The End of Telecom

The most recent FCC Trend Report (May 2004, Table 14.2) shows a 50% decline in the amount of usage of each residential telephone line since 1997. The same report shows the arrival of significant Internet use in 1997 (Chart 16.1) along with rapid expansion of cell phones (Chart 11.1). The data shows what we all know from day to day experience - the information technology industry is annexing communication as an application - email, IM, VoIP, e-commerce, etc. We have fewer and fewer reasons to use plain-old-telephone-service. The numbers reflect a world where RBOC's focus their energies on battles allowing them to raise prices and the information technology industry delivers even more powerful communication platforms and applications of the Internet. The trend represents the final outcome of forces set in motion in 1968 with the FCC's MCI/Carterfone decisions and the founding of Intel. In the regulatory parlance of telecom, innovative information services are increasingly displacing the ever more expensive telecom services.

Every supplier dreams of the ability to raise prices without improving value. This nightmare for customers represents the status quo in local telephone service as dominated by Verizon, SBC, and BellSouth. The employees and economic growth suffer as profit growth comes from cost cutting rather than improvements in the value proposition that grow demand. The long running nightmare is coming to an end according to FCC data. Charging more for less value drove people toward the Internet and low cost cellular plans. Ignorance of time and distance give communication applications of the Internet a structural competitive advantage over services depending on the Public Switch Telephone Network (PSTN). The model of setting price based on time and distance only works with a captive customer base. The volume of traffic on the PSTN peaked in 1997 when it was largely the only communication option. Verizon and the other kings of copper have lost 40% of their value since 1999.

The telephone incumbents find themselves in a bind not unlike the railroads with the arrival of the automobile or the mainframe with the arrival of minicomputers/PC's. Reliability and ubiquitous market presence does not defeat more nimble insurgents offering a better and improving value proposition. Conventional wisdom already recognizes the difficulties faced by companies explicitly dependent on usage based charges like AT&T, MCI, and Sprint, but falling usage also undermines the grip of the local exchange companies.

Price discrimination business models succeed only where there exists market control. The Verrazano Narrows Bridge successfully charges $7.00 for crossing only because there exist no viable alternatives. Price discrimination business models work by defeating competition not continuously improving the value proposition. The obstacles to bridge building and expensive telephone networks make for compelling barriers to entry, but the inexorable price increases of greedy bridge owners and telephone companies increase the incentive for bypass. The arrival of low cost Internet and wireless connectivity put a hole in the monopoly over communication options enjoyed by the Bell System through 1997. The cost of a cellular telephone call dropped below the cost of wireline for a significant number of customers by 2000.

Absent a bullet proof monopoly, the challenge of winning moves from controlling supply to creating demand. In the good old days, Verizon's control of copper meant it benefited from the innovation of others as with the fax machines and later dialup Internet. AT&T's profit for a given quarter got significant boosts from natural disasters like the San Francisco earthquake in 1989. Starting in 1997, all new communication applications benefit the Internet. It seems likely we have barely dented the potential of useful new communication applications. Consider the range of communication options anchored on one end by the telegraph and at the other by face-to-face encounters. The traditional telephone call serves as the basis a trillion dollar business around the globe addresses a very narrow slice of this communication spectrum. The cost of service and underachieving value mean over 80% of people on earth have no regular access to communication.

The much noted convergence of data and voice networks really amounts to a hostile takeover of communication by the information technology sector. The Internet did not get invented to displace the PSTN, but continuous improvement makes this outcome inevitable. The info tech czars like Bill Gates and Andy Grove are loathe to explicitly challenge the telecom incumbents, but the information technology solutions will replace not converge with the traditional telephone networks. The business models of the telephone incumbents work only to the extent the regulated biosphere does not get infiltrated by unregulated infoservices. The telecom service versus info service dichotomy dissolved with the arrival of VoIP. Game over. The PSTN remains invulnerable to innovation while the platforms leveraged by the info tech industry get faster and cheaper. The next wave is already underway with the computing power of PC's incorporated into consumer electronics of various form factors. Consider the emerging battle between Microsoft, Sony, and Nintendo's voice enabled multiplayer games.

The landscape changes are not lost on Verizon and other incumbents, but no one can serve more than one master. Skype, Free World Dialup, and many others continue to add value while the telephone incumbents continue their hunt for ways to raise prices. Standard Oil and most other monopolies over commodities did not survive the 1920's, but even the geniuses keeping the Bell System intact through the breakup of AT&T have run out of ideas. The success of incumbents in defeating the 1996 Telecom Act created Competitive Local Exchange Companies (CLEC's) receives lots of press coverage, but the largest CLEC never grew more than a matchbox toy car (1:64) in relative size to the incumbents. The regulatory victories mean little as the Bells long ago found ways to escape compliance. The battles to get state PSC's in Florida, New York, New Jersey, Virginia, Washington, and just about everywhere else to raise prices merely gives the communicating public more reason to seek alternatives. The telephone companies delayed deploying DSL to avoid cannibalizing high profit data circuits, but this conceded connectivity to the cable companies. The practice of forcing DSL users to maintain traditional telephone service is under assault in state PSC's. Qwest increasingly breaks ranks with the Bell cartel as they did with their "nake DSL" product.

The incumbents still enjoy an advantage in reliability and ubiquity, but the insurgents continue to whittle away. The collective reliability of several best effort services starts to match the reliability of plain old telephone service. The Internet exists as a solution to the fragility of the telephone network. The direct peering of VoIP end points gets around the need to use the PSTN for all terminations. For example, the University of San Diego installed equipment that terminates VoIP calls directly to the campus PBX. This one day upgrade made at the behest of Michael Robertson and SIPPhone took 20,000 people off dependence on the PSTN. The awareness of communication alternatives continues to grow and the outcome no longer seems uncertain. The fixed nature of expenses turn the revenues lost to line losses directly into profit losses. Access to capital is threatened by the obsolescence of assets serving as collateral for debt. The sale of supposedly profitable supposedly non-strategic wireline and directory assets amounts to little more than burning the furniture to keep warm.

The victory of communication insurgents will generate a renaissance just as the demise of IBM's dominance over computing served to unleash an enormous expansion of the information technology sector. Communication serves as an input for the entire economy in a manner not unlike oil, so the defeat of the Bell Cartel represents great news for economic growth. The Bell System not only did not expand employment over the last twenty years, it served as a job destruction machine. The Bells not only failed to grow employment they destroyed the ambitions of competitors that wanted to create jobs. Converting the communication landscape to one of competition means a value and demand driven industry. It means annual 30% growth associated with the information tech industry replacing the 3% growth rates of traditional telecom. Over a period to 10 years this means growth of jobs and a tax base associated with an industry that grows ten fold rather than one that grows 30%.



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