The Great Telecom Meltdown For a listing of recent titles in the Artech House Telecommunications Library, turn to the back of this book. The Great Telecom Meltdown Fred R. Goldstein a r techhouse. com Library of Congress Cataloging-in-Publication Data A catalog record for this book is available from the U.S. Library of Congress. British Library Cataloguing in Publication Data Goldstein, Fred R. The great telecom meltdown.—(Artech House telecommunications Library) 1. Telecommunication—History 2. Telecommunciation—Technological innovations— History 3. Telecommunication—Finance—History I. Title 384’.09 ISBN 1-58053-939-4 Cover design by Leslie Genser © 2005 ARTECH HOUSE, INC. 685 Canton Street Norwood, MA 02062 All rights reserved. Printed and bound in the United States of America. 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International Standard Book Number: 1-58053-939-4 10987654321 Contents ix Hybrid Fiber-Coax (HFC) Gave Cable Providers an Advantage on “Triple Play” 122 RBOCs Took the Threat Seriously 123 Hybrid Fiber-Coax Is Developed 123 Cable Modems Sparked a Cable ISP Boomlet 124 Fiber to the Home Kept Moving Further into the Future 125 Exuberant Prices for Existing Systems as Industry Consolidated 127 Overbuilding Was Often a Costly Disaster 129 Endnotes 130 8 DLECs and ELECs: An Exercise in Oversupply 133 DSL First Failed as a Video Offering 134 The Telecom Act Invites Novel Use of Unbundled Loops 134 Collocation Did Not Come Cheap 134 ILECs Controlled the Mass Market for DSL 135 Capital Poisoning Led DLECs to Overexpand 136 Dropping Like Flies 138 Survivors Face the ILECs’ Regulatory Might 139 Ethernet LECs Were Data CAPs 140 Endnotes 142 9 CLECs’ Winning Strategies Are Met by Rule Changes 145 The Telecom Act Anticipated CAPs and Resellers 146 Total Service Resale Had Little Value or Margin 146 State Commissions Had to Administer Federal Rules 147 Unbundled Network Elements Reduced Capital Needs 147 Initial Strategies for Serving “Classical” Voice Business 149 “Smart Build” and UNE-Loop CLECs 149 UNE Platform Displaced Resale and Discouraged UNE-Loop 150 EELs Created an Opportunity to Serve Businesses 152 The ISP Dial-In Business and CLECs: A Match Made in Heaven 152 Contents Preface xi Acknowledgments xiii 1 Ma Bell and Her “Natural Monopoly,” 1876–1969 1 Natural and Unnatural Monopoly 1 Western Union 2 Patent Protection 3 The Kingsbury Commitment 4 The Slow Pace of Progress 5 The Smith Decision and Universal Service 6 The Final Judgment 7 Hushaphone and the First Cracks in the Monopoly 7 The Disruptive Transistor 8 Endnotes 10 2 The Rebirth of Competition 11 Carterfone Made the Network More Valuable 11 Registration Opened up the Floodgates 12 Digitization from the Outside In 13 v vi The Great Telecom Meltdown The Integrated Voice and Data PBX Bubble 15 Computer II and the Detariffing of Terminal Equipment 18 American Bell and the Embedded Base 19 MCI’s Shared Microwave Opened New Doors 20 Private Line Competition Led to Rate Restructuring 20 Execunet Gives Birth to Competitive Long Distance 22 Sharing and Resale Had Profound Implications for the Future 23 The ENFIA Agreement Made Subsidies Explicit 24 MCI’s Growth Fueled by Antitrust 24 Endnotes 25 3 Divestiture: Equal Access and Chinese Walls 27 Vertical Integration 27 AT&T Kept Out of the Computer Industry 28 Legislative and Antitrust Actions Took Shape 29 The Money’s in Long Distance, Right? 32 Long Distance Rate Restructuring Had Been Planned Before Divestiture 32 Birth of the Baby Bells 34 Stopping at the LATA Boundary 34 Access Charges Milked the Monopoly 36 Selecting Equal Access Carriers 38 800-Number Competition 38 The Centrex Revival 39 Digital Switching Becomes the Norm 40 Digitization of the Transmission Network 43 The First Fiber-Optic Boom 43 ISDN Fails to Make a Dent 45 Digital Access Held Hostage to Local Measured Service 49 Broadband ISDN Led to the ATM Boomlet 50 Regulators Made the Deal, but Fiber Did Not Make it Home 52 Endnotes 53 Contents vii 4 The Internet Boom and the Limits to Growth 57 The ARPAnet Was a Seminal Research Network 57 Other Packet-Switching Technologies Had Their Adherents 58 OSI, the Big Committee That Couldn’t 62 TCP/IP Becomes the Standard 63 The Acceptable Use Policy 64 Commercialization at Last 65 Peering and Tiering 66 An Industry Structure Develops 67 Internet Traffic Explodes as the Public Joins 69 Data Traffic Finally Tops Voice 70 Short-Term Versus Long-Term Trends 71 WorldCom Set a Suspicious Pace 72 ISP Pricing Creates Permanent Losses 74 Investors Subsidized Prices 76 Dotcoms Create a Demand Bubble 76 Carrier Hotels Created Too Much Room at the Inn 80 The Bubble Bursts in Equipment Manufacturers’ Faces 81 Surplus Gear Met Demand 82 Endnotes 83 5 The Deuteronomy Networks 85 The Short-Term Bandwidth Crunch Invited More Suppliers 86 ISPs Wanted Dark Fiber 86 Qwest Follows Sprint’s Lead Along the Rails 87 Kiewit Sells MFS, Creates Level 3 88 Williams Sold Wiltel, Created Another One 90 Metromedia Sold Cellular and Long-Haul, Created MFN 91 XO Communications Recycles Cellular Profits 92 Undersea, Undersea, Under Beautiful Sea 93 viii The Great Telecom Meltdown How Much Bandwidth Was Available? 94 A Falling Price Lowers All Carriers’ Ships 95 Endnotes 96 6 Losing by Winning: Wireless License Auctions 97 Original License Lotteries Led to Farcical Resale 99 The Top Cellular Networks Grew to Profitability 100 Networks Go Digital 101 Auctions as a Fair Way to Allocate Scarce Spectrum 102 The PCS Auction Was a Success 103 “3G” Combined the Allure of Both Internet and Wireless 105 European PTTs Had Recently Been Privatized 106 Bubble-Era Timing Led to Spectacular Bids 107 “2.5 G” Technologies Suffice for Most Users 107 Many Large Incumbents Were Left with Huge Debt 109 Endnotes 109 7 Competitive Access Providers, the Costly Way to Local Competition 111 RBOC Prices to Large Customers Were Out of Line 111 States Supported RBOC Monopolies More Than the FCC Did 113 The FCC Preferred a Market-Based Approach 113 Satellite Bypass Did Not Quite Fly 114 Teleport Cracks the NYNEX Monopoly 114 Competitors Outrace RBOCs to Provide Local Fiber-Optic Connections 115 Overbuilding Each Other in Top Markets 116 The Telecom Act Opens Local Service Competition 117 The Long Distance Business Declined 117 CAPs Had Head Start on Both Service and Debt 118 Fixed Wireless as an Alternative to Fiber? 119 Overexpansion Led to More Bankruptcies 121 x The Great Telecom Meltdown “Virtual NXX” Made Dial-In Available in More Areas 154 Reciprocal Compensation Led to Large Initial Profits 156 ILECs on the Attack 157 The Grandfather Clause Locked Out New Entrants and Squeezed the Old 158 New Generation Switching Equipment Lowered Capital Costs 159 Enter the Softswitch 160 The CLEC Boom and Bust Led to Glut of Vendors 160 UNE-P Dominated CLEC Statistical Growth 162 An ILEC-Friendly FCC Throws New Obstructions at Surviving CLECs 163 The Triennial Review Order Fiasco 164 ISPs Face New Survival Threat from Bush Reelection 165 Role Reversal: States Become Champions of Competition 166 Endnotes 167 10 Focusing on the Bottom Line 169 Asset Valuation is Risky 170 Accounting Was Scandalous 171 Investors and Entrepreneurs Played Each Other for a Loss 171 WorldCom and the Limits to Mergers 172 AT&T Acted on Faith in WorldCom’s Numbers 173 Global Double Crossing 174 New Services Need to Fit Into a Food Chain 174 Competitive Realities Will Change 176 Old Dinosaurs Die Hard 176 The Next Big Thing Usually Is Not 177 Endnotes 178 List of Acronyms 179 About the Author 187 Index 189 Preface The economic boom of the late 1990s included huge investments in the tele­ communications industry and related sectors. It was followed by a downturn of unusual severity, which reduced total paper wealth by trillions of dollars, cost many thousands of jobs, and saw some of the biggest bankruptcies in history. While there certainly was a general business cycle at work, the downturn in tele­ com was not just a cyclical correction, itself a healthy event that routinely shakes out the weakest players. The downturn was unusually severe, impacting many well-established as well as young companies; the price pressures that resulted from so many distressed vendors then put an impossible squeeze on the profit margins of many of their stronger competitors. These conditions led investors to avoid anything remotely resembling telecom; the resulting capital squeeze fur­ ther hurt the remaining survivors. This was not just a low point in the business cycle; it was economic metastasis, an epic failure, a full-bore meltdown. Analysts, reporters, and other pundits have frequently sought to identify the cause of the telecom industry crash. So have industry participants them­ selves, both market participants and their regulators, eager to pin the blame on someone else. At the top of many commentators’ lists is the Telecommunica­ tions Act of 1996, which opened up local telephone service to competition across the United States. The Act led to the creation of a huge number of new companies, many of which went public quickly and visibly, and which failed, equally visibly, not long afterwards. The Act became law just as the boom was beginning, and in many ways set the direction of the industry, making it an obvious culprit.