The process of determining appropriate pricing levels is so fundamental to wholesale telecoms that failure to calculate these costs correctly can mean financial collapse. In an industry where margins are ever tighter, successful pricing models have never been more important.
Not too long ago, the industry was driven by a near universal belief that low latency and premium services were the silver bullet to many of its pricing conundrums. Focussing on the top end of wholesale business could generate untold returns. Every milisecond shaved off a fixed route would generate prices multiplied by generous factors.
The financial sector has done its best to cooperate with this premise but, by and large, other verticals have proved reluctant to pay top-end prices for top-end connectivity. The carriers that adopted this model defend their decision, and it has indeed proved highly successful for a few.
But without question, the industry is today looking more widely to different forms of pricing. From flat-rate charging to swap deals, from automation to stimulation of demand, across voice and data markets, wholesale providers have become aware that they must find a model which suits their business, their customers and their needs. Has the time come when sensitivity to the market is about to outweigh pure speed in the networks?
Traditional models
How can pricing cause such turmoil? The basic model is hardly rocket science. “It’s price times Q,” explains Edwin van Ierland, global sales officer at iBasis. “You send out an A to Z price list to a carrier, so they know how much they have to pay to terminate a certain amount of traffic to a certain destination. I don’t see any reason why the market will change that concept.”
Rates should be set logically. Diarmid Massey, VP of international carrier services at Cable&Wireless Worldwide, says: “Pricing levels set by wholesale operators depend largely on their cost base. Here is where operators must make the right network investments and develop the right carrier partnerships that would offer a competitive return. Cost is not necessarily pegged to what other wholesale operators are offering, so wholesalers must know what their customers are after and develop strong relationships with them.”
Traditional pricing relationships do not in fact come stronger than the bilateral deal, which has always played an important role in the wholesale telecoms industry. As van Ierland puts it: “The benefit of locking into a bilateral deal is that it’s guaranteed, and you don’t have the operational hassle every day of rerouting traffic. It’s locked in for a three or six month period of time.”
There is inevitably an administrative cost to preparing and implementing the bilateral deal: managing the pricing, the routing and the settlements. But the administrative burdens are more than offset by the stability and security they can bring. Van Ierland says: “All the incumbents were predominantly involved in bilateral deals, because they brought sticky traffic, sticky revenue and sticky margins.” He finds it harder to estimate how much voice traffic is carried through bilateral deals today, but would estimate about half, with the rest labelled as free floating traffic. The days when incumbents needed to establish and maintain links with only each other are over.
“Free floating or non-committed traffic exchange is now extremely common as it allows operators the flexibility to move traffic based on market changes,” says Massey. The market is much more complicated, with geographical variations and significant fluctuations in pricing making the process much more difficult to manage. “Sticky” revenue is still a valuable asset, sought after by all players in wholesale telecoms, but the bilateral deal is no longer the exclusive route towards it.
Adaptive models
The need to develop highly functional carrier partnerships is where some carriers break down. Jack Lodge, chief operating officer at Global Capacity, believes that many are struggling within the current system. “Most organisations don’t have the resources to be able to deal with the vast number of suppliers out there. For simplicity’s sake, they negotiate with a small number of suppliers, which then negotiate with their suppliers. You create this multi-tiered delivery mechanism.”
Alexandre Pebereau, EVP for international carriers at Orange, seems very open to explore some of the pricing options available. It is, he says, “time to offer a pricing structure that allows us to make complex deals with many wholesellers throughout the world”. One of the models he refers to is the “swap deal”, a variant on the basic bilateral deal which underpins much of the industry pricing.
“More and more, the players we are dealing with are, like us, multinational groups, with retail and wholesale operations, offering mobile or fixed broadband and having several domestic operations. Swap deals have evolved from the basic deals where one incumbent arranges a deal with another incumbent,” Pebereau says. “Instead, several countries are traded against several other countries. It’s not so much a question of size, but rather the number of destinations a counterpart is willing to address.” The formula is driven by a desire to find the most efficient way to trade international voice, and to find a good and well balanced deal for both parties in a world with an increasing number of destinations.
However, not all pricing model evolutions are to do with such large scale efficiencies. Pebereau also refers to the recent developments in flat rates, one of the options Orange is putting forwards to simplify processes for smaller customers. This involves new carriers and customers, such as card resellers, agreeing to pay a flat rate for three or six months, and thereby being spared the credit check and other burdensome administrative processes involved in the usual market dealings.
Pebereau explains: “For a flat rate, these smaller players don’t have to worry about the cost of terminating to Slovakia or to Russia. For three months, we warranty the price that it will cost them, whatever happens in those destinations. They don’t have the time to watch the wholesale market, and so are attracted to a flat rate. Only players such as Orange can really evaluate and assess the risk involved in giving a flat rate for three to six months. That’s where our know how comes into play; it depends on the destination, the geography, if it’s mobile or fixed termination, in order to decide whether you can take on such a commitment.”
Price vs performance
One substantial element which seems to be changing in the market, however, are the actual rates being paid. Price pressures and margin pressures are becoming ever more familiar and, particularly in the voice market, are being stretched even tighter by the regulations being placed upon carriers. As van Ierland says: “The US is already a one penny destination. Will Europe become a one cent desination? Most likely, yes. All the regulators are trying to put pressure on termination rates, both on the mobile termination rates and the fixed termination rates.”
There are pressures in non-regulated markets too. As Massey explains: “In non-regulated markets, prices are largely determined by competition. This may not be ideal if operators undercut each other in order to win customers, and end up making losses in return. Operators must compete based on the quality of their services, network expansion and variety of services, rather than lowering the prices.”
Andrew Kwok, senior vice president, international business at Hutchison Global Communications, agrees that the competitive drive to reduce prices can be a damaging factor in the wholesale business: “Whatever the customer needs, whether it’s a network or a lower wholesale price, Tier 1 operators are bending over backwards to supply that. The market is competing on pricing, which means that every day pricing levels are going down continuously.” Kwok doesn’t believe this is the best strategy for the wholesale industry.
There is clearly a sense – certainly amongst some providers – that general quality of service is a hugely important factor. As van Ierland says: “The strange thing is, in the last three or four years most parties are looking more generally at wholesale pricing instead of premium pricing. Purchasers are looking for quality routes and are looking for the best price, but not always for the cheapest price. There’s a significantly increased demand for quality traffic, and people are willing to pay for that.”
There are other factors offering the opportunity for higher pricing, which Kwok refers to this as “stimulation of demand”. He explains: “You cannot deviate from supply and demand, but you can do things to advance market requirements.” He gives the example of mobile operators joining forces through the Conexus Mobile Alliance in Asia to offer a data flat rate plan, offering unlimited data roaming in member countries for the rate of $20. While the revenue generated per end user has fallen, he claims that the overall demand and thus the accumulated revenue has increased significantly. Such a pricing model is only available if wholesale operators are willing to join together to make these pricing levels available across multiple countries.
Kwok also refers to HGC’s move to create a “totally diversified network” in the Greater Mekong Subregion, offering leased line IPLC, IPVPN and Ethernet. “Instead of competing on pure price, we enhance the network and tell our carrier customers that they are not buying point-to-point. They are buying a one-stop solution. When the carrier brings this to the end user, they like it a lot. Our pricing model can favour us, instead of only competing on price and going endlessly down.”
Seeking differentiation
Competition is nevertheless placing pressures on what operators can charge. Aaron Blazar, VP and lead wholesale analyst at Atlantic-ACM comments: “Long-haul pricing between major data facilities is always under pressure. If you’re pricing a circuit between heavily connected data centres in London and New York, there are going to be four or five operators, or more, selling that circuit. You differentiate yourself by having unique routes, or capacity to regions where there’s undercapacity. There’s a lot of demand to Latin America right now, and players like Global Crossing and GlobeNet have been successful at selling those services.”
In an effort to escape the ubiquitous downward spiral, some telcos are seeking differentiation by offering better service offerings to the market. Lower latency is the most obvious differentiator, and a number of carriers have made significant investments into building premium routes.
Some carriers have found success in meeting the demanding requirements of the financial markets. Blazar highlights Hibernia’s success at building a unique route between New York and Ireland, which has allowed it to command a premium because of its diversity from other Atlantic crossings. Others highlight Spread Networks, offering low latency routes in the US between New York and Chicago and charging pricing connectivity significantly above the norm in the market. But low latency routes have not perhaps always proved the golden ticket that may have been initially envisaged.
Brett Johnson, VP of business development at AboveNet, explains his business strategy: “It makes a difference if you’re the fastest; people really want that service. If you’re the second, or third, or fourth fastest, you can charge a slight premium more. We do charge a premium for our fastest service, but we don’t want to charge too much, because if you do that only a few people will buy it. We still want to be competitive.”
Blazar seconds that opinion: “With premiums paid for lower latency routes, demand has really stuck in the financial sectors vertical. We don’t see much demand in enterprise. We’re all looking for opportunities, but financial services has been the only vertical willing to pay that premium for low latency.” Offering different classes of service level – such as silver, gold and platinum packages – is one strategy for carriers looking to capitalise on these markets. Blazar explains: “Platinum is the ultra low latency, high premium service; and the silver is much lower latency but still a high quality network, perhaps targeted at the content and media buyers.” Whatever the strategy, telcos developing low latency networks need to be sure that there’s sufficient demand to sustain the necessary investment.
Scott Ritchie, MD of BSO Network Solutions, has an interesting perspective on the situation, having just announced the launch of their low latency network between London and Hong Kong. “What is different about our business model is that it is squeezing the globe to make the top 18 central business districts closer. I hope that we know exactly who our customers are and exactly what they’re going to buy, so we only need to buy and procure what we know our customers want. You really design the network you need and right-size it, rather than having to buy a lot of extra capacity just to give you wriggle room.”
Based on a business strategy that involves updating their low-latency option every 18 months means that the business can offer several layers of service. “What used to be the low-latency route becomes the back up,” says Ritchie. “You don’t just have that ultra low-latency route; you’ve got three or four other options, which used to be the fastest. So the pricing model is constantly becoming more attractive for a number of different industries.”
The mechanics of pricing
While variations are starting to enter the offerings available, what impact is this having on pricing mechanics? Data centres are proving to be particularly popular interconnect points, allowing carriers to embrace a more fluid interconnection model. AboveNet recently found itself being celebrated as the 400th customer to go into Ancotel in Frankfurt. “In the data centres, there’s an abundance of carriers,” says Johnson. “We’d ask three or four of the most reputable companies for quotes for 1Gbps or 10Gbps, or whatever the size service is, to the end destination. It’s done like that because in the telecoms market, prices change very quickly.”
However as the markets become more open, there are administrative difficulties resulting directly from the sheer scale and volume of individual quotations and deals conducted between operators. This can be a significant burden on businesses if working practices are not amended. Kwok’s example of the challenges faced by HGC illustrates the point: “Nowadays in the wholesale market, especially for data services, there are huge numbers of enquiries and requests for pricing information. As a global provider, we receive thousands of enquiries every month. It is impossible to handle each one manually every time we negotiate a price.”
Automation is therefore playing a much more significant role in the pricing market. iBasis’ IP routing is already 99% automated, explains van Ierland, and the business is current working on a project called Common Routing, which will enable it to route traffic over both IP and TDM. “That significantly reduces our costs in the back office. The key trick to survive for the future is to manage your costs in the back office, and find a certain percentage of automation,” he says.
“Pricing simulation tools help service providers to launch new pricing plans and bundles with optimal forecasting precision of customer adoption, projected revenue and ARPU,” says Massey. “With such tools, operators have an easier time identifying high-value customers.”
Global Capacity’s Lodge is another supporter of automation, no surprise considering that its One Marketplace Access Exchange provides an automated pricing tool to ease the process generating rates from global network operators. Lodge explains: “Without the automation, you’re in a manual process where people would spend weeks and months on the phone with spreadsheets trying to coordinate the underlying solutions. We automate both the supply and the price of the access, so that buyers can go directly to underlying suppliers, and get the most efficient market price.”
In the debate between automated pricing and vendor-negotiated rates, Kwok clearly agrees that the trend towards standardisation and the implementation of fixed pricing is a good thing. Automation allows telcos to handle very large volumes of information and to implement changes in pricing strategies very quickly and easily. But Kwok is keen to point out the need to preserve the vendor-negotiated rate, and the power of human input, when it comes to solution sales.
When a project reaches a certain size or complexity, automation alone is unlikely to be sufficient, believes Kwok. “Solution sales means an agreement which is tailor made for your customers or your partners. An automated system can never handle this kind of complication.”
He therefore is a strong advocate of the hybrid system: “I think the two models will co-exist. For those vendors where we need to process a large volume of information, which is relatively standardised, we use automated systems. However, we also use humans to handle the solution sales, and to give advice on the more complicated projects.”
