Advisory Report Wholesale Ethernet: U.S. Metro, Long-haul and International Demand Drivers

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1 and International February 9, 2011 Issue Brian Washburn Current Analysis Research Director, Network Services The U.S. wholesale transport market has a reputation for cut-throat pricing coupled with high customer expectations for network performance. Ethernet services whether using virtual circuits over MPLS and/or via VPLS, riding over SONET/SDH circuits, or running directly over dedicated wavelengths manage to squeeze greater efficiency out of networks. Those margins are going straight back into pushing down prices further along the most competitive U.S. domestic long-haul, and U.S.-international routes. Through February 2011, Current Analysis conducted interviews with major carriers doing business in the U.S. and internationally, to find out more about their Ethernet wholesale services positioning products, marketing, and views on where the market s current state and its trajectory. This is the first in a two-part series, which addresses observed overall trends in wholesale Ethernet services. The second part will address individual competitors and their market positioning to capture a slice of growing Ethernet services demand. Current Perspective Carrier Ethernet describes a category of services that presents the customer with a simple Ethernet interface. Behind that interface, traffic can be handled in a variety of ways. The most common categories today are Layer 1 Ethernet transport, which provides point-to-point connectivity over SONET/SDH rings or via dedicated wavelength; and Layer 2 Ethernet, which transports Ethernet across switched MPLS or VPLS networks in mesh, hub-and-spoke or point-to-point virtual circuits. In December 2010-January 2011, Current Analysis spoke with nine providers to gauge the state of the wholesale Ethernet services market, including U.S.-based incumbent long-haul carriers (AT&T, Verizon and Sprint); fiber-based transatlantic and global network providers (Cogent Communications, Global Crossing, Level 3 Communications and Tata Communications); and Europe-based service providers that extend business to the U.S. (Colt, Tinet/Neutral Tandem). Current Analysis additionally maintains dialogues regarding the Ethernet offers from other significant U.S. service providers with a high potential international reach including Qwest and XO, U.S. providers including PAETEC and tw telecom, and the major U.S.-based cable providers. Cost Efficiencies of Ethernet vs. TDM and the Switched vs. Dedicated Debate One reason why carrier Ethernet particularly switched Ethernet over MPLS/VPLS is succeeding Europe +33 (0) Or visit our Web site: 1

2 in the market, according to several carriers, is because these approaches are more efficient to operate and port speeds more flexible than TDM transport. Cost savings can come to the fore when a partner is building larger networks with more endpoints, where an EVPL service can consolidate customers traffic into regional and/or national hubs. Switched Ethernet gives the seller better margins, which can turn into lower price quotes for buyers. But dedicated Ethernet also remains popular because it provides guaranteed traffic performance, security, and control over the service. These aspects appeal to customers that are skeptical whether switched Ethernet will offer sufficient traffic performance (i.e., delivery, latency and jitter). Some switched Ethernet proponents (e.g., Colt Telecom, Qwest and Sprint, the latter not offering formal long-haul Ethernet services at this time) underscore that they design their MPLS core network to ensure there is no contention that could degrade service performance and result in increased latency or dropped traffic. Which technology underpinnings dedicated or switched do service providers lean toward with wholesale Ethernet? About half of the carriers involved in Current Analysis discussions describe themselves as technology agnostic, not actively recommending either technology. Tata Communications noted the advantages of its Ethernet over SDH service for clients, though the company also provides Ethernet over MPLS. By contrast, Colt Telecom, which only offers Ethernet over SDH capacity services between Europe and the U.S. at this time, took a balanced view of the technology. At port speeds below 1 Gbps, respondents saw customers being pragmatic about whether to purchase switched or dedicated Ethernet. Most customers are still transport oriented, said one respondent, they look for capacity between endpoints instead of sophisticated features and networking. But at speeds of 1 Gbps and above, buyers lean toward dedicated Ethernet services. If a carrier needs 10 Gbps, they re going to build it themselves, not buy it from us, noted one respondent. The exception in capacity purchases is wireless backhaul, where regional aggregation can mean that switched Ethernet hub ports might range up to 10 Gbps. With the mad growth in wireless backhaul, carriers with extensive metro/access networks could see switched Ethernet demand reaching 40 Gbps and 100 Gbps, as these port options become available. Wholesale Ethernet providers have turned to consolidating ports by using hub-and-spoke architectures made possible by Ethernet virtual private lines (EVPL) to help drop their costs and provide lower, more competitive price quotes. But while wholesale buyers have adopted Ethernet over MPLS and VPLS, they have stayed with point-to-point and hub-and-spoke network architectures for now, staying away from E-LAN mesh architectures. Mesh networks introduce a level of complexity in which wholesale buyers have not been interested though some large competitors have described that they are actively looking to recruit customers buying mesh network configurations, among other reasons to legitimize the technology for wholesale applications. Application Opportunities: Wireless Backhaul in the Front Seat Carriers and cable operators with extensive access/metro Ethernet assets are deeply invested in the wireless backhaul opportunity. AT&T, Verizon and Sprint all identify wireless backhaul as the one, and generally only big standout wholesale Ethernet opportunity. Even though demand in Ethernet services is growing across the board, wireless backhaul stands out. A lot of demand is coming from wireless, noted one respondent, while another summed it up by noting, all roads lead to wireless backhaul. Domestic competitor Time Warner Cable breaks out its wholesale Ethernet revenues related to wireless backhaul and shows they are roughly tripling, from $26 million in 2009 to what industry observers anticipate around $75 million when the company s 2010 financials are formally announced. Ethernet wholesale providers without a large U.S. metro investment saw little wireless op- Europe +33 (0) Or visit our Web site: 2

3 portunity, even in looking for the potential to carry international traffic for mobile providers. Outside of the wireless backhaul segment, specific customer applications were hard to pin down. The next-most referenced wholesale Ethernet opportunity was a broad category of sell-through for service providers with enterprise customers. Carriers described rarely having visibility into enterprise customers being served indirectly through wholesale. But based on what they did know, they were able to reference general verticals: Mainly financial, but also healthcare, education, legal and manufacturing. In terms of the wholesalers purchasing wholesale Ethernet services, carriers referenced CDN/ content providers; a general category of ISPs; media/video/broadcast players; specific broadband ISPs (e.g., cable and DSL providers); VARs and systems integrators; traditional incumbent/competitive carriers; data center/cloud services providers; and finally, storage specialists and VoIP providers. Competing on Price and Features Among the carriers with which Current Analysis held wholesale Ethernet discussions, Cogent Communications and Tinet are examples of companies that offer international wholesale Ethernet ports with especially aggressive pricing. In the market, 20 Mbps/month (the minimum international speed where most wholesale Ethernet providers start to pay attention) starts at well below $1,000 per month for transatlantic services among many competitors, both for dedicated and switched Ethernet options. At the start of 2011, lowest-cost providers charged less than $2,000 per month for 100 Mbps transatlantic circuits; 100 Mbps routes between major U.S. destinations started at the $2,000-$3,000 range per month. It s important to note these prices are specifically for the lowest-cost combinations of service connecting some of the nation s best-known carrier hotels, excluding non-recurring charges as well as any bells and whistles such as class of service (CoS). Carriers see that price is usually the over-riding factor that wholesale customers look at first. Price per Mbps is the deciding factor. Clients might not even be interested in the SLA because they will buy the service and self-monitor and configure the network, said one respondent. Another respondent noted that in addition to Cogent, competitors such as XO, PAETEC and AboveNet would tend to focus on price; while competitors such as AT&T, Verizon and Level 3 looked to provide customers with value as a way break out of direct competitive price pressures. There are several ways to interpret value, which boils down to providing something that the lowest-priced competitors can t. One way is reach, going to geographic locations that competitors don t provide. Major U.S. long-haul Ethernet competitors can connect between the biggest telco hotels in New York City, Chicago and Los Angeles. Fewer competitors can assemble owned routes to secondary and tertiary cities, and to more data centers/colocation facilities, or directly into telco central offices. A second way to produce value is to offer a collection of services that the carrier may want to buy as one package. This might include a bundle of wholesale Ethernet and managed router services, a comprehensive portal that includes detailed reporting, and/or automated order processing through an e-bonding interface. A third way to add value is to provide consulting and professional services, for example to supply wholesale partners with technicians in markets where they do not have their own presence; or to bring in on a project basis to assist with network design and traffic performance optimization. Finally, some respondents noted that wholesale Ethernet providers may buy the least-cost service to start, only to find out later that they do want better quality and performance. This need for improved performance can turn into an opportunity to upgrade the customer to class of service (CoS)/committed data rate tools, or even to basic managed services. Europe +33 (0) Or visit our Web site: 3

4 Ethernet Exchanges: Too Early to Tell Wholesale Ethernet providers have a range of divergent opinions over the success or failure of carrier-neutral Ethernet exchanges. Some carriers that are not participating in these exchanges and have no current plans to do so, still note they will re-evaluate their stance, and see joining as relatively harmless. On the other hand are some of the strongest proponents, which admit to having seen only modest positive results to date, regarding the fledgling carrier-neutral exchanges as too early to call a failure or success. Differences also need to be acknowledged between Equinix, which operates its exchange as a model for trading partners at its facilities to connect to each other; and CENX, which has a model more like a clearinghouse for services, where anyone can participate. Respondents with more optimistic views of carrier-neutral Ethernet exchanges note that the exchanges can assist potential buyers. These buyers can use exchanges to identify and procure services quickly, which might be attractive to market newcomers, such as international providers entering the U.S. market for the first time. Smaller providers may also consolidate their purchases from multiple carriers by going through an Ethernet exchange. But on the sales side, Ethernet providers note seeing more sellers than buyers at exchanges for now. There have been small opportunities noted via carrier-neutral Ethernet exchanges, coming from service providers that might otherwise not have made the same connections. However, all competitors participating in Ethernet exchanges intend to convert any relationships over to E-NNIs as soon as a new customer s purchases grow to volume. Conclusion As carriers continue to see the wholesale Ethernet opportunity evolve, they are focused on addressing some of the challenges they currently face. Several peers are looking to automate and tweak their quoting and provisioning processes, to make services available faster and easier for customers to procure. Fine-tuning provisioning is of particular interest to carriers with metro/ access Ethernet services, where turning on or raising capacity in metros quickly means both making customers happy and recognizing revenues faster. Complex E-NNIs are an ongoing issue under development, with several respondents noting that both they and their customers are keeping a close eye on the evolving MEF 26 interconnection standards. For now, customers note that it remains difficult to offer services consistently end-to-end across interconnections with multiple providers. Other carrier challenges moving forward include customer education: To make sure customers understand that switched Ethernet can be as reliable and perform as well as dedicated Ethernet; and to grow services both in terms of portfolio and geography. Recommended Vendor Actions Wholesale Ethernet providers that do not participate in carrier-neutral Ethernet exchanges today, can note that they are not losing out by not participating in these ventures. Most exchange members come on board looking to sell their services rather than buy. To date, the buyers have been smaller opportunities. For those carriers that are evaluating whether or not they should participate in an Ethernet exchange, however, there seems to be little harm in it. Even though carriers describe price as the over-riding factor in the decision process, that is not entirely true. Buyers do (or at least should) take a step back and assess (1) whether the Ethernet services they are buying provide the level of transport and performance they need; and (2) whether the company from which they are purchasing has long-term viability. If a wholesale Ethernet provider can t deliver acceptable performance, or seems financially unsteady, even a low price isn t enough to win customers. Europe +33 (0) Or visit our Web site: 4

5 The biggest incumbent U.S. carriers offer an array of global wholesale Ethernet services, but these are unlikely to be lowest-cost solutions. Customers should consider purchasing services from these carriers if they need a broader reach, a broader portfolio of services under one roof, or additional assistance that lowest-cost discount competitors cannot supply. When it comes to mixing low-cost, international coverage and a collection of services, Global Crossing, Level 3 and Tata Communications are likely to vie for this sort of business. Wireless backhaul is the single largest identified wholesale Ethernet opportunity. Buyers of services for wireless backhaul need metro and access footprints: AT&T, Verizon, Sprint, PAETEC, AboveNet and Zayo are among the competitors that have access footprints that can help wireless operators pull their footprints together and manage the explosion of mobile data traffic. Wholesale long-haul Ethernet transport between major destinations is a low-margin affair, and competitors shouldn t enter the market expecting big revenues. Participants along highly competitive long-haul and transatlantic routes are under constant pressure to lower costs, grinding them down. Wholesale Ethernet cuts some cost corners to deal with eroding prices. But 100 Mbps along major domestic U.S. routes cost only a few thousand dollars per month and transatlantic pricing is even lower. Europe +33 (0) Or visit our Web site: 5