Why IXCs are biding their time

Judging from the new players that continue to appear, the competitive local exchange carrier market is booming. GST Telecommunications, Genesis Communications and US LEC are just three CLECs that made infrastructure announcements recently. Yet AT&T claims to have invested more than $3 billion in local service for revenues of only $65 million. What's going on here?

For starters, most CLECs are offering bundled services-including Internet access, wireless and long-distance-which help boost overall profitability. Interexchange carriers eyeing the local service market already offer all or most of these services. They're looking at local service only in terms of its incremental profitability.

Also, AT&T admits that not all its investment was in building local infrastructure. Until recently, the company primarily focused on reselling the local incumbent carrier's network. Regulations require incumbents to offer resellers only modest discounts-around 20%. Whatever the customer's call volume, the discount is about the same. Add marketing and administrative costs, and it's hard to come up with a winner.

Most CLECs, on the other hand, are installing at least some local infrastructure. Even if a company just deploys switches-leasing transport and the local loop from the incumbent-the cost of network elements is calculated differently, using a flat monthly fee. That means if the carrier can find enough customers with enough volume, the business can look pretty good. With few exceptions, facilities-based CLECs are targeting the business market for that very reason.

Why, then, don't IXCs use a facilities-based approach? Such an approach seems like an even better choice for IXCs when you factor in a concern not shared by most CLECs: According to The Yankee Group Director Boyd Peterson, d30% to 40% of an IXC's cost of delivering a call is paid to the incumbent local carrier in access charges. If the IXC can become that customer's facilities-based local carrier, some of those charges go away. Resellers without local infrastructure, however, still have to pay for access.

Until Jan. 1, access charges were collected primarily on a per-minute basis at each end of the call. Since then, IXCs have had to pay a fixed presubscribed interexchange carrier charge to the incumbent for all long-distance customers receiving local service from the incumbent. Per-minute charges were reduced to keep overall costs the same. Eventually, fixed fees are expected to completely replace per-minute charges.

Until then, though, in areas where an IXC has built or acquired local infrastructure, its most lucrative strategy is not what we might expect: One of an IXC's best targets for local service is the grandmother who receives a lot of long-distance calls from callers served by that IXC. If she's using another carrier for long-distance, that may be even better: Let it pay the pre-subscribed IXC charge. By data mining call detail records, IXCs can identify such targets.

With further access charge adjustments looming ahead, however, it's not clear how long such opportunities will exist. Even installing switches takes time and money-and IXCs are not rushing to make such investments when the long-term revenue effect is so uncertain.

Also, as Prudential Securities analyst Guy Woodlief points out, an IXC has less opportunity to reduce access charges in the business market than in the residential market. Large businesses are likely to be using special access lines-trunks that connect a company's PBX directly to an IXC-in which case the IXC already is avoiding per-minute charges at that end of the call.

And in the residential market where call volumes are lower, it's harder to turn a profit-even with fixed pricing for unbundled network elements. Compared with other investments that an IXC could be making, local service often just isn't a "home run."

Meanwhile, the Bell regional holding companies are coming closer to meeting their 14-point checklist, arguing that when they do, they should be allowed into long-distance-even if no competitor has chosen to offer local service. Once allowed into long-distance, RHCs expect to turn a profit quickly. With multiple IXCs driving a competitive wholesale market, the RHCs won't even have to invest much in infrastructure to enter the business.

At that point, IXCs will have to be in local service as a defensive measure. If CLECs weren't so busy building, IXCs might be more concerned about that eventuality: When pressed, IXCs will buy-or buy from-the CLECs.