Telecom world spins on change
Cable, wireless, Net all pose threats to the Bells' turf
By KEN BROWN and ALMAR LATOUR
The Wall Street Journal
Posted on Thu, Aug. 26, 2004
In just over a year, one out of every eight households in the Portland, Maine, region has signed up for Internet phone service supplied by Time Warner Inc.'s cable-television unit.
For many, the phone jack in the wall that connects to the phone company's network is now just a useless hole. Time Warner is rolling out the same service to millions of consumers nationwide, including in the Kansas City area.
It's one more sign of a telecommunications upheaval unfolding at warp speed. And it's bad news for Bell phone companies such as Verizon Communications Inc., which through its predecessors has controlled local phone service in the Northeast since the start of the 20th century.
Already, Verizon's traditional phone lines are down by 9 million, or 16 percent, since the end of 2000, according to research firm Precursor Group.
Across the nation, the business models that have worked for decades for Verizon and other phone giants are showing signs of unraveling. The cable industry's push into the phone business and a torrent of innovations such as Internet calling and advanced wireless technology are threatening the foundations of the nation's $300 billion telecom industry.
“Our industry and our business is going to change more in the next five years than it has during the last 20 combined,” said Duane Ackerman, chairman and chief executive of BellSouth Corp., the local phone company in nine states.
Phone companies are scrambling to avoid the same fate. AT&T Corp. is retreating from the traditional consumer phone business. The onetime business icon recently saw its bonds reduced to junk status.
Two years ago, the regional Bells that were created by the 1984 AT&T breakup looked as if they would emerge as the winners. As owners of the nation's local phone systems, they had the direct lines into America's homes and offices.
Now, new technology is hurting the value of that network. The Bells have lost approximately 28 million local phone lines since the end of 2000 — a drop of more than 18 percent.
This is the first time since the Great Depression that phone companies have seen their lines decline. The Bells are now losing 4 percent of their residential lines a year. The trend is worsening as cable companies rush to match the kind of success that Time Warner has enjoyed in Maine.
Cox Communications Inc., an Atlanta-based cable company, is already the 12th-largest phone company in the country, with 1.1 million Internet and traditional phone customers. Comcast Corp., the nation's biggest cable company, plans to offer Internet phone service to 40 million homes by the end of next year. And Internet phone start-ups like Vonage Holdings Corp. are signing up thousands of customers.
The phone companies are furiously trying to cut costs to stay ahead of declines in revenue.
The Bells are trying to add new kinds of revenue by teaming up with satellite television companies, offering packages of phone, broadband and TV service. But their basic business still is selling a high-priced commodity in a market that is now highly competitive. Standard & Poor's has put three of the Bells — Verizon, BellSouth and SBC Communications Inc. — on “credit watch” for a possible downgrade.
Overland Park-based Sprint Corp., with major operations in long-distance, local and wireless phone service, has struck several deals with cable companies to provide Internet-based service. On Wednesday, for example, Sprint announced a deal to provide Internet voice service to Mediacom Communications Corp.'s cable subscribers.
Many industry executives expect consolidation, although deals have been few because buyers are afraid of paying too much for businesses that have uncertain futures. Last fall, BellSouth considered making an offer for AT&T. It later backed off, but many still believe the Bells will eventually buy AT&T and MCI Inc., formerly called WorldCom.
Internet upheaval
Behind the telephone earthquake is a giant force in business history, the Internet. Today phone calls — just like music, photos, and video — can be turned into digital information and delivered much like e-mail over the Internet.
While the upheaval is harsh for companies and their investors, it is a windfall for consumers, who benefit from ever-lower prices and new services.
A glut of fiberoptic networks built during the telecom bubble of the late 1990s means any new phone-service competitor that wants to tap into it can do so cheaply.
For decades, the only way to make a call was on a dedicated line over a phone company's network. Phone companies paid for those networks by selling calls by the minute. But now, those expensive networks represent just one of several ways to send a call.
“Anyone who wants to go into the phone business can do it,” says Bryan Martin, the chief executive officer of 8x8 Inc., in Santa Clara, Calif. His company offers unlimited local, long-distance and video calling service under the Packet8 brand name for $29.95 per month.
The shifts have intensified pressure on the long-distance companies. AT&T's revenue is down 18 percent in the past three years and is expected by some securities analysts to decline a further 30 percent over the next three years.
The Bells are also feeling the pain, with the weakest of the four, Qwest Communications International Inc., getting hit hardest.
In Omaha, Neb., cable company Cox has replaced Qwest as the city's largest phone company. Qwest has lost 3 million lines since the end of 2000, including 200,000 in the second quarter alone. At that rate, Qwest is losing an estimated $200 million in high-margin revenue each year, according to Gimme Credit, a bond-research company. Qwest has laid off 10,000 people in the past two years.
Qwest Chief Executive Richard Notebaert's strategy is to jump over to the new technology as quickly as possible. Qwest became the first Bell to start its own Internet-calling service last year. Qwest is also testing advanced wireless technologies. “It has become one big communications sector. People really haven't grasped that,” the Qwest CEO says.
The three other Bells are far stronger than Qwest and are benefiting from their own wireless operations. But the U.S. wireless market is one of the most competitive in the world, with six national players. Meanwhile, the Bells all have contracts with powerful unions that make it harder for them to cut workers.
In the past century, telephone companies invested $200 billion to build networks that give each call a unique path. The voices of callers are turned into a series of electric pulses that travel over a dedicated line between them, just as when Alexander Graham Bell invented the telephone in 1875.
Although mobile phones transmit calls initially over radio waves to cell phone towers, the calls are then carried through those same networks in much the same way.
With Internet calls, the speaker's voice is converted into the zeros and ones of digital data and divided into dozens of packets that make their way through the public and private networks that form the Internet. Within a split second, they are reassembled and converted back to sound.
Such calls usually require users to have a broadband, or high-speed, connection to the Internet. They can be carried over privately owned networks, such as those owned by cable companies, or over the public Internet. In most cases, the caller uses a regular phone that plugs, indirectly, into the computer's modem.
Getting into the Internet-calling business is fairly easy. With less than $100 million in start-up funds and just 450 employees, Vonage has signed up nearly 250,000 paying telephone customers in two years. “We're aiming to become what AT&T was not that long ago: a national local and long-distance player,” said Jeffrey Citron, founder and chief executive of the privately held company in Edison, N.J.
Prices are already falling quickly. With a slew of ads during the Olympics, AT&T is pushing an introductory offer of unlimited Internet calling for $19.95 a month. That is $10 less than similar plans at Vonage and Verizon.
Entrepreneurs who want to start a Vonagelike phone company can get access to software, ready-made Web sites and fiberoptic networks from wholesalers such as Covad Communications Group Inc. Covad charges $25,000 for a basic set of services needed to start an Internet phone business.
One of its customers is Unity Business Networks LLC of Denver, which has been selling Internet calling services since March 2003. With 20 employees, Unity has signed up about 70 small businesses as customers. “It's unbelievable how much we can offer for such a small investment,” said Bob Paulsen, Unity's co-founder and president. The company has revenue of roughly $750,000 and says its cash flow turned positive earlier this year.
Analysts predict that roughly a third of U.S. households will have high-speed broadband connections by sometime in the next year, up from 21 percent at the end of 2003. Once people have broadband, they are likely to end up using an Internet phone.
In Japan, about half of the 14 million broadband households are using Internet phones — so many that the government has created a new area code for them. The number of U.S. households with Internet phone service — about 100,000 at year-end 2003 — is on pace to hit 800,000 by the end of 2004.
The most ominous assault on the traditional phone business is coming from cable companies, which increasingly need to move into a new business because of competition from satellite-TV companies.
Cablevision recently offered new customers a package of high-speed Internet access, digital cable television and Internet phone service for $100 a month. Time Warner Cable aims to have phone service available in all of its 31 markets by the end of the year.
Doreen Toben, Verizon's chief financial officer, says she isn't overly worried about the rise of start-ups such as Vonage because they have only a small number of customers. However, she calls phone service from cable-TV companies “a real threat.”
Making an end run
New Internet technologies could also help people make an end run around traditional cellular networks. One such technology is Wireless Fidelity, or Wi-Fi, which many people use for high-speed access to the Internet at coffee shops and other public places. Just as broadband connections designed for computers paved the way for Internet calling from home, wireless broadband connections for computers could transform the traditional cell phone.
In July, Motorola Inc. announced it would start selling a combination Wi-Fi cell phone later this year. The phone is designed for businesses that have installed a Wi-Fi station in their offices. The phone works as an Internet phone via the Wi-Fi link when the caller is in the office. Elsewhere, it must use the regular cell phone network.
One limitation of Wi-Fi is that the range of the base station is only a few hundred feet. But a Waltham, Mass., company called TowerStream Corp. has installed transmitters in Boston, New York, Chicago and other cities that can serve businesses in a radius of five to 10 miles. The private company says it can offer wireless broadband service for half the price of traditional phone companies.
Base stations using a new standard called WiMax can send and receive signals from as far as 30 miles away. Executives at Intel Corp., a big WiMax backer, boast that base stations to supply the entire city of San Francisco with broadband signals could be built for just $250,000.
The regional Bells hardly consider themselves endangered. With their marketing muscle and big research budgets, the companies believe they will be the ones to bring the masses into the Internet-phone age.
Verizon and other Bells are also investing billions to run fiber-optic lines into homes and offices, hoping to offer faster and more reliable broadband service than the newer competitors.
Says Shaygan Kheradpir, Verizon's chief information officer: “We can wait for disruptive technologies to create new markets we have to try to catch up to, or we can be our own transformation machine.” |
