The DLECs’ demise

Upstart DSL providers claim dirty tricks by incumbents contributed to their downfall; end result is that customers might be paying more and waiting longer for broadband.

By Steve Ulfelder
Network World, 01/07/02

“I guess the ‘no facilities’ lie is my favorite,” says Joe Plotkin, director of marketing for DSL at Bway.net, a New York ISP that resells telecommunications services. “We would have, say, an order for Covad DSL at a 10-person law firm in the city. Verizon tells Covad there are no available facilities in that building.”

“We’d say, ‘That’s a 60-story high-rise in midtown Manhattan,” Plotkin says, his voice dripping with incredulity. “You’re telling us there’s not another twisted pair available?”

If you were Steven Spielberg, putting together a documentary on the fate of the DSL start-ups would be easy – a montage of whirling headlines would do the trick. As the 1990s flipped by into 2000, the headlines would blare: CLECs exploit innovation in race against RBOCs. Advances could spell faster DSL delivery. DSL outlook rosy.

But as 2000 gave way to 2001, the headlines would turn first uncertain, then tragic: Caution flags flying as CLEC woes mount; DSL providers’ bloodbath continues; NorthPoint, Rhythms reeling; Covad lost almost $1.5 billion in 2000.

Finally, a full-blown funeral dirge: Rhythms files for Chapter 11; Covad files Chapter 11 to ‘reorganize’; NorthPoint files for Chapter 11.

Unfortunately, IT executives can’t simply dust the popcorn from their laps as the credits roll. They want to find out whodunit, and they need to know if there will be a DSL sequel.

Wipeout
Made possible by the Telecommunications Act of 1996, DSL local exchange carriers (DLECs), like competitive local exchange carriers, were launched on not one, but two, bubbles.

The first was optimism surrounding the telecom act, which was intended to create new competition; and the second was the unprecedented venture-investment mania of the late 1990s.

While many CLECs were founded with modest goals, three companies stood out for their national aspirations: Covad Communications in Santa Clara; NorthPoint Communications in Emeryville, Calif.; and Rhythms NetConnections in Englewood, Colo.

While each member of this Big Three began as a regional provider, by 1998 all were racing to establish a national footprint. Analysts estimate they spent as much as $1.5 billion building out networks.

Today, Rhythms and NorthPoint are out of business, their physical assets snapped up by WorldCom and AT&T, respectively, at garage-sale prices. Only Covad remains standing, sort of. In August, it won bondholders’ agreement to forgive $1.4 billion in debt, allowing the company to file Chapter 11, restructure and remain in business.

A recent Meta Group report by analyst David Willis proclaims DLECs equals DeadLECs. “Covad’s Chapter 11 filing puts the final nail in the coffin for competitive DSL services in the U.S.,” Willis says.

Today, the majority of DSL connections – more than 80%, according to TeleChoice – are provided by the incumbent local exchange carriers (ILEC) that, some claim, “starved out” the DLECs through incompetence, dirty tricks or a blend of both.

Competition is not pretty
Ah yes, the alleged dirty tricks.

The telecom act granted DLECs the use of infrastructure belonging to their competitors, the incumbent carriers. In addition, the act attempted to spell out just what incumbents must do to comply.

It was clear from the start the DLECS faced an uphill battle. “The ILECs owned the copper, they owned the central office space, they owned the customers,” he says.

The kindest comment about the incumbents comes from Gartner analyst Jay Pultz, who says, “They followed the letter of the law, but they didn’t go out of their way. They certainly didn’t make it easy on their new foes, who had to come to them for everything from access to central offices, in which they needed to install equipment, to order-taking systems, to installation requests.”

Many think Pultz is being overly generous. “There were a million dirty tricks,” says a source with more than two decades of experience in the telecommunications industry who requested anonymity. Lots of times a DLEC would go out to a central office on a weekend to install equipment and find the doors locked. “There were orders ‘lost’ – truckloads of orders,” the source says.

The DLECs filed many lawsuits and complaints with state public utility commissions. The complaints span a range of issues, from allegations that one party has failed to follow a billing agreement to allegations of “LEC slamming.”

The California ISP Association (CISPA) claims ILECs use their control of the last-mile infrastructure to favor their own ISPs and to hobble competitors – which has resulted in SBC Communications controlling 90% of the DSL business in the state.

Independent ISPs and DLECs are supposed to receive service installations at the same rate that RBOC ISPs do. CISPA alleges that “[R]BOCs have placed their ISPs’ orders ahead in the line for [DSL access multiplexers] port allocations.”

Located in the central offices, DSLAMs cross-connect DSL to customers’ phone lines. A DSLAM contains a number of ports, each of which serves a single customer’s line. CISP claims that when asked about delayed installations, the RBOCs said the cause was “port exhaust,” a lack of DSLAM capacity.

ILECs deny playing dirty tricks on competitors. Verizon, BellSouth and SBC say they provision DLECs accounts just as they provision their own, and that small ISPs may be charged higher rates for DSL because they don’t qualify for volume discounts. Moreover, the ILECs add, they have faced technical challenges in opening up their networks to competitors, and those challenges have caused some of the delays that ILECs view as dirty tricks.

Cost of doing business?
Covad has filed antitrust suits against three RBOCs. Last year, as part of a settlement, SBC paid Covad $150 million for an equity stake. In November, SBC agreed to pump another $150 million into Covad, whose executives say the infusion will allow them to emerge from Chapter 11 nearly debt free this month.

DLECs complain that hyperlitigation is part of the incumbents’ strategy to move as slowly as possible, do as little as possible, and use deep pockets to wait out the upstarts. One source calls the strategy “success by incompetence.”

“These dirty tricks stories are absolutely true,” Meta Group’s Willis says. “Time was on the ILECs’ side; the slower they acted, the more the competitors were at risk.”

Regardless of whether ILECs have intentionally starved out DLECs, experts say the DLECs contributed mightily to their own difficulties. Gartner’s Pultz believes the business model was flawed from the start.

“Covad, NorthPoint and Rhythms [worked] as wholesale suppliers,” Pultz says.

Initially, they poured enormous resources into building nationwide DSL networks, but relied heavily on ISPs to sell their services. The DLECs then had to split profits with those ISPs on one end. Meanwhile, on the other end, the DLECs had to obtain copper lines from the enemy ILECs. The result was “too little profit to go around,” Pultz says.

The DLECs also found themselves whipsawed by the changing demands of fickle venture capital firms. Encouraged to grow at all costs, DLECs spent heavily building out national networks. Then in early 2000, as the technology sector faltered, venture capitalists changed their tune and demanded profitability.

The DLECs couldn’t produce; their narrow margins and pricey buildouts made profitability a distant dream. “Until the [DSL] networks are loaded, they’re unprofitable,” Covad’s founder Charles McMinn says. “Many of our competitors took too much time to load the network.”

Moreover, analysts say that in the DLECs’ initial, giddy rush to grow, they spent heavily on leading-edge technology, such as order-entry systems, that proved nearly useless because they needed to interface with the ILECs’ systems – which were much older.

“The new entrants bought all this new technology, then went to an ILEC and said, ‘Let’s work together,'” says Rich Nespola, CEO of The Management Network Group, a telecom consulting company. “Meanwhile, the ILECs had old technology. The [DLECs] came in with a Ferrari, ready to race, and the ‘OK, but we have to race on my track – and it’s a dirt track.'”

Higher prices, slower rollouts
Although the cause of the DLECs’ demise is controversial, the effect is predictable. SBC, BellSouth and Verizon have announced price increases for DSL.

SBC also announced it is scaling back its project to make high-speed Internet access available to 80% of its customers by the end of 2003.

SBC currently offers DSL to about 23 million customers across its service areas, or about 58% of its customer base.

What’s next
The DLECs may be in dire financial straits, but DSL is still considered a growing area. In terms of customer demand, “DSL is still a viable service,” Gartner’s Pultz says. Despite the present economic downturn, he expects the service to grow about 70% per year. “DSL is going to be a major technology, especially for small and branch offices.”

Optimistic predictions are not unanimous. Martin McDermott, senior vice president at New Paradigm Resources Group in Chicago, says, “DSL was a good technology in the late ’80s, when it was invented. . . . Now, for business, T-1s are so inexpensive.'”

Also the failure of NorthPoint and Rhythms, combined with widespread complaints about shoddy and late DSL installations, have led to a perception the technology is less reliable than cable modems and T-1.

The view from Washington
In Washington and state governments, there’s an ongoing tempest of broadband- and telecom-related activity:

FCC. Michael Powell, who became chairman of the Federal Communications Commission last January, is widely perceived as a laissez-faire leader unlikely to offer CLECs and DLECs much relief. However, in May, Powell wrote that “CLECs may have been stymied by practices of [ILECs] that appear designed to slow the development of local competition,” and recommended that fines for certain ILEC violations be raised from $1.2 million to “at least $10 million in order to enhance the deterrent effect.”

Congress has not yet acted on Powell’s recommendations.

Congress. ILECs and CLEC/DLECs are each lobbying hard for passage of pet broadband-competition bills.

The American Broadband Competition Act of 2001 and the Broadband Competition and Incentives Act of 2001 were introduced in May by Rep. Chris Cannon (R-Utah) and Rep. John Conyers (D-Mich.).

The Cannon/Conyers bills are favored by CLECs; they would prevent RBOCs from expanding out of their home regions until they face additional local competition.

The bills would also simplify the dispute-resolution process between CLEC/DLECs and the incumbents.

Meanwhile, Rep. Billy Tauzin (R-La.) and Rep. John Dingell (D-Mich.) introduced the Internet Freedom and Broadband Deployment Act of 2001, which is supported by the incumbent carriers: It is intended to hasten the rollout of broadband by limiting FCC and state regulation of RBOCs.

Courts and state utility commissions. Suits remain very much a part of the broadband landscape, as do complaints with state public utility commissions.

In many states, ISPs have formed associations in efforts to slug it out with ILECs.

For now, analysts say, RBOCs have wrested control of DSL away from competitors. Such a vacuum cannot hold for long, though; analysts expect the next wave of competition to come from AT&T (which snapped up NorthPoint’s assets for about $135 million last March), and WorldCom (which recently bid $40 million for 700 former Rhythms central offices). Unlike the DLECs, these carriers have existing cash-cow products they can lean on while they invest in a DSL buildout.

Whatever happens in the future, though, “There is no DSL-vs.-competitive DSL anymore,” Meta Group’s Willis says. “We’ve already seen prices rise, and for business-grade DSL, we anticipate rates are going to rise again. There’s just no alternative.”