Industry eruptions

Industry watchers continue to use the Richter scale to measure activity in the evolving competitive local exchange carrier industry, which has rumbled continuously as new companies emerge, collide and disappear all over North America. In the early 1990s, pressure created by outdated regulatory structures developed beneath the surface of the telecom industry and caused the eruption of CLECs into the local market. Competition spewed forth from a previously - and artificially - dormant local telecom mountain. Since this initial explosion, the face of the CLEC industry has undergone tremendous change.

In 1996, New Paradigm Resources Group analyzed 78 companies, then known as competitive access providers, which principally offered private line and dedicated access services. In 1997, these evolving companies began offering switched services. Their number grew to 112, and they became known as competitive local exchange carriers. In 1998, as CLECs began to provide a host of communications services, including data, their number again grew. A new 1999 report has tracked some 160 service providers, and the monikers "integrated communications provider," and "data CLEC" emerged, reflecting the changing business model of the industry. By 2000, New Paradigm predicts that the industry will have more than 200 facilities-based local competitors.

As the lava cools

Many factors have fueled the explosive growth of competitive service providers. And, with any competitive industry, only the strong endure. Some companies have survived by consolidating with others, only to continue operating under a different name. Ovation Communications, for example, acquired Phone Michigan, only to be gobbled up by McLeodUSA. WorldCom, in order to provide local phone service, first acquired MFS Communications and then bought MCI, which previously had purchased Brooks Fiber. AT&T absorbed both Teleport, previously the largest independent CLEC, and Tele-Communications Inc., the largest cable TV provider, in order to seize the CLEC opportunity.

Sometimes, instead of redefining a company through mergers and acquisitions, seasoned CLEC executives simply start overat new companies.

The knowledge and business skills experienced players bring to the table give the new companies an increased likelihood for success. For example, Brad Evans, formerly of Phone Michigan, founded Cavalier Telephone; Robert Brooks of Brooks Fiber started Gabriel Communications; Royce Holland, formerly of MFS, founded Allegiance Telecom; and Mike Viren, formerly of Intermedia, founded 2nd Century Communications (Table 1).

With each tectonic shift in the CLEC market, existing service providers seize the opportunity to expand their footprints, build out networks and expand into new territories. As the market shifts and evolves, new entrants find niches others have ignored. One of the measures of this expansion and growth can be seen in the increased number of voice switches deployed by CLECs. Since 1996, the number of CLEC voice switches has grown by 31.3% (Figure 1). An even more impressive story can be told about the data side of the house. The number of data switches grew from zero in 1996, to more than 400 in 1997, and then nearly doubled in 1998 (Figure 2).

Additional switches demand additional services to make use of them and additional customers to buy what CLECs sell. All of this translates into revenues, another dimension of CLEC success. In 1997, the CLEC industry generated revenues of less than $6 billion, and nearly doubled its revenues in 1998. CLECs are expected to generate revenues of nearly 15 times the 1997 figure by 2001 (Figure 3).

The pool of customers, which ultimately drives CLEC revenues upward, has expanded, as evidenced by the large number of access lines now controlled by CLECs. Beginning with zero access lines in 1996, the CLEC industry has shown amazing strength, capturing more than 5.5 million access lines in just two years.

The pressure continues

With the pyroclastic flow of new technologies, CLECs have modified their strategies to include data services. Because data services are relatively new, CLECs can deploy the emerging data technologies with more ease than the RBOCs, which often are encumbered with legacy systems and networks. In contrast, by opting for new access technologies such as digital subscriber line (DSL) and networking systems such as ATM and IP, CLECs have created more efficient systems with an improved cost structure.

As network elements fall into place, CLECs have hurried to provide the high-speed, high-bandwidth products for which customers are clamoring. The demand for high-speed Internet access and business networking has prompted established local service providers, including Allegiance, GST Communications and KMC Telecom to add data to their service portfolios. Companies such as Covad Communications, NorthPoint Communications and Rhythms NetConnections concentrate solely on provisioning DSL access products. As a result of this focus, data revenues continue to increase and will soon surpass voice revenues in the CLEC industry (Figure 4).

The incumbent LEC (ILEC) response to the rapid development of CLECs has been a no-holds-barred resistance to change. Despite the rules laid out in the 1996 Telecom Act for opening the public network to competition, RBOCs steadily continue to resist offering unbundled network elements. Contrary to vocal expressions of their intent to embrace competition, the incumbents have stymied attempts to simplify the interface of operations support systems (OSSs). And in spite of continued pressure from competitive providers, the RBOCs draw out co-location efforts with claims of space limitations, security issues and restrictive rules.

In the face of these obstacles, CLECs continue to battle creatively by developing work-arounds to avoid many of the headaches of dealing with an RBOC. CLECs build their own networks to avoid resale and leasing agreements and develop interfaces so that OSSs can communicate or co-locate in carrier hotels. They also make use of the courts and regulatory commissions to ease restrictive rules. In general, CLECs use whatever resources are handy to limit RBOC attempts to hold them at bay.

Future eruptions

The volcanic growth of the CLEC industry has lured many to contemplate joining the action. Unfortunately, becoming a successful CLEC is still not an easy task. ISPs, with their easily addressable customer bases, appear to have backed off from the initial urge to enter the local voice market. The technical difficulty and capital costs associated with laying fiber and installing switches have proved to be too daunting an endeavor.

CLEC personnel departments are scrambling to compete for qualified engineering and installation specialists. Building these networks requires financing - 1998 CLEC capital investment reached an estimated $18 billion - and all the problems associated with attracting and retaining investors. Meanwhile, advances in technology keep increasing the number and the complexity of services required by customers. Plus, the logistics of putting it all together are simply too much for many aspirants to juggle.

During the past few years, some entrepreneurs planned to circumvent the problems of raising capital and building infrastructure by reselling the incumbent facilities. The foremost example of this approach, USN Communications, declared bankruptcy in 1998, calling a quick halt to the business strategy as initially conceptualized. Companies such as RCN Telecom Services Inc.,and e.spire that served customers in Bell Atlantic's territory via resale decided to curtail that practice. The costs were too high to make a profit, and the problems dealing with ILECs just too much to overcome.

Electric utilities, with their infrastructures already in place, seem to be another set of likely candidates for success in the competitive telecom market. A few have partnered with CLECs in successful joint ventures. BecoCom (a subsidiary of Boston Edison) formed a partnership with RCN to provide voice, video and data services to Massachusetts customers. A similar enterprise was fashioned by Hyperion and PECO Energy in Philadelphia.

But with a regulated mindset and a heritage of serving geographically restricted areas, few utility players have been able to enter the telecom marketplace on their own.

Those companies that have managed the transition to become fully operating CLECs - such as Dakota Telecom of South Dakota (purchased by McLeodUSA last year) and Avista of Washington state - have met with success.

In any dynamic industry, there is no one path to success. Instead, strategies are adopted immediately, implemented and then perpetually adjusted. The early market entrants in these rapidly evolving industries continuously give birth to new trends and growth patterns. The CLEC industry is no different. During 1998, the CLEC entry strategy of smart-build, or pay-as-you-go, and the new tactic of DSL only providers were acknowledged by the investment community. Ideas that succeed today, however, require alterations as the marketplace changes.

Out-of-region forays by the RBOCs, sustained merger and acquisition activity and an increased level of customer sophistication are just a few of the measures that will drive future CLEC business initiatives and mold the focus of the industry. Although it is impossible to predict the exact path CLECs will chose to follow, one course is certain: The CLEC industry will continue its triple-digit growth, fueled by the expansion in data services.

And that should blow the top off the once-staid telecommunications industry.