Selling in a Slowdown: Industry Leaders and Analysts Debate the Impact of an Economic Downturn on Telecom

Reality is a stark and constant ghoul. Oil is topping $100 per barrel. The subprime mortgage collapse has seeped into the rest of the economy. As foreclosures mount, carriers and cablecos lose millions of dollars because customers can’t pay their bills. Now there’s a credit crunch, not only on consumers, but on companies seeking money for M&A or needing to refinance debt. Plus, bad assets are resulting in billions of dollars in writeoffs. Finally, figure in the exorbitant cost of the five-year-old Iraq War, analysts say, as well as the uncertainty over the presidential elections, and you have a formula for recession.

But telecom executives aren’t worried. A number of insiders recently interviewed by PHONE+ all say a downturn equals opportunity for their companies. They’ve been there; done that. Whether they can offer lower prices and higher-value services to business users, or flexibility the incumbent can’t match, the result, they say, is continued, if not elevated, revenue.

Not so fast, say analysts. This recession is made up of different external factors (for starters, a protracted war and a mortgage bust) than previous slowdowns; and within telecom, the revenue models largely have shifted from usage-based to flat-rate pricing. All of these elements could add up to more exposure than anticipated.

Before we get ahead of ourselves, let’s ask the question: Is there a recession? Technically, recession sets in when a nation records two consecutive quarters of negative growth in its gross domestic product, or GDP. The GDP measures the value of goods and services produced in the United States. By press time, the consistent negative growth had not been declared and federal officials were shying away from the word "recession" at all costs. Yet, billionaire Warren Buffett declared on CNBC in early March that, "by any common-sense definition," the country already was experiencing recession, mostly due to the housing crisis. And several earlier surveys showed Americans felt the same. In mid-February, the Pew Research Center said public views of the economy had taken a drastic turn in one month. Just 17 percent of Americans rated the nation’s economy as excellent or good, down from 26 percent in January, Pew found. Meanwhile, the percentage of Americans rating the economy as "poor" skyrocketed — up from 28 percent in January to 45 percent in February. "Negative ratings of the economy have reached levels comparable to those seen during the recessions of the early 1990s and early years of the current decade," wrote the report’s authors.

The National Association for Business Economics (NABE) made a similar prediction in late February. "U.S. economic growth is expected to slow to a crawl in the first half of 2008," says Ellen Hughes-Cromwick, NABE president and chief economist at Ford Motor Co. However, NABE says the second half of 2008 could be better. The association foresees growth that will lead to a 2.9 percent improvement in GDP throughout 2009.

We’re not there yet. So, the challenges in the intervening months are to understand why the slowdown is happening, and how to navigate its ups and downs.

There are three main reasons for this recession, analysts say: the Iraq War, the mortgage-caused credit crunch and the presidential elections.

First, the war has lasted longer than most people expected, says Hall Gardner, a CPA and director of investments for Legacy Wealth Management, a financial advisory firm in Memphis, Tenn. To be sure, the war’s daily cost now stands at more than $270 million. Not only does that push the United States deeper in debt, but oil prices are reaching record highs — they surpassed $104 per barrel at press time. Everyone is affected, Gardner says.

"Any time oil rises, everything rises just because the cost of transportation is increased," he says. The situation leads to inflationary pressures because prices are going up while growth, on the other hand, is not. "The fed is in a real tough situation because to fight inflation, you need to raise rates. To increase growth, you need to lower rates," says Gardner.

Amid inflation concerns, businesses and consumers alike are having trouble landing credit. Since the subprime mortgage debacle, banks and other lenders have tightened their terms; it’s tough for almost anyone to secure debt for acquisitions or capital. "It’s more difficult to obtain financing at rates that aren’t expensive," says Jessica Zufolo, senior policy director for telecommunications, media and technology for research firm Medley Global Advisors. "The tremendous amount of writedowns and volatility has permeated every sector of the economy."

In telecom, the latest, and largest, example was Sprint Nextel Corp.’s $29.5 billion writedown stemming from the Nextel acquisition. If companies keep recording such financial losses, economic recovery moves further away. "It doesn’t look like it’s going to let up – it’s just more of the same," says Zufolo.

Legacy Wealth Management’s Gardner disagrees somewhat. He thinks the subprime-caused credit crunch will "work itself out" by June. But, he says, there’s yet another unknown in store: the presidential elections. If the Democrats take over, there will be tax changes, "and more likely than not it’s going to affect the capital gains rate," Gardner says. To wit, under George W. Bush, capital gains taxes have remained at 15 percent. Under a Democratic administration, "I believe that number will go back up to 28 percent," Gardner says, adding that there could be market volatility if the incumbents lose.

Gardner’s view is supported by findings from investment advisor Ned Davis Research Inc. The firm has tracked the Dow Industrials’ reactions to presidential elections from 1900 to 2004. When the incumbent party wins, the market historically soars 11 percent during the calendar year, according to Ned Davis Research. If the incumbent loses, the market drops 1 percent.

So how will telecom fare in the economic slowdown? Will companies buy new products and services during a downturn? Opinion is divided. If insiders are right, the industry will do just fine, thank you very much. Analysts, conversely, are more guarded about the impact of a recession.

PHONE+ talked with a number of CEOs and other execs to gauge opinion on the economic recession. To a tee, interviewees say a downturn, while not ideal for anyone, invites opportunity.

For example, wholesaler RCN Metro Optical Networks just got a short-term upgrade request from an investment bank that needed to accommodate bandwidth peaks from frenetic Wall Street trading. RCN Metro, which now owns NEON Communications, can accommodate such temporary account changes because it has a narrow focus, says Felipe Alvarez, president of RCN Metro. Succeeding in a recession, he says, requires knowing your space. "If you want to be everything to everybody, you’re going to have a problem," Alvarez warns.

Dave Falter, director of domestic wholesale for Sprint Nextel Corp., agrees. Resellers and agents "have got to be able to understand the technology and the benefits to take care of your customers’ business problems" in an economic slowdown, he says.

"Price pressure is always out there," says Falter. The beauty of technology such as MPLS, however, is it costs less and offers more flexibility than frame relay and ATM-based WAN services. "There’s value inherent with the solution," Falter says.

Opportunity also lies in pricing, says One Communications Corp. CEO Howard Janzen. For example, telecom subscribers (usually ILEC customers) in previous downturns have scrutinized budgets and tried to save money wherever possible. "So, ironically, [a slowdown] opens doors because now some of those customers are interested in ways to save 15 or 20 percent, where before they wouldn’t have bothered," says Janzen. "It’s not a huge negative for us at all."

Indeed, provided a recession doesn’t last too long or run too deep, competitive telecom providers will come out ahead because LEC customers need to save money, says Arunas Chesonis, chairman and CEO of PAETEC. Users also need to be able to disconnect services if they lay off workers or cut costs, he says. PAETEC actually went cash-flow positive in the last downturn, Chesonis says. Regardless, if a recession lasts five years or more, "we all have bigger problems," he adds.

Those are encouraging anecdotes, analyst Zufolo says, although CEOs have to maintain a positive outlook "to keep shareholders from bolting." The reality is the "health of the economy is in a very delicate place right now, and it does not appear we are headed toward recovery," she says.

There’s also a potential hiccup in how telecom execs view this recession compared to those in the ’80s and ’90s, says Joe Gillan, a long-time telecom economist and consultant. "Pricing has really de-emphasized usage," says Gillan. Telecom profits now come from capacity, such as revenue per line or per DS1 or per megabyte, he explains.

"We know from last time that as the economy went south, usage increased and revenues increased. It is not so clear that capacity will increase, which would be required for revenues to go up this time," Gillan says. In other words, there’s a good chance there will be "less immediate benefit from a slowdown than people used to see."

That may be true for voice, which tends to be all-you-can-eat these days, but bandwidth may be a different story. New research from the Telecommunications Industry Association (TIA) forecasts "booming" bandwidth consumption throughout the year. As a precedent, usage doubled in 2006 and quadrupled in 2007, says Arthur Gruen of Wilkofsky Gruen Associates Inc., principal author of the TIA report. "The action is on the data side," says Gruen.

Such action gives service providers a "significant opportunity" to compensate for any bandwidth shortage resulting from video and peer-to-peer data sharing, says Grant Sieffert, president of TIA.

Still, economist Gillan points out, if general, extended inflation kicks in, people will have to temper their expectations for growth. "To the extent that prices are locked in, either through contracts or through price caps, inflationary pressures might ultimately have a larger effect on planning," Gillan says. In turn, Moore’s Law — the advance in computing power per unit cost that’s said to double every 18 months — would be apt to slow if inflation affects wages, capital costs and other elements, Gillan says.

Compass Intelligence already sees such a slowdown. The Scottsdale, Ariz.-based research company said on March 5 that annual spending on IT services will fall from 5.3 percent growth in 2007 to 3.9 percent growth this year. Infrastructure providers will have the hardest time during the first half of 2008, says Kneko Burney, president and chief strategist for Compass Intelligence. That’s because "customers will hold off on non-essential investments until the second half of this year."

What it comes down to is that a recession provides possibilities for success, just not always in traditional areas. Take Boston-based M/C Venture Partners, which has funded the likes of MetroPCS,NuVox and Cavalier Telephone, as an example. The private equity firm says it’s bullish on mobile broadband, CLEC investments and network infrastructure plays in 2008.

For Gardner, that’s proof that "in every market, there is something that is working. There may be a whole bunch of things that are not working, but there are some things that are working really well and you just want to make sure you’re on the right side of that trade."

Being in the right place is key for channel partners facing prospects with tightening budgets. So where is that exactly? Self-styled guerilla marketing expert Peter Radizeski, president of RAD-INFO, says he is getting calls from telecom companies looking for different ways to market now that sales are slowing. He points to niche marketing as a key strategy. Target companies that are profiting from the slowdown — debt reconsolidators and loan refinancers are a few that come to mind. Better yet, exploit the markets you already know. "Every one thinks that it’s about saving 10 percent, but I think they are tired of hearing about that," says Radizeski, noting that swapping customers back and forth does not make for growth, you have to find the new users or uses. Instead, Radizeski says, "Find out what the ‘aha’ is." Don’t assume you know what tools make their business lives easier. He says a great way to find out those hot buttons is to take an existing client to lunch and just ask. It’s likely that others in their industry will feel the same. "The first few sales are really hard, but after that it’s easier because of word-of-mouth," Radizeski says.

VoIP and mobility solutions are two options that can help businesses gain productivity by supporting remote and mobile workforces.

This doesn’t mean that telecom spend is not a concern, Radizeski cautions. "One of the largest bills for small businesses is communications," he says, noting even the smallest companies have a voice line or VoIP package, DSL or cable access, a wireless voice plan and EV-DO cards for wireless data. Providing asset management and expense management can be an opportunity. The issue is whether you would charge for that service or take a percentage of the savings. "In a tight model, will they pay you? It’s an easier sale to split the difference," he says.

In addition to targeting telecom spend directly, partners also can look at how telecom can displace other spend. Travel is an obvious place where telecommunications is a cheaper substitution. Conferencing of all flavors is expected to flourish as the companies seek to avoid T&E costs. VoIP also can help companies reduce or avoid growing their real estate costs by enabling more workers to be housed at home offices rather than in leased space. Indeed, a company’s pursuit of a virtual work environment could be triggered or hastened by the slowdown.

Closing deals, mind you, is only half the battle; getting paid is the other. Telcos, which already are taking writeoffs for non-paying clients, particularly those in the mortgage and real estate industries, are likely to tighten credit policies. McGraw Communications Inc., as one example, has issued new procedures for its sales agents to hedge against future bad debt as much as is possible. Cbeyond Inc. also announced the same strategy in its fourth quarter earnings call. It reported 300 non-paying customers and a boost in churn to 1.4 percent in the quarter, but said the new policies would ameliorate future losses.

Agents should also expect more scrutiny from their suppliers, who will be looking closely at sales performance in an effort to avoid unnecessary spend on non-producing agents. Radizeski says it makes sense for people to stick to what they know best during tight times to get the greatest return on investment. For example, he says, now’s not the time for partners who are good at transactional sales to attempt to become elephant hunters and vice versa.