Bandwidth Trading: The Commoditization of Bandwidth
Just as commodities such as natural gas, oil and electricity are traded, bandwidth trading in telecommunications is just emerging as a way to buy and sell capacity and hedge the risks of building new routes and buying capacity. For example, a competitive local exchange carrier (CLEC) that sells both long distance and local service can decrease its risk of price spikes by locking in a future price for bandwidth leases. The seller, a carrier, can cut its risk of adding expensive electronics such as wavelength division multiplexing (WDM) to dark fiber by selling future capacity. A future sale locks in a price floor and future revenues. It guarantees the price won't drop below a certain price for the seller and fixes a price ceiling for the buyer. Bandwidth trading is the listing, buying and selling of various telecommunications services through participants such as brokers, traders and exchanges. The following factors make bandwidth trading viable:
Readily available public lists, or indices, of prices for services—i.e., DS-3 (45 megabits), OC-3 (155 megabits) routes; for example, Los Angeles to Miami (this is referred to as price transparency).
Services offered should be essentially the same for all buyers—Services should be perceived as commodities.
Widely recognized standards such as speed, capacity and quality of service (QoS) that can be priced accordingly.
Locations with readily available interconnections in which bandwidth can be accessed by multiple carriers—This creates readily available services and products (liquidity).
Multiple buyers and sellers.
Standardized contracts to shorten negotiation intervals.
Guaranteed delivery with performance guarantees.
In telecommunications, traders buy and sell point-to-point routes at a given speed such as OC-3 between London and New York City. Other products such as dark fiber, conduit for fiber and minutes also are traded. Merchants help manage risk by guaranteeing that prices won't drop beneath a certain level (a floor) or increase above a price (a ceiling). They also guarantee the availability of products in the event of a spike in demand. They offer risk management. Buyers include large enterprises, resellers, facilities-based carriers and companies that build networks for other carriers. Sellers are large facilities-based carriers and carriers or resellers with excess capacity.
Bandwidth trading is still in its early stages. It is evolving as a result of growing capacities in long distance networks and commoditization of networks. Technological innovations such as wavelength division multiplexing have added tremendous capacity to telecommunications networks in Europe and the United States. Not only is there more capacity, but services are reliable and there is very little difference to end users and other carriers among the networks. Finally, capital is drying up for expansion of more diverse routes. Thus, when a carrier is faced with the decision of building new routes or leasing them, it often chooses to lease capacity from other carriers to conserve capital. For carriers of existing networks, selling spare capacity lets them fill their “pipes” more fully.
Companies such as Enron Corporation, Dynergy Corporation, Williams Communications Group and Aquila Broadband Services offer different types of brokerage, trading and risk management services. Many of these companies developed skills in the energy business in which brokering, trading and managing risks of building and buying energy is common. Firms that offer brokerage and exchange services don't take title to the routes, fiber or collocation space for which they are the middleman. They operate in a similar fashion to stockbrokers. They receive commissions on routes that are brokered.
Enron and Aquila Broadband Services are traders and merchants. Traders buy the routes they sell or swap routes with carriers or other traders. Examples of routes traded are DS-3 [44 megabits per second (Mbps)], OC-3 (155 Mbps), miles in the United States and STM-1 (155 Mbps) routes internationally. The routes are listed at DS-0 (64 thousand bits per second) monthly per-mile rates. For example, New York to Los Angeles might list at .004¢ per DS-0 mile. Because there are 672 DS-0s in one DS-3, this equals $2.69 per mile (672 × .004). Traders sit at trading desks, their computers, where prices of routes are available. If they see prices of routes they own going up, they hold them and hope to sell them at higher prices. If they think prices are high, they sell routes they don't have and try to buy them later at a lower price. They don't actually take physical possession of most of what they trade.
Merchants—Managing Risk for Carriers
Wholesale telecom merchants do trading and also perform more risk management functions for carriers and large enterprises. They do more actual buying, financing and selling than trading. They offer services to Internet service providers, network builders and very large enterprises. The following are types of transactions telecom merchants might make:
Sell a route to a carrier that the merchant doesn't own, at for example, .007¢ per DS-0 mile. Buy the actual physical route for .005¢ per DS-0 mile, making a profit of .02¢ per mile. This guarantees a price to a carrier.
Some competitive local exchange carriers (CLECs) have contracts for bandwidth at prices that are much higher than those currently available. A merchant will buy the expensive contract that results in high operating costs for the CLEC and sell it back to them at a lower price plus a premium (a fee). The merchant will get an agreement from the CLEC to buy routes the following year at a fixed price.
Sell an option to a carrier that is growing fast to buy bandwidth at a fixed price in the future. This guarantees the carriers' future costs.
Pooling points are being developed as places where, in a short period of time—perhaps a day—interconnections between carriers can be set up. A neutral pooling point is a place where large carriers and local telephone companies terminate and interconnect their circuits. Neutral pooling points are run by third parties rather than by a particular carrier. The company managing the pooling point connects local carriers to large backbone carriers as deals are made. For example, the neutral pooling point operator will make connections between carriers by programming an optical switch such that carrier A's traffic is routed to carrier B. Neutral pooling operators include LighTrade, Equinix and Switch and Data Facilities Company. See Chapter 5 for optical switches.
Williams is using its existing connections in carrier hotels for links with carriers with whom it arranges trades. It calls their carrier hotels virtual pooling points. Carrier hotels are warehouse-type sites where carriers have their routers and multiplexers and exchange traffic with each other and interconnect to local and long distance networks. Enron uses its own carrier hotels as pooling points and has stated that it also will participate in neutral pooling points.
Exchanges—A Place to Make Trades
Just as the New York Stock Exchange is a place where buyers and sellers come together to buy and sell stock, exchanges are being developed to exchange excess bandwidth capacity. Exchanges can be electronic or physical sites. Two of these exchanges are Arbinet-thexchange and Band-X. Arbinet-thexchange is an online exchange that lists available routes to, for example, Japan and Brazil, for members of its exchange. Band-X operates international exchanges where dark fiber, ducts for fiber, minutes of long distance and bandwidth are traded. Popular routes in Europe are between Amsterdam, Frankfurt, London and Paris. Exchanges typically charge about 2.5% for their service. They might require that buyers provide letters of credit. The most popular route in the United States is between New York City and Los Angeles. Some exchanges also offer brokerage services. Indexes are lists of prices of trades. Dow Jones and Enron Online have indexes.
Master Trading Agreements—Shortening the Transaction Cycle
Purchasing optical fiber routes from carriers can take six months to a year in a traditional purchase and sale. Master trading agreements are key to shorter negotiating intervals when acquiring bandwidth through trading mechanisms. Master agreements spell out terms in advance for service levels, type of service and liquidated damages. With liquidated damages, suppliers agree to pay a penalty if they don't deliver or perform as agreed. Customers with poor credit might be required to prepay for service. According to Pat Peldner, Vice President of Business Development for Aquila Broadband Services,
“The development of standard contractual terms and conditions is a vital and necessary effort during the development of a commodity market. The brokers, exchanges and merchants support a contract with strict financial liabilities for non-performance that are similar to agreements that govern the trading of other commodities.”
There are a few standard contracts that businesses use. An industry group, the Competitive Telecommunications Association (CompTel) has formed an ad hoc group that is developing a standardized agreement.