The resale route

Consider the recent statistics on resale: The local resale market, which has grown to more than 1000 active competitive local exchange carriers, was projected to have more than 3 million access lines and $5 billion in revenues by the end of 1998, according to The Association for Local Telecommunications Services. CLEC revenues totaled about $3 billion in 1997, half of which came from switched and special access services. CLEC local revenues totaled $1.5 billion, representing about 1.3% of the total market share.

Clearly, some companies are profiting from local telephone resale.

But there's still plenty of room for growth. According to a membership survey conducted by the Telecommunications Resellers' Association, 89% of respondents earn less than $12 million annually from local service resale (Figure 1).

Much of the potential remains untapped because many local markets have been slow to open to competition, which is why the FCC has yet to allow the regional Bell operating companies into the long-distance market. And although some facilities-based CLECs started business earlier in the decade, the market for local competition has grown sharply since the Telecommunications Act of 1996, which paved the way for resellers that had no facilities.

Several issues still must be resolved. Local resellers still need procompetitive pricing for interconnection, unbundled elements and resale, says Cronan O'Connell, vice president of industry affairs for ALTS. They also need equal access to rights of way and operations support systems (OSSs).

No universal resale rules There have been several speed bumps on the road to local competition, says Ron Gavillet, executive vice president of strategy and external affairs for USN Communications, a Chicago-based reseller.

Local resale is much different from long-distance resale, Gavillet says. Local resale includes services such as 911, 411 and inside wire maintenance, to name a few. These all have different rules for resale, depending on the state writing the rules. Resale is also different depending on the RBOC the reseller works with, so what works in one market may not work in another.

Even pricing in the same market can be a tangled web. For example, between O'Hare Airport and downtown Chicago, Ameritech has some 180 different ways to price a telephone call-one reason why local reselling can be so tricky.

Although local carriers can choose to build their own telecommunications infrastructures-as MFS and Teleport did before the telecom act-it's much more effective to resell local service, Gavillet says. Building requires a significant capital investment that few carriers are willing to make. Only 6% of CLECs provide entirely facilities-based interconnection services, according to the TRA (Figure 2).

However, offering a combination of resale and facilities is the best bet, according to Daniel Ernst, director of competitive telephony for The Strategis Group. If a company doesn't have at least some of its own facilities, it can't keep a good handle on service. He points to USN as a case in point. USN had been growing quickly, but it recently has run into financial difficulties.

USN, which targets businesses with at least 10 lines, is adding 50,000 lines a quarter-the equivalent of adding the 25th largest exchange carrier every 90 days. Such fast growth isn't for everyone. "Speed can be dangerous," Gavillet says. "Control is critical."

But it's hard to have that control when 100% of the business is resale, Ernst says. He recommends that USN adopt more of a hybrid strategy to improve its financial results.

Not all resellers are growing as fast as they like, says Derek M. Geitzen, president of Genesis Communications, a reseller based in Grover Beach, Calif. "Regulators want local competition at the residential level, and they favor facilities-based competition vs. resale," he says.

But Geitzen sees little competition from facilities-based carriers stemming from infrastructure costs alone. "Most of the companies that offered local service in 1997 have since withdrawn from the market," he says.

Beyond the telecom act Companies such as Genesis believed that the FCC crafted fairly pro-competitive legislation when it drafted the Telecom Act of 1996. The company thought the act "would lead to a free market, driving down costs and creating an environment that would support local competition; profitability would come from larger discounts on resale and the ability to recombine unbundled network elements," Geitzen says.

However, according to Geitzen, incumbent LECs did not comply with the requirements of the act. Any time there was a problem with service, RBOCs "cited inside wire trouble," Geitzen says. "This is still happening." Without discounting customer service, network quality and other factors, he maintains that to effectively compete, local resellers must be able to differentiate on price, an issue cited by other resellers as well.

Although he agrees that the RBOCs aren't welcoming competition with open arms, Tom Jenkins, a senior consultant for TeleChoice, says that viable opportunities exist for resellers in some markets, particularly with value-added services.

The RBOCs are starting to offer more competitive resale agreements so that they can get into long-distance service, but more needs to be done, says Martin McDermott, former senior vice president of e.spire. Ameritech and Bell Atlantic are the leading RBOCs supporting resale, he says. "The market is beginning to open up. The Bell companies want to get into long-distance," he says. "And [customers] don't want to deal with the Bell companies any more."

Several things must change before resellers can truly compete with incumbent LECs, according to McDermott, including:

* Local number portability must become a reality.

* OSS standards must be established. Carriers currently use several types of OSSs, which don't always communicate with each other.

* RBOCs must offer discounts for resale of greater than 30%.

Similarly, according to respondents in the TRA survey, three major barriers to local competition include wholesale discount rates, inadequate OSSs and problems with the incumbent carrier (Figures 3 and 4).

TeleChoice's Jenkins says low rates are an important factor, but not the only one.

"Local service is a several million-, if not a billion-dollar market," Jenkins says. "But it's a low-margin business. The [Bell companies] are like any other business: They'd rather not have the competition. But they do want to get into the long-distance markets."

Jenkins attributes some of the slowness in developing more competitive local markets to incumbent LECs' inexperience as wholesale providers. But more profit opportunities for resellers will emerge as the competitive markets evolve. Those markets will eventually include the RBOCs as they resell service in other Bell company territories, he says.

Genesis' Geitzen doesn't foresee much profit for resellers until regulators take a closer look at incumbent LEC business practices. He claims that incumbent LECs have predatory marketing practices and that as many as 30% of their bills are often inaccurate. Genesis has successfully disputed some $1 million in incorrect bills. These disputes aren't won easily-incumbents often cite their legacy billing systems as having a history of being correct. But Geitzen urges other resellers to carefully audit their bills from the incumbent LECs.

Ameritech, which according to Jenkins is one of the more progressive companies in opening its markets to competition, solves the billing problem by sending CLECs the same billing information that the company uses internally, according to Neil Cox, former president of Ameritech Information Industry Services. The unit, which handles wholesale transactions, was formed in 1993.

"Our wholesale operations are growing rapidly, and the CLEC segment is one of the fastest growing of our market segments," says Cox, who is now president of SecurityLink from Ameritech. "Ameritech's goal is to be the nation's leading telecommunications wholesaler."

The carrier sees value in working with resellers, and with good reason: Competing carriers are offering service in more than 80% of the communities that Ameritech serves. "In 1997 CLECs represented only about 15% on $760 million in revenues," Cox says. "We project the CLEC share to jump to 39% on nearly $1 billion in revenues for 1998."

As of mid-1998, Ameritech had signed nearly 150 interconnection agreements. Of these, 69 were active resellers and 24 were unbundled loop CLECs. As of July 1, 1998, nearly 750,000 access lines had been resold or unbundled in the region, and more than 180,000 end office integration trunks were in service. This was expected to grow to nearly 250,000 by the end of 1998. Ameritech is abiding by the FCC's full 14-point checklist to ensure local competition, Cox adds.

But he disputes Geitzen's stance that regulators need to mandate local resale discounts in the range of 35% to 45%, with vertical features such as voice messaging discounted 70% to 80%. Ameritech discounts its services from 18% to 25%, depending on the service and the market. "The resellers have no risk on their capital and no investment in a network," Cox says. "They don't have to worry about obsolescence, installation or repair services."

Cox points to the fact that Ameritech has spent $30 billion on its network so far, and it spends an additional $2 billion a year on expansions and upgrades. "We want to make sure the network is used," he says.

Where Cox sees a potential problem with resale is with the possible "pick-and-choose" aspects of a case now before the U.S. Supreme Court. Under current law, any deal that Ameritech-or any other RBOC-offers to one company must be offered to another at the same price. That's fine, Cox says, as long as the other companies are also held to the other parameters of the existing contract, including total volume and voided expenses.

A ruling in October 1997 by the Federal Court of Appeals for the 8th Circuit in St. Louis agreed. That decision overturned a lower court ruling, which said that in a contract with the incumbent LEC, a CLEC could get the same discount or other features as other CLECs but didn't necessarily have to agree to all the other terms of the contract. The case was still pending at press time. "I can't believe the Supreme Court even agreed to hear this case," Cox says.

Another ruling that could add to market competitiveness, Cox says, is if regulators agree to equalize business and consumer rates. Now, resellers are focusing only on business customers because that's the only area where good profit potential exists.

By removing the business "subsidy" and raising consumer rates, there would also be profit potential in the consumer market, Cox says.

Enhanced services nirvana As local resellers look to become more profitable, many see enhanced services as the Holy Grail. Enhanced services tend to provide better profit margins, and the more complex a suite of products a customer has from a company, the less likely that customer will go to a competitor.

Facilities-based CLECs might have some advantages in providing value-added services because they have equipment to add features such as voice mail and unified messaging to basic telephone service, says TeleChoice's Jenkins. However, non-facilities-based resellers can buy wholesale local service from one source, long-distance service from another company, cable from a third and value-added services from another source, then profitably offer them to customers as a single package.

Call answering is the most successful of enhanced services to date, with a 15% market penetration, says Dan DesRuisseaux, senior product manager for Priority Call Management, Wilmington, Mass. "Call answering is known and understood worldwide," DesRuisseaux says. "It's a stepping stone to selling other services."

But subscribers want more than call answering: They want enhanced applications and interfaces, including:

* Unified mailboxes that combine messaging for multiple devices.

* A network answering machine that allows a customer to increase messaging penetration.

* Virtual mailboxes that generate revenue from users who don't subscribe to voice mail.

* Services such as family or business mailboxes and one-key call return for network traffic.

* Fax messaging.

* Messaging notification.

* Internet services.

* Unified messaging that features text to speech for a telephone and e-mail notification.

Jenkins sees tremendous potential in Internet services. Some studies show Internet usage doubling annually, although other studies question those figures. But it's not enough just to provide enhanced offerings. For resellers to profit from these value-added services, DesRuisseaux recommends that they employ multi-application platforms. This will allow them to easily add additional revenue-generating features; scalable switch-based architectures, which allow service providers to scale systems as the network grows; and interface emulation, which enables resellers to offer additional services without changing the current interface.

The profitability and number of enhanced services also depends partly on the region of the country the reseller serves. While Ameritech, for example, does offer voice messaging and other "non-telecommunications" enhanced services on a wholesale basis, other RBOCs do not. Resellers want regulators to force the RBOCs to offer these services to wholesalers at steeply discounted rates.

Whether resellers and incumbents are at odds over regulation or in agreement over bringing competition into the local market, one thing is clear: The resale route willbind them together for better or worse. But where that road will lead has yet to be determined.