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Users and Suppliers Must Both Unite around a Common Agenda.

Our two sectors--equipment suppliers and users--have a lot in common these days. Arguably, 1985 has been the toughest and most-challenging year for the interconnect industry since its birth 17 years ago. Givenr the post-divestiture confusion afflicting users, I am sure the same has been true for you.

Gazing into the crystal ball, I envision more of the same for both sectors for the foreseeable future. Before detailing the handful of actions I believe our two sectors can take together for our mutual benefit, let me first provide a quick review of what today's marketplace looks like from NATA's perspective.

Thanks largely to the 1983 decision by US District Judge Harold Greene to let the divested regional Bell operating companies (RBOCs) back into the equipment-marketing business, the customer-premises equipment (CPE) industry has been turned upside down, held hostage to a destructive two-year price war that shows no signs of abating. The incentives for such a price war are simple, and the facts documenting it are compelling.

The RBOCs, the new players on the post-divestiture equipment block, had to buy market share starting in 1984, which they have done with a vengeance. Their efforts ahve been especially telling in the Centrex marketplace, where they ahve succeeeded in resuscitating a dying technology by convincing state regulators to slash Centrex prices well below cost and by convincing federal regulators to let them get away with it.

These Centrex price cuts for business are coming at the same time rates for local exchange service are going through the roof. Incredibly, users have not complained about the disparity. Also not complainging are PBX customers, who often are paying more for dial tone from their local phone company than Centrex users are paying for dial tone with a wide array of calling features.

Not so silent, however, are the hundreds of interconnect vendors who are being hurt by these artificial Centrex price cuts. Last year, NATA's statistics showed how the RBOCs boosted Centrex sales by about 415,000 new lines in 1983 and 1984. We recently completed a follow-up study that projects an additional five-percent net increase in Centrex lines for each year through 1987.

These Centrex gains are coming at the expense of CPE suppliers. Our new study projects a net loss of more than 2 million PBX and hybrid lines between 1983 and 1986. Those reflect estimates of CPE lines that were not sold, but which would have been without the artificially low Centrex prices. Those lost sales translate into lost revenues of about $1.6 billion in that four-year period, which is devasting for an industry whose aggregate annual sales total only about $2 billion.

Significantly, while previous Centrex marketing focused on large

installations, new Centrex growth is now and will continue to be overwhelmingly concentrated on the very small line sizes of under 125 extensions per customer. That shift could prove especially harmful for small-business interconnect key system specialists who heretofore have been relatively unaffected by the "Star Wars" clashes over giant Centrex systems.

Finally, if the RBOCs can't close a Centrex sale, they can turn around and sell CPE, which they also have been doing with some success in 1984 and 1985. Although NATA is still in the process of preparing the 1985 Statistical Review, it is clear RBOCs' 1985 sales of PBX and key systems will surpass 1984 sales. Then, the Bell phone companies cornered about 15 percent of the market, an incredible achievement for "start-up" ventures. In 1985, the RBOCs' new sales of business CPE are expected to increase about seven percent, to about 22 percent overall.

Interconnect CPE Sales Down

The RBOCs gains are coming directly at the expense of interconnect vendors. Our preliminary projections show that interconnects' share of 1985 new business CPE sales will be about 30 percent, down 10 percent from 1984 levels. AT&T's increase in market share will be about half that of the RBOCs, up from 29 percent in 1984 to 33 percent in 1985. Independent phone companies such as GTE will retain about 15 percent of the market for new business CPE.

As for AT&T, its comparative success is due partly to its aggressive use of termination penalties to hold on to predivestiture customers and freeze the market for new equipment sales by independent vendors. Countless hundreds of large, medium and small businesses have stayed with their old AT&T equipment or have been prompted into trading up to newer one of the world's largest corporations.

Thus, interconnects are getting pinched from both directions: by the RBOCs through both Centrex and CPE and by AT&T.

Needless to say, public policy is largely responsible for this squeeze. Under the direction of Mark Fowler, the Federal Communications Commission (FCC) has gone on a deregulatory binge in the past few years. For the most part, telcos have benn able to write their own tickets.

The FCC has turned its cheek to the serious contract-termination-penalty problem. The commission tossed the problem to the state courts, where several users are now fighting the issue. To date, the FCC also has ducked the equally serious Centrex problem, especially as it relates to cut-rate pricing.

From NATA's perspective, the FCC's errors of omission have been matched by the RBOCs have gotten FCC permission to offer protocol conversions through the basic network and ahve won a series of marketing wavies that have made mincemeat of the Computer Inquiry II ban on joint sales of network services and CPE. From the antitrust court, RBOCs have been given the green light to diversify into several fields, ranging from financial services to computer services to real estate. As for AT&T, the FCC has relaxed its regulatory grip over several optional long-distance calling plans, and more significantly from NATA's point of view, elimianted the Computer II requirement that AT&T establish a separate subsidiary for CPE sales.

The only thing these regulatory and judicial policies have in common is that the ground rules are being configured to encourage competition only among a handful of major multinational corporations. Envisioned are global marketing battles among the Goliaths. Heaven help the entrepreneurial small and medium-sized firms that get in the way.

As a result, the long-predicted shakeout in the interconnect industry has arrived. The rate of consolidation in the industry is unprecedented. We estimate a few hundred interconnects have gone out of business this year, many of which were extremely small businesses to begin with. At the same time, dozens of companies have merged or been acquired, including major national or regional companies such as ROLM, Mitel, Compatch and Commtel. Few companies--and certainly not the equipment subsidiaries of AT&T and the RBOCs--are making any money in this environment.

How does this shakeout and consolidation affect you, as users? It affects you all in the long term and probably for the short term as well. Today, you might be getting the technology you need, at low prices during these unprecedented price wars. But tomorrow, as competition dries up or becomes cartelized, you probably won't be in the driver's seat.

Survivors Will Call the Shots

Once again, the survivors will be able to call the shots and to dictate the solution. This will be especially true if the network itself becomes the solution, and if all technological advances become embedded in the network through such vehicles as enhanced Centrex, protocol conversions and other technologies that are still on drawing boards. If such a scenario comes to pass, as now seems clear, we will have essentially recreated the old monopoly conditions that existed in the industry before divestiture.

I submit that it is in the long-term interest of users to ensure the viability of a strong and healthy independent communications equipment industry. The challenge is for competitive suppliers and users alike to unite around a common agenda. In that respect, there are three elements of the agenda that are clear.

First, the network must remain nothing more than a neutral transmission pipeline. The advantages of such an efficient telecommunications highway are obvious for suppliers and users alike. If the network remains essentially a neutral pipeline, innovation will thrive. Hundreds of suppliers will have both the incentive and ability to design and manufacture equipment and enhanced services that can be plugged into the network. And users will have the option to pick the products and services they want, from the suppliers they want. In short, the'll have the option to drive either a Volkswagen or a Cadillac over the netural highway.

But once you allow the network to become contaminated, through the commingling of basic monopoly services and enhanced competitive services, all provided through the same bottleneck central-office switching facilities, you invite the type of cross-subsidies and anticompetitive behavior that stifle innovation in the long run. Efforts to enhance the phone company's Centrex service are a perfect case in point. By enhancing Centrex, through the additons of such features as call forwarding, least-cost routing and the like, RBOCs essentially are trying to make the network itself the sole repository of technological innovation, at prices below cost. That's no surprise, given that they own the network.

But from the perspective of users and competitive vendors, the scenario is chilling. If these enhancements are permitted to continue, only a handful of suppliers--those that control the network--will be responsible for, and benefit from, future innovation. Users ultimately will have fewer options, for the network itself will be the only solution to users' telecommunications requirements. The national will be left with essentially the same conditions that previously prevailed when a single supplier unilaterally controlled the network and decided what services could be provided through it.

I believe users and vendors alike can agree that America's telecommunications networks should be operated in the same netural manner as its electric utility networks. The transmission lines of electric companies provide power to all. To the extent individual users want to customize and enhance their use of network electricity, they do so on their own through value-added features or hardware.

A hypothetical user might want better toast, for instance. If so, the customer can buy better bread or a fancier toaster, or both. Customers certainly cannot call on their local power utilities to custom-design and reconfigure their electrical grids to provide better toast. Not only would such a configuration reflect a grotesquely inefficient use of the network, it would enable the power company to gain a blatantly anticompetitive advantage over all bakers, toaster makers and suppliers. There is every reason to hope that the rationality that applies to the operation of the nation's electric network can also be applied to its telecom networks.

Second, it is in the common interest of users and suppliers alike to avoid, at all costs, a trade war with Japan and Western Europe. A telecommunications trade war would have two principal consequences: higher prices for users and the destruction of the independent distribution network for equipment, which has been painstakingly established in this country in the past decade. In their rush to retaliate against perceived offshore threats, policymakers unfortunately have lost sight of the primary reason for America's growing trade deficit--the absurdly inflated dollar, which automatically adds a 30 to 40-percent surcharge on all US exports. Users and competitors in telecommunications hve a joint responsibility to bring that salient fact to the attention of their legislators.

Third, competitors and suppliers share a desire for certainty about the policy ground rules governing the telecommunications marketplace. Since 1984, the industry has been forced to weather the twin shocks of deregulation and the AT&T break-up, the single largest corporate divestiture ever. Customer confusion is at all-time highs, and destructive price wars among suppliers are rampant.

Divestiture is less than two years old, yet already the federal judge in Washington has significantly altered the basic agreement by allowing the Bell companies to diversify carte blanche into fields rangin from software to real estate, from consulting to banking. Now the court is under siege from Congress to undermine the last safeguards of divestiture by allowing the RBOCs to manufacture equipment and provide a full range of transmisison services. Similarly, the FCC's Computer Inquiry II deregulation policy has barely been finalized, but already federal regulators have drafted a Computer Inquiry III substitute.

Enough is enough. Everyone would be well-served if policymakers declared a two-year moratorium on making any further major changes to the basic ground rules. Regulators and judges should enforce the current rules and let the dust settle before embarking on an ill-conceived, experimental "quick fix" that is sure to exacerbate the current chaos.

The joint, three-step agenda I just outlined is undoubtedly ambitious. In some quarters, it might be considered controversial. Yet, I am convinced that it, or something very similar, is essential if competition is ever to be fully realized.
COPYRIGHT 1986 Nelson Publishing
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Copyright 1986 Gale, Cengage Learning. All rights reserved.

Article Details
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Author:Spievack, Edwin
Publication:Communications News
Article Type:transcript
Date:Jan 1, 1986
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