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Baby bells on hold

Regional local telephone companies have long been unassailable in their core market, providing local phone service to most U.S. homes and businesses. But McKinsey explains why the incumbents now face real threats on several fronts.

The Baby Bells, which own the wires connecting the vast majority of U.S. homes and businesses to global communications networks and lease access at regulated rates to other companies that want to provide voice or data services, may have escaped the worst of the current telecom turmoil.

But despite their advantages, their traditional revenues are faltering. Competitors are making inroads into the local-phone-service market--so far, 6 percent of it. Meanwhile, the number of fixed-access telephone lines in U.S. homes and businesses declined sharply in 2001, by 9 million lines (nearly 5 percent), because wireless communications are expanding and many customers, who now want high-speed Internet service, are relinquishing their second dial-up line. Furthermore, the Baby Bells? version of high-speed access, DSL (digital subscriber line), is increasingly losing out to the broadband offers of cable companies.

More and more people are switching to wireless providers.

A recent study uncovered an unexpected and even larger problem. Growth is topping out in the biggest profit center of the Baby Bells: call-management services, a financial cushion that generated about half of their gross profits and 40 percent of their revenue growth from 1995 to 2001, as well as $12 billion in 2001 revenues.

These high-margin services are activated by software that directs a central switch to send a message to a customer?s telephone from a database, such as the one holding the originating phone numbers for calls. Because the Baby Bells have upgraded all of their equipment over the past 15 years to support digital signaling and switching, that software is a basic part of their networks. An offer such as caller ID, which costs a customer $5 to $8 a month, costs the provider about 1 cent for every ten calls. The only real expense is the initial activation, for which companies usually charge customers a onetime fee averaging $7.

Our analysis shows that profits from call-management services come almost entirely from call waiting and caller ID, each with a national penetration rate of more than 40 percent. Getting customers to sign up for additional services--even undeniably useful ones such as voice mail, call forwarding and three-way calling--has proved far more difficult.

Growth rates are now stagnant or falling for all kinds of services, and as growth rates in penetration fall, so does the rate of growth in revenue. At BellSouth, for example, revenue growth fell by 50 percent in 2001. Moreover, this huge but hard-to-expand market is also threatened by the range of basic and advanced call-management services offered by most wireless providers and by many competitive local-exchange carriers. Wireless customers are particularly avid users of the services, most likely because the providers include some of them in the basic price and they are much easier to use on wireless phones thanks to the programming and screens.

Growth is topping out in the biggest profit center of the Baby Bells: call-management services.

As a result, more and more people are switching to wireless providers. (Although all of the Baby Bells do have wireless operations, they generally operate as separate entities that don?t affect the economics of the traditional fixed-line business.)

Restarting growth in call-management services would surely help stabilize the finances of the Baby Bells, but it won?t halt the erosion of their traditional markets.

For more insight, go to the McKinsey Quarterly Web site.

Copyright © 1992-2002 McKinsey & Company, Inc.