A final word on UNE-P

While the FCC’s Chairman Powell spends these last few minutes maneuvering Republican and Democrat commissioners into position before rolling out the triennial review conclusions, let’s take a final look at UNE-P, the centerpiece of the FCC’s upcoming report, and weigh in on how this four-letter word should be adjudicated.

Congress did not invent UNE-P. It was not part of the warp and weft of the 1996 Telecommunications Act. What Congress did infuse into the Act was the competitive entry of CLECs that would resell service, construct their own facilities or supplement such construction with unbundled network elements from the incumbent carriers. That much is a reasonable idea for getting the new industry out of the starting block. UNE-P, though, is a concoction of the FCC’s making, which has socialized the telephone companies’ unique DNA so that everyone, for a farthing, could be just like Ma Bell. This all seems pretty harmless at first blush--a Robin Hood-esque maneuver where there is an appearance that everyone wins. That is, unless that is you think the phone company deserves to win too, which it doesn’t. Oh yes, and there are other losers, but let’s not get ahead of ourselves.

Of itself, the Telecom Act was a winning idea. Before long, venture capitalists were force-feeding almost $500 million per day into the communications industry. That which didn’t go to fund CLEC start-ups fueled infrastructure manufacturers and software companies dedicated to serving CLECs.

On top of all the private equity money, banks loaned another $800 billion to fuel the new industry. With so much cash available, it is hard to comprehend that the FCC didn’t believe entrepreneurs could tap into some of it. However that must have been the case. The idea of UNE-P was made to order for anyone short of funds.

Now UNE-P didn’t cause the telecom industry to crash, but like a stroke delivered after a fall down a flight of stairs, it has kept the victim on the floor.

UNE-P has created several serious problems for the communications industry. First, since state commissions have kept these wholesale rates very low, facilities-based carriers can save money eschewing construction and picking up UNE-P instead. This leaves manufacturers of central offices, converged switches, fiber, monitoring devices and software beached. It is not surprising the industry has lost a half million jobs in recent years.

Second, UNE-P has created look-alike competitors. By purchasing telephone company facilities for very little money, adding a small markup, and selling uninspired same-old-services for less than it cost the phone company to construct them in the first place, competitors bring nothing to market that a customer cannot already get (and probably has) from the phone company. Price is the differentiator, albeit a transient one. Once cutover takes place, here come additional competitors also selling the same UNE-P services from the phone company. So now the price advantage is gone, too, as is the force behind the Act, which envisioned many new and inspired services.

Third, UNE-P has kept telecom investors sidelined. Last year about $80 million per day was invested in nascent companies by venture capitalists. Little of it went into telecommunications. As an advisor to several private equity firms, my advice has been to steer clear of carrier start-ups for now. Those with the greatest promise would obviously be facilities based, but there are no assurances that after investing in a new network, 500 cheaper competitors with a bag of UNE-P will not cover the landscape. And why shouldn’t a private equity company invest in a business plan based on UNE-P? Because there is little in the way of unique value, barriers to entry, ability to control costs (the same government who set UNE-P rates can change them) or an exit strategy. In other words, little probability of getting liquid.

At the time, the FCC correctly understood the high cost of purchasing a central office, which could easily run into the millions of dollars; however, times have changed. Every new city targeted by a CLEC no longer requires such a large investment, or even a central office. Converged switches can concentrate traffic in a city such as Ft. Worth and then backhaul it to perhaps a Dallas central office. Small converged switches can be purchased for as little as $30,000, or roughly $30 per DS-0. Small central offices are also available for under $100,000, or $50 per DS-0. Numerous manufacturers would gladly provide these products, if only the FCC would give them a chance.

If the FCC recommends against UNE-P, which it should do, here is my assessment of what happens to the carriers who employ the device. Some, whose businesses have been constructed entirely on UNE-P, may sell off their installed base of customers to facilities-based carriers. Others, who are already largely facilities-based carriers with some UNE-P, may refocus to add more customers on their existing networks. Yet a third UNE-P dependent carrier group may have sufficient UNE-P customers in given geographies to warrant purchasing new switches, or buying concentrators to backhaul traffic to an existing switch.

Clearly UNE-P must go away. Doing so will reward consumers, who will see the resurrection of new services growth. It will also reward infrastructure creators, who will benefit from a return of capital used to build and manage networks; facilities-based carriers, who can exploit their product differentiation; and investors, who will return to the market. The phenomenon of UNE-P must be permanently dismembered, over a time period that makes sense. For my money, the sooner the better.

John Malone is President and CEO of Eastern Management Group, a management consulting firm focused exclusively on the communications industry. He can be reached at jmalone@easternmanagement.com.