Posted: 05/1999

Prepaid Providers Take Risk out of Dial Tone
Business
By Jennifer Knapp and Liz Montalbano

Labeled "phone
sharks" by many a regulator, prepaid local service providers are finding a following
among an estimated 6 million households without dial tone by enabling them to pay for
local service up front–avoiding credit checks and large deposits.

"Prepaid local is not enjoying the best reputation I’ve ever seen," says Fred
Voit, senior analyst, consumer communications for The Yankee Group, Boston. "A lot of
the companies doing this are just taking serious advantage of people."

Voit’s observations, shared by some regulators, stem from pricing that is two and three
times the going rate for local telephone service from the incumbent local exchange carrier
(ILEC).

In their defense, prepaid dial tone providers say that it’s an entirely different
business–less like the telephone business and more like the insurance business, wherein
premiums are lower for the safe driver and higher for the accident-prone.

While many customers of prepaid local are credit-challenged, identity-challenged or
undocumented, there are many others who are not necessarily unemployed but simply poor
money managers, providers say.

"[There are] people who just don’t want a phone, but have a need for short-term
phone service," Voit says. "There are plenty of legitimate reasons to do it that
way. But there are no financial reasons to do it that way."

But the news isn’t all bad: Increased competition not only has driven rates down, but
also has caused some providers to add long distance into the mix as a value-added offering
for prepaid dial tone customers. One provider, Derek Gietzen, president of Genesis
Communications International Inc., San Diego, estimates the market potential for prepaid
local is $3.7 billion.

New Spin

The opportunity captured the attention of many would-be local telephone companies
following the passage of the Telecommunications Act of 1996. But its origins predate the
act. Industry pioneers Dial Tone Corp. and Thomas Communications, formed in Oregon and
Washington, respectively, by convincing the LECs and the regulators that buying
residential service in their name and selling it to someone else was not in fact resale
(illegal at the time), but a credit-lending function over which the regulatory commission
had no jurisdiction.

Dial Tone expanded from Oregon to several western states but later met with trouble
from the Department of Justice (DoJ) and was shut down. Thomas was purchased in 1995 by a
later entrant, Ameritel Corp., Portland. Ameritel was formed in 1992 and was the largest
third-party dial tone provider, serving 10 western states. Ameritel’s sister company,
1-800-RECONEX, has become a certified reseller and has taken over its accounts and
expanded into more than 30 states.

In the past, third-party dial tone providers would order Centrex or residential lines
at the retail rate in their company name, assuming the credit risk. Today and since the
Telecom Act, prepaid local dial tone providers are certified as competitive local exchange
carriers (CLECs) with an interconnection to an ILEC to resell local service.

Target Market

Providers of prepaid local have targeted the approximately 6 million American
households the Federal Communications Commission (FCC) estimates do not have local phone
service.

And while these services address a niche customer, not all of them are without local
phone service because they cannot afford it (see customer profile on page 72). "There
certainly is a mistaken attitude that our customers on the whole are poor customers,"
says Jeff Walker, vice president of legal and external affairs for Dallas-based Phones For
All, a prepaid dial tone provider with offerings in 25 states. One Phones For All customer
wrote the company saying she was in dispute with her ILEC over a $2,000 phone bill from an
old roommate, so the ILEC would not give her local phone service, Walker explains.
Although she was initially suspicious of the product, she quickly had a phone line and
Internet access.

There are, in fact, several profiles for customers that are attracted to prepaid dial
tone services. One segment is indeed those people that do not have proper identification
to obtain a local account, which regional Bell operating companies (RBOCs) require to
establish credit, says Gietzen, whose company initially has targeted California’s Hispanic
market for its prepaid dial tone product. Another category of customers are those
individuals who lost local phone service previously and cannot pay their required deposit,
which can be as much as $300, to the RBOC to restart service, Gietzen adds.

Implementing a convenient method to pay for service has been tantamount to successfully
luring and keeping these potential customers. Prepaid dial tone providers have designed
card-based systems and virtual systems for their products in an effort to make service
subscription as convenient as possible.

Card as Voucher

Some providers offer prepaid dial tone via calling cards. But these are not to be
confused with their long distance cousins.

"[Prepaid dial tone] cards act as a voucher," Walker says. Unlike prepaid
long distance calling cards, which offer the access codes and personal identification
numbers (PINs) for accessing the long distance network, a prepaid local card must be tied
to a landline phone in a specific location just like postpaid local service.

"It is the means for the customer to make a utility payment to establish service
and then to recharge service on a monthly basis after that," Walker says.

A handful of prepaid dial tone providers market their service on phone cards at
convenience stores and grocery stores.

"We have tried Western Union, money orders, faxing and even a system where
customers go in to a bank with the equivalent of a deposit slip," says Mike Ritter,
chief information officer of EZ Talk Communications Inc., a Houston-based prepaid dial
tone provider. "Mostly, though, we wanted it to be simple, which has led us to the
card service we launched in earnest at the beginning of 1999."

EZ Talk’s prepaid dial tone program has four service cards a customer can choose
from–one to initiate service, one to pay for monthly service, one for features such as
caller ID and call waiting and one card to restore service for an EZ Talk customer whose
account has been disconnected.

When a customer pays for a card, the sales clerk swipes the card through a
point-of-sale (POS) card reader, which sends a notification to EZ Talk’s platform that the
card has been purchased. If the sale is for an existing EZ Talk account, the sales clerk
enters the customer’s phone number and the payment automatically is credited to the
customer.

If the purchase is for new service, the notification of payment sits on the platform
until the customer calls an 800 number on the back of the card to establish an account.

Not all card-based prepaid dial tone offerings, however, follow the EZ Talk model.
Phones For All, for example, does not sell feature cards or restoration cards. Its
customers choose only from an initial service card and a monthly renewal card, which
includes call waiting. Also, Phones For All does not require its distribution centers,
which include Circle K and 7-Eleven, to use a POS device. Instead, customers purchase a
card, and call the 800 number on the back. When the call connects to a Phones For All
representative, the customer reads the personal identification number (PIN) number on the
card to verify the purchase.

Not in the Cards

Circumventing the card-based system altogether, some providers have taken advantage of
a rich network of check-cashing centers across the United States for their customers to
pay for service–including chains such as Western Union, Atlanta, which boasts 50,000
locations in 160 countries, and American Payment Systems Inc. (APS), Hamden, Conn., which
has a nationwide network of more than 4,500 agents.

Genesis has reached an agreement with APS to take payment for its prepaid local
products. "Most of the people we are marketing to, if they don’t have a phone, don’t
have a bank account either," Gietzen says. "If we don’t have a convenient
payment location, then we are forcing our customers to go to the bank and get a money
order."

"We get virtually all of our prepayment, especially our initial ones, through our
payment locations, where they accept cash over the counter, and it is transmitted to
Genesis electronically," he says.

Initiating service with Genesis, however, still requires a new customer to access a
phone in order to call the Genesis 800 number for establishing an account.

Considering Cost

As mentioned, the price that the dial tone-impaired consumers must pay per month for
these services does not compare favorably to traditional local service. Voit says he
believes it can be even higher than three times what an incumbent would charge for local
service, which ranges from $15 to $30 per month, depending on the ILEC. The prevailing
rate for prepaid local, however, is around $40 to $50 per month.

EZ Talk’s monthly service fee is $54.50, while Phones For All and 1-800-RECONEX offer
monthly service for $49.99.

Service initiation and service restoration is a different matter. Phones For All
charges $69.99 to activate an account, while EZ Talk’s fee can be as high as $94.50,
depending, once again, on the location of the subscriber’s lines, Ritter says.

Some providers also charge a reconnect fee to their customers who fail to prepay their
account; others do not.

"We feel that [a reconnect fee] would constitute a penalty on our customers,"
Walker says, "which likely will drive away someone who already has shown interest in
our product." Phones For All customers who fail to purchase their monthly renewal
card simply purchase a new service card to start over again.

In contrast, Genesis appears to have lowered the bar for its competitors with a
$24.95-per-month offering. Gietzen cites efficiencies gained through Genesis’s automated
ordering system as enabling the company to make such drastic price cuts.

"We recognized early on that automation was going to be critical–margins were
going to be low," he says. "We decided to start out day one with an electronic
order interface with the ILEC’s that we’re dealing with so all of our orders come in
automated through our marketing processes, [and] they go out electronically to the ILECs.
All of that data exchange is fully automated. There’s huge administrative headaches if
you’re not doing it electronically."

And even the skeptical analyst Voit concedes that the service Genesis provides is as
good as it gets when it comes to prepaid local. "Genesis is not taking advantage of
people–they saw a need, and they’re filling it," he says. "From what I can see,
they offer the best deal on prepaid local."

Adding Long Distance

As the price for prepaid local decline and margins are squeezed, prepaid local
providers are looking at other ways to lure subscribers. For some, tying long distance
into their product portfolio has been the answer.

"A lot of companies do not offer the long distance portion because they have to
block usage-sensitive services, but we are announcing a long distance sister product in
April to go along with our local cards," Walker says. "Phones For All is
certified to offer local and long distance. We knew from the start that long distance
would come into the mix, but we wanted to nail down the local side from the start."

Genesis currently offers its prepaid local customers a long distance package based on a
traditional prepaid card platform. A customer can go to a payment center and make a
payment for long distance services, which is loaded onto the customer’s account. The
system is modified, however, so customers do not have to dial a PIN, Gietzen says.
Instead, the Genesis platform matches the caller’s ANI against the prepaid account before
connecting the call.

Customers who do not subscribe to a prepaid local service with a long distance package
are not without options. They can purchase a traditional prepaid phone card, and dial the
toll-free access number to make a long distance call.

Selling It

The integration of prepaid long distance and prepaid dial tone is yet another example
of the Telecom Act at work, but this marriage still is at its infancy.

"The Telecom Act was passed to increase competition and make new and unique
services available that have never been available before," Walker says. "In
order to get a unique service successfully into the market, it requires a lot of customer
education."

He adds that Phones For All targets customers mainly through its distribution in retail
stores and through radio, television, print and some billboard advertising. Since
education takes time and money, prepaid providers will need to partner with national
distributors that are willing to take on some responsibility for educating prepaid local
service customers on the front line, while service providers educate distributors from the
trenches.

Jennifer Knapp is former news editor for PHONE+ magazine. Liz Montalbano is copy
editor for PHONE+.