Dawn Of the Big Bells - Company Business and Marketing

Seventeen years after the Big Breakup, the Baby Bells are back. And one of them -- SBC -- could be the next Ma Bell.

ASK SBC COMMUNICATIONS' EDWARD Whitacre how he's feeling these days, and you won't hear any good news. "The economy is taking its toll," he says, a toll forcing the former Baby Bell, which posted $51 billion in sales last year, to heed every expense. What's more, "we face competition from the wireless carriers, including Verizon; from cable -- AT&T is the biggest cable company in the land; from satellite providers," he adds, "It's a tough marketplace right now, and it will only become more so."

Behind Whitacre's gloom, however, there's more than a little posturing. Bell executives never miss an opportunity to state how competitive their business is getting. As the company is expected to announce weak earnings this week, the truth is SBC and its regional Bell brethren are better-positioned than any of their rivals in telecommunications. After all the upheaval caused by years of technological change, deregulation and the Internet, it's an outcome that hardly anyone anticipated.

For most of the '90s, the conventional wisdom was that the Bells were too slow to keep up with the hundreds of technology-charged telecom upstarts flying out of the gate. The Web was changing the basic architecture of the public telephone network, and the Bells couldn't adjust. They got trounced in their early forays into Internet access. Business customers, if not consumers, suddenly had all kinds of alternatives to the local phone companies, especially for data services. The Baby Bells seemed to be stuck with a declining business, and a heavily regulated one at that.

Now it seems clear that in the world of trenches and copper wires and heavy-duty regulatory politics, things actually move at Baby Bell speed. What's left of Ma Bell's progeny -- BellSouth, Qwest, SBC and Verizon -- have maintained their lock on local phone service and driven most of their newfangled rivals to the hills. They've moved successfully into new markets like wireless and broadband Net access. They're poised to fulfill their longstanding ambition of getting full permission to enter the long-distance business; there is even talk that one of the Bells could buy the matriarch herself, AT&T. In short, "Baby Bells" doesn't fit anymore. Try Big Bells.

That's not to say the Big Bells are immune to economic downturns or severe problems in the telecom sector. Last week, for instance, BellSouth's profits fell 11 percent. But their troubles are mere blips in an industry where a whole category of newcomers -- the competitive local exchange carriers, or CLECs -- are going bankrupt, and even stalwarts like AT&T and Sprint are worrying about cash flow. The Bells have billions to ride out the storm. And if they ever get serious about competing outside their territories, one of them, quite possibly SBC, just might become the dominant national communications company.

THE BABY BELLS BEGAN LIFE IN 1984 as the unwanted offspring of the biggest antitrust battle in American history. When AT&T agreed to a court-ordered bust-up of what was then a national phone monopoly, no one really wanted to claim the seemingly stagnant business of providing local phone service. Seven new companies, the Baby Bells, were born to do that work, while AT&T took the more promising businesses of long-distance telephony and communications equipment. SBC -- or Southwestern Bell, as it was known in 1984 -- was the runt of the litter. But after acquiring its siblings Pacific Telesis and Ameritech, SEC has emerged as the second-largest Bell, behind Verizon.

The power of the Big Bells is rooted in their control of the physical infrastructure of local telecommunications. Basically, they own the wires that connect the vast majority of households and businesses to the network, and they own the switches and trunk lines that support most services. The two biggest wireless phone companies are Bells; they're also the biggest providers of the high-speed access services known as DSL, as well as the biggest providers of business lines. According to the FCC, the Bell companies have more than 140 million consumer lines installed in this country for residential customers and small businesses. The CLECs have 8 million. In nearly half of the ZIP codes in this country, there are no competitive local phone carriers to even compete with the Bell giants.

All of this is a cruel surprise to many in the business. As recently as two years ago, Bill Schrader, CEO of Internet networking company PSINet, dismissed the Bells as "dinosaur carcasses." Now Schrader and his company are about to join countless other fledgling networking and phone providers in bankruptcy court. In order to compete with the Bells, the CLECs had to start from scratch and build their own networks -- taking on billions in debt to do so. When the CLECs failed to steal customers, the debt proved crushing.

It was also just two years ago that Dhruv Khanna, executive VP at broadband company Covad, said, "I don't think the Bells are committed to or interested in DSL, or they would've taken the bull by the horns by now. Today, the Big Bells have effectively driven every major competitor except Covad out of the picture and are poised to control 90 percent of the high-speed digital subscriber lines in the country.

SBC HAS AN AMBITIOUS PLAN TO TURN DSL into much more than lust a fat Internet connection. The idea is to build a system that ensures no consumer is more than 12,000 feet, or about 2 miles, from a building where the DSL equipment is kept. This way, the company can guarantee everyone gets at least VCR-quality video on their PC.

"We will be able to make all sorts of content available through the Net that people would never go to the phone company for," says Jason Few, SBC's vice president of DSL. "We will be able to stream a DVD-quality movie to your home. Will we be Disney? No. But we will definitely not be just a phone company.

If consumers provide the opportunity, business clients offer the jackpot. SBC and its Bell cousins plan a complete range of phone, data and Internet services. SBC claims its customers spend only 10 percent to 15 percent of their communications budgets on services with SBC. The rest goes mostly to long-distance carriers like AT&T, which can provide long-distance phone and data connectivity like Internet access.

The company has slowly been investing millions in new hosting facilities for Internet services, and, according to one Silicon Valley venture capitalist, has been kicking the tires at a number of Internet-hosting companies. This is all just the beginning of a push to become a full-service data company for big businesses when the regulatory hurdles come down.

And that's what critics are afraid of. CLEC executives contend the Bells have effectively driven them out of business by refusing to cooperate on the interconnection of equipment and sharing of facilities. In the Internet world, a debate rages over whether the Baby Bells are the key drivers -- or the biggest obstacles -- in the deployment of high-speed Net access. A related argument, one that's been batted around for more than a decade, surrounds the question of whether the Bells should be granted their biggest prize: permission to enter the long-distance telephone business.

It's been five years since Congress enacted the Telecommunications Act of 1996, a broad piece of legislation designed to fix the ground rules for competition across the telecom business. The act barred the Baby Bells from offering long distance and other services until there was real competition in their local phone territories. The idea behind this carrot-and-stick approach was simple: The Baby Bells were given a legal monopoly on local phone networks when they were born, so they ought to be required to support competition on that network.

But the Bells are tantalizingly close to throwing off those legal restraints, even though competition for local phone service has often been anemic. "The biggest issue for us is always regulatory. And the biggest regulatory issue is long-distance data," says Rich Dietz, president of enterprise services at SBC. "We are not allowed to compete with every other telco in the world. It is critical and crucial for us to compete in the long-distance businesses." [See sidebar, page 42.]

Across the country, regulators in a half-dozen states have already cleared the local phone giants to offer long-distance service. While the long-distance phone business is in a slump, largely because of fierce price competition, it's still a $70 billion market, and it has been simple for the Bells to enter. In Texas, where SBC was recently cleared to offer long-distance service, the company signed up 2 million customers in eight months.

The real victory will come when the Bells are cleared in every state, which they expect to occur early next year. "SBC's growth will come from data, from wireless and from long distance," says CEO Whitacre. "Our goal is to be the only communications company our customers will ever need."

NONE OF THIS SITS WELL WITH THE hundreds of telecom companies in this country that compete with SBC, from small startups to titans like AT&T. Indeed, it's fair to say the Big Bells are the most hated companies in the telecommunications industry. Rivals complain that instead of competing in the open markets as expected, the Bells have merged with each other, creating ever more formidable companies with a stranglehold on huge swaths of territory.

"These retrenchment tactics by the Bells have stalled hope for a lot of competitors' says Gerry Salemme, senior VP with competitor XO Communications. Salemme was part of AT&T's lobbying force when the Telecom Act was written. "The biggest mistake was letting them merge. If they had to compete with each other, things would be very different," he adds.

Salemme's complaint has some merit. It's one thing to control a local market, but until the Big Bells demonstrate that they can compete in one another's territory, they will be provincialized. Lately, the Bells have been raising prices on DSL and other services, something competitors angrily point to as evidence of a complacent monopoly.

The most frustrating thing for competitors is that, since the Bells own the local phone networks, they own the customer databases, making it easy and cheap for them to sell other services. "They didn't spend a dime on advertising, but somehow all my customers ended up with them," says Sue Ashdown, the former head of a Net services company and current executive director of the American ISP Association, a lobbying group for small Internet firms.

This issue was outlined in a speech by AT&T CEO Mike Armstrong in February, on the fifth anniversary of the signing of the Telecom Act: "The bad news is that we lose money on every customer we win. Why? Because after we pay Verizon their so-called wholesale fee, there's no margin between what it costs us to provide service and what we can charge for it. And when there's no margin, there's no business."

It is increasingly clear competition will come not so much from government intervention, or even other phone companies, but from firms that have an alternative technology that gets around the Bells' aging local phone networks: satellite, cable or wireless.

If they're afraid of anybody, SBC fears the cable companies, which have a two-year head start offering broadband Internet access. AT&T even spent $100 billion to buy cable companies and use those networks to offer phone and Internet services without having to deal with the Baby Bells.

WHATEVER THEIR INHERENT ADVANtages, the Bells' ultimate victory in the communications war will be hard-won.

While the companies' local phone revenues give them a level of comfort few telecoms enjoy, those revenues are largely fixed, with little room for growth. And even though SBC has made a huge bet on data services and DSL to compensate for the flat local service market, the new markets are not taking off fast enough to compensate for the investments.

A bunch of new companies are moving into the Bells' metro markets, trying to steal business customers with new networking technology. Companies such as San Francisco's Yipes and Denver's Telseon are offering more bandwidth and promising to deliver it faster than the Bell companies ever could.

But if the Bells have their way, people may someday remember the 17 years since the breakup of AT&T as an aberration. The days when consumers bad a local phone company, a different long-distance provider and another company for Internet access are going to go away.

"I've been in this business 35 years," says SBC's chief technical officer, Ross Ireland. "People have predicted our downfall a lot in the last couple of decades. We never let that get to us, and we never will."

                               Big Babies
                  The once unpromising Baby Bells have
                       grown into telecom giants
                                            2000
COMPANY     TERRITORIES                     REVENUES
Verizon     Northeast, Middle Atlantic      $64 billion
SBC         Southwest, West, Midwest        $51 billion
Bell South  South                           $26 billion
Qwest       Northwest, West, upper Midwest  $16 billion
COMPANY     RECENT ANCESTRY
Verizon     Bell Atlantic bought GTE
SBC         SBC bought Ameritech
Bell South  N/A
Qwest       Qwest bought US West
SOURCE: COMPANIES LISTED

Calling on Washington

It's been five long years for the Baby Bells since Congress passed the Telecommunications Act of 1996. A thousand new competitors have blossomed, and for a while it seemed as if the key decision makers on Wall Street and at the Federal Communications Commission were only too happy to see the regional Bell operating companies eclipsed.

Aaron Pressman

But not anymore. Thanks to the stock market's tumble, the money has dried up for the Bells' competitors, throwing many into bankruptcy. And November's election put Republicans in control of the FCC for the first time in almost a decade. The new commission, led by Chairman Michael Powell, will likely take a more laissez-faire approach to local phone competition.

"The last five years have been the dark ages for the Bells. They've been on the regulatory rack for some time," says Scott Cleland, president of the Precursor Group, an independent analysis firm. "They've been the most heavily regulated industry, so they will enjoy a regulatory and investment renaissance because of the change of administration."

The FCC is already making changes. Last week the agency. approved Verizon's application to offer long-distance service in Massachusetts - under a much easier standard than the one used during the Clinton administration. Now that the gates are finally open, expect a flood of Baby Bells seeking approval to provide long-distance service in states from California to Florida later this year and early in 2002.

Only a week earlier, the Bells asked the FCC to roll back rules forcing them to lease segments of their networks to competitors at big discounts -- the centerpiece of the previous FCC's efforts to jump-start competition.

Reaching even further, the Bells also are planning to seek changes in the 1996 act itself. They already got a huge boost when Rep. Thomas Bliley (R-Va.), chairman of the House Commerce Committee and a close friend of AT&T, retired last fall. Now the critical committee through which all telecom legislation must flow is run by Rep. Billy Tauzin, a Louisiana Republican with strong ties to the Bells.

That has competitors worried. "[The Baby Bells] have raw political power from spreading money around and buying influence in Washington," says Dhruv Khanna, executive VP at Covad, which offers high-speed Internet service. Covad and its brethren plan their own lobbying campaign to counter the coming Bell blitz. They'll have their hands full just keeping even.

COPYRIGHT 2001 Standard Media International
COPYRIGHT 2001 Gale Group