THE
TELECOM MELTDOWN…Looking for the Underlying Reasons
By: Thomas K. Crowe, STC Regulatory Counsel
In 2001, approximately 77
telecommunications companies sought bankruptcy protection, up from 20 in
2000. Of this number, many competitive
local exchange carriers (“CLECs”) have sought bankruptcy protection, including
GST Telecommunications, Inc., Winstar Communications, and Rhythms
NetConnections, Inc. This alarming trend has continued throughout 2002.
A Spectacular Bankruptcy Filing
WorldCom’s
recent filing under Chapter 11 of the Bankruptcy Code represents the single
largest bankruptcy in U.S. history. Not
far behind is the recent bankruptcy of the fiber optic network operator, Global
Crossing, representing the fourth largest bankruptcy in U.S. history. Other former telecommunications leaders,
such as Williams Communications Group and Network Plus have also sought
bankruptcy protection since January 2002.
The
telecommunications industry is experiencing nothing less than a meltdown. Characterized by multiplying bankruptcies,
including the infamous WorldCom reorganization filing, this particular meltdown
may be the largest affecting any industry sector in recent U.S. history. What is causing this meltdown?
The answers, at least in part, lie
both with the failure of the Telecommunications Act of 1996 (“1996 Act”) to
successfully open markets, and with the erosion of the traditional switched
long distance market.
The meltdown appears to be driven
in part by the failure of the 1996 Act to successfully promote local
telecommunications competition. In the
years following enactment of the 1996 Act, it was expected that by this year
several of the major interexchange carriers (“IXCs”), along with possibly a
handful of new entrants, would be significant forces in local communications
markets across the country. Clearly,
this has not occurred. To the contrary,
IXCs and start-up CLECs are struggling, and increasingly the RBOCs appear to
have won the battle for overall market supremacy and made significant inroads
into long distance markets. Some have
questioned whether what we are witnessing is nothing less than a
remonopolization of the telecommunications industry.
After five
years of experience under the 1996 Act, it is apparent that deregulating entry into
local telephony has not done enough to open local markets to competitive
forces. New CLEC entrants have been
unable to crack the local telephone monopoly to any significant extent. While CLECs have captured about 8% of the
total local lines in the country, they only control about 4% of local lines for
residential and small business consumers.
Worse yet, most of this “competition” is not across new distribution
facilities. New facilities competition
only accounts for about 1% of the total number of lines nationwide and, in the
residential and small business sector, it is less than 1%. In short, the incumbent local exchange
carriers (“ILECs”) still have a complete stranglehold on local telephone plant.
Further
illustrating that local markets are not open to competition is the failure of
the RBOCs to compete against one another.
With the advent of the 1996 Act, it was hoped that the RBOCs would
attack each other’s service areas, as they are best situated to do. However, this has not occurred. Rather than compete, the RBOCs have
merged. Before 1996, the largest four
ILECs owned fewer than half (48%) of all lines in the country. Today, the largest four local
providers-Verizon Communications, Inc. (consisting of GTE, NYNEX and Bell Atlantic),
SBC Communications, Inc. (consisting of Southwestern Bell Telephone, PacTel,
Southern New England Telephone, and Ameritech), BellSouth Corp. and Qwest-own
about 85% of all of the lines in the country.
Blurred Vision
In the
final analysis, it very well may be that the 1996 Act was predicated upon
unrealistic economic assumptions and therefore imposed unrealistic economic
signals, leading to widespread failures in telecommunications markets. One of those assumptions was that
telecommunications is not a natural monopoly.
In the month that the 1996 Act was
enacted, former FCC Chairman Reed Hundt stated, “The old law [the Communications Act of 1934] assumes that
communications was a natural monopoly.
The new law [the 1996 Act] assumes that all parts of the communications
marketplace can be made competitive.
The new law is intended to end the era of big government in
communications and begin the era of genuine competition.”
Hindsight appears to be
demonstrating that this grand vision was flawed and that local telephone
companies may have distribution networks that cannot be duplicated.
The second
erroneous assumption of the 1996 Act appears to be that the RBOCs would grant
access to their local distribution monopoly networks on fair and competitive
terms to prospective competitors.
Granting such unfettered access is an unnatural business act, with no
rational economic incentive. This is
amply demonstrated by the failure of the local competition to take hold under
any of the three interconnection methods, which the 1996 Act authorized: facilities-based competition; the purchase
of unbundled network elements (or UNEs); or resale.
If a
remonopolization of telecommunications is occurring, the future U.S. market
structure may bear more resemblance to the pre-AT&T-divestiture era than it
does to today’s market. Presently,
three RBOCs dominate the U.S. market: Verizon, SBC and BellSouth. Each of these companies has a direct billing
relationship with, and distribution facilities to, its customers. Together, they already own the largest
mobile telephone businesses in the nation.
The prospect of these companies acquiring the remaining, ailing IXCs is
foreseeable in today’s chaotic market, consolidating once again long distance
and local service operations. The
ultimate irony may be that if the RBOCs end up dominating local and long
distance residential markets, Congress may face the need to dismantle
significant portions of the 1996 Act, returning instead to a model reminiscent
of the AT&T Consent Decree.
Driver #2: Long Distance Erosion
Technology Substitution
The second
force driving the telecommunications meltdown is the erosion of the long
distance market. Technology
substitution involving wireless networks and IP telephony appears to be eroding
a once-identifiable, switched long distance market. The result: destructive long distance price competition
in pursuit of retaining market share.
The long
distance industry is experiencing significant technology substitution, with
users substituting alternative technologies, such as wireless mobile services
and IP telephony, for wireline long distance.
The effects of technology substitution are reflected in declining
FCC-reported switched, interstate telecommunications revenues. Such revenues declined in 2000 for the first
time since such statistics were compiled and declined as well in the first half
of 2001.
The decline in long distance markets cannot be underestimated in understanding the current economic chaos faced by the telecommunications industry. The decline in long distance revenues and destructive price competition that technology substitution has caused is undoubtedly fueling IXC bankruptcies and may have played a significant role in the recent WorldCom bankruptcy. With entry into local markets blocked, and the long distance market eroding, revenue growth for carriers dependent upon conventional long distance pricing models and historical demand assumptions will be severely limited.