Local Phone Companies Brace Themselves for New Competition

Pacific Bell President Philip J. Quigley is about to see his California phone market thrown open to competition from the likes of AT&T;, MCI and a host of other carriers anxious to steal his best customers--and he couldn’t be happier.

“Between expanding technology and the bias toward deregulation, competitors are in our face all the time. . . . Five years ago we decided that we wouldn’t try to fight it anymore,” Quigley explains. “Under the right conditions, we will fully embrace an open marketplace.”

With state and federal regulators expected soon to allow new competitors to enter businesses now dominated by local phone companies, Quigley is hardly an unlikely or foolhardy champion of open competition.

The 50-year-old executive, who ran the phone company’s successful cellular business before being promoted to president five years ago, expects the nation’s phone companies to profit from the new order emerging in the telecommunications industry.

But the key, as Quigley well knows, will be the phone companies’ ability to win the regulatory freedom needed to exploit new business opportunities in information services, cable television and equipment manufacturing. The phone companies want these new freedoms in exchange for giving up virtual monopolies on their local turf.

It won’t be easy.

Already, California consumer groups are opposing rate hikes of nearly 60% proposed for most of the state’s 14 million residential phone subscribers--the result of the new competition. Opposition is also emerging from cable television operators, newspaper publishers and other communications businesses that are going to court, Congress and to state and federal regulators to prevent the phone companies from invading their territories.

And even if the phone companies do prevail, analysts say there is ample reason to wonder if the phone companies will be able to survive or prosper in new and highly competitive markets, given their history as highly bureaucratic and regulated monopolies.

Telephone companies are “very bureaucratic and lack key competitive skills . . . and thus will suffer to some degree,” says Joel D. Gross, a telecommunications analyst at Donaldson, Lufkin & Jenrette, a New York brokerage.

Amid all this high-stakes corporate muscling, analysts are questioning whether residential customers will benefit at all from this competition--or whether the real beneficiaries will be large telecommunications customers, new communications providers and, possibly, the phone companies themselves

Like earlier deregulatory moves in the telecommunications, airline and financial services industries, the introduction of free-market policies into local phone service has two main goals: to spur technology advances and to introduce price and service competition into the once-staid telephone monopolies.

But the price will be steep for the average consumer, and it could prove especially bitter if phone service entrepreneurs reap tremendous profits from these new business opportunities at the expense of consumers, as some analysts already suspect will happen.

“Dismantling the traditional telecommunications system of the United States could be the equivalent of the leveraged buyouts of the 1980s” says William Davidson, a USC business professor. “The profits to be made from this are going to look shockingly like those made by the LBO carnivores.”

At the state level, the Public Utilities Commission is considering a plan to open California’s 10 local-calling areas--now the exclusive provinces of Pacific Bell, GTE and other local phone companies--to long-distance carriers, such as AT&T;, MCI and Sprint.

Under current regulations, long-distance companies are allowed to carry calls between the state’s local-calling areas, such as calls between Los Angeles and San Francisco or Sacramento and San Jose. Calls within an area, such as those from Hollywood to Long Beach or Riverside to Anaheim, are handled exclusively by local phone companies.

Under the proposed plan, however, long-distance companies would be allowed to handle calls within the 10 local-calling areas, if they traveled more than 16 miles--so-called “local long-distance.” Proponents say entry of the long-distance carriers would lead to rate drops of as much as 50% as the rival phone companies fought to win customers with competitively priced charges.

The major beneficiaries of these new rates would be business customers and residential subscribers making a significant number of local long-distance calls.

However, to make up for the loss of local long-distance revenue, money that has traditionally subsidized the cost of providing basic residential phone service, Pacific Bell and GTE have proposed increasing their basic monthly rates as much as 60% over the next three years.

Under Pacific Bell’s proposal, basic monthly service charges, now at $8.35, would jump to $11.35 in 1993 and rise an additional $1 per year in each of the next two years. GTE, whose basic rate now stands at $11.35, has proposed a $15.55 rate for 1993 and a $16.50 rate for the following year.

Pacific Bell and GTE, which estimate the actual cost of providing basic residential service at about $22 per month, say that once local long-distance service is opened to competition, residential customers will have to bear a greater share of the actual cost of basic service.

State regulators have accepted this argument--in theory. They have supported the opening of California’s local long-distance service to outside competitors and recently completed public hearings on the plan’s details, including the proposed rate hikes. A final decision is expected later this year or in early 1993.

“The trick for us is to minimize the number of people whose bills dramatically increase and to ensure that low-income people have the alternative of an effective (low-cost) ‘life-line’ program,” says David Gamson, a senior regulatory analyst at the PUC in San Francisco.

Meanwhile, the Federal Communications Commission is expected to vote next month on a plan to require local phone companies to allow so-called “alternative carriers” direct access to their networks.

The move to throw open the $25-billion-a-year local phone service market to competition is expected to give alternative carriers, such as Metropolitan Fiber Systems and Teleport Communications, even more ammunition with which to fight the local phone companies for their highest-volume, biggest-spending business customers.

At last count, alternative carriers had built fiber-optic communications loops in downtown areas of 32 of the nation’s largest cities, including Los Angeles, Sacramento, San Francisco, and San Diego, and were providing data and voice communications between businesses within those areas. In addition, these services install connections between their loops and the networks of long-distance companies, essentially bypassing the local telephone companies’ networks.

However, in order to expand their offerings and lower their costs, alternative carriers need access to the local phone companies’ networks. Under the FCC proposal, they would win the right to connect directly to the local phone companies’ central call-switching computers.

The latest FCC proposal is part of its larger effort to promote new competition for both the telephone companies and the cable TV industry, an effort that is already generating results. Cable TV providers already own interests in seven alternative telephone carriers and are poised to expand their presence in the local phone market.

At the same time, phone companies are winning some important new freedoms. Last month the FCC gave phone companies the right to offer video programs over phone lines.

These are the kind of trade-offs Pacific Bell’s Quigley, who recently approved a new statewide advertising blitz and a $100-million network upgrade for downtown Los Angeles, is happy to make.

“We know that we must make ourselves somewhat vulnerable to competition to be allowed to participate in some of the fields that we are not allowed in now,” he says.

Q uigley said the onslaught of new competition and the phone company’s desire to expand its services are the primary motivations behind the decision earlier this year by Pacific Telesis, Pacific Bell’s parent company, to study the benefits of dividing itself into two separate corporations.

One would be the traditional phone company, and the other would concentrate exclusively on new communications services, including video entertainment and the emerging new wireless phone technologies. Pacific Telesis expects to make a decision on the plan sometime next year.

“If our competitors have freedoms that we don’t because we’re still a traditional phone company, then we’re disadvantaged,” Quigley explains. “This is a critical time for us.”