Oh, Margin, Where Art Thou?

Faced with pressure to boost margins and generate profits, Global Crossing Ltd. and Qwest Communications International Inc. have begun raising the rates they charge long-distance phone companies to ride their networks.

The actions reverse a trend of spiraling price declines in the wholesale voice market, which had allowed big carriers like Global Crossing and Qwest to load their giant networks at the expense of margins.

Global Crossing and Qwest have developed wholesale programs tailored for long-distance phone companies without their own switching equipment and have been known for offering these resellers some of the lowest wholesale voice rates in the industry.

The carriers have struggled to improve their financial position. Neither company is profitable, but the wholesale rate increases are clearly part of a strategy to help them get there.

In October 2004, Global Crossing announced a large business restructuring plan geared to woo worldwide enterprise customers and de-emphasize lower-margin legacy services. The company said in an SEC filing that it expected revenue to decrease between $40 million to $60 million in the fourth quarter of 2004 and fall further in the first quarter of 2005. Global Crossing forecasts the reductions would primarily result from declines in carrier voice services.

The carrier anticipated the legacy North American voice business would be the most significant business impacted by its restructuring initiatives. “We anticipate that the restructuring actions will result in significant reductions in revenue from this business area, while continuing with a core, higher-margin revenue base sufficient to maintain network efficiencies,” the company said in a November SEC filing.

Donna Stina, director of global voice product management with Global Crossing, says the company evaluated all its product sets and customers to align prices with profits. “We have done a number of things that just align with company profitability,” she says. “We implemented increases based on whether we thought the margin targets didn’t meet the company’s goals.”

Stina says Global Crossing completed the majority of changes by the end of the year. Wholesale customers, she says, viewed the changes as a positive sign that the company was positioning itself to be viable over the long term. Global Crossing emerged from one of the largest bankruptcies in late 2003, two years after collapsing under $12.4 billion in debt, but the company is still losing money: It has posted a combined loss of $324 million through the first nine months of 2004.

“They want to see our longevity,” Stina says of Global Crossing’s wholesale customers. ‘They feel we’re doing the right things to maintain our business strategy and be careful with the long-term viability [of] the company.”

Improving the bottom line also has been a driver behind Qwest’s decision to raise wholesale voice rates. The Denver-based regional phone company indicated that rate increases were looming even before resellers were notified in December. In a thirdquarter earnings announcement, Qwest revealed that growth in the use of long-haul minutes had driven “higher variable facilities costs.”

“We are … experiencing growth in longdistance revenues from our wholesale customers. This revenue has related costs that are highly variable,” the company stated in a November filing with the SEC. “We are currently evaluating the pricing and terms of certain of these customer relationships as well as the manner in which the services are provided, in order to minimize future cost and improve operating results.”

Roland Thornton, the new executive vice president of wholesale markets with Qwest, says the company made a discovery through a thorough examination of its long-distance business. “We found in a lot of cases we were losing money,” Thornton says. “We were under market, considerably under market.”

He says Qwest decided to determine pricing on a LATA-by-LATA basis for switched and dedicated long-distance. The objective is to arrive at market-based pricing. “That’s what our goal is, that’s where we think we’re headed,” Thornton says. “We’re making some minor adjustments along the way. We should be more profitable at the end. Clearly, we can’t sell at a loss.”

RESELLERS DISMAYED

Some resellers say the rate increases at Global Crossing are manageable, but they expressed dismay at the Qwest price hikes. Qwest notified at least some of them about the changes in rates in December through an e-mail, explaining the rates would be adjusted in one month.

A Qwest spokesperson said some rates were adjusted downward while others rose.

But what alarmed some resellers was the extent of the increases. Sources tell PHONE+ Qwest has raised its wholesale voice rates by up to 40 percent for some switchless resellers. Other increases were significantly lower or higher on particular routes depending on various circumstances, according to sources.

Long-distance phone companies say some of the rate hikes are excessive in a resale industry that has traditionally undercut larger competitors on price.

Tom Jacobs, chairman and CEO of OPEX Communications Inc., a Global Crossing and Qwest reseller for several years, says the company was prepared for the rate hike at Global Crossing. “It really hasn’t hurt us at all,” he adds. However, Jacobs says the 41 percent rate hike Qwest planned to impose came as a surprise. “I called them and said, ‘You’ve got to be kidding me,'” says Jacobs.

“The least-cost provider has been the name of the game since aggregation began,” he says. “That’s why we’re in this business - to give you a better rate and obviously quicker service.”

Cliff Rees, president and COO of Qwest reseller Global Touch Telecom, says the rate increases varied by service and whether they involved a territory served by a regional Bell like Qwest and Verizon Communications Inc. Most of the rates for Bell origination and termination increased between 5 percent and 15 percent, Rees says, but he adds the rates for non-Bell areas increased by as much as 500 percent to terminate and originate calls.

“Our recourse is to behave in a rational manner,” Rees says. “We have many other choices for origination and termination, and we will continue to least-cost route as we have in the past.”

He adds Global Touch Telecom has a ‘very good relationship’ with Qwest, and expects it to continue.

One Qwest reseller who spoke on condition of anonymity says Qwest had not increased rates in three years - until now.

“They basically threw all existing rates and business cases … out the window. Our margins go from 38 percent to zero,” this person says. “I told them if it’s going to stand like this, we’re walking.”

Another Global Crossing and Qwest reseller who requested anonymity says Global Crossing implemented about a 5 percent rate increase over the fall. He says Qwest raised rates across the board and did not take into account specially negotiated rates on certain routes. “I may as well just walk up and take a book off the shelf and say I want the Qwest plan,” this person says. “There is less opportunity for customization.”

Ernie Kelly, senior advisor to The KDW Group, says he is aware of at least one-to-two dozen resellers facing increases at Qwest. It was his understanding the rate increases affected smaller resellers, although one reseller says he was told the “increases are agnostic to the companies and their size.” Kelly says he was hearing about pending rate increases of 30 percent to 35 percent. He says a reseller can’t sustain such increases. “You’re not going to survive passing on that kind of increase. You’ve got to find another home,” says Kelly, a former president of ASCENT, the Washington, D.C. group that has supported long-distance resellers and merged with CompTel in 2003.

ARE INCREASES HEALTHY?

Tom Coughlin, chairman of Alliance Group Services Inc., a switchless reseller, says the price increases at Global Crossing and Qwest are healthy for the industry, particularly if other carriers stop engaging in cutthroat pricing. The end game for big carriers now, he says, is margin, not volume.

“I don’t think it’s a bad thing as long as we get the whole industry to do it and quit beating everybody up,” Coughlin says of the rate hikes. “The public has gone from a 25- cent minute to about a 3- or 4-cent minute. The public has to see it’s as low as it can go, and the companies that got it down there all went bankrupt.”

Still, the wholesale rate increases may cause resellers to jump to other network providers; some resellers told PHONE+ they were hunting for alternative suppliers; Sprint Corp. and WilTel Communications LLC were among the names mentioned; both companies declined to comment for this story.

Will Qwest see an exodus of resellers? That remains to be seen, but Thornton would not be surprised to learn some resellers are looking. “I think they’ll shop,” he says.

Thornton just hopes they’ll still come back to Qwest when they’re finished bargain hunting. “It’s our desire to create margin for us and to leave enough margin for the reseller to perform profitability as well,” he says.