NCTIA 2005 Annual Convention Taking Charge of your Telco's Future...

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NCTIA 2005 Annual Convention

Taking Charge of your Telco’s Future…

Manny Staurulakis

John Staurulakis, Inc.

August 23, 2005

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A Need for Change

It is almost certain that traditional regulated revenue streams will be diminished over time due to regulatory changes, competition, and technology. Regardless, incumbent communications providers can remain viable and successful. In order to do so, ILECs need to diversify their revenue streams, control their expenses, and become market focused.

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Market Focused

Market focused means:

• learning what your customers want

• creating services to meet customer expectations

• putting together attractive plans to meet their needs

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Commitment

With a dedicated plan, it is possible to significantly shift revenues from highly regulated based sources to more competitive/ commodity based sources.

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Regulatory Issues

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State Regulation Trends

• A number of states are providing ILECs with the opportunity to seek alternative forms of regulation or deregulation

• Impact on rural exemption

• Impact on future universal service funding

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The U.S. Supreme Court ruled in the so-called “Brand X” case that the FCC acted properly in declaring cable modem offerings as “information services” not subject to common carrier regulation under Title II of the Communications Act. The FCC provided similar relief to facilities-based wireline broadband Internet access service providers on August 5, 2005.

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ICC FNPRM - Notable Quotes

• “The record confirms the need to replace the existing patchwork of ICC rules with a unified approach”

• “With respect to rate-of-return LECs in particular, we recognize that an approach that retains some ICC payments from IXCs for switched access services may be appropriate”

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Intercarrier Compensation

• FCC released a FNPRM in the Matter of Developing a Unified Intercarrier Compensation regime on March 3, 2005

• Comments were filed May 23rd

• Reply comments filed July 20th

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COBAK Impact/LinePer NTCA Ex Parte

Impact Per Access Line Per Month Interstate State Total

Common Line Elimination - $ (4.93) $ (4.93) $

Local Switching Elimination (3.48) $ (4.90) $ (8.38) $

Originating Local Transport Elimination (1.34) $ (1.50) $ (2.84) $

Elimination of Net Settlement (1.54) $ (0.39) $ (2.28) $

Payment for Transiting Orig. Transport (0.64) $ (0.55) $ (1.18) $

Optional Calling Plan CCL, LS & Orig Trans. Elim. (0.41) $ (0.41) $

Optional Calling Plan Paymnt for CCL, LS Elim. 0.01 $ 0.01

$

Optional Calling Plan Orig. Transit Payment Inc. - $ -

$

Estimated special access reduction (2.49) $ (2.49) $

Total (including special access) (9.50) $ (12.67) $ (22.16) $

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JSI Peer Group Data - 2003

• 148 client company LECs included in database

• LECs from 31 states included in database

• Largest LEC in database – over 100,000 A.L.

• Smallest LEC in database – approx. 200 A.L.

• 1,476,000 total access lines

• $1.5 billion in regulated revenue - 2003

• 5.3 billion state & interstate access MOU

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Summary of Plan Impacts – Per A.L.

Impact per access line, per month

ICF NARUC FACTS FNPRM

Reduction in switched access rev.

$22.20 $21.17 $15.28 $21.42

Increase in SLC Caps $2.85 0 0 0

Additional HCLS due to cap removal

$1.50 0 $1.50 0

Shift to a bulk access charge or additional USF

$17.85 $21.17 $13.78 $21.42

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Plan Impacts on JSI Peer GroupRevenue Percentages - 2003

Revenue Type ICF NARUC FACTS Original

Local Service Revenue 30.7% 30.7% 30.7% 30.7%

EUCL Revenue (SLCs) 11.4 8.2 8.2 8.2

Network Access Revenue 5.5 6.6 13.4 30.9

Universal Service Revenue

&/Or Bulk Access Charge

44.1 46.2 39.4 21.9

Other Revenues 8.3 8.3 8.3 8.3

Total Regulated Revenues

100.0%

100.0%

100.0%

100.0%

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Summary of Plan Impacts – SLC Caps

• Increase in SLC Caps

– ICF

– NARUC (optional for non-rural LECs only)

– EPG (optional)

• Decrease or no change in SLC Caps

– ARIC (possible decrease in SLC charges)

– Home/ PBT

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Plan Impacts – MOU Charges

• Retention of MOU charges

– ICF retains terminating MOU charge for CRTCs

– ARIC retains orig. & term. MOU charges

– EPG retains orig. & term. MOU charges for common trunks

– NARUC – retains terminating MOU charge

• Elimination of MOU charges

– ICF – non rural LECs

– Home/ PBT eliminates orig. & term. charges for all LECs

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Plan Impacts – USF

• Increase in federal and/or state USF

– ARIC (via creation of SEF)

– NARUC (via creation of RACTF)

– EPG (via creation of ARC)

– ICF (via creation of TNRM for rural carriers)

• Restructure of federal and/or state USF mechanisms

– Home/PBT (bulk access charge mechanism)

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Take it to the Bank

• Increased Accountability and Scrutiny for Universal Service Support

– Need for ILECs to prepare

• Continued FCC examination on scope of program

• Increased state examination of purpose and need of universal service

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Federal-State Joint Board On Universal Service - Proposals

• Several proposals released on August 17, 2005 relating to high-cost support

• Proposals & recommendations being made by individual JB members & staff

• Comments due September 16, 2005

• Reply comments due October 3, 2005

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Four Recommendations/Proposals

1. The State Allocation Mechanism (SAM)– Ray Baum

2. Three Stage Package for Universal Service Reform – Billy Jack Gregg

3. A Holistically Integrated Package – Robert Nelson

4. Universal Service Endpoint Reform Plan (USERP) - Joel Shifman, Peter Bluhm & Jeff Pursley

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State Allocation Mechanism (SAM)

• Plan would begin in June 2009 (4 year transition)

• FCC to allocate high cost USF & lifeline/linkup funds to accounts for each State maintained by USAC

• Each State would determine distribution of funds to ETCs

• USAC to remain as fund administrator

• States would be allowed to support additional universal service efforts via increments to federal funding mechanism

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SAM – Cont’d

Allocation of federal USF to States determined via:

• Forward-looking or embedded cost models

• A rate affordability benchmark

• The intercarrier compensation reform plan adopted by the FCC

• Number of consumers in the State eligible for Lifeline and Linkup support

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Three Stage Package

Stage 1 – five parts (short term plan: 3 – 5 years)

1. Combine Study Areas within a state

2. Large rural carriers (>100,000 lines) would have support determined via FCC’s High Cost Model but not subject to state averaging of costs

3. For rural LECs, per line support frozen upon competitive entry

4. Support based on each ETC’s own costs

5. Rate comparability review extended to rural carriers

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Three Stage Package – Cont’d

Stage 2 – Mid-Term Plan

1. Support to be based on total costs of rural carriers

2. Federal support based on a comparison of embedded costs of rural carriers to available revenues

3. Amount of federal support received would be based on a percentage of excess costs (not 100%)

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Three Stage Package – Cont’d

Stage 3 – Long-Term Plan

1. Unified system of support to high-cost areas to be developed. Differences in carrier status, technologies, etc., would be eliminated

2. Federal support would be allocated to states in the form of block grants

3. Amount of block grants would be adjusted annually for changes in the GDP-CPI index

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Holistically Integrated Package

Reflects portions of other proposals submitted:

1. Allocation of federal USF to states via block grants

2. Eliminates rural vs. non-rural carrier distinction: all carriers serving rural areas eligible for support

3. Combination of study areas within a state

4. Existing support mechanisms to be combined

5. Change in contribution methodology through use of connections, bandwidth or numbers

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USERP

Addresses changes in support to ILECs and CETCs

1. States commissions would determine allocations to wireline ILECs within the state

2. Costs used to determine amounts of funding and allocation to states would be based on embedded or “accounting” costs

3. Costs would be non-jurisdictional

4. Existing state averaging policy would be adopted

5. Affordability index equal to 125% of the national average urban cost would be established

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USERP – Cont’d

Wireless CETCs

1. Support no longer based on support received by incumbent ILEC ( except for wireline CETCs)

2. Creation of a separate “Portability Fund” available only to wireless carriers and capped at $1 billion/year

3. Portability Fund to last 5 years and then sunset

4. State commissions would allocated funds to wireless carriers using a competitive grant method

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Regulatory Conclusions

• Monitor Federal Activity

• Be Proactive

– Vocalize Positions

– Work with Associations

• Strategically Plan for the Future

– Take full advantage of existing settlement mechanisms

– Firm up Cap X Plans

– Have Flexible Long Range Plans

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Technology Trends

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Where Are We Headed?

• All Communications is moving towards IP –

Voice and Video migrating toward data structure

– Once all services are on the same platform, new applications can link all the media

– The network will evolve and become a platform to support applications developed by multiple sources

• Similar to a PC with several different software applications

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IP Impact on Technology

• IP provides a stable well know protocol which is inexpensive with proven performance

• IP is an enabler for packet technologies and is embedded in electronic equipment

– Outside Plant technologies

– Switching

– Transport

– Video

• Keep in mind that IP is a technology that can be implemented just like any other technology in the network without impacting settlements

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IP Technology

• Telecommunications architecture is migrating to the IP model.

– Intelligence continues to become distributed

– Circuit Switching migrating to Packet Switching

– SONET structure moving Ethernet structure

– Software control becoming available to end users via standard data interfaces

• LECs must analyze both the technology and their market to offer as many services as possible while keeping it affordable based on revenues generated.

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Broadband

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Broadband is thefirst step to the future of

communications/entertainment

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The New Basic Service

Broadband service tomorrow will be the equivalent of local service today. It should be considered our basic service which will provide our subscribers access to feature rich advanced services.

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Broadband Today

• Rural markets are often underserved

– Coverage is excellent

– Prevailing retail rates are too high

– Margins are perceived as being anemic

• JSI believes

– Broadband margins improve dramatically with increased penetration

– Rural Broadband penetration equal to Urban penetration is realistic and achievable

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Broadband Growth

It is projected that the US home broadband audience will double from approximately 55 million in 2004 to approximately 108 million by 2009

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Services

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VoIP

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ILEC VoIP

• ILECs need to view VoIP as an evolutionary technology service. In the near term, we need to use VoIP to lower operating costs and be prepared to meet a competitive challenge. In the future, VoIP will be our platform as the technological and regulatory environments change.

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VoIP Technology vs. Service

Technology

• Lower cost equipment

• Packet Voice

• Efficient, shared transport

Service

• Pressure to further lower prices

• Web-based account management

• Advanced calling features

Arbitrage

• Loss of Revenue

• Elimination of access charges and taxes

– Per minute access savings: 1¢ - 5 ¢

– Tax / Surcharge savings: 10% - 20%

• Some carriers don’t assess access charges for VoIP calls

VOIP can be used in three ways:

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Video Services

Business Strategies

Financial Assessment

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Telco Move into Video

It is less of a question of whether or not we should start providing a video signal. It is more of a question of when and how to do it.

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Technological Advancements

• Advances in video technologies are increasing at a rapid pace. Video compression, head-end applications over the Internet, set top boxes, MPEG encoders are all areas seeing positive changes in terms of their application to ILEC’s.

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IPTV

• By capitalizing on technologies such as IP video and xDSL, Internet management, middleware applications, etc., ILEC’s can offer cable TV type services, high-speed Internet access, voice services, and other attractive services over existing copper and fiber facilities

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Options to offer Video

• Purchase existing CATV provider

• Offer Satellite based services as reseller

• Over-build service area with HFC/FTTH

• Leverage existing copper/fiber facilities (IPTV)

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Decision to Overbuild• Technology

• Timing

• Cost

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Copper as Triple Play

• Is Copper Enough?

– DSL data rates are increasing

– Video compression allows more video channels to be delivered on DSL

– Copper loop distance is the big gamble:

• Will Video and Data compression techniques keep pace with bandwidth demand of Gaming applications and HDTV?

• Advantages

– Video over DSL (IPTV) leverages existing investment

– Implementation is faster than a complete overbuild

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HFC

• Video is migrating from Analog to Digital– Digital Programs make up approx. 50% of the

available channels

– As more programs become available in digital format, HFC capacity for video will increase

• Video is migrating to IP– New Providers will implement IP Video

– Traditional CATV has not yet embraced full transfer to IP video

• Internet and VoIP technology is very compatible with HFC RF architecture– Drives new service revenues & margins

– Low cost to add customers

– Can expand bandwidth available for voice/data

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Fiber to the Home

• Can be more economical for very rural areas because ILEC only purchases electronics for customers that buy service.

• Fiber is a very future proof technology

– Not susceptible to water damage

– Capacity is only dependent on electronics

– No electronic interference

• Both LECs with copper plant and CATV companies with HFC plant are evolving their plant to have fiber closer to the home.

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Rural IPTV VoD / PPV Market Opportunity

• VoD/ PPV are needed to augment broadband and video margins

• Rural subscribers do buy VoD/ PPV services — once they’ve tried them

• Expensive front end server costs can be defrayed by pooling resources amongst companies

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Video Market Summary

• There is increasing demand for entertainment services– CATV adding new services with

• Digital Channels

• Video On Demand

• Digital Video Recording

• Gaming

• Bundling with the triple play services is becoming a reality for CATV companies.

• Who will offer the triple play first?

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Entertainment

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Just How BIG is “Gaming”?

• Young people -- those under 30 -- see games as a mainstream entertainment medium just like we think of TV, music or movies

– $8 Billion and growing industry

– Game introductions often gross more than movies!

• 49% of kids own games (i.e. Xbox, PlayStation)

• Kids spend 1 – 2 hours playing per day!

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Online Music / Video Market

• The distribution system for the $35B global recorded music market is shifting to the Internet

• Who owns an iPod or MP3 player?

– 20% of Americans under 30

– 14% of users between 30 and 48

– 15% of Internet users

– 23% of users with broadband at home

– 31% of users with broadband at home AND work

Source: Pew Internet & American Life Project, 2005

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Broadband Entertainment Service Observations

• Aim Higher! Expect More!– Rural markets are untapped

– Profitability is driven by new services (as proven by the cable companies…)

• Business opportunities abound and rural markets are ripe for rolling out broadband enabled entertainment services! – New services provide “ground-floor”

business opportunities

– Create and market bundles to encourage usage of value added services

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Bundling

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Why Bundle Services?

• Subscribers buy bundles

– Value

– Simplicity

• LECs benefit from bundles

– Bundles increase “revenue per subscriber”

– Can be used to protect access lines and reduce churn

Marketing Is A BIG Reason Why BundlesAre So Effective

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Financial Impact

• Customers with bundles of local, LD, data, and wireless generate an expected lifetime revenue of $25,508 versus $10,251 for those without bundles

• The prime reason is that the value of the churn reduction exceeds the bundle discount

• Churn is reduced by two thirds

• Cable companies are proof that bundling works!

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What does our future hold?

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Can We succeed?

Pros

• Advanced networks

• Existing customer base/relationship

• Strong resources

• Rural nature

• Continued regulatory support

Cons

• Not market driven

• Need for additional expertise

• Decision paralysis

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Viability of Local Market

• While change will occur, ILECs are well positioned to be successful in the future

• There will be continued availability of federal and state support for carriers

• Control of the last mile and the broadband connection is key

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Outlook

While there are uncertain times ahead, the ILEC sector is still an attractive market. There continues to be a high interest in this space by investors who see the markets as somewhat protected with good growth potential. While there will be some losers, we believe the bulk of the industry will survive and survive well

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Customers are the Key

• In the end as long as we have a reasonable customer base we will be able to sell a profitable mix of services to them. In saying this, it is important to note that we will need to modify our operating structure as we go. As much as we hate the concept, we need to convert our platform to one of a commodity provider.

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Keys to Success

• Build a superior network, but not at all costs

• Only spend what we have to spend

• We can no longer be the “end all, be all”

• Partner

• The ultimate service platform needs to be based on what the customer wants and what we can afford to provide them

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Any Questions?

Contact Information:

Manny Staurulakis

[email protected]

301-459-7590

www.jsitel.com