Bell Rivals Struggle to Connect

Rule Changes Have Hurt FCC Bid
To Foment Telecom Competition

By ANNE MARIE SQUEO
Staff Reporter of THE WALL STREET JOURNAL
November 30, 2004; Page A4

CLARKSTON, Mich. -- In early March, QuickConnect U.S.A. Inc. was planning to expand its Michigan-based phone business to Wisconsin and Illinois, building on its 11,000 customers to become a regional presence. Then a federal appeals-court ruling forced the company's executives to shelve growth plans and fire their 11-person sales staff.

Competing against the big Bell phone incumbents is tough enough but next to impossible when Washington is constantly changing the rules of the game. A 1996 law that scrapped the vestiges of the Ma Bell phone monopolies lured dozens of competitors to the $300 billion local and long-distance telephone industry. Many have since failed. While the stock-market bust dried up crucial funding, industry executives and investors say the new rivals' biggest obstacle to success has been legal and regulatory uncertainty.

In the past eight years, rules for how local-phone competition should work in a mostly deregulated world have been written by the Federal Communications Commission three times and repeatedly rebuffed by the courts. Now, as the FCC struggles to draft another set of rules, possibly as soon as next month, congressional leaders are pushing a Telecom Act of 2005 that probably would further muddy the waters for those attempting to plot successful strategies.

The number of Bell rivals peaked at 203 in 2000, according to New Paradigm Resources Group, a Chicago market-research firm. Only 63 remain, and that number is expected to drop further in the next year or two. Even AT&T Corp., the biggest Bell competitor nationally, decided this year to stop marketing residential phone service because of difficulties competing profitably amid the tumult.

QuickConnect is hardly AT&T. "We don't have corporate jets, marble floors and downtown buildings," says Saulius Anuzis, co-owner of QuickConnect, whose one-story headquarters about 32 miles north of Detroit has unadorned beige walls and a water-stained ceiling. "My partner and I have borrowed on 100% of everything we own. Then the government makes a public policy decision and you just can't compete."

Chris LaDuke, president of Affinity Telecom, another new competitor in Michigan, says, "How do we invest money to build infrastructure when we're spending to fight regulatory battles that for [Bell companies] is just a cost of doing business? How do we plan ahead when a [court] decision takes effect in 45 days?"

Much of the confusion stems from the system established by Congress in 1996 to spur entrants to the local phone market. Lawmakers decided Bell phone giants such as Verizon Communications Inc. and SBC Communications Inc. had to let competitors lease use of their local phone networks; in return, the Bells would win the right to begin offering long-distance service. Without such a requirement, lawmakers reasoned, new competitors would have to build their own networks, a prohibitively expensive endeavor.

While the Bells initially agreed to these terms, a fight ensued almost immediately about FCC rules dictating how the leasing arrangement should work. In particular, the Bells objected to being told how much to charge rivals to use their networks or what pieces of the network they had to make available. After all, the rivals would be using the Bells' networks to steal Bell customers.

"Ultimately it became clear that [the leasing system] is a pipe dream, because it relies on companies subsidizing other companies," says James Smith, senior vice president of SBC, the nation's second-largest Bell company. "Now it is up to the FCC to end the most destructive, costly experiment in telecommunications history."

In January 1999, the Supreme Court found the FCC did have authority to set leasing requirements. It was the first of several decisions in 2000 and 2001 to go largely in the favor of Bell rivals, and executives took them as a sign it was finally safe to forge into the market.

Companies like QuickConnect, which opened its doors in August 2001, focused more on small-business customers, using a personal touch the Bells rarely bothered with. The company's sales representatives went door-to-door making their pitch. They ran television advertisements in Michigan markets that said, "Don't go with the big fat telephone company. Call Larry." Soon the entire staff at the company headquarters was answering to that name, even the women.

In May 2002, the Supreme Court rejected arguments by the Bell phone companies that the discounted leasing prices authorized by the FCC were unfair. That was a big win for the Bell challengers, but it was short-lived. Less than two weeks later, the U.S. Court of Appeals for the D.C. Circuit knocked down the FCC's second attempt at writing specific procedures for the leasing arrangement. And yet another set of FCC rules got swatted down in March 2004.

Within days, the Bells put QuickConnect and others on notice that their current contracts, based on discounted leasing rates, soon would be void. New ones would be negotiated at presumably higher rates. Mr. Anuzis and his partner, Bruce Yuille, have been treading water since then, awaiting another set of FCC rules while they try to diversify in the less regulated world of Internet-based phone service.

Recently, FCC Chairman Michael Powell, a Republican who has pushed to roll back several leasing requirements to the benefit of Bells, is said to be trying to retain at least part of the competitive telephone market that serves small-business customers.

That would be good news for QuickConnect, which estimates that about 95% of its business comes from small customers such as Milda's Corner Market in Union Pier, Mich., and Yager Auto Parts in Sandusky, Mich. The Bells are expected to resist, especially since business customers, even small ones, generate more profit than residential ones.

While such a measure would be helpful, it likely would be limited to four or more phone lines, meaning QuickConnect still would lose about half its business customers, which have fewer than that. Still, "it would buy us some time to convert our customers to Internet phone services," Mr. Yuille says.

Write to Anne Marie Squeo at annemarie.squeo@wsj.com

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