http://shirky.com/writings/zapmail.html
Customer-owned Networks:
ZapMail and the Telecommunications Industry
First published January 7, 2003 on the 'Networks, Economics, and
Culture' mailing list.
By Clay Shirky
To understand what's going to happen to the telephone companies this
year thanks to WiFi (otherwise known as 802.11b) and Voice over IP
(VoIP) you only need to know one story: ZapMail.
The story goes like this. In 1984, flush from the success of their
overnight delivery business, Federal Express announced a new service
called ZapMail, which guaranteed document delivery in 2 hours. They
built this service not by replacing their planes with rockets, but with
fax machines.
This was CEO Fred Smith's next big idea after the original delivery
business. Putting a fax machine in every FedEx office would radically
reconfigure the center of their network, thus slashing costs: toner
would replace jet fuel, bike messenger's hourly rates would replace
pilot's salaries, and so on. With a much less expensive network, FedEx
could attract customers with a discount on regular delivery rates, but
with the dramatically lower costs, profit margins would be huge
compared to actually moving packages point to point. Lower prices,
higher margins, and to top it all off, the customer would get their
documents in 2 hours instead of 24. What's not to love?
Abject failure was not to love, as it turned out. Two years and
hundreds of millions of dollars later, FedEx pulled the plug on
ZapMail, allowing it to vanish without a trace. And the story of
ZapMail's collapse holds a crucial lesson for the telephone companies
today.
The Customer is the Competitor
ZapMail had three fatal weaknesses.
First of all, Federal Express didn't get that faxing was a product, not
a service. FedEx understood that faxing would be cheaper than physical
delivery. What they missed, however, was that their customers
understood this too. The important business decision wasn't when to pay
for individual faxes, as the ZapMail model assumed, but rather when to
buy a fax machine. The service was enabled by the device, and the
business opportunity was in selling the devices.
Second, because FedEx thought of faxing as a service, it failed to
understand how the fax network would be built. FedEx was correct in
assuming it would take hundreds of millions of dollars to create a
useful network. (It has taken billions, in fact, over the last two
decades.) However, instead of the single massive build out FedEx
undertook, the network was constructed by individual customers buying
one fax machine at a time. The capital expenditure was indeed huge, but
it was paid for in tiny chunks, at the edges of the network.
Finally, because it misunderstood how the fax network would be built,
FedEx misunderstood who its competition was. Seeing itself in the
delivery business, it thought it had only UPS and DHL to worry about.
What FedEx didn't see was that its customers were its competition.
ZapMail offered two hour delivery for slightly reduced prices, charged
each time a message was sent. A business with a fax machine, on the
other hand, could send and receive an unlimited number of messages
almost instantaneously and at little cost, for a one-time hardware fee
of a few hundred dollars.
There was simply no competition. ZapMail looked good next to FedEx's
physical delivery option, but compared to the advantages enjoyed by the
owners of fax machines, it was laughable. If the phone network offered
cheap service, it was better to buy a device to tap directly into that
than to allow FedEx to overcharge for an interface to that network that
created no additional value. The competitive force that killed ZapMail
was the common sense of its putative users.
ZapPhone
The business Fred Smith imagined being in -- build a network that's
cheap to run but charge customers as it if were expensive -- is the
business the telephone companies are in today. They are selling us a
kind of ZapPhone service, where they've digitized their entire network
up to the last mile, but are still charging the high and confusing
rates established when the network was analog.
The original design of the circuit-switched telephone network required
the customers to lease a real circuit of copper wire for the duration
of their call. Those days are long over, as copper wires have been
largely replaced by fiber optic cable. Every long distance phone call
and virtually every local call is now digitized for at least some part
of its journey.
As FedEx was about faxes, the telephone companies are in deep denial
about the change from analog to digital. A particularly clueless report
written for the telephone companies offers this choice bit of advice:
Telcos gain billions in service fees from [...] services like Call
Forwarding and Call Waiting [...]. Hence, capex programs that shift a
telco, say, from TDM to IP, as in a softswitch approach that might have
less capital intensity, must absolutely preserve the revenue stream. [
http://www.proberesearch.com/alerts/refocusing.htm] You don't need to
know telephone company jargon to see that this is the ZapMail strategy.
Step #1: Scrap the existing network, which relies on pricey hardware
switches and voice-specific protocols like Time Division Multiplexing
(TDM).
Step #2: Replace it with a network that runs on inexpensive software
switches and Internet Protocol (IP). This new network will cost less to
build and be much cheaper to run.
Step #3: "Preserve the revenue stream" by continuing to charge the
prices from the old, expensive network.
This will not work, because the customers don't need to wait for the
telephone companies to offer services based on IP. The customers
already have access to an IP network -- it's called the internet. And
like the fax machine, they are going to buy devices that enable the
services they want on top of this network, without additional
involvement by the telephone companies.
Two cheap consumer devices loom large on this front, devices that
create enormous value for the owners while generating little revenue
for the phone companies. The first is WiFi access points, which allow
the effortless sharing of broadband connections, and the second is VoIP
converters, which provide the ability to route phone calls over the
internet from a regular phone.
WiFi -- Wireless local networks
In classic ZapMail fashion, the telephone companies misunderstand the
WiFi business. WiFi is a product, not a service, and they assume their
competition is limited to other service companies. There are now half a
dozen companies selling wireless access points; at the low end, Linksys
sells a hundred dollar device for the home that connects to DSL or
cable modems, provides wireless access, and has a built-in ethernet hub
to boot. The industry has visions of the "2nd phone line" effect coming
to data networking, where multi-computer households will have multiple
accounts, but if customers can share a high-speed connection among
several devices with a single product, the service business will never
materialize.
The wireless ISPs are likely to fare no better. Most people do their
computing at home or at work, and deploying WiFi to those two areas
will cost at worst a couple hundred dollars, assuming no one to split
the cost with. There may be a small business in wiring "third places"
-- coffee shops, hotels, and meeting rooms -- but that will be a
marginal business at best. WiFi is the new fax machine, a huge value
for consumers that generates little new revenue for the phone
companies. And, like the fax network, the WiFi extension to the
internet will cost hundreds of millions of dollars, but it will not be
built by a few companies with deep pockets. It will be built by
millions of individual customers, a hundred bucks at a time.
VoIP -- Phone calls at internet prices
Voice over IP is another area where a service is becoming a product.
Cisco now manufactures an analog telephone adapter (ATA) with a phone
jack in the front and an ethernet jack in the back. The box couldn't be
simpler, and does exactly what you'd expect a box with a phone jack in
the front and an ethernet jack in the back to do. The big advantage is
that unlike the earlier generation of VoIP products -- "Now you can use
your computer as a phone!" -- the ATA lets you use your phone as a
phone, allowing new competitors to offer voice service over any
high-speed internet connection.
Vonage.com, for example, is giving away ATAs and offering phone service
for $40 a month. Unlike the complex billing structures of the existing
telephone companies, Vonage prices the phone like an ISP subscription.
A Vonage customer can make an unlimited number of unlimited-length
domestic long distance calls for their forty bucks, with call waiting,
call forwarding, call transfer, web-accessible voicemail and caller ID
thrown in free. Vonage can do this because, like the telephone
companies, they are offering voice as an application on a digital
network, but unlike the phone companies, they are not committed to
charging the old prices by pretending that they are running an analog
network.
Voice quality is just one feature among many
True to form, the telephone companies also misunderstand the threat
from VoIP (though here it is in part because people have been
predicting VoIPs rise since 1996.) The core of the misunderstanding is
the MP3 mistake: believing that users care about audio quality above
all else. Audiophiles confidently predicted that MP3s would be no big
deal, because the sound quality was less than perfect. Listeners,
however, turned out to be interested in a mix of things, including
accessibility, convenience, and price. The average music lover was
willing, even eager, to give up driving to the mall to buy high quality
but expensive CDs, once Napster made it possible to download lower
quality but free music.
Phone calls are like that. Voice over IP doesn't sound as good as a
regular phone call, and everyone knows it. But like music, people don't
want the best voice quality they can get no matter what the cost, they
want a minimum threshold of quality, after which they will choose phone
service based on an overall mix of features. And now that VoIP has
reached that minimum quality, VoIP offers one feature the phone
companies can't touch: price.
The service fees charged by the average telephone company (call
waiting, caller ID, dial-tone and number portability fees, etc) add
enough to the cost of a phone that a two-line household that moved only
its second line to VoIP could save $40 a month before making their
first actual phone call. By simply paying for the costs of the related
services, a VoIP customer can get all their domestic phone calls thrown
in as a freebie.
As with ZapMail, the principal threat to the telephone companies'
ability to shrink costs but not revenues is their customers' common
sense. Given the choice, an increasing number of customers will simply
bypass the phone company and buy the hardware necessary to acquire the
service on their own.
And hardware symbiosis will further magnify the threat of WiFi and
VoIP. The hardest part of setting up VoIP is simply getting a network
hub in place. Once a hub is installed, adding an analog telephone
adapter is literally a three-plug set-up: power, network, phone.
Meanwhile, one of the side-effects of installing WiFi is getting a hub
with open ethernet ports. The synergy is obvious: Installing WiFi?
You've done most of the work towards adding VoIP. Want VoIP? Since you
need to add a hub, why not get a WiFi-enabled hub? (There are obvious
opportunities here for bundling, and later for integration -- a single
box with WiFi, Ethernet ports, and phone jacks for VoIP.)
The economic logic of customer owned networks
According to Metcalfe's Law, the value of an internet connection rises
with the number of users on the network. However, the phone companies
do not get to raise their prices in return for that increase in value.
This is a matter of considerable frustration to them.
The economic logic of the market suggests that capital should be
invested by whoever captures the value of the investment. The telephone
companies are using that argument to suggest that they should either be
given monopoly pricing power over the last mile, or that they should be
allowed to vertically integrate content with conduit. Either strategy
would allow them to raise prices by locking out the competition, thus
restoring their coercive power over the customer and helping them
extract new revenues from their internet subscribers.
However, a second possibility has appeared. If the economics of
internet connectivity lets the user rather than the network operator
capture the residual value of the network, the economics likewise
suggest that the user should be the builder and owner of the network
infrastructure.
The creation of the fax network was the first time this happened, but
it won't be the last. WiFi hubs and VoIP adapters allow the users to
build out the edges of the network without needing to ask the phone
companies for either help or permission. Thanks to the move from analog
to digital networks, the telephone companies' most significant
competition is now their customers, because if the customer can buy a
simple device that makes wireless connectivity or IP phone calls
possible, then anything the phone companies offer by way of competition
is nothing more than the latest version of ZapMail.
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