David = Goliath

It used to be easy to spot the good guys, and for a short time, the regulatory bang of the Telecommunications Act of 1996 made it even easier. As new regulations tore down many barriers to success, CLECs charged the gates, eager to battle the established local telcos.

Traditional measures of success declared a CLEC victory: CLEC access lines jumped from 800,000 in 1995 to 5.1 million in 1998, fiber route miles quadrupled and the number of switches increased by a factor of 10. Six companies with a market cap of $1.3 billion exploded into 20 publicly traded facilities-based CLECs with a market cap of $33 billion. A total of 78 facilities-based CLECs at the end of 1996 evolved into 160 companies two years later. By mid-1999, CLECs claimed nearly 7% of the local telecommunications market. David seemed to have beaten Goliath.

But did the up-from-scratch, independent CLECs really score a victory? Today's CLECs are different from the Davids of 1995. Relentless M&A activity is creating an increasingly concentrated industry. The largest CLECs are no longer entrepreneurial upstarts. The merger of MFS WorldCom and MCI created a Goliath of a CLEC. Teleport Communications, previously the largest independent CLEC, second only to MFS WorldCom, was acquired by AT&T. The victory seems to have merely enabled a new Goliath, one that is closer and even more competitive with the original CLECs.

The number and diversity of large competitors are mushrooming. In addition to the IXCs, electric utilities have begun to edge into the market. The RBOCs and other LECs promise increasing activity as well. The revenue and asset gap between these players and the major independent CLECs stretches wide. The IXCs, RBOCs and LECs benefit from the same regulatory freedoms that the independent CLECs fought so hard to obtain. David's regulatory success has fortified Goliath.

The entrance of aggressive, deep-pocketed competitors with operating expertise has altered the criteria for success. CLECs no longer are "alternative" carriers - they are mainstream. Survival now demands distinct market positioning, superior service and a profitable structure.

To remain independent, CLECs must achieve more economies of scale. They must reduce the costs of customer acquisition, billing and provisioning. Until operations are streamlined and EBIDTA is robustly positive, the cost of capital will remain excessively high. For the legacy CLECs - those that began as competitive access providers and fought the hardest - growth is now limited not by regulatory barriers but by their ability to execute.

The investment community has increasingly demanded mature, disciplined performance from CLECs. While the precipitous declines and wild volatility that characterized the past year have been tempered, for many CLECs, the calm has occurred at relatively low price levels. The designation of CLEC now includes the "big boys," and the independent CLECs need to operate at comparable or better levels.

David, of course, still exists. New CLECs will continue to sprout. Founded on a breakthrough technology or marketing premise, these start-ups, for a short time, will benefit from valuations and access to capital predicated on the likelihood of being acquired. Once acquired, company executives will spin off to set up the next generation of newbies. This process continues to compress into shorter cycles. Those companies not quickly acquired must learn how to operate for profit. Goliath is now a CLEC.