Delivering Profitable Virtual

Private LAN Services (VPLS)

Business Case White Paper
November 2003

Virtual Private LAN

Table of Contents

Executive Summary................................................................................................................. 1

Overview ............................................................................................................................... 5

Why Ethernet Virtual Private LAN Service?................................................................................. 6

What is VPLS? ........................................................................................................................ 7

Architecture of a VPLS Network................................................................................................ 8

VPLS: Addressing the Issues of Multipoint Ethernet TLS............................................................. 11

Service Provider VPLS Business Case Study .............................................................................. 11

Summary ............................................................................................................................. 18

Appendix A: Business Case Assumptions ................................................................................ 20

Executive Summary

Frame relay virtual private networks (VPNs) have been successful in the market because they
enable service providers to efficiently share their high fixed cost infrastructures among many paying
customers—while at the same time delivering a packet service that is compatible with an
increasingly large percentage of the traffic generated by enterprise customers. Now, for customers
requiring higher bandwidth than frame relay-based VPNs, a new service is emerging. Virtual
private LAN services (VPLS) 1 use IP/MPLS to deliver a highly scalable, any-to-any connectivity.
Alcatel offers a full range of VPN solutions, including frame relay, VPLS, and IP-VPNs.

This paper illustrates the economics of deploying VPLS services via a detailed business case and
examines a way for carriers to deploy the Alcatel 7750 Service Router to profitably combat
competitive threats in home regions or to aggressively bolster top line growth and increase market
share out of territory, through the delivery of VPLS as part of their VPN portfolio.

In particular, we illustrate a business case in which an operator deploys VPLS within one medium
sized North American city through the introduction of the Alcatel 7750 Services Router, the
industry’s first commercially deployed Services router.

Based upon a conservative five year market penetration of 12.5 percent of medium and large
enterprises in this metro, the business case yields the following results:

> Internal rate of return (IRR): 180 percent

> Net present value (NPV): $27.2 million USD
> Positive cash flow in less than 2 years
> Payback in 2.15 years

A one year payback could be achieved with an aggressive marketing campaign focused on
selling higher bandwidth services to larger Medium sized enterprises thereby driving an increased
year 1 adoption rate and increased market penetration as demonstrated in the table below:

1
VPLS is and new MPLS based Ethernet Service that can be deployed on a metro, national or global basis to extend an
enterprise’s local area network (LAN) to multiple locations over a fully meshed Layer 2 multipoint connection.

1
 Assumptions Parameter 2.1 Year Payback 1 Year Payback
Market Penetration 12.50% 15%
Year 1 Adoption Rate 4% 8%
# of Sites per Medium Enterprise 5 8
1.5Mbps 5.0 % 5.0 %
6Mbps 45.0 % 20.0 %
Subscriber BW
10Mbps 35.0 % 45.0 %
% of Total Subs by BW
45Mbps 10.0 % 10.0 %
100Mbps 5.0 % 20.0 %

This business case is most sensitive to the number of sites in the Medium Enterprise definition and
assumes only 5 sites per medium business however this varies by vertical and analysis of the North
American market by Infonetics 2 indicates averages of up to 9 site s for this market segment.

In addition, as a result of its superior density and scalability, the Alcatel 7750 SR in this scenario
delivers:

> CAPEX Savings of up to 46 percent over competitor offerings

> Reduced maintenance costs by up to half that of competitors’ products
> Payback up to 38 percent faster than competitors

While the business case yields results that justify the deployment of the Alcatel 7750 SR for the
delivery of VPLS services alone, it is important to note that the 7750 SR also provides the
foundation for the delivery of additional services that can much more positively impact the business
case. These include direct Internet access, IP/MPLS VPN (2547bis), and point-to-point Ethernet
virtual leased line services in a service aware OAM environment where SLAs with guaranteed QoS
can be created, managed, and delivered connection by connection with confidence.

As the industry’s first purpose-built service router for delivery of Ethernet and IP/MPLS based
services, the 7750 SR provides:

> Unique quality of service capabilities, enabling service differentiation and structured service
pricing and billing
> Generational leap in technology that provides fully programmable 10 Gbps line rate deep
packet inspection
> Industry’s only built-in service aware OA&M toolkit that speeds troubleshooting and
reduces OPEX

2
“User Plans for VPN Products and Services, US/Canada, May 2001”, Infonetics Research

2
In summary, this paper demonstrates how Alcatel can help you deliver profitable yet competitive
new data services, enabling simplicity through the use of Ethernet, differentiation through VPLS
and per service QoS graduated SLAs, and reduced risk through multiple service type capability
at reduced cost in one platform. Flexible and manageable, the Alcatel 7750 SR VPLS solution will
help you meet and exceed your goals while working within the “real world” of your existing
networks and variable customer demands.

3
Introduction

Metro Ethernet services have been viewed by some as the “holy grail” of service offerings because
they promise to lower CAPEX and OPEX for service providers’ network infrastructures while
delivering higher bandwidth at a lower cost to the enterprise. They also promise to simplify the
relationship between service provider and enterprise customers by working with the most
ubiquitous and well understood of all protocols: Ethernet.

Service providers need to preserve the high margin private data services they provide today over
ATM and frame relay (FR) technologies, but at the same time must defend and aggress against
competition with a more flexible, efficient approach that allows them to cater to end customers’
needs without building expensive network overlays. Since a growing number of service applications
are IP based, providing solutions that expand the basic forwarding and routing capabilities of best-
effort IP with sophisticated service handling is a practical way to deliver on these expectations.

According to Yankee Group 3, the North American market for new Layer 2 services such as point-
to-point Ethernet private line (VLL/EPL), dedicated Ethernet Internet access (EIA) and multipoint
Ethernet virtual private LAN service (VPLS) is expected to grow to just under $4B by 2007. The
Layer 3 IP VPN market, well known to service providers today, is expected by IDC 4 to generate over
$13B in revenues in North America by 2007. By the same year, in Europe, Yankee Group
estimates that market to reach 6.4B Euros 5.

The need for service-oriented solutions is driving the demand for a new class of router, called a
“service router.” A service router is a scalable Internet router that offers best effort Internet services
and enables the migration of traditional data services. But, it also supports an expanded range of
differentiated, private data services on a single, low cost network infrastructure and management
system. These services, such as VPLS and IP-VPNs, allow operators to attract and retain a wider
customer base at a lower cost while offering increased flexibility and quality to the end user.

Objective

The objective of this paper is to demonstrate the flexibility and cost effectiveness of the Alcatel 7750
Service Router as the platform for delivering a new data network service and underlying
architecture developed by the Internet Engineering Task Force (IETF) 6 called Virtual Private LAN

3
“Metro Ethernet Services Could Change the Face of Telecom…”, by Nicholas Maynard and Mark Bieberich, Yankee Group, July
2003
4
“US IP VPN services Forecast, 2002-2007”,by Steven Harris, IDC, December 2002
5
“Navigating the IP VPN Market: A Decision-Making Guide for European Businesses”, by Camille Mendler and Amy Rodger,
August 2003.
6
IETF L2VPN working group (formerly the PPVPN working group)

4
Service (VPLS). For the first time, carriers will have a highly scalable, easy to manage platform for
the delivery of Metro Ethernet services.

The business case herein focuses on VPLS service delivery; however, it is important to note that the
Alcatel 7750 SR was designed from the ground up to deliver efficient and effective provisioning
and operation of a full range of revenue-generating services in addition to VPLS, including:

> Direct Internet access (DIA)

> Ethernet, frame relay and ATM point-to-point Layer 2 VPNs (also known as virtual leased lines
or VLLs)
> BGP/MPLS IP-VPNs (RFC2547bis): (R2.0 1Q04)

The Alcatel 7750 SR can transport tens of thousands of individual services using flexible IP and
MPLS tunneling with per-service QoS and accounting.

Alcatel’s focus on OA&M and QoS capabilities with the 7750 SR provides unmatched flexibility and
scalability to increase revenue generation while minimizing capital expenditures and driving down
operational expenses in the carrier’s network. VPLS lowers operational expenses for both the
service providers and their enterprise customers by reducing the amount of enterprise router
configuration and management. In addition, VPLS offers protocol transparency, highly granular
bandwidth, and full mesh connectivity resulting in ease of implementation, flexibility in service
offering, and enhanced scalability.

Overview
Frame relay virtual private networks (VPNs) have been successful in the market because they
enable service providers to efficiently share their high fixed cost infrastructures among many paying
customers—while at the same time delivering a packet service that is compatible with an
increasingly large percentage of the traffic generated by enterprise customers. In this sense, the
frame relay network itself adds value by addressing some of the key shortcomings of TDM
networks and services. Now, for customers requiring higher bandwidth than frame relay-based
VPNs, a new service is emerging. Virtual private LAN services (VPLS) use IP/MPLS to deliver a highly
scalable, any-to-any connectivity. Alcatel offers a full range of VPN solutions, including frame
relay, VPLS, and IP-VPNs.

This paper explores the business case supporting the emergence of virtual private LAN services and
examines ways for carriers to deploy the Alcatel 7750 Service Router to profitably deliver VPLS as
part of their VPN portfolio.

5
It is important to recognize the wide range of customer requirements, service provider network
architectures, and economic factors that VPN technologies are required to address. There is no
“one-size-fits-all” answer to the question of what sort of VPN service is best for customers or which
VPN architecture is best for service providers. Notwithstanding the relative success of VPNs to date
— particularly point-to-point Layer 2 VPNs constructed using frame relay and ATM —many
enterprise customers and service providers would agree that existing solutions are not optimal. As
a simple illustration of this, enterprise customers frequently find that the price structure of VPN
solutions available from their current service provider forces them either to make do with inter-site
connectivity topologies that are not optimized for their business needs or to look to a new or
additional supplier for a more flexible option. Similarly, service providers worry about bandwidth
scalability of existing services and the substantial management and provisioning overhead of many
network-based solutions in addition to the threat from competitors who may not be encumbered by
the need to maintain legacy networks.

Introduction of a VPLS service based upon the Alcatel 7750 Service Router can address both the
pent up demand from enterprises for increased, more flexible bandwidth, and provide a customer
retention vehicle for carriers facing potential loss of revenue from traditional FR/ATM products. In
addition, the 7750 SR is the perfect platform for Service Providers who are expanding outside of
their traditional territories by allowing them to aggressively position VPLS as a differentiating
service and then using the same platform to offer additional services such as Ethernet based
Internet Access and IP/MPLS VPNs. The Alcatel 7750 SR provides the bridge between existing
access and private line technologies and their existing IP cores that are evolving to MPLS. For
service providers who have not yet transitioned their core to MPLS, the scalability and feature
richness of the Alcatel 7750 SR enables it to operate flexibly in both capacities: as an edge services
router and as the MPLS core transport router.

Why Ethernet Virtual Private LAN Service?

Ethernet is the de facto standard Layer 2 technology for enterprise LANs, and the use, operation,
and configuration of Ethernet systems is familiar to virtually every IT worker across the world. The
networking industry has pushed Ethernet technology through a seemingly endless cycle of
development that has produced faster and cheaper implementations with every passing year. Until
recently, virtually all of the work surrounding Ethernet has been focused on its application in
enterprise networks, with relatively little attention devoted to enabling Ethernet traffic to easily flow
in and out of our public telecommunications infrastructure. In fact, some of the basic operational
characteristics of Ethernet networks are quite hard to reproduce or emulate with the existing carrier
infrastructure. As a corollary, this focus on Ethernet in the enterprise LAN means that the vast
majority of existing equipment is unsuitable for use in large service provider networks.

6
For many years, the telecom industry has worked to deliver a VPN service that is optimized to
enable enterprises to simply and cost-effectively interconnect their various remote locations using
Ethernet technology. Called multipoint Ethernet transparent LAN service (TLS), this type of VPN has
many desirable characteristics from the perspective of an enterprise customer. Unfortunately,
delivering a reliable, economically viable multipoint TLS is far from simple, and to date, most
carriers have deployed point-to-point Ethernet services almost exclusively.

As enterprise computing applications migrate from being largely client-server towards an increase
in peer-to-peer and distributed computing, the advantages to the enterprise of a richly connected
VPN (or at least the option for rich connectivity) become apparent. A specific driver for this is the
widespread use of distributed web servers and the resulting unpredictable traffic patterns. The
binding between the node-to-node connectivity of the VPN and underlying virtual circuit topology
introduces a variety of operational problems for both the enterprise and the service provider in the
areas of scalability, ease of use and fault tolerance. This is where the Alcatel 7750 SR VPLS
advantage can benefit the service provider.

What is VPLS?
Virtual private LAN service, as defined in IETF draft-l2vpn-vpls-ldp (formerly draft-lasserre-
vkompella), provides each customer with a connectivity service between multiple locations. To the
end customer, the entire VPLS service looks like a single Layer 2 switch with one interface at each
location. This makes it an extremely simple service to use, since no interaction between customer
and service provider is required. At each location, the customer plugs his router into the Ethernet
port provided by the service provider and traffic is automatically forwarded to the correct
destination using standard Ethernet/IP forwarding techniques. As an alternative, where an existing
FR/ATM/PoS or other local loop access connection exists, the connection between the access
system and the PE router is made in the service provider’s VPLS PoP. Unlike VLL and frame relay,
where each pair of locations has a point-to-point connection, VPLS is a multipoint service—each
customer requires only one connection at each location. This service is sometimes referred to as
TLS (transparent LAN service) or E-LAN (Ethernet LAN).

The work of defining the VPLS architecture has been occurring under the auspices of the L2VPN
working group (formerly the PPVPN working group) within the IETF. Virtually all of the major
telecom service providers actively participate in the L2VPN group ensuring that the concerns and
requirements of carriers will be at the center of the debate that shapes the definition of VPLS. With
VPLS, the IETF is defining an architecture that, for the most part, uses protocols and interworking
technologies that are already specified and in service today in other network applications. For
service providers, this is good news because it means that large portions of the basic technology of

7
VPLS are already tested and field-proven. What is new is the application of these technologies to
the problem of delivering high-quality multipoint TLS. The bulk of the new technology development
required by the VPLS architecture is in specific system functions—packet replication, for example—
that the architecture requires to be implemented by certain nodes within a VPLS network.

The architects of the Alcatel 7750 Service Router (SR) have led the IETF effort to define VPLS, and
have brought one of the first implementations to market with a systems solution designed for the
scalable delivery of TLS based on the VPLS architecture. From the customer’s perspective, a
multipoint Ethernet VPN service delivered over a VPLS-enabled network will have the look and feel
of a private switched Ethernet service: in other words, the Ethernet TLS described previously. VPLS
will, for the first time, enable service providers to deliver a highly scalable, economically viable
multipoint Ethernet TLS. This section introduces some of the basic concepts of the VPLS architecture
and explains how the architecture addresses some of the technical problems of delivering a
multipoint Ethernet TLS. Readers interested in a comprehensive discussion of VPLS are encouraged
to review the relevant IETF documents.

Architecture of a VPLS Network

While the VPLS architecture has the flexibility necessary to support numerous different deployment
scenarios, its basic structure can be decomposed into three areas: access, edge and core. The
edge of the service provider’s VPLS infrastructure is formed from a set of edge nodes called
Provider Edge (PE) routers, which are often located in service provider points-of-presence. The PE
routers surround a high-bandwidth packet core and are responsible for key Layer 2 functions like
MAC address learning and packet replication, functions enabled by supporting a “virtual bridge”
per service instance (see Figure 1).

8
 Figure 1. VPLS Architecture

Branch Office

Corporate HQ V

V PL S

Serv ice P rov ider V

Infras tru ctu re

Branch O ffice

The PE devices communicate via tunnels they establish through the core, and it is over these tunnels
that they forward encapsulated customer Ethernet frames. In all cases, Ethernet frames are
encapsulated according to the widely accepted IETF “draft Martini” standard. The access network
delivers point-to-point transport of Etherne t frames from customer premises locations to the nearest
PE router, enabling the various customer locations to connect to the multipoint Ethernet service
provided by the VPLS network. An extension to the architecture called “Hierarchical-VPLS” (see
Figure 2) presents a scalable way to deliver multipoint TLS in situations where it is desirable to
perform customer aggregation across the access network (for example, when serving an MTU or
office complex).

Figure 2. Hierarchical VPLS

9
One of the primary advantages of the VPLS architecture is that it locates virtually all of the service
intelligence in the edge of the carrier network. This has clear operational and economic
advantages for the service provider in that it enables the VPLS architecture to be easily integrated
with existing access and core network infrastructure. As a consequence of this focus on the network
edge as the location for service delivery, much of the new technology required to construct a VPLS
network is found in the PE routers. Although similar in concept to a traditional edge router, VPLS PE
routers must perform a variety of system-level functions that are unique to VPLS including support
for packet replication and the ability to learn MAC addresses and maintain per-customer MAC
address tables.

Another benefit of this concentration of service intelligence at the network edge is that the
requirements VPLS places on the core network are relatively limited. As a result, the VPLS
architecture is compatible with a variety of packet networks including standard IP-routed and more
advanced IP/MPLS cores. The key capability required of the core is that it enables the PE routers to
establish high-bandwidth transparent tunnels between one another. In networks where the core
supports an MPLS contr ol plane, the VPLS network can potentially benefit through the use of
techniques like traffic engineering and fast path restoration. The benefits the VPLS network will
receive from a more sophisticated core are primarily determined by the capacity of the PE router to
exploit the advanced features of the core.

As an Ethernet-based service, it is obvious that the access network plays a critical role in the VPLS
architecture. As service providers build out new fiber access infrastructure, the network footprint
over which they can provision high-bandwidth Ethernet transport circuits will continue to grow. In
the context of VPLS, the role of the access network is to deliver point-to-point Ethernet connections
between the customer locations and the PoP-located PE routers at the edge of the carrier network.
Because VPLS is independent of the technology used in the access (or core) networks, customer
locations can be connected over any infrastructure that can transport standard Ethernet MAC
frames, including Etherne t-over-SONET, 802.17 RPR, EPON, Ethernet-over-DSL and bridged
Ethernet per RFC-2878. PE routers perform service and customer demultiplexing across the access
network using either 802.1Q VLAN tags or MPLS labels (H-VPLS).

10
VPLS: Addressing the Issues of Multipoint Ethernet TLS
In order to deliver a service such as multipoint Ethernet TLS with profitable economics, the carrier
must be able to offer it on a large scale. The scale with which TLS is being delivered can be
measured in several dimensions, including:

> The number of customer locations that are members of each multipoint service
> The number of customers being served by the TLS network
> The geographic area over which the customer locations are distributed
> The bandwidth provisioned for each customer service

Carriers face a number of practical problems when they attempt to deliver a TLS that can scale
simultaneously in all four of these dimensions. These problems arise from the mismatch between
Ethernet systems and technology on one hand and the architecture and operational requirements
of carrier networks on the other.

Through a combination of sophisticated control plane technology and new network system
functionality, the VPLS architecture from Alcatel is able to bridge the divide between carriers and
the delivery of scalable multipoint Ethernet TLS.

For additional technical information, please refer to Alcatel Technical White Paper 3CL 00469
0449 TQZZA Ed.01 17304 – Virtual Private LAN Services, The Evolution of Layer 2 VPNs available
at the following URL
http://www.alcatel.com/atr/abstract.jhtml?repositoryItem=/x/articlepaperlibrary/vpls.jhtml —or
contact your local Alcatel representative.

Service Provider VPLS Business Case Study

The following business modeling exercise investigates the opportunity available for service
providers to roll out a new VPLS Ethernet multipoint service, based upon the Alcatel 7750 SR in
both the provider edge and IP/MPLS core, in a single medium sized North American city (MAN
application).

Key criteria included in the input are a five year subscriber forecast (by enterprise size), bandwidth
demand, capital expenditures, operational expenses, cash flow assumptions (such as revenue skew
rate) and geographical traffic distribution (number of points of presence for the provider edge
services router).

The business case models anticipated revenue, capital expenditures and operational expenditures,
both cumulative and per subscriber.

11
 Figure 3. Model Architecture

Edge Core Management

POP 1
Ethernet,
POS:
10/100/
GigE/
10GE 7750 SR

Non-Redundant POP 2
Access 7750 SR
GigE/
Ethernet, IP/MPLS
10GE
POS: 5620 NM
10/100/ 5620 SRM
Optional Links
GigE/ Core Redundancy (+1)
10GE 7750 SR
Core Dual Homing (X2)
Optional Links
Redundancy (+1)
Dual Homing (X2)

Additional POPs

Key metrics of the model are as follows:

> Based upon a medium sized North American target city such as Toronto (Pop. 4M), with 2750
medium businesses (>100 < 500 employees) and 250 large businesses (> 500 employees),
service demand for a carrier class (QoS, SLA capable) multipoint Ethernet virtual private LAN
service has been assumed to follow an “S” curve adoption rate—with relatively low penetration
in Year 1 and with accelerating adoption in years 2, 3, and 4 until an overall medium and
large enterprise penetration rate of 12.5 percent is reached by the end of Year 5.

Subscription Rate and Enterprise Definitions

"S" Curve Adoption Rates Total Enterprises 3,000 Target Penetration 12.5%

Year 1 2 3 4 5

Percent of Target Market Penetrated 4% 16% 62% 95% 100%

Cumulative Subscriber Forecast

Business Subscribers Year 1 Year 2 Year 3 Year 4 Year 5

Number of Large Business 2 4 19 30 31

Number of Medium Business 14 55 213 326 343

12
 Average # of Sites per
Business Type # of Employees Business

Large Business > 500 12.00

Medium Business >100, < 500 5.00

Sources: IDC, Gartner, Alcatel Analysis

> Revenues are based upon average anticipated rates for a new unregulated service such as
VPLS, and are similar to TLS service rates available in Canada today. Revenue also includes
one time setup charges. Annual revenue erosion has been estimated at eight percent per year
to reflect a new service that will experience price erosion as competitors enter this market.
Revenues include access and VPLS connectivity (monthly), service management (monthly) and
installation/setup (one time). CPE/aggregation equipment is not included in this model due to
the multiplicity of access options, however, it is assumed that 1.5 Mbps and 45 Mbps service
would enter the PE router over PoS DS1 and PoS DS3 interfaces. All other service rates would
enter the PE router via 10/100 Ethernet interfaces.

VPLS Tariffs

Ethernet Monthly Tariff / One-time Install Fee

VPLS Provisioned Service Customer Facing service per Service
Bandwidth Interface Type
USD USD

1 1.5 Mbps PoS DS1 $815 $740

2 6 Mbps 10/100 $1150 $740

3 10 Mbps 10/100 $1444 $1850

4 45 Mbps PoS DS3 $4260 $1850

5 100 Mbps 10/100 $8333 $1850

> Capital expenditures are modeled as incremental throughout the five year study period and
include Initial and incremental PE services routers, core IP/MPLS routers, and element
management system hardware and software. Also included in CAPEX is fiber drop costs (75m)
to 5 percent of large business target subscribers and 40 percent of medium business target
subscribers at a cost of $80/m. 7
> Operational expenses include maintenance (estimated at 5 percent of CAPEX); sales, general
and administration costs (SG&A); OSS supervision (estimated as 3 percent of recurring
revenue); and upgrade labor (estimated at 2 percent of recurring revenue), initial transport
facility installation and setup, and monthly transport costs between PE and core and the core

7
Lehman Bros. June 4, 2001: build cost $145,000 per mile

13
 transport networ k. Network connectivity is carrier class utilizing dual homing redundancy in
both the edge-to-core link and core-to-network link.
> Although the element management system CAPEX and OPEX is included, OSS/BSS
development costs have not been included since this business model is focused on the financial
metrics of delivery of only one new service (VPLS) in only one city —whereas deployment would
likely be across the whole service footprint and leverage the ability of the 7750 to deliver
additional services such as IP VPN and dedicated Internet access. OSS/BSS costs should be
assessed relative to full application and deployment.
> Traffic distribution is modeled in conjunction with a typical medium sized metro where an
“anchor” CO (POP 1) will be the hub point for half of the traffic. In this location, it is assumed
that the PE services router and the IP/MPLS core router are co-located. POP traffic distribution
has been assumed as follows:

POP 1 POP 2 POP 3 POP 4 POP 5

50.00% 20.00% 20.00% 5.00% 5.00%

> The number and complexity of applications carried by the VPLS service will generally scale by
the size of the enterprise customer and number and size of sites connected and will
predominantly determine the bandwidth requirement for each site. Bandwidth requirements
assumptions have been made for the subscriber base as follows:

Percentage of Subscribers by Bandwidth Increase or

Provisioned Service Bandwidth
Bandwidth Decrease / Sub. /Yr.

1.5 Mbps 5.0 % 5.00%

6 Mbps 45.0 % 5.00%

10 Mbps 35.0 % 5.00%

45 Mbps 10.0 % 5.00%

100 Mbps 5.0 % 0.00%

Business Case Results

Figure 4 demonstrates the results of the example VPLS service deployment just described. The
business case becomes cash flow positive in the second year, returning a net present value of
$27.2 M and an internal rate of return (IRR) of nearly 180 percent by Year 5. The payback period
is 2.15 years.

The carrier achieves positive cash flow in the second year of offering the new VPLS service.

14
 Discount Rate (Cost of Capital) 12.00%

Net Present Value $27,239,910

IRR 179.85 %

Time To Positive Cash Flow Year 2

Discounted Payback Period 2.23 years

Payback Period 2.15 years

Figure 4. Business Case Results

Net Cash Flow (NPV)

25,000

20,000

15,000

10,000
$'000

5,000

(5,000)

(10,000)
Year 1 Year 2 Year 3 Year 4 Year 5

Total Revenues 1,086 3,740 12,014 19,203 19,136

Total Capital Expenses (2,140) (575) (2,102) (1,635) (320)
Total Operating Expenses (1,171) (1,958) (5,413) (6,852) (5,772)
Net Cash Flow (2,225) 1,207 4,498 10,716 13,044

A one year payback could be achieved with an aggressive marketing campaign focused on
selling higher bandwidth services to larger Medium sized enterprises thereby driving an increased
year 1 adoption rate and increased market penetration as demonstrated in the table below:

Assumptions Parameter 2.1 Year Payback 1 Year Payback

Market Penetration 12.50% 15%
Year 1 Adoption Rate 4% 8%
# of sites per Medium Enterprise 5 8
1.5Mbps 5.0 % 5.0 %
6Mbps 45.0 % 20.0 %
Subscriber BW
10Mbps 35.0 % 45.0 %
% of Total Subs by BW
45Mbps 10.0 % 10.0 %
100Mbps 5.0 % 20.0 %

15
This case is most sensitive to the number of sites in the Medium Enterprise definition and assumes
only 5 sites per medium business however this varies by vertical and analysis of the North
American market by Infonetics indicates averages of up to 9 sites for this market segment.
In addition, further positive changes to the results could be achieved by leveraging the capability of
the Alcatel 7750 SR in delivering additional services such as Ethernet Internet access or IP-VPN
(2547bis) services.

Figures 5 and 6 demonstrate how the Alcatel 7750 SR’s superior density and scalability results in
reduced NE counts, relative to competitive products, as the subscriber base grows. This reduced NE
count translates to reduced capital expenditures (up to 46 percent less than that of competitors).

Figure 5. Network Element Count

Network Element Count

14
Competitor Core
12 Routers

10 Competitor Edge
Routers
8
# NEs

Alcatel Core
6
Routers
4
Alcatel Edge
2 Routers

-
1 2 3 4 5
Year

16
 Figure 6. Total Capex

Total Capex

20,000,000

15,000,000 Alcatel
Competitor

$ 10,000,000

5,000,000

0 1 2 3 4 5 Total
Year
Alcatel 2,140,210 574,671 2,102,172 1,634,906 320,225 6,772,185
Competitor 3,605,005 718,184 4,351,219 3,108,998 780,575 12,563,981

Based on the reduced NE count and assuming maintenance costs at 5 percent of cumulative
CAPEX, the value of the Alcatel 7750 SR as a vehicle for reducing operational expenses while
introducing a new revenue generating service such as VPLS, becomes very apparent.

Figure 7. Maintenance Costs

Operational Costs - Maintenance

(Present Values)

$2,000,000

$1,500,000
Alcatel
Competitor

$ $1,000,000

$500,000

$0 1 2 3 4 5 Total
Year
Alcatel $107,011 $124,279 $205,673 $248,538 $234,882 $920,382
Competitor $180,250 $196,847 $376,292 $484,127 $460,199 $1,697,714

17
As can be seen in the previous chart, the scalability and value of the 7750 SR leads to dramatic
declines in costs (CAPEX and maintenance as a percent of CAPEX) per link from day one as
compared to competitive offerings.

Figure 8. Competitive Costs per Connection

Costs per Connection

Comptitor Capex Per Connection Comptitor Opex Per Connection

Alcatel Capex Per Connection Alcatel Opex Per Connection

$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$0
1 2 3 4 5 Av.
Year

Summary
As the demand for IP/MPLS services continues to grow, “best-effort”, “status quo” solutions are no
longer a viable approach to developing a network to support them. A new generation of router is
needed that incorporates the service-oriented features, flexibility and scalability required to deliver
revenue and profit. The Alcatel 7750 SR is this new generation router, and the economics of
deploying this industry leading Alcatel solution have been demonstrated by the example business
case herein.

Carriers needing to expand their Layer 2 service portfolios to include VPLS will find the Alcatel
7750 SR’s implementation delivers the bandwidth and geographic scalability necessary for the
rollout of a large scale, profitable multipoint service. Adding VPLS will provide a profitable
defensive play in home territories under attack by competitors. In out of region applications the
Alcatel 7750 SR based VPLS service can provide a significant differentiator for the operator,
leading to increased revenue growth and market share.

The Alcatel 7750 SR supports draft-ppvpn-vplsldp (formerly draft-lasserre-vkompella) for multipoint

Ethernet (VPLS/H-VPLS) services. These private data services are typically delivered in accordance
with an SLA, and the 7750 SR’s advanced flexible fast path traffic management—combined with a

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system architecture optimized for the support of protocols such as MPLS fast reroute—ensures that
the Alcatel 7750 SR delivers each and every customer services with guaranteed QoS and
availability. It offers fully programmable10 Gbps packet processing and hierarchical per-service
queuing and delivers next generation density and performance, unmatched scalability and a set of
unique integrated OA&M tools specifically designed for the efficient operation of scalable
multipoint services. All Layer 2 services supported by the Alcatel 7750 SR can also be provisioned,
managed, and billed through the Alcatel 5620 SRM.

The robust, cost effective Alcatel 7750 SR enables providers to deliver differentiated service
offerings that expand their customer base, simplify their networks and improve service quality.
Attributes which lead not only to an increase in revenues at less cost, but to an increase in
Customer loyalty. In today’s competitive environment these key deliverables will ensure success for
both the provider and their customers.

“Alcatel’s 7750 Service Router is enabling us to deliver the industry’s first production virtual private
LAN service in an extremely compact and cost effective footprint. The 7750 SR allows us to
efficiently extend the private data services being demanded by our customers, while providing the
scalability and flexibility necessary to meet their future needs.”

KENNETH FRANK, SENIOR VICE PRESIDENTOF ENGINEERING AND SYSTEMS,

MASERGY — A GLOBAL PROVIDER OF IP/MPLS-BASED SERVICES

“Support for a wide range of enterprise services, coupled with a comprehensive OAM&P feature set,
differentiates Alcatel’s service routers from those of other vendors and delivers tangible value to
service providers. Based on our research with service providers worldwide, Alcatel’s service routers
are clearly aligned with the most challenging network problems carriers face today.”

MARK BIEBERICH, SENIOR ANALYST, COMMUNICATIONS NETWORK INFRASTRUCTURE,

THE YANKEE GROUP

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Appendix A

Business Case Assumptions

General and Financial

> Study life: Five years
> Discount rate: 12 percent
> Currency: $U.S.
> Terminal value multiple: Zero
> Revenue skew factor: 44 percent
> Business market target penetration after 5 years: 12.5%of a base of 250 large enterprises
(> 500 employees) and 2750 medium sized enterprises (> 100 < 500 employees)
> Study includes installation and services revenue from VPLS service only
> VPLS Services price erosion 8% per year (new service high price erosion expected in first few
years)
> Provider edge and core router included
> Element management system included

Capital Expenditures
> Global list prices used without discounts in all cases
> Alcatel: September 2003
> Competitor: July, 2003
> Annual price erosion: 5%
> Equipment installation cost: 5 percent of CAPEX
> Network management costs:
Year 1: 15% of cumulative CAPEX
Years 2-5: 5% of cumulative CAPEX
> Redundant and dual homing GigE trunks used from edge services router to core router (core
and edge router assumed to be co-located in PoP 1 only) and 10GE trunks used from core
router to transport network. (Estimated at 50% off market price for internal use)
> Customer premises fiber installation
$80/m installed
75m Average drop length
2% annual cost erosion

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> CAPEX Depreciation: Number of years of economic life
Edge service router – 3 years
Core router – 3 years
Installation – 3 years
NSM – 5 years

Operational Expenses
> Maintenance: 5% of cumulative CAPEX
> SG&A: 18% of revenue average over five years
(Year1 30%, Year2 25%, Year 3 20%, Year 4 15%, Year 5%10)

> Operations:
NOC supervision: 3% of recurring revenue
Network upgrade labor: 2% of recurring revenue
Link utilization: 55 percent

> Transmission facilities8: at 50% off market price for internal use
Edge services router to core router: GigE: $4064/mo. + one-time: $1600
(unless co-located)
Core router to transport network 10GigE: $16,256 /mo.+ one-time: $1600

> Annual decrease in cost of transport facilities: 5%

8
(Source: SBC Gigaman GE EthernetVPN service @ 50% discount

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