Verizon: Take That, Cable

It seeks to reclaim lost ground with a gutsy plunge into pay-TV services

Reality TV doesn't get any more painful than this. The cable-television companies have smacked around their telecom rivals in broadband over the past few years, grabbing most of the fast-growing market. Even worse, the cable players have started to swipe customers in the traditional voice market in recent months. "Cable companies have emerged as telecom's fastest-growing threat," says Brian Adamik, chief executive officer of researcher the Yankee Group (RTRSY ). Now, Verizon Communications Inc. (VZ ) is striking back. BusinessWeek has learned that the nation's largest telecom provider is preparing to seek cable-TV franchises in parts of Texas and eight other states so that it can offer video in head-to-head competition with cable companies. The service would provide a powerful new source of competition in the pay-TV market, where most consumers have a choice of one local cable-TV company and two satellite operators.

Although Verizon won't comment on specific TV plans, it has confirmed that it's building a system capable of carrying the service this year. The company will deliver signals over fiber-optic lines that it's connecting directly to homes and offices. It plans to offer digital TV, videoconferencing, and movies-on-demand either this year or next. Says Paul A. Lacouture, who oversees Verizon's network and is in charge of the project: "The battle is going to get a lot more intense."

$1 BILLION ROLLOUT

More intense and more expensive. Verizon expects to spend about $1 billion on the first phase of its rollout, making fiber lines available to 1 million homes by this fall. The Texas markets will include Keller, a suburb of Dallas. Although the identities of the other eight states could not be learned, one is likely to be California, a person familiar with the strategy says. Verizon plans to offer the service to 1 million more homes next year and a total of 12 million by 2008. Over the next 15 years, Verizon expects to spend $20 billion to $30 billion to extend service to nearly all 35 million customers.

Television is only part of the strategy. The new fiber-optic lines also will allow Verizon to offer the most advanced consumer broadband service the U.S. has ever seen. Internet connections of up to 30 megabits per second, more than 10 times faster than a state-of-the-art cable modem or digital subscriber line (DSL), will be possible, Verizon executives say. Five- and 15-megabit versions will be available for customers who don't require all that juice. Although specific pricing hasn't been decided, the 5-meg version will be competitive with cable modem service, which typically costs $40 to $45 a month. Eventually, if there's demand for it, Verizon intends to offer consumers Net connections of 100 megs or more.

Cable rivals in Texas insist they're not quaking in their cowboy boots. For one thing, Verizon has tried this before. Its corporate predecessor, Bell Atlantic Corp., unveiled grand plans to offer pay TV to its customers on the East Coast during the 1990s, but the project failed because of high costs and technological problems. Even if Verizon can make the economics work this time, it has no experience in entertainment, where it will have to face off against Time Warner Inc. (TWX ), Comcast Corp. (CMCSK ), and other powerful rivals. "We are already in a highly competitive marketplace. We face satellite in every market we are in," says David Mack, a spokesman for Charter Communications Inc. (CHTR ), which provides cable service in Keller. "We believe we will do just fine because we offer superior choice, price, and quality of customer care."

RAW FEAR

Verizon's TV sequel may fare better than the original production, however. For one, equipment has gotten cheaper and more reliable in the past 10 years, even as the market has grown. Digital set-top boxes, for example, cost about 50% less than they used to. And new network designs have lowered the expense of construction by more than 50%. A fiber connection now costs $1,100 to $1,700, depending on whether the cable is buried or strung from an easily accessible telephone pole. That is only 10% more than the cost of installing a regular copper phone connection.

Just as important is the motivational force of raw fear. Without an effective video strategy, the Bells likely will lose 30% of their telephone market to cable companies over 10 years, estimates analyst John C. Hodulik of UBS (UBS ). He believes losses could be limited to 15% if telecom companies can provide video -- because consumers are more likely to remain with a carrier when they purchase a bundle of services.

Verizon's peers are more cautious. BellSouth Corp. (BLS ) is testing fiber technology, and SBC Communications Inc. (SBC ) is planning to offer video service over fiber optics in some new housing developments this year. But no mass deployments are planned. "I'm not sure it's going to make sense to take fiber all the way to the home in existing neighborhoods," says Jeffrey G. Weber, vice president of corporate planning at SBC. So far, Verizon is on its own in its aggressive response to the cable threat. But if this gamble succeeds, it could prove to be the catalyst for a new generation of communications in the U.S.

By Steve Rosenbush with Tom Lowry in New York, Roger O. Crockett in Chicago, and Brian Grow in Atlanta

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