Business & Finance: SURVIVING THE CLEC-Tive Market

Posted 08/01/2001

SURVIVING THE CLEC-Tive Market

By Judy Reed Smith and Marilyn Shen

It was not long ago that CLEC players were forging ahead with abundant capital and soaring stocks. Then the market slowed down and investors shifted their rationale for CLEC investments.

Once sold on the vision of networks and "latest" technologies, the less than exuberant investors now expect firms to meet traditional metrics and demonstrate a clear route to profitability.

CLEC players that implemented an illusory "build-it-and- they-will-come" business model found it difficult to survive. The suggested model focused on aggressive network expansion instead of building a customer base and carrying sufficient traffic volume necessary to generate profits.

The downturn in the market halted the industry momentum and left many players in shock.

While the lucky CLECs were forced to scale back on their expansion plans, the unlucky ones were forced to shut down. It is important to reiterate that this industry shakeout is not because there is a lack of demand for CLEC service or because of a weak value proposition. It is because overconfident CLECs followed the technology hype without a sound business plan.

Although this consolidation is a consequence of reduced overall industry growth, it offers some positives for established players. For instance, the reduced competition may result in decreased pricing pressure and customers captured from financially troubled competitors.

In the end, a selective few CLECs will survive and remain strong.

Growing demand for communications services create ample opportunities for CLECs. U.S. communications market revenue was $285 billion in 2000 and revenue is estimated to reach $422 billion by 2005.

Atlantic-ACM (www.atlantic-acm.com), a Boston-based telecommunications market research and consulting firm, projects CLEC revenues to grow at a compound annual growth rate (CAGR) of 27 percent, to reach $62 billion by 2006.

The business customers that are CLECs' target accounted for 43 percent of the $285 billion market. In addition, CLECs are accelerating their growth in the local market.

According to FCC (www.fcc.gov) statistics, CLECs reported a 50 percent increase in the number of local access lines from 1999 to 2000.

Industry signs indicate that demand for CLEC services remain strong, but factors such as scaled back expansion plans, tight capital markets and more bankruptcies will affect the industry's market share gained from RBOCs.

Examples of those that curtailed expansions include XO Communications Inc. (www.xo.com), McLeodUSA Inc. (www.mcleodusa. com) and Adelphia Business Solutions Inc. (www.adelphia.com).

XO cut $2 billion off of its budget and McLeodUSA shaved off $300 million. Adelphia reduced its year-end target of 175 markets to 80 markets.

In addition, the increasing number of troubled CLECs has affected overall industry growth. In the past six months, numerous CLECs, including Teligent Inc. (www.teligent.com), Winstar Communications Inc. (www.winstar.com), ICG Communications (www.icgcomm.com), and e.spire (www.espire.com) have filed for bankruptcy protection.

Still others appear to be headed down that same path. CLEC local service revenues accounted for about 8 percent of the local market in 2000 and grew at a CAGR of 66 percent from 1996 to 2000. During the next six years, this growth rate is expected to contract to 13 percent. By 2006, CLECs will control approximately 12 percent of the local market, according to Atlantic-ACM estimates.

Once vulnerable players are filtered out, the remaining CLECs will dominate the industry and account for most of the growth. Successful CLECs, such as Allegiance Telecom Inc. (www.allegiance.com) McLeodUSA, Time Warner Telecom Inc. (www.timewarner.com) and XO, predict 25 percent to 40 percent revenue growth for 2001.

The companies that survive and flourish will do so by defining a clear path to profitability and developing contingency plans for accessing capital markets. This will require reevaluating their key financial, network, product and customer strategies to reset objectives for the current climate.

Success for these companies also results from sticking with time-tested formulas that work. For example, McLeodUSA chose to build its network through acquisition and alliances, thus maintaining a solid financial position, generating 14 consecutive quarters with positive EBITDA. XO introduced the flat-rate pricing scheme offering 18+ different bundles to its users, thus customizing services to acquire and retain clients. Allegiance Telecom committed significant resources to a sophisticated back-end system for customer care, developing strong, long-term relationships with its service users. Time Warner Telecom leveraged its brand and technology, offering high margin products and stable prices.

Applying Darwin's principal of natural selection, only the fittest companies will survive. At a time when customers and investors are selective, companies need to define realistic objectives and establish key strategies to reach those goals in order to be "CLEC-ted" by the market.

Dr. Judy Reed Smith is CEO of Boston-based consulting and research firm ATLANTIC-ACM, and can be reached at
jrs@atlantic-acm.com
or 617-720-3700 x102.

Marilyn Shen is a CLEC analyst at ATLANTIC-ACM and co-wrote the CLEC report. She can be reached at
marilyn_shen@atlantic-acm.com
or 617-720-3700 x110.