TCS Daily

Bells Block Broadband's Roll Out

By James K. Glassman - April 16, 2001 12:00 AM

"It's a common sense behavioral analysis principle that you don't reward somebody for bad behavior," EPIK Communications President John McClellan tells TechCentralStation host James Glassman. The CompTel board member says that proposals to let regional Bell operating companies into long distance data services would do exactly that. "The Bells clearly dragged their feet; they blocked the competitive use of physical plant wherever and whenever they could," says McClellan about the implementation of the Telecommunications Act of 1996. McClellan, whose company provides fiber optic and interconnection services to the Bells' local competitors, long distance companies and Internet Service Providers, also says that analysts talk about overcapacity in telecom misses the mark. "Every time somebody said, 'Oh, this is all the fiber we are ever going to need,' it was always used up in just a very short number of years," McClellan says.

James Glassman: U.S. Rep. Billy Tauzin, the House Commerce Committee chairman, in a presentation recently to the Progress & Freedom Foundation asked, "Why should we have different regulations for broadband delivery on a satellite as opposed to a cable, as opposed to a DSL line, as opposed to a wireless delivery terrestrial system if it's all the same product that is delivered to the consumer?" Now, as a Board Member of CompTel, the Competitive Telecommunications Association, representing competitive telecommunication companies in local markets, long distance and the Internet, how do you respond to what Congressman Tauzin said?

John McClellan: I think Mr. Tauzin assumes a condition that doesn't exist in the marketplace. I think implicit in his statement is an assumption that there is a well-functioning competitive market for broadband services. And if that did exist, I could find myself in violent agreement with him. But I think we need to recognize that the product isn't getting delivered to the customer. I don't know the exact statistics, but there's probably only about 5 or 10 percent of that penetration of broadband services. So, I think inherent in his statement is a leap that's just isn't there in terms of benefits to consumers. The leap of faith is making it only good for the Bells. But if we go back to basics here, is broadband service good? Yes. Is it here yet? Well, only in limited markets, and where it is available, it's really only available with a struggle.

Glassman: Why isn't it available?

McClellan: Why don't we just take a look at the technology Tauzin mentioned, because he's saying, "OK, there's these four different ways we can get it. We can get it through terrestrial, or fixed, wireless. We can get it through cable. We can get it through DSL. We can get it satellite wireless." If you look at the different technologies, the satellite and terrestrial wireless technology are still in their nascent stages. And there are still a lot of technology risks, and execution and capital market risks. So these things haven't really rolled out yet. And I think that given where they are, what we need the government to do is really just encourage unfettered competition. Let the marketplace determine if there's a viable combination of technology and business model that's going to bring a compelling service to the customer. If we move to cable, I think that you're seeing some deployment of cable. Cable modems are reaching some neighborhoods, so I think a lot of the risks inherent in wireless and satellite have been addressed. But at the same time, you've got a physical plant that still needs to be substantially upgraded in most markets. And upgrading is expensive. So people talk about a second pipe to the home. The second pipe isn't really there in most houses yet. And so, you need to give that some opportunity to develop. Right now, there's a lot of pressure to open up the second pipe, and I think that makes a lot of sense once the second pipe is there.

Glassman: Right, but the first pipe to the home was supposed to be made available to competitors. Are you saying that it's not there?

McClellan: That's it exactly. If we look at the satellite and terrestrial wireless, they're still just starting up; cable, you know there's a pipe in there, but a coaxial pipe that exists right now isn't configured for telephony services. The upgrade is taking place; it's underway. There's a risk of stifling the development of that if you over-regulated before it's there; it's a viable alternative. So you're down to one pipe. That's the Bells' pipe. So the broadband service that can ride over the copper wire going to houses - DSL, it's riding on physical plant that was installed a long time ago. The Bells have earned a monopoly return on that for the longest period of time. So the Act of '96 was intended to have them open up the pipe.

Glassman: But it doesn't seem to have done that. Why?

McClellan: I think that the record of compliance with the act is a matter of public record and hard to dispute: The Bells clearly dragged their feet; they blocked the competitive use of physical plant wherever and whenever they could. The Bells have made it all but impossible for competitive DSL providers to survive. They've been very slow to roll out their own DSL services, and what's really interesting is that now that the competitive DSL providers are all going out of business, suddenly I'm starting to see newfound enthusiasm from the Bells in rolling out DSL. Now that Covad and NorthPoint and all those folks are just dying on the vine, now the Bells are suddenly interested. Now, is this coincidence or is it intent? If I were a regulator, I'd be looking at that. But whether it is coincidence or intent, the outcome of it is that customers had been denied choice. And Tauzin's logic really just perpetuates this undesirable outcome. If customers had a choice, then we could have one omnibus regulatory environment. But we don't have a viable competitive market, and the alternative technologies you spoke about aren't deployed yet. There's only one monopoly choice, and the Bells haven't made that available.

Glassman: One solution to this problem is what's called functional or structural separation. I just want to get to that question. H. Russell Frisby Jr., president of CompTel, told Congress last November that functional separation of the Bells' retail and wholesale operations wouldn't be enough to promote competition in a local telecommunications market. He said structural separation was needed. Pennsylvania's Public Utility Commission recently decided to pursue functional rather than structural separation at least for the time being. Can you tell us what the distinction is, and whether functional or structural separation will solve the problem that you have just highlighted, that the Bells have not really cooperated in opening up their one pipe to competitors?

McClellan: Well, as I understand it and I'm not going to claim to be an expert on the legal nuances here, a structural separation would basically be breaking apart the company into wholesale network and retail services companies, so they have to truly operate independently. Under a functional separation, the retail and wholesale operations would be under the same house, only with a set of rules under which they would operate, ideally, at an arm's length economic relationship between the retail and wholesale functions. The thought process here is that the network itself is the structural monopoly. You do only have one pipe coming to the house, and it's going to take awhile for alternative pipes to get into the house. So we have the network that's a true monopoly. The marketing of services however, need not be a monopoly. Now, you have the Bells set up with the network and the marketing under one roof. If you had separation between the two, and the network side had to treat the marketing side at an arm's-length basis that's just the same, no better no worse, than competitive providers, then what we would see is very, very different behavior.

Glassman: How might it be different?

McClellan: The foot-dragging and the noncompliance with service and installation and all that stuff would end, and the network side would improve its performance to serve all customers. Because there would be an arm's-length business transaction, the marketing side of the Bell shop would suffer the same nonsense that the network divisions of the Bells currently throw in the face of the competitive providers. So what you get out of this is that the new competitors could make much more effective use of the network assets, they'd put competitive pressure on the services side of the Bells' shop that would push down prices, that would force improvements in customer service. Now, my own personal perspective on this is that the regulatory side of this thing is quite complicated, and it needs to be approached carefully because this is clearly a significant government intervention into the marketplace. And the history of major government intervention is a kind of a mixed record. So, this needs to be done carefully so that the cure is not worse than the disease. But I think that there is a solution that would foster competition.

Glassman: Is there any other solution to the problem we have now where Americans are not getting broadband fast enough? The major reason appears to be that the Bells are not cooperating with their responsibilities under the Telecom Act of 1996 because they don't seem to think they have much in the way of incentive to get into long distance?

McClellan: Yes, the incentive to get them into long distance is interesting because they talked the big game about that prior to the act, and then when the bill had been passed, they looked at things and decided that the status quo worked very well for them. So there is a lot of foot-dragging and half-hearted attempts to comply with the (Federal Communication Commission's 14-point) checklist (for regional Bell operating companies gaining permission to provide long-distance service).

Glassman: Is that partly because long distance has become so competitive?

McClellan: Well, the long distance market is a very interesting place. Let's take a step back and ask what is the appropriate role of government in all of these. And, again, I'm somebody who believes that there is a role for government to help to create a viable competitive marketplace. If you look at what happened to long distance, what the government did 20 years ago was create a viable, competitive market in long distance. And prices indeed plummeted and service quality has soared. I think that you still see that the long distance companies made, and continue to make, a lot of money. You do see right now aggregate revenue for long distance voice services falling, but at the same time, the cash generation is still very strong because the cost structure has fallen. The key thing that's interesting here is that as prices fall for long distance, with the point of penetration and demand curve and stuff like that, there's not a lot of elasticity. If long distance prices go from 7 cents to 5 cents, are you going to make a lot more voice calls? Probably not. I just spend the whole day on the phone already anyway. But at the same time, though, let's say, " OK, the Bells probably don't have a compelling case to get into long distance if that means sacrificing the wonderful protective environment that they have in the local business." At the same time the market for data services is growing very rapidly, with very strong revenue and cash flow growth. And so if you separate the long distance market, there's a very strong incentive for the Bells to want to get into the interLATA data services. Now, there I say, we have not seen good behavior on the part of the Bells in terms of opening up their markets, and what was held out was as reward for opening up their markets was entrance into long distance services. And I think a long distance data service is part of that mix.

Glassman: Yes, but Tauzin has proposed legislation to allow the Bells into that long-distance data market.

McClellan: Yes. It's a common sense behavioral analysis principle that you don't reward somebody for bad behavior. So, if they haven't opened up their markets, why would we be contemplating letting them into the long distance data services?

Glassman: Do you think that one of the reasons that they haven't opened up their markets is the anticipation of winning a political victory and getting into data services without opening them up?

McClellan: Absolutely. Yes, of course.

Glassman: Let me move on just to talk about your own company. I'm sorry we've neglected it.

McClellan: Oh, that's OK.

Glassman: Your company operates as a carrier's carrier. Can you explain what you do?

McClellan: Sure, as a carrier's carrier, we don't provide services to end-users, either consumers or businesses. We provide network services to other telecomers. For example CLECs (competitive local exchange carriers to incumbent Bell operating companies) that offer local services need capacity to connect different cities that they serve, or Internet service providers need high capacity circuits between cities. We operate in the Southeast, and there are a lot of international carriers coming in on submarine cables into South Florida, so they need connections as well. We help long distance carriers fill in gaps and holes in their network or where they have overflow because the growth in their wireless and data services has outstripped the capacity of their networks, which had really been engineered for voice traffic

Glassman: Do you actually own fiber-optic systems?

McClellan: Yes, we do. So, we've installed dark fiber on conduits that were owned by a parent company, which is a railroad, and then we put optical equipment on to the fiber. So we have high capacity circuits operating throughout the Southeast.

Glassman: I was just going to ask what dark fiber is, is it fiber that actually not in use, not lit up?

McClellan: Right. A dark fiber is very simply fiber that doesn't yet have optical equipment on it. So the optical equipment is what makes the fiber useful. It's the lasers that shoot the signals down the network. So we can provide customers with lit capacity, where they basically lease space on our lit network, or, alternatively, we could sell them dark fiber, and then they would put their own optical equipment on the dark fiber. We would also provide them then with co-location space, so every 40 or 50 miles, they would need a repeater and a place where their optical equipment is in a safe environment with lots of power and lots of air-conditioning. In addition, we've begun to roll out a set of Internet services so that we can help our customers move up the value chain and offer broader sets of services without them having to deploy the capital to put on Internet routers and things like that.

Glassman: Now, how does your network fit in with long distance carriers and with the regional Bells?

McClellan: In terms of how it fits in with long distance carriers, we fill out holes in their networks. So, for example, we have a number of customers who are wireless carriers, and they can get capacity from their parent company or they can get it on the open market. And where their parent company doesn't have services, doesn't have the adequate capacity, we fill that in for them. With respect to the Bells, they cannot today provide the interLATA services, so they can't provide the connection between, say, Miami and Atlanta. However, we do compete with the Bells because we have networks that connect major telecom facilities in metro areas, telecom hotels, the Bell's central offices, the tandem switches and things like that. So we interconnect those facilities because if you've got a CLEC customer, it needs to connect up those different facilities and they have a choice of going to the Bell or going to somebody like us. They'd obviously much prefer to go to somebody like us because they're competing with the Bells, so why give them more money? So the Metropolitan part of the network is a very valuable part of what we're doing as well, because it really strengthens our value proposition to the customers.

Glassman: So, you compete with the Bells, but they still control that last mile or last hundred yards or whatever into people's homes.

McClellan: A good situation would be, in Miami for example. There's a Bell South Central office in downtown Miami, and nearby are also points of presence for most of the major carriers, as well as some telecom hotels where a lot of different competitive carriers and ISPs have their switches and their routers co-located and interconnect their networks with each other. So, typically, in Miami, Bell South would provide the interconnection services between those locations and control the facility that goes to the business or residential locations, and the CLEC would be reselling services across the Bell facility. What we could do is provide that interconnection between the Bell South central office and the carrier hotel and then the points of presence of the other carriers. So, we're not in the last mile business, but we are in the connecting major telecom locations business.

Glassman: So do you actually have to work with the Bells?

McClellan: Oh, yes. We work with the Bells everyday.

Glassman: And what's been your experience?

McClellan: Well, it's been mixed. One thing I'll say unequivocally is that the Bells, as at every company, are made up of people. And I do believe in the inherent goodness of people. And at the same time, there are people who are operating in an environment that has a lot of internal bureaucracy, a lot of systems and processes and procedures that impede rapid response and slow down our activity and all the other competitive players in the industry. The people we work with on a daily basis are good people, but they are operating in an environment that forces them to have a low-level of responsiveness to the kinds of things that competitive providers need to do. Customer turnaround time is absolutely critical, and we can call up Bell to get a circuit and a six-month provisioning interval is not at all unusual. At the same time, we're offering customers a 15-day turn up interval, and we're often turning up circuits in less time than that. So, there's not a law of physics that dictates the responsiveness we get out of them. It's internal procedures and policies that just don't help the end user.

Glassman: Let me just ask you this last question. Many CLECs, as you've noted, are faced with problems in the current environment. How is your company faring?

McClellan: The market situation is very interesting and it is very challenging. The financial markets are hammering the telecom sector, and while some of that makes sense, I think the pendulum has probably swung too far. If you look at it a year ago, the market was too hot, and if you look at it now, it's gone too far the other way. Too many companies jumped into the marketplace without fully baked plans and adequate funding, and the market is sorting out the fully funded companies from those that are going to run out of cash. If you look at us, we're very fortunate because, we have very strong backing from a parent company and we are fully funded for the strategic initiatives that we've announced. So I think that fully funded status gives us a big advantage. We also have been pretty capital-efficient in our plan for growth. I didn't mention this but we've been very aggressively swapping fiber. We put in more fiber in our system than we needed for our own use and we've been swapping that to reach into other markets. So it gives us an inherently lower cost base than people who are busy digging up the countryside. At the same time, we also are seeing very, very strong underlying growth in the marketplace. And we put together the business plan for this thing about two years ago. Right now, we're chasing much, much larger opportunities than we have ever envisioned. For example, when we were deciding what kind of optical gear to put on, we considered installing a system that operated on OC48 speed -- the equivalent to carrying 32,000 voice-grade circuits. As we sit here right now, we're provisioning multiple OC192 circuits -- 129,000 voice-grade circuits. So, the growth and demand has been outstanding. I think that our company is doing well.

Glassman: What do you see in regard to the overall telecom market?

McClellan: I think that although you do see a sorting out of the marketplace driven by the financial markets, the underlying demand for the telecom services is still very strong. We talked about the demise of some of the CLECs. I saw some statistics a few months ago that said CLEC revenues have grown at over 50 percent. So you've got a bunch of companies that are going out of business but a lot of them are thriving. So as long as the Bells continue to maintain low levels of responsiveness, the CLEC share of the market is going to continue to grow. And as prices continue to fall for data and Internet services, we really see a virtuous cycle with explosive demands. I think people look at things in the marketplace and draw the wrong conclusion. There is a shaking out of the marketplace, it's a winnowing process, and it's natural. How many car companies were there in 1910, how many in 1920, how many are there today? There's surely going to be a sorting out. But overall, I remain very bullish for the long-term of the telecom sector. I like where we stand right now, I like the fact that we're funded and I like what we're doing.

Glassman: Now, your parent company is a railroad company?

McClellan: Yes, Florida East Coast Industries.

Glassman: So, if anybody wanted to buy your stock, what would they do?

McClellan: Well, there's no free standing EPIK stock but the parent company is Florida East Coast Industries, FLA on the New York Stock Exchange.

Glassman: I have one other question. I was reading Business Week, last week or the week before, and they were talking about overcapacity in the economy, and there was a statistic there that just jumped out of me that was kind of unbelievable. It was that only 2 percent of fiber optic capacity is being used. Now, I don't know what that means. Does it mean that you have the dark fiber, only 2 percent is lit up or what?

McClellan: I've seen different numbers on that. And so I don't know if it's 2 percent or 5 percent or what the right number is. But that's what it means, only a small percentage is lit up, and I'm about to get into another rant.

Glassman: OK.

McClellan: When people talk about the overcapacity in the industry, usually what they do, is they look at how much the fiber in the ground is lit up. And if all the fiber in the ground were lit up, what would be the capacity of that? And they come up with some number that is just science fiction in its dimensions. And so they say, we've got this capacity glut. What's going on here is that you have demand that rises, demand that is growing very, very strongly, but it goes up in a smooth pattern. When you install a network, once you get the ground opened up and put in a conduit, the minimum efficiency scale of your build is an awful lot of fiber. I mean you don't open up the ground and only put in two strands of fiber because most of the cost is opening up the ground. The fiber is relatively cheap, so you put in a lot of fiber. Then if you're a telecom company, you're facing an incremental investment decision, which is, "OK, now I have to put up optical equipment on it and I have to decide how much capacity do I provision?" And what happens, what we're seeing in the marketplace, is that people are bringing capacity online in, I would say, logical increments. Prices are falling rapidly, but that's driven more by the improvements in the technology. And if you look at the price performance curve of telecom, you can move today about 16,000 times more information per dollar of capital than you could six years ago. So, of course, prices are going to fall in the face of that. But the overcapacity argument is based on making a theoretical calculation of what the fiber could carry as opposed to looking at how do people actually bring capacity online. So I think what this means is that we don't need a lot more fiber put into the ground for a few more years. But if you go back to history, every time somebody said, "Oh, this is all the fiber we are ever going to need," it was always used up in just a very short number of years.

Glassman: I understand what you said, but is it any of it the result of what we're talking about earlier, the foot-dragging of the Bells, the fact that not enough residences have broadband?

McClellan: Well, let's look at that. Right now, we have not enough residences getting broadband. And in the face of that, we see Internet service growth, as in the amount of bandwidth committed to carrying Internet traffic, doubling every 120 days. So, if we start to see more aggressive penetration of broadband connectivity to the household, I think that curve is only going to accelerate. There is another fully fascinating thing that is worth mentioning. I was talking with somebody just yesterday that as the price of bandwidth keeps going down and down and down, people would find more uses for it. So I will spend more time online, once I have a broadband connection to my house -- and it certainly won't come from the Bells, but probably come first from the cable companies -- I will certainly do more things on the Internet because there will be forms of research, forms of entertainment, forms of e-commerce I don't have available to me today. So there's going to be that beneficial substitution effect and also the information content of what I get would be much, much richer. So that's one effect that's going on.

Glassman: And another?

McClellan: That is just a better version of something that is already out there. But you are also going to see completely new uses for bandwidth. There is an experiment going on in Canada right now where they are using an optical wavelength as a storage medium for information. So, rather than have information live on some magnetic hard drive somewhere, the information is actually going to reside, bits and bytes of binary signals, on an optical wavelength. So anybody that is hooked on to that particular network could get immediate access and download to - I don't want to say, all the knowledge in the world - but if you take it to a sort of Gilderesque conclusion, that that's kind of where you'd be on it. So the application of this for universities, medical research, or, God-forbid, improving the efficiency of government services is just tremendously exciting. I don't know if that's something we're going to see next year, but it certainly is something in the works. I'm just somebody who believes that we're just seeing the tip of the iceberg of the opportunities that are going to come out of this marketplace.

Glassman: Thank you very much, John.

McClellan: Thank you very much.

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