ANALYSING THE EVOLUTION OF INDUSTRY: THE

RELEVANCE OF THE TELECOMMUNICATIONS INDUSTRY1

Martin Fransman
Department of Economics and
Institute for Japanese-European Technology Studies
University of Edinburgh
25 Buccleuch Place
Edinburgh EH8 9LN

Phone: +44-131-650-4061
Fax: +44-131-667-4340
e-mail: M.Fransman@ed.ac.uk

1
Several scholars have influenced this study, though are not implicated by its conclusions. Dick Nelson
and the group working with him on the long term evolution of a number of key industries have, through
their discussions, helped me to formulate and clarify some of the issues discussed here. Brian Loasby, also
through discussion, has stimulated my thinking and influenced the direction of my thought. Steve
Klepper’s work on industrial shakeouts and Dick Langlois and Paul Robertson’s on modular systems and
the economics of networks have also been sources of stimulation. Finally, I am endebted to the work of
G.B. Richardson, particularly his 1972 article in The Economic Journal.

1
 There is “a fundamental unity of action between the laws of nature in the
physical and moral world. This central unity is set forth in the general rule, to
which there are not very many exceptions, that the development of the organism,
whether social or physical, involves an increasing subdivision of functions
between its separate parts on the one hand, and on the other a more intimate
connection between them. Each part gets to be less and less self-sufficient, to
depend for its wellbeing more and more on the other parts, so that any disorder in
any part of a highly-developed organism will affect other parts also.

This increased subdivision of functions, or ‘differentiation’, as it is called,

manifests itself with regard to industry in such forms as the division of labour,
and the development of specialised skill, knowledge and machinery: while
‘integration’, that is, a growing intimacy and firmness of the connections
between the separate parts of the industrial organism, shows itself in such forms
as the increase of security of commercial credit, and of the means and habits of
communication by sea and road, by railway and telegraph, by post and printing-
press.” (p.201)

“…we say broadly that while the part which nature plays in production shows a
tendency to diminishing return, the part which man plays shows a tendency to
increasing return. The law of increasing return may be worded thus: An increase
in labour and capital leads generally to improved organization, which increases
the efficiency of the work of labour and capital.” (p. 265, emphasis added)

Alfred Marshall, Principles of Economics.

INTRODUCTION

What does an analysis of the telecommunications industry have to offer the growing
literature on industry evolution from an evolutionary/institutional perspective? The first
answer is that it provides another example of industry evolution to compare with the
increasing number of industries that are receiving attention from this perspective. A
number of scholars have called for just such an extension. For example, reacting to the
strong body of literature in this field which emphasizes the product life cycle model and
the related concept of a dominant design in a number of industries, Nelson (1998) has
argued: “Some writers clearly believe [that the applicability of these ideas is] universal.
I confess some skepticism about that. The story seems to fit best industries where the
product is a ‘system’, and where customers have similar demands. It is not at all clear if

2
the notion of a dominant design fits the experience of the chemical products industry
where often a variety of quite different products are produced for similar uses, or
pharmaceuticals where customer needs are divergent and specialized.” (p.324) The
implication is that more detailed studies are needed of other industries, a point that is
supported by Klepper (1997) who has made major contributions to this literature:
“Additional products need to be studied, particularly less traditional products whose
evolution might be more likely to depart from the product life cycle.” (p.176) 2

A second benefit from studying the evolution of the telecoms industry, as the present
study emphasizes, follows from the role played in this industry by specialist suppliers.
Klepper’s (1997) study suggests that various processes of specialization may be causally
connected to the absence of typical product life cycle patterns in a number of industries
and, correspondingly, to the absence of ‘shakeouts’ as he defines them, although Klepper
does not reach any definitive conclusions on this matter. Nevertheless, he concludes that
“a particularly fertile area for further research is tracing the evolution of firm
specialisation, including the circumstances underlying it, in a range of products….If, in
fact, the horizontal structure of the market co-evolves with the vertical structure, as the
review of the products [in this paper] would suggest, then this research would be
particularly valuable for understanding why some products do not evolve according to the
product life cycle.” (p.177) The present paper deals with the issue of specialisation
through the study of the telecoms industry.

Thirdly, the study of the ‘telecoms industry’ raises in a rather stark way the conceptually
difficult questions of what is meant by an ‘industry’ and how we should define that
industry’s boundaries, which in turn will determine the limits of the analysis of any
industry (i.e. to put it more concretely, what needs to be included, and what can
legitimately be left out, in an evolutionary analysis of any industry?) An examination of
the evolutionary/institutional literature reveals that, while the concepts of the ‘firm’ and
‘market’ are widely used (even though on closer inspection there is often lack of clarity

2
The implicit equation of ‘product’ and ‘industry’ in the quotation is an issue that is taken up later in this
paper.

3
or even overt disagreement regarding what is meant with the use of these concepts), and
while there is a well-developed literature on the boundaries of the firm, the same cannot
be said for ‘industry’ and ‘industry boundaries’. This matter is closely related to that of
the level of aggregation that is appropriate in the evolutionary analysis of industries
(whether the analysis is statistical or formal-theoretical or appreciative-theoretical) that
Dosi, Malerba, and Orsenigo (1997) have recently raised: “there is a problem of
interpretation of statistical data and in particular of aggregation. The data that are
available and the regularities that are observed refer actually to entities and phenomena
that are defined at different levels of aggregation and at different time scales. For
example, in the life cycle approach, the emphasis is sometimes on narrowly defined
products and other times on ‘industries’. But how would this approach consider, for
example, mainframes and personal computers? Are they to be taken as different products
with distinct life cycles or as variants of the same basic product and of the same life
cycle? Probably the interpretation of patterns of evolution would turn out to be quite
different in the two cases….” (p.17)

Other examples of aggregation problems also need to be considered. For instance, to go

back to our earlier quotation from Klepper regarding the importance of specialisation, is
it necessary to include an analysis of specialist suppliers, if they exist, in order to
understand the evolution of even an industry that is narrowly defined around a product?
The issue of appropriate industry boundaries is obviously central here. For example, in
one of the few studies that explicitly poses the problem of industry boundary – his
subheading reads “Defining The Boundaries Of The Traded Software Industry” –
Mowery (1996) opts for traded software in three areas: operating systems, applications
tools, and applications solutions. But this, as he points out, presents problems. To begin
with, “determining the boundaries between ‘computer services’ and ‘computer software’,
even in the traded software sector, may be virtually impossible.” (p.5) Even more
problematical is his observation that “Rapid hardware diffusion…has tended to erode
vertical integration between hardware and software and until recently appears to have
reduced the competitive significance of economies of scope among different standardized
applications, limiting the tendencies toward producer concentration that might otherwise

4
be even stronger in an industry such as this, whose costs are primarily
fixed….[Furthermore,] the expanding installed base of ever cheaper computers has been
an important source of dynamism in and entry into the traded software industry.” (p.6)

For these and other reasons, Mowery concludes that “applications software is an example
of an industry that does not adhere to a model of technology life cycles…in which the
emergence of a ‘dominant design’ in an industry is followed by a gradual decline in
entry.” (p.11) These issues, it seems, raise in stark form the question of where the
boundaries of this particular ‘industry’ should be drawn, and, if appropriate boundaries
are thought to be problem-contingent, what kinds of problems require what kinds of
boundaries. For example, Grove’s (1996) account of “the new horizontal computer
industry” and its boundaries – driven by his own purpose to make sense of the
competition problems that Intel faces - includes not only operating systems and
application software in his definition of the industry, but also semiconductors and sales
and distribution.

As these examples make clear, a key question is how far we need to go in terms of the
boundary that is appropriate for the analysis of any industry. This question is central in
the present study of the telecoms industry. The approach that is taken here, to anticipate
the crux of this paper, is that this question can only be answered with reference to what
Schumpeter has called (though in a more general context) the “prime movers” or
“fundamental impulses” or “engines” of the system3. It is not claimed, however, that this
approach offers a panacea. Apart from the additional complexity that it adds, it raises the
difficult problem of how the industry’s dynamics or driving forces are to be identified.
At present, the author’s only answer to this problem is that a good deal of knowledge of
the industry is necessary. But this, clearly, is inadequate in view of the interpretive
ambiguity that is likely to arise, even among those knowledgeable about the industry,
regarding what the driving forces of the industry are.

3
Capitalism, Socialism and Democracy (1966), p.82-3.

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THE EVOLUTION OF THE TELECOMMUNICATIONS INDUSTRY

The analysis of the evolution of the telecoms industry is divided into two parts. In the
first, the evolution of the industry is briefly described. The second part contains an
analysis of the dynamics or driving forces of the industry as well as an analysis of the
implications for industrial structure.

PART ONE: DESCRIBING THE EVOLVING TELECOMMUNICATIONS

INDUSTRY

Natural Monopolies With Different Forms Of Organization Governing The Relationship

Between Carriers And Their Suppliers

Until the 1980s the conventional wisdom was that the telecoms industry should be
regarded as a ‘natural monopoly’. This meant that for reasons of efficiency, namely the
primacy of economies of scale, telecommunications services should be provided by a
single monopoly carrier. Although this was the conventional wisdom in all countries,
fundamentally different forms of organization evolved governing the relationship
between the government-owned monopoly telecoms carrier and the supplier/s of its
equipment (mainly switches and transmissions systems). Amongst those countries that
were industrially large and sophisticated enough to have their own telecoms equipment
suppliers, the U.S. and Japan represented the polar extremes.

More specifically, while vertical integration was the dominant form of organization in the
U.S., a characteristic that was only to end in September 1995 when AT&T voluntarily
trivested itself, in Japan a cooperative form of organization evolved whereby a ‘family’
of four main suppliers catered for the needs of the monopoly carrier, NTT. Britain was
more similar to the Japanese pattern, although its experience with cooperation was not
nearly as happy as the Japanese. (For an analysis of the origins of these different forms

6
of organization, see Fransman (1995).4 Most smaller industrialized countries (Sweden
being a major exception) and developing countries, lacking indigenous equipment
companies, obtained their telecoms equipment from the major global suppliers who
competed vigorously in these markets.

Dynamism Under Natural Monopoly

Whilst the conventionally-trained economist might suppose that the industrial structure
just described would be un-innovative and inefficient, it is worth stressing that this was
not the case. For example, the real cost and price of calls tended to fall significantly in
most countries, telecommunications services were rapidly diffused and included universal
service, and, most significantly, there was a rapid rate of both incremental and radical
innovation. Indeed, most of the fundamental innovations that are driving the so-called
Information and Communications Revolution of the 1990s were made during the natural
monopoly period up to the mid-1990s. Examples include digital switching, optical fiber
(although some of the fundamental breakthroughs came from the glass industry), digital
transmissions systems, cellular mobile systems, packet-switched networks (though some
of the key initial innovations come from the computer community), and satellite
communications.

Why was there so much innovation under natural monopoly? Part of the answer has to
do with the success of long term fundamental but mission-oriented research undertaken in
places like AT&T’s Bell Laboratories, NTT’s Electrical Communications Laboratories,
BT’s Martlesham Laboratories, and France Telecom’s CNET. Another part of the
answer lies in the non-market competition, but competition nevertheless, that existed
between the carriers of the major countries and their laboratories, vying for the prestige
of being first and best in particular areas. Coinciding with this competition were

4
G. B. Richardson’s (1972) comment are relevant apropos this apparently conflicting ‘choice’ of form of
organization in the U.S. and Japan: “Theories of industrial organization, it seems to me, should not try to
do too much. Arguments designed to prove the inevitability of this or that particular form of organization
are hard to reconcile, not only with the difference between the capitalist and socialist worlds, but also with
the differences that exist within each of these. We do not find the same organization of industry…in the
United States and Japan. We ought to think in terms of the substitutability of industrial structures.” (p.896)

7
important forms of international cooperation, such as the regular international switching
conferences, which were important sources of information and stimulated processes of
search and experimentation.

A further part of the explanation lies in the political and other pressures that were put on
national carriers to improve their provision of telecoms services which were, after all,
vital, though in different ways, for everyone. Finally, the institutions of regulation were
also important. In addition to constituting a source of pressure for improvement,
regulation also helped to make knowledge created in the telecoms industry more open
than it would have been in a market-regulated industry. One notable example is
AT&T/Western Electric’s patents for the transistor which were made almost freely
available to whoever wanted them (including small and then-insignificant companies like
Sony). (See Fransman (1995) for further details.)

Part-Liberalization In Some Countries From The Mid-1980s

In the mid-1980s a sea-change occurred with part-liberalization of the telecoms industry

in the U.S., Japan and Britain. In the U.S. AT&T was broken up into one long-distance
company, the reconstituted AT&T, and seven regional holding companies providing
regional services, the so-called Baby Bells. Furthermore, long-distance competition was
admitted with MCI and Sprint being the main original new-entrants. In Japan, three long-
distance competitors emerged to challenge NTT, namely DDI, Japan Telecom, and
Teleway Japan. In the U.K. a duopoly was established with Mercury, a subsidiary of
Cable and Wireless, as the new entrant.

However, although some competition was introduced, the liberalization was only partial.
While there was some competition in long-distance services it was limited by regulatory
restrictions on the number of new entrants and the absence of regulations requiring the
incumbent to open its networks to interconnection by new entrants at cost-based prices.
In general, local access (access to offices and homes) and local services remained

8
monopolized by the incumbents. International accounting rate agreements ensured that
international rates were determined by an international oligopoly of national incumbents.

Although liberalization was only partial, this stage produced some important structural
changes that were to become important influences shaping the further evolution of the
telecoms industry. Amongst these were the new business opportunities that were opened
up, largely for powerful national business organizations hitherto denied openings in the
telecoms industry. As Douglas North (1996) has argued, organizations such as these are
also “action groups” which, through their actions, drive institutional change. And this
they did, helping to shape the new “rules of the game” that influenced the subsequent
evolution of the telecoms industry.5

The Context Provided By The Information And Communications Revolution

The decade from the mid-1980s was marked by an explosion in demand for new
information and communication products and services. From the point of view of the
telecoms industry, most important were mobile telecoms services and the Internet. Both
created rapid growth in relatively new markets and at the same time generated new
business opportunities for incumbents, original new entrants, and ‘new new entrants’
alike. From the late 1990s, the Internet became particularly important and, indeed,
became a new paradigm within both the communications and the information industries.

5
“Institutions are the rules of the game of a society or more formally are the humanly-devised constraints
that structure human interaction. They are composed of formal rules (statute law, common law,
regulations), informal constraints (conventions, norms of behavior, and self imposed codes of conduct), and
the enforcement characteristics of both. Organizations, too, specify the constraints that structure human
interaction inside the organization but in addition they are action groups. They are composed of groups of
individuals bound by a common purpose to achieve objectives. They include [firms and other economic,
political, social, and educational bodies]. Organizations in pursuit of their objectives are the primary
source of institutional change.” (North, 1996, p.12, emphasis added) While there are many problems with
North’s conceptualization of institutions and organizations, for present purposes they are useful largely
because they allow a causal connection to be made between the economics of new entry (expected market
share, rates of return etc) and the political processes that accompany new entry and the possibility of new
entry. These political processes in turn structure the institutions, in North’s sense, which have played an
important role in shaping the evolution of the industry. Key issues in the industry, such as how the industry
should be regulated, how regulation should change over time, what specific regulations are needed, how
regulation itself should be organized, who should be given licenses to operate and according to what
criteria, etc are examples of institutional change in the Northian sense, all of which are subject to
determining political processes.

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Based on the triad of technologies contained in packet-switching, IP (internet protocol),
and the World Wide Web, the Internet, as is discussed later, provided an alternative
infrastructure for most telecoms services, including services such as voice and video-
conferencing.6 The rapid growth in markets, the improvement of existing technologies
and the emergence of new substitute ones helped to fuel new entry and intensified
competition in the industry.

Further Liberalisation And Globalisation

The latter 1990s saw a further round of liberalisation, this time on a global scale. In the
U.S. the Telecommunications Act was passed in 1996 with the intention of introducing
competition at the regional and local levels (although this legislation soon became
bogged down in litigation as the Baby Bells successfully challenged the attempt to prise
open their markets). From January 1st 1998 the European Union officially opened all its
telecoms markets to competition (some markets having been opened earlier) although in
practice liberalisation is not yet complete in a few of the major European countries while
other countries were given extra time to liberalise. In 1997 the World Trade Organisation
(WTO) concluded an international agreement committing most countries in the world to
telecoms liberalisation.

Equally importantly, for the first time incumbents such as AT&T, NTT7, BT, Deutsche
Telecom, and France Telecom began to globalise their activities and become ‘new new
entrants’ in each other’s markets. Furthermore, with the notable exception of NTT, a
latecomer to the global race, these incumbents also established global alliances aimed at
providing multinational corporations with end-to-end services.

The late 1980s and early 1990s also saw the emergence of new breeds of ‘new new
entrants’. Two groups are particularly important. The first consists of industrial
companies and utilities that saw the growth and liberalisation of the telecoms industry as

6
For further details see Fransman (1998b).
7
The complicated situation in Japan which in December 1996 resulted in the decision to allow Japan’s
largest carrier, NTT, to globalize is examined in Fransman (1997a and b).

10
an opportunity for profitable diversification. The second group is made up of
entrepreneurs, usually without any background whatever in telecommunications, financed
by venture capital financial institutions8. The modus operandi of the entry of both these
groups, facilitated by one of the most important dynamic characteristics of the telecoms
industry, is analysed in the following section.

By 1995, as is shown in Figure 1, the size of the global telecommunications market was
estimated to be $519 billion (the table also showing the most important sub-markets).

PART TWO: THE DYNAMICS OF THE TELECOMMUNICATIONS INDUSTRY

The main argument of the present paper is that there are five determinants that together
constitute the driving forces behind the evolution of the telecoms industry and therefore
determine its dynamics. These five factors also determine the ‘structure’ of the telecoms
industry. In this paper the definition of ‘industrial structure’ suggested in Afuah and
Utterback (1997) is followed, namely to refer to “barriers to entry, the nature and sources
of substitutes, the number and kinds of rivals, suppliers and customers” (p.184). (The
important problem of the meaning and definition of ‘industry’, ‘industrial structure’ and
‘industry boundary’ is considered further in the conclusion to this paper. 9)

DYNAMIC 1: QUASI-VERTICAL SPECIALISATION

THE SIGNIFICANCE OF SPECIALIST SUPPLIERS

The present organisation of the telecoms industry may be described as one of quasi-
vertical specialisation. One of the most important characteristics of the industrial
organisation of the telecoms industry is the role played by specialised equipment and
software suppliers. As noted in the last section, the equipment suppliers evolved in

8
To return to North’s definition of institutions, reference here, strictly speaking, should be to financial
organizations. However, as is shown later, the role played by capital markets in the evolution of the
telecoms industry constitutes one of the crucial ‘rules of the game’ (in a general, rather than game-theoretic
sense) under which the industry is evolving. Therefore, capital markets may also be thought of as
institutions in the Northian sense.

11
different ways in different countries. In Japan and Europe, although the monopoly
telecoms carrier did a significant amount of equipment-related R&D, the activities of
equipment research, design and development were, from the outset, left largely to
specialist equipment companies. It was in this way that companies like NEC, Fujitsu,
Ericsson, Alcatel and Siemens emerged as telecoms equipment suppliers (although all of
these companies are diversified beyond the telecoms equipment market). In different
countries, however, the pattern of co-operation between telecoms carrier and equipment
supplier/s differed. In Japan, for example, right from the outset in the late 1800s the
Ministry of Communications insisted on a degree of competition between its suppliers, a
form of industrial organisation that has been referred to as “controlled competition”10. In
Germany, on the other hand, Siemens was in effect the only supplier to the Deutsche
Bundespost and did the lion’s share of telecoms R&D.

In the U.S., however, "from the time that Alexander Graham Bell co-operated with
instrument-maker Thomas Watson in producing the first telephone sets, it was the same
organisation that both developed the telecommunications network and developed and
manufactured the equipment that it required. This pattern was firmly established in 1880,
when the American Bell Telephone Company purchased Western Union’s telephone
supplying subsidiary, the Western Electric Company of Chicago. According to an 1882
agreement, American Bell restricted itself to purchasing all its telephone equipment from
Western Electric, while the latter agreed to limit its activities to supplying American Bell
and its licensees.”11 This vertical integration of network operation and equipment
production in AT&T continued until the company’s voluntary trivestiture in September
1995 into one company providing telecoms services, the new AT&T, one providing
equipment, Lucent, and one providing computers and computer services, essentially the
former NCR that had been acquired in a hostile take-over by AT&T in 1993.

9
In the conclusion it is suggested that there is no consensus in the literature regarding the meaning and
definition of these terms and that this may be a drawback for the analysis of industry evolution. Some
suggestions are made using the present example of the telecoms industry.
10
See Fransman (1995).
11
See Fransman (1995), p.24.

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Why these different forms of industrial organisation in the different countries? The basic
problem that needed to be solved, as G. B. Richardson (1972) has analysed, was one of
organising complementary but dissimilar activities (dissimilar in the sense that network
operation, on the one hand, and equipment design and manufacture on the other, required
different sets of capabilities12). That in AT&T these activities were organised inside the
same company, while in Japan and Europe they were separated in different companies, is
a reflection of Richardson’s observation that “It will be clear, in some situations, that co-
ordination has to be accompanied by direction [i.e. within a firm], by co-operation or
through market transactions, but there will be many others in which the choice will be
difficult…”13. It is worth adding, however, that apart from AT&T in the U.S., in all the
other countries the form of organisation adopted for co-ordinating the activities of
network operators and equipment providers was one of co-operation (in Richardson’s
sense14) rather than a market-based relationship.15

Distribution Of R&D Between Carriers And Specialist Equipment Suppliers

With the increasing intensity of competition in the 1990s has come a tendency for a
greater proportion of telecoms industry R&D to be undertaken in equipment companies,
rather than carriers. In 1995, for example, while the global top eight carriers (including
NTT, AT&T, Deutsche Telecom, France Telecom and BT) spent a total of $7.5 billion on

12
I follow Afuah and Utterback (1997) here in making “competencies + firm-specific assets = capabilities
or resources [in the Penrosian sense]”, p.183.
13
Richardson (1972), p.896.
14
According to Richardson (1972), “The essence of co-operative arrangements…would seem to be the fact
that the parties to them accept some degree of obligation – and therefore give some degree of assurance –
with respect to their future conduct. But there is certainly room for infinite variation in the scope of such
assurances and in the degree of formality with which they are expressed.” (p.886). In Fransman (1995) I
have analyzed in detail the form of co-operative organization that evolved in the Japanese telecoms
industry, which I called “controlled competition”.
15
This raises the question of the causes behind AT&T’s voluntary trivestiture in September 1995, which
resulted in the U.S. ‘falling in line’ with Japan and Europe in this aspect of its industrial organization of its
telecoms industry. While this matter is too complex to analyze fully here, it is worth noting that one of the
reasons officially given by AT&T for the trivestiture was the difficulty that its equipment divisions were
having in trying to sell equipment to AT&T’s competitors who in some cases suspected that these divisions
would give competitive preference to their mother company. It is likely, however, that a related reason was
the realization that as an independent company the equipment divisions (that later became Lucent) would
be able to take greater advantage of economies of specialization. In addition, the trivestiture allowed the
management of AT&T to give greater focus to the company’s core telecoms services businesses.

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R&D, the top eight equipment companies (including Lucent, Ericsson, Northern
Telecom, Siemens, Motorola, and NEC) spent $23.4 billion.

The Emergence Of Specialist Data Networking Equipment Suppliers

A significant new trend that emerged from the late 1980s, on the back of the explosion of
Internet-related demand, was the rapid growth of a new breed of companies producing
data networking equipment for the Internet and IP (internet protocol) networks more
generally. Many of these new companies emerged through the activities of individuals
involved in designing and building the early computer networks, like the ARPANET, that
led to the development of the Internet. These companies include Cisco, 3Com, Bay
Networks, and Cabletron. It is highly significant that in 1996 these four companies
together spent $9.6 billion on R&D, compared to the $7.5 billion spent the previous year
by the top eight carriers (NTT, AT&T etc). Cisco, the largest of them, only started in late
1984 as a venture by a group of Stanford University computer scientists. By March
1998, Cisco had grown into the third-largest company on Wall Street; with a market
value of $71 billion it was worth more than General Motors, making it “the fastest-
growing technology firm in history”16. Significantly, although some of the major
telecoms-related companies claimed that they had successfully integrated computer
competencies into their portfolio of competencies – this was the official reason AT&T
acquired NCR, and the Japanese companies NEC and Fujitsu were both computer and
telecoms equipment producers – none of them has made much headway in the rapidly
growing markets for data networking equipment.17

16
The Economist, March 28th, 1998, p.98.
17
The difficulties that established firms often have in reconfiguring their competencies and routines in
order to produce new products competitively is now a well-established finding in the evolutionary literature
on firms (see, for example, Henderson and Clark, 1990). In this case the firms concerned (e.g.
AT&T/NCR, NEC, Fujitsu) were significant players in computer markets, in addition to having important
competencies in communications networking, and a rigorous story still needs to be told to explain why they
failed to enter successfully the markets for data networking equipment. It is likely that an important part of
this story will be the significance of the circuit-switching paradigm in traditional telecoms products as
opposed to the packet-switching on which the new data networks were based and, in the case of the
Japanese companies, the relatively slow adoption of distributed client-server systems and the greater use of
proprietary mainframe platforms.

14
The Emergence Of Specialist Software Suppliers

Also important to the dynamic of competition in the telecoms industry has been the
emergence of specialist software suppliers. For instance, it has become apparent that
billing systems can play an important role in the competitive struggle. One famous
example is the Friends and Family option offered by MCI in a bid to attract customers
away from the dominant incumbent, AT&T (which involved offering cheaper rates on a
few frequently-called numbers). Billing systems can offer customers more information
about the services they are using and how they are charged, which may allow a carrier to
differentiate its product. More generally, billing systems can be integrated with the
carrier’s other information systems, such as network operation and management, giving
the carrier far more details about customer behaviour and therefore allowing for a more
sophisticated marketing of customised service packages. These packages, in addition to
the conventional fixed-wire voice service could also include mobile service, Internet
access, video-phone, as well as home banking and shopping.

The Consequences For Industrial Structure Of The Availability Of Specialist Suppliers

The availability of specialist suppliers is a particularly important determinant of industrial

structure (as defined above) and it is for this reason that it has been singled out as one of
the main driving forces in the telecoms industry. What impact does the availability of
specialist suppliers have on the structure of the industry?

The first effect is on entry barriers. More specifically, while barriers such as the amount
and cost of capital needed for entry, management and marketing competencies,
regulations, and brand name and reputation of the incumbent remain, the availability of
specialist suppliers has significantly lowered technology barriers. ‘Original new
entrants’, such as MCI in the U.S., DDI in Japan, and Mercury in Britain, as well as ‘new
new entrants’ like WorldCom and Quest in the U.S. and Energis, Colt, Ionica and Esprit
in Britain, have been able to enter to begin with without any R&D capability to speak of.

15
Two processes, both emerging from the specialist suppliers, have facilitated this
technological ease of entry. The first process has involved both the sale of telecoms
equipment and software to the new entrants as well as significant development work done
on their behalf to customise equipment and software systems to meet the entrant’s
specific requirements.18 The second process works through labour markets and involves
the entrant hiring staff who have accumulated knowledge, skill and experience in a
specialist supplying company and who accordingly are able to operate, manage, and
develop the new entrant’s network. These two processes, working together, have
considerably eased the entry process. The contrast with other industries, such as motor
cars, where technological and organisational barriers are far higher, is great.

The second component of industrial structure defined earlier is “the nature and sources
of substitutes”. Here too the specialist suppliers have played a key role. Several
examples will highlight this point. One example is Voice-on-the-Internet (VOI), a
substitute for conventional telephony over circuit-switched lines, which with its far lower
costs (the result of Internet tariffing) is already beginning to reduce standard telephone
charges by the established carriers. Some estimates suggest that by 2002 as much as 13
percent of voice calls may be made over the Internet19. VOI was pioneered in 1995 by a
small Israeli-owned start-up called Vocaltec. Vocaltec is now working with Deutsche
Telecom in Germany to introduce VOI.

A second example is a possibly radical breakthrough called Power Line. Essentially,

Power Line involves the provision of data communications, including VOI and Internet
access, through the electric power cables that are already connected to firms and homes,
thus avoiding the need to dig up streets (as with optical fibre cables) or establish radio
base stations (as with mobile or fixed radio access connections). Power Line works
through radio frequencies being transmitted through electric power cables. Relatively

18
In a personal interview, a senior executive from WorldCom explained to me how the company, which in
1997 achieved global prominence when it snatched MCI away from BT in a takeover bit, while doing
virtually no R&D, works extremely closely with traditional suppliers like Northern Telecom and Alcatel
and new suppliers like Cienna. The size of WorldCom’s network and its buying power guarantees it the
closest attention from its suppliers with the result that the company does not feel it necessary to make in-
house R&D a priority.

16
cheap enabling technology is required at the electricity substation (serving 250 homes)
and at the customer’s electricity meter. The original innovation was made by an engineer
working with Norweb, the electricity company that supplies the Manchester and
Yorkshire areas of Britain. (Apparently, the engineer persisted with his research after
being told my his managers that the project was not feasible and should be ended.) In the
event, Norweb obtained the commanding patents for Power Line. However, Norweb,
lacking the technological competencies, also entered into a strategic alliance with
Northern Telecom (Nortel), the established Canadian telecoms equipment company
which went on to develop the necessary technology to make Power Line both
technologically and economically feasible. Although it is too soon to tell whether this
new technology will be a serious substitute for other alternative telecoms transmission
and local access technologies (Norweb and Nortel claim that it is significantly cheaper
than the other alternatives), the example is a good illustration of the importance of
specialist suppliers as a force driving the dynamics of the telecoms industry.

The third component of industrial structure is “the number and kinds of rivals [and]
suppliers”. From what has already been said it is clear that the specialist suppliers have
had, and are continuing to have, a significant impact on this component too. The fourth
and final component, customers, are dealt with below.

The Question Of Shakeout

Specialist equipment suppliers also have important implications for another aspect of
industrial structure, not included in the definition we have used here by Afuah and
Utterback (1997) but emphasised by Klepper (1997) and Klepper and Simons (1997),
namely the process of shakeout which was briefly discussed in the introduction to this
paper. More specifically, by making most of the network technologies available to all
entrants able to pay the market price, specialist suppliers may have circumvented a major

19
Business Week, April 6, 1998, p.49.

17
source of shakeout20 that has occurred in industries such as motor cars, tires, televisions,
and penicillin, namely increasing returns to innovation, which may accrue to the early-
entering incumbents. Correspondingly, the availability of specialist suppliers and the
access to technologies that they supply has also had the effect of shifting the thrust of
competitive strategies away from equipment-oriented R&D towards the achievement of
other objectives such as service differentiation (that may depend on software
development), speed of response to market opportunities, reliability of services, security,
etc.

The issue of shakeout, however, raises an intriguing question regarding the future
evolution of the telecoms industry, namely, will this industry experience shakeout as
defined here? With the liberalisation and globalisation of telecoms markets there has
been a significant increase in net entry (i.e. entry minus exit) of firms. In Britain, for
example, by 1998 the national regulator, Oftel, had granted 20 licenses to fixed link
public telecommunications operators (which included companies like WorldCom, AT&T,
Deutsche Telecom, France Telecom, and NTT), 56 licenses to international facilities-
based services operators, and 78 licenses to international simple resale operators (who
provide services based on capacity leased from other carriers).21 (These figures exclude
entrants into the mobile, cable, and satellite markets.) How will net entry change over the
next five years? How many of the players will be left in the market in five years time?
These are key questions requiring an understanding of the dynamics of the industry.

Klepper and Simons (1997) conclude that

“Our findings suggest that shakeouts are not triggered by particular

technological developments but are part of an evolutionary process that is
driven by continual technological change. Technological innovation

20
According to Klepper (1997) “a product [i.e. industry] is deemed not to have experienced a shakeout if
the number of firms never declined below 70% of the peak number, or if it did but subsequently recovered
to over 90% of the peak.” (p.165)
21
Author’s calculation based on data from Oftel. As far as the author is aware, there are no reliable
statistics regarding net entry rates for the major industrialized countries. One of the problems regarding

18
 apparently contributes to a mounting dominance by some of an industry’s
early-entering firms which eventually makes entry untenable and steadily
drives out smaller firms with relatively high costs and low quality.”
(p.381, emphasis added)

While the process of full competition has not been going long enough in the telecoms
industry for this industry to provide further evidence against which to test this
Klepper/Simons hypothesis, from the ex ante viewpoint of the present it seems at least
possible that, whether or not a shakeout as technically defined here emerges in the future,
the presence of specialist equipment and software suppliers will limit ‘mounting
dominance by some of the industry’s early-entering firms’ and will provide increased
viable options for smaller firms by providing them with both cost and quality competitive
advantages. In short, it may well turn out that the telecoms industry is more in line with
the second group of industries referred to in Klepper (1997, p. 168-174) which do not
conform to the conventional product life cycle pattern of entry and exit and which do not
experience shakeouts as defined, industries that include petrochemicals. Significantly, as
Klepper notes, these latter industries are also characterised by the presence of specialised
suppliers of one sort or another, though not necessarily confined to equipment suppliers.

DYNAMIC 2: FOUR KINDS OF COMPETITION

Many of the applications of the product life cycle model to the evolution of particular
industries have emphasised the importance of technical change as a driving force (see,
e.g. Klepper (1997), Klepper and Simons (1997), Utterback and Abernathy (1975),
Utterback and Suarez (1993), and Afuah and Utterback (1997). Particular attention has
been paid to the process of convergence around a dominant design in product technical
change and, once this has occurred, to the priority assigned to process technical change.
Although competition between technologies is undoubtedly an important part of both

these statistics is that they should measure ‘effective entry’ i.e. refer to firms that have not only been
granted licenses but have made credible entry into telecoms markets.

19
product and process technical change, this competition per se has not received
prominence in most of the explanations.

In the present analysis of the telecoms industry, however, it will be argued that
competition between technologies is so important as to constitute the second dynamic
driving the evolution of the industry. But competition between technologies, as will be
shown, is also intricately tied up with competition between networks and competition
between services, as well as the more conventionally recognised competition between
firms.

Complementarity Between Technologies And Network Assets

Although there are always specific technologies embodied in network assets, it is

necessary to separate conceptually network assets from the ongoing process of technical
change because they (i.e. the assets) are often the object of further technical change. The
example of asynchronous digital subscriber line (ADSL) technology illustrates this point
as well as highlighting some of the processes driving the co-evolution of technologies,
firm strategies and competition.

One of the main advantages enjoyed by the incumbent telecoms operators is their existing
extensive networks with greater geographical coverage than any of the entrants, whether
original new entrants or ‘new new entrants’. These networks, however, embody different
generations of technologies that are, nevertheless, designed to be compatible and
interoperable with one another. Accordingly, while part of the incumbent’s networks are
‘state of the art’ (for example, using digital or ATM – asynchronous transfer mode -
switching and SDH/SONET transmissions), other parts consist of old technology, such as
the copper cables that still connect the metaphorical ‘last mile’ to most homes. Although
the upside to the use of these old technologies and the assets in which they are embodied
is the low fixed cost of using fully-depreciated assets (albeit counterbalanced by possibly

20
high running costs), the downside is the limited capacity (bandwidth) provided by these
assets.

It was in order to address this bottleneck22 that a wave of research was undertaken
globally, particularly by incumbents, to develop ASDL technology, a technology that at
first was thought to be of limited relevance. A good deal of this research in the early
stages, such as that undertaken by BT in conjunction with trials in the vicinity of its
Martlesham Laboratories, was done in order to establish the viability of ADSL for use in
a hoped for ‘killer application’, namely video-on-demand (VOD) over copper telephone
lines. As things have turned out, however, much of the demand for VOD appears to be
still-born but ADSL (now called XDSL, to include later generations of the technology)
has been significantly improved through a process of rapid incremental change and is
now seen as a competitive technology for the transmission of data at sufficiently high
bandwidths to allow, for example, voice and video over the Internet to be received in
homes where the ‘last mile’ is connected by copper cables.23

Competition Between Technologies

XDSL also provides an example of competition between technologies that, as will shortly
be shown, is an important driver of other aspects of telecoms industry evolution. The
main site for the battle between XDSL and its rival technologies is the local access
market. The crux of the matter is portrayed in the following extract from a partisan paper
by BT in response to a document by the industry’s regulator, Oftel, the paper carrying the

22
As scholars of innovation and technological systems have noted, techno-economic systems produce an
internal dynamic that influences the innovation process and through it the future evolutionary path of the
system. This dynamic is created by the incentives and focussing mechanisms that arise in addressing
systemic bottlenecks that impede the system’s performance. Tom Hughes uses the military terminology –
reverse salient – to describe this process (see Hughes (1984). A similar analysis is contained in Rosenberg
(1976). XDSL provides a telecoms example.
23
Interestingly, at the Competitive Carrier Forces conference held in Versailles in March 1998 attended by
the author, one of the main meeting points for members of the industry, XDSL was branded by one of the
speaker’s as “the incumbent’s technology”, and was portrayed as a negative force with the potential to
increase the staying-power of incumbents who were otherwise seen as uncompetitive, bureaucratic,
anticompetitive, and reactionary forces in the industry! For present purposes, however, the XDSL example
provides an instance of the co-evolution of technologies, firm strategies, competitive process, and industrial
structure (in terms of the effect on entry, exit, shakeout, the positioning of rivals etc).

21
underlying message that BT faces effective competition even in the UK local access
market which in terms of market share it appears to monopolise with a share of 90
percent. (This extract also raises the important related issue of the impact of technologies
on the definition and boundaries of markets through the effect of the technologies on the
substitutability of telecoms services.):

“When analysing the market for access from the point of view of the
customer wishing to obtain access to the telecommunications networks in
the UK, there are a number of products that can reasonably be regarded as
substitutable. Analogue lines [based on copper cables], ISDN lines
[integrated services digital network capable of carrying voice, data, text,
and video], telephone lines offered by cable TV companies, fixed and
mobile radio access and PCN [another mobile service] are all currently
available alternatives. The cost of access to the customer may vary
depending upon the technology used, and the different means of access
may be regarded as more or less substitutable, taking into account
functionality, price and the speed of delivery….the different technologies
are likely to become more and more substitutable and the degree of
substitutability over time needs to be taken into account when determining
whether a number of different alternatives are in the same market, and
whether that market can be described as competitive.” (BT, 1996, p.19)

While this observation is standard fare for those in the telecoms industry, from the point
of view of evolutionary analysis the significance lies in the co-evolutionary processes
that are at work. These processes are worth spelling out at a general level. There are at
least seven distinct technologies that can be identified which are involved in the process
of local access. These are: optical fibre, copper/XDSL, co-axial cable TV, fixed radio
access (which uses radio to provide access on fixed lines), mobile cellular and PCN,
satellite, and power line (involving the use of electricity cables, as discussed above). The
first point to make about the co-evolutionary process is that the evolution of each of these
seven technologies is co-determined by each of the other technologies in that the

22
performance parameters that the technology must meet in order to remain viable is
determined by the performance of the competing technologies. For example, within
certain cost and price limits, XDSL using copper cables must be able to carry comparable
bandwidth to that available over optical fibre or co-axial cables.

But competition between these technologies is also influenced by the firms (their
strategies and their competitive fortunes) with a vested interest in the technology’s
development and performance. For instance, as noted in the last footnote, it is the
incumbents who have a particular interest in increasing the performance of copper cables
through XDSL since these cables still form an important part of their network. For this
reason XDSL has been referred to as the ‘incumbent’s technology’. On the other hand,
new entrants have usually entered on the basis of later generations of technology and
therefore have different technological vested interests. For example, MCI in the U.S. was
an early adopter of optical fibre as it rolled out its network to compete with AT&T. In
Britain, Ionica, a ‘new new entrant’ based in Cambridge, created its network on the basis
of fixed radio access, with a radio connection covering the ‘last mile’ and linking the
customer to the fixed network. In this case the technology was developed for Ionica by
Nortel, the Canadian equipment-maker, but clearly Ionica has a vested interest in the
future progress of fixed radio access technology. (Ionica has recently run into difficulties
leading to speculation that it may become one of the first major examples of exit in the
U.K., though these problems have not been specifically technological in nature.) In
Japan, DDI, the main original new entrant competing with NTT, based its network on
microwave radio (partly to overcome rights-of-way problems) although the bandwidth
constraints of this technology subsequently created problems for the company with the
explosion of Internet and IP (internet protocol) demand for bandwidth.

From these examples it is clear that the causal influences shaping the evolution of each of
the technologies are closely bound up with the factors influencing the firms which
support these technologies. In turn, the evolution of these firms is determined by their
success in the various selection processes that define winners and losers, an outcome that
is partly dependent on the capabilities of the firms (i.e. their competencies and

23
complementary assets) and the strategies they have formulated. However, while this
brief and partial account of the co-evolutionary process is very much at the general level,
far more detailed research is necessary to show precisely how specific technological
changes have come about under the influence of the co-evolutionary process.
Evolutionary studies of industries have thus far, for understandable reasons, generally not
delved too deeply into this detailed complexity.

Competition Between Networks

Telecoms networks are complex systems made up of aggregations of different

generations of technologies. While in the last section competition between different
‘micro-technologies’ was discussed, it is also necessary, in order to understand the
dynamic of the telecoms industry, to analyse competition at a higher level of aggregation,
namely between networks and the services they provide (and are constrained from
providing). The reason is that in many instances these networks provide alternative ways
of providing similar services. The networks also complement one another in various
ways. For this reason it may be suggested that the telecoms industry as a whole may be
understood as being based on a network of networks, an overarching network consisting
simultaneously of complementary and competing sub-networks that are interconnected
and interoperable.

The Evolution Of Packet-Switched Networks

An important example illustrating this point is the evolution of packet-switched networks

that eventually, together with other complementary innovations, facilitated the emergence
of the Internet, an outcome totally unforeseen by the original creators of these networks.
Packet-switching is essentially a technology used for the transmission of data. It involves
the breaking up of data (in the form of bits) into ‘packets’ which are then given an
‘address header’ enabling the packet to be routed in the way that is most efficient at the
time, different packets from the same data set possibly taking different routes to the final

24
destination. At the destination the packets are re-assembled and may be re-constituted in
different forms, for example as voice, text, fax, sound, or video.

From an evolutionary perspective it is significant that packet-switching and packet-

switched networks emerged from research undertaken in the computer world rather than
the telecoms world. More specifically, the context of the earliest research in the mid-
1960s makes it clear that packet-switching is best understood as an outgrowth of time-
sharing computing. (Time-sharing involved the sharing of a central computer by multiple
simultaneous users.) Partly in order to increase the efficiency of time-sharing computer
systems an attempt was made to link these computers through a widespread network.
Packet-switching was the technology that was chosen to send data through the network
from one computer to another. In the mid-1960s minicomputers were used to gather the
data, to packetize it, to route it, and to reassemble it at the receiving end. In time this
effort led to the development of a protocol to facilitate the networking function, namely
the transmission control protocol/internet protocol, TCP/IP.

Again from an evolutionary perspective, two further points are worth noting. The first is
that packet-switching technology was not a new technology. Indeed it was a re-
application of dynamic allocation techniques that had been used more than a hundred
years earlier in the mail and telegraph industries. The second point is that it was well into
the 1970s before the telecoms companies became interested in packet-switched networks.
This point is all the more interesting since studies done from the mid-1960s conclusively
established the economic superiority of packet-switching over the alternative of circuit-
switching (where an entire circuit is dedicated to the data being transmitted). Indeed, in
the early 1970s AT&T was invited to take over the first major U.S. packet-switched
network established by the Advanced Research Projects Agency (ARPA), called
ARPANET, and offer a public packet-switched service. It was the ARPANET that
eventually evolved into the Internet. However, AT&T declined. But not all the telecoms
carriers were as reticent to adopt this technology. In France the PTT (that later became
France Telecom) began research on packet-switched networks in 1974, by which stage

25
they had already decided to develop a packet-switched network, TRANSPAC, which
improved rapidly and is the centre-piece today of the company’s data network.

The subsequent evolution of packet-switched networks was influenced by many other

factors including the PC revolution beginning in the late 1970s and the consequent
emergence of client-based distributed computing, the related proliferation of local area
networks connecting computers (LANs), the facilitating evolution of the TCP/IP and
other protocols, and an explosion in user demand for services such as electronic-mail and
later World Wide Web applications (which depended on another key complementary
innovation, namely the technology on which the World Wide Web was built (facilitating
the subsequent production of Web browsers) originally developed by Tim Berners-Lee at
the CERN physics laboratory in Switzerland).

By the mid-1990s, packet-switched networks were able to offer substitutes (with varying
elasticities of substitution) for most of the services offered by telecoms companies using
conventional circuit-switched networks. Accordingly, there is currently increasing
competition between these two kinds of networks. Nevertheless, some important
distinctions remain as a result of the original purposes served by these networks. More
specifically, having originally been developed for the purposes of voice communication,
circuit-switched networks are real-time based and therefore currently offer the best
quality of voice reception. On the other hand, packet-switched networks, though near-
real-time, still exhibit a slight delay, the result of packets arriving at different times and
orders. Whether packet switching and transmission technologies will ever improve so as
to offer a more perfect substitute for circuit-switched voice remains an open question
currently.

For present purposes, this example highlights the role played by competition between
networks and the services they provide as a driver of the evolutionary process in the
telecoms industry.

26
Competition Between Services

As we have just seen, different networks may support different, competing, services. A
further example is fixed versus mobile telephony, the latter offered over land or satellite
based networks. However, there is not necessarily a one-to-one correspondence between
network competition and services competition. Competing services may also be offered
on the same network. For example, both packet-switched and circuit-switched networks
can offer voice, fax, and e-mail services that to some extent, for some purposes, are
substitutable services. It is for this reason that a conceptual distinction between
competition between networks and competition between services is necessary. From the
co-evolutionary point of view, it is clear that the outcome of competition between
services will have knock-on implications for the relationship between networks and
technologies.

‘Layers’ Of Competition

To facilitate the conceptual distinctions required, it is helpful to think of ‘layers’ of

competition (the generic layer model, incidentally, playing an important conceptual role
in telecommunications design thinking more generally). While the lowest layer consists
of competition between ‘micro-technologies’ (i.e. the alternative building-blocks of
telecoms systems), the following layers, in ascending order, consist of competition
between networks, competition between services, and finally, competition between firms.

Competition Between Firms

Competition between firms – more specifically, between incumbents, original new

entrants, and ‘new new entrants’ – may therefore be thought of as overlying the other
‘layers’ of competition. As already stressed, the relationship between the layers is not
necessarily one-to-one. For example, incumbents may have circuit-switched, packet-
switched, mobile, and even cable and satellite networks as part of their overall network,
although new entrants typically have a far narrower range of networks. Similarly,

27
different firms will offer different combinations of services and will depend on different
combinations of technologies. Furthermore, to make matters even more complex, the
competition between technologies that according to the present layer model takes place in
the technology layer, may also simultaneously take place within the firm layer. This
happens with inter-technology competition within firms. Examples studied in detail by
the present writer include the battles between supporters of space-division switching and
digital time-division switching within firms like AT&T and NTT, which were in
principle similar to the rivalry that took place between proponents of silicon-based
semiconductors and III-V compound semiconductors such as gallium arsenide in
semiconductor firms like NEC, Fujitsu and Toshiba.24 Once again, there are important
implications of these kinds of competition for the co-evolution of firms, services,
networks, and technologies.

DYNAMIC 3: THE ROLE OF FINANCIAL INSTITUTIONS

Financial institutions also play a key role in the dynamics of the telecoms industry,
particularly in the current phase of rapid expansion, liberalisation and globalisation. In
the sense of Douglas North (quoted earlier), financial firms play a dual role in the
evolution of the telecoms industry. On the one hand, they are Northian organisations,
action groups with their own vested interests, seeking to make profit from financial inter-
mediation. As action groups, however, they also collectively play a crucial role in
assigning market values to the competencies and complementary assets of both telecoms
operators and their specialist suppliers. These market values, based essentially on the
present value of expected25 future net earnings, play a crucial role in the evolution of the
industry as will shortly be demonstrated. On the other hand, financial firms are also

24
See Fransman (1995) for details.
25
A perennial debate in the telecoms industry, as in all other industries, relates to the ‘rationality’ of the
procedures financial analysts use in order to arrive at their ‘strong buy/buy/hold/sell’ recommendations,
conclusions which are not necessarily free of self-interest (even if these are explicitly declared) and which
themselves often come to constitute a key part of the set of information which investors use to make their
buy and sell decisions, which in turn drive the process of company valuation. The “interpretive ambiguity”
(see Fransman, 1998a) involved in the financial analysts’ calculations is often manifestly apparent, raising
important questions regarding the whole role of financial valuation and its role in industry evolutionary
processes.

28
Northian institutions insofar as they influence the “rules of the game” and the “humanly-
devised constraints that structure human interaction” in the telecoms industry.

The role played by financial institutions in the evolution of the telecoms industry is
illustrated most dramatically by the case of WorldCom, the ‘new new entrant’ in the U.S.
market that rose to global prominence in 1997 when it frustrated BT’s attempt to merge
with MCI, the U.S.’s second largest long distance carrier, with a takeover bid for MCI of
$30 billion. Originally set up in a coffee shop in Hattiesburg, Mississippi in 1983 as
Long Distance Discount Service (LDDS) – WorldCom on its web-site proudly recording
that this was “a name suggested by a waitress [in the coffee shop]” – the company from
an early stage, having captured the imagination of financial analysts, was able to grow
primarily through stock-financed merger and acquisition. By the time it made its bid for
MCI, WorldCom had already acquired UUNet, the U.S.’s largest Internet access
provider, and MFS a telecoms company providing local access and services largely in
major financial and business centres around the world. By 1998 it was clear that
WorldCom - with its strength in the U.S. in local, long distance and international markets,
as well as Internet traffic, and its rapidly growing global network - arguably posed the
greatest competitive threat to incumbents like AT&T, NTT, and BT.

Figure 2 provides data on the ratio of firms’ market capitalisation to their sales for 1997.
WorldCom clearly stands out. While the other established players – mainly incumbents
but for the U.S. also including original new entrants MCI and Sprint – have a multiple of
around 2 to 3, World Com enjoys about 5. More recently, in fact, even newer entrants
such as Quest and Teleport in the U.S. have been given multiples of around 1026
facilitating similar rapid growth in part through merger and acquisition. In Europe, ‘new
new entrants’ like Energis, Colt, and Esprit have been able to play a similar role, though
on the basis of a market capitalisation that has not been as high as that obtained by the
U.S. entrants.

26
Business Week, April 6, 1998.

29
From the perspective of the evolution of the telecoms industry, as these examples show, it
is clear that financial institutions and their modus operandi play an important role in the
entry (and exit) processes. In addition, they also provide a key mechanism allowing for
the re-shuffling and re-combination of existing complementary assets (part of the capital
stock) that constitute telecoms networks. In this way they facilitate the realisation by the
successful firms of both economies of scale and scope, which, in turn, further shape the
competitive and selection processes and ultimately influence industrial structure through
the effect on factors such as entry, exit, and shakeout. More generally, they also facilitate
the realisation of dynamic increasing returns which, as noted by Marshall in the quotation
at the beginning of this paper, may come about through the improvement of organisation
that takes place as greater quantities of capital and labour are concentrated in particular
firms.

DYNAMIC 4: HETEROGENEOUS AND CHANGING CUSTOMER DEMAND

The fourth dynamic driving the evolution of the telecoms industry is heterogeneous and
changing demand. An important characteristic of the industry is the complex
segmentation of consumer demand and rapid change in the characteristics that are being
demanded. (This section emphasises final demand by businesses and residential
customers, as opposed to what may be referred to as intermediate demand, for example,
demand from specialised telecoms service providers, like Internet access providers, for
network services of various kinds provided by telecoms network operators. Intermediate
demand also includes the demand by some network operators for the network services of
other network operators, and is expressed through wholesale markets. For instance, when
AT&T, Deutsche Telecom or France Telecom enter the U.K. market they are forced, by
the lack of their own comprehensive network in the country, to buy, in one form or
another, network services from other operators in the U.K., such as BT or Energis. Such
intermediate demand adds further to the heterogeneity of customer demand that is
emphasised in this section.)

30
The example of voice telephony will be examined briefly to make clearer the
evolutionary implications of heterogeneous and rapidly changing consumer demand.
From the beginning, and until relatively recently, voice telephony was confined to a
rather homogeneous service that is now rather nostalgically referred to in the industry as
POTS, plain old telephone service. In the days of POTS the main differentiator was
distance, with different tariffs being charged for local, long-distance, and international
services. More recently, things have changed radically since one of the main
implications of the technological advances introduced primarily by optical fibre (with its
almost unlimited bandwidth) and packet-switching is the so-called ‘death of distance’
where the cost of sending bits of information is no longer a function of distance.

At first sight one might suppose that this would result in a greater homogenisation of
voice services. However, this has not been the case since voice services themselves have
become differentiated in a number of different directions. One example is the advent of
cellular mobile voice telephony, an invention that was first made in Bell Laboratories
between 1947 and 196027 but which at first diffused most rapidly in Sweden and the other
Nordic countries.28 At first there was a great degree of ‘interpretive ambiguity’ in the
industry regarding the extent to which consumer preferences for the characteristic of
mobility would be sufficient to compensate for the additional cost of mobile voice
services, the frequently lower quality of these services (due to radio interference), the
limited geographical availability of the services, and other disadvantages such as the
initial heavy handsets. With time, however, an explosion of demand (largely unforeseen)
for mobile voice telephony occurred, spurred by the dynamics of increasing returns
which, via Marshallian interactions between improving organisation and knowledge,
resulted in improving and cheaper mobile services. Furthermore, the adoption of
regional, if not global, standards, such as the highly successful European GSM (Global

27
See Mellman (1984), p.235-7.
28
It was early diffusion in Sweden and the other Nordic countries that, through processes of path-
dependency and dynamic increasing returns, presented distinctive opportunities to companies in this region,
advantages that were strategically seized by Ericsson and Nokia which still enjoy dominant positions in
global mobile markets.

31
System for Mobile Phones) for digital mobile voice telephony, has further increased the
utility of the service.29

Mobile voice telephony, however, is in the throes of further evolutionary differentiation.

One important trend is captured by the decision in early 1998 by ETSI (the European
Telecommunications Standards Institute) to adopt a new standard for so-called third
generation mobile services, referred to as UMTS (universal mobile telephone system).
This set of standards will facilitate the provision of multimedia services – including, in
addition to voice, Internet access and the receipt of live video – on mobile handsets.30
Voice is also becoming integrated with other services in other areas too. One example is
so-called computer-telephony integration (CTI), where voice telephony is integrated with
computer functionalities with applications in areas such as call centres where an operator
can answer a query from a customer while simultaneously getting information from a
database regarding that customer’s past purchasing history, payments record, other
purchases etc, therefore at the same time facilitating attempts to market other products to
the customer. More recent is the integration of Internet telephony with Web sites so that
at a click it is possible to speak to a sales person to get immediate answers to queries that
arise from the information presented at the site.

For present purposes, these examples point to heterogeneous and rapidly changing
customer demands and products as important dynamic influences on the evolving
structure of the telecoms industry, as defined earlier in terms of barriers to entry, the
nature and sources of substitutes, the number and kinds of rivals, suppliers and
customers. For instance, it may be hypothesised that both the heterogeneous as well as
the rapid change in customer demand will have a positive effect on net entry and

29
GSM was also widely adopted in Asia and Latin America, although the U.S. went its own way with
another set of standards.
30
The adoption of UMTS was preceded by a standards battle around two competing standards. The one,
TD-CDMA, was supported by suppliers like Alcatel, Siemens, Lucent and Motorola, while the opposing
standard, WB-CDMA, was proposed by Ericsson and Nokia, two of the strongest suppliers in the mobile
area, as well as most of the European telecoms operators. Furthermore, WB-CDMA also had the advantage
of drawing significantly on similar standards that had been developed by an NTT mobile subsidiary, NTT
Docomo, opening up the future possibility of this also becoming the dominant standard in Japan and the
rest of Asia. In the event, although a compromise was announced, it was the WB-CDMA standard that
dominated. The U.S., meanwhile, has decided to go its own way with a somewhat different standard.

32
significantly reduce the probability of shakeout as defined earlier. As these examples
testify, it is clearly necessary to ‘model demand’ as an integral part of the dynamic
processes that drive the evolution of the telecoms industry, even if this is done
qualitatively rather than quantitatively in order to capture the essential complexities and
causalities of heterogeneous and changing demand.

DYNAMIC 5: PERMEABLE INDUSTRY BOUNDARIES

The fifth and final dynamic driving the evolution of the telecoms industry that will be
considered in this paper is the permeability of industry boundaries, more particularly,
ease of entry from neighbouring industries. The specific case that will be examined is
entry from the computer and software industries.

From the author’s interviews with senior executives from companies like AT&T and BT
it is clear that computer and software companies are viewed as increasingly threatening
new entrants into some of the markets being contested by these incumbent telecoms
companies. (Although this issue should simultaneously be analysed from the perspective
of computer and software companies diversifying into new areas, it is the perspective of
the telecoms industry that will be followed here.) Where precisely is the threat perceived
as coming from? Two areas will be identified in this section.

The first area is a new emerging market that may be referred to as the solutions market.
What is the solutions market? It is the market where telecoms companies not only act as
‘bit transporters’ for their customers, but go further up the latter’s value chain to offer
solutions to their communications problems. This requires, metaphorically, that the
telecoms company does not simply take its ‘pipes’ up to the door of the customer, but
also ‘enters’ the customer’s establishment – whether firm or residence – and helps
customers with solutions to their communications problems. A telecoms company that
has begun to articulate a solutions strategy, as part of its strategic portfolio, is AT&T
which explicitly has begun to define itself as an information and communications
company. In Europe, for instance, AT&T and its partners in Unisource are attempting to

33
differentiate themselves from other competitors by offering what they term “solutions
and applications”.31

What are the attractions of the solutions market for telecoms companies? The first
attraction is that the solutions market is seen as a potentially high profit margin area, in
contrast to the bit transportation market which some argue has become ‘commoditized’,
with correspondingly low margins, as substantial economies of scale are realised by
companies like WorldCom which have invested in ‘huge pipes’, that is high speed, high
capacity networks which, with sufficient traffic, yield relatively low unit costs. A further
factor making for the commoditization and low margins of bit transportation is the
competition between different kinds of networks – such as cable TV coaxial, mobile, and
satellite networks in addition to the fixed public switched network – which are
increasingly interconnected and interoperable thus providing alternative ways of
transporting bits. Secondly, it is argued that there is a complementarity between
solutions and bit transportation insofar as a telecoms company that sells solutions to a
customer is also more likely to get that customer’s bit transportation business. For
intensive potential users of these kinds of services, such as leading financial institutions,
complementarity is an important issue. It is for this reason that AT&T has begun to sell
itself in Europe as a company which specialises in all aspects of data, including the
storage, processing, and communication of data. This has taken the company into the
areas of Intranets (using the TCP/IP protocol for intrafirm communications) as well as
Extranets (using the same protocols for network-based communications with suppliers
and customers, including electronic commerce).

The problem, however, is that while this seems like a natural competence-based
diversification for telecoms companies like AT&T,32 entering a domain that is also
contested by computer and software companies raises important strategic questions of the

31
Author’s interview.
32
Interestingly, AT&T’s solutions strategy is, if anything, being more strongly articulated since the
company’s voluntary trivestiture in September 1995 when NCR was spun off. However, the rationale for
the acquisition of NCR in 1993 was that AT&T needed in-house computer competencies in order to
provide information and communication solutions. Evidently, the new AT&T has come to the conclusion
that the earlier assumption was a mistake.

34
distinctive competencies and complementary assets of the two sets of firms. While it
might be supposed that telecoms companies have distinctive competencies in designing,
managing, and maintaining networks, the advent of data networks based on packet-
switching which, as shown earlier, emerged from the computer rather than the telecoms
industry, and IBM’s capabilities in running its own extensive global corporate network,
provide reasons for doubting the exclusivity of the telecoms companies’ competencies in
this area.

The second area where telecoms companies are being challenged by computer and
software companies is in more conventional telecoms services such as voice and fax. In
part the threat comes from packet-switched data networks that have already been
discussed in this paper. But threat also comes from the domination of what may be
thought of as ‘strategic heights’ (to again use a military analogy) by computer and
software firms. To take a key example, Microsoft’s dominance of the de facto standard
for desktop computers, which it is currently attempting to extend into Internet servers
through its Windows NT format, as well as into browsers with its Internet Explorer, and
into networked consumer electronic products with Windows CE, raises the possibility of
Microsoft having the power to ‘guide’ consumers to the use of particular telecoms
services over particular networks. For example, Microsoft networked meeting software,
used for remote users to communicate with each other and share data, already has
Internet telephony incorporated. Although at various points Internet traffic is carried
over the networks of telecoms companies – such as the Internet backbones – and although
this means that some of these companies benefit from the growth in demand for Internet
usage, the worry for telecoms companies is clearly that they will be excluded from
profitable business areas as a result of the dominance of commanding heights by
computer and software companies.

Again from the point of view of the evolutionary analysis of the telecoms industry, these
examples make clear that an important dynamic driving force emerges from the
permeability of the boundaries of this industry. This permeability clearly influences all
the elements of industrial structure considered in this paper.

35
CONCLUSION

What are the implications of the evolution of the telecoms industry for the general
evolutionary/institutional analysis of industry? The first implication relates to a set of
issues revolving around what may be called the Product Life Cycle Paradigm.

How well does the telecoms industry fit into the Product Life Cycle Paradigm? The
general answer is not very well. There are several reasons for this answer. To begin
with, in the industries that supposedly conform to this paradigm – industries such as
motor cars, televisions, tires, and penicillin – there is a tight coupling or correspondence
between three sets of factors: consumer tastes and characteristic preferences, design
configurations that provide these tastes and characteristics, and manufacturing or process
technologies which are used to produce the products embodying these design
configurations. The telecoms industry, conversely, is characterised, firstly, by a far
greater degree of heterogeneity in each of these three areas, and secondly, by a much
looser correspondence between each of them.

The example of voice telephony, analysed in this paper, illustrates this point. The
relevant consumer characteristic preferences in the case of voice telephony relate to
factors such as mobility, quality of reception, ease of use, portability, geographical range,
‘combinability’ with other complementary services, in addition to price. Furthermore,
there is a wide variety of ‘configurations’ capable of providing all or some of these
consumer characteristics (configurations of product/service packages, the networks over
which these characteristics are provided, and the technologies provided in these
networks, as has been shown in detail in this paper). If the notion of ‘dominant design’
does have a relevant meaning in the telecoms industry, and in the author’s view it does, it
is in a far more restricted area such as the design of individual products (e.g. mobile

36
handsets or digital switches) or even the design of particular kinds of networks (e.g. local
area networks (LANs). But these designs do not provide a central organising principle
for the industry as a whole as the dominant design does in the Product Life Cycle
Paradigm.

The second reason the telecoms industry does not fit the Product Life Cycle Paradigm
very well has to do with the important role played in this industry by specialist equipment
and software suppliers, a major theme in the present paper. While Klepper (1997) has
suggested that a key behavioural characteristic of ‘product life cycle industries’ is the
appearance of a shakeout once a dominant design has been established and once some of
the industries firms, often early entrants, have managed to reap the rewards of dynamic
increasing returns to innovation, in the telecoms industry it would seem that the presence
of specialist suppliers constrains the shakeout process by making key technologies and
other inputs available to all able to pay the price. A further consequence of the presence
of specialist suppliers is that the dynamic of competition, and the thrust of corporate
strategy, at least as far as the suppliers of telecoms services to final consumers are
concerned, has tended to move away from technology based determinants towards other
attempts to segment customer markets and differentiate services.

The importance of specialist suppliers – also noted by Klepper (1997) in the case of
industries that do not exhibit shakeouts – also raises questions regarding the appropriate
conceptualisation of industry boundaries. A notable feature of the industry studies based
on the Product Life Cycle Paradigm has been the close identity in these studies of
‘product’ and ‘industry’. The importance of specialist suppliers, however, suggests that
where they exist this narrow identity is not justified and a broader definition of industry
boundary is necessary. Apart from the telecoms industry analysed in this paper, other
examples may include the importance of specialist equipment suppliers (such as the
makers of optical lithography equipment) in the semiconductor industry and the
importance of specialist chip suppliers in the case of industries like PCs. In the latter
case the availability of specialist chip suppliers like Intel has allowed firms like Dell to
become significant players in the PC market largely on the basis of marketing, sales, and

37
distribution capabilities, rather than technology-based capabilities. Clearly, this pattern
of specialisation has directly influenced all aspects of industry structure, including
barriers to entry, the nature and sources of substitutes, the number and kinds of rivals,
suppliers and customers.

Following on from the last point, a major conclusion of this paper is that more discussion
is needed on the conceptualisation of appropriate industry boundaries. As noted in the
paper, if the appropriate definition of industry boundary is problem-contingent then we
need to understand better the relationship between problem and industry boundary. In the
present paper it is suggested that a key issue in defining an appropriate boundary relates
to the dynamic forces that are driving the industry and influencing its structure as
defined. It would appear that not enough attention has been paid to precisely what, in any
particular industry, these dynamic forces are. Certainly, the conventional definitions of
‘an industry’ – such as that given by Porter (1990) who defines “An industry (whether
product or service) [as] a group of competitors producing products or services that
compete directly with each other” (p.33) – do not seem to go far enough in providing a
more robust understanding of what forces are driving and changing a particular industry.
In the present paper, five dynamic driving forces where identified that in turn influenced
industry structure and determined industry boundaries: quasi vertical specialisation and
the presence of specialist suppliers; four processes of competition between technologies,
networks, services, and firms; the role of financial institutions; the heterogeneity and
change in consumer characteristic preferences (for both final an intermediate consumers);
and the permeability of industry boundaries (as evidenced, for example, by the new role
being played in the communications industry by computer and software companies). But
this raises the question of how ‘industry driving forces’ are to be identified and how they
influence industry structure as defined, and define industry boundaries. The present
paper suggest, that although difficult, these are key questions for an
evolutionary/institutional analysis of industries.

38
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