Bandwidth Markets

Kostis Sakellaris

June, 2004

1. The Emergence of Bandwidth Markets

In the 1990s there were foreseen shortages of global bandwidth

Internet traffic was said to be doubling every three months

The bandwidth markets presented an effective and efficient mechanism for matching the needs of users and suppliers

1. … and their downfall.

No shortage of bandwidth: capital expenditure on fiber infrastructure far exceeded actual demand

Internet traffic grew closer to 100% per year (instead of 1000%).

Failure of the highest profile bandwidth trader, Enron.

1. … and their downfall.

Telecommunications sector “depression”

Deregulation has opened the market to dozens of new operators

Excess capacity is flooding the market

Competition has heightened dramatically

Revenues have plummeted

Where “dynamic” was once used to describe the international bandwidth market, “volatile” seems to be the current adjective of choice

2. Bandwidth Trading

Corrosive effect of demand/supply mismatch on bandwidth pricing.

Annual STM-1 lease prices on major European routes have fallen by 85 to 90 percent from 1999 to 2002.

While the decline of prices has been consistent across the sector, prices themselves vary widely among carriers. On major routes, the highest price was often four times the lowest price

2. Bandwidth Trading

Currently, bandwidth trading can be considered:

A market for surplus inventory

Distressed sales market

Bandwidth trading permits the participation in a surplus inventory market by re-sellers and intermediaries.

2. Bandwidth Trading

Typical Contract Structures:

IRUs (Indefeasible Right of Use) Lease Contracts.

2. Bandwidth Trading

Lease Contracts

Initially lease agreements were no less than five years and typically limited to 10 years.

More recently in what is now a clearly distressed, or ‘buyers’ market, shorter term leases have become available.

2. Bandwidth Trading

IRUs

IRU contracts are pre paid leases

Enabled buyers to treat the asset purchased as a fixed asset until late 1999.

Majority of the capital sum is paid in advance with a smaller operation and maintenance charge paid annually.

IRU durations available in the market range between 10 to 25 years.

2. Bandwidth Trading

Traditionally, bandwidth negotiations are:Bilateral Time consumingRequire a business relationshipLack of price informationFully specified price, quality, minimum

usage and performance

3. Bandwidth as a Commodity

Deregulation of the telecommunications industry has changed the landscape.

Existing bilateral nature of buyer-seller relationship is inefficient and impractical. Long provisioning times compared to

the speed of business, Uncertain traffic profiles Necessity of ‘global coverage’

3. Bandwidth as a Commodity

Special considerations:Bandwidth capacity is generic with the

exception of Quality of Service.Bandwidth is not storableGeographical arbitrageIntegration of voice/data traffic

Also: liquidity, standardization and connectivity.

4. Arbitrage Issues

At least four arbitrage opportunities in bandwidth trading:

Temporal arbitrageProduct arbitrageGeographical arbitrageDistributional arbitrage

Theoretically arbitrage can be eliminated by appropriate market design.

4. Arbitrage Issues

Example: geographical arbitrage

Monthly fee of a one-year DS-3 contract between NY and Prague offered at $70,000.

Cost connecting NY-London is $18,000 and London-Prague is $28,000.

Therefore buying the two segments will incur a cost of just $46,000.

4. Arbitrage Issues

Example: geographical arbitrage

5. Bandwidth Risk Management

Market Participants see as the most important benefit from bandwidth trading the development of bandwidth derivatives and their application in:

Risk ManagementSpeculationArbitrage

5. Bandwidth Risk Management

Risk ManagementLock-in the future price of bandwidth stabilising future revenue streamsCap possible losses in case of price fluctuations. Deconstruct risks in order to bear only the acceptable risk desired and offload all other risk in the market.

5. Bandwidth Risk Management

Real OptionsCan be defined as opportunities to respond to changed circumstances of a project by management. These opportunities are rights, but not obligations, to take some action in the future. Aim to quantify management’s flexibility.

6. Bandwidth Exchange

NeutralityAnonymitySpeedCoverageFinancial Safety NetsQuality of Service ManagementStandard Contract

6. Bandwidth Exchange

Benefits for sellers:Offer broader range of termination servicesOffer termination services at or below

marginal cost for short term periodsArbitrage pricing and capacityMore manageable cash-flowsPlan network utilisation in a real-time

environment

6. Bandwidth Exchange

Benefits for buyers:Acquire termination services at lower price

than the bilateral agreementsLimit market exposureManaging cash-flowsProvision of management tools in terms of

the routing table

7. Existing Markets

The survivors are profiting:

Arbinet-The exchange

- 298 Members in 2003 (up from 135 in 2001)

- 7.9 billion minutes in 2003 (+57% 2002)

Band-X

- 20 carriers in 2002

- 0.5 billion minutes in 2002

7. Existing Markets

Arbinet:Services offered include:Marketplace for voice minutes (three

products)Marketplace for data (three products)SwitchAxcess, for optimized routingRapidClear, for accelerated settlement

servicesInformation products

7. Existing Markets

Arbinet:

It can minimize or eliminate risks like:Burying Codes: Argentina

- Each city assigned its own mobile codes

- Buried seven digits in phone number so most carrier routing software is unable to read them.

Geographical Arbitrage

7. Existing Markets

Band-X Case Study: Real Data Services Ltd

(London-based ISP)

Became facilities-based carrier:Cut down middle-manVirtually no capital expenditureNo additional operations or engineering

resourcesWith benefits of BT interconnect rates

8. Bandwidth Markets Outlook

Through bandwidth trading carriers can: reduce their costs of doing businessrestore some of the profit margin lost due to increased competition, andapply risk management techniques.

Still, bandwidth trading in an elementary stage.

8. Bandwidth Markets Outlook

Future of bandwidth trading is not bright, but still it has potential.

It is not impossible that it could evolve to being a primary or major secondary market.

Whether this potential is realised depends upon the state of competitiveness in telecommunications markets over the next few years.