Creating the 21st Century Communications Company

1
Creating the 21st CenturyCommunications Company

• Global Executive Symposium
• La Costa, California
• September 28, 1998

2
Key issues facing executives
Regulatory changes?
Access to customers?
Technology choices?
Optimum size?
Non-traditional challengers?
Cheaper, better operations?
Customer demand?
Retail- wholesale split?
One-stop shopping?
Harder choices larger stakes
3
Five sets of drivers

• Customer demand
• Propensity to use services, patronize providers
• Technology
• Progress on new technologies, standards
• Capital markets
• Degree of support from investors, lenders
• Government policy
• Impact of regulation, antitrust, taxation
• Providers
• Proficiency of incumbents, challengers

4
Four Sets of Scenarios

• A. Incumbency Counts - hype evaporates
• B. Mass Matters - megacarriers dominate
• C. Pinpointing Prevails - specialists win
• D. The Revolution comes

5
Incumbency Counts definition

• Despite the hype, incumbents prove much stronger
  than initially expected
• Market share losses are small and manageable
• No more big new entrants (e.g. WorldCom)
• Former PTTs continue to dominate their home
  markets and fail everywhere else
• A few basic changes, e.g., convergence of
  domestic-intl in Japan, long distance-local in
  U.S.

6
Incumbents win why?

• Customers Prefer incumbents, dont trust new
  entrants. Demand growth is manageable.
• Technology New technologies slower to roll out
  than expected incumbents adapt faster
• Government policy Continues to protect
  incumbents
• Capital Markets support for challengers fades
• Providers Incumbents get fresh blood and become
  more entrepreneurial. Challengers fall into same
  old traps.

7
Incumbency Counts customer demand

• Customers dont want to switch, or require a high
  premium (gt25 discount) to do so -- trust
  incumbents, or dont really trust challengers
• Demand for new services is unexpectedly low
• Demand differs by country or territory, not so
  much by market segment
• Demand shift from voice to data slows
• Overall demand grows fast but not so fast that
  incumbents simply cannot handle it, e.g., shifts
  from doubling every 4 months to doubling every
  year

8
Incumbency Counts technology

• New developments occur at a manageable pace
• Some important new technologies help incumbents
  leverage existing investments
• xDSL
• DWDM (maybe)
• circuit -gt packet conversion devices
• Incumbents use their market power with equipment
  makers to get cutting edge tech
• New, more advanced technology appears, but the
  incumbents are not left behind -- they have it,
  too
• KEY incumbents keep up with challengers

9
Incumbency Counts government policy

• Governments prefer continuity leery of
  disruption
• Worry about big job losses at incumbents
• Big is bad dubious about megacarriers
• Strong anti-trust enforcement less concerned
  about jump-starting competition
• Wary of foreign carriers maintains national
  domains dominated by incumbents

10
More on big is bad
The SBC-Ameritech deal is not good for what were
trying to get. Im not sure bigger is going to be
better. Ron Johnson, Chmn., Nebraska PUC
11
Incumbency Counts providers

• HR Incumbent management becomes flexible (may
  hire outside innovators and entrepreneurs)
• HR Incumbents not hurt by brain drain
• Incumbents are better lobbyists than challengers
• Challengers have no compelling management
  advantage. Flexibility fades as scale grows.
• Capital markets support incumbents, and become
  more wary of challengers. Huge funding for new
  challengers starts to dry up.

12
Incumbency counts, they say
The bulk of traffic will migrate from switched
circuits over the next 10 years, but this will be
a gradual process. The current circuit-based
networks will be the cheapest and most convenient
for most customers during that period. SVP,
European PTT
13
Conclusions Why Incumbency Counts

• Incumbents are HUGE, with great brand presence
• They control the critical link in the network,
  the local loop
• They are protected by governments, pampered by
  equipment manufacturers, trusted by customers,
  and massively wealthy
• Their managements are getting smarter all the time

14
Mass MattersEra of Consolidation

• Vertically-integrated
• All segments, all services
• Huge size room for only 3 in a given market
• PTTs not necessarily OK megacarriers may invade
  their turf
• New household names possible in 2005
• Geographic market is regional (N. America,
  Europe, Asia)

15
Why the giants dominate

• Customers Brand is very important size helps
  build brands. Mass market services are fine.
• Technology Economies of scale in developing and
  implementing new technologies (maybe with help
  from equipment manufacturers)
• Government policy Weak anti-trust
• Capital markets Size brings stock price advances
• Providers Vertically-integrated generalists
  achieve economies of scope and scale

16
Senate testimony by SBC chairman/CEO Edward
Whitacre
In SBCs view, this globalization will result in
a half dozen or so integrated global competitors
vying with a very large number of regional,
niche, and local competitors.
17
More supporters
Customers are looking for single-source
providers. They are looking for
simplicity. Senior RBOC exec.
We must commit to provide end-to-end service to
customers, any place anywhere, any time. Senior
ATT exec
There will always be some niche players but,
basically, the world is going to be three or four
300-pound gorillas. VP Canadian telco
18
WorldCom COO John Sidgmore Mass Really Matters
Customers say they want bundled working
solutions, not just parts. They want us to show
them how to deploy these products within their
existing fabric of networks.
Weve combined the 4th-largest long distance
company in the U.S. with the largest provider of
local-access services -- outside of the RBOCs --
with the largest ISP in the world.
19
Mass Matterscustomer demand

• Factors that advantage huge companies
• Customers are willing to try new providers and
  services
• Limited demand for specialized offerings and
  personal treatment from telcos
• Many customers (business and residential) prefer
  one-stop shopping
• National and trans-national brands dominate
  massive marketing expenses required

20
Why customers like big providers
SVP of large IXC/wireless carrier
Our experiment in calling party pays (for
wireless) entails the shared use of a 500 number
for long distance and wireless (with a single
bill). To deliver CPP, long distance must be
provided. Cant break out the two services.
Integrated communications carriers will be in the
best position to satisfy customer demand for
simplicity. Not just one-stop-shopping, but
fully-integrated products. What we now see as
different products will be integrated not just at
the customer end but in the actual delivery so
they cant be pulled apart.
21
Mass Matters technology

• Speed New developments occur rapidly
• Economics Real economies in spreading new
  technology investments (including HR investments)
  over widest possible customer base
• Money Huge capital investments required
• Integration Technology developments foster
  integration
• For example, wireless CPP is facilitated by
  integration with long distance services

22
More technology drivers
for Mass Matters
Intelligence in the network is key. It enables
simplicity and transparency. As customers sign up
for more and more services -- and indeed as
bundles of services become the only way of
signing up -- the intelligence in the network
becomes more and more applicable.
I call this strong bundling or integrated
bundling as opposed to weak bundling that
simply stuffs various services into a single
package.
IXC/Wireless VP
23
Mass Mattersgovernment policy

• Weak antitrust vision and enforcement -- 3
  dominant players per market is OK
• Megacarriers allowed into monopoly markets to
  challenge incumbents
• Governments dont worry too much about protecting
  incumbents
• Governments disinclined to protect incumbents
  from foreign predators

24
Mass Mattersproviders, capital markets

• Real economies of scope and scale. These favor
  extremely large, integrated entities
• (Some) management teams assemble and then run
  vast enterprises successfully
• Big companies successfully leverage business
  infrastructure across many diverse businesses
• Capital markets favor large, portfolio entities
  (but not necessarily incumbents). Mergers
  generate increased stock values.

25
WorldCom COO Sidgmore sees acquisitions as core
competency...
Acquisitions are essential
We know how to make them work
MFS, UUNet, and WorldCom are all acquisitive
companies. Together weve acquired 65 companies
in the past 4 to 5 years. Weve developed a
significant expertise in integrating cultures and
putting manage-ment teams together that balance
the organizations cultures. Its a core
competency of WorldComs.
26
Mass really really matters
27
Pinpointing Prevails
Focus is Everything
28
Pinpointing Prevails definition

• Focused, specialized carriers have an advantage
• Efficiency and profitability
• Flexible and responsive to differentiated market
  requirements
• All things to all people means mediocre
  performance for all customers
• Todays megamergers are the last gasp of the
  dinosaurs resisting the new reality
• Strategy Focus

29
Market Segment Focus

• Customer requirements differ -- sometimes
  significantly
• Products and services
• Level of service and customization
• Economic viability
• Organizational requirements / focus differ
• Service strategy
• Support platforms
• Alliance relationships
• Examples
• Business v. consumer
• Global Alliances - Concert, World Partners,
  Unisource MNC
• Affinity groups - AARP, church groups
• RMTS - GE Rescom, US Online

30
Value chain focus examples

• Infrastructure focus
• Qwest, Level 3, NextWave
• Attraction to migrate down value chain, get
  higher margins
• Retail/customer interface focus
• ArbiNet, Excel, CLECs, LD resellers
• Viability a function of excess capacity or
  regulatory rules on access pricing

31
Why pinpointing prevails

• Incumbents and megacarriers collapse under their
  own weight. Size brings inflexibility,
  bureaucracy, stagnation
• Wrong strategy for the market, not execution
  failure
• Focus creates opportunities for real
  efficiencies, cutting costs
• Customers want customized service bundles, and
  personal treatment
• Some want high-quality, high-touch service
• Others want economy class to save money

32
Megacarriers collapse of their own weight
If you have an under-depreciated,
over-regulated, attacked, monopoly phone
company, why double the size of that? President,
RBOC subsidiary
The colossus mergers, seeking economies of scale
and geographic coverage, are solving all the
problems of yesterday. You have to ask a
fundamental question -- What got better from a
customers point of view ? President, wireless
carrier
33
Focused competitors

Ameritechs wholesale business has increased from
150m to more than 1bn in 2 years. The wholesale
retail split is aready here. RBOC VP
Disintermediation and the collapse of the value
chain is occurring in every industry affected by
IT. VP Strategy, equipment manufacturer
34
Is owning the network necessary? No
Network ownership will be less and less important
as time goes on. Today it is reasonably
important. Twenty years from now it wont be
important at all. President, wireless carrier
We already have contracts to buy long distance
minutes at an 80-90 discount from retail. Why do
I need to own the network? RBOC VP
A successful carrier of the future doesnt
necessarily own networks. It controls and
operates networks, but it may not own them.
President, equipment manufacturer
35
Value in telecoms 2005
Of the value created (in the telecom process),
45 will go to the content provider, 45 will go
to those that actually work with the customer,
and bill and innovate with the customer, and 10
will go to the infrastructure provider. Presiden
t and CEO, LEC
W(h)ither the incumbents in this case.?
36
Pinpointing Prevails customer demand

• Both business and residential customers want
  customized services, not mass offerings
• Falling prices and new services create major
  market growth, where specialists have an
  advantage
• Differences in customer requirements help to
  define appropriate scale for geographic focus

37
A few comments.
Customer service wins us customers every day. We
expect to get 80 of the GTEs business in our
town within 3 years CLEC COO
WinStar will deliver a level of personal service
that will amaze businesses. Customer care will be
a primary focus for WinStar." Bill Rouhana,
Winstar CEO
38
Pinpointing Prevails technology

• Technology creates excess network capacity,
  helping resellers, e.g. DWDM
• Open standards and open software enable 3rd party
  applications development
• Fast change devalues legacy systems
• Network intelligence migrates to customer
  interface or to customers access equipment, away
  from legacy switches
• Gateway and intelligent agent software allow
  aggregators to create differentiated, value-added
  services, and customer self-provisioning

39
Pinpointing Prevails government policy

• Policymakers support new entrants
• Wholesale pricing policies (resale discounts and
  unbundled elements) make resellers viable
• Pro-change constituencies are strong
• Policy retains hidden subsidies, helping
  specialists
• Policymakers let incumbents suffer, shrink, or
  even be acquired and broken up
• If regulators set the rules for the
  marketplace, any structure is sustainable because
  the rules keep it in place. President,
  wireless carrier

40
Pinpointing Prevails providers, capital markets

• The costs of operating integrated, centralized
  organizations and systems prove higher than
  economies of scale the latter are elusive
• Operational strategies and supporting IT systems
  are so varied that integrated companies have no
  significant scale economies in the back office
• Focused competitors steal enough high margin
  market share to undermine large organizations
• Capital markets reward focused competitors over
  portfolio companies, i.e., incumbents worth
  more broken up than whole

41
Revolutionary Change
Price/performance ratios shift by at least one
order of magnitude, within 5-7 years
42
Revolutionary scenarios

• Data Dominates
• Cable Connects
• Wireless Wins

Unlike evolutionary scenarios, these scenarios
are not mutually exclusive
43
Long-shot scenarios

• Voice/data over electric power lines
• Satellite delivery systems (LEOs)
• Content convergence

44
Data Dominates
45
Data Dominates

• Data traffic doubling every 4 months
• PS networks clearly superior for handling data
• Data could be 95 of traffic by 2005
• Voice will be a pimple of the side of data
• Voice infrastructure is a handicap at a minimum,
  new data-centric market entrants have big cost
  advantages

46
Data Dominates

• Incumbents
• Cant move to PS fast enough
• Cultural shift too severe
• Rapid loss of dominance
• Challengers
• PS-centered
• New business models based on data
• Voice just another datastream

47
Data Dominates
Our business model calls for 50 revenues from
data within 5 years. VP European PTT
Intelligent networks are useless in the age of
data. Stupid networks win every time former ATT
exec
BT is spending 12bn over the next 5 years to
build a world-class data network. The main issue
is migration. Dir. Strategy, European PTT
48
Data Dominates
Scale will come from a focus on data, not voice,
and from a willingness to be a growth company,
not a safe cash cow for investors. IP has some
advantages over CS, but scale is the key.
Senior exec, Microsoft
49
Data Dominatescustomer demand

• Internet demand continues to grow fast
• Mass market for video applications
  --videoconference, streaming video
• Interactive high bandwidth apps (IP- voicemail,
  video email)
• Telecommuting
• Fax and voice apps move to IP

50
Data Dominatestechnology

• IP solves QOS issues -- priority routing, etc.
• Bandwidth availability expands rapidly,
  especially in the local loop
• Scalability problems resolved -- terabit routers
  and beyond
• Reliability reaches CS levels
• Capacity crunch resolved -- more bandwidth, IP
  multicasting, premium IP networks, etc.

51
Data Dominatesgovernment policy

• Privacy/encryption issues resolved
• New entrants encouraged
• Access charges/taxes held off for 2-3 years
• E-commerce encouraged
• Intellectual property issues resolved
• None of these is mission critical

52
Data Dominatesproviders, capital markets

• Incumbents remain slow-moving and bureaucratic
• Incumbent dividends remain untouchable
• Series of key assumptions retained by incumbents
  
• Cannot cannibalize voice markets
• Cannot get ahead of the data pricing curve
• Switched networks are more reliable
• Smart networks with central intelligence are the
  future
• New entrants unencumbered by legacy networks,
  apps, business models, cultures

53
Show-stoppers

• Capacity crunch dries up effective demand
• Pricing models fluctuate or fail, limiting
  investment
• Incumbents move faster than expected to IP
• Reliability, scalability issues unresolved
• Bandwidth glut crashes data market
• Last mile problems unresolved

54
Data Dominates - Naysayers
Price differences between CS and PS are based
more on regulation than reality. VP Networks,
global ISP
The existing network is a critical source of
competitive advantage. the issue is how to take
advantage of it. VP, RBOC wholesale group
Ameritech is going to replace its CS network
with a state of the art packet switched design.
Richard Notebaert, Ameritech
55
Cable Connects
56
Cable Connects

• MSOs upgrade to 750Mhz or better to meet
  challenge from DBS
• Internet access offers substantial revenue
  stream, at limited marginal cost
• With 2-way communications established, cable
  telephony over IP becomes option for additional
  service at less than 300/pop
• Cable moves to Free voice in U.S. as part of
  bundle

57
Cable Connects

• Cheap bandwidth for the last mile
• Stable technology
• Video services pay for infrastructure
• ROW in place in many countries
• IP really makes the difference
• Monopoly pricing possibilities to subsidize voice
  investments
• Rolling in cash right now (stocks flying)

58
Cable Connects
Cable operators will have 2-way plant running to
40-50m homes by the end of 1999, and will be
offering high speed data to 20-30m
subscribers. Tele.com article
59
Cable Connectscustomer demand

• Cable overcomes traditional lousy image
• Customers care more about price than quality
• Customers buy video/Internet/telephony bundles
• Customers dont worry much about security or
  reliability
• Customers dont worry about cables
  inflexibility, e.g., single ISP policy, vertical
  integration with content

60
Cable Connectstechnology

• Traditional problems with two-way cable mostly
  resolved now, rest will be soon
• IP problems resolved (such as QOS)
• Powering issues resolved

61
Cable Connectsgovernment policy

• No more price caps
• No early application of universal service/access
  charges
• Must carry and other universal service
  questions resolved favorably
• Cross-subsidies permitted (bundling)
• Economies of scale permitted (permissive
  anti-trust enforcement)

62
Cable Connectsproviders

• HR Cable MSOs add weight and planning capacity
  to HQ staffs find thousands of data and
  telephony technicians
• Customer care becomes central to culture, with
  matching investments
• MSOs become more entrepreneurial (currently, more
  monopolistic than the ILECs)

63
Showstoppers

• Wall St. financing for upgrades dries up
• IP issues unresolved
• Weak customer demand for telephony from cable
  customers
• Universal service/access charges
• HR cable operators cannot retool and add
  technicians fast enough
• Management misses the window of opportunity on
  voice over IP

64
Naysayers
Cable telephony faces all the problems of voice
over IP, plus another layer of cable
problems. Research analyst
Cable has huge problems in setting up effective
back office and customer service systems for
Internet access, let alone Internet
telephony. Research analyst
Seven years is not long enough to change consumer
behavior. Cable assoc. exec
65
Wireless Winsdefinition

• Mobile substitutes for landlines
• Fixed-mobile integration comes fast
• WLL gains volume in 3rd world, then 1st
• Broadband fixed wireless outcompetes other
  delivery technologies
  FTTH, FTTC, HFC, xDSL, LEOs.

66
Wireless Wins
In Europe, wireless revenues are already about
20 the size of the revenues of fixed network
voice traffic . Mobile services could deliver
50 of fixed service revenues by 2001. Tele.com
Worldwide, the number of fixed wireless
subscribers will grow from 4m in 1997 to more
than 45m in 2001. NBI
Independent wireless companies are already cost
competitive with BTs landline rates in some
cases. Dir. Strategy, European wireless co.
67
Why wireless world is different problems for
incumbents

• Already a competitive environment
• For incumbents, means moving from monopoly to
  competition immediately
• Offers some serious disadvantages for incumbents,
  such as
• Being blocked from entry in some markets (Telecom
  Italia)
• Limited resources (e.g. spectrum)

68
Wireless Winscustomer demand

• Price falls to compete with landline (happening
  now) and customers respond
• Mobile becomes first phone of choice (happening
  now in some countries)
• Either customers do not insist on FMC/bundling,
  or all wireless carriers integrate to provide it.
  No advantage to incumbents or megacarriers.

69
Wireless Winstechnology

• QOS continues to improve
• FMC comes on stream smoothly
• 3G wireless isnt too late (a huge uncertainty)
  and fulfills its promises (another huge
  uncertainty)
• Broadband delivers as promised

70
Wireless Winsgovernment policy

• Regulators do not attack wireless profit margins
  through re-regulation
• Not too many players in each market (3 max in
  most places)
• Regulators approve unlicensed spread spectrum
  technologies
• Rights of way available (legislation)

71
Wireless Winsproviders, capital markets

• New entrants scale effectively
• New entrants do not crash the market by cutting
  prices to generate more business than the
  infrastructure can handle
• Market funds extensive build-out by new entrants

72
Show-stoppers

• Market gluts from oversupply?
• 3G technologies badly delayed
• Continuing standards fights (U.S. and global)
• Regulators attack margins
• Prices stop falling

73
Wireless- Naysayers
74
Combination scenario

• In each of the four sets of scenarios, drivers
  align to produce a single future
• But more complex scenarios are also possible

75
Meltdown for incumbents?

• Mobile takes all growth in voice markets
• New entrants steal best customers for voice and
  data
• Cable companies offer unbeatable free voice
• VOIP erodes premium voice services (e.g. intl)
• Data revenues go first to hungry challengers
• Legacy networks, legacy ideas, and legacy
  regulators hold incumbents back

76
Vicious circle
Stock declines
Incumbents position weakens
Investments slip
Managers and customers leave