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From the May 20, 2002, Worcester Business Journal

Whose line is it, anyway?
The struggle for more telecom competition
By Ed Hilow

There was a time when picking up the phone was simple. When, as a customer, the choice for telephony services was simple, when there wasn’t any need to worry about who handled the service at the other end of the line. Now, not only are there new phone services to contend with, but also Internet and data services as well as who is providing these services.

Verizon Communications Inc., in all its forms, has been viewed by its competitors as the lumbering giant, difficult to deal with, uncaring and perhaps complacent in its size. But such an image is changing, as the telecom market vies for the growing competition in the small- to mid-sized business segment in Massachusetts. After the telecom shakeout, those competitors left standing are perhaps big enough and smart enough to compete with Verizon.  But let there be no mistake: All these telecoms at one point or another are ultimately customers of Verizon.

The scene, however, is no longer one of Verizon hoarding its network, like a selfish school child taking his or her ball and going home, but of a company that must compete if it expects to survive. What was once familiar in the past with few or no choices for customers has given rise to many choices and even choices about choices.

There is no going back to simpler times. What the telecom landscape will look like over the next few years is still anyone’s guess. But it’s clear competition will continue to grow and customers will have more choices to make.

Fed up with Ma Bell
For nearly 100 years, the American Telegraph and Telephone Co. dominated the telephone market, until 1984, when the federal government ordered the company to divest into seven Regional Bell Operating Companies (RBOCS). New Jersey Bell Telephone Co. became one of the seven "Baby Bells" and became Bell Atlantic Corp. In 1994, it changed its name to Bell Atlantic-New Jersey. Following the acquisition of Nynex in 1997 and a merger with GTE in 2000, the company became Verizon Communications, the largest provider of local phone service in Mass. as well as several other states.

In 1996, the federal government enacted the Telecommunications Reform Act. Its premise: Promote competition by eliminating the monopolistic structure of incumbent providers and by eliminating legal barriers for other facilities-based competitors in the telecom market. While the Telecom Reform Act was enacted with the best of intentions, its success has been slow in spurring the fervent competitive spark that was originally predicted.

With all the changes New Jersey Bell underwent before becoming Verizon, and in spite of the Telecom Reform Act, it has a century of history as a monopoly to overcome. It’s a task, despite its shear size and presence, that requires still more change.

While the markets for local and long-distance phone services have clearly matured with decades of history, the market for other services, such as digital subscriber lines (DSL), broadband and Internet access, are still relatively immature. Combined with the still-young deregulated market, which is going on six years, competition is now arising among telecom companies that are large enough and smart enough to hold their own against the incumbent.

"X" marks the spot
Launching its network in Mass. in 1999, Reston, VA-based communications services provider XO Communications, with offices in Waltham, spent $40 million to build out its network in this state. Despite the network’s size, which is primarily in Eastern Mass., XO must lease lines from Verizon at certain points for crossovers onto Verizon’s network when providing services to its own customers, which are exclusively businesses. In 2001, XO posted revenues of $1.3 billion and a net loss of $2.1 billion. As of December 31, 2001, it employed about 1,000 people.

Early on, XO encountered some difficulties in dealing with Verizon, says Paul Keefe, vice president and general manager of XO Communications Massachusetts. "There was a period of time [at] the end of 2000 through 2001 where it was really difficult to get services in a timely fashion from Verizon," he says. "There were tremendous lead times." He attributes part of the difficulty to the number of competitors early on that were trying to provision services to their own customers but needed to lease lines through Verizon. He also notes part of the difficulty was within Verizon itself as it needed to shift gears into a competitive market.

Jack Hoey, director of the Northeast Bureau of Verizon, agrees there was some technical difficulty in opening Verizon’s networks. But, he says, "[In] the first couple of months, it took some ironing out on both parts [of Verizon and other carriers]. There was a learning curve on both sides [where we] were taking systems that were not designed to be used by others." On the competitive-market front, he notes, Verizon started offering bundled services to business customers in May 2001.

Despite XO’s goal of providing services to its customer entirely across its own network, says Lisa Lawless, XO’s executive director of corporate communications, it will never be completely independent of Verizon, especially in the Greater Boston area. She does note, however, that the amount of services that XO provides on its own network has grown. About two years ago, about 30 percent of XO’s traffic went entirely across its own network, she reports, and about 70 percent was, in part, handled by the incumbent. Today, she adds, XO is seeing about 65 percent of its traffic run across its own network. "As the market matures," she says, "we’ll see more and more our ability to deliver services entirely across our [own] network." The majority of XO customers still require a connection to Verizon’s network.

What has been a challenge, XO’s Keefe says, is the paradoxical relationship that his company has with Verizon as both a direct competitor as well as a customer. While for the most part, XO’s relationship with Verizon has been a good one, he reports, early on in the process there were more difficulties with long lead times for orders and connections. And while he prefers being able to provide all his XO customers with direct connections without cross connections onto Verizon’s network, he says, he knows there will be cases where that is not possible. "I can’t think of another industry where you’re depending on your biggest competitor," he observes.

However, there’s a measure of concern in Keefe’s voice with regard to Verizon’s entry into the long-distance telephone market. The Telecom Reform Act of 1996 laid out a path to opening the markets to competition, he points out, and having all of the RBOCs like Verizon open up their networks and allowing these competitors to use them. The carrot for many of these local exchange carriers, Verizon included, he adds, was that they could get approval to sell long-distance, which at the time was a really a good carrot for those companies. Many of these LECs have now gotten the authority from state utility regulators to offer long-distance. "So there really is no incentive for them now to provide us with excellent service," he maintains. "There’s no more carrot there."

Verizon’s Hoey strongly disagrees that his company lacks an incentive. He notes that although Verizon opened its networks and met the necessary criteria to offer long-distance, it’s not a one-time deal. Every month, he points out, Verizon must submit a report to the state Department of Telecommunications and Energy showing it has provided service to its wholesale customers. "We have every reason in the world not to backslide on that," he says, "because if we do, we pay penalties. ... We always have the DTE looking over our shoulder, and our wholesale customers would not stand for it."

Verizon has filed for rate increases for the lines it leases to competitors. Depending on where the lines are located, the proposed rates reflect increases ranging from 18 percent to 91 percent. Keefe does not want to see the DTE approve the proposed rates since XO would have to pass the costs on to its own customers. He cites the precedent set by the New York State Public Service Commission, which not only rejected a rate increase, but instead ordered Verizon to lower rates. Keefe expresses the belief that the Mass. DTE will not approve rate hikes, either. "I hope the pricing remains the same," he says. "I would consider it a strong vote of confidence from the DTE in the future of competition in the state." The DTE expects to complete its review of Verizon’s rates by this summer.

Such concern aside, Keefe says he believes that competition is increasing in the state, as more and more businesses begin to realize that the incumbent is no longer the only choice. While there is some differentiation among the costs and the types of services and products companies, including Verizon, offer, what’s going to set them apart is customer service. Of that, he says, "Customers are looking for competitors - [for] better customer service, customer loyalty, lower prices [and] innovative service offerings. The people who are buying voice and Internet service in companies around Massachusetts, they’re well aware of competition.".

Giving customers more than one choice
Rochester, NY-based Choice One Communications Inc. first made its presence in our region in 1999 with the acquisition of Worcester-based Atlantic Connections LLC, which also had offices in Portsmouth, NH. By the end of 2000, Choice One had about 28,000 clients, all of which are business customers. It now services more than 80,000.

Its annual revenue in 2001 was $181.6 million with a net loss of $248.8 million. Total employees in 2001: 1,758.

Ythan Lax, director of corporate communications for Choice One, notes that Worcester has been a very successful market for her company, particularly in the area of DSL, because Choice One bundles its services. "It is difficult for Verizon to compete with us on price because, in general, we will save the average client between 30 percent and 40 percent," he adds. "And by offering a bundle of local, long distance and DSL, it’s like getting the DSL line for free because our product pricing is equivalent or sometimes even less than what the client would normally expect to pay for local and long distance alone."

Like XO, Choice One entered our market with a plan that involved building a network as needed. "We’ve never overbuilt out our market," Lax says. "We always did significant business planning and market research to determine where there was a market for our service. We did not go into markets and immediately start laying fiber and immediately start overbuilding to handle future potential."

Wendy Wilusz, regional director of sales for the Central Mass. market for Choice One out of the Worcester office, agrees. She also cites the high level of integration between Choice One’s and Verizon’s systems. "If you take a look at what’s made Choice One successful, it’s really been the provisioning," she maintains. "Many companies in this marketplace have been able to sell lots of line but have not been able to get them on to their networks successfully in a way that the customer doesn’t lose services." But because Choice One is electronically bonded with Verizon’s network, she notes, Choice One customer information and orders are quickly and accurately processed.

Lax describes Choice One’s relationship with Verizon as good, in the sense that they both have to exist in the same market. "We are competitors, but we are also business partners," she explains. "There’s a benefit to Verizon to make sure they work with us. They have to, by the nature of the regulation but also [because] we’re a fairly large customer of theirs. Based on the size of our business, we do lease a lot of these local loops from Verizon and therefore we’re a sizable wholesale account to them."

While Choice One is reliant on Verizon for leasing the local loops, Choice One has been successful in reducing that dependency by using intra-city fiber, its own network with a switch in Springfield that also serves Worcester, and through co-location, by which it locates its own equipment in Verizon central switching offices to tie into the incumbent’s network. "By decreasing that dependency," Lax says, "we increase our profit margins, which is one of the reasons we’ve been successful through being a facilities-based carrier."

Both Lax and Wilusz agree there is telecom competition in Mass. While they agree the telecom shakeout has thinned the competition, they note that other factors have also contributed to Choice One’s success. One of the things that has been determined as a winning strategy," Wilusz says, "is a company that has the complete bundle [and] does everything on their own network." She attributes the failure of many companies to doing a lot of reselling first and then trying to build networks later.

On the other end, Lax adds, were the telecom companies that took the approach of trying to sell only new services, such as DSL, and nothing else. A lot of these companies went on a data-only strategy, he observes. They felt that since other companies were already offering local and long-distance phone service, he adds, they would focus elsewhere. This meant telecom companies were selling non-voice phone services to business customers, he continues, while those same customers had to go elsewhere for voice phone services.

Of Verizon’s bid to increase its leased line-rates, Choice One expects the DTE to follow the lead of other states, such as Maine, New York and Rhode Island, where the increases were rejected and lower rates were imposed. "The public utility commissions in those states essentially ruled the other way - they’ve lowered the rates we have to pay to use local loops," Lax says. "We’re seeing this as a trend."

From the success of Choice One as with XO, it seems that size is a factor when competing against a RBOC like Verizon. But as Choice One’s Lax notes, "It’s not necessarily bigger [that’s better], as much as it is [being] properly scaled." Wilusz also adds that customers are not just picking a telecom provider blindly, she notes they’re looking for "stability" when it comes to services because they don’t want to keep re-doing the work of finding another provider.

Being conversent with the market
Marlboro-based communications service provider Conversent Communications, started in 1998, provides network and phone services to about 18,000 small- to large-sized business customers in 54 communities throughout Mass. It co-locates in 125 central switching offices. It expects to see a positive cash flow by the fall of 2002. The company employs 630 people.

Of competition in the state, Robert Shanahan, Conversent’s co-founder, president and CEO, points to the long-time presence of Verizon in its various forms. "Verizon was the only alternative for 100 years. There’s a market awareness challenge that businesses think that Verizon is the only option," he says. "Part of our sales presentation is, the 1996 Telecom Act has created an opportunity for consumers to choose local carriers and get people to feel comfortable that Verizon isn’t the only phone company. So that’s a bit of a challenge, but I think that’s becoming less and less of an issue now. Customers are starting to feel comfortable now that there are viable alternatives.

In all fairness, though, Shanahan also sees Verizon’s own history as a factor in its own efforts to change in a competitive market. "I think they’ve been slow to react," he says. "It’s like turning the Titanic around in Boston Harbor. I think there’s going to be a threshold of pain when they start losing enough market share. They’ll start to think about how they can be more innovative and customer friendly - two factors that will make competitors stand out."

However, Verizon’s Hoey says, the same history that the competition cites as a handicap is actually a strong point. "We think our scale and scope," he says, "gives us the opportunity to be competitive on price and with reliability of a company that has been around for so long."

Shanahan describes the relationship between Verizon and Conversent as a good one. He does, however, note that it has its challenges. "We’re competitors, but we’re also a wholesale customer of theirs. It’s a cooperative relationship," he explains. "Sometimes, we get into a bit of a tussle and we’ll have to have it go to the regulators, but for the most part its pretty cooperative. I think the length or our relationship matters - that we have a good understanding of what’s required from both sides."

While Conversent is not the largest telecom provider - based on number of customers - in the state, it is one of the successful ones that survived the telecom shakeout. Its strategy has been the same as that of other surviving telecoms: Build infrastructure as it is needed, not before.

Shanahan sees the market for newer telecom services as still fairly immature, but thinks it will grow with time. He feels innovative products, costs and customer service are going to be the benchmarks that separate telecom companies in the future. However, on deregulation under the Telecom Reform Act, he thinks it could go a little further. "I think it’s been kind of successful," he explains. "In theory, it’s sets the stage for competition. [But] it needs to go one step further, and that step is the separation of services from network at Verizon." In Pennsylvania, that state proposed breaking Verizon into two companies. One is a network company that would sell networks to other companies, including Verizon. The other would sell just services.

Shanahan sees Verizon’s proposed price hikes in Mass. for leased lines and its attempts to secure all of its central switching offices from even its competitors, as "nothing more than smoke and mirrors." He doesn’t think the rate hike is going to pass DTE muster. "In New York, [Verizon officials] were forced to lower their rates. We saw about a 20 to 25 percent decrease in our costs in New York. I expect the same thing will happen in Massachusetts."

In the courts, Verizon is challenging the decision by state utility regulators that lowered the rates it charges competitors for leased lines. Interestingly, Hoey says, the federal pricing formula is based on a hypothetical network, which is based on the most efficient design that could be built with today’s technology rather than the actual network that exists. "It’s a fantasy network," he says. The current pricing strategies does not allow us to make a reasonable profit." The U.S. Supreme Court is reviewing the case.

On heightening security, Shanahan thinks "it’s a case of Verizon trying to get what they can, and they keep bringing it to the table and getting it slammed back in their face." He says he believes such measures would be disastrous. "That would be a step backwards for the competitive telecommunications landscape," he adds.

Hoey elaborates on security by pointing out that it was the DTE that prompted an investigation of its own security measures last January. As part of that probe, the agency surveyed Verizon as well as other carriers for ideas on what types of security measures could or should be necessary. One of Verizon’s suggestions included limiting access to critical switching stations, which would prevent competitors from gaining access even to their own equipment. These sites would be maintained by Verizon, but through virtual co-location, competitors could monitor operations. While this was criticized by competitors, Hoey quickly points out that the plan would apply to "a handful" of offices and these high-risk locations would be determined by the DTE, not Verizon.

When size matters
Blaik Kirby heads the carrier practice for Boston-based Adventis Corp., a management and strategy consultant firm. He notes that with the Telecom Reform Act, a lot of new players entered the telecom business after raising capital. Many of them, he observes, made the assumption that they were easily going to get 15 percent market share within two to three years of building a network. The problem was, he notes, there were so many players, each assuming that they were going to get 15 percent market share. So it’s pretty easy to see how there’s an excess of capacity that was built. He notes the over-building frenzy of many of these companies put them out of business while the smarter companies built on a strategy of finding markets first — like the three telecom providers interviewed for this story. (See "Blaik Kirby tells why there’s $70 billion of dark fiber," April 22 issue).

While there is some telecom competition in the state, it has been primarily in the business market, says Michael Lauricella, analyst at research and consulting firm Yankee Group in Boston. "The simple fact is, there really isn’t, in my opinion, sufficient competition in the business market," he says. "There isn’t as much competition in the market as Verizon likes to believe or likes to indicate." Conversent’s Shanahan agrees.

Laureicella also notes that the motivation for Verizon to want competition in order to meet regulatory controls, is not necessarily the same as how it will deal with competition once it achieves regulatory approval in different states. He does agree there is a challenge that Verizon faces to change its ways given that it has never had to compete before. "It is not an easy task to put all the processes in place and change the mindset of many of your employees, to deal more equitably with competing providers," he says. "It’s a major paradox."

Telecom competition in the Bay State is alive but still far from intense. With a still maturing telecom market, excluding traditional local and long-distance phone services, the larger well-positioned telecom companies that survived the shakeout will have the best chances of attracting the small- to medium-size business customers that Verizon has historically ignored.

It’s a case where size does matter in competing against the incumbent, but where size can be a handicap in turning things around. Innovative products, responsive customer service and controlling costs will be the major factors for which business customer will look as they become use to the competitive market.

As the telecom market begins to mature, whether Verizon is ready or not, other telecoms - who are Verizon’s wholesale customers — are going after the market. And they’re going to be key competitors.