UNE-P: Regulating toward the end of the industry?

Signaling dire consequences for the telecommunications industry, market mover UBS Warburg analyst John Hodulik downgraded the Baby Bells in late August citing an alarming trend he had been monitoring in UNE-P pricing. Hodulik believes the dropping prices that competitive local exchange carriers (CLECs) pay to Bell operating companies Verizon, SBC, BellSouth and Qwest for bundled packages of network elements could severely hamper the Bells moving forward.

UNE-P prices have been tumbling downward over the past 12 months due to decisions being made by regulators who are dissatisfied with the state of local competition in the residential sector. Taking it out on the Bells, states like New York and New Jersey have slashed UNE-P rates hoping to encourage competition.

Unwittingly, policymakers have started a trend that has the potential to weaken the financial situation of the very companies that build and maintain the telecommunications infrastructure upon which every company in the industry relies. Rather than benefiting their constituents, PSCs around the country are putting the viability of the entire landline network at risk.

Although most CLECs that sprung up in the wake of the Telecommunications Act of 1996 market their services to business customers, the Big Three long-distance companies and a handful of smaller firms such as Z-Tel Communications have targeted the residential market. Rather than going after customers that spend thousands of dollars per month communications services, these carriers sought to make a profit on customers that spend, on average, around $35 per month on local services. Long-distance companies, the largest providers of UNE-P service, have had to go after these less than attractive customers in an attempt to stave off the effects of depleting margins and escalating competition.

A political hot potato

It would be wrong to blame competitors for creating the current situation--in the mind of residential CLEC, there is only one way to make the service profitable, and that is getting UNE-P rates as close to zero as possible. The other option, i.e., raising residential rates to market prices, is not an option any company can lobby for without engendering a massive backlash.

Although almost any industry analyst would tell you that Aunt Tilly is simply not paying enough for the telephone services she currently enjoys, it's nigh impossible to convince a lawmaker or regulator of this. No ratepayer wants to pay more, and the PSCs are beholden to powerful folks who listen when large lobbies like the AARP speak. If residential prices were right-sized, we could expect greater levels of competition. However, few policymakers are willing to work towards that goal. Instead, they have taken the easy way out. Brand the local phone company as a monopolist and lower UNE-P rates.

That has put us where we are today--regulating toward the end of the industry. If the Baby Bells continue to be treated as they were in the days of rate-of-return regulation and not the private companies with shareholder responsibilities that they are, we can expect little more than a gradual demise of the communications network. America's telecom infrastructure, the envy of the world, will crumble if current trends continue. Competition is vital to this industry, but it should not come at such a high price.

Regulators must consider the ramifications of their actions. Ratepayers, countless equipment vendors and UNE-P carriers all depend on the ability of the large incumbents to maintain and upgrade their networks. In the past, the danger of politically motivated decisions to push UNE-P rates lower merely threatened the health of individual state's communications infrastructure, but the several recent decisions have turned a ripple into a tidal wave that threatens to wash away a hundred years of progress.

Robert A. Saunders is a senior analyst with The Eastern Management Group, Inc. (TEMG, Bedminster, N.J.), a management consulting firm focused exclusively on the communications industry. He can be reached at rsaunders@easternmanagement.com.