7/98 Netwatcher on carrier services market
cimicorp.com
July 1998 Volume 16.7
Netwatcher (ISSN 0890-5800) is a monthly publication of CIMI Corporation. Subscription information is
available here . Copyright c 1998, CIMI Corporation. All rights reserved. No publication or reproduction of
this document is permitted without the express written consent of CIMI Corporation.
Management Briefing
The proposed acquisition of TCI by AT&T and the merger of Bell Atlantic and GTE are clearly major events
in the telecommunications field. One might rightfully wonder if there's a trend underway here, and if so what
it might mean.
In past issues, we've looked at the shake-out in the equipment vendor space, a shake-out arising from
changes in the nature of enterprise network-building. It's time to do the same for the carrier services space,
and to do that we have to look back into the past.
The Carrier Regulatory Trends
The carrier service market has been shaped from the first by the regulatory process. Since communications is
a "community" function valued because of who can be reached with it, it was critical to insure that
competition didn't fragment the user base into small enclaves whose populations would not have been large
enough to provide a basis for useful communications. The concept of a regulated national monopoly was an
effective solution to the problem, guaranteeing a carrier a market and encouraging investment in equipment.
It was, in fact, the model adopted worldwide to promote the growth of telephony.
In the early 1970s, it became clear that competition in at least the long-distance area could promote savings
for buyers. MCI and Sprint, among others, provided that competition, but these new competitors believed
that AT&T's position as the local exchange carrier with the largest market by far gave them a preferential
position in the competition. The result was the voluntary break-up of AT&T in a complex set of steps
administered by the Federal judiciary, and often called the "Modified Final Judgement" or MFJ. This created
the seven Regional Bell Operating Companies, and opened full competition in the long-distance area, with
regulated monopolies still controlling the local access market.
Telecom '96 changed that, providing the RBOCs with the incentive (release from offering long-distance calls
in their regions) to open their local market to competition. PUCs in various states moved with varying
degrees of aggression to mandate local competition, but none of the RBOCs have yet filed papers with the
FCC proving adequate compliance with the 14 competitive requirements of the Act, and so the Act's
mandated reforms are not yet effective.
Carriers Respond in the Boardroom
What has happened instead is a change in the business makeup of the carrier market, as players position for
the enforcement of the Act. Bell Atlantic and Nynex merged, as did SBC and PacBell. SBC bought SNET and
is seeking consent to acquire Ameritech, and Bell Atlantic wants GTE. AT&T tried to link up with SBC, and
now wants to acquire cable giant TCI.
All this maneuvering is aimed at the reality of the 21st-century market, which will pit every carrier against
every other one. In such a world, size counts, and so it is likely that there will be continued M&A activity
until none of the RBOCs or IXCs that existed at the time of the MFJ will remain "unmarried".
The goad behind this is the principle of one-stop shopping. A carrier with a broad service repertoire is more
attractive to buyers because that carrier can serve all the buyers' needs. Such a carrier can also avoid
competitive pressure by keeping other players out of their key accounts-something that couldn't be done if
these accounts needed a service the primary carrier couldn't offer. Broad service offerings alwo provide a
better base for discounting, so it's clear that bigger is better.
There are also other issues on the table. The RBOCs, at the end of the compliance process, will essentially be
full-service carriers in their region, and able to expand into any other region they choose. They need
long-distance capability to insure they can capitalize on what the Act lets them do-enter the IXC space.
The IXCs, on the other hand, have no region where they are incumbent in the local exchange market. Thus,
the balance of power is shifted by the Act from the IXC to the RBOCs-especially the big ones.
The first effect of this second issue of service breadth was the validation of what we've called "special
service interexchange carriers (SSIXCs), like Quest, Williams, and Level 3. The motivation here, we believe
was to offer the RBOCs a long-distance partner who was securely not in the local exchange business,
preparing for the possibility that the traditional IXCs would enter the local market to level their playing field
with the RBOCs. The SSIXCs have no local infrastructure or marketing, and need LEC channels to connect to
their customers and sell their services. So far, lacking enforcement of the Act, these guys have been having a
bit of a tough time.
The second effect of this issue was the AT&T/TCI announcement. AT&T needs to establish their own link
to their customer base. If the FCC and PUCs had set the wholesale rate of local service low enough, AT&T
would probably have passed local access through to the customer at cost in order to encourage users to up
their access bandwidth and enable sale of more nodal long-distance services. Since the wholesale margins on
local access were limited to about 23%, AT&T needed something more, and TCI provides it-maybe.
Cable access for telephony is a tough call, considering that the cable TV provider is the
second-most-unreliable (after the Internet provider) carrier in the buyer's experience. It may well be that
AT&T hopes to scare the RBOCs into lowering access charges, in which case it might never provide
anything over the TCI plant except data services. Only time will tell here.
Speaking of time telling things, we're waiting for the dice to stop rolling on the question of what happens to
BellSouth and US West in the RBOC space, and MCI/WC and Sprint in the IXC space. None of these firms
are viable in stand-alone mode in a fully competitive market, and the number of possible match-ups are
shrinking.
Who Might Marry Whom
We believe that both BellSouth and US West are courting IXC partners-MCI or Sprint. Such an acquisition,
however, would require the RBOC have complied with the Telecom Act, and we also believe the players are
holding that compliance off as long as possible. Since Congress reviews the progress of reform next year, we
expect compliance in early 1999, and that would time the match-up of both US West and BellSouth. If we had
to bet on partners now (which is really risky), we'd link Sprint with US West and MCI/WC with BellSouth.
The next group of carriers to begin the M&A dance will be the second-tier long-distance players and
second-tier national frame relay players. These carriers are also non-viable in a highly competitive market
because they can't secure the economy of scale in their infrastructure equal to that of the major players, and
profit margins will thin out with increased competition. The hope of all these folks is that an RBOC will buy
them, but we believe that the only ones with a shot will be those with facilities. The SSIXCs like Quest may
want to be bought at this point, but some others (Williams, for example) may go on a shopping spree
themselves to build their mass and hope to compete on a larger scale.
VPN services may be the key to this stage of market activity, because only data VPNs can introduce enough
new revenue and profit into the picture to permit wholesale capital infrastructure spending. The players who
get a big VPN boost will be able to build up their networks, enabling them to either go it on their own if they
like, or strike an attractive deal if they're so inclined.
ISPs will follow as the last phase of this market. Media hype notwithstanding, the Internet is a revenue
pimple in today's market, and nobody smart is going to try to secure it when the bigger sectors are still up for
grabs. By about 2001 or 2002, however, the VPN market will have grown enough to encourage more
traditional players to buy a larger position in the public IP space. This will send all the merged megaplayers
to the ISP supermarket, and the result will be the consolidation of the Internet space with the traditional voice
space. This will be done by about 2005.
Do I Need To Do Anything?
Users shouldn't worry about service levels or stability of their carriers, unless they have selected somebody
really sleazy. All of the major players will either live independently or as a valuable part of a merged unit.
The ones to worry about will be the smaller guys, who will be under considerable pressure and may skimp on
network cost in order to stay profitable. This would result in lower levels of service or more outages.
Users should be wary of signing long-term deals, though. The best negotiating times will be around the turn
of the millenium, so don't get locked into a long contract at that point. Most IXCs today are trying to give
buyers "incremental" new deals annually on the condition that they extend their service contract for three
years. This is a play to control the customer during the period of greatest competition, so if you're hoping to
shop for a deal you should expect to give up a few percent now to keep your options opened.
It also may be useful to watch the technology choices that carriers make. There are rumors (we think
unfounded) that AT&T is going to go to a complete IP-based network, for example. If you don't think IP is
the right technology for your voice service, you may want to be sure that you aren't committed to AT&T (or
any player with similar plans) through the period of conversion. At the least, give yourself a "technology
change" or "service level experience" clause that lets you bow out of the contract if you don't like how
things are going.
One thing to keep in mind about the carrier space is the dependence on regulatory policy that we cited at the
opening of this section. Regulations are government, and government is politics. Anything can happen. |
