The Shifting Telecom Landscape

With AT&T and MCI going, the Bells will compete with cable and tech companies

In the span of two quick weeks, longtime telecom icons AT&T (T ) and MCI (MCIP ) have toppled from the corporate scene. First, SBC Communications Inc. (SBC ) announced on Jan. 31 that it would buy AT&T for $16 billion. Then, on Feb 14, Verizon Communications (VZ ) said it would snap up MCI for $6.7 billion, persuading MCI's board to reject a higher bid from Qwest Communications International (Q ).

The swallowing of the stalwarts of long distance by their Bell rivals marks a historic shift as a long and bruising battle in telecom draws to a close. Since the 1996 Telecommunications Act, long-distance giants have been duking it out with Baby Bells over the residential phone market. Now the Bells have vanquished both Ma Bell -- their former corporate parent -- and former upstart MCI Inc.

But as that era fades, another is dawning. "This is the end of World War I -- the Bells vs. AT&T and MCI," says Scott C. Cleland, a telecom analyst at Precursor Group in Washington. "Now, World War II, among the phone, cable, and tech companies, is about to begin."

Indeed, should the SBC-AT&T and Verizon-MCI takeovers go forward, they will be just the beginning of a massive transformation sweeping the telecom industry as the shift to digital technology gains speed. That's rapidly eroding the barriers between phone companies, cable providers, and other tech companies. The Bells are moving from the residential phone market they've dominated into a new set of digital ventures in wireless, data, video, and corporate services. Phone calls delivered over wires are becoming a commodity service that is under assault from wireless calling, e-mail, and Internet phoning over cable operators' wires. So the Bells have little choice but to seek fresh markets.

Verizon and SBC have already announced ambitious plans to offer TV service over superfast fiber networks in residential neighborhoods. Now the purchases of AT&T and MCI help them accelerate selling phone and data services to corporations -- beyond their traditional consumer market. Selling to corporations, which are less likely to change providers than fickle consumers, is seen as a source of potential growth and a hedge against the high-stakes play for residential video and other services via fiber. As Verizon CEO Ivan G. Seidenberg told Wall Street analysts on Feb. 14: "If we don't change, we'll be caught repricing old products."


The phone giants' efforts to break down the barriers among the voice, data, and video industries come at an opportune time for Washington policymakers. Outgoing Federal Communications Commission Chairman Michael K. Powell set the stage for the latest mergers by undercutting rules that would have helped AT&T and MCI challenge the Bells in local phone markets. Now, whoever succeeds Powell must tussle with the issues raised by the evolving competitive landscape. Meanwhile, new Senate Commerce Committee Chairman Ted Stevens (R-Alaska) plans to start a rewrite of the 1996 Telecom Act. "These deals represent a change in 20 years of market structure," says former FCC Chairman Reed E. Hundt. Policymakers "will have to scratch their heads hard." But the Bush Administration isn't likely to block the mergers over antitrust or competitive concerns. And the large corporate customers being targeted by the new behemoths have the clout to negotiate favorable prices for themselves.

For the two super Bells, AT&T and MCI offer a fresh corporate customer base and a leg up for some of their consumer businesses. One example: The long-distance carriers' extensive Web backbones can speed the Bells' deployment of Internet TV. "By using AT&T's network, SBC can offer TV more rapidly," says AT&T CEO David W. Dorman. Perhaps more important, corporations are a largely untapped market for the Bells' consumer-oriented wireless business. As offices adopt wireless phoning -- a shift many see happening soon -- Verizon and SBC can sell phones that double as mobile handsets for employees on the road and voice-over-Internet phones that worker bees at their desks can use over office Wi-Fi networks. "You're going to see business and consumer overlap," says MCI Chief Executive Michael D. Capellas.

Yet in each of their new endeavors, both Verizon and SBC will face experienced rivals with a big head start. The enterprise market is already teeming with the likes of IBM (IBM ), Electronic Data Systems (EDS ), Accenture (ACN ), and other systems integrators. While those longtime corporate consultants may not have the Bells' wireless capabilities, they know how to sell corporate software applications over the Web -- a fast-growing and highly profitable business that both MCI and AT&T are trying to crack. In the consumer market cable behemoths such as Comcast Cable (CMCSA ) and Time Warner Cable (TWX ) are already delivering the bundles of voice, data, and video services telecoms want to offer. "We have spent the past three years preparing for a major rollout of Internet Protocol phone service, and that doesn't change by what other companies do," says Comcast Cable COO Stephen B. Burke.

Clearly, the Bells have plenty of catching up to do. They're still building the fiber networks over which their TV services will run and lack the programming expertise that is part of cable execs' DNA. Verizon, which spent $1 billion to serve 1 million homes last year, plans to cover an additional 2 million homes this year. And SBC is spending $5 billion to reach 18 million homes in major markets within its 13-state territory by 2007. But compare that to the cable industry, which already has the ability to deliver TV, broadband, and phone service to 99 million households. Indeed, some smart money is getting behind cable. Over the past six months, Warren Buffett's Berkshire Hathaway Inc. (BRK ) has doubled its stake in Comcast, to 10 million shares, now valued at $328 million. And late last year, George Soros made an initial investment of $51 million in Time Warner, according to government filings.

While the phone giants will face stiff competition, regulators can't rest easy. The recurring problem for policymakers is the lack of competition for the last-mile connection to homes. There the Bells and cable companies still typically are the only relatively affordable options consumers have for broadband connections. Chances are the two rivals will "settle into a cozy duopoly" to avoid price wars, says former FCC Chairman William E. Kennard, now a managing director at Carlyle Group, a private equity firm in Washington. Policymakers' best hope for more price competition may come from startups such as wireless mogul Craig O. McCaw's ClearWire Corp., which sells broadband at affordable rates in select markets via WiMax wireless technology.


Competition in residential broadband will become even more vital as the telecoms and cable operators plan to sell more services on top of that basic fast Web link. Both want to move up the food chain to reap more revenues per subscriber, potentially putting them in conflict with others that need access to the same broadband pipes. Vonage Holdings Corp., for instance, is selling voice-over-Internet phone service over cable just as cable operators are entering that business, too. Regulators will need to provide safeguards so the phone and cable giants that control the broadband networks don't discriminate against service providers that they compete with.

The takeovers of AT&T and MCI officially usher in the long-heralded Internet era. The old phone companies are artifacts, and the new telecoms will look more like their counterparts in cable and computers. As players realign themselves during this upheaval, Washington will need to remain on the lookout for signs of monopoly power. But for the most part, consumers and companies will increasingly have their pick of new services from a bunch of providers that are fighting hard to win their business.

By Catherine Yang in Washington, with Brian Grow in Atlanta, Steven Rosenbush in New York, and Roger O. Crockett in Chicago

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