The Israeli Internet market has taken quite a few hits since the high-tech bubble burst, but the survivors of 2002 won the whole pot. Not only is Internet not dead, it is thriving better than every other telecommunications market. In fact, the phenomenon is not just a local one, although, as so often, the Israeli reaction is faster and sharper, and ISPs have become the darlings of the capital market as their shares soar.
Internet Gold Golden Lines (Nasdaq: IGLD) has shared in the unexpected wave of enthusiasm for ISPs, which had sunk through the floor lately. Internet Gold has surged 167% since January 1, 2003.
When discussing the rapid growth of Israel’s Internet market in 2002, the reference is solely to high-speed Internet. Here are some figures to grab your attention: the number of high-speed Internet subscribers more than quadrupled from 50,000 to 210,000 in 2002; as of December 31, 2002, 28% of Internet subscribers had broadband; and the number of high-speed Internet subscribers will grow by 86%, to 390,000 in 2003, accounting for 45% of all Internet subscribers.
Most of the growth does not come from new subscribers, but from the cannibalization of dial-up Internet services. The figures indicate that high-speed Internet will continue to be the dominant Israeli market telecommunications subsector in 2003, as far as growth rates are concerned.
Bezeq International has become the dominant Israeli high-speed ISP player. Bezeq International president and CEO Kobi Hayon says the market has become the most hyperactive and complex telecommunications field, and will continue to be so in 2003.
Vega Consultants co-manager Udi Savithsky says high-speed Internet’s penetration of the Israeli market is impressive, both in terms of its speed, and higher rate of use, compared with most Western countries. The penetration rate in Israel rose from 4% to 11% during 2002, compared with 5.5% in the US, 8.3% in Sweden, and 7.3% in Germany. Only some Far Eastern countries have a higher penetration than Israel: penetration in South Korea is 39%.
The question is what is behind the massive leap in high-speed Internet within only one year? As so often, the answer is money: high-speed Internet has become a lot cheaper, falling to a fraction of its cost of a year earlier. In early 2002, a consumer paid NIS 400 for a hook-up; by December, a high-speed Internet package cost NIS 150-250, and some current promotions campaigns are offering deals for NIS 70.
The change followed the ISPs’ decision to eliminate all unprofitable activities and to halt signing up subscribers who do not contribute to the bottom line. The result is that Internet prices via an ordinary modem are staying the same, and even rising, because the unprofitable packages have been cancelled. When consumers have comparable prices for ordinary and high-speed Internet, there is an obvious incentive to convert.
Savithsky adds that Israelis are quick to adopt new technologies. Examples are the rapid penetration of cellular telephones and the transition from analog to digital cable television. “The small size and intimacy of the Israeli market leads to a rapid spread of recommendations, while those who do not adopt the technologies are no longer hip. An increasing number of people subscribed to high-speed Internet, as part of a fashion and technology trend,” he says.
Another key reason for the rapid penetration of high-speed Internet is a two-front marketing war by the ISPs and infrastructure providers: the cable companies and Bezeq (TASE:BZEQ), through WOW. The cable companies entered the field in the second half of 2002, launching an aggressive ad campaign in September, which lead to a counter-campaign by Bezeq. The ISPs in turn intensified their own rivalry, launching new ad campaigns. The artificial structural separation in the Israeli Internet market was thus the key cause for its success.
Savithsky found additional, albeit marginal, reasons for the rising popularity of high-speed Internet in Israel. One is the intifada which caused more people to seek out home entertainment and information online. Second, the Internet, like other types of entertainment, has become a form of daily escapism. Third, the amount of online content is expanding, and therefore increasing the interest in surfing.
On the other hand, intense competition among suppliers has led to a less positive development for consumers: bandwidth reduction that slows high-speed Internet down to a crawl. The ISP’s basic cost in hooking up subscribers to high-speed Internet is the provision of sufficient bandwidth, which is expensive. The result is prices fall in inverse proportion to the rising competition, and ISPs are uninterested in signing up unprofitable subscribers, after the previous failure of this business strategy. The result is an attempt to save costs by providing narrower bandwidth. The consumer picks a suitable package, and the decision determines the price paid and the bandwidth obtained.
Foresight director, consulting and research Amiram Boehm says the trend among ISPs to reduce bandwidth will eventually catch up with them. While consumers know how much bandwidth they are getting, most do not understand what that means; they just know they are supposed to be on the information superhighway, but have found themselves in a traffic jam. Boehm says this is severely damaging consumer confidence in the service, which will hurt sign-up rates. He also thinks that some subscribers will disconnect, even though the ISPs believe there is no way back from high-speed Internet. On the other hand, high-speed Internet is always on, and does not use the telephone line, so even slow high-speed Internet has clear advantages over ordinary Internet.
Foresight managing director Shally Tshuva reveals an interesting fact: most Internet users do not need broadband. 90% of Internet use is for e-mail, the undisputed Internet killer application of all time. E-mail usually does not require transmitting a great deal of data, such as pictures or music that waste bandwidth. Other successful Internet uses, such as viewing news and other information sites, e-commerce and instant messaging, also do not require broadband.
Tshuva says that ironically, the applications that must use broadband are streaming video, picture and games, are not particularly popular. The conclusion is that the average consumer barely needs high-speed Internet, and can easily suffice with the old tried and true dial-up service, without greatly impinging on the surfing experience. Tshuva adds a caveat: use of the bandwidth-intensive services is growing, and there is an interdependent connection between them. In other words, the need for high-speed Internet will grow proportionally to the expanded use of broadband services, and as more people subscribe to high-speed Internet, the use of broadband services will grow.
It is impossible to analyze Israel’s high-speed Internet market without reference to Bezeq International, the market leader and local gorilla, which entered the market first, and investment immense marketing and infrastructure resources at a cost of NIS 100 million. Bezeq International now has a 40% market share, with 100,000 subscribers. In addition to its corporate success, its aggressive strategy has unquestionably driven the market forward, by forcing its competitors to keep up, thereby accelerating the penetration of high-speed Internet in Israel.
Bezeq International VP virtual private networks Rami Hazan says, “The hype peaked in 2000; everyone signed up subscribers, but failed to generate profits. More subscribers was everything. Then came the crash, which led everyone to realize that their behavior had created a bubble, and a non-paying customer was no customer at all. We analyzed the situation, and built a sustainable high-speed Internet business model, enabling us to put an emphasis on the field in 2001.”
Hazan adds that Bezeq International understand that the first high-speed ISP would win. “While other companies were licking their wounds, we were already acting. We decided on a strategy to become number one in the field, and we intend to preserve our lead, i.e. we’ll continue to hold onto a 40% market share.”
Hazan raises the basic point, that signing up subscribers will not generate profits, despite the sweeping success of high-speed Internet in Israel, because of its low prices and high costs. “I cannot claim the sector is profitable, but you must understand that this is a long-term investment. We must invest now to be ready for market stabilization. Right now, prices are low; I don’t think they will rise soon,” he concludes.
Published by Globes [online] - www.globes.co.il - on March 5, 2003