War of the wires
Special technology report The cable and phone giants are in a battle royal to provide new data, voice, and video services
By James M. Pethokoukis
usnews.com
9/27/04
In the Wire Wars of 2004, price has been the ultimate weapon for the Baby Bells in their campaign to ward off customer-poaching by the cable companies. If you want high-speed Internet access from cable giant Comcast in Chicago, for example, it's going to cost you $42.95--assuming you're already one of Comcast's cable TV customers. Your other option is high-speed phone Internet access from telecom SBC Communications. It may be only half as fast, but that's speedy enough for most people. Order online and you can get it for as little as $26.95 per month. That sort of pricing advantage enabled phone companies in the second quarter to sign up more customers for broadband service than cable did for the first time ever.
But when you're involved in a hard-fought marketing war that may decide the future of your industry, price attacks can't go unanswered forever. In response to $29.95 digital-subscriber-line phone (DSL) service from telecom rival Verizon, Cablevision decided to do a little discount pricing itself. In June, the nation's sixth-largest cable operator, with 3 million subscribers in New York, New Jersey, and Connecticut, began temporarily offering new customers a "triple play" bundle of high-speed Internet service, unlimited phone service, and, of course, digital cable TV, for $90 per month for the first year. That dramatically undercut Verizon's combined voice, DSL, and satellite TV package of $135.
Escalation. It was a bold move--though not one applauded on Wall Street, where Cablevision shares tumbled. Smith Barney analyst Niraj Gupta pronounced the Cablevision triple-play price "dangerously low" with the potential to provoke "irrational competitive response" from Verizon. Whether smart or foolish, Cablevision's salvo was undeniably an escalation in a ferocious, wire-to-wire death match now being waged between the cable and telephone companies to supply all our current and future telecommunications needs.
While the Bells have been using low-cost broadband as their weapon of choice, cable companies have been using cheap Internet-based phone service--voice over Internet protocol--to steal customers. It's all part of the battle to own the broadband pipe into your home as well as to supply the voice, video, and data services that zip through it.
What's behind this crazed competitive environment is a mix of technological change--ubiquitous broadband, the emergence of voice over Internet technology--and the slowdown in both the core phone and cable businesses. "This battle is just beginning, and I expect it to intensify with quite a bit of turmoil," says Andrew Odlyzko, director of the Digital Technology Center at the University of Minnesota. "Who is going to come out on top? You can't predict."
In fact, both sides may lose, if advances in wireless technology, such as 4G or Wi-Max, render all this wired wrangling for naught. That may explain why Wall Street has been lukewarm about the stocks of both camps: Verizon, SBC, BellSouth, and Qwest on the phone side, and Comcast, Cox Communications, and Time Warner in cable. Whoever triumphs, industry insiders think the combat will be fast, furious, and decisive. Think Gulf War I rather than Vietnam. "Right now we're in the land-grab phase of all this, and the competition is becoming more and more desperate," says UBS Warburg analyst Aryeh Bourkoff.
It's a new world order for the former Bell phone companies, which grew up in the cozy, regulated world of local phone service, and for the cable firms that enjoyed monopoly franchises handed out by local governments. "They were all very careful not to step on each other's toes," Odlyzko says. Each industry had its own separate line of business--video for cable, voice for the Bells--and they rarely crossed wires. But several factors upset that entente cordiale. For starters, satellite television began to steal subscribers from cable--thanks to a combination of smaller satellite dishes and cheaper program packages--with nearly 1 million cable customers defecting during the past two years, according to Kagan Research LLC.
And just as this new competitor revved up its attack, cable's core business began maturing into a slower-growth business with new dollars coming mostly from rate increases rather than from new subscribers. Cable penetration rates are forecast to be pretty much flat between now and 2008, according to Alan Bezoza, cable analyst at Friedman, Billings, Ramsey. "Most homes that would potentially buy the service are already customers," he explains.
Phone home. On top of all this, the cable industry has amassed billions in debt as it spent some $80 billion upgrading its networks to deliver digital and interactive television, high-speed access, and telephony services. "The [Bells] may have a similar vision as us, but from a technology standpoint, cable has a huge advantage because we have already made the big investment," says David Pugliese, vice president of product marketing and management at Cox.
The answer to cable's revenue crunch: phone service. In 2003, the cable industry generated $47 billion in revenue, an amount dwarfed by the $145 billion generated by the Bells and long-distance providers. So came voice over Internet service, which allows consumers with high-speed Web access to make voice calls over the Internet. "The threat [to the phone companies] from cable is not theoretical," says Scott Cleland, CEO of Precursor, a research firm that serves institutional investors. "It is real, and it is devastating." He notes that in Orange County, Calif., and Omaha, Cox has a 40 percent market share for voice.
"The Bells can't afford to lose that kind of share with a business model that requires 70 percent share to work because of their enormous fixed costs," Cleland adds. He also calculates that $125 billion in old-fashioned phone circuit switches could all be replaced by digital VOIP switches costing a few billion. One initial response by the Bells was to partner with satellite TV providers to offer some version of the triple play as soon as possible. "To compete, you had to get video out there fast," says Randall Stephenson, SBC's chief operating officer, whose company is allied with Dish Network. But the phone companies know that ad hoc arrangement is hardly a long-term solution since the bundling in their case is merely a billing exercise rather than a revenue generator.
Still, the phone firms are making headway, especially now that they are also embracing VOIP technology. In addition, there's their edge in offering the "quadruple play." The Baby Bells' wireless ability gives them a capability--in addition to voice, data, and video--that the cable companies don't have. "We feel strongly that wireless will be a real differentiator in offering bundles of services," says Stephenson of SBC, which along with BellSouth co-owns wireless provider Cingular.
Ultimately, to compete with cable the phone companies have to offer digital and interactive video over their own fast networks, which is why Verizon announced plans in June to extend fiber-optic connections to every home and business in its 29-state footprint over the next 10 to 15 years. The price tag could run as high as $40 billion. SBC followed that news with a less ambitious plan to push fiber deeper into local neighborhoods and to offer higher speeds and digital video capabilities at a cost of $4 billion to $6 billion over the next five years. "The Bells have talked about this for 15 years, but what I think we are seeing now is a sense of urgency," says analyst Bourkoff of UBS.
To communications analyst Mike Paxton of In-Stat/MDR, essentially the battle comes down to this: Cable has the first-mover advantage and the newer networks, but the Baby Bells "are the historic incumbents with long-established reputations with millions of households," which may be loath to change.
Even as this struggle intensifies, a larger one looms. By the end of the decade, wireless broadband--whether 3G, 4G, Wi-Max, or some other technology--may dethrone whoever wins the wired war. The potential threat of wireless is one reason some analysts doubt the wisdom of bold attempts to extend fiber-optic cable to the home. "The trouble with this industry is that when you put anything in, it costs a lot," says John Maxwell, a telecom analyst with Waddell & Reed. "So you build a network that you expected to use for 15 years, and then there comes a better mousetrap three years later." But if that better mousetrap creates more competition, lower prices, and new and improved services, there is at least one sure group of winners: consumers. |
