The fall of a corporate queen

BUSINESS

Corporate mergers

Feb 3rd 2005
From The Economist print edition

AT&T, once one of the world's greatest companies, loses its independence

FROM the very first words spoken over a telephone in 1876 by its inventor Alexander Graham Bell—“Mr Watson, come here, I want to see you!”—AT&T always wanted to have its own way. And for much of its 128-year history, the American Telephone & Telegraph Company got it. First, as a brash start-up that won over 600 patent lawsuits in its first 18 years, then as a cut-throat competitor that pushed the limits of lawfulness to consolidate America's telecoms market and finally, until 1984, as a government-sanctioned monopoly.

But the modern era has been less generous, as the business behind AT&T's central activity of connecting long-distance calls crumbled. This week, SBC, one of the “baby bells” that was spun out of the company as part of a court-ordered break-up in 1984, acquired “Ma Bell”, as AT&T is known, for around $16 billion, ending its reign as an independent firm. The new owner may yet adopt the famous brand as its corporate name. But the firm born in the 19th century, and which dominated the 20th, failed to survive long into the 21st.

The deal creates America's largest telecoms firm, with combined revenues of $70 billion and 210,000 employees (of which 10% are to be cut). AT&T had been for sale for a while, and had slashed debt and staff to pretty itself for suitors. SBC gets to sell to AT&T's millions of corporate customers sophisticated data and voice services—around $20 billion of AT&T's revenues. The deal may prompt further consolidation (MCI is fingered as the next target by three other Bell companies, Qwest, Verizon and BellSouth), now that the period of internal rebuilding by telecoms firms after the bubble burst in 2000 is over.

Ask not for whom the Bell tolls

For much of the past century AT&T was the envy of the corporate world—the largest firm on the planet both by revenue and market capitalisation. No share was more widely held—the firm was so solid it was considered ideal for “widows and orphans”. Its legendary research arm, Bell Laboratories, was responsible for some of the 20th century's greatest inventions, from the transistor to the laser, and fielded seven Nobel Prize winners. At the time of the break-up in 1984 AT&T boasted around 1m employees. So what went wrong?

In short, the industry changed but AT&T failed to change with it. A century-old ethos of public service and reliability—thanks in part to its cosseted life as a protected monopoly with regulated rates—was ill-suited to competition in a world in which new technology cut the cost of calls and lowered rivals' barriers to entry. Despite owning the world's foremost corporate research lab, it missed moving into new technologies such as wireless and the internet that would become the cornerstone of modern communications.

“It is a tragic fall and I lament the passing, because it was a huge disruptive success in its day”, says Clayton Christensen of Harvard Business School, author of the best-selling “Innovator's Dilemma”. “The world is filled with companies that are marvellously innovative from a technical point of view, but completely unable to innovate on a business model.” In the early 1980s, AT&T negotiated an antitrust settlement with the Department of Justice to separate its long-distance operation and create seven local telephone firms, spread across different regions. “AT&T will now be free”, gushed The Economist, to put a computer on every desk connected by “broader-band links” and “pocket-mobile telephones in big cities”. Yet at three critical junctures over the past two decades—involving wireless, computing and cable—the company misplayed its hand.

First, AT&T underestimated how important wireless communications would become. At the time of the break-up in 1984, AT&T relied on a report by McKinsey, a consultancy, that claimed there would be fewer than 1m wireless phone users by 2000. In fact, there were 740m. Cellular technology was then spotty—calls were often lost, the signal short and the power used by devices high—so AT&T declined to enter this small market. Until, that is, 1994, when it paid $11.5 billion for McCaw Cellular, which became AT&T Wireless and was sold last year for $41 billion.

The second stumble was in computing. After the break-up, AT&T expected to become a powerhouse in computers. Shedding the slow-moving local operators and retaining the Western Electric equipment business seemed a brilliant result from the antitrust process. AT&T even bought a computer maker, NCR, in 1991. But the fast-paced computing industry did not suit the stodgy former monopolist. And the equipment arm struggled because local operators declined to rely on a single supplier and gave half their business to other firms.

So, in 1995, AT&T voluntarily broke itself up still further, shedding Lucent, its re-named equipment maker, and NCR, at a huge financial loss. Now the downsized AT&T would focus on services.

This was the dawn of the commercial internet, yet AT&T was nowhere. Two decades earlier it had dismissed the technology as unworkable, and later, as too small a market. It had even rejected numerous requests from American officials over three decades to operate the internet backbone. Just as by inventing the transistor AT&T unleashed one of the central forces in technology that would eventually undermine the company, so it also missed the potential of the internet despite it running over its long-distance lines. In the 1970s, Bell Labs developed the UNIX computer operating system, which (evolved by others) still powers most of the world's large corporate computers. Alas, at that time AT&T was prevented by regulators from moving into computing, so UNIX was commercialised by others.

The third big mistake was to buy cable operators in the late 1990s. This was the right strategy at the wrong time and for too much money. At the height of the tech boom, AT&T's then boss, Michael Armstrong, paid over $100 billion for two cable firms, TCI and MediaOne. AT&T realised it needed direct access to consumers, as it could no longer count on the regional bells, now moving into long-distance after the 1996 Telecom Act opened up competition in the sector. But the cable infrastructure required costly upgrades, and Ma Bell's domineering ways clashed with the cable firms' culture of co-operation.

Barely a year later, as the stockmarket turned on telecoms firms, AT&T faced a debt crisis. It had to abandon the firms it had just bought, and with them, the strategy of offering a basket of communications services including voice, TV and internet access—a strategy now regarded as the likeliest way to succeed.

“The main lesson is that it is very hard to change a culture that has evolved for a particular type of environment,” says Andrew Odlyzko, a former Bell Labs researcher now at the University of Minnesota. AT&T grew up believing that communications comprised voice calls charged by the minute and the distance. But data subsumed voice, web traffic burst through the network via always-on broadband connections and distance is dead.

Is there a silver lining to this sorry tale? “It ought to be humbling to any empire-builder to see what was once the greatest corporation in America be acquired by one of its offspring”, says Paul Starr, a communications historian at Princeton University. “But it's not necessarily a bad thing when the mighty lose sleep at night.”

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