Survivor: Telecom

Posted: 10/2002

Survivor: Telecom
Who Will Outdo the Competition?
Experts Pick Their Favorites

CONTESTANTS ON THE CBS series
Survivor have nothing on today’s telecom executives. Dropped into the heart of
the tech bust, these players have had it tougher longer than any two-bit game
show contestant. Of course, today’s telecom marketplace is far more challenging
than a two-month stint in a scripted setting with the losers awarded a quick
return to the good life. Players in the telecom game are facing the dreaded
"bust" following the boom with their professional lives on the line
and no nets to catch them, no endorsement deals to buoy them and no immunity
idols to shelter them from the storm. This is the true game of survival, and
now, as never before, the strategies they choose will result in irreversible
consequences.

However, there is good news. We know
from history the reciprocal of the boom-to-bust cycle also exists, and all the
biggest and best brands emerge after tech sector shakeouts. And, unlike the
television game, more than one player will survive. The question, then, is who
will survive the storm to see the next series of bountiful days. We assembled
our own tribe of experts to analyze the current playing field and identify who
is likely to survive the shakeout, and why. Meet our tribal elders:

Two characteristics are evident when
reviewing this list. First, it represents a broad range of thought leaders. This
is a time for potent insight. Second, we have two Ernies and no Bert. This is no
time for convention.

Subjective topics often produce
diverse opinions and this was no exception. On most subjects, our tribal elders’
opinions are varied. Nonetheless, there are thematic threads that link many of
our experts while providing a broad perspective on the subject of survival.

Survivor Characteristics

The ability for players to fund
their ongoing activities from operations is almost universally recognized as a
necessity for survival in the new telecom arena. "The days are over for
companies who were in business to raise money. Now it’s the turn of companies
who are in business to make money," says Network Conceptions’ Jacobson.
This is not earth shattering in and of itself — most telecom executives
recognize that funding sources have all but dried up in the current climate.
There are multiple methods of reaching positive cash flow, and there is by no
means a consensus on the proper approach to the problem.

"Simplicity is the key,"
says Jacobson. "Providers need to offer basic products at a good price
combined with outstanding customer service." Ernie Bergstrom of In-Stat/MDR,
who spews the timeless wisdom of focusing on what you do best, echoes Jacobson’s
viewpoint. "Companies should never extend themselves," he says.

Brian Savin of de Fontenay, Savin
& Kiss concurs with Jacobson in terms of providing outstanding service.
"The general golden rules of business are even extra critical given current
customer skittishness — e.g., customer service, as in keeping your commitments,
being easy to deal with, making the customer’s problem your own, and so
forth," he says. However, Savin places significant emphasis on affordable
channels. "Whether you are a network provider, a service provider, a
content provider, a hosting company, or whatever, you need affordable and
quality access to your potential customers. You can’t just stand on a street
corner waving brochures in this sector. In most of these businesses, you need to
get to customers through wires or airwaves that most often belong to someone
else. That’s the main challenge for many."

Deloitte’s Raynor lies at the other
end of the complexity spectrum. He recently developed the theory of Value Chain
Integration with Harvard’s Clayton M. Christensen documented in the new Deloitte
report "Integrate to Innovate." Raynor argues telecommunications
companies need to dispense with the conventional wisdom of focus and embrace a
willingness to diversify across industry boundaries. Accordingly, telecom giants
can, in theory, grow into the relative, absolute and implied growth assumptions
built in to their lofty market values by intelligently embracing diversification
in the areas of application services provision (ASP), advanced mobile services (AMS)
and interactive broadband services. The report points out that between these
three services exists a growth potential in excess of $100 billion in new
revenue — nearly as much as the revenue of existing local services incumbents.
By diversifying into these areas, giants can, in theory, break free of the
growth constraints associated with the commoditization — or at least
commoditized pricing — of their core services. Since these firms operate under
growth-for-survival pressure, companies that make these adaptations are best
suited for long-term survival.

Like many large consulting firm
works, "Integrate to Innovate" is targeted at giants facing growth
dilemmas. Nonetheless, the principles may be adapted for smaller competitors.
"Smaller players may need to find a service with a more modular approach to
the value chain," Raynor told us. (see inset). "The viability of a
reseller or mobile virtual network operator (MVNO) is based on the belief that
the value chain for voice has modularized."

Ultimately, the route executives
take may be the cost-control side, the growth side or both, depending upon
financial, technical and, in some cases, geographic limitations. The needs of
target markets also must be properly assessed — especially when it comes to
smaller players. "Companies must provide services their customers want, not
just ‘me too’ services," says Management Profiles’ McDermott.

One thing is certain. All
initiatives, including growth initiatives, need to deliver rapid ROI so
providers don’t overextend themselves. Jacobson advises companies to invest only
in opportunities that contribute quickly to the bottom line.

As for companies already in trouble
and looking to pull their fat from the fire, Atlantic-ACM’s Reed Smith says
companies that are close to or in bankruptcy will need to reestablish investor
support. "This requires either a framework of established supporters who
want to work together to pull the company out," she says, "or the
ability to shape a reorganization which satisfies all those with all the classes
of debt."

External Pressures

Though our tribal elders have
divergent opinions on the internal characteristics of likely survivors; there is
broad consensus on current external forces crucial to telecom company survival.
At the very top of the list are regulatory issues — especially as they pertain
to competitors. Probe’s Starr says pending measures such as the Tauzin-Dingell
or Breaux-Nickles bills and FCC review of UNEs will have a profound impact on
survivability. "If the former RBOCs are freed from having to unbundled and
allow access to network facilities, the CLECs will be in trouble unless they
have their own networks or other access."

KDW’s Kelly, who formerly led the
competitive industry association ASCENT, concurs. "State and federal
regulators must act to protect local competitors," he says. "They must
expand, not restrict or retract UNE availability."

Regulatory challenges are not
limited to the United States. TTI’s Thayer reminds us "difficult problems
remain in many countries as regulators attempt to introduce competition into a
previously regulated monopoly market and harmonize de facto monopolies with
competition. Or, as in many other developed nations, privatize state-owned PTTs
and introduce competition."

Economic recovery also lies at the
heart of many of our experts’ perspectives on external pressures — particularly
in the areas of broadband services adoption. The Yankee Group’s Libby says
growing demand for broadband services, which drives demand for transport, is
linked to overall spending conditions. He is looking for signs of an economic
recovery, which drives enterprise spending on network services.

Atlantic-ACM’s Reed Smith sees a
direct correlation between such spending and street psychology, which also has a
significant industry impact, and wants to see industry pipes filled with
"music, games, photo sharing and video clips and whatever else [will build]
faith in the need for the networks our industry has built." Of course, the
telecom industry has more credibility problems with Wall Street than proving
services demand. Reed Smith points out that that faith needs to be reestablished
in players as well as the business models.

Libby also sees this as a crucial
issue and claims companies need to offer no evidence of operational malfeasance.
"They need to employ consistently straightforward accounting practices,
accountable management and demonstrate success measured as paying customers or
real revenue or both," he says.

Surviving Models

On the subject of models best suited
for survivability, our leaders generally agree ILECs will survive. In-Stat/MDR’s
Bergstrom sums up the prevailing viewpoint when he says ILECs are classic
"cash cow" companies with plenty of staying power to wait out
political and economic challenges.

Raynor’s Value Chain Integration
theory makes a strong case for the need for these firms to diversify into the
growth areas identified earlier if they are to survive over the long term,
however.

Network Conceptions’ Jacobson says
BellSouth is the most progressive of these firms. "They have done the most
to deal with their business problems in the marketplace instead of a complete
focus on regulatory issues," he says. "For example, they have done the
most to develop a data strategy." This is in stark contrast to how he views
SBC. "They’ll obviously be around in 12 months, but there’s nothing
exciting happening at SBC. MCI used to be called the law firm with an antenna on
the roof. SBC is a lobbying firm with a rotary dial phone and copper cable in
the basement."

Probe’s Starr and KDW’s Kelly see
promise in mobile wireless. Starr points to lifestyle trends that must be
balanced with ease of use. Kelly notes tenuous near-term prospects will play a
role in survivability here as with all models. TTI’s Thayer concurs.
"Wireless is an area of service that is fraught with some serious
difficulties at present, but the future of wireless is so promising that it must
be regarded as a success area," he says. "Among the difficulties U.S.
wireless providers face are a severe shortage of spectrum and a government
policy and regulatory framework that has encouraged over-expansion and cutthroat
competition. Quality of service and the incompatibility of various wireless
technologies continue and will not be completely worked out for some time yet.

On an up note, Thayer says,
"New and emerging wireless technologies are opening the rich resources of
telecommunications and IT to vast numbers of people in developing nations
rapidly and affordably. More than that, wireless technologies and applications
are having a transforming effect on the conduct of business, government and
other institutions, and personal, family and social interactions as well."

The IXC and CLEC models also were
tagged for survival by a number of experts. Savin of de Fontenay, Savin &
Kiss says CLECs and IXCs are more suited for survivability than some of the
other models because these are generally much more efficient businesses, but
with the caveat that enlightened regulation is a necessity. "Most of these
companies are at the mercy of the nine-hundred-pound gorillas when it comes to
accessing a mass of critical customers," he says.

Nearly all of our tribal elders
identified integrated services models — ICPs, ASPs, broadband providers, etc.
— as solid models for the long term. Management Profiles’ McDermott says
single-service companies are in extreme danger, period. "Customers may not
need to have all their services supplied from one vendor, but bundled voice and
data services are attractive to both customers and suppliers," he says.
Additionally, he cites continued Internet growth as evidence of an ASP
resurgence. "The time has come for managed service providers to assist
customers with the management and operation of their communications systems,
their Internet services and, for carriers, their OSS systems. It just makes
sense for smaller operators."

Our experts had some thoughts on the
survivability of channel models as well (see lists).

Likely Survivors

Games of survival aren’t for the
faint of heart and we put the heat on our tribal elders by asking them for
specific examples of companies likely to weather the current storm — the type
of question that makes consultants squirm. This is a bold group as many offered
predictions for a number of companies.

Davenport & Company’s Johnstone
puts AT&T ahead of its peers. "It is in far better financial
condition," says Johnstone. "It has $17 billion in long-term debt
after the Comcast deal and $3 billion in free cash flow to pay down debts or buy
distressed assets.

"If you look at a recent IDC
study, AT&T carries as much Internet traffic as WorldCom, but it has more
enterprise traffic. This is up from fifth or sixth a year ago. It has made
significant strides and will lead the data/Internet space over the next 12
months. It actually has generated better growth than its peers, increasing
data/Internet revenue 7 percent, compared to Sprint’s loss of 3 percent and
Qwest in the low single digits."

Johnstone also points out that
AT&T’s peers aren’t doing as well in their business units. "Given the
financial difficulties at Qwest and the difficulties at Sprint, AT&T is
positioned to capture a greater share of the business market. It is the only
long-distance carrier that is generating profits in its business unit."

He points out an advantage for
AT&T on the consumer side, provided UNE-P remains available. The giant had
1.5 million customers at the end of the second quarter and is adding about
200,000 on a quarterly basis.

Johnstone also classifies the RBOCs
as survivors, which dovetails with the general consensus that the ILEC model
will survive. His firm also predicts Time Warner Telecom will survive. "We
believe TWTC has the best business model in the CLEC sector and is likely to
succeed over the long-term. While most CLECs built out long-haul networks, TWTC
constructed extensive local fiber-optic networks to serve carriers and
medium-to-large business customers. In the 1990s, MFS and Teleport had a similar
focus and were acquired by WorldCom and AT&T, respectively. TWTC derives
most of its revenue from providing carriers and corporations with high-capacity
local connections. TWTC has plenty of cash on hand and no significant principle
payments on debt for the next four years. It is poised to capture share when
spending returns."

Network Conceptions’ Jacobson also
sees AT&T, Time Warner Telecom and the RBOCs as survivors. He also points to
Allegiance Telecom for its "…outstanding operations, focus on enterprises
and solid growth throughout the downturn." He acknowledges the firm has
issues relating to bank covenants but says they are being negotiated. Jacobson
also singles out Talk America and US LEC.

Agreement on the RBOCs, Allegiance
and Time Warner also can be found in comments from McDermott of Management
Profiles. He says the major IXCs will survive but "probably not Touch
America, Williams or CalPoint." McDermott also cites the CLECs who have
emerged from Chapter 11 (Covad, ICG, McLeod, etc.), RCN, Z-Tel, and most
wireless providers. As for "regular CLECs," it’s hard to tell, he says
"But I would bet that those who have not yet had to file for Chapter 11
will survive."

Probe’s Starr predicts the following
survivors: Allegiance, Alltel, AT&T Wireless Services, Citizens, Cogent,
Focal, GoAmerica, GRIC, Hickory, Infonet, Leap, Motient, Nextel, Primus, SBC,
TWTC, Verizon, Vodafone, Weblink.

De Fontenay Savin & Kiss’ Savin
will go as far as AT&T and the RBOCs, but says beyond that it’s a pure
crapshoot.

Reed Smith of Atlantic-ACM also
cites the RBOCs and AT&T and also likes Sprint. Additionally, she picks
"feisty, adaptive competitors" like IDT, Allegiance and McCloud as
survivors.

Overshadowing all of these
predictions are the regulatory issues that permeate the competitive community.
In this light, picking individual survivors may not be as important as picking
survivors period. "The survival of individual companies is not as important
as the survival of the species," says KDW’s Kelly. "This is what we
should be focused on."

Survival Factors & Strategies
for Carrier’s Carriers

Source: Panelist Interviews

Click Here for Chart
Source: Deloitte Research, Integrate
to Innovate Report, 2002

Survival Factors & Strategies
for Resellers

Source: Panelist Interviews

Survival Factors and Strategies
for Agents/Partner Sales Organizations

Source: Panelist Interviews

Survival Factors and Strategies
for Other Wholesalers

Note: Other Wholesalers consists
of companies not necessarily selling network, but conferencing, hosted
applications, etc. Source: Panelist Interviews