Bypass Issue Worries Phone Companies

Times Staff Writer

Farmers Insurance Group has begun linking its 3,000 sales agents and 170 claims offices to its Wilshire Boulevard headquarters through a $20-million two-way satellite telecommunications system that is replacing much of a leased telephone network.

In Dallas, Southland Corp., parent of 7-Eleven Stores, recently signed a contract with M/A-Com Inc. to install a $6-million satellite network connecting its district offices to headquarters, similarly replacing telephone lines.

“We see the satellite communications network as a way of improving reliability, availability and flexibility of our communications facilities, while at the same time controlling costs,” explained David Karney, Southland’s vice president for management information services.

Lewis Bohache, Farmers’ senior vice president for systems planning, said: “Our primary motive was to improve the reliability of the system.” But Farmers also expects the system, which is being installed by Equatorial Communications, to shave its telecommunications budget by $1 million a year.


Local telephone companies fear that their revenues will fall precipitously if many more major customers choose to follow such examples. And, if that happened, they contend, operating costs would be borne by fewer customers, resulting in higher telephone bills. That, in turn, would lead to a further exodus, ultimately stranding small businesses and residential customers who don’t have the same alternatives.

This is the so-called bypass issue. It is an issue that state and federal regulators are only beginning to confront as technological advances and deregulation make bypassing not only possible, but attractive, to major telecommunications users.

Indeed, evidence is mounting that large companies with many locations are forsaking leased telephone links in favor of their own telecommunications networks--using satellites or other available technologies. This opportunity--born of deregulation, the breakup of the Bell System and technological advances--inspired the founding of Equatorial Communications five years ago in Mountain View, Calif. It also attracted M/A-Com, a 7-year-old company based in Germantown, Md., whose corporate roots go back 30 years.

“In 1984, for the first time since the recession, we have seen tangible interest in establishing private networks to augment or replace existing transmission capabilities,” M/A-Com said in its annual report. “Retail chains, petroleum companies, large distributors of goods or services--in fact, any large geographically diversified organization--are all potential users of satellite networks. Managers of businesses are eager for solutions that offer operating efficiencies, economy and flexibility for future growth.”


But what of smaller businesses and residential customers who have no alternative to the telephone company?

The National Regulatory Research Institute in Columbus, Ohio, recently released the most comprehensive study so far of the bypass phenomenon, which it described as an inevitable new form of competition while warning:

“If large numbers of customers install alternative telecommunications systems and thereby reduce their use of telephone-company facilities, there could be significant amounts of idle telephone company plant. If the costs of this idle plant were then spread among remaining customers, rates would rise, leading to more bypass and also to drop-offs of residential customers, . . . causing financial problems for the carriers as well as rising rates for remaining customers.”

In response to this “threat” to its basic business, Pacific Bell has asked the California Public Utilities Commission to let it slash $232 million from the charges that long-distance carriers pay for local connections. The lost revenue would be made up from “access charges” placed on local customers, who now receive basic service, Pacific claims, at about one-third of actual cost.

Pacific argues that beginning such a cost shift now and continuing it over four years “could well prevent even larger increases in the future . . . because the fees will allow reduced long-distance rates.” This, it contends, “should discourage large business firms from building their own telephone systems to bypass the Pacific Bell network.”

The first regulatory response so far to the bypass issue has come from the Federal Communications Commission. The FCC will impose a $1 monthly access charge on residential and single-line business customers, starting next month; it will double in June, 1986. (Multi-line business customers have been paying $4.78 monthly for each of their lines since last summer.) This “access-charge” revenue is distributed to local telephone companies to replace internal Bell System subsidies from lucrative services to cover losses for unprofitable basic service.

In its study, the research institute acknowledged that a certain amount of bypassing is probably inevitable, given the different strong points of competing transmission technology and the varying needs of corporate customers. But it also pinpointed a number of areas that telephone companies and state regulators can deal with to remove or reduce existing incentives for bypassing the local network.

“Avoidable” incentives are created by regulators, for example, when they inflate the costs of certain business services to provide revenue to finance such social programs as low-cost local telephone service. Incentives are created by the telephone companies themselves through inept marketing or the inability to fill orders promptly or provide reliable service.


Whatever the motives for bypassing, companies that are leaving the public network are significant telephone customers: The report found that their monthly telephone bills ranged from $500 to $12 million.

While much bypassing now takes place among a firm’s own buildings and distant locations, the result still is a revenue loss for local telephone companies and a potentially significant reduction in use of their services, the study found.

The institute surveyed 700 manufacturers and 300 financial institutions, 561 of whom responded, and reported that:

- 56 of 89 present “bypassers” have installed their systems since 1980.

- An additional 16 have “firm commitments” to expand their present bypass networks.

- 90 other companies are considering building bypass networks; 29 of those previously had rejected the idea.

In another study, the Conference Board, a business-supported research agency in New York, surveyed 348 companies. It reported that 92% planned “significant changes” in telecommunications operations and that at least 80% use or plan to use bypass facilities. The bypassers most frequently cited dissatisfaction with the quality of their telephone service but also said they sought to take advantage of newly available technology to increase flexibility while restraining growth of telecommunications costs.

Bohache of Farmers estimated that the insurer’s new system will save $1 million a year while sheltering it from unforeseeable rate increases. But reliability, not economics, was Farmers’ main reason for seeking alternatives to leased phone lines, Bohache said.


“Many times, due to Mother Nature and to other foul-ups, (land) lines go down,” he explained, “and our agents and claims offices have trouble reaching the home office.”

What’s more, leasing costs have increased substantially and service has declined since the integrated Bell System was apportioned between AT&T; and its former local subsidiaries, now re-formed into seven independent regional operating companies (including Pacific Telesis Group, parent of Pacific Bell).

The result, said Steven B. Salamoff of M/A-Com’s Satellite Communications Group, “is a bypass opportunity among those (Bell System customers) turned off by service delays and prohibitive costs.” While those taking advantage of alternative systems are drawn from large concerns, Salamoff predicted that technological advances will soon make bypassing increasingly attractive for smaller businesses.

The telephone companies that stand to lose revenue from Farmers, Southland and the growing number of bypassers are fighting hard to protect their turf. Pacific Bell has estimated that $85 million in lost revenue would mean a $1 increase in customers’ monthly bills. Since 1% of Pacific’s customers generate 40% of its revenue, according to the company, loss of even a few of these clients would make a significant dent in revenue.

Still, the National Regulatory Research Institute concluded, regulators should not overreact to the bypass phenomenon because no single or simple mechanism will put this genie back into the bottle. Instead, it said, telephone companies and regulators should first assess the bypass activity in their states and learn why it is taking place. Then business practices can be adjusted and a new rate structure devised.

“These steps,” it said, “would remove some of the causes of avoidable bypass.”