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Behind Global Crossing's failure

The company built a huge fiber-optic network to meet seemingly endless demand for bandwidth. Knowledge@Wharton chronicles how the dream went sour.

It seemed like a no-brainer at the time: As more people surfed the information superhighway, demand for bandwidth would skyrocket, companies would send and receive ever larger amounts of data, consumers would watch feature-length movies with a click of the mouse, and everyone would have a sudden yearning for streaming audio at all hours of the day.

Naturally, any company that built infrastructure to support that kind of data transmission would be hailed as the great enabler, the all-powerful provider of transport nirvana. From a technology standpoint, optical networking seemed to be the perfect way to realize this vision.

Simply put, these networks transmit data as light through specially made glass fibers. Surrounded by protective cabling, bundles of these fibers can be laid under water to connect distant continents, allowing high-speed traffic to zip back and forth with ease. Anyone needing bandwidth for their operations could pay for access to the network.

That's what Gary Winnick was banking on when he founded Global Crossing in 1997. Laying fiber and selling its use to large companies, telephone giants and Internet service providers seemed a slam-dunk business model. As reported in The New York Times, many high-profile investors, including former President George Bush and Democratic National Committee Chairman Terry McAuliffe, agreed. Other companies jumped on the bandwagon as well, moving quickly to pursue their own submarine strategies. After all, the market for such services, just like the Internet itself, seemed to have no limits.

Reality, however, has been quite different. Five years after it began, Global Crossing was forced to admit that its goals were too ambitious: The company's network links more than 200 major cities in 27 countries, but because it couldn't secure enough customers to make all that bandwidth pay off, it was never profitable.

Accounting doesn't sink a company. Accounting that tries to cover up bad business sinks a company. With $12.5 billion in debts, the company filed for bankruptcy Jan. 28 and commenced a restructuring process with the understanding that two Asian companies--Hutchison Whampoa and Singapore Technologies Telemedia--would chip in $750 million for a controlling stake. The process may be far from smooth, however; both the SEC and FBI have reportedly launched investigations into the possible artificial inflation of revenue by Global Crossing and other companies it may have dealt with.

What went wrong? According to several experts, Global Crossing's woes are largely representative of an industrywide problem.

"Accounting doesn't sink a company," noted Gerald Faulhaber, professor of management and public policy at Wharton. "Accounting that tries to cover up bad business sinks a company. Everyone overestimated the demand for these networks. There was a general presumption that the Internet was doubling every three months.

"People were building fibers believing that was the right forecast," he added. "Plus, they were dumping it wherever it was cheap to dump it--not where it would actually get traffic. There's a ton of fiber under the North Atlantic now. Everyone was getting into the long-haul, transatlantic part, but no one was doing the distribution network, because that's more expensive."

Tim Meyer, CEO of Crisp Wireless and former chief technology officer at Ericsson Mobile Internet Solutions, agrees.

"When I was at Ericsson, we were asking companies like AT&T what they saw themselves doing in the future," he said. "They said they would be selling slices of optical bandwidth--selling wavelength to other resellers. The idea of a carrier's carrier had come about because companies like Global Crossing realized that some of their assets were unique--such as the ships that laid undersea cable. It was pretty sophisticated stuff, clearly beyond the scope of the regular telecom companies who know only how to dig trenches by the roadside.

"Telecoms should have known better than to believe in all the dot-com hype of demand," Meyer said. "But they bought into it. In reality, Napster might have been the most interesting thing you needed bandwidth for, at least in the near term. And look where that is now."

Martin T. McCue--a telecommunications consultant and former senior vice president and general counsel for Frontier, which was acquired by Global Crossing in 1999--had this to add: "The immediate potential of the Internet and the impact of the 1996 Telecommunications Act were overstated, and plenty of money chased speculative opportunities. The dot-com crashes reduced the number of big customers for transport services. Smaller carriers failed first because they worked at the margins of competitiveness, leading to domino effects on some larger carriers."

Telecoms should have known better than to believe in all the dot-com hype of demand. But they bought into it. Will there be demand in the future for the scale of the network built by Global Crossing? "It really is up to the consumers," Meyer said. "It depends on whether people accept the price points for the services that use such capacity. But market forces have yet to come to the point where you'll see such a demand uptick."

McCue believes the industry has some tough times ahead. "A number of well-known firms are not going to survive as they currently are, because there is a lot of supply chasing too little revenue, taking into account demand and declining prices," he said. "Some wire-based competitive local exchange carriers (CLECs) out there can't do what they promised to do when they took on debt. They can't sell their assets to anyone else because they overvalued them to borrow more money in the first place, capitalizing labor and things that aren't really hard assets.

"Some CLECs might actually have covenants requiring them to pay money to their debt holders to cover shortfalls between sales prices and the valuations established to borrow," he added. "That house of cards is unsustainable and is a recipe for a downward spiral for some of them."

When it shakes out, "probably over the next 12 months," McCue projects that "somebody is going to be able to own local, long-distance, international and Internet transport assets for pennies on the investment dollar; there will be a consolidation, and then the market will right itself. But there will be a whole new crop of investors that make out there."

The dark horse in the telecom race, of course, is the growing use of wireless technology. "Unlike Europe and other parts of the world, the U.S. has long been fixated on landlines. But eventually, wireless certainly has the potential to surpass landline usage," Meyer said. "One could imagine that in 10 years, everyone will have a third-generation (3G) wireless phone, and the whole infrastructure will revolve around these fancy devices."

McCue has a similar take on the issue. "I am more and more impressed with the future impact of wireless. It is expensive to remain a player in that niche, however, and there are going to be two or three more technology upgrades before any of these players know what market share they'll end up with," he said. "The recent calling plans suggest that there will be increasing cross-elasticity effects on the long-distance and wired local businesses. It may not pay to be the sixth competitor in a market--but maybe a national player can do OK as the third or fourth."

 
To read more articles like this one, visit Knowledge@Wharton.

All materials copyright © 2002 of the Wharton School of the University of Pennsylvania.