Breathing Room for CLECs?
Nothing ever remains the same in the communications business. And for the moment, at least, many competitive local exchange carriers operating in Verizon and at&t footprints will be able to make stable assumptions about their costs for at least a couple of years, and possibly for as long as a decade.
Had a recent Verizon request for regulatory forbearance in a half dozen markets gotten Federal Communications Commission approval, CLECs might have found their underlying costs going high enough that they’d been forced to exit those markets.
That’s what McLeodUSA was forced to do in Omaha, which is the benchmark the FCC used to determine whether sufficient competition exists in a market to deregulate special access rates, says Royce Holland, McLeod CEO.
Reviewing McLeod’s prospects some two years ago when he took the CEO post there, Holland noted that special access prices were so high McLeod simply couldn’t compete there. “Nebraska isn’t a place you can make money,” Holland says.
“Our T1 prices went up by a factor of 2.5 to three after price deregulation,” Holland says. “It made no sense for us to compete there,” he notes.
So there’s no question but that the denial of the Verizon forbearance petition means the existing business models for all CLECs remain stable, at least for some time, given the high cost of building new high-capacity optical access loops.
In the at&t and former BellSouth region, there is a similar effect. “The merger conditions for the at&t and BellSouth merger helped as well,” says Holland. As part of conditions required for approval of the merger, at&t agreed to reduce interconnect rates for CLECs by as much as 15 percent.
“I will say, though, that over the last year things have improved for the competitive carriers,” says Holland. “We are over the darkest point.”
At least for a while, it seems. The longer term issue is that once the major carriers replace their copper networks, the current rules say those carriers have pricing freedom and no mandatory obligation to provide new wholesale access.
In other words, if a carrier decides not to grant any wholesale access, it is within its rights to do so. Any carrier can negotiate any commercial rates it deems appropriate, of course, but CLEC executives suspect the rates will be high enough to discourage many business cases.
Had the Verizon petitions been granted, McLeod and other CLECs might have faced an immediate and similar problem. If rates rose as much as they have in Omaha, contestants would have faced the choice of abandoning markets altogether or building their own facilities. In many cases, building would have proven
uneconomical.
“Only two percent of buildings in Omaha have more than one local loop, including all competitors,” says Holland. It also is the “same story elsewhere.
“The problem is that unless it is a building with four T1s in it, you can’t afford the construction,” he notes.
So the good news for CLECs serving the business market is that a crucial element of the current cost structure remains in place. McLeod had focused on small business and consumer phone lines. Though profit margins on those lines ranged between 25 and 40 percent, even that wasn’t enough.
Over time, McLeod would have gotten into the “high-50s” margin range even with its old strategy. But “Cbeyond really showed the demand for an IP-based integrated access,” he says.
Many CLECs already had moved to a T1-centric strategy that boosted margins as high as 70 to 80 percent, Holland notes, in part by layering voice services on top of a T1 data circuit.
Given limitations of its footprint, Cbeyond primarily makes a living on single-site customers. McLeod has other options. It has a much broader service footprint, allowing greater ability to serve multi-location customers using an IP-VPN network, for example.
Today, “that’s mostly what we sell,” says Holland.
“The game isn’t about access lines anymore, it’s about managed and enhanced services,” he says. “Companies cannot thrive on POTS.”
Getting bigger is part of the future survival pattern for independent CLECs, Holland firmly believes. Since telecom is a business of scale, the industry would be better off if it largely was composed of three or four players, each billing three billion to four billion dollars each.
The same sort of logic probably is going to make sense for other contestants as well. Covista Communications, for example, recently completed its acquisition of GT3 Holdings Corporation and ClearEnd Corporation. In that case, scale is one advantage.
But the merger also will extend Covista’s VoIP offerings and add capabilities in the hosted IP-PBX and unified communications market.
Holland isn’t optimistic about how well cable companies will do in the multi-site enterprise communications market. One might argue they’ll do better in the small business segment, though. The latest data from the Federal Communications Commission indicates that, of the 28.7 million CLEC end-user switched access lines in service at the end of December 2006, 6.8 million lines were provided over coaxial cable connections.
The 6.8 million lines represent about 61 percent of the 11.2 million end-user switched access lines that CLECs reported providing over their own local loop facilities, the FCC says.
The 28.7 million lines reported by all CLECs is about 17 percent of the 167.5 million total end-user switched access lines reported for the end of December 2006.
And one indication of the direction of things is that reporting CLECs were serving 12.2 million (or 12 percent) of the 101.4 million lines that served residential end users and 16.4 million (or 25 percent) of the 66.1 million lines that served business, institutional, and government customers.
So CLEC market share is twice as high in the business segment as in the consumer segment. About 39 percent of the CLEC lines were provisioned over local loops operated by the service providers. IP
