Rate Hikes in Offing After Phone Takeovers

Buyers not giving long-term contracts

Published May 29, 2005

Although the giant telecom mergers are about a year from completion, there are already signs that the two dominant carriers will raise rates for business customers once they get the chance.

Corporations are finding it difficult to land long-term contracts to lock in low rates, said Charlotte Yates, chief executive of Telwares, a consultant that helps businesses negotiate telecom deals.

"For the short term, we still see price erosion as carriers are eager to grab additional market share," she said. "But they've become very reluctant to negotiate long-term contracts or optional renewals with rate stabilization.

"Obviously, they plan on raising rates."

The two biggest local service carriers--SBC Communications Inc. and Verizon Communications Inc.--have pending deals to merge with long-distance giants AT&T and MCI, respectively. Once completed, the combinations will concentrate market power for SBC and Verizon and could mark an end to falling rates that have lately defined the industry.

SBC downplays the market power it will have once its purchase of AT&T is complete.

"Our goal is to get into market segments we've not been able to compete in," said SBC spokesman Selim Bingol, who cited AT&T's presence in the enterprise market. "The competitive environment is very intense, and that isn't going to change dramatically as a result of these mergers."

But there is little doubt that the new phone giants will have enormous leverage.

Control Point Solutions, another firm that negotiates telecom contracts, surveyed 51 or its top clients that spend a combined $2.8 billion a year on network communications. It provides insight into just how much the SBC/AT&T and Verizon/MCI combinations will consolidate the telecom industry.

"Prior to these buyouts the top two vendors represented approximately 50 percent of their telecom spend," said Greg Carr, Control Point chief. "After SBC's acquisition of AT&T, 76 percent of the spend will be consolidated with two vendors.

"With the Verizon buyout of MCI, the consolidation increases to 87 percent with two vendors," Carr said.

Long-distance has traditionally been more competitive than local service. Over the past several years it has been common for large businesses to get rate reductions of 25 to 40 percent when they signed a new long-distance contract, said Nick Wray, Control Point strategic sourcing vice president. For local service, reductions were more in the 10 percent range.

Residential customers have enjoyed lower rates as well in recent years as incumbent carriers like SBC scrambled to meet or beat low rates offered by MCI and AT&T.

However, federal regulatory rulings last year favoring local carriers caused AT&T and MCI to back away from the residential market. The full effect of those rulings won't be felt until next spring, about the time the megamergers are expected to close.

"The companies will try to raise rates anyplace they can," said Daniel Berninger, a senior analyst for Tier 1 Research. "There's really no point to these mergers unless they can raise rates."

Berninger said that in many markets where cable TV companies provide competing phone service at low rates, SBC and Verizon may be stymied, but that in other markets rates will go up.

"It will certainly change the competitive landscape," said Bill Capraro Jr., chief of CIMCO Communications Inc., an Oakbrook Terrace firm that supplies communications services to businesses. "It's almost like remonopolizing the industry."

Even with consolidation it is not a sure thing that Verizon and SBC will be able to raise rates to corporate customers.

Large corporations, which have been slow to adopt Internet telephony, may be more open to it if they perceive that sticking with their traditional service is getting pricey, Yates said. "Whenever you have a platform change, that's an opportunity for the customer to look around at the other options," she said.

Robert Rosenberg, president of Insight Research Corp., said one reason Verizon and SBC wanted the long-distance carriers was to grab new revenue to offset their declining core business of supplying phone service to consumers.

"In most areas, the incumbent carrier still has 80 to 90 percent of the residential market," said Rosenberg. "But in the next few years those numbers will fall significantly as consumers sign up with cable operators for phone service."

Boosting prices is not the only merger goal, noted Michael Weaver, Chicago-based director for Fitch Ratings. "Another consideration for the mergers is the opportunity to integrate wireless within the enterprise market," he said.

Indeed, Verizon spokesman William Kula said his company hopes to use the MCI acquisition to sell wireless products to enterprise customers.

He would not comment beyond that. "We're still in the planning stages of this merger," he said.

Verizon and SBC have had some success bundling wired and wireless service to residential customers. They provide discounts to consumers who buy high-speed Internet, wireline voice and wireless service.

Both carriers also offer video through satellite services and are upgrading their networks to eventually offer video over their own lines. Residential bundling is primarily a strategy to slow the exodus of customers to cable TV operators offering voice.

In the business market, carriers have had less success selling integrated wired and wireless service.

The mergers will give SBC and Verizon access to large corporate customers, but they will face some obstacles in selling wireless service to them.

In businesses large and small, it is common for employees to buy their own wireless phone service and write off part or all of it on their expense accounts.

That is a bad deal for enterprises, said Wray.

Compared to what an average consumer spends each month on mobile phones, corporations tent to pay $20 to $25 more, said Wray. If firms made deals to buy wireless service for 10,000 employees in a block, they should get deep discounts, he said.

But it has been difficult for most corporations to get control of mobile phone expenditures.

Many had anticipated that once customers could keep their phone number when they switched carriers, corporations would wrest control of wireless service. The excuse from salespeople and executives had been that they couldn't change carriers because it meant losing the number dozens of clients used to reach them.

But it turns out there are other obstacles, Wray said.

Each employee has a service contract with a carrier that expires at different times from other workers, he said. Many have spouses and children with phones tied to contracts. That can make employees reluctant to give up control over their wireless phone. But cost considerations as well as business liability issues make it necessary for corporations to take control.

"It's no different than the way personal computers were introduced into the workplace," Wray said.

Employees who had PCs at home would buy computers for the office out of departmental funds without consulting a corporation's information technology office, he said. Before long, companies were spending huge amounts on PCs withou much centralized planning or control.

"It took 10 years for IT departments to recentralize distributed computing," said Wray.

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