Game Over for UNE-P?

To say that CLECs have had a difficult time would be an understatement by anyone’s standards. Following meteoric rises in valuation on the heels of the Telecommunications Act of 1996, stock market declines and restricted market penetration led to a shakeout that ultimately left standing fewer than 80 of the 330 CLECs that were operating in 2000, according to one study. Now, with the future of affordable UNE-P in question, today’s competitors could be facing yet another series of challenges.

A playing field without UNE-P would be dramatically different from the one we see today and require new strategies - not only for growth, but also for survival itself. The implications would be far reaching, however, impacting not only competitors, but equipment makers, consumers and future services development and deployment. Simply put, if UNE-P as we know it evaporates, it will take competitors with it.

ATLANTIC-ACM expects that the direct impact on competitors, coupled with indirect complications, such as restricted access to capital as customer base and growth erodes, would decimate the competitive industry. While we can predict with a high degree of certainty that at least one third of all local competitors would be forced to close their doors, historical precedent established during the previous shakeout indicates the competitive industry would do well to retain one in two players.

Players dependent upon UNE-P will have to determine two things to survive: how to hold and to grow revenue. First, to hold revenue, they must find solutions for maintaining current UNE-P customers. Negotiating with incumbents is one option that is not bearing fruit in most cases. In the late April negotiations, Cbeyond Communications CEO James Geiger was quoted in the trade press saying increases demanded by the Bells “would not allow us to sustain our business.” The second unattractive option is raising prices to cover increased costs. The third option is transitioning customers to new connections. Again, the possibilities are not pretty, but barring UNE-P, they must be investigated. Choices include:

This requires regional concentration and clustering. Variations on this theme could include many of the strategies used by the long-distance entrants during the 1980s and early 1990s, such as partitioning switches, sharing purchases and exchanging traffic in different regions.

The most effective options here would be VoIP with cable modems. Some cable firms could be open to this type of option because the telecom provider could absorb the round-the-clock headaches associated with customer service and with the regulation of common carriers.

For larger players, installing wires from switches to customer sites is an option. This, of course, is not economically feasible for serving many customers, such as small business, consumers and those too far from core facilities, etc., but metro networks may have a revival of interest in the post-UNE-P world. How are those sewer networks looking these days?

Using broadband over power line would require working with the utility, which is no small task. Further, with one provider in each region, securing a partnership could be challenging for individual firms. On the other side of this coin, since the market is geographically fragmented by service provider, establishing a national footprint via this approach would be extraordinarily cumbersome at best as agreements would need to be established with each utility.

Employing wireless options, such as wireless local loop, could be appropriate in some instances but requires certain customer density. Mobile wireless services for consumers also could present an avenue of opportunity, but wireless resale has been unable to achieve full stride. Further, it is important for all competitors to realize that the same companies that dominate the wireline industry also are now the largest wireless players. Non-LEC wireless players, such as Sprint PCS, T-Mobile and Nextel, should be getting telephone calls.

Since broadband connections are required, there are limited applications here in the near term. However, if affordable UNE-P disappears, a heavy concentration on broadband development will occur (see below).

When looking at these options, it is clear that customer density and usage are key profitability issues that will drive regional clustering. In an environment where incentives based on UNE-P regulation evaporate, we are likely to see an increased (and expedited) shuffling of customer bases and assets, and network and facilities sharing and swapping as competitors seek economies. Further, we would expect to see immediate consolidation as companies lacking sufficient regional scale seek to rapidly achieve it.

IT ALL ROLLS DOWNHILL

Fewer competitors greatly reduces the pressure for efficiencies, which means an environment without UNE-P as an entry vehicle will result in less investment by telecom players.

Despite RBOC arguments about holding back upgrades because of having to share networks with competitors, empirical data shows that when telcos have faced competition, they invest significantly more than they invest without competition. A need for greater efficiencies in a competitive environment drives investment to reach efficiencies. This reality is evident throughout telecom history. Before competition was introduced in the 1980s, there were two major advancements: rotary dial telephones to replace operators required to switch calls and above-ground wires. Compare those two with the many evolutionary leaps forward the industry has experienced in the past two decades.

Accordingly, providers of equipment, platforms and the like will face the compounded effects of fewer customers overall, with remaining companies facing less pressure to invest in new technologies and upgrades. Similarly, employment across the competitive landscape will be reduced via the conspiring forces of competitors closing their doors or consolidating and their suppliers responding accordingly to lower demand.

In a UNE-P-free environment, the broadband connection takes on more significance. More businesses will be offered voice over T1s, with fractional T1s for smaller businesses in high-density areas. IP PBX or IP Centrex customers using VoIP over their broadband, will become even more prized as the lack of local connection choice drives more companies to offer VoIP.

The broadband consumer already is a coveted customer, spending $30 to $50 a month on the connection and receiving discounts only when they also purchase other services, with bundles of more than $100 per month. These bundles offer cable and telecom players good margins and less churn than with single products.

This revenue will lure competitors to the easiest consumers to reach. Consumer offers in more lucrative metropolitan areas are likely to experience rapidly declining broadband connection costs as competitors of all types target that service to gain valueadded revenue from telephony and entertainment services. In other words, the value of the connection itself will rapidly deteriorate as it becomes the means to other revenue streams.

The same cannot be said for consumers located outside of metropolitan hotspots. These players will have little or no competitive choice for telephone services without UNE-P. These folks on the rural side of the digital tracks will not reap the benefits of broadband competition that metropolitan consumers will enjoy as their physical locations retard or prohibit the scale economies necessary for competitive development.

Further, without UNE-P as an entry point to gain customers before developing facilities in such areas, the only competitive incentive alternative providers will have to target consumers in these regions would be, ironically, the lack of competition in these markets when compared to competition in metropolitan areas.

Nonetheless, a forward-moving concentration of competitive forces weighted heavily toward broadband consumers and small businesses could conceivably lead to a counterintuitive market dynamic wherein the lack of competition for basic connections coupled with intense competition for high-speed consumers results in pricing for broadband connections on par with, or perhaps even less than, basic connections.

We note with interest that prices for DSL services have been cut in half over the past several quarters from cable-RBOC competition, even without broadband emerging as the single competitive outlet in the absence of UNE-P, and even before President Bush called for the federal government to encourage universal broadband services to the home by 2007. Hence, the irony of broadband becoming more affordable than basic connections would be that, after all arguments were made, the contrast between consumer benefit with and without easily facilitated competition would become glaringly obvious, which would likely lead regulators - and the industry - full circle with respect to facilities sharing requirements to introduce competition.

WINNERS

There are two sides to every coin. While consumers, businesses too small for a T1 as well as UNE-P-oriented competitors and suppliers would be obvious losers if affordable UNE-P disappears, there would be a group of winners. These include the Bells, cable MSOs, utilities poised to use their lines for voice and data and facilities-based competitors.

The Bells obviously would be winners in this scenario, as their access revenue would be secure again, with the type of competition that released the stranglehold on long distance significantly reduced and definitely hobbled. Meanwhile, the Bells strategically moved to acquire and build the most likely access service substitute - wireless.

Having gained full access to provide in-region long-distance services, they have strategically protected their positions. Now they are offering entertainment and working on TV. They practically have checkmate in the bag. Cablecos also would be winners, as slowed declines in retail price help to cost-justify their own network deployments. Their second line to the home also offers partnership opportunities for voice providers.

Powerline telephony providers, with the third wire into the home, also have an opportunity to build some partnerships and see what technology and innovation can offer. In terms of competitive telecom providers, those companies that have deployed services outside the UNE-P model would likely experience significant increases in value. The model of building with 5ESS switches and no UNE-P, such as that employed by PAETEC Communications Inc., look very wise in retrospect.

The wide variety of metro solutions: MCI’s metro lines, Eureka Network’s BLEC development, OnFiber Communications Inc.’s network, and many others can serve the cities and business parks.

There are several effective competitive models for consumer services. The emerging competitors that have built VoIP customer bases, assuming regulation sticks while they grow, look pretty smart now, too. Companies like Vonage, USADatanet, and Jeff Pulver’s FreeWorld Dialup and AT&T Corp.’s Call Vantage offer a few consumer choices.