Carrier Channel: Sizing the U.S. Long Distance Market

Posted: 12/1999

Sizing the U.S. Long Distance Market
By Dr. Judy Reed Smith and Wona Park

Source: )1999 Atlantic-ACM, Boston

The U.S. long distance industry is being drastically reshaped by mergers and
acquisitions, legitimization of Internet protocol (IP) telephony, convergence, expansion
of domestic and international wholesale services and by a new tier of data-centric
carriers. Companies targeting growth will leverage the trends reflected in the eighth year
of Boston-based Atlantic-ACM’s research on share shifts in the industry.

With the glut of bandwidth currently available in the U.S. marketplace, many existing
switchless resellers are opting to remain switchless, or be very selective in where and
how they deploy facilities domestically. The lack of owned facilities allows these
carriers to offer a broader range of services than they could build and to focus capital
on marketing. Their challenge is to provide successfully managed end-to-end services to
their customers with a single point of contact, integrated billing, responsive customer
service and differentiating service quality. Many resellers are holding their customers
with good service, but many facing margin pressures are opting to become facilities-based.

As the Internet craze caught the attention of Wall Street and the general public in
1998 and 1999, telecommunications companies adapted network as well as sales and marketing
strategies to capitalize on the shifting industry dynamics. While the industry agreed on
integrated access, or convergence of voice, video and Internet services over one line,
some debate still ensued between asynchronous transfer mode (ATM), IP or a combination of
both transmission technologies. In reality, ATM is likely to provide a base for most IP
networks. In 1998 and 1999, voice over IP (VoIP) became a reality and brought public
market profits as companies such as IDT Corp., Hackensack, N.J.; RSL Communications Ltd.;
Hamilton, Bermuda; iBasis Inc. (formerly VIP Calling), Burlington, Mass.; and ITXC Corp.,
New Brunswick, N.J., rolled out retail and wholesale offerings.

Interexchange Services

The emerging growth centers of the U.S. long distance marketplace include IP and data
services, wholesale, international services and the small-to-medium-sized enterprise
retail segments. The leaders in these new markets include the new data-centric carriers,
the IP service providers and wholesale providers. Carriers with a targeted approach to
customer or service segmentation will succeed in today’s marketplace. Incumbent as well as
competitive long distance and local exchange companies are responding to pressure by
acquiring other companies and bundling local, long distance, data and Internet services
for their customers.

The U.S. long distance market has been growing at a compound annual growth rate (CAGR)
of more than 7 percent from 1984 to 1999, according to research from Atlantic-ACM’s
recently released report, "U.S. Long Distance Services Market: Sizing & Share
Analysis 1999-2002." Although more than 1,200 long distance carriers operate in the
United States, the "Big Three" carriers, or possibly the "Big Two,"
still account for more than 70 percent of the U.S. long distance market (1998).
Facilities-based carriers account for approximately half of these, while switchless
resellers and others, such as payphone or debit card providers, make up the other half.
The market share of the next closest group of carriers, including Qwest Communications
International Inc., Denver; Frontier Corp. (now Global Crossing Ltd.), Rochester, N.Y.;
STAR Telecommunications Inc., Santa Barbara, Calif.; and Teleglobe Inter-national Inc.,
Montreal, drops to 7 percent. However, as the U.S. long distance retail revenue will grow
to almost $100 billion by the year 2002, smaller carriers will account for a large portion
of the growth.

The largest carriers are expected to grow their retail revenues at a rate of 2 percent
per year between 1998 and 2002, while small-to-mid-sized carriers will experience a growth
rate of more than 20 percent through 2002. Thus, the overall interexchange market will
continue to grow, with the largest carriers losing share and the wholesale market
maintaining steady growth.

Several new international resellers have entered the U.S. market to capture the growth
in international calling. More than 300 carriers offer international facilities-based or
resale services to U.S. customers, including groups of wholesale, prepaid card, callback
and dial-around providers. Total international revenue for facilities-based and resale
services exceeded $20 billion in 1997. Domestic carriers wishing to expand into new
markets may be well served to look at the international outbound market for wholesale and
retail services. As prices continue to come down, calling volumes for all types of
customers are growing. Domestic markets in Europe and parts of Asia and Latin America are
not as far down the deregulation curve as the United States and offer more opportunities.

While AT&T retains the largest market share, even with the possibility of the MCI
WorldCom Inc. and Sprint Corp. merger, AT&T’s share of the toll services market is
growing at a slower rate than that of its competitors. The market share of the top three
carriers is growing at a CAGR of approximately 5 percent. The business retail segment will
remain stronger than the residential segment as the top-tier players lose residential
revenue to smaller carriers. In anticipation of this trend, these top carriers have
diversified their revenue sources to limit their dependence on long distance. As the big
two carriers migrate customers toward flat-rate calling plans, most long distance revenue
growth is from frame relay and high-speed private-line products.

The next tier of carriers, including Qwest, Teleglobe Inc. and Frontier, showed more
dynamic growth in the toll market than the top two or three carriers. Qwest’s acquisition
of LCI International Inc. in 1998 created the largest carrier in this group with more than
$2 billion in revenue for 1998. The Canadian carrier, Teleglobe, entered the U.S. market
by acquiring Excel Communications Inc., Dallas, and Frontier was acquired by Global
Crossing, Hamilton, Bermuda. This tier of the market will continue to grow revenue at a
rate of more than 11 percent through the year 2002, with international business services
adding growth at a rate twice that of the total segment. The best of these players have
followed sound strategies of focusing on target markets and diversifying revenue sources
among wholesale, retail, voice and data services.

The next tier of carriers includes dial-around providers, local exchange carriers
(LECs), competitive LECs (CLECs) and other niche providers. This group accumulated more
than $7 billion in toll services. The CAGR for this smaller segment is more than 30
percent. This group of carriers will continue to be successful in winning retail customers
away from the larger carriers. Merger and acquisition (M&A) activity heavily impacted
this group as carriers such as Cable & Wireless Inc., Vienna, Va., acquired MCI
Internet and GTE Corp., Stamford, Conn., agreed to merge with Bell Atlantic Corp., New
York.

Wholesale Market

The wholesale market reached $12.8 billion in 1998 and continues to show double-digit
growth. The pending entry of regional Bell operating companies (RBOCs) into the long
distance market will be a major factor in the growth of future wholesale revenue. The top
six or seven carriers generate almost 60 percent of wholesale revenue, with the largest
shareholder being MCI WorldCom. Growth in international traffic will help several smaller
carriers who almost exclusively target the U.S. outbound market. The wholesale market
remains the most competitive segment in terms of company market share.

Private-Line and Data

Private-line and data services will remain the fastest-growing segment of the long
distance market. Increased use of the Internet, ATM and frame relay services are spurring
growth. The largest carriers in the market are well positioned to take advantage of this
growth with new high-capacity networks being built across the country. Private-line and
data services reached more than $16 billion in 1998, generated largely by the top eight
companies in the market. Increases in retail data revenue from the smaller carriers will
result in larger wholesale data revenue for the larger carriers.

The inherent bottleneck at the last mile as well as the insatiable appetite for speedy
Internet and data access created the spark for convergence between telecom data and cable.
AT&T’s frustration with local resale led to a rethinking of the 1993-1994 idea of
utilizing the cable connection to access the home. Through acquisitions and partnerships
with cable companies, AT&T expects to offer voice, high-speed Internet and cable to
nearly 60 percent of U.S. households.

Conclusions

Convergence between the computer and telecom industries was evident in 1998 and 1999.
By the end of 1998, the traditional distinctions among long distance providers, Internet
service providers (ISPs), cable providers and wireless companies were blurred. The
emergence of CLECs that offer integrated services affected the current long distance
market structure, as will the entrance of the RBOCs. AT&T and MCI WorldCom will
continue to grow market share by acquisitions and by bundling local, long distance and
Internet services. Their residential market share will decrease as they shift their focus
to the business markets, expecting the residential market to be plucked easily by the
RBOCs.

New carriers such as Qwest and Williams Communications, Tulsa, Okla., will lead the
next tier of companies to gain share in the wholesale market.

Atlantic-ACM’s model suggests that even with the threat of RBOC entry, the large long
distance carriers and smaller resellers still will control the market. Small business
retail customers are seen as the most lucrative and sought-after segment for all but the
largest carriers. With growth rates ranging from 7 percent to 30 percent, the market
offers rewards for the established as well as the up-and-coming.

Retail Switched Service Revenue by Segment 1996-2002

Source: )1999 Atlantic-ACM, Boston

Dr. Judy Reed Smith is CEO and Wona Park is the long distance industry analyst for
Atlantic-ACM, a Boston-based strategy consulting firm. They can be reached at [email protected]