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Phone Frenzy


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PHONE FRENZY

The Area Code Cafe in New York's Greenwich Village may look like just another diner, but it's actually at the forefront of a communications revolution. There's a telephone on every table, and when you order $5 worth of food, you get a token to make a three-minute call to anywhere in the U.S. The restaurant owns the phones and pays a negotiated rate to a long-distance reseller. Owner Joe Marino says the cafe does not make much of a profit, if any, on the service, but the token gesture is popular among students and tourists who like the idea of bundling a meal and a call home into one service.

What's the significance? The Area Code is just one droplet in a flood of players and services pouring into the rapidly deregulating U.S. telecommunications market. Open markets and technologies such as fiber optics and wireless transmission that create huge amounts of low-cost calling capacity mean that just about anyone who wants to become a phone company can. From basement startups to cable-TV operators, energy companies to railroads, literally thousands of outfits are poised to offer phone service. And what happens to your trusty old phone company? Ask Daniel J. Miglio, chairman of Southern New England Telecommunications Co. "There is no future," he says flatly. "They must become something different."

It's the end of the phone company as we know it--part of a massive restructuring of the country's $1 trillion communications industry. Everything from your local phone company to Hollywood studios will be affected. While policymakers rush to keep up, dealmakers, entrepreneurs, and executives are pressing ahead. Mergers, alliances, new entrants, and new services are already changing the telecom landscape. Phone companies want into cable. Cable operators will sell phone service. Long-distance companies will take on local carriers--and vice versa. And everyone will seek "content"--from electronic yellow pages to movies--to lure traffic onto the emerging Information Superhighway.

Who will come out on top? At this point, it's anyone's guess. "By the turn of the century, we'll forget which of the companies were long-distance, local, cable, wireless, etc., because everybody will be offering new services, new sets of services, national brands, local niche products," says Bell Atlantic Corp. Vice-Chairman James G. Cullen. Certainly it will be confusing at first, but a decade of deregulation in long distance has conditioned Americans for what's ahead. After all, until 1984 nobody had ever thought about choosing a long-distance company. Today, 30 million Americans a year switch--jumping among AT&T, Sprint, MCI, and others for the best service and prices.

"DREAM BUSINESS." The driving force behind today's phone frenzy is technology. Most striking is fiber-optic cable. Conventional twisted-pair copper phone wires carry only a few conversations at a time. But a single glass strand can carry at least 32,000 conversations at once. And by beefing up the electronics, AT&T has been able to transmit as many as 320,000. Continuous improvements in both wired and wireless technologies promise a steep and steady decline in the cost of communications--analogous to the way microprocessors drove down the cost of computers and sparked the personal-computer revolution. Now, new communications technology is bringing forth new ways to deliver a flood of voice, information, and entertainment.

Ordinary phone calls, in fact, will be just one of a half-dozen forms of digitized information that can flow across so-called broadband networks (table, page 95). All this capacity means that a network can handle a virtually unlimited amount of traffic and add new services with almost no new capital investment. "The phone industry is really a dream business. It's the only one where the marginal costs of doing business are zero," says Harry Newton, a New York telecommunications consultant.

Before the legions of would-be telecom titans cash in on that promise, however, there's still one obstacle to remove: a regulatory framework based on the notion of phone service as a "natural" monopoly. That theory made sense when the system was being created. The undertaking was so vast and costly that it was assumed that only one system could be built. Carriers were granted a monopoly but had to provide universal service--low-cost calling available everywhere.

Since the U.S. broke up the Bell System, deregulating the long-distance market but leaving local monopolies intact, the deregulatory movement has circled the globe. "The idea of the natural monopoly has lost all credibility around the world," says Ken Zita, a partner with the consulting firm Network Dynamics Associates Inc. in New York. The most recent example: Germany's decision to accelerate deregulation--because the Deutsche Telekom monopoly isn't delivering the prices and services that German businesses demand.

Now, deregulation is about to hit the last U.S. phone monopolies: the $98 billion local-calling industry dominated by the seven Baby Bells and independents such as GTE Corp. There is virtual agreement in the telecommunications industry, on Capitol Hill, and in the statehouses that deregulating local service will be a boon to the nation. For proof, look at what happened in long distance. Since 1984, carriers have tripped over each other to add new services, and their market-share battles have sliced rates more than 60%. Competition could do the same in local calling, says Senator Larry Pressler (R-S.D.), chairman of the Senate Commerce Committee: "Progress is being stymied by a morass of regulatory barriers that balkanize the telecommunications industry."

Deregulating this massive industry has implications for the entire economy. Americans dialed up some $160 billion worth of domestic calls last year, and analysts estimate that the figure will pass $200 billion by 2000. Lower costs and new services will be a boon to business. And even though many Baby Bells are shedding employees to be more competitive, deregulation should be an overall job creator. An econometric study done by the consultancy WEFA Group Inc.--sponsored by the Baby Bells, mind you--estimates that competition in local calling will spark so much demand for new services that there will be a net gain of 3.6 million jobs by 2003. That's in addition to 1 million phone workers today.

CABLE'S GRASP. When will it all happen? Much depends on Congress. Pressler now leads the effort to replace vintage-1934 regulations. If he can find a compromise between Democrat and Republican approaches, deregulation could begin next year. On the other hand, the legislation could be killed by partisan infighting--as happened last year. Pressler has outlined a bill allowing competitors into local calling immediately but keeping the regional Bell operating companies (RBOCs) out of long distance and cable for one to three years. The Bells want simultaneous entry, while long-distance and cable companies want local carriers shackled until there's measurable local competition.

The market isn't waiting. New players are pushing into local service, and at least 10 states already allow some level of competition in local calling. All but three allow competition on some in-state toll calls. On Jan. 1, Rochester, N.Y., became the first U.S. municipality since 1919 to allow full competition in local residential service (page 97). The rest of the state could follow by August.

You might expect Nynex Corp., the regional Bell, to try to block competition, which will take chunks of its market. But the company is cooperating with New York regulators--because deregulation will let the $13.3 billion phone giant leap into all sorts of new businesses such as long distance and cable TV. "I'd rather have 10% of the world than 100% of New England," says President Ivan G. Seidenberg. Nynex took another big step into the competitive era on Jan. 25, when it announced plans to treat MFS Communications Co., a competitive access provider that links business customers to long-distance carriers, as a co-equal common carrier. It's the first such pact between an RBOC and a rival.

MFS, a pioneer eight years ago, is about to get plenty of company. Within a few years, consumers may start getting phone bills from cable-TV operators, utilities, or wireless carriers. They could even get service from a totally unexpected type of provider--such as the New York State Thruway Authority. It's gauging the feasibility of laying fiber-optic cable along its rights-of-way and offering phone service.

It's not so far-fetched. Deregulation brought nearly 500 new entrants into long distance. Wiltel Communications Systems, now part of LDDS, the No.4 long-distance company, got its start by running fiber along the Williams Cos. gas pipelines. Anyone with a right-of-way could do the same. In Britain, 12 electric companies created Energis, a 2,000-mile fiber-optic phone system. New Jersey's Public Service Electric & Gas Co. is developing a system with AT&T to read meters and offer appliance management, home security, and medical alert services. New Orleans-based utility Entergy Corp. is testing a similar network in Chenal Valley, Ark. These systems could just as easily double as phone lines.

While some players putter, cable-TV operators are plunging in. They own wires that reach the homes of 59 million Americans, and phone service looks like a no-lose situation. Time Warner Inc. executives are expecting an extra $10 per customer each month, and Morgan Stanley & Co. calculates that phone services should add 8% to 10% to a cable system's value. Also, coaxial wiring can handle broadband speeds right away, so it will be cheaper for cable companies to add voice than for phone companies to add video. "It's a huge competitive advantage," says Glenn A. Britt, president of Time Warner Cable Ventures.

Some of the nation's top cable-TV operators--Tele-Communications, Cox Enterprises, and Comcast--have formed an alliance with Sprint to build and operate a nationwide wireless phone network. The group is the top bidder for licenses to operate a new form of wireless phoning known as personal communications services (PCS), betting $1.4 billion so far that the new technology can fill gaps in a national network. Regulations permitting, the group will offer one-stop shopping for local calling, long distance, cellular, PCS, and cable, says Sprint Long-Distance President Ronald T. LeMay. "We have the chance to offer something that's not in the market right now," says LeMay.

Time Warner Cable already offers bypass services in 15 cities and has applied to offer residential service across New York and Ohio. California regulators say they'll let cable operators offer telephony as soon as any phone company in the state receives approval to offer TV.

The confusing blur between cable and phone operators is intentional: Executives in both industries say their futures may depend on it. "We're going to be an integrated communications company with telephony, video--which is our core--and new products: interactive audio and video products," says William T. Schleyer, executive vice-president of Boston-based Continental Cablevision Inc. "If you don't make the move, you'll have trouble competing in the future. If all you do is play defense, you have no defense."

DEALMAKING. You don't have to tell the Bells. U S West Inc. is furiously repositioning itself for video, paying $2.5 billion for 25.51% of Time Warner and launching video-on-demand trials. U S West, Bell Atlantic, BellSouth, Ameritech, and Nynex have all won federal court rulings allowing them to provide video over phone lines, also known as video dial tone. On Jan. 29, a federal court gave the same right to most of the nation's small phone companies.

The next phase of the wireless boom is another Bell challenge. Most RBOCs have profited handsomely from their cellular holdings, as the industry has streaked to its current $12 billion level. But PCS will bring dozens of rivals. The FCC auctions have attracted hundreds of bidders, ranging from the Baby Bells to one-person startups to cellular tycoon Craig O. McCaw, who has bid more than $300 million for licenses in New York.

Why the scramble? PCS, using higher frequencies and smaller "cells" than cellular, holds out the promise of low-cost phones for use around a town or building--a possible rival to the wired local phones. A study by BIS Strategic Decisions projects that some 77 million U.S. subscribers would consider using a wireless service to replace or upgrade their existing home phone if it were the same price.

In addition to attracting new players, phone frenzy is inspiring a swirl of joint ventures and acquisitions. Worldwide mergers and deals among communications, information, and entertainment companies hit a record $27.8 billion last year, according to KPMG Peat Marwick. "If the phone companies want to stay profitable they'll have to offer multiple services," says Jeffrey Miller, a telecommunications specialist with Andersen Consulting. "But that's going to require a big investment, and they don't necessarily have to carry the whole weight on their own."

"TELECOMPUTER" COMPANIES. Deals now cross every industry line. Pacific Telesis, Bell Atlantic, and Nynex have formed a joint venture sith Hollywood superagents Creative Artists Agency to develop new multimedia programming, while Ameritech, BellSouth, and SBC have joined up with Walt Disney for the same purpose. "We've got to make sure we have access to programming," says Ameritech Corp. Chief Executive Richard C. Notebaert. That's why Nynex has invested $1.2 billion in Viacom, while SBC Communications Inc. (formerly Southwestern Bell) has paid $650 million for the Hauser Communications cable system in Maryland and U S West has teamed with Time Warner. "Entertainment and information, we believe, is the wave of the future," says U S West Vice-President for Strategy Development Chuck M. Lamar.

The biggest spender is AT&T. In addition to its $12.7 billion purchase of McCaw Cellular Communications, it has bought into a string of technology startups, including game makers 3DO and Spectrum Holobyte and software publisher Knowledge Adventure. It's one of the big backers of General Magic Inc., which provides the software for the phone giant's new PersonaLink messaging system. "We've come to the gradual realization that we can't afford to do everything ourselves," says AT&T Chairman Robert E. Allen.

Computer giant IBM doesn't want to be left out, either. It flirted with telecom in the 1980s and got burned. But with communications and computing merging, it can't afford to sit this one out. IBM already operates the world's largest data network and resells voice services to some customers. John M. Whiteside, general manager of IBM's Global Network, says the company won't compete with voice carriers but will sell customers services to conduct electronic commerce. As he puts it: "It's the birth of the telecomputer company."

FIBER GLUT. What will all this bring to consumers? For a glimpse, visit Bell Atlantic's $200 million so-called "digital factory" in Reston, Va. There, the company is devising a system to deliver movies on demand, home shopping and banking, interactive programming, and information services to TVs over copper phone lines--all without interfering with regular calling. Up at AT&T in New Jersey, engineers have a gadget to turn your TV into an answering machine/home-banking/interactive-shopping terminal. GTE Corp. has a cordless phone that turns into a cellular phone when you leave the house. BellSouth Corp. is pushing personal digital assistants that send and receive E-mail, faxes, and voice calls wirelessly.

The new telecom world won't just be big companies with whizbang techno-goodies. A glut of fiber capacity has created a bonanza for entrepreneurs. Anyone who can make a deal with MCI Communications Corp. or AT&T to buy capacity at bulk rates can become a reseller. Former dental hygienist Kathy Haycock, 43, mortgaged her home to start Call-America, an AT&T reseller, in Mesa, Ariz.. "No one would give me a loan because they thought it was crazy," she says. Now, she has 25 employees and 20,000 customers. Deregulation should bring reselling to local calling, too. In fact, in Rochester, rivals will start by leasing Rochester Telephone Corp. capacity.

The specter of hundreds of competitors where once there were none has energized the Baby Bells to turn efficient--fast. Until the past year or two, they had little incentive to cut costs. Most states capped rates at a predetermined profit level, and about half still do. Nynex, the most tightly regulated Bell, is allowed a rate of return on assets in New York of only 9.15%--anything more is returned to customers in the form of rate cuts.

Now local phone companies have plenty of motivation. In addition to competition for local calling, they could face a sharp reduction in their most lucrative business: the access fees they collect from long-distance carriers. Those fees totaled $30.8 billion in 1994, some 30% of the RBOCs' total revenue--and more than 40% of the long-distance carriers' expenses.

Deregulation will change that. The Bells expect to get into long distance, but long-distance carriers also expect to get into local service--in part to slash access fees. Each of the big three of long distance is preparing direct local connections--Sprint through its cable consortium, AT&T through McCaw, and MCI through a bypass network planned to reach businesses in 200 cities within five years. It will be worth the $2 billion cost, says MCI President Gerald H. Taylor. "Cut access, cut access, cut access, that's what it's all about." AT&T Executive Vice-President Alex J. Mandl says the phone giant will try any form of local access--wireless, cable, building its own local loops, even reselling Bell service. "We must have as many links to the customer as possible," he says.

Can the Baby Bells thrive amid all this competition? Or will they be mere victims? "It's a wake-up call," says SBC Executive Vice-President James R. Adams, who has glimpsed his future in Britain. There, SBC is part of a cable-TV joint venture in which 60% of the 1.3 million subscribers use the cable system for local phone calls. The way he sees it, SBC's cable unit "is the hunter, and we're the hunted....We just have to make sure we're not the easiest deer for our rivals to find."

All the local phone companies are furiously trying to look less like prey. They're spending billions to create stronger brand names and build broadband networks. Pacific Telesis plans to spend $16 billion over seven years; Bell Atlantic has budgeted $11 billion; U S West $10 billion; Southern New England Telecommunications $4.4 billion.

The Bells are also investing in new management talent. Two years ago, Ameritech hired 40-year-old James Firestone away from American Express Co.'s Travelers Check Group to run its residential business. A quarter of Nynex' executive staff has been hired from outside the phone business--mainly to boost marketing. It's an important step toward the day when customers will have a local service choice, says Seidenberg. "Our obligation to our customers is to get on with the change."

Such sentiments are becoming the norm rather than the exception among Bell execs. And why not? Despite the risks, deregulation has been, above all, a boon to phone companies. The International Telecommunication Union notes that in every market where competition has been introduced, rates have fallen and calling volumes have risen dramatically. Just consider AT&T: It has lost 40% of its market share and dropped rates by 60% over the past decade--and it's doing better than ever. Revenues for 1994 jumped 8.3%, to $75.09 billion, equal to its predivestiture level, while operating profits soared 26%, to $4.71 billion. "The people who are worried about their slice of the pie today are goofy. They should be worried about expanding the pie," says Southwestern Bell Mobile Systems Chief Executive John T. Stupka. If they're not convinced, they should stop by the Area Code Cafe for a token.

SAY THAT AGAIN?

Here are some of the terms you'll need to know as new calling choices multiply:

ACCESS LINE The circuit that connects a customer to the telephone network.

BANDWIDTH The range of frequencies that can be transmitted. The greater the bandwidth, the greater the capacity.

BROADBAND A fuzzy term describing high-bandwidth connections--generally those that can carry numerous voice, data, and video channels simultaneously.

COMPETITIVE ACCESS PROVIDER (CAP) An alternative to the local phone company.

COMMON CARRIER A company offering telecommunications to the public on a nondiscriminatory basis.

INTERACTIVE Refers to the ability to carry two-way transmissions. Phones are interactive. Cable TV is not--yet.

MULTIMEDIA NETWORK A system that can carry several forms of communications, among them voice, data, and video.

NUMBER PORTABILITY Lets a customer retain the same number when changing carriers.

PERSONAL COMMUNICATION SERVICE (PCS) A digital wireless service that might be inexpensive enough for full-time local calling.

RESELLER A company that buys transmission services at bulk rates for resale to the public for a profit.

SPECIALIZED MOBILE RADIO (SMR) A two-way, radio-dispatch service being upgraded to provide cellular-like phone services.

VIDEO DIAL TONE An automatic connection to a network transmitting video.By Catherine Arnst in New York, with Kevin Kelly in Chicago, Peter Burrows in Dallas, and bureau reports


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