Future Vision

Gale-force winds of change are blowing across the telecommunications industry, ushering in new competitive models unimagined even as recently as two years ago. And nowhere is this change more apparent than the local exchange.

The Telecommunications Reform Act of 1996, the wide-ranging legislation passed by Congress and signed by President Clinton in February, will go down in history as the death knell of an archaic, paternalistic local telephone system-a system whose monopolistic approach to service delivery fostered inefficiencies and stifled technological advancement in ways that could not survive innovative technological developments and marketplace realities.

After 10 years of reform that began with the breakup of the Bell System, progressed through the rise of competitive long-distance providers and continues today as competitors emerge market by market in the local exchange, telecommunications users will finally benefit from economically efficient competition across all facets of the telecom market, which now includes the Internet. As the Internet continues to grow at a phenomenal pace-currently there are 30 million to 40 million users and traffic is doubling every five months-it may become the dominant vehicle for business communications and residential entertainment. Historical Perspective

Local exchange competition in the early 20th century emerged in hundreds of cities and towns across the United States. In the vast majority of cases, the competing carriers were the local, Bell-owned carrier and an Independent. The competitive Independent carriers faced a near-impossible task, however, because the Bell System refused to let competing carriers interconnect to Bell's local affiliates or the Bell long-distance network to complete or receive calls.

This situation meant that the Independent carriers' subscribers had to purchase local service from both an Independent carrier and the local Bell affiliate to place and receive local and long-distance calls. This additional financial burden on their subscribers put Independent carriers in an untenable competitive and financial position, with most going out of business or selling out to the Bell System at "fire sale" prices.

Lack of network interconnection had largely eliminated local exchange competition by 1913, when the United States government began investigating the Bell System for antitrust violations. In a historic settlement agreement called the Kingsbury Commitment, the Bell System agreed to interconnect with the remaining Independents, which by then were primarily monopoly local carriers serving sparsely populated rural areas that the Bell System simply was uninterested in serving.

These interconnection agreements, addressing traffic interexchanges and compensation arrangements between local exchange carriers, ratified a monopoly local exchange environment that has endured for more than 75 years. In an unexpected consequence, however, these early 20th century agreements provided the model for a rebirth of local exchange competition in the 1990s.

State Leadership Two years ago, only one state-New York-allowed a competitive access provider to originate or terminate a switched local call on its own network. And that freedom had its cost: The CAP paid more than 100% of its local exchange revenue to the LEC for interconnection, call termination, phone number assignment, phone number retention, directory listings and access to essential services such as signaling, databases, 411, 911 and directory assistance. In essence, these argonauts of the local competitive rebirth were on the same difficult side of the financial coin as their early 20th century ancestors.

Fortunately, recent actions by state regulators and legislators avoided a repeat of early 20th century history. Under the leadership of the New York Public Service Commission, the barren economic wasteland of local competition was dramatically transformed by historic co-carrier agreements between MFS Communications and Nynex and between Time Warner and Frontier Corp.

These agreements incorporated a number of elements of the longstanding arrangements between the Bell regional holding companies and Independent telcos, and it addressed major co-carrier issues such as interconnection, reciprocal compensation, interim number portability, unbundled loops and access to other essential services.

Others joined New York in the vanguard of the rebirth of local competition, and by the end of last year, nearly 25 states had taken some action-either on a legislative or regulatory basis or both-toward authorizing local competition. These jurisdictions, including California, Connecticut, Florida, Illinois, Maryland, Massachusetts, Michigan, New York, Oregon, Pennsylvania and Washington state, account for about 50% of the nation's local telephone business. It was in these markets that CAPs were most effective both in lobbying the regulatory bodies and legislatures for equality in identifying what elements were necessary to achieve co-carrier status and in compelling entrenched LECs to accommodate their presence and recognize their legal rights.

Additionally, New York and a number of other states have begun a process to reform a well-intentioned but outdated system for universal service. A number of regulatory bodies are evaluating issues, including possible contributions by all carriers in a competitively neutral manner, a neutral administrator for universal service funds, subsidies for low-income and high-cost subscribers, and competition for carrier-of-last-resort responsibilities. Needless to say, several of these proposals have evoked strident opposition from monopoly local carriers.

National Policy With tangible progress occurring as a result of the high-profile federal debate, and with activity among the states having opened so many of the larger markets, some might have questioned the need for a new national law governing local telephone competition. In truth, however, federal legislation was needed to affirm and enhance the progress already made. For too long, it was the burden of CAPs themselves to raze the barriers and inject competition into local markets. And although the industry has done a remarkable job state by state, only action at the federal level could have altered the competitive environment so quickly by making local competition the law of the land.

Indeed, it took the federal government to engineer the single most important enabling element to achieve lasting competition. With the new law, linkage exists for the first time between regulatory reform that both satisfies the supposed desires of the RHCs to enter the long-distance market and opens up local markets to meaningful competition.

Specifically, the new law enables the RHCs to enter long-distance markets and other previously closed businesses according to how competition has taken hold in the local markets they serve. In short, the new law was written so that the RHCs will have every incentive to pursue and achieve the highest standards of compliance with local competition requirements in the shortest time.

RHCs will be rewarded or penalized based on their individual behavior in facilitating the transition from a monopoly to a competitive market. They will no longer function as a monolithic group with no individual incentive to accept competition.

Under the federal statute, RHCs will be able to begin providing long-distance service within a state after certain provisions are met (see sidebar). These provisions are calculated to eliminate any foot-dragging on the part of the entrenched carriers.

The Shape of Things to Come Dynamic technological innovation, rapidly changing market dynamics and an increasingly competitive global economy are irreversibly transforming the telecommunications industry. These are the same factors that have transformed the computer and software industries with resulting explosive growth during the last decade. These factors are also driving a convergence of the telecommunications, cable television, media, computer and software industries.

The primary difference between the telecommunications and computer/software industries is the existence of century-old regulatory barriers. The events of the past two years, as well as the passage of the federal telecommunications legislation, indicate that these barriers are rapidly falling. And leadership by state regulatory bodies, as well as by CAPs, has been the driving force and catalyst for change.

Perhaps a sneak peek to the future can be seen in the explosive growth over the past year of the Internet and the World Wide Web. Previously unknown companies such as America Online, CompuServe and Netscape now appear about as frequently in daily newspapers as the weather forecast.

Not surprisingly, the unregulated and competitive information production business is far outpacing the regulated and largely monopolistic information distribution business. Internet users that have downloaded graphics and images using a dial-up modem or slow-speed leased line can easily verify this bottleneck.

Although the Telecom Reform Act of 1996 has had a long gestation period, its arrival coincides very nicely with the rapid growth of information availability and market demand. The removal of regulatory barriers and development of a dynamic competitive environment will further stimulate demand for distributed processing, telecommuting, telemedicine, the Internet and the Web.

It looks like Congress has finally written the eulogy for a stodgy, slow-growth local exchange market and ushered in a period of dynamic growth and excitement in the telecommunications industry. Royce J. Holland is President and Chief Operating Officer of MFS Communications Co. Inc., Omaha.