TCS Daily

McLeod Demands 'Damages or Discounts' from Bells

By James K. Glassman - June 29, 2001 12:00 AM

McLeod Demands 'Damages or Discounts' from Bells

Clark McLeod could be one happy man standing at the helm of the country's largest independent Competitive Local Exchange Carrier. But he's not -- at least not about the developments of recent years in the telecom marketplace. In an interview with Tech Central Station Host James K. Glassman, the longtime telecom industry chief describes "a cartel environment" forming among the Bells. He details his view of the Bells driving the telecom agenda for years in Washington, and includes a recounting of Sen. Hollings' recent story of his call to a Bell CEO for a sign-off on the Telecommunications Act of 1996.

Hopes for that landmark legislation have since been dashed. As a result, the search for solutions has proven especially contentious this year. For his part, McLeod has proposed some pretty stiff, but novel medicine to open Bell-dominated local phone markets to competitors. To Congress, he has testified in favor of heavy doses of fines that the Bells would pay to injured parties instead of the government. "Congress needs to recognize that these Bell companies are $100 billion market-cap companies," the Cedar Rapids, Iowa, based CLEC exec said. "Fines of $100 million to $1 billion would have a meaningful impact on these companies; whereas a fine of $1 million to $10 million is more like a parking-meter violation."

James K. Glassman: Mr. McLeod, why don't you describe to us the nature of your business. You are a CLEC [Competitive Local Exchange Carrier]. But, you are unusual in the sense that you were originally in the long-distance business. Can you tell us how you got into the long-distance business, and then, about moving from there into local?

Clark McLeod
: There are really two companies involved. The first company I founded was a company called Teleconnect in the 1980s. We built, from scratch, a company that grew to be the fourth largest long-distance company in the USA. MCI purchased the company in 1990. Several years passed and then a handful of us from Teleconnect formed a new company called McLeodUSA. In anticipation of the opening of the local phone market, we actually began offering a bundle of local, long-distance and data services starting in 1994, and went public in '96. We then added our white-yellow page directory business unit. We have since grown this company to be the largest independent competitive local exchange company in the U.S.

: So, you now have about $2 billion in revenues?

: Approaching $2 billion for 2001.

: Now, you are having problems dealing with the incumbent Bells in providing the kind of local competition you would like to provide. Could you tell us some of those problems?

: I would liken what we have today as unequal access to the Bell local loop -- unequal in two ways. Functionally, we do not receive 100% service from the Bell companies. And there are plenty of illustrations of that. Second, we receive uneconomic access to the Bell network. This causes the local service portion of our business model to not be profitable. Now, in our case, we have bundled other products with local service, allowing us to have a margin to deal with. But, today our access is unequal to the Bell network

"In America, I think consumers will pick choice over monopolies every time."

Glassman: You know both of us have highlighted the capital access problems that the CLECs have suffered since the introduction of the Tauzin-Dingell bill. Why should the public care whether smaller telecom firms survive any more than any other group of companies that hits hard times?

McLeod: If you look at the telecom industry, you need to make a decision whether you would prefer to have it controlled by a monopoly, or have a competitive environment where consumers have choices. In America, I think consumers will pick choice over monopolies every time. In telecommunications, the monopolies -- the Bell companies -- have been very good at lobbying our policymakers and our regulators and creating uncertainty in the market.

The reason uncertainty is favorable to the Bell companies is that it makes it more difficult for competitors to access capital. Not having access to capital makes it more difficult for competitors to offer alternative products and platforms and to build alternative networks.

Glassman: Now, your company is different from the average in the sense that you have other streams of revenue. But has your company had a difficult time raising capital as a result of two things: the foot-dragging by the Bells and this bill?

McLeod: Very definitely. The foot-dragging by the Bells translates into less than ideal economic conditions for us, which affects our bottom line. And, of course, the Tauzin-Dingell bill affects us because it guts key provisions of the '96 Act and strengthens the Bells' monopoly over the local network. This is sending a signal to Wall Street that is counter to the trend towards competition.

`Damages or Discounts`

Glassman: During your testimony to the House Judiciary Committee earlier this month, you outlined a punitive approach to recalcitrant Bells. Could you explain that to us?

McLeod: When we look at remedies today, first of all, we need to understand what our goal is. Our goal is for the competitive industry to have equal access. I break that down into two areas. First we must be able to get equal access in a functional sense, which means that we need to be in a position to order services in exactly the same way the Bell companies order, through the same systems, receiving the same level of service. In fact, those systems need to be "blind" to who is placing the order, thus eliminating the opportunity to discriminate.

This seems like common sense, but we simply don't have it today. As a result, without a functional separation of their systems from their retail operations, we have a number of instances where we are getting inferior or unequal access to the network from our main competitor on the retail side.

Then, from an economic standpoint on equal access, we would suggest that two things need to occur. One, when the Bell companies fail to provide 100% service, competitors who have been damaged need to be compensated. Compensation should be in the form of either damages or discounts.

We have a rather positive situation, we believe, in several of the markets that are served by Qwest today. In Minnesota, Iowa and Colorado, damages are automatically paid to us on a monthly basis according to our interconnection agreement. Our quality and level of service from Qwest have improved over the last six to twelve months. So that's one way of remedying the damage done to us by Bell companies and their errors in providing us service.

The second remedy would be similar to the model used in the long-distance industry. In long-distance, from 1982 when we started to offer service all the way to 1986, we received a lower rate for access to the Bell network because it was recognized that our access was unequal. We received a 55% reduction in our rates across the board because of that unequal access.

Glassman: When you say unequal, you mean the service was inferior in the same way it is frequently inferior for lots of other things today with the local companies?

McLeod: Exactly right. And it was recognized that that was the case. There was also a date-certain mandate when the Bell companies were to provide equal access to all competitors. We certainly need to get into that same kind of situation eventually with the Bell companies for local access. That won't happen overnight. What has to happen for us to get equal access is that we need to be in a position where we receive the same level and the same quality of service. Service must also be deployed through the same systems, which are "blind" to the Bell company worker as to who is placing the order -- whether it is their retail order or a competitor's order. Then, and only then, will we have equal access. I believe the '96 Act intended for competitors to have equal access. So, this is an implementation issue.

"Fines need to go to the damaged party"

Glassman: Do you think the FCC has been lax in enforcing the law?

McLeod: There have been a number of things that have gone on. But, let me say first that the Bell companies have driven the agenda. If you watched the hearing on June 19 before the Senate Commerce Committee, you heard Chairman Hollings indicate that he played a key role in drafting the '96 Act. The last thing he did before voting on the '96 Act was to place a phone call to the then-CEO of BellSouth, John Clendenin, asking him if the language of the bill was exactly right. And his answer was affirmative.

The Bell companies drove not only the concept of the '96 Act -- because they wanted to be in long-distance so they could leverage their local network -- they drove the language of the Act. They were actually the instigator of the Act. Or that Act would have never passed. Interestingly enough, after the '96 Act became law, every Bell company filed suit against it.

What the Bell companies have done is create a vehicle that will eventually bring them into long-distance services, they believe. But they have blocked competitors' access to the local network through legal maneuvers since 1996. They still have the TELRIC pricing in a state of uncertainty because it has been challenged and is now before the U.S. Supreme Court.

Before I comment on the FCC, I have to stress that the Bells' actions have been designed to block competitors from entering and competing in the local marketplace.

The '96 Act probably didn't give the FCC as much enforcement authority as I would have liked. The FCC has asked for more. What they have today is the ability to fine a Bell company up to $1.2 million. Congress needs to recognize that these Bell companies are $100 billion market-cap companies. Fines of $100 million to $1 billion would have a meaningful impact on these companies; whereas a fine of $1 million to $10 million is more like a parking-meter violation.

Let me also emphasize that these fines need to go to the damaged party, not to the government.

Glassman: By the way, Raymond Smith, who was the CEO of BellAtlantic up until 1998, in late '97 gave a speech at the American Enterprise Institute in which he said the Telecommunications Act was working fine. Not only did the Bells agree with the Act, but even two years into it they were saying, "Oh, it is fine. No need to make any changes."

McLeod: Let me add one additional fact. A monopoly is something that exists because of a policy and regulatory fiat. That's why a monopoly exists in a marketplace like we have today. In a country that generally favors free enterprise, that's the only way a monopoly is going to exist. Monopolies are very good at the regulatory process. They are certainly better than competitors. We fight the battle in the marketplace where we will eventually win, while the monopolies fight on the regulatory front where they will eventually lose. Ultimately, the monopolies will have positioned themselves to be relegated to some kind of wires company. They will always have a piece of the network that is in scarce supply, and they will be able to profit from that.

Glassman: Well, there is a question there.Recently, Hughes unveiled a two-way satellite broadband system. Now, in one sense, that's an argument for those who say the marketplace will evolve out of its problems in a facilities-based direction, that there will be new facilities that will bypass the wires that you just talked about. How do you respond to that?

McLeod: My response would be that at some point in time there will be enough alternative facilities that Bell companies will finally recognize that they need to wholesale their network. We don't need alternatives to every home and every business, but we need significant alternative choices so that we actually put pressure on the Bell companies to sell their network on an equal-access basis to all competitors. So, eventually, yes, I think technology will help us open the last-mile bottleneck. But in the meantime, we will all be dependent on getting access to that last mile.

Argentina Over North Dakota?

Glassman: Margaret Greene of BellSouth in her testimony before the Senate made this statement: "Competition," she said, "is robust in every sector of the communications market, except long-distance." What is your response to that statement?

McLeod: You know, it is interesting. That statement went by me, maybe because it is so absurd. Certainly we have robust competition in the long-distance industry. The ultimate measure of that is to track the declining trend in rates in the long-distance industry. And, of course, you see that in wireless as well.

We have gone back over the last seven years and analyzed the rates for local telephone service, and compared those rates to long-distance and wireless rates during the same seven-year period. Over the last seven years, there has been no rate reduction in local telephone service. Arguably, in some areas there have been slightly higher rates. In contrast, long-distance has dropped 40% in the last seven years and wireless rates have dropped nearly 50%.

So Ms. Greene's assertion went by me. Certainly it is an argument the Bells would like to make. When they enter long-distance and have superior access to the customer through their local loop, they can leverage that position. In fact, they can re-monopolize portions of what are now competitive industries, such as the long-distance industry.

What was interesting during the Senate Commerce hearing last week, Jim, was when Ms. Greene was asked about BellSouth's investment, and why they weren't investing out of region in places like North Dakota. Instead BellSouth has been investing in Argentina. Her response was that they really wanted to invest in their footprint. If you look deeper into that, you can see that what the Bell companies want to do in the U.S. is monopolize their current footprint and take cash and capital from that and invest in other countries where they have better competitive access. They're forming in this country a cartel environment, if you will, with Bells entering long-distance and staying only within their current region.

Glassman: So essentially, the Bells have certainly what looks like a set of four regional cartels; that is to say, four regional monopolies.

McLeod: Well, yes, certainly. And the one exception, to some extent, is Qwest. While Qwest has substantial facilities out of region, the other three Bells do not.

"Their [the Bells`] preliminary moves out of region have been a sham."

Glassman: Even though both SBC and Verizon, and I'm not sure about Qwest, made promises that they would compete at the local level across regions?

McLeod: They sure did. When you look at the amount of competition they have created out of region, you can see that it is almost nonexistent. In most cases, they have indicated that they are really pulling back from those operations. So their preliminary moves out of region have been a sham. All they did was take away a potential competitor, the neighboring Bell company, by merging with them. Of course, regulators allowed that to happen here in this country. Arguably, you could say that was a mistake.

Glassman: One of the reasons that it was allowed to happen was because of this promise that they would compete.

McLeod: That's exactly right. You certainly could question whether or not those companies should be taken to task, and substantially taken to task. There was another piece of the SBC agreement with Ameritech, whereby the new SBC agreed to provide data on its provisioning of services and facilities to their competitors. The FCC recently fined SBC $88,000 for providing misinformation on these reports. The FCC said that SBC willfully failed to comply with the merger conditions and provided misinformation. So here again, we have the Bell companies breaking the rules they played a part in establishing, and then being fined the equivalent of a parking-meter violation.

Glassman: Clark McLeod, Chairman and Co-CEO of McLeodUSA, thank you so much.

McLeod: You are welcome, Jim.


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