ISPs Find No CLEC Gold Mine

Contrary to intuition and simple logic, the number of CLECs is still growing. ISPs beware: industry insiders suggest that many are becoming CLECs without any business justification.

by Max Smetannikov [August 23, 2002]

FCC records say that the number of CLECs registered and operating in the U.S. has grown from 2000 to 2001, from 607 to 725 in spite of the record number of bankruptcies within the telecom industry over the last two years. On the other hand, industry insiders say that in nine out of 10 cases, ISPs have little business trying to secure a CLEC certification.

While the vast majority of these companies are startups, some are ISPs looking for greener pastures. Indeed, old timers in the industry, like Akamai chief architect Avi Freedman who has been through a number of Internet infrastructure start ups, still list a number of reasons why ISPs might want to consider investing time and money, and ponder carefully the responsibilities that come with becoming competitors.

"A few reasons to do it are reciprocal compensation, if you can get it, and cheap data T-1 lines (as big carriers are still selling below-cost local T-1s)," says Freedman.

Indeed, reciprocal compensation was a major reason why ISPs were interested in obtaining the new status, made possible by the Telecommunications Act of 1996. For the uninitiated, reciprocal compensation is a term for payments made by telephone companies to alternative service providers that terminate calls into their networks.

The system of reciprocal compensation was developed with voice services in mind, where payments made by telephone companies would balance out the expenses of terminating each others' calls. But ISPs tossed a monkey wrench into this setup, because ISPs don't receive any phone calls from telephone companies—they have users that only make phone calls via modems.

Hence the reason for ISPs to seek a CLEC status—a change in legal status could result in a fat check from the RBOC. Indeed, this is how the business was done until the FCC put a stop to reciprocal compensation generated by Internet access-related costs. The FCC's decision was challenged in court, but for now reciprocal compensation does not have a guaranteed future.

There is enough doubt for attorneys advising ISPs on becoming CLECs to recommend against counting on this revenue stream. Charles Kennedy is a partner in the Northern Virginia and Washington, D.C. offices of law firm of Morrison & Foerster who often represents ISPs and telcos before the FCC and state public utilities commissions. Kennedy's practice is the one responsible for registering companies to be CLECs.

Kennedy believes without the reciprocal compensation check, the costs and hassles of becoming a CLEC may be hard for an ISP to justify.

"One ISP client that I talked to was only interested in becoming a CLEC because of the availability of reciprocal compensation, and when I told them they couldn't count on this revenue they could not find a business reason to become a CLEC," said Kennedy.

It is true that there are savings associated with buying telecom services like T-1 leased lines wholesale from RBOCs, since becoming a CLEC makes ISPs full fledged carriers eligible for special carrier pricing plans, but being a regular customer instead of a carrier may not be so bad right now, Kennedy says. Telecom services have fallen in price so much that the savings ISPs derive from buying services from telcos as CLECs may not work out to be significant in the final analysis.

The battle to get access to Unbundled Network Elements (UNEs), as wholesale RBOC services available to CLECs are known, may turn out to be a costly affair. Kennedy notes that the costs of becoming a CLEC entail not just direct payments to federal and state governments, but also legal fees, tariff filings, contributions to various funds and so forth. The costs go up dramatically if a service provider seeks a national footprint and seeks to replicate this process in 50 states plus Washington D.C., a trek through the legal system that typically takes up to six months.

Any ISP considering the CLEC option should perform a feasibility study to determine whether investing in a CLEC certification in their area of operation is indeed worth the savings. Such a study could be performed by any number of law firms, telecom consultants, or by the telecom practices of accounting firms.

But most ISPs don't need to pay for an elaborate study to know that CLEC business is not for them. ISPs have largely stopped applying for CLEC status after the initial wave of enthusiasm in the late 1990s, at least through MoFo's practice that Kennedy heads up.

"Being a CLEC turns out to be a tough way to make money if your business model is to buy telecom services from incumbent carriers—the margins are small even at the PUC prices," said Kennedy. "This business turned out to be no gold mine."

— End