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The Coming Telescramble


Cover Story: TELECOM'S NEW AGE

THE COMING TELESCRAMBLE

Deregulation is launching a $1 trillion digital free-for-all

And so are we. The U.S. is embarking on a bold experiment--going further than any other major nation to deregulate the communications industries that are building the infrastructure for the 21st century's information economy. With a stroke of his electronic pen, on Feb. 8 President Clinton signed the sweeping Telecommunications Act of 1996, ending government rules that have maintained barriers between local and long-distance calling, cable TV, broadcasting, and wireless services. In the age of digital communications, those rules have become as anachronistic as, well, the rotary phone. The microchip is putting all forms of communications--from satellite-TV images and long-distance phone calls to E-mail and World Wide Web pages--on the same digital footing. Now, Washington has caught up.

The short-term effect will be to unleash a frenzy of restructurings, mergers, and dealmaking--rearranging industries that, according to DRI/McGraw-Hill, will account for $1 trillion in annual revenues by 2000. Phone companies, publishing companies, Hollywood studios, broadcasters, cable-TV operators, and information-technology outfits will go racing into each others' businesses. AT&T, for instance, has filed in all 50 states to offer local service. On the very day the act was signed, Central & South West Corp., a Dallas utility, filed for the right to offer telecom service.

The new age's approach has inspired a series of megadeals. In 1994, Bell Atlantic Corp. bid $12 billion for Tele-Communications Inc. (TCI) to form a multimedia behemoth. The deal fell through, but AT&T's $13 billion takeover of McCaw Cellular Communications Inc. was consummated. Then came entertainment megamergers aimed at providing content for the Information Superhighway: Disney's purchase of Capital Cities/ABC and Time Warner's bid for Turner Broadcasting. In February, U S West Inc. announced a $10.8 billion bid for Continental Cablevision Inc., the nation's No.3 cable operator. Perhaps the most significant move, however, was AT&T's decision to break itself up a second time: To focus on the coming shake-up, it is spinning off telecom equipment and computer operations that account for a third of its sales.

From all this dealmaking will emerge a new crop of supercarriers--companies that either on their own or through alliances will offer a full menu of electronic communications, a telebazaar with everything from video phones to Internet services to a single phone number that will follow you wherever you go.

LOWER RATES. AT&T is leading the way. It offers long-distance, cellular, Internet access, satellite-TV--and soon local service--all under the AT&T brand and all billable to the AT&T Universal Card. But AT&T isn't alone. MCI is getting into satellite TV and the Internet. Media giant Time Warner is getting into local phone service in U.S. cities--as is Britain's Cable & Wireless PLC. GTE Corp. sells long distance in two states, and Ameritech, Bell Atlantic, Nynex, BellSouth, and SBC Communications sell long distance to their cellular customers.

As carriers begin to market bundles of communications services, consumers should benefit. The communications companies say low-cost services will offset higher-cost ones in a package. And in just about every service, competition and more efficient technology should push prices down. That includes your local phone bill, even though the ancient system of using high business rates to subsidize low residential ones is ending. "It would be remarkable if, after this legislation is enacted, local service prices didn't come down, or at least the price of the total communications package didn't come down," says AT&T Chairman Robert E. Allen. "Competition has worked everyplace else. There's no reason why it won't work here."

There's something vastly more important than better prices that will arise from deregulation, however. Now that the players know where they stand, they can finally build the long-awaited high-speed (so-called broadband) links of the Information Superhighway. Like the transcontinental railroads that turned the U.S. into a world economic power in the 19th century, this I-way infrastructure has the potential to put the U.S. economy ahead of the rest of the world in the 21st.

Digital networks will make possible efficient new ways of doing business--so-called electronic commerce. Increasingly, buyers and sellers, producers and consumers, will interact on the Net, squeezing time and cost out of all sorts of transactions. For example, the rapidly falling price of communications can cut tens of billions of dollars off the country's health-care bill, as hospitals buy supplies electronically rather than processing each order by hand. The new networks will also be fertile ground for all sorts of new ventures--everything from Web 'zines to movies on demand.

PAINFUL. The shift to the wired economy could even affect federal monetary policy. Today, the Federal Reserve keeps a damper on economic growth, not letting the unemployment rate fall below 5.5% for fear of igniting inflation. But the economics of communications changes the model. Although it is enormously expensive to build a fiber-optic or wireless network, the cost of serving each additional user is small. The more users a network has, the lower the overall tariff. In the era of pervasive digital communications, faster growth may mean less inflation, not more.

At first, though, the shift to a communications-driven economy will cause painful dislocations. During the Republican Presidential primaries, AT&T's plan to lay off 40,000 workers as part of its restructuring became the symbol of Middle America's economic insecurity. But it is just the latest and most visible event in a massive industry makeover that started with the 1984 breakup of the Bell System. AT&T and its offspring have slashed 250,000 jobs since then, in areas such as manufacturing and operator services, where new technology has made the old jobs obsolete.

But behind the dismal headlines lurk some upbeat facts. Despite all the pink slips, total phone-industry employment has risen by 54,000 over the past two years, thanks to demand for cellular calling and other new services. If you look at the converging complex of communications, computers, and entertainment, you'll find these overlapping industries generated 400,000 new jobs over the past year, about 20% of the total new jobs in the economy. Those numbers will only grow as the digital economy takes off. The Telecom Act, asserts Vice-President Al Gore, will fire up a "massive job-creation engine."

It's not just political rhetoric. "In total, these major market changes will make the economic pie bigger, maybe a lot bigger," says Gerald R. Faulhaber, an economist at the Wharton School. "In the aggregate, we may increase national income big time." Compare it with the American railroad boom of the 1800s: Between 1865 and 1890, the number of miles of track grew from 35,000 to 166,000, much of it running through sparsely populated lands. The cost of both freight and passenger transportation fell sharply, and huge swaths of frontier were opened up for farming, mining, and industry.

There's money to be made in building the information rails, too. Now that Congress has given them the carrot of unregulated markets, communications companies are set to pour billions into new plant and equipment. The Telecom Act "sets out a much more rapid path toward the interconnected, multiple-network approach," says Gerald W. Brock, an economist at George Washington University. In the past two years, spending on everything from modems to high-speed digital switches has soared by 53%, to almost $100 billion, double the rate of spending growth in computers and other capital equipment. "This is a great time to be a supplier," says John A. Roth, Northern Telecom Ltd.'s North American president. "Everybody out there is doing a lot of planning on infrastructure."

TECHNICAL KINKS. They won't deliver the I-way overnight, however. For starters, although the reform bill affects just about every corner of the communications business, many details of deregulation must still be hashed out by the Federal Communications Commission (page 86). The agency will spend the next year promulgating rules and overseeing the transition to unregulated markets.

Then there are lingering technical problems. The I-way envisioned in the early 1990s--a swirl of broadband networks delivering everything from wireless E-mail to interactive TV--has been considerably delayed by kinks in technology and high costs. For example, pumping cable TV over phone lines--or calls over cable--remains prohibitively expensive (page 82). Still, innovation is accelerating, especially on the fast-growing Internet. The Web now seems destined to become a universal format for bringing digital entertainment and information services together.

When the converged communications industry does emerge, who will the winners be? Observers predict that by the end of the decade the telecom and entertainment businesses will be dominated by a handful of "convergence conglomerates." The rest will have merged, partnered, or fallen by the wayside. The companies most likely to come out on top are those with the best marketing skills, the strongest brands, the deepest pockets, and a familiarity with competition. In other words, AT&T, MCI, and Sprint--the long-distance giants--are best positioned for the future.

"FINAL MILE." Cable-TV operators, on the other hand, may be the least well-equipped. They are entering the race saddled with a heavy debt load, low profitability, and a reputation for poor service. They are combining high-capacity fiber-optic lines with coaxial wiring into the home, so that they can deliver video, voice, and data simultaneously. But turning that link into a two-way path for video on demand or voice service is a difficult process that no cable company has yet pulled off (page 75).

Local phone companies would seem to have huge advantages. With 12% aftertax margins, they are the most profitable carriers. Plus, they have a lock on the "final mile"--the wiring that reaches into homes and businesses. Years of operating in monopoly markets, however, leave the seven Baby Bells and GTE with outmoded networks ill-suited to the new era. Probe Research Inc., a telecom consultancy in Cedar Knolls, N.J., estimates that the Bells have spent $170 billion on networks since 1984--as much as their total plant investment prior to divestiture. But most of that went to rebuild existing networks rather than prepare for new digital services. "They didn't increase the bandwidth," says Probe consultant Alan Tumolillo. "They have built a big, obsolete phone network."

Not so the long-distance companies. AT&T, MCI, and Sprint all boast advanced fiber-optic networks that speed zillions of voice and data calls around the globe (page 70). Getting similar links to homes will be a lengthy and costly process that could cut into profit margins for a few years. But the infighting between the three has taught them marketing tricks that the monopolies haven't had to learn. "You can't improvise when it comes to competition. It's either in your face or it's not," says Frontier Corp. Chairman Ronald L. Bittner. He should know--Frontier's Rochester Telephone is the first local phone company to face competition.

Still, at the outset of deregulation, it wouldn't be safe to discount any players. Twenty years ago, who would have predicted that Delta Air Lines Inc. would be among the top carriers and Pan Am would be out of business? "In the long run, this is not a technology game. It's a marketing and brand-name game," says T. Mark Maybell, managing director of Merrill Lynch & Co.'s telecom investment-banking group.

While everyone is out there building convergence brands for the I-way, it might help to remember the uneven progress of those rail barons. Because they were pushing their lines into undeveloped land, it was sometimes tough to make a profit. Overbuilding was common, and so were bankruptcies. In 1894, 40,000 miles of track were being operated by bankrupt companies--a lesson for potential investors in today's communications companies. But keep in mind that the track didn't disappear--it was just taken over by somebody else. The nation's travelers still got where they wanted to go, at ever lower fares. It's hard to imagine that travelers on the Information Superhighway won't find the cyberroads just as convenient, no matter who owns them.By Catherine Arnst, with Michael Mandel, in New York and bureau reportsReturn to top


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