A growth plan for ILECs

Jul 31, 2002 12:00 PM, Glenn LeBrun

Incumbent telephone companies are facing the toughest strategic issues in their long history. Market valuations are at the lowest point in a decade. In order to boost earnings, ILECs are primarily focused on reducing expenditures. This reduction in expenditures is, in essence, a shrinking of their business, yet it continues to be the ILECs' only alternative for managing the bottom line.

Why have they resorted to continual headcount and capital expenditure reductions? Mostly because revenue growth from Internet services and IP technology did not materialize as expected. ILEC growth is caught in limbo--no new revenues from old technology, and little near-term hope for revenues from the new technology. 

There is a plan, however, that can get ILECs back on track to improved earnings and re-focused on managing their business through growth. It is a plan that recognizes--but mitigates--the fears and concerns of shifting from the old technology to new, a plan that creates new services today, and a plan that allows them time to evaluate and trial packet-based technologies.  But first a little background.

The reasons why carriers are not investing

Excuses are easy to come by in telecom these days. Blame the economy, regulators, fear of terrorism, rapid changes in technology, etc. Taking the brunt of the blame is the wireline business, and here's why:

1. Current circuit-switched technology works. The current technology to deliver voice service is very reliable--and it should be, with more than 100 years of development. The bulk of investment delivering voice service is fully paid for and depreciated. People are trained on how to use the current network and derive revenue from it. They understand it well, and despite all the headaches, the systems issues are slowly getting better.

2. There's no competitive pressure. Though ILECs' market valuations have suffered, just look at the competitors. Of the many original competitive LECs, few remain. Competition, which was apparently driving the need for ILECs' network and services innovation, is driving it no more. 

3. There's no killer apps. Everyone would like to see the great days of the early '90s return. New circuit-switching technologies created mass-market killer apps like caller ID and voice messaging that made a significant mark. But the new stuff is more complex. IP-based applications seem very niche-oriented, and many wonder if they are not better suited in a distributed environment vs. the ILECs' traditionally centralized focus. Some of the promised services from IP like "follow-me" are already being done to some success in the circuit-switched network. 

4. Too many processes tied-up in Class 5. Network planning staffs are looking at softswitches and even trialing them for things like Internet offload and tandem replacement. But there is no credible plan for full Class 5 replacement. There are far too many supporting systems and processes that are tied into the heart of the network - the Class 5 switch. Limited talent remains that can make the necessary changes in systems, methods and procedures. Besides, this is not just a systems issue--it could take years to change the behavior and work processes of people who are tied to the switch, particularly for organized labor.

5. Regulation stifles any moves. Close to the top of the risk list, regulation continues to be the better of the reasons for delaying new infrastructure decisions. The FCC's line-sharing and unbundling requirements are unfair and stifle new investment. The '96 Telecom Act and various merger agreements are still tying ILECs' hands. ILEC attorneys conservatively warn about the dangers of mixing voice and data in many circumstances. Yet cable, without these requirements, retains an inherent regulatory advantage over DSL.

The reasons why they should be

While the previously mentioned reasons not to invest in the wireline business have many ILEC managers nodding their heads in agreement, the following trends highlight why it is imperative that ILECs choose a strategy of action rather than reaction:

Managing bottom line by downsizing/shrinking the business. Veteran executives know that this does not really mean "doing more with less." At some point it means "doing less with less." Cost-cutting is a part of good management. But after the downsizings, rightsizings and RIFs of the last decade, there is little left on ILECs' bones to pick at. Still, the "Top 10" list of corporate projects remains littered with IT savings, group consolidations and the next round of rebundling efforts--rarely are revenue-generating investments included. However, by reducing their investments in new products, ILECs are stunting their own growth. Without investing in growth platforms today--and working the inevitable kinks out of them--the end result will be the shrinking of the business. 

And then there's cable. Cable, by all accounts, is winning at broadband for the masses. Cable modems are rolling along with excellent industry standards and relatively good market perception, albeit after some tough starts.

Voice quality-of-service concerns with DOCSIS 1.0 are becoming a thing of the past. DOCSIS 1.1 and 2.0 enable excellent quality voice service. With relatively little additional investment, cable companies can now offer Class 5-derived voice services on cable modems. When looking at their potential for cable modem penetration and the economies of scale they can reach as the numbers grow even greater, things are looking grim for ILECs' residential wireline voice service. 

Cable is also primed to take business customers away. Granted, this will take longer because initially they will lack the staffs to provide a full set of features and support. But cable companies have learned that they can do voice, and they pass a substantial number of customers in the rich small and medium business markets. For cable, voice is there for the taking.

DSL a commodity? With cable modems far ahead of the race, DSL is beginning to look like a very commoditized transport. The only way to move DSL beyond a transport commodity is to enable it with additional feature functionality and value. However, virtually no applications for mass markets have been developed on top of DSL. The most obvious application, voice over DSL, has not been deployed for a variety of internal and regulatory reasons. ILECs will soon find that such reasons do not exist for cable providers, which have an equally workable--and perhaps superior--technology for delivering voice service over broadband.

Sleeping with the enemy. Some ILECs are "partnering" to provide pipe-plus-IP PBX solutions. These partnerships are often at customers' requests, since the ILECs have no equally competing technologies. Despite apparent rhetoric about "working together," the focus of these IP PBX providers is no different than what it was 20 years ago: to move all switching and value creation to the premises equipment and away from the ILEC. Any student of economics knows that a high maintenance, commodized pipeline wholesaler is probably not a very profitable place to be.

What IP PBX providers will not say is that the enterprise is just as readily served from a centralized point as decentralized. In fact, the centralized architecture has inherent advantages of scale economies, multilocation capabilities, and cost efficiencies that exceed decentralized architectures.

IP, as well as voice over IP, is the great equalizer of PBXs--ILECs simply need to understand that. With a little work, they now have the opportunity take back some of what was taken away by PBX over the last 20 years.

Competitors are gnawing at ILECs' T-1 business.  This is the competitors' grab at low-hanging fruit. Historically, ILECs' T-1 prices to businesses have been irrationally high. Many SMBs were required to buy multiple T-1s--one for data, one for local voice, and one for long distance. Then along came the combination of voice and data on a single "fractional" T-1, and competitors are beginning to reap the harvest. With DSL deployment problems, the old standard T-1 is now becoming the default means for SMB voice and data access, and the coming years will find T-1 based "converged voice and data" competitors gaining considerable market share from the ILECs.

SIP revolution. The most insidious enemy of the ILECs will be SIP. SIP functionality is provided within Windows XP, and a large groundswell of support is beginning to emerge for SIP-based applications. The key to SIP's success will be its ease-of-application. Any number of "SIP phones" can be attached to an IP network. When the amazingly new SIP functionalities--such as call screening and management and intermingling of voice, video, and data--are coupled with the reliability of circuit-switched networks, the ILECs will stand to suffer untenable losses for basic telephone service. 

SIP is the perfect disruptive technology, as it will be integrated onto virtually every access device, whether text, audio, or video-based. It will allow ISPs and others to become low-cost telephony providers with little effort. The ILECs have no magic pill to counter SIP.  At best, they can embrace it, but at a huge cost to their embedded telephony customers.  

Restructuring the ILEC business for growth

Rebuild based on revenue growth.  Eventually, the pendulum swings back.  The extreme focus on meeting quarterly earnings objectives through expense reduction must eventually be balanced with long term, top-line revenue growth. This growth will have to be created from inside the company, as there are few success stories from "buying revenues" from business acquisitions.

There is no killer app for IP--yet. Instead, ILECs have to create the killer apps the hard way--through market research and development of new product ideas. This means reinvesting in the human resources that can make new products happen, from product developers to IT managers to market researchers. 

Change business case evaluation to share platforms. Projects must be allowed to share platforms. Like the Class 5, IP-based switching platforms have multiple uses. If they are forced to prove themselves by a single project alone, new projects will never get off the ground. Business cases must be combined for these shared investments. In addition, ILECs must avoid deploying single purpose platforms for pet projects. They must employ a disciplined product roadmap process that recognizes the common platform needs of all projects and that the common good sometimes supercedes the best solution for a particular need.

Make DSL investments and expertise work harder. With cable modems far in the lead and DSL still wading through its deployment issues, DSL will remain a money-loser unless additional added value is provided. ILECs should implement voice over DSL where it makes sense to do so, providing voice and data packages selectively to business customers that are at high competitive risk. They should use their embedded ATM infrastructure that was created for frame relay and DSL to carry new IP or ATM voice and data applications. In addition, they need to finally expand with voice over DSL or T-1 in out-of-region areas, where all revenue is new revenue. 

Buy some time. The end game of IP convergence is the softswitch, but as indicated previously, numerous issues are holding up mass deployment. It will be a matter of many months and possibly years before the softswitch will be integrated into the ILECs' current infrastructure such that it could effectively replace a Class 5 switch. This is not to say that some softswitches won't or haven't already been introduced for packet trunking applications--that is the easy stuff. The real challenge is making all the attendant details and systems associated with line-side functionality actually work for existing customers.

ILECs understand the significant issues associated with softswitch integration. Yet some are under the impression that packet voice and data convergence is inextricably tied to softswitches. Voice over IP is not softswitch. Softswitch is not voice over IP. Voice over IP can be done immediately--today--using a Class 5 as a proxy for a softswitch.

Take advantage of new services that are deployable now. ILECs need to counter the IP PBX immediately with an offering that is reasonably comparable. Though line-side softswitch integration might be years away, an effective alternative for the interim is Class 5-derived IP Centrex. This service simply provides Centrex features from a Class 5 over broadband packet transport such as DSL or packet T-1.

T-1 based converged service delivery (CSD) is another opportunity. CLECs have finally found a niche of profitability in offering lower-priced T-1 offerings to ILEC customers. Using T-1 ATM, ILECs have a compelling and cost-effective alternative. Consider a customer currently with 12 voice lines on one T-1 who also uses another T-1 for data. By using ATM on a single T-1, 12 voice lines that normally would use half (768K) of the T-1's bandwidth might now only use one quarter (384K) of that bandwidth, with the savings (384K) being used for data. In addition, when lines are either on hook or during silence intervals in speech, additional bandwidth can be applied for data.

With this example, T-1 ATM can provide a minimum data bandwidth (768K + 256K = 1024K), an average bandwidth (maybe 1200K) and a maximum bandwidth (1500K).

Beyond CSD, both in-region and out-of-region voice over DSL provide a good strategy for growing revenues at a low cost. In the case of out of region deployments, most ILECs already have high capacity transport, many have existing OOR customers and sales presence, most have access to Class 5s directly or through CLECs, and the DSL and T-1 business is quite lucrative.

Assuming an average 5-line VoDSL customer and $50 average revenue per line per month, 2 weeks of sales activity capturing 300 customers equates to $900,000 annually.

In region, whether using ATM or IP, allows for huge discounts on voice service because it is so cost-effective. Since up to 24 lines can be provided on a single copper loop, the loop cost per derived line is negligible. This allows for tremendous regulatory flexibility in pricing VoDSL to the end customer.

A significant side benefit of VoDSL--one that has been all but forgotten--is the savings in copper. VoDSL for a 24 line business can free-up 23 working copper pair. Working copper pairs are regularly in short supply, particularly in business districts, causing expensive network refurbishments and repairs. Industry estimates are typically around $700 for each new or refurbished pair. These expenditures can be substantially reduced when VoDSL is offered.

Plan of action

The time is at hand for ILECs to take hold of the wheel and start steering on a new path of revenue growth and increasing profits. Some of the key steps to moving down that path are:

• Rebuild and reinvest in the people who can create earnings growth, particularly new product development, market research staffs, and supporting groups

• Dedicate more resources to new VoIP services--the killer apps will come, it will just take some work

• Develop new voice and data converged service offerings that depend on Class 5 reliability but can be easily ported to softswitch when ready

• Attack out-of-region markets with VoDSL--the low-hanging fruit is there for the picking, and the business case is extremely profitable; as well, deploy VoDSL in-region to prevent customer defection and improve infrastructure savings

• Deploy Class 5-based IP Centrex immediately--this is the only near-term effective competition that ILECs may have against the onslaught of IP PBX.

The end result will be a new class of carrier that looks less like a utility company and more like the any-service provider of tomorrow. 

Glenn LeBrun is Carrier Business Case Manager for General Bandwidth Inc.

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