Meter Might

Electric and gas companies across the country are going head-to-head against telecommunications carriers in a quest for new revenues, but the jury is still out on how big of a competitive threat they pose.

Driven by deregulation of the telecom and energy industries, dozens of utility companies, from small municipal providers to large interstate suppliers, are seeking new fortunes in voice and data services.

They're hardly potent competitors now, but experts say they have the motives and the means to become serious players in the $200 billion telecom industry.

"Utilities have so many miles of fiber lines, it's logical for them to say, 'Gee, how can we leverage this and make money?'" says Joanne Thompson, a utilities analyst at Renaissance Worldwide, Atlanta. "Because this is not mature, it's hard to say who's going to be successful and who's not."

Utilities are using various strategies-including buying in, building out and wholesaling capacity-to gain a foothold in telecom. The smart money, according to some analysts, is on those that stick close to their core businesses-and that gives the edge to wholesalers.

Deregulation prompts market entry What's spurring utilities to explore new territory? In a word, deregulation.

The Telecommunications Act of 1996 allowed utility public holding companies-that is, the larger interstate suppliers-to sell telecom services for the first time. Previously, a 1935 federal law barred this activity.

So far, the FCC has approved 42 "exempt telecommunications companies" for 19 utilities, including powerhouses such as Central and South West Corp. and the Southern Company.

Energy deregulation is also prompting utilities to shift gears. To date, 18 states have passed laws giving consumers the right to choose their electricity suppliers, according to the Edison Electric Institute, a Washington, D.C.-based trade association. Like local telcos before them, these long-time monopolies will soon face competition for the first time in decades.

"When you start out with 100% market share and your business turns competitive, you have only one way to go," says Dick Hahn, vice president of technology at Boston Edison, which sells telecom services in a joint venture with RCN Corp. In March, Massachusetts became one of the first states in which energy deregulation took effect.

This specter of lost customers is driving many utilities to seek new sources of revenue, and many see telecom as their golden opportunity. And no wonder-the electric power industry will see a compound annual growth rate of just 1.1% from 1996 through 2003 vs. 7% for the telecom industry, predicts Frost & Sullivan.

"The opportunity is too overwhelming to pass up," says a spokesman for the Edison Electric Institute. "You've got the infrastructure, you've got the technical expertise, you've got the telecom companies as partners." Taking the lead are large electric companies-Central and South West Corp., American Electric Power and others-although gas suppliers such as the Williams Companies and Enron Corp. are also active. Some companies are investing millions of dollars in fiber optic network expansions, but most are taking it slow because of the uncertain pace of state-by-state deregulation.

Many energy companies also remember their less-than-successful forays into banking, real estate and other industries during the 1980s, so now "they're much more conservative about these non-core activities," says Mitch Mitchell, a Dallas-based utilities consultant for A.T. Kearney.

Success is far from assured. Just ask Utilicorp United Inc. and Peco Energy Co., which ended their year-old marketing alliance in April.

The partners tried to market gas and electric services with non-energy services, including AT&T long-distance, under the brand name "EnergyOne." The goal was to recruit at least 10 other utilities as franchisees that would sell EnergyOne services in their own territories. Not a single company signed on.

"We were ahead of the marketplace," says a spokesman for Kansas City, Mo.-based Utilicorp. Not enough states have deregulated their power industries yet to make competitive energy sales possible nationwide, he explains.

EnergyOne won't be revived any time soon, the spokesman adds.

Competitive advantages, competitive disadvantages Despite EnergyOne's failure, plenty of utilities are forging ahead into the telecom business. The general idea is to retain customers by selling them non-energy services. Opinions are split as to whether this is what the public wants. Most consumers, 57%, oppose buying telecom services from electric or cable companies, according to a January survey by CDB Research & Consulting Inc., New York.

The young and the affluent are relatively comfortable with the idea, but even most of them opposed it. But Noel Dunivant, managing director of FGI Inc., a market research firm in Chapel Hill, N.C., says his studies show "there's a fairly significant demand for telecom services by electric utilities, with conditions." Utilities' main assets, according to Dunivant and others, are their widespread infrastructure and respected brand names.

On the first count, many utilities operate extensive internal communications networks to keep their grid operators, power stations and other areas in contact.

These fiber optic networks run along underground electric cables and gas pipelines on companies' rights of way. Utilities often lease dark fiber on these networks to carriers.

On the second count, utilities possess well-known, respected brand names in their markets. They rate well on consumer satisfaction surveys. State public utility commissions know them.

But there's no shortage of disadvantages. Utilities face a steep learning curve in the telecom industry. They don't know the marketing side of the business, and it's hard to adapt billing systems and other back-office operations, analysts say. In addition, some states such as California heavily restrict utilities' telecom activities.

"They're lumbering giants," says Mitchell of A.T. Kearney. "You're seeing utility companies picking off telecom executives to help them through the shift and learn the telecom business." For example, AEP Communications, the telecom subsidiary of Columbus, Ohio-based American Electric Power, is run by former Sprint executive Peter R. Thomas.

"A lot of utilities are finding it's more difficult [than they expected] to get into this business," says Thompson of Renaissance Worldwide. "The MCIs and Sprints of the world already have a lot of experience, and utilities can leverage that. If they go it alone, they will be less successful."

Strength in partnering These market realities are leading utilities to cooperate rather than compete with carriers. Two heads-utilities' infrastructure and carriers' marketing muscle-are better than one, they figure. The partnerships take many forms, from network interconnection agreements to joint ventures.

Historically, the two industries' agreements allowed interexchange carriers to run fiber along utility rights of way.

"Now what you see are much more complex deals with providers, whether wireless or wireline," says Glenn James, a telecom consultant for Deloitte Consulting. "It's getting more and more retail-oriented. People are fighting over customers."

The king of partnerships among carriers is ICG Communications Inc.

The Englewood, Colo.-based competitive local exchange carrier has formed 10 alliances with utilities across the country, including Central and South West, Southern California Edison and Alabama Power. In some cases, ICG shares the cost of new network construction. In other cases, it leases dark fiber.

Either way, the idea is to lower capital costs, says Sheldon Ohringer, president of ICG Telecom Group. "We're able to get the network in place faster and much less expensively than doing it on our own," he says. "We think we save 30% to 40%-in the tens of millions of dollars and one to two years per project-by working with utilities."

The alliances appeal to utilities because they are nonexclusive, Ohringer adds. Nothing precludes the utilities from selling telecom services on their own, although many of them realize "it's not an easy business to get into retail," he says.

Wholesale vs. retail Utility companies' entry strategies vary widely and include wholesaling capacity on existing fiber lines, expanding and interconnecting with networks, and investing in telcos and wireless carriers. Services range from local and long-distance voice to wireless and cable. It's a mix of urban and rural, business and residential markets.

In most cases, Mitchell says, "they want to find synergy between energy and telecom." One key decision-whether to go wholesale or retail-depends on utilities' size and geography. In general, smaller utilities operating in tightly focused markets can tackle the more difficult retail market. But wholesale makes more sense for larger utilities with multistate networks.

Texas Utilities Co., an electric company with 2.5 million customers, went retail last November by buying Lufkin-Conroe Communications Co., a local telco with 100,000 access lines in the state, for $320 million.

The carrier sells local, long-distance, Internet and wireless services in Texas, with estimated annual revenues of $100 million.

Herb Zureich, president of TU Communications, the utility's subsidiary for telecom ventures, says he chose the buy-in strategy after being rebuffed by large carriers and CLECs. In both cases, it boiled down to who would control the customer, he says.

Boston Edison, which serves 680,000 electric customers in the Boston area, also chose the retail route but with a partner, RCN Corp., Princeton, N.J.

The joint venture has added several hundred miles to BE's 200-mile fiber ring and sells local and long-distance, Internet, cable TV and video service to residential and business customers in the Boston area, says BE's Hahn. It's too soon to tell if the $300 million venture, in which a BE holding company owns 49%, will be profitable, but "I firmly believe this will be a good business opportunity for us," Hahn adds.

For other utilities, wholesale is the way to go. For one thing, it's less competitive than the retail market. For another, wholesale telecom revenues are projected to grow from $19.7 billion this year to $35.7 billion in 2003, according to Frost & Sullivan (Table 1).

With the telecom act loosening restrictions, several utilities are expanding what's been a steady source of revenue-leasing capacity to IXCs, telcos, wireless companies and others. Even here, strategies diverge. Some utilities, such as the Williams Companies, are aggressively building out their networks. Others, such as AEP, are interconnecting with other networks in agreements that let the partners reach customers they otherwise would not.

As a major gas pipeline company with an expertise in laying fiber and managing infrastructure, "we felt our core competencies were in the wholesale arena. We're trying to stay focused," says Ron Harden, vice president of marketing at Williams Network, an arm of Tulsa, Okla.-based Williams' telecom subsidiary.

Williams Network is spending $2.7 billion to extend an 11,000-mile network, built as part of WilTel in the 1980s, by laying high-speed fiber along gas rights of way. It plans to have 18,000 miles coast to coast by the end of this year and 32,000 miles by the end of 2001. Wholesale data services include private-line capacity, frame relay, asynchronous transfer mode and by December, T-1 lines and Internet protocol capability.

"We make a good partner for a [regional Bell operating company] because we're wholesale only and we're not in direct competition with them," Harden says.

The advantage of Williams over an established wholesaler such as WorldCom is "a low-cost position," he added.

Uncertain future Will utilities succeed in the telecom business? It's hard to say. Many industry analysts are doubtful and say telcos have nothing to worry about, at least for now. "Most utilities don't have a snowball's chance in hell of challenging telecom companies," says Michael C. Krauss, a principal at OmniTech Consulting Group Inc., Chicago. "I don't think most utilities realize just how complex the telecom business is. It's not a slam-dunk."

Utilities that sell wholesale capacity on their networks may fare the best.

"The marginal cost of entering the business is virtually zero. You have nothing to risk," says Craig Moffett, vice president of the telecom practice at Boston Consulting Group, New York. "There's almost no way you can lose money."