Posted: 09/1997

The Death of a Salesman

Resellers Face a Critical Juncture

By Bob Titsch, Jr.

For years pundits have predicted their demise, and resellers
continually made fools of them, but it’s resellers themselves who
are doing the talking lately.

Some industry insiders say the competitive market brings with
it the death of a salesman-specifically resellers, who face a
critical juncture as margins continue to contract. Rigid legacy
programs and strategies sound the death knell for an industry
segment that must now redefine itself to survive.

Clearly, any industry cycling through contracting profit
margins necessitates a competitive response. But with little room
for error, the wrong response could be lethal. Obviously,
creative resellers can build and hold onto a niche position that
larger carriers under-serve or ignore to stay alive, but
competitive long distance companies without a unique marketing
twist that lures and holds customers (despite price) must gain
mass quickly and develop switch-based strategies to survive, say
industry veterans.

"In the new resale model, the operative word is
control," says Frank Scardino, president of Atlas
Communications. "A lot of resellers are getting pushed
sideways by market forces and, in some instances, their
underlying carriers. So they’re scrambling to gain some command
of the situation. They want to control their own destiny."

Though in its infancy, Signs of a strategic shift for more
control already are evident. Several resellers are scrambling to
deploy switches to least-cost routing and lower costs of goods
sold, as well as to position themselves for an assault on local
markets. Others are seeking partition arrangements with third
parties and underlying carriers (that are open to the idea) to
gain similar efficiencies without the capital outlays. Greater
numbers of resellers are turning to sub-CIC (carrier
identification code) arrangements to increase brand awareness and
better manage automatic number identifications (ANIs). In some
cases, resellers are spending up to $700,000 to deploy and
translate their own CICs with Bell companies nationwide. And
scores of companies are in discussions and actual negotiations
for potential mergers to consolidate ANIs in concentrated
geographies, gain network efficiencies and increase scale.

Switching Solutions

Some industry leaders are convinced that two years from now
switchless resellers will not exist. They believe long distance
companies must have network to stay alive. Others say the notion
is ridiculous.

"If switchless resellers aren’t panicked, they should
be," warns Jerry Cadey, vice president of operations for
Midcom, Seattle. "You have to be a switch-based carrier to
survive over the next several years."

Midcom employs a powerful marketing and sales machine. But
current management is convinced that sales and marketing savvy
alone will not sustain a long-term play. Thus, the company is
deploying Nortel DMS 250s in Seattle, Dallas and Atlanta, and DMS
500s in Los Angeles, Chicago and New York.

We will be originating 90 percent of our own traffic just nine
to 10 months after deployment," says Jim Ottinger, vice
president of carrier sales. "That’s going to earn us sizable
reductions in costs of goods. When you’re switchless, your cost
of goods is only as good as your contract."

Others say a good contract is all you need. "A vendor
calls me every week to tell me how much money he can save me if I
buy a switch," says Robert Mocas, president of Easton
Telecom. "My answer is always the same: If I had features
groups and circuits all over the nation, I still wouldn’t be able
to put together a network that made sense for me due to my size
and the fact that I have traffic scattered all over the
country."

Certainly, economics drive the determination to become
switch-based. That will never change. But few can deny the
decision tree is growing. Issues such as control, independence
and valuation are weighing heavily on the minds of resellers who
have moved to a facilities-based model. "If you have to
exercise control, you must be facilities-based," says Rob
Hale, president of Network Plus, Quincy, Mass. "Purchasing a
switch is not just about economies of scale. It’s about the
information concerning patterns of usage and demographics–and
how you can turn that information into revenue.

"If you’re switchless, you buy at the ‘telecom
store,’" he adds. "If you don’t like the price, you
have no options. Carriers, meanwhile, buy at the ‘telecom mall.’
If you don’t like one product, you can buy from others."

Facilities also offer companies higher valuation. "Wall
Street looks at switch-based carriers differently," says
Ottinger. "Switchless public companies are valued around
six, seven and eight times’ monthly revenues. But Telco
(Communications Group) just sold for a huge multiple, something
like 27 times revenue."

Resellers are a diverse group with different business models
and human and capital resources. How, then, can they determine
whether or not they can absorb the cost of a switch? "If
you’re a reseller averaging 700,000 minutes a month, with 80
percent of the traffic coming from one concentrated region, you
would lose about $267 a month after buying one of our
products," explains Keith Brown, eastern regional sales
manager for IEX Corp. "But 10-percent growth, to 770,000
minutes a month, would yield a savings of $1,100 a month. Grow
another 10 percent, and it’s $2,500. By the end of the first
year, with growth to 1.4 million minutes per month, the
cumulative savings reaches $90,000."

The Intimidation Factor

One factor holding back a number of switchless resellers from
moving to a switch-based model is their lack of technical
experience. And the talent pool for network technicians is very
thin. "Any talent that’s out there has been sucked up, given
huge salaries and stock options," says Melissa Craig,
president of New York-based General Telecom, a company that
offers switch-partitioning services. "It’s one of the
reasons we’re in business. It takes a lot of time and talent to
administer a network."

Ross Dahl, president of Huntleigh Telecom, El Paso, Tex.,
decided to home grow his technical talent. Huntleigh employs
three engineers and four technicians who recently decommissioned
an old switch and deployed a new one from DTI Technologies.
"None of this is rocket science, but it’s not Tinker Toys
either," he says. "You have to have good people who
have an understanding of the business and are able to learn
quickly."

Dahl found relief in the National Veterans Outreach Program
(NVOP), a program designed to help employers hire veterans.
"When soldiers and veterans are leaving the service, they’ll
register with the state employment office," he explains.
"We went to the Texas Workforce Commission and explained we
were looking for individuals who served in the communications
arena.

"Although the hires we made did not have any experience
in our business, they had a background in digital communications
theory, which is obviously more fertile than candidates without
any knowledge," he says. "And, it’s worked like a
dream. These are federal- and state-funded programs that
subsidized our bringing on these techs for 30 percent to 50
percent of their training. It’s one of the few things I ever got
back from the government."

And Now, for Something Completely Different

A few wholesale carriers are offering an alternative switching
solution via creative partition arrangements with resellers,
essentially leasing them switch ports on an unbundled basis.

"The only way you can survive with acceptable profit
margins is to purchase your own switch or use someone else’s
while they run it and least-cost route for you," says Skip
Lane, president of Network One. "Considering our needs,
skill sets and strategic plan, we opted for a partition
arrangement with our underlying carrier."

Lane concedes his kind of arrangement is rare, but suggests
that resellers explore similar opportunities. "Very few
companies allow you to do it, but resellers should seek out
carriers that have similar synergies and strategies in the same
geographic regions. The MCIs and the Sprints aren’t going to it
because they want to be in control, and this is truly a
partnership.

"Though the benefits can be absolutely critical for
survival, resellers need to do their due diligence before
choosing a partner. You don’t want to team up with the wrong
partner–a company that’s overextended its network, is not paying
its bills or has a weak back office, for example," Lane
notes.

One can only speculate that the majority of wholesale carriers
are watching this development with a mix of fascination and
horror. Obviously, these arrangements allow resellers to
least-cost route to competing networks. But some industry
observers say these arrangements will multiply. "Over the
next year, we’ll see a number of regional players do deals with
other regional players," predicts Mark Haney, a partner with
Haney & Ticknor, a telecommunications law firm.
"Incredibly diverse companies are going to need network en
masse to survive, and they’ll strike mutual partitioning
arrangements with each other to squeeze the last penny out of
their individual networks."

The natural extension of those partnerships, says Haney, would
be a series of mergers to create mini "super regionals"
capable of dominating specific markets. "They could dig in
like Georgia ticks," he adds. "Play up the colloquial
warm fuzzies, supporting local schools, industry and such. This
way, when the Bell companies get in the business, they’ll have to
buy you."

Crunch Time

Churn and the incremental costs of acquiring new customers
continues to rise, forcing providers to run even faster and spend
greater sums of cash on new customer acquisition just to stand
still, let alone to grow the subscriber base, according to a
recent report from Bear, Stearns & Co. Inc. Equally
disturbing, the competitive long distance community is losing its
middle class, creating a substantial gap between small and large
providers–and the wholesale buy rates available to them.

As a result, many resellers are running out of money, which
will lead to massive consolidation, say industry analysts.
"Presently, there are two schools of thought in the venture
capital markets," says Blackburn. "One school is
convinced that smaller resellers cannot survive, that they have
no hope because they lack the management sophistication, depth of
management and access to capital. Similarly, the second school
concedes that smaller resellers are in serious jeopardy but will
actually strengthen their positions through consolidation
opportunities."

One thing everyone agrees on is that the next few months are
going to be telling. The mad scramble is on, and resellers cannot
afford to sit pat.

TANDEM SWITCH SCENARIO

Approximate costs and benefits associated with moving from
switchless to switched resale, using the new generation of small,
class 4 tandem switches with remote maintenance.

Components: Single, 19-inch rack/cabinet, class 4
tandem with 12 T-1s, SS7 and PRI

Cost: $140,000 (installed with spares, warranty and
training)

Assumptions:

*$140,000 @ 11-percent interest, 60 months **19-inch
rack/data cabinet, power: 9 a.mps @48vdc. Simple Break-Even:
400,000 minutes at a savings of 2 cents per minute = $8,000 per
month

Incremental Revenue Opportunities Can Include: