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The Wires Will Cool Off A Bit


Industry Outlook 1991: HIGH TECHNOLOGY

THE WIRES WILL COOL OFF A BIT

To get a preview of how telecommunications will fare in 1991, look at Shearson Lehman Brothers Inc., whose business was sideswiped a year before everyone else's. "For us, cost reduction is a way of life," says John J. Lane, Shearson's director of communications. He is ditching many leased long-distance circuits, ridding branch offices of unnecessary lines, blocking employees from calling on 900 numbers, and poring over phone bills for mistakes. "There's a tremendous amount of error in invoices," Lane says. "It requires a systematic review to make sure we aren't being overcharged."

In short, nickel-and-diming may be the theme of telecommunications in 1991. Instead of just looking to use phone or data services as a strategic weapon, customers are viewing them as more of an expense--sort of like the electric bill.

HUNKERING DOWN. Telecommunications will remain a growth business this year, stimulated by falling prices and rising demand. But while the phone industry should outpace the overall economy, it won't escape the recession. Until recently, Northern Business Information, a market research arm of BUSINESS WEEK publisher McGraw-Hill Inc., was projecting 6.3% growth in local phone-service revenue, 10.1% in long distance, and 8.9% in phone-equipment sales. Now, research director Susan Kalla is scaling back those projections--especially for gear that business buys.

The new caution among customers is a big change from the booming `80s. Susan Morrow, communications manager for Kemper Financial Companies Inc. in Chicago, recalls what has happened to spending on 800 numbers that top brokers use to let clients call in free. "In 1987, it was carte blanche," she says. Now, each request for special service is scrutinized. The hunker-down mentality has even infected little Smith Hardware Co., a distributor in Goldsboro, N. C., with annual sales of about $2 million. Says Mary Ann Diaz-Wilson, its accounting manager: "Telecommunications is just one of those things we have to have. We look for ways to save money on it."

Still, the recession may have a silver lining for services that produce an immediate bottom-line result. At Kemper, for example, Morrow is expanding a videoconferencing network so that executives don't have to travel so much. Data-compression devices are selling well, since they cram more traffic onto existing lines. And long-distance carriers are picking up business from customers that have abandoned expensive private networks of leased long-distance circuits. The phone companies move traffic over their regular networks, while offering features the private ones did, such as special dialing plans.

In a nutshell, the conflicting forces of the economic slump should produce a middling year for most phone companies. At American Telephone & Telegraph Co., the giant of the industry, most profits will continue to come from long distance. Last year, the No. 1 carrier slowed the erosion in its 67% market share with unusually aggressive marketing. It also won from regulators the pricing flexibility it needs to target discounts more strategically. Meanwhile, the ranks of its competitors were shrinking. No. 2 MCI Communications Corp. bought fast-growing No. 4 Telecom USA Inc., which had 1.4% of the market and was given the best chance of becoming a third rival to AT&T, after MCI and U. S. Sprint Communications Co.

This year, analysts think AT&T will lose a point or two of market share at most, down from three or four a year in the mid- and late 1980s. Moreover, price competition is diminishing. Bloodied by the fight for customers, MCI and Sprint are likely to decide that an all-out price war hurts too much.

Analyst Joel Gross of Donaldson, Lufkin & Jenrette Securities Corp. thinks that price competition has not ended--that it has only become more targeted, like the multi-tiered pricing of airline tickets. But many other analysts agree with James McCabe of Nomura Securities International Inc., who argues that "pricing will come down as costs come down, but not more so." Gross expects AT&T's earnings to be flat or up slightly, with MCI and Sprint posting modest operating gains.

In the phone equipment business, by contrast, the recession won't do anything to abate the long-running price wars that have ruined profits and promoted consolidation. Last year, Canada's Northern Telecom Ltd. agreed to pay $2.8 billion to acquire the 72.9% of the British gearmaker STC PLC that it didn't already own. More such deals may come in 1991, involving makers of big digital switches for phone companies. About a dozen manufacturers worldwide are jockeying to be among the half-dozen or so survivors as full-line suppliers of phone equipment. Industrywide profit projections are meaningless, given the varying fortunes of the players. But earnings at Northern Telecom, the biggest pure play in phone equipment and one of the stronger performers, should rise about 10%, according to a survey of analysts by Zacks Investment Research.

HEALTHY BABIES. Companies that provide local phone service should fare better than their industry cousins, simply because more of their revenue comes from fixed monthly charges. Analyst Gross forecasts 5% to 7% earnings growth for the seven Baby Bells, which own regulated local carriers.

But for the companies without such sinecures, the byword is be on your toes. "We're looking hard at both sides of the equation--costs vs. benefits," says Shearson's Lane. An economic upturn could change that quickly. But probably not in 1991.Peter Coy in New York


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