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The recession may prompt more consumers to switch from landline to wireless services, according to some analysts. ((Paul Fawcett/iStock))

The telecom sector is already feeling the effects of the market meltdown, but some market watchers are saying the dot-com bust of 1999 will seem like a ripple compared to the coming economic tsunami.

'Companies are like rabbits on the highway, watching the truck bearing at them.' —Duncan Stewart, Deloitte

And when the wave hits, it could wipe out many providers of telecommunications equipment and services, along with some of the income sources that telcos have been taking for granted for years.

"Companies are like rabbits on the highway, watching the truck bearing at them," says Duncan Stewart, Toronto-based director of research in technology, media and telecommunications at global consultancy Deloitte.

The upside for telcos is that while consumers are tightening their belts in many areas, few are cutting back on internet and cellphone services, according to a survey conducted by Toronto-based Solutions Research Group.

These communications services are now considered as essential as utilities such as water and gas — which is good news for major carriers, since they rely heavily on monthly subscribers for revenue. They can also bundle phone, cable and internet services together to build packages that are too attractive for many consumers to forgo lightly.

The recession, though, is driving another nail into the coffin of landline services, traditionally a stable source of revenue for many telcos.

There's a lot of inertia in consumer decisions, and during good times it's easier to just pay for an existing home phone than to evaluate if it's really needed, says Mark Goldberg, a telecommunications consultant based in Thornhill, Ont. People take harder looks at their bills during bad times.

"If all the kids have their own cellphones, people question why they're still spending about $40 bucks a month for a home line," he says. "It becomes a choice between going out to dinner once month or paying for an extra phone."

Goldberg says that as a result, he expects the downturn will accelerate the switch from landline to wireless services.

More than a quarter of American consumers have already replaced their traditional connections and now rely exclusively on wireless devices, according to a 2008 survey by global market research firm J.D. Power and Associates.

"Wireless will be a stable force in the telecom sector," says Tamara Casey, CEO of 4DK Technologies Inc, a wireless consultancy based in Herndon, Va. "[Some] wireless content may suffer, but not basic voice and messaging services."

Technology projects in limbo

Like consumers, businesses are also cutting back on non-essential spending. As a result, information technology budgets are being hit, and it's starting to affect telecom infrastructure and service contracts. 

About 16 per cent of IT spending was deemed "new discretionary" in a 2006 survey, says Andy Woyzbun, analyst at London-based Info-Tech Research Group. That figure may grow dramatically now that the economy has soured.

"I'm not sure recent history is a predictor about what companies will consider 'discretionary' now," he says.

Landlines and telephony services are prime targets for cuts, but as with consumers, most wireless services are deemed essential for business, he says.

Still, companies are putting most of their major IT expansion projects on hold. Few Canadian companies have the cash reserves needed to invest in new IT products, services or network infrastructure, says Bill St. Arnaud, director of network projects at Ottawa-based CANARIE Inc., Canada's advanced internet development organization.

"We're deferring upgrades to the phone systems and an integration project around voice mail and dial plan changes, as these necessitate system software upgrades that are relatively expensive," says Michel Labelle, telecom manager at TSI Terminal Systems Inc., a container port operator in Vancouver.

Few telecom-related initiatives are really critical, he adds, so they are prime candidates for cuts or postponement.

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The iPhone boosted Rogers' profits notably in the last quarter, providing the company with money to purchase enterprise solutions. ((Manu Fernandez/Associated Press))

"Voice system upgrades are very expensive, relative to their return on investment, and they're usually done for non-bottom-line reasons," Labelle points out.

And there's a lot that organizations can get along without during hard times when it comes to technology, he adds.

"Most organizations can operate without a service or maintenance contract," Labelle says by way of example. "Why pay $50,000 for a contract on your [network] switch, when you can probably get emergency support from your telecom provider for less? In good years, it's not worth the hassle — but in bad, it can save money."

Only companies that are in strong positions are likely to make major investments in communications IT in a questionable economy, says St. Arnaud, so companies providing equipment to them are seeing business dry up.

"Rogers' profits jumped significantly in the last quarter, largely due to the iPhone. It's one of the few companies that is buying enterprise solutions, because it needs to make those investments to sustain its growth," he says. "But Bell Canada reported a 1.8 per cent return, so it's in go-slow mode."

Credit crunch squeezes telecom sector

The sudden drop in spending on IT and communications by businesses is having dire effects on many vendors of telecom equipment and services. It has stifled their cash flow, and with the credit crunch many are finding it difficult to get credit from banks so that they can continue operating.

Companies that seem strongest from a capital market perspective appear to be winning the lion's share of new business, says Stewart, as customers try to make safe long-term investments in technology. "The weaker ones are being abandoned by their customers."

'If Nortel vanishes, I think there will be significant concern about Canada's research and development infrastructure, and our ability to continue to be a telecom talent.' —Mark Goldberg, telecommunications consultant

The problem is that few vendors are in strong positions any more across the telecommunications sector.

"Cisco has huge cash reserves, but all the other equipment providers are in trouble," says St. Arnaud. 

Cisco's Canadian rival, Nortel Networks, was already in a precarious position before the economy went sour. Now it is filing for bankruptcy protection. Its problems are causing pain for many other companies, too. Ottawa's high-tech corridor owes much of its success to Nortel, as it acted as a seedbed for nurturing IT talent and new creative companies, says Goldberg.

Ultimately, this could affect Canada's future as a leader in communications technology.

"If Nortel vanishes, I think there will be significant concern about Canada's research and development infrastructure, and our ability to continue to be a telecom talent," he says.

Expansion or consolidation

Many assumed telecom equipment suppliers would get a boost in the coming months as the wireless industry in Canada expanded after spectrum licences were auctioned off in 2008. Existing carriers were expected to expand their networks with the new spectrum available to them, and newcomers to the industry planned to build new networks. While wireless is expected to continue to generate revenue for existing telecommunications carriers, however, the future of new players in the wireless market is now in question as the economy slides.

"All those new companies licensed in the last round [of the wireless spectrum auction] with Industry Canada can't raise money to keep going," says St. Arnaud. "New entrants in the wireless space are all doomed."

Goldberg says this view is excessively gloomy.

"Some of these companies have foreign partners who've already anted up their investments, although they may face challenges getting sufficient Canadian investments to match them," he says. "They will probably sit on their spectrum for awhile, but I don't think they're doomed."

Many industry observers do agree a wave of consolidation among telecom carriers is coming, though.

It probably won't start until mid-2009, as many acquirers are playing the waiting game, says Stewart.

Companies can be bought cheap today, but maybe if they wait longer, they'll be even cheaper. And anyway, things are frozen now — buyers can't get credit from banks."

St. Arnaud predicts the return of big phone companies as consolidation proceeds among the carriers. Incumbent carriers such as Rogers and Bell Canada are in relatively good shape with stable revenue flows. And they can reduce their capital costs and increase their profits via mergers and acquisitions, he says.

"They're all saying, oh wow, the threat of competition just went away. So they won't need to invest in future infrastructure as much now."

But this doesn't necessarily mean a return to the monopolies of yore when Bell Canada dominated telephone services in Ontario and Quebec, Telus ruled in the West, while Rogers and Shaw dominated these regions in cable services, says Goldberg.

"These companies won't be re-establishing their monopolies," he says, pointing out many players now compete nationally in multiple communications sectors and regions.

"Their consolidation will likely tend to be expansion into new geographic areas, rather than buying up their market competitors," he adds.

"Rogers and Shaw might acquire smaller mom-and-pop companies, while Bell might consolidate its holdings in Bell Alliance or acquire smaller independents. Consumers will be better off as these companies get stronger, as there will be more national competition."

And although times are tough, it's important to keep perspective, Deloitte's Stewart adds. Economies bounce back, and so does business.

"When the Nikkei crashed in 1991, Japan had the second-largest economy by GDP," he says. "It's taken decades for that bubble to unwind — but Japan is still the second-largest economy today."