Phone frenzy
A spate of mergers signals a new era in telecom services
Taking a page from its own "Join the Neighborhood" advertising campaign, MCI hopes to join its neighbor Verizon to bring local and long-distance phone service back together again.
In a transaction valued at $6.75 billion, MCI earlier this month agreed to be acquired by the nation's largest regional Bell operating company. While the purchase is still subject to last-minute wrangling by competing suitor Qwest, as well as legal brinkmanship from some MCI shareholders and regulatory approvals that could take a year, there is no doubt that the plain old telephone service you used to love--and hate--will soon be no more.
Indeed, the Verizon purchase of MCI is the culmination of what has been a vertiginous round of mergers and acquisitions in the telecommunications industry in the past few months. In January, regional Bell operator SBC announced it planned to buy AT&T, the nation's largest long-distance company, for $16 billion. In December, Sprint agreed to merge with Nextel, creating a company with a combined equity value of approximately $70 billion. Just weeks earlier, wireless behemoth Cingular finalized its $41 billion purchase of AT&T Wireless, creating the nation's largest cellular service with more than 49 million subscribers.
If all the outstanding deals are consummated, there will be just four major phone companies--BellSouth, Qwest, SBC, and Verizon--putting more phone lines under the control of fewer firms. The combined forces of SBC and AT&T alone, for example, would control 27 percent of the nation's local phone service and 37 percent of the country's consumer long-distance service, according to TNS Telecoms, a telecommunications market and analysis firm. Moreover, there will be just as few national wireless providers left standing: Cingular, Sprint Nextel, T-Mobile, and Verizon Wireless. The consolidation is even more stunning when one considers that SBC owns 60 percent of Cingular, and Verizon owns 55 percent of Verizon Wireless, which has 43.8 million subscribers.
The recent pairings have sparked concern. Both the Consumer Federation of America and Consumers Union have asked Congress to investigate the possible anticompetitive threat of the Verizon-MCI and SBC-AT&T unions. However, it is unclear how the marriages will affect consumers' phone bills, as regional companies will still have to negotiate for access to one another's networks.
In many respects, the implosion of the long-distance and telecom business is due to a host of evolutionary, regulatory, and technological forces that have been percolating for years. But the final shove that pushed stand-alone long-distance service into the telecom grave came from a single source: the Federal Communications Commission. "The number of alternative traditional phone providers is shrinking rapidly because of recent regulatory decisions that make it too expensive to be in the business," says Lisa Pierce, an industry analyst at technology research firm Forrester.
The FCC decided last year, for example, that it would no longer force the regional phone companies to offer their local phone networks at wholesale rates to long-distance companies. That had allowed AT&T and MCI to sell all-in-one long-distance and local service at rates competitive with regional operators. The restrictions are to be gradually lifted this year, however, so Verizon and other regionals will be able to raise the rates they charge AT&T and MCI to use their lines. "The reason we de-emphasized the consumer business a long time ago was the regulatory environment," says MCI company spokesman Peter Lucht.
That's why AT&T in July announced that it would stop competing for residential local and long-distance business, although it will continue to support existing customers. In essence, the company concluded that unless it returned to the days when Ma Bell owned both the long-distance and local phone lines, it would be unable to compete against the SBC s and Verizons of the world under the new FCC rules.
Of course, it took more than a single shove to get long-distance carriers to the precipice. "What really killed the long-distance business were cellphones and the Internet," says Verizon's Peter Thonis, senior vice president of external communication. With the advent of low-cost nationwide cellphone plans, E-mail, and instant messaging, the days when consumers would pay hefty long-distance phone charges just to stay in touch with friends and family across the country were quickly coming to an end. Some consumers have, in fact, dropped their traditional landlines in favor of cellular service. And last year, cellular phone spending per U.S. household surpassed that spent on traditional phone services, according to TNS Telecom.
Further undermining traditional phone service has been the burgeoning use of the Internet to place calls. Known as voice over Internet protocol or VOIP (pronounced voyp), services like that from Vonage, the largest consumer VOIP company in the United States, offer users unlimited local and long-distance calling for a fraction of what companies like AT&T and Verizon charge for traditional phone service. For customers who already have a broadband Internet connection, Vonage charges $24.99 a month for unlimited nationwide calling. Verizon doesn't even deliver conventional local and regional calling for that price.
Net talk. Many VOIP customers are enthusiastic about the new technology. Bruce Phillips, an executive recruiter who switched his office phone service to Vonage in February and will soon plug his home in too, says he spends around $50 per month, down from $250 to $300. He also enjoys the special features, including the ability to change location but keep the same service and phone number. Clients and friends who call him don't know if he's in his office in midtown Manhattan, his home in Pleasantville, N.Y., or his girlfriend's house in Dummerston, Vt., "unless I tell them."
So in an "if you can't beat 'em join 'em" move, Verizon and SBC plan to beef up their VOIP services. Both companies have an advantage over VOIP-only firms like Vonage. Not only do they own the wires that ultimately reach consumers' homes (the so-called last-mile connection), but they can also offer high-speed digital subscriber lines--DSL--along with phone service.
In fact, part of the attraction for Verizon in procuring MCI is the long-distance hauler's extensive Internet infrastructure. MCI has 98,000 miles of fiber-optic connections and an Internet network that could circle the globe more than four times. These are the kinds of assets Verizon believes it needs to fend off upstarts like Vonage and to compete against high-speed Internet access from cable companies like Comcast and Cablevision. But so far, the cable companies have been winning the broadband battle. Adoption of high-speed cable Internet access has been about 1 1/2 times that of the phone companies' digital subscriber lines, according to technology research firm IDC.
That clearly worries the regional phone companies. "We don't have the only last mile," says Verizon's Thonis. "Every cable company has the ability to do VOIP." And that's not all. Cable companies have already become a triple threat with their television, Internet, and phone services. To compete on that level, the new generation of phone companies will have to introduce even more bells and whistles.
Plugging in. To that end, Edward Whitacre Jr., CEO of SBC, recently announced that the company planned to roll out bundled services that will include not only faster Internet access and VOIP but TV as well. To deliver on that promise, SBC plans to spend about $4 billion to upgrade its network, stretching high-capacity fiber cable to about 18 million households by the end of 2007. Verizon is making a similar investment and has already placed fiber channels within reach of about 1 million homes. These fiber networks have the potential to exceed the capabilities of cable TV networks and deliver not only movies on demand and online gaming but also features such as videophones.
Furthermore, the phone company newlyweds could go the cable companies one better by selling not just voice, Internet, and video service but also cellular service. Verizon Wireless, for example, has just added video downloads for $15 a month to subscribers using its high-speed cellular network. So now cellphone users can annoy fellow train commuters not only by yammering on their phones but also by watching music videos and special CNN news spots.
So will the new telecom landscape mean consumers have only two choices: their regional phone company or local cable company? Not necessarily.
Many industry analysts say that within a few years, all voice and data traffic will be transmitted using Internet standards, meaning that phone service is going digital. So companies like Vonage shrug off the merger mania. In fact, Vonage CFO John Rego believes the acquisitions will usher in a new era of competition and mobility. For example, Vonage plans to introduce a wireless phone that lets customers make VOIP calls over any public Wi-Fi network, such as those in coffee shops and hotel lobbies. Vonage videophones will follow later this year.
Nevertheless, these technological upheavals may mean there are more mergers on the horizon. Analysts point to the fact that BellSouth, Qwest, and T-Mobile still haven't found dance partners. And Vonage itself is a likely takeover target. But a dark horse may conduct the next scherzo in the telecom revolution. Companies like Intel and IBM are pushing new wireless technology called WiMax that delivers high-speed communications directly to homes. A single WiMax tower could cover an entire neighborhood.
One of the prominent WiMax backers is also a figure familiar to the telecom world: Craig McCaw, the cellular phone pioneer who sold his wireless company, McCaw Cellular Communications, to AT&T for $11.5 billion back in 1994. His new company, called Clearwire, is now using WiMax to circumvent phone and cable companies' exclusive last-mile connections. So far, Clearwire offers Internet service in only four U.S. cities. Of course, that's how McCaw started his original wireless business back in 1982, and it became the nation's largest cellular phone company.
Even with all these changes, telecom history just might be repeating itself. Upstart MCI was partly responsible for instigating the breakup of AT&T--the original, all-in-one local and long-distance company--back in 1984. Now, the rebellious child has matured. And it is beginning to look a lot like Ma Bell.
This story appears in the March 7, 2005 print edition of U.S. News & World Report.