DOLLAR SIGNS Fundamental market changes call for fundamental pricing changes >BY KAREN STROUSE

While the nation's telecommunications infrastucture might not qualify as poetry in fiber, it is at least elegant and practical. Driven by the need for reliability, speed, efficiency and universal reach, it is not surprising to find that today's public network bears a striking resemblance to client-server computer systems, airline hub-and-spoke arrangements, and other modern geodesic architectures.

On the other hand, pricing the services provided by the network has required a blend of alchemy and social responsibility. And even as the industry moves toward a market-based model, what consumers pay for service resembles nothing found in market model economics.

Nobody ever pretended that pricing for telecom services was related to the architecture or even the underlying cost of provisioning services. Value-of-service pricing- charging more from business users who benefit most from telecommunications and can most afford it-gave us universal service.

Universal service-the idea that everyone should have access to the network regardless of ability to pay-benefits both users and providers. The goal is to price services to enjoy a profit without pricing customers out of the market. When everyone is on the network, the network is most valuable for everyone. This is still true for voice, and it is even more true for Internet access.

Universal data access allows businesses to target their advertising dollars at actual prospects. What business would not want to flash an ad in front of the user who has just conducted a search about its product? While the concept of universal service is by no means obsolete, some of the traditional means used to achieve it will not work in the new marketplace. Fortunately, new approaches are available that can work more effectively by using real market forces.

For a century, consumers, regulators and providers have been convinced that phone service is not just a consumer product but a necessity, and access to that service is not simply a purchase decision but a right. This belief will not go away, nor should it, as telecom technology promises to become more universal, more useful and even cheaper. Any alternative pricing mechanism must not only accomplish affordable universal service but must sustain market and public scrutiny.

The first step is to identify concepts that until now have been virtual givens in this industry but must be revisited and questioned before too much additional investment is made on their behalf in the future. These concepts include that: the definition of local service automatically means unlimited usage.

low-cost service must be provided to all subscribers, even if unprofitable to the providers.

there is a sharp distinction between wholesale and retail service.

there is a distinction between wireline and wireless service.

The local calling area Ironically, although the very nature of the telephone network renders geographical distances irrelevant, a great deal of regulatory ink has flowed regarding the definitions of "local" calling. Technology, through the Internet, may have at last caught up with today's concept of local service, which often means unlimited calling through a single area, or "community of interest," for a fixed monthly price.

Most on-line services and Internet access points can be reached by a local call. Once connected, the user has access to the World Wide Web as well as the ability to reach other individuals anywhere on the planet. How local is this call? Right now, it's priced as it if its destination were right down the street, and even though the user pays the Internet service provider for Internet access, low ISP rates reflect the lack of any sort of access charge payment to the telco-much to the telcos' chagrin.

The ongoing feud between long-distance carriers and ISPs results from semantics. ISPs maintain that their services should not be subject to access charges, while IXCs see ISP services as interexchange traffic subject to the charge. Both arguments are based upon what could soon be outmoded pricing concepts.

Customers pay for value, not cost, and part of customers' perceptions of value is their ability to control the level of their own expenditures. Before long-distance deregulation, most consumer concerns about price appeared to be that local service-priced under cost-was too expensive, but few complaints surfaced about long-distance service-priced above cost. This contradiction was probably caused by a perception that local service is a necessity and long-distance a controllable luxury.

With flat-rate and cheaper long-distance, this distinction is disappearing. Nevertheless, as long-distance prices fell, usage increased considerably. AT&T's long-distance revenues stayed constant or grew even as its market share dropped by about 40%. In the aggregate, customers' long distance expenditures have increased, yet they are not complaining. Customers have obviously found value in long distance calling.

How should IXCs price their services in a way that recovers their costs without annoying their customers? Many ISP users already enjoy unlimited network access for about $20 a month in addition to their local phone bill.

Whether the total price really recovers the total cost is not the primary business issue because it's not the customer's issue. The acceptable price for an unlimited on-line modem and voice connection to the local central office could very well be somewhere between the present price of local service and the additional $20 price point.

The long-term solution does not distinguish among providers of public network connections-as opposed to the concept called local exchange service. Distinctions between voice and data, or local and long-distance service, will become irrelevant.

Universal service The problem of making service affordable will be a great deal easier to solve if the beneficiaries of subsidies are limited to those who need support. Universal affordable service does not imply that all customers need subsidies, even though this was the historical interpretation.

Today, nearly every residential user, regardless of need or network usage, receives local service subsidies. Bill Gates, for example, undoubtedly gets his residential phone service below cost. Heavy long-distance users do pay local service support subsidies because they contribute through high access charges for the minutes they use, even if they receive small discounts from the IXC. Still, millions of residential customers receive local service at a rate lower than its cost, and far lower than their willingness to pay.

With good intentions, regulations have required costs to be tracked, but not necessarily recovered, to achieve pricing goals. Many fixed costs are covered through variable access charges. At one time, even the labor to install phone service was capitalized.

Usage-based subsidies to support fixed costs will not be sustainable in a competitive market. They cause everyone's favorite customer, the high-volume user, to pay a premium, while the low-volume user gets a price break. This does not happen in a real marketplace.

In a genuine marketplace, users will migrate to those providers that do not make subscribers pay usage charges to support fixed costs. As an example, not too long ago, all subscribers rented their station equipment and paid installation costs for additional jacks over time. Few subscribers would now do that by choice. Eventually the lower-cost, wealthier users might purchase their connections to the network to avoid monthly charges for access. This process would be accelerated if access subsidies continue.

A market-based approach to pricing, however, could enable telecom providers to offer true lifeline service-even if it includes safety features such as caller ID-to customers who truly use it as a lifeline and not to play multi-user computer games for hours on end.

Regulators should appreciate that the industry has taken the initiative to demonstrate that it can solve pricing problems without compromising social goals. With all services priced correctly, regulatory intervention should be unnecessary.

Carriers will need to rethink their investment strategies, however-such as the relationship between capital and expense dollars and the relationship between in-house investment and outsourcing and resale. Most LECs are facing the dilemma confronted by AT&T about 15 years ago: How does the company transform itself successfully from one with 100% market share to one with significantly less? Complicating matters is another issue: How does the provider plan, build and price for a market with very different usage and widely different expectations from the original investment predicted?

Existing plant is a curse and a blessing for carriers. On the plus side, the network is in place, tested and under contract with many customers. On the other hand, new entrants to the network connection market have only to make the build-or-buy decision, based on the traditional decision factors of price and investment control, including the pace of new technology. Visualizing investments to be made on a clean slate will provide insight into the potential investment of local competitors that choose to build, or it will provide a window to the needs of local providers-potential distributors-that choose to resell in the short or long term.

When only one provider is franchised, the wholesaler equals the distributor equals the retailer. But these distinctions will become more vague, if not downright indistinguishable. For the most part, the high-volume user will get deeper discounts for more usage.

Even now, in long-distance, some companies-from airlines to defense companies and Fortune 500 companies-are reselling services to ramp up their usage.

Very little of their savings are passed on to the low-volume users, such as small businesses, to which service is resold. This is transmission service, treated as the commodity product.

To compete successfully, existing LECs will need to decide whether they are public network wholesalers, retailers or both. In the past, they served both the wholesale and retail market by decree, and pricing most often followed much lobbying on all sides. AT&T's 1995 break-up demonstrates the difficulty of sharing a market with one's own customers.

Today's LEC needs to offer a blend of good prices and no hassles to be successful in wholesale selling. The early returns on interconnection do not lean in that direction. Local telcos that see themselves selling to resellers in the future must develop partnership-like ventures so strong that they nullify the inherent conflict any wholesaler incurs when they also sell direct to the end user.

Wireline vs. wireless Some of the larger carriers and manufacturers propose that in the next few years, the handset-which may be cordless or some version of wireless-will be smart enough to be "local" within range of the transceiver and will connect to a wireless carrier with a seamless handoff once out of range. How will those calls be priced? Early proposals imply that local pricing applies within cordless range, and once out of range, the user pays the prevailing cellular rate.

In the long term, will customers accept flat-rate pricing in one spot and timed service several yards away? AT&T recently stepped up to a similar issue by offering a 15¢-per-minute service that is relatively independent of the geography or time of day. Can freedom from transmission technology be far behind? Flat-rate long-distance service has eliminated our fascination with the nature of the destination and, for many customers, the time of day. Customers want to control the facilities they use, but they do not want to become telecom nerds.

When technologies are seamlessly mixed, there are business issues as well. Few carriers have shown much initiative in organizing their companies around customer communication needs. Many companies try to organize around business processes within the operations group or around market segments under the marketing heads.

Still, at the highest levels, most LECs and IXCs continue to maintain separate organizations for traditional vs. newer products, such as wireline and wireless. If these organizational structures remain, for example, a simple problem involving both wireline and wireless might require the arbitration of the chief executive officer.

The customer will order service and will not want to be concerned with whether the product is voice or data or how the call is switched and transmitted. The prospect of interacting with multiple departments or divisions of a local telecom provider-or waiting for departments to agree on solutions-will not appeal to customers.

The alternative is to organize around your customers and their requirements. Customers will not care how telecom providers resolve internal differences, as long as it's always invisible. If convergence is your destiny, then eliminate artificial distinctions that divide customers. These distinctions are everywhere in the present and planned organizational charts of large telecom providers-divisions for products, divisions for international services and divisions based on volume.

When your successful customer moves from one volume level to the next, does your valued client lose all the contacts that helped make it successful? Is a small business like a residential customer? Is a telecommuter a different customer during off-business hours? Pricing is no longer a way to recover a huge amount of investment and expense in a way that is great for some customers and awful for others. Nor is the pricing decision simply a marketing issue. Prices need to reflect the financial profile of the provider, even if operations need to be reviewed to meet pricing requirements. The customer's willingness to pay is virtually foregone; everything else about the business is not.

Karen Strouse is the owner of Management Solutions, Fort Lauderdale, Fla. Her e-mail address is kstrouse@msn.com.