TCS Daily

Caution, Competition Ahead

By James K. Glassman - September 23, 2002 12:00 AM

Just when nearly everyone had given up hope of breaking the monopoly in local telephone service, competition has suddenly blossomed, and consumers and small businesses around the country are beneficiaries.

The plan set by Congress in a law enacted six years ago is at last working. More Americans are choosing companies other than the Bells, the longtime monopolies, as their local carriers, and, as a result of the new competition, prices are falling and quality rising.

The Bush Administration, which earlier seemed to be toying with the idea of giving up on competition - both in local service and in high-speed Internet access, or broadband -- now has a success on its hands. So do members of Congress of both parties going into the mid-term elections. After all, there's nothing elected officials like to brag about more than policies that save money for consumers. And with telecom, they deserve bragging rights.

But the game isn't over. The chairman of the Federal Communications Commission, Michael Powell, has some important decisions to make, and at least one of the giant Bell companies is trying to use its clout to halt the progress. But, as Business Week put it, "If Powell abandons the approach of the 1996 law and gives the Bells the rules they want, he may well cut off competition just as it's getting good."

How good? By the end of June, thanks to a process called UNE-P, the Bell's competitors had signed up customers for 7.7 million telephone lines, a gain of 33 percent, in just six months. Just two and a half years ago, the competitors had fewer than a half-million lines.

UNE-P stands for "unbundled network element platform." It's telecom gobblydegook, but it's vital. The Telecommunications Act of 1996, passed overwhelmingly by both parties, allowed competitors, paying a reasonable price, to use UNE-P to hook up to the local Bell network. That network, of course, was built over a century by the original nationwide monopoly, American Telephone & Telegraph Co., with the help of government subsidies and protection. AT&T managed the lines in a kind of public trust.

With the AT&T breakup two decades ago, the local system was bequeathed to seven regional Bell monopolies (now, through mergers, just four) while AT&T went into the long-distance business.

Long distance was opened up to competition, with companies like MCI and Sprint getting their start by leasing AT&T's long-distance lines, then, after gaining a foothold, building their own facilities. The result was higher quality and lower prices - down 40 percent since 1992 alone, according to the FCC. The 1996 law applied the same leasing model - in this case called UNE-P - to local service, in hopes of gaining similar benefits from competition.

But, until lately, local competition hasn't happened - mainly because of lawsuits and foot-dragging by the Bells - and, as you would expect in a monopoly market, rates have risen and service deteriorated. Now, much of the underbrush has been cleared, and state public utility commissions are paving the highway to competition by setting sensible UNE-P prices.

Michigan led the way more than a year ago, and Illinois, New York, Indiana, New Jersey, California and Ohio have followed. The Bells' competitors have responded by offering service in these states and several others with hopeful prospects, and the Bells have countered, scrambling to retain customers by cutting prices and boosting services.

The process is no mystery. It's called free-market competition, and it's at the heart of the economy philosophy of the Bush Administration - and of most members of Congress.

Here's a concrete example: In June, the Grand Rapids (Mich.) Press reported, "Pushed by a growing number of competitors, SBC Ameritech, the state's dominant local-phone provider, cut the price of its basic local-call plan by one-third and lifted the limits on local and toll calls in other plans." Savings for Michigan consumers: $26 million. In 1999, competitors had only 4 percent of Michigan's local lines. Today, they have about 15 percent.

Comments by executives from Verizon, Qwest and BellSouth indicate they can live with UNE-P. CEO Ivan Seidenberg, for instance, "assured investors that UNE-P wouldn't hurt Verizon's finances right now," according to Communications Daily on Sept. 10.

After all, as UNE-P lets competitors enter local service, the law (under Section 271) allows the Bells to get into long distance, which so far has provided the Bells with more than they have lost on the local side. In a recent report, Lehman Brothers noted, "BellSouth emphasized that their success in entering the long-distance market through the 271 approval process offer a considerable advantage over the UNE providers." BellSouth, by offering a bundle of local and long-distance services, believes it has an appealing package to sell customers, which "will obviate the need for a major change in UNE regulations."

But SBC Communications, which seems to have dropped the ball on developing the competitive local-plus-long-distance packages that BellSouth talks about, is screaming bloody murder and making extravagant claims about the damage UNE-P is doing.

Thanks to the mandated rates, complained Edward Whitacre, SBC's chairman, his company's financial situation is "a downward spiral" that "will lead to the ultimate demise of our network." But that's nonsense. Certainly, life is a lot easier when you're a monopoly, but recent reports by investment firms show that SBC - which is the regional Bell for the Midwest, West and Southwest and has investments in 25 phone companies internationally, from South Africa to Uruguay - is alive and well.

Among the top 30 companies listed in Fortune's annual survey, SBC was number-one in profit margin, earning 16 cents on every dollar in sales. The average company in the Fortune 30 earned less than 5 cents on the dollar.

In a recent presentation to stock analysts, Whitacre bragged about SBC's rising wireline profit margins - most recently 42 percent. In fact, all of the Bells have excellent prospects. As Value Line analyst David Reimer put it, Bell "stocks should be able to break out of their current funk, given the companies' significant market scale and ability to further pursue the more promising of growth avenues." Value Line, as of its latest report (July), rated SBC "A-plus" for "financial strength" and calculated SBC's return on capital at a hefty 17 percent, compared with an average of 4 percent for the industry.

Lehman Brothers told clients last month that the Bells are "expected to deliver strong free cash flow growth over the next five years" and rated SBC "outperform" (that is, expected to do better than the market as a whole). Of 23 analysts surveyed by Yahoo, 12 rate SBC a "strong buy" or "buy" and none rates it a "sell."

Value Line estimates that SBC's earnings will continue to rise this year to $2.45 a share - that's up from just 86 cents in 1986. SBC's cash flow is a whopping $18 billion, according to Value Line - considerably higher than that of giants like Microsoft, Wal-Mart and General Motors.

The objective of Whitacre and William Daley, the former chairman of Al Gore's presidential campaign who is now SBC's president, is to get Congress or the FCC to pre-empt the states and jack up the rates that consumers pay. According to the Detroit Free Press, SBC is trying to frighten Michigan policymakers into raising rates by using one of the oldest tricks in the corporate playbook: threatening that the company will have to lay off some of its 16,000 employees in the state.

Again, that's nonsense. If SBC loses business to competitors, it might have to lay off workers. But, meanwhile, those same competitors will be hiring workers - perhaps the same people. In fact, if local service grows as competitive as long distance, then the total pie - that is, the amount of local business in general - will expand, and, overall, jobs should increase.

It is true, however, that SBC - and the other Bells - have a real fight on their hands. That's what competition is all about. And that's great for consumers. In July, SBC's Illinois subsidiary announced a major rate cut, and in August, SBC's Ohio subsidiary introduced "significant cost savings [for] approximately 96,000 small businesses."

AT&T, one of the Bells' new competitors on the local scene, expects to offer service to half of the Bells' residential customers by the end of this year, entering states like California and New Jersey. In New York, where Verizon was once a rock-solid monopolist, AT&T offers unlimited local calling for $19.95 a month. Consumer Reports quoted a study finding that, thanks to the new competition, consumers in the state reduced their bills by nearly $13 a month.

Judging from these results, Business Week is right to warn that changing to "a regulatory scheme that ensures rich profits for the Bells alone is likely to hit consumers in the wallet - and slow innovation even more."

The Bells have traditionally focused their attention on lobbying and lawyering rather than on innovation and customer service. Competition is a new and scary development for them, and their aim over the past six years has been to kill it off- not by offering cheaper and better products but by persuading politicians and filing lawsuits.

Lately, the Bells' arguments are growing threadbare. For example, they claim that UNE-P is only "synthetic competition." But the Bells currently provide long distance service to customers by leasing lines from incumbents in precisely the same process. Discounts to the Bells from companies like Sprint and AT&T range from 55 percent to 70 percent. (In fact, some securities analysts encourage the Bells to embrace the idea of leasing out their local lines as a source of extra income, rather than reflexively opposing the idea as a threat.)

In time, competitors plan to build their own local networks, thus developing what is called "facilities-based" competition. But, according to a recent report by the investment firm Stephens, Inc., "the FCC is likely to keep the current system, thus allowing CLECs [that is, the Bell competitors] to accumulate a customer base large enough so that competition can truly take hold. The 'build it and they will come' facilities-based approach has obviously not worked as well as planned. We believe the FCC will recognize this failure and allow the UNE-P CLECs to build enough scale so that a gradual transition to a facilities-based network can be done."

Let's hope so. Chairman Powell has a momentous decision to make. He has been wise to postpone action until he could see the lay of the telecom landscape. Thanks to actions on UNE-P by the states - with Massachusetts, Pennsylvania, Minnesota, Maryland and many others expected to follow leaders like New York and Michigan - competition is working at the local level.

But eternal vigilance is the price of telecom freedom. Some lawmakers on the Hill could try to insert language in appropriations bills that would gut the work of states that are setting wise UNE-P rates. The Bush Administration, which stands to benefit from this consumer-telecom success, must throttle any of these attempts, and it would be a disaster if Michael Powell, the son of the Secretary of State, were to panic and overturn a major policy achievement for the White House.

In the end, it appears the Bells are going to have to compete - in long distance, broadband and local service - whether they like it or not. The winners in telecommunications will be entrepreneurs and innovators, not monopolists. Of course, the biggest winners of all are America's consumers and small business owners, who, in these tough economic times, are starting to enjoy the benefits of lower telecom rates and better services -- just as the advocates of competition in the Administration and Congress have been saying all along.



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