1.0 Executive Summary

2.0 Significant FCC Rulings

3.0 The Connecticut Experience

4.0 Atlanta Metropolitan Service Area

5.0 Dallas Metropolitan Service Area

6.0 Seattle Metropolitan Service Area

7.0 Carrier Profiles

8.0 U.S. Competitive Telecom Markets: 1997 Database

The 1997 U.S. Competitive Telecom Markets Report analyzes the local competitive environment of four diverse areas of the country. The criteria for selecting the areas was based on the level of growth and the number of companies competing for market share in the following telecom markets: Local Exchange Service, Switched Carrier Access Service, State Toll Service, and Interstate Toll Service. One conclusion readily drawn from this report is that the incumbent Local Exchange Carriers (LECs) are under heavy revenue pressures as a result of Access Reform and aggressive competitors anxious to get a share of the combined revenue in excess of $9 billion U.S. dollars. The incumbents stand to lose substantial telecom market share in regions targeted by competitors such as, AT&T, MCI, Sprint, WorldCom, and a host of lesser players, as Access Reform and local competition come to fruition.. The report also estimates current and future local exchange and long distance phone revenues, reviews the competitive strategies pursued by the local and national telephone companies, and analyzes the potential impact of state and federal regulations and other trends affecting the telecom marketplace.

Two major considerations formed the basis for this report. First, government regulations to implement the U.S Telecommunications Act of 1996 (1996 Telecom Act) may be the most important element in shaping the new competitive telecom marketplace. Second, the conventional method of studying the telecom marketplace on a national basis is no longer valid because the market is not developing that way. Using these considerations, Northern Business Information took the following approach to assess whether and to what extent competition in the major components of the telecom market does exist and to assess how the market will develop in the coming years. U.S. Competitive Telecom Markets: 1997 Edition:

• Provides background and regulatory history, including an analysis of the 1996 Telecommunications Act and related regulatory activity of the Federal Communications Commission and the regulatory bodies of the states of Georgia, Texas, and Washington, and an assessment of the impact that these regulations may have on the telecom market. A review of the three most impacting orders on the telecom marketplace issued by the FCC concerning local competition, access charge reform, and universal service is provided in Section 2. A review of the key state regulatory and legislative events affecting the telecom markets and the forecasts are included with each studied metropolitan area: Atlanta — Section 4; Dallas — Section 5; and Seattle — Section 6.

• Examines the evolution of the local exchange and carrier access markets, primarily in the largest metropolitan areas; explains how these areas have been affected by service bypass, the situation in which a customer moves from one service, such as switched access, to another service, such as dedicated access, in order to save costs, as well as by dedicated and switched facilities' bypass arrangements in competition with the incumbent LEC. (Section 1).

• Updates the competitive picture first analyzed in the 1996 Edition of the U.S. Competitive Telecom Report. Connecticut was the first state to open up the local exchange and interstate/state long distance markets to competition. The study focuses on some of the issues and concerns encountered by the Connecticut Department of Public Utility and Control (CtPUC); how competition in the local exchange market in Connecticut has evolved since the last report (Section 3).

• Profiles the major competitors that currently operate or will potentially operate in the metropolitan areas of Atlanta, Dallas, Seattle, and Connecticut (Section 7).

• Estimates current and expected developments of the local exchange, carrier access, and long distance markets in the Atlanta, Dallas, Seattle, and Connecticut metropolitan areas. Included are historic (1990-1996) and forecast data (1997-2001) and estimates of current market shares by major carrier, and expected market shares of the incumbent carriers. An interactive database and forecast documentation are provided in Section 8.

Local competition is not expanding uniformly across the country. Certain areas are experiencing aggressive competition, while in other areas, progress is much less. In certain markets, as with geographic areas, competition is much greater than other markets. For example, in the U.S. Competitive Telecom Markets: 1996 Edition, Northern Business Information studied the markets of New York City, Chicago, Los Angeles and San Francisco. In that report, Northern Business Information identified extensive competition in the largest and most concentrated markets of local exchange services, access services, and long distance services. In fact, Northern Business Information demonstrated that NYNEX (now Bell Atlantic) has only an 80% share of the business local exchange services market in New York City yet NYNEX maintains nearly 100% of the residential local exchange market. The study contained in this 1997 edition shows that while there is competition developing in the switched access and long-distance markets, there is very little competition in the local exchange markets in the smaller metropolitan areas of Atlanta, Dallas, and Seattle. But Why? Because these markets and areas provide lower margins. Generally long-distance and carrier access rates are higher than they normally would be in a fully competitive market and the local exchange rates — especially residential rates — are priced residually and not on an economic basis. In many cases these rates are subsidized and therefore offer limited margins to attract competitors. This rating scheme has historically been followed by state and federal regulators as a way of promoting connections to the network, by keeping residential rates artificially low. As this report shows, it all boils down to the fact that the level of competition is directly correlated to the available margins necessary to attract competitors.

These findings fly in the face of having a national policy of common rules for all carriers and all markets governing the evolution of competition. This single-minded focus on regulating open markets may only delay their arrival. While competitors indulge in marketing and regulatory strategies to defend their markets, arguing about proper levels of interconnection charges and whether or not there is competition, the customer suffers by continuing to pay inflated rates for long distance services, the incumbent local exchange carriers continue to hemorrhage their more profitable revenue streams to competitive bypass, and the aspiring competitive local exchange carriers continue to lose access to that narrow window of opportunity through which they must enter in order to establish themselves as full service providers. This study also shows that:

• Analysis of the telecom marketplace can no longer be performed at the national level or, for that matter, the state level because competition in these markets is evolving on a local level.

• Regulation may be the most important element in shaping the new competitive telecom marketplace, and existing regulations may have created artificial markets and may prove to be a barrier to competitive entry. For example, despite the good intentions of the Washington Utilities and Transportation Commission (WUTC), its mandated local rate reductions and expansion of extended area calling in the Seattle area, could slow competitive entry into the residential local exchange market. The limited margins of the residential local exchange services could serve as a competitive barrier to entry. Moreover, if other rates (such as long-distance and carrier access) are required to be higher than they normally would be, this may artificially attract competitors to these markets just to take advantage of the high margins.

• Competition is inevitable and it may be in the best interest of the incumbent to cooperatively open its network and participate in the delivery of services to an end-user customer. Making interconnection nearly impossible could drive competitors to bypass the incumbent’s networks at all costs. Maintaining a partial delivery of service to an end-user customer may be superior to no delivery at all.

• Quality of service, performance standards and parity issues will be an important determinant in successfully competing in the telecom market. Right or wrong the incumbent local exchange provider will be looked at more critically in this regard than other providers, particularly by resellers. Even the perception of bad service can sway customers to a competitor.

• The timing of entering the local exchange market will be critical to a competing carrier’s success in this market. Any delays could mean permanently lost market shares. Certain competing carriers are actively negotiating interconnection agreements and moving ahead with a focused marketing plan. These carriers are being quite successful. Other carriers are prepared to undertake full advantage of the regulatory process and are entering the market through fits and starts. These carriers are experiencing market share losses of their incumbent markets. Who is correct?

• While there is room for niche players in these markets, the real opportunity lies in becoming a large, full-service provider who can weather early investment costs — profit will be in large-volume, small-margin services such as local and toll. The bigger profits lie in data, on-line services, and future broadband offerings, which should go to the large or dominant full service providers. Competitive Access Providers and Competitive Local Exchange Carriers may be things of the past as phenomena of regulatory mandates.

• An updated review of the events in Connecticut reveals that in less than one year (in most cases in just six months), local exchange competitors have been able to garner nearly 20% market share in the local exchange marketplace in the areas where they choose to operate, and that it took the incumbent Local Exchange Carrier three years to make the same inroads into the interstate long distance market. The competitors are going after the more lucrative markets. The initial insurgence of competition is moving ahead one year later and will be stimulated even further with a customer ballot effort planned for July 1998.

• While AT&T has been very slow to enter the local exchange market, when it does, it will most likely initiate a campaign of short-term discounts, bundled with toll offerings designed to attract customers. This will set off a flurry of offerings from the other competitors and will create a small price war. In other words, AT&T will be the market leader in these promotions, and the success of these campaigns will set the stage for changes in market share for the various competitors. AT&T itself could obtain additional market share, due to its name recognition and to confusion in the marketplace.

• It is not contemplated that the local telecom markets will grow more than 3-5% nationally just because new entrants are entering the market. This is unlike the long-distance market of the mid-1980s. The difference is that state and federal regulators were eliminating subsidies from long distance rates and local rates are currently subsidized.

• Both the interstate toll and local markets are at their peak growth rates for the foreseeable future. Prices will not stimulate big growth in the local exchange market and interstate margins are getting smaller. Package discounts of some kind could offset this somewhat.

The level of competition in the local exchange and exchange access marketplace is and has been impacted by technology, economics, and regulatory design. Local exchange and exchange access markets, primarily in the largest metropolitan areas, have been affected by service bypass (customers moving from one service, such as switched access, to another service, such as dedicated access, in order to save costs) as well as dedicated and switched facilities bypass arrangements in competition with the incumbent LEC. Many of these bypass arrangements are a product of regulatory mandates that require the pricing of many of the LEC services to achieve regulatory policy goals rather than to achieve economic efficiencies. The end result is that, to the extent possible, customers will choose alternatives that do achieve economic efficiencies. The evolution of this phenomena is explained following.

First, at divestiture, large concentrations of traffic were handed off to the Interexchange Carriers (IXCs) from the incumbent LEC central offices to the IXCs' Points of Presence (POPs). Initially, the incumbent LEC network consisted primarily of copper-based technology. Over time, fiber optic technology significantly reduced the cost of large volume transport and caused a migration from copper technologies to fiber-based technologies. This technological migration prompted IXCs and large business users to move from usage-based switched transport services to more cost-based dedicated service offerings from the incumbent LEC. In addition, the high concentrations of traffic began to attract competition from outside suppliers.

The increasing number of small IXCs and the average price structure of the incumbent LEC offered a marketing opportunity to the Competitive Access Providers (CAPs).* * The first CAP, now known as Teleport Communications Group, first obtained a Certificate of Public Convenience and Necessity to provide local exchange services and exchange access services in 1985 in New York State. Initially, they targeted the high-capacity, POP-to-POP markets (at divestiture, a smaller IXC without a nationwide network would hand off its traffic to a large IXC such as AT&T, creating high-volume, POP-to-POP markets).

Subsequently, large business users have found it far more economical to use dedicated fiber facilities (either the incumbent LECs', the CAPs', or their own) to reach the IXC (Premises-to-POP market). Where the incumbent LEC was involved, this resulted in service bypass, moving customers from usage-based switched services to more economically priced dedicated services. Where CAPs were involved, this was initially accomplished through the use of a PBX (or in the case of interconnecting LANs, a CSU/DSU or router) placed at the CAP node. Using this PBX, the CAP could route originating traffic directly to the IXC using the CAP's facilities and, using the IXC's switching equipment, directly route terminating calls to the end user's or CAP's PBX using assigned direct inward dialed (DID) trunk numbering (NXX) code. Using this type of network configuration, the CAPs began to advertise diverse services, including:

• POP-to-POP access transport

• large business-to-POP transport

• private line networks

• large business disaster recovery

• facilities management services

• metropolitan area centrex-like services

• local area network services

• LAN Interconnect

• local PBX loop services

• local and regional calling services

• terminating long distance calling

• public telephone services

Where CAPs were not involved, large business users provided facilities directly to the IXC's POP, using network configurations similar to those described for the CAP.

Next, CAPs began seeking access to the incumbent LECs' local loop plant to avoid running fiber to multiple customer locations and to expand the CAPs' ability to reach additional customers without extensive network buildouts. In 1986, MFS filed a petition with the FCC seeking such relief. In October 1992, the FCC ordered Expanded Interconnection to special access services in its action in CC Docket 91-141, and subsequently in 1993 ordered switched transport interconnection in this same proceeding to be concurrent with its local transport rate restructure ordered in CC Docket 91-213.* * See Expanded Interconnection with Local Telephone Company Facilities, Second Report and Order, 8 FCC Rcd 7374 (1993), and Transport Rate Structure and Pricing, Third Memorandum Opinion and Order on Reconsideration, 10 FCC Rcd 3030 (1994), respectively. Expanded Interconnection became an important vehicle for CAPs to reach additional end user customers without the expense of building the local exchange network. These arrangements entail interconnecting with the incumbent LEC's local exchange network either through "physical collocation" (establishing a CAP node within the incumbent LEC's central office) or through virtual collocation (establishing a CAP node at a "meet me" location such as a manhole). Some state regulatory commissions have mandated the unbundling of incumbent LECs' local exchange services into "link" and "port" components to facilitate these arrangements and to encourage local switching competition.

For intrastate intraLATA toll, most state regulations provide for intrastate intraLATA toll competition and a number of states have enacted requirements for intraLATA presubscription (see Sections 3 through 6 for events in the states of Connecticut, Georgia, Texas, and Washington). The majority of the intrastate intraLATA competition facing the incumbent LEC is from the large IXCs, namely AT&T and MCI. AT&T is just beginning to initiate major marketing initiatives into selected intraLATA toll markets by offering time-limited discount plans.

Local Exchange revenues will continue to rise, while prices will be kept relatively constant. This is mainly due, for residence customers, to: (i) continued demand for online and data services; (ii) additional line growth to meet the needs of telecommuting and home businesses, access to online services and the Internet, and other second-line needs (which will soon taper downward because the FCC’s mandated Subscriber Line Charge increases — see Section 2); and (iii) growth in optional features and functions, CLASS services, and ISDN services. For business customers, the cause is continued demand for multiline service, including centrex (which will soon taper downward because the FCC’s mandated Subscriber Line Charge increases).

Switched Access revenues will decline briskly once full competition enters the market. An even bigger influence, however, is the FCC’s Access Charge Reform order (see Section 2). Following the rules the FCC has adopted will phase out local loop and other non-traffic sensitive costs from those charges and with the increased productivity factor, carrier revenues will reduce substantially after the FCC’s transition period (year 2002).

Intrastate Long Distance revenues will begin declining nationally in 1998 due to price competition from new entrants. This will take place sooner in the more competitive markets.

Interstate Long Distance revenues will continue to rise until the RBOCs enter the market. This will be the result of initial price increases in domestic long distance services and an increase in international calls brought about by the expanding global economy. However, there could be a slight decrease in revenues as AT&T flows through the initial access charges reduction to basic interstate rates. Hopefully, international long distance rates will begin coming down as settlement rates are renegotiated.