Deregulation may have prompted the restructuring of the telecommunications industry, but technological innovation is what keeps the process going. And for technological innovation, there is no business like the software business. In the 1980s, the computer industry was transformed when microprocessing technologies allowed new companies such as Microsoft to create a software industry that was largely independent of hardware. In the near future, a series of technological changes could likewise transform the structure of the telecommunications industry by shifting much of the value it creates from hardware to software.

For incumbents, the implications are far-reaching. Traditional providers of telecom equipment, already challenged by newcomers, will now have to struggle against more and tougher software-oriented competitors, though it is possible that the traditional providers will themselves seize emerging software opportunities. Changes in the software arena will have a more subtle impact on network operators, which may lose control over many of the services provided over their networks as the balance of power shifts toward software. Yet the impending transformation also offers network operators novel business opportunities—in network management, for example, and hosting software applications on their networks.

Advances in software will eventually blur the distinction between network operators and equipment...