WHOLESALE PRICES STABILIZE AMID HIGHER TRAFFIC VOLUMES

Level 3 Communications reported in its third-quarter earnings call last month that wholesale pricing pressure was easing, but proof of the hazards still facing wholesalers came just two weeks later, when Broadwing reported a sequential revenue decline in the third quarter resulting from its own wholesale price increase.

Trying not to raise hopes prematurely, Level 3 attributed the apparent price stabilization to higher traffic volumes industry-wide from broadband rollouts and other sources. More traffic means less unused fiber, which means less desperation among carriers to fill that unused fiber at any price. Competition may also have eased as a result of carriers such as Broadwing and Global Crossing focusing harder on their more promising retail enterprise businesses than their wholesale segments.

In the past two quarters especially, wholesalers like Level 3 have tried to define value outside of price and to be braver about protecting margins even when it means turning away business. Another motivator to do so, said TeleGeography senior analyst Rob Schult, is the fact that traffic increases are forcing them to invest in network upgrades, which financial executives won't allow until wholesale margins stop dropping. “A year to 18 months ago, it was all about beating the other guy out and getting the customer,” Schult said. “Now I think the finance guys are saying upgrade costs need to be recovered.”

According to Atlantic-ACM analyst Fedor Smith, wholesale rates are still falling this year, but at half last year's rate. A turning point occurred late last year, he said, when Qwest Communications and Global Crossing did away with their cheapest contracts, giving others the confidence to follow. Like Qwest, some wholesalers that tried raising prices this year found customers more loyal than they expected, Smith said. So why wasn't Broadwing as pleasantly surprised? Perhaps because Broadwing, which was unable to comment for this story, attracts more price-sensitive clients than many of its peers, said Donna Jaegers, who covers Broadwing for Janco Partners.

Still, she said, “I wouldn't be surprised to see some of those revenues come back in the next few quarters.”

Then again, wholesale business lost on the current price plateau could be lost longer than expected if customers ask their new suppliers for longer contracts, as some suspect they will.

“It's almost like a variable-rate home mortgage,” Jaegers said. “As you see pricing start to stabilize, I'd think customers will start to lock in a little longer terms.”

In a survey of U.S. wholesale customers conducted by Atlantic-ACM last December, amid the first rate increases, 45.5% said they expected to lengthen their next contracts, while 32.5% expected to shorten them. A nearly 18% plurality said they expected to elongate their contracts by six to 12 months. Last year, the average contract was 21.4 months, Atlantic-ACM said.

Although industry experts agree that the coming consolidation of WilTel and the IXCs will help further flatten wholesale prices, no one thinks prices will go up in the foreseeable future. In fact, as Verizon and SBC Communications use their new IXC networks for long-haul traffic, the wholesale long-distance market will shrink slightly, from $24.5 billion last year to $23.5 billion in 2009, Atlantic-ACM said. Even after the mergers, the only wholesale price increases experts expect to see, if any, are on select underserved routes.

“There are places where there's intense competition, and it's a food fight,” said Brad Cheedle, OnFiber's vice president of sales and marketing. “There are other segments where you might have some unique ability to deliver something, and the pricing pressure's not as bad.”