Case Analysis: British Telecom(4 pages)

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British Telecom: Searching for a Winning Strategy

Case

Author: Tuomo Summanen & Michael Pollitt

Online Pub Date: March 31, 2016 | Original Pub. Date: 2018

Subject: Competitive Strategy, Corporate Strategy

Level: Intermediate | Type: Indirect case | Length: 7742 words

Organization: British Telecom | Organization size: Large

Region: Northern Europe | State:

Industry: Telecommunications

Originally Published in:

Summanen, T., & Pollitt, M. (2015). British Telecom: Searching for a winning strategy.

Cambridge: University of Cambridge, Judge Business School.

Publisher: University of Cambridge, Judge Business School

DOI: http://dx.doi.org/10.4135/9781473974517 | Online ISBN: 9781473974517

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Abstract

United Kingdom was – alongside the United States – among the first countries to deregulate the telecommunications market in the early 1980s. Competition in the UK telecommunications started gradually about ten years earlier than in most other European countries. This paper traces the development of the corporate strategies of the incumbent, British Telecom, after the reform of the telecommunications market in the UK from the beginning of the 1980s. We explore how British Telecom utilised its early mover advantage when technological, institutional and competitive forces were shaping the telecommunications service industry in the 1980s and 1990s towards a competitive market. The paper illustrates the complexity and uncertainty that corporate strategists face in a fast changing environment. The paper suggests lessons for the telecommunications, media, and information technology service sectors, as well as the regulatory and institutional environment.

Case

Introduction

The development of the telecommunications market in the United Kingdom and the corporate strategy and development of the incumbent, British Telecom, represents an interesting object of analysis for several reasons. First, the UK telecommunications market was - along with the U.S. market - among the first telecommunications markets that were deregulated in the early 1980s. Also some regulatory innovations, such as price cap regulation, were developed, and first implemented in telecommunications in the UK. Second, British Telecom was the first large incumbent in telecommunications that was privatised in the early 1980s. Third, competition in the UK telecommunications started gradually about ten years earlier than in most of the other European countries, and for a long period the UK market was, in number of competing companies at least, well ahead of other European countries. However, competition evolved gradually, and had some country specific features that have affected the development of the telecommunications market, and particularly British Telecom.

The main question to be explored in this paper is how the incumbent, British Telecom, in its strategies utilised the early mover advantage in the deregulated market? First, the development of telecommunications market in the UK after deregulation will be reviewed, and second, the development of corporate strategies of British Telecom will be described.

Telecommunications Market in the United Kingdom

The History of Liberalisation

Before privatisation in 1984 British Telecom had a legal monopoly over fixed line network operations (local, long-distance, international) and the supply of network services, most apparatus supply, and value added network services. In the beginning of 1980s the agenda was not to privatise British Telecom, but rather to clarify the financial and operational routines and tighten financial control on the company. In 1981 the Beesley report recommended liberalisation of the resale of leased circuits. In the same year the British Telecommunications

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Act split BT from the Post Office and began liberalisation. As a result in 1982, Mercury, a subsidiary of Cable and Wireless, was licensed as a national fixed line network operator in competition with BT. In 1982 a White Paper announced the government's intention to privatise BT. In 1983 the government announced its “duopoly policy”, which meant that for the next seven years there were to be only two operators, BT and Mercury, for nation-wide fixed line networks. This duopoly policy also prevented cable television companies from providing telecommunications services in their own right. In 1984 British Telecom was privatised: 50.2% of its shares were sold. Two possible models of privatisation of BT were considered: to privatise it as an integrated company, or to follow the recent model of restructuring of AT&T in the USA, and break up BT, for instance by separating off local services, long-distance services and apparatus supply services. The former model, which also BT's management strongly supported, was chosen. BT was also forbidden from carrying television services on its network. The liberalisation of the telecommunications market in the UK can be divided into two periods: first, the period of duopoly 1984-1990, and the period of more liberalised market after 1991.

The duopoly policy ended in 1991 following the publication of a White Paper. Earlier in 1989 further liberalisation had taken place: domestic, but not international, simple resale was permitted and the duopoly policy in the mobile telecommunications – until 1989 only two operators, namely Vodafone and BT's Cellnet were licensed as network operators – expired. White Paper allowed cable TV companies to start to offer telecommunications services in their own right through their cable networks. At the same time national public telecommunications companies were not permitted to carry TV services on their networks for a further decade.

Armstrong, Cowan and Vickers (1994) describe the first period of liberalisation in the UK telecommunications as a decade of lost opportunities. Competition in the market grew very slowly, e.g. only in 1986, four years after its license was granted, could Mercury could get access to BT's local loop. And due to weak competition there was no need for BT to restructure itself: major restructuring of the company only started at the beginning of 1990s.

The essential developments are listed below:

Gradualism

Deregulation of the market and the privatisation of BT were the first major liberalisation decisions and were at that time radical politically, starting a new period world-wide in the network industries. However the liberalisation policy itself during the 1980s tried to ensure a soft transition to a more competitive market.

Duopoly

In the duopoly policy the gradual, the planned transition to the competitive market can be seen perhaps most clearly. In the literature (e.g. Laffont and Tirole, 2000) it has been pointed out that market forces would have done a better job at selecting worthy competitors to BT than did regulators, and that Mercury might have not been the optimal choice.

Regulation by bargaining

There were three regulatory bodies in the UK – the Department of Trade and Industry (DTI), Oftel and the Monopolies and Mergers Commission (MMC). The regulatory authority of Oftel can be extended beyond the powers and duties of the 1984 Telecommunications Act because

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it can always employ the threat of a reference to the MMC to seek regulatory change. In fact regulation has involved what seems like bargaining between Oftel and BT. This is in quite sharp contrast to the rather legalistic type of regulation in the USA, and to very weak regulation in the Nordic countries.

Growth of the role of regulation

It is difficult to believe that the aim of the lawmakers was to increase gradually the role of regulatory bodies in developing the competitive market.

At privatisation about half of BT's business was subject to price control, but in mid 1990s around 70% of its business (by revenue) was under price control. The duopoly between BT and Mercury might have created the illusion of the possibility of effective regulation by bargaining with Oftel and with final referee of the MMC. To regulate hundreds of companies is a different kind of task.

Cherry picking

New entrants, such as Mercury during the duopoly and others after 1994, concentrate upon the high-value-added parts of the network, comprising major cities and especially the City of London, and upon the relatively profitable long-distance and international markets.

Competitive mobile telecommunications

The duopoly policy was applied also to mobile telecommunications, and initially in 1980s only two operators were licensed, namely Cellnet and Vodafone. However, after cancellation of the duopoly policy the licences were granted for two more operators. At the moment all four operators have almost similar market share. Oftel's recent benchmarking work, reflecting prices in August 2001 shows that UK mobile prices are slightly below average when compared to major European economies.

Slow restructuring of BT

The duopoly period, 1984 – 1990, created for BT a soft landing into competition. Although BT sold its manufacturing businesses soon after privatisation it employed more people in 1990 than it did in 1984. The restructuring of the company started only in the beginning of 1990s. Although competition emerged after 1991, the telecommunications market in the UK in 1990s still had very typical problems coming from 1980s, e.g. the low level of competition in the local, especially residential, market. This is by no means only a British phenomenon. This is crucial in the U.S. telecommunications market and also in the EU telecommunications market as a recent declaration of the European Commission on the slow development of competition in the local telephone markets shows.

The Market Structure

The Office for National Statistics (ONS) estimates that there are over 7,000 businesses in the U.K. whose primary businesses can be considered telecommunications. This estimate includes a large number of companies such as those involved in consultancy or hardware and network installations, most of which are outside the scope of regulation. Data used in this section is based on Oftel's Market Information 2000/2001, and 2001/2002 surveys that

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collected data from 82 licensed telecom operators in the U.K. ONS estimates that the turnover of the UK telecommunications industry was £41.4 billion in the four quarters to March 2001, and £45.4 billion in the four quarters to March 2002.

Gross turnover is, however, a relatively crude measure of the size of the industry because it does not properly take into account purchases by the industry including transactions within the industry. ONS estimates that, the value added by the industry was £18 billion in 1999 and £21 billion in 2001, or around two percent of GDP. The growth in revenue has been mainly in newer services such as mobile and Internet but also through interconnect revenue as a result of increased competition. During 2000 the number of mobile subscribers exceeded the number of fixed lines for the first time in the UK. In 1996/1997 there were 30.7 million fixed lines and 7.1 million mobile subscribers but in 2000/01 there were 34.8 million fixed lines and 43.5 million mobile subscribers in the UK. Growth in fixed call volumes is almost entirely driven by the internet. In 2000/01 it is estimated that around 40 percent of all call minutes

originating on the PSTN were to Internet service providers.1

Table 1.Estimated turnover of the UK telecoms industry 2000/01 (£billions)2

Industry total

BT group

BT share of revenues (%)

Simple voice telephony

- Inland calls 3.4 2.3 67

- Outgoing international 1.2 0.6 50

Other calls 4.5 2.9 65

Exchange lines 4.0 3.5 85

Private leased circuits 1.8 1.2 66

Mobile telephony – retail 6.9 1.6* 23

Interconnect 6.5 2.5 38

Other revenues reported to Oftel 1.7 0.4 32

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Estimate of other licensed operator turnover **

5.6 5.6

Turnover from other telecoms activity ** 5.9 32

Total turnover 2000/01 ** 41.4 20.4 49

Total turnover 2001/02 ** 45.4 20.5 45

* Prior to de-merger of MMO2.

** May include some non-UK turnover.

The fixed lines market

In March 2001 there were 35 million exchange line numbers; that is one million higher than a year earlier. In March 2002 there were 35.7 million exchange line numbers.

Table 2.Fixed operators: summary of all operators’ volumes3

Volumes

2001/02 1997/98 C.A.G.R. (per cent)

Call minutes (millions)

Local calls 74,953 90,070 4.5

National calls 54,476 43,465 5.8

International calls 7,935 5,465 9.6

Calls to mobiles 13,579 3,837 37.2

Others calls 159,663 13,062 87.0

All calls 310,606 155,940 18.8

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Lines at year end (thousands)

Connections 5,272 4,525 3.9

Lines at year end 35,701 32,015 2.8

Growth was primarily in the number of business access lines. Call volumes from fixed telephones increased by 25 per cent. This was driven mainly by huge growth in dial-up Internet usage. Local and national calls were stable while fixed to mobile call volumes and international call volumes increased.

BT's share of the total fixed line telephone market continued to decrease to 65 per cent in March 2001.

Residential fixed line telephone market

In March 2001 there were 24.6 million residential exchange line numbers. The annual decrease was 100,000. Residential fixed telephone volumes have increased from 86,598 million minutes in 1996/97 to 166,320 million minutes in 2000/01. Residential local call volume has decreased, and national and international call volumes have increased. Calls to mobiles have increased substantially.

(See appendix 1, Fixed operators: residential call volumes by type of call by operator).

Business fixed line telephone market

Business fixed telephone call volumes increased from 49,436 million minutes in 1996/97 to 95,137 million minutes in 2000/01. Local call volumes slightly fell while national, international and calls to mobiles increased substantially. (See appendix 2, Fixed operators: business call volumes by type of call by operator).

The market shares

In the residential fixed line market competition has developed rather slowly. On the one hand BT has been able to defend its local loop position, and has been heavily criticised by its competitors, for example, for using uncompetitive access pricing, and, on the other, new entrants have been more interested in cherry picking the faster growing business fixed line market.

Table 3.The residential fixed line market shares (%) in all calls – volumes

BT C&W NTL & Telewest Others

All calls

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1996/97 89.1 1.7 9.0 0.2

1997/98 83.8 6.1 8.2 1.9

1999/00 76.4 7.3 12.3 4.0

2000/01 73.9 1.1 19.6 5.3

2001/02 74.7 n/a 19.7 5.6

Abbreviations used in the tables: n/a: Information not supplied by operator, -: operator did not offer this service.

Source: Oftel. The UK Telecommunications Industry: Market Information 2001/02, March 2003.

In the business fixed line market competition has emerged fast. BT has lost during 1990s a substantial market share to its competitors.

Table 4.The business fixed line market shares (%) in all calls – volumes.

BT C&W NTL & Telewest Worldcom Others Includes Concert

All calls

1996/97 76.3 13.0 1.4 0.0 7.3

1997/98 64.3 18.2 2.7 n/a 14.8

1998/99 59.4 18.0 3.8 n/a 18.8

1999/00 56.5 16.1 4.7 n/a 22.7

2000/01 51.7 15.5 6.1 9.0 17.8

2001/02 49.7 13.4 6.8 9.9 20.1

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Source: Oftel. The UK Telecommunications Industry: Market Information 2000/01, December 2001, and 2001/02, March 2003.

However, it seems that the almost inevitable trend of BT losing its residential and business fixed line market shares has stopped during 2001 and 2002. Partly this might be the result of strategic change in the company, and partly the result of heavy financial problems of BT's competitors.

The mobile telephony market Table 5. Cellular services: summary of all operators' volumes

(Million minutes)

Volumes C.A.G.R. Volumes C.A.G.R.

2002/03 Q1 2001/02 Q1 (per cent) 2000/01 1996/97 (per cent)

Retail

UK calls 12,346 10,509 17.5 37,983 6,613 55

Outgoing international 185 128 44.3 452 75 56.9

Whilst roaming abroad 286 238 20.4 882 118 65.8

All calls 12,817 10,874 17.9 39,317 6,806 55

Interconnection 6,032 5,679 6.2 19,833 3,491 54

SMS messages (millions) 4,136 2,762 49.8 8,041 n/a n/a

Subscribers (000's)

Connections during period 3,553 4,597 −22.7 24,189 3,324 64

Post paid 14,650 12,937 13.2 13,745 7,109 18

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Pre-pay 32,272 29,799 8.3 29,707 n/a 57.2

Total subscribers 46,922 42,736 9.8 43,452 7,109 64

Source: Oftel. The UK Telecommunications Industry…Dec 2001; Oftel. Market Information, Mobile Update: October 2002.

Commercial mobile telephone services started in the UK in 1985 when British Telecom and

Securicor founded a joint venture company – Cellnet – on 7th January. Later in the same year Vodafone started operations. The joint venture company was named BT Cellnet in 1999, and in the same year BT announced that it would be acquiring Securicor's minority stake in the joint venture. In 1993 Mercury Communications launched its One 2 One mobile telephone service.

Table 6.Mobile market shares by operator 2000/01 and 2001/02 in the UK (in %)

Subscribers Retail revenues Call volumes

2000/01 2001/02 2000/01 2001/02 2000/01 2001/02

Orange 27.8 27,6 23.4 26,4 26.2 28,7

T-Mobile 22.1 22,8 17.0 16,9 21.0 19,7

O2 25.5 24,8 23.4 22,3 23.6 20,8

Vodafone 24.7 24,8 36.2 34,4 29.3 30,8

Source: Oftel. The UK Telecommunications Industry…December 2001, and March 2003.

The mobile telephone market in the UK has developed rapidly and market shares of the operators have changed substantially. The fourth and the latest entrant in this market – Orange, entered the market in April 1994 – is at the moment the biggest mobile operator by number of subscribers. (See more detailed information about the development of market shares in the appendix 3, Cellular services: subscribers. Connections, stocks, and net changes by operator). In October 1999 Mannesman acquired Orange. In February 2000 Vodafone acquired Mannesman and undertook according the conditions set by the regulator to sell Orange. In May 2000 Orange announced an agreed acquisition by France Telecom. In 2001 BT demerged, as a part of its financial rescue plan, BT Cellnet, which was named MMO2. In the same year One2One was re-named by Deutsche Telekom as T-Mobile.

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Development and Corporate Strategies of British Telecom

BT's origins date back as far as to the introduction of the first commercial telegraph services in the early nineteenth century. The survivors of these companies were transferred to state control under the Post Office. Thus as in many other developed countries in the early days of telephony telephone services in the United Kingdom were provided by the Post Office in competition with private telephone companies. However, in 1912 the Post Office became the monopoly supplier of telephone services except in a few municipalities. Post Office was a state department until 1969, when under the Post Office Act it was transferred into a public c o r p o r a t i o n . T h e B r i t i s h T e l e c o m m u n i c a t i o n s A c t , 1 9 8 1 , s e p a r a t e d p o s t a l a n d telecommunications activities and created British Telecom as a distinct public corporation. In the beginning of 1980s the process of opening up the telecommunications market to competition started. The Telecommunications Act, 1984, confirmed the privatisation of British Telecom. In 1984, 50.2 per cent of British Telecom shares were sold to the public. In December 1991 the government sold half of its remaining holding of 47.6 per cent of shares, and all the remaining government shares were sold in July 1993. The outcome of the 1984 Act was that British Telecom finally lost its monopoly in running telecommunications network in the UK. The Act, by creating Oftel, completed the separation of regulatory and operational functions that had started in 1981.

A Government White Paper “Competition and Choice: Telecommunications Policy for the 1990s”, issued on 5 March 1991, cancelled the duopoly and opened the market for competition. The first major restructuring of BT as an integrated telecommunications company was done in the beginning of 1990s. In April 1991 BT unveiled a new organisation structure, which was the result of twelve months of reorganisation. BT's new organisation focused on specific market sectors to meet better the needs of different customers – the individual, the small business, and the multinational corporations. For the first time after privatisation BT started to cut jobs. The objective of becoming a leading global telecommunications operator was set during that time. The main strategic approach for this goal was to expand rapidly into overseas using strategic alliances with telecommunications companies. Earlier, in 1990, British Telecom had sold its telephone manufacturing businesses. At its largest the Post Office/British Telecom manufacturing division consisted of eight factories around the country (three in London, three in Birmingham, one in Edinburgh and one in Cwmcarn) and employed 4,000 people. In the same year British Telecom sold also its holdings in cable operating companies: Thames Valley Cable, Ulster Cable, Aberdeen Cable Services Ltd., Swindon Cable and Coventry Cable as a part of its general strategy of concentrating on providing network-related products and services to customers all around the world.

In 1987 Sir George Jefferson resigned as Chairman of British Telecom, and the CEO Iain Vallance became also the chairman of the company. Sir Iain Vallance had joined the Post Office in 1966. He was appointed a director of British Telecom in 1984, and served as CEO f r o m 1 9 8 6 . I n 1 9 9 3 B T a n d M C I , t h e s e c o n d l a r g e s t c a r r i e r o f l o n g d i s t a n c e telecommunications services in the USA, announced a joint global alliance through a new joint venture company Concert Communications. This new company was planned to play the main role in transforming BT into a leading global telecommunications operator. During the next few years in order to create a global network around Concert to serve multinational corporate clients BT acquired stakes or founded several joint venture companies overseas: e.g. in 1995 Albacom – a joint venture company in Italy with BNL, Viag InterKom KG – joint venture company in Germany, Telenordia in Sweden with TeleDanmark and Telenor; in 1996 BT acquired Bell Canada's 25% stake in Clear Communications, New Zealand's second

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largest telecommunications company and a joint venture company in Korea with Dacom, a joint venture company Telfort B.V. in the Netherlands.

In 1996 at the annual shareholding meeting the chairman Iain Vallance formulated BT's corporate strategy in the following way. “We have a clear strategy…that has been in place for some time now.” “First, we will continue to defend market share in the UK… Second, we will expand our overseas presence and our interests, particularly in partnership with others. Third, we will develop the market for advanced, interactive and multimedia services”. BT's overseas activity targets were set in three parts of the world: North America – in partnership with MCI; mainland Europe (defined as BT's extended home markets), and the Asia-Pacific region. As Vallance put it: “Your company already has a significant presence in most of the major European markets and we are looking forward to the time when we can compete head-to- head with the incumbent operators. We have 12 years’ experience of competition, they have none.” BT also aimed to develop advanced services and with trials of interactive services from video-on-demand to home shopping.

In January 1996 Sir Peter Bonfield, the former chairman of ICL, joined BT as Chief Executive. Sir Iain Vallance continued as Chairman of BT. The general strategy was to transform BT into a global telecommunications player. The major role in this was planned to be taken by Concert Communications, a one billion joint venture with MCI Communications. In June 1996 BT and MCI announced that they were close to completing the world's largest Internet network. Later in November in the same year BT and MCI announced that they had entered into a merger agreement. However, the management of BT underestimated Worldcom's CEO Bernie Ebbern. The bid battle between BT and Worldcom for MCI finally came to the end in November 1997 when Worldcom offered $37 billion for MCI. This left BT in need of a global partner.

In July 1998 BT and AT&T agreed to pool their international operations into a joint venture. In January 2000 Concert, a global joint venture between BT and AT&T formally came into existence. However, its estimation of $7 billion in revenues in 2000 was about $3 billion less than originally predicted. Soon Concert with the end of the telecommunications boom became a heavy burden for both of the companies. Finally in October 2001 BT and AT&T announced the close of Concert. This meant a £1.2 billion charge for BT and charges of $5.3 billion for AT&T.

Aftermath of Abandonment of Global Player Strategy

Rapidly changed market conditions in 2000 forced BT, as many other incumbents too, to concentrate all efforts to secure the financial stability of the company. Now the debt issue was on the agenda of every meeting of the senior management, and every management decision was constrained by the serious financial problems of the company.

After the third generation (3G) mobile phone licence auctions BT, just like other European telecommunications companies who won licences, became heavily indebted. At the start of 2000 it was expected that in the UK each licence would cost £500 million - £1 billion. The result was £4.5 billion per licence. And it is estimated that the licence winner must invest around £3 billion - £4 billion per network. BT won licences in the UK, Germany, and in the Netherlands. During 2001 the financing of the massive debt of BT became the key issue driving the rescue strategy of the company. European telecommunications companies paid a r o u n d E u 1 2 8 b i l l i o n o n 3 G l i c e n c e s . H o w e v e r , t h e m a s s i v e d e b t o f E u r o p e a n telecommunications companies results not only from the 3G licence payments, although they

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certainly are the largest single debt item. In early 2001 the total debt of France Telecom, Deutsche Telekom, BT, Telefonica, KPN, Telecom Italia, and Sonera – to mention some of the most indebted European incumbents – was Euro 233 billion. The very high licence fees were part of a strategy of aggressive growth that was based on optimism and faith in a sort of technological determinism that would create high and growing consumer demand for new services. The fact that most new entrants in telecommunications services on the both sides of Atlantic are now in serious financial problems although they did not pay high licence fees tells us something. On the one hand, it suggests the growth optimism and confused strategies of these companies, and on the other how easy it was to raise funds for future investment projects. The change in market conditions has exposed these companies’ shortcomings. Until spring 2000 non-incumbent companies like Atlantic Telecom, Colt, Viatel could easily raise hundreds of millions of pounds to fund ambitious expansion plans. A representative of Viatel, a Nasdaq-listed company, which has 4,000 corporate clients in the UK after buying AT&T's business in the UK, says: “We have been a victim of circumstances, which is the change in market conditions. The investment houses that were preparing to provide money for the purpose of building this network are the same investment houses that are punishing us for

carrying so much debt”.4

Table 7

Telecom debt Projected 2001 net debt (Euro bn) Debt/earnings ratio

France Telecom 62 5.0

Deutsche Telekom 56 4.3

BT (before restructuring) 45 4.5

Telefonica 24 1.9

KPN 22 5.9

Telecom Italia 19 1.3

Sonera 5.7 3.8

Source: Financial Times

Business Week in April, 2001, reported that “The saga of BT is full of lost changes”. The journal argued that while trying to create a global BT through partnerships with the US telecommunications companies – with MCI and later with AT&T – the management of BT missed what was happening in Europe. Later BT tried to compensate this by “an 18-month

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buying binge in mid-1999”. However, BT, unlike Vodafone, spent billions to acquire mainly minority stakes in second-tier mobile telephone companies. In the spring 2001 BT faced all the problems of high debt. If the company is not able to pay off at least $15 billion of its debt

by spring 2002, its credit rating will fall to the lowest investment grade, triple B.5 This would raise the cost of BT's interest payments by as much as $300 million annually.

Table 8

Projected 2001 net debt (Euro bn)

Required debt reduction

Triple-B rating (Euro bn)

Single-A rating (Euro bn)

France Telecom

62.0 18.3 30.8

Deutsche Telekom

56.0 10.5 23.5

BT 45.0 10.1 20.1

KPN 22.0 9.1 12.8

Sonera 5.7 2.9 3.7

Source: Financial Times March 16, 2001

Also refinancing of the debt would become more expensive. The financial situation of BT had become critical. The financial rescue plan approved in November 2000 became insufficient in only six months. A new more radical rescue plan was approved in May 2001. Would this plan save the company? And can the management deliver it? There seemed to be some scepticism in the City, and particularly in the media. The market seemed not to believe in effectiveness of the dual management of the new chairman and the old CEO.

The plan in November 2000

Aim

To cut debt by £10 billion and give individual businesses more freedom.

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Method

Float a 25% stake in BT Wireless to raise £5 billion or more.

Float a 25% stake in Yell, BT's directory business. *

Create a new network company serving other telecoms carriers to isolate regulatory skirmishing with Oftel.

Retain full ownership of newly created BT retail, Ignite, and Btopenworld.

Management

Sir Ian Vallance to be chairman until July 2002.

The reality, May 2001

Aim

To cut debt to £15-20 billion by March 2002.

Method

Right issues of shares to raise £5.9 billion.

Sale of Japanese mobile interest to Vodafone.

Sale of Airtel in Spain for £1.1 billion.

Dividend payments scrapped to save £1.4 billion.

Demerger of BT Wireless.

Future BT to embrace BT Retail, BT wholesale, BT ignite and Btopenworld.

Management

Sir Christopher Bland replaces Sir Ian Vallance.

Sir Peter Bonfield's contract extended.

* Yell was sold in June 2001 for £2.14m to a partnership of venture capitalists, Apax Partners Ltd and Hicks, Muse, Tate and Furst.

Source: The Sunday Times, May 13, 2001

Rebuilding credibility

The changing market conditions forced BT, like other telecommunications incumbents and new entrants, to reformulate their strategies. In November 2000 BT announced a radical restructuring that will break the business into five separate public companies. In the spring 2001 the management of BT with new chairman Sir Christopher Bland announced that BT's

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strategy was to concentrate on the voice and data markets in the UK and elsewhere in Europe. This was a major change from the previous strategy of the global leadership in telecommunications. A substantial part of this strategy is the reorganisation of the company. Two separately quoted companies were to be created: BT Wireless (later MMO2) and Future BT (later BT Group plc). MMO2 demerged 19 November 2001 from BT and became an independent company. BT Group plc was the listed holding company for the BT group companies. BT Group plc represented the group as a whole to external audiences such as s h a r e h o l d e r s , f i n a n c i a l a n a l y s t s a n d t h e m e d i a . U n d e r t h i s s t r u c t u r e B r i t i s h T e l e c o m m u n i c a t i o n s p l c w a s a w h o l l y o w n e d s u b s i d i a r y o f B T G r o u p p l c . B r i t i s h Telecommunications plc was to own separately managed businesses comprising:

BT Ignite – an international broadband business network business focused primarily on corporate and wholesale markets; BTopenworld – an international mass-market Internet business; BT Retail – serving end-business and residential customers; BT Wholesale – which sells network capacity and call terminations to other carriers; BTexact Technologies – engineering and technology R&D activities; BT Affinitis – a business offering services, which can be bought stand alone or in integrated offerings

The new corporate structure of BT

What are the strategic options facing BT? The strategy of becoming a leading global telecommunications company finally came to an end when it became impossible to finance an aggressive global enlargement programme. The Concert joint venture with AT&T became a heavy burden, which worsened the already shaky financial position of both companies. If these companies could not conquer the telecommunications world, who could? The question asked in many articles, and most probably in the boardrooms of telecommunications incumbents, is whether to be an integrated telecommunications company, or to focus on some of the strengths of the company, or to move into new businesses?

Only a few years ago it seemed to be inevitable that “content is king” would be true in telecommunications. There was a strong belief that the market will no longer reward ownership of infrastructure and that there would be a swift move toward a market that rewards the ownership of content: “the development and provisioning of content and advanced

services will be key to telecom's future”.6 However, there are now not so many strong believers in such a claim.

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Recently BTopenworld's chief executive Andy Green said: “We have taken a very simple position: we are running an access business. Telecoms companies are taking a huge risk already by investing in infrastructure, other people have got to think about providing attractive broadband content” (Financial Times September 18, 2001). However, only a few months later the chairman Sir Christopher Bland said that BT could become a fully-fledged broadcaster within two years. The chairman even highlighted the more ambitious possibility of BT producing its own content. (Financial Times January 8, 2002). However, Sir Christopher took a

few steps back a few days later on 9th January and pointed out that BT would eventually use its network for television but would not enter directly into the media and entertainment business.

These announcements illustrate the complexity and uncertainty facing strategists in the changing environment of telecommunications, media, and information technology.

The reality by the end of March 2002

Result

Debt has been cut to 13.7 billion

Method

Cost-cutting

£5.9 billion rights issue in June 2001

£8 billion of disposals

The closure of a loss making Concert joint venture with AT&T

£2.4 billion sale and leaseback of its UK properties

Floating off wireless activities into MMO2

Management

Sir Christopher Bland replaced Sir Ian Vallance in April 2001

Ben Verwaagen replaced Sir Peter Bonfield in December 2001

Senior executive team reduced from 16 to 5

The heads of BT's three main business – retail, wholesale and international network business – placed on the board

Source: The Birmingham Post, May 17, 2002; The Guardian, April 08, 2002, and July 25, 2002.

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However, gradually the measures for rebuilding the credibility of BT started to bring positive results. The target to cut the massive debt set in the spring 2001 was reached a year later in March. The credit rating of BT did not fall to the lowest investment grade. Standard & Poor's rates the company A-. The sale of non-core assets, including BT's stake in Cegetel, the French telecoms group, in January 2003 for £2.6 billion brought BT's debt down near to £10 billion level. In March 2003 BT's net debt was £9.6 billion. In its debt cutting BT seems to be succeeding rather well: now its debt level is near to its European peers. However, there is an important lesson to be learned, about how a company, which during the 1990s had one of the lowest debt-to-assets ratio among its European peers became one of the most indebted incumbents in Europe.

Table 9. Long term debt-to-total assets ratio

Source: Datastream.

BT's Current Strategy

In April 2002 Ben Verwaayen, announced BT's new three-year strategy. The main elements of this strategy are: to cut costs, increase revenues in BT's core UK business and reduce borrowings:

“After three years of rapid expansion followed by an embarrassing u-turn on its international strategy, BT has returned to its home territory. Under the plan, BT aims to improve revenues from its residential and business customers in the UK and stop losses in its remaining international network business, Ignite”. (The Guardian, April 09, 2002)

BT Ignite supplies large corporate customers and other telecommunications operators with international voice and data communications. It operates BT's core 35,000 mile network spanning 290 European cities. Ben Verwaayen set in the strategy a 12-month deadline for BT Ignite to break even.

In the strategy major acquisitions are ruled out for the foreseeable future. The CEO scotched

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speculations over BT's ambitions to move into broadcasting. Broadband is a central plank of its strategy for the next few years. BT reduced rather substantially wholesale Internet prices for Internet service providers. BT announced that it would also offer mobile services to business customers under BT brand using MMO2's network. Later in October 2002 BT announced that it plans to sell mobile services to customers using the MMO2 network under the brand Mobile Sense also to the consumer market.

The strategy also points out changes in the management style of the company. BT's senior executive team was reduced from 16 to 5 in an effort to speed up decision-making within the group. Sir Christopher Bland had already earlier noticed that BT's divisional heads focused on independence rather than cooperation. This accelerated particularly when the stock market took off in the late 1990s. “That caused some disruptive patterns of behaviour”, admits Sir Christopher. One of the first things to do was to place the heads of the group's three main businesses – retail, wholesale, and the international network business, Ignite – on the board. “It has had quite a unifying effect,” says Sir Christopher. (The Guardian, July, 25, 2002). From the first of January 2003 BT Openworld results are reported within BT Retail. During the 2003 financial year BT consists three lines of business: BT Retail, BT Wholesale, and BT Global Services (formerly BT Ignite).

In the strategy Mr Verwaayen set targets for each of the company's four businesses – ranging from 3% annual revenue growth at BT Retail to 35% revenue growth at Openworld. Overall the company plans to attain 25% compound annual growth in earnings per share, and 6% to 8% organic revenue growth.

The focus in the UK core business, however, does not mean that BT would have forgotten lucrative opportunities of broadcasting, and in general opportunities of convergence of media and telecommunications. In July 2002 BT announced a new approach to broadcasting, but now in the framework of the new strategy. BT Group and BSkyB announced a broadband interactive TV alliance. The deal gives Sky customers the option to upgrade their interactive TV facility to a faster BT broadband connection. Sky hopes that this will boost demand for its interactive TV services such as betting and shopping. BT plans to use its DSL network to enhance communications experience to the PC through video and multimedia. BT will focus on new applications in the communications/PC area that linking PC, telephone, sound system and TV will provide. BT announced that its network strategy includes principles of multimedia capable network intelligence offering a customer-centric open architecture with opportunities for third party applications. The company plans to exploit new technology and partnerships to extend broadband reach to a wider customer base.

During the 2003 annual shareholders’ meeting BT's chief executive Ben Verwaayen confirmed that the three main parts of the company's strategy are strong orientation for customers, broadband and financial discipline. During the 2003 financial year the growth of broadband customers was 380% over the previous year. In the end of March 2003 BT had 800,000 ADSL lines. The BT target was to reach one million connections during summer 2003. The following tables show BT's business results on the three lines of business.

Table 10

2003 2002 2001

BT Retail £m £m £m

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Group turnover 13,301 12,811 12,541

Group operating profit 1,425 984 655

EBITDA 1,634 1,200 874

Capital expenditure 115 153 167

Operating free cash flow 1,519 1,047 707

BT Wholesale

Group turnover 11,260 12,256 11,728

Group operating profit 1,924 2,242 2,538

EBITDA 3,847 4,156 4,276

Capital expenditure 1,652 1,974 2,273

Operating free cash flow 2,195 2,182 2,003

BT Global Services

Group turnover 5,251 4,472 3,468

Group operating profit −427 −358 −309

EBITDA 178 146 50

Capital expenditure 439 609 935

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Operating free cash flow −261 −463 −885

Source: BT Annual Report 2003.

In July 2003 BT Group announced its new mobile services, BT Mobile Home Plan, which in fact brings BT back to the mobile business as a MVNO (mobile virtual network operator). Under this plan BT will resell time on Deutsche Telekom's T-Mobile network, and will be able to compete with other mobile operators, including its former mobile arm, MMO2. The press already named BT as the sixth biggest mobile operator in the UK. One of the main objectives is to make an optimal use of the ongoing mobile and fixed convergence. According to Pierre Danon, the chief executive of BT Retail, the cost of running mobile calls across a fixed network is approximately a third of the cost of running it across a cellular network, and substantial cost savings, up to 50 per cent, could be passed on to consumers. It is not surprising that BT wants to get its share of the lucrative mobile market. It is estimated that the UK's fixed communications market is worth £13,4 billion and the mobile communications is worth £13 billion. The difference is that the mobile market is growing, but the fixed is stagnating. After BT's announcement the city in August was full of rumours that BT is planning a £5 billion all-share offer for MMO2. However, BT's spokesman denies this. “We demerged MMO2 two years ago; it made strategic sense then and it makes strategic sense now. We don't need to own a network to offer decent mobile services to customers. You saw us enter a partnership last week with T-Mobile and that shows we are going back into mobile. We do recognise it is important to deliver a full service to customers and that must include a mobile offer.”

So why did BT demerge its mobile arm in November 2001? The analysts give the answer: to cut its huge debt, and reduce its cost. BT was able to remove around £500 million of its debt into the mobile phone operation, and get rid of the costs of upgrading the mobile network. According to the demerger deal, MMO2 has a three-year contract to carry all the mobile calls of BT's business customers. The deal expires in November 2004, but BT has the right to start searching for other mobile carriers for its business traffic already in November this year. BT Retail's chief executive, Pierre Danon, recently confirmed that BT will contact a number of alternative mobile operators. For MMO2 this is a serious threat, because BT's mobile business customers account for around six per cent of MMO2's UK revenues. The additional pressure for MMO2, as well as for other UK mobile operators, comes from the regulator. Recently MMO2 warned that revenue growth would “slow significantly” in the second half of 2003, as the UK's Competition Commission's decision that termination chargers must be lowered by 15 per cent each for three years comes into effect. (FT September 29 2003).

The figures from Oftel on interconnection revenues from UK mobile seem to confirm on the one hand that here are substantial growth opportunities, and on the other that mobile-fixed interconnections have been a cash cow for BT. The volume of interconnections from the point of view of the receiving operator grew in 1997/98 from 7 301 million minutes to 31 536 million minutes in 2001/02. However, during the same period the growth of the revenues of the receiving operator grew tenfold from £97 million to £978 million. BT's share in these revenues w a s £ 8 9 m i l l i o n a n d £ 8 7 5 m i l l i o n r e s p e c t i v e l y . D u r i n g t h e s a m e t i m e p e r i o d B T ' s interconnection payments to UK mobile grew from £623 million to £2 249 million. In 2001/02 for BT interconnection revenues from UK mobile represented almost 40 per cent of all its received interconnections revenues. In the same year BT's interconnection payments to UK mobile consisted 68 per cent of all its interconnection payments. The recent announcements of Hutchison 3G U.K. (see The Asian Wall Street Journal 14 August 2003) that it will reduce

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the cost of voice calls to less than half the rates offered by rival mobile operators in the U.K., would diminish the gap in the cost to consumers of 3G mobile calls and fixed-line calls. This would no doubt affect also BT's plans in convergence of mobile and fixed-line networks.

Notes and References

1. Oftel. The UK Telecommunications Industry… p. 6.

2. Oftel. The UK Telecommunications Industry…2000/01, December 2001, and 2001/02, March 2003.

3. Oftel. The UK Telecommunications Industry: Market Information 2001/02, March 2003.

4. The Sunday Times, March 18, 2001

5. Standard and Poor's investment grades are AAA, AA, A, and BBB. Ratings BB, B, CCC, CC, and C are regarded as having significant speculative characteristics. Source: www.standardandpoors.com

Charles Sirois (1999) “Telecom in the new millenium: A shift of power”, Telecommunications – American Edition, May 99, Vol. 33 Issue 5, p.18.

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