Thrown for a Loop

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A small but growing number of consumers are taking a bigger leap, buying their phone service from a cable company like Cox Communications, which has grabbed a 25% market share in Orange County, Calif., and Omaha, Neb., or the new Comcast, which recently merged with AT&T Broadband. And as more households upgrade to high-speed Internet access (2 out of 3 choose a cable modem over a dsl phone connection), the Bells are losing a valuable source of revenue: the second phone line that customers use for dial-up Internet service.

For the first time since the Great Depression, the number of residential phone lines in the U.S. declined last year, about 1%, a trend that is expected to continue for the foreseeable future. Says BellSouth ceo Duane Ackerman: "We have enough on our plate without having to deal with contrived competition."

To rid themselves of it, Ackerman and his colleagues Ivan Seidenberg at Verizon and Edward Whitacre at SBC are pressing FCC chairman Michael Powell to modify the competitive rules during the agency's "triennial review" early next year. If they don't get relief, the Bell chiefs warn, the last relatively healthy sector of the ailing telecom industry will soon be facing financial ruin, and America's communications infrastructure will follow it into disrepair.

"It makes no economic sense for the competitors to invest capital at these prices," says Randall Stephenson, chief financial officer of SBC Communications. "We still maintain the network and provision it, and the cost structure doesn't change. From a financial perspective, the model is unsustainable." As long as they are subsidizing their rivals, the Bells insist, there's no reason for them to upgrade their networks, which puts a further drain on the depressed equipment sector, including companies like Lucent Technologies and Nortel Networks.

The Bells' crying and moaning might elicit more sympathy if, over the past six years of deregulation, they had delivered on their promises to compete against one another for local service. During that period, they have incurred repeated fines by federal and state regulators for not opening their networks. "They were so busy trying to prevent real competition that they let a monster develop," says Royce Holland, ceo of Dallas-based Allegiance Telecom, which has $517 million in annual sales and is one of the few surviving small, competitive local exchange carriers that have built a solid business selling telecom bundles to small and midsize businesses. As for the Bells' poor-mouthing, Holland quips, "If anybody thinks they'll invest more money in their networks if they get their monopoly back, I've got some swampland in Texas to sell."

Many in the know, including staff members at the FCC, share Holland's incredulity about the Bells' dire warnings. Earlier this year, the Bells' critics point out, the U.S. Supreme Court ruled that the resale pricing methods used by regulators are appropriate, guaranteeing the Bells their costs plus a reasonable rate of return. If the rules are such a great deal for the resellers, "why aren't the Bells competing in each other's territory?" asks AT&T president Betsy Bernard. To be sure, both sides in this argument have valid claims. While it's probably true that the Bells aren't heading for bankruptcy, it's also clear that regulators are assessing the Bells' costs on the assumption of super-efficient communications networks that in most cases don't yet exist.

"This is not science. It's a policy goal," says Eli Noam, director of the Columbia Institute for Tele-Information in New York City. "It's pretty clear that, given the head start of the Bells, it's difficult for someone to come in without a little regulatory weighting of the scales. But you don't want to prolong it. It puts regulators in the driver's seat."

AT&T and MCI claim that they don't want to remain under the government's wing forever. They insist they will eventually build their own local facilities and networks in densely populated major metro areas (except for the last mile to the home, which no one expects will ever be replicated). But in a business with massive fixed costs and economies of scale — in which the current local networks were built with government subsidies and a guaranteed rate of return — the newcomers say they can't make the necessary investments until they have built up a critical mass of customers. Wayne Huyard, chief operating officer of MCI, which is part of WorldCom, currently enmeshed in bankruptcy proceedings, says the Bells' claims are "absolutely a scare tactic. We don't want to ride a competitor's networks any longer than necessary. But they realize that forcing a premature migration to our own networks will kill competition. It's classic monopolistic maneuvering."

The irony, not lost on observers from Wall Street to Washington, is that if the Bells' rivals stay in the business long enough and persuade wary capital markets to finance their separate networks, the Bells' distress could grow worse. Instead of getting paid a nominal amount by rivals who piggyback on their networks, the Bells would be getting almost nothing from customers they lose. Lawrence Babbio, president of Verizon, insists, "I'd rather take that risk [than see the situation persist]. It's a trade I'd make any day of the week." But Babbio knows it's not likely that he will get the chance anytime soon. Even if Powell can give the Bells some of what they so desperately want — and many believe the FCC chairman will try to do so — the access requirements will probably be gradually phased out over a few years.