AT&T: Fall of an icon

While name to live on, deal marks end of era.

Ed Block knew the future was bleak. "What the hell do we do now?" he asked himself when AT&T agreed to the 1984 consent decree that broke up the company and gave birth to the regional Bell operating companies, one of which, SBC, is finalizing its $16 billion acquisition of AT&T.

Block, then senior vice president of advertising and assistant to AT&T Chairman Charles Brown, knew the company made a catastrophic decision when it agreed to divest its local-exchange assets in return for the right to retain its long-distance, equipment manufacturing and R&D operations. "Without the local exchange, you had no future," Block says.

Divesting the RBOCs was only one of a string of pre- and post-breakup blunders that led to the demise of this 130-year-old American business icon, whose stock was once the most widely held in the country. Although the brand AT&T will live on, with SBC adopting it as its new corporate name, the company as we know it will be gone.

Interviews with former AT&T insiders, regulators, analysts and other observers concluded one thing: It didn't have to end this way.

"It's a sad, sad outcome," says the reflective Block.

The M trait

AT&T's end actually has something to do with its beginning. The company became a monopoly in the early 1900s and tried to continue to operate this way even after the 1984 breakup, observers say.

"AT&T always thrived in the old days on the absoluteness of its monopoly," says Fred Goldstein, principal of Ionary Consulting and author of The Great Telecom Meltdown. "The company was built around the structure."

That structure was introduced in 1907 by then AT&T President Theodore Vail, who created the Bell system by lashing together several local phone networks across the country. Vail argued that the most efficient way to make telephone service universal was to establish AT&T as a monopoly protected by government regulation.

The Vail model stood for the next 77 years, building the company into a behemoth with $150 billion in assets, $70 billion in revenue and 1 million employees. Yet it also made management complacent, insular and resistant to change.

Being a monopoly meant having few, if any, competitors. And having no competition meant few strategic decisions had to be made - it was all about maintenance of the status quo.

At the root of the problem was management inertia. Up until the mid-1990s AT&T was reluctant to hire outsiders, for fear of introducing philosophical change, Goldstein says.

"To get to the top of the company you had to be promoted over 25 times," he says. "If you're entitled to one promotion a year at most, each time you took a job you immediately began work on your next promotion. You never stayed more than a year so you never had time to learn your job. You had a management culture composed of people who didn't really understand the business but they understood internal politics and they understood sucking up. When the world changed it was very hard for the organization to adapt."

The company couldn't even capitalize on its own innovations, such as the 1947 invention of the transistor, which reinvented electronics, communications and computing. "They put themselves out of business because [the transistor] led to an increase in the rapidity of change," Goldstein says.

Breaking up is hard to do

Change was finally foisted on AT&T in 1984 when it agreed to divestiture to end a long, contentious antitrust suit brought by the U.S. Department of Justice. AT&T had two choices: spin off its 22 local operating companies into seven Bell holding companies, while retaining equipment manufacturing and R&D - Western Electric and Bell Labs, respectively; or retain the Bell operating companies and divest equipment manufacturing and R&D.

AT&T chose the former and it turned out to be a colossal blunder. The carrier didn't foresee that equipment would become a commodity, that calls would just become calls - no matter local or long-distance - and that the real value would be in owning the customer, a truism that would ultimately give the Bells control of the market.

"An awful lot of money was wasted in trying to find a way to stay in the equipment business long after it was obvious that's the last business you wanted to be in," says Block, who retired from AT&T in 1986. "The whole economics of the business was built around the local exchange."

What's more, Block says it felt like AT&T never really shook off the monopoly cloak. "It seemed to me that management was not sufficiently aware that the divestiture of the Bell companies destroyed the Vail model, and a whole new business model had to be devised," he said. "Instead, all of the efforts seemed to go into taking the leftover parts and trying to make businesses out of them. Some of them had no future."

Although it was a shadow of its former self, after divestiture AT&T was still the industry heavyweight with $34 billion in revenue and 373,000 employees.

More change to bungle

While AT&T landed on its feet and successfully built up its services and brand, the 1990s saw a series of high-profile strategic fits and starts, none of which went right.

By acquiring computer vendor NCR in 1991 for $7.3 billion, AT&T placed a bold bet on a future about integrated computing and communications. But the deal never resulted in any advances and AT&T jettisoned NCR in 1996 at a substantial loss. It also spun off its Western Electric equipment and Bell Labs R&D business into what is now known as Lucent, a restructuring that was known at the time as "trivestiture."

"I'm not aware of any NCR successes," says Sheldon Hochheiser, a 16-year company historian at AT&T who left the company last year. "By the mid-'90s [AT&T Chairman Robert] Allen realized there were negative synergies having long-distance and manufacturing businesses. Recognizing this and acting on it is a very positive thing for Allen to have done."

Concurrent with AT&T's trivestiture, Congress was passing new telecom legislation in the form of the Telecommunications Act of 1996. The act sought to spur competition by allowing the RBOCs to enter the long-distance market if they allowed long-distance carriers access to local loops at government-mandated wholesale rates.

At the time of the Telecom Act, AT&T's market capitalization was larger than any of the Bell companies'.

"Before the '96 act, the government policy was to keep the two industries from battling each other," says Reed Hundt, the FCC chairman from 1993 to 1997. "It's the battle that was declared by the '96 Telecom Act that has produced this result. You'd have to say that the local phone companies nine years later have won that battle."

NCR and AT&T's other ill-advised forays into the computer business - the 3B minicomputers and the AT&T-branded PCs - was a sideshow to more significant blunders, one of which was the mishandled foray into wireless, says Leslie Cauley, a telecom reporter for USA Today and author of End of the Line: The Rise and Fall of AT&T.

AT&T Wireless was formed by the 1994 $11.5 billion acquisition of wireless operator McCaw Cellular. It was a bold and prescient move, given the importance of cellular today. And while AT&T grew the cell business tremendously, it couldn't make the numbers work and spun off the assets in 2001.

"It was a huge missed opportunity," Cauley says. "Having sold America and the board on this one-stop-shopping strategy, and then selling it off, it was pretty stunning. All they had left was legacy long-distance, enterprise and consumer, [and the latter] was losing 20% a year."

But the backbreaker, according to Cauley, came later that decade with AT&T's next big bet - its entry into the cable broadband business.

In 1999, AT&T acquired TCI, the second-largest cable company in the U.S., and renamed it AT&T Broadband. In 2000, AT&T Broadband acquired cable company MediaOne to become the largest cable company in the U.S.

The acquisitions were then CEO C. Michael Armstrong's way back into local access. But the ante was too big and the timing poor.

The cable acquisitions cost AT&T $100 billion at a time when the stock market was overheating on the Internet bubble. When the bubble burst, AT&T Broadband's worth disappeared into thin air and AT&T had to divest its cable investments.

"It all came down to the way the deal was financed," Cauley says. "And they got caught in the shifting; the market was imploding and they got caught short with all the debt. That event, that one deal - had they not done it, in my view - they'd have been just fine."

"If industry pricing hadn't deteriorated so rapidly we could have managed and serviced the debt," says Dick Martin, a 32-year AT&T veteran who was executive vice president of public relations when he left the company in 2003. "Industry pricing was going to hell in a handbasket. Armstrong was on the right path and I would like to have seen his strategy realized. In fact it is, but just not by AT&T."

Adds ex-FCC Chairman Hundt, "Cable and wireless are the two most powerful weapons in the communications business today. Spinning off the wireless business was a catastrophic strategic mistake."

Armstrong declined to comment for this story.

Armstrong left AT&T in 2002 to become chairman of AT&T Comcast, the company formed from Comcast's acquisition of AT&T Broadband. What he left behind was a company that consisted of two units, AT&T Business and AT&T Consumer, and that was in bad shape.

In the past five years AT&T had seen $11 billion in consumer long-distance revenue evaporate, and a 22% drop in 2002 alone. Even AT&T Business was having problems, with 2002 revenue down 4%.

By the time the board handed the reins to new CEO David Dorman in July 2002, the company was a shell of its former self: revenue of $38 billion, half of what it tallied only eight years previous, and a 2002 loss of $13 billion, mainly because of discontinued operations.

Part of AT&T's revenue shortfall was caused by aggressive price-cutting to stay competitive with MCI, which was reporting mystifyingly better financials. Little did AT&T or anyone else outside of MCI management know that MCI was cooking the books.

"Believing MCI's numbers was a terrible mistake," Cauley says. "But how can you say a major Fortune 50 company is lying through their teeth? You don't expect that. An innocent mistake but a fatal mistake."

While a crippled and confounded AT&T was shrinking, the FCC fired the "final shot to the head," as Hundt calls it, by announcing in 2004 a phase-out of the government-mandated wholesale rates for local access.

Four months after that ruling, AT&T and MCI announced intentions to exit the consumer telephony market. And seven months after that, AT&T and MCI accepted buyout offers from SBC and Verizon, respectively.

"It probably need not have ended this way," Block says. "But in our society, a corporation that lives beyond 100 years is a freak. In that sense, life goes on."

Copyright © 2005 IDG Communications, Inc.

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