News: Analysis & Commentary: STRATEGIES
MA BELL RIDES AGAIN
13.5 billion dollars. Keep that number in mind as you marvel at how much AT&T is willing to spend, the regulatory hassles it will have to endure, the acquisitions it might make in the coming years to get into local calling. That's because $13.5 billion is what AT&T shells out every year to the nation's local phone companies for access to their networks. That constitutes about 40% of AT&T's cash operating costs and equals almost one-third of its total revenue.
It's a number that is sparking the next great battle in telecommunications: In an effort to shed the expense of access charges, AT&T is gearing up to compete with local phone companies on their own turf. On Oct. 26, AT&T finally announced that it will offer local service anywhere, any time that it is allowed, for the first time since being forced out of the business in 1984 by the Justice Dept.
In the next few weeks, say sources close to the company, AT&T will unveil a partnership with one or more so-called alternative access providers, allowing it to bundle local, long-distance, and cellular services--even, possibly, cable TV and enhanced features such as voice mail--into a single AT&T-brand offering. "We will fight for the right to give our customers a choice for local service through every option open to us," Chairman Robert E. Allen said in a statement.
In its momentous undertaking, AT&T is well behind rivals. Sprint Corp. has been developing a local-service strategy for more than a year, through its alliance with three of the nation's top cable-TV operators. And MCI Communications Corp. has spent $600 million during the past two years to build local networks in 17 cities. AT&T, meanwhile, has only dabbled in local service in Rochester, N.Y.
LONG HAUL. One stumbling block has been legislation that strictly limits the long-distance companies' abilities to offer local service. But telecommunications-reform legislation, expected to be hammered out by Christmas, would throw the local-calling market wide open to competition. And AT&T itself removed the other barrier: On Sept. 20, it said it would spin off its Network Systems equipment unit, whose biggest customers are the local carriers. For years, AT&T was reluctant to do battle with those big spenders. Now, the gloves are off.
The fight, however, will be tough. And the options all are expensive. The costs of constructing a new national phone network from scratch, for instance, would be exorbitant. Royce J. Holland, president of alternative local carrier MFS Communications Co., estimates that it would take some $5 billion and the rest of the decade for AT&T to build local systems just in the 50 largest markets.
Instead, AT&T might decide to buy a company that already has access--such as MFS, which serves businesses in 42 cities. Alternatively, it could acquire or partner with cable operators Time Warner Inc. or Continental Cablevision Inc., neither of which have joined the Sprint alliance. An acquisition wouldn't be cheap, either--MFS has a market valuation of $3 billion. And only a handful of cable systems have been upgraded to offer phone service. Either route, though, would jump-start AT&T's independence from access fees, giving it direct access to customers.
For local phone companies, that's a menacing prospect. UBS Securities Inc. analyst Linda B. Meltzer estimates that while AT&T may lose 10% of its long-distance customers to the Baby Bells during the next few years, the Bells could lose anywhere from 20% to 40% of their local customers once AT&T enters the market. AT&T's edge: It will be able to bundle together local, long-distance, and international calling, a cellular service, Internet access, even a credit card to pay for it all. Most of all, AT&T has a brand name that is virtually synonymous with phones and spends $700 million a year on advertising.
GORILLA WARFARE. The result: Big-time credibility. A recent Morgan Stanley & Co. survey found that only AT&T inspires brand loyalty among phone customers. In the local residential market, 30% of those asked said that if prices were the same, they would switch to AT&T. "They are not coming in as a beggar with a tin cup," says Thomas J. Reiman, Ameritech Corp.'s senior vice-president for state and governmental affairs. "Truly, AT&T is the 800-pound gorilla."
For now, though, this gorilla has little choice but to rely on the Bells' networks. "The only way in is through resale," says Joseph P. Naccio, head of AT&T's consumer calling business. "It's just the prudent way to start." The problem: It's nearly impossible to make money in resale unless the dominant carrier offers significant reductions off retail prices. ATT, which was forced to give a 55% discount to MCI and Sprint when competition started in long distance, wants Washington to require the Bells to offer discounts of 25% to 35%.
The Republicans directing telecom legislation would prefer to leave pricing up to the market. In some cases, that could be the right solution. "We figure AT&T will come in as a reseller and stimulate the hell out of the market," says Richard A. Jalkut, president of Nynex Corp.'s telecommunications group. "We'll end up growing our wholesale business." So Nynex plans to offer resale prices low enough to prevent AT&T and others from building a competing infrastructure.
WIRELESS WONDERS. Ultimately, though, AT&T can only control its own service if it owns its own network. And that won't happen anytime soon. Naccio notes that AT&T owns just 136 highly advanced digital switches across the U.S., while Ameritech has half that number in Chicago alone. "There is a myth going around that we have some big secret network just waiting to handle local service," says Naccio. "But all our switches operate at engineered capacity. We do not have surplus assets lying around."
What it does have is wireless. AT&T's cellular network covers 30% of the nation's population. The licenses it owns for the new Personal Communications Service (PCS) will give it 80% coverage. If offered comparable price and reliability, analysts say, most customers will choose mobile phone service over their wired phone. And equipment is reaching the market that will address wireless' capacity limitations.
Naccio cautions that wireless local access "is not imminent." But AT&T's national network should be in place in 1997, and analysts figure that by 2000, wireless will emerge as a real threat to stationary local service. It isn't hard to figure how AT&T will find the $2 billion to $3 billion that construction of such a high-capacity wireless network will cost. Just keep thinking: $13.5 billion.
AT&T could buy local network capacity from existing phone companies at wholesale prices, then resell it to consumers.
PROS: AT&T could leap into the business immediately.
CONS: It would be tough to make money unless local carriers discount steeply.
By building its own competing local phone systems, AT&T could bypass existing local carriers.
PROS: AT&T could have complete control and save of billions in access fees for long-distance calls.
CONS: A network could cost $5 billion or more, and take several years to build.
AT&T's McCaw deal gives it a cellular network covering 30% of the U.S.; throw in PCs, and the number hits 80%.
PROS: Mobile phones are booming, so marketing would be easy. Plus, there would be no long-distance access fees.
CONS: Bandwidth capacity can't yet equal the nation's wired network.
FIND A MATE
AT&T could bypass Baby Bells by hitching up with cable companies or alternative local carriers.
PROS: Bye-bye, access fees.
CONS: It will take years to upgrade most cable systems to carry voice traffic, and Sprint already has a deal with three of the largest cable companies.By Catherine Arnst in New York, with bureau reports