17th European Regional ITS Conference
Restructuring Diversified Telecom Operators
Svein Ulset Norwegian School of Economics and Business Administration Bergen Breiviksveien 40, 5045 Bergen, Norway April, 2006
[email protected] Tel: +47 55959721 Fax: +47 55959430
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Abstract The paper examines the recent restructuring cycle among diversified major telecom operators from two different perspectives, the governance deficiency perspective of agency theory and the governance efficiency perspective of transaction cost economics, the former being less consistent with the spirit of recent pro-competitive regulatory reforms than the latter. This restructuring cycle describes how incumbent operators grew larger and more diversified during the telecom boom before they were transformed into more efficient scale and scope either by economizing managers or by market forces along with actively intervening owners and bondholders during the subsequent telecom bust. A cycle whose expansion phase is characterized by highly acquisitive companies expanding into non-related activities followed by a delayed contraction phase where overdiversified companies are being restructured by market forces and intervening owners and bondholder is consistent with the reformincompliant governance deficiency thesis of agency theory. A cycle whose expansion phase is characterized by acquisitive companies expanding into related activities followed by a contraction phase where companies are restructured by their own mangers after having realized that previously acquired assets have become more redeployable and their services more tradable is consistent with the reform-compliant governance efficiency thesis of transaction cost economics. Now, in the aftermath of the contraction phase of the business cycle, more narrowly focused incumbents are once again ready for another round of acquisitive expansion. Anecdotic evidence from our five restructuring cases, along with available secondary information about the development of the industry, seem to support the reform-noncompliant governance deficiency thesis of agency theory more than the reform-compliant governance efficiency thesis of transaction cost economics.
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1. Introduction As the telecom boom went bust in March 2000, the last decade’s impressive series of corporate expansions, mergers and acquisitions among telecom operators changed into an equally impressive series of corporate contractions, divestitures, restructurings and even bankruptcies. 1 Although several critical events may have caused markets to grow and incumbents to expand such as technological advances along with regulatory reforms and a booming Internet market, the resultant size and diversity may actually have exceeded what integrated incumbents could efficiently manage under prevailing conditions. Consequently, incumbents started to divest and withdraw, turning themselves into less diversified companies or even into entirely different organizations. Many writers have described and commented on these rather dramatic expansion/contraction events in the telecom industry, but no one has so far provided a coherent organizational economics framework capable of explaining them (for a brief overview of the “organizational economics” domain, see Augier, Kreiner and March, 2000). One partial exception is Martin Fransman’s cognitive “Consensual Vision” framework (2002a), a kind of institutional evolutionary economics approach, under which the faulty vision apparently represent the bad investment gene (routine) that more generally may be inherited or transferred across firms (Nelson and Winter, 1982). Another partial exception is Jackie Kraftt’s study of the evolving info-communications industry (Krafft, 2003), examining the gap between theoretical result derived from mainstream economic contracting theory (Tirole, 1988; Kreps, 1990) and observable trends. In general, institutional evolution studies are more concerned with describing the co-evolving pattern of organizations, regulations, technologies and markets
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In the first expansion phase telecom incumbents invested heavily (mostly through acquisitions) not only into rapidly growing complementary networks such as cable, mobile and satellite networks but also into more distantly related activities such as IT and data services, system integration and various Internet-related businesses.
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17th European Regional ITS Conference (Fransman, 2002a, 2002b; Li and Walley, 2002; Krafft, 2003), than with explaining performance with reference to changes in such organization, regulation, technologies and markets. To accomplish the latter, a simpler model will be needed like one used to explain previous decades’ restructuring (merger and acquisition) waves among major US companies (Shleifer and Vishney, 1994; Williamson, 1988). Thus, drawing mainly on the governance deficiency perspective of agency theory and the governance efficiency perspective of transaction cost economics, the purpose of this paper is to develop a corporate economics framework capable of explaining differential firm performance (deficiency/efficiency) associated with the above expansion/contraction and concurrent integration/disintegration cycles. In essence, these cycles reflect a more general tendency observed among incumbent firms to expand beyond efficiency limits in the first growth phase of technology development before they are either overturned by more agile entrants (Christensen, 1997) or transformed into more efficient operations by their own managers in the second and more mature phase (Williamson, 1988). To explain this integration/disintegration cycle, governance failure theory of corporate finance and agency theory (Jensen, 1986) should therefore be combined with the governance efficiency theory of transaction cost economics (Williamson, 1988). Both theories recognize that corporations may drift into inefficiency before returning to more efficient operations, but for different reasons and influenced by different forces. Governance deficiency theory (Jensen, 1997, Shleifer and Vishny, 1994) regards the corporation as basically rigid, myopic and less adaptive and the capital market as the main correction mechanism (e.g.; through acquisitions, stock buybacks, hostile takeover, leveraged buyout, and divisional sales). The emergence of vastly oversized and overdiversified firms can be explained partly as the result of managers’ compensation systems that depend more on the company’s size and growth than on its efficiency and profitability (Jensen, 1986), partly as the 4
17th European Regional ITS Conference result of an overly optimistic and faulty “consensual visions” about the growth prospective of the telecom services industry (Fransman, 2002a), reinforced by escalating commitment to a failing course of action (Levinthal and March, 1993; Staw, 1976), not unlike the excessive pride and ambition (hubris) that usually leads to the downfall of a hero in classical tragedy. Finally the company collapses and top management is discharged. The governance efficiency perspective (Chandler, 1962, 1977, 1990; Williamson, 1975, 1981), on the other hand, regards managers as basically farsighted (neither myopic nor hubristic) and corporations as essentially capable of adjusting their governance structure to changing conditions in a fairly responsive and mainly cost efficient way. The state of being oversized or over-diversified should not be defined with reference to absolute size and diversity, but rather with reference to attributes of scale and scope assets that enable operating units inside the larger enterprise to develop and utilize these assets more productively than similar operating firms in the market (Williamson, 1981; Teece, 1980, 1982). Thus, under the governance deficiency view, myopic and hubristic mangers will tend to grow their companies oversized and overdiversified during the boom and well into the bust before they finally under the threat of financial collapse start to transform their vastly oversized and overdiversified companies into smaller and more specialized “pure play” firms through takeovers, demergers and division sales. Under the governance efficiency view, however, farsighted managers will, relatively independent of business cycles, turn their companies into smaller specialized firms as previous non-redeployable assets are later transformed into redeployable ones. 2 The question we therefore ask is what role expansionist managers may have played in creating the larger and more diversified incumbents, and to what extent such integrated firms appear as a less efficient mode of organizing the resulting activities than
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In telecommunications, redeployable facilities concern the abilities of different vendors’ facilities (hardware and software) to interoperate seamlessly across industry-standard interfaces. As part of being interoperable (compatible), they are also interchangeable (called “modularization” by Fransman (2002b)).
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17th European Regional ITS Conference disintegrated firms in diversified markets. A better understanding of the relation between the first expansion/integration phase and the second contraction/disintegration phase will also help us understand what may happen in subsequent phases. In particular, it will help us understand the conditions for revival and possible reintegration in the third phase. After this introductory section, our theoretical framework is presented in greater detail in section two, covering the main elements of the above restructuring process. Recent restructuring efforts by selected telecom companies are described in section three. Section four interprets the case histories, and section five concludes with a discussion of regulatory implications.
2. Governance Deficiency versus Governance Efficiency
Before we start elaborating on our two restructuring theses, consider first the following restructuring events in the telecom services industry. In the early 90s, incumbent operators started their acquisition spree as cash-rich monopoly operators. They continued, after being gradually deregulated and privatized, to expand into a growing number of national and international markets. Then, at the end of the 90s, most incumbents started to withdraw and reorganize themselves into more decentralized divisionalized enterprises, financial holding companies or even as independent divested firms under the pressure of increasing competition, global recession, overcapacity and tumbling stock prices. Whereas substantial revenue from the still monopolized access market saved the hardest hit incumbents from bankruptcy, no similar revenue source could save the hardest hit new entrants. Indeed, the bankruptcy of once the most successful entrant, WorldCom, became known as the largest in history so far. Now, consider more closely the first expansion phase. By the early 90s, a series of technological and regulatory changes had contributed to a rapidly expanding market of which 6
17th European Regional ITS Conference both the older incumbents and a rapidly growing number of new entrants wanted to capture a larger share, mostly by way of acquisitions. By then, advances in technology had not only contributed to higher transmission capacity, but also to the development of more advanced content and value-added services demanding higher transmission speed. Regulatory reforms reinforced this development. Not only did regulators grant new entrants the right to buy network capacities from the previous monopoly incumbents at attractively low prices, but regulators also granted incumbents the freedom to expand, diversify and price their new products and services as they pleased, only restricted by anti-trust laws and pro-competitive regulation. The resultant positive supply and demand shifts were further reinforced by a booming Internet economy. Then, through a series of acquisitions and investments, incumbents hoped to capture a larger share of the profit associated with such a rapidly expanding telecom market. Several factors may have contributed to the subsequent decisions to withdraw and divest. These may not only include collective overinvestment from the preceding telecom boom that now needed to be corrected as the Internet bubble burst and the telecom boom went bust, but also more fundamental changes in telecom technology that now started to impact the industry. Like in many other industries, the emergence of disruptive technologies that interoperate across standard interfaces, may also here have contributed to disintegration (Christensen, 1997). Standard interfaces such as the Internet Protocol (IP) are the technical rules that enable seamless interaction between components of larger system. Unlike in many other industries, integrated incumbents were not completely overturned by specialized new entrants. On the contrary, only the most hardly hit new entrants went bankrupt, none of the old diversified incumbents collapsed (The Economist, 2003). Despite the fact that interface regulation and standardization support disintegration, the extent by which incumbents really prefer to disintegrate may differ. For example, due to strong 7
17th European Regional ITS Conference political support and deeply entrenched monopoly traditions, previous monopoly operators may not even consider breaking themselves into independent stand-alone firms until seriously threatened by financial collapse (bankruptcy). However, since most previous monopoly operators still tend to profit from their dominant position in the fixed and mobile access market long after they have been deregulated, and since they still may gain a lot from cutting in bloated costs and oversized staffs, quasi-disintegration (holding company) is a more likely response than total disintegration (divestiture) even under the most disintegration-supportive conditions. Consequently, the level of disintegration following supportive changes in transaction conditions depends on whether other institutional and financial conditions also support disintegration. In particular, the last two decade’s rise and fall of telecom giants such as AT&T, BT and WorldCom may be explained by similar forces that explain earlier decades’ rise and fall of American conglomerates (large non-related diversified enterprises). In particular, the latter cycle that lasted from the early 60s to the late 80s, has been explained as the result of a series of governance deficiencies (Shleifer and Vishny, 1994). Such deficiencies may occur when managers pursue their own private interests (more money, power and prestige) that deviate from stockholders’ interests (more profits). Such deviating incentives motivate mangers to make their firms larger and more diverse rather than more efficient and profitable. Such adverse effects are all the more likely the more (i) management compensation depends on size and growth rather than efficiency and profitability, (ii) company ownership is diffuse and passive rather than concentrated and active, (iii) board of directors favors managers’ interests over owners’ interests, (iv) internal governance system is inconsistent and messy rather than consistent and ordered, (v) capital markets favor growth and diversity over efficiency and profitability, (vi) government policy favors larger and more diversified enterprises over smaller and more specialized firms. Thus, to the degree the above governance deficiency conditions (i8
17th European Regional ITS Conference vi) apply, we expect telecom managers to overinvest into new exciting growth businesses. Then, as failing performance is gradually revealed in the second period, we expect overdiversified operators to continue to invest and diversify before they finally under the threat of bankruptcy are forced to withdraw. Among plausible reasons for such delayed withdrawal we include escalating commitment to a chosen and increasingly failing course of action (Staw, 1976), combined with deeply entrenched monopoly traditions and strong desire for market dominance. Alternatively, the rise and fall of diversified enterprises may be explained as productive adjustments of governance structure to changing conditions, as outlined in the “structure follow strategy” postulate (Chandler, 1990) and transaction cost economics (Williamson, 1988). By combining low-powered incentives with extensive administrative control and resolving most disputes within the firm, corporate governance provides better support for cooperative adaptation than contractual governance can provide (Williamson, 1999:313). 3 That is, according to transaction cost economics, corporate governance (integration) may initially have been used to economize on transaction costs which tend to arise when incompletely specified transactions are carried out by actors who are boundedly rational, opportunistic and locked into each other through investment in less-redeployable assets producing less-tradable intermediate services (Williamson, 1975, 1985). 4 Then, gradually, as shared production assets and interfaces become increasingly more standardized and redeployable, spinning the respectively unlocked
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This approach based on the assumption that managers are farsighted can also be extended to include experiential learning by less farsighted managers (Williamson, 1999). As firm performance decline due to changing market conditions, mangers’ search for new solutions will intensify and risk tolerance improve, causing new governance solutions to be discovered and implemented (Greve, 2003) after which rigidity and myopia will be remedied, mistaken integration eliminated and efficiency restored. Thus, under the conditions of both farsightedness and experiential learning, the divestiture trend among major telecom operators may be explained by changes in critical resource and transaction conditions for economic organization. 4 Interdependency is a more general term for such lock-ins. Interdependency may characterize both vertical buyerseller relations when investment in relationship-specific assets is needed to accomplish least-cost supply and horizontally related activities when extra investment in the development and marketing of related products is needed so that excess capacities in non-tradable production assets are more fully utilized and least-cost production achieved. The less relationship-specific the vertically specialized assets and the less tradable the horizontally
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17th European Regional ITS Conference assets (core businesses) out into separate firms that specialize in the further development, production and sales of products and services to a larger group of downstream service providers, may turn out to be a more productive solutions than holding on to the integrated model and trading only with internal service providers. Conversely, when previously nonredeployable assets in the subsequent standardization and deregulation phase are transformed into redeployable or tradable ones, fully integrated corporations may constitute a too complex, costly and protective governance form, and should therefore be replaced by a simpler and less protective contractual one. 5 Table 1 below summarizes defining attributes characterizing the two perspectives discussed above, whereas Table 2 summarizes the associated causes and effects.
Table 1. Governance deficiency/efficiency: defining attributes
Behavioral assumption
Most important governance form Institutional environment
Governance Deficiency Hubristic Myopic Opportunistic (moral hazard)
Governance Efficiency Boundedly rational Farsighted Opportunistic
Capital market, rather than corporate governance, but dependent on institutional environment Weak property rights (ambiguous rights) Inefficient regulation (lenient regulation) Inefficient markets (late liberalization)
Firm, market or hybrid dependent on transaction attributes and institutional environment Strong property rights (unambiguous rights) Efficient regulation (pro-competitive regulation) Efficient markets (early liberalization)
shared resources, the less benefit can be derived from integrating the respective activities under one unified company, and the more often integrated companies will be replaced with alliances and supply contracts. 5 Many incentive and control mechanisms used for management of internal transaction will resemble those used for external transactions, but in different strength combinations. Under corporate governance incentives are typically weaker and administrative controls stronger than under contractual governance. Some mechanisms are qualitatively different, especially the roles of the court usually having the final say only for external, not for internal transactions where the firm (represented by top management) may serve as its own ultimate court of appeal.
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17th European Regional ITS Conference Table 2. Governance deficiency/efficiency: causes and effects
Causes Reasons for expansion
Effects Financial performance Expansion Volume Expansion composition Contraction Time Contraction Speed
Governance Deficiency
Governance Efficiency
Management compensation dependent on size and growth, combined with ownership being diffuse and passive, internal governance system being inconsistent and messy, capital market favoring growth and diversity, and government policy favoring large diversified enterprises
Excess capacity in shared assets that are valuable, rare, non-substitutable, and non-redeployable or whose services are less-tradable
Low
High
Large
Small
Unrelated Late
Related (shared assets) Early
Slow
Fast
Firm-standard interfaces that facilitate proprietary bundling of services and support constitute probably the most important non-redeployable asset. Such interface standards, that define how network components interact, also allow bundled services to be produced at lower cost and higher quality (e.g.; “triple play” of voice, internet and television over shared broadband connections). These interfaces may either be designed as firm-standard interfaces (proprietary and closed), as industry-standard interfaces (non-proprietary and open) or as mixed modes (proprietary and open). To the degree they are open, interface standards will also contribute to making individual components increasingly replaceable and upgradeable. 6
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Although increasing standardization of component interfaces (e.g.; through widespread use of the Internet Protocol) may have eliminated most of the associated transaction cost, and facilitated contractual bundling/unbundling of the respective service producing components, the degree of standardization varies between systems and technology layers. It applies less to higher-layered and more advanced technology components providing value-added and content services than to lower-layered and more basic infrastructure components providing ordinary transmission services. To efficiently bundle higher-layered system components whose interfaces are less specified and standardized, closer cooperation and more specialized service provision capabilities may therefore be needed (Spiller and Zelner, 1997).
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17th European Regional ITS Conference That is, when service bundling is simple and facilitated by industry-standard interfaces, or when the customers are highly sophisticated, the customers will essentially carry out bundling themselves (i.e.; buying equipment, content and transmission from separate suppliers). When service bundling is non-standard, complex and demanding, or the customer less sophisticated, service bundling will be carried out by some outside bundling specialist, either organized as an independent bundler or as an integrated bundling unit of one of the participating network operators, content producers or equipment suppliers (i.e.; buying transmission, content and equipment from one rather from several vendors) (Spiller and Zelner, 1997). 7 Then, the bundling specialist may prefer an integrated solution with one or several of the contributing players over an independent or quasi-independent (partnership) solution to the degree the contracting hazards from dealing with these players are significant. 8 Such hazards are associated with attributes of the respective service-producing devices and their technical interfaces, or with attributes of the services provided by these devices along with associated support (billing, fault finding, repair, technical adjustment, customization, user support etc.). 9
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The agreement between Ericsson, Tele 2 and Time Warner illustrate the point: “European operator Tele2 today launched Ericsson's mobile music service M-USE. The service, which is branded "MusicBox" by Tele2, allows Tele2 customers to easily download a wide variety of music content from BMG, Sony Music, and Warner Music to their mobiles. Content from additional record labels will be available soon. The "MusicBox" service, which can be found on top of Tele2's mobile portal GoLive, is integrated, hosted, and managed by Ericsson” (Ericsson Press releases: “Ericsson's M-USE service delivers world-class mobile music to Tele2's customers” December, 01, 2004; http://www.ericsson.com/press).
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To be sure, the merger and acquisition wave in the late 90s was based on the widespread belief that expansion, diversification and service bundling would help telecom companies capture extra profit. 9 In particular, transaction hazards occur to the degree bundled services and support (i) are real-time interactive and functionally interdependent so that each service provider’s individual contributions to joint performance becomes almost impossible to measure separately (technical non-separable), (ii) require firm-specific investment in proprietary technology and interface standards, (iii) need to be customized not only to the unique needs of customers but also to the unique features of contributing networks, or (iv) are produced by proprietary technology that may easily leak out to one or several of the other participating service providers, equipment suppliers or content providers (Spiller and Zelner, 1997). Such leakage problems will be mitigated, however, to the extent the respective technologies are firm-specific (customized) and therefore incompatible or useless for other firms, tacit and therefore difficult to communicate, or diffused and therefore difficult to assemble and prepare for sale and transfer. Additional leakage protection can be achieved through legal patents or by acquiring complementary resources that happen to be monopolized or co-specialized to one’s own primary assets (Teece, 1986). Although it will be rather difficult to transfer valuable private technology and knowledge that are specific, tacit, diffused or potentially leaky also to internal units without suffering some of the associated transaction costs (frictions and leakage), these difficulties will normally be harder and more costly to solve when knowledge is transferred to
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17th European Regional ITS Conference As a consequence, companies should only expand and diversify to the degree their superior and widely applicable assets (physical as well as human) are costly to trade or rent out to downstream external producers (Barney, 1991). Interface standards are the main factor that determine to what degree this is possible. Thus, in line with the governance efficiency thesis, we expect incumbent operators to diversify into related businesses to the degree these will be sharing valuable and widely applicable assets (e.g.; bundling technology and capabilities) whose intermediate services are less-tradable across firm-standard interfaces. As a consequence, we would also expect to find more firm-standard interfaces along with other lesstransferable shared resources and capabilities within “pure plays” companies such as mobile, broadband, satellite, data service and online firms than between such firms. 10 All in all, the above discussion calls for a closer examination of several key factors, including not only valuable physical and human assets (i.e.; interface standards and bundling expertise) shared by previous core businesses (spin-off candidates) along with the respective corporate organization used to exploit those assets, but also financial results and regulatory reforms (liberalization, deregulation, privatization) that also may have affected their decision to integrate/disintegrate.
external partners under weaker contractual protection than to internal units under stronger corporate protection (Liebeskind, 1995). 10 As indicated above, such shared intra-firm assets are supposed to be less contractible because they are not easily separated from contributing individuals and groups (sticky), because they cannot be visualized, observed or clearly articulated and taught (tacit), because productive knowledge is dispersed over a larger number of operating individuals or groups (diffused), or because private technology easily leak out to potential competitors through the products and/or services developed in collaboration with outside partners (leaky). Although stickiness, tacitness, diffuseness and leakage always is a problem, it is reasonable to expect that sticky and tacit knowledge will be easier to teach, diffused knowledge easier to assemble and transfer, and leaky technology easier to protect when
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3. Lessons from recent restructuring attempts
General To reiterate, the recent restructuring cycle among major telecom operators can be explained either as the result of governance deficiency corrected by the capital market, or as efficient adaptation of governance structure to changes in interface standards and other capabilities connecting various operating activities. Such restructuring cycles consist of two concurrent series of events: (1) expansion followed by contraction of the production activities of certain companies and (2) integration followed by disintegration of the same companies. Among the expanding/contracting companies, we find both incumbent operators and new entrants. As shown below, recent candidates for reorganization are many, including not only a range of different basic network facilities and services, but also a number of related products and services. 11 They may emerge from one or several of the following business areas: (1) Network operation: operation of wireline and wireless networks carrying basic services such as voice, data and video, plus associated support. (2) Service provision: provision of basic network and value-added services plus associated customer support. (3) Content services: provision of various information and entertainment services over the Internet (mostly supplied by external content producers such as television, news papers, record companies, film studios etc.) (4) IT/data systems and services: provision of web-related services, service application, facility outsourcing, system integration, call center operation, plus associated consulting and support.
Support services are included as integrated parts of each of these four services categories. Whereas some of these such as installation, maintenance, network repair, office renting, cellular tower services, and other infrastructure service are increasingly considered non-core
the receiving units not only share common firm-specific information codes, knowledge, norm and values, but also common control apparatus and unifying incentives. 11 This activity classification is similar to one used by many diversified major telecom operators that prefer to divisionalize their business according to platforms and activities rather than according to product-markets (i.e.; Deutsche Telekom and Telenor). This classification corresponds also to the so-called layer model of the larger telecommunications industry, (Fransman, 2002b; Krafft, 2003), particularly layer 2, 3 and 5. This layer model spans at least the following layers: Layer 1: Equipment provision, Layer 2: Network operation/management and
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17th European Regional ITS Conference and consequently outsourced to specialist suppliers, others such as marketing, ordering, billing, diagnostics, and customer service are more often considered core support activities and closely integrated with their respective core activities (i.e.; network operation, service provision, content provision and IT-/data services). Most network owners regard network operation along with the provision of primary voice and internet/data traffic to final customers as integrated parts of their company. They differ, however, in the degree to which they also prefer to integrate competing networks and services along with content and IT-systems. The most diversified incumbents have expanded from traditional fixed network supplying only plain old voice services into a complete range of alternative fixed and wireless networks producing voice, data and video services plus a range of more peripheral activities like content services (mostly Internet-related services) and IT-data services (system integration and outsourcing mostly for corporate customers). The new entrants expanded within a more restricted range of activities into more specialized fields containing some, but not all of the following services: long distance services, international traffic, mobile communication, content services (online) and IT/data systems (outsourcing, system-integration). Typically, the stock market would reward new specialized entrants with more steeply rising share prices during the boom, and punish them with more steeply declining share prices during the following bust compared with more diversified incumbent operators. The following organization chart portrays one such diversified telecom operator (similar to Deutsche Telekom). As its core businesses, X-Telecom would typically include various wired and wireless communications networks (X-Fixed and X-Mobile) used to transport primary services such as voice, data and video to business and residential customers, supported with various technical services, sales and marketing activities. In addition, most diversified operators may also include as their core business various IT/data expertise (X-
associated services provision, Layer 3: Internet connectivity and associated services provision, Layer 4:
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17th European Regional ITS Conference System) and Internet expertise (X-Online) with the purpose of developing IT-systems and Internet portals enabling more advanced services and content to be transmitted to more customers. BoD Management
X-Fixed
Network
Network
Operation
Operation
Service
Service
Provision
Provision
Country 1
X-Mobile
X-Cable
Country 2
X-Online
X-System
National
International
Country 3
Country 4
Country 5
BoD: Boards of Directors
Figur 1. Diversified network operator
To survive as an integrated enterprise, diversified telecom operators must be able to develop and leverage superior resources and capabilities shared by these integrated activities more efficiently than a similar group of disintegrated firms in diversified markets. To the degree no such shared assets exists, or to the degree these are equally accessible to all operators, no significant economic reason may remain for keeping diversified activities integrated. Without doubt, physical network resources are the most important assets shared by various services provided by diversified operators. Not only are physical networks the most expensive production facilities, primary network services are also by far the largest services category generating most of the revenue. No other assets display such a potential for
Navigation and software/middleware provision, Layer 5: Content provision
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17th European Regional ITS Conference economies of scale and scope. Recently, technological advances have further expanded such scale and scope economies by extending transmission capacity and functionality rather dramatically, thus enabling voice, data/internet and video/television to be transmitted over the same (broadband) network (so-called triple play services). As fixed, cable and mobile networks are turned into broadband networks, they are also increasingly turned into competing networks (divisions), creating growing interdivisional tensions within diversified operators. Besides, regulatory reforms combined with technological standardization have made the respective intermediate network services both increasingly tradable and less profitable (at lower regulated prices). Remaining online and IT systems activities on higher application layers are mostly based on standard Internet and IT technology that connect with the underlying basic network resources mostly across industry-standard open IP (Internet Protocol) interfaces. Another critical asset shared between higher-layered Internet/IT/data systems and services and lowerlayered network services are shared customers and customer relations (including brand name). Since ordinary voice customers are also potential data and video customers, and since all of these are also potential buyers of terminal equipment, system integration services, outsourcing services and customer care services, network operators may want to integrate all of these products and services and sell as much as possible to as many customers as possible through the same sales force. The customers, on the other hand, will not necessarily be equally interested in locking themselves into long term contracts unless being guaranteed that bundled services will beat similar unbundled services delivered by competing service providers. Since such performance guarantees seldom can be given, the bundling strategy pursued by most diversified operators has so far been rather unsuccessful. Indeed, over the last decade, operators have lost significant control over many of their previously scarce and valuable assets, and thus eradicated part of the economic basis for 17
17th European Regional ITS Conference staying integrated and diversified. Among such scarce assets we find leading technology and best industry practice, exclusive network licenses, and dominant market positions. That is, leading technology is now either non-proprietary and accessible to all, or proprietary and controlled by upstream suppliers. Nor will public authorities any longer award exclusive network licenses, and dominant facility-based operators are forced by regulators to rent out their networks to any licensed service provider or to any facility-less operator that wants to start competing service provision. Nor are content providers likely to grant single operators long-term exclusive distribution rights to their most popular content unless alternative channels are virtually non-existent or non-available which seldom is the case. Our five telecom operators (AT&T, British Telecom, WorldCom, Deutsche Telekom, and Telenor) were chosen to provide sufficient variation in competition, regulation, corporate strategy and structure to illustrate the importance of our two restructuring theses. Our five operators also represent highly different beliefs concerning the virtue of synergy (economies of scope) derived from integrating various telecom/Internet/IT activities. That is, AT&T and British Telecom (BT) will be used to illustrate the development of giant and gradually more synergy-skeptical operators in one of the most liberalized and competitive markets, whereas WorldCom illustrates the development of one of the once most successful and increasingly also synergy-skeptical new entrant in rather competitive markets. Deutsche Telekom illustrates the development of the largest and most synergy-optimistic European operator in one of the least liberalized and least competitive of the previous European Union markets (15 member states), whereas Telenor of Norway illustrates restructuring of one of the smallest, but also one of the financially strongest and most synergy-optimistic European incumbent in the post March 2000 bust period.
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17th European Regional ITS Conference Five illustrative cases AT&T 12
The story of AT&T over the last decade is essentially a story about a company’s less successful search for operating synergy. Essentially, such synergy potential would include any opportunity to exploit excess capacities in fixed productive assets. Besides tradable network resources and service applications, fixed productive assets may include various less tradable production assets such as general management, brand name, reputation and marketing skill. Services operators such as AT&T exploit their synergy potential by selling an increasing volume and number of branded services using shared resources and capabilities. After the regulatory enforced 1984-breakup, where the local exchange businesses were spun-off into seven local exchange companies (LEC), 13 AT&T continued as a combined equipment supplier & long-distance operator. It subsequently diversified into related computing and information businesses by buying the computer firm NCR, and by expanding into a full range of communication and information services including wireless calling, credit cards, online services, consulting and electronic commerce. Despite of impressive growth in stock value after the 1984-breakup (close to 20% per year over 10 years), AT&T failed miserably in computing, and NCR was sold at great losses. 14 It subsequently also decided to withdraw from the equipment business, probably for several reasons, partly to avoid accusation of favoring their own operations over competing longdistance and local operators, partly to benefit from international competition in equipment
12
This account is based on the company’s web page, Fransman (2002a), Wikipedia, the free encyclopedia (http://en.wikipedia.org/wiki/AT%26T) and various business magazine articles (Fortune (2000), The Economist (2004a, 2005a, 2006)). 13 These are also called Baby Bells, or Regional Bell Operating Companies (RBOCs). 14 This supports the prediction put forward by Michael Jensen (1991:16) about the likely effect of the legal shutdown of the US corporate control market: “As a result, takeover today are likely to revert to the pattern of the 60s and the 70s, when large companies used takeovers of other companies to build corporate “empires”. The recent AT&T acquisition of NCR is an example. And if the past is a reliable guide, many such acquisitions are likely to end up destroying value and reducing corporate efficiency.”
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17th European Regional ITS Conference production. The spin-offs of NCR and Lucent were later combined with heavy investment into cable TV assets (TCI and MediaOne) and into wireless communications, all this to counter increasing competition and falling prices and profit margins in the long distance voice business. With these assets AT&T intended to offer a raft of consumer services, from mobile services and local telephony to high-speed Internet access and digital television, made possible by the acquisition and modernization of a large chunk of America’s cable system. At this time, no other rival was in a position to offer such a rich bundle of services to US residents and companies. As it turned out, AT&T never succeeded with its ambitious plan. The company had invested $100 billion in cable networks only to realize that it took a lot more time and effort than expected to upgrade previously investment-starved cable networks to carry data and voice. Besides, vicious price competition had seriously obscured the long-distance part of the strategy. With a rapidly increasing number of long-distance competitors (amounting to several hundreds), prices started to tumble. AT&T also failed in tying up agreements with other cable operators to offer telephony over their networks, a key element of the strategy. Neither did the investment community any longer fancy gigantism like it did under the foregoing telecom merger boom of the 90s. Instead highly focused telecoms “pure plays” were favored, such as Nextel, a wireless operator coveted by AT&T, or Level 3, a wholesaler of bandwidth. AT&T’s started to trade at prices far below their sum-of-parts valuation, silencing the formerly vaunted one-stop-shop strategy. Although many investors still remained passionate about the prospects of wireless, broadband cable and the business-data markets, few were any more regarding AT&T as an attractive vehicle. With AT&T’s share price almost halved in less than a year, management came under huge pressure to change and improve.
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17th European Regional ITS Conference Hence the announcement of October 25th, 2002 to split the firm into four publicly held companies. 15 Under the plan, the old core of AT&T became the business-services division, AT&T Business. It retained the right to trade under the “T” stock symbol and served as the legal owner of the AT&T brand, the main fixed-line network and AT&T’s research labs. It also became the parent company of AT&T Consumer, holding the residential long-distance and WorldNet Internet access businesses. A new tracking stock was created for the consumer business, to be distributed among AT&T shareholders. AT&T Wireless, which already existed as a tracker stock, and AT&T Broadband, essentially the cable business, were fully spun out as publicly traded entities. Despite splitting AT&T into four companies, the CEO of AT&T, Michael Armstrong, insisted that the new firms would still be able to co-operate closely and accomplish the bundling that for so long has been the strategic main focus of the company. Many now seemed to believe that AT&T had failed to reach their ambitious bundling goal (“one-stop-shop”), but the company CEO, concluded differently. According to Michael Armstrong, nothing could be gained from bundling services running on different networks. Only services transmitted over the same network should be bundled, or in his own words: “The strategy was about bundling services that travel over the same network. For example, on our wireless network, we bundled a local wireless call, a roaming charge, and a long distance call—and charged a flat rate for it. That redefined the whole industry. In cable, we took a broadcast analog video business and transformed the network into a high-capacity, digital interactive network, and we're bundling digital TV, high-speed Internet access, telephone service, and we're testing video on demand. That's bundling communications services ''on net''. What some people thought they heard was that we would put your cable bill on your telephone bill, or put your telephone bill on your cable bill, and they called that bundling. I guess you'd call that cross-network bundling. That kind of bundling doesn't keep customers or attract customers to any degree. We never put a big emphasis on bundling all kinds of services, only
15
“On October 25th, 2000, AT&T announced plans to create a family of four new companies, each operating under the "AT&T" brand, committed to uniform standards of quality and continuing to bundle each other's services through inter-company agreements. Under the company’s restructuring plan, which it expects to complete in 2002, each of its major units will become a publicly-held company, trading as a common stock or a tracking stock.” (see: http://www.att.com/restructure/)
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17th European Regional ITS Conference those that travel over the same network. This confusion really frustrates me.” (Business Week Online, Armstrong on the Record, February 5, 2001).
After a series of setbacks, AT&T also decided to draw back from marketing to residential customers after regulatory decisions had increased the prices it had to pay to access the lines of US local telecom operators (Economist, 2004a). Before this, numerous new entrants, overinvestment and fierce competition had gradually squeezed most remaining profit out of long distance business, the core business of AT&T. After more or less constantly declining share prices over the last 5-6 years, AT&T was finally sold to the local exchange company SBC, a merger of two of its former daughter companies, spun off more than 20 years ago. Shortly after, the new AT&T unveiled its plan to buy BellSouth, another of its previous daughter companies. Under the more powerful AT&T brand, their prerequisite for providing high-valued triple-play services may improve significantly (subject to regulatory approval). Also other big telecoms companies started to disintegrate their businesses (see below), but among the big incumbents only BT wanted to go as far as AT&T.
British Telecom 16
At about the same time as AT&T decided to split, British Telecom (BT) also decided to restructure, combining divestiture with structural separation, and specialization. Officially, the main restructuring motive was partly to exploit new market opportunities partly to overcome recent financial difficulties. At the start of the millennium, BT’s financial situation resembled the one characterizing many other European incumbents. A series of huge investments in new business activities and expensive third generation (3G) mobile licenses, combined with the
16
This account is based on the company’s and homepage and press releases (www.bt.com and http://www.btplc.com/Thegroup/BTsHistory/History.htm) and various newspaper and magazines articles (The Sunday Times (2000), The Economist (2001, 2002b, 2004b).
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17th European Regional ITS Conference collapse of telecom market, had left this and other telecom incumbents not only heavily indebted, but also rather unfocused and increasingly unprofitable. In April 2000 BT started the process of transforming the company into a structure more compatible with the new opportunities created by the development of Internet, e-commerce, mobile networks and broadband services. Four international businesses were thus created - BT Ignite, BT Openworld, BT Wireless and Yell - dedicated to each of the key technological areas in which BT would be investing for the future. BT Openworld became the mass-market Internet business, at the time delivering services to more than 1.3 million customers in the UK via BT internet and BT Openworld broadband. BT Ignite was established as a broadband and protocol data and solution business with the aim of delivering a complete communication portfolio to business customers in Europe and around the world via Concert and other partners as appropriate. BT wireless was given the responsibility of the international mobile business focusing primarily on mobile data and next generation services. Finally, the international directories businesses were organized under Yell. The fixed network businesses were separated into Wholesale and Retail divisions to allow more focused management and greater clarity in regulation. BT Wholesale should offer a large portfolio of wholesale products and value-added solutions to the intermediate market, including other licensed operators, mobile operators and service providers. BT Retail became the primary marketing, sales and distribution channel in the UK. Operating alongside the new businesses was Concert - BT's global venture with AT&T. In the months to come, BT became increasingly convinced that the telecom industry was about to develop into a highly innovative and differentiated consumer service business. To avail themselves of the associated growth opportunities, the management decided to make their business operations more customer-focused, faster and more flexible. So on November 9, 2000, BT announced a radical and unprecedented restructuring of the company. This involved 23
17th European Regional ITS Conference the creation of a new BT Group Holding company with their sister companies separately listed to unlock shareholder value. Initial public offerings (IPOs) were announced for BT Wireless (up to 25 per cent, second half of 2001), BT Ignite (100%, by end of 2001) and Yell (up to 25%, later). A new network-based company, with a working title of NetCo (separately listed, subject to regulatory agreement) was also announced whose customer base would be the intermediate market, including licensed operators, mobile operators and various service providers. From this series of initial public offerings, and from the sale of a number of other businesses outside their focused markets of Western Europe and Japan, debt could now be reduced with at least £10 billion. This would both help to improve shareholder value and to encourage BT management to focus on its main customer groups. The BT Group Holding Company was designed to be lean, focused and light touch, making the people agile and the company ready for the next round of acquisitions, joint ventures and listings. Although operating as separate businesses, BT Retail, BT Openworld, BT wireless, BT Ignite and Yell were expected to work closely together to create complete solutions for their customers in the wireless, internet, broadband and e-commerce areas. As it turned out, investors’ sentiment toward telecom soured, and the grand plans for spinning off the units fell flat. The restructuring initiative was postponed, and the company’s strategy and structure remained in disarray for several months. Gradually, the company managed to reduce its huge debt from £ 30 bn to £ 17.5 bn by selling various minority stakes in overseas operators and by rights issues. Its pan-European mobile arm, mmO2, was spun off and Concert, its international venture with AT&T, was also abandoned. The new boss, Ben Verwaayen, continued the policy of retreating from loss-making foreign markets, spinning off peripheral units and narrowing the business focus. Regulator’s instruction to organize specialized wholesale units separately from retail units, contributed to 24
17th European Regional ITS Conference the same. Accordingly, management decided that broadband access should be offered as a bare-bone product to which outside Internet Service Providers (ISPs) could add their own information services. In wireless business, BT decided to act as a reseller of mmO2, rather than as an integrated mobile operator. BT Ignite, operating in Europe, should concentrate exclusively on large companies, and avoiding previous consumers and small businesses. If it failed to yield result by March, 2003, BT Ignite should also be abandoned. With such a restructured company, the new CEO hoped to reach its ambitious 6-8% yearly growth target (The Economist, 2002b). The new BT that subsequently emerged was structured so that BT Group plc provided a less diversified holding company for the separately managed businesses which made up the group. These were BT Retail, BT Wholesale, BT Openworld and BT Global Services (previous BT Ignite). Each of these had the freedom to focus on its own markets and customers. By understanding their customers better, they were expected to move quicker to seize opportunities and meet challenges. These businesses were supported by BT Exact, BT's research and development organization. Then, on November 8, 2004, BT announced it has signed a definitive agreement to acquire Infonet, one of the world’s leading providers of international managed voice and data network services. Infonet’s $620m in revenue from sales of cross-border services to 1,800 multinational corporate customers significantly increased the global reach of BT Global Services’ business. With this decision, BT clearly signaled its continuing interests in global expansions. This time, however, the acquisition also compensated for the previous contraction in global services that resulted from abandoning Concert and sharing the remnants with AT&T.
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17th European Regional ITS Conference WorldCom
17
After a decade long relentless and audacious acquisition trail, the WorldCom stock deteriorated quickly as the booming telecom market went bust. The company had recently bought the second largest long distance operators in the US, MCI, and was about to take over the third largest operator, Sprint, when anti-trust authorities decided to put an end to further major telecom acquisitions. Due to the company’s dominant market position, the anti-trust authorities could from now on only accept acquisitions of smaller niche players. As it turned out, WorldCom had succeeded too well with its acquisition strategy, and had to be stopped for the sake of competition. Due to increasing competition in the preceding years, prices on long distance calls had been declining steadily. Now, the declining Internet shares caused similar decline in telecom shares, and WorldCom, the largest Internet backbone operator, was punished with a 70% record decline in half a year. The company’s strategic position was consequently turned upside down. The company that had achieved such a gigantic size through stock financed acquisitions, now had to demonstrate its ability to survive as giant firm by operating efficiently. Splitting the company into two business segments was chosen as most preferred solution. The WorldCom part of the enterprise should be responsible for growth activities such as Internet, data services, web hosting and international businesses, and MCI for the supply of basic telecom services to consumers and small businesses, for wholesales of long distance capacity, and for dialed-up Internet access, all of which with positive cash flow potentials. The two companies were issued separate tracking stock. The revenue company MCI was supposed to pay dividend, whereas the growth company WorldCom was not. The purpose of the reorganization was to focus resources and management on implementing strategies more
17
This account is based on “Breaking up is fashionable to do…”, Public Network Europe, December 2000/January 2001, Vol. 11, No 1, and from WorldCom’s home page: http://www.worldcom.com, ”WorldCom to Realign Businesses, Create Two Tracking Stocks”
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17th European Regional ITS Conference appropriate for the two segments, one being aimed at business customers and based on development of new services (innovative growth market), the other aimed at the consumer and retail market and based on exploitation of excess capacities (mature markets). In this case, mounting dept load cannot be an explanation for restructuring since the company’s growth mostly had been financed with stocks and since the transformation did not include sales of larger units, only separation and restructuring. Apparently, management had finally realized that integrated activities were less dependent on shared less-tradable assets and intermediate services, and would therefore benefit from structural separation and more focused specialization. 18 By organizing fairly independent businesses as semi-autonomous tracking stock companies, the management hoped to achieve specialization benefits without the accompanying coordination losses. 19 Increasingly, tracking stock companies were regarded as a new corporate structure by which additional gains could be achieved without much additional cost. In this case, tracking stocks can also be regarded as a takeover defense. Upon dramatic stock and revenues decline, top management always stands the risk of being fired by restless owners and aggressive buyers. By designing a governance structure that dampen the discontented by granting owners and the financial community closer supervision and stronger influence, takeover can be avoided, at least for a while. The tracking stock structure did not stop the company’s stock from falling, however, and its much-heralded CEO was subsequently forced to resign on April 30th, 2002. The company’s capitalization value was then only USD 7 billion, a mere 4% of its value of its peak
18
According to the company’s CEO, Bernard J. Ebbers:”This plan is a triple-tiered win. For our shareholders, who will gain more targeted investment opportunities. For our customers, who will experience a more efficient operation attuned to their individual needs. And for our employees, who will be enabled to execute targeted business strategies that play to the strengths of each operation.” 19 According to CEO Ebbers: ”By issuing a tracking stock, the company will retain the advantages of doing business as a single company as we do today because each group will benefit from cost savings and synergies. These advantages include lowering overall borrowing costs by maintaining the credit rating of the combined company, retaining tax consolidation benefits, and allowing the businesses attributed to each group to capitalize on relationships with businesses attributed to the other group. These benefits would not be available if the two
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17th European Regional ITS Conference two years earlier (The Economist, 2002a). Shortly after, the company announced the dismantling of its tracking stock structure to be replaced by a simpler one. A few months later, the company admitted its accounting fraud of wrongly capitalizing expenses of 7-8 bn $, and filed for Chapter 11 bankruptcy protection. By the end of 2003, it was estimated that the company's assets had been inflated by around $12 billion. The company emerged from Chapter 11 bankruptcy in 2004, renamed as MCI with a three-year business plan, outlining new initiatives to position the company as a leader in the move toward convergence of local, long-distance and data services. It also returned with about $5.7 billion in debt and $6 billion in cash. About half of the cash was intended to pay various claims and settlements. Previous bondholders ended up being paid 35.7 cents on the dollar, in bonds and stock in the new MCI company. The previous stockholders' stock was valueless. Under the bankruptcy reorganization agreement, the company paid $750 million to the Securities and Exchange Commission (SEC) in cash and stock in the new MCI, which once was intended to be paid to wronged investors. At the end of 2004 the new MCI had yet to pay its creditors and former employees, who have waited for 2 years for a portion of monies owed. Then, shortly afterwards at about the same time as SBC acquired AT&T the two local exchange companies Quest and Verizon started to bid on MCI. A series of bids, counter-bids and vitriol followed until MCI four months later accepted Verizon’s lower bid worth $ 8.5 billion, 25% above its original offer. Together, Verizon and MCI may seem well placed to compete against the combined SBC-AT&T now as the US telecom market has started to consolidate.
businesses were separated in a spin-off transaction. See : WorldCom and MCI. Frequently Asked Questions, Q6 (July, 2001, on http://www.worldcom.com)
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17th European Regional ITS Conference Deutsche Telekom 20
Until quite recently, the largest of the European incumbents, Deutsche Telekom, was also considered to be the most indebted one. Most of the dept was used to finance acquisitions and investment in infrastructure and third generation mobile licenses. Also financially DT performed worse than average for several years and significantly worse than the other Big 5 incumbents (AT&T, BT, France Telecom and NTT; see Fransman, 2002a: 126). Unlike most other European incumbents, DT also declined to withdraw from international markets and more distantly related businesses as the telecom boom went bust. One important reason was the growth ambitions of its former CEO Ron Sommer, strongly supported by his largest owner, the center-left government of Gerhard Schroeder.21 So far, DT had not succeeded particularly well with its global strategy. Its highly ambitious policy had resulted in a series of acquisitions, by 2001 totaling 94 billion Euros, particularly in mobile communications, of which of VoiceStream (US) and One2One (UK) were the largest. Some of these also caused severe conflicts between the CEO and its autonomous division CEOs, especially as the latter (T-Online) grew increasingly more acquisitive and risk loving, threatening the finances of the mother company. Similar conflict also occurred in relation to their international partners (France Telecom, Sprint) when DT officially proposed to buy Telecom Italy without consulting their international partners, thus compromising their own joint venture, Global One. Similar attitudes and ambitions also characterized DT’s governance policy and market strategy in relation to its many acquisitions. Unlike most other incumbents, DT claimed full ownership and control and pursued dominant market position whenever possible. Even if the respective divisions operationally were treated as highly autonomous, financially they could
20
Information about DT is based on Fransman (2002a), DT press releases (Deutsche Telekom, 2004) and various business press articles (The Economist, 2002c; BusinessWeek, 2003).
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17th European Regional ITS Conference not since they all belong to the same holding company. As DT’s shares and net income continued to fall as the company continued to invest in unprofitable and declining foreign firms, the company’s CEO gradually lost the support from his largest owner, the federal government. Ron Sommer was consequently forced to resign, and were replaced by Kai-Uwe Ricke. Ricke immediately started to refinance and reintegrate the company. Since the foreign investments were not likely to give any immediate and significant payback, the new management started to look for potential synergy among its diversified businesses. Although shared infrastructure existed that could be more fully exploited by a larger number of internal operators and service providers, these could be even more fully exploited by selling their services to an even larger number of external operators and service providers, thus leaving only less tradable assets such as service bundling capabilities and brand name to be exclusively exploited internally. Ricke therefore proposed to start buying back all the free-floating shares of T-Online and to integrate the respective internet activities closer with the infrastructure business of T-Com. It remains to be seen, however, if the respectively shared assets can be developed into sufficiently proprietary and valuable assets so that full integration can be justified.
21
The new German regulation imposed on DT by the new regulator, RegTP, was at the time considered to be one of the harshest in Europe.
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17th European Regional ITS Conference Telenor 22
Like many other European incumbents, Telenor of Norway also chose a rather expansive acquisition strategy to counter growing competition in their home market. However, unlike most other incumbents, its finances have been relatively strong. Beauty contest saved them from using billions on the UMTS auction whereas stock emission plus sales options on their mobile operations in Ireland and Germany brought in huge amounts of extra cash. Dramatic divestitures and restructuring was therefore less needed for this operator compared with other heavily indebted companies such as AT&T, WorldCom and BT. Still, a continuous series of modest reorganizations has characterized the company’s development over the last 10 years, as they continuously have tried to adapt to changing technologies, regulations and market conditions. The decision to privatize was by far the most consequential. As the time for privatization drew closer, private investors’ demands for external monitoring and preference for “pure plays” could no longer be ignored. Growing competition from other long-distance operators, combined with regulatory enforced access to the local loop, also contributed to opening of the value-chain and to establishing a clearer distinction between core (fixed, mobile, cable, satellite networks) and non-core business (installation/IT services, media/catalogue) as well as between different core businesses (e.g. wholesale versus retail services; fixed telephone network versus mobile, cable and satellite networks). Telenor’s first reorganization as general stock company was announced 4th of April 2001 with the aim of strengthening its profile as a customer-orientated, innovative company, better adapted to the telecommunications and IT markets of the future. According to the company’s announcement, the reasons for the proposed changes was the recognition that the telecommunications and IT industry were now standing at a cross-roads, with stronger focus on content-associated and customer-adapted services and solutions. The company thus decided to
22
This account is based on Telenor ASA Prospectus, Annual Reports (2002-2005) and press releases (e.g.;
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17th European Regional ITS Conference focus on the following four core business areas: (1) Telenor Business Solutions combining activities aimed at the business market, earlier distributed through several business areas; (2) Telenor Plus, combining a major part of Telenor’s portfolio for the private market into a single business area in the fields of fixed network telephony, Internet, TV and content services; (3) Telenor Network, a separate business area focusing on cost-effective production of the basic services and the wholesale of fixed network capacity, transport and access, whereas (4) Telenor Mobile, covering mobile communications activities in Norway and abroad, continued as before. Remaining non-core activities consisted of Telenor Media, EDB Business Partner, Bravida (installation & IT service), Telenor Satellite Network and Telenor Research and Development. The most significant change characterizing the new business structure consisted of a larger proportion of private customer services being combined into a single business area. These include telephony solutions for the private market and Telenor Internet’s activities in Norway, as well as TV and content services supplied by Telenor Broadband Services. Hopefully, this change would facilitate the realization of potential synergies existing across the present business portfolio and help to achieve more cost-effective operations. The company warned, however, that additional activities might later be defined as noncore activities and subsequently spun-off as stand-alone companies or sold to other diversified companies. These processes of cost-cutting, down-sizing and structural simplifications have been going on ever since, aiming at a 4 billion NOK reduction in total operating costs by mid 2004, forced upon them by impatient shareholders having grown increasingly dissatisfied with deflated share prices. From January 1, 2003, this process was backed up by another regrouping of core activities, increasing the company’s focus on streamlining and coordinating sales and marketing for the Norwegian home market. A year later, the company decided to centralize and
Telenor, 2001).
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17th European Regional ITS Conference reintegrate Telenor Mobile which, due to rapid growth in foreign markets, now had become the company’s largest business. In short, both financially troubled companies such as AT&T, BT, WorldCom and Deutsche Telekom and financially more healthy ones such as Telenor have during the last 5-6 years actively pursued downscaling and downscoping to improve profit and shareholder value. Being a financially less troubled company, Telenor could restructure at a smoother and slower pace than the other less fortunate companies. After having trimmed their scale, narrowed their scope and restructured their business, these companies are now ready for another round of acquisitive expansions, this time heading for more focused and less diversified growth.
4. Interpretation
Our company cases seem to reveal at least an early expansion phase fairly consistent with our governance deficiency thesis: 23 Threatened by increasing competition and stimulated by a booming Internet market and enormous growth expectations, most incumbent operators chose to grow and diversify, mainly through acquisitions, away from their “plain old telephony” business into more exciting growth businesses, including not only alternative network infrastructures such as mobile, cable and satellite, but also more distantly related activities such as content provision, IT/data systems and services and various Internet-related businesses. Whereas initially, the stock market supported this growth and diversification strategy with escalating share prices, gradually the stock market leveled off and started to value the sum of “pure plays” significantly above their going concern value. As diversified operators were just about to respond by way of divestiture and IPOs (initial public offerings) the telecom market
23
This pattern is also fairly consistent with Fransman’s (2002a) Consensual Vision in Telecoms.
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17th European Regional ITS Conference collapsed. Tumbling share prices left many operators stuck with their indebted and increasingly less-valuable “growth” businesses. (Figure 2).
Figure 2. Rise and fall (Source: The Economist (2000) “When big is no longer beautiful”)
Under the threat of financial collapse, highly indebted and diversified incumbents were subsequently forced to retract and divest, starting with their most peripheral non-core activities. Potential divestiture candidates increased significantly as operators increasingly realized that different telephone, cable, mobile and satellite networks developed into competing rather than synergetic businesses. Most clearly this was recognized by the previous AT&T CEO Michael Armstrong stating that bundling services across different telephone, cable, wireless and satellite networks (cross-net bundling) will not create much customer value; bundling services on the same network (on-net bundling) is the only bundling that creates value that stimulates consumption and service production. That is, by using the same broadband network to produce a larger quantity of bundled services (“triple-plays”), on-net bundling will not only create value for customers but also lower unit costs as broadband capacities will be more fully exploited. 34
17th European Regional ITS Conference For several years, insufficient broadband capacity in the local networks had prevented this from happening. Only quite recently have this capacity started to grow, now stimulating another round of synergy-seeking mergers and acquisitions (particularly in the US market). The following table summarizes the integration/disintegration pattern associated with our five case companies.
Table 3. Integration/disintegration over the business cycle
AT&T British Telecom
Telecom Boom 1995 – 2000 Acquisitions Acquisitions
WorldCom
Acquisitions
Deutche Telekom
Acquisitions
Telenor
Acquisitions
Telecom Bust 2000 – 2004 Break-up Mini-break-up, reorganized Quasi-break-up, then reintegration, Finally bankrupt Decentralized (holding company) Decentralized (divisionalized)
Telecom Upturn 2004 Acquired by SBC More focused, Acquisitions of Infonet New company (MCI), finally acquired by Verizon Centralized/reintegrated (holding company) Centralized/reintegrated (divisionalized)
In the contraction phase, the two incumbent operators that had been deregulated and privatized first, AT&T and BT, were also the ones that restructured earliest, fastest and most comprehensively (total breakup of AT&T, mini-breakup of BT), consistent with our governance efficiency thesis. But, since AT&T’s shares have been in almost constant decline before as well as after the breakup, their support seems dubious. Similar dubious support was provided by the new entrants. Most new entrants were highly focused and specialized, but since most of them also failed during the bust, their support for the pure-plays governance efficiency hypothesis also failed, with the exception of the pure-plays mobile operator Vodafone (Whalley, 2004), probably the most successful of them all. The remaining two incumbents, Deutsche Telekom and Telenor, that were deregulated and privatized later, and operated in more recently liberalized markets, were also the ones that retracted and restructured later, slower and more reluctantly, consistent with our governance 35
17th European Regional ITS Conference deficiency thesis. But, since both diversified companies still profited handsomely from previous dominant positions and monopolized markets, negative deficiency effects were masked, also here. The “older” entrant WorldCom, run by one of the most admired chief executive officers (CEOs) in the industry, was also the company that failed most dramatically (The Economist, 2000, 2002a, 2005a). In this case, escalating commitment to a chosen, and increasingly fraudulent, course of action by an extremely acquisitive and hubristic CEO seems to have overshadowed any disciplinarian market forces, consistent with the governance deficiency thesis. Similarly acquisitive and hubristic (but not fraudulent) managers may have affected other major incumbents such as Telefonica (Trillas; 2002; Bell and Trillas, 2005) and Deutsche Telekom (Fransman, 2002a; this paper’s case study). That is, a similar “detour away from efficiency” that many American corporations took during the three decades from the early 60 to the late 80s (Shleifer and Vishny, 1994: 409), many telecom operators may also have taken during the following decade or so. This time, however, it was not aggressive anti-trust policy that prompted the over-diversification mistake, but the growth optimism initiated by the preceding technological advances and regulatory reforms, combined with management compensations dependent on size, growth and share prices and further magnified by the Internet boom. By the end of the 90s, the bubble economy of the Internet had spread into the telecom world and grossly inflated the value of the most Internet-related telecom operations. This had also grossly inflated the value of managers’ stocks and stock options, turning management compensation into a stronger growth and diversification force than ever before. This was particularly the case for the fastest growing and most Internet-related operators whose stock options promised to make executive managers incredible rich as their companies kept growing. Furthermore, rising stock prices facilitated debt financing which speeded up the acquisitive diversification process even further, before the
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17th European Regional ITS Conference stock market started to send the opposite signal that the break-up value of diversified telecom operators were increasingly surpassing their going concern value. Then the market collapsed faster than the companies managed to divest, and they got stuck with most of their indebted and increasingly lower-valued “growth” businesses. Now, extra money had to be raised through public offerings, stock emissions and sales of telecom businesses to pay back enormous debt that grew increasingly expensive as credit ratings were downgraded. As it turned out, insolvency, bankruptcy and break-up were avoided by most major incumbents as they were saved by a declining, but still substantial revenues stream from quasi-monopolized local access markets. Combined with extensive right issues and impressive cost-saving program, such monopoly revenue facilitated a slower and less dramatic structural adaptation among incumbents than among their younger competitors. Again, the fastest growing Internet-dependent operators were the most affected, this time negatively. Among these we find WorldCom, Global Crossing, 360networks, Williams Communications, Viatel and dozens others that went bankrupt (The Economist, 2003). What failing companies such as AT&T and new entrants such as WorldCom was lacking was ownership to the local access (local loop) which is the most costly, but also most profitable (monopolized) part of the telecom infrastructure. AT&T and the new entrants were forced either to stay out of the fixed access market and to concentrate on long distance and international traffic instead or to buy access from dominant local operators at less favorable prices. Although national regulators prevented local access prices from becoming prohibitively high, heavily indebted entrants could not survive as access-less service providers (resellers or virtual operators). Only the leanest, the most efficient and innovative companies managed to survive in such price-squeezed monopolized markets, given favorable access regulation that forced access owner to unbundle their network or sell network capacity to competing service providers (Spiller and Ulset, 2005). Such access regulation also forced incumbent to separate 37
17th European Regional ITS Conference network operation from service provision and to organize the respective internal service transactions through internal markets. By doing this, an element of internal competition was also introduced, further reinforced by growing competition between fixed, cable, satellite and mobile networks as these started to compete on voice, internet and even television. As a consequence, incumbents evolved into the kind of decentralized divisionalized companies or even holding companies observed by Fransman (2002a) and exemplified above. Then, take another look at the above restructuring cases, this time from the governance efficiency point of view. According to this view, incumbents expanded into related markets more selectively and for different reasons. That is, threatened by increasing competition and motivated by a booming Internet market, operators expanded into related activities mainly to exploit excess capacity in less tradable network resources and capabilities. As such excess capacities gradually became more tradable at the end of the boom period, the share prices of integrated incumbents started to fall, and centralized integrated companies started to decentralize and disintegrate, particularly in the most competitive markets (Fransman, 2002a). Before this, both technological advances (digitization, computerization, automation) and regulatory interventions (regulatory enforced interconnections, unbundling and roaming agreements) had contributed to making excess capacities more accessible and their services therefore tradable. After the EU internal market liberalization of 1998, and the US liberalization of 1996, technical interfaces had gradually developed into more open, advanced and user-friendly standards. As these standards started to regulate the interaction between networks and components, these also started to replace human effort with software programs and to replace intra-firm with inter-firm organization (Spiller and Ulset, 2005). That is, interface standards enhanced not only component and network interoperability, but also made new technology embodied in such networks and components accessible to most operators, including access-less operators leasing most of their local access lines from the incumbents 38
17th European Regional ITS Conference (thus replacing intra-firm with inter-firm organization). In fact, over the last few years, new technology had not only improved transmission speed rather dramatically, but also network functionality such as network monitoring and network management functions. This again enabled network performance (quality of services) to be monitored and evaluated more accurately and defects to be located more precisely, diagnosed more correctly, and repaired more quickly. Consequently, supplied with more open and user-friendly interface standards, facility-less service providers were able to access almost any technology and distribution network and carry out almost any downstream service bundling, marketing and sales activity almost as easily as facility-based operators. All in all, due to technological advances, standardization and supportive interconnection and unbundling regulations, the efficiency of markets organization had increased relative to corporate organization, resulting in more extensive outsourcing and disintegration, most notably exemplified by the growing number of independent resellers and facility-less operators. These pro-competitive changes in technology and regulation have probably also affected incumbents’ internal organization. As pointed out by Fransman (2002a: 224), the first companies in the large industrialized countries to face liberalization and competition (AT&T, BT and NTT of Japan) all moved in the same direction in terms of their corporate organization – from centralized hierarchical integration to decentralized integration and finally breakup (for two of them). Despite the fact that open interface standards made network operation and services provision increasingly autonomous and corporate integration increasingly superfluous, most dominant incumbents chose to decentralize instead of divesting their core businesses. This, however, created another deficiency. In telecom, decentralization means essentially two things: (i) freedom to operate as semi-autonomous business units organized as profit centers with full profit and loss responsibility; and (ii) freedom to trade with external competitors of their own 39
17th European Regional ITS Conference internal service providers. Now, semi-autonomous business units organized as profit centers were also expected to maximize their revenues. Since the volume of internal sales is obviously limited, this would essentially mean maximizing their external sales in competition with other business units of the same enterprise organized as profit centers. To achieve such ambitious external sales goals, additional investment in product development, interface standards, sales channels, and marketing campaigns had to be made which led to even higher fragmentation and corporate disintegration among decentralized profit centers. Internal markets therefore increasingly resembled external markets, rending the corporate model increasingly messy, inconsistent and non-manageable. Besides, since corporate headquarters were still financially responsible for the investment failures of semi-autonomous units, diverging incentives sometimes caused serious conflicts. To counteract such tendencies, and to provide sufficient cooperative support for the development of proprietary, advanced and less standardized shared production assets, incumbent operators such as Deutsche Telekom and Telenor decided to recentralize decisions and reintegrate their business units. To what extent such reintegrated operators will succeed in developing and utilizing the respective technologies and capabilities, remains to be seen.
5. Conclusion This paper explores and explains restructuring cycles among major telecom operators from two partly competing perspectives: the governance deficiency perspective of agency theory and the governance efficiency perspective of transaction cost economics. Not only accompanying business cycles, but also internal governance systems along with technological advances and regulatory reforms may explain recent restructuring cycles among major telecom operators, as documented in the above business cases. Whereas the deficiency perspective explains the restructuring cycle as the result of inefficient governance corrected by the capital market, the 40
17th European Regional ITS Conference efficiency perspective explains the restructuring cycle as responsive and mainly cost efficient adaptation of governance structures to changing transaction conditions and institutional environments. Both perspectives relate restructuring cycles to prior regulatory reforms of which open network provisions, monopoly deregulation, privatization and market liberalization were the most prominent. Whereas the deficiency perspective expects incumbents to exploit the investment opportunities created by such regulatory reforms in a highly acquisitive, inefficient and reform-noncompliant way, the efficiency perspective expects incumbents to adapt to changing transaction attributes caused by regulatory reforms in a responsive, efficient and mainly reform-compliant way (but only if disciplined by appropriate governance systems) . According to the deficiency perspective, the investment and acquisition spree characterizing the telecom boom was primarily driven by hubristic and expansionist managers whose compensation depends more on size and growth than on efficiency and profitability. Overinvestment tendencies may then be prolonged well into the bust as the same hubristic managers in charge of increasingly unprofitable firms progressively develop escalating commitment to the chosen and increasingly failing course of action. According to the efficiency view, and disciplined by appropriate governance mechanisms, less opportunistic managers chose to expand in a less myopic and more selective way, searching for opportunities to exploit excess capacities in non-tradable assets. Then, in the second contraction phase, these managers would also retreat earlier, faster and more selectively as previously less-tradable intermediate assets and services turned increasingly tradable. Whereas both perspectives agree that inefficiently structured telecom operators later may be changed into more efficiently structured enterprises, they disagree on the relative importance of corporate adaptation versus market selection in bringing about such restructuring under the various regulatory regimes. Such disagreements are mainly due to different 41
17th European Regional ITS Conference assumptions about the damage caused by opportunistic and hubristic behavior and the ability of the respective corporate governance mechanisms to correct such behavior. Although only suggestive, our case data seems to support the reform-noncompliant deficiency theses more than the reform-compliant efficiency thesis. Our impression is that incumbents expanded not primarily to exploit excess capacities in less-tradable shared assets (related diversification), but rather to exploit their monopoly positions by expanding into adjacent markets (unrelated diversification). As network resources, due to open network regulation, turned increasingly interoperable and network services increasingly tradable, and as the capital market started to price the sum of parts far above their going concern value, incumbents started, some more reluctantly than others, to divest and retreat into less diversified and more focused enterprises. Apparently, the speed by which incumbent retreated depended on their capital market exposure which tended to be weaker for partly state-owned incumbents in the most recently liberalized markets than for privately owned incumbents in the not so recently liberalized markets. Unassisted by fully efficient capital markets, internal governance systems failed to prevent opportunistic and hubristic managers from expanding into unrelated and less profitable fields. Nor did these governance systems prevent the same managers from continuing their expansion and delaying their contraction as conditions changed. As such, this study also clearly indicates that the effects of regulatory reforms may depend not only on the reforms themselves and their regulatory regimes, but significantly also on the behavioral propensities of managers and the governance systems characterizing operating companies and financial markets. Insufficient data prevent us, however, from drawing more definite conclusion as to the relative importance of these causal factors and mechanisms. This we must leave for later research to examine.
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