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The 2001 Telecom crisis: was it just a timing error?

During market disruptions, market players often make timing errors. Most people underestimate their impact. Such errors have created major surprises and sometimes huge disasters. The 2001 Telecom crisis is a striking illustration of such a phenomenon. During the crisis, market players made a fatal mistake that triggered the crisis: they misjudged the timing of the effect of the internet traffic upon global telecommunications networks.

Internet traffic first takes off in 1993 when the first browser, Mosaic (later renamed Netcape), hits the market. Then, an unprecedented growth takes place. A new market is born, with new products (e.g. Internet Explorer), new players (e.g. Internet Service Providers), new services (e.g. Instant Messaging) and new business models (e.g. on-line services).

In 1999, a major milestone is reached in the global Telecom network: data traffic, which internet is part of, outreaches voice traffic. Until then, voice communications dominated bandwidth usage. Their evolution was slow and predictable with 3 % growth per year. Internet traffic represented a small volume and could accommodate the bandwidth left unused by voice traffic. In 1999, the picture is quite different. Not only Internet traffic is now a major part of the total traffic, but ISPs notice that it doubles every 3 months. Such growth requires a radical extension of the Telecom network.

The entire industry rallies to a new noble cause: optical fibres must be installed everywhere in the world to meet the almost infinite Internet demand. A flow of optimism swarms: the vibrant enthusiasm of one part of the players reinforces the ambitious vision of the other part. Telecommunications Service Providers engage into an unprecedented fury of investments. New Service Providers are born. Between 1997 and 1999, Telecom equipment vendors' revenue rise to unseen highs.

The timing error occurs at the end of 2000. Internet traffic growth decreases and is now way below the initial forecast. Thanks to multiple network optimization initiatives, Internet traffic doubles every 24 months instead of every 3 months. Investments that are already engaged are not justified anymore. Market players altogether make the same mistake. They misjudge the time when traffic growth drops and demands a more reasonable investment pace.

The crisis is inevitable. Offer for bandwidth is overabundant and surpasses the weak demand. Prices fall. This adds up to Service Providers' inflated debts. At the start of 2001, these combined factors generate an unprecedented crisis in the global Telecom Industry. Some Service Providers go bankrupt, others slash their payroll. They suddenly stop all investments. As a consequence, their suppliers, Telecom Equipment vendors, stumble as well. Many small companies disappear; larger companies are forced to lay off half their work force. Only in 2003 does the situation get back to a stable state.

What is the cause of this stunning error that drove to such catastrophic consequences? The first cause can be explained by a curious characteristic of the fibre optic technology. Thanks to technology evolution, low-cost upgrades of terminating equipment provide the possibility to double the capacity of an optical fibre every 9 months. If traffic grows faster, trenches have to be dug and new optical fibres have to be buried in the ground. That is the premise that Service Providers choose to build their business case. But while they invest, growth is slowing down (doubling every 24 months from 2000 on) and such investments are not justified anymore. We see here that the error is very subtle. It is centred on Service Providers not anticipating the inflexion of the traffic growth curve.

The second reason is that it is a collective error. All players, Services Providers, Equipment Suppliers, Bankers and Financial Analysts are making decisions out of the same flawed numbers. Some make optimistic assumptions; they confirm the unrealistic plans that others are building; in return, the latter influence the former to raise their forecasts. Encouraged by the surrounding light-hearted frenzy, nobody questions the fundamental hypothesis.

This example shows us the catastrophic consequences of a timing error that caused the near collapse of the Telecom industry. Which conclusion can we draw? In a market disruption, anticipating the new market trends is not enough. It is imperative to precisely evaluate their timing.

May 24, 2005 |

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