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. Last Updated: 07/27/2016

Phone Firm Gives City Rival a Helping Hand

Borrowing $76 million on attractive terms from your government to build up a business in Russia sounds like a good deal.

Using 80 percent of the money to assist your Russian competitor does not.

Yet that is what Comstar, the main alternative, or "overlay," phone network in Moscow, is doing. What's more, Yury Pavlenko, its chief executive, thinks he has a good deal. "Growth is faster than expected," he said.

The British-owned Comstar is now spending a $76 million loan from the British government to build a fiber-optic ring around Moscow. Pavlenko put the sum invested to date in the network at $28 million, with 600 kilometers of cable laid and 40 switches installed.

But the bizarre thing is that, as a condition of the loan, Comstar must transfer 80 percent of the lines constructed using the loan to MGTS, the Moscow City Telephone System.

This is odd: MGTS is basically in exactly the same business as Comstar. In fact, Comstar exists to provide a competitive phone service to MGTS within Moscow.

For a connection fee, Comstar subscribers are linked, via the existing phone line in most cases, to a network encircling much of central Moscow that, in theory, gives better quality hook-ups, especially for computer data, fax and e-mail transmission.

It should be in Comstar's interest to ensure that the MGTS system is bad so customers will turn to Comstar. So why should Comstar be funding MGTS, its biggest competitor ?

Part of the answer is that Comstar is half-owned by MGTS, so managements' hands are tied. But the real reason for what looks like a suicidal gift to a rival is that the link with MGTS is a unique way for Comstar to open doors into Moscow's phone system.

The loan and the 50 percent share provide a useful incentive for MGTS to look after Comstar: It gets a major investment in its network free of charge, while also taking a half-share of the profits from the Comstar network.

Financing for the city public network would undoubtedly have been harder if MGTS had tried to go it alone. With a total overhaul of the network estimated to cost as much as $8 billion, the local network needs all the help it can get. Much of the switches and wiring -- still 90 percent analog -- is decades old. Yet the relationship with the local phone company is also good for Comstar. The deal ensures Comstar gets good terms for things like the cost of connection of its network to that of MGTS and cooperation on other issues like the allocation of phone numbers.

Comstar is betting that its main competitors in Moscow overlay networks, Combellga and Sovintel, will lose out because they do not have such close connections with MGTS.

The city phone network has a stake in Combellga, but much smaller at 5 percent, while the Russian partner in Sovintel is the long-distance and international operator Rostelekom. Perhaps as a result, Sovintel stresses its role as a nationwide overlay network provider rather than one for just Moscow.

As a result of its insider status, Comstar was able to gain an advantageous license that not only gives it the right to offer direct international service and its own "7-503" call code from abroad, but also leaves it free to choose its own international carrier.

This means Comstar can offer customers the choice of going through the Russian operator Rostelekom, or through BT in Britain. BT is cheaper for almost all calls except those around Europe, and is chosen for 80 percent of Comstar's outgoing international traffic, Pavlenko said. The Moscow city phone network itself does not have the right to choose any operator but Rostelekom.

Comstar is dependent upon MGTS for numbers, and also for interconnection with the MGTS network, but Pavlenko says Comstar receives both at advantageous rates. To date the city has allocated 70,000 numbers. Another 30,000 are due to be allocated to Comstar this year.

One risk for Comstar and the other alternative networks is that the Moscow phone network has slowly but surely gotten better, at least in the center of the city. Now it is possible to get "8" -- the long distance and international dial tone -- almost immediately from most central local exchanges.

Yet despite the improvement in MGTS service, Comstar says it is finding itself more popular of late, not less. Managing director Pavlenko says demand is increasing faster than expected. Comstar director Bryan Casbourn said the company had some 20,000 lines in use and 4,500 customers.

So why do customers need Comstar or Combellga or Sovintel at all? Why not just use MGTS?

Well for one thing, price competition is not that fierce. Comstar has had to cut prices to remain attractive. For instance, the sign-up cost to be linked to the fiber-optic trunk network has been cut to $833 from the $5,000 of 1991 and 1992. But MGTS has also raised rates sharply, lifting its call rates for international service in about direct proportion to the ease of getting the tone.

Big telecommunications users generally think that Comstar's better line quality and advanced telecommunications services are worth the now relatively small premium in tariffs. Residential customers with small call volumes are not a major target group -- Comstar charges a minimum $150 per month per line.

One large Western multinational customer, Coca-Cola, said it switched from the local MGTS network to Comstar some two years ago because it was not satisfied with the quality of the local network. "Making phone calls is the main part of our work as the office of a foreign company in Moscow," said the company's information systems specialist Dmitry Zakharov. Though Coca-Cola does not transmit large quantities of data, he said the improved quality of digital lines compared with analog was important.

Zakharov added that he believed Coca-Cola now saves money by using Comstar rather than the MGTS network. The reason is that Comstar, and indeed other overlay network operators, usually gives volume discounts to major customers, Pavlenko said. MGTS does not use these sophisticated marketing tools.

In fact, despite its extra costs such as the $76 million loan, Comstar could probably undercut MGTS in other areas as well.

But one uncomfortable aspect of the relationship between MGTS and Comstar is that the two companies form a sort of cartel, with the promise of lackluster service and no real competition.

Pavlenko said it was against agreements for Comstar to undercut the public network overall. If there were further increases in public rates, "We will have to increase tariffs to match," he said. Charges are likely to be introduced for local calls in Moscow early in 1997, and Comstar will follow suit.

There are, of course, other overlay networks competing with Comstar, and strong competition between them.

Formed in 1989, Comstar was one of the first telecommunications joint ventures. It has grown to have 400 staff and a turnover of $55 million. It started off with the blue booths that can be seen in the Soviet-era hotels in Moscow, such as the Intourist and Cosmos. When they were first installed six or seven years ago, the booths provided the sole means for visitors to direct dial out of the country -- the only alternative was to wait hours for a pre-booked call via the operator.

Large-scale expansion came in 1992 with a decision to construct a fiber-optic ring, and associated switches, around the city center.

GPT, the British half-owner of Comstar, is apparently happy with its biggest investment in a phone network. It had a stake in a similar venture in St. Petersburg called Peterstar, which it has subsequently withdrawn.

GPT, 60 percent owned by British industrial giant GEC plc and 40 percent by Siemens of Germany, is a telecommunications equipment manufacturer of digital equipment. Much of the Comstar network has been built with GPT equipment.

Casbourn, who is GPT's representative on the board, said Comstar's growth has exceeded the company's expectations, and that he sees no slowdown in expansion at present.

The Moscow business telecommunications market is growing rapidly, and Pavlenko believes it will be 15 years before the city network can rival Comstar's.

But if the future in market terms looks reasonably easy to map, sector analyst Van Beek of Rinaco-Plus believes the future of Comstar could be affected by what he called the "wild card" of Russian telecommunications, the currently shelved investment tender for Svyazinvest, the state telecommunications holding company.