Effects of Deregulation on the Big Three of Long-Distance

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1 Effects of Deregulation on the Big Three of Long-Distance By: Karen Miller Economics 320 April 17, 1997

2 Effects of deregulation on the Big Three of Long-Distance Introduction The competition for long distance customers may result in some unexpected winners and losers. Companies are already expanding to include either local or longdistance services. Several new companies are entering the long-distance competition. Economists often talk about the rule of three, noting that many market free-foralls end up with just three big players still standing. (Kanell, 1996) Along the way there are mergers, acquisitions, and some failures. The idea of the big three has been prevalent in the long-distance market in the past, but the future of AT&T, MCI, and Sprint s long-distance control is in question. Background of Long Distance Competition in the long distance market for residential and small business owners was not working in the long distance market. AT&T acted as a dominant firm in the longdistance industry with MCI and Sprint acting as fringe firms. Whenever AT&T raised their rates MCI and Sprint followed with rate increases of their own that matched AT&T s increases. MCI justified their increases by stating that, the company has historically been competitive in pricing our services relative to AT&T s rates. Despite these increases our prices remain competitive with AT&T s, said an MCI spokesman. (Internet)

3 A spokeswoman for Sprint said, We face the same costs and competitive pressures as the rest of the long distance industry and we routinely adjust our rates to reflect those pressures. (Internet) However, MCI s and Sprint s explanations did not make economic sense. The access charges paid by the long-distance companies to local companies had decreased over the same period that the long-distance companies had been increasing their prices. These access costs are by far the largest component of long distance services (about 40% to 45%), therefore, long-distance prices should have been decreasing, not increasing. (Internet) When AT&T raised prices MCI and Sprint could have kept their prices the same and gained some market share. However, they chose to increase prices along with AT&T; they found increasing prices more profitable. The effect of their pricing behavior was happening at the expense of the consumers. According to Professor Paul MacAvoy, Dean of the Yale Business School, An announcement of a price increase causes the stock prices of all three carriers to rise. Thus, the stock market believes that when AT&T increases prices, it will not be challenged competitively by MCI and Sprint. Instead, these companies will raise their prices also, and all three companies will earn higher profits at the expense of consumers who will pay higher long-distance prices. (Internet) This price leadership behavior is often found in oligopolies which exhibit a low level of competition. The common industry elasticity estimates for the interstate longdistance service was in the range of 0.5 to 0.75, therefore, AT&T found it profitable to raise prices so long as it was confident that MCI and Sprint would follow the price

4 increase. For example, if AT&T were to raise prices by 5% and MCI and Sprint followed, demand would decrease by only about 3.7%. (Internet) The price increases would be profitable because revenue would increase by about 1.3% and the costs would decrease due to not having to meet the 3.7% decrease in demand. (Internet) The clear conclusion is that the long-distance industry was not competitive, an oligopoly existed. This means that as costs decreased for the companies they were still increasing their prices. In a competitive market when the companies costs decrease their prices will decrease. Therefore, increases in competition, not price caps, is the answer to the problem. It would eliminate the situation of the dominant price leader and followers. Telecommunications Act The Telecommunications Act of 1996 has set the stage for hordes of new competitors to enter the long-distance market, among them the powerful Baby Bells. Deregulation means that companies like AT&T have no choice but to expand out into local calling if they wish to stay competitive. New Markets New competition in the long distance market is sure to bring lower rates for customers. The long-distance industry will soon leave the oligopoly stage and become closer to perfect competition. AT&T, MCI, and Sprint are sure to use their name power to sweep into the $105 billion market for local phone services. However, none of them will sink their

5 fortunes into just one market. Most carriers will plan to offer a full array of local, longdistance, wireless, and data-transmission services. The government still remains a central player. The regulatory and legal confrontations surrounding the implementation of the Telecom act are the most important issues in the industry right now, says Chicago Corp. Analyst Eric Strumhinger. (Arnst, 1997) New Competitors While AT&T, MCI, and Sprint are tangled up in court battles with local phone companies, competition is coming in on a different line. The non-bell local phone companies, the so called independents that include giant GTE Corp., are getting the most out of the deregulated market. Unlike the Bells, which still face restrictions on how they can enter long distance, GTE and other independents gained immediate entry. (Jackson, 1997) The winner so far is $21 billion GTE, the largest local-phone company in the U.S. Less than an hour after President Clinton signed the Telecom law, GTE locked up a deal to resell long-distance service purchased from WorldCom Inc. (Jackson, 1997) Currently GTE has 827,000 customers, which is 10% more than expected. GTE Long Distance, pulled in an estimated $50 million to $60 million in revenues by year end. (Jackson, 1997) GTE Long Distance has predicted a sevenfold increase in long-distance sales in the 1997 year and expect a profit by late (Jackson, 1997) Along with entry into the new market GTE and other independents are the first to offer a one-stop shopping for phone services. (Jackson, 1997) By providing all the

6 services these companies have a key marketing advantage. People yearn for the old days, when one company provided you with everything, says Richard C. Toole, a telecommunications analyst with Merrill Lynch & Co., in New York. (Jackson, 1997) Toole also predicts that consumers will be less likely to switch when they have one-stop service. (Jackson, 1997) AT&T, MCI, and Sprint are locked in legal battles with local carriers over the rules for entering local markets. One of their largest adversaries is GTE. Therefore, the Big Three are not yet able to sell bundles. While the Big Three are battling to enter the local market some new competitors such as GTE and independent Southern New England Telephone Company (SNET) are getting experience in the long distance area. They are playing every card they ve got, and they re doing it well, says Boyd C. Peterson, a telecom analyst with Yankee Group in Boston. SNET which gained entry into its long-distance market in 1994, has won 35% of Connecticut s long-distance customers, mostly from AT&T. (Jackson, 1997) It took AT&T a while to realize the nature of their competition was changing, says Peterson. (Jackson, 1997) Currently, Frontier Corp., the former Rochester Telephone Co., is considered a role model for many of the upcoming long-distance carriers. Frontier is the fifth largest long-distance supplier, as well as, the 12th. Largest local-phone company. Frontier resells its network to other long-distance providers and offers direct service through 34 subsidiaries in 13 states. (Jackson, 1997) In 1996, Frontier received $2.6 billion in revenue, 75% of the revenue was from long-distance. (Arnst, 1997)

7 AT&T s Approach Currently AT&T has said it will do whatever it takes to crack the market in every state - either struggling through negotiations to resell Baby Bell services, building local networks of its own, or aligning with bypass companies like Teleport, which runs fiberoptic telephone lines into office buildings. (Kupfer, 1997) So far, AT&T has only begun selling Baby Bell service to a small number of residential and small business companies in Illinois and California. (Kupfer, 1997) Part of AT&T s problem is their large size. Many believe that AT&T has a lack of focus which comes from indecision. The company has shifted strategies several times, often ignoring fundamentals, and they have been slow at implementation of any strategy. (Kupfer, 1997) One setback facing AT&T is that they have not created a billing system which will combine all their services and offer a single bill to customers. Single-billing is considered a key advantage in the marketing of bundle sells. About two-thirds of AT&T s current market is residential. (Kupfer, 1997) Therefore, they plan to target these customers first. However, margins on residential service is typical very thin. MCI s Approach Rather than trying to be everywhere, like AT&T, MCI has decided to focus on more narrow areas. In 1994 MCI Metro began building local telephone systems for business customers in city center. (Kupfer, 1997)

8 MCI is confident in its geographic approach. City centers have dense concentrations of telephone users and MCI believes it can profitably build miniature local networks there from scratch. (Kupfer, 1997) Sprint s Approach Sprint owns local phone networks with about seven million customers in 19 states, primarily in rural districts. Sprint only plans to expand into the local competition in a moderate manner. Sprint president of national integrated services, D. Wayne Peterson says, We re not going to throw dollars at what might be. When we go into a city we ll know which customers we re going after, and that will determine where we build or lease facilities. (Kupfer, 1997) Sprint is committed to spending billions on new wireless telephone systems and simply can not afford to go after the local market in a big way. Prognosis for 1997 Positives: Fueled by Internet growth and deregulation, telecommunications traffic around the world will zoom. The rules for entering local and long-distance markets in the United States will finally be spelled out. Negatives: Increases telecom competitions in all sectors will put pressure on prices and profits.

9 Capital spending will increase as phone companies build wireless, local-calling, and data networks and upgrade systems. Conclusion The Telecom Act of 1996 was a huge stepping stone for many companies wishing to enter the long distance market. Things have suddenly gotten more hectic for the Big Three of long-distance. They have not only had to contend with the downfall of their oligopoly in long-distance, but they must also try to expand into the local market in order to stay competitive. By having to focus on so many different things at once they are not able to put forth a strong battle in either field. The overall winner seems to be the consumer. Consumers are no longer forced to accept the increasing prices of the oligopoly. Now that there is competition the cost of long-distance should fall for consumers when it falls for the producers. Consumers will also be winning in the convenience department with one-stop shopping for services. However, in the beginning consumers may be overwhelmed by all of their new choices. Eventually, when AT&T, Sprint, and MCI are able to enter local markets more freely, as well as Bell being able to enter the long-distance market more freely, people will probably begin to opt for a company that can handle all of their services. Due to this, Sprint may find itself in some trouble since they are not aggressively attacking the local-industry.

10 Bibliography Arnst, Catherine. Telecommunication. Business Week. Jan. 13, Pg 108. DCR. Long Distance Industry Faces Competitive Threats From RBOCs, GTE: DCR Report. PR Newswire Assoc. Inc. Jan. 30, Pg 130. Fox, Justin. What a Little Competition Can Do. Fortune. June 10, Jackson, Susan. Trench Warfare in Long Distance. Business Week. Feb. 17, Kanell, Michael E. Long-Distance Competition Likely to Leave Many by the Wayside. The Atlanta Journal and Constitution. Sept. 30, Kupfer, Andrew. The Telecom Wars. Fortune. March 3, Pg 136. Internet. The Long Distance Telephone Industry. Carrier/Reports/FCC-StateLink/ixc.html.

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