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Now for the Hard Part

In his first 18 months as CEO, Michael Armstrong announced $140 billion worth of acquisitions, an amount equal to 71 percent of AT&T’s current market capitalization. He’s raising expectations as he turns Ma Bell into an edgy, coaxially cross-dressing dot-corn telecom. Soon we’ll see how well Ma Broadband can duke it out with upstart advanced capacity networks and former Baby Bells that have matricide on their minds. So far, so good. But the biggest obstacle lies just ahead.

Once a monopoly, always a monopoly? Since the telecom industry’s beginning at the turn of the century, large national monopolies provided mostly basic service on a take-it-or-leave-it basis. In the U.S., deregulation nation in the early 1980s opened up long distance, e industry is in turmoil as never before. Challengers such as Qwest, Global Crossing, and Level 3-all of which have technologically advanced, high-capacity networks-are hotly pursuing customers, while operators with established customer bases are frantically updating obsolete networks. M&A activity is at an all-time high as the quest for strength and infrastructure intensifies. Almost two decades after Judge Greene’s decision broke up the Bell system, we are beginning to see the communications industry compete with the gloves off and no quarter given. Convergence, that overripe term for the conjunction of telephony, computing, and multimedia, may soon be upon us in unanticipated ways.

Since Armstrong assumed the CEO title in November 1997, he’s forced AT&T to redefine how it reaches its customer base. To get back into the local consumer business, it bought TCI, the cable industry’s No. 2 giant telecom, for $59.4 billion last year. This year, it agreed to acquire No. 3, MediaOne Group, pending government approval, for $62.5 billion, as well as Lenfest Communications for $2.2 billion. If the deals fly, AT&T will have access to 60 percent of the nation’s households.

Make no mistake, Armstrong’s gambit is not just transforming a big long-distance carrier to a big any-distance carrier. His move makes cable the preferred way of delivering access to total telephony, as well as to unlimited video, music, and interactive entertainment. He reckons the best way for AT&T to achieve its goals is to have a direct connection with its customers the way it did before deregulation severed the link between local and long distance. Unlike most of its long-distance rivals, which derive revenue from business customers, AT&T gets 50 percent of its revenue from its 75 million residential customer base. This will fund Armstrong’s ambitious goal to transform the $53 billion giant’s entry into the Internet age. If successful, AT&T will not only become less dependent on long-distance revenue, it will compete head-on with the former Bells that have been siphoning AT&T profits by charging access fees to complete calls.

There are other technologies than cable, including satellites and digital phone lines. (AT&T is switching its networks from circuit to packet transmission, such as Internet protocol, enabling the convergence of communication services.) It’s not clear which will have the best cost advantage in the end, but Armstrong is adopting Confederate General Nathan Bedford Forrest’s strategy of whoever gets there “firstest with the mostest” wins. To that end, AT&T is insisting its cable system is proprietary and should not be treated as a utility. Armstrong wears a halo in Congress and among telecom regulators because he promises to bring direct competition for local phone service. But AT&T is fighting local rulings in Portland, OR, and Broward County, FL, which seek to impose open-access requirements to its cable system in those areas. And while rivals such as Bell Atlantic are crying foul, saying AT&T wants its own monopoly, Armstrong maintains that users can avail themselves of any Internet service provider and that open-access should be decided at the national level.

His aggressive moves have clearly energized the somnolent giant of Basking Ridge, NJ. But are the sweeping claims of faster growth and market share gains credible? Three years ago, then-AT&T chief Robert Allen asserted that the firm would pocket 30 percent of the former Baby Bells’ local customers by reselling the local exchange’s service under its own brand-which, of course, never happened.

Having spent 40 years with three companies, 30 with IBM and five with Hughes Electronics, Charles Michael Armstrong, 60, has seen how technological shifts can suddenly undermine one’s market position. He joined IBM in 1961 and by the mid-1980s had worked his way into senior management. He belonged to IBM’s personal computer group, which started the decade as the industry leader. But, by the end of the 1980s, faster-moving competitors such as Compaq and Dell left it in the dust. This failure proved bracing. At Hughes, he demonstrated a strategy for competitive success in fracturing markets of not simply unbundling one’s business, but unbundling and rebundling to create a new enterprise. Steering the company away from military electronics, Armstrong pursued commercial satellites as well as DirecTV, the service that uses satellite dishes instead of cable.

A Detroit native, Armstrong spent much of his youth playing baseball and running before fixing on football as his main sport.His style remains building inclusive teams rather than creating a cult of personality. Executives who have worked with him say he is a listener who has a great capacity to take in streams of information and quickly drill down to essential details. He came to both Hughes and AT&T as an outsider and didn’t hesitate to trim thousands of jobs. At AT&T the chop came on top of 34,000 jobs cut under Robert Allen. With his perennial grin and shock of silver white hair, he exudes confidence from every pore and is no stranger to overcoming adversity.

Retelling the story of his efforts to convince his future father-in-law to allow his daughter, Anne-who would later become Armstrong’s wife-to attend Miami University of Ohio with him, Armstrong recounts being told by the GM executive that “it was likely that I would end up selling popcorn” at the home stadium of the Detroit Tigers. Hughes Electronics, which Armstrong would later non, is one of GM’s major subsidiaries.

But this time, making his audacious goals work as advertised will be tough. “I admire him as a CEO; he’s the right guy for the job. But I wonder whether it’s a moon-shot,” observes Bell Atlantic’s Ivan Seidenberg, reflecting on whether making cable a truly interactive media will be beyond AT&T’s reach. Industry observers point to other more immediate challenges. While telephone is the most common bridge to cyberspace, as an integrated Internet and multimedia provider will AT&T be responsive to customer sensitivities or will it be mired in the behavior of its former monopoly self? It’s a rare customer today who doesn’t have a telephone horror story about wireless service. AT&T’s Digital One Rate cellular phone service, which promises to make one’s cell phone as simple and affordable as a land line, is a marketing success, but customers report frustration with dead spots, call cutoffs, and frequent inability to place or receive calls. Such problems are not unique to AT&T, but they signal a potential chasm between the promise of Big Technology and the quality of service customers actually receive.

While AT&T’s customer service record has rebounded of late, it’s been relatively weak overall, according to consumer surveys by Odyssey, a San Francisco-based consumer research firm. Its wireless margins are also half to one-third that of some of the former Baby Bells. Armstrong and his team may yet prove their technology’s capabilities, but getting the value proposition right is another matter.

IN THE FRAME

What is it that you still need to complete the AT&T picture? And what’s it going to look like when it’s done?

All of the investments that you’ve seen us do have been consistent with five underlying strategic principles laid out back in January of 1998: resale to facilities, narrowband to broadband, circuit switch to packet switch, domestic to global, and building a wireless business-it’s not a regional analog cellular business, but a national digital-integrated business.

We have not completed what we need to do. In consumer space, with MediaOne, we now have 25 percent of homes that have access to cable service. We’d like to get more, and we think we can by negotiating with the Time Warner Entertainment investment, and with joint ventures from there.

In the business space, we are running very successfully against the build out of 0C-48s [Internet Protocol-capable fiber-optic cable]. We anticipated about 3,000 sections, and we’re probably going to do 4,000 0C-48 sections domestically this year.

Internationally, a targeted joint venture with British Telecom gave us a presence in 859 cities in 60 countries around the world, with 5,000 skilled people. But now we have to complete other investments, such as our 30 percent Japan Telecom investment. In wireless, we’re up to about a 60 percent service area footprint, and we want to get to an 80 percent footprint, so that we’re not buried by roaming charges.

At the same time, we have to execute quarter by quarter against the opportunities and the marketplace to be competitive and to grow our firm.

To do the MediaOne deal, shareholders had to absorb a 30-cents-a-share dilution on top of the $1.10 in the T01 deal. How does this affect earnings, not to mention future deals?

Dilution has been offset by three things: One, a $1 billion or $2 billion cost reduction that we’re committed to in 2000. Two, a $9.2 billion inflow from our swaps with Comcast; and, three, a $5 billion investment by Microsoft. When you get done with that, that 28 percent dilution for MediaOne looks more like 10 percent.

To address the question of shareholder value, we’re deploying the significant free cash flow from our mature long-distance business, $18 billion to $20 billion this year, in growth opportunities. These include cable and the new digital business streams from that cable infrastructure, the solutions business, the data business, and the Internet, as well as global and local.

To measure new and emerging technology-driven growth businesses like these in earnings per share (EPS) is ridiculous. They ought to be measured by cash flow per share or on an EBITDA like standalone companies. We’ve become a company that must be valued on a sum of the parts basis-mature businesses that are EPS generators, and new growth businesses, technology-driven business, that are EBITDA multiple. When people do that, they see a company that should have a mid-70s value. And in a year or two, with our published commitments, a mid-90s value in stock price.

The deal-making prowess and the vision of putting these disparate and not-so-disparate pieces together are impressive, but where are you in terms of execution?

The best measurement for execution is results, rather than rhetoric. First, we have progressively increased our revenue growth from 1 to 1.5 percent in the first quarter of ’98 to 6.1 percent in the first quarter of ’99. And our projection of 7 percent to 9 percent will be realized.

Second, we said we would get cost competitive. We took $1.6 billion of cost out, we downsized 20,000 people in 1998. We got a rush G&A from 29.6 to 24.4 percent. We will get it below 21 percent by the end of this year. We’ll take another $2 billion out of our cost structure in 2000.

Third, in each of the last four quarters we have increased the EBITDA of this company by $1 billion or more and improved the EPS on the final bottom line by more than 45 percent. We’re demonstrating we can make strategic investments and bring them into the strategy, culturally combine disparate companies, and execute against growing our business and conducting our earnings in EBITDA, exceeding the expectations of the market.

Time and scale are my biggest enemies in execution. The reason we’re going so fast is we have to go this fast. Deregulation, competition, and technology are all driving against us executing that strategy as we do new things. I bought a digital infrastructure to build an Internet business on a broadband basis rather than a narrowband basis-to drive telephony over broadband, and penetrate the local market. I bought TCG to have 12,000 miles of fiber and 8,000 people to accelerate the growth of connectivity from us on the end-to-end basis with businesses.

Working on these investments to realize the opportunity and to-in a timely way-scale the systems, the training, the deployment, and the market acceptance are the two biggest challenges. And I’d say they’re all I bargained for.

What didn’t you bargain for?

The biggest surprise is the amount of interaction that I have with Washington. I probably assumed that AT&T had been a deregulated company, it was no longer a dominant carrier, and certainly I would have to go through Hart Scott Rodino. But there’s much more interest in Washington as that continues.

Obviously you have had to lay off people. How did you get past all the friction that inevitably erupts?

By the way you do it. We offered an enhanced pension voluntary retirement program, so that of the 20,000 downsizing, 15,000 were voluntary. People who took it appreciated that we respected their tenure and the 88 percent who were still here respected that we chose to deal with people that way.

DOT.COM FEVER

How do you deal with Internet envy-when talented people see peers leave a company for some dot-com operation, get fantastic options, and become rich. And the others say, “Shouldn’t I be out there doing the same thing?”

There are right reasons and wrong reasons people leave companies. For some of the people who have left AT&T, it was the right thing for both the company and them. Then there are people you don’t want to lose. I have lost several executives I wish were still here, and that will continue because AT&T has such a wealth of talent. We develop people, we give them challenges, and they become known in the industry for their accomplishments. We’ve got a vibrant and young management team. I’m the old man. It’s hard to find anybody here over 50 years old. And that’s good, because we work like hell. But people are attracted by other opportunities. It’s a way of life.

We put a retention package in place. But there’s nothing I can do if somebody gets an offer that’s astounding-such as an executive who recently left did. You shake the guy’s hand and say, “I understand; good luck to you.” But as long as we continue to develop people, give them challenging responsibilities, and support them in the development of themselves as well as the business, we’re going to keep more people than we lose. As soon as we stop doing that, we’re going to have more departures.

You have new competitors, like Global Crossing, Qwest, Level 3, as well as existing ones that want to take you down a peg. How do you assess your competition?

Well, the RBOC entry in long distance is going to be one of the classic commercial battles, since they have 98 percent of the market I’m going after. The incumbent is well-lodged. On the other hand, I compete today against 500 long-distance companies, I think I know how to compete.

One of the things I live by is that you assume nothing in the pursuit of opportunity, and never underestimate competitors. We’re going to have plenty of new competitors, as communications is redefined by the Internet, deregulation, technology, and globalization.

Is it safe to say that technology will blow past the regulatory hurdles in the end?

One of the reasons telecom technology didn’t flourish at the same rate as, say, the semiconductor industry is that it was a regulated monopoly. In fact, it was the only business I know where you could redecorate your office and increase your rate of return. Unless deregulation is fairly and evenly applied, technology will only result from competition. DSL, for example, has been around for how many years and never deployed? Now that we’re getting the cable infrastructure upgraded, and cable modems deployed, DSL’s suddenly coming to market. What a surprise.

John Chambers of Cisco says that telephony of the future will be basically free-an add-on to the Internet services. Your view?

Everybody’s saying that communications is a commodity, and that the world is going from circuits to packets. I agree with that. That we’re going to go from usage-based pricing to some form of flat-rate pricing. I agree with that, too.

I don’t think that John’s going to be giving away his routers, switches, and multiplexers. So if the networks are still going to cost something, then we’ll be able to pay for his equipment, and in turn offer flat rate services that people will pay for.

When people say, “this will be free” they’re not saying that their equipment is free, or my service is free. You’re going to pay for capacity in some form. The Digital One wireless phone rate is a good example. We took wireless calling, roaming charges, and long distance, and put them in a bucket of minutes, and you pay $149 for 1,500 minutes, period, flat rate. It’s not free, but you get three services. So you can say long distance is free because I’m getting wireless minutes or wireless is free with long distance.

With all these people building networks, will there be excess capacity after the smoke clears-even with the demand increasing?

If I get a new computer that costs half as much and is three times faster than my old one and put the same applications into it, my utilization might go from 76 percent of capacity down to 22 percent. What do I do with that extra capacity? I consume it. By the time the next computer comes out I’m back up to 76-78 percent, and I want better resolution, faster response time, and quicker spreadsheet calculations. The same thing will happen to bandwidth. Will we overbuild? Sure. Will there be more capacity than utilization? Sure.

Some firms may have a real problem. We won’t, because we have traffic. Networks are funny beasts; they’re very hungry. They have to eat traffic or they don’t spit out return. If you build a network and linger too long without volume, you lose your shirt. Will we invest ahead so that we don’t get caught capacity-short? Sure. But we’re not a start-up, building and laying fiber without traffic. We’re building fiber ahead of traffic we know we’re bringing in. AT&T has an enormous volume of traffic. Today, it’s voice and data; tomorrow it’s voice, data, and video. With our end-to-end broadband strategy, we’re able to fill the capacity that we invest in and buy.

MODELS WITH MICROSOFT

Your arrangement with Microsoft seems like a sweetheart deal. You get $5 billion in investment, and they don’t get an exclusive on their Windows applications. Where is that relationship headed?

I was delighted that Bill Gates offered to invest. First, it was an endorsement of broadband, and that meant something in the marketplace. Second, it was an endorsement specifically of AT&T’s broadband strategy. Third, Bill offered to partner with us for rapid deployment. A lot of the vision is just that, and it’s got to turn from vision to execution. Bill and I agreed to team up to deploy technology, function, feature, and demonstrate what we can do.

At the same time, we protected the fact that this is an open systems architecture. It will absolutely be multivendor. Bill not only got the Model Cities Program with us, but we gave him an additional 2.5 million copy commitment, so he now has a 7.5 million copy commitment of the Windows CE operating layer. That’s against a potential of 26 million, so there’s plenty of runway left for anyone else, such as Java or Sony, to supply equivalent functionality.

We’re going to go out there and show what the set-top box interactivity can bring to television sets and PCs. In ’99 we’re going to pilot it, so that when the brand goes on, the quality of service you would expect equals that brand respect. In our first pilot city of Fremont, CA, we delivered more features, more function, more bundles, at 16 to 33 percent lower prices. There’s nothing like “I’ll give you more, but I’ll charge you less” to demonstrate the reality of it all.

In 2000, we will take it from pilot to communities, so that we know that we can satisfy paying customers against real demands of the marketplace. And in 2001, we’re going to take it to scale to market. So we’re going to go from thousands of pilot customers in ’99 to hundreds of thousands of real customers in 2000, to millions of customers in the year 2001.

The reason that I can’t go any faster is that scaling to America is 103 million households. It took 75 years to build the public switch network; it took 40 years to build the cable infrastructure of America. And what we’re taking on is equally large in a very condensed period of time.

Will you be forced, as in the computer world, to adopt some kind of Moore‘s Law and push harder for better technology?

Sure. A little while ago, we were thinking about how fast we’re going to go with OC/3 deployment. And we’ll do 4,000 0C48 sections this year. We’re talking about orders of magnitude. We’ll put in more capacity this year alone than in the entire prior history of AT&T. And it won’t be different going forward.


AT&T’s Brain Drain

Keeping top-notch management talent is proving one of AT&T-and Michael Armstrong’s-biggest challenges. “I’ve lost several executives who I wish were still here,” says Armstrong, reflecting on the revolving door at AT&T headquarters. “I’ve also lost people for whom it was the right thing for both the company and them.”

“Large companies are going to lose people to small companies or better opportunities for the reasons that are right,” he shrugs. “But as long as we continue to develop people, give them challenging responsibilities, support them in the development of themselves as well as the business, we’re going to keep a lot more people than we lose.”

Top execs who left AT&T to follow their own stars include:

August 19, 1996 Alex J. Mandl, president and COO, departs to head teligent as chairman and CEO.

December 22, 1996 Joseph P. Nacchio, executive vice president and 26-year AT&T veteran leaves for the president and CEO post at Qwest Communications.

 Jan. 22, 1998 Jeffrey Weistzen, president of business markets, leaves for the president and COO post at Gateway.

Aug. 19, 1998 Gail McGovern, president of consumer markets, leaves after a 24-year tenure to become a senior operating officer at Fidelity.

Feb 24, 1999 Robert Annunziata, president of business services, departs for the CEO seat at Global Crossing.

June 17, 1999 Daniel H. Schulman, president of consumer markets, leaves for president and COO post at Priceline.com.

About JP Donlon

JP Donlon
JP Donlon is the Editor-in-Chief of Chief Executive magazine.