Are shelling out $41 billion for network gear in ’07

Telephone companies are on pace to spend in excess of $41 billion this year on network equipment, from edge routers and switches to a variety of IP-based networking components. Just by way of comparison, during the cable industry’s most free-spending era, when HFC networks were being upgraded, MSOs needed three whole years (2000-2002) to spend $45.2 billion — and they’re still trying to live that down.

The forecast in a recent report from iSuppli Corp. (a technology research and advisory group) that the telecom industry is set to invest $41 billion in network equipment in 2007, makes it crystal-clear that phone companies are sparing no expense to compete in the massive multi-service, bundled package market of video, voice, data and wireless services.

And there’s no sign that spending will slow down any time soon.

For example, iSuppli estimates $9 billion will be spent on IPTV-related communications equipment in ’07 to attract subscribers in modest increments of a hundred thousand. But by 2011, there could be as many as 105.8 million IPTV subscribers worldwide, a 98 percent compound annual growth rate (CAGR) from 3.4 million in 2006.

Figure 1
Figure 1: Growth of pay TV delivery medium, 2006-2011.

Building the infrastructure to support such a huge customer base will require 20 percent of the telcos’ total capital spending by 2011, the report concludes. “We found the telcos are spending big dollars on providing broadband access, either at access points or building up core networks to handle data traffic. They’re very realistic about plans to put in IPTV-centric versus circuit-switched networks to provide broadband access to the home. They’re all building up their IP infrastructures,” says Steve Rago, principal analyst for iSuppli.

The $41 billion isn’t chump change and will “stay there for the next several years to help transition the telcos away from voice and data carriers to value-added services and multimedia,” he maintains.

For service providers to remain competitive, investing in equipment that will move them to triple and quad-play service bundles is absolutely essential, he says.

“The telcos realize revenues are down or flat the past five years, and they’re seeing a 3 to 4 percent annual erosion of their subscriber base. They can’t exist as bulk voice carriers and must become multimedia content providers. As a result, they must increase spending on the access portion of their networks with deep fiber, DSL, and other types of network equipment worldwide. They must re-invent themselves,” Rago said.

And there’s no shortage of reasons why capital expenditures (capex) are growing for IP-based networks capable of delivering a host of revenue-generating services.

VoIP, for instance, is expected to reach 24 million households by 2012 and is now a staple of many triple and quad-play packages, reports Jupiter Research.

And, a study by Leichtman Research Group found that the 19 largest cable and telephone providers in the U.S. acquired nearly three million new high-speed Internet customers in Q1 of ’07.

The result is a spike in equipment spending, evidenced by a 22 percent increase in IP and Ethernet transport and services to $2.4 billion in Q1 of ’07, reports the research and analysis group Ovum-RHK.

Yet getting to those numbers, experts maintain, will require a level of equipment spending rarely seen before.

“As the market grows and more customers are added, the total spending on CPE and other equipment increases. But for carriers like Verizon and AT&T, the operational expenses are expected to decline after building out fiber networks, while AT&T must spend to reach its 19 million homes.

You can never say you’re done spending on equipment,” says Michelle Abraham, principal analyst for In-Stat, a research and analysis group.

That should bode well for the supporting cast of companies responsible for providing the equipment to the telecom industry. “As the telcos add IP, they need more capable edge devices to handle video traffic, so we’re seeing increased levels of spending on devices to handle quality of service (QoS) in those enriched environments. We’re also seeing spending on 3G equipment going up, and will see an explosion of 3G spending in China and Europe,” says Mark Tubinis, CTO for Cedar Point Communications.

And what’s driving this capex spending on equipment? “There’s a competent group of telcos that can now compete against cable with video. But both must become more competent at managing video (telcos) and mobility (cable),” he says.

In addition, 4G technology is expected to increase the capex spending for both cable and the telcos. Adds Tubinis: “There’s excitement about 4G technology to build networks very cost-effectively. But the competitive pressures will keep capex spending relatively high.”

Those competitive pressures are translating to increased capex spending, and prompting a next-generation of spending strategies among the telcos.

“When you look at services like Verizon’s FIOS, they were initially focused on putting the infrastructure in place. Step two is likely to be increased spending in the VOD and programming areas. But it’s all being fueled by the competitive pressure of the telcos. For us, the international market is where we see the telco spending increases,” says Ken Wright, CTO of C-Cor.

Rago concurs. “Cable isn’t strong outside the U.S., so the global market is open space for the telcos. The OEMs that can supply the Verizons and AT&Ts with equipment will win the battle. But cable is in the driver’s seat in the U.S., although not in the rest of the world.”

In the world of IP set-top boxes (STBs), which is projected to be a $1.7 billion industry by 2010, according to In-Stat, its time is coming.

Figure 2
Figure 2: IPTV capex spend by product category, 2005-2011.

“The U.S. is focused on trials and infrastructure builds before it moves to deployment of IP STBs. But in the global markets, there’s more spending on ramping up STBs. The trend is for a fairly steep growth curve for IP STBs over the next several years, but today, a large portion of the telco spending is on network buildouts,” says Marty Stein, senior marketing director for Motorola.

SureWest, a quad-play provider servicing 250,000 subscribers in the Sacramento, Calif. area via its IP network, presents a classic example of the new telecom spending strategy.

Its plan is to spend $32 million in plant upgrades and expansion, mostly for fiber upgrades, with a total capex spend of $55 million this year.

“We’re adding more channels each year, like high definition, so we need the equipment to increase network capacity. Our capex strategy is consistent, but the spending challenge has been for unbudgeted items, and since IP is such a fast-paced technology, some decisions made two years ago require new direction,” says Greg Chamberlain, executive vice president of network engineering for SureWest.

The direction for key players such as Alcatel-Lucent in the telecom spending strategy is to think more IPTV and mobility. And it’s changing the way they do business. “It absolutely changes our approach to markets. The dollars being spent on equipment are growing, and it changes our strategy. We now have to look at several different dimensions, like IP-edge. And with telecom and IT spending coming together, we’re seeing more requests for service delivery and how to upgrade networks,” says John Marinho, vice president of corporate strategic markets and business development for Alcatel-Lucent.

Those upgrades, and the dollars spent to build them, aren’t likely to go away anytime soon, and in fact will generate new capex spending streams. Concludes Rago: “A major chunk of spending will be on software, and access will be a sweet spot for spending — from the aggregation point to the home. That will be the most obvious place for spending.”