The overbuilders may need undertakers

Insight Communications is a small fish in a big pond. As the ninth largest cable company in the U.S., it serves many little communities in rural Midwest areas, with names like Poseyville, Ind.; Homer, Ill.; and Shelbyville, Ken. But Insight Communications is anything but a local yokel. It has an impressive broadband business, and recently it has loaded up on bank debt and tapped into its cash reserves to create a telephone overbuild that can enable the company to provide phone service to more than 100,000 homes in Columbus, Ohio. Insight Communications is going to take on the telephone company in the ILEC's own backyard. Now that's competition as envisioned by the Telecommunications Act.

Insight Communications spends about $50 million per quarter on capital expenditures. To some, that's not a lot of money. But it's real money that creates jobs, contributes to the tax base, helps communities, promotes capitalism and encourages investors to lay down their bets. 

Clearly, Insight Communications is not afraid of risk. But the FCC just stacked the deck here. In one fell swoop it let all overbuilders know that battling the ILEC may be the least of their problems.

Someone is not being true to the Telecom Act

It is obvious to anyone with knowledge of the Telecom Act that legislators envisioned a market in which new competitors would construct new networks and offer consumers new services. The FCC's UNE-P ruling is an affront to this ideal. Effective immediately, everyone can make a mockery of companies that invest risk capital to overbuild a network with the intent of providing services to the consumer market. Newcomers without a checkbook are free to rent phone company facilities at prices not seen since John's Bargain Store days, pocket 50 points of gross margin, sidestep the risk associated with starting a business, and compete against the overbuilder, not just the phone company.

I know why the FCC created UNE-P. In 2000, our firm did a multistate study of residential competition. We found that four years after the Act, consumers had few choices. CLECs typically did not want to build out the residential market because PUCs had kept local phone company rates so low that newcomers probably couldn't make a dime constructing laterals to every home. Unable to reverse PUC access line policy-making, and eager for competition to take off in the consumer market, UNE-P was invented. Of course, it did the trick, though it probably severely hurt the communications industry as a whole.

Recently, cable companies, in search of growing revenues and profits, have begun to reap the benefits of cable modem deployment. Beating the pants off the phone companies, and generating attractive profit margins, has motivated cable providers to release more profitable communications offerings. Voice telephony, so basic it should be a food group, is a natural. Cable companies have begun to overbuild to deliver voice telephony services against the established ILECs.

In doing so, overbuilders target that portion of the consumer market that spends the most money on voice and data services. It is enormously complex for the ILECs to completely wall off this market segment from competition since it involves too many consumers. Unsurprisingly, millions have begun to migrate their voice communications to cable companies. 

Overbuilders may not know what hit them

UNE-P dissolves barriers to market entry. Facilities-less carriers, using UNE-P from the telco, likewise target the high end of the consumer market. Overbuilders are not likely to know what hit them as state PUCs look to entice more consumer competition ushered in by cheap UNE-P prices. In fact, it is reasonable to assume that UNE-P has already cost the overbuilders hundreds of millions of dollars in forgone revenue from the consumer market.

The FCC's UNE-P decision is not an incentive to build a network. It's a disincentive. Anyone can come to Columbus, or a thousand other cities and towns, use the ILEC network to provide service, and sell telephone service at a price well below any and every facility carrier's cost. It's complex to imagine future investors putting up money to construct any local network, or backing a telecom company, when a hundred new competitors may spring up tomorrow, using UNE-P.

There is no clear end in sight for UNE-P. With 51 jurisdictions now calling the shots, it is certain that UNE-P will be around for a very long time. As businesses built on the UNE-P model multiply, the forfeited revenues that might have gone to the overbuilders will continue to mount.

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