Masters of the Telecom Game

By: Erik Linask

Anyone who has ever enjoyed the game of chess knows well that to be successful, you need to be able to not only outplay your opponent, but outthink him or her as well. That means having the ability to think several moves ahead and sometimes it works out as planned, while other times it doesn’t.

This strategy is not unlike that which makes for a successful, growing business, where management is charged with predicting what the next moves will be for customers as well as competitors. It also means taking certain risks, hoping they pay off – using the pawns on the chess board, so to speak. When properly played, pawns can provide a fierce attack on an opponent’s strategy, but if the moves don’t work out, you risk losing only a pawn.

This same strategy is what Paetec’s Chairman and CEO, Arunas Chesonis (News - Alert), professes has helped Paetec grow over the years, even now, in the midst of a major economic downturn that has seen many businesses – including many in the telecom space – suffer, and even fold entirely. Paetec’s approach has been to offer as broad portfolio of services as possible, allowing it to not only grow its business with existing customers, but engage new customers with a variety of propositions.

“You’re never sure which is the path of least resistance into a prospective customer,” Chesonis said. “You just have to have a broad enough portfolio, so that any time in the life of their company, you have something that can help them.”

Paetec’s expansive offerings include telecom services, equipment, data center hosting, last mile fiber, last mile fixed wireless, business continuity, security and more. Such a breadth of offerings allows the company to bundle services as required by any individual customer, and is what drove its acquisition of PBX manufacturer Allworx (News - Alert) back in 2007.

A large portion of Paetec’s customer base has a number of small satellite locations, in addition to one or more main sites, and the challenge with many large enterprise communications systems and their providers today is that they tend to focus most, if not all of their energy on servicing the larger sites, leaving the smaller locations to fend for themselves. The problem, of course, is such a strategy does little to promote a unified corporate infrastructure and business operations.

This is where the Allworx acquisition comes into play. It allows Paetec to offer these smaller pieces of large corporations an enterprise-grade communications solution that can easily be integrated into the corporate infrastructure and services set, all of which it can get through Paetec. It also allows Paetec to get much more creative with financing, since customers are looking to buy more of its products and services. And that’s really the strategy that epitomizes Paetec – the goal is to be able to offer prospective customers as few or as many pieces of their telecom needs as the customer wants, but to at least get a foot in the door.

But, with the economy a major factor in play, along with existing contractual obligations, especially on the network services side, the challenge is finding a way into a customer. In most cases, large telecom services contracts – especially with Paetec’s two key competitors, AT&T and Verizon (News - Alert) – come with minimum spend guarantees that preclude them from moving to an alternative provider, like Paetec, at least until their contracts expire. With budgets as tight as they are, many customers are likely even struggling to meet those minimum spend thresholds, making it even more difficult for a company like Paetec to make inroads.

“So, you’re trying to work around the fringe and around different areas of the IT organization, trying to find out where you can get to know them and how you can help them,” explained Chesonis. “Can you build them a business continuity system? Can you offer them a backup MPLS network instead using ISDN dial-up as a back-up? Can you provide them enhanced toll-free services or ACD and call center services that they might not even have been considering earlier, because they have a small, 30-person customer service center in one of their locations? Can you do something on the equipment side that can help them, because they can’t afford the real high-end equipment, but have systems that are reaching end-of-life?”

Again, this is where the strategy of building a business model focused on breadth of offering, including the Allworx solution, proves itself. Knowing the forces that are playing against it, Paetec looks to leverage its wide product set to find a way to help a business is a way that doesn’t impact its existing AT&T or Verizon obligations.

Though it takes years to develop – Paetec has made 15 acquisitions in 11 years – the approach pays out in spades. By getting to understand a prospective customer, and by coming up with creative ways of helping them build their own business, Paetec can work its way into the inner circle of decision makers, such that when their contracts expire with their current providers, they are already considering ways to work with Paetec in some greater capacity. If nothing else, market turbulence has created a need for companies, large enterprises, in particular, to diversify their service provider strategies.

“Once you get a little piece of a customer’s business, you can prove yourself and then, we like to call it the little Paetec quicksand,” described Chesonis. “Once we’re in, we’re going to get you stuck forever by doing a good job and then trying to sell you more products and services.”

Now, don’t mistake this strategy for a market takeover play. Paetec has about a two percent share of the business with its typical customer, yet, it generates $1.6 billion in revenues. Projecting over the next five to 10 years, if Paetec can win a single percentage point of market share with its network side businesses that would amount to $800 million in additional revenues, a 5 to 8 percent growth rate. That’s what Paetec’s strategy is built for.

“We’re not looking to take over the world and put AT&T and Verizon out of business,” qualifies Chesonis. “We just want a little piece.”

Don’t be misled, though. As diverse as Paetec’s own portfolio is, Chesonis also recognizes that in order to be successful, he must be willing to work with other key market players. In fact, even though the company can offer a complete hardware and network services solution, the bulk of its business comes through partnerships, including a referral program with VARs and interconnects companies, as well as its indirect channel, which includes Cisco VARs, Avaya (News - Alert) dealers, and Mitel or ShoreTel resellers, among others.

With its own PBX business in place, it would be easy to fall into the trap of shutting out other vendors. But, Cisco, Avaya, and Mitel combined for more than a quarter of the PBX market in 2008 (Nortel and NEC (News - Alert) made up another quarter or so), according to The Eastern Management Group. Given those figures, a business model that disassociates Paetec, at its core a network provider, from other vendors, would be tantamount to laying down its king in defeat.

Of course, having its own product set to offer allows Paetec to go after that competitive client base when it sees an opening.

“Just because someone else has a relationship with a customer doesn’t mean we’re not going to build our own relationship with that client,” noted Chesonis. “If people are not really being your partner, you want to have a way to go after that same customer base.”

But, knowing it is competing with two of the world’s largest service providers, as well as the biggest hardware providers, and understanding the challenges is faces – as the adage goes, nobody gets fired from buying from AT&T or Verizon. They might not exactly what they need, but they won’t lose their jobs.

So, it circles back to an innovative and diverse service offering, and though Chesonis won’t divulge all of Paetec’s secrets, he acknowledges that a big part of it is being able to find success in specific vertical markets, like financial services, healthcare, hospitality, and higher education, where Paetec tends to get a disproportionate amount of business in many cases. It’s a function of getting to know the customers, their industries, and their specific businesses, and, more importantly, according the Chesonis, knowing who to talk to within these vertical markets.

For instance, with its fixed wireless program, Paetec can build anything from a 10Mb to Gigabit Ethernet last-mile system for customers, and already has about 200 deployments in the market. It plays well into Paetec’s strategy of looking for alternative solutions with which to add value to its customers. They may not be able to buy landline service from Paetec, but they need a reliable, resilient back-up solution to conform to HIPAA or other industry-specific or state of local regulations. Chesonis says his customers attest that Paetec’s wireless backbones are as reliable as fiber networks.

“It isn’t that our products are so much different,” he says. “It’s that we know what the issues are, we know how to approach decision makers, and we know why our products are important to their organizations.”

In vertical markets, there is also a tremendous benefit in past successes, since customers tend to be much more comfortable knowing you have a solid understanding of their industry. For instance, it makes it much easier to sell into a university when they know you have hundreds of other university customers under your belt. That also makes them more likely to use Paetec as a one-stop shop, rather than dividing their business among several carriers.

So, the big question is, why? Why would Paetec diverge from what was a proven model to embark on a mission that could result in as many failures as successes?

It was a calculated gamble. Initially, Paetec expected 80 percent of its revenues to come from demarcation point out – all the voice, data, international, toll-free and other network services that go from the customer premises out into the network. But, the idea occurred to them that, if they could generate 20 percent from the demarc in, they would not only be able to collect from different budget pools, but also create a much stickier service bundle because it would create an outsourcing effect with their different components of their internal networks and infrastructures.

“We always had that 80/20 rule in place and that’s why we, in the early days, bought Pinnacle in 2000, that’s why we became a Cisco (News - Alert) VAR in 2000, that’s why we bought an Avaya interconnect in 1999,” explained Chesonis.

“A lot of people were confused when we started buying those other companies, but now they get it. It’s very powerful when you can be working with a Cisco reseller, but you’ve been a Cisco reseller yourself for 10 years and know what they’re going through. It builds a much better relationship with your partners when you can help them grow their business, which isn’t possible with a traditional network provider model.”

In fact, with all of its network and on-premises products and solutions, about the only business Paetec has not gone after is the mobile wireless market. It’s largely because not having that service to offer hasn’t impacted its ability to win business, because many wireless provides were facing challenges in the market, and, perhaps most importantly, the enterprise space has yet to look to bundle fixed and mobile services in a meaningful way. That said, the market is changing, and Paetec has its eyes on the wireless market as well.

“With our national footprint and large customer base, our distribution systems, our IT capabilities, and with the ability to integrate wireless and wireline networks in IP environment, you can expect to see that from us in the not too distant future,” said Chesonis.

But that’s just in the telecom space. With Paetec’s history of challenging traditional models, it shouldn’t be surprising to learn it has also made a foray into the energy business by acquiring a small utility brokerage. It makes sense, if you consider the growing focus on energy utilization, and when you understand that Paetec already has barter arrangements with energy companies, exchanging capacity in their power networks for Paetec’s acquired fiber capacity. Paetec also has several arrangements in place where it has funded a variety of alternative energy solutions in exchange for long-term telecom contracts.

With its understanding of the energy business through its existing customers and partnerships in the utility space, and with its tradition of straying from the norm with some of its business interests, this move shouldn’t be overly surprising, especially factoring in the growing interest in green technology and energy conservation.

In fact, Chesonis argues that it actually makes more sense than most people realize. Most businesses have very little understanding of how much they are spending on energy across their organizations, despite the fact that, aside from payroll, real estate costs, IT and telecom, and energy are the three largest budget line items. So the fact that there is so little information available around energy usage, especially in distributed enterprises, where usage crosses state lines and energy company territories, presents an opportunity for a telecom vendor willing to make the move and combine telecom with power, especially with energy costs expected to continue to rise for the next 20 to 30 years.

“For someone like Paetec, who has a very large IT infrastructure, a large customer base, sales offices around the country, trusted relationships with people and the financial strength to be able to deal with the energy companies and other providers, it’s not that crazy that you’d see us wanting to get into this kind of business to help make our telecom offering that much more unique,” explained Chesonis.

He acknowledges this venture is not a significant source of revenue now, and it may not be for some time. But he has made the bet that it will in five or 10 years.

More important, not only has Paetec made technology and other service moves for the future, it also has taken measures to ensure its financial stability over the next decade and beyond. With the economy as it is, many companies are struggling with keeping themselves out of bankruptcy or restructuring and are forced to devise short-term strategies to simply stay in business. Hundreds of billions of dollars in loads are going to come due and need to be restructured in the next three to five years, and with the economy and the financial industry as weak as it is, there’s no telling who will come out of that restructuring period unscathed.

Paetec, which was first started through investments from friends and family, not banks and venture capitalists, has taken steps – including restructuring its existing debt – to ensure that, even if its revenue remains flat, it will be able to pay down that debt almost entirely over the next eight years from its free cash flow.

“We just wanted to get ahead of it and do it now,” said Chesonis. “You just want to make sure you’re thinking long term ahead of the curve and that’s what we’ve always tried to do as a company.”

When you look at each of the strategic moves Paetec has made over the past 11 years, individually, many of them don’t make a whole lot of sense. Some of them do, like the acquisitions of US LEC, McLeodUSA, and even Allworx, but others, like getting into energy, may not. But each one is part of a bigger picture that Chesonis sees, merely moves on his telecom chess board, all leading to the ultimate outcome.

Check and mate. IT

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