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June 15, 2005

Telecom strategy models

Based on her research for the Columbia Institute for Tele-Information, Kathryn Harrigan discusses strategy models for players in the rapidly evolving telecommunications industry.


Can you discuss your research of the telecom industry for CITI?

One of the things I’m really interested in is how the nature of competition changes as industries evolve. As the basis of competition changes, the success requirements also change. When CITI wanted me to give my view of what was likely to happen in the telecommunications industry, I noticed that there were many different interested parties coalescing on this whole digitization of media. That meant that we were going to be creating products that consumers might want. It could possibly represent new lifestyles. Certainly there would be a new group of players, of competitors, who would be offering those products to the customers. And this would have implications for the ongoing companies as well as, of course, the policymakers and the investors.

The industry is going through a period of mergers as things are consolidating, and they’re not necessarily the kind of mergers that just suck up excess capacity. They’re the kind of mergers that are putting together interesting new capabilities to form hybrid companies. In a perverse way, we’re going back to vertical integration, even after the courts had tried so assiduously, back in 1984, to break the companies all into pieces.

If you want to use AT&T as an object lesson, here’s a company that for a long time was vertically integrated, then it was told it had to be “deintegrated.” Now, that put out a fabulous offer for people to try to figure out which part of AT&T would prove to be most valuable. We now know the last mile turned out to be the most valuable part, because the part that is surviving is the part that has access to the ultimate consumer. You look at a company like AT&T, and over time what has happened is that it has been restructuring itself. It broke itself into separate companies for telephone, wireless and cable back in 2001. Now what we’re seeing in 2005 is companies still looking for a way to be able to marry all those different ways of communicating: wired, wireless, broadband.

Any company in a high-tech situation that is gambling on the future carries an enormous amount of risk, and that means costs that are not immediately going to be recovered. And a company that wants to change its structure that dramatically really should make sure that the right kind of investors are putting their money into it. Because if you’ve got a lot of impatient investors — the typical widows and orphans that used to own AT&T — their cash flow needs are not set up for a company that’s going to try to somehow meld together broadband and wireless and plain old telephone wire-line service into one company, which is what AT&T was trying to put together. We can say it was ahead of its time and the market wasn’t prepared to reward it for that.

And not only that, but all the other companies that were not as fast as AT&T could not get on the bandwagon quickly enough, and therefore you didn’t have the kind of network effects that you need to be able to make these things become economically viable. A network effect is where you get economies of scope across companies because they’ve all decided to jump onto the same technological protocol or to create products that work on the same platform and thereby increase the utility for the consumer of using a product.

So what we’ve got is a new industry structure — new from my point of view because I started studying this industry in the mid-’70s. Basically, in those days vertical integration was the way to fly, and you did it all yourself and you could not rely that much on outsiders. Now you are extremely dependent upon outsiders, you are extremely dependent upon sharing information with other companies and moving them along so that you create good potential dancing partners.

Are we now seeing a return to vertical integration?

I wouldn’t say it’s so much that they’re doing vertical integration as they’re trying to combine different modes of distribution. Let’s say that you’re a media company and you have the capability to make the programming, whether it’s movies or television or books or financial information or whatever. You have the capability to make that yourself and then distribute that through your own outlets, as well as syndicate that across all of your other distribution conduits.

Although there are some companies in the entertainment business that have tried this, what we’re finding is that now, four years after AT&T’s decision to break itself into pieces, we are seeing a much clearer recognition that the last mile is definitely the best part of that industry to be in. And so everyone is now looking for a way to get to the consumer with the different ways of distributing whatever they’ve got to digitize — whether that’s music or communications, voice, entertainment, data. That involves working with outsiders in a variety of alliances.

One of the things that working in alliances will do is accelerate the product life cycle. We found a statistically significant pattern of what we call a sinusoidal curve, like a sine wave, which means that the rate of change when you’re working in alliances increases geometrically. So you have all of these companies working together and trying to fill in the gaps in their offerings. Everybody is like a one-stop shopping center. Everybody wants to be your personal information provider. They’re hoping that they can take some profits somewhere along the line through the device, if they’re a company like LG Electronics or Nokia, and if they’re a content company, they’re hoping to find a way to collect some money by providing their content.

I’ve been studying the megamergers in the entertainment industry, because all of these things are kind of converging together. And the entertainment companies are asking the same question, which is, basically: Which are the nice bits to own? Which are the ones that are going to make the best amount of money for us? And which are those things that we won’t be able to make as much money in or in which we won’t be able to get a strong enough position internally? And those are the ones they would use the alliances for.

Do you think this is leading to more alliances between entertainment and telecom companies?

No, I would call the relationships mostly contractual. I don’t think the content companies are going to want to share the risk and share the rewards. The entertainment companies understand consumers pretty well. But if they can get the telecom companies to fork over some money to create programming, then they might cooperate. Otherwise, it’s going to be strictly buyer-seller contractual kind of relationships.

How has the ease of sharing digitized media hurt the entertainment industry and affected its cooperation with telecoms?

They just don’t know how to take their rents out yet. The entertainment industry is thriving. There are oodles of independent producers out there. We’re having a real boom in creativity, as far as content. But the entertainment companies may not yet have figured out how to collect their profits. They own something very valuable. The question is, can they collect the rent on it?

Can you talk about effective and ineffective strategies for telecom companies?

In situations where there are a lot of perfectly good suppliers out there and the rate of technology is changing rapidly, you’re much better off to assemble as opposed to trying to make a lot of the value added yourself — as long as you control the access to the ultimate customer. An ineffective strategy would be to try to be vertically integrated, do it all yourself and not work a lot with outsiders. Alliances are sort of a decision about risk sharing and profit sharing and how wide you’re going to open the kimono in letting the other guy across the table see what makes your company tick.

In what direction do you think the telecom industry and its structure are going?

I think that eventually it will once again congeal in a couple of big companies that will have a whole bunch of little companies working in kind of a spiderweb configuration with them. And that will hold for a while, until we get to the next big thunderclap or discontinuous change. We’re working toward that point of equilibrium, but it sure is rocky going if you’re in the telecom industry right now. I think that all of this thrashing around and competition is good because out of this we ultimately learn a lot of things and see a lot of alternatives and we get to make choices, and that’s good.

What can other industries learn from the telecom industry?

Well, I think one thing that they’re certainly going to have to recognize is the importance of a very close understanding of what customers want, this rising consumerism. Even if your consumer is industrial, you’re going to have to have a much more participative kind of a way of serving your customers. It also tells you that you can never be sure which part of your business model is going to be the most sensitive to competition in the future.

 

Kathryn Harrigan is the Henry R. Kravis Professor Business Leadership at Columbia Business School.

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