More Consumers Answer Call
Of Cable for Phone Service

For years, telephone-industry executives chuckled as cable companies tried to use their TV lines to break into the local phone business. But today, no one is laughing.

The cable companies, after working out the bugs in their systems, are beginning to chalk up impressive results in signing up telephone subscribers. Their pitch is simple and persuasive: Buy an attractive package of phone, cable and high-speed Internet service, pay only one bill and, most importantly, cut local phone costs as much as 30%.

COMPETITIVE THREAT Cable companies are luring customers from local phone companies. Below, cable companies with the most phone subscribers. COMPANY CABLE SUBSCRIBERS LOCAL PHONE SUBSCRIBERS AT&T* 13.3 million 1.2 million Cox 6.3 million 578,000 RCN 507,000 190,000 Comcast 8.5 million 40,000 Insight 1.4 million 20,000 *ATT Broadband Source: the companies

The two leaders in this business, AT&T Corp.'s AT&T Broadband unit and Cox Communications Inc., have signed up over 1.7 million local telephone customers and are adding new ones at a rate of more than 60,000 a month. Other industry leaders, including Comcast Corp. and AOL Time Warner Inc.'s Time Warner Cable, plan to launch cable phone service next year using a less expensive Internet-based technology that transmits sound digitally.

To be sure, cable's beachhead is tiny when compared with the 102.2 million U.S. households with phone service. But the industry has spent an estimated $65 billion over the past six years to upgrade its wires to carry digital television, high-speed Internet and a wide range of other services including telephone. Some 70 million of the 90 million U.S. homes that cable wires now pass by are able to receive high-speed Internet service and, within 10 years, analysts estimate that most will be able to get cable phone service as well.

Already, cable companies have shown they can build significant market share in targeted areas. In Omaha, Neb., and southern Orange County, Calif., for example, Cox says it is providing phone service to more than 25% of all homes. "We had 20 presold homes in a brand-new subdivision and everyone's asking 'Can we get Cox,' " says Omaha real-estate developer Dan Witt. "The mentality is that people want to get all the services from one company."

The dominant local phone companies already have begun to feel some pain. Earlier this summer, when SBC Communications Inc. lowered its earnings outlook for the year, executives partly blamed subscribers lost to cable. Edward Whitacre, SBC's chief executive, describes cable phone service as one of his company's biggest competitive threats.

Meantime, Verizon Communications Inc. has noticed it is losing subscribers to the cable-Internet-telephone bundle that AT&T Broadband is offering in the Boston area. That is one of the reasons Verizon chose eastern Massachusetts to launch its "Veriations All" program, which offers a package of long-distance, local, wireless and high-speed Internet services. "We are prepared to battle for our customers," says Maura Breen, Verizon's chief marketing officer.

It could be quite a fight to win back customers such as Shannon King. The Laguna Beach, Calif., resident had heard so much about Cox's lower prices from her friends that she switched her service from Verizon in May when she changed apartments. Today, her local phone bill is only $12 a month, compared with $30 when she used Verizon. "It was kind of a no-brainer," she says.

Fortunately for phone companies, the cable companies are hitting their stride on the technical and marketing sides of local phone service at a time when industry turmoil is likely to slow down their expansion of the business. The fraud scandal that sent Adelphia Communications Corp. into bankruptcy badly rattled the cable industry, sharply driving down shares. Growth in basic cable subscribers is flat. And capital is scarce due to the slow economy and investor dissatisfaction over the industry's high debt levels and the low returns so far on its huge investments.

One wild card is how ambitious AT&T Broadband will be with its cable-phone plans once the unit is acquired by Comcast. Before the merger plan was announced, AT&T predicted that by the end of 2004, it would be capable of offering phone service to almost all 25 million homes that its cable system passes by. But Comcast hasn't embraced AT&T's time frame, although it eventually wants to offer phone service systemwide. When its executives talk about phone service, they stress the importance of balancing it with other products, subscriber growth and revenue. "Phone is going to an important new product," says Steve Burke, president of Comcast's cable system. "But it's not necessarily going to be our No. 1 priority after the merger."

Cable companies dreamed of offering phone service ever since they began upgrading their wires on a major scale in the early 1990s. Only a few decided to launch it, using the phone industry's traditional technology, called circuit switch. But those companies have now mastered the complexities of providing phone service, which involve everything from making sure lines don't go dead in a power outage to dealing with the Federal Bureau of Investigation when it wants to do wiretaps. Gone are the days of embarrassing technical glitches, like the time in San Diego when Cox accidentally published 11,400 unlisted phone numbers in a directory. Early cable-phone setups also suffered some billing problems, such as customers getting charged twice for the same calls.

As it turns out, subscribers who sign up for phone service along with cable TV and high-speed Internet are more likely to stay loyal to their cable company and not switch to, say, satellite TV. "As a stand-alone business, telephone is very strong," says David Pugliese, a Cox vice president in sales and new-product marketing. "It's even greater for us as a piece of a three-product bundle."

Cable companies also figured out quickly that discounts go a long way toward severing any loyalty people may feel toward their local phone company. Kawan Willis, a 48-year-old surgical technician in Chicago, says she switched to AT&T Broadband from SBC's Ameritech unit last fall after her goddaughter told her about the potential savings. Since then, her monthly bill for local and long distance has fallen to about $68 to $78 from over $100. "I thought she was lying, but she was right," Ms. Willis says.

So far, the so-called Baby Bells that control about 90% of the local phone market have had a hard time fighting back on price because of regulations that require them to apply special discounts to their entire systems. So while Cox can offer a special deal in a particular market, the more heavily regulated Bell companies need to offer the discount to their entire region. "They can come into a market and do what they want and we can't compete with them," says Jason Few, an SBC vice president for business development.

But Bells have found other ways to defend their dominance of the local phone market, which brings in about $130 billion in revenue annually. SBC, for example, has teamed up with satellite-TV company EchoStar Communications Corp. to offer a package of TV, telephone and high-speed digital subscriber lines, or DSL, Internet service. Other Baby Bells, such as Verizon, are racing to get regulatory approval to offer long distance in more states so they can compete against cable companies and others with package deals of their own.

The more services subscribers get from their phone companies, the more difficult it will be for cable companies to pry them away, says Thomas Eisenmann, an assistant professor at Harvard Business School. "When you bundle local with long distance, that's a very compelling package," he says. "The cable companies have got a two-to-five-year window of opportunity."

Write to Peter Grant at peter.grant@wsj.com

Updated September 5, 2002