Convergence of Market Forces Is Future of SpotMarket

Posted: 11/1999

Convergence of Market Forces Is Future of Spot Market

Downward pressure in the spot market on rates is having a decisive impact on the fundamental structure of the industry. As rates decline, the industry adjusts contract structures and trading mechanisms on its own in the spot market, while regulators must account for these rapid changes. These two evolutionary paths eventually will meet to form the spot market of the future. Below are two examples of this phenomenon, one from the minutes market, one from the bandwidth market.

Graph: DS-3 Bandwidth RTBX*RPI and RTBX*RFP-360 Indices

In the minutes market, high-volume routes such as Japan and Germany have experienced tremendous declines over the past year. The usual suspects for this trend can be cited (liberalization, competition, technology advances and access to capital), and declines in the top 20 routes average about 50 percent during this period. Now it is clear that this gray market activity is directly impacting settlement rate reform and some suggest we can expect major settlement rate adjustments in line with spot-market pricing in major country routes.

In the bandwidth market, we have witnessed a similar decline in the most competitive markets. In our Revealed Price Index for U.S. coast-to-coast DS-3 bandwidth, we have seen a 30 percent decline over the past year. DS-0 channel pricing throughout the United States commonly has fallen from 5 cents per channel mile to 2.5 cents during the last six months alone. The Revealed Forward Price Index points indicate that the market could be stabilizing on these routes.

The impact of this rate movement is a decreased demand for long-term indefeasible rights of use (IRU) agreements with most demand centered on one-, two- or three-year lease agreements. In fact, carriers are even demanding shorter-term commitments.

By contrast, international private line (IPL) pricing still has a way to go until this impact is felt. DS-0 mile pricing for trans-Atlantic and European continental routes has declined from 45 cents to 20 cents per mile. Clearly, this decline will continue until IPL agreements are negotiated with similar terms as a U.S. domestic private line.

There is a barrier, however, to the market's evolution. Without adopting a switch-based "bandwidth exchange" such as RateXchange, contract lengths cannot grow shorter because provisioning new agreements takes 60 to 90 days and it incurs high marginal costs every time a circuit is put up or taken down. As pricing structures shift to accommodate the market, from cost-plus-required-rate-of-return to demand-based pricing, volatility will increase. This volatility requires a web-based exchange for flexible term trading and risk management.