COMPETITON AND TECHNICAL CHANGE IN TELECOMMUNICATIONS:
SOME LESSONS FROM WORLDCOM
José Rogerio Vargens Filho[1]
1. Introduction
The telecommunications industry has been changing rapidly in the last two decades. Technological change, institutional reorganization, and globalization are the most important factors that have transformed and intensified competition in the industry. However, competition does not increased symmetrically in every telecom segments. It increased faster in the long distance telephone segment than in the local one. New services were developed, specially those related to the Internet, but some of this services did not provided the return that telecom companies expected they could do. The case of WorldCom brings some lessons about how technology and competition changed in telecommunications, since the company strongly suffered the impacts of the long distance consumer segment and virtual business slowdown.
At the beginning of the 1990’s, WorldCom was an unknown telecom long distance carrier from Mississippi. In few years, the company experienced a fast growth based on aggressive acquisitions and financial trends. In 1997, WorldCom took over MCI Communications with the highest value corporate bid in US history, producing the greatest merger in telecommunications history: MCI WorldCom. The new company emerged from the fusion as the No. 2 overall telecom operator in the world, behind AT&T, and the No. 1 business-telecom service provider. However, this telecom giant fell down in 2002. The main reasons of its collapse can be explained by the changes in competition and technology of telecommunication, specially those changes which modified the long distance competition and created the Internet and the business related to it.
This paper summarizes WorldCom history in the telecom industry contest and then tries to explain the economic reasons of the company collapse. To reach this goal, this paper is divided into 7 sections, in addiction to this introduction. The first section comments about the major forces that have been reshaping telecommunications industry. Section 2 shows the USA telecommunications ambient, presenting the main changes that influenced WorldCom performance. Section tree summarizes WorldCom growth and section four tells about MCI WorldCom merger. In section five, it is presented the history of MCI WorldCom from the merger to the collapse. Section 6 presents and explains four reason to the collapse, based on economics and technological changes that happened in telecommunications and, finally section 7 concludes this work.
2. Competition in telecommunications
The telecommunications industry is one of the fastest-growing and changing in the world. It is also technologically complex. The industry experienced two distinct phases. Until 1980, a “analogical-monopolistic” structure prevailed in the sector, when there were monopolies offering telephone service upon electromechanical technologies in almost all the countries. Since the decade of 80, the structure of telecommunications has become “digital-competitive”, because of the fast technological change, with the gradual network digitalization, and a vast set of institutional reforms in the majority of the developed countries and in development. In the last two decades three forces have transformed the industry: technological change, institutional reorganization, and globalization. These factors intensified competition in the telephone business segments in an asymmetric way. While local fixed telephony kept its monopoly characteristics, competition fell down barriers to entry in the long distance segment (VARGENS FILHO, 2001).
2.1. Technological change
In a recent past all the information transmitted in telecommunication, basically voice, had a analogical transmission, which copied the original forms of the signals. Now, all the information that can be codified into bits can be transmitted. So voice, data, text and image can be transmitted in form of bits upon the same network. This possibility increased the range of telecom services which can be offered. The technical changes, specially the DSL technology, have also rejuvenated the local copper networks, multiplying their capacity to transmit information and increasing its intelligence. This way, new telecom services and the basic ones can be offered upon a big network, called ISDN (Integrated Services Digital Network), which has been built up with the gradually digitalization of the old local networks.
According to Laffont & Tirole (2000), Networks were being rapidly enhanced to give greatly increased carrying capacity for data as fiber optic cables replace traditional copper ones. Fiber optic cables have a large capacity and a very low marginal cost. The fiber optic has been substituting copper for presenting higher capacity of transmission, and thus reducing operation costs and allowing to greater diversification and quality of the telephone services. The fiber is used successfully in those parts of telephone network where there is great concentration of signals, generally in the transport networks (backbone), responsible for the connection among central switches. However, the copper wire is still the only viable alternative to the last mile, since this network stretch presents low concentration of signals and great geographic dispersion, what it becomes the difficult and expensive installation.
The local telephone network has high fixed costs of implantation and maintenance, and a high marginal connection cost, this is, the cost of connecting a plus user. It occurs because of not only the great capillarity of the copper pairs in the last mile, in result of the geographically dispersed users, but also the impossibility to optimize these transmitters by commutation and multiplex technologies. As the commutation is made in the local switch, each user must be individually connected to the central office with a single pair of copper. Of this form, it is not possible to rationalize the use of access network copper wires through commutation, as it happens in the transport network (VARGENS FILHO, 2001).
In the long distance network, the investment is also high, but the marginal cost is minimum. The transmitters used for long distance telephony can be maximized through commutation and multiplex technologies, which endows them with great capacity of traffic, making that the cost of a supplemental connection be very reduced. However, a long distance connection needs two local connections to bind the users in the tips of the process. Thus, the great problem of the competition in the industry is that the access to the consumer by last mile remains monopoly of the local incumbent (Ibid).
The wireless segment has been expanded beyond unwired phones and cell sites to include a few strong satellite players. The evolution of the wireless industry has translated into a new-found freedom for consumers, who can access information and communicate anytime and anywhere. The mobile telephone market has increased rapidly in the world. It moved away from business and elite users to the mass market with falling costs and the use of pre-paid cards. It is expected the growth of the “mobile multimedia services”, i.e. mobile communicators with advanced facilities for video, Internet/Intranet access, remote database interrogation, fax, e-mail and normal voice communication. However, wireless is not an alternative to replace the copper pairs in the last mile, since these technology does not yet provide the necessarily bandwidth to offer quality and high speed in data services.
The principal innovation in telecommunications is the Internet, which has experienced a very fast compound annual growth rate since the decade of 90. Internet can be delivered very fast by ISDN, by satellite and digital mobile phones. It is much cheaper than the public switched telephone network (PSTN): for example, in 1995 the ITU estimated the cost of sending a conventional 42-page fax from New York to Tokyo was nearly US$29, while the Internet e-mail cost of the same document was less than 10 cents. The high speed access to Internet is other service which it is possible to add value. Firms offers this service placing a DSL access multiplier (or DSLAM) in the central office of your local phone company. This piece of hardware, which acts like a switch, transfers the data coming over the phone wires from a high-speed DSL modem, onto their private networks and then to the Internet's backbone. With the develop of Internet Protocol networks, voice over IP can be a alternative to the basic voice service. If the quality improve, the voice over IP will push the price of voice traffic down over the next few years.
2.2. Institutional reorganization
In many countries, previously separate and protected public monopolies have been broken down and transformed in private companies. The governments so passed to regulate these companies. There are two extreme ways to regulate telecom companies: as a private monopoly and as competitive firms. Both ways bring problems to regulation. If the telecom operator is a private monopoly, the rapidly technical change produce a technological slack between firm and regulator. In this situation, the information asymmetry between both can become so great to make the regulation impracticable.
On the other hand, competition in telecommunications is very difficult and complex. The institutional reforms in most countries divided telecommunications in two main segments, local and long distance, and put separated firms to operate in each one. After a period of transitory monopoly, these two segments have been opened to competition; first the long distance, later the local one. Because of the local access to the customer remain a monopoly of local telephony operator, competition was developed in the long distance but did not in the local segment. In result, long distance carriers do not have means to access the retail consumers, still they are connected to them by other access technologies, like wireless and cable TV, since these technologies do not yet have capacity to support most part of the telecom data services.
Anyway, most regulators believe that competition is the best alternative for the telecommunications industry. So, regulations have been relaxed in many cases, including the USA, which possess the world's greatest and most competitive telecom market. US telecommunications deeply changed with institutional reforms, like the introduction of long distance competition in 1970, the AT&T breakdown in 1982, and the 1996 Telecommunications Act, which will be analyzed at section 3.
2.3. Globalization
There is an effort to get the liberalization of the telecom national markets all over the world. In 1998, the World Trade Organization tried to implement an agreement covering 71 governments and 91 per cent of telecom revenue to maximize basic market access for basic telecom services. These agreement is part of the General Agreement in Trades and Services – GATS. Also in 1998, the European Union expected the majority of EU Member States to liberalize voice telephony and telecom infrastructure in that year, although exemptions on the deadline have already been granted to less-developed members. This effort aims to open national markets worldwide to the big long distance players can appropriate of the international traffic.
The most visible aspect of globalization in the telecommunications industry is the sprouting of “global service alliances” (GSAs) among telecom operators. This in turn is a result of the internationalization of transactions and services and new technology in communications. The growth in the scope of multinational companies has increased demand for “seamless” or “one-stop shopping” provision of telecom services. The international traffic in telecommunications is growing faster that the domestic traffic. The global services alliances were almost exclusively traditional circuit-switched telecom operators offering fairly similar global services. However, GSAs have change to respond to the advances in technology and new entrant telecom operators, media and IT companies offering value-added services in the high value end of business process solutions for multinational companies.
A good global strategic alliance can bring strong competitive advantages for firms which have global interest like WorldCom. In 1997, the three key international strategic alliances were: i) Concert Communications Services; which is $1 billion joint-venture communications company created by BT and MCI in 1994 with seamless global products and services distributed by BT in Europe and Asia/Pacific and by MCI in the Americas; ii) WorldPartners/Unisource which is a fusion between WorldPartners, set up in 1993 by AT&T, KDD of Japan and Singapore Telecom, and Unisource, a consortium of telecom operators from The Netherlands, Spain and Switzerland; iii) Global One, which was set up in 1995 between France Telecom, Deutsche Telecom and Sprint (USA) to operate in continental Europe (except the UK).
3. Telecommunications in USA
The USA has the strongest national telecom industry in the world, which accounts for approximately one third of the total world's telecom revenue. Competition in USA’s telecommunications was introduced in the 1970s, when MCI Communications Corp. became the first company authorized to compete against the giant national telecom monopoly American Telegraph and Telephones (AT&T) in the long distance market. Despite MCI was not a threat to AT&T monopoly, it worked keeping a long distance call price-limit.
To provide competition in USA telecom, the US Department of Justice broke up AT&T in 1982 into seven (now five) Regional Bell Operation Companies (RBOCs), with local telephone monopolies. They became known as “Baby Bells”: Bell Atlantic, Bell South, Verizon, SBC Communications and Quest Communications. Then, AT&T was confined to the businesses of long-distance and manufacturing. After the AT&T brake-down, a lot of telecom carriers entered in the long-distance market, specially to offer LD services to the business sector. Since them, the long distance became progressively more competitive and the average price of a US long-distance call dropped by 70 per cent between 1984 and 1997.
At February 1996, the Telecommunications Act for the first time permitted local, long distance and other telecommunications providers to enter each others' markets in the USA. It was the first major revision and adjustment in the USA telecommunications law in it’s 62 years old. The 1996 Act opened the local telephony, which was Baby Bells monopoly until this time, and became regulation less tight.
However, the 1996 Telecommunications Act did not produce competition into local telephone markets, because of the technical characteristics of monopoly which the Act could not minimize. Newcomers have so far not been able to enter in the local telephone market, which the Baby Bells keep a 98% market share, as it is showed at Table 1.
Table 1 - US Telecom Market Shares in per cent (1996).
Source: Stonham (1998).