What Will the Big Three Do?

Posted: 11/1997

What Will the Big Three Do?

By Gary Kim

Perhaps the only job in corporate America more
challenging than the helm of AT&T is the CEO spot at Apple
Computer. For with the addition of the IXC Communications and
Qwest networks, there now are six nationwide optical long
distance infrastructures. WorldCom is setting a new standard for
what a competitive carrier looks like. And fast-growing assaults
by resellers continue to chip away at market share held by the
largest three players.

To make matters worse, in just a few years, the Big Three long
distance carriers (AT&T, MCI and Sprint) will face new
competition from the regional Bell operating companies (RBOCs).
Indeed, the evidence suggests that RBOC entry into long distance
could have profound market share impact. According to Lehman
Brothers analyst Blake Bath, GTE picked up 6 percent long
distance share after 15 months of effort, while Southern New
England Telephone (SNET) snagged 35 percent share over three
years.

So just what are the Big Three going to do? One way or the
other, their strategic options would seem to hinge on going
global and local. In other words, they’ve got to secure a bigger
slice of the burgeoning international market while, at the same
time, biting off a significant chunk of the local business in the
United States. Moreover, wireless will be a factor, as will
service bundling and data. "Eighty percent of their revenue
will come from non-voice services in the 21st century," says
CIMI Corp. President Tom Nolle.

The Big Three must concentrate on protecting their most
lucrative accounts, while doing what they can to slow share
erosion and, at the same time, recognizing they probably can’t
prevent continued share losses. "There’s no way they can
prevent the erosion of their customer base," says Ray Horak,
president, The Context Group.

A move to providing managed services and outsourcing currently
internal customer functions are two ways to differentiate
themselves. One measure of Big Three success will be the degree
to which they can stay ahead of the emerging second-tier
carriers, who also will be adding virtual private network, data
and Internet offerings to their own service bundles.

Focus Required

And, given reseller strength in the small business market, the
largest carriers must hope to lock down the big business
accounts. That’s because "22,000 sites represent 38 percent
of domestic telephone demand," Nolle says. "You pull
OC-3 to those sites, period." The Big Three also need to
connect about 1.5 million branch office sites.

The future belongs to those who market the best, says Eileen
Eastman, director of telecom research, Business Research Group.
On that score, many analysts give high marks to the Big Three,
while questioning the assumption that RBOC success is a slam
dunk.

"The Big Three also have to look for game-changing
offerings, something the RBOCs aren’t expecting," says
Yankee Group analyst Boyd Peterson. "They can’t just offer
64 kbps service in the local markets," for example. Instead,
the Big Three might try rearranging consumer expectations in a
major way, at the same time putting financial pressure on RBOCs.
"They can give away high-margin enhanced services to snag
share and destroy RBOC margins," Peterson says.

In some cases, while faced with continued nibbling at their
markets from smaller carriers, the Big Three also may be forced
to look the other way. "Resellers may help the majors,
because they sell into markets the majors have a hard time
reaching," says Lawrence Gasman, president, Communications
Industry Research-ers. "The small guys nibble all the time.
It simply may be a thing you live with."

What the Big Three ought to do in the residential area is
problematic. AT&T clearly has the most to lose, since it gets
as much as half its revenue from the residential segment,
representing perhaps 80 million customers. "When the RBOCs
come in, AT&T’s share drops to 30 percent," says NBI
senior analyst Steve Koppman. Indeed, to the extent the RBOCs can
expect to be successful in long distance, it is with residential
customers, Koppman says.

MCI may waffle a bit about the residential segment, while
Sprint seems intent on picking up more consumer share. Still,
perhaps two-thirds of Sprint’s business comes from the business
side. Beyond the Big Three, WorldCom largely seems to ignore
residential consumers, while LCI cultivates them.

In any event, the Big Three must secure the international and
big business segments, attack the domestic local business,
maintain the marketing edge and introduce new bundles of service,
particularly in data and wireless. Small business and residential
segments are where smaller carriers will continue to grow, and
about the best the majors can hope for is a controlled descent.
The wild card is whether the overall market will grow fast enough
so all competitors are chasing a far-larger target.

Not Hobbled

The Big Three are far from hobbled giants,
despite the market share pressure all three already feel from the
second-tier carriers (Worldcom and LCI) and resellers. In 1997,
AT&T’s minutes-of-use (MOU) growth should be in the 6 percent
range, with revenue growth in the 1 percent range, according to
Goldman Sachs. That may pale before LCI’s sizzling 37 percent MOU
and 26 percent revenue growth, but declining share doesn’t mean
absolute shrinkage of MOU or revenue.

MCI’s expected 1997 MOU growth is about 8 percent, with
revenue growth in the 9 percent range, Goldman Sachs projects.
Sprint should come in at 15 percent MOU growth and 11 percent
revenue growth.

Doable

Can they pull it off? Maybe they can, though many within the
reseller community say they just aren’t worried about the Big
Three or the RBOCs. "The Big Three, at least, are big
losers," says Sherman Henderson, president and CEO, UniDial
Communications. "They don’t know anything about customers
and service."

But Henderson says the RBOCs also will lose big–and for
pretty much the same reasons. Others aren’t so sure. Lehman
Brothers analyst Bill Garrahan thinks "most of the RBOCs
will gain 15 percent long distance share by 2002." That
isn’t so much the issue, though, Garrahan says. From a Big Three
perspective, the important angle is that the RBOCs likely will be
most successful with residential customers, which suggests margin
will be low, contributing less cash flow than their market share
gains would suggest.

Using experiences GTE and SNET have had so far, Garrahan says
GTE’s 6 percent market customer share represents 3 percent of
revenue share. SNET’s 35 percent customer share translates into
just 12 percent revenue share. That’s nothing to sneer at, but it
mitigates the revenue impact of lost share.

Go Local

In almost anybody’s scenario, the Big Three must attack the
U.S. local markets, which are too big to avoid. Of the $100
billion or so annual revenues, about $55 billion is generated by
the commercial sector. Employing the same logic competitive local
exchange carriers (CLECs) use, the Big Three would concentrate
direct sales efforts on the more lucrative local customers.

Wireless also figures to be an important factor, given the
cellular industry’s current $27 billion in revenues, AT&T’s
big cellular position and Sprint PCS holdings. It remains to be
seen whether MCI sticks with its current resale strategy.

The Big Three must hope to use wireless and local as a way to
offset share losses in long distance by picking up high-margin
local accounts. "Business access lines represent only 35
percent of the total access lines in the United States, but 55
percent to 60 percent of local revenues and 67 percent of the
cash flow profits (earnings before interest, taxes, depreciation
and amortization)," Lehman Brothers’ Bath says.

Like CLECs, who generally focus on business customers, the Big
Three would concentrate on relatively small pockets of customers,
since the top 10 percent of central offices generate 60 percent
of the business customer revenue, while the bottom 80 percent of
central offices produce only 20 percent of the business customer
revenue, Bath says.

Go International

The international market is the other place the Big Three must
hope to find even wider success, especially as international
deregulation gathers steam. Of the top 25 international carriers,
21 are based outside the United States, and 13 already have
signed partnership agreements with one of the U.S. Big Three.

Of the more than $70 billion international long distance
revenues booked in 1995, 80 percent is contributed by markets
outside the United States, according to Furman Selz analyst Todd
Scott.

Watch Out for Internet Protocol (IP)

One potentially destabilizing trend that could negatively
affect the Big Three and international resellers alike is the
emergence of IP networks. IP transmission is especially enticing
in the international arena because tariffs are high, making
alternatives attractive. Estimates vary, but Kenan Systems Corp.
suggests $1.7 billion in international carrier revenues might
move by IP telephony channels in 2001. Forrester Research
suggests that U.S. IP telephony revenues might reach $3 billion
by 2004, representing about 4 percent of carrier revenue.

Smaller Carriers Benefit

According to analysts at ATLANTIC*ACM, revenues from the
retail sale of switched long distance services in the United
States will grow at about 6 percent annual rates, reaching more
than $74 billion by 1998.

Without much doubt, smaller carriers will keep growing. Over
the past decade, the smaller carriers’ share of toll revenue has
shot up from 4 percent to 16 percent–a faster pace than
originally estimated–according to the Federal Communications
Commission (FCC). Although toll revenue earned by long distance
carriers has increased consistently since 1984, AT&T’s market
share has fallen from 90 percent to 51 percent during that time.
MCI’s share jumped from 5 percent to 18 percent, and Sprint’s
share rose from 3 percent to 9 percent. In Oregon, AT&T has
lost market share, while Sprint, MCI and a host of smaller
carriers have gained share.

But the majors aren’t backpedaling everywhere. AT&T
continues to hold more than 80 percent of the residential market
in Vermont, Wyoming and Maine. MCI’s biggest market penetration
is in Maryland, Delaware and Virginia. Sprint has substantially
increased its share in Utah, Nevada and Arizona. But SNET has
managed to draw almost half of AT&T’s long distance customers
in Connecticut since it began marketing to its current local
services customer base, an FCC report suggests. Over the past
year, AT&T has lost a big chunk of business in large markets
like New York, Florida and Illinois. But the company gained
market share and revenue in Texas.

In some channels, the Big Three are pushing ahead. According
to market research firm InfoTech, at the end of 1996 MCI held 17
percent of the $1.15 billion total prepaid card market in the
United States, for example. Infotech’s analysts also say MCI’s
market share among facility-based carriers was 25 percent.

The Big Three have their work cut out for them, and the
measure of their success will be the degree to which they replace
nearly certain long distance losses with gains in the local,
international, data and wireless markets.