Creating the 21st Century Communications Company

1. Creating the 21st CenturyCommunications Company Global Executive Symposium La Costa, California September 28, 1998

2. Key issues facing executives Regulatory changes? Access to customers? Technology choices? Optimum size? Non-traditional challengers? Cheaper, better operations? Customer demand? Retail- wholesale split? One-stop shopping? Harder choices larger stakes

3. Five sets of drivers • Customer demand • Propensity to use services, patronize providers • Technology • Progress on new technologies, standards • Capital markets • Degree of support from investors, lenders • Government policy • Impact of regulation, antitrust, taxation • Providers • Proficiency of incumbents, challengers

4. Four Sets of Scenarios A. Incumbency Counts - hype evaporates B. Mass Matters - megacarriers dominate C. Pinpointing Prevails - specialists win D. The Revolution comes

5. Incumbency Counts: definition • Despite the hype, incumbents prove much stronger than initially expected • Market share losses are small and manageable • No more big new entrants (e.g. WorldCom) • Former PTTs continue to dominate their home markets and fail everywhere else • A few basic changes, e.g., convergence of domestic-int’l in Japan, long distance-local in U.S.

6. Incumbents win: why? • Customers: Prefer incumbents, don’t trust new entrants. Demand growth is manageable. • Technology: New technologies slower to roll out than expected; incumbents adapt faster • Government policy: Continues to protect incumbents • Capital: Markets’ support for challengers fades • Providers: Incumbents get fresh blood and become more entrepreneurial. Challengers fall into same old traps.

7. Incumbency Counts: customer demand • Customers don’t want to switch, or require a high premium (>25% discount) to do so -- trust incumbents, or don’t really trust challengers • Demand for new services is unexpectedly low • Demand differs by country or territory, not so much by market segment • Demand shift from voice to data slows • Overall demand grows fast but not so fastthat incumbents simply cannot handle it, e.g., shifts from doubling every 4 months to doubling every year

8. Incumbency Counts: technology • New developments occur at a manageable pace • Some important new technologies help incumbents leverage existing investments • xDSL • DWDM (maybe) • circuit -> packet conversion devices • Incumbents use their market powerwith equipment makers to get cutting edge tech • New, more advanced technology appears, but the incumbents are not left behind -- they have it, too • KEY: incumbents keep upwith challengers

9. Incumbency Counts: government policy • Governments prefer continuity; leery of disruption • Worry aboutbig job lossesat incumbents • Big is bad: dubious about megacarriers • Strong anti-trust enforcement: less concerned about jump-starting competition • Wary of foreign carriers: maintains national domains dominated by incumbents

10. More on “big is bad” The SBC-Ameritech deal is not good for what we’re trying to get. I’m not sure bigger is going to be better. Ron Johnson, Chmn., Nebraska PUC

11. Incumbency Counts: providers • HR: Incumbent management becomes flexible (may hire outside innovators and entrepreneurs) • HR: Incumbents not hurt by brain drain • Incumbents are better lobbyiststhan challengers • Challengers have no compelling management advantage. Flexibility fades as scale grows. • Capital markets support incumbents, and become more wary of challengers. Huge funding for new challengers starts to dry up.

12. A breakthrough in price or performance is necessary for the [revolutionary] scenario. I am relatively pessimistic about it. I don’t see the shift from circuit switching to IP as providing a sufficient jump. VP, new telecom venture Incumbency counts, they say The bulk of traffic will migrate from switched circuits over the next 10 years, but this will be a gradual process. The current circuit-based networks will be the cheapest and most convenient for most customers during that period. SVP, European PTT

13. Conclusions: Why Incumbency Counts • Incumbents are HUGE, with great brand presence • They control the critical link in the network, the local loop • They are protected by governments, pampered by equipment manufacturers, trusted by customers, and massively wealthy • Their managements are getting smarter all the time

14. Mass Matters:Era of Consolidation • Vertically-integrated • All segments, all services • Huge size: room for only 3 in a given market • PTTs not necessarily OK: megacarriers may invade their turf • New household names possible in 2005 • Geographic market is regional (N. America, Europe, Asia)

15. Why the giants dominate • Customers:Brand is very important; size helps build brands. Mass market services are fine. • Technology: Economies of scale in developing and implementing new technologies (maybe with help from equipment manufacturers) • Government policy: Weak anti-trust • Capital markets:Size brings stock price advances • Providers: Vertically-integrated generalists achieve economies of scope and scale

16. Senate testimony by SBC chairman/CEO Edward Whitacre In SBC’s view, this globalization will result in a half dozen or so integrated global competitors vying with a very large number of regional, niche, and local competitors.

17. More supporters: Customers are looking for single-source providers. They are looking for simplicity. Senior RBOC exec. We must commit to provide end-to-end service to customers, any place anywhere, any time. Senior ATT exec There will always be some niche players but, basically, the world is going to be three or four 300-pound gorillas. VP Canadian telco

18. WorldCom COO John Sidgmore: Mass Really Matters Customers say they want bundled working solutions, not just parts. They want us to show them how to deploy these products within their existing fabric of networks. We’ve combined the 4th-largest long distance company in the U.S. with the largest provider of local-access services -- outside of the RBOCs -- with the largest ISP in the world.

19. Mass Matters:customer demand • Factors that advantage huge companies: • Customers are willing to try new providers and services • Limited demand for specialized offerings and personal treatment from telcos • Many customers (business and residential) prefer one-stop shopping • National and trans-national brands dominate: massive marketing expenses required

20. Why customers like big providers SVP of large IXC/wireless carrier: Our experiment in calling party pays (for wireless) entails the shared use of a 500 number for long distance and wireless (with a single bill). To deliver CPP, long distance must be provided. Can’t break out the two services. Integrated communications carriers will be in the best position to satisfy customer demand for simplicity. Not just one-stop-shopping, but fully-integrated products. What we now see as different products will be integrated not just at the customer end but in the actual delivery so they can’t be pulled apart.

21. Mass Matters: technology • Speed:New developments occur rapidly • Economics:Real economies in spreading new technology investments (including HR investments) over widest possible customer base • Money:Huge capital investments required • Integration:Technology developments foster integration • For example, wireless CPP is facilitated by integration with long distance services

22. More technology drivers for “Mass Matters” Intelligence in the network is key. It enables simplicity and transparency. As customers sign up for more and more services -- and indeed as bundles of services become the only way of signing up -- the intelligence in the network becomes more and more applicable. I call this “strong bundling” or integrated bundling” as opposed to “weak bundling” that simply stuffs various services into a single package. IXC/Wireless VP

23. Mass Matters:government policy • Weak antitrust vision and enforcement -- 3 dominant players per market is OK • Megacarriers allowed into monopoly markets to challenge incumbents • Governments don’t worry too much about protecting incumbents • Governments disinclined to protect incumbents from foreign predators

24. Mass Matters:providers, capital markets • Real economies of scope and scale. These favor extremely large, integrated entities • (Some) management teams assemble and then run vast enterprises successfully • Big companies successfully leveragebusiness infrastructure across many diverse businesses • Capital markets favor large, “portfolio” entities (but not necessarily incumbents). Mergers generate increased stock values.

25. Where the growth rate and the change rate are so high, acquisition is often the superior approach, even though there are these issues, because you get there so much faster. WorldCom COO Sidgmore sees acquisitions as core competency... Acquisitions are essential We know how to make them work MFS, UUNet, and WorldCom are all acquisitive companies. Together we’ve acquired 65 companies in the past 4 to 5 years. We’ve developed a significant expertise in integrating cultures and putting manage-ment teams together that balance the organizations’ cultures. It’s a core competency of WorldCom’s.

26. It’s the same story we’ve seen in U.S. industry for 100 years. Big companies are not as agile as smaller ones, and there are always big opportunities for smart people everywhere. But continent-wide or even global operations require a company with appropriate scale to handle that size of operations. That means a very large company. VP, major wireless carrier You can’t even imagine what dealing with 70 million customers involves. VP, TCG (now part of AT&T) Mass really really matters

27. Pinpointing Prevails Focus is Everything

28. Pinpointing Prevails: definition • Focused, specialized carriers have an advantage: • Efficiency and profitability • Flexible and responsive to differentiated market requirements • All things to all people means mediocre performance for all customers • Today’s megamergers are the last gasp of the dinosaurs resisting the new reality • Strategy: Focus

29. Market Segment Focus • Customer requirements differ -- sometimes significantly • Products and services • Level of service and customization • Economic viability • Organizational requirements / focus differ • Service strategy • Support platforms • Alliance relationships • Examples: • Business v. consumer • Global Alliances - Concert, World Partners, Unisource = MNC • Affinity groups - AARP, church groups • RMTS - GE Rescom, US Online

30. Value chain focus: examples • Infrastructure focus • Qwest, Level 3, NextWave • Attraction to migrate down value chain, get higher margins • Retail/customer interface focus • ArbiNet, Excel, CLECs, LD resellers • Viability a function of excess capacity or regulatory rules on access pricing

31. Why pinpointing prevails • Incumbents and megacarriers collapse under their own weight. Size brings inflexibility, bureaucracy, stagnation • Wrong strategy for the market, not execution failure • Focus creates opportunities for real efficiencies, cutting costs • Customers want customized service bundles, and personal treatment • Some want high-quality, high-touch service • Others want economy class to save money

32. Megacarriers collapse of their own weight “ If you have an under-depreciated, over-regulated, attacked, monopoly phone company, why double the size of that? President, RBOC subsidiary The colossus mergers, seeking economies of scale and geographic coverage, are solving all the problems of yesterday. You have to ask a fundamental question -- “What got better from a customer’s point of view “? President, wireless carrier

33. Focused competitors Ameritech’s wholesale business has increased from $150m to more than $1bn in 2 years. The wholesale retail split is aready here. RBOC VP Disintermediation and the collapse of the valuechain is occurring in every industry affected by IT. VP Strategy, equipment manufacturer

34. Is owning the network necessary? No Network ownership will be less and less important as time goes on. Today it is reasonably important. Twenty years from now it won’t be important at all. President, wireless carrier We already have contracts to buy long distance minutes at an 80-90% discount from retail. Why do I need to own the network? RBOC VP A successful carrier of the future doesn’t necessarily own networks. It controls and operates networks, but it may not own them. President, equipment manufacturer

35. Value in telecoms: 2005 Of the value created (in the telecom process), 45% will go to the content provider, 45% will go to those that actually work with the customer, and bill and innovate with the customer, and 10% will go to the infrastructure provider. President and CEO, LEC W(h)ither the incumbents in this case….?

36. Pinpointing Prevails: customer demand • Both business and residential customers want customized services, not mass offerings • Falling prices and new services create major market growth, where specialists have an advantage • Differences in customer requirements help to define appropriate scale for geographic focus

37. A few comments…. Customer service wins us customers every day. We expect to get 80% of the GTE’s business in our town within 3 years CLEC COO WinStar will deliver a level of personal service that will amaze businesses. Customer care will be a primary focus for WinStar." Bill Rouhana, Winstar CEO

38. Pinpointing Prevails: technology • Technology creates excess network capacity, helping resellers, e.g. DWDM • Open standards and open software enable 3rd party applications development • Fast change devalues legacy systems • Network intelligence migrates to customer interface or to customer’s access equipment, away from legacy switches • Gateway and intelligent agent softwareallow aggregators to create differentiated, value-added services, and customer self-provisioning

39. Pinpointing Prevails: government policy • Policymakers support new entrants • Wholesale pricing policies (resale discounts and unbundled elements) make resellers viable • Pro-change constituencies are strong • Policy retains “hidden” subsidies, helping specialists • Policymakers let incumbents suffer, shrink, or even be acquired and broken up “If regulators set the rules for the marketplace, any structure is sustainable because the rules keep it in place.”President, wireless carrier

40. Pinpointing Prevails: providers, capital markets • The costs of operating integrated, centralized organizations and systems prove higher than economies of scale; the latter are elusive • Operational strategies and supporting IT systems are so varied that integrated companies have no significant scale economies in the back office • Focused competitors steal enough high margin market share to undermine large organizations • Capital markets reward focused competitors over “portfolio” companies, i.e., incumbents worth more broken up than whole

41. Revolutionary Change Price/performance ratios shift by at least one order of magnitude, within 5-7 years

42. Revolutionary scenarios • Data Dominates • Cable Connects • Wireless Wins Unlike evolutionary scenarios, these scenarios are not mutually exclusive

43. Long-shot scenarios • Voice/data over electric power lines • Satellite delivery systems (LEOs) • Content convergence

44. Data Dominates

45. Data Dominates • Data traffic doubling every 4 months • PS networks clearly superior for handling data • Data could be 95% of traffic by 2005 • “Voice will be a pimple of the side of data” Voice infrastructure is a handicap; at a minimum, new data-centric market entrants have big cost advantages

46. Data Dominates • Incumbents • Can’t move to PS fast enough • Cultural shift too severe • Rapid loss of dominance • Challengers • PS-centered • New business models based on data • Voice just another datastream

47. Data Dominates Our business model calls for 50% revenues from data within 5 years. VP European PTT Intelligent networks are useless in the age of data. Stupid networks win every time former AT&T exec • BT is spending $12bn over the next 5 years to build a world-class data network. The main issue is migration. • Dir. Strategy, European PTT

48. Data Dominates Scale will come from a focus on data, not voice, and from a willingness to be a growth company, not a safe cash cow for investors. IP has some advantages over CS, but scale is the key. Senior exec, Microsoft

49. Data Dominates:customer demand • Internet demand continues to grow fast • Mass market for video applications --videoconference, streaming video • Interactive high bandwidth apps (IP- voicemail, video email) • Telecommuting • Fax and voice apps move to IP

50. Data Dominates:technology • IP solves QOS issues -- priority routing, etc. • Bandwidth availability expands rapidly, especially in the local loop • Scalability problems resolved -- terabit routers and beyond • Reliability reaches CS levels • Capacity crunch resolved -- more bandwidth, IP multicasting, premium IP networks, etc.