A regime restructured

Prior to the 1996 Telecommunications Act, the only telecom businesses that existed were essentially the same ones that had been in place since the breakup of AT&T. The Act was understandably ushered in with great exuberance. A plethora of new companies were effectively green-lighted to pursue communications ventures of various breeds--long distance, local, Internet service providers, wireless, etc., heralding an unprecedented surge of new blood in telecom.

Many of these new types of businesses focused on pursuing local and often metropolitan markets in the hopes of knocking current incumbents (Pac Bell, AT&T, etc.) out of long-standing positions. These new businesses, which are known as competitive local exchange carriers, or CLECs, were mostly in the business of selling voice services and/or data services. Businesses that pursued only data were known as DLECs (data local exchange carriers). Most of these local carriers tended to pursue similar customers, primarily small and medium sized business (SMBs) with large data traffic needs, and residential customers. After the initial explosion of entrepreneurial activity, the market was eventually unable to sustain the high number of new companies competing against one another. Numerous startup CLECs that were focused on rapid growth, instead of long-term sustainability, quickly caved in. Ultimately, their decline proved to be another reverberation of the mid and late 90s climate: too much available capital and the tendency to create promises of a ripe market instead of realistic assessments.

"The CLEC market, often seen as a barometer of the industry since so many equipment vendors had shifted their sales to these startups, faced the harshest realities," says Robert Saunders of Eastern Management Group, a telecom management consulting firm that has worked extensively with CLECs. "Most of these companies had created business plans that only took into account the presence of the incumbent phone company whose pre-1996 market share was near 100%. In truth, the companies faced their most vigorous competition with each other, pursuing similar customers. When the capital spigot was turned off, these companies were left in the lurch."

However, the effects of this boom may transcend the negative economic impact that is currently pervading the industry. A large cause of the current downturn was the saturation of new telecom businesses, along with the decline of SMBs (while revenue padding may have had a hand in some of the larger corporations). But the boom that created so many telecom players did set the stage for the ones that survived to benefit from the new territory and infrastructure that was created.

Growing penetration

"There's consolidation under way," says Larry Plumb of Verizon, who used to work with the company's broadband business and is now more involved with its philanthropic efforts. "I don't think anyone expects AT&T to go away. They have problems, but they'll be around for awhile. Rather than having 20 or 30 CLECs across the country, maybe it boils down to when it's all over that there are maybe a half a dozen big phone companies."

The current penetration rate for CLECs since the downturn has witnessed an impressive ascent, evidence in favor of Plumb's prediction.* CLECs reported that 17.3 million of the 192 million nationwide users had switched access lines in service by the end of June 2001, compared to 14.9 million by the end of 2000 -- a 16% increase in a very short, six month time frame. On the consumer market side, at least one CLEC was serving local phone service to end-user customers in 60% of the nation's zip codes by mid-2001 (over 90% of US households reside in these zip codes).

More consolidation and shakeout is inevitable, but this upward trend in penetration is a strong indicator that CLEC businesses that were focused on sustainability may reap the benefits of the telecom bubble burst. Revenue streams could become healthier as companies depend less and less on capital from investors, which had been necessary in order to build out networks and infrastructure as CLECs entered the market in the years following 1996.

Enabling technologies for a turnaround

New innovations have proved to be as disruptive to the telecom sector as they were to many information industries at the close of the last century. The wireless industry had to adapt to some of the most considerable changes in technology, as companies tried to spin out better, faster, cheaper, and more convenient communications offerings in the hopes of keeping and growing their fickle customer bases. The downside to this trend was that the number of companies in the space made competition brutal, and subsequently, price slashing games arose. Although lower prices were to the obvious benefit of the consumer, companies did create pricing strategies that were unrealistic. "This downward pressure of competitive pricing can't go on forever or these companies are going to go under," says Saunders. As more consolidation and rationalization replaces the old strategies, Saunders feels that companies will need to begin grooming customers to look for an upgrade in service at a higher price.

The consumer telecom market in the past three to five years has been driven by the trend of replacing technologies, not necessarily with more sophisticated ones, but with cheaper and simpler ones. One trend that is expected to gain more momentum is the substitution of cellular phones as primary phones. An estimated 3 percent of users have terminated their traditional phone lines for their cell phones. An extension of this trend is in long distance, where a growing number of customers have terminated their long distance service because of the cheaper rates offered by their wireless carriers. This trend is heavily disruptive to traditional telecom but could be beneficial to wireless companies that are left standing in the post-shakeout time frame. Businesses that continue to sell technologies that bundle more telecom services in a simple, affordable package stand to grow and sustain their customer bases.

Another technology boost, or more of a pricing boost, is one that could serve CLECs: the drop in price of T1 lines, which are mainly sold to the SMB customer base that CLECs cater to. The prices of those lines are now almost half of where they were three years ago. T1s also come with the advantage of being able to carry both voice and data traffic, allowing a business to use a single T1 line for both its Internet access and phone system. Carriers have lost customers due to the unreliability with DSL and regular phone lines, and CLECs are at a greater advantage selling T1 service, which has a strong track record in reliability.

Another T1-related technology that will be introduced later this year by AOL-Time Warner could do more than just create a boost: the ability of cable providers to provide telephone services over their networks. This will first be unveiled in AOL-Time Warner's Tampa, Florida market and holds the potential for a significant industry impact for two crucial reasons. The first being that the price will be very low compared to earlier experiments that involved circuit switching over cable. "What AT&T and some of the other companies did early on was a hodge podge of a telephone type of service plus the cable service," says Saunders. "That was rather expensive, and they couldn't really market the service as something that can go into a market and break the paradigm of pricing." The second is that penetration is already in place, due to the high number of cable subscribers across the country.

"I really think you're going to see some major shifts in how the companies are going after customers, so it could really cause a shift in how you're going to see the approach from the rest of the telecommunications industry."

by Wendy Hall
Larta Staff Writer

*this data was taken from the Eastern Management Group Report, Competition in the Telecom Sector