Evolving technologies and market structures: Schumpeterian gales of creative destruction and the United Kingdom Internet service providers' market.

Author:Javary, Michele

In the United States, there are diverging views on the need for intervention in the Internet service provider (ISP) market. Jason Oxman, representing the Federal Communications Commission (FCC) argued that, given the nascent development of the relatively immature ISP market, there is no basis for intervention because of the larger number of entrants to this market (1999). In contrast, Francois Bar et al. suggested that sustained intervention in the market is needed to encourage the evolution of an open internetworking environment that is consistent with economic and social policy (1999). One close observer of the evolution of the communication industry in the United States, Harry Trebing, has demonstrated that many market developments in recent years have been inconsistent with an inadequate standard of protection of the public interest (1995, 1998). He has argued that the emergence of tight oligopolies may mean that societal goals for greater participation in using networks are not met (Trebing 1995; Trebing and Eastabrooks 1995).

In the United Kingdom, a parallel discussion of the case for public intervention in the emergent ISP sector has been underway. The phenomenal growth in the number of firms providing access to the Internet (Durlacher 1999) suggests that rapid technological innovation was producing "creative gales of destruction" (Schumpeter 11942] 1962) with sufficient strength to reduce barriers to market entry and to counteract any tendencies toward the formation or exploitation of oligopolistic market power. A recent study by Michele Javary and Robin Mansell (2002) analyzed the development of ten firms in the U.K. ISP market in the late summer of 1999. The results suggested that while the Internet appears to offer prospects of free entry and open competition, private sector efforts to secure market shares might raise new forms of entry barriers to competitive services.

A number of writers have characterized the Internet as a "spontaneous order." Others have heralded its exotic urban cultures and communities (Castells 2001). This article argues that the rise of the Internet as a mass infrastructure has to be viewed as an industrial and business experience. While the Internet may be "breaking" up the established ways of the "old telecommunications" and offering the opportunity for an open internetworking environment, the consolidation of the Internet access market as the central infrastructure of the "information society" and the "new economy" requires a transition in the sector's existing market, corporate, and institutional governance structures. It requires a shift in the development and deployment of the sector's network technologies and services and a change to the organization of the powers of control over its business processes.

The U.K. ISP dial-up market is a highly dynamic market, easily qualified as a very competitive market at the retail end of the delivery of Internet access products and services to domestic (and small business) users. This market has grown substantially over recent years, experiencing its fastest growth to date from subscribers from lower income groups in 2000-2001. (1) The turnover of market players is exemplary of its present intense evolutionary and "revolutionary" momentum. Successive waves of new entrants, disputes between larger as well as between larger and smaller players, arbitration, consultation and directives issued by the regulator, mergers and acquisitions, and bankruptcies are all included in the daily market, corporate, and institutional activities. However, despite these rapid changes this article aims to show that market developments are characterized by powerful tensions between the pace of change and the forces of contrivance upon change. Institutional, corporate, strategic, and technological tensions unfold within and between this novel market's expansionist thrust and the forces pulling toward "contraction" and consolidation.

This article documents the industrial dynamics and the innovation processes inherent in the fast-emerging dial-up Internet access segment of the new telecommunication sector in the United Kingdom for the period between 1992 and 2002. It shows that evolving market structures and related product and service innovations in the wholesale and retail branches of the ISP market have to be understood in the context of (a) an entrepreneurial thrust that seizes the advantage of a glut of finance accumulated from the privatization of the utilities, (b) the evolution of the relationship between the U.K. voice and data transfer markets after the privatization of British Telecommunications (BT) and the strategic development of its "intelligent network," (c) the related network technologies and services available for deployment at the start of the implementation of the Internet as a mass infrastructure, (d) BT's quasi-monopoly in call origination, and finally (e) the wider evolutionary industrial dynamics, that is, a cumulative process of conjectures and feedback loops of market power, strategic management, and transformation in corporate and institutional governance following the market's expansion and the transition from metered to unmetered dial-up Internet access (Javary 2002). (2)

The first section gives the historical background to and outline of an overlapping three-phase historical model (1992/November 1999; April 1999/February 2001; April 2000/2002) of the emergence of unmetered dial-up Internet access inspired by Joseph Schumpeter's work ([1934] 1955; [1939] 1982; [1942] 1962). The model depicts the three different phases of "creative gales of destruction" ([1942] 1962, 83) highlighting the emergence of the dial-up Internet access mass market and the transition from metered to unmetered dial-up access for domestic consumers. These phases are characterized in terms of the technological, organizational, and institutional innovation processes taking place in the U.K. ISP and the "new telecommunications" markets. The model shows how each phase merges into a path dependency of continuities, discontinuities, and feedback loops (Myrdal 1944) that are imputed to the cumulative effects and conjectures of the dynamics of the technological and social processes driving change.

The second section looks at the first phase of the development of the U.K. dial-up Internet access market. It shows how two successive waves of entrepreneurial ventures shifted market dynamics by encroaching upon BT's market share in the (wholesale) call termination segment of the dial-up Internet mass market. These first two waves of entrepreneurial activity caused a substantial growth in demand/traffic flow and created a feedback loop which (a) stimulated an increased revenue share for BT's competitors from termination and (b) exerted a downward pressure on the cost of interconnection and conveyance related to the network and business platforms for value-added voice telephony services originally deployed to support the emergence of the dial-up Internet access services. Hence rapid demand growth led to a lowering of barriers to entry and provided conditions for a reorganization of the market out of which the next phase of entrepreneurship and market expansion arose.

The third section looks at the second phase of the expansion of the U.K. dial-up Internet access market. It associates an intensification of competition with a third wave of new entrants fueled by still abundant and enthusiastic venture capital. New Internet entrepreneurs are closely coupled with regional operators that have been relatively successful in capturing market share in the termination segment of the market in the previous phase. This new wave of entrepreneurs launches the first "unmetered" dial-up Internet access packages using BT's Freefone 0800 service on a wholesale network and services platform for which interconnection and conveyance costs are still metered by the minute. However, an unexpected cataclysmic surge in customer demand sabotages the technological and business rationale of the "economics of 0800" package that is based on an estimated volume and duration of calls. Network, support services, and financial bottlenecks multiply, leaving customers with interrupted and/or deteriorating quality of services and both network service providers and customers with substantial financial losses. WorldCom and BT enter into a dispute arbitrated by the regulator. This dispute becomes central to negotiations between BT and other licensed operators (OLOs)/ISPs that are aiming to settle terms and conditions for the creation of a viable network/service platform for unmetered access. This platform becomes known as Flat

Rate Internet Access Call Origination (FRIACO). However, BT resists change on the grounds of inadequate network capacity. A transitory solution is sought in the form of FRIACO hybrid. The first FRIACO platform delays the deployment of a wholesale platform for unmetered access and requires new negotiations with the Office of Telecommunications (Oftel). The downturn in the stock market in 2000 compounds the mounting debt burden and a rise in bankruptcies, increasing instability for all market players. This signals the onset of a period of contraction by acquisitions.

The fourth section considers the last phase in the ISP market's development from the point of downturn in financial markets to entry into a maturing phase in April 2002. This section documents BT's strategic response to (a) the alarming destabilization of the market, (b) its loss of market share in call termination, and (c) significant competition from OLOs and larger ISPs in connectivity. BT's response is twofold. First, BT introduces an unmetered service (SurfTime) at the retail end of the voice telephony market, available for resale by all ISPs, just ahead of the deployment of the FRIACO platform. After initial turbulence and despite its higher costs compared with alternatives on the market, Surftime...

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