Focus: Buzzing along the Internet highway

IMAGINE IF, every time you wanted to drive on the motorway you had to have an entire lane to yourself. If you woke up in London one morning and decided to travel to, say, Bristol, you would first have to call the Highways Agency and ask it to reserve one of the lanes on the motorway for you. While you were on the road, nobody else would be able to use that lane. Only once you had arrived in Bristol would the lane be clear for another car to use.

For the purposes of car travel, the notion is clearly unworkable. However, this analogy, currently a favourite in the telecom industry, is a rough approximation of how most telephone networks currently work. It also illustrates the huge efficiency gains that will be available from the introduction of new technology.

This technology - which is based on the standards that form the backbone of the internet - has been a long time in coming. But suddenly, the telecoms industry is buzzing with talk of building new networks based on IP, short for Internet Protocols.

In an industry not known for its clarity, this may sound like just another tedious acronym. However, this development heralds a transformation that threatens to completely change the economics of the telephone, eventually turning the entire industry on its head. In a few years' time, executives confidently predict, businesses and possibly residential customers will no longer pay for traditional telephone calls.

At the moment, the vast majority of telecoms networks operate on a circuit- switched basis. Every time someone picks up the phone a circuit is opened up between them and the person they are calling. That circuit stays open for the duration of the call, regardless of whether the people on either end are talking or not.

Internet protocols, however, allow the telecom operator to divide each call into small packets of data before firing them down a fibre-optic cable at high speed, and reassembling them at the other end.

The people on either end of the line should not notice the difference in quality. But the efficiency gains for the operator are immense. Ray Dutton, chairman and chief executive of Telemonde, an aggressive new start- up, calculates that a pair of fibre-optic cables will be able to carry up to 74,000 phone calls at the same time.

And that is only the beginning. An even newer innovation known as wave division multiplexing - which divides a ray of light into the component parts of the spectrum and uses each part separately - raises the number of simultaneous phone calls that can be carried on the same pair of cables to more than 57 million.

The implications are enormous. The cost of telephone traffic, which has been tumbling rapidly in recent years, will come down even further. Not surprisingly, most telecom operators are rushing to build networks based on the new technology. BT recently announced spending of pounds 5bn over the next five years upgrading its UK network to IP, while its IP long- distance network in continental Europe went live last week. Cable & Wireless plans to build a similar network on the continent.

However, the investment is not limited to established companies. A clutch of brash new operators, flush with capital raised from US investors, are building new networks from scratch based on the technology. Level 3, a venture staffed by former executives of MFS, the operator which was taken over several years ago by the industry giant Worldcom, is building local networks in the business centres of the main European cities. Qwest, another aggressive US operator, has joined forces with the former Dutch state telecom company, KPN, to set up a long-distance IP network.

Meanwhile Telemonde is attempting to establish itself as the main supplier of carrier services - providing long-distance network capacity to other operators - in Europe.

At the moment, these new networks are still in their infancy. Colin Williams, the managing director of Level 3's international arm, points out that 80 per cent of revenues in the UK are still made from conventional switched calls - the majority of which are likely to be voice calls.

Mr Williams believes that the new entrants have a distinct advantage over established operators because they are not weighed down by existing investments. While large companies such as BT and Cable & Wireless have announced plans to build networks based on IP, they still want to generate the best possible returns from their existing networks. This means they will probably be reluctant to cut their prices by as much as they should.

But as IP networks catch on, the way in which telecoms services are charged for is set to change. Because all calls are divided into packets, the distinction between separate voice, fax and internet calls becomes largely meaningless.

This means that telecom operators are more likely to charge their customers according to how much physical capacity, or bandwidth, they use on the network. In the end, companies may find themselves paying quite highly for services such as internet traffic which use a lot of capacity. The implication is that voice calls, which use relatively little capacity, will be virtually free. "We could end up bundling services and charging a flat-rate price," says Rob McLeod, managing director of Level 3's UK division. "It would allow customers to budget very easily."

An added advantage of charging for bandwidth, rather than usage, would be that telecom operators could dispense with their complicated billing systems - one of the most expensive and troublesome bits of information technology involved in running a network.

"If you are bundling all the traffic together and using an IP network it probably costs you more to produce a bill than it costs to actually run the service," says Telemonde's Mr Dutton.

To begin with, this brave new world is likely to only be available to businesses in areas where telecom operators such as Level 3 can justify digging up the roads to lay cable to their front doors. Most residential users will have to carry on using the existing local copper telephone networks, which limit the bandwidth available. Given the current pace of change of technological development, however, it should only be a matter of years before they too can enjoy the benefits of the new telecoms world.