When I first started in telecommunications in 1984 the average monthly telephone bill of a medium-sized foreign exchange broker was about £2m per month. Today it is probably less than one per cent of this. Think about that.
When Mercury started selling switched services in 1986, we were offering a 20 per cent discount to BT and we were still making a healthy profit – it was easy. When the duopoly was broken and competitors piled into the market, Mercury came under the same price pressure as we had previously put on BT.
What would you do in your own business if your input costs halved every 18 months? You would probably put all your customers on long-term contracts and take the margin improvement for as long as you could.
In the meantime, you would find the optimal time to sell the business before competition attacks your base and destroys your revenues, margins and perhaps even the relationship with your customers.
Consider this real example.
Before we sold Griffin, a small reseller came to us to quote on his business. He had a mature base of leased-line customers who were putting him under pressure and his current (and previously enthusiastic) supplier inexplicably refused to return calls and emails.
On the first customer we looked at, the reseller was paying around £2,000 per month for a 2Mb leased line and we could supply a 20Mb replacement for £450 per month. We would be making a 20 per cent margin on this.
If the incumbent ISP could delay the decision to move away by a month, it would be the equivalent of nearly 18 months' margin at the new price. You can understand why they might refuse to speak to the reseller.
You might also see why ISPs and telcos are happy to give away thousands of pounds of installation and router costs on leased lines in exchange for long-term contracts at fixed prices.
Of course this is not a sustainable business model for the ISP and in the medium term the only way they can survive is through the synergies – mainly by stripping out duplicated cost to boost EBITDA – of buying a competitor, or selling to a competitor for them to do the same.
Move up a level and you will understand the pressures on companies such as BT which have thousands of these examples.
Furthermore, they are paying to upgrade their networks to create these new products. This is why there is a constant carousel of senior management coming and going at these companies.
They are given impossible growth targets to achieve and 18 months or so after having accepted the poisoned chalice they are usually up for reassignment. Their bosses tell them to "diversify and up-sell", which of course with 24-month product development cycles is virtually impossible.
The constant management changes destabilise the workforce and customer relationships and further exacerbate the problems of margin erosion and commoditisation.
There really is no solution.
In fact, if you're the end business customer, there isn't really a problem either so long as you have a way of monitoring what you should be paying for communications products.
If you're a reseller, you could diversify, cross-sell, up-sell and try to add value beyond the raw commodity cost. This is easy to say and much harder to do because although you can launch new products more quickly, you can still end up working very hard just to stand still.
Alternatively, build a business rapidly and sell it before the effects of innovation and commoditisation begin to bite. Then start again, hoping that your old customers will stay loyal to you and switch to the new company (why wouldn't they? You now have much better prices).
Many resellers already do this; in fact some are on their fourth or fifth business.
Why, knowing the risks, do networks continue to buy resellers? Mainly because, as we know, they have tough growth targets to meet in very short time scales and organically they are stagnant or going backwards.
The only way to get close to their targets is to buy resellers supplied by a competitor or force the reseller to stay loyal to them by offering to buy the business at a point in the future according to an agreed formula.
If you're a network or a big ISP, the only long-term strategy is to focus only on growing EBITDA through consolidation and almost to give up on organic growth. For organic growth you need investment, innovation, great leaders and great staff.
Who wants to work in a company where the main objective is to keep costs as low as possible and where you have to re-apply for your job every six months?
The cost of processing power is halving every two years and has been since the mid-1960s. Such is the appetite for speed, this generally means that businesses are buying twice the speed, whether it be servers or broadband, for the same price.
The communications market is so competitive. SMBs must employ trusted advisers to properly assess their IT and communications needs and recommend appropriate products.
Many suppliers will offer this communications audit for free, and this is fine so long as they are transparent and declare their vested interests.
Andrew Dickinson is managing director of Jola Cloud Solutions
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