Global cunning: how carriers are profiting from regulatory loopholes—and laziness – Cover story
Grahame Lynch
By many measures, the international voice sector is a dying animal. What was formerly a brilliant source of oligopoly rents has now ostensibly become a shrinking sector, cannibalized by the Bells’ long distance entry on one side, and bypass mechanisms such as voice-over-broadband on the other.
According to the Federal Communications Commission, international call revenues recognized by facilities-based operators fell in value from $14.2 billion in 2000 to just $10.8 billion in 2001–a fall of 24% in the last year for which data is available. This was despite an 11% rise in volumes, equating to an extra 3.2 billion minutes. Resellers fared even worse with their revenues falling $2 billion to $5.4 billion–a 37% fall.
The trend continued in 2002, according to analyst firm Telegeography. “International long distance across the world is no longer a growth market,” says Stephan Beckert, chief analyst with the firm. “According to our latest research, total industry revenues declined for the first time on record to approximately $61 billion.”
Much of this decline has been driven by the worldwide outbreak of international voice competition. When India deregulated its IDD sector last year, prices fell by 50%.
But despite these challenges, pure-play long distance companies are confident that conditions are stabilizing or even improving.
Primus Telecommunications, which with operations in 11 countries is the fifth largest independent international direct dial (IDD) carrier in the world, says price erosion is flattening.
“Our price per minute fell just two percent over the past year, but our cost per minute fell six percent,” says Primus chief financial officer Neil Hazard. This is an important development in a sector where margins are typically only 10-15% after cost of revenue and business operating costs are deducted.
Much of this margin improvement pertains to reductions in termination charges, driven by market and regulatory forces.
The FCC says that despite 11% volume growth in 2001, the net settlement rates paid by US operators to their foreign counterparts fell by 10% to US$3.5 billion.
“Declines in IDD revenues are slightly less alarming than they seem,” argues Telegeography’s Beckert. “Total revenues began declining about five years ago. However, settlement outpayments fell at roughly the same rate as prices, so net revenues actually remained relatively stable.”
That state of affairs looks likely to continue indefinitely, aided by a laissez-faire regulatory environment that has rubber stamped price hikes, while continuing to pressure other countries to reduce termination rates and turning a blind eye to some questionable termination methods.
Price hikes
One key reason that long-distance margins are holding up so well is that carriers are raising rates.
Despite fears that a newly lean-and-mean MCI would embark on a price war, the reverse seems to be the case, with the firm hiking prices on some 20 different calling plans by some 10% last January, as well as implementing a $1 surcharge on some plans. Sprint followed up with a similar 10% hike on seven of its popular international calling plans in March. AT&T followed suit, hiking its international tariffs by 8% the same month.
Some of the increases are less transparent. Most long distance providers now charge extra wireless termination fees for calls to international mobiles, purportedly reflecting the higher differential that many countries charge for wireless termination compared to fixed termination.
But close examination of these charges shows that US carriers are adding in their own generous margins. Sprint, for example, increased its wireless termination charge to the Philippines from 4c to 7c a minute in March. But although Philippines’ termination charges have increased, Sprint’s 3c hike is disproportionate. What’s more, the FCC has placed a stop order on carrier payments to the Philippines while it negotiates lower termination, raising the prospect that Sprint may grab an even larger portion of the charge as profit.
Furthermore, Sprint and other carriers have increased wireless termination charges worldwide, even though many countries–particularly in Europe–have instituted pricing regulation designed to dramatically reduce wireless termination rates. Over the past six months, AT&T has extended wireless termination charges to 23 new countries, despite the fact that just one–China–appears to have increased its charges in the same period.
Extra wireless termination charges provide a lucrative new revenue stream for long distance operators. Already some 21% of outgoing international calls terminate on mobile phones, and the percentage is likely to increase as mobile teledensity supplants fixed teledensity rates across Europe, Asia and the rest of the world.
FCC keeps up the pressure
While long distance operators are passing on allegedly increasing wireless termination charges to their customers, the FCC is gearing up for a new assault on international termination prices some five years after it helped push a mass reduction of rates by some 50% or more.
Back in 1998, the FCC instituted a benchmarking system that essentially made it illegal for US carriers to pay termination rates of more than 15c-22c per minute, with the highest rates going to the countries with the lowest income levels. The policy was not without its international critics who resented the FCC naming their prices.
“Anecdotally, the FCC’s policy on browbeating seems to have had an impact on termination rates”, says Telegeography’s Beckert. “However, it’s difficult to say how much of the drop was due to the FCC’s initatives and how much was due to the impact of competition from settlement rate bypass and VoIP”.
Five years on, the FCC acknowledges the need for a new approach. The original benchmarking system was not without its methodological inconsistencies–not least in the fact that poorer countries often enjoy lower, not higher, network costs. And the 15c-22c rates were still well above a real cost-based price–which typically is more in the order of 2-5c.
Of late, the FCC benchmarking system has been used to actually justify foreign rate increases. China was first cab off the rank, hiking its termination rates by a massive 750% from 2c to 17c last year–a number just under China’s nominated FCC benchmark. In this instance the FCC didn’t need to object, as Hong Kong operators and legislators got in first, successfully watering down a price hike that would cost them eight times more to phone their own country!
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The real test case is the Philippines, which in February hiked rates from 8-12c to 12-16c, explicitly using the FCC benchmark as a justification for the rise. However, the Philippines’ carriers made the mistake of colluding on the price increase and then blocking calls from operators who held out on the new rates, such as AT&T and MCI. This opened the way for the FCC to lay a charge of “whipsawing” on the Philippines’ operators and to declare a stop payment order on US carrier payments to the Philippines. The issue is still being debated as we go to press, but it is likely to figure heavily in the mind of FCC policymakers who are currently reviewing the international benchmarking policy. It appears likely they will recommend a reduction in rates to a lower cost-oriented level and back it up with a powerful legal sanction.
Bypass options
Of course, renewed FCC pressure on benchmarks will be welcomed by international voice operators, as it will back up efforts by the World Trade Organization to extend cost-oriented methodologies across the full basket of network termination services. But it is a moot point as to how much long distance operators even subscribe to the official settlement system anymore, especially in the light of the development of bypass options using VoIP or spot-market systems such as those offered by Arbinet and Band-X.
Pioneering VoIP wholesale operator iBasis carried 792 million minutes in the first quarter, charging its carrier customers an average 5.3c per minute for the privilege. iBasis claims AT&T, MCI and Sprint as customers of its service. Rival carrier ITXC carried 884 million minutes, attracting a higher yield of 9.2c per minute, and claims to serve all major operators in the US. ITXC CEO Tom Evslin says that the company is now making progress in selling directly to retail carriers, instead of being a routing option for wholesalers.
Major long distance operators are also using even more unorthodox by-pass options in their efforts to squeeze greater margins. In one extraordinary example, high wireless termination rates are avoided in one Asian country through use of a low-profile wholesaler who routes traffic through a satellite VoIP link connected to a rack of mobile phones. “The phones generate a call directly into the cellular network using a domestic pre-paid SIM card, enabling a 50% saving on the official termination rate,” says the chief manager of the wholesaler, who declines to be identified. “Because we’re using anonymous pre-paid SIM cards, the local operator doesn’t realize that it is terminating an international call.
And here’s the catch–we operate the rack several hundred feet across the border of the neighboring country, so we’re not even technically breaking the law.” The biggest cost? The labor of hiring a local to keep the mobiles loaded with fresh pre-paid SIMs. The payback? The calling card traffic of one of the US’s largest long distance operators.
GRAY MARKET TOLERANCE
With its renewed activism on global termination rates comes new indications that the FCC is prepared to turn an official blind eye to the use of gray market termination by US operators. In a recent order, the FCC said it was abandoning the concept of “international comity”–in other words, recognition of other countries’ laws–when it came to US-operated callback services. Previously, the FCC agreed to help foreign regulators take action when US callback operators were offering services in contravention of their laws. Even then, the FCC was half-hearted about it–it only recognized the claims of 36 countries to callback bans, even though the ITU estimates over 100 countries prohibit it. And in eight years, the FCC only ever took up the complaints of two countries–Saudi Arabia and the Philippines.
In turning a blind eye to potentially illegal acts by US operators overseas, the FCC invokes an interesting argument. The old policy was “inconsistent with and undermining the commission’s goal of promoting global competition. We will therefore no longer devote commission resources to analyzing and investigating allegations that a US carrier is offering uncompleted call signaling in a foreign jurisdiction.” But foreign governments could argue that US tolerance of unlicensed and possibly illegal telecom operations is a little at odds with a successful prosecution of the war on terrorism.
Indeed, it seems that US international operators are benefiting from an extraordinarily benign–indeed, an actively supportive–regulatory regime. And it is perhaps in the light of this that they are acting particularly boldly to increase retail prices. After all, they have confidence that they will likely benefit from further reductions in settlement costs. These in turn will place pressure on bypass VoIP providers such as iBasis to provide even greater benefits. Increasing charges now provides recourse for future discounts, if and when they are required.
Quiet confidence
Indeed, all signs are that the large operators are surprisingly confident about their prospects, and dismissive of the competitive threat posed by VoIP.
A senior executive with a global top ten IDD carrier sees new opportunities for value-added margins. “The greatest opportunity for growth is from prepaid calling cards,” said the executive, who declined to be identified as his employer is in a legally-imposed quiet period. “Differentiated grades of service for this and other market segments will underpin growth in voice margins. For example, mobile carriers are demanding enhancements such as CLI [calling line identifier] and SMS [short message service] over international calls.”
Even VoIP provides margin opportunities, he said. “VoIP can also support integration of applications of interest to some customer sets, providing new revenue opportunities for us.”
NET SETTLEMENT RATES PAID BY
US CARRIERS TO FOREIGN CARRIERS
1997 $5.57b
1998 $4.94b
1999 $4.79b
2000 $4.08b
2001 $3.50b
Note: Table made from bar graph.
RELATED ARTICLE: The broadband threat.
The international voice market potentially faces a new threat–the broadband connection. Cheap or even free VoIP has become one of the killer applications of broadband. VoIP activist Jeff Pulver estimates that 150,000 broadband users are using VoIP and counts 22,000 active users for his own “Free World Dial-Up Project,” a service whose very name portends an ominous future for carriers’ $10.8 billion of international toll revenues.
Pulver describes his project as the Napster of telephony–but with one key difference. “”Unlike Napster, telephone users own their voice, so while telephone companies like Verizon might not like it they can’t stop people from using Free World Dialup,” says Daniel Berninger, who is the CEO of the project.
Interestingly, traditional international toll providers don’t seem to be falling over themselves to combat this new threat. The story of AT&T and VoIP carrier Net2Phone illustrates just how difficult it has been for traditional carriers to come to grips with VoIP.
AT&T boasted 100% market share just three decades ago, but now commands just 34% of the long distance market. Its business long distance sales fell 3% over the past year, despite an 11% volume rise. In its consumer market, overall sales fell 17.8%, despite a move into bundles with local service. Of course, AT&T flirted with VoIP when it invested $1.4 billion into Net2Phone, but its resistance to new business models ensured that deal would never prevail in the long term. “We really never developed a strategic business relationship inside AT&T other than with the people at the top,” lamented Net2Phone CEO Stephen Greenberg in a recent magazine interview.
Ultimately, however, the story of AT&T and Net2Phone could prove to be a cautionary tale. While AT&T records double-digit revenue declines, Net2Phone is expanding into new markets such as India and Korea, while spending a paltry $1.4 million on capital expenditure in the last quarter. Such are the economics of VoIP and softswitches.
–Grahame Lynch
COPYRIGHT 2003 Advanstar Communications, Inc.
COPYRIGHT 2003 Gale Group
