MCI's local difficulty

MCI's problems in snapping up lucrative regional operators are setting alarm bells ringing over BT's planned acquisition. By Ian Griffiths

It was not unusual for the MCI sales representative to receive yet another letter from the local telephone operator explaining why it could not process the order to transfer one of their customers to the new local service MCI had been offering in the area. The letter was not unusual but the explanation was. It read along the lines that the order cannot be processed because your application uses the letters St., not the word street.

Another disappointed customer and another small victory for the local telephone companies in their rearguard action to keep MCI, one of the US's main long distance telephone operators, out of their local monopolies.

It is these problems in cracking open local telephone markets which is at the root of concerns that BT is paying too much to acquire MCI. MCI admitted last month that it is taking longer and costing much more than anticipated to penetrate the lucrative US local calls market. That has prompted calls for BT to renegotiate the terms of a merger which is due to go ahead in the autumn. BT and MCI are locked in a review of the financing and logic underpinning the strategic thrust into the US market. It is a thrust which has its roots in the 1996 Telecommunications Act which was aimed at opening up local telephone markets to greater competition.

MCI is no stranger to breaking up monopolies and creating competition. The company was founded on its determination to crack open the long-distance telephone market and MCI was instrumental, two decades ago, in breaking AT&T's stranglehold on both local and long distance markets. Indeed the break-up of the Bell System which saw AT&T, Ma Bell, focus on long distance and the Regional Bell Operating Companies, Baby Bells, maintain local services.

The prospect of adding local calls to the package of services it already offered was too great to resist. The local US market is worth $100bn (pounds 69bn) and offers margins of 46 per cent against the 19 per cent available in long distance. "Local is a relatively simple thing to add to a sophisticated service, so for us it was a no-brainer assuming all the systems work," one senior MCI executive says. "Nobody ever questioned whether MCI would be successful in the local market. It just seemed natural to people that we would succeed."

So they would have done had the Telecommunications Act delivered what politicians wanted. It has not. The Act has proved not to have the teeth it needed to bring the Baby Bells into line. The spirit of the Act has been flouted by a combination of prevarication and obstruction at a local level while the letter of the Act has been undermined by the courts. A Federal Communications Commission order setting out how the Act should work in practice was deemed unconstitutional in respect of some key aspects, in particular pricing. The consequence is that without any federal support to impose a national framework MCI has been forced to address each local market on a state by state basis. Different rules and different attitudes require a different response in each state.

It has been the weakness of the regulatory process which has proved to be MCI's biggest stumbling block.

"We always knew that the Bell companies would put up a fight," the MCI executive says. "We just did not imagine that they would have any real power."

That power has been something of an embarrassment to politicians on Capitol Hill and to the regulators who believe that the same intense competition which MCI has helped create in the long-distance market now should be replicated in the local market.

Indeed, one theory doing the rounds in the US is that the MCI announcement which has so upset British shareholders was a carefully crafted hint to the Hill that unless MCI got more help from the authorities then it may have to withdraw its help in opening up the local markets. "We are not in the business of pouring money down the drain," says another MCI executive.

That is not to say that MCI has misjudged the local market. It remains as attractive as ever. The opportunity has not diminished; it has been deferred and that is frustrating. However, BT shareholders are in no mood to tolerate mounting losses and increased investment unless the returns can be more readily identified.

There is certainly no difficulty in identifying the demand for a unified telephone package which puts charges for long distance calls, an Internet service, cellular telephone, pagers and finally local calls all on one bill. When MCI took its local call service to California it secured 25,000 customers in a matter of days. But MCI had to withdraw when the local telephone operator put obstacles in processing customer orders in its way.

The problem in processing orders where MCI relies heavily on the incumbent operator for co-operation has driven the company to focus less on residential customers and more on business users where the company can justify installing its own facilities.

However, facilities means extensive capital investment, which explains why the local markets are costing more than MCI anticipated.

That is not displeasing. MCI has a strong business franchise and its customers are happy to sub-contract the telecoms decision to a supplier which has a proven record in servicing its needs both nationally and internationally.

MCI knows that the more services it can deliver to a customer, the cheaper those services become, the more reliant the customer becomes on MCI and the stronger the relationship becomes.

So far, MCI operates in 23 different markets offering business customers a local calls service, and will be in 31 at the end of the year. The one- stop phone service is proving very popular but is putting pressure on the facilities MCI has installed.

The company knows it cannot afford to replicate a national telephone system, which is why it is dependent on the co-operation of the local operators if it is to mount an effective challenge on the residential market.

That co-operation can easily be withdrawn by blaming operational systems support interface which is critical in ensuring the efficient transfer of new customers from the incumbent operator. Too often MCI has found that systems for new customers are manual rather than electronic.

At the same time with no national framework for interconnection charges which dovetails MCI facilities with those of the incumbent, it is extremely easy for the local operator to price the would-be competitor out of the market.

However, when the challenge comes MCI has a tremendous infrastructure already in place. It has a national brand supported by a national sales force which is ready and waiting to spring into action. It also has an impressive portfolio of sophisticated service it can offer alongside local calls. "Objectively, we have a terrific machine we are just waiting to turn on," says an MCI insider.

But it will not be turned on until MCI gets more support from politicians and regulators. But already, there are signs that the tide is beginning to turn MCI's way.

A speech from MCI chief, Tim Price, setting out the company's competition philosophy was well received. Called The Fair Play test, it set out five principles which should guide competition in local markets.

On almost every principle MCI can point to examples where state and national regulators and legislators have supported the Fair Play Test in the last few weeks.

"We have been meeting with federal and state regulators and believe there is a recognition among regulators in general of the importance of getting local markets open. We have been encouraged by the recent action which demonstrate regulatory resolve but I have to emphasise there is still a good deal more to be done," says one of MCI's legal specialists.

How much more will be a key element in BT's decision on whether or not to proceed with the MCI deal and, if so, at what price.