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Mr. Chairman, and distinguished members of the subcommittee, thank you very
much for allowing me the opportunity to discuss my views on the state of
competition within the telecom industry. My name is Frank Louthan, and I am the
senior Wireline Analyst in the Telecommunications group for Raymond James. The
majority of my testimony will center around the current state of competition in
the telecommunications industry and how it relates to current regulations and
investors.
Convergence of services, providers, and service offerings are all blurring the
lines between local voice, long distance voice, wireless, data, and video
services. We see technological barriers becoming weaker and competition for
these services increasing. As the RBOCs integrate their offerings with satellite
providers through joint ventures, the cable operators roll out telephony
services, wireless data becomes a larger mass-market offering, and other new
technologies complicate matters further, we believe the regulatory community
should be aware of the impact these trends will have on the industry
participants, investors, and consumers.
While local voice services were historically dominated by the local Bell
monopolies, these services are now experiencing a higher degree of competition
from a number of sources. IXCs and CLECs are attacking the mass market largely
as UNE providers, although this source of competition has higher concentrations
in states with lower UNE rates. Cable operators are increasingly rolling out
switched voice services, although their mass roll-out has been somewhat limited
thus far as they wait for VoIP (voice over Internet Protocol) to become more of
a reality. Other factors impacting local telephone companies include a decline
in second lines as consumers abandon them for a broadband connection or wireless
phone, and the replacement of primary lines by wireless phones as that
technology becomes a more ubiquitous service.
The overexuberance of the capital markets following the Telecom Act of 1996
created a large influx of competitors using different sets of assets to somehow
capture revenue from either voice or fast-growing Internet services. The result,
of course, has been significant competition at almost every corner of the
industry. The other, less obvious result is the erosion of the health of the
industry as these competitors all seek to cover their high fixed costs with
lower and lower contributions from incremental sales. The real issue, in my
opinion, gets down to the general economics of the business, which I believe to
be largely fixed, thus making it difficult for multiple network providers in the
same market to generate a positive return. The high fixed costs can create high
incremental margins and significant profitability over time, although this
should not be mistaken for an open invitation for many competitors to enter the
market, as those profits erode quickly in the face of multiple providers.
Eroding profits, in turn, provide disincentives to investors, which I view as a
negative scenario in a capital-intensive industry such as telecommunications. We
are currently in a state of industry flux that discourages spending on new
assets, as the recent large investments in capital have not earned returns, thus
discouraging innovation from telecom equipment providers due to pressure on
pricing, revenue, and cash flow. Meanwhile regulation has done its part in
discouraging investment where it can be deployed most effectively, namely the
"last mile."
I believe there is more competition than necessary in the telecom industry at
the present time. The investment community is largely uncomfortable with
spending on new facilities due to continued erosion of industry fundamentals and
a general lack of comfort with the regulatory environment. With some level of
competition, I believe incumbent providers and new entrants are kept on their
toes, innovation ensues, and pricing is likely to remain at a lower level than
under a monopoly-regulated regime. However, the current state of the industry is
not healthy, as carriers are seeing their returns decline and investors are
growing less likely to participate in an industry that is perceived to be
irrational.
Competition that has been most evident for local, wireline voice services to
date has been UNE-P competition, which dictates rates through state regulatory
commissions. Rates are set by theoretical cost models, where the incumbent and
competitors (along with consumer protection agencies) bicker amongst themselves.
UNE-P has flourished once prices hit a certain threshold; yet we have seen
little evidence of the providers' desire to build their own facilities, as they
are earning very healthy returns under the current model. We believe a resale
business model makes sense in some instances, yet there are too many arbitrage
opportunities in the marketplace set forth by a telecommunications market with
no real market-based rates. Such a system promotes "cherry-picking"
attractive customers and neglecting others, while reducing the RBOCs' incentives
to develop, deploy, and sustain new services.
Meanwhile, as the RBOCs get a firmer handle on UNE-P competition, their focus
has been shifting to a large degree towards cable competition, which will
effectively provide real facilities based competition regardless of regulations
currently in place. Currently, the RBOCs are betting their voice / data /
wireless / and satellite bundles can beat the cable industry's voice / data /
entertainment bundles, with the ultimate winner of this clash unclear at the
present time. However, the scales are currently tipped in the cable providers'
favor, in our opinion, with these companies not having to deal with an out-dated
regulatory model that is becoming increasingly irrelevant in the face of
technological innovation.
A great example of how market-based forces can spur facilities creation is the
broadband marketplace. Most consumers have at least 2 choices of facilities
based broadband offerings (cable and the incumbent telecom provider), with
several others that are not facilities based. We believe there is sufficient
competition that has evolved for broadband services between the local cable
company and the incumbent telecom provider to spur facilities creation, price
competition, and innovation.
Cable has done an excellent job of deploying broadband, in the process
demonstrating how market forces can be the best driver of companies bringing new
and innovative services to the marketplace. I believe this is largely due to the
certainty of the investment for the MSOs, as they may have been reluctant to
roll out a mass broadband offering had they been required to resell it under
regulatory driven rates in a similar manner to the RBOCs. Meanwhile, the RBOCs
have lagged cable providers in deploying broadband and simply gaining customers,
in part due to issues with their plant, but also out of concerns over stifling
regulation, be it either allowing competitors to use their facilities or simply
paying more attention to their battles over voice regulation. Considering the
amount of choice customers have in broadband, not to mention the nascent
wireless data offerings that are further changing the game for broadband and
data access, regulation of this market would simply stifle rather than promote
competition over the long run, in my opinion.
When discussing the obvious technological change that is spurring real,
market-based competition for voice services, VoIP (Voice over Internet Protocol)
is the largest near-term driver of such forces. Once again the cable provider,
with plant already deployed and an embedded customer base to market the service
towards, appears to have an advantage. The cable operators have the financial
resources, economic justification, and expertise to pull-off mass-market
offerings that should spur competition and new services.
However, the RBOCs must deal with this market-based competition for wireline
voice services in addition to devoting resources towards regulatory requirements
and UNE-P debates. UNE-P providers leverage the RBOCs' networks even while the
RBOCs must provide universal service and lifeline services to unprofitable
customers. A large portion of incumbent service providers' revenue comes from
long distance and network access revenue, which is being eroded by wireless and
other forms of technological substitution. We believe consumers now view
wireless long distance as free and are therefore more likely to use their
wireless phone to make long distance calls. This significantly reduces both long
distance revenue the incumbent can generate or at the very least originating
access fees. Terminating access fees are also being reduced as consumers utilize
wireless phones. We note this is a key motivator for the RBOCs to roll out
any-distance bundles (in addition to matching UNE-P competitors products), as
they look to replace a declining revenue source with a stable, non-usage
dependant, and possibly increased revenue source. We estimate network access and
long distance represents between 20% and 60% of total revenue for the RBOCs and
ILECs, making this revenue source significant. We view this as another subtle
impact of intramodal competition.
In addition, wireless phone and increasingly data services are becoming very
competitive alternatives to wireline voice connections to the home. We believe
the roughly 9.6% of the population that are single between the ages of 20 and 34
are the most likely to disconnect their wireline phone for a wireless phone
(with a significant proportion of this age group having already done so). As
young consumers between 15 and 19 (another 6.6% of the U.S. population) become
households, we believe these households could become prime wireless substitution
candidates. At the same time, we believe a portion of these consumers are likely
to keep phone lines for Internet connections or simply choose not to forgo a
wireline phone.
We also believe a large portion of the population that is married, currently
around 62 million couples (124 million people) or around 58% of households are
less likely to cut the cord. Factors such as a need for common points of
contact, wireless handset and battery quality, connections to
security/monitoring services, and other practical limitations of wireless phones
are also expected to play a part in multiple person households retaining a
wireline phone, in my opinion. I believe 10% to 15% of households could
disconnect their primary phone line for a wireless phone, although the speed at
which this could occur is unclear, and the advance of wireless data options,
network quality, and changes in consumer preferences are expected to be the
gating factors. A key change in consumer preference would include acceptance of
less than "5-9's" reliability for phone coverage, which I believe is
already to emerging, as evidenced by the significant numbers of consumers that
already view wireless as an acceptable alternative to a landline phone.
The actual impact of wireless substitution is difficult to estimate because it
is highly dependent on consumer preferences that can change over time. However,
we believe age and marital status are key factors to look at when trying to
predict this preference. Other factors include wireless coverage, local culture
(we believe wireless substitution is more prevalent in larger cities than less
densely populated areas due to better wireless coverage, a larger prevalence of
wireless phones, and different conventions), customer service, and economic
factors. We believe wireless substitution will be a secular trend that continues
in the industry for quite some time, which will have a larger impact on second
lines, long distance revenue, and access minutes of use over the near term.
In summation, the lines are becoming increasingly blurred in the eyes of the
consumer toward the medium within which they are receiving their
telecommunications services in the residential market. Yet regulation has
generally been enacted without considering the broader market for telecom
services, particularly whether or not customers have some alternative form of
service, regardless of the medium. I do not believe residential or business
customers suffer from a lack of choice in telecommunications services, which is
a development that will be proliferated by the quickening pace of technological
innovation in the coming years. Hence, the total impact of all mediums of
telecom competition and consumers' indifference between them should be strongly
considered in the continuation and modification of telecom regulation.
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