Blog Post

Tough Times Ahead for U.S. Phone Companies?

[qi:074] The second-quarter 2008 financial reports are in –- and the tea leaves aren’t showing a sunny future for phone companies. While their financials today look bearable, economic and demographic trends are acting as gale-force headwinds for the future. Here are some of the major issues they’re facing:

  • A slowing economy means people are choosing wireless phones over landlines, resulting in increased access line losses. That, in turn, is reducing the number of people the phone companies can convince to switch to their higher-speed networks and video services.
  • Cable’s triple-play bundles, which include higher speeds and voice, are starting to resonate with the residential customers, leading to further landline losses.
  • Phone companies’ own higher-speed services are starting to cannibalize their installed base instead of luring customers away from cable companies.

In broadband, cable rules for now

According to Leichtman Research, there were 65.1 million U.S. broadband subscribers at the end of the second quarter of 2008, with cable companies getting a larger share of the total –- 35.3 million subscribers. In comparison, phone companies have 29.7 million subscribers.

The two big cable operators, Comcast and Time Warner Cable, continue to add broadband subscribers at a furious pace, though their growth rate is starting to lose speed. In contrast, phone companies are having trouble adding subscribers, even as they roll out video and faster networks.

Phone companies’ broadband offerings are taking the shine off their DSL services. AT&T, for example, added 46,000 new subscribers (down from 491,000 last quarter) and 170,000 U-verse subscribers. John Hodulik of UBS Research suggests that when taken together, it lost around 124,000 DSL subscribers.

Verizon is experiencing similar issues. It added 187,000 FiOS Internet subscribers, but the total broadband tally came in at just 54,000 net additions for the quarter — a loss of 133,000 DSL lines, using the UBS method.

It shouldn’t come as a surprise. Once you hear about a much higher speed Verizon FiOS connection in your neighborhood, why would you want DSL? Cable companies have used this “more is better” mantra to their advantage, offering up all sorts of geewgaws, like Comcast’s Powerboost.

An AT&T spokesman told the Wall Street Journal that speed is only one component of a broadband service and offered up other arguments such as shared capacity and other technical mumbo jumbo to justify that their DSL connections are better. “We offer the best broadband for the price,” he told the Journal.

I was amused, because when you sell broadband, speed is the most critical component — and all these points made by the phone company guys don’t translate too well in the winner-take-all world of consumer marketing.

The divergence between U.S. cable and telephone companies can be easily explained: Cable companies added phone service and offered triple-play service, stealing voice customers from the phone companies. Phone companies are responding to the triple-play threat by rolling out their own video networks, but it is early days and really slow going. Since voice networks are easy to roll out compared with big video networks, phone companies are finding themselves on the losing end of the equation.

Where did my lines go?

As I’ve said before, the biggest problem for phone companies is that they’re losing voice customers at a rapid clip -– either to cable operators or to wireless. Many believe that uncertainty regarding the economy is making people pick a wireless-only option — a theory supported by robust growth in the wireless additions at Verizon (1.5 million net new subscribers) and AT&T Wireless (1.3 million net new subscribers).

This continuous line loss reduces the pool of potential switchers to video and higher-speed broadband services. You want to know how bad it is? Here’s a quick rundown of second-quarter losses: Qwest saw a 10.2 percent decline in residential lines; AT&T an 8.7 percent drop; Verizon lost 8.5 percent (1.4 percent decline in residential switched access lines), and Embarq lines dropped 7.8 percent. All four percentage losses were higher than in the previous quarter.

What phone companies should do

I think between the bluster and hype, the reality is that phone companies are facing an uncomfortable today and an uncertain tomorrow.

Big phone companies should take a cue from Roseville, Calif.-based Surewest Communications, a smaller player that’s been very aggressive about offering broadband at competitive prices, offering higher speeds and, in general, meeting consumer demands. It reported a 1 percent sequential decline in voice lines for the quarter and a 2 percent jump in broadband subscribers. It’s trying hard to compensate for access line losses with VoIP services. The company said that “over 82 percent of existing data subscribers who signed up for VoIP increased their Internet speeds to enhance the overall experience.”

Maybe it’s time for the big boys to let go of their legacy and fully embrace the future — including offering better broadband, advanced services and new voice at prices that are much lower than cable. At least that way they can start to stem the tide of losses.

35 Responses to “Tough Times Ahead for U.S. Phone Companies?”

  1. John Thacker

    I have to say I was persuaded by the article, then confused by the graph at the end of it. The graph, sans numbers, seems to clearly show phone company net broadband adds beating cable company net broadband adds. Of course, that wouldn’t vitiate the existing argument; even if the phone companies are slightly catching up in broadband, the cable cos could be doing much better at voice than the phone companies at video.

    Cannibalization of DSL by FIOS is not entirely bad for Verizon, either. Their revenue per customer is higher on FIOS, after all.

  2. Excellent article. Cable has been more proactive about building out their networks than the phone companies. I lived is a small town in south Texas and Time Warner beat Verizon into the area by several years. The phone company must get proactive and start moving into areas that aren’t so lucrative. There is something to be said for being first in an area. The only other challenge is to provide top notch product and support. This would help stem the tide in my opinion.

  3. Good points & well researched Om!

    And I fully see that they shall stick to increase bandwidth as you mentioned.

    However, I would like to add, that they shall stop spending money on IP based applications that look like phone systems which they do not now to build anyhow. This generates stranded cost that shall rather be spent on the buildout of their last mile. These are the only assets they really have and they can really handle this turf.

    And to Allens comment, They need to make the transition to fiber networks anyhow if they will become MSOs which is essential for competing with the cable operators, support cloud computing and other things like feeding TV & Video.

  4. Allen makes a good point. I think a lot of the wireless adoption is going to be driven by how much data can get pulled down through that medium. It really is nice to have some kind of physical data line of some sort to ensure regular connectivity through inclement weather, deadspots, etc. That said, I do think a lot of where the big telecos want to be is in the wireless space.

  5. @Nick:

    There is only so much that can be done to improve the data rate that can be squeezed down a given chunk of shared spectrum. Unless you’re arguing that optical fibres (not being made from wire) are “wireless”?

  6. DG Lewis

    “Lines run to fewer homes?” There are about 116.5M households in the US. The top 8 cable companies pass about 106.5M of them. The remaining small operators probably hit another 4M-5M. So even if one assumes that REA and USF succeeded in wiring up every single US household, that puts maybe 5M-6M households that are wired by a telco that aren’t wired by a cableco. And, honestly, those 5M-6M households aren’t exactly high on anyone’s priority lists for FTTH. They’re probably lucky if they can even get DSL.

    Verizon is going to pass 20M houses with FiOS. AT&T is going to pass 30M with U-verse. Together, that’ll give them (by 2012) as many households passed with FTTX as Comcast alone currently passes with HFC.

    You can argue that the wireless bundle opportunity will give the edge to the telcos, but you certainly can’t argue that the telcos have an edge in what’s wired. Especially inasmuch as you’re talking about wired with technology able to support greater than about 2 Mb/s.

  7. I wouldn’t bet on cable operators over the long term. As Rahul mentions, they don’t have wireless services. Also their lines run to fewer homes, and the whole video broadcast model is about to collapse anyway.

    Cable broadband started with 4-5 million subscriber advantage over DSL in the US, and the two have been selling at around an even rate since then. Between high-speed fiber, wireless and IP video, cable will start falling behind soon.

  8. Om,

    ATT and Verizon are well aware of the land-line loss and have been anticipating and planning for it for 5 years now. That is hardly an issue and I don’t beleive its a strong “sticky factor” as you mention.

    If Bundling is the name of the game, then ATT wireless subscribers would eventually want to move to U-verse or ATT DSL and get voice, video and data all on the same bill ? You have completely ignored that cable has no wireless presence at all and Comcast partnerships with Sprint have been questionable in long-term revenue forecast.

    I’d like to know how many of the 170K U-verse consumers switched from comcast who continues to have the most expensive product for long-term triple-play services.


  9. Let go of their legacy? Ha! They’re INCAPABLE of being proactive, period.

    They will embrace the future only after they first try to litigate it out of existence.