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Can the Baby Bells do broadband?

Competition in the high-speed Internet market has become intense enough to turn around an old saw: Even if you can beat them, the rule now runs, join them anyway.

Competition in the high-speed Internet market has become intense enough to turn around an old saw: Even if you can beat them, the rule now runs, join them anyway.

The two largest telephone companies in the United States, SBC Communications and Verizon Communications, each have hitched their high-speed Internet businesses to a smaller national competitor. SBC has put its consumer DSL business in the hands of Prodigy Communications, and Verizon yesterday said it would merge its high-speed Net business with relative newcomer NorthPoint Communications.

The deals, each of which will give considerable brand power and control to the new partners, are radical steps for megacorporations in the midst of reinventing themselves as Internet businesses.

But does this mean the local phone companies themselves--which have faced considerable consumer criticism for customer service and DSL reliability issues--are beginning to admit that smaller companies are simply better at the business?

Yes and no, analysts say. The big local phone companies are desperately trying to become national players. Partnering with the smaller companies will give them this presence faster, at a point when the race to the market is crucial, they say.

"Time is of the essence," said Zia Daniell Wigder, a Jupiter Communications analyst. "If they were to lose a year or two building out their own infrastructure, they'd be two or three years behind in the market."

But the smaller companies also bring a more aggressive culture and a stronger focus on customer service to the table, two things that haven't been the Bells' strongest points, analysts note. And it's exactly these features that the Bells need to move to increase their prowess as high-speed Net companies, they say.

"Fundamentally, the (big local phone companies), or at least their DSL portion, understand that they need a boost in terms of customer service and a more aggressive response in the DSL market outside their regions," said Fritz McCormick, an analyst with The Yankee Group.

The deals come as all of the big telecommunications companies are scrambling to establish as large a footprint as possible in the United States, across a wide spectrum of telecommunications services. Most of the big local phone companies have merged with each other or with newcomers to expand their profiles, while AT&T has snapped up cable companies for its broadband and local telephone services. Only Sprint and WorldCom's attempt to bulk up by joining forces has been nixed by regulators.

Although the vast majority of revenues for these companies still come from traditional phone calls, the merger frenzy is being driven by huge growth in both the high-speed Net and wireless phone markets.

Each of the companies hopes to carve as large a geographical territory for itself as possible with these technologies while constructing as large a loyal customer base as they can before the market settles.

According to The Yankee Group, the DSL market will grow from 1.45 million subscribers this year to 8.4 million subscribers in 2001. The cable modem service providers, the Bells' biggest rivals, will grow from 2.4 million subscribers this year to 9.6 million subscribers in 2004, the analyst firm says.

But getting to those figures will require the Baby Bells to expand their regional markets to compete nationally. That's where the deals come in.

You scratch my back...
The two most recent major deals hint at slightly different expansion plans.

SBC's deal with Prodigy gives control of the consumer ISP business to the venerable online company, allowing the telephone company to retain control of its own high-speed network assets.

NorthPoint and Verizon, by contrast, are merging their network assets, which will be sold wholesale nationwide under the NorthPoint brand. Some of the consumer services will remain under the Verizon brand, although the companies say they are still working out branding issues.

Verizon executives say the two companies have "complementary assets," and the merger is not an indication of NorthPoint filling in for the telephone company's service shortfalls.

"Over the course of the last six months, the DSL technology has been completely changed," Verizon vice president Larry Babbio said in a conference call yesterday. "In my mind, those service issues are behind us."

Verizon's share price has dropped sharply since the news was released, falling from above $47.50 on Monday to $39.50 at midday today. Much of the drop stemmed from disappointing earnings results released yesterday, analysts said.

The two deals Small towns in the fast laneshare the ability to bring the telephone companies' services to a nationwide audience quickly, while giving the smaller companies access to a huge amount of capital and a near-captive customer base.

Other Bells are proceeding differently, however. US West, now part of Qwest Communications International, is building a national presence on its own. It's already entered a few California markets, with others planned throughout the next year.

BellSouth has been content to keep its high-speed service in its southeastern U.S. home territory, at least for now.

These other companies, too, are likely to partner with smaller national companies, simply in the interest of speed, analysts say.