Tone-deaf approach hinders SBC

From the Chicago Tribune:

Tone-deaf approach hinders SBC
Chairman's combative stance backfires; consumers lose out, critics say

By Michael Oneal and Jon Van
Tribune staff reporters
Published July 6, 2003

By all accounts, including his own, Edward Whitacre Jr. is on a crusade.

The lanky, 61-year-old chairman of SBC Communications Inc. believes it is grossly unfair that the federal government has forced his company to sell budget-rate access to its local wires to competitors such as AT&T and MCI.

So, with high-powered lobbyists, he has pressed his case in Springfield and Washington seeking to get rules changed.

Critics say he's trying to get what he can't get in the marketplace--that he has embarked on a path to deny phone customers choice and raise prices by discouraging competition. They point out that SBC can't even offer the bundles of unlimited long-distance and local calling that are catching on all over the country.

Whitacre responds that he is losing money every time he leases a line to a rival.

But since 1996, when Congress passed the act that opened the Bell monopolies to local competition, he has been less than convincing.

Having been rejected by state regulators from Illinois to California, he last winter participated in a massive Bell company lobbying effort to convince the Federal Communications Commission to overturn the access rates but was frustrated there, too.

Then this spring, Whitacre and his chief lobbyist, SBC President William Daley, produced banner headlines with an effort to bypass the Illinois Commerce Commission and appeal directly to the Illinois General Assembly for relief.

A bill designed to double the access rates charged to competitors passed the legislature May 9 after just four frantic days of politicking. But a month later, U.S. District Judge Charles P. Kocoras struck it down, handing SBC a withering, highly public defeat. The decision took the wind out of several other legislative efforts brewing in other states around the country.

Now, as Whitacre elevates his case to the U.S. Court of Appeals and contemplates other strategies to battle the regulators, there is building evidence that his efforts may be backfiring. A recent Tribune poll showed that the Springfield gambit was overwhelmingly unpopular with Illinois consumers. And while phone users around the country enjoy the choice of buying long-distance service from their local phone company, Midwestern consumers are forced to look elsewhere.

That means nothing good for SBC. In the five years since Whitacre marched into Hoffman Estates and bought the former Ameritech Corp. for a staggering $55 billion, his company has experienced a persistent decline in its competitive prospects. Once the crown jewel of the so-called Baby Bells, the former Ameritech is now "a gaping wound" for SBC, says Scott Cleland, an analyst with the Precursor Group in Washington, D.C.

Experts agree all the Bells face big challenges from cable companies, wireless phones and local competition. But largely because it has alienated regulators in the former Ameritech territories, SBC alone has failed to win the right to counter those threats by launching long-distance in the Midwest, one of its major regions.

That has left it vulnerable to competitors like AT&T, who are selling cut-rate "bundles" of unlimited local and long-distance service that are quickly catching on with consumers. With no way to counter the threat, SBC has lost more customers to competition faster than any of the other Bell companies. Winning them back is becoming an increasingly expensive proposition.

"The tactics they employ give us a real advantage," says David Dorman, chairman of AT&T.

If the millions of SBC investors, customers and employees who watched the recent hullabaloo in Springfield are wondering if it really had to be this way, they need only look at the fortunes of Verizon Communications, SBC's sibling in New York. While SBC has been wrestling with service problems and regulators, Verizon has developed a unified national strategy that allows it to compete more effectively in local, long-distance and wireless service.

Verizon's chairman, Ivan Seidenberg, says he admires Whitacre and makes no secret of his disdain for the federal rate rules. But while Fortune Magazine has dubbed Whitacre "The Angriest Man in Telecom," Seidenberg has made it a point to be much less pugnacious. His stock price, in part, reflects it. Over the past year, Verizon shares have risen 7 percent while SBC's have lost 13 percent.

"Ed's my friend. He makes me laugh," Seidenberg said during a recent interview in his New York office. "He calls me up and says `You're a sissy. You should go out and beat them up like us.'"

Whitacre declined to comment for this article.

In many ways, the trouble in SBC's Ameritech states--Illinois, Wisconsin, Indiana, Michigan and Ohio--presents a cautionary tale for anyone who thinks deregulating a monopoly is as easy as changing the rules. When William L. Weiss, convened 30 top executives at the plush Breakers Hotel in Palm Beach, Fla., a decade ago, the avuncular former Ameritech chairman had a very different future in mind.

Faced with a new world of competition brought on by the 1984 breakup of the Bell system, Weiss wanted to incite a revolution of sorts at the stodgy old Baby Bell. Over three days of meetings in Florida, he systematically weeded out the executives he felt were clinging to the old monopoly and elevated those he believed were ready to compete.

Richard Notebaert, who emerged as Weiss' heir apparent, quickly dedicated himself to ripping out the bureaucracy that had grown like moss during the monopoly years. Anticipating the sweeping 1996 law that let local and long-distance companies into each other's markets, Notebaert was the first Baby Bell chief to seek long-distance approval in 1994.

"Gentlemen, ladies, start your engines," he said at the time. "The race is on."

Long-distance a difficult battle

Winning access to long-distance markets, however, proved much more difficult than anyone imagined. A Baby Bell first had to prove to state and federal regulators that it had truly opened its local markets to competitors by selling them access to its lines and systems at pre-approved wholesale rates.

The reasoning was simple: No competitor would ever be able to replicate the networks the Bells had created over decades using billions of dollars of rate-payer money. But that didn't make it any easier for a monopoly to overcome the cultural or technical hurdles required to link up with a fresh-faced competitor.

Notebaert tried and failed in two highly publicized attempts to win long-distance approval in Michigan. Then he all but gave up. Starved for growth, he instead latched onto the mid-1990s craze for interactive video and focused the company on building cable TV systems. Notebaert, now the chairman of Quest Communications in Denver, declined to comment for this article.

Down at SBC headquarters in San Antonio, Whitacre wasn't interested in things like interactive video. Installed as chairman of the former Southwestern Bell in 1990, the Texas native inherited the smallest of the seven AT&T offspring and saw little sense in wasting precious capital on unproven ideas.

When it came to new businesses, says one former lieutenant, his first question was always "`What is the margin?' If you couldn't answer that, get out of the office."

Instead, Whitacre saw strategic acquisitions as the surest path to growth. Already strong in Texas and the middle of the country, he savored the West Coast's Pacific Telesis region and, in 1997, he pounced, wrapping up PacTel for $16.5 billion after an unusually swift negotiation.

With the Internet in full bloom, California was a gold mine. Second phone lines were in high demand, and exploding business in Silicon Valley presented a rich vein of business. The acquisition couldn't have been better timed, and Whitacre followed it quickly with the $5 billion purchase of Connecticut's Southern New England Telecommunications Inc.

"With that financial wind at their backs, they looked like geniuses," said a former high-ranking PacTel executive.

Then came Ameritech. Stymied in long-distance and muddling along in its expensive cable foray, Notebaert's company was largely dependent on the low-tech Midwest region's growth. But its stock, buttressed by the telecom craze on Wall Street, was soaring.

Eager for still more growth, Whitacre decided he wanted the company anyway and in 1998 offered Ameritech's board a rich $55 billion in stock. Faced with a fat premium to Ameritech's already inflated market value, Notebaert handed over the reins.

Fortunes about to change

What Whitacre didn't know was that Ameritech was headed for trouble. The deal took 18 months to close, allowing the phone network to deteriorate as Ameritech management focused more on preserving earnings than deploying capital. Once it did close, a provision giving rich exit packages to more than 1,200 top managers just about assured that most of them would leave. At PacTel, only a few hundred managers were guaranteed such a deal. That meant Whitacre could count on a much richer base of incumbent management.

Paul Osland, a former Ameritech executive who is now the CEO of a network consulting firm called Orius Corp. in Barrington, said the buyout package was only one reason so many managers defected. SBC's culture also seemed an eerie reminder of the dusty monopoly Ameritech had just shaken off.

"The day the merger happened, Whitacre--to his credit--flew up for a meeting at the Ameritech Center in Hoffman Estates," Osland recalled. "He and Dick were standing at the front of the room, and Whitacre threw up a chart of the SBC organizational structure. I thought, `Oh my God, look at all those levels.' People came out of that meeting and said `Can you believe this?' It was like a movie we had seen five years ago."

Almost immediately, things began to get worse. Service quality in the Ameritech region melted down disastrously in 2000, leaving customers waiting weeks, then months for new phone lines and fixes. That triggered a public outcry that soured state regulators on SBC. With Ameritech's management gutted, Whitacre rushed to install his own soldiers to fix the problem. But it wasn't until he freed up $2 billion in additional spending for new equipment that the crisis began to abate.

Verizon's eyes on prize

Through all of this, Verizon was steadily building its long-distance businesses. Born of the merger between Bell Atlantic and Nynex, the company had been lured by the Internet bubble into several embarrassing missteps. But it had also worked in close harmony with local-service rival Allegiance Telecom to demonstrate to New York regulators it was truly opening up its local market by forging electronic links with its competitor. That led to long-distance approval in the crucial New York market in 1999. By May 2003, Verizon was offering long distance in all its markets.

Seidenberg also worked deftly to create what is perhaps his greatest asset. Well aware that cell-phone calling threatened his land-line business, Seidenberg made a run at Airtouch Communications in 1998. He lost a heated bidding contest to Britain's Vodafone but quickly offered the British company's chief executive Chris Gent another deal.

He proposed Verizon and Vodafone combine their U.S. businesses in a joint venture owned 55 percent by Verizon. That allowed Seidenberg to sell service under the Verizon brand name and instantly gave the company a string of retail stores nationwide. It also allowed him to advertise across the country, further burnishing his trademark. Verizon is now the leading national wireless company.

Whitacre hardly stood still at SBC. He also worked with Allegiance to win long-distance approval in Texas and used that experience to do the same in his other territories, including California. But in the five Ameritech states, he got stuck.

As the company began to emerge from the long service meltdown, Midwestern regulators told SBC it would have to charge competitors some of the lowest rates in the country for access to its lines. As rivals began to take advantage of the low rates to pick off SBC's customers in the region, they also started to complain loudly that SBC wasn't working with them as the law intended.

Conflict with foes persists

Even today, competitors claim SBC routinely presents them with bills that are unintelligible and inaccurate. Pay disputes get stretched out for months, they say, despite the fact SBC demands cash up front. Regulators have charged that SBC has denied competitors access to certain lines they are entitled to by law. And rivals complain the company has failed to tell them when a customer switches back to SBC so the competitive company keeps billing, and annoying, that customer.

Rather than try to appease his competitors in the Ameritech region to grease the skids toward long-distance approval, Whitacre declared war on the rules that force him to sell his rivals access. In late 2001, he hired William Daley, a Clinton administration Cabinet member and the Chicago mayor's brother, charging him with lobbying for change. He also hired Carrie Hightman, a lawyer for several competitors, and installed her as president of SBC Illinois to argue for his side.

Over the past three years in Illinois alone, SBC has absorbed $53 million in penalties brought on by the competitors' complaints of poor service. It has paid $81 million more to the U.S. government. When a national consulting firm hired to audit the wholesale process repeatedly backed up many of the competitors' assertions, SBC publicly lobbied to have the consultant's standards relaxed, despite the fact similar standards were used industrywide.

The other regional phone companies, Verizon included, are hardly angels when it comes to making life difficult for competitors, often resorting to similar tactics, says Phil Jacobsen, co-founder of research company Network Solutions. The difference is, Seidenberg's company has found a way to work with its rivals well enough to win long-distance approval in all of its regions and SBC hasn't.

That has left Whitacre's company wide open to competitive assault and Midwest consumers without the choice of bundled local and long-distance service from its local telephone company.

SBC appears to have improved its behavior with competitors sufficiently that weary regulators will likely begin approving long-distance service in the Ameritech region by late this year or early next. Already, Illinois regulators have granted approval, and SBC will soon present an application to the FCC.

But even if approval comes this year, SBC already has lost precious time and about 14 percent of the market in its Ameritech states. The irony is, it might have done better by competing outright.

Bundles create buzz

What phone companies are discovering is that bundling services is a powerful marketing tool. When Verizon offers a $60 monthly package of unlimited local and long-distance calling, it says it is finding that customers with a history of spending just $40 a month are signing up for the more expensive package anyway. They are apparently willing to pay extra for the convenience, especially when it comes from a company they know and trust.

Seidenberg hopes his national Verizon brand will provide the same sort of marketing umbrella for selling wireless, broadband and data services nationwide. As he hunkers down to chase cable and long-distance companies, "we had to have a single, common brand," Seidenberg says.

Whitacre admirers abound

Whitacre has no shortage of fans in the business world. Industry experts say he has done a remarkable job of taking the smallest former Baby Bell and constructing a national company with many of these same strengths. Not only has he created the second-largest local phone company with the lightest burden of debt in the industry--no small feat--but he has also helped build the nation's third-largest wireless company in terms of revenue--Cingular--and has a promising broadband Internet alliance with Yahoo.

"There is no way he doesn't get into the Hall of Fame for doing that," says William J. Hannigan, a former executive vice president at SBC and now the chairman of online travel company Sabre Holdings.

The problem is that Cingular is a 60-40 joint venture with BellSouth, and a lot of consumers have no idea at first glance that it is associated with SBC. That prevents the Texas company from using it to bolster its brand image and promote the sale of its wired products like DSL and voice service. While the Yahoo alliance is clearly a smart move that is driving healthy penetration of the DSL market, it may do more for Yahoo's brand than SBC's.

Perhaps the biggest impediment to SBC's brand identity, however, is Whitacre's ongoing combativeness in Illinois. Consumers want phone-service choice and, as the Tribune poll showed, many were put off by the legislative end-run in Springfield. SBC will eventually get long-distance service in the Midwest and begin marketing bundles. But at what cost?

Seidenberg refuses to criticize Whitacre but explains his own philosophy this way: "We will continue to make the argument that [wholesale] rates are unfair. But we don't want to put our customers and employees in the middle of a regulatory fight."

A prime example of Seidenberg's restraint is the battle Verizon waged doggedly against a proposal to let wireless consumers take their phone number with them when they change service providers--a battle Verizon ultimately lost.

"We were a pain about number portability," Seidenberg says. "But we were getting mixed signals from our customers about whether it was in their best interest. During the fight, we put our marketing guys in jail. But when we lost they said, `OK guys, get off your kick. You're hurting the brand.'"

SBC has said volumes about why the wholesale rate structure is unfair. The competition has been equally vociferous. Neither is especially convincing by themselves, but the state and federal regulators have made their call in favor of competition and lower costs.

Seidenberg, meanwhile, insists his customers admire companies that compete and take risks.

"They want us to come across that way," he says.

"Consumers are not stupid," agrees Christie Nordhielm, an assistant professor of marketing at Northwestern University's Kellogg School of Management. "It doesn't take a brain surgeon to figure out that lower costs are better than higher costs."