Informational Hearing

Competition In Telecommunications Markets

State Capitol, Room 112
June 10, 2002
1:30 p.m.

I. Opening Comments

• Senator Debra Bowen, Chairwoman
  Senate Energy, Utilities & Communications Committee

II. Panelists

• Loretta Lynch, President
  California Public Utilities Commission
   
• Cynthia Marshall, Vice President, Regulatory
  SBC Pacific Bell
   
• Kurt Rasmussen, Director of Regulatory Affairs
  Verizon
   
• Jay Kinder, Executive Vice-President and Chief Operating Officer
  Roseville Telephone Company
   
• Rose Johnson, Vice President of Regulatory Affairs
  AT&T
   
• Richard Severy, Director of Public Policy
  WorldCom
   
• Jim Leach, Governmental Affairs
  Cox Communications
   
• John Sumpter, Vice President, Regulatory Affairs
  PacWest Communications
   
• Dane Jasper, Chief Executive Officer
  Sonic.Net

Competition In Telecommunications Markets

Background Paper

A Little History

At the end of the 19th century America’s telephone industry was highly competitive. Roughly 3,000 telephone companies were operating in the United States, all with their own wires and, sometimes, poles. One hundred years ago, 52% of towns with populations greater than 4,000 had two or more telephone companies. Fierce competition led to industry consolidation and by the end of World War I, telephone service was provided by a regulated monopoly. AT&T was the dominant provider, controlling local and long-distance service throughout the United States.

In 1984, the U.S. Department of Justice fundamentally changed the telecommunications industry by settling a long-standing anti-trust case against AT&T in which it charged AT&T with, among other things, maintaining an unlawful monopoly on long-distance service. The settlement broke apart AT&T’s monopoly and opened up long-distance telephone service to competition. The major new companies created by breaking up AT&T were seven local telephone companies, known as Regional Bell Operating Companies, or "Baby Bells." The RBOCs, one of which was Pacific Bell, were independently owned companies which provided local telephone service. They were barred from providing long-distance service within the areas where they were the local telephone service provider. AT&T was allowed to provide long-distance service and was the dominant provider, but as that service was opened to competition, and companies such as MCI and Sprint soon began to thrive.

In 1996, the telecommunications industry landscape was changed again with the passage of The Telecommunications Act of 1996. The Act promised competition and lower rates for local telephone service. RBOCs were required to lease parts of their networks to competitors. As an inducement, once the RBOCs had made their networks available and competitors had surfaced in the marketplace, the RBOCs would be permitted to offer long-distance service within their service areas.

The passage of the Act was met with great enthusiasm. Hundreds of new companies sprung up, all hoping to take advantage of the newly opened markets. Companies like Covad, PSINet, and Northpoint Communications provided competitive, high speed telephone access by leasing facilities from the RBOCs. Other companies, like Winstar Communications, Williams Communications Company and Global Crossing, installed their own facilities to try and compete. Yet despite unprecedented access to investment capital, the one thing all of these companies have in common is they’ve all filed for bankruptcy.

Where Have All the Telcos Gone?

The competitive burst that followed the passage of the Act has bust. A May article in the Wall Street Journal notes that in 1998, the number of RBOC competitors had risen from about a dozen in 1996 to over 150 in 1998 and nearly hit 400 in 1999. In 2001, the figure declined to less than 100 and is surely lower today. Even the three largest long-distance competitors, household names all, are in trouble what with Sprint having to sell its lucrative Yellow Pages business and its debt rated at just above junk bond level, WorldCom (MCI) under SEC investigation and its stock having lost 80% of its value this year, and AT&T debt downgraded to just two levels above junk bond level.

The incumbent RBOCs which serve California, Verizon and SBC, have not exactly had banner years either. Verizon’s and SBC’s stocks are down around 25% over the last 12 months. Each has seen the number of telephone lines it serves decline a bit. Yet these companies are relatively better off than their competitors, each having grown much bigger through mergers and acquisitions (the original seven RBOCs are now four). Both Verizon and SBC dwarf their biggest rival, AT&T, with each of them being about triple the size of AT&T as measured by stock market value.

Competition Still Exists

The Federal Communications Commission (FCC) has compiled data on telecommunications competition. Its latest report, issued in February, shows that competitors provided service to about 7% of the telephone lines in California as of June 2001, up from 5% in June 2000. Service is provided to about one-third of those customers over lines are owned by the competitors; service to the other two-thirds is provided over lines owned by the RBOCs. The California Public Utilities Commission has analyzed competition in telephone markets and will discuss its findings with the Committee during today’s hearing.

One can look at other telecommunications markets and see that competition has been more effective. For example, the market for short-distance toll calls, which had been an RBOC monopoly, is now quite competitive. Markets for other, less important services are also more competitive, such as pay telephones and calling cards, though the benefits of competition to consumers for these services is debatable.

Competition to the RBOCs is emerging from non-traditional telephone service providers who rely less on the RBOC equipment to offer service. Some competition comes from cable television companies. In California, Cox Communications provides competitive telephone service through its cable systems in parts of Orange and San Diego counties. Other competition comes from the substitution of cellular service for traditional telephone service. Recent research finds 3% of Americans have discontinued their local telephone service and rely entirely on their cell phones. However, Verizon and SBC, through its joint ownership of Cingular with BellSouth (another RBOC), control the two biggest cellular carriers in the country. Competition from satellite telephones (think Iridium) is virtually non-existent.

Some Hope for the Future

Recent regulatory and judicial decisions also provide some hope that competition for local telephone service can thrive. In May, the California Public Utilities Commission lowered the rates that competitors pay SBC and Verizon to use their networks from among the highest in the nation to among the lowest. Also in May, a Supreme Court decision validated the method by which the FCC sets rates for services sold by the RBOCs to their competitors, a decision lauded by competitors. Tempering this optimism are threats by RBOCs to challenge those rates. Also, in May, an appellate court ruled that the FCC must reconsider its rules requiring RBOCs to lease parts of their networks to competitors.

Whether we can go back to the future and return to the competitive world of the 19th century is not at all clear. Federal and state policies continue to encourage competition and decisions are being made which reflect that policy. Wall Street has so far rendered its judgement on who the winners and losers in the telecommunications industry will be, and so far, they’ve clearly selected the RBOCs as the winners. The days where a new company could access large amounts of cheap capital to compete for telecommunications customers are long gone. Yet it wasn’t so long ago, in the shadow of The Telecommunications Act of 1996, that Wall Street had thought of the RBOCs as stodgy old losers. Given this dynamic, quickly changing world, the fruits of federal and state policies designed to promote telecommunications competition bear close watching.