Saturday, July 30, 2005

The Economist Gets It--RBOCs going down

The venerable magazine The Economist has an article in the current issue worth reading if you want to understand some crucial background to Lafayette's recent fiber fight. The article outlines the "challenges" that the phone companies face and their meager resources for answering that challenge. Much of BellSouth's recent questionable behavior in Lafayette is most charitably understood as desperation and this article lets you know why that desperation is appropriate.

If you've read this blog for awhile you've likely come away with the (accurate) impression that we think the Regional Bell Operating Systems (RBOCs), the offspring of the breakup of the Bell Telephone system, are in real trouble. They are, and the tools that BellSouth Louisiana was forced to use over the last year's fiber fight is evidence of their desperation—if you've got anything else, you don't use fear, uncertainty and doubt. You field a real argument and make it openly. Further evidence, if such is needed, of BellSouth's desperation as is the fact that even after it became clear that referendum would pass and that further opposition would serve mainly to damage an already weakened competitive stance among Lafayette voters they could not follow Cox's lead and back off completely. The difference? Cox, as little as they may like the idea, can mount a serious competitive response to LUS if necessary. BellSouth simply cannot. They may reasonably feel cornered and a cornered animal will take any shot they can get.

Here's the nice, succinct way that The Economist describes the problem in the context of the necessity for the Regional Bell Operating Systems (RBOCs) to offer Internet Protoc0l TeleVision:
IPTV forms part of a larger, and quite desperate, defensive strategy now being adopted by telecoms firms against fierce attacks on multiple fronts. On one front are cable giants, such as America's Comcast, which are luring customers with an enticing “triple-play bundle” of TV, broadband and telephony services. On a second front are mobile-phone operators, which young customers in particular are increasingly using to “cut the cord” from their fixed-line company.

But arguably most dangerous of all is the third front, where traditional telecoms firms are under attack from voice-over-internet-protocol (VOIP) providers, which use the internet to carry conversations that would previously have taken place via a conventional phone.

The Economist's author, true to the discipline of economics, does not try to pretend that cell phone "modal" competition is direct competition for landline telephony. Such "competition" only incidentally erodes the old market while building a new one. Rather than directly competing with traditional telephony it has little effect on the price of traditional telephone service except, ironically, to force system costs on fewer users producing a long-term pressure to raise prices. Such "competition" is not good for those who remain on landlines. Would that the FCC understood the basic situation as well as The Economist. [If this seems strange reasoning to you, as it does to the FCC, please consider the case of the Railroad industry in the US. The car and the Interstate system didn't compete with railroads; it displaced and destroyed the old railroad market--and with it an entire economic infrastructure. Railroads could not afford to lower prices and chose, wisely for their investors, to exploit their remaining niches ruthlessly.--In fact, LUS has had previous dealings with declining monopolies trying to protect their remainder niche businesses at the cost of LUS customers.]

The author correctly focuses on VOIP (Voice Over Interenet Protocol) which can directly compete for landline users offering the same quality of services in what appears to be an identical package--for less. That's much closer to real competition and threatens to force price competition on the Bells wherever a competing network exists to carry VOIP. The problem, of course, is that the Bells need to milk their declining landline business for all that it is worth--doing so is how they financed a move into the new business of cell phone provision which is their current best hope of survival. A nifty graphic from The Economist more dramatically reveals their plight than any words of mine could do:

That's a forecast of 30% revenue loss over 7 years. 25% if they can effectively answer the VOIP challenge. Either way the loss is devastating. They can't hope, by competing with VOIP, to do anything more than slow the decline of their core market. And the attempt will make those last customers less profitable. They had surely intended to milk their installed base to, finally, rebuild the network that paid for their successful venture into wireless. But in the new situation that intention looks ever less likely than ever to be realizable. The cable companies spent their ample profits bulking up their systems, not to fully modern standards but to something that has a distinct competitive advantage over the RBOCs.

But if the RBOCs have missed the historic moment when they could have rebuilt their network with the profits from a healthy monopoly (and instead bought themselves into a cell phone future) they can still hope to recover by rebuilding part of their network--the most lucrative part. And that is why the RBOCs love Senator Ensign's new bill recently put before Congress and why BellSouth was the first out of the gate with praise for the bill: it relieves them of their duty to serve the whole of the communities they are in. Local franchise agreements have forced this on the Cablecos, by and large, so being able to build only to the most highly profitable customers would give them at least some advantage vis-a-vis the cable companies. Probably not enough, frankly. But something. And as already been remarked, the desperate will grasp at any straw.

The death throes of large corporations are often downright dangerous for those still in its sphere of influence. And even a partially rebuilt RBOC network would, as is probably now clear, be in desperate straights. The Enconomist has one last warning for us all about a temptation that would be next to impossible to resist for a company that believes it has a natural right to the best telephone system:

Having literally sunk their billion-dollar investments in the ground, the telecoms firms will need to get a decent return on them. But in their nightmare scenario, customers may simply sign up to their huge bandwidth and then use it not to buy the services touted by the telecoms firms but instead to obtain independent or web-based services, such as Skype for making calls or (when the service is launched) Netflix for downloading movies. Can the telecoms firms do anything to stop that?

Stoyan Kenderov, an IPTV expert at Amdocs, a firm that makes back-office software for telecoms companies, says that the telecoms firms are building into their residential gateways new technology that will inspect the packets of zeros and ones passing through. This will let them identify traffic from third-party rivals, which might then end up at the back of the queue and thus be slow and patchy. The only hint that users might have of that going on, says Mr Kenderov, would be some very fine print on their bills explaining, in turgid legalese, that the provider guarantees the quality of its own services only.

The telecoms firms counter such suggestions with well-rehearsed indignation. In a hearing before the judiciary committee of America's Senate in March, Edward Whitacre, SBC's chairman, said in emphatic Texan that “SBC would not block any Vonage traffic or anybody else's and has never done that, would not do that. That's not the way we do business, and it's just not going to happen.”

But we here in Lafayette know better. That is just the way they do business...

There's rough waters ahead folks. And not just for Lafayette's project.

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