Rescuing the CLECs - Industry Trend or Event

Communications News,  June, 2001  by Rob Fisher

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In few other industries is your primary supplier also your primary competitor.

As has been widely reported, the telecom industry, as a whole, and competitive local exchange carriers (CLECs), in particular, are experiencing difficult times. The over-arching reason for this decline is that, from the beginning, the CLECs created themselves to be mini-incumbent local exchange carriers (ILECs).

Nearly every CLEC has built circuit-switched networks that provide no technical cost advantage over the incumbents' networks. CLECs generally lease the last-mile connection from and install switching equipment inside the ILECs' central offices to carry the traffic. Technologically, there is little difference whether a call is carried over the ILEC's vs. the CLEC's network, so the cost advantages of a CLEC's network are not obvious.

The cost of building these networks, however, is immense. From 1997 to 1999, the top 10 independent CLECs spent $1 billion, on average, on capital expenditures, half of which was spent in 1999 alone. In addition, CLECs do not have the vast economies of scale that ILECs possess, and few would argue with the premise that telecom is a scale-intensive business.

A CLEC's cost position is further eroded by the need to promote its services. Without an established brand name or clear technical advantages, CLECs must spend much more on sales and marketing. Customer acquisition costs for CLECs, on average, have been $390 per net line added, more than twice the $185 spent by ILECs.

SUPERIOR PRODUCT NEEDED

As a result of their attempts to create mini-ILECs, CLECs are left without a lead product with Which to convert new customers. The CLECs cannot expect to take significant market share from the incumbents until they can offer a superior lead product that generates a compelling reason for customers to switch over to them.

Other factors for the demise of CLECs include the multitude of operational issues that they have encountered. The easy culprit of these difficulties is the local ILEC. The impediments that the ILECs have created for the CLECs in ordering, provisioning and billing for services have been well documented. In few other industries is your primary supplier also your primary competitor.

The ILECs have played the balancing act between providing mechanisms for competition to enable their entry into long distance and constructing sufficient impediments so that the CLECs do not steal significant market share. As a result, the average install interval for a CLEC, which is between 30 to 60 working days, is almost twice as long as the 20 to 38 business days for an ILEC.

The issues surrounding interfacing with the ILECs, however, are only part of the problem. CLECs have had to face the stark reality that local service is difficult to provision. Compared to local, long distance is a breeze.

WHAT ARE THE SOLUTIONS?

What can the CLECs do to save themselves?

Revisit the basic economics of the business model. Most CLEC business plans were created three to five years ago, during a much more favorable lending climate. Market conditions have since reversed, however, and the easy financing is no longer available. As a consequence, many CLECs have found themselves with half-executed business plans and no financing -- and no prospects of obtaining it. Each CLEC has to validate that, at the customer level, its mix of products can provide sufficient revenue to cover its variable and defray its fixed costs.

Understand the customer base better. Thus far, CLECs have taken an opportunistic approach to acquiring customers, rather than systematically segmenting the potential customer base. Segmentation analysis needs to be performed to understand the profiles of the various customer sets in terms of size (number of employees/lines), industry (SIC code) and telecom intensity, so that service offerings and marketing efforts can then be matched to their needs.

Aggressively implement new technologies. CLECs can utilize new technologies to provide them with a cost advantage over their incumbent competitors, and to provide attractive lead products that compel customers to switch their services.

Fixed wireless technologies have been only moderately successful because they bypass (in other words, duplicate) the existing local network. On the,other hand, packet technologies stand to provide more success because they leverage the existing network, rather than compete with it. VoDSL/IP provides a cost savings for small and midsize enterprises by eliminating the need for a T-1 to offer multiple lines. VoDSL presents the opportunity to offer new and enhanced services, such as videoconferencing, over a single line.

Sacrifice some of their entrepreneurial spirit for a little professional expertise. CLECs need to tap into the ILEC resource pool and pluck out the few good people who could excel in a start-up environment. At the same time, CLECs need to improve training and systematize processes.

This year will be a pivotal time for the industry, as the various CLECs attempt to raise additional required capital. These proscriptive recommendations begin to attack the unenviable position in which the CLECs find themselves--trying to reach sufficient scale with a differentiable product so that they can begin waging a formidable battle against the ILECs' dominance.