Posted: 04/2002

The Good, The Bad and the UNE

Resellers Draw on
UNE-P in Local Service Showdown

By Kim Sunderland

INSTEAD OF LETTING THE Bell operating companies (BOCs) beat them at the local game, numerous competitive carriers are opting to use the unbundled network element platform (UNE-P).

UNE-P increasingly is viewed as the best first step on the road to becoming facilities-based. UNE-P provides new competitors the ability to choose and combine essential network elements, or UNE combinations (a.k.a. the UNE-P), from the incumbents and apply new technologies to these elements to offer services over and above the traditional “plain vanilla” local services the Bells offer.

UNE-P is an attractive alternative to resale and facilities-based deployment strategies because the margins for

UNE-P typically are better. In fact, UNE-P margins are projected to be as much as 30 percent higher than the margins for standard resale, says Dean M. Perrine, an analyst with New Paradigm Resources Group Inc.

So far, fewer than 20 companies have employed the strategy
(see list
below).

Perrine explains, “Although profit margins are enticing, in a market where available funds are virtually nonexistent, it seems unlikely many CLECs will choose a provisioning strategy as legally and economically unstable as UNE-P.”

But all that may change. State and federal regulators appear to support the UNE-P and are helping to make it more accessible to the BOCs’ rivals.

Along these lines, state telecom regulators are evaluating what the incumbent carriers charge for these elements. In New York, for example, the state Public Service Commission in January ordered Verizon Communications Inc. to lower its UNE rates in 10 categories. Verizon had to file a tariff in February that embodied the new rates.

The Public Utility Commission of Ohio (PUCO) also in January clarified prior orders governing UNE-P pricing, holding that rates, terms, and conditions for new UNE-P combinations would be reviewed and evaluated under requirements set by the Telecommunications Act of 1996.

And on the federal level, the Federal Communications Commission (FCC) wants to set national performance rules for the incumbent local exchange carriers (ILECs) in their provisioning of wholesale facilities and services to rival carriers. To create certainty in the marketplace, the FCC wants to provide all carriers with bright-line guidance regarding whether an ILEC has provided interconnection, colocation and access to UNEs in a nondiscriminatory manner. The FCC could have national ILEC performance guidelines in place by mid year.

Last December, the FCC began its first “triennial” review of its UNE policies and a review of the regulatory requirements applicable to ILEC provisioning of high-speed services. The FCC specifically is examining the framework under which the ILECs must make UNEs available to competitive carriers. The FCC wants to ensure its regulatory framework reflects recent technological advances and marketplace developments, while remaining faithful to the Telecom Act’s Section 271, which contains the 14-point competitive checklist.

This item, says FCC Chairman Michael K. Powell, underscores the FCC’s ongoing commitment to promote facilities-based competition. “I believe this commitment should focus, in particular, on both so-called ‘full facilities-based’ competition and competition from newer entrants who supplement their own facilities with network elements leased from the incumbent.”

Powell said he fully supports the use of facilities and individual UNEs as ways to promote local competition while also encouraging deregulation and innovation. Specifically, Powell plans to consider how the Telecom Act’s goals of encouraging broadband deployment and investment in competing facilities should shape unbundling policy.

This UNE review is one of several proceedings the FCC has initiated as part of a broader overview of its competition policies. Such review is needed, the commission says, because of advanced technological developments in the marketplace. Together, these various state and federal actions could be good news for competitors seeking reduced UNE rates.

“Depending on how things iron out in the current round of [federal] UNE proceedings, we could see more confident and well-funded CLECs using UNE-P as a market-entry strategy,” Perrine says.

Randy Browning, a partner in Pricewater-houseCoopers LLC, says the companies “I’m talking to are moving more and more toward a comfort level with operating in the UNE-P space.”

While times are tough in general for telecom players, midsize CLECs with a focus on developing key markets rather than building out huge footprints “are still very well positioned for surviving,” Browning says. “UNE-P is going to be a significant part of that.”

Rough Riding

A pure facilities-based strategy still is not self-sustaining, largely because of capital costs and current capital challenges, executives say. PRG’s Perrine says a carrier provisioning service via UNE-P acts much like a facility-based provider but without the necessary up-front capital.

Several revenue-enhancing factors contribute to the attractiveness of using the UNE-P. As a service-delivery method similar to resale, the UNE-P generally has more attractive rates. It allows a local competitor to purchase the same network elements as a facilities-based carrier, including switching, without making the capital investment of a physical switch.

Another positive aspect of using the UNE-P is a provider can collect additional revenue, including switched access, from long-distance providers and reciprocal compensation from other local providers, namely the incumbents. There is customer retail revenue from the UNE-P such as monthly recurring charges, usage-based charges and end user common line charges.

Usage and features can drive profitability with the UNE-P, because UNE-P gross margins increase as usage increases, and in most states, revenue generated from features is totally marginal, analysts say.

But there are some costs. For these margins to rise, entrants first must buy CLEC billing software capable of capturing all revenue associated with bundled services. Perrine says the software must incorporate ILEC tariff charges to ensure proper discounting against ILEC rates.

“Even if proper back-office software is in place, a CLEC must hire a staff capable of running a complicated billing and provisioning system, another expense versus resale,” Perrine says. “Unlike [resale], the UNE-P Local Service Request (LSR) process must interface with the ILEC’s network systems, rather than simply updating customer records.”

The UNE-P company must be able to manage a Carrier Access Billing system (CABs), as well. CABs represent charges payable by interexchange carriers to CLECs for the access and termination of long-distance calls over the CLEC network. These charges can amount to as much as $5 to $10 of revenue per access line, with little or no associated costs.

“So, managing this revenue is imperative to achieving acceptable profit margins,” Perrine says. Operations support systems (OSS) providers have been addressing billing and integration issues that will help UNE-P CLECs bridge the back-office gap needed to fully realize projected profit margins, Perrine notes.

Silver Bullet?

Despite these gains, Perrine says pressure to provision end-to-end service independent of the ILEC will keep many new market entrants focused on the ultimate goal of total independence. Conventional wisdom on Wall Street holds a financially viable entry strategy is one that shows a provider has clear plans for migrating to its own facilities once critical mass is achieved. Grabbing critical mass is tough for some of these providers, but UNE-P is helping them to do it.

“UNE-P is essential for our business strategy because we’re trying to leap-frog circuit-switched technology,” says Peter Karoczkai, senior vice president of sales and marketing for InfoHighway Communications Corp. “We must be able to provide voice while building out our data network. UNE-P helps us to do that.”

The privately held InfoHighway provides local services (voice, data, Internet) to business customers in New York state. In 2000, the company nailed down a $150 million funding commitment and using it to build out its network and expand service offerings. The company plans to migrate its voice network over to a data network as it becomes financially feasible, using VoDSL and eventually VoIP, Karoczkai says.

InfoHighway leases all the incumbent’s elements needed for voice: the loop, switch and transport. “The UNE-P key versus resale is that by purchasing elements individually and bill data separately, we are beginning migration to the facilities-based mode because I’m already acting like a carrier of record,” he explains.

A similar business strategy exists for nii Communications, based in San Antonio, Texas. “Our team has worked on and deployed different entry strategies,” says Richard E. Burk, president and CEO of nii. “We settled on UNE-P because we felt it was the best use of capital and has the best promise for long-term survivability.”

The privately held nii started business three years ago in Texas when it inked an interconnection agreement with SBC Communications Inc. to provide integrated service to small businesses in medium-sized markets. Burk says business has grown steadily, and UNE-P now is available in Texas with little or no limits (see table below).

“We will invest in facilities,” he adds. “The financial community is placing a premium on top-line revenue and self-sustaining businesses that are profitable. UNE-P is crucial for us to do this.”

Into the Sunset

Some companies are looking at UNE-P as a longer-term strategy. Atlanta-based Access Integrated Networks is a prime example. The five-year-old, privately held company has 700 customers in nine Southeastern states (in small and medium-sized towns) and operates 63,000 lines. Access Integrated doubled in size in 1999 and in 2000, and expects the same for 2001. Access Integrated Networks wouldn’t be where it is without the UNE-P, says Rodney Page, vice president of marketing and strategic development for the company.

“We are looking at the economies of deploying our own technologies once we get a broader customer base and customer density, just like any sane CLEC would do,” says Page, but adds the problem is a lack of customer density. “Our customers are very spread out geographically. To build a new business plan based on buying or building facilities is not feasible due to the sheer dispersion of our customers — not that we wouldn’t want to,” he says.

Joseph Gillan, a consultant with Gillan Associates, a consultancy specializing in the economic evaluation of telecom regulatory policies, says UNE-P is a sound business strategy, so long as the entrant finds a way to differentiate its service from that of the incumbent.

Many people misunderstand the telecommunications business by thinking it is a network business and differentiation comes from installing a different network plant than the incumbent, Gillan says.

“The telecommunications business is first and foremost a service business, not a network business,” he says. “That is, what differentiates providers is pricing, customer support, packaging, billing and marketing.”

Gillan predicts — barring any FCC policy change that might favor one entry approach over another — an entirely new avenue of differentiation will develop. “In today’s network, the place where differentiation can be the most dramatic is if UNE-P providers can combine cost-effective platforms with AIN triggers and remote databases to develop additional services,” Gillan says. “As the switch gets ‘dumber,’ the key isn’t duplicating this architecture, it is using AIN features to create new services.”