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COVER STORY June 14, 1999
THE ARMSTRONG EFFECT
STEALING HOME
With the deals done, AT&T gets ready to roll out cable phone service
BRIAN QUINTON
Paleontologists aren't sure how fast the dinosaurs could move. Once they thought them lumbering beasts of great strength but crippled by their own size. Then a few clues were found--some footprints farther apart than seemed logical for a slow walker. Now many experts claim that some of these great animals combined muscle and speed into one amazing, darn near unstoppable package.
Will economists of the future have to revise their thinking about AT&T, a company long considered one of the world's premier thunder lizards--massive, mighty in its way, but hamstrung by its own size and fated to disappear from the earth because of a change in the telecom business climate?
The answer will lie in how well AT&T executes Chairman and CEO C. Michael Armstrong's strategy to refashion itself from a long-distance carrier to an all-access, all-distance communications provider with a new survival tactic: local telephone over cable.
AT&T's unstoppability as a local competitor has yet to prove itself, particularly after a U.S. District Court recently required the company to unbundle its system in Portland, Ore. AT&T says it will appeal that descision, but one thing's certain: Its gigantic new cable footprint already has competitors, from the regional Bell operating companies to America Online, about as nervous as a lawyer with an E-ticket to Jurassic Park.
War on the home front
It will start with long-distance. Specifically, it will start when the RBOCs are permitted to get into long-distance. Then, AT&T's revenues as the long-distance leader can only go down--a bigger worry for AT&T than for long-haul competitors MCI WorldCom and Sprint because 42% of AT&T's 1998 long-distance revenue came from residential customers (Figure 1).
The home market has always been AT&T's ground zero--it now has 66 million residential long-distance customers--and Armstrong wants to keep that focus as the best use of the company's marketing muscle. It's also more efficient for AT&T to upsell current customers on new services than to recruit new ones.
Under previous CEO Robert Allen, AT&T began reselling service leased in California. Telephone Service Resale resold local access lines from Pacific Bell at a 22% discount, and it failed dismally. Worse, it jeopardized the AT&T brand by failing to deliver service to customers.
"We tried to put 400,000 customers on our service," Armstrong says. "After four and a half months, we were only able to provision 200,000 of those. We had to incent the rest to go back to their old carriers. We were embarrassed and we lost $3 billion. It was a very unfortunate experience." Armstrong discontinued new TSR signups after taking over as chairman in 1997.
About 65% of the 108 million households in the United States are passed by cable. In the early 1990s, the cable industry began replacing coaxial tree-and-branch networks with laser-driven hybrid fiber/coax (HFC), producing an infrastructure that can be converted cheaply from one-way video to two-way voice and data. And HFC cable offers much greater bandwidth than copper.
"It's a good feeling," says Jerry DeFrancisco, former AT&T Broadband & Internet Services' former vice president for wireline telephony. "AT&T really turned into a competitive business with divestiture 15 years ago, and people have been attacking our market for all that time. So it's good to be on the other side for a change, to be going into a growth market."
Not good enough to leave New Jersey, though. At press time, AT&T announced that DeFrancisco had left the cable division--based in Denver--for a post at AT&T consumer services. Named as chief operating officer of cable telephony is Curt Hockemeier, a former Cox Communications executive who joined AT&T when it purchased Teleport Communications Group in 1997.
To market, to market
The first piece in Armstrong's cable puzzle was not a multiple systems operator (MSO) but TCG, bought from Tele-Communications Inc. and several other stakeholders for $11.4 billion in 1997. A competitive provider of local phone services to business accounts, TCG--renamed AT&T Local Services--gave the company a local link to the public switched network in 29 of the 30 largest U.S. metro markets.
In June 1998, AT&T spent $48 billion to pick up TCI's 10.5 million cable customers and a network passing 33 million homes, along with affiliates that hold 10 million subscribers and pass an additional 16 million homes. It also netted a new executive in former TCI President Leo Hindery, who quickly became CEO of the new AT&T Broadband & Internet Services division.
But TCI alone would not alone give AT&T the national footprint it needed. Armstrong spent several months preaching AT&T phone partnerships to cable operators without success; they weren't convinced that teaming up on voice was better than doing it themselves.
In February 1999, Time Warner announced a 20-year joint venture to sell AT&T's local phone service to its 12 million subscribers, pushing AT&T's access up to 40% of U.S. households (Figure 2). In return, AT&T would pay to help upgrade Time Warner's already advanced network to equip the home of phone subscribers--$300 to $500 per subscriber--and to reward Time Warner for cable phone bills exceeding $100 a month.
Still, large questions remained. What would AT&T be able to sell Time Warner customers besides phone service? Time Warner offers its customers high-speed Road Runner service; AT&T wants to sell a bundle, including @Home, the cable Internet service in which it bought a majority stake with its TCI purchase. Disputes such as that--over how much bandwidth would be allotted to AT&T on the Time Warner network, billing and revenue issues--have caused the deal to languish past its announced April closing date.
Winning--Armstrong style
Then in April Comcast and MediaOne announced they were joining in a network with 11 million subscribers and an instant No. 3 ranking among cable operators--a highly advantageous position from which to sell HFC telephony.
"AT&T couldn't allow that to happen," says William Feuermath, a researcher with TeleGlobe Consulting Inc. "AT&T still needed national coverage, especially in some big markets. MediaOne was one of the largest cable operators not closely held by a single family. So where everyone else saw a natural merger between MediaOne and Comcast, AT&T saw a chance to shop."
And shop it did, paying $58 billion for MediaOne. In return, AT&T gets more than 5 million subscribers and 8.5 million homes passed (Table 1). It also gets clusters in essential metro markets, including Boston, Chicago, Detroit, Los Angeles, Miami and St. Paul, Minn.
AT&T also gets 35% of Road Runner and a 25% interest in Time Warner Entertainment, the company that manages Time Warner's cable properties. That has added a new twist to the stalled AT&T/Time Warner deal.
"Now that we're going to buy MediaOne, we'll own 10 million of the subscribers we were dealing for [with Time Warner]," Armstrong says. "It doesn't make any sense to go into a joint venture and then two or three months later redo it all when MediaOne closes."
Side deals made the battle for MediaOne even more productive. AT&T got Comcast to drop out for $1.5 billion in breakup fees and subscriber swaps that will add 750,000 subscribers to its system. The MSO will also get the chance to buy 1.25 million subscribers from AT&T over the next three years. In return, Comcast will offer AT&T cable telephony to all its subscribers--at the most favorable rates--as soon as AT&T concludes deals with two non-affiliated MSOs.
Comcast President Brian Roberts called the deal "an elegant win-win result."
"It's 'win-win,' all right," says Feuermath. "But notice that it's a bigger win for AT&T. They needed the deal to get real about their cable strategy; Comcast just wanted it to get big. Also, AT&T got the MSO alliance it hasn't been able to line up yet with Time Warner. That's what you can call the Armstrong style--everybody wins, but AT&T wins biggest."
All told, after a swirling year of cable deals and pending regulatory approval, AT&T stands to own a network with 13.5 million subscribers and 25.5 million homes passed--25.4% of U.S. residences. Alliances could add another 20 million subscribers and put the company within reach of 62% of all the homes in America.
AT&T probably doesn't have any more major cable buys in its future. "We've spent more than $100 billion this year," Armstrong says. "That's enough. But I do hope that we can reach cable arrangements, alliances and joint ventures that will increase our competitive stance. There are other companies out there, and we're talking to them."
Weaving nets
Getting cable networks ready for telephony requires upgrading them to 750 MHz bandwidth and two-way transmission capability. The upgrade usually involves two main tasks: adding inbound amplifiers to the existing outbound ones and revamping the network architecture so that fewer homes are downstream of each fiber node. Cable networks traditionally put about 100,000 homes on a node; announcing the TCI deal, AT&T said it would bring that number down to 500 or 600, bringing fiber closer to each home for better transmission quality.
MediaOne is farther along than TCI in readying its network for broadband, having reached a 70% upgrade at the end of last year. Slower TCI had only 3% of its system ready for two-way cable by the end of 1997. That's one reason AT&T paid $4900 for each of MediaOne's subscribers, but only $2950 per subscriber in the TCI deal.
But the TCI upgrade is now "moving along rapidly," says De Francisco. "I've been to the 10 sites around the country where we're going to pilot, and it's progressing well--in most cases, ahead of schedule." TCI's network was upgraded 26% at the end of 1998. That figure will reach 70% to 85% this year, and the entire system will be two-way ready by the end of 2000, De Francisco says.
But cable won't reach all of AT&T's residential long-distance customers. To serve the rest, the company will look to other means. Fixed wireless is now undergoing a field test in Dallas, transmitting voice, video and data via radio. Dubbed Project Angel, the technology was tabled by AT&T when per-home costs were $1150. Now those costs are $750 per subscriber. AT&T will move Project Angel to a market trial later this year and expects to roll it out widely in 2000.
In some markets the last resort will be to get to customers via resold access lines from incumbent carriers. One such resale agreement with Bell Atlantic in New York is awaiting approval from state and federal officials--and AT&T.
The assembly line
Last December, shortly after closing on TCI, AT&T announced that it would field test circuit-switched telephony over HFC in 10 domestic markets around the country in 1999. The first pilot is a voice-only market test of cable phone in Fremont, Calif., in the San Francisco metro market. Other tests are scheduled this year in Chicago, Dallas, Denver, Pittsburgh, Portland, Ore., Salt Lake City, Seattle, St. Louis, Mo., and a second site in the San Francisco Bay area.
All tests are slated for cities where AT&T Local Services offers phone service to businesses. "When we go in to convert an area, we equip the customer's house, equip our cable headend and then connect to an [active line state] local office," says De Francisco. "They are very large factors in the 10 pilots we are rolling out."
The tests should solidify the systems surrounding cable telephony rather than the technology itself, which De Francisco says is "absolutely ready to go technically."
TCI, Time Warner and Cox have done cable telephony successfully, but on a smaller scale than AT&T's plans. It's the difference between building a few great custom performance cars and producing them on an assembly line for millions of consumers.
The tests will focus on backroom functions: taking and processing orders; hiring, training and dispatching technicians to install the necessary network interface units on the side of homes to split cable signals; and various customer-care and follow-up issues to make sure people get the services they request.
"It's no easy task," says Bill Fitzgerald, chief operating officer for AT&T Broadband and Internet Services. "There are so many parts that need to operate absolutely right on the screws, from systems support to provisioning." For now, the company is using a lot of manual workarounds such as entering orders manually in the database; these functions will eventually be automated.
Right now, AT&T is using eight-hour home batteries to provide lifeline service for cable telephony. That allows the company to roll phone service out quickly, De Francisco says. AT&T will look at powering the network itself as more subscribers make it economical.
AT&T is also working to add diagnostic capabilities to the system. "If a customer calls with a problem, we want to be able to see from our network operations center all the way down into the box on the side of the house," De Francisco says. "That's a fundamental change from the cable model."
Once AT&T has given cable telephony a shakedown through these pilot markets, it plans to scale up to the community level in 2000 followed by wide-scale product rollout in 2001.
Judging by very preliminary reports, some of the lessons those tests teach may be tough ones. Call quality is impaired when cable phone penetration approaches 30% on a given node, and the battery monitoring system does not perform as hoped. The latter problem will have to wait until AT&T comes up with an acceptable way to power the network, but the former may be solved by a new "mini-fiber node" that the company will test in its upcoming Salt Lake City pilot.
The node uses digital multiplexing to run optical fiber deeper into the network. Instead of containing connections for about 600 homes, like the nodes used in Fremont, these mini-fiber nodes will have only 50 to 75 homes in a ring (Figure 3).
"The system is totally passive after the optics, so it's cost-effective to deploy," says Tony Werner, executive vice president for engineering and technical operations with AT&T Broadband & Internet Services. "The final advantage is that it's totally backward-compatible, so that you don't have to go back and change out the whole network."
Such nodes would add to the capital cost of building out the network but need not alter the economics until take-up rates get much higher than they are now.
Markets--mass and segmented
On the marketing and product side, AT&T expects this year's tests will reveal the price points and bundled services that customers want most. In Fremont, AT&T is offering several discount long-distance packages and giving customers a choice of one, two or three phone lines with custom calling features. A single phone line costs $12.50 a month; a line with call waiting, call return and three-way calling costs $20.25 a month. Long-distance calls cost 10¢ a minute, and toll calls and intrastate long-distance calls cost 6¢ a minute.
"Flat pricing will be an option in the future," De Francisco says. "More of our business is going to buckets of minutes. But for customers who would prefer to buy on a per-minute basis, we'll certainly offer that as well."
Armstrong expects AT&T to offer phone-over-cable packages that are priced 16% to 34% lower than prices charged by incumbents, depending on the features selected. As for those features, if AT&T follows MediaOne's example, they may include items such as distinctive rings for separate phone numbers on one line, priority rings for certain calling numbers and continuous redial.
And AT&T may find it doesn't want to be in every market, or every market segment. It has been paying pretty high prices for its acquisitions. To recoup, it will need to find customers who will buy large bundles of telecommunications services. Some analysts have suggested that only one-third of American homes meet AT&T's price point for telecommunications services of all kinds--voice, video and data.
In long-distance, the cost of sales is straightforward--mainly marketing, advertising and acquisition. But each new cable phone customer represents an incremental cost in infrastructure. Internet protocol telephony will eventually reduce those costs, but it's at least a year to 18 months out. Meanwhile, AT&T will need to answer the questions: Who are we selling to, and how much do they have to buy to make this profitable?
"To be successful, AT&T is not necessarily aiming to be a mass-market company," says Boyd Peterson, a senior analyst with The Yankee Group. "Their image is as a company born out of universal service--'Whatever we do, we do for everyone.' But going out there intending to put together bundles for everyone would be bad business, because you won't make money on everyone."
That's the most ironic thing about competitors' claims that AT&T is reassembling the monolithic old Bell dinosaur, says Peterson: "If AT&T becomes a monopoly again--boy, will they have made a mistake."
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THE ARMSTRONG EFFECT
October 1997
C. Michael Armstrong appointed AT&T's chairman and CEO
January 1998
AT&T buys Teleport Communications Group, the nation's largest competitive local exchange carrier, for $12 billion
June 1998
Announces $53 billion acquisition of TCI, the nation's second-largest cable operator
July 1998
Enters into $10 billion global joint venture with BT for global telephony; announces $30 billion bond issue
December 1998
Completes purchase of IBM Global Services for $9 billion
April 1999
Last-minute bid of $58 billion in cash and stock wins MediaOne from Comcast
AT&T makes $1.5 billion payment to Comcast and agrees to provide cable telephony in the future
AT&T and BT buy 30% of Japan Telecom, No. 3 in that country's long-distance market, for $1.8 billion
May 1999
First AT&T cable telephony market trial begins in Fremont, Calif.; about 10 more slated for 1999
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Looking at my notes from the annnual meeting, I find these comments:
"ATT looking for smaller nodes, higher penetration. Would like a few hundred on a node. [speaking of wireless:] Running system for a year now. . . will launch quickly. . . have tested in many environments: Bay Area, Phoenix, Denver. . ."
Apart from today's announcement with AT&T Labs, I don't know CMTO's status with T, but I've been told their modems pass more TCI homes than anyone else's.
That's good enough for now.
Pat |
