ENTERPRISE PRICES PLUMMET, COMPETITION TAKES ITS TOLL

Throughout the second-quarter earnings season, a veritable chorus of carriers unanimously bemoaned the intense competition and price pressure in the enterprise market. And no one expects the agony to end any time soon.

Qwest Communications was hit particularly hard in the second quarter, reporting 284 fewer retail business lines and almost $130 million less in total wireline revenue than it had a year earlier (both single-digit percentage drops). When competitors offer lower prices, said Qwest CEO Richard Notebaert, “We have to make a decision: Do we walk? In some cases, we walked away. Because we are not going to price below positive cash. In other cases, though, we've got a little bit of room.”

Several forces are feeding into the price war, including cheaper technologies such as voice over IP and metro Ethernet, the desperation of struggling interexchange carriers, the expansion of competitive carriers and the efforts of Bell companies to target well-heeled clients. The brawl was no doubt exacerbated in January when AT&T CEO David Dorman, perhaps realizing that MCI's bankruptcy led to fewer customer defections than he'd expected, abandoned the company's traditional high-margin strategy and vowed never to be underbid for another business contract.

AT&T's plight is no less perilous now, however; the firm expects its margins to shrink in the second half of the year as the price war continues.

“The race to the bottom cannot be sustained,” AT&T President William Hannigan said during the company's second-quarter earnings call. “It's important for us to not lead the parade.”

In this buyer's market, enterprise customers make bold new demands, truncating contracts to one year or insisting on frequent contract reviews — sometimes refusing to sign a contract at all. Carriers often are being forced to lower prices even for existing customers. “There's constant, continual contract renewal,” MCI CEO Michael Capellas said during the company's second-quarter earnings call. “A lot of your contracts move to market prices more quickly than you thought…every customer thinks they should [have] the lowest rate in the market.”

Bell companies can often use their last-mile control as leverage in price fights because it gives them lower costs. Doreen Toben, chief financial officer of Verizon Communications, who said the company's “enterprise advance” initiative is on track to find $250 million in new revenue this year, said she doesn't believe in “buying market share in challenged market segments.” But her boss, CEO Ivan Seidenberg, said during the RBOC's second-quarter call that Verizon would do so where it makes sense.

Time Warner Telecom gained some ground, reporting a 13% ($9.3 million) year-over-year rise in enterprise revenue for the second quarter. Other competitive carriers such as Broadwing Communications and XO Communications didn't grow as much, though their expansion through mergers (with Focal Communications and Allegiance Telecom, respectively) should fan the flames of competition. And no one expects a break in the price war until major carriers begin to merge (if then).

In the meantime, each carrier is racing to lower its operating costs faster than the rate of falling prices. Qwest in particular may not have much time, according to Guzman & Co. analyst Pat Comack, who warned Qwest on its earnings call, “After this quarter, people are going to start wondering about your ability to execute…on fixing this broken cost structure you have.”