see Fransman, 1998a) involved in the financial analysts calculations is often manifestly apparent, raisingimportant questions regarding the whole role of financial valuation and its role in industry evolutionary

processes.


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Northian institutions insofar as they influence the rules of the game and the humanly-

devised constraints that structure human interaction in the telecoms industry.

The role played by financial institutions in the evolution of the telecoms industry is

illustrated most dramatically by the case of WorldCom, the new new entrant in the U.S.

market that rose to global prominence in 1997 when it frustrated BTs attempt to merge

with MCI, the U.S.s second largest long distance carrier, with a takeover bid for MCI of

$30 billion. Originally set up in a coffee shop in Hattiesburg, Mississippi in 1983 as

Long Distance Discount Service (LDDS) WorldCom on its web-site proudly recording

that this was a name suggested by a waitress [in the coffee shop] the company from

an early stage, having captured the imagination of financial analysts, was able to grow

primarily through stock-financed merger and acquisition. By the time it made its bid for

MCI, WorldCom had already acquired UUNet, the U.S.s largest Internet access

provider, and MFS a telecoms company providing local access and services largely in

major financial and business centres around the world. By 1998 it was clear that

WorldCom - with its strength in the U.S. in local, long distance and international markets,

as well as Internet traffic, and its rapidly growing global network - arguably posed the

greatest competitive threat to incumbents like AT&T, NTT, and BT.

Figure 2 provides data on the ratio of firms market capitalisation to their sales for 1997.

WorldCom clearly stands out. While the other established players mainly incumbents

but for the U.S. also including original new entrants MCI and Sprint have a multiple of

around 2 to 3, World Com enjoys about 5. More recently, in fact, even newer entrants

such as Quest and Teleport in the U.S. have been given multiples of around 1026

facilitating similar rapid growth in part through merger and acquisition. In Europe, new

new entrants like Energis, Colt, and Esprit have been able to play a similar role, though

on the basis of a market capitalisation that has not been as high as that obtained by the

U.S. entrants.

26

Business Week, April 6, 1998.


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The example of voice telephony will be examined briefly to make clearer the

evolutionary implications of heterogeneous and rapidly changing consumer demand.

From the beginning, and until relatively recently, voice telephony was confined to arather homogeneous service that is now rather nostalgically referred to in the industry as

POTS, plain old telephone service. In the days of POTS the main differentiator was

distance, with different tariffs being charged for local, long-distance, and international

services. More recently, things have changed radically since one of the main

implications of the technological advances introduced primarily by optical fibre (with its

almost unlimited bandwidth) and packet-switching is the so-called death of distance

where the cost of sending bits of information is no longer a function of distance.

At first sight one might suppose that this would result in a greater homogenisation of

voice services. However, this has not been the case since voice services themselves have

become differentiated in a number of different directions. One example is the advent of

cellular mobile voice telephony, an invention that was first made in Bell Laboratories

between 1947 and 196027 but which at first diffused most rapidly in Sweden and the other

Nordic countries.28 At first there was a great degree of interpretive ambiguity in the

industry regarding the extent to which consumer preferences for the characteristic of

mobility would be sufficient to compensate for the additional cost of mobile voice

services, the frequently lower quality of these services (due to radio interference), the

limited geographical availability of the services, and other disadvantages such as the

initial heavy handsets. With time, however, an explosion of demand (largely unforeseen)

for mobile voice telephony occurred, spurred by the dynamics of increasing returns

which, via Marshallian interactions between improving organisation and knowledge,

resulted in improving and cheaper mobile services. Furthermore, the adoption of

regional, if not global, standards, such as the highly successful European GSM (Global

27 See Mellman (1984), p.235-7.28 It was early diffusion in Sweden and the other Nordic countries that, through processes of path-dependency and dynamic increasing returns, presented distinctive opportunities to companies in this region,advantages that were strategically seized by Ericsson and Nokia which still enjoy dominant positions in

global mobile markets.


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System for Mobile Phones) for digital mobile voice telephony, has further increased the

utility of the service.29

Mobile voice telephony, however, is in the throes of further evolutionary differentiation.

One important trend is captured by the decision in early 1998 by ETSI (the European

Telecommunications Standards Institute) to adopt a new standard for so-called third

generation mobile services, referred to as UMTS (universal mobile telephone system).

This set of standards will facilitate the provision of multimedia services including, in

addition to voice, Internet access and the receipt of live video on mobile handsets.30

Voice is also becoming integrated with other services in other areas too. One example is

so-called computer-telephony integration (CTI), where voice telephony is integrated with

computer functionalities with applications in areas such as call centres where an operator

can answer a query from a customer while simultaneously getting information from a

database regarding that customers past purchasing history, payments record, other

purchases etc, therefore at the same time facilitating attempts to market other products to

the customer. More recent is the integration of Internet telephony with Web sites so that

at a click it is possible to speak to a sales person to get immediate answers to queries that

arise from the information presented at the site.

For present purposes, these examples point to heterogeneous and rapidly changing

customer demands and products as important dynamic influences on the evolving

structure of the telecoms industry, as defined earlier in terms of barriers to entry, the

nature and sources of substitutes, the number and kinds of rivals, suppliers and

customers. For instance, it may be hypothesised that both the heterogeneous as well as

the rapid change in customer demand will have a positive effect on net entry and

29 GSM was also widely adopted in Asia and Latin America, although the U.S. went its own way withanother set of standards.30 The adoption of UMTS was preceded by a standards battle around two competing standards. The one,TD-CDMA, was supported by suppliers like Alcatel, Siemens, Lucent and Motorola, while the opposingstandard, WB-CDMA, was proposed by Ericsson and Nokia, two of the strongest suppliers in the mobilearea, as well as most of the European telecoms operators. Furthermore, WB-CDMA also had the advantageof drawing significantly on similar standards that had been developed by an NTT mobile subsidiary, NTTDocomo, opening up the future possibility of this also becoming the dominant standard in Japan and therest of Asia. In the event, although a compromise was announced, it was the WB-CDMA standard that

dominated. The U.S., meanwhile, has decided to go its own way with a somewhat different standard.


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significantly reduce the probability of shakeout as defined earlier. As these examples

testify, it is clearly necessary to model demand as an integral part of the dynamic

processes that drive the evolution of the telecoms industry, even if this is donequalitatively rather than quantitatively in order to capture the essential complexities and

causalities of heterogeneous and changing demand.

DYNAMIC 5: PERMEABLE INDUSTRY BOUNDARIES

The fifth and final dynamic driving the evolution of the telecoms industry that will be

considered in this paper is the permeability of industry boundaries, more particularly,

ease of entry from neighbouring industries. The specific case that will be examined is

entry from the computer and software industries.

From the authors interviews with senior executives from companies like AT&T and BT

it is clear that computer and software companies are viewed as increasingly threatening

new entrants into some of the markets being contested by these incumbent telecoms

companies. (Although this issue should simultaneously be analysed from the perspective

of computer and software companies diversifying into new areas, it is the perspective of

the telecoms industry that will be followed here.) Where precisely is the threat perceived

as coming from? Two areas will be identified in this section.

The first area is a new emerging market that may be referred to as the solutions market.

What is the solutions market? It is the market where telecoms companies not only act as

bit transporters for their customers, but go further up the latters value chain to offer

solutions to their communications problems. This requires, metaphorically, that the

telecoms company does not simply take its pipes up to the door of the customer, but

also enters the customers establishment whether firm or residence and helps

customers with solutions to their communications problems. A telecoms company that

has begun to articulate a solutions strategy, as part of its strategic portfolio, is AT&T

which explicitly has begun to define itself as an information and communications

company. In Europe, for instance, AT&T and its partners in Unisource are attempting to


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differentiate themselves from other competitors by offering what they term solutions

and applications.31

What are the attractions of the solutions market for telecoms companies? The first

attraction is that the solutions market is seen as a potentially high profit margin area, in

contrast to the bit transportation market which some argue has become commoditized,

with correspondingly low margins, as substantial economies of scale are realised by

companies like WorldCom which have invested in huge pipes, that is high speed, high

capacity networks which, with sufficient traffic, yield relatively low unit costs. A further

factor making for the commoditization and low margins of bit transportation is the

competition between different kinds of networks such as cable TV coaxial, mobile, and

satellite networks in addition to the fixed public switched network which are

increasingly interconnected and interoperable thus providing alternative ways of

transporting bits. Secondly, it is argued that there is a complementarity between

solutions and bit transportation insofar as a telecoms company that sells solutions to a

customer is also more likely to get that customers bit transportation business. For

intensive potential users of these kinds of services, such as leading financial institutions,

complementarity is an important issue. It is for this reason that AT&T has begun to sell

itself in Europe as a company which specialises in all aspects of data, including the

storage, processing, and communication of data. This has taken the company into the

areas of Intranets (using the TCP/IP protocol for intrafirm communications) as well as

Extranets (using the same protocols for network-based communications with suppliers

and customers, including electronic commerce).

The problem, however, is that while this seems like a natural competence-based

diversification for telecoms companies like AT&T,32 entering a domain that is also

contested by computer and software companies raises important strategic questions of the

31 Authors interview.32 Interestingly, AT&Ts solutions strategy is, if anything, being more strongly articulated since thecompanys voluntary trivestiture in September 1995 when NCR was spun off. However, the rationale forthe acquisition of NCR in 1993 was that AT&T needed in-house computer competencies in order toprovide information and communication solutions. Evidently, the new AT&T has come to the conclusion

that the earlier assumption was a mistake.


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distinctive competencies and complementary assets of the two sets of firms. While it

might be supposed that telecoms companies have distinctive competencies in designing,

managing, and maintaining networks, the advent of data networks based on packet-switching which, as shown earlier, emerged from the computer rather than the telecoms

industry, and IBMs capabilities in running its own extensive global corporate network,

provide reasons for doubting the exclusivity of the telecoms companies competencies in

this area.

The second area where telecoms companies are being challenged by computer and

software companies is in more conventional telecoms services such as voice and fax. In

part the threat comes from packet-switched data networks that have already been

discussed in this paper. But threat also comes from the domination of what may be

thought of as strategic heights (to again use a military analogy) by computer and

software firms. To take a key example, Microsofts dominance of the de facto standard

for desktop computers, which it is currently attempting to extend into Internet servers

through its Windows NT format, as well as into browsers with its Internet Explorer, and

into networked consumer electronic products with Windows CE, raises the possibility of

Microsoft having the power to guide consumers to the use of particular telecoms

services over particular networks. For example, Microsoft networked meeting software,

used for remote users to communicate with each other and share data, already has

Internet telephony incorporated. Although at various points Internet traffic is carried

over the networks of telecoms companies such as the Internet backbones and although

this means that some of these companies benefit from the growth in demand for Internet

usage, the worry for telecoms companies is clearly that they will be excluded from

profitable business areas as a result of the dominance of commanding heights by

computer and software companies.

Again from the point of view of the evolutionary analysis of the telecoms industry, these

examples make clear that an important dynamic driving force emerges from the

permeability of the boundaries of this industry. This permeability clearly influences all

the elements of industrial structure considered in this paper.


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CONCLUSION

What are the implications of the evolution of the telecoms industry for the general

evolutionary/institutional analysis of industry? The first implication relates to a set of

issues revolving around what may be called the Product Life Cycle Paradigm.

How well does the telecoms industry fit into the Product Life Cycle Paradigm? The

general answer is not very well. There are several reasons for this answer. To begin

with, in the industries that supposedly conform to this paradigm industries such as

motor cars, televisions, tires, and penicillin there is a tight coupling or correspondence

between three sets of factors: consumer tastes and characteristic preferences, design

configurations that provide these tastes and characteristics, and manufacturing or process

technologies which are used to produce the products embodying these design

configurations. The telecoms industry, conversely, is characterised, firstly, by a far

greater degree of heterogeneity in each of these three areas, and secondly, by a much

looser correspondence between each of them.

The example of voice telephony, analysed in this paper, illustrates this point. The

relevant consumer characteristic preferences in the case of voice telephony relate to

factors such as mobility, quality of reception, ease of use, portability, geographical range,

combinability with other complementary services, in addition to price. Furthermore,

there is a wide variety of configurations capable of providing all or some of these

consumer characteristics (configurations of product/service packages, the networks over

which these characteristics are provided, and the technologies provided in these

networks, as has been shown in detail in this paper). If the notion of dominant design

does have a relevant meaning in the telecoms industry, and in the authors view it does, it

is in a far more restricted area such as the design of individual products (e.g. mobile


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handsets or digital switches) or even the design of particular kinds of networks (e.g. local

area networks (LANs). But these designs do not provide a central organising principle

for the industry as a whole as the dominant design does in the Product Life CycleParadigm.

The second reason the telecoms industry does not fit the Product Life Cycle Paradigm

very well has to do with the important role played in this industry by specialist equipment

and software suppliers, a major theme in the present paper. While Klepper (1997) has

suggested that a key behavioural characteristic of product life cycle industries is the

appearance of a shakeout once a dominant design has been established and once some of

the industries firms, often early entrants, have managed to reap the rewards of dynamic

increasing returns to innovation, in the telecoms industry it would seem that the presence

of specialist suppliers constrains the shakeout process by making key technologies and

other inputs available to all able to pay the price. A further consequence of the presence

of specialist suppliers is that the dynamic of competition, and the thrust of corporate

strategy, at least as far as the suppliers of telecoms services to final consumers are

concerned, has tended to move away from technology based determinants towards other

attempts to segment customer markets and differentiate services.

The importance of specialist suppliers also noted by Klepper (1997) in the case of

industries that do not exhibit shakeouts also raises questions regarding the appropriate

conceptualisation of industry boundaries. A notable feature of the industry studies based

on the Product Life Cycle Paradigm has been the close identity in these studies of

product and industry. The importance of specialist suppliers, however, suggests that

where they exist this narrow identity is not justified and a broader definition of industry

boundary is necessary. Apart from the telecoms industry analysed in this paper, other

examples may include the importance of specialist equipment suppliers (such as the

makers of optical lithography equipment) in the semiconductor industry and the

importance of specialist chip suppliers in the case of industries like PCs. In the latter

case the availability of specialist chip suppliers like Intel has allowed firms like Dell to

become significant players in the PC market largely on the basis of marketing, sales, and


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distribution capabilities, rather than technology-based capabilities. Clearly, this pattern

of specialisation has directly influenced all asp

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