Will LECs and IXCs be segmented?: Or decimated?

Carriers intent on becoming all-service providers must find new ways to reduce the scope of their businesses without hurting revenues. This will require a dramatic shift.

Regional Bell operating companies want to offer interLATA services, and most are steadily building larger markets outside their traditional territories. They are committed to investing in the newest technologies across the board. Even low-use, high-cost, low-income end users are important to them; in other words, no customer or product will be overlooked.

In a truly competitive marketplace, these companies will need an enormous amount of capital. This capital will carry more risk because facilities will be duplicated and usage will be lower overall in a competitive market. The increased risk and demand for capital will undoubtedly lead to more expensive borrowing.

Furthermore, carriers will have other expenses, including advertising, selling costs and churn. Margins will be smaller. Above all, telecommunications providers must learn how to acquire and retain customers when similarly talented competitors are everywhere.

So how is the forward-thinking carrier preparing its market strategy? First, service providers need to scope the business. The question is not so much "what business am I in?" as "what business am I not in?"

One difference from traditional planning efforts is that carriers will need to select from and target customer segments rather than offer a comprehensive set of product lines. A segment is not the same as a niche. Virtually every unregulated company practices market segmentation and limits its market presence to areas in which it will succeed. This requires a strategic transformation that will affect local exchange carriers' and interexchange carriers' management processes.

Today's segmentation comes in two forms, neither of which makes sense for the future.

The first is geographical segmentation for local service, resulting partly from regulatory processes limiting local service to a single provider. No company will remain regional if it intends to serve the Fortune 1000 market.

The second form is product segmentation. Most product segmentation is either required by or a legacy of regulation. Service providers offer wireless but not wireline local service, or wireline and wireless but not long-distance or Internet service. Few of the leading telecom providers are prominent in offering satellite communications. As with geographical segmentation, no company with a choice would set up a telecom enterprise in this manner.

These two areas of segmentation will not survive. Already, the FCC has recommended that incumbents be exempt from unbundling or reselling elements of their data networks if they deploy those networks through a separate subsidiary.

Channel surfing The first narrowing of scope will undoubtedly occur between the two largest market channels, wholesale and retail. As marketing telecom services gets more sophisticated, companies will narrow their focus further. True segmentation to targeted industry groups or to demographic segments will follow.

This trend is appearing already. Medium-sized companies Frontier Corp. and Southern New England Telecommunications have announced plans to divide their operations into wholesale and retail divisions, although neither has implied it would commit to one side or the other. SNET's acquisition by SBC Communications leaves the planned organizational structure in question. Reactions from IXCs to these strategic initiatives have been mixed. While LCI has been supportive and recommended a fast track, other IXCs have balked.

The largest companies will be able to serve most customers in almost any market they define within the wholesale/retail split. Not making the split, however, will be virtually unsustainable.

First, competing against one's own customers in the marketplace jeopardizes both future customers and current ones. AT&T learned that lesson well before it split into two companies (the NCR Corp. divestiture was a spinoff).

Second, skills and assets that make a company successful in wholesale markets are different from the success factors for retail markets.

Third, targeting either retail or wholesale will increase the telecom provider's effectiveness in the competitive market: Customers need and expect to have their specific requirements met.

There are three views of the marketplace: wholesale, retail and something in the middle. Within these categories, customers will be driven mostly by price or by features and quality, including customer service. The scope of business might be one or several compatible segments.

Note that the distinctions between markets do not cover the divisional distinctions we so often see today:* Voice/data/video* Wireline/wireless* Loca l/long-distance

* Internet service provider/LEC

* Business/residential

In a free market, these distinctions are not only meaningless but counter-productive.

The voice/data/video split will disappear when available bandwidth makes it irrelevant. Wireline telecommunications that are Internet protocol-based won't draw this distinction.

The wireline/wireless split is already becoming unimportant, other than the huge organizational distinction that service providers make.

The local and long-distance split is for the most part a fiction of the regulatory process and survives primarily as a way to divert revenues to universal service.

The ISP/LEC distinction will also be threatened when PCs are ubiquitous in households and Internet telephony competes freely with the existing architecture.

Regulators invented the business/residential split to support the value-of-service concept. It will not survive either.

Ameritech recently equalized its rates for business and residential customers with equivalent single lines. It will be a necessity as home-based commerce and telecommuting become the norm. Competition will create new distinctions to more creatively maximize the willingness to pay, in the same way that airlines manage to increase their revenues from business travelers.

Still, most large telecom providers maintain separate organizations to support these distinctions, even when regulators do not require it. Why?

For all the talk about bundling services, most of today's providers are organizationally unable to do so. Structuring by market would facilitate the sale or spin-off of the non-strategic division.

Next year's model A marketplace divided by customer segments has two dimensions: the wholesale/retail view and the buyer's primary requirement (Table 1). Some customers will be driven primarily by price, in which case they will be willing to forgo special features or exceptional customer service. Others will require high-end service and be willing to spend slightly more for it. It is unlikely that a customer in any category would be willing to sacrifice the traditional notion of quality such as clean connections and network reliability.

Nonetheless, some customers will be willing to pay a premium for superior service, software enhancements, special customer care and features yet undreamed.

The wholesale/retail dimension concerns the sales channel, either pure wholesale or retail, or a category in between, in which customers require some network assistance but do not support the volume of calling to fall into the wholesale category.

Competition will change the success model radically. Few of the most important future success factors have been a priority in the past, or were even within the provider's control. In the past, success hinged on access to capital, managing relationships with regulators, and providing unilaterally consistent services and quality. Customer service was rarely a goal in itself; it was a means to improved relationships with regulators and thus higher revenues (or lower penalties).

Often, today's LEC sees customers through the filter of the regulatory process or the focus group. Instead of a customer focus, there is a customer image. In the future, the success factors will include marketing, pricing, selling and managing customer loyalty. These markets' diverse needs will make it virtually impossible to sustain leadership in all of them, whether or not a single provider could afford to try.

For example, note that each model segment requires its own selling strategy (Table 2).

Carriers will use loyalty programs to counteract the appeal of lower prices to the price-driven buyer. The service-driven segment will have product loyalty and will not be as swayed by programs designed to prevent churn. Custom services tailored to business or personal needs are more important for this buying group.

The buyers in these enterprises also vary by segment. This means that the sales force, not only the distribution channel, will be different for each segment (Table 3).

Profitability in the service-oriented segments could occur in an inverse proportion to volume, because the customers with the highest sales and service cost per revenue dollar will undoubtedly be at the low end of volume. The resellers market, with the highest volume and significant price sensitivity, will maintain the lowest margins in a truly competitive marketplace, but at volumes that enable the wholesaler to earn an acceptable return.

Today, there is little distinction in the characteristics of the price-sensitive and service-driven segments at the wholesale level. Similarly, the customer's ability to manufacture vs. buy has not been a part of their buying decisions.

Prices to the highest-volume customers are encumbered with subsidies and a dearth of diverse facilities-based providers. Similarly, companies have not demonstrated the need or the ability to compete on the basis of any characteristic other than price. This is partly because of the public's high expectations of any network provider, engendered by more than 100 years of uniquely reliable service and network availability.

The definition of quality is simply too unidimensional to be a basis for real competition. All providers give us great network access and service. Advances in technology, especially Internet-based telephony, will eventually make features and quality an active differentiation opportunity.

Other than the network's capabilities and capacity, few similarities will exist between customer groups. Today, sales and marketing efforts resemble the product-driven strategies that have been used for a century. No other competitive industry succeeds by dangling products before all potential customers. Tomorrow, customer-driven marketing will determine who succeeds in the telecom market.

The segmentation process helps sort out the future scope of business for a service provider. For example, selling at the wholesale level will require access to capital, which is ordinarily available only to the largest companies at an attractive rate. Selling to consumers requires managing many customer contacts and handling significant churn.

Most long-distance providers and wireless companies are already skilled at this; most wireline LECs are not. Customers in the wholesale and network categories will require a technically knowledgeable sales force, especially one with few allegiances to a single product. Systems integration will be highly regarded by the network segment.

Technician, heal thyself Success will come to the telecom service providers that can transform their strategies, investments, product portfolios, pricing and marketing efforts.

The next step is to conduct a self-assessment that includes the following questions:

* Will I be able to compete if I continue to target my customer universe, including planned new services, technologies and geographies? If so, how will I differentiate my company's services from my competitors'? If not, which customer segments or planned opportunities would I be willing to forgo? Can my company retain the remaining segments or opportunities without the segments I give up?

* What are my company's strengths? How important are they to my targeted customers? What segments are the best matches for my present and potential strengths?

* What are my competitors' strengths? Which companies will target my customers? What will I do to retain customers against their initiatives?

* In what ways can my company prepare now to be strong in the targeted segments?

The winning telecom provider of the future will look outside and see customers in plain view and competitors on the radar screen, rather than the reverse. The weapon of choice is a missile, not a shotgun.

The customer segment (more like a universe) is too diverse to understand or to serve adequately. Through the discipline of scoping the business and targeting market segments, companies can evaluate the customer group or groups that they are best equipped to serve, or respond to gaps in their skills and assets to improve their prospects with the segment that is most attractive.