The rise of Internet Protocol (IP)–based services, coupled with changes in technology, will significantly disrupt the US long-haul telecommunications industry, according to a joint study by McKinsey and J. P. Morgan. The study results show that traffic transmitted using the IP will increase explosively, dominating long-distance telephone networks and leading to long-distance traffic growth of more than 60 percent a year, compared with 20 percent a year historically.¹ Moreover, IP-based services are set to take significant market share from traditional voice and data services—a development that will push telecom prices down and slow the growth of the industry's overall revenue.

Telecom providers must continue to invest in new technology to meet demand and cut costs, but network scale and use will emerge as the most important determinants of cost-competitiveness. Carriers will therefore have large incentives to compete for traffic on their networks by slashing prices. The industry will likely undergo considerable turmoil as challengers seek to exploit and accelerate this disruption and as incumbents wrestle with the problems of cannibalization and restructuring. These underlying economic forces, combined with an excess of industry players, could make aggregate returns on capital insufficient, which in turn would drive consolidation and a...