Rescuing the CLECs

Why is it that CLECs have experienced this recent misfortune?

The over-arching reason for this decline is that, from the beginning, the CLECs have created themselves to be mini-ILECs. Nearly every CLEC has built circuit-switched networks that provide no technical cost advantage over the incumbents' networks. CLECs generally lease the "last mile" connection from the ILECs and install switching equipment inside the ILECs' central offices to carry the traffic. From a technology standpoint, there is little to no difference whether a call is carried over the ILECs' vs. the CLECs' networks, so the cost advantages of a CLEC's network are not obvious. The cost of building these networks is immense. From 1997 to 1999, the top 10 independent CLECs spent on average $1 billion on CapEx, half of which was spent in1999 alone. In addition, the CLECs do not have the vast economies of scale that the ILECs possess, and few would argue with the premise that telecom is scale-intensive business. A CLEC's cost position is further eroded by the need to promote its services. Without an established brandname or clear technical advantages, CLECs must spend much more than the ILECs on sales and marketing. Customer acquisition costs for CLECs on average have been $390 per net line added, more than twice the $185 spent by ILECs per net line added.

(It should be noted that the CLECs cannot be terribly faulted for this network strategy. Two years ago, any other technology but circuit switching was not sufficiently reliable. Packetized voice technologies are just beginning to reach quality of service levels of POTS service, and gaining the trust of the customers that packets are reliable enough for voice will delay adoption even further.)

As a result of their attempts to create mini-ILECs, CLECs are left without a lead product with which to convert new customers. Their product offerings actually are not as robust as their incumbent competitors'. The CLECs cannot expect to take significant market share from the incumbents until they can offer a superior lead product that generates a compelling reason for customers to switch over to them.

However the issues surrounding interfacing with the ILECs is only part of the problem. CLECs have had to face the stark reality that LOCAL SERVICE IS REALLY DIFFICULT TO PROVISION. Compared to local, long distance is a breeze. Most CLECs have experienced a rude awakening when they realized this fact. In an attempt to engender an entrepreneurial spirit within these start-ups, the CLECs (understandably) have shied away from hiring former Bell employees in favor of younger netizens. The problem with this approach is that few of these netizens have the experience with and knowledge of complicated local services. As a result, the CLECs find themselves in a difficult Catch 22.

So what can the CLECs do to save themselves?

1. Revisit the basic economics of the business model
Most CLEC business plans were created 3-5 years ago, during a much more favorable lending climate. Market conditions have since reversed however and the easy financing, still attainable even a year ago, is no longer available. This has increased the difficulty in obtaining financing for CLECs and increased the cost of capital. As a consequence, many CLECs have found themselves ms with half-executed business plans and no financing, or prospects of obtaining it. Additional financing needed to fully execute business plans, if available, carries a substantial price tag that not many CLECs can afford. The first step to resolving this dilemma is to reevaluate the basic economics of a CLEC's business plan in face of the changed market conditions. Each CLEC has to validate that at the customer level its mix of products can provide sufficient revenue to cover its variable costs and to defray its fixed costs. This is a "back to basics" approach, with realistic assumptions, that will determine whether the business model is still worth backing.

2. Understand the customer base better
Thus far, in an effort to meet aggressive growth targets, CLECs have taken an opportunistic approach to acquiring customers rather than systematically segmenting the potential customer base. Segmentation Analysis has to be performed to understand the profiles of the various customer sets in terms of size (number of employees/lines), industry (SIC code), telecom intensity, etc. Service offerings and marketing efforts can then be matched to the needs of each segment, or groups of segments.

3. Aggressively implement new technologies
CLECs can utilize new technologies to provide them with a cost advantage over their incumbent competitors. Fixed wireless technologies have been only moderately successful because they bypass (in other words, duplicate) the existing local network. On the other hand, packet technologies, such as VDSL and Voice over DSL/IP, stand to provide more success because they leverage the existing network rather than compete with it. Voice over DSL/IP provides a cost savings for small and medium size enterprises by eliminating the need for a T-1 to offer multiple lines.

New technologies also are necessary to provide CLECs with attractive lead products that give customers a compelling reason to switch their services. VDSL presents the opportunity to offer new and enhanced services such as video conferencing and interactive TV over a single line. ILECs have been slow to adopt these new technologies due to a lack of focus and a general resistance to new services that cannibalize their existing services.

4. Sacrifice some of their entrepreneurial spirit for a little professional expertise.
A dot.com atmosphere is desirable, but not at the expense of missed install dates and incorrect bills; not to mention a depressed stock price. The CLECs need to tap into the ILEC resource pool and pluck out the few good people who could excel in a start-up environment. At the same time the CLECs need to improve training and systematize processes. Many customer orders are escalated through the process in order to be installed on time because a particular customer or sales person has screamed the loudest. While it is admirable that resources are summoned to push the order through, the result is two-fold:

• While the service date is met on that one particular order, the needs of several other (often equally important) customers are not met,
• Eventually nearly all orders are escalated and pushed through the process, leading to a complete break-down in processes.
• The goal suggested here is not to eliminate individual drive and entrepreneurial spirit, but rather to provide more structure around it.

The next year will be a pivotal time for the industry as the various CLECs attempt to raise additional required capital. These proscriptive recommendations begin to attack the unenviable position in which the CLECs find themselves - trying to reach sufficient scale with a differentiable product so that they can begin waging a formidable battle against the ILECs' dominance.