It's not that providers of wholesale carrier services are sitting around waiting for their lots to improve. They're not. They are innovating and finding ways to protect their margins. But after watching market forces drive down the value of their primary wholesale products — private line and transport services — the carriers and divisions within carriers that live and die by the wholesale model can't be blamed for hoping some good will come of the AT&T's acquisition of BellSouth.

There are many market dynamics affecting wholesale, but the most meaningful is the instability of pricing, said Robert Rosenberg, president of Insight Research. However, that may change, thanks to the new AT&T and other acquisitors.

“A lot of the wholesale market is going to change radically because of this industry consolidation,” Rosenberg said. “We may not see it immediately, but there will be some real stability in pricing, which we haven't seen in five or six years.”

So far, despite increasing demand for wholesale services, price pressures have offset the increase in usage and potential revenue. In the private-line sector, for example, the market stood at $36.6 billion in 2002. The wholesale market accounted for $16 billion of that. At the end of 2005, that market was down to $32.4 billion, with wholesale dropping to $14 billion, according to Insight Research.

“Demand has continued to grow on a usage basis, but because there were so many competitors and they were playing a cost-cutting game, there was no stability in the market,” Rosenberg said. “With fewer players — and not through any collusion, but by the nature of capitalism — we should reach an equilibrium.”

This new leverage should carry over into the enterprise market as well, Rosenberg said. Over the last few years, large enterprises could put the squeeze on carriers for 20% to 30% in cost reductions over the term of a contract.

“There will be a lot less squeezing going on. The idea that you could cut the carrier off at the knees may not work anymore,” he said.

Debra Swann, director of segment management carrier data for Global Crossing, said it's time to get beyond the whole price thing anyway. “We don't want anyone to win on price alone,” she said. “So as consolidation continues, we'll all have to strike out beyond the lowest price point.”

That won't stop some carriers from pursuing that model, Swann said. “Let the Cogents of the world drive their IP transit price down to the bottom of the bucket; they'll never be able to out-run the volume. This is more than a commodity market.”

Wholesale carriers across the board say they are seeing demand continue to grow. Some just see it growing differently than others. Whereas Level 3 doesn't see voice over IP (VoIP) as a big driver of wholesale minutes, Global Crossing does.

“VoIP is a part of IP growth, but truth be told, it's not a huge traffic consumer relative to video, conferencing and other multimedia apps driving IP growth today,” said Glenn Russo, senior vice president for Level 3.

Instead, Level 3 continues to see private-line and wavelength usage increase. The company's Internet backbone business has grown 70% per year. “That's like re-creating an entire network's worth of capacity every year,” Russo said.

Global Crossing, on the other hand, sees both VoIP and video as intensifying consumers of bandwidth. Its own growing penetration in the Asian markets could have help from this view. “It's incredible how many Asian carriers have reached out from the VoIP side of the house. They are trying to find the most economical way of pushing their VoIP packets around,” Swann said.

Although VoIP may or may not be consuming a lot of bandwidth for all carriers, it is having an impact on carrier revenue. Of the $300 billion in international voice traffic last year, VoIP providers siphoned off $83 billion. “That's revenue lost by the traditional carrier market,” Rosenberg said.

So where besides eventual price stabilization are wholesale carriers looking to find light at the end of the tunnel? The IP/virtual private network (VPN) tunnel for one. A Global Crossing spokesman said the company's IP/VPN usage has grown to 100 million IP interconnect minutes per month from last year. That's a 350% increase.

The company also is seeing what Swann calls a huge demand for 10 Gb/s wavelength and 10 Gigabit Ethernet. Customers aren't using 10 Gig yet, but they are buying it and committing to utilization of 3 Gig to 4 Gig.

What's not in demand, but which still portends well for the increasing pace at which carriers are shifting to all-IP networks, is protocol conversion. In one year, Global Crossing has gone from nearly 100% of its interconnections requiring TDM-to-IP conversion or vice versa to only 40%. Sixty percent of handoffs are straight session initiation protocol (SIP)-to-SIP.

Swann said her company is still building out its 10 Gigabit network in Europe, North America and Asia and expects to have much of it completed within the next quarter. The difference between the buildout of 2006 and the one before the bubble burst is that, “it's no longer a “build it, and they will come' strategy,” Swann said. “It's building out in real time to meet real demand.”

Infrastructure investment continues in other wholesale networks as well. By now, Level 3 should be finishing an upgrade to its IP backbone, which will take capacity to 150 Gb/s. IP backbone capacity doubled between 2004 and 2005 and will triple from the second quarter of 2005 to the same quarter in 2006.

Level 3 expanded private-line and wavelength capacity by 50% in 2005. It has been doubling every two years. Partly through a voracious acquisition strategy — including WilTel, Progress Telecom in January for $137 million and 360networks' nationwide long-haul transport business — it has expanded its transport network into 11 markets in the last two years. The Level 3 global IP backbone network currently carries more than 3.7 petabytes of IP traffic daily.

Looking ahead, Level 3 announced last month a significant expansion of trans-Atlantic capacity through the purchase of up to 600 Gigabit capacity from Apollo Submarine Systems, starting with a commitment to buy 300 Gigabits with an option to add 30 more. Three-hundred Gigabits is enough to support about 10 million simultaneous IP-based calls.

And with the next-generation wavelength platform it rolled out in 2005, Level 3 is confident that it can meet its demand for both IP- and TDM-based applications.

“Wavelengths are a big part of what Level 3 does both for its internal consumption and its customers, so putting this platform in place gives us a great deal of the flexibility and scalability we felt we needed,” Russo said.

Of course, all this talk of demand and growth doesn't mean that the glut has been neutralized. There is still a lot of unused fiber in the ground.

Although Insight Research's last study on fiber utilization was two years ago, it showed that only 3% to 5% of fiber was actually lit and in use. However, whenever people talk about fiber capacity, they have to talk on a route-by-route basis, Rosenberg said.

“On major metro routes domestically, we will have excess capacity for years to come,” he said. “On principal routes between, say, two points in Wyoming, you might have to trench, but in NFL cities, probably not.”

In addition to VoIP — and given that the outlook for price stability holds — another big opportunity for wholesale providers can be found in wireless backhaul, particularly the international variety. The world's 1.9 billion wireless subscribers last year generated about 270 billion minutes of use. Eight billion of those minutes were backhauled internationally, Insight's Rosenberg said.

Still, other opportunities for growth are presented by the acquisitions themselves, and AT&T isn't the only one making whoppers. Verizon and MCI have combined to create another global wholesale powerhouse.

“We believe with the new Verizon organization, there is a lot we can do for our wholesale customers,” said Lisa Houser, director of new product development for Verizon Business.

The company rolled out its wholesale VoIP offering late last year, so it's too soon to quantify growth, but over all, wholesale revenues in 2005 for the former Verizon business unit were up over 2004, despite the price pressures.

“I think that's a real good sign,” Houser said. “Through 2006 we expect growth to be quite strong in VoIP, and there is significant activity in this very viable market.”

However, waiting on good signs and anticipated growth in VoIP is not an option. Verizon Business and other wholesalers are looking to value-added services that go beyond traditional wholesale.

Saying it is too soon to announce anything specific, Mike Yancey, director of product development for voice products in the wholesale division of Verizon Business, said Verizon is looking to leverage voice and add applications and functionality to the network. He pointed to the growing number of ISPs looking to add telephony services to their portfolios.

“We are looking at what other applications need to come with this IP stream using SIP signaling,” he said.

The company's SIP Gateway service now comes in three configurations: two-way complete, two-way local and inbound complete. It also has two IP termination products for TDM and SIP traffic.

“With gateway services, we found that wholesale customers have different buying patterns and behaviors than retail customers,” said Gary Elliott, product manager for Verizon Business. “They often want to only buy specific functionality, so we created that flexibility in the product suite with these configurations.”

IMPACTS OF VoIP ON WORLDWIDE TELECOM REVENUE ($ BILLIONS)

Global service revenue

2002: 1047
2003: 1129
2004: 1213
2005: 1296
2006: 1382
2007: 1472
2008: 1567
2009: 1660
2010: 1758
2011: 1861
CAGR: 6.6%

International service revenue

2002: 232
2003: 251
2004: 271
2005: 292
2006: 311
2007: 332
2008: 354
2009: 379
2010: 402
2011: 425
CAGR: 7%

International VoIP revenue

2002: 73.7
2003: 78.7
2004: 82.1
2005: 83.8
2006: 86.1
2007: 87.6
2008: 88.9
2009: 90.7
2010: 93.2
2011: 96
CAGR: 3%

Source: Insight Research

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