CLECs still struggling to make a difference

Since their emergence, CLECs have seen limited success

Six years after passage of the Telecommunications Act of 1996 set the groundwork for their emergence, competitive local exchange carriers have failed to make the significant impact on telecom pricing for business customers that advocates had predicted.

But CLECs have managed to introduce new services, such as integrated voice/data access. And in some large markets – such as New York City, where CLECs AT&T and WorldCom operate their own local facilities – they are competing with the regional Bell operating companies.

Competition has helped lower pricing in the long-distance market, but the effect has been much less noticeable on the local services side. Pricing has come down since 1996, but not any more dramatically than it declined before passage of the telecom act.

“The CLECs only won very limited market share,” says Michael Lauricella, an analyst with The Yankee Group. “So the incumbents were never forced to really drive down prices.”

The CLECs’ impact has been blunted by the fact that droves of them were forced out of business when the capital markets became less forgiving in 2000. About 50 CLECs have filed for bankruptcy or left the market, leaving 80 to 100 in place, according to the Association for Local Telecommunications (ALTS), a CLEC group.

Impact has been felt in places

The overall effect of CLECs on pricing might be negligible, but in markets where they have a significant presence, CLECs have made a difference. Those markets tend to be major metropolitan areas where there’s a large enough concentration of customers to make it profitable for CLECs to build out their networks, says Hank Levine, a partner in Levine, Blaszak, Block and Boothby, a firm that specializes in telecom contract negotiations.

In some cases the RBOCs will lower their local prices to maintain market share in these major metropolitan areas, Levine says.

“A few years ago you would do a deal with the RBOCs and they’d offer you a 4% discount if you’d sign for three years,” he says. “Those discount numbers have doubled and tripled.”

Still, Levine notes, no large corporation that he’s aware of has pieced together a national telecom services contract that relies primarily on a CLEC.

“Overall, because the penetration is so spotty and many of them have gotten into trouble, their impact has been limited,” he says.

In areas where the CLECs operate, they generally promise savings of between 15% and 20%, says Lynda Starr, an analyst with Probe Research. They also try to win customers with promises of superior service.

“With a CLEC there will actually be personal contact with the customer,” Lauricella says, “whereas you pretty much have to be a company with at least 2,500 employees for the RBOC to consider you worthy of a dedicated sales rep.”

One company that has made a CLEC an important part of its national telecom strategy is Marcus Evans, a corporate-event, training and market-analysis firm in Chicago.

Until recently, Marcus Evans relied on WorldCom to fill its voice and data needs, says Nicholas Convey, vice president of IT. But over the past year the company changed to a diverse carrier strategy.

“It encourages more competitiveness from our suppliers,” Convey says. “It reduces the cost of our service and increases our redundancy.”

Marcus Evans began by trialing Allegiance’s services in two of its offices. Once that proved successful, the relationship expanded.

For eight of its 14 U.S. offices, Marcus Evans now uses a variety of voice and data services supplied by CLEC Allegiance Telecom.

“We looked at the cost, network redundancy and billing systems,” Convey says. “Something we also did that was new for us was look at the financials. I talked to Allegiance’s [CFO] before signing a contract. That wouldn’t have happened with a larger provider.”

One market niche where CLECs such as Allegiance Telecom, US LEC and Choice One Communications have had considerable success is in selling integrated voice and data services to small and midsize businesses.

Typically, an integrated access service uses customer premises equipment to carry voice and data traffic over a single T-1 line, saving customers money on their overall telecom bills. The reason for the CLECs success here is simple – they created the market.

“Subscribing to this service will lower a customer’s price, but not absolutely,” Yankee’s Lauricella says. “You pay the same price for a T-1, but it reduces your voice charges because it’s packaged more economically.”

The CLECs have been successful enough in pushing integrated access that the RBOCs have begun to follow suit. All but Qwest have started offering integrated access services in at least some markets.

The problem some CLECs ran into, though, was saturation of the market. The result was that many went out of business.

Probe’s Starr says that 200 CLECs each predicted they’d capture 20% of the market.

“That’s a 4,000% market, so that tends not to work,” she says.

Now that many of the weaker CLECs have been weeded out, the survivors should have a better chance, she says.

Despite the carnage of 2001 and 2002, many CLECs continue to operate.

Royce Holland, chairman and CEO of Allegiance Telecom, says the key to Allegiance’s survival has been that the company had time to scale its business.

“A lot of our competitors didn’t have adequate funding,” he says. “So when the capital markets shut down, they didn’t have the opportunity to grow their business to fit their capital structure.”

Other CLECs, such as Winstar and Teligent, bet on cutting-edge technologies such as broadband wireless that didn’t work out.

Offerings get more practical

“Our goal is to offer what customers want now – not what they might want down the road,” Holland says. “Anyone that’s gone with that Field of Dreams approach – ‘Build it and they will come’ – has had their dreams turn into nightmares in this capital market.”

Aaron Cowell, president and CEO of US LEC, says his company has managed to survive the CLEC shakeout because it followed a strategy of controlled growth – adding customers only in markets where the company could reach profitability quickly.

The Bells have responded to CLEC competition with some buyback programs, Holland says, offering customers better deals to return to the RBOC fold. But the buyback offers aren’t that common, he adds.

“They respond to competition,” he says. “But they’d be stupid when they have a 91% market share to go and cut prices across the board. There needs to be more penetration by CLECs in order for prices to fall.”

Ultimately, the fate of the surviving CLECs could be determined by regulators as much as by the CLECs’ business practices.

The Federal Communications Commission is scheduled to hold its triennial review of unbundled network elements – the pieces of the RBOC networks that CLECs are able to purchase at wholesale rates – early this year. If the FCC cancels too many of the unbundled elements available to the CLECs, it could seriously hurt the industry, says John Windhausen, president of ALTS.

“The big question really is whether the FCC is going to let us survive,” he says.