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Finally, a Free Market for Telecom

By Steve Rosenbush When it comes to assigning blame for the telecom meltdown, there are plenty of obvious candidates. Was it the fault of Bernie Ebbers, who now faces criminal charges related to bankrupt and scandal-scarred WorldCom (now MCI)? Was it Jack Grubman, the Salomon Brothers (C) analyst who played both sides of the fence, covering WorldCom and other upstarts while helping to "sculpt" the industry as an investment banker? Was it former Drexel Burnham banker Gary Winnick, whose Global Crossing (GLBC) empire was tarnished by bankruptcy and scandal? They all had a hand in creating the financial mess, which wiped out $2 trillion in capital and cost the economy several hundred thousand jobs.

The industry's problems can't be fully explained by the actions of a few individuals, though. All of these people were part of a grand but ill-fated experiment in public policy. The Telecom Act of 1996 sought to end the Bells' 100-year-old domination of the local phone market. It was a well-intentioned but misguided scheme -- one that was dealt a severe blow on June 9, when the U.S. Solicitor General declined to ask the Supreme Court to hear a case that could have forced the Bells to continue leasing parts of their networks to rivals at reduced rates.

ASSEMBLY-LINE UPSTARTS. In the wake of the Telecom Act, hundreds of upstarts, confident that the government was going to take away a significant share of the Bells' market and turn it over to a new generation of rivals, poured into the market. The Federal Communications Commission even forced the Bells to share their networks with rivals at government-set prices, an easy-money policy that led investment banks to manufacture telecom upstarts in assembly-line fashion.

As these outfits rolled off Wall Street's factory floor, the industry's overcapacity turned into a crisis. A price war drove nearly all of the newcomers out of business. As the end neared, WorldCom and other companies cooked the books rather than admit that they couldn't fulfill the overblown promises they made to investors.

That era is now officially over with the Solicitor General's June 9 decision. Theodore Olson decided not to ask the Supreme Court to hear a D.C. circuit case that scrapped key parts of the FCC's rules about network leasing. The rules will now expire June 15, unless the Supreme Court chooses to hear the case, which is considered unlikely. It's a huge win for the Bells and could worsen the financial outlook for rivals such as AT&T (T) and MCI (MCIA).

BETTER ALTERNATIVES. By 2005 -- certainly not before the election -- the Bells are likely to ask state regulators for permission to raise the wholesale prices they charge such rivals, according to telecom analyst John Hodulik of UBS. The fallout could be a long-anticipated round of consolidation, in which stronger players acquire the weaker, more dependent ones.

It's not the end of telecom competition, though. This market has changed profoundly since the Telecom Act was established eight years ago. The regular phone had few alternatives. Cell phones were still in their infancy. The scratchy, analog cell service that most people used was too expensive and unreliable to serve as a primary connection. Voice over the Internet protocol (VoIP) was even worse, a high-tech ham radio for geeks. It sounded just dreadful.

All that has changed now. Wireless and VoIP have come into their own and are more than just alternatives to the regular phone. Traditional phone companies like Verizon (VZ), SBC, BellSouth (BLS) and AT&T are redefining themselves around these new technologies, lest they get left behind.

PLENTY OF COMPETITION. The rivalry will only intensify. Between now and 2006, cable-TV companies are going to flood the telecom market with Internet-based phone services of their own. Telecom companies are expected to lose an additional 30% of their market. It's all but impossible to argue that telecom suffers from a lack of competition. If anything, it has too much.

Competition is taking off for good reason. The technology has improved immeasurably since the mid '90s, and the price has fallen. You can now pack a tiny cell phone with a crisp color screen and a tiny hard drive that rivals the power of a laptop. And these phones are connected to wireless networks that soon will allow people to access the Internet at speeds that approach a household broadband connection. At home, people use high-speed links make VoIP sound better than regular phone service, not worse.

This competition won't be diminished whatsoever by the end of the FCC's rules. Wireless, cable telephony, and Internet phone upstarts like Vonage don't need to lease lines from the Bells, because they have independent networks or rely on the Internet to carry their traffic. Even AT&T, which has been a big beneficiary of the wholesale rules, is moving into wireless and VoIP. It should be able to survive on its own. And if it can't, that's a sign that long-distance companies no longer make sense as separate entities in an era of bundled services and digital convergence.

After years of trying to micromanage telecom, the government finally is stepping aside and letting technology drive the market. And the telecom revolution, which got bogged down in years of court battles, financial disaster, and scandal, is moving ahead once again. Rosenbush is BusinessWeek's Telecommunications editor

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