THE GAMBLER

There's a school of thought out there that says it isn't the competition that separates the carriers in the local exchange, it's the class system. That deep down, most CLECs want to rub elbows only with the ritzy locals. "Ritzy," meaning the wired-for-sound corporate outfits that use "network" as both a verb and a noun. "Ritzy," meaning those in the residential set who have phone bills as thick as their current issue of Vanity Fair.

And about the only choice the rest of the locals get, the argument goes, is whether to pay their local phone bills by mail or at the bank. If anyone wanted to buck this trend, it would make sense they'd come from Las Vegas. After all, the slot machines and blackjack tables there don't discriminate between rich and poor, ritzy and kitschy.

So here we have Nield Montgomery, CEO of MGC Communications, a Las Vegas-based CLEC with a more, shall we say, egalitarian approach. Residential and small business customers actually do spend money on local service, he insists. At least enough for a certain CLEC to deliver what customers want and to make a profit in the process. And now he's taking this idea and-hate to say it-he's leaving Las Vegas.

Ouch.

But it looks like he may be on the money, or at least getting close. MGC got a head start back in early '95, when Nevada deregulated the local exchange. A year later, when the feds finally got around to opening the local market nationwide, MGC began to expand. Now, the switch-based CLEC is also doing business in suburban Los Angeles, Chicago, Atlanta and Fort Lauderdale, Fla. In each market, MGC attracts customers, at least initially, by charging a flat $15 a month for basic service. Montgomery expects the company to move into the black by late this year or very early next year.

Low-end jackpot Now you might be thinking these are bad odds. You're wondering how MGC could possibly be making money in the low end of the market with rates like that. After all, in most states, a telco has to spend about $13 to $14 per customer to provide service. It would seem that MGC's margins must be slim to non-existent.

They are not, says Montgomery. Unlike a casino, which draws people in with free drinks and snacks but loses them when they lose money, MGC gets the customers by charging a low promotional fee. It keeps the customers by offering them the things they really want at prices they're willing to pay. MGC packages a few basic services (local dial tone, custom-calling features, long-distance service and even Internet access). They price the packages at rates that beat those of the incumbent. Then they put the whole magilla on one easy-to-understand bill.

So how do you work the numbers to make any money? The real rainmaker in the MGC portfolio is what Montgomery calls "a disproportionate take rate on enhanced features by the low-income sector of the community." In English, that means some customers-apparently a lotta customers-just love all that CLASS stuff. They want the rich-folk apps.

"They typically take the full slate of features-three-way calling, call forwarding, caller-name-and-number display," he says. "When you consider the cost of [providing those], it's very small."

Montgomery is quick to point out that not all low-end customers are on MGC's hit parade. Folks like his parents, for instance. The elder Montgomerys, he says, have "an olive-green, rotary-dial wall phone that was made by Western Electric in 1950. All they buy is local service. I cannot make a business plan work with that kind of customer."

By packaging and pricing basic services to boost the take rate on enhanced features, MGC also can roll out competitively priced long-haul service. "While I have, I think, an unbeatable price on long-distance-10 cents a minute on residential and 9 cents a minute on business-I really start to make things work very nicely when I add in those additional [enhanced] elements," he says. Guess "make things work very nicely" is a another way of saying "profitable," or at least "almost profitable."

High-stakes number game Montgomery points out that MGC is a wicked number cruncher when it comes to controlling costs, too. That means everything from owning its own switches-at last count, Nortel DMS-500s in seven cities-to building, not buying, its own ISP capabilities.

Sure, MGC is about to wrap up its purchase of LjNet, a Las Vegas ISP. However, Montgomery says that does not mean the CLEC will be shopping for ISPs in each of its cities. It's too tough and too expensive to integrate acquir ed companies with one's own operation.

"Our belief is that organic solutions ensure there is consistency, that there is a functionality essential to how we want to do business." Say again?

Montgomery explains: Dealing in the low end of the market means you're dealing in the "lower unit values." In turn, that means "you have got to be absolutely intense in the way you focus on cost," he says. So MGC plans to build its own ISP capability, not go out and buy it.

Instead, the LjNet buy simply seeds MGC's ISP ambitions by providing precisely the type of ISP assets Montgomery's company wants to deploy. LjNet also is providing "some talent, some exceptional talent, people who understand the world of telephony as well as the world of data."

He says MGC will use both the hard assets and human talent picked up in the LjNet acquisition to launch itself into the Internet arena. That is, basic access, along with Web hosting and other Internet-based services.

"In fact, technically, we're deployed in all those markets now-'technically,' meaning we've gotten the equipment there and it's being installed," Montgomery says. "By the middle of March, we will have our ISP product universally deployed."

Keeping poker-faced Rumor has it that MGC the ISP is going to offer not only access but high-capacity, pedal-to-the-metal access. Something along the order of digital subscriber line access. But Montgomery gets a bit edgy here. He doesn't want to get too specific about MGC's plans, at least not right now. He does say the CLEC is planning to offer, for lack of a better term, "smart bandwidth." DSL is "the underlying technology."

To be clear: "We've looked at DSL, and the problem we've had with it is that its early appearance in the market has been as a product. We don't believe that DSL is a product-it's a facilitator or a medium or a capability, but it's not a product," Montgomery says.

In fact, MGC is evaluating what company execs and engineering types think is "a much more comprehensive solution, one that says DSL facilitates the connection between the customer and our network in a way that gives us multiple capabilities-not the least of which is bandwidth."

Maybe a few more specifics here could help. He tries again. "What we [will] provide to the customers is bandwidth, in the same fashion as they would get bandwidth over a DSL product, as well as multiple-line capability on the premises that share that bandwidth. Smart bandwidth."

Fine, guess we'll wait for it to come out on video.

Hold on, he says. Knows he's being a bit vague. People should just understand that in every MGC market, this "smart bandwidth" is going to position the company as the facilitator of access.

"When you compare us with the CLECs," he says, "we're in that broader mass of the market that is already underserved. And the next generation we're talking about-smart bandwidth-gives us the ability to address-all the way down to the residential level-the demand we think is there, with a technology that is better integrated than what we've seen to date."

As for other upcoming news he can't talk about yet, Montgomery says MGC has gone about as far as it intends to go with circuit-switched technology. There'll be some announcements soon about MGC and Internet protocol-based gear.

Like what? "We would like to believe that we will be the first to take that IP-switching fabric down to the end-user level." Montgomery hastens to add he's certainly not talking about the Internet, where he worries about latency screwing with voice traffic. "We do not have that concern [with] an intranet-in other words, where it is closed and we own it end to end."

A bit early yet to show his full hand.

Know when to walk away... >From the looks of things, MGC is sailing right along with nary a hitch. >When the company posted its third-quarter results last October, James >Henry, an analyst for Bear Stearns, said MGC had "successfully tapped into >small business and residential customer segments, and geographic areas that >other competitive carriers have ignored." Henry expects MGC margins to >expand during 1999 as "traffic volumes and revenue start to flow across >its networks in large scale."

In the lingua franca of Wall Street, James says MGC is "a compelling way to play the strong fundamentals of the competitive telecommunications sector."

But unfortunately, there are a few significant challenges staring Montgomery and colleagues in the face. Montgomery says there are two, one on the customer side and another on the ILEC side.

MGC has discovered that it is "a day-in/day-out, uphill battle" to educate customers about the fact that they now have an alternative provider. The problem is, the relentless marketing assaults of the long-haul carriers have rendered many customers stupefied. Actually, "desensitized" is the word he uses.

It seems that people have been hammered for so long by so many long-distance carriers that as soon as MGC reps start to talk, the customer immediately says, "Yeah, yeah, I've already picked a long-distance carrier." Then, even if the MGC sales rep manages to communicate that it offers local service now, some people get nervous.

Montgomery understands this hesitancy, especially in the middle-aged and older set. He spent most of his career in the Bell system, spanning the years when people were not allowed to plug in extension phones without getting Ma Bell's permission first.

"The irony is that so much of the market still views the telephone company with that level of authority," he says. "When we say to them, 'Do you know you've got a choice in local service?' the customer starts to shake and says, 'You can't be doing that, that can't be legal!'" He says this sets up a whole lot of advertising challenges for the company, just to get the message out.

So what's the challenge with the Bell companies, at the risk of asking a rhetorical question? Surely, the RBOCs and GTE aren't being less than cooperative when negotiating interconnection agreements? Say it isn't true.

Nah, that's not the problem, Montgomery says. In fact, the interconnection agreement has become "a rather routine event these days." The problems arise after the interconnection agreements are signed, when it comes time to hammer out the details.

"What they will do rather characteristically is define the details and then suggest that if we don't agree with their definition, we're seeking to breach an interconnection agreement that was signed in good faith," Montgomery explains.

This RBOC behavior, relative to the rules of interconnection, he characterizes as "minimal literalism."

It is a term Montgomery picked up many years ago in a parenting course. "It means unless you know specifically what you want and ask them specifically for that, they will interpret the agreement or the law in the most minimal way for their benefit."

But that's not the only problem Montgomery has with the RBOCs. In fact, his biggest beef with the incumbents is "getting ever-increasing performance" from them. That cuts across a lot of areas, he says, from their "inability to meet the provisioning demands we've got, either in volume or the time frame required, to the ongoing service performance criteria." By that last, he means restoring services "where the problem clearly is within their domain."

Nevertheless, it appears that MGC is handling it. As of the end of '98, the company had co-located in 207 central offices nationwide and had about 11.4 million "addressable" lines. That translates into about 285,000 customer phone lines.

So, if many ILECs and CLECs adopt Marie Antoinette's "let-them-eat-cake" attitude, MGC is happy to hustle around to those residential and small business customers with slices of cake. MGC execs clearly know what happened to Marie Antoinette. It's one gamble they won't take.