New Boss, New Plan

CEO Armstrong is moving fast to cut costs and position the giant for the Digital Age. Will his strategy work?

It didn't take long for C. Michael Armstrong to demonstrate that old-style thinking won't cut it at AT&T anymore. In mid-November, President John D. Zeglis and Vice-President Harry Bennett were explaining how AT&T had been trying to crack the crucial, $80 billion local-phone market by reselling service it bought from the Baby Bells. But Armstrong, who had joined AT&T less than three weeks earlier, wasn't buying it. AT&T had spent more than $3 billion on the local-market drive, yet its resulting revenues were a piddling $65 million. "We're not a nonprofit organization," he reminded his lieutenants--and promptly pulled the plug on what had been the centerpiece of the company's post-deregulation strategy.

Clearly Armstrong, the first outsider to head AT&T in nearly 80 years, is bringing fresh thinking to a company that desperately needs it. On Jan. 26, the blunt-spoken, Harley-riding former CEO of Hughes Electronics is scheduled to lay out his fix-it plan for what ails AT&T before a gathering of Wall Street analysts. While much of Armstrong's strategy revolves around fine-tuning AT&T's chief businesses--from making its wireless operation more profitable to beefing up its international operations--it also calls for bold measures.

Most startling is a wrenching cost-cutting that will leave no piece of the company untouched. Armstrong vows to shrink AT&T's overhead from a bloated 29% of revenues to an industry average 22% in just two years--a $3 billion to $3.5 billion reduction in annual costs that analysts have said would take five years. "We'll either get there, or the market will punish us for every month that we don't get there," says Armstrong in an exclusive BUSINESS WEEK interview. "I haven't seen a cost structure like this since IBM in the days of the mainframe."

Just as gutsy is Armstrong's plan to reverse course and back out of the costly local residential market--at least for now. That move flies in the face of prevailing wisdom: With AT&T losing share in its core long-distance market, most observers expected the company to spend heavily to enter new turf. But the high price tag for reselling service from the Baby Bells makes the effort "a fool's errand," Armstrong insists. That doesn't mean that he's about to give up on the market. Armstrong says he can't see an economical path in the immediate future. He does plan to offer phone service to local customers over whizzy new digital cable and wireless networks, but those could be several years away. More immediately, Armstrong is focusing the company's guns on the $20 billion local business market.

What's more, Armstrong is preparing AT&T, long thought to be a telecom dinosaur, for the Digital Age. He wants to push aggressively into the explosive Internet and digital-wireless markets by improving the company's Internet-access business and bundling the new technologies with the company's basic long-distance service. Insiders also say Armstrong may announce that AT&T will take an equity stake in Silicon Valley startup @Home, which offers high-speed Internet access over the cable network.

ENCOURAGING SIGNS. For all this, though, the key aspect of Armstrong's revival plan may rest on his continuing what he has already started--busting up AT&T's bureaucracy and placing greater emphasis on execution. He's streamlining the duties of his top brass, tying 75% of their bonuses to quantitative goals, and stepping up pressure to better analyze markets and make decisions fast. "I am demanding," he says. "If we're going to think through something, then get on with it. Don't study it to death. We'll never know everything we need to know. But we do know that if we don't make a decision in a timely way, we're in trouble."

Are these steps enough to pull AT&T out of the danger zone? Investors will be pleased with Armstrong's jihad to cut costs--and especially his willingness to commit to a deadline for accomplishing the task. "I would be surprised--encouraged, but surprised--if they said they could go to 22% in two years," says analyst Stephanie G. Comfort of Morgan Stanley, Dean Witter, Discover & Co. That should help meet the sky-high expectations Armstrong has raised: In the three months since he was named CEO, the stock has jumped 44%, to 65.

But the rest of Armstrong's tactics may not get the same applause. After all, the new chief still doesn't have an answer to AT&T's fundamental problem: It's back to being almost completely dependent on its core long-distance business just as the Baby Bells are poised to enter that market, grab market share, and cause margins to plummet. And he still has only the vaguest of plans for beefing up the company's international presence.

What's more, with the exception of stepping up cost-cutting and pulling out of the local market, Armstrong's agenda is not dramatically different from that of his predecessor. Former CEO Robert E. Allen also pledged to cut costs, expand overseas, and do away with AT&T's bloated bureaucracy. "Everything that I've heard has been tried before," says Michael Adamian, a retired AT&T manager. Even Armstrong's local approach is sure to raise a key question: whether he's sacrificing future revenue growth for a quick fix on the bottom line.

Armstrong insists this time will be different. To make the cost-cutting work, he's putting a freeze on hiring for new positions and says layoffs are in the offing. Analysts estimate that some 12,500 people could lose their jobs--10% of AT&T's workforce. What's more, say AT&T execs, Armstrong is proving to be a can-do CEO. They marvel, for example, at how the company acquired Teleport Communications Group on Jan. 8, just nine weeks after Armstrong arrived. AT&T had been in merger talks with the competitive local phone provider for several years. "Everything we do takes about a third the time it used to take," says Zeglis, who lost out to Armstrong for the CEO job but is now one of his biggest supporters.

There's no time to waste. For years, the telecom titan has been badly adrift. Under ex-CEO Allen, AT&T suffered market-share losses, boardroom blunders, and failed acquisitions. One of the biggest missteps was the 1991 purchase of computer maker NCR for $7.4 billion. After losing close to $4 billion, AT&T exited the business by spinning NCR off in 1997. The stock, one of the most widely held in the country, has been on a long trip to nowhere. During the four years prior to Armstrong's appointment, average annual return was 5.2%, vs. the 22.7% of the Standard & Poor's 500-stock index.

MUSICAL CHAIRS. Meanwhile, AT&T's executive suite has had more intrigue than a John Le Carre novel. Allen, who had been the company's golden boy since becoming CEO in 1988, turned reclusive in the face of media and Wall Street criticism. His first designated successor, Alex J. Mandl, grew impatient and left for a tiny wireless startup less than a year after being named chief operating officer. Allen then tapped John R. Walter, CEO of R.R. Donnelley & Sons. But Allen criticized his hand-picked heir apparent to the board, and last July, it decided to deny Walter the CEO title. Walter resigned--with AT&T paying him $26 million for less than nine months' work.

That set the stage for Armstrong's arrival. The 59-year-old executive left a 30-year career at IBM after then-CEO John F. Akers made it clear he wouldn't recommend him for the top job. Armstrong was "bitterly disappointed," according to a friend. He then sparked a remarkable turnaround at Hughes by taking many of the steps he's planning for AT&T--cutting costs 30% across the board, streamlining management, pushing pay for performance, and plunging into new, booming markets, including the satellite-TV business. Now, AT&T gives Armstrong a chance to prove himself at one of the great names in Corporate America. He clearly relishes the opportunity. "The favorite part of my week is Monday morning," he says.

Early Monday morning, that is. Armstrong radiates a sense of urgency. During a visit to the Seattle headquarters of AT&T Wireless Services, President Daniel Hesse told Armstrong he wanted to do three trials of a new wireless technology that could be used to skip over the Baby Bell networks. "He was so excited about it, he just said, `Go do it,"' says Hesse. It was Armstrong's second day on the job. He also opted to sell off AT&T's underperforming paging unit after just two months at the helm.

Now, Armstrong is trying to get AT&T to match his decision-making speed. In one telling case, he found that three committees were involved in similar top-level strategic decisions on everything from marketing to the local strategy--but even he couldn't figure out which one had the final say. So he pared them down to one group that will meet every Monday to discuss the company's top priorities. In some ways, Armstrong's approach is reminiscent of Lou Gerstner's when he joined IBM in 1993. On Jan. 23, for example, Armstrong will tell his senior staff he wants to make 120 top executives responsible for relationships with at least two large clients each. "When we make decisions, it won't be abstract," he says. "We'll have specific customers in the back of our minds."

He's also pushing pay for performance. At its December meeting, the board approved a new compensation structure in which 75% of most employees' bonuses will be tied to quantitative goals, including sales, profits, and costs. In the past, only 25% of the bonus was hitched to such results. And top executives will have stock-ownership targets so that their interests will be aligned with those of shareholders. Executive vice-presidents, for example, will be expected to own stock worth three-and-a-half times their annual salary. The much-criticized board also is on the hook: They set themselves a goal of owning close to $500,000 worth of stock each within five years.

Armstrong's early efforts have already eased one of AT&T's most persistent problems of late: morale. With a generous helping of positive press and a newly pumped-up stock price, Armstrong has convinced many employees that the company finally has a strong hand at the rudder. "We've been adrift for too long," says Lee Wheeler, a manager at the company's Mesa (Ariz.) facility. Still, others caution that Armstrong needs to take advantage of the honeymoon. "This euphoria will only last so long," says industry consultant Jeffrey Kagan.

Armstrong is guarding against that. Over the past three months, the new CEO has been trying to build support within the company's senior ranks. While Allen's style was likened to a judge presiding over a courtroom, Armstrong is said to be more like a coach. He asks questions, suggests alternatives, and then tries to reach a consensus. "The process is designed to allow the team to rally behind an idea," says Gail J. McGovern, executive vice-president for consumer markets. He has become particularly close to Zeglis, the former general counsel much valued by the board for his regulatory expertise. Armstrong converted Allen's old conference room into an office for Zeglis so the two could work next door to each other.

SUIT OPTIONAL. Armstrong also has stripped AT&T's executive suite of much of the formality it had under the reserved and aloof Allen. The new chief often wears slacks and sweaters to the office. And he's known for his humor. When CFO Somers told him he was going to New York for a few days, Armstrong leaned over to Zeglis and, according to Somers, said: "Dan's going to New York for the rest of the week--now we can spend money." He also encourages execs to stop by his office whenever they want to chat instead of scheduling meetings, as Allen preferred. "People don't book [an appointment] three days in advance," says Zeglis. "You just stick your head in and say, `Hey, Mike."'

Other changes are coming to the executive suite as well. Armstrong is planning to streamline the duties of his top lieutenants to improve accountability. That will include the hiring of a chief marketing officer, who will have companywide responsibility for promoting the AT&T brand. Today, that's handled by the head of each operating unit, with the biggest chunk in the hands of consumer-markets chief McGovern. Armstrong also says CFO Somers will give up international responsibility. Mark Baker was recently promoted to executive vice-president for international operations to give that market more attention.

Even with such streamlining of duties, Armstrong's employees are working harder than they have in years. No detail appears to be too small for his scrutiny. In mid-December, when long-distance execs were discussing a plan to send free calling cards to U.S. troops in Bosnia, they originally figured that 10 free minutes to be used by the end of the year would be a nice gesture. Armstrong's reaction? "Well, that seems kind of cheap," according to one executive at the meeting. The cards were upped to 60 free minutes, to be used anytime. "I'd like to say that he sets goals and leaves you alone, but he doesn't," says Jack Kuehler, a retired IBM executive who worked with Armstrong at Big Blue. "He sets goals and checks back frequently to make sure you're meeting them."

AT&T's ranks are finding that out the hard way. In all-day meetings that the new CEO calls "deep dives," his grilling is relentless. "He can home in on the critical issue like a heat-seeking missile," says Frank Ianna, general manager of AT&T's network. Indeed, when AT&T's Wheeler was boasting that his customer-service phone center won back customers who had defected to other carriers, Armstrong asked an incisive question: How long did these customers stay? Wheeler didn't know and tried to continue. "I got about four or five words out, and he held his hand up," says Wheeler. Armstrong stopped the meeting until he got the answer. Execs now realize that a 90-minute meeting scheduled by Armstrong can wind up lasting six hours. The result: Work days have stretched from 10 hours to 14.

Bu then, AT&T execs have a boatload of work to do. After asset sales and spin-offs, the long-distance business now accounts for a huge 90% of the company's revenues. That would be fine except that prices are sliding and AT&T is bleeding market share--down to 50%, from 67% in 1990.

That's certain to fall more. A recent Wichita Falls (Tex.) court decision could allow the Bells into the long-distance business in a matter of months. Although the decision may be held up in appeals, the Bells will enter within the next two years. Those rivals vow to break up what has been a cozy, lucrative relationship among the Big Three long-distance players. "[The Bells'] entry into long distance is clearly a strategic problem for them, because AT&T, MCI, and Sprint have been an industry cartel that has moved prices in lockstep," says James G. Cullen, president and CEO of Bell Atlantic Corp.'s Telecom Group.

Those are more than fighting words. Once the Bells get into long distance, they could swipe as much as 10% of the U.S. market each year for the next three years, analysts estimate. That could mean revenue losses of $1 billion annually in AT&T's core business. Margins also are headed for a fall.

U S West says that if the Bells get into AT&T's home court, average prices would decline 15% to 25% within a year. "All hell is going to break loose," says Brian Adamik, vice-president at market researcher Yankee Group Inc.

Armstrong may have unintentionally sped up that process. Buying Teleport will make it easier for the Bells to argue that AT&T is already in the local business--so under the Telecommunications Act of 1996, they should be allowed into long distance. That would give AT&T full-blown competition in its core business, while it only is pushing into the local business market--some 20% of the local market. And that could be optimistic. With Teleport's base of less than $500 million in 1997 revenues, it will take years before it has much impact on the company's overall revenues--an estimated $51.6 billion in 1997. "I think that may be a strategic blunder," says analyst Blake Bath of Lehman Brothers Inc.

At the same time, AT&T is facing scrappy new competitors who are providing cut-rate long-distance service using Internet technology. So Armstrong will have to scramble for growth opportunities. "The challenge is to change the airplane's engines at 30,000 feet," says H. Brian Thompson, chief executive officer of long-distance competitor LCI International Inc.

GLOBAL SEARCH. To swing that maneuver, Armstrong will try to expand in international markets--a $400 billion prize. The new chief executive, who spent three years in Paris when he was working for IBM, point outs that some of AT&T's current partnerships are failures--just last year, Spain's Telefonica left the AT&T fold to join British Telecommunications. The patchwork that remains is producing poor service for corporate customers. "What [customers] don't appreciate is compromise," he says.

Instead, he thinks AT&T needs to own its networks overseas--and that means building some facilities and probably making an acquisition or two. Britain's Cable & Wireless PLC is a logical candidate--and a company with which Allen discussed a merger. Armstrong says he hasn't talked to Cable & Wireless and that he needs time to study all the international carriers. Given that most of the big foreign players are former monopolies with partial government ownership, an acquisition won't be easy to pull off. In the meantime, even BellSouth and SBC Communications have scored big with deals in Brazil and South Africa.

The wireless operation also is a work in progress. Armstrong wants better performance out of the business, now No.1 in terms of subscribers in the U.S.--but not the most profitable. Armstrong thinks many wireless companies are unwisely chasing customers with low monthly bills, high turnover, and risky credit. So he and Hesse have sketched out a more conservative strategy of sacrificing growth in exchange for profits. Hesse won't have to match industry growth rates for revenues, now averaging about 20% annually. But he will have to push up operating profits, now 10% of revenues, into the top quartile of similar companies, about 15%. He's got a good chance of making it if he can keep rapidly converting AT&T subscribers to the lower-cost, higher-margin digital service. AT&T has already converted 2.1 million of its 8 million customers.

But the real value in owning the nation's largest wireless operation lies in combining it with the rest of the company to allow AT&T to offer bundled service that no competitor can match. AT&T has tried--and failed--to integrate the Seattle-based wireless unit ever since its purchase from Craig McCaw in 1994. "They might have worked extra hard to assure their independence and self-sufficiency," concedes Armstrong. He has charged McGovern and Hesse with figuring out ways for them to work together. One plus: Hesse, who took the helm of the wireless unit last year, is the first AT&T executive to head the group.

Armstrong wants a similar overhaul of AT&T's Internet operations. Its WorldNet Internet service was launched in 1995, and it has since grown to 1.1 million subscribers. But WorldNet's growth is slowing in the $6.5 billion Internet-access market that is jammed with giants and scrappy startups alike, from Microsoft and America Online to Netcom and EarthLink. Worse, Armstrong admits he's not sure how a company can make money in that market by selling $20-a-month access.

The rescue plan? If AT&T takes an equity stake in @Home, that would make it possible for the telecom giant to offer high-speed service at a premium price--and a profit. @Home could also manage the AT&T accounts so that the startup would bear the costs of providing the service while AT&T could bundle Net access with its other offerings. "We're not making money today," says Armstrong. "If you can't make money, why are you doing it?"

And making money is Armstrong's No.1 priority. He plans to lop off expenses through big and small measures, from layoffs to halving the $80 million the company spends each year on consultants. He has even stopped executives from using the company's chauffeured limos to get from home to the office. "Now, I can ride my Harley to work in the summer," Armstrong says. Jokes aside, the results could be profound. With lower costs, AT&T could afford to drop its long-distance rates and stem its market-share slide.

He does see one new opportunity to generate cash: corporate outsourcing of communications. Armstrong thinks phone systems are becoming increasingly complex and important to corporations, just as computers did 20 years ago. When they look for outside help, he wants them to turn to AT&T. "If there's one thing AT&T knows how to do, it's manage communications," he says. Landing customers won't be easy, though. Rivals MCI and WorldCom, in particular, already offer similar services.

Armstrong has plenty of time to find a solution. He says persistent rumors that he has only a three-year contract are false. "It's a six-year contract, and I'll retire at 65," he says. "Can you imagine trying to turn AT&T around in three years?" Maybe not. But for three months, he's off to a good start.

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