AT&Ts divestiture and fiber optics

STEPHEN N. BROWN

Some industry observers may still be perplexed by AT&T`s recent divestiture, but one Lehman Brothers` analyst, Ken Leon, was right on target with his diagnosis: "AT&T would never have done this unless it expected legislation to go through." Truer words have never been spoken in the entire telecommunications industry. No matter what transpires with telecommunications reform legislation, whether it is passed or dead for now, AT&T has improved its competitive position by implementing a new strategy in telecommunications: When in doubt, divest. Bell Atlantic Chief Executive Raymond Smith immediately recognized the significance of AT&T`s move and described it as "all the additional evidence anyone might need to rally behind the quick passage of the telecommunications reform bill."

AT&T will split into three separate entities, including a communications and financial services company, a communications equipment company and a business computer systems company. The communications and financial company will include AT&T`s long-distance and networking groups, the credit card operation, the business consulting operation and AT&T`s Wireless Systems (formerly McCaw Cellular). Last year, AT&T had $78 billion in revenue, and $50 billion came from the communications services group. The equipment company brought in $20 billion from the sale and manufacture of telephone switches and their auxiliary components, including the sale and distribution of copper and fiber-optic cable. The business computer systems company had revenues of only $8 billion and a profit of $75 million. The computer company was acquired in 1991. Then and now, the takeover was seen as AT&T`s delirium over the computer business instead of a well-thought-out strategy. AT&T has stubbornly and belatedly recognized that its computer unit is just a tired old dog even though AT&T paid a purebred`s price for NCR, the now-defunct National Cash Register company that was owned by the Rockefeller family before AT&T bought the company and changed its name to Global Information Systems.

Although the financial world gasps in awe at AT&T`s actions, they were as predictable as rain because they solve several problems for the company: By dumping Global Information Systems, AT&T frees itself from a dead weight--pure and simple. Layoffs at the company are expected to include 8500 to 20,000 positions. By spinning off the equipment company, AT&T puts to rest the long-standing suspicion that the communications services and equipment operations were quietly colluding to exclude potential rivals from both sides of the market.

Cannibalization

In the 11 years since AT&T`s original divestiture in 1984, such suspicion has had a negative effect. AT&T`s equipment sales could never achieve the volume and market strength required to develop extensive new products. Cannibalization--where a company phases out its best product and over time replaces it with something better--has been forbidden in the telecommunications equipment industry. Perhaps the best example of the process is Intel`s constant movement from the 8086 chip through the 486 chip and on to the Pentium. Each time that Intel brought out a new design, it left the competition behind and garnered more of the market. This is just the opposite of what has happened in the telephone equipment markets, particularly in the switching sector. The time between design, sale and installation is measured in four- to eight-year spans. In addition, the switches are offered in stripped-down forms that can be incrementally augmented by various software additions over several years. The switch users also have to commit to service contracts as well as to key upgrades to enhance service offerings. Thus, cannibalization doesn`t occur in the telecommunications equipment sector, and the users tend to be locked into a specific supplier for years.

After the 1984 divestiture, the seven regional Bell holding companies initiated an explicit policy to reduce their dependence on AT&T`s equipment. For the past decade, they have sought out alternative suppliers in Europe and Canada, including Stromberg Carlson, Ericsson Cables AB, Siemens AG and Northern Telecom. However, most of this traffic has gravitated to Northern Telecom, which by 1990 was supplying the regional Bells with major digital switches such as the DMS-10 and DMS-100. Northern Telecom was getting the lion`s share of new contracts and by 1994, approximately 20% of the local telephone lines in the United States were being served by its switches. Thus, the first major loser in AT&T`s divestiture may well be Northern Telecom.

The company`s stock price weakened during the few days that AT&T`s divestiture was getting media attention. Its trading and closing prices fell to approximately $35 per share, declining more than $2 dollars per share in just two days, thanks to AT&T`s divestiture; this translates to a 7% decrease in market value. The company`s stock had been soaring earlier this year, reaching a price of more than $40 per share in March. It is too early to say that Northern Telecom is definitely a loser in this situation, but the stock market`s jitters are a sure sign of the tumult ahead for any equipment company that has to compete with the former AT&T equipment manufacturer.

Other likely casualties are the manufacturing plans of the regional Bell holding companies. They have campaigned rigorously to overturn the current legal restrictions that prevent them from developing and manufacturing their own equipment. The House and Senate telecommunications reform bills allow the Bells to conduct research and development but stop them from manufacturing equipment. The inability to manufacture is not considered a loss because research and development is 75% of the process in bringing a product to market. Manufacturing could be farmed out to a third party through licensing and royalty agreements. However, all that has changed, and the Bells now face the prospect of selling their dreams to a mutated form of their perennial rival, AT&T.

Wireless market

The other part of the divestiture strategy--and one that fiber-optic aficionados might dismiss--is the wireless telecommunications market. In a press conference, AT&T`s Chief Executive Robert Allen said, "In the future, we don`t expect customers to discriminate between wired and wireless telecommunications." This understatement masks the expected intensity of the all-out battle expected between AT&T and the regional Bell operating companies. In Pennsylvania, AT&T recast its McCaw acquisition as "AT&T Wireless." The result, according to AT&T, was a doubling of customer inquiries and potential inroads into Bell Atlantic Mobile`s customer base. Not to be outdone by Allen and AT&T, in a recent speech, Bell Atlantic`s Smith highlighted his company`s battle preparations and tactics. "We have also built a nationwide wireless presence through mergers and joint ventures that will have the scale, scope and brand identity to compete in what is rapidly becoming a consolidated wireless industry. ...Buy our cable, get a wireless phone. Subscribe to our phone service, get Internet access for free. Put together your own customized service from our shelves--local and long-distance, wired and wireless phone service, Internet access and e-mail, basic cable and video-on-demand. ...We`ll be announcing a brand name for our wireless consortium this fall."

With or without brand-name recognition, and at least for the next five years, the telecommunications markets will no longer be driven by technological change. Marketing and gimmicks will move to the forefront. The current trend is unfortunate for fiber optics because the wireless craze will delay, if not foreclose, the penetration of fiber into the local telephone loop. This is ironic because fiber investment in the long-distance networks has been very successful, adding so much spare capacity that 500 companies are able to make a living by offering long-distance telephone services. The spare capacity also makes it easy for the Bells to challenge AT&T`s supremacy. However, entry into the local markets is not so easy. Rather than go with wireline competition, AT&T and others have opted for personal communication systems--the generic term for advanced radio technology carrying voice and data traffic that bypasses the local loop, the twisted-pair copper wire that runs from premises and businesses to the switches.

This is not say that fiber will not play a key role in AT&T`s local competition plans. Personal communication systems networks are composed of so-called base stations that pass data and conversations from point to point over land lines before the messages are retransmitted over the air. Fiber will be used to link the base stations of these networks. With regard to competition in local markets, AT&T plans to rely on its fiber network to offer local service rather than build thousands of local telephone switches--the historical pattern inherited by the Bell companies. For example, along the eastern corridor of the United States, AT&T is planning to pick up local calls by the thousands, ship them over fiber links to a remote switch several hundred miles away and then redirect the calls to their local destination. All of this can be done quickly and in large volumes, thanks to the speed and capacity of fiber optics, which is now an effective substitute for switch technology. Thus, fiber optics is playing an important, but hidden, part in AT&T`s divestiture, which Smith described as "a clear signal that...AT&T is preparing to focus on its entry into the local-exchange business, which [will]...be packaged with its long- distance and wireless capabilities."

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