U S West Scouts A New Frontier

It turns to digital services after a phone-cable TV misstep

You would think U S West Inc. might be a little gun-shy about jumping ahead of its Baby Bell brethren with glitzy new technologies. After all, the Denver-based Bell bet heavily on the "convergence" of telephone and cable-TV services in 1993 when it began amassing the third-largest collection of cable properties in the country. Last year, the company conceded the experiment wasn't working, and at the June 4 annual meeting, shareholders are expected to approve a plan to split the company in two: a telco to be called U S West Inc. and a cable company, MediaOne Group Inc.

But even before the cable plan is laid to rest, the new U S West is back to its trailblazing ways. This time, the company is diving into risky new ventures in an aggressive bid to become the telephone industry's technology pacesetter. By July, it will offer superfast Internet access in 43 Western cities with a largely untested technology called digital subscriber line--even though most other Bells have refrained from broad deployment because of high costs and a lack of industrywide standards. U S West also is building a digital wireless network--just as rising competition is dragging down profits for others in the business. The company even plans to deliver TV service via the phone lines to Phoenix residents this fall. Never mind all the technical challenges, says Solomon D. Trujillo, chief executive of the phone company: "We're not piloting. We're deploying."

MERGER CANDIDATE. Why go back out on a limb? Trujillo has no choice but to create new markets--and fast. After the split, U S West will again be the smallest, least diversified Baby Bell in a fast-consolidating industry. Unless it finds fertile new ground, it could be swallowed by a hungry rival like SBC Communications Inc. or Ameritech Corp., analysts say. Trujillo should have a two-year hiatus from unwanted bids, thanks to tax laws that make a merger prohibitively expensive in that time. By then, Trujillo had better have plenty to show for his digital forays. "U S West already is a likely merger candidate," says analyst Robert B. Wilkes of Brown Brothers Harriman & Co. "If it stumbles, that would accelerate the process."

What are Trujillo's chances for success? His odds are long. U S West could lose 20% to 40% of its core local phone business in the next five years as competition from new rivals grows, executives admit. Its entry into long distance could be delayed for a year or more because of regulatory challenges from AT&T and others. And if its bold new ventures fall flat, its best customers may leave for cable companies and others that plan to bundle phone service. "If we lose the 25% of customers that give us 75% of our profits, we have a survival issue," admits Richard D. McCormick, who is CEO of the combined U S West and will become chairman of the new phone company.

Trujillo insists this effort will be different, in part because he learned vital lessons from U S West's cable effort. Instead of leaping headlong into technologies, he's installing gear city-by-city to work out kinks. And rather than jumping to a new network, like cable, he's focused on exploiting the phone network to offer new services. One example: Customers can now get one number for both their home and wireless phones. The goal is to persuade today's $40-a-month phone customers to spend $100 or more for Internet access, wireless, long distance, and TV charges--along with local phone service. "Making all this stuff work together, that's our mission," says Trujillo, who hopes the new services will account for 60% to 70% of revenues in 10 years.

So far, Trujillo is getting kudos from Wall Street. U S West's shares have risen from 30 to 54 since July, largely because management has improved a terrible customer-service record and slashed costs by more than $1 billion. "The company is just blocking and tackling much better," says analyst Tod A. Jacobs of Sanford C. Bernstein & Co.

"TOO EXPENSIVE." Still, U S West's plan is loaded with risk. Consider its DSL service, which went live in Denver, Boise, and Salt Lake City on May 4. DSL turbocharges traditional copper phone lines so they can carry data at speeds of up to 7,000 kilobits per second--100 times faster than today's modems. U S West is offering several different flavors of DSL. The top speed is aimed at big companies that would pay $840 a month, while small businesses and consumers can opt for slower service that costs $40 to $80 a month.

Even with tiered pricing, cost could be an obstacle. DSL may be popular with businesses willing to pay top dollar in cableless downtown sites, but "DSL will be too expensive for the consumer side," says Don Hutchison of @Home Network, which offers rival high-speed Net access over cable networks.

Indeed, U S West is staring down a challenge from @Home and the cable industry. While the company is just starting to offer high-speed Net access, Cox Communications, Tele-Communications, MediaOne Group, and others have sold 200,000 cable modems. There's a reason: Cable connections to the Net are typically 33% cheaper than U S West's service and their download speeds are four times as fast. DSL subscribers also must live within three miles of the phone company's central office. By contrast, cable modems soon will be available to almost any home with access to cable TV. Cynthia B. Brumfield, an analyst with Paul Kagan Associates, figures 3.7 million cable modems will be sold by 2000, vs. 1.4 million DSL modems.

U S West is moving aggressively in its 14-state Western territory to fend off cable players, which have focused on the Northeast. The company's 43-city DSL rollout will reach 5 million potential consumers by July. And it may lower its $40-a-month charge for DSL bandwidth within the next few months. "I'm deliberately driving my margins as low as I can bear, because we need massive adoption," says data networking chief Joseph R. Zell.

But cost could still snag U S West's grand plan. The company will have to invest roughly $700 per home to offer the consumer service and won't see a profit for at least four years on DSL alone, says Zell. Executives figure they can cut the payback time in half by urging customers to also use U S West as its Internet access provider and to buy software for things like protection against computer viruses.

Even then, there must be no surprise DSL costs--a rarity with new technologies. In 1994, for example, a pilot in Omaha to install new broadband cables encountered costs that ballooned to nearly $2,000 per home because U S West had to dig up user's yards for the installation. Indeed, the DSL plan assumes no major upgrades are needed to bring decades-old phone lines up to snuff. Says McCormick: "I don't think it's a big gamble because we'll never have to dig up the rose bushes."

It will be even tougher to make the company's Phoenix video service a success. What U S West wants to do is use a high-powered version of DSL to provide TV over traditional phone lines. That presents tremendous technical challenges because TV programs require 10 times as much bandwidth as U S West's residential DSL service. Many analysts simply doubt the technology can be installed at acceptable costs. They also see U S West's entry into video as a knee-jerk response to Cox Communications, which has been selling phone service in Phoenix along with cable-TV packages since December. "A huge chunk of this is cage-rattling to try to put the fear of God into the cable operators," says analyst Brumfield.

What will make or break U S West's digital future is whether it can go beyond simple bundling of its phone, Internet, and DSL services into more innovative offerings. Trujillo envisions a "unified messaging" platform that lets consumers hear their E-mail on portable phones or see the text of voice messages on their TV screen. While U S West's single number for wireless and wireline phones is a good start, Trujillo knows that he needs more ways to distinguish his products. "Sol's impatient for more integration," says Vicki Callen, head of the unit rolling out TV over phone lines. That's hardly the stance of the gun-shy--but then, Trujillo has no time to hesitate.

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