Telecom: The Day After

Will unleashing the Baby Bells serve to heighten competition -- or stifle it?

Eight years ago, Congress enacted a grand plan to open up the local phone monopolies left by the breakup of the Bell system. Lawmakers drew up a road map in the 1996 Telecommunications Act. Key to that plan: The Baby Bells would be forced to rent their networks at discounts to competitors such as long-distance carriers AT&T (T ) and MCI Inc. Ultimately, once the newcomers won enough local phone customers, they would build their own networks and free themselves from the Bells' systems.

On June 9, the Bush Administration ended support for that path, reasoning that newer technologies such as wireless and Internet phone service would provide plenty of fresh competition for the Bells. The Justice Dept. declined to challenge a D.C. Federal Appeals Court ruling that threatens to end this experiment in telecom deregulation. The ruling allows the Bells to stop the practice of providing long-distance companies and other competitors deeply discounted access to local networks for resale. Now, AT&T and MCI are mulling a retreat from the local consumer business.

So is the Administration's move a good decision for consumers? And how will it affect the various telecom players as the sector begins to shake out and new technologies catch on? Here's a look at how the Justice Dept.'s decision will play out:

How big a win is this for the Baby Bells?

Huge. Verizon (VZ ), SBC Communications (SBC ), BellSouth (BLS ), and Qwest Communications (Q ) have won a major round against their traditional foes. Under state and federal rules, they'll still have to lease pieces of their network to competitors, but they'll probably be able to charge more starting next year. Those higher wholesale rates may shrink rivals' businesses. Next year the Bells could win back 4 million of the 15 million lines they've lost to the consumer and business customers of the long-distance carriers and small startups, according to Lehman Brothers Inc. (LEH ). If the trend continues, the Bells could reap $3 billion in additional revenues over the next three years. Even sweeter, the Bells get to keep the business they gained in the 1996 Act, bundling long-distance along with local service.

What will the shift do to wholesale rates, and how will that affect consumers?

Rates won't rise this year but may in 2005. The Bells promised the feds that they would hold their leasing rates steady until then. But they're pushing the states, which set rates, to increase leasing prices to about $28 a line, up from today's typical $19. With households paying about $40 a month for local service, according to the Yankee Group, the Bells argue that higher rates still leave long-distance carriers room for a tidy profit.

But AT&T and its allies contend they may not be able to make enough to justify staying in the local consumer phone business. The total cost per local customer comes to $29, says AT&T. That leaves a scant $1 for profit in the local business, as AT&T calculates it, in the $50 local and long-distance packages it sells. Most competitive carriers will have to raise rates to stay in the local market. This will likely hit consumers. The Competitive Telecommunications Assn. calculates that 7.5 million consumers who buy local service from AT&T and MCI are now saving $11 billion a year. Those savings will probably diminish. At the same time, the Bells may opt to keep rates down in the face of stepped-up competition from wireless and Internet calling.

Will long-distance carriers stop selling consumers local phone service?

AT&T says it will halt local service in some states and is continuing to review its options. If it can't sell bundled local and long-distance services, the company will find it harder to match the Bells. MCI has already refocused its business on the corporate market, emphasizing Internet services. And Sprint Corp. (FON ), which owns its own local phone network, is also pushing wireless and Internet services .

So it's back to the old Bell monopoly in local phone service?

Not quite. Even if the long-distance carriers pull back their local offerings, wireless and voice-over-Internet technologies provide an alternative to the Bells' local phone service. But not all consumers will view them as substitutes. Today, about 160 million Americans subscribe to wireless phones. Yet because cell phones are still unreliable, 95% of those subscribers hold onto their traditional wired local phone service, according to Yankee Group. By 2008, as wireless calling quality improves, the market researcher predicts, 15% of U.S. wireless subscribers will cut the cord, up from 5% today.

Here Come THe I-Phones
Internet-based phone service should also shake up the industry. The Net market is still in its infancy, with only about 150,000 U.S. consumers sending and receiving calls via their broadband hookups now. But that's about to change. This year, major cable operators, including Comcast Corp. (CMCSA ) and Time Warner Cable (TWX ), plan to roll out consumer Web phone services -- as do AT&T and Verizon. Next year, the other Bells will launch such products. By 2008, 19% of U.S. households will adopt Web calling, says Gartner Inc. (IT ).

Will the new technologies force local phone prices down?

Maybe not. Wireless and Internet calling come with new capabilities and features, and so far consumers are willing to pay extra to get them. Consider that today the average tab for phone service for families that have both wireless and traditional lines is about $103 a month: The Bells' local and long-distance packages sell at about $50 a month, and consumers pay an average $53 more per month for wireless phone plans, although that could fall to about $45 by 2008, according to Yankee Group.

Internet calling will be cheaper -- but only for those who have or want broadband access. To get Net calling, customers need both a broadband connection and the phone service. Broadband will cost about $35 a month by 2008, with the Internet phone bill adding another $30 or $40, according to Gartner Inc. With cable companies winning new broadband customers, the Bells may be forced to lower their Internet phone prices to hold on to their local customers.

What will the Bells and the long-distance carriers have to do to survive?

The Bells are in the stronger position, but they are still racing to cover every bet. Verizon, SBC, and BellSouth already control big wireless companies, and all four Bells will launch their own Net phone services soon. They may lose some ground to cable operators, whose broadband pipes are the launching site for Web access, Net calling, and advanced video services. For AT&T, MCI, and Sprint, the fight is on just to stay alive. Their Internet and wireless bets have to pay off soon, because they're getting hammered in both declining long-distance business and local calling. Otherwise, they may become takeover bait for stronger players like the Bells.

Is this new formula for competition good or bad for consumers?

The explosion of new technology gives consumers conveniences they've never had before. But these services don't come cheap. Consumer advocates fear that, in the future, only two players -- the Bells and the cable operators -- will dominate this landscape. The Bells will control land lines and wireless and have a strong stake in Internet calling. The cable giants will wield a powerful array of broadband, phone, and video offerings. But will these two behemoths fight to undercut each other's rates -- or simply settle into a comfy facsimile of competition? That's the main question left unanswered by the the Bush Administration's decision to step back and watch as technological changes sweep through the industry.

By Catherine Yang in Washington, with Roger O. Crockett and Brian Grow in Chicago

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