CONSOLIDATION REDUX

From approximately 1999 through the end of 2002, telecom employees and executives saw option packages worth tens of millions of dollars, and their jobs, evaporate. Some of the most prestigious companies in the business were thrown into turmoil. Lucent Technologies, parent of Bell Labs, shrunk its global workforce from 153,000 to 35,000.

The nation’s top telecom clusters in New Jersey, San Francisco, Boston, Dallas, Atlanta, and Washington suffered as well. High-flying startups initially flush with venture capital ran out of money and simply ceased operations or declared bankruptcy.

In early 2003, a deeply divided Federal Communications Commission considered and left in place rules passed in the wake of the 1996 Telecom Legislation that were intended to foster local telephone competition. Seven original RBOCs had consolidated into four. Ameritech and Pacific Telesis became children of SBC. Bell Atlantic merged with Nynex. GTE, once independent, that is, not part of the original AT&T, or a Regional Bell, merged with Bell Atlantic to form Verizon. Ostensibly, this action was to free the Bells so they could foster growth in broadband services. Freeing the Bells ideally would have allowed them to stop making their network elements available to resellers, allow them to compete in the long distance market as well as offer Internet services, the new name for the old ‘‘data’’ services. Part of the rationalization for allowing the Bells to compete in broadband services, allows them to compete with cable companies’ Internet service offerings. However, this ideal was not to be.

The structure of the new rules removes restrictions on broadband, also known as high-speed Internet access, but not traditional telephone service, part victory and part setback because the Bells’ traditional telephone service will remain subject to regulation of state PUCs, and thereby likely to continue to require the Bells to make their network elements available for resale by competitive carriers. So it seems like the world, at least in the United States, the communications landscape will continue to include the courts, various regulatory bodies, and to quote FCC Chairman Michael Powell, ‘‘Picassoesque,’’ predicting it will lead to ‘‘legal and regulatory chaos.’’

Where is all this turmoil leading? It’s difficult as always to predict, but it’s not difficult to get an indication from a simple look at the status of the local exchange business from the perspective of the dominant and not so dominant players.

First, the dominant players are generally considered to be the ILECs. The former RBOCs have for many years prospered from voice services sold to enterprise and residential customers. For the most part, these services are delivered via single-pair copper wire. Even where the services are delivered via fiber, the nature, character, and performance of the facilities delivering the service is bound by the constraints inherent in channelized, 64-Kbs T-carrier or PDH access, switching and transport hierarchy. Unchannelized facilities are available, but are simple point-to-point private lines. Digital interface to, and transport through, ILEC network facilities is limited to T1 and DS3.

A financial glance will show suffering from declining revenue and high debt. Declining revenue from wired voice services—their bread-and-butter—is being made up by mobile or wireless voice services. Overall, opportunities for growth are constrained geographically and technically. Relief from the geographic restraint provides opportunity in the form of incremental revenue from long distance services, but it is in exchange for unbundling network elements for sale to competitive local exchange carriers (CLECs), who turn right around and bundle and sell these same network elements in the same market, depriving them of pieces of their most profitable revenue streams.

Many of the ILECs profess to be interested in broadband equipment and facilities. Establishing significant levels of service requires significant investment in new equipment. There’s been an initial ‘‘toe in the water’’ in the form of digital subscriber line (DSL) equipment acquisition and service offerings. But for anything significant such as would allow them to take market share from broadcasting, cable television, or satellite operators, the investment would have to be fiber replacement of copper wire, with IP access, switching and transport, in essence a wholesale replacement of existing infrastructure over time and that wouldn’t necessarily relieve them of their regulatory requirement to continue selling unbundled network elements (UNE).

On the less than major player side of the market, there are the CLECs mentioned previously. CLEC business strategy comes in two forms: one sells Internet access and the other buys and sells unbundled network elements mentioned previously. Others, there are a few who have invested in their own facilities in large markets where the investment level is potentially rewarding because of short transmission distance and access to the more lucrative enterprise customer. One or two of the cable television operators have installed SONET/SDH equipment on common fiber with TV service and offer voice service in the residential market. They have been moderately successful, but real returns are only incremental mostly because of the limitations imposed by voice service pricing in a monopoly market dominated by incumbents.

Many are betting voice-over IP (VOIP) will be at the roots of the next major wave of change in the industry. Some maintain that this could be the next utopian storm. And it may come at faster speed than the classical telephone world is used to enjoying. Remember the game you learned as a child whereby a series of dots were placed on paper in a matrix form and then you and another player started connecting two dots at a time with a single mark? The objective of the game was to reach a point where the last line drawn created a box into which the player could put their initial and claim ownership. The end of the game came when all boxes had been claimed, and the winner was the player who had acquired the most boxes. In the VOIP game, there’s a lot of dots out there now, including laptop personal computers (PCs) with a microphone and speaker, to say nothing of the number of desktops with circuitry and plugs, even microphones and speakers thrown away or languishing in a desk drawer. Microsoft started shipping operating system (OS) software with QOS capabilities in 2000. The next generation OS includes what they called a real-time communications client.

PC technology is pervasive or becoming that way in enterprise and consumer market places. Just connecting these dots alone could make a devastating impact on ILEC voice service business. Sooner or later, the owner of a PC will discover that many or most of the other people they talk to on the telephone can be reached by an alternate route through their PC and Internet access and wonder what else they could buy with the $30 or $40 they spend for local and long distance telephone service.

Local area network (LAN) technology and products have been as much a business necessity as telephone products and services for many years. Their utility started out as a way to share printers and later files. Somewhere along the path, the MIS department figured out they were a cheap replacement for the coaxial cable used to connect expensive terminals to mainframe computers. When the Internet came along, what did the business connect it to? For sure they didn’t connect it to the telephone system.

Cable television operators discovered cable modems could provide Internet access. This immediately made a significantly positive impact on revenue from an incremental investment, far less than the incremental investment required to offer telephone service using SONET/SDH equipment. These devices connect to a PC, not a telephone.