Telecom/1996-04-telecom-walnutcreek.iso/reports/cable.role.in.telephony

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This article was too long for a regular issue of the Digest and is
being submitted FYI. It will also be filed in the Telecom Archives.

PAT

  Date: Thu, 11 Feb 93 14:22:40 -0500
  From: matt lucas <[e-mail]>
  Subject: Feb. TS Insight: CABLE'S FUTURE ROLE IN TELEPHONY

This is the lead article in the February 1993 issue of TeleStrategies
Insight. Information about TeleStrategies, Inc., and TeleStrategies
Insight appears at the end of the article.

Matt.

                     ----------------------

CABLE'S FUTURE ROLE IN TELEPHONY or how cable MSOs can eat the RBOCs' lunch!

           By Dr. Jerry Lucas, President, TeleStrategies, Inc.
                  and Publisher, TeleStrategies Insight

This year the biggest question in the cable TV industry isn't whether
cable should get into the telco world -- they're already in it. It's
what future role they should play in next-generation telephony. This
analysis covers (1) where cable is today regarding the telephony
world, (2) why they must partner and who they must partner with to
succeed and (3) how the cable industry should define their business to
establish a winning vision for the 21st century.

THE FIBER WAVE

Prior to 1989 there was virtually no fiber in a cable TV system. This
situation was much like the telephony world in 1979 -- no fiber in the
network. And just as the '80s saw a technology revolution with the
advent of almost total fiber connectivity between central office
switches, within the next several years you'll see a similar
revolution in cable TV.

Companies like TCI, the largest multiple system operator (MSO), state
that within two years 80 percent of their subscribers will be served
via a fiber backbone system. The industry as a whole will average 70
percent. All of this plunge into fiber is totally cost justifiable in
serving the entertainment marketplace alone. To the cable industry,
fiber to the neighborhood means better quality, higher reliability and
more capacity (500 channels or more).  These are exactly the kind of
things that will help keep a franchise at renewal time or beat the
direct broadcast satellite people, both of which will become important
in the post-1994 time frame.

During the initial front (1989-91) of the fiber wave, cable companies
weren't sure they should take the plunge (using this fiber backbone
architecture) to compete with the LECs in the telco world. But
TeleStrategies, industry consultants, cable equipment vendors and
others kept delivering one message: there are big dollars to be made
if you do. But along with the good news there is bad news.

First the good news: cable is a $20 billion per year business with
over 90 percent of households passed by and an overall subscriber rate
of 60 percent nationally. Future growth from video services is likely
to be only in pay per view and interactive TV. My view is that, when
you factor in competition and price regulation, these new services
will not be enough to sustain the growth rates cable had in the '80s.
The only alternative yielding strong growth will be in the telco area.
And here local exchange carriers' (including cellular) revenues are
more than $90 billion, with over 50 percent open to competition with
the right regulatory changes. (See TeleStrategies Insight, September
1991) That's nearly a $50 billion market and it's two and a half times
bigger than cables' market! That's the "lunch" the cable companies can
go after.

Then there's the bad news: telcos want to get into your business, and
given the right set of circumstances, they, too, could have a
subsidized backbone network and favorable regulatory rulings allowing
them to eat cable's lunch (as discussed later).

CABLE'S PLUNGE INTO TELCO

1992 saw the cable industry and RBOCs enter into a battle that shows
every sign of becoming a full-scale war. Four of the six largest MSOs
(TCI, Cox, Continental and Comcast) own one of the two largest CAPs
(Competitive Access Providers), Teleport. If you take out the other
large CAP, Metropolitan Fiber Systems, cable controls over 80 percent
of the CAP market. Almost every MSO today has CAP activity underway.

Again, this is good news and bad news for the cable industry. The good
news is that they have a business vehicle (the CAPs) that is a start
in their quest to capture the $50 billion telco prize. The bad news is
that the cable-dominated CAP business as it is now cannot maintain its
competitive edge over present and future competitors without a change
in strategy. Why?

First, the CAPs' business represents an investment of a little over
$500 million and had service revenues via its fiber optic plant of
roughly $200 million in 1992. A number of players could easily
duplicate what the CAPs have in place today. An RBOC, for example, has
the resources, with no regulatory barriers, to establish a CAP-only
business outside its serving area.

Second, the CAPs' major customer set is the IXCs. Note that AT&T
spends 50 percent of its revenue for access ($18 billion per year) and
the other LECs pay roughly the same percentage for access, a big part
of the $50 billion telco lunch. Today CAPs' revenues are IXC expenses
that are targets for cost reduction.

Third, the CAPs' principal resource after its fiber is their
contracts: contracts for rights-of-way for their fiber, carrier
interconnection agreements and, more importantly, future collocation
agreements with the LECs. Within a year's time, these agreements could
be obtained by anyone with resources and patience including IXCs and
large end users.

Does this mean the CAP business is a loser and that cable shouldn't go
surging into that market? No. Does this mean cable has to do more to
succeed as a CAP? Yes. They need to have a clear vision of where
they're going as CAPs, they need a partner and they have to redefine
their overall business.

CABLE'S PROBLEM

The cable industry has a major problem or challenge when it comes to
taking charge of an infant industry like the CAPs'. There are three
reasons for this. First, the cable industry has a lot of diversity; it
is not a unified industry. Take the two largest MSOs; TCI, the
largest, has strong, centralized management with a fairly uniform
approach to the CAP business.  The second largest, Time Warner, is
highly decentralized with regional managers having a lot of autonomy.
The sixth largest MSO, Comcast, is heavily involved in cellular. All
three are in the CAP business but with different resources and
strategies. The net result of this diversity is that no one company
can serve as a model for the rest of the cable industry and lead by
example.

Second, the cable industry is small potatoes compared to the telephony
industry in which it wishes to establish itself. Cable's annual
revenues, $20 billion, are less than 13 percent of the telephony
market's $160 billion. As Lee Iacocca says, in this business you
either lead, follow or get out of the way. Cable is going to have to
follow in the telco world and structure its CAP business strategy
accordingly.

Third, cable has entered the telco business largely by acquiring CAPs
already in the business. Almost to an operation the following
statement holds true.  The CAP people know a lot about the telco world
and little about the cable business, and vice versa. CAPs and cable
are two different businesses with the only thing in common being
ownership and some fiber plant carrying hub-to- hub traffic. Because
of a yet to be established synergy between CAP and cable businesses
there is a lack of vision in the cable industry as to what cable's
role will be as telco and entertainment merge.

Without a clear vision of cable's role in telco and a clear business
definition of what a cable company is to be in the 21st century as it
enters the telco world, today's entree via the CAP business, I
believe, will fail.  Without a clear vision of the business, it will
be impossible for vendors to identify a broad, lucrative market for
which to build equipment, business users to understand the role cable
will play in the future, investors to understand business plans, etc.

PARTNERING

For these reasons and others, the cable industry must select partners
to move into the telco world. While there are several leading
candidates, one industry stand out: the interexchange carriers. First,
lets look at why the others don't have as much to offer.

1. RBOCs as partners -- At first glance the RBOCs should be natural
partners of the cable industry. At one time, as early as six months
ago, this was the case and together venturing had been mutually
beneficial. The telcos (See TeleStrategies Insight, March, 1992) could
have made peace with cable by agreeing to stay out of entertainment in
return for infrastructure services rendered (billing, service
provisioning, switching, IXC interconnection, etc.).

Today, however, in many regions cable and RBOCs have declared war.
Bell Atlantic, in particular, has made it clear they plan to be a
major player in the video business. Over the last two months they have
inked a $1.5 billion deal with the state of New Jersey to bring fiber
to the curb along with cable TV service in the 1996-99 time frame;
they initiated a video dial tone field trial in the Washington, DC
area with Blockbuster Video as a potential partner; and, they
petitioned the courts to strike down the prohibition that keeps telcos
from being full-fledged cable operators in their regions. Again, if
you're going to be in this business you lead, follow or get out of the
way. For the RBOCs, leading is certainly the fun way to go even if the
approach fails.

But there's another option in partnering with RBOCs -- forming
ventures that are geographically located outside their serving areas
(the extra-territorial strategy). Last summer, the U. S. Court of
Appeals overturned Judge Greene's prohibition on RBOCs entering the
information service business. Now, if Bell Atlantic wants to be a
cable operator, they can do so as long as they don't operate within
their six-state/Washington, DC serving area.

The cable industry should forget this partnering option unless you're
a cable operator with franchise "dogs" looking for a sucker willing to
bail you out.  Why? The RBOCs cannot hold themselves out to the public
as long distance carriers. That mean no interLATA facility ownership,
interLATA resale, joint venturing with long distance companies to
provide service, etc. Take note of Pac Tel's recent announcement that
they're splitting off their cellular and international divisions away
from their regulated business. Why? The leading reason for doing this
is their desire to expand their cellular venture into Personal
Communications Services (PCS) and this means an interLATA operation.
Besides, if US WEST and TCI, partners in European cable TV and telco
activities, haven't ventured here at home it probably means their
lawyers haven't figured out how to do it without violating the
interLATA restriction.

2. Other partners -- What about cellular companies, computer and/or
central office switch vendors as partners? No, they're not strong
partnering candidates. First, cellular: unless you own the local
franchise, like Comcast, it's better to go after the new PCS licenses
rather than act in a supporting role to cellular. A cable company
would probably have to choose between being a wholesaler to a cellular
company or a PCS license holder and PCS appears to be more lucrative
(more on this later). Regarding the computer industry, the only
players with technology and clout are IBM and DEC. I don't think IBM
has the bucks today to make two-way cable a profitable venture anytime
soon. (They lost $5 billion in 1992.) DEC is also hurting.

Finally, the two big switch vendors, AT&T and NTI, are not the door to
knock on. AT&T will very likely venture with cable but it will do so
through its Communications Services Division rather than through
Network Systems (its manufacturing arm), taking the lead much as in
the McCaw deal. As for NTI, I don't think they could afford to
alienate their largest customer set, the RBOCs, by promoting a
technology strategy to eat the telcos' lunch.

3. IXCs as partners -- I saved the best for last. There are three
reasons why cable should partner with the IXCs. First, as mentioned
above, they are the CAPs' best customer today. Second, they provide a
means to get into PCS with relatively low risk (to be discussed).
Third, they can provide the technology expertise and the
infrastructure (SS7, ATM, SONET, etc.) required to capture all
emerging opportunities in the telco world.  You might be asking why an
IXC would want to partner with cable. First, a cable company does not
have the restrictions of the RBOCs. It can enter into joint service
arrangements that are exclusive. Regulated LECs can't do this in their
serving areas. It's a mechanism to gain a competitive advantage in
this marketplace. Second, the IXCs will be entering the PCS arena and
challenging the RBOCs and cellular companies. PCS traffic carried over
the fiber/coax backbone of a cable company makes the economies right
(See TeleStrategies Insight, July 1992).  Finally, from a strategic
perspective, it's not in the IXCs' interest to see the RBOCs get
stronger. Sometime down the road, the RBOCs will enter the long
distance market. It's not likely anytime soon, if ever, that a cable
company will move into the IXC business. In the era of the pending LEC
level playing field, who would you trust with the last-mile connection
to your customer?  My assessment: cable will be a better bet than an
RBOC for IXC partnering.

A CABLE STRATEGY IN TELEPHONY

With the IXC industry at its side, here's how cable should enter the
telco world and here's its role.

Step One: Be a CAP -- With friendly IXCs, the CAP business is a
winner. If a cable company isn't a CAP in their serving area, they
should go ahead ASAP under the following two conditions. First, If
there isn't a CAP in town, be the first one. Note that the first CAP
in a market generally gets the majority of business from corporations
that want either access redundancy or a second (non-LEC) competitor in
the local loop. Just as the early bird gets the worm, it's hard for
later entrants to challenge the first CAP. The second condition is to
buy into or invest in an existing CAP.

The reason it's important to enter the CAP business, in addition to
longer- term benefits, is that it prepares cable for the real action,
PCS. The resources you put in place as a CAP can be used in PCS. The
interconnection and collocation agreements with the LECs, SS7 and soon
to be added digital switching, and the fiber backbone in the business
area will be required for PCS. If you have those resources, you will
be a stronger partner for an IXC when the PCS opportunity opens up.

Step Two: PCS Entree -- The FCC has yet to establish the rules on who
gets what in the pending reallocation of spectrum for PCS. The rules
are expected sometime this year after the new FCC chairman is in
place, probably in May or June. The plan most talked about is MCI's
proposal, which calls for PCS licenses to be awarded to three national
consortia. These consortia would not be controlled by any one company;
a consortium would be owned by an IXC and regional license holders
(probably serving areas much like those that were defined for cellular
 -- 305 metro and 425 rural areas). In addition, present cellular
license holders and LECs could not get licenses in their serving areas
but could get regional licenses outside those areas, heavy LEC
participation in a consortium would count against applicants, and all
license applicants would go through the comparative hearing process.

This approach has merit. The FCC would be in hot water with Congress
if it gave large spectrum awards to a few companies. Three national
licenses would likely involve individually the top three IXCs (AT&T,
MCI and Sprint). An idea all three can agree with! A consortium headed
by an IXC other than those three would not be in a good position to
win in a comparative hearing because of the lack of resources needed
to win. Finally, the FCC staff likes the idea of national licenses. It
eliminates the massive effort and resources that individual cellular
franchises needed to create the big systems. Note that McCaw, the
largest cellular carrier with over 100 licenses, never won a lottery.

The big three IXCs will head up the structuring of PCS consortia if
the MCI plan is adopted as expected here. The strongest player to
partner with in a market will be a cable company with a CAP business
up and running. This is the trump card the cable companies have to
play when dealing with the IXCs.

Step Three: Fiber to the Home -- The next development will be the
cable industry knock-out punch to the telcos. Although the technology
isn't quite right for 45 Mbps, two-way multimedia communication to the
home via cable TV, the environment for hype is. Step three calls for
hyping what cable can do to solve the nation's ills. Hype much like
this was used in the franchise war days during the late '70s and early
'80s when the institutional cable networks promised the local
governments that they would improve communications for public safety,
education, health, etc. Why? Because starting on January 20, 1993 the
Clinton-Gore team had to begin working on keeping their campaign
promises. Except for the pledge to reduce the deficit, no promise
sticks out more than the one to bring down the high cost of health
care (nearly $90 billion last year). Then there's the pledge to
improve education and the one to create jobs. You can make the case,
as the consulting firm Arthur D. Little did in a recent study, that
with improved telecommunications and information processing you can
improve access to health care, improve quality of care and save $40
billion a year right off the top. Big bucks are going to be spent on a
fiber optic infrastructure to solve the health, education and
employment problems. The bad news for the cable industry is that the
RBOCs are going to make the case they're in the best position to do
this with fiber optics to the home, and, by the way, if the government
lets them into cable TV, it will require less government resources to
achieve this goal. The good news for the cable industry, on the other
hand, is that the bulk of newly available funds for an improved
infrastructure will be administered at the community level by the same
government jurisdictions (city, county, etc.) that issue cable
franchises.

The cable industry is going to have to get on the "save the nation
with a new fiber optic/telecommunications infrastructure" band wagon
and stake out its piece of the action. Why? Because government actions
can totally change a market. For example, after World War II, Vice
President Gore's father, former Senator Albert Gore, Sr., sponsored
the National Highway Act. When enacted, the bill did more than
anything else to destroy the railroad monopoly in movement of goods
and passengers. It literally crippled the railroad industry. Trucks,
buses and cars could move as swiftly as trains at a lower cost and it
was good for the country. Vice President Gore is the champion of the
National Research and Education Network (NREN). This network will have
a dramatic effect on the Information Age and our nation's
telecommunications network as we know them today. (See TeleStrategies
Insight, June 1992). Note that almost every RBOC is involved in an
NREN gigabit networking project, and to my knowledge, not one cable
MSO is.

Step three in summary: the cable industry should call its favorite IXC
and its local government and start working on an approach to solve
problems in health care, distance learning, education and
work-at-home. Field trials and demonstrations of cable technologies to
provide telemedicine to the home would be a good start. In short,
cable people, put on a helmet and get into the game. If not, the cable
industry under Vice President Gore could witness the creation of an
infrastructure plan that takes the wind out of their sails -- just
like Senator Gore, Sr. did to the railroads 45 years ago.
Additionally, step four would be to follow up the hype with two-way
multimedia service to the home when the technology is ready.

THE CABLE VISION

The cable industry has to broaden its definition of its business. The
old definition was "we are an information service company providing
entertainment video. Our customers are residential users and the
community governments who gave us the franchise." The new definition
proposed here is that cable should be full service providers (voice,
data and video) with its customers consisting of residential users,
local governments and interexchange carriers.

Copyright CC 1993 TeleStrategies Inc.
No part of this publication may be reproduced or re-transmitted in any form
without written permission of the publisher.
TeleStrategies Inc.
1355 Beverly Road, Ste. 110
McLean, VA 22101

                  ____________________________


If you have comments about this article, please contact Lynn Stern,
editor of TeleStrategies Insight, by email ([e-mail]) or by
telephone at 703- 734-7050.

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