Busted By Broadband

By John Greenwald

Tucked into a corner of Lucent Technologies' Bell Labs in Murray Hill, N.J., stands a small box that houses what could be the future of the telecommunications industry. Called a LambdaRouter, the device contains 512 microscopic mirrors, each of which can switch light waves packed with more than 10 billion bits of information--roughly the contents of 10,000 novels--from one hair-thin strand of optical fiber to another.

You could conceivably jam thousands of these micromirrors into a soccer ball and have enough capacity to connect everyone on the planet simultaneously to everyone else without the time and expense of converting the light to electronic impulses and back again--as today's networks require. Kick that around. Declares Bell Labs scientist David Bishop, who led the development team: "You will either have a technology that does this, or you will have a going-out-of-business sale."

Nobody knows the vicissitudes of technology better than Lucent, which had to negotiate a $6.5 billion loan package last month to avoid a cash crunch. Lucent was first a beneficiary and then a victim of the race to wire the U.S. with the speed-of-light data pipes known as broadband. And now it has company in its misery, as broadband carnage has spread from phone companies like AT&T and WorldCom to fiber makers like Corning to optical-systems builders like Nortel Networks to components makers like JDS Uniphase and networking companies like Cisco Systems.

Broadband growth figured to be limitless. Given that every business and every household is moving online, data transmission has been expanding at phenomenal rates. But as phone companies and Internet service providers sprang up everywhere, capacity raced light-years ahead of demand. So the price for using the pipes tumbled, hobbling the telcos' ability to expand and to buy more gear. "Never in the history of industry has the sheer number of competitors been so underestimated and misunderstood," says former AT&T Broadband president Leo Hindery. "And never have the implications of technology advancement been so misunderstood as well."

The results have been plunging profits, mass layoffs and imploding stock values for companies that had been NASDAQ supernovas and among the chief reasons for the stock market's rise. At BlueStone Capital Securities, an index of 13 fiber-optic heavyweights that includes Lucent, Cisco, Nortel and JDS Uniphase has fallen 78% since last July, a plunge that has cost investors more than $1.1 trillion in market value. The percentage decline exceeds the drop for NASDAQ as a whole, which fell 51% over the same stretch.

Investors who see those falling stock prices and think "bargain" should think again. Few industry leaders expect business conditions to improve much this year. Phone companies "are really conserving their capital because of the severe downturn in the economy," says Clarence Chandran, Nortel's chief operating officer. Nortel is a one-company bear market. The world's No. 1 producer of fiber-optic systems, Nortel accelerated the industry's slide and NASDAQ's sell-off last month by abruptly slashing its 2001 forecasts and declaring that it would idle 10,000 employees, or nearly 10% of its work force.

You would think we had all stopped calling home or logging on. Not at all. Internet traffic continues to grow at the astonishing rate of 200% annually. Every 45 minutes, AT&T transmits a quantity of data--meaning everything from e-mail to streaming video--equal to 34 times the contents of the Library of Congress. But the broadband buildout has been so furious that it could take three years for the traffic to catch up.

Behind this overbuilding is the telecommunications deregulation act of 1996, which brought a flood of new local and long-distance broadband carriers--including satellite and wireless systems operators--into the telecom market. Their very presence forced incumbents like AT&T to upgrade their systems to keep up. And since deregulation coincided with the Internet bubble, Wall Street was happy to throw money at the telecom upstarts, many of which now resemble dotcoms.

The broadband revolution promised to bring every household fast Internet access along with video-on-demand, interactive TV and the ability to flash Libraries of Congress around the world at whim. Amazingly, the sellers of this dream overlooked the fact that many homes and offices connect to the 21st century fiber network with twisted-pair copper wires--late 19th century tech. These could hardly keep up with the bandwidth demands of the Napster age.

So, for example, a dial-up modem that connects to the Net over copper has a typical download speed of 56 kilobits--or 56,000 bits--per second, at which rate it would take nearly 10 minutes to download a three-minute song. By contrast, a modem connected to a TV cable that feeds into a fiber-optic loop could claim that tune in under a minute. Yet even today only about 6% of U.S. households have cable modems or digital subscriber lines, which carry compressed data over copper wires at broadband speed. But that hasn't stopped carriers from blanketing the country with high-bandwidth networks.

The advent of the Internet also transformed how phone companies move messages in a way that made Cisco the networking king. Traditional voice phone systems are circuit switched, meaning that a call opens a dedicated line between the parties that outsiders can't share. But data traffic is packet switched: messages are broken into discrete units, or packets, that share their lines with the packets of other users, greatly increasing the speed and volume of the data sent. It's mass transit for data. Moreover, packets can take different paths to their destinations, which is where Cisco's routers come in. They read the address on each packet and speed it along the most efficient route.

As the buildout accelerated, phone companies were creating a painful paradox in which their new technology generated a lower return on investment. The payoff for Internet traffic was particularly dismal, since data can travel across the street or around the world for the same basic charge. And this forced equipment suppliers to slash their prices, putting a further squeeze on their profits. "For the first time in history," says Tracey Vanik, a technical director of the RHK consulting firm, "there's no penalty for distance"--compliments of the Internet.

These same suppliers are now racing to deliver the Next Big Thing when the market turns up. You don't want to be late in an industry where missing a beat can put a big hole in your order book for years. That fate befell Lucent in the late 1990s when archrival Nortel rolled out the first 10-gigabit laser system, which flashes the 0s and 1s of computer binary code at the rate of 10 billion times a second through fiber. Lucent's share of the market for optical transport gear dropped from 28% at the start of 1999 to 14% at the end of 2000, according to the Dell'Oro Group consulting firm. Meanwhile, Nortel's share of the $22 billion market rose from 28% to 43%.

Today both companies are preparing to launch 40-gb/s systems. And by using lasers of different colors, engineers can pack 160 gb/s into a single strand of fiber--enough to transmit the text of 4,800 encyclopedia volumes.

At Nortel's optoelectric labs in suburban Ottawa, Canada, researchers in baby blue antistatic "bunny suits" work around the clock to put as many as 160 wavelengths on a fiber. "It's speed and the number of channels that make the difference," says Carla Miner, a senior lab manager. As recently as 1996, she says, "What we're doing now we thought was impossible."

In Silicon Valley, Cisco--which two weeks ago announced layoffs of up to 5,000 full-time employees, or 11% of its work force--is aiming at the largely untapped big-city market. Even though crews are digging up streets everywhere, only 7% of U.S. office buildings have fiber-optic lines running into their basements. "It's as if you're building a big interstate highway system without any feeder roads," says Carl Russo, Cisco's vice president for optical networking, "and you're wondering where all the traffic is." Nortel's Chandran has noticed that too. He vows to battle from "city to city and building to building" to "unclog the metro."

In fact, the fiber giants have little choice but to focus on the long-neglected "last mile," since that's where the people are. There are signs that broadband could soon reach far more consumers than the relative handful who get it now. According to the Gartner consulting firm, nearly 30% of U.S. households will have high-speed access to the Internet in 2004.

By then, the overbuilt long-haul networks could also be filling up. "They will stimulate commerce that otherwise would not happen," says Susan Kalla, an Internet and telecommunications analyst for BlueStone Capital.

And by then the endlessly hyped convergence of computers, phones and televisions may start to take shape, bringing interactive high-definition TV and Internet phone calling--remember, there's no long-distance charge--within affordable reach. "The ultimate endgame is fiber everywhere," says John Coons, who tracks e-business for Gartner. "Everything will be digitized and sent over one infrastructure." But the beleaguered companies that have developed some of the most dazzling products on the planet will have to get there first.

--With reporting by Steven Frank/Ottawa and Chris Taylor/San Francisco

With reporting by Steven Frank/Ottawa and Chris Taylor/San Francisco