How VoIP Hits the Sticks

Rural carriers complain that telecom giants are turning to the Net to dodge access fees. That could mean big trouble for the small fry

The town of Forestville sits close to Lake Michigan along the Door Peninsula, a rural swath of northern Wisconsin known for luscious cherries and miles of untrammeled shorelines. It's a quiet hamlet of 500 -- and one battleground in a war over rural phone service that will have wide-ranging consequences. On one side of the conflict are the big long-distance companies such as AT&T (T ), Sprint (FON ), and MCI, which have to pay an access fee every time they hand off a call from their networks to a local carrier. In the 20 years since Ma Bell was broken up, those fees have added up to hundreds of billions of dollars.

On the other side are the recipients of such fees -- an estimated 1,100 phone companies that provide service to small-town America. These include everyone from the behemoth Baby Bells to large rural carriers such as Forestville provider CenturyTel (CTL ) to tiny companies whose single switch pulls in revenues of around $5 million a year.

So what's the problem? Basically you can blame it on the Internet, whose ability to carry voice communications has muddied the whole access-charge issue. In October, 2002, AT&T asked the Federal Communications Commission to let it stop paying access charges on long-distance calls it delivers partially by means of voice over Internet protocol (VoIP) networks, a change that would save it $8 billion to $9 billion annually. In total, long-distance carriers pay $22 a year in these access charges, according to the FCC. AT&T has already withheld at least some of these payments from the rural carriers since its filing.


  The long-distance leader argues that the system of access charges provided for in its 1984 breakup plan is an outdated and unfair subsidy to rural carriers. In response, rural carriers allege that AT&T has been bending the rules by using the Net to mask the origins of calls it delivers -- and thus underpay its access charges.

This issue suddenly has moved to the front burner thanks to a February FCC announcement that it plans to set policies governing VoIP -- and plenty besides AT&T's finances is riding on its decision. More than 80% of all U.S. counties are classified as rural, according to the National Exchange Carriers Association (NECA), a lobbying group for rural carriers. Just about all rural telecom companies besides the Baby Bells argue that reducing their take could force them to charge their customers much more -- or topple them into financial distress.

A ruling in favor of AT&T would hit the very smallest telecoms the hardest. Such outfits collect $2 billion in access charge revenues per year, according to NECA, and they argue that the damage would be significant. "Access charges [paid by long-distance carriers] represent a very large portion of the total revenue for a small telephone company" says Robert Anderson, NECA's president and CEO. "It can be as much as 70%."


  Eliminating those payments, critics argue, could make phone service much more expensive for rural customers as compared to their city cousins -- and that could limit access and the types of equipment and services rural phone companies could afford to provide. "If AT&T were successful and the FCC set access charges to zero, we would have to increase our local rates by more than $25 per month. In Wisconsin, we would have local rates of over $50 per month for plain telephone service," says Jeff Glover, CenturyTel's vice-president for external relations.

Long-distance carriers complain that their rural-access charges are much higher than those they pay in cities. For instance, while long-distance carrier MCI might pay local-phone company Verizon (VZ ) less than a penny a minute for a call to a customer in New York City, a similar long-distance call terminating in rural Wisconsin, Vermont, or Iowa could cost MCI as much as 2.5 cents per minute.

CenturyTel's Glover explains the rationale for this: Because his company has fewer customers spread over a wider area, it has invested about $3,000 in infrastructure and plant per subscriber -- about double the amount per customer that a carrier might pay in an urban area. What's more, the industry's CenturyTels represent a crucial part of the nationwide phone network and thus provide significant value to the long-distance carriers. As it costs rural carriers more to provide access to these customers, the long-distance carriers should absorb the difference, in part, as a cost of running their business.


  Be that as it may, long-distance carriers have long tried to hold down the charges they pay rural carriers by executing complex zigs and zags through the national and local-phone network to make an incoming long-distance call look local. Over the past five years, the introduction of advanced networks that move voice calls as bits of data over the public Internet have made such maneuvers harder than ever to uncover. In many cases these calls are indistinguishable from data traffic traveling between a Web server and a PC. "Phantom traffic" -- phone calls that slip unnoticed through data networks -- could add up to 20% of all minutes processed by switches on rural networks, argues NECA.

A further complication for rural carriers is that the FCC doesn't regulate data traffic, which it exempts from access charges. Naturally, AT&T and others see this as an opportunity to not only deliver their calls using economical technologies but also to connect to rural networks far more cheaply. In place of access charges, AT&T pays rural carriers much lower reciprocal connection fees, such as the ones Internet service providers fork over to phone companies.

Rural carriers thus "get something more aligned to the actual cost of completing the call, but what they don't get are the inflated access fees that are a remnant of the subsidy given to the Bells at divestiture," says Claudia Jones, an AT&T spokesperson. In fact, Jones claims that rural carriers have avoided upgrading their systems to handle calls carried over the Net precisely to avoid losing their access-charge subsidies.


  Even NECA concedes that AT&T is restricting its use of alternative methods of delivering calls to companies that can absorb the impact -- the Baby Bells and other large rural providers, such as CenturyTel, AllTel (ALLT ), and Citizens Communications (CZN ) -- while leaving the smallest carriers alone.

Ironically, though the Baby Bells strenuously object to AT&T's tactics, they're expanding their businesses in ways that could put them on its side of the fence: Verizon, Qwest (Q ), BellSouth (BLS ), and SBC Communications (SBC ) all are quickly moving into long-distance -- which eventually will require them to pay the same access fees to rural carriers that they themselves have been collecting.

The current system of access charges "was set up for a very good reason, and it has a lot of political support" from Congress, says Jeffries & Co. telecom analyst Richard Klugman. Since rural communities pop up in nearly every state, it's hard to find a member of that political body who isn't extremely wary of jacking up phone charges for their local constituents.


  Thus, it's likely that the FCC will make a narrow decision designed to address only AT&T but not the entire issue. A broader decision might not come until after next fall's elections, a point at which the FCC may well have a new chairman, should Michael Powell depart. In the meantime, rural carriers should perhaps start thinking about strategies that go beyond relying on the FCC for help. Some are doing so by offering more broadband data and even video services, competing with satellite providers.

These new revenue streams could enable the small-fry to survive, as new ways of making phone calls continue to proliferate. But at some point, rural carriers may have no option but to find a new business model.

By Alex Salkever, Technology editor for BusinessWeek Online

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