If Congress has its way, by this time next year, a high-tech gold rush will be unleashed on a U.S. industry that accounts for almost one-fifth of the country's entire gross domestic product: the $1 trillion telephone and television communications industry.
The prize nugget these prospectors are fighting over is the "local loop," the wires and cables that deliver a dial tone into U.S. homes and businesses. Those best positioned to control the local loop are the companies that already dominate it: the seven major U.S. "Baby Bell" phone companies created by the Justice Department's 1982 break up of the AT& T monopoly. The Baby Bells have enjoyed a decade-long monopoly, albeit a heavily-regulated one. Last year, each Bell took in from $10 billion to $17 billion in revenue. U.S. citizens made some $160 billion in local and domestic long distance phone calls last year. Analysts estimate that by end of the century, the nation's annual phone bill will exceed $200 billion.
Out of the loop
The Baby Bells now face competition from a handful of so-called "major independents" that maintain various kinds of national or regional telecommunications monopolies. These include:
At stake for all of these companies in the gold rush is previously protected turf - their own and that of their competitors. The Bell companies have had the local loop to themselves for most of the decade since the courts broke up "Ma Bell." CAPs have been allowed to infiltrate major business markets and offer alternative phone service only in the last year. Just as other competitors were kept out of the local loop until recently, the Bells have been banned from such operations as long distance service and manufacturing.
Cable companies also have enjoyed monopolies. Cable operators forge deals - called franchise agreements - at the municipal government level that guarantee them a monopoly on local cable service. In return, the local government gets to collect the franchise fees and usually requires the cable company to hook up the local school systems to the cable network.
The AT& T breakup barred Bell companies from cable services. Last year, a federal district court struck down that ban as unconstitutional on First Amendment grounds. The ban violated the Bell companies' rights to constitutionally-protected free speech, the court said. Finally, long distance companies have been banned from local telephone service, a market that they desperately want to penetrate.
As the walls that once sealed off different sectors of the telecommunications industry come tumbling down, many of the companies in each sector have fought to preserve whatever protections they can for themselves, even as they labor to undermine the surviving barriers that bar them from branching out into diversified telecommunications services. Companies protect their monopolies in various ways, some subtle, others not so subtle.
Litigation is one common tool. When the government makes a ruling that's unfavorable to one group of companies, a law suit is almost certain to follow. For example, earlier this year the Federal Communications Commission (FCC) mandated that all Bell companies must give competitors physical access to their central offices. These offices contain the computerized switches that route local and long distance calls and handle advanced services such as caller identification and call forwarding. The Bells revolted, arguing that the FCC had no right to grant their competitors access to their equipment and facilities. A federal district judge ultimately ruled in their favor.
Cable companies, for their part, tie up local telephone companies with endless filings before the FCC. For every Bell company that filed applications with the FCC to build cable-like "video dial tone" (VDT) networks, the cable companies filed reams of paper opposing the plans. By law, the FCC had to act on all complaints. As a result, some Bell companies have been waiting more than two years for FCC approval to install these services. Bell Atlantic cited these delays in announcing recently that it would scrap all of its VDT plans.
Off to the races
Coveting each other's markets, each group wants freedom from market restrictions - at least for itself. Legislation before Congress in May 1995, however, would bring sweeping deregulation to the industry, allowing companies in each sector to feed on everyone else's market.
Senator Bob Packwood, R-Oregon, has likened this deregulatory process to the Indy 500, the high speed car race that traditionally got under way with contestants being instructed, "Gentlemen, start your engines." During Senate Commerce Committee hearings on the bill in March, Packwood said, "We should just pick a date and let the competition begin." But unless deregulation is carefully refereed, the outcome may end up resembling a demolition derby in which drivers race around the track, smashing into their opponents until just one victorious car is left running.
The Bell companies say they are fighting for their competitive lives. They claim that the idea of a "natural monopoly" - caused by the prohibitively expensive costs of entering a market (i.e. installing phone lines) - is a fallacy. Roy Neel, president of the United States Telephone Association, a leading trade group, points to the 25 most populated U.S. cities and says, "There are two or more competing telephone companies in each of these markets ... if that's not a sign that our current regulatory scheme [designed to regulate a single monopoly company] is outdated, I don't know what is."
Neel is right - in part. Businesses in these markets now are free to choose between their traditional Bell provider and a CAP. What Neel, a former Clinton administration White House deputy chief of staff, leaves out is that the combined revenues of all CAPs does not add up to even 1 percent of the combined revenues of the Bells. But the Bells also are eager to expand beyond the confines of their monopoly roles. There is no future in remaining just a phone company and the Baby Bells must change to survive, says Daniel Migilo, president of the Southern New England Telephone company.
For whom the Bells toll
A crucial question that offers insight into the advisability of the deregulatory proposals is: Who would benefit? The telephone companies claim consumers will. According to an economic study the Bells commissioned from the WEFA Group, a Washington, D.C.- based economic consulting firm, barring the Bells' entry into the markets they covet until the turn of the century would shave $137 billion off the U.S. gross domestic product and would prevent the creation of 1.5 million new jobs.
"Freed from outdated restrictions," says Gary McBee, chair of the Alliance for Competitive Communications, a trade group for the Bells, "the Bell companies can help ensure that America's communications industry continues to be an engine for economic growth." The WEFA study claims that, if the telecommunications market were deregulated immediately, every U.S. household would "gain an average of $850 in disposable income annually over the next decade." The estimate is based on projected lower costs for cable TV and local and long distance phone calls.
Armed with these claims and backed by a new deregulatory Republican majority in Congress, communications executives sound confident. By the year 2000, "we will all probably forget which company once offered long distance, which local, which cable service," says Bell Atlantic Vice-Chair James Cullen. Consumers will find such changes "confusing at first," Cullen acknowledges, "because everybody will be offering new services." There will be a myriad of new "national brands" he says. After 10 years of choosing between long distance providers, U.S. consumers have been "conditioned" to shop "for the best service and prices," Cullen says.
But critics argue that deregulation will strip state regulators of the authority to examine the rates of local telephone companies. As written, the telecommunications reform bill would increase telephone bills by "more than $44 billion over 4 years," says Brian Moir, staff counsel for the International Communications Association (ICA), which represents large commercial firms such as financial and insurance companies. Moir's data is derived from an ICA-funded study.
McBee alleges the ICA study exemplifies attempts by "the sky-is-falling" crowd to skew the deregulation debate. "The study is so preposterous that I hesitate to dignify it with a response," McBee says. Similar claims were made when the AT& T monopoly was broken in 1984, he points out. At that time, consumer groups including the Consumer Federation of America predicted that as many as six million telephone customers would be priced out of the market by 1986, McBee says. Such predictions, "weren't even close and in fact, telephone subscribership has increased."
Though the telecommunications industry argues that deregulation will stimulate competition, Bradley Stillman of the Consumer Federation of America says the impact of the legislation would be "anticompetitive" because it "doesn't have adequate provisions to keep telephone companies from buying up their competitors." Consumer advocates also argue that consumers will be stuck with the cost of such acquisitions. "Consumers are going to be left paying the bill" through rate hikes designed to finance such expansion, says Gene Kimmelman, director of the Washington, D.C. office of the Consumer's Union. Kimmelman warns that it is foolish to relax telecommunications regulations prematurely, before the industry attains a truly competitive environment.
Cabling for assistance
The cable companies have also been confined to their narrow sectoral fish bowl for a decade. TCI, the biggest cable operator in the United States, is the only cable company to turn a profit so far, and that was just $1 million for a single quarter in 1994.
The cable industry has plowed its revenues back into its infrastructure, which "can now reach 95 percent of American homes," says Decker Anstrom, president of the National Cable TV Association (NCTA). Over the next five years, the cable industry will double its band-width capacity, he says, allowing it to carry new multimedia information technologies.
Capacity is being expanded to beef up the industry's ability to offer phone service and online computer graphic images. The industry invested about $2.6 billion in 1994, up from $1.8 billion in 1993, to upgrade its facilities to be able to deliver phone service, says Meredith Jones, head of the FCC's Cable Bureau.
The cable industry is now pressuring Congress and the FCC to forestall the Baby Bells' entry into the cable business. NCTA's Anstrom says that the Cable Reregulation Act of 1992, which brought price controls to an industry that Congress felt was out of control, undermined the industry's ability to compete and that it should be given some protection from the telephone company giants. The cable industry is worth $20 billion, whereas the Bells are worth more than five times this amount, Anstrom says. Cable reregulation cost the industry $20 billion in revenues, depriving the industry of its ability to borrow money, Decker adds.
That argument is "bogus," says Bradley Stillman, director of legislative affairs for the Consumer Federation of America. The cable industry's "revenues are up; their subscribers are up for an industry supposedly struggling to survive, they seem to be doing all right," he says. A study by Paul Kagan Associations, a Wall Street analyst firm, found that cable company stocks rose four times faster than the average stock in the Standard & Poors 500 in the two-year time period following passage of the 1992 Cable Reregulation Act.
The Paul Kagan report jibes with the picture the industry presents its investors. "The telephone industry is a $100 billion dollar industry and cable is a $20 billion dollar industry," says Cox Cable Enterprises in its 1994 annual report. "For [cable] to get into the telephone business we need to spend X in capital investment. For [the phone companies] to get into the cable business, they need to spend 2, 3 or maybe 4 times X. For that 2 to 4 times X they get to chase a $20 billion pie. For our single X, we chase a $100 billion pie. That paradigm drives [our industry's] entire thinking. Can we run circles around those guys? Yes!"
Striking the Cable Reregulation Act would also be "a disaster" for consumers, says Consumer Union's Kimmelman. It would wipe out more than $3 billion that consumers have saved as a result of the lower rates the act mandated, he says.
Long distance runners
The long distance phone companies are also scheming to expand their spheres of influence. Last year, MCI, the nation's second- largest long distance phone company, announced that it would launch a new company subsidiary, MCI Metro, to compete aggressively for local phone customers. MCI Metro is part of a $20 billion initiative to capture market share in the local loop and in information services such as those found on the Internet, the global computer network.
In another development earlier this year, the cable industry formed a coalition with the long distance industry in an effort to enter the local loop. These parties decided to "work together on a state-by-state basis" to lobby state regulators to open local telephone markets to competition, said NCTA's Anstrom. The group has targeted six states - Florida, Georgia, North Carolina, Ohio, Texas and Virginia - for its initial campaign. Heather Gold, president of the Association of Local Telecommunications Services, which represents companies that resell local telephone services, says this state campaign is part of an ongoing strategy and does not reflect doubts about deregulatory legislation before Congress.
This long distance-cable coalition draws sneers from the Baby Bells. The cable industry is not really interested in fostering competition, charges Bell Atlantic Vice President Edward Young. The FCC is not "fooled by the cable TV smoke screen and state regulators shouldn't be deceived either," he says. NCTA's Anstrom counters that it is the Baby Bells that loathe competition, with 40 states still protecting "telephone monopolies."
Of the 10 states that have experimented with local phone competition - Connecticut, Illinois, Massachusetts, Maryland, Michigan, New York, Oregon, Washington and Wisconsin - New York has gone the furthest. In a pilot test, the state completely deregulated the city of Rochester's phone market. Regulators let Rochester Telephone, a large independent regional phone company, break itself into separate companies and open local markets up to competition. The biggest competitor to come along is AT& T. By buying local loop capacity from Rochester Telephone, AT& T is offering local phone service. For its part, Rochester Telephone makes money from AT& T as well as by offering its own local telephone service.
The idea for the experiment was first floated by Rochester Telephone itself. "If these were the good old days, we'd all probably be comfortable, fat and happy" with the status quo, says company President Ronald Bittner, explaining his company's unusual position. "We realized that the telecommunications industry was on the brink of major upheaval and we decided to meet the transformation head on."
Plotting the future
Not content to wait for formal deregulation of the industry by Congress, the phone companies are already scrambling to get a head start on their deregulated futures.
Over the past two years, federal courts in every district encouraged them to do so when they all overturned the ban on phone companies offering cable-like services. Taking advantage of this victory, the phone companies plan to offer these new services over "video dial tone" systems (VDTs). Although VDTs are being hailed as "information superhighways," all they are likely to deliver in the near future are "on-demand" video movies, given that technologies for other advanced services are still in the laboratory testing phase. Advanced services include arcade-like, multi-player video games, full internet access, online banking and shopping.
Several Bells have launched investments on VDT networks that will end up costing tens of billions of dollars (since they have to lay their own lines), but no commercially viable system is yet in place. The FCC, which has cleared just three VDTs for construction, has slowed the process. The agency is reviewing another 26 VDT applications.
Many Bells are diversifying their holdings. US West, for example, spent $2.5 billion to buy 26 percent of entertainment giant Time Warner. US West is also a part owner, along with TCI, of a dual cable and phone company in the United Kingdom. This experience "should give us a good head start in the U.S." says Chuck Lamar, US West's vice president for strategic development.
Bell companies Pacific Telesis, Bell Atlantic and NYNEX recently formed a joint venture with Hollywood's Creative Artists Agency create video programming content that eventually they plan to "front load" on their VDT networks, according to Bell Atlantic spokesperson Larry Plumb.
In April 1995, the FCC granted approval for the first time for the Bells to produce and deliver their own home-grown programming on their future VDT systems. "We've got to make sure we have access to programming," explains Ameritech chair Richard Notebaert. Toward this end, Bell Atlantic has spent $200 million to build its own video services unit in Reston, Virginia to develop program content; Nynex has spent $1.2 billion to buy into cable program provider giant Viacom; and Southwestern Bell has spent $650 million for two small cable companies in Maryland.
Home team advantage?
In an effort to free themselves from market restrictions, while preserving as many barriers to their would-be competitors as possible, the Bells have emerged as one of the most powerful lobbying forces in Washington. Blocking tactics used by the Bells include forcing customers who opt to switch phone companies to change their phone number and forcing competitors' customers to dial up to 14 digits to place a local call. Scoring public relations points, the Bells have offered schools and non-profits "at-cost" access to new information technologies. Bell Atlantic, for example, has given schools in its market free access to its new cable system. Beyond public relations, the individual Bells have spent $105 million in the past two years to lobby state and federal officials.
But the biggest Bell advantage is that they are "local constituents," says Pacific Telesis CEO Philip Quigley. "The Bells are headquartered and can claim a representative in every district," he says. "That gives us a lot of access and a lot of ability to monitor" the activities of members of Congress, he says. In local congressional districts, many members of Congress cannot afford to write off the votes of an active, unionized Bell workforce.
Despite the Bells' political tour de force, "We aren't sticking our heads in the sand," said Bell Atlantic's Cullen. He estimates that his company stands to lose between 10 percent and 20 percent of the local loop, once it is opened to competition. On the other hand, Cullen calculates that, by the turn of the century, his company could pick up between 10 percent and 15 percent of the long distance market and 10 percent to 40 percent of the cable market in its region.
Bell Atlantic Chair Raymond Smith says Congress is determined to dismantle the local monopoly and, if the Bells refuse to acknowledge it, they risk being "mowed over by the forces of technological convergence."
If the legislation passes, "the resulting conglomerate[s] would be extremely powerful multistate, multifaceted utility monopol[ies], potentially controlling every aspect of utility services for ratepayers: electric, gas, telephone, cable, mass media and even information services," warns Larry Frimerman, legislative liaison for the Ohio Office of the Consumers' Counsel. "Such powerful entities could control both the content and the methods of delivery for all of these services. An entity controlling so much of our utility network would be difficult to police."
A pending bill moving through Congress would remove restrictions on the ability of electric utilities to diversify into unregulated telecommunications businesses. These restrictions were imposed under New Deal legislation, the Public Utility Holding Company Act (PUHCA), after a period when a few massive holding companies controlled virtually all U.S. utilities and non-utility businesses as well. These companies cost investors and ratepayers untold sums through such monopoly ploys as cross-subsidization, whereby ratepayers subsidize the utility's ventures in unregulated industries.
PUHCA ensures that companies benefiting from government-granted franchises make serving their "captive" customers their primary obligation and that states can effectively protect consumers by regulating utility rates. Its key provisions impose strict limits on diversification into unrelated businesses and promote local ownership and control. PUHCA's most strict regulations govern "registered" holding companies, which are generally larger and operate in multiple states, because they are less susceptible to effective state regulation. (The 10 registered electric holding companies hold about $115 billion in assets and earned more than $3 billion in profits in 1994.)
A broad coalition of consumer and environmental groups - ranging from organizations representing large industrial electric consumers and state consumer advocates to national public interest groups - oppose allowing energy companies to participate in telecommunication markets. In a letter to Senate Republican leadership in March 1995, the coalition wrote: "The anti-competitive aspects of the current [Senate] bill are two-fold: it places millions of electric and gas customers at risk from the tremendous market power these utilities continue to enjoy, and it jeopardizes the development of true competition in telecommunications markets because of the likelihood of cross subsidies. ... The only real guarantee that anti-competitive behavior can be prevented is to prohibit the possibility of cross-subsidization in the first place, by preventing monopoly owners from entering telecommunication markets."
Utility executives have been surprisingly forthright about their intention to reach into the pockets of electric ratepayers to subsidize their telecommunications ventures. At a congressional hearing on similar legislation last summer, utility representatives advocated that ratepayers serve as the "anchor tenant" for construction of the information highway. Paul DeNicola, president and chief executive officer of the Southern Company, which has 3.4 million captive ratepayers in Alabama, Georgia, Florida and Mississippi, argued that few companies will build fiber optics at the local level "unless they have a predictable source of revenue that supports most, if not all, of the capital cost."
One of the utility's primary arguments for legalizing entry into telecommunications is the potential use of telecommunications for "real-time" electricity pricing, which, in theory, allows consumers to adjust their consumption to accurate price signals (although utilities can manipulate this system by charging ratepayers a higher total cost for all electricity consumed during a given period, although only a portion of that electricity actually costs more to produce). "Customers like real-time pricing because it will give them lower bills," argues Thomas Schockley, an executive vice president with Central and South West Corporation, another large holding company operating in Texas, Oklahoma, Arkansas and Louisiana. "Utilities like the idea because it will permit them to use their existing plants more efficiently. The environmental community likes the idea because it will allow utilities to defer construction of new plants. Real-time pricing appears to be a potent demand-side management tool."
But many environmentalists are highly skeptical of the utilities' environmental arguments. The coalition letter states that the "alleged environmental benefits of unrestricted energy utility entry into telecommunications have been overstated by utility representatives." The group argues that "diversification into non-utility businesses also will diminish the utility's primary mission of providing least cost energy service."
Critics also point out that when electric utilities have been permitted to diversify into unrelated businesses, customers rarely benefit and often bear the brunt of higher costs. In 1992, Charles Studness, a columnist for the trade publication Public Utilities Fortnightly, analyzed the diversification experiences of utilities, finding them "horrendous in the aggregate ... and satisfactory to disastrous for individual utilities." If shareholders want to invest in non-utility businesses like telecommunications, critics argue, they are free to invest on their own, independent of their utility investments, without exposing ratepayers to new risks.
Mark Cooper, who testified at last summer's hearing for Environmental Action and Consumer Federation of America, compared the risks of the legislation to the nuclear power plant debacle now costing utility ratepayers and shareholders billions of dollars in excessive costs. "In the aggregate, it will cost more than all the money spent on all the nuclear power plants started or finished, in the past several decades," Cooper said, noting that the cost of building the information superhighway will be well over a quarter trillion dollars. "Most of the entities seeking to build it are looking for a subsidy. They seek to have current captive ratepayers pay excessive rates for existing services as a source of funds to build the superhighway."
"While we understand the desire to build the information superhighway and to have regulatory parity between potential entrants into the information age, assuring companies with immense market power an opportunity to abuse ratepayers is not what we have in mind," Cooper said.
- David Lapp